PIMCO California Flexible Municipal Income
Fund
Prospectus
April 30, 2023
(as supplemented January
12, 2024)
PIMCO California Flexible Municipal Income Fund
Common Shares | |||||
Institutional Class | Class A-1 | Class A-2 | Class A-3 | Class A-4 | |
PIMCO California Flexible Municipal Income Fund | CAFLX | CAFMX | CAFNX | CAFOX | CAFPX |
Neither the U.S. Securities and Exchange Commission nor the U.S. Commodity
Futures Trading Commission has approved or disapproved of these securities or
determined that this prospectus is truthful or complete. Any representation to
the contrary is a criminal offense.
The Fund.
PIMCO California Flexible Municipal Income Fund (the “Fund”) is a newly
organized, non-diversified, closed-end management investment company that continuously
offers its shares of beneficial interest, par value of $0.00001 per share (the “Common
Shares”), and is operated as an “interval fund.” The Fund currently has five separate classes
of Common Shares: Institutional Class, Class A-1, Class A-2, Class A-3 and Class A-4.
Investment Objectives.
The Fund seeks to provide high current income exempt from federal
and California income tax. Capital appreciation is a secondary objective.
Investment Strategy.
The Fund attempts to achieve these objectives by investing, under
normal circumstances, at least 80% of its net assets (plus any borrowings for investment
purposes) in a portfolio of municipal bonds and other municipal securities, the interest from
which, in the opinion of bond counsel for the issuer at the time of issuance (or on the basis of
other authority believed by Pacific Investment Management Company LLC (“PIMCO” or the
“Investment Manager”) to be reliable), is exempt from federal income tax and California
income tax (i.e., excluded from gross income for income tax purposes but not necessarily
exempt from the alternative minimum tax or from the income taxes of any other state or of a
local government) (the “80% policy”). To a lesser extent, the Fund also expects to invest in a
full range of preferred securities with an emphasis on preferred securities that, at the time of
issuance, are eligible to pay dividends that qualify for certain favorable federal income tax
treatment.
Portfolio Contents.
California municipal bonds generally are issued by or on behalf of the
State of California and its political subdivisions, financing authorities and their agencies. By
concentrating its investments in California municipal securities, the Fund will be subject to
California State-Specific Risk, among other risks. Both within and outside the 80% policy, the
Fund may invest in debt securities of an issuer located outside of California. The Fund's 80%
policy is a fundamental policy, which may not be changed without the approval of the holders
of a majority of the Fund's outstanding Common Shares and Preferred Shares (as defined
below) voting together as a single class, and of the holders of a majority of the outstanding
Preferred Shares voting as a separate class.
The Fund may invest without limit in municipal bonds and other securities that are rated below investment grade (or unrated but determined by
PIMCO to be of comparable quality). 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.” The Fund may also invest without limit
in investment grade securities.
Included within the general category of municipal bonds in which the Fund may invest are loans (including participations and assignments) and
participations in lease obligations.
The Fund may invest in and/or originate loans, including, without limitation, to, on behalf of, authorized by, sponsored by, and/or in connection
with a project for which authority and responsibility lies with one or more U.S. states or territories, cities in a U.S. state or territory, or political
subdivisions, agencies, authorities or instrumentalities of such states, territories or cities, which may be in the form of whole loans, assignments,
participations, secured and unsecured notes, senior and second lien loans, mezzanine loans, bridge loans or similar investments, including to
borrowers that are unrated or have credit ratings that are determined by one or more nationally recognized statistical rating organizations and/or
PIMCO to be below investment grade.
In addition to other types of securities and assets described in this section, the Fund may invest the balance of its assets (i.e., not towards its
80% policy noted above) in securities and assets that produce taxable income. Such assets are normally expected to include, but are not limited
to, preferred securities, with an emphasis on preferred securities that, at the time of issuance, are eligible to pay dividends that qualify for certain
favorable federal income tax treatment, such as dividends that are treated as qualified dividend income and eligible for the dividends received
deduction (in each instance, provided certain requirements and holding periods are satisfied).
It is possible that the Fund could own no preferred securities at any given time, including, for example, if municipal securities are expected to
produce a higher yield than preferred securities on an after-tax basis.
Subject to the Fund's investment policies described above, the Fund may invest in other securities, including commercial paper, securities eligible
for resale under Rule 144A of the Securities Act of 1933, as amended (the “1933 Act”), and other privately placed securities, and other debt
securities subject to federal and/or California income tax, including privately negotiated debt obligations with respect to which the principal and/or
interest is determined by reference to the performance of a benchmark asset, market or interest rate (an “embedded index”), such as specific
securities, an index of securities or specified interest rates, or the differential performance of two assets or markets, such as indexes reflecting
bonds. The rate of interest on an income-producing security may be fixed, floating or variable. The Fund may also engage in credit spread trades.
A credit spread trade is an investment position relating to a difference in the prices or interest rates of two bonds or other securities, in which the
value of the investment position is determined by changes in the difference between the prices or interest rates, as the case may be, of the
respective securities. The Fund may purchase and sell securities on a when-issued, delayed delivery or forward commitment basis and may
engage in short sales. The Fund may invest in trust certificates issued in tender option bond programs. In these programs, a trust typically issues
two classes of certificates and uses the proceeds to purchase municipal securities having relatively long maturities and bearing interest at a fixed
interest rate substantially higher than prevailing short-term tax-exempt rates. The Fund may also invest up to 5% of its total assets in securities of
other investment companies (including those advised by PIMCO), including closed-end funds, exchange-traded funds and other open-end funds,
that invest primarily in municipal bonds and other municipal securities of the types in which the Fund may invest directly.
The Fund may, but is not required to, invest in derivative instruments, such as options, futures or forward contracts or swap agreements. For
purposes of the Fund's 80% policy, the Fund values its derivative instruments based on their market value. The Fund may, without limitation, seek
to obtain market exposure to the securities in which it primarily invests by entering into a series of purchase and sale contracts or by using other
investment techniques (such as buy backs or dollar rolls).
To the extent consistent with the applicable liquidity requirements for interval funds under Rule 23c-3 of the Investment Company Act of 1940, as
amended, the Fund may invest without limit in illiquid investments.
Interval Fund/Repurchase Offers.
The Fund is an “interval fund,” a type of fund which, in order to provide liquidity to shareholders, has adopted
a fundamental investment policy to make quarterly offers to repurchase between 5% and 25% of its outstanding Common Shares at net asset
value. Subject to applicable law and approval of the Fund's Board of Trustees, for each quarterly repurchase offer, the Fund currently expects to
offer to repurchase 10% of the Fund's outstanding Common Shares at net asset value.
Leverage.
The Fund currently utilizes leverage through its outstanding Remarketable Variable Rate MuniFund Term Preferred Shares (“RVMTP
Shares” and, together with any other preferred shares the Fund may have outstanding, “Preferred Shares”). The Fund may also choose to add
leverage through the use of tender option bonds, the issuance of additional Preferred Shares or the use of reverse repurchase agreements,
selling credit default swaps, dollar rolls/buy backs or borrowings, such as through bank loans or commercial paper and/or other credit facilities.
The Fund may issue additional Preferred Shares without the approval of holders of Common Shares (“Common Shareholders”). If the Fund
issues additional Preferred Shares in the future, all costs and expenses relating to the issuance and ongoing maintenance of the Preferred
Shares will be borne by the Common Shareholders, and these costs and expenses may be significant. Leveraging transactions pursued by the
Fund may increase its duration and sensitivity to interest rate movements. The Fund may also enter into transactions other than those noted
above that may give rise to a form of leverage including, among others, futures and forward contracts (including foreign currency exchange
contracts), total return swaps and other derivative transactions, loans of portfolio securities, short sales and when-issued, delayed delivery and
forward commitment transactions. The Fund may utilize certain kinds of leverage, including, without limitation, tender option bonds,
ii
opportunistically and may choose to increase or decrease, or eliminate entirely, its use of leverage over time and from time to time based on
PIMCO's assessment of the yield curve environment, interest rate trends, market conditions and other factors. The Fund may also determine to
increase its leverage through the issuance of
additional
Preferred Shares
,
or
decrease the leverage
it
currently
maintains through
its
outstanding
Preferred Shares through
Preferred Share
redemptions or tender offers
and
may or may not determine to replace
such
leverage
through other
sources. By using leverage, the Fund seeks to obtain a higher return for Common Shareholders than if the Fund did not use leverage. Leveraging
is a speculative technique and there are special risks and costs 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.
Investment Manager.
The Fund’s investment manager is Pacific Investment Management Company LLC. As of December 31, 2022, PIMCO
had approximately $1.74 trillion in assets under management.
◾
The Fund’s Common Shares are not listed for trading on any national securities exchange. The Fund’s Common Shares
have no trading market and no market is expected to develop.
◾
An investment in the Fund is not suitable for investors who need certainty about their ability to access all of the money
they invest in the short term.
◾
Even though the Fund will make periodic repurchase offers for its outstanding Common Shares, subject to the
limitations described herein, investors should consider Common Shares of the Fund to be an illiquid investment.
◾
There is no guarantee that you will be able to sell your Common Shares at any given time or in the quantity that you
desire.
◾
There is no assurance that the Fund will be able to make any distributions or maintain a certain level of distributions to
Common Shareholders.
Institutional Class, Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares are offered in this prospectus. Each share class represents
an investment in the same portfolio of investments, but each class has its own expense structure and arrangements for shareholder services or
distribution, which allows you to choose the class that best fits your situation and eligibility requirements. Class A-1, Class A-2, Class A-3 and
Class A-4 Common Shares are primarily offered and sold to retail investors by certain broker-dealers that are members of the Financial Industry
Regulatory Authority and that have agreements with PIMCO Investments LLC, the Fund's principal underwriter and distributor, to sell Class A-1,
Class A-2, Class A-3 and/or Class A-4 Common Shares, but may be made available through other financial firms, including banks and trust
companies and to specified benefit plans. Only certain investors are eligible to purchase Institutional Class Common Shares. See “Plan of
Distribution – Share Classes.”
Institutional Class
The minimum initial investment for Institutional Class Common Shares is $1 million per account, except that the minimum investment may be
modified for certain financial firms that submit orders on behalf of their customers, the Trustees and certain employees and their extended family
members of PIMCO and its affiliates. There is no minimum subsequent investment amount. See “Plan of Distribution – Share Classes.”
Class A-1, Class A-2, Class A-3 and Class A-4
The minimum initial investment for Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares is $2,500 per account, except that the
minimum investment may be modified for certain financial firms that submit orders on behalf of their customers, the Trustees and certain
employees and their extended family members of PIMCO and its affiliates. The minimum subsequent investment amount for Class A-1,
Class A-2, Class A-3 and Class A-4 Common Shares is $50. See “Plan of Distribution – Purchasing Shares.”
Investors should carefully consider the Fund’s risks and investment objectives, as an investment in the Fund may not be appropriate
for all investors and is not designed to be a complete investment program.
Before buying any of the Fund’s Common Shares, you should read the discussion of the principal risks of investing in the Fund in
“Principal Risks of the Fund” beginning on page
43
of this prospectus. No assurance can be given that the Fund’s investment
objectives will be achieved, and you could lose all of your investment in the Fund.
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.
Please read this prospectus carefully before deciding whether to invest and retain it for future reference. It sets forth concisely the information
about the Fund that a prospective investor ought to know before investing in the Fund. The Fund has filed with the Securities and Exchange
Commission (“SEC”) a Statement of Additional Information dated April 30, 2023, as
supplemented from time to time, containing additional
information about the Fund (the “Statement of Additional Information”). The Statement of Additional Information is incorporated by reference into
this prospectus, which means it is part of this prospectus for legal purposes. The Fund also produces both annual and semi-annual reports that
will contain important information about the Fund. Copies of the Statement of Additional Information and the Fund’s annual and semi-annual
reports, when available, may be obtained upon request, without charge, by calling 844.312.2113 or by writing to the Fund at Regulatory
Document Request, 650 Newport Center Drive, Newport Beach, California 92660. You may also call this toll-free telephone number to request
iii
other information about the Fund or to make shareholder inquiries. The Statement of Additional Information and the most recent annual and
semi-annual reports are available free of charge on the Fund’s website at www.pimco.com. Information on, or accessible through, the Fund’s
website is not a part of, and is not incorporated into, this prospectus. You may also access reports and other information about the Fund on the
EDGAR Database on the SEC’s Internet site at www.sec.gov. You may get copies of this information, with payment of a duplication fee, by
electronic request at the following E-mail address: publicinfo@sec.gov.
The Fund has not authorized anyone to provide you with information other than that contained or incorporated by reference in this prospectus.
The Fund does not take any responsibility for, and does not provide any assurances as to the reliability of, any other information that others may
give you. The Fund is not making an offer of these securities in any jurisdiction 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.
iv
PIMCO California Flexible Municipal
Income Fund
Prospectus Summary
This is only a summary. This summary may not contain all of the
information that you should consider before investing in PIMCO
California Flexible Municipal Income Fund (the “Fund”) shares of
beneficial interest, par value of $0.00001 per share (the “Common
Shares”). You should review the more detailed information contained in
this prospectus and in the Statement of Additional Information. In
particular, you should carefully read the risks of investing in the Fund’s
Common Shares, as discussed under “Principal Risks of the Fund.”
The Fund
The Fund is a non-diversified, closed-end management investment
company that continuously offers its Common Shares. The Fund
commenced operations on June 27, 2022. The Fund is operated as an
“interval fund” (as defined below). The Fund currently has five separate
classes of Common Shares: Institutional Class, Class A-1, Class A-2,
Class A-3 and Class A-4.
Continuous Offering
The Fund continuously offers its Common Shares through PIMCO
Investments LLC (the “Distributor”), as principal underwriter, on a best
efforts basis. Except as set forth below, Common Shares are sold at their
offering price, which is net asset value (“NAV”) per share. While neither
the Fund nor the Distributor impose an initial sales charge on
Institutional Class, Class A-1 or Class A-3 Common Shares, if you buy
Institutional Class, Class A-1 or Class A-3 Common Shares through
certain financial firms, they may directly charge you transaction or other
fees in such amount as they may determine. Please consult your
financial firm for additional information.
Unless you are eligible for a waiver, Class A-2 and Class A-4 Common
Shares are sold at a public offering price equal to their net asset value
plus an initial sales charge. The initial sales charge varies depending
upon the size of your purchase. The minimum initial investment for
Institutional Class Common Shares is $1 million per account. The
minimum initial investment for Class A-1, Class A-2, Class A-3 and
Class A-4 Common Shares is $2,500 per account. These investment
minimums may be higher or lower for certain financial firms that submit
orders on behalf of their customers, the Trustees and certain employees
and their extended family members of Pacific Investment Management
Company LLC (“PIMCO” or the “Investment Manager”) and its
affiliates. The minimum subsequent investment amount for Class A-1,
Class A-2, Class A-3 and Class A-4 Common Shares is $50. Proceeds
from the offering will be held by the Fund’s custodian.
For additional information regarding each share class please see “Plan
of Distribution – Share Classes” in this prospectus. The Fund and the
Distributor each reserves the right, in its sole discretion, to reject any
purchase order, in whole or in part, when, in the judgment of
management, such rejection is in the best interests of the Fund.
Shareholders will not have the right to redeem their Common Shares.
However, as described below, in order to provide some liquidity to
shareholders, the Fund will conduct periodic repurchase offers for a
portion of its outstanding Common Shares.
Periodic Repurchase Offers
The Fund is an “interval fund,” a type of fund which, in order to provide
liquidity to shareholders, has adopted a fundamental investment policy
to make quarterly offers to repurchase between 5% and 25% of its
outstanding Common Shares at NAV. Subject to applicable law and
approval of the Fund’s Board of Trustees (the “Board” or “Board of
Trustees”), for each quarterly repurchase offer, the Fund currently
expects to offer to repurchase 10% of the Fund’s outstanding Common
Shares at NAV. Written notification of each quarterly repurchase offer
(the “Repurchase Offer Notice”) will be sent to shareholders at least
21 calendar days before the repurchase request deadline (i.e., the date
by which shareholders can tender their Common Shares in response to a
repurchase offer) (the ���Repurchase Request Deadline”). Subject to
Board approval, Repurchase Request Deadlines are expected to occur
each February, May, August and November, and Repurchase Offer
Notices are expected to be sent each January, April, July and October
preceding each such Repurchase Request Deadline. The Fund’s Common
Shares are not listed on any securities exchange, and the Fund does not
anticipate that a secondary market will develop for its Common Shares.
Accordingly, you may not be able to sell Common Shares when and/or
in the amount that you desire. Investors should consider Common
Shares of the Fund to be an illiquid investment. Thus, the Common
Shares are appropriate only as a long-term investment. In addition, the
Fund’s repurchase offers may subject the Fund and shareholders to
special risks. See “Principal Risks of the Fund — Repurchase Offers
Risk.”
Investment Objectives and Principal Strategies
Investment Objectives
The Fund seeks to provide high current income exempt from federal and
California income tax. Capital appreciation is a secondary objective. The
Fund attempts to achieve these objectives by investing, under normal
circumstances, at least 80% of its net assets (plus any borrowings for
investment purposes) in a portfolio of municipal bonds and other
municipal securities, the interest from which, in the opinion of bond
counsel for the issuer at the time of issuance (or on the basis of other
authority believed by PIMCO to be reliable), is exempt from federal
income tax and California income tax (i.e., excluded from gross income
for income tax purposes but not necessarily exempt from the alternative
minimum tax or from the income taxes of any other state or of a local
government), as described under “Portfolio Contents” below. In
pursuing its investment objectives, the Fund may invest without limit in
investment grade securities and may invest without limit in below
investment grade securities.
Portfolio Management Strategies
Flexible allocation strategy.
The Fund seeks to achieve its
investment objectives by utilizing a flexible, multi-sector tax-efficient
approach to investing, under normal circumstances, primarily in
municipal bonds and other municipal securities that carry interest
payments that are exempt from federal and California income tax. The
1
PIMCO California Flexible Municipal Income Fund |
Prospectus
Prospectus
principal issuers of these securities are state and local governments and
their agencies located in any of the fifty states, as well as in Puerto Rico
and other U.S. territories and possessions. To a lesser extent, the Fund
also expects to invest in a full range of preferred securities with an
emphasis on preferred securities that, at the time of issuance, are
eligible to pay dividends that qualify for certain favorable federal income
tax treatment. With PIMCO's macroeconomic analysis as the basis for
top-down investment decisions, the Fund seeks to offer investors an
actively-managed municipal bond portfolio that aims to capitalize on
what PIMCO believes are attractive opportunities in California and, to a
lesser extent, other states, and across sectors within the California and
U.S. municipal markets.
Investment selection strategies.
In selecting securities for the
Fund, PIMCO develops an outlook for interest rates and the economy,
analyzes credit and call risks, and uses other security selection
techniques. The proportion of the Fund's assets committed to
investment in securities with particular characteristics (such as quality,
sector, interest rate or maturity) varies based on PIMCO's outlook for the
U.S. economy.
PIMCO attempts 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. There
is no guarantee that PIMCO's investment selection techniques will
produce the desired results.
Credit quality.
The Fund may invest without limit in municipal bonds
and other securities of any credit quality, including without limitation, in
securities that are, at the time of purchase, rated below “investment
grade” by at least one of Moody's Investors Service, Inc. (“Moody's”),
S&P Global Ratings (“S&P”) or Fitch, Inc. (“Fitch”), or unrated but
determined by PIMCO to be of comparable quality. “Investment grade”
means a rating, in the case of Moody's, of Baa3 or higher, or in the case
of S&P and Fitch, of BBB- or higher. 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 may also invest
without limit in investment grade securities. The Fund generally expects
to invest at least 60% of its total assets in above investment grade
securities and not more than 40% of its total assets in below
investment grade securities, but may determine to allocate more heavily
or exclusively to either category at any time and from time to time based
on PIMCO's economic outlook, market conditions, and other factors.
Independent credit analysis.
PIMCO relies primarily on its own
analysis of the credit quality and risks associated with individual
municipal bonds and other municipal securities considered for the Fund,
rather than relying exclusively on rating agencies or third-party research.
The Fund's portfolio managers utilize this information in an attempt to
manage credit risk and to identify investments that are undervalued or
that offer attractive yields relative to PIMCO's assessment of their credit
characteristics. This aspect of PIMCO's capabilities will be particularly
important to the extent that the Fund invests in high yield municipal
bonds or other securities.
Duration management.
The Fund does not target a specific duration
or maturity for the municipal bonds and other securities in which it
invests, and the Fund's average portfolio duration, as calculated by
PIMCO may vary significantly depending on market conditions and other
factors. There is no limit on the maturity or duration of any individual
security in which the Fund may invest. Duration is a measure used to
determine the sensitivity of a security's price to changes in interest
rates. The longer a security's duration, the more sensitive it will be to
changes in interest rates. The portfolio managers focus on municipal
bonds with the potential to offer attractive current income, typically
looking for bonds that can provide consistently attractive current yields
or that are trading at competitive market prices. Capital appreciation, if
any, generally arises from decreases in interest rates or improving credit
fundamentals for a particular state, municipality or issuer.
Portfolio Contents
The Fund will invest, under normal circumstances, at least 80% of its
net assets (plus any borrowings for investment purposes) in a portfolio
of municipal bonds and other municipal securities, the interest from
which, in the opinion of bond counsel for the issuer at the time of
issuance (or on the basis of other authority believed by PIMCO to be
reliable), is exempt from federal income tax and California income tax
(i.e., excluded from gross income for income tax purposes but not
necessarily exempt from the alternative minimum tax or from the
income taxes of any other state or of a local government) (the “80%
policy”). California municipal bonds generally are issued by or on behalf
of the State of California and its political subdivisions, financing
authorities and their agencies. By concentrating its investments in
California municipal securities, the Fund will be subject to California
State-Specific Risk, among other risks. Both within and outside the 80%
policy, the Fund may invest in debt securities of an issuer located
outside of California. The Fund's 80% policy is a fundamental policy,
which may not be changed without the approval of the holders of a
majority of the Fund's outstanding Common Shares and
Preferred
Shares
(as defined below
) voting together as a single class, and of the
holders of a majority of the outstanding Preferred Shares voting as a
separate class.
The Fund may invest without limit in municipal bonds and other
securities that are rated below investment grade (or unrated but
determined by PIMCO to be of comparable quality). 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.” The Fund
may also invest without limit in investment grade securities.
Included within the general category of municipal bonds in which the
Fund may invest are loans (including participations and assignments)
and participations in lease obligations. A lease obligation is an
obligation in the form of a lease or installment purchase that is issued
by a state or local government to acquire equipment and facilities.
Income from such obligations generally is exempt from state and local
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
2
PIMCO California Flexible Municipal Income Fund
tax in the state of issuance. Lease obligations may be secured or
unsecured. Lease obligations do not constitute general obligations of
the municipality for which the municipality's taxing power is pledged.
The Fund may invest in and/or originate loans, including, without
limitation, to, on behalf of, authorized by, sponsored by, and/or in
connection with a project for which authority and responsibility lies with
one or more U.S. states or territories, cities in a U.S. state or territory, or
political subdivisions, agencies, authorities or instrumentalities of such
states, territories or cities, which may be in the form of whole loans,
assignments, participations, secured and unsecured notes, senior and
second lien loans, mezzanine loans, bridge loans or similar investments,
including to borrowers that are unrated or have credit ratings that are
determined by one or more nationally recognized statistical rating
organizations (“NRSROs”) and/or PIMCO to be below investment
grade. This may include loans to public or private firms or individuals,
such as in connection with housing development projects. The loans the
Fund invests in or originates may vary in maturity and/or duration. The
Fund is not limited in the amount, size or type of loans it may invest in
and/or originate, including with respect to a single borrower or with
respect to borrowers that are determined to be below investment grade,
other than pursuant to any applicable law. The Fund's investment in or
origination of loans may also be limited by the requirements the Fund
intends to observe under Subchapter M of the Internal Revenue Code of
1986, as amended (the “Code”), in order to qualify as a regulated
investment company (a “RIC”). The loans acquired by the Fund may be
of the type that count towards the Fund's 80% policy or they may be
loans that produce income that is subject to regular federal income tax
or California income tax.
In addition to the other types of securities and assets described in this
section, the Fund may invest the balance of its assets (i.e., not towards
its 80% policy noted above) in securities and assets that produce
taxable income. Such assets are normally expected to include, but are
not limited to, preferred securities, with an emphasis on preferred
securities that, at the time of issuance, are eligible to pay dividends that
qualify for certain favorable federal income tax treatment, such as
dividends that are treated as qualified dividend income and eligible for
the dividends received deduction (in each instance, provided certain
requirements and holding periods are satisfied). The Fund may also
invest non-80% policy assets in other municipal bonds (like those of
other jurisdictions, such as New York and Puerto Rico). See “Tax
Matters.” It is possible that the Fund could own no preferred securities
at any given time, including, for example, if municipal securities are
expected to produce a higher yield than preferred securities on an
after-tax basis.
Subject to the Fund's investment policies described above, the Fund may
invest in other securities, including commercial paper, securities eligible
for resale under Rule 144A of the Securities Act of 1933, as amended
(the “1933 Act”), and other privately placed securities, and other debt
securities subject to federal and/or California income tax, including
privately negotiated debt obligations with respect to which the principal
and/or interest is determined by reference to the performance of a
benchmark asset, market or interest rate (an “embedded index”), such
as specific securities, an index of securities or specified interest rates, or
the differential performance of two assets or markets, such as indexes
reflecting bonds. The rate of interest on an income-producing security
may be fixed, floating or variable. The Fund may also engage in credit
spread trades. A credit spread trade is an investment position relating to
a difference in the prices or interest rates of two bonds or other
securities, in which the value of the investment position is determined
by changes in the difference between the prices or interest rates, as the
case may be, of the respective securities. The Fund may purchase and
sell securities on a when-issued, delayed delivery or forward
commitment basis and may engage in short sales. The Fund may invest
in trust certificates issued in tender option bond programs. In these
programs, a trust typically issues two classes of certificates and uses the
proceeds to purchase municipal securities having relatively long
maturities and bearing interest at a fixed interest rate substantially
higher than prevailing short-term tax-exempt rates. The Fund may also
invest up to 5% of its total assets in securities of other investment
companies (including those advised by PIMCO), including closed-end
funds, exchange-traded funds and other open-end funds, that invest
primarily in municipal bonds and other municipal securities of the types
in which the Fund may invest directly.
The Fund may, but is not required to, invest in derivative instruments,
such as options, futures or forward contracts or swap agreements. For
purposes of the Fund's 80% policy, the Fund values its derivative
instruments based on their market value. The Fund may, without
limitation, seek to obtain market exposure to the securities in which it
primarily invests by entering into a series of purchase and sale contracts
or by using other investment techniques (such as buy backs or dollar
rolls).
To the extent consistent with the applicable liquidity requirements for
interval funds under Rule 23c-3 of the Investment Company Act of
1940, as amended (the “Act”), the Fund may invest without limit in
illiquid investments.
Use of
Leverage
The Fund currently
utilizes leverage through its outstanding
Remarketable Variable Rate MuniFund Term Preferred Shares (“RVMTP
Shares” and
,
together with any other preferred
shares the Fund may
have outstanding,
“
Preferred Shares
”)
. The Fund may also choose to
add leverage through the use of
tender option bonds, the issuance of
additional Preferred Shares or the use of
reverse repurchase
agreements, selling
credit default swaps, dollar rolls/buy backs or
borrowings, such as through bank loans or commercial paper and/or
other credit facilities. The Fund may also enter into transactions other
than those noted above that may give rise to a form of leverage
including, among others, futures and forward contracts (including
foreign currency exchange contracts), total return swaps and other
derivative transactions, loans of portfolio securities, short sales and
when-issued, delayed delivery and forward commitment transactions.
The Fund may utilize certain kinds of leverage, including, without
limitation, tender option bonds, opportunistically and may choose to
3 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
increase or decrease, or eliminate entirely, its use of leverage over time
and from time to time based on PIMCO's assessment of the yield curve
environment, interest rate trends, market conditions and other factors.
The Fund may
also determine to increase its
leverage
through the
issuance of additional Preferred Shares, or decrease the leverage it
currently maintains through its
outstanding Preferred Shares
through
Preferred Share redemptions or tender
offers and may or may not
determine to replace such leverage
. The Fund may issue
additional
Preferred Shares without the approval of holders of
Common Shares
(“Common Shareholders”). If
the Fund issues
additional
Preferred
Shares in the future, all costs and expenses relating to the issuance and
ongoing maintenance of the Preferred Shares will be borne by the
Common Shareholders, and these costs and expenses may be
significant. Leveraging transactions pursued by the Fund may increase
its duration and sensitivity to interest rate movements. The
Fund’
s net
assets attributable to its Preferred Shares and the net
proceeds the Fund
obtains from the
issuance of additional Preferred Shares
or the use of
tender option bonds
or other forms of leverage will be invested in
accordance with the Fund
’
s investment objectives and policies as
described in this prospectus. So long as the rate of return, net of
applicable Fund expenses, on the debt obligations and other
investments purchased by the Fund exceeds the dividend rates payable
on the Preferred Shares together with the costs to the Fund of
other
leverage it utilizes
, the investment of the Fund
’
s assets attributable to
leverage will generate more income than will be needed to pay the costs
of the leverage. If so, and all other things being equal, the excess may be
used to pay higher dividends to Common Shareholders than if the Fund
were not so leveraged.
The Fund is subject to the requirement under the Act that an investment
company satisfy an asset coverage requirement of 300% of its
indebtedness measured at the time the investment company incurs the
indebtedness. This means that at any given time the value of the Fund's
total indebtedness may not exceed one-third the value of its total assets
(including assets attributable to such leverage). The interests of persons
with whom the Fund enters into leverage arrangements will not
necessarily be aligned with the interests of the Fund's shareholders and
such persons will have claims on the Fund's assets that are senior to
those of the Fund's shareholders.
Under the Act, the Fund is not permitted to issue Preferred Shares
unless, immediately after such issuance, the value of the Fund's total net
assets (as defined below) is at least 200% of the liquidation value of
any outstanding Preferred Shares and the newly issued 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.
The Fund may enter into derivatives or other transactions that may
provide leverage (other than through the issuance of Preferred Shares or
bank borrowing). Rule 18f-4 under the Act (the “Derivatives Rule”)
regulates a registered investment company's use of derivatives and
certain other transactions that create future payment and/or delivery
obligations by the Fund. This new rule became operative in August
2022. The Derivatives Rule prescribes specific value-at-risk (“VaR”)
leverage limits that apply to the Fund (although the Fund in the future
could qualify as a limited derivatives user (as defined in the Derivatives
Rule) and would therefore not be subject to all of the requirements of
the Derivatives Rule). VaR is an estimate of potential losses on an
instrument or portfolio over a specified time horizon and at a given
confidence level. The Fund may apply a relative VaR test or an absolute
VaR test (if the Fund's derivatives risk manager determines that a
designated reference portfolio would not provide an appropriate
reference portfolio for purposes of the relative VaR test). The limit under
the relative VaR test when a fund has outstanding preferred shares is
250% (or 200% when no preferred shares are outstanding) of the VaR
of a designated reference portfolio, which, very generally, may be a
designated unleveraged index or the Fund's securities portfolio
excluding derivatives. If applicable, the limit under the absolute VaR test
when the Fund has outstanding preferred shares is 25% (or 20% when
no preferred shares are outstanding) of the value of a fund's net assets.
The Derivatives Rule also generally requires the Fund to appoint a
derivatives risk manager, maintain a derivatives risk management
program (“DRMP”) designed to identify, assess, and reasonably
manage the risks associated with transactions covered by the rule, and
abide by certain board and other reporting obligations and
recordkeeping requirements. With respect to reverse repurchase
agreements or other similar financing transactions in particular, the
Derivatives Rule permits a fund to enter into such transactions if the
fund either (i) complies with the asset coverage requirements of
Section 18 of the Act, and combines the aggregate amount of
indebtedness associated with all reverse repurchase agreements and
similar financing with the aggregate amount of any other senior
securities representing indebtedness when calculating the relevant asset
coverage ratio, or (ii) treats all reverse repurchase agreements and
similar financing transactions as derivatives transactions for all purposes
under the Derivatives Rule. The Fund has adopted procedures for
investing in derivatives and other transactions in compliance with the
Derivatives Rule. Compliance with the Derivatives Rule could adversely
affect the value or performance of the Fund. Limits or restrictions
applicable to the counterparties or issuers, as applicable, with which the
Fund may engage in derivative transactions could also limit or prevent
the Fund from using certain instruments.
The Fund
’s ability to utilize leverage
is
also
limited by asset coverage
requirements and other guidelines imposed by the terms of the
Preferred Shares and
are
imposed by rating agencies that provide
ratings for the Preferred Shares
which
are
more restrictive than the
limitations imposed by the Act noted above. Please see “Description of
Capital Structure and Shares
-
Preferred Shares.”
April 30, 2023
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|
Prospectus
4
PIMCO California Flexible Municipal Income Fund
Leveraging is a speculative technique and there are special risks and
costs involved. The Fund cannot assure you that its use of
Preferred
Shares and any other
forms of leverage (such as tender option bonds)
will be successful or result in a higher yield on your Common Shares.
When leverage is used, the net asset value of the Common Shares and
the yield to Common Shareholders will be more volatile. In addition,
dividends paid on
Preferred Shares (including
the
Preferred Shareholder
Gross-Up (as
described below)) and interest and other expenses borne
by the Fund with respect to its use of tender option bonds or other
forms of leverage are borne by the Common Shareholders (and not by
the holders of Preferred Shares
(“Preferred
Shareholders
”
)
)
and result in
a reduction of the net asset value of the Common Shares. In addition,
because the fees received by the Investment Manager are based on the
total managed assets of the Fund, which includes total assets of the
Fund (including assets attributable to any reverse repurchase
agreements, dollar rolls
, tender option bonds, borrowings and Preferred
Shares that may be outstanding, if any), the Investment Manager has a
financial incentive for the Fund to use certain forms of leverage (e.g.,
Preferred Shares and
tender option bonds
), which may create a conflict
of interest between the Investment Manager, on the one hand, and the
Common Shareholders, on the other hand.
Please see “Use of Leverage,” “Principal Risks of the Fund – Leverage
Risk” for additional information regarding leverage and related risks.
Investment Manager
PIMCO serves as the Investment Manager for the Fund. Subject to the
supervision of the Board, PIMCO is responsible for managing the
investment activities of the Fund and the Fund's business affairs and
other administrative matters. David Hammer, Amit Arora and Kyle
Christine are jointly and primarily responsible for the day-to-day
management of the Fund.
PIMCO is located at 650 Newport Center Drive, Newport Beach, CA
92660. Organized in 1971, PIMCO provides investment management
and advisory services to private accounts of institutional and individual
clients and to RICs. PIMCO is a majority-owned indirect subsidiary of
Allianz SE, a publicly traded European insurance and financial services
company. As of December 31, 2022, PIMCO had approximately $1.74
trillion in assets under management.
Distributions
The Fund intends to distribute substantially all of its net investment
income to shareholders in the form of dividends. The Fund intends to
declare income dividends daily and distribute them monthly to
shareholders of record.
Distributions
can only be made from net
investment income after paying any accrued dividends to holders of the
Preferred Shares. At least annually, the Fund also intends to distribute to
you your pro rata share of any available net capital gain and taxable
ordinary income, if any. Net short-term capital gains may be paid more
frequently. The dividends that the Fund pays will depend on a number of
factors, including dividends payable on any Preferred Shares issued by
the Fund, including
the
Preferred Shareholder Gross-Up (as defined and
described below) (and expenses associated with other forms of
leverage).
Although it does not currently intend to do so, the Board may change
the Fund’s dividend policy and the amount or timing of Fund
distributions, based on a number of factors. Unless shareholders specify
otherwise, dividends will be reinvested in Common Shares of the Fund
in accordance with the Fund’s dividend reinvestment plan (the “Plan”).
The Fund may pay distributions from sources that may not be available
in the future and that are unrelated to the Fund’s performance, such as
from offering proceeds and/or borrowings. See “Distributions” and
“Dividend Reinvestment Plan.”
The
Preferred Shares
pay dividend distributions at a stated
rate, which
rate
is
based generally on the assumption that such dividend
distributions will consist entirely of dividends that pass through the
character of exempt interest earned by the Fund and are therefore not
taxable to shareholders for regular federal and California income tax
purposes (“exempt-interest dividends”). Internal Revenue Service
(“IRS”) rules nonetheless require a RIC having two or more classes of
stock for U.S. federal income tax purposes to characterize amounts
distributed as dividends to each class for the taxable year in accordance
with their pro rata share of income or gains of any type. Therefore,
the
Fund might be required to characterize a portion of dividends paid to
Preferred Shareholders as ordinary income or capital gain dividends. The
terms of such Preferred Shares
provide further that, in the event less
than the entire amount of any particular dividend distribution paid
pursuant to the stated rate were to consist of “exempt-interest
dividends” (i.e., if a portion of any particular dividend were to derive
from ordinary income or capital gain, including short-term capital gain
taxable as ordinary income when distributed), the amount of such
dividend would increase by an amount (
the
“Preferred Shareholder
Gross-Up”) such that the after-tax amount of such dividend, as
increased by the Preferred Shareholder Gross-Up, would equal the total
amount the holder of such Preferred Shares would have received if the
dividend at the stated rate had consisted entirely of “exempt-interest
dividends.” Any Preferred Shareholder Gross-Up would reduce the
amount that would otherwise be distributable to Common
Shareholders.
The Fund might not distribute all or a portion of any net capital gain for
a taxable year. If the Fund does not distribute all of its net capital gain
for a taxable year, it will pay federal income tax on the retained gain.
Each Common Shareholder of record as of the end of the Fund's taxable
year will include in income for federal income tax purposes, as
long-term capital gain, his or her share of the retained gain, will be
deemed to have paid his or her proportionate share of the tax paid by
the Fund on such retained gain, and will be entitled to an income tax
credit or refund for that share of the tax. The Fund will treat the retained
capital gain amount as a substitute for equivalent cash distributions. The
Fund will send shareholders detailed tax information with respect to the
Fund's distributions annually. See “Tax Matters.”
5 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
Distributor, Custodian and Transfer Agent
PIMCO Investments LLC, an affiliate of PIMCO, serves as the Fund’s
principal underwriter and distributor. State Street Bank and Trust
Company serves as the primary custodian of the Fund’s assets and also
provides certain fund accounting, sub-administrative and compliance
services to the Fund on behalf of the Investment Manager. UMB Bank,
n.a. serves as a custodian of the Fund for the purpose of processing
investor subscriptions and repurchases. SS&C Global Investor and
Distribution Solutions, Inc.
serves as the Fund’s transfer agent and
dividend disbursement agent.
The Bank of New
York Mellon serves as
transfer agent, registrar, redemption and paying agent and calculation
agent with respect to the RVMTP Shares.
Unlisted Closed-End Fund Structure; Limited
Liquidity
The Fund's Common Shares are not listed for trading on any securities
exchange. There is currently no secondary market for its Common Shares
and the Fund does not expect any secondary market to develop for its
Common Shares. Shareholders of the Fund are not able to have their
Common Shares redeemed or otherwise sell their Common Shares on a
daily basis because the Fund is an unlisted closed-end fund. In order to
provide liquidity to shareholders, the Fund is structured as an “interval
fund” and conducts periodic repurchase offers for a portion of its
outstanding Common Shares, as described herein. Investors should
consider Common Shares of the Fund to be an illiquid investment. An
investment in the Fund is suitable only for long-term investors who can
bear the risks associated with the limited liquidity of the Common
Shares. Investors should consider their investment goals, time horizons
and risk tolerance before investing in the Fund.
Investor Suitability
An investment in the Fund involves a considerable amount of risk. It is
possible that you will lose money. An investment in the Fund is suitable
only for investors who can bear the risks associated with the limited
liquidity of the Common Shares and should be viewed as a long-term
investment. Before making your investment decision, you should (i)
consider the suitability of this investment with respect to your
investment objectives and personal financial situation and (ii) consider
factors such as your personal net worth, income, age, risk tolerance and
liquidity needs. An investment in the Fund should not be viewed as a
complete investment program.
Principal Risks of the Fund
New/Small Fund Risk
A new or smaller fund’s performance may not represent how the Fund is
expected to or may perform in the long term if and when it becomes
larger and has fully implemented its investment strategies. Investment
positions may have a disproportionate impact (negative or positive) on
performance in a new and smaller fund, such as the Fund. New and
smaller funds may also require a period of time before they are invested
in securities that meet their investment objectives and policies and
achieve a representative portfolio composition. Fund performance may
be lower or higher during this “ramp-up” period, and may also be more
volatile, than would be the case after the fund is fully invested. Similarly,
a new or smaller fund’s investment strategy may require a longer period
of time to show returns that are representative of the strategy. New
funds have limited performance histories for investors to evaluate and
new and smaller funds may not attract sufficient assets to achieve
investment and trading efficiencies. If a new or smaller fund were to fail
to successfully implement its investment strategies or achieve its
investment objectives, performance may be negatively impacted, and
any resulting liquidation could create negative transaction costs for the
fund and tax consequences for investors.
Interest Rate Risk
Interest rate risk is the risk that fixed income securities and other
instruments in the Fund’s portfolio will fluctuate in value because of a
change in interest rates. Interest rate changes can be sudden and
unpredictable, and the Fund may lose money as a result of movements
in interest rates. The Fund may not be able to effectively hedge against
changes in interest rates or may choose not to do so for cost or other
reasons.
A wide variety of factors can cause interest rates or yields of
U.S. Treasury securities (or yields of other types of bonds) to rise
including, but not limited to, central bank monetary policies, changing
inflation or real growth rates, general economic conditions, increasing
bond issuances or reduced market demand for low yielding investments.
Risks associated with rising interest rates are heightened under current
market conditions given that the U.S. Federal Reserve (the “Federal
Reserve”) has begun to raise interest rates from historically low levels
and has signaled an intention to continue to do so. Further, in market
environments where interest rates are rising, issuers may be less willing
or able to make principal and interest payments on fixed-income
investments when due.
Fixed income securities with longer durations tend to be more sensitive
to changes in interest rates, usually making them more volatile. Duration
is a measure used to determine the sensitivity of a security’s price to
changes in interest rates that incorporates a security’s yield, coupon,
final maturity and call features, among other characteristics. Duration is
useful primarily as a measure of the sensitivity of a fixed income
security’s market price to interest rate (i.e., yield) movements. All other
things remaining equal, for each one percentage point increase in
interest rates, the value of a portfolio of fixed income investments would
generally be expected to decline by one percent for every year of the
portfolio’s average duration above zero. For example, the value of a
portfolio of fixed income securities with an average duration of eight
years would generally be expected to decline by approximately 8% if
interest rates rose by one percentage point.
During periods of very low or negative interest rates, the Fund may be
unable to maintain positive returns. Very low or negative interest rates
may magnify interest rate risk. Changing interest rates, including rates
that fall below zero, may have unpredictable effects on markets, may
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
6
PIMCO California Flexible Municipal Income Fund
result in heightened market volatility and may detract from the Fund’s
performance to the extent the Fund is exposed to such interest rates in
connection with management of the Fund.
Municipal Bond Risk
Investing in the municipal bond market involves the risks of investing in
debt securities generally and certain other risks. The amount of public
information available about the municipal bonds in which the Fund may
invest is generally less than that for corporate equities or bonds, and the
investment performance of the Fund’s investment in municipal bonds
may therefore be more dependent on the analytical abilities of PIMCO
than its investments in taxable bonds. The secondary market for
municipal bonds also tends to be less well developed or liquid than
many other securities markets, which may adversely affect the Fund’s
ability to sell municipal bonds at attractive prices
.
The ability of municipal issuers to make timely payments of interest and
principal may be diminished during general economic downturns, by
litigation, legislation or political events, or by the bankruptcy of the
issuer. Laws, referenda, ordinances or regulations enacted in the future
by Congress or state legislatures or the applicable governmental entity
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
also 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.
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 municipal bonds in a particular state or
geographic region.
The Fund may invest in trust certificates issued in tender option bond
programs. In these programs, a trust typically issues two classes of
certificates and uses the proceeds to purchase municipal securities
having relatively long maturities and bearing interest at a fixed interest
rate substantially higher than prevailing short-term tax-exempt rates.
There is a risk that the Fund will not be considered the owner of a
tender option bond for federal income tax purposes, and thus will not
be entitled to treat such interest as exempt from federal income tax.
Certain tender option bonds may be less liquid or may become less
liquid as a result of, among other things, a credit rating downgrade, a
payment default or a disqualification from tax-exempt status. The Fund’s
investment in the securities issued by a tender option bond trust may
involve greater risk and volatility than an investment in a fixed rate
bond, and the value of such securities may decrease significantly when
market interest rates increase. Tender option bond trusts could be
terminated due to market, credit or other events beyond the Fund’s
control, which could require the Fund to dispose of portfolio investments
at inopportune times and prices. The Fund may use a tender option
bond program as a way of achieving leverage in its portfolio, in which
case the Fund will be subject to leverage risk. The use of tender option
bonds
will impact the Fund's duration and cause the Fund to be subject
to increased duration and interest rate risk.
The Fund may invest in revenue bonds, which are typically issued to
fund a wide variety of capital projects including electric, gas, water and
sewer systems; highways, bridges and tunnels; port and airport facilities;
colleges and universities; and hospitals. Because the principal security
for a revenue bond is generally the net revenues derived from a
particular facility or group of facilities or, in some cases, from the
proceeds of a special excise or other specific revenue source, there is no
guarantee that the particular project will generate enough revenue to
pay its obligations, in which case the Fund’s performance may be
adversely affected.
The Fund may invest in taxable municipal bonds, such as Build America
Bonds. Build America Bonds are tax credit bonds created by the
American Recovery and Reinvestment Act of 2009, which authorized
state and local governments to issue Build America Bonds as taxable
bonds in 2009 and 2010, without volume limitations, to finance any
capital expenditures for which such issuers could otherwise issue
traditional tax-exempt bonds. The Fund’s investments in Build America
Bonds or similar taxable municipal bonds will result in taxable income
and the Fund may elect to pass through to Common Shareholders the
corresponding tax credits. The tax credits can generally be used to offset
federal income taxes and the alternative minimum tax, but such credits
are generally not refundable. Taxable municipal bonds involve similar
risks as tax-exempt municipal bonds, including credit and market risk.
See “Principal Risks of the Fund – Credit Risk” and “Principal Risks of
the Fund – Market Risk.”
The Fund may invest in participations in lease obligations or installment
purchase contract obligations of municipal authorities or entities.
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, which
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 the disposition or re-leasing of the property
might prove difficult.
Municipal securities are also subject to interest rate, credit, and liquidity
risk.
Interest Rate Risk
. The value of municipal securities, similar to
other fixed income securities, will likely drop as interest rates rise in
the general market. Conversely, when rates decline, bond prices
generally rise.
7 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
Credit Risk.
The risk that a borrower may be unable to make
interest or principal payments when they are due. Funds that invest in
municipal securities rely on the ability of the issuer to service its debt.
This subjects the Fund to credit risk in that the municipal issuer may
be fiscally unstable or exposed to large liabilities that could impair its
ability to honor its obligations. Municipal issuers with significant debt
service requirements, in the near-to mid-term; unrated issuers and
those with less capital and liquidity to absorb additional expenses
may be most at risk. To the extent the Fund invests in lower quality or
high yield municipal securities, it may be more sensitive to the
adverse credit events in the municipal market. The treatment of
municipalities in bankruptcy is more uncertain, and potentially more
adverse to debt holders, than for corporate issues.
Liquidity Risk
. The risk that investors may have difficulty finding a
buyer when they seek to sell, and therefore, may be forced to sell at a
discount to the market value. Liquidity may sometimes be impaired in
the municipal market and because the Fund primarily invests in
municipal securities, it may find it difficult to purchase or sell such
securities at opportune times. Liquidity can be impaired due to
interest rate concerns, credit events, or general supply and demand
imbalances. Depending on the particular issuer and current economic
conditions, municipal securities could be deemed more volatile
investments.
In addition to general municipal market risks, different municipal sectors
may face different risks.
Revenue bonds are secured by special tax revenues or other revenue
sources. If the specified revenues do not materialize, then the bonds
may not be repaid.
Private activity bonds are yet another type of municipal security.
Municipalities use private activity bonds to finance the development of
industrial facilities for use by private enterprise. Principal and interest
payments are to be made by the private enterprise benefiting from the
development, which means that the holder of the bond is exposed to
the risk that the private issuer may default on the bond.
Moral obligation bonds are usually issued by special purpose public
entities. If the public entity defaults, repayment becomes a “moral
obligation” instead of a legal one. The lack of a legally enforceable right
to payment in the event of default poses a special risk for a holder of
the bond because it has little or no ability to seek recourse in the event
of default.
In addition, a significant restructuring of federal income tax rates, such
as the changes to federal income tax rates that occurred in 2017, or
even serious discussion on the topic in Congress could cause municipal
bond prices to fall. The demand for municipal securities is strongly
influenced by the value of tax-exempt income to investors relative to
taxable income. Lower income tax rates potentially could reduce the
advantage of owning municipal securities.
Similarly, changes to state or federal regulation tied to a specific sector,
such as the hospital sector, could have an impact on the revenue stream
for a given subset of the market.
Municipal notes are similar to general municipal debt obligations, but
they generally possess shorter terms. Municipal notes can be used to
provide interim financing and may not be repaid if anticipated revenues
are not realized.
Puerto Rico-Specific Risk
The Fund may be affected significantly by political, economic,
environmental, social, regulatory or restructuring developments affecting
the ability of Puerto Rican municipal issuers to pay interest or repay
principal. Certain issuers of Puerto Rico municipal bonds have
experienced serious financial difficulties in the past and reoccurrence of
these difficulties may impair the ability of certain Puerto Rico issuers to
pay principal or interest on their obligations. Provisions of the Puerto
Rico Constitution and Commonwealth laws, including a
federally-appointed oversight board to oversee the Commonwealth’s
financial operations, which limit the taxing and spending authority of
Puerto Rico governmental entities may impair the ability of Puerto Rico
issuers to pay principal and/or interest on their obligations. While Puerto
Rico’s economy is broad, it does have major concentrations in certain
industries, such as manufacturing and service, and may be sensitive to
economic problems affecting those industries. Future Puerto Rico
political and economic developments, constitutional amendments,
legislative measures, executive orders, administrative regulations,
litigation, debt restructuring, and voter initiatives as well as
environmental events, natural disasters, pandemics, epidemics or social
unrest could have an adverse effect on the debt obligations of Puerto
Rico issuers.
Municipal Project-Specific Risk
The Fund may be more sensitive to adverse economic, business or
political developments if it invests a substantial portion of its assets in
the bonds of specific projects (such as those relating to education,
health care, housing, transportation, and utilities), industrial
development bonds, or in general obligation bonds, particularly if there
is a large concentration from issuers in a single state. This is because the
value of municipal securities can be significantly affected by the
political, economic, legal, and legislative realities of the particular
issuer’s locality or municipal sector events. Similarly, changes to state or
federal regulation tied to a specific sector, such as the hospital sector,
could have an impact on the revenue stream for a given subset of the
market.
Municipal Project Housing-Related Risk
The Fund may invest in the bonds of projects focused on low-income,
affordable or other housing developments and businesses located in
low-income areas or invest in or originate loans that finance or are
generally related to such projects. There are significant risks associated
with the Fund’s investment in the bonds of these types of projects and
loans related to such projects. There may be federal, state and local
governmental regulatory restrictions on the operation, rental and
transfer of these projects, such as the requirement that the owners of
these affordable housing developments rent or sell certain residential
units to persons or families of low or moderate income and that the
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
8
PIMCO California Flexible Municipal Income Fund
amount of rent that may be charged for these units may be less than
market rates. These restrictions may adversely affect economic
performance relative to properties that are not subject to these
restrictions. There are also no assurances that a project owner will be
able to achieve and maintain sufficient rental income in order to pay all
operating expenses and maintenance and repair costs of such a project
and the debt service on the related bonds or loan on a timely basis. In
the event that a project owner is unable to pay all such costs, expenses
and debt service, a default on the related bonds or loan is likely to occur.
Loans and Other Indebtedness; Loan Participations and
Assignments Risk
Loan interests may take the form of (i) direct interests acquired during a
primary distribution or other purchase of a loan, (ii) loans originated by
the Fund or (iii) assignments of, novations of or participations in all or a
portion of a loan acquired in secondary markets. In addition to credit
risk and interest rate risk, the Fund’s exposure to loan interests may be
subject to additional risks. For example, purchasers of loans and other
forms of direct indebtedness depend primarily upon the
creditworthiness of the borrower for payment of principal and interest.
Loans are subject to the risk that scheduled interest or principal
payments will not be made in a timely manner or at all, either of which
may adversely affect the value of the loan. If the Fund does not receive
scheduled interest or principal payments on such indebtedness, the
Fund’s share price and yield could be adversely affected. Loans that are
fully secured may offer the Fund more protection than an unsecured
loan in the event of non-payment of scheduled interest or principal if
the Fund is able to access and monetize the collateral. However, the
collateral underlying a loan, if any, may be unavailable or insufficient to
satisfy a borrower’s obligation. If the Fund becomes owner, whole or in
part, of any collateral after a loan is foreclosed, the Fund may incur costs
associated with owning and/or monetizing its ownership of the
collateral.
Moreover, the purchaser of an assignment typically succeeds to all the
rights and obligations under the loan agreement with the same rights
and obligations as the assigning lender. Assignments may, however, be
arranged through private negotiations between potential assignees and
potential assignors, and the rights and obligations acquired by the
purchaser of an assignment may differ from, and be more limited than,
those held by the assigning lender.
In connection with purchasing loan participations, the Fund generally
will have no right to enforce compliance by the borrower with the terms
of the loan agreement relating to the loan, nor any rights of set-off
against the borrower, and the Fund may not directly benefit from any
collateral supporting the loan in which it has purchased the loan
participation. As a result, the Fund will be subject to the credit risk of
both the borrower and the lender that is selling the participation. In the
event of the insolvency of the lender selling a participation, the Fund
may be treated as a general creditor of the lender and may not benefit
from any set-off between the lender and the borrower. Certain loan
participations may be structured in a manner designed to prevent
purchasers of participations from being subject to the credit risk of the
lender, but even under such a structure, in the event of the lender’s
insolvency, the lender’s servicing of the participation may be delayed
and the assignability of the participation impaired.
The Fund may have difficulty disposing of loans and loan participations.
Because there is no liquid market for many such investments, the Fund
anticipates that such investments could be sold only to a limited number
of institutional investors.
Economic exposure to loan interests through the use of derivative
transactions may involve greater risks than if the Fund had invested in
the loan interest directly during a primary distribution, through direct
originations or through assignments of, novations of or participations in
a loan acquired in secondary markets since, in addition to the risks
described above, certain derivative transactions may be subject to
leverage risk and greater illiquidity risk, counterparty risk, valuation risk
and other risks.
Loan Origination Risk
The Fund may invest in and/or originate loans, including, without
limitation, to, on behalf of, authorized by, sponsored by, and/or in
connection with a project for which authority and responsibility lies with
one or more U.S. states or territories, cities in a U.S. state or territory, or
political subdivisions, agencies, authorities or instrumentalities of such
states, territories or cities, which may be in the form of whole loans,
assignments, participations, secured and unsecured notes, senior and
second lien loans, mezzanine loans, bridge loans or similar investments,
including to borrowers that are unrated or have credit ratings that are
determined by one or more NRSROs and/or PIMCO to be below
investment grade. This may include loans to public or private firms or
individuals, such as in connection with housing development projects.
The loans the Fund invests in or originates may vary in maturity and/or
duration. The Fund is not limited in the amount, size or type of loans it
may invest in and/or originate, including with respect to a single
borrower or with respect to borrowers that are determined to be below
investment grade, other than pursuant to any applicable law. The Fund’s
investment in or origination of loans may also be limited by the
requirements the Fund intends to observe under Subchapter M of the
Code in order to qualify as a RIC. The loans acquired by the Fund may be
of the type that count towards the Fund's 80% policy or they may be
loans that produce income that is subject to regular federal income tax
or California income tax. The Fund may subsequently offer such
investments for sale to third parties; provided, that there is no assurance
that the Fund will complete the sale of such an investment. If the Fund
is unable to sell, assign or successfully close transactions for the loans
that it originates, the Fund will be forced to hold its interest in such
loans for an indeterminate period of time. This could result in the Fund’s
investments having high exposure to certain borrowers. The Fund will be
responsible for the expenses associated with originating a loan
(whether or not consummated). This may include significant legal and
due diligence expenses, which will be indirectly borne by the Fund and
Common Shareholders.
9 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
Bridge loans are generally made with the expectation that the borrower
will be able to obtain permanent financing in the near future. Any delay
in obtaining permanent financing subjects the bridge loan investor to
increased risk. A borrower’s use of bridge loans also involves the risk
that the borrower may be unable to locate permanent financing to
replace the bridge loan, which may impair the borrower’s perceived
creditworthiness.
Loan origination and servicing companies are routinely involved in legal
proceedings concerning matters that arise in the ordinary course of their
business. In addition, a number of participants in the loan origination
and servicing industry (including control persons of industry
participants) have been the subject of regulatory actions by state
regulators, including state attorneys general, and by the federal
government. Governmental investigations, examinations or regulatory
actions, or private lawsuits, including purported class action lawsuits,
may adversely affect such companies’ financial results. To the extent the
Fund engages in origination and/or servicing directly, or has a financial
interest in, or is otherwise affiliated with, an origination or servicing
company, the Fund will be subject to enhanced risks of litigation,
regulatory actions and other proceedings. As a result, the Fund may be
required to pay legal fees, settlement costs, damages, penalties or other
charges, any or all of which could materially adversely affect the Fund
and its holdings.
California State-Specific Risk
The Fund invests a substantial portion of its assets in municipal bonds
issued by or on behalf of the State of California and its political
subdivisions, financing authorities and their agencies, and therefore may
be affected significantly by political, economic, regulatory, social,
environmental, or public health developments affecting the ability of
California tax exempt issuers to pay interest or repay principal. Certain
issuers of California municipal bonds have experienced serious financial
difficulties in the past and reoccurrence of these difficulties may impair
the ability of certain California issuers to pay principal or interest on
their obligations. Provisions of the California Constitution and State
statutes that limit the taxing and spending authority of California
governmental entities may impair the ability of California issuers to pay
principal and/or interest on their obligations. While California’s economy
is broad, it does have major concentrations in advanced technology,
aerospace and defense-related manufacturing, trade, entertainment,
real estate and financial services, and may be sensitive to economic
problems affecting those industries. Future California political and
economic developments, constitutional amendments, legislative
measures, executive orders, administrative regulations, litigation and
voter initiatives as well as environmental events, natural disasters,
pandemics, epidemics or social unrest could have an adverse effect on
the debt obligations of California issuers.
New York State-Specific Risk
The Fund may invest in municipal bonds issued by or on behalf of the
State of New York and its political subdivisions, financing authorities
and their agencies, and therefore may be affected significantly by
political, economic or regulatory developments affecting the ability of
New York tax exempt issuers to pay interest or repay principal. Certain
issuers of New York municipal bonds have experienced serious financial
difficulties in the past and reoccurrence of these difficulties may impair
the ability of certain New York issuers to pay principal or interest on
their obligations. Provisions of the New York Constitution and State
statutes which limit the taxing and spending authority of New York
governmental entities may impair the ability of New York issuers to pay
principal and/or interest on their obligations. While New York’s economy
is broad, it does have major concentrations in certain industries, such as
financial services, and may be sensitive to economic problems affecting
those industries. Future New York political and economic developments,
constitutional amendments, legislative measures, executive orders,
administrative regulations, litigation and voter initiatives as well as
environmental events, natural disasters, pandemics, epidemics or social
unrest could have an adverse effect on the debt obligations of New York
issuers to pay principal or interest on their obligations. The financial
health of New York City affects that of the State, and when New York
City experiences financial difficulty it may have an adverse effect on
New York municipal bonds held by the Fund. The growth rate of
New York has at times been somewhat slower than the nation overall.
The economic and financial condition of New York also may be affected
by various financial, social, economic, environmental, political and
geopolitical factors.
Insurance Risk
The Fund may purchase municipal securities that are secured by
insurance, bank credit agreements or escrow accounts. The credit quality
of the companies that provide such credit enhancements will affect the
value of those securities. Certain significant providers of insurance for
municipal securities have incurred significant losses as a result of
exposure to sub-prime mortgages and other lower credit quality
investments that have experienced recent defaults or otherwise suffered
extreme credit deterioration. As a result, such losses reduced the
insurers’ capital and called into question their continued ability to
perform their obligations under such insurance if they are called upon to
do so in the future. The insurance feature of a municipal security does
not guarantee the full payment of principal and interest through the life
of an insured obligation, the market value of the insured obligation or
the net asset value of the common shares represented by such insured
obligation.
Inflation/Deflation Risk
Inflation risk is the risk that the value of assets or income from the
Fund’s investments will be worth less in the future as inflation decreases
the value of payments at future dates. As inflation increases, the real
value of the Fund’s portfolio could decline. Inflation has recently
increased and it cannot be predicted whether it may decline. Deflation
risk is the risk that prices throughout the economy decline over time.
Deflation may have an adverse effect on the creditworthiness of issuers
and may make issuer default more likely, which may result in a decline
in the value of the Fund’s portfolio and Common Shares.
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
10
PIMCO California Flexible Municipal Income Fund
Call Risk
Call risk refers to the possibility that an issuer may exercise its right to
redeem a fixed income security earlier than expected (a call). Issuers
may call outstanding securities prior to their maturity for a number of
reasons (
e.g.
, declining interest rates, changes in credit spreads and
improvements in the issuer’s credit quality). If an issuer calls a security in
which the Fund has invested, the Fund may not recoup the full amount
of its initial investment and may be forced to reinvest in lower-yielding
securities, securities with greater credit risks or securities with other, less
favorable features.
Credit Risk
The Fund could lose money if the issuer or guarantor of a fixed income
security (including a security purchased with securities lending
collateral), or the counterparty to a derivatives contract, repurchase
agreement or a loan of portfolio securities, is unable or unwilling, or is
perceived (whether by market participants, rating agencies, pricing
services or otherwise) as unable or unwilling, to make timely principal
and/or interest payments, or to otherwise honor its obligations. The risk
that such issuer, guarantor or counterparty is less willing or able to do
so is heightened in market environments where interest rates are rising.
The downgrade of the credit of a security held by the Fund may
decrease its value. Measures such as average credit quality may not
accurately reflect the true credit risk of the Fund. This is especially the
case if the Fund consists of securities with widely varying credit ratings.
Securities are subject to varying degrees of credit risk, which are often
reflected in credit ratings. This risk is greater to the extent the Fund uses
leverage or derivatives in connection with the management of the Fund.
Municipal bonds are subject to the risk that litigation, legislation or
other political events, local business or economic conditions, or the
bankruptcy of the issuer could have a significant effect on an issuer’s
ability to make payments of principal and/or interest. Rising or high
interest rates may deteriorate the credit quality of an issuer or
counterparty, particularly if an issuer or counterparty faces challenges
rolling or refinancing its obligations.
Issuer Risk
The value of a security may decline for a number of reasons that directly
relate to the issuer, such as management performance, major litigation,
investigations or other controversies, changes in financial condition or
credit rating, changes in government regulations affecting the issuer or
its competitive environment and strategic initiatives such as mergers,
acquisitions or dispositions and the market response to any such
initiatives, financial leverage
,
reputation
or reduced demand for the
issuer’s goods or services, as well as the historical and prospective
earnings of the issuer and the value of its assets. A change in the
financial condition of a single issuer may affect
one or more other
issuers or
securities markets as a whole. These risks can apply to the
Common Shares issued by the Fund and to the issuers of securities and
other instruments in which the Fund invests.
Liquidity Risk
To the extent consistent with the applicable liquidity requirements for
interval funds under Rule 23c-3 of the Act, the Fund may invest without
limit in illiquid investments. Liquidity risk exists when particular
investments are difficult to purchase or sell. Illiquid investments are
investments that the Fund reasonably expects cannot be sold or
disposed of in current market conditions in seven calendar days or less
without the sale or disposition significantly changing the market value
of the investment. Illiquid investments may become harder to value,
especially in changing markets. The Fund’s investments in illiquid
investments may reduce the returns of the Fund because it may be
unable to sell the illiquid investments at an advantageous time or price
or possibly require the Fund to dispose of other investments at
unfavorable times or prices in order to satisfy its obligations, which
could prevent the Fund from taking advantage of other investment
opportunities. Additionally, the market for certain investments may
become illiquid under adverse market or economic conditions
independent of any specific adverse changes in the conditions of a
particular issuer.
Further, fixed income securities with longer durations until maturity face
heightened levels of liquidity risk as compared to fixed income securities
with shorter durations until maturity. The risks associated with illiquid
instruments may be particularly acute in situations in which the Fund’s
operations require cash (such as in connection with repurchase offers)
and could result in the Fund borrowing to meet its short-term needs or
incurring losses on the sale of illiquid instruments. See “Principal Risks
of the Fund —Repurchase Offers Risk.” It may also be the case that
other market participants may be attempting to liquidate fixed income
holdings at the same time as the Fund, causing increased supply in the
market and contributing to liquidity risk and downward pricing pressure.
See “Principal Risks of the Fund—Valuation Risk.”
Repurchase Offers Risk
As described under “Periodic Repurchase Offers” above, the Fund is an
“interval fund” and, in order to provide liquidity to shareholders, the
Fund, subject to applicable law, conducts quarterly repurchase offers of
the Fund’s outstanding Common Shares at NAV, subject to approval of
the Board. In each quarter, such repurchase offers will be for at least 5%
and not more than 25% of its outstanding Common Shares at NAV,
pursuant to Rule 23c-3 under the Act.
The Fund currently expects to conduct quarterly repurchase offers for
10% of its outstanding Common Shares under ordinary circumstances.
The Fund believes that these repurchase offers are generally beneficial
to the Fund’s shareholders, and repurchases generally will be funded
from available cash or sales of portfolio securities. However, repurchase
offers and the need to fund repurchase obligations may affect the ability
of the Fund to be fully invested or force the Fund to maintain a higher
percentage of its assets in liquid investments, which may harm the
Fund’s investment performance. Moreover, diminution in the size of the
Fund through repurchases may result in untimely sales of portfolio
securities (with associated imputed transaction costs, which may be
significant), and may limit the ability of the Fund to participate in new
11 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
investment opportunities or to achieve its investment objectives. The
Fund may accumulate cash by holding back (i.e., not reinvesting)
payments received in connection with the Fund’s investments. If at any
time cash and other liquid assets held by the Fund are not sufficient to
meet the Fund’s repurchase obligations, the Fund intends, if necessary,
to sell investments. To the extent the Fund employs investment leverage,
repurchases of Common Shares would compound the adverse effects of
leverage in a declining market. In addition, if the Fund borrows to
finance repurchases, interest on that borrowing will negatively affect
Common Shareholders who do not tender their Common Shares by
increasing the Fund’s expenses and reducing any net investment
income. If a repurchase offer is oversubscribed, the Fund may, but is not
required to, determine to increase the amount repurchased by up to 2%
of the Fund’s outstanding shares as of the date of the Repurchase
Request Deadline. In the event that the Fund determines not to
repurchase more than the repurchase offer amount, or if shareholders
tender more than the repurchase offer amount plus 2% of the Fund’s
outstanding shares as of the date of the Repurchase Request Deadline,
the Fund will repurchase the Common Shares tendered on a pro rata
basis, and shareholders will have to wait until the next repurchase offer
to make another repurchase request. As a result, shareholders may be
unable to liquidate all or a given percentage of their investment in the
Fund during a particular repurchase offer. Some shareholders, in
anticipation of proration, may tender more Common Shares than they
wish to have repurchased in a particular quarter, thereby increasing the
likelihood that proration will occur. A shareholder may be subject to
market and other risks, and the NAV of Common Shares tendered in a
repurchase offer may decline between the Repurchase Request Deadline
and the date on which the NAV for tendered Common Shares is
determined. In addition, the repurchase of Common Shares by the Fund
may be a taxable event to shareholders.
High Yield Securities Risk
To the extent that the Fund invests in high yield securities and unrated
securities of similar credit quality (commonly known as “high yield
securities” or “junk bonds”), the Fund may be subject to greater levels
of credit risk, call risk and liquidity risk than funds that do not invest in
such securities, which could have a negative effect on the NAV of the
Fund’s Common Shares or Common Share dividends. These securities
are considered predominantly speculative with respect to an issuer’s
continuing ability to make principal and interest payments, and may be
more volatile than other types of securities. An economic downturn or
individual corporate developments could adversely affect the market for
these securities and reduce the Fund’s ability to sell these securities at
an advantageous time or price. The Fund may purchase distressed
securities that are in default or the issuers of which are in bankruptcy,
which involve heightened risks.
Issuers of high yield securities may have the right to “call” or redeem
the issue prior to maturity, which may result in the Fund having to
reinvest the proceeds in other high yield securities or similar instruments
that may pay lower interest rates. The Fund may also be subject to
greater levels of liquidity risk than funds that do not invest in high yield
securities. Consequently, transactions in high yield securities may
involve greater costs than transactions in more actively traded
securities. These factors may result in the Fund being unable to realize
full value for these securities and/or may result in the Fund not receiving
the proceeds from a sale of a high yield security for an extended period
after such sale, each of which could result in losses to the Fund. Because
of the risks involved in investing in high yield securities, an investment in
the Fund should be considered speculative.
To the extent the Fund focuses on below investment grade debt
obligations, PIMCO’s capabilities in analyzing credit quality and
associated risks will be particularly important, and there can be no
assurance that PIMCO will be successful in this regard. See “The Fund’s
Investment Objectives and Strategies—Portfolio Contents—High Yield
Securities” for additional information.
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 factors including, but
not limited to, PIMCO's assessment of the credit quality of the issuer of
such security, the price at which such security could be sold and the
rating, if any, assigned to such security by other rating agencies. Analysis
of creditworthiness may be more complex for issuers of high yield
securities than for issuers of higher quality debt securities.
Market Risk
The market price of securities owned by the Fund may go up or down,
sometimes rapidly or unpredictably. Securities may decline in value due
to factors affecting securities markets generally or particular industries
represented in the securities markets. The value of a security may decline
due to general market conditions that are not specifically related to a
particular company, such as real or perceived adverse economic
conditions, changes in the general outlook for corporate earnings,
changes in interest or currency rates, adverse changes to credit markets
or adverse investor sentiment generally. The value of a security may also
decline due to factors which affect a particular industry or industries,
such as labor shortages or increased production costs and competitive
conditions within an industry. During a general downturn in the
securities markets, multiple asset classes may decline in value
simultaneously. Equity securities generally have greater price volatility
than fixed income securities. Credit ratings downgrades may also
negatively affect securities held by the Fund. Even when markets
perform well, there is no assurance that the investments held by the
Fund will increase in value along with the broader market.
In addition, market risk includes the risk that geopolitical and other
events will disrupt the economy on a national or global level. For
instance, war, terrorism, social unrest, recessions, supply chain
disruptions, market manipulation, government defaults, government
shutdowns, political changes, diplomatic developments or the
imposition of sanctions and other similar measures, public health
emergencies (such as the spread of infectious diseases, pandemics and
epidemics) and natural/environmental disasters can all negatively
impact the securities markets, which could cause the Fund to lose value.
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
12
PIMCO California Flexible Municipal Income Fund
These events could reduce consumer demand or economic output, result
in market closures, travel restrictions or quarantines, and significantly
adversely impact the economy. The current contentious domestic
political environment, as well as political and diplomatic events within
the United States and abroad, such as presidential elections in the
U.S. or abroad or the U.S. government’s inability at times to agree on a
long-term budget and deficit reduction plan, has in the past resulted,
and may in the future result, in a government shutdown or otherwise
adversely affect the U.S. regulatory landscape, the general market
environment and/or investor sentiment, which could have an adverse
impact on the Fund’s investments and operations. Additional and/or
prolonged U.S. federal government shutdowns may affect investor and
consumer confidence and may adversely impact financial markets and
the broader economy, perhaps suddenly and to a significant degree.
Governmental and quasi-governmental authorities and regulators
throughout the world have previously responded to serious economic
disruptions with a variety of significant fiscal and monetary policy
changes, including but not limited to, direct capital infusions into
companies, new monetary programs and dramatically lower interest
rates. An unexpected or sudden reversal of these policies, or the
ineffectiveness of these policies, could increase volatility in securities
markets, which could adversely affect the Fund’s investments. Any
market disruptions could also prevent the Fund from executing
advantageous investment decisions in a timely manner. To the extent
the Fund has focused its investments in a region enduring geopolitical
market disruption, it will face higher risks of loss. Thus, investors should
closely monitor current market conditions to determine whether the
Fund meets their individual financial needs and tolerance for risk.
Recently, there have been inflationary price movements. As such, fixed
income securities markets may experience heightened levels of interest
rate, volatility and liquidity risk. As discussed more under “Interest Rate
Risk,” the Federal Reserve has begun to raise interest rates from
historically low levels and has signaled an intention to continue to do
so. Any additional interest rate increases in the future could cause the
value of any fund, such as the Fund, that invests in fixed income
securities to decrease.
Exchanges and securities markets may close early, close late or issue
trading halts on specific securities or generally, which may result in,
among other things, the Fund being unable to buy or sell certain
securities or financial instruments at an advantageous time or accurately
price its portfolio investments.
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 municipal bonds at
attractive prices or value municipal bonds.
Management Risk
The Fund is subject to management risk because it is an actively
managed investment portfolio. PIMCO and each individual portfolio
manager will apply investment techniques and risk analysis in making
investment decisions for the Fund, but there can be no guarantee that
these decisions will produce the desired results. Certain securities or
other instruments in which the Fund seeks to invest may not be
available in the quantities desired. In addition, regulatory restrictions,
actual or potential conflicts of interest or other considerations may
cause PIMCO to restrict or prohibit participation in certain investments.
In such circumstances, PIMCO or the individual portfolio managers may
determine to purchase other securities or instruments as substitutes.
Such substitute securities or instruments may not perform as intended,
which could result in losses to the Fund. To the extent the Fund employs
strategies targeting perceived pricing inefficiencies, arbitrage strategies
or similar strategies, it is subject to the risk that the pricing or valuation
of the securities and instruments involved in such strategies may change
unexpectedly, which may result in reduced returns or losses to the Fund.
The Fund is also subject to the risk that deficiencies in the internal
systems or controls of PIMCO or another service provider will cause
losses for the Fund or hinder Fund operations. For example, trading
delays or errors (both human and systemic) could prevent the Fund from
purchasing a security expected to appreciate in value. Additionally,
actual or potential conflicts of interest, legislative, regulatory, or tax
restrictions, policies or developments may affect the investment
techniques available to PIMCO and each individual portfolio manager in
connection with managing the Fund and may also adversely affect the
ability of the Fund to achieve its investment objectives. There also can be
no assurance that all of the personnel of PIMCO will continue to be
associated with PIMCO for any length of time. The loss of services of one
or more key employees of PIMCO could have an adverse impact on the
Fund’s ability to realize its investment objectives.
In addition, the Fund may rely on various third-party sources to calculate
its NAV. As a result, the Fund is subject to certain operational risks
associated with reliance on service providers and service providers’ data
sources. In particular, errors or systems failures and other technological
issues may adversely impact the Fund’s calculations of its NAV, and such
NAV calculation issues may result in inaccurately calculated NAVs,
delays in NAV calculation and/or the inability to calculate NAVs over
extended periods. The Fund may be unable to recover any losses
associated with such failures.
Reinvestment Risk
Income from the Fund’s portfolio will decline if and when the Fund
invests the proceeds from matured, traded or called debt obligations at
market interest rates that are below the portfolio’s current earnings
rate. For instance, during periods of declining interest rates, an issuer of
debt obligations may exercise an option to redeem securities prior to
maturity, forcing the Fund to invest in lower-yielding securities. The Fund
also may choose to sell higher yielding portfolio securities and to
purchase lower yielding securities to achieve greater portfolio
diversification, because the portfolio managers believe the current
holdings are overvalued or for other investment-related reasons. A
13 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
decline in income received by the Fund from its investments is likely to
have a negative effect on dividend levels
and the market price
, NAV
and/or overall return of the Common Shares.
Leverage Risk
The Fund’s use of leverage (as described under “Use of Leverage” in the
body of this prospectus) creates the opportunity for increased Common
Share net income, but also creates special risks for Common
Shareholders. To the extent used, there is no assurance that the Fund’s
leveraging strategies will be successful. Leverage is a speculative
technique that may expose the Fund to greater risk and increased costs.
The Fund’s assets attributable to any outstanding Preferred Shares or
the net proceeds that the Fund obtains from its use of tender option
bonds, derivatives or other forms of leverage, if any, will be invested in
accordance with the Fund’s investment objectives and policies as
described in this prospectus. Dividends payable with respect to any
Preferred Shares outstanding and interest expense payable by the Fund
with respect to any tender option bonds, derivatives and other forms of
leverage will generally be based on shorter-term interest rates that
would be periodically reset. If shorter-term interest rates rise relative to
the rate of return on the Fund’s portfolio, the interest and other costs to
the Fund of leverage (including interest expenses on tender option
bonds and the dividend rate on any outstanding Preferred Shares,
including the Preferred Shareholder Gross-Up) could exceed the rate of
return on the debt obligations and other investments held by the Fund,
thereby reducing return to Common Shareholders. In addition, fees and
expenses of any form of leverage used by the Fund will be borne entirely
by the Common Shareholders (and not by Preferred Shareholders, if any)
and will reduce the investment return of the Common Shares. Therefore,
there can be no assurance that the Fund’s use of leverage will result in a
higher yield on the Common Shares, and it may result in losses. In
addition, any Preferred Shares issued by the Fund are expected to pay
cumulative dividends, which may tend to increase leverage risk.
Leverage creates several major types of risks for Common Shareholders,
including:
◾
the likelihood of greater volatility of NAV of Common Shares, and
of the investment return to Common Shareholders, than a
comparable portfolio without leverage;
◾
the possibility either that Common Share dividends will fall if the
interest and other costs of leverage rise, or that dividends paid on
Common Shares will fluctuate because such costs vary over time;
and
◾
the effects of leverage in a declining market or a rising interest
rate environment, as leverage is likely to cause a greater decline in
the NAV of the Common Shares than if the Fund were not
leveraged.
In addition, the counterparties to the Fund’s leveraging transactions and
any Preferred Shareholders of the Fund will have complete priority over
the Fund’s Common Shareholders in the distribution of the Fund’s
assets.
In addition to tender option bonds and any future issuance of Preferred
Shares, the Fund may engage in other transactions that may give rise to
a form of leverage including, among others loans of portfolio securities,
short sales and when-issued, delayed delivery and forward commitment
transactions, credit default swaps, reverse repurchases, or other
derivatives. The Fund’s use of such transactions gives rise to associated
leverage risks described above, and may adversely affect the Fund’s
income, distributions and total returns to Common Shareholders. The
Fund may offset derivatives positions against one another or against
other assets to manage effective market exposure resulting from
derivatives in its portfolio. To the extent that any offsetting positions do
not behave in relation to one another as expected, the Fund may
perform as if it is leveraged through use of these derivative strategies.
See “Use of Leverage.”
The Fund is
required to satisfy certain asset coverage requirements in
connection with its use of Preferred Shares, including those imposed by
regulatory and rating agency requirements. Accordingly, any decline in
the net asset value of the Fund’s investments could result in the risk that
the Fund will fail to meet its asset coverage requirements for any such
Preferred Shares or the risk of the Preferred Shares being downgraded
by a rating agency. In an extreme case, the Fund’s current investment
income might not be sufficient to meet the dividend requirements on
any Preferred Shares outstanding. In order to address these types of
events, the Fund might need to
dispose of
investments in order to fund
a redemption of some or all
Preferred Shares
.
Dispositions
at times of
adverse economic conditions may result in a loss to the Fund. At other
times, these
dispositions
may result in gain at the Fund level and thus in
additional taxable distributions to Common Shareholders. See “Tax
Matters” for more information. Any Preferred Shares, tender option
bonds, loans of portfolio securities, short sales and when-issued,
delayed delivery and forward commitment transactions, credit default
swaps, reverse repurchases, or other derivatives by the Fund or
counterparties to the Fund’s other leveraging transactions, if any, would
have, seniority over the Fund’s Common Shares.
When
the Fund issues Preferred Shares, the Fund
pays
(and the
Common Shareholders
bear) all costs and expenses relating to the
issuance and ongoing maintenance of Preferred Shares. In addition,
holders of any Preferred Shares issued by the Fund would have
complete priority over Common Shareholders in the distribution of the
Fund’s assets. Furthermore, Preferred Shareholders, voting separately as
a single class,
have the right to elect two members of the Board at all
times and to elect a majority of the trustees in the event two full years’
dividends on the Preferred Shares are unpaid, and
also have separate
class voting rights on certain matters. Accordingly, Preferred
Shareholders may have interests that differ from those of Common
Shareholders, and may at times have disproportionate influence over
the Fund’s affairs.
Because the fees received by the Investment Manager are based on the
average daily “total managed assets” of the Fund, which includes total
assets of the Fund (including assets attributable to any reverse
repurchase agreements, dollar rolls/buy backs, tender option bonds,
borrowings and Preferred Shares that may be outstanding, if any), the
April 30, 2023
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PIMCO California Flexible Municipal Income Fund
Investment Manager has a financial incentive for the Fund to use certain
forms of leverage (e.g., Preferred Shares and tender option bonds),
which may create a conflict of interest between the Investment
Manager, on the one hand, and the Common Shareholders, on the other
hand.
Derivatives Risk
The Fund may, but is not required to, utilize a variety of derivative
instruments (both long and short positions) for investment or risk
management purposes. Derivatives are financial contracts whose value
depends on, or is derived from, the value of an underlying asset,
reference rate or index. The Fund may use derivatives to gain exposure
to securities markets in which it may invest (
e.g.
, pending investment of
the proceeds of this offering in individual securities, as well as on an
ongoing basis). The Fund may also use derivatives to add leverage to its
portfolio. See “Principal Risks of the Fund—Leverage Risk.” Derivatives
transactions that the Fund may utilize include, but are not limited to,
purchases or sales of futures and forward contracts (including foreign
currency exchange contracts), call and put options, credit default swaps,
total return swaps, basis swaps and other swap agreements. The Fund
may also have exposure to derivatives, such as interest rate or
credit-default swaps, through investment in credit-linked trust
certificates and other securities issued by special purpose or structured
vehicles. The Fund may also use derivatives for leverage, in which case
their use would involve leveraging risk, and in some cases, may subject
the Fund to the potential for unlimited loss. The use of derivatives may
cause the Fund’s investment returns to be impacted by the performance
of securities the Fund does not own and result in the Fund’s total
investment exposure exceeding the value of its portfolio.
The Fund’s use of derivatives or other similar instruments (referred to
collectively as “derivatives”) 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 (which
may be heightened for highly-customized derivatives), interest rate risk,
market risk, leverage risk, counterparty (including credit) risk,
operational risk, legal risk, tax risk and management risk, as well as
risks arising from changes in applicable requirements, risks arising from
margin requirements and risks arising from mispricing or valuation
complexity. They also involve the risk of unfavorable or ambiguous
documentation and the risk that changes in the value of the derivative
may not correlate perfectly with the underlying asset, rate or index. If
the Fund invests in a derivative instrument, it could lose more than the
principal amount invested and derivatives may increase the volatility of
the Fund, especially in unusual or extreme market conditions. The Fund
may be required to hold additional cash or sell other investments in
order to obtain cash to close out a position and changes in the value of
a derivative may also create margin delivery or settlement payment
obligations for the Fund.
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. The Fund’s use of derivatives may increase or accelerate
the amount of taxes payable by Common Shareholders. See “Tax
Matters.”
Over-the-counter (“OTC”) derivatives are also subject to the risk that a
counterparty to the transaction will not fulfill its contractual obligations
to the other party, as many of the protections afforded to
centrally-cleared derivatives might not be available for OTC derivatives
transactions. For derivatives traded on an exchange or through a central
counterparty, credit risk resides with the Fund’s clearing broker or the
clearinghouse itself.
Participation in the markets for derivative instruments involves
investment risks and transaction costs to which the Fund may not be
subject absent the use of these strategies. The skills needed to
successfully execute derivative strategies may be different from those
needed for other types of transactions. If the Fund incorrectly forecasts
the value and/or creditworthiness of securities, currencies, interest rates,
counterparties or other economic factors involved in a derivative
transaction, the Fund might have been in a better position if the Fund
had not entered into such derivative transaction. In evaluating the risks
and contractual obligations associated with particular derivative
instruments, it is important to consider that certain derivative
transactions may be modified or terminated only by mutual consent of
the Fund and its counterparty. Therefore, it may not be possible for the
Fund to modify, terminate, or offset the Fund’s obligations or the Fund’s
exposure to the risks associated with a derivative transaction prior to its
scheduled termination or maturity date, which may create a possibility
of increased volatility and/or decreased liquidity to the Fund. Hedges are
sometimes subject to imperfect matching between the derivative and
the underlying instrument, and there can be no assurance that the
Fund’s hedging transactions will be effective. In such case, the Fund may
lose money.
Because the markets for certain derivative instruments (including
markets located in foreign countries) are relatively new and still
developing, appropriate derivative transactions may not be available in
all circumstances for risk management or other purposes. Upon the
expiration of a particular contract, the Fund may wish to retain the
Fund’s position in the derivative instrument by entering into a similar
contract, but may be unable to do so if the counterparty to the original
contract is unwilling to enter into the new contract and no other
appropriate counterparty can be found. When such markets are
unavailable, the Fund will be subject to increased liquidity and
investment risk.
When a derivative is used as a hedge against a position that the Fund
holds, any loss generated by the derivative generally should be
substantially offset by gains on the hedged investment, and vice versa.
Although hedging can reduce or eliminate losses, it can also reduce or
eliminate gains. Hedges are sometimes subject to imperfect matching
between the derivative and the underlying instrument, and there can be
15 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
no assurance that the Fund’s hedging transactions, impede the
employment of the Fund’s derivatives strategies, or adversely affect the
Fund's performance will be effective. In such case, the Fund may lose
money.
The regulation of the derivatives markets has increased over the past
several years, and additional future regulation of the derivatives markets
may make derivatives more costly, may limit the availability or reduce
the liquidity of derivatives or may otherwise adversely affect the value or
performance of derivatives. Any such adverse future developments could
impair the effectiveness or raise the costs of the Fund’s derivative
transactions, impede the employment of the Fund’s derivatives
strategies, or adversely affect the Fund’s performance and cause the
Fund to lose value.
Credit Default Swaps Risk
Credit default swap agreements may involve greater risks than if the
Fund had invested in the reference obligation directly since, in addition
to general market risks, credit default swaps are subject to leverage risk,
illiquidity risk, counterparty risk and credit risk. A buyer generally also
will lose its investment and recover nothing should no credit event occur
and the swap is held to its termination date. If a credit event were to
occur, the value of any deliverable obligation received by the seller (if
any), coupled with the upfront or periodic payments previously received,
may be less than the full notional value it pays to the buyer, resulting in
a loss of value to the seller. When the Fund acts as a seller of a credit
default swap, it is exposed to many of the same risks of leverage
described herein. As the seller, the Fund would receive a stream of
payments over the term of the swap agreement provided that no event
of default has occurred with respect to the referenced debt obligation
upon which the swap is based. The Fund would effectively add leverage
to its portfolio because, If a default occurs, the stream of payments may
stop and, in addition to its total net assets, the Fund would be subject to
investment exposure on the notional amount of the swap.
Although the Fund may seek to realize gains by selling credit default
swaps that increase in value, to realize gains on selling credit default
swaps, an active secondary market for such instruments must exist or
the Fund must otherwise be able to close out these transactions at
advantageous times. In addition to the risk of losses described above, if
no such secondary market exists or the Fund is otherwise unable to
close out these transactions at advantageous times, selling credit
default swaps may not be profitable for the Fund.
The market for credit default swaps has become more volatile as the
creditworthiness of certain counterparties has been questioned and/or
downgraded. The Fund will be subject to credit risk with respect to the
counterparties to the credit default swap contract (whether a clearing
corporation or another third party). If a counterparty’s credit becomes
significantly impaired, multiple requests for collateral posting in a short
period of time could increase the risk that the Fund may not receive
adequate collateral. The Fund may exit its obligations under a credit
default swap only by terminating the contract and paying applicable
breakage fees, or by entering into an offsetting credit default swap
position, which may cause the Fund to incur more losses.
Valuation Risk
Certain securities in which the Fund invests may be less liquid and more
difficult to value than other types of securities. Investments for which
market quotations are not readily available are valued at fair value as
determined in good faith pursuant to Rule 2a-5 under the Act. See
“How Fund Shares are Priced.” Fair value pricing may require subjective
determinations about the value of a security or other asset. As a result,
there can be no assurance that fair value pricing will result in
adjustments to the prices of securities or other assets, or that fair value
pricing will reflect actual market value, and it is possible that the fair
value determined for a security or other asset will be materially different
from quoted or published prices, from the prices used by others for the
same security or other asset and/or from the value that actually could be
or is realized upon the sale of that security or other asset.
Counterparty Risk
The Fund will be subject to credit risk with respect to the counterparties
to the derivative contracts and other instruments entered into by the
Fund or held by special purpose or structured vehicles in which the Fund
invests. In the event that the Fund enters into a derivative transaction
with a counterparty that subsequently becomes insolvent or becomes
the subject of a bankruptcy case, the derivative transaction may be
terminated in accordance with its terms and the Fund’s ability to realize
its rights under the derivative instrument and its ability to distribute the
proceeds could be adversely affected. If a counterparty becomes
bankrupt or otherwise fails to perform its obligations under a derivative
contract due to financial difficulties, the Fund may experience significant
delays in obtaining any recovery (including recovery of any collateral it
has provided to the counterparty) in a dissolution, assignment for the
benefit of creditors, liquidation, winding-up, bankruptcy, or other
analogous proceeding. In addition, in the event of the insolvency of a
counterparty to a derivative transaction, the derivative transaction
would typically be terminated at its fair market value. If the Fund is
owed this fair market value in the termination of the derivative
transaction and its claim is unsecured, the Fund will be treated as a
general creditor of such counterparty, and will not have any claim with
respect to any underlying security or asset. The Fund may obtain only a
limited recovery or may obtain no recovery in such circumstances. While
the Fund may seek to manage its counterparty risk by transacting with a
number of counterparties, concerns about the solvency of, or a default
by, one large market participant could lead to significant impairment of
liquidity and other adverse consequences for other counterparties.
Confidential Information Access Risk
In managing the Fund (and other PIMCO clients), PIMCO may from time
to time have the opportunity to receive material, non-public information
(“Confidential Information”) about the issuers of certain investments,
including, without limitation, senior floating rate loans, other loans and
related investments being considered for acquisition by the Fund or held
in the Fund’s portfolio. Pursuant to applicable policies and procedures,
PIMCO may (but is not required to) seek to avoid receipt of Confidential
Information about such issuers so as to avoid possible restrictions on its
ability to purchase and sell investments on behalf of the Fund and other
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
16
PIMCO California Flexible Municipal Income Fund
clients to which such Confidential Information relates. In such
circumstances, the Fund (and other PIMCO clients) may be
disadvantaged in comparison to other investors, including with respect
to the price the Fund pays or receives when it buys or sells an
investment. Further, PIMCO’s and the Fund’s abilities to assess the
desirability of proposed consents, waivers or amendments with respect
to certain investments may be compromised if they are not privy to
available Confidential Information. PIMCO may also determine to
receive such Confidential Information in certain circumstances under its
applicable policies and procedures. If PIMCO intentionally or
unintentionally comes into possession of Confidential Information, it
may be unable, potentially for a substantial period of time, to purchase
or sell investments to which such Confidential Information relates.
Private Placements Risk
A private placement involves the sale of securities that have not been
registered under the 1933 Act, or relevant provisions of applicable
non-U.S. law, to certain institutional and qualified individual purchasers,
such as the Fund. In addition to the general risks to which all securities
are subject, securities received in a private placement generally are
subject to strict restrictions on resale, and there may be no liquid
secondary market or ready purchaser for such securities. See “Principal
Risks of the Fund - Liquidity Risk.” Therefore, the Fund may be unable to
dispose of such securities when it desires to do so, or at the most
favorable time or price. Private placements may also raise valuation
risks. See “Principal Risks of the Fund - Valuation Risk.”
Privacy and Data Security Risk
The Gramm-Leach Bliley Act (“GLBA”) and other laws limit the
disclosure of certain non-public personal information about a consumer
to non- affiliated third parties and require financial institutions to
disclose certain privacy policies and practices with respect to
information sharing with both affiliates and non- affiliated third parties.
Many states and a number of non-U.S. jurisdictions have enacted
privacy and data security laws requiring safeguards on the privacy and
security of consumers’ personally identifiable information. Other laws
deal with obligations to safeguard and dispose of private information in
a manner designed to avoid its dissemination. Privacy rules adopted by
the U.S. Federal Trade Commission and SEC implement GLBA and other
requirements and govern the disclosure of consumer financial
information by certain financial institutions, ranging from banks to
private investment funds. U.S. platforms following certain models
generally are required to have privacy policies that conform to these
GLBA and other requirements. In addition, such platforms typically have
policies and procedures intended to maintain platform participants’
personal information securely and dispose of it properly. The Fund
generally does not intend to obtain or hold borrowers’ non-public
personal information, and the Fund has implemented procedures
reasonably designed to prevent the disclosure of borrowers’ non-public
personal information to the Fund. However, service providers to the
Fund, including their custodians and the platforms acting as loan
servicers for the Fund, may obtain, hold or process such information. The
Fund cannot guarantee the security of non-public personal information
in the possession of such a service provider and cannot guarantee that
service providers have been and will continue to comply with the GLBA,
other data security and privacy laws and any other related regulatory
requirements. Violations of GLBA and other laws could subject the Fund
to litigation and/or fines, penalties or other regulatory action, which,
individually or in the aggregate, could have an adverse effect on the
Fund. The Fund may also face regulations related to privacy and data
security in the other jurisdictions in which the Fund invests.
Regulatory Changes Risk
Financial entities, such as investment companies and investment
advisers, are generally subject to extensive government regulation and
intervention. Government regulation and/or intervention may change
the way the Fund is regulated, affect the expenses incurred directly by
the Fund and the value of its investments, and limit and/or preclude the
Fund’s ability to achieve its investment objectives. Government
regulation may change frequently and may have significant adverse
consequences. The Fund and the Investment Manager have historically
been eligible for exemptions from certain regulations. However, there is
no assurance that the Fund and the Investment Manager will continue
to be eligible for such exemptions.
Moreover, government regulation may have unpredictable and
unintended effects. Legislative or regulatory actions to address
perceived liquidity or other issues in fixed income markets generally, or
in particular markets such as the municipal securities market, may alter
or impair the Fund’s ability to pursue its investment objectives or utilize
certain investment strategies and techniques.
Actions by governmental entities may also impact certain instruments in
which the Fund invests and reduce market liquidity and resiliency. For
example, the Fund’s investments (including, but not limited to,
repurchase agreements, collateralized loan obligations and
mortgage-backed securities), payment obligations and financing terms
may rely in some fashion on LIBOR. For more information related to the
LIBOR transition, see “Principal Risks of the Fund – Regulatory Risk –
LIBOR.”
Also, nationalization, expropriation or confiscatory taxation, currency
blockage, market disruptions, political changes, security suspensions or,
diplomatic developments or the imposition of sanctions or other similar
measures could adversely affect the Fund's investments. In the event of
nationalization, expropriation or other confiscation, the Fund could lose
its entire investment. The type and severity of sanctions and other
similar measures, including counter sanctions and other retaliatory
actions, that may be imposed could vary broadly in scope, and their
impact is difficult to ascertain. These types of measures may include, but
are not limited to, banning a sanctioned country or certain persons or
entities associated with such country from global payment systems that
facilitate cross-border payments, restricting the settlement of securities
transactions by certain investors, and freezing the assets of particular
countries, entities or persons. The imposition of sanctions and other
similar measures could, among other things, result in a decline in the
value and/or liquidity of securities issued by the sanctioned country or
companies located in or economically tied to the sanctioned country,
17 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
downgrades in the credit ratings of the sanctioned country's securities
or those of companies located in or economically tied to the sanctioned
country, currency devaluation or volatility, and increased market
volatility and disruption in the sanctioned country and throughout the
world. Sanctions and other similar measures could directly or indirectly
limit or prevent the Fund from buying and selling securities (in the
sanctioned country and other markets), significantly delay or prevent the
settlement of securities transactions, and adversely impact the Fund’s
liquidity and performance.
Regulatory Risk - LIBOR
Certain instruments in which the Fund may invest rely in some fashion
upon the London Interbank Offered Rate (“LIBOR”). LIBOR was
traditionally an average interest rate, determined by the ICE Benchmark
Administration, that banks charge one another for the use of short-term
money. On March 5, 2021, the Financial Conduct Authority (“FCA”), the
United Kingdom’s financial regulatory body and regulator of LIBOR,
publicly announced that all U.S. Dollar LIBOR settings will either cease
to be provided by any administrator or will no longer be representative
(i) immediately after December 31, 2021 for one-week and two-month
U.S. Dollar LIBOR settings and (ii) immediately after June 30, 2023 for
the remaining U.S. Dollar LIBOR settings. As of January 1, 2022, as a
result of supervisory guidance from U.S. regulators, U.S. regulated
entities have generally ceased entering into new LIBOR contracts with
limited exceptions. Publication of all Japanese yen and the one- and
six-month sterling LIBOR settings have ceased, and while publication of
the three-month Sterling LIBOR setting will continue through at least
the end of March 2024 on the basis of a changed methodology (known
as “synthetic LIBOR”), this rate has been designated by the FCA as
unrepresentative of the underlying market that it seeks to measure and
is solely available for use in legacy transactions. Certain bank-sponsored
committees in other jurisdictions, including Europe, the United Kingdom,
Japan and Switzerland, have selected alternative reference rates
denominated in other currencies. Although the transition process away
from LIBOR has become increasingly well-defined, any potential effects
of the transition away from LIBOR on the Fund or on certain instruments
in which the Fund invests can be difficult to ascertain, and may vary
depending on factors that include, but are not limited to: (i) existing
fallback or termination provisions in individual contracts and (ii)
whether, how, and when industry participants adopt new reference
rates for affected instruments. So-called “tough legacy” contracts have
LIBOR interest rate provisions with no fallback provisions contemplating
a permanent discontinuation of LIBOR, inadequate fallback provisions
or fallback provisions which may not effectively result in a transition
away from LIBOR prior to LIBOR’s planned replacement date. On
March 15, 2022, the Adjustable Interest Rate (LIBOR) Act was signed
into law. This law provides a statutory fallback mechanism on a
nationwide basis to replace LIBOR with a benchmark rate that is
selected by the Board of Governors of the Federal Reserve System based
on the Secured Overnight Financing Rate (“SOFR”) for tough legacy
contracts. On February 27, 2023, the Federal Reserve System’s final rule
in connection with this law became effective, establishing benchmark
replacements based on SOFR and Term SOFR (a forward-looking
measurement of market expectations of SOFR implied from certain
derivatives markets) for applicable tough legacy contracts governed by
U.S. law. In addition, the FCA has announced that it will require the
publication of synthetic LIBOR for the one-month, three-month and
six-month U.S. Dollar LIBOR settings after June 30, 2023 through at
least September 30, 2024. Certain of the Fund’s investments may
involve individual tough legacy contracts which may be subject to the
Adjustable Interest Rate (LIBOR) Act or synthetic LIBOR and no
assurances can be given that these measures will have the intended
effects. Moreover, certain aspects of the transition from LIBOR will rely
on the actions of third-party market participants, such as clearing
houses, trustees, administrative agents, asset servicers and certain
service providers; PIMCO cannot guarantee the performance of such
market participants and any failure on the part of such market
participants to manage their part of the LIBOR transition could impact
the Fund. The transition of investments from LIBOR to a replacement
rate as a result of amendment, application of existing fallbacks,
statutory requirements or otherwise may also result in a reduction in the
value of certain instruments held by the Fund or a reduction in the
effectiveness of related Fund transactions such as hedges. In addition,
an instrument’s transition to a replacement rate could result in
variations in the reported yields of the Fund that holds such instrument.
Any such effects of the transition away from LIBOR, as well as other
unforeseen effects, could result in losses to the Fund.
Other Investment Companies Risk
The Fund may invest up to 5% of its total assets in securities of other
investment companies (including those advised by PIMCO), including
closed-end funds, exchange-traded funds and other open-end funds,
that invest primarily in municipal bonds and other municipal securities
of the types in which the Fund may invest directly. As a shareholder 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 investment management fees and other expenses with
respect to the assets so invested. Common Shareholders would
therefore be subject to duplicative expenses to the extent the Fund
invests in other investment companies. In addition, these other
investment companies may utilize leverage, in which case an investment
would subject the Fund to additional risks associated with leverage. Due
to its own financial interest or other business considerations, the
Investment Manager may choose to invest a portion of the Fund’s assets
in investment companies sponsored or managed by the Investment
Manager or its related parties in lieu of investments by the Fund directly
in portfolio securities, or may choose to invest in such investment
companies over investment companies sponsored or managed by
others. Applicable law may limit the Fund’s ability to invest in other
investment companies. See “Principal Risks of the Fund – Leverage
Risk.”
Tax Risk
The Fund has elected to be treated as a RIC under the Code and intends
each year to qualify and be eligible to be treated as such, so that it
generally will not be subject to U.S. federal income tax on its net
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
18
PIMCO California Flexible Municipal Income Fund
investment income or net short-term or long-term capital gains that are
distributed (or deemed distributed, as described below) to shareholders.
In order to qualify and be eligible for such treatment, the Fund must
meet certain asset diversification tests, derive at least 90% of its gross
income for such year from certain types of qualifying income, and
distribute to its shareholders at least 90% of its “investment company
taxable income” as that term is defined in the Code (which includes,
among other things, dividends, taxable interest and the excess of any
net short-term capital gains over net long-term capital losses, as
reduced by certain deductible expenses).
The Fund’s investment strategy will potentially be limited by its intention
to continue qualifying for treatment as a RIC and can limit the Fund’s
ability to continue qualifying as such. The tax treatment of certain of the
Fund’s investments under one or more of the qualification or
distribution tests applicable to RICs is uncertain. An adverse
determination or future guidance by the IRS or a change in law might
affect the Fund’s ability to qualify or be eligible for treatment as a RIC.
If, in any year, the Fund were to fail to qualify for treatment as a RIC
under the Code, and were ineligible to or did not otherwise cure such
failure, the Fund would be subject to tax on its taxable income at
corporate rates and, when such income is distributed, shareholders
would be subject to further tax on such distributions to the extent of the
Fund’s current or accumulated earnings and profits.
To qualify to pay exempt-interest dividends, which are treated as items
of interest excludable from gross income for federal income tax
purposes, at least 50% of the value of the total assets of the Fund must
consist of obligations exempt from federal income tax as of the close of
each quarter of the Fund’s taxable year. If the proportion of taxable
investments held by the Fund exceeds 50% of the Fund’s total assets as
of the close of any quarter of the Fund’s taxable year, the Fund will not
for that taxable year satisfy the general eligibility test that otherwise
permits it to pay exempt-interest dividends.
The value of the Fund’s investments and its net asset value may be
adversely affected by changes in tax rates and policies. Because interest
income from municipal securities is normally not subject to regular
federal income taxation, the attractiveness of municipal securities in
relation to other investment alternatives is affected by changes in
federal income tax rates or changes in the tax-exempt status of interest
income from municipal securities. Any proposed or actual changes in
such rates or exempt status, therefore, can significantly affect the
demand for and supply, liquidity and marketability of municipal
securities. This could in turn affect the Fund’s net asset value and ability
to acquire and dispose of municipal securities at desirable yield and
price levels. Additionally, the Fund is not a suitable investment for
individual retirement accounts, for other tax-exempt or tax-deferred
accounts or for investors who are not sensitive to the federal income tax
consequences of their investments.
Potential Conflicts of Interest Risk-Allocation of Investment
Opportunities
The Investment Manager is involved worldwide with a broad spectrum
of financial services and asset management activities and may engage
in the ordinary course of business in activities in which its interests or
the interests of its clients may conflict with those of the Fund. The
Investment Manager may provide investment management services to
other funds and discretionary managed accounts that follow an
investment program similar to that of the Fund. Subject to the
requirements of the Act, the Investment Manager intends to engage in
such activities and may receive compensation from third parties for its
services. The results of the Fund’s investment activities may differ from
those of the Fund’s affiliates, or another account managed by the
Investment Manager or its affiliates, and it is possible that the Fund
could sustain losses during periods in which one or more of the Fund’s
affiliates and/or other accounts managed by the Investment Manager or
its affiliates, including proprietary accounts, achieve profits on their
trading.
Distribution Rate Risk
Although the Fund may seek to maintain a level distribution rate, the
Fund’s distribution rate may be affected by numerous factors, including
but not limited to changes in realized and projected market returns,
fluctuations in market interest rates, Fund performance, and other
factors. There can be no assurance that a change in market conditions or
other factors will not result in a change in the Fund’s distribution rate or
that the rate will be sustainable in the future. For instance, during
periods of low or declining interest rates, the Fund’s distributable
income and dividend levels may decline for many reasons. For example,
the Fund may have to deploy uninvested assets (whether from sales of
Fund shares, proceeds from matured, traded or called debt obligations
or other sources) in new, lower yielding instruments. Additionally,
payments from certain instruments that may be held by the Fund (such
as variable and floating rate securities) may be negatively impacted by
declining interest rates, which may also lead to a decline in the Fund’s
distributable income and dividend levels.
Securities Lending Risk
For the purpose of achieving income, the Fund may lend its portfolio
securities to brokers, dealers, and other financial institutions provided a
number of conditions are satisfied, including that the loan is fully
collateralized. Please see “Investment Objectives and Policies—Loans of
Portfolio Securities” in the Statement of Additional Information for more
details. When the Fund lends portfolio securities, its investment
performance will continue to reflect changes in the value of the
securities loaned, and the Fund will also receive a fee or interest on the
collateral. Securities lending involves the risk of loss of rights in the
collateral or delay in recovery of the collateral if the borrower fails to
return the security loaned or becomes insolvent. The Fund may pay
lending fees to a party arranging the loan, which may be an affiliate of
the Fund. Cash collateral received by the Fund in securities lending
transactions may be invested in short-term liquid fixed income
19 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
instruments or in money market or short-term mutual funds, or similar
investment vehicles, including affiliated money market or short-term
mutual funds. The Fund bears the risk of such investments.
Portfolio Turnover Risk
The Investment Manager manages the Fund without regard generally to
restrictions on portfolio turnover. The use of futures contracts and other
derivative instruments with relatively short maturities may tend to
exaggerate the portfolio turnover rate for the Fund. Trading in fixed
income securities does not generally involve the payment of brokerage
commissions, but does involve indirect transaction costs. The use of
futures contracts and other derivative instruments may involve the
payment of commissions to futures commission merchants or other
intermediaries. Higher portfolio turnover 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. Such sales may result in realization of taxable
capital gains (including short-term capital gains, which are generally
taxed to shareholders at ordinary income tax rates when distributed net
of short-term capital losses and net long-term capital losses), and may
adversely impact the Fund’s after-tax returns. See “Tax Matters.”
Operational Risk
An investment in the Fund, like any fund, can involve operational risks
arising from factors such as processing errors, human errors, inadequate
or failed internal or external processes, failures in systems and
technology, changes in personnel and errors caused by third-party
service providers. The occurrence of any of these failures, errors or
breaches could result in a loss of information, regulatory scrutiny,
reputational damage or other events, any of which could have a
material adverse effect on the Fund. While the Fund seeks to minimize
such events through controls and oversight, there may still be failures
that could cause losses to the Fund.
Market Disruptions Risk
The Fund is subject to investment and operational risks associated with
financial, economic and other global market developments and
disruptions, including those arising from war, terrorism, market
manipulation, government interventions, defaults and shutdowns,
political changes or diplomatic developments, public health
emergencies (such as the spread of infectious diseases, pandemics and
epidemics) and natural/environmental disasters, which can all negatively
impact the securities markets, interest rates, auctions, secondary trading,
ratings, credit risk, inflation, deflation and other factors relating to the
Fund’s investments or the Investment Manager’s operations and the
value of an investment in the Fund, its distributions and its returns.
These events can also impair the technology and other operational
systems upon which the Fund’s service providers, including PIMCO as
the Fund’s investment adviser, rely, and could otherwise disrupt the
Fund’s service providers’ ability to fulfill their obligations to the Fund.
Cyber Security Risk
As the use of technology
,
including cloud-based technology,
has
become more prevalent in the course of business, the Fund is potentially
more susceptible to operational and information security risks resulting
from breaches in cyber security. A breach in cyber security refers to both
intentional and unintentional cyber events from outside threat actors or
internal resources that may, among other things, cause the Fund to lose
proprietary information, suffer data corruption and/or destruction, lose
operational capacity, result in the unauthorized release or other misuse
of confidential information, or otherwise disrupt normal business
operations. Cyber security breaches may involve unauthorized access to
the Fund’s digital information systems (e.g., through “hacking” or
malicious software coding), and may come from multiple sources,
including outside attacks such as denial-of-service attacks (i.e., efforts to
make network services unavailable to intended users) or cyber extortion,
including exfiltration of data held for ransom and/or “ransomware”
attacks that renders systems inoperable until ransom is paid, or insider
actions
(e
.
g.,
intentionally or unintentionally harmful acts of PIMCO
personnel).
In addition, cyber security breaches involving the Fund’s
third party service providers (including but not limited to advisers,
sub-advisers, administrators, transfer agents, custodians, vendors,
suppliers, distributors and other third parties), trading counterparties or
issuers in which the Fund invests can also subject the Fund to many of
the same risks associated with direct cyber security breaches or
extortion of company data.
PIMCO's use of cloud-based service
providers could heighten or change these risks. In addition
,
work-from-
home arrangements by
the Fund
,
the Investment Manager or
their service providers could increase all of the above risks,
create
additional data and information accessibility concerns, and make
the
Fund
,
the Investment Manager or their service providers susceptible to
operational disruptions, any of which could adversely impact their
operations
.
Cyber security failures or breaches may result in financial losses to the
Fund and its shareholders.
For example, cyber security failures or
breaches involving trading counterparties or issuers in which the Fund
invests could adversely impact such counterparties or issuers and cause
the Fund’s investment to lose value.
These failures or breaches may also
result in disruptions to business operations, potentially resulting in
financial losses; interference with the Fund’s ability to calculate its NAV,
process shareholder transactions or otherwise transact business with
shareholders; impediments to trading; violations of applicable privacy
and other laws; regulatory fines; penalties; third
-
party claims in
litigation; reputational damage; reimbursement or other compensation
costs; additional compliance and cyber security risk management costs
and other adverse consequences. In addition, substantial costs may be
incurred in order to prevent any cyber incidents in the future.
Like with operational risk in general, the Fund has established business
continuity plans and risk management systems designed to reduce the
risks associated with cyber security. However, there are inherent
limitations in these plans and systems, including that certain risks may
not have been identified, in large part because different or unknown
threats may emerge in the future. As such, there is no guarantee that
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
20
PIMCO California Flexible Municipal Income Fund
such efforts will succeed, especially because the Fund does not directly
control the cyber security systems of issuers in which the Fund may
invest, trading counterparties or third
-
party service providers to the
Fund. Such entities have experienced cyber attacks and other attempts
to gain unauthorized access to systems from time to time, and there is
no guarantee that efforts to prevent or mitigate the effects of such
attacks or other attempts to gain unauthorized access will be successful.
There is also a risk that cyber security breaches may not be detected. The
Fund and its shareholders may suffer losses as a result of a cyber
security breach related to the Fund, its service providers, trading
counterparties or the issuers in which the Fund invests.
Non-Diversification Risk
The Fund is “non-diversified,” which means that the Fund may invest a
greater percentage of its assets in the securities of a single issuer (such
as bonds issued by a particular state) than funds that are “diversified.”
A fund that invests in a relatively small number of issuers is more
susceptible to risks associated with a single economic, political or
regulatory occurrence than a more diversified portfolio might be.
Similarly, the Fund may be subject to increased economic, business or
political risk to the extent that it invests a substantial portion of its
assets in a particular currency, in a group of related industries, in a
particular issuer, in the bonds of similar projects or in a narrowly defined
geographic area outside the U.S. Notwithstanding the Fund’s status as a
“non-diversified” investment company under the Act, the Fund intends
to qualify as a RIC accorded special tax treatment under the Code,
which imposes its own diversification requirements.
Certain Affiliations
Certain broker-dealers may be considered to be affiliated persons of the
Fund and/or the Investment Manager due to their possible affiliations
with Allianz SE, the ultimate parent of the Investment Manager, or
another Allianz entity. Allianz Asset Management of America LP merged
with Allianz Asset Management
of America LLC
, with the latter being
the surviving entity, effective January 1, 2023. Following the merger,
Allianz Asset Management
of America LLC
is PIMCO LLC’s managing
member and direct parent entity. Absent an exemption from the SEC 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.
The Fund has received exemptive relief from the SEC that, to the extent
the Fund relies on such relief, permits it to (among other things)
co-invest with certain other persons, including certain affiliates of the
Investment Manager and certain public or private funds managed by the
Investment Manager and its affiliates, subject to certain terms and
conditions. The exemptive relief from the SEC with respect to
co-investments imposes extensive conditions on any co-investments
made in reliance on such relief.
Anti-Takeover Provisions
The Fund’s Amended and Restated Agreement and Declaration of Trust
,
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. See “Anti-Takeover and Other Provisions in the
Declaration of Trust and Bylaws.”
21 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
Summary of Fund Expenses
This table is intended to assist investors in understanding the various
costs and expenses directly or indirectly associated with investing in the
Fund. You may qualify for sales charge discounts on Class A-2 and/or
Class A-4 Common Shares of the Fund if you and your family invest, or
agree to invest in the future, in a certain amount of Class A-1, Class A-2,
Class A-3 and/or Class A-4 common shares of the Fund (to the extent
available) or other eligible closed-end interval funds that are sponsored
by PIMCO. More information about these and other discounts is
available in the “Plan of Distribution—Share Classes” section on page
66
of this prospectus or from your financial advisor.
Shareholder Transaction Expenses (fees paid directly from
your investment):
Institutional Class | Class A-1 | Class A-2 | Class A-3 | Class A-4 | |
Maximum Initial Sales Charge (Load) Imposed on Purchases (as a percentage of offering price) | None (1) | None (1) | 3.00% | None (1) | 3.00% |
Maximum Early Withdrawal Charge (Load) (as a percentage of the lower of the original purchase price or repurchase price) | None | None | 1.00% | None | 1.00% |
Dividend Reinvestment Fees | None | None | None | None | None |
1
While neither the Fund nor the Distributor impose an initial sales charge, if you buy
Institutional Class, Class A-1 or Class A-3 Common Shares through certain financial
firms, they may directly charge you transaction or other fees in such amount as they
may determine. Please consult your financial firm for additional information.
Annual Fund Operating Expenses (expenses that you pay each
year as a percentage of the value of your investment
(reflecting estimated leverage attributable to Preferred
Shares and tender option bonds representing approximately
21.65
% and 3.00%, respectively, of the Fund’s total managed
assets)):
Institutional Class | Class A-1 | Class A-2 | Class A-3 | Class A-4 | |
Management Fees (1) | 1.00% | 1.00% | 1.00% | 1.00% | 1.00% |
Distribution and/or Service (12b-1) Fees | N/A | 0.50% | 0.50% | 0.75% | 0.75% |
Interest Payments on Borrowed Funds (2) (3) | 0.17% | 0.17% | 0.17% | 0.17% | 0.17% |
Dividend Costs on Preferred Shares (2) (4) | 1.61% | 1.61% | 1.61% | 1.61% | 1.61% |
Other Expenses (5) | 0.06% | 0.06% | 0.06% | 0.06% | 0.06% |
Total Annual Fund Operating Expenses | 2.84% | 3.34% | 3.34% | 3.59% | 3.59% |
Fee Waiver and/or Expense Reimbursement (6) | (0.03%) | (0.03%) | (0.03%) | (0.03%) | (0.03%) |
Total Annual Fund Operating Expenses After Fee Waiver and/or Expense Reimbursement (2) | 2.81% | 3.31% | 3.31% | 3.56% | 3.56% |
1
Management fees include fees payable to the Investment Manager for advisory
services and for supervisory, administrative and other services. The Fund pays for the
advisory, supervisory and administrative services it requires under what is essentially
an all-in fee structure (the “unified management fee”). Pursuant to an investment
management agreement, PIMCO is paid a Management Fee of 0.75% of the Fund’s
total managed assets. The Fund (and not PIMCO) is responsible for certain fees and
expenses, which are reflected in the table above, that are not covered by the unified
management fee under the investment management agreement. Please see
“Management of the Fund - Investment Management Agreement” for an explanation
of the unified management fee and definition of “total managed assets.”
Management Fees have been restated to reflect leverage attributable to Preferred
Shares issued on January
12, 2024.
2
“Interest Payments on Borrowed Funds” and “Dividend and Other Costs on Preferred
Shares” will be borne by the Fund separately from the management fees paid to
PIMCO. Excluding such expenses, estimated Total Annual Fund Operating Expenses
After Fee Waiver and/or Expense Reimbursement are
1.03
%,
1.53
%,
1.53
%,
1.78
%
and
1.78
% for Institutional Class, Class A-1, Class A-2, A-3 and Class A-4 shares,
respectively. Although the Fund did not have leverage through tender option bonds or
Preferred Shares as of December 31, 2022, the estimates reflect
anticipated leverage
for the fiscal year ending December
31, 2023,
and the Preferred Shares issued by the
Fund on January
12,
2024
.
3
“Interest Payments on Borrowed Funds” reflects the Fund’s anticipated use of leverage
in the form of tender option bonds in an amount equal to 3.00% of the Fund's total
managed assets, at an estimated annual interest rate to the Fund of 4.16% (based on
estimated market interest rates as of December 31, 2022). The actual amount of
leverage used and borrowing expenses borne by the Fund will vary over time in
accordance with the level of the Fund's use of tender option bonds and/or other forms
of borrowings and variations in market interest rates. Borrowing expense is required to
be treated as an expense of the Fund for accounting purposes. Any associated income
or gains (or losses) realized from leverage obtained through such instruments is not
reflected in the Annual Expenses table above, but would be reflected in the Fund's
performance result.
4
“Dividend and Other Costs on Preferred Shares
”
have been restated to reflect the
Fund’s
issuance of Preferred Shares
on January
12, 2024
in an amount
representing
approximately 21.65
% of the Fund's total managed assets, at an estimated annual
dividend cost to the Fund of
5.12
% (based on estimated Preferred Share dividend
rates
as of December
31, 2023
)
,
and including the amortization of Preferred Share
offering costs of
$
360,000 over the three
-
year term of the Preferred Shares.). The
actual dividend rate paid on any Preferred Shares issued by the Fund will vary over
time in accordance with variations in market interest rates. See “Use of Leverage” and
“Description of Capital Structure.” Dividend and Other Costs on Preferred Shares are
borne directly by the Fund and will be reflected in the Fund's financial statements.
5
“Other Expenses” are based on estimated amounts for the current fiscal year.
6
PIMCO has contractually agreed, through May 2, 2024, to waive its management fee,
or reimburse the Fund, to the extent that organizational expenses and pro rata
Trustees’ fees exceed 0.10% of the Fund’s average daily net assets (the “Expense
Limitation Agreement”). Under the Expense Limitation Agreement, in any month in
which the investment management agreement is in effect, PIMCO is entitled to
reimbursement by the Fund of any portion of the management fee reduced as set forth
above (the “Reimbursement Amount”) during the previous thirty-six months, provided
that such amount paid to PIMCO will not (1) together with any recoupment of
organizational expenses, pro rata share of expenses related to obtaining or
maintaining a Legal Entity Identifier and pro rata trustee fees or management fees
exceed 0.10% of average daily net assets; (2) exceed the total Reimbursement
Amount; or (3) include any amounts previously reimbursed to PIMCO. For the
avoidance of doubt, any reimbursement of PIMCO’s management fee pursuant to the
Expense Limitation Agreement plus any recoupment of organizational expenses, pro
rata share of expenses related to obtaining or maintaining a Legal Entity Identifier and
pro rata Trustees’ fees will not exceed the lesser of (i) the expense limit in effect at the
time of waiver or reimbursement and (ii) the expense limit in effect at the time of
recoupment. This Expense Limitation Agreement will automatically renew for one-year
terms unless PIMCO provides written notice to the Fund at least 30 days prior to the
end of the then current term.
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
22
PIMCO California Flexible Municipal Income Fund
Example
As required by relevant SEC regulations, the following example
illustrates the expenses (including any applicable sales charge) that you
would pay on a $1,000 investment in the Common Shares, assuming a
5% annual return
(1)
:
If you redeem your shares at the end of each period:
1 Year | 3 Years | 5 Years | 10 Years | |
Institutional Class | $28 | $88 | $150 | $207 |
Class A-1 | $33 | $102 | $174 | $363 |
Class A-2 | $62 | $129 | $199 | $382 |
Class A-3 | $36 | $110 | $186 | $385 |
Class A-4 | $65 | $136 | $210 | $404 |
If you do not redeem your shares:
1 Year | 3 Years | 5 Years | 10 Years | |
Class A-2 | $62 | $129 | $199 | $382 |
Class A-4 | $65 | $136 | $210 | $404 |
(1)
The example above should not be considered a representation of future expenses.
Actual expenses may be higher or lower than those shown. The example assumes that
the estimated Interest Payments on Borrowed Funds, Dividend and Other Costs on
Preferred Shares and Other Expenses set forth in the Annual Expenses table are
accurate, that the Total Annual Fund Operating Expenses (as described above) remain
the same for all periods shown, and that all dividends and distributions are reinvested
at NAV. 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. In addition to the fees and expenses described above,
you may also be required to pay transaction or other fees on purchases of Institutional
Class, Class A-1, Class A-2, Class A-3 or Class A-4 Common Shares of the Fund, which
are not reflected in the example.
23 Prospectus
| PIMCO California Flexible Municipal Income Fund
PIMCO California Flexible Municipal Income Fund
Financial Highlights
The financial highlights table set forth below is intended to help you understand the Fund's recent financial performance. Information shown reflects
performance of the Fund's Institutional Class. Because Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares of the Fund had not
commenced operations as of December 31,
2023
no performance data for such share classes is provided. The information in the table below is for the
fiscal period ended December 31,
2023
, audited by PricewaterhouseCoopers LLP (“PwC”), whose report on such financial statements is contained in
the Fund's December 31,
2023
annual report and is incorporated by reference into the Statement of Additional Information.
Investment Operations | Less Distributions (c) | ||||||
Selected Per Share Data for the Period Ended^: | Net Asset Value Beginning of Period (a) | Net Investment Income (Loss) (b) | Net Realized/ Unrealized Gain (Loss) | Total | From Net Investment Income | From Net Realized Capital Gain | Total |
PIMCO | |||||||
Institutional Class | |||||||
06/27/2022 - 12/31/2022 | $ 10.00 | $ 0.17 | $ (0.18) | $ (0.01) | $ (0.16) | $ 0.00 | $ (0.16) |
^
A zero balance may reflect actual amounts rounding to less than $0.01 or 0.01%.
*
Annualized, except for organizational expense, if any.
(a)
Includes adjustments required by U.S. GAAP and may differ from net asset values and performance reported elsewhere by the Fund.
(b)
Per share amounts based on average number of shares outstanding during the period.
(c)
The tax characterization of distributions is determined in accordance with federal income tax regulations. See Note 2, Distributions—Common Shares, in the Notes to Financial
Statements for more information.
(d)
Includes adjustments required by U.S. GAAP and may differ from net asset values and performance reported elsewhere by the Funds. Additionally, excludes initial sales charges and
contingent deferred sales charges.
(e)
Ratio includes interest expense which primarily relates to participation in borrowing and financing transactions, dividends paid to RVMTP shareholders and the amortization of debt
issuance costs of these Preferred Shares. See Note 5 Borrowings and Other Financing Transactions and Note 13, Preferred Shares in the Notes to Financial Statements for more
information.
(f)
Expense ratio as presented is calculated based on average total managed assets for the period presented. Due to significant fluctuations in total managed assets during the period, the
expense ratio to average total managed assets differs from the total operating expense ratio in effect for each class. See Note 9, Fees and Expenses in the Notes to Financial Statements
for additional information on how the Fund’s expenses are calculated.
(g)
Certain organizational costs were incurred prior to the commencement of operations and reflected in the financial statements accompanying the initial registration statement. If the
Fund had incurred all organization and trustee related expenses in the current period, the ratio of expenses to average net assets excluding waivers and ratio of expenses to average
net assets excluding interest expense and waivers would have been 1.98% and 1.93% respectively.
25 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
Ratios/Supplemental Data | ||||||||
Ratios to Average Net Assets | ||||||||
Net Asset Value End of Period (a) | Total Return (d) | Net Assets End of Year (000s) | Expenses (e)(f) | Expenses Excluding Waivers (e)(f) | Expenses Excluding Interest Expense (f) | Expenses Excluding Interest Expense and Waivers (f) | Net Investment Income (Loss) | Portfolio Turnover Rate |
$ 9.83 | (0.08 )% | $ 46,863 | 0.65 %* | 1.18 %* (g) | 0.60 %* | 1.13 %* (g) | 3.38 %* |
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
26
PIMCO California Flexible Municipal Income Fund
The Fund
The Fund is a non-diversified, closed-end management investment
company registered under the Act. The Fund continuously offers its
Common Shares and is operated as an “interval fund.” The Fund
currently has five separate classes of Common Shares: Institutional
Class, Class A-1, Class A-2, Class A-3 and Class A-4. The Fund was
organized as a Massachusetts business trust on February 8, 2022,
pursuant to a Declaration of Trust (the “Declaration of Trust”), which is
governed by the laws of The Commonwealth of Massachusetts. The
Fund commenced operations on June 27, 2022. The Fund has limited
operating history as of the date of this prospectus. The Fund’s principal
office is located at 1633 Broadway, New York, New York 10019.
Use of Proceeds
The Fund will invest the proceeds of the continuous offering of Common
Shares on an ongoing basis in accordance with its investment objectives
and policies as stated below. It is currently anticipated that the Fund will
be able to invest all or substantially all of the net proceeds according to
its investment objectives and policies within approximately three
months after receipt of the proceeds, depending on the amount and
timing of proceeds available to the Fund as well as the availability of
investments consistent with the Fund’s investment objectives and
policies, and except to the extent proceeds are held in cash to pay
dividends or expenses, satisfy repurchase offers or for temporary
defensive purposes. Pending such investment, it is anticipated that the
proceeds of an offering will be invested in high quality, short-term,
municipal or other tax-exempt securities, although the Fund may, if
necessary, also invest in other high-quality, short-term securities.
The Fund’s Investment Objectives and Strategies
Investment Objectives
The Fund seeks to provide high current income exempt from federal and
California income tax. Capital appreciation is a secondary objective. The
types of securities and instruments in which the Fund may invest are
summarized under “The Fund's Investment Objectives and
Policies-Portfolio Management Strategies – Portfolio Contents and
Other Information.”
Portfolio Management Strategies
PIMCO serves as the Investment Manager of the Fund and manages the
Fund’s portfolio. See “Management of the Fund.” The portfolio
management strategies and techniques to be utilized by PIMCO are
described below.
Flexible Allocation Strategy.
The Fund seeks to achieve its
investment objectives by utilizing a flexible, multi-sector tax-efficient
approach to investing, under normal circumstances, primarily in
municipal bonds and other municipal securities that carry interest
payments that are exempt from federal and California income tax. The
principal issuers of these securities are state and local governments and
their agencies located in any of the fifty states, as well as Puerto Rico
and other U.S. territories and possessions. To a lesser extent, the Fund
also expects to invest in a full range of preferred securities with an
emphasis on preferred securities that, at the time of issuance, are
eligible to pay dividends that qualify for certain favorable federal income
tax treatment. With PIMCO's macroeconomic analysis as the basis for
top-down investment decisions, the Fund seeks to offer investors an
actively-managed municipal bond portfolio that aims to capitalize on
what PIMCO believes are attractive opportunities in California and, to a
lesser extent, other states, and across sectors within the California and
U.S. municipal markets.
Investment selection strategies.
In selecting securities for the
Fund, PIMCO develops an outlook for interest rates and the economy,
analyzes credit and call risks, and uses other security selection
techniques. The proportion of the Fund's assets committed to
investment in securities with particular characteristics (such as quality,
sector, interest rate or maturity) varies based on PIMCO's outlook for the
U.S. economy.
PIMCO attempts 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. There
is no guarantee that PIMCO's investment selection techniques will
produce the desired results.
Credit quality.
The Fund may invest without limit in municipal bonds
and other securities of any credit quality, including without limitation, in
securities that are, at the time of purchase, rated below “investment
grade” by at least one of Moody’s, S&P or Fitch, or unrated but
determined by PIMCO to be of comparable quality). “Investment grade”
means a rating, in the case of Moody’s, of Baa3 or higher, or in the case
of S&P and Fitch, of BBB- or higher. 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 may also invest
without limit in investment grade securities. The Fund generally expects
to invest at least 60% of its total assets in above investment grade
securities and not more than 40% of its total assets in below
investment grade securities, but may determine to allocate more heavily
or exclusively to either category at any time and from time to time based
on PIMCO's economic outlook, market conditions, and other factors.
Independent credit analysis.
PIMCO relies primarily on its own
analysis of the credit quality and risks associated with individual
municipal bonds and other municipal securities considered for the Fund,
rather than relying exclusively on rating agencies or third-party research.
The Fund’s portfolio managers utilize this information in an attempt to
manage credit risk and to identify investments that are undervalued or
that offer attractive yields relative to PIMCO’s assessment of their credit
characteristics. This aspect of PIMCO’s capabilities will be particularly
important to the extent that the Fund invests in high yield municipal
bonds or other securities.
27 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
Duration management.
The Fund does not target a specific duration
or maturity for the municipal bonds and other securities in which it
invests, and the Fund’s average portfolio duration, as calculated by
PIMCO may vary significantly depending on market conditions and other
factors. There is no limit on the maturity or duration of any individual
security in which the Fund may invest. Duration is a measure used to
determine the sensitivity of a security’s price to changes in interest rates.
The longer a security’s duration, the more sensitive it will be to changes
in interest rates. The portfolio managers focus on municipal bonds with
the potential to offer attractive current income, typically looking for
bonds that can provide consistently attractive current yields or that are
trading at competitive market prices. Capital appreciation, if any,
generally arises from decreases in interest rates or improving credit
fundamentals for a particular state, municipality or issuer.
Portfolio Contents and Other Information
Investment Parameters
The Fund will invest, under normal circumstances, at least 80% of its
net assets (plus any borrowings for investment purposes) in a portfolio
of municipal bonds and other municipal securities, the interest from
which, in the opinion of bond counsel for the issuer at the time of
issuance (or on the basis of other authority believed by PIMCO to be
reliable), is exempt from federal income tax and California income tax
(i.e., excluded from gross income for income tax purposes but not
necessarily exempt from the alternative minimum tax or from the
income taxes of any other state or of a local government) (the “80%
policy”). California municipal bonds generally are issued by or on behalf
of the State of California and its political subdivisions, financing
authorities and their agencies. By concentrating its investments in
California municipal securities, the Fund will be subject to California
State-Specific Risk, among other risks. Both within and outside the 80%
policy, the Fund may invest in debt securities of an issuer located
outside of California (for example, other jurisdictions may also issue
securities, the interest from which, in the opinion of bond counsel for
the issuer at the time of issuance or other authority believed by PIMCO
to be reliable is exempt from federal income tax and California income
tax). The Fund's 80% policy is a fundamental policy, which may not be
changed without the approval of the holders of a majority of the Fund's
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 Capital Structure and Shares – Preferred Shares
– Voting Rights” for additional information with respect to the voting
rights of holders of Preferred Shares.
The Fund may invest without limit in municipal bonds and other
securities that are rated below investment grade (or unrated but
determined by PIMCO to be of comparable quality). 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.” The Fund
may also invest without limit in investment grade securities.
Included within the general category of municipal bonds in which the
Fund may invest are loans (including participations and assignments)
and participations in lease obligations. A lease obligation is an
obligation in the form of a lease or installment purchase that is issued
by a state or local government to acquire equipment and facilities.
Income from such obligations generally is exempt from state and local
tax in the state of issuance. Lease obligations may be secured or
unsecured. Lease obligations do not constitute general obligations of
the municipality for which the municipality's taxing power is pledged.
The Fund may invest in and/or originate loans, including, without
limitation, to, on behalf of, authorized by, sponsored by, and/or in
connection with a project for which authority and responsibility lies with
one or more U.S. states or territories, cities in a U.S. state or territory, or
political subdivisions, agencies, authorities or instrumentalities of such
states, territories or cities, which may be in the form of whole loans,
assignments, participations, secured and unsecured notes, senior and
second lien loans, mezzanine loans, bridge loans or similar investments,
including to borrowers that are unrated or have credit ratings that are
determined by one or more NRSROs and/or PIMCO to be below
investment grade. This may include loans to public or private firms or
individuals, such as in connection with housing development projects.
The loans the Fund invests in or originates may vary in maturity and/or
duration. The Fund is not limited in the amount, size or type of loans it
may invest in and/or originate, including with respect to a single
borrower or with respect to borrowers that are determined to be below
investment grade, other than pursuant to any applicable law. The Fund's
investment in or origination of loans may also be limited by the
requirements the Fund intends to observe under Subchapter M of the
Code in order to qualify as a RIC.
In addition to other types of securities and assets described in this
section, the Fund may invest the balance of its assets (i.e., not towards
its 80% policy noted above) in securities and assets that produce
taxable income. Such assets are normally expected to include, but are
not limited to, preferred securities, with an emphasis on preferred
securities that, at the time of issuance, are eligible to pay dividends that
qualify for certain favorable federal income tax treatment, such as
dividends that are treated as qualified dividend income and eligible for
the dividends received deduction (in each instance, provided certain
requirements and holding periods are satisfied). See “Tax Matters.”
It is possible that the Fund could own no preferred securities at any
given time, including, for example, if municipal securities are expected
to produce a higher yield than preferred securities on an after-tax basis.
Subject to the Fund's investment policies described above, the Fund may
invest in other securities, including securities eligible for resale under
Rule 144A of the 1933 Act, and other privately placed securities, and
other debt securities subject to federal and/or California income tax,
including privately negotiated debt obligations with respect to which
the principal and/or interest is determined by reference to the
performance of a benchmark asset, market or interest rate (an
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PIMCO California Flexible Municipal Income Fund
“embedded index”), such as specific securities, an index of securities or
specified interest rates, or the differential performance of two assets or
markets, such as indexes reflecting bonds. The rate of interest on an
income-producing security may be fixed, floating or variable. The Fund
may also engage in credit spread trades. A credit spread trade is an
investment position relating to a difference in the prices or interest rates
of two bonds or other securities, in which the value of the investment
position is determined by changes in the difference between the prices
or interest rates, as the case may be, of the respective securities. The
Fund may purchase and sell securities on a when-issued, delayed
delivery or forward commitment basis and may engage in short sales.
The Fund may invest in trust certificates issued in tender option bond
programs. In these programs, a trust typically issues two classes of
certificates and uses the proceeds to purchase municipal securities
having relatively long maturities and bearing interest at a fixed interest
rate substantially higher than prevailing short-term tax-exempt rates.
The Fund may also invest up to 5% of its total assets in securities of
other investment companies (including those advised by PIMCO),
including closed-end funds, exchange-traded funds and other open-end
funds, that invest primarily in municipal bonds and other municipal
securities of the types in which the Fund may invest directly.
The Fund may, but is not required to, invest in derivative instruments,
such as options, futures and forward contracts or swap agreements. For
purposes of the Fund's 80% policy, the Fund values its derivative
instruments based on their market value. The Fund may, without
limitation, seek to obtain market exposure to the securities in which it
primarily invests by entering into a series of purchase and sale contracts
or by using other investment techniques (such as buy backs or dollar
rolls).
To the extent consistent with the applicable liquidity requirements for
interval funds under Rule 23c-3 of the Act, the Fund may invest without
limit in illiquid investments.
Temporary defensive investments.
The Fund may make short-term
investments when attempting to respond to adverse market, economic,
political, or other conditions, as determined by PIMCO. Upon PIMCO’s
recommendation, the Fund may, for temporary defensive purposes,
deviate from its investment strategy by investing some or all of its total
assets in investments such as high grade debt securities, including high
quality, short-term debt securities, and cash and cash equivalents. The
Fund may not achieve its investment objectives when it does so.
The following provides additional information regarding the types of
securities and other instruments in which the Fund will ordinarily invest.
A more detailed discussion of these and other instruments and
investment techniques that may be used by the Fund is provided under
“Investment Objectives and Policies” in the Statement of Additional
Information.
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, and may be either taxable
or tax-exempt instruments. The municipal bonds that the Fund may
purchase include without limit general obligation bonds and limited
obligation bonds (or revenue bonds), including industrial development
bonds issued pursuant to former federal tax law. General obligation
bonds are obligations involving the credit of an issuer possessing taxing
power and are payable from such issuer’s general revenues and not
from any particular source. Limited obligation bonds are payable only
from the revenues derived from a particular facility or class of facilities
or, in some cases, from the proceeds of a special excise or other specific
revenue source. Tax-exempt private activity bonds and industrial
development bonds generally are also limited obligation 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 may invest in Build America Bonds, which are tax credit bonds
created by the American Recovery and Reinvestment Act of 2009, which
authorized state and local governments to issue Build America Bonds as
taxable bonds in 2009 and 2010, without volume limitations, to finance
any capital expenditures for which such issuers could otherwise issue
traditional tax-exempt bonds. State and local governments may receive
a direct federal subsidy payment for a portion of their borrowing costs
on Build America Bonds equal to 35% of the total coupon interest paid
to investors. The state or local government issuer can elect to either take
the federal subsidy or pass the 35% tax credit along to bondholders. The
Fund’s investments in Build America Bonds will result in taxable income
and the Fund may elect to pass through to shareholders the
corresponding tax credits. The tax credits can generally be used to offset
federal income taxes and the alternative minimum tax, but such credits
are generally not refundable. Build America Bonds involve similar risks
as municipal bonds, including credit and market risk. They are intended
to assist state and local governments in financing capital projects at
lower borrowing costs and are likely to attract a broader group of
investors than tax-exempt municipal bonds. Although Build America
Bonds were only authorized for issuance during 2009 and 2010, the
program may have resulted in reduced issuance of tax-exempt
municipal bonds during the same period. The Build America Bond
program expired on December 31, 2010, at which point no further
issuance of new Build America Bonds was permitted. As of the date of
this prospectus, there is no indication that Congress will renew the
program to permit issuance of new Build America Bonds.
The Fund may invest in pre-refunded municipal bonds. Pre-refunded
municipal bonds are bonds that have been refunded to a call date prior
to the final maturity of principal, or, in the case of pre-refunded
municipal bonds commonly referred to as “escrowed-to-maturity
bonds,” to the final maturity of principal, and remain outstanding in the
municipal market. The payment of principal and interest of the
pre-refunded municipal bonds held by the Fund is funded from
securities in a designated escrow account that holds U.S. Treasury
securities or other obligations of the U.S. Government (including its
agencies and instrumentalities (“Agency Securities”)). Interest payments
on pre-refunded bonds issued on or prior to December 31, 2017 are
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exempt from federal income tax; pre-refunded bonds issued after
December 31, 2017 will not qualify for such tax-advantaged treatment.
Pre-refunded bonds usually will bear an AAA/Aaa rating (if a re-rating
has been requested and paid for) because they are backed by
U.S. Treasury securities or Agency Securities. Because the payment of
principal and interest is generated from securities held in an escrow
account established by the municipality and an independent escrow
agent, the pledge of the municipality has been fulfilled and the original
pledge of revenue by the municipality is no longer in place. The escrow
account securities pledged to pay the principal and interest of the
pre-refunded municipal bond do not guarantee the price movement of
the bond before maturity. Issuers of municipal bonds refund in advance
of maturity the outstanding higher cost debt and issue new, lower cost
debt, placing the proceeds of the lower cost issuance into an escrow
account to pre-refund the older, higher cost debt. Investment in
pre-refunded municipal bonds held by the Fund may subject the Fund to
interest rate risk and market risk. In addition, while a secondary market
exists for pre-refunded municipal bonds, if the Fund sells pre-refunded
municipal bonds prior to maturity, the price received may be more or
less than the original cost, depending on market conditions at the time
of sale.
The Fund may invest in municipal lease obligations. A lease is not a full
faith and credit obligation of the issuer and is usually backed only by the
borrowing government’s unsecured pledge to make annual
appropriations for lease payments. 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 lease obligation for
the Fund, PIMCO will assess the financial condition of the borrower or
obligor, the merits of the project, the level of public support, other credit
characteristics of the obligor, for the project and the legislative history of
lease financing in the state. These securities may be less readily
marketable than other municipal securities.
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 warrants, which are essentially call
options on municipal bonds. In exchange for a premium, municipal
warrants give the purchaser the right, but not the obligation, to
purchase a municipal bond in the future. The Fund may purchase a
warrant to lock in forward supply in an environment in which the
current issuance of bonds is sharply reduced. Like options, warrants may
expire worthless and may have reduced liquidity.
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 to 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, nongovernmental 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. 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 met their claims, there is no assurance that this will continue. A
higher-than expected default rate could strain the insurer’s loss reserves
and adversely affect its ability to pay claims to bondholders. Because a
significant portion of insured municipal bonds that have been issued
and are outstanding is insured by a small number of insurance
companies, not all of which have the highest credit rating, an event
involving one or more of these insurance companies, such as a credit
rating downgrade, could have a significant adverse effect on the value
of the municipal bonds insured by such insurance company or
companies and on the municipal bond markets as a whole. 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
re-marketed 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.
Tender Option Bonds.
The Fund may invest in trust certificates
issued in tender option bond programs. In a tender option bond
transaction (“TOB”), a tender option bond trust (“TOB Trust”) issues
floating rate certificates (“TOB Floater”) and residual interest
certificates (“TOB Residual”) and utilizes the proceeds of such issuance
to purchase a fixed-rate municipal bond (“Fixed Rate Bond”) that either
is owned or identified by the Fund. The TOB Floater is generally issued to
third party investors (typically a money market fund) and the TOB
Residual is generally issued to the Fund, which sold or identified the
Fixed Rate Bond. The TOB Trust divides the income stream provided by
the Fixed Rate Bond to create two securities, the TOB Floater, which is a
short-term security, and the TOB Residual, which is a longer-term
security. The interest rates payable on the TOB Residual issued to the
Fund bear an inverse relationship to the interest rate on the TOB Floater.
The interest rate on the TOB Floater is reset by a remarketing process
typically every 7 to 35 days. After income is paid on the TOB Floater at
current rates, the residual income from the Fixed Rate Bond goes to the
TOB Residual. Therefore, rising short-term rates result in lower income
for the TOB Residual, and vice versa. In the case of a TOB Trust that
utilizes the cash received (less transaction expenses) from the issuance
of the TOB Floater and TOB Residual to purchase the Fixed Rate Bond
from the Fund, the Fund may then invest the cash received in additional
securities, generating leverage for the Fund. Other PIMCO-managed
accounts may also contribute municipal bonds to a TOB Trust into which
the Fund has contributed Fixed Rate Bonds. If multiple PIMCO-managed
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PIMCO California Flexible Municipal Income Fund
accounts participate in the same TOB Trust, the economic rights and
obligations under the TOB Residual will be shared among the funds
ratably in proportion to their participation in the TOB Trust.
The TOB Residual may be more volatile and less liquid than other
municipal bonds of comparable maturity. In most circumstances the TOB
Residual holder bears substantially all of the underlying Fixed Rate
Bond’s downside investment risk and also benefits from any
appreciation in the value of the underlying Fixed Rate Bond.
Investments in a TOB Residual typically will involve greater risk than
investments in Fixed Rate Bonds.
A TOB Residual held by the Fund provides the Fund with the right to: (1)
cause the holders of the TOB Floater to tender their notes at par, and (2)
cause the sale of the Fixed Rate Bond held by the TOB Trust, thereby
collapsing the TOB Trust. TOB Trusts are generally supported by a
liquidity facility provided by a third party bank or other financial
institution (the “Liquidity Provider”) that provides for the purchase of
TOB Floaters that cannot be remarketed. The holders of the TOB Floaters
have the right to tender their certificates in exchange for payment of par
plus accrued interest on a periodic basis (typically weekly) or on the
occurrence of certain mandatory tender events. The tendered TOB
Floaters are remarketed by a remarketing agent, which is typically an
affiliated entity of the Liquidity Provider. If the TOB Floaters cannot be
remarketed, the TOB Floaters are purchased by the TOB Trust either from
the proceeds of a loan from the Liquidity Provider or from a liquidation
of the Fixed Rate Bond.
The TOB Trust may also be collapsed without the consent of the Fund, as
the TOB Residual holder, upon the occurrence of certain “tender option
termination events” (or “TOTEs”) as defined in the TOB Trust
agreements. Such termination events typically include the bankruptcy or
default of the municipal bond, a substantial downgrade in credit quality
of the municipal bond, or a judgment or ruling that interest on the Fixed
Rate Bond is subject to federal income taxation. Upon the occurrence of
a termination event, the TOB Trust would generally be liquidated in full
with the proceeds typically applied first to any accrued fees owed to the
trustee, remarketing agent and liquidity provider, and then to the
holders of the TOB Floater up to par plus accrued interest owed on the
TOB Floater and a portion of gain share, if any, with the balance paid
out to the TOB Residual holder. In the case of a mandatory termination
event (“MTE”), after the payment of fees, the TOB Floater holders would
be paid before the TOB Residual holders (i.e., the Fund). In contrast, in
the case of a TOTE, after payment of fees, the TOB Floater holders and
the TOB Residual holders would be paid pro rata in proportion to the
respective face values of their certificates.
If there are insufficient proceeds from the liquidation of the TOB Trust,
the party that would bear the losses would depend upon whether the
Fund holds a non-recourse TOBs Residual or a recourse TOBs Residual. If
the Fund holds a non-recourse TOBs Residual, the Liquidity Provider or
holders of the TOBs Floaters would bear the losses on those securities
and there would be no recourse to the Fund's assets. If the Fund holds a
recourse TOBs Residual, the Fund (and, indirectly, holders of the Fund's
Common Shares) would typically bear the losses. In particular, if the
Fund holds a recourse TOBs Residual, it will typically have entered into
an agreement pursuant to which the Fund would be required to pay to
the Liquidity Provider the difference between the purchase price of any
TOBs Floaters put to the Liquidity Provider by holders of the TOBs
Floaters and the proceeds realized from the remarketing of those TOBs
Floaters or the sale of the assets in the TOBs Issuer. The Fund may invest
in both non-recourse and recourse TOBs Residuals to leverage its
portfolio.
In December 2013, regulators finalized rules implementing Section 619
(the “Volcker Rule”) and Section 941 (the “Risk Retention Rules”) of
the Dodd-Frank Wall Street Reform and Consumer Protection Act (the
“Dodd-Frank Act”). Both the Volcker Rule and the Risk Retention Rules
apply to tender option bond programs. The Volcker Rule precludes
banking entities from (i) sponsoring or acquiring interests in the trusts
used to hold a municipal bond in the creation of TOB Trusts; and (ii)
continuing to service or maintain relationships with existing programs
involving TOB Trusts to the same extent and in the same capacity as
existing programs. The Risk Retention Rules may require the sponsor to
a TOB Trust (e.g., the Fund) to retain at least five percent of the credit
risk of the underlying assets supporting the TOB Trust’s municipal bonds.
The Risk Retention Rules adversely affect the Fund’s ability to engage in
tender option bond trust transactions or increase the costs of such
transactions in certain circumstances.
In response to these rules, industry participants explored various
structuring alternatives for TOB Trusts and agreed on a new tender
option bond structure in which the Fund hires service providers to assist
with establishing, structuring and sponsoring a TOB Trust. Service
providers to a TOB Trust, such as administrators, liquidity providers,
trustees and remarketing agents act at the direction of, and as agent of,
the Fund as the TOB residual holders.
Under the new TOB Trust structure, the Liquidity Provider or remarketing
agent will no longer purchase the tendered TOB Floaters, even in the
event of failed remarketing. This may increase the likelihood that a TOB
Trust will need to be collapsed and liquidated in order to purchase the
tendered TOB Floaters. The TOB Trust may draw upon a loan from the
Liquidity Provider to purchase the tendered TOB Floaters. Any loans
made by the Liquidity Provider will be secured by the purchased TOB
Floaters held by the TOB Trust and will be subject to an interest rate
agreed with the Liquidity Provider.
The use of TOBs typically will impact the Fund's duration and cause the
Fund to be subject to increased duration and interest rate risk.
Bonds
The Fund may invest in a wide variety of bonds of varying maturities
issued by non-U.S. (foreign) and U.S. corporations and other business
entities, governments and quasi-governmental entities and
municipalities and other issuers. Bonds may include, among other
things, fixed or variable/floating-rate debt obligations, including bills,
notes, debentures, money market instruments and similar instruments
and securities. Bonds generally are used by corporations as well as
governments and other issuers to borrow money from investors. The
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issuer pays the investor a fixed or variable rate of interest and normally
must repay the amount borrowed on or before maturity. Certain bonds
are “perpetual” in that they have no maturity date.
Reverse Repurchase Agreements and Dollar Rolls
/Buy Backs
As described under “Use of Leverage,” the Fund may use, among other
things, reverse repurchase agreements and/or dollar rolls/buy backs to
add leverage to its portfolio. Under a reverse repurchase agreement, the
Fund sells securities to a bank or broker dealer and agrees to repurchase
the securities at a mutually agreed future date and price. A dollar
roll/buy back is similar to a reverse repurchase agreement except that
the counterparty with which the Fund enters into a dollar roll/buy back
transaction is not obligated to return the same securities as those
originally sold by the Fund, but only securities that are “substantially
identical.” Generally, the effect of a reverse repurchase agreement or
dollar roll/buy back transaction is that the Fund can recover and reinvest
all or most of the cash invested in the portfolio securities involved
during the term of the agreement and still be entitled to the returns
associated with those portfolio securities, thereby resulting in a
transaction similar to a borrowing and giving rise to leverage for the
Fund. The Fund will incur interest expense as a cost of utilizing reverse
repurchase agreements and dollar rolls/buy backs. In the event the
buyer of securities under a reverse repurchase agreement or dollar
roll/buy back files for bankruptcy or becomes insolvent, the Fund’s use
of the proceeds of the agreement may be restricted pending a
determination by the other party, or its trustee or receiver, whether to
enforce the Fund’s obligation to repurchase the securities.
Loans and Other Indebtedness; Loan Participations and
Assignments
The Fund may purchase indebtedness and participations in loans, as
well as interests and/or servicing or similar rights in such loans. Such
instruments may be secured or unsecured and may be newly-originated
(and may be specifically designed for the Fund). Such investments are
different from traditional debt securities in that debt securities are part
of a large issue of securities to the public whereas indebtedness may
not be a security for purposes of the 1933 Act and may represent a
specific loan to a borrower. Loan participations typically represent direct
participation, together with other parties, in a loan to a borrower, and
generally are offered by banks or other financial institutions or lending
syndicates. The Fund may participate in such syndications, or can buy all
or part of a loan, becoming a lender. When purchasing indebtedness
and loan participations, the Fund assumes the credit risk associated
with the borrower and may assume the credit risk associated with an
interposed bank or other financial intermediary. The indebtedness and
loan participations that the Fund may acquire may not be rated by any
nationally recognized rating service.
A loan is often administered by an agent bank acting as agent for all
holders. The agent bank administers the terms of the loan, as specified
in the loan agreement. In addition, the agent bank is normally
responsible for the collection of principal and interest payments from
the borrower and the apportionment of these payments to the credit of
all institutions which are parties to the loan agreement. Unless, under
the terms of the loan or other indebtedness, the Fund has direct
recourse against the borrower, the Fund may have to rely on the agent
bank or other financial intermediary to apply appropriate credit
remedies against a borrower.
A financial institution’s employment as agent bank might be terminated
in the event that it fails to observe a requisite standard of care or
becomes insolvent. A successor agent bank would generally be
appointed to replace the terminated agent bank, and assets held by the
agent bank under the loan agreement should remain available to
holders of such indebtedness. However, if assets held by the agent bank
for the benefit of the Fund were determined to be subject to the claims
of the agent bank’s general creditors, the Fund might incur certain costs
and delays in realizing payment on a loan or loan participation and
could suffer a loss of up to its entire investment, including principal
and/or interest. In situations involving other interposed financial
institutions (e.g., an insurance company or governmental agency)
similar risks may arise.
Purchasers of loans and other forms of direct indebtedness depend
primarily upon the creditworthiness of the borrower for payment of
principal and interest. If the Fund does not receive scheduled interest or
principal payments on such indebtedness, the Fund’s share price and
yield could be adversely affected. Loans that are fully secured may offer
the Fund more protection than an unsecured loan in the event of
non-payment of scheduled interest or principal if the Fund is able to
access and monetize the collateral. However, the collateral underlying a
loan, if any, may be unavailable or insufficient to satisfy a borrower’s
obligation. In the event of the bankruptcy of a borrower, the Fund could
experience delays or limitations in its ability to realize the benefits of
any collateral securing a loan.
The Fund may acquire loan participations with credit quality comparable
to that of issuers of its securities investments. Indebtedness of
borrowers whose creditworthiness is poor involves substantially greater
risks, and may be highly speculative. Some borrowers may never pay off
their indebtedness, or may pay only a small fraction of the amount
owed. Consequently, when acquiring indebtedness of borrowers with
poor credit, the Fund bears a substantial risk of losing the entire amount
of the instrument acquired. The Fund may make purchases of
indebtedness and loan participations to achieve income and/or capital
appreciation.
Loans and other types of direct indebtedness (which the Fund acquires
or otherwise gains exposure to) may not be readily marketable and may
be subject to restrictions on resale. In some cases, negotiations involved
in disposing of indebtedness may require weeks to complete.
Consequently, some indebtedness may be difficult or impossible to
dispose of readily at what the Investment Manager believes to be a fair
price. In addition, valuation of illiquid indebtedness involves a greater
degree of judgment in determining the Fund’s net asset value than if
that value were based on available market quotations, and could result
in significant variations in the Fund’s daily share price. At the same time,
some loan interests are traded among certain financial institutions and
accordingly may be deemed liquid. Please refer to “Illiquid Investments”
for further discussion of regulatory considerations and constraints
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PIMCO California Flexible Municipal Income Fund
relating to investment liquidity. Investments in loan participations are
considered to be debt obligations for purposes of the Fund’s investment
restriction relating to the lending of funds or assets.
In purchasing loans, the Fund will compete with a broad spectrum of
lenders. Increased competition for, or a diminishment in the available
supply of, qualifying loans could result in lower yields on such loans,
which could reduce Fund performance.
Investments in loans through a purchase of a loan or a direct
assignment of a financial institution’s interests with respect to the loan
may involve additional risks to the Fund. The purchaser of an
assignment typically succeeds to all the rights and obligations under the
loan agreement with the same rights and obligations as the assigning
lender. Assignments may, however, be arranged through private
negotiations between potential assignees and potential assignors, and
the rights and obligations acquired by the purchaser of an assignment
may differ from, and be more limited than, those held by the assigning
lender. For example, if a loan is foreclosed, the Fund could become
owner, in whole or in part, of any collateral and would bear the costs
and liabilities associated with owning and holding or disposing of the
collateral. In addition, it is conceivable that under emerging legal
theories of lender liability, the Fund could be held liable. It is unclear
whether loans and other forms of direct indebtedness offer securities
law protections against fraud and misrepresentation. In the absence of
definitive regulatory guidance, the Fund relies on the Investment
Manager’s research in an attempt to avoid situations where fraud or
misrepresentation could adversely affect the Fund.
The Fund may invest in debtor-in-possession financings (commonly
known as “DIP financings”). DIP financings are arranged when an entity
seeks the protections of the bankruptcy court under Chapter 11 of the
U.S. Bankruptcy Code. These financings allow the entity to continue its
business operations while reorganizing under Chapter 11. Such
financings constitute senior liens on unencumbered security (i.e.,
security not subject to other creditors’ claims). There is a risk that the
entity will not emerge from Chapter 11 and be forced to liquidate its
assets under Chapter 7 of the U.S. Bankruptcy Code. In the event of
liquidation, the Fund’s only recourse will be against the property
securing the DIP financing.
In making a direct loan, the Fund is exposed to the risk that the
borrower may default or become insolvent and, consequently, that the
Fund will lose money on the loan. Furthermore, direct loans may subject
the Fund to liquidity and interest rate risk and certain direct loans may
be deemed illiquid. Direct loans are not publicly traded and may not
have a secondary market. The lack of a secondary market for direct loans
may have an adverse impact on the ability of the Fund to dispose of a
direct loan and/or to value the direct loan.
Various state licensing requirements could apply to the Fund with
respect to investments in loans and similar assets. The licensing
requirements could apply depending on the location of the borrower,
the location of the collateral securing the loan, or the location where the
Fund or PIMCO operates or has offices. In states in which it is licensed,
the Fund or PIMCO will be required to comply with applicable laws and
regulations, including consumer protection and anti-fraud laws, which
could impose restrictions on the Fund’s or PIMCO’s ability to take
certain actions to protect the value of its investments in such assets and
impose compliance costs. Failure to comply with such laws and
regulations could lead to, among other penalties, a loss of the Fund’s or
PIMCO’s license, which in turn could require the Fund to divest assets
located in or secured by real property located in that state. These risks
will also apply to issuers and entities in which the Fund invests that hold
similar assets, as well as any origination company or servicer in which
the Fund owns an interest.
Loan origination and servicing companies are routinely involved in legal
proceedings concerning matters that arise in the ordinary course of their
business. These legal proceedings range from actions involving a single
plaintiff to class action lawsuits with potentially tens of thousands of
class members. In addition, a number of participants in the loan
origination and servicing industry (including control persons of industry
participants) have been the subject of regulatory actions by state
regulators, including state attorneys general, and by the federal
government. Governmental investigations, examinations or regulatory
actions, or private lawsuits, including purported class action lawsuits,
may adversely affect such companies’ financial results. To the extent the
Fund seeks to engage in origination and/or servicing directly, or has a
financial interest in, or is otherwise affiliated with, an origination or
servicing company, the Fund will be subject to enhanced risks of
litigation, regulatory actions and other proceedings. As a result, the
Fund may be required to pay legal fees, settlement costs, damages,
penalties or other charges, any or all of which could materially adversely
affect the Fund and its holdings.
Loan Origination
The Fund may invest in and/or originate loans, including, without
limitation, to, on behalf of, authorized by, sponsored by, and/or in
connection with a project for which authority and responsibility lies with
one or more U.S. states or territories, cities in a U.S. state or territory, or
political subdivisions, agencies, authorities or instrumentalities of such
states, territories or cities, which may be in the form of whole loans,
assignments, participations, secured and unsecured notes, senior and
second lien loans, mezzanine loans, bridge loans or similar investments,
including to borrowers that are unrated or have credit ratings that are
determined by one or more NRSROs and/or PIMCO to be below
investment grade. This may include loans to public or private firms or
individuals, such as in connection with housing development projects.
The loans the Fund invests in or originates may vary in maturity and/or
duration. The Fund is not limited in the amount, size or type of loans it
may invest in and/or originate, including with respect to a single
borrower or with respect to borrowers that are determined to be below
investment grade, other than pursuant to any applicable law. The Fund's
investment in or origination of loans may also be limited by the
requirements the Fund intends to observe under Subchapter M of the
Code in order to qualify as a RIC. The loans acquired by the Fund may be
of the type that count towards the Fund's 80% policy or they may be
loans that produce income that is subject to regular federal income tax
or California income tax.
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In making a direct loan, the Fund is exposed to the risk that the
borrower may default or become insolvent and, consequently, that the
Fund will lose money on the loan. Furthermore, direct loans may subject
the Fund to liquidity and interest rate risk and certain direct loans may
be deemed illiquid. Direct loans are not publicly traded and may not
have a secondary market. The lack of a secondary market for direct loans
may have an adverse impact on the ability of the Fund to dispose of a
direct loan and/or to value the direct loan.
When engaging in direct lending, the Fund’s performance may depend,
in part, on the ability of the Fund to originate loans on advantageous
terms. In originating and purchasing loans, the Fund will often compete
with a broad spectrum of lenders. Increased competition for, or a
diminishment in the available supply of, qualifying loans could result in
lower yields on and/or less advantageous terms of such loans, which
could reduce Fund performance.
As part of its lending activities, the Fund may originate loans (including
subprime loans) to borrowers that are experiencing significant financial
or business difficulties, including borrowers involved in bankruptcy or
other reorganization and liquidation proceedings or that are rated
“below investment grade” by a NRSRO or unrated. Although the terms
of such financing may result in significant financial returns to the Fund,
they involve a substantial degree of risk. The level of analytical
sophistication, both financial and legal, necessary for successful
financing to borrowers experiencing significant business and financial
difficulties is unusually high. Different types of assets may be used as
collateral for the Fund’s loans and, accordingly, the valuation of and
risks associated with such collateral will vary by loan. There is no
assurance that the Fund will correctly evaluate the value of the assets
collateralizing the Fund’s loans or the prospects for a successful
reorganization or similar action. In any reorganization or liquidation
proceeding relating to a borrower that the Fund funds, the Fund may
lose all or part of the amounts advanced to the borrower or may be
required to accept collateral with a value less than the amount of the
loan advanced by the Fund or its affiliates to the borrower. Furthermore,
in the event of a default by a borrower, the Fund may have difficulty
disposing of the assets used as collateral for a loan.
Bridge loans are short-term loan arrangements (e.g., 12 to 18 months)
typically made by a borrower in anticipation of intermediate-term or
long-term permanent financing. Most bridge loans are structured as
floating-rate debt with step-up provisions under which the interest rate
on the bridge loan rises over time. Thus, the longer the loan remains
outstanding, the more the interest rate increases. In addition, bridge
loans commonly contain a conversion feature that allows the bridge
loan investor to convert its loan interest into senior exchange notes if
the loan has not been prepaid in full on or prior to its maturity date.
Bridge loans may be subordinate to other debt and may be secured or
unsecured. Like any loan, bridge loans involve credit risk. Bridge loans
are generally made with the expectation that the borrower will be able
to obtain permanent financing in the near future. Any delay in obtaining
permanent financing subjects the bridge loan investor to increased risk.
A borrower’s use of bridge loans also involves the risk that the borrower
may be unable to locate permanent financing to replace the bridge
loan, which may impair the borrower’s perceived creditworthiness.
Various state licensing requirements could apply to the Fund with
respect to the origination, acquisition, holding, servicing, foreclosure
and/or disposition of loans and similar assets. The licensing
requirements could apply depending on the location of the borrower,
the location of the collateral securing the loan, or the location where the
Fund or PIMCO operates or has offices. In states in which it is licensed,
the Fund or PIMCO will be required to comply with applicable laws and
regulations, including consumer protection and anti-fraud laws, which
could impose restrictions on the Fund’s or PIMCO’s ability to take
certain actions to protect the value of its holdings in such assets and
impose compliance costs. Failure to comply with such laws and
regulations could lead to, among other penalties, a loss of the Fund’s or
PIMCO’s license, which in turn could require the Fund to divest assets
located in or secured by real property located in that state. These risks
will also apply to issuers and entities in which the Fund invests that hold
similar assets, as well as any origination company or servicer in which
the Fund owns an interest. Loan origination and servicing companies
are routinely involved in legal proceedings concerning matters that arise
in the ordinary course of their business. These legal proceedings range
from actions involving a single plaintiff to class action lawsuits with
potentially tens of thousands of class members. In addition, a number of
participants in the loan origination and servicing industry (including
control persons of industry participants) have been the subject of
regulatory actions by state regulators, including state attorneys general,
and by the federal government. Governmental investigations,
examinations or regulatory actions, or private lawsuits, including
purported class action lawsuits, may adversely affect such companies’
financial results. To the extent the Fund seeks to engage in origination
and/or servicing directly, or has a financial interest in, or is otherwise
affiliated with, an origination or servicing company, the Fund will be
subject to enhanced risks of litigation, regulatory actions and other
proceedings. As a result, the Fund may be required to pay legal fees,
settlement costs, damages, penalties or other charges, any or all of
which could materially adversely affect the Fund and its holdings.
Commercial Paper
Commercial paper represents short-term unsecured promissory notes
issued in bearer form by corporations such as banks or bank holding
companies and finance companies. The rate of return on commercial
paper may be linked or indexed to the level of exchange rates between
the U.S. dollar and a foreign currency or currencies.
U.S. Government Securities
U.S. government securities are obligations of and, in certain cases,
guaranteed by, the U.S. government, its agencies or instrumentalities.
The U.S. government does not guarantee the NAV of the Fund’s
Common Shares. Some U.S. government securities, such as Treasury bills,
notes and bonds, and securities guaranteed by GNMA, are supported by
the full faith and credit of the United States; others, such as those of the
FHLBs, are supported by the right of the issuer to borrow from the
April 30, 2023
(as supplemented January
12, 2024)
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34
PIMCO California Flexible Municipal Income Fund
U.S. Department of the Treasury (the “U.S. Treasury”); others, such as
those of FNMA, are supported by the discretionary authority of the
U.S. government to purchase the agency’s obligations; and still others
are supported only by the credit of the instrumentality. U.S. government
securities may include zero coupon securities, which do not distribute
interest on a current basis and tend to be subject to greater risk than
interest-paying securities of similar maturities.
Preferred Securities
Preferred securities represent an equity interest in a company that
generally entitles the holder to receive, in preference to the holders of
other stocks such as common stocks, dividends and a fixed share of the
proceeds resulting from liquidation of the company. Unlike common
stocks, preferred securities usually do not have voting rights. Preferred
securities in some instances are convertible into common stock. Some
preferred securities also entitle their holders to receive additional
liquidation proceeds on the same basis as holders of a company’s
common stock, and thus also represent an ownership interest in the
company. Some preferred securities offer a fixed rate of return with no
maturity date. Because they never mature, these preferred securities
may act like long-term bonds, can be more volatile than other types of
preferred securities and may have heightened sensitivity to changes in
interest rates. Other preferred securities have a variable dividend,
generally determined on a quarterly or other periodic basis, either
according to a formula based upon a specified premium or discount to
the yield on particular U.S. Treasury securities or based on an auction
process, involving bids submitted by holders and prospective purchasers
of such securities. Although they are equity securities, preferred
securities have certain characteristics of both debt securities and
common stock. They are like debt securities in that their stated income is
generally contractually fixed. They are like common stocks in that they
do not have rights to precipitate bankruptcy proceedings or collection
activities in the event of missed payments. Furthermore, preferred
securities have many of the key characteristics of equity due to their
subordinated position in an issuer’s capital structure and because their
quality and value are heavily dependent on the profitability of the issuer
rather than on any legal claims to specific assets or cash flows. Because
preferred securities represent an equity ownership interest in a
company, their value usually will react more strongly than bonds and
other debt instruments to actual or perceived changes in a company’s
financial condition or prospects, or to fluctuations in the equity markets.
In order to be payable, dividends on preferred securities must be
declared by the issuer’s board of directors. In addition, distributions on
preferred securities may be subject to deferral and thus may not be
automatically payable. Income payments on some preferred securities
are cumulative, causing dividends and distributions to accrue even if
they are not declared by the board of directors of the issuer or otherwise
made payable. Other preferred securities are non-cumulative, meaning
that skipped dividends and distributions do not continue to accrue.
There is no assurance that dividends on preferred securities in which the
Fund invests will be declared or otherwise made payable.
Preferred securities have a liquidation value that generally equals their
original purchase price at the date of issuance. The market values of
preferred securities may be affected by favorable and unfavorable
changes affecting the issuers’ industries or sectors. They also may be
affected by actual and anticipated changes or ambiguities in the tax
status of the security and by actual and anticipated changes or
ambiguities in tax laws, such as changes in corporate and individual
income tax rates or the characterization of dividends as tax-advantaged.
The dividends paid on the preferred securities in which the Fund may
invest might not be eligible for tax-advantaged “qualified dividend”
treatment. See “Tax Matters.” Because the claim on an issuer’s earnings
represented by preferred securities may become disproportionately large
when interest rates fall below the rate payable on the securities or for
other reasons, the issuer may redeem preferred securities, generally after
an initial period of call protection in which the security is not
redeemable. Thus, in declining interest rate environments in particular,
the Fund’s holdings of higher dividend-paying preferred securities may
be reduced and the Fund may be unable to acquire securities paying
comparable rates with the redemption proceeds.
Bank Capital Securities and Bank Obligations
The Fund may invest in bank capital securities of both non-U.S. (foreign)
and U.S. issuers. Bank capital securities are issued by banks to help fulfill
their regulatory capital requirements. There are three common types of
bank capital: Lower Tier II, Upper Tier II and Tier I. Upper Tier II securities
are commonly thought of as hybrids of debt and preferred securities.
Upper Tier II securities are often perpetual (with no maturity date),
callable and have a cumulative interest deferral feature. This means that
under certain conditions, the issuer bank can withhold payment of
interest until a later date. However, such deferred interest payments
generally earn interest. Tier I securities often take the form of trust
preferred securities.
The Fund may also invest in other bank obligations including, without
limitation,
CoCos
, certificates of deposit, bankers’ acceptances and fixed
time deposits. CoCos have no stated maturity, have fully discretionary
coupons and are typically issued in the form of subordinated debt
instruments. CoCos generally either convert into equity or have their
principal written down (including potentially to zero) upon the
occurrence of certain triggering events (“triggers”) linked to regulatory
capital thresholds or regulatory actions relating to the issuer’s continued
viability. Certificates of deposit are negotiable certificates that are
issued against funds deposited in a commercial bank for a definite
period of time and that earn a specified return. Bankers’ acceptances
are negotiable drafts or bills of exchange, normally drawn by an
importer or exporter to pay for specific merchandise, which are
“accepted” by a bank, meaning, in effect, that the bank unconditionally
agrees to pay the face value of the instrument on maturity. Fixed time
deposits are bank obligations payable at a stated maturity date and
bearing interest at a fixed rate. Fixed time deposits may be withdrawn
on demand by the investor, but may be subject to early withdrawal
penalties which vary depending upon market conditions and the
remaining maturity of the obligation. There are generally no contractual
restrictions on the right to transfer a beneficial interest in a fixed time
35 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
deposit to a third party, although there is generally no market for such
deposits. The Fund may also hold funds on deposit with its custodian
bank in an interest-bearing account for temporary purposes.
High Yield Securities
The Fund may invest without limit in debt instruments that are, at the
time of purchase, rated below “investment grade” by at least one of
Moody’s, S&P Global Ratings or Fitch, or unrated but determined by
PIMCO to be of comparable quality. “Investment grade” means a
rating, in the case of Moody’s, of Baa3 or higher, in the case of S&P and
Fitch, of BBB-or higher. The Fund may invest in securities of stressed or
distressed issuers, which include securities at risk of being in default as
to the repayment of principal and/or interest at the time of acquisition
by the Fund or that are rated in the lower rating categories by one or
more NRSROs (for example, Ca or lower by Moody’s or CC or lower by
S&P or Fitch) or, if unrated, are determined by PIMCO to be of
comparable quality. The Fund may invest in defaulted securities and
debtor-in-possession financings. Below investment grade securities are
commonly referred to as “high yield” securities or “junk bonds.” High
yield securities involve a greater degree of risk (in particular, a greater
risk of default) than, and special risks in addition to, the risks associated
with investment grade debt obligations. While offering a greater
potential opportunity for capital appreciation and higher yields, high
yield securities typically entail greater potential price volatility and may
be less liquid than higher-rated securities. High yield securities may be
regarded as predominantly speculative with respect to the issuer’s
continuing ability to make timely principal and interest payments. They
also may be more susceptible to real or perceived adverse economic and
competitive industry conditions than higher-rated securities. Debt
securities in the lowest investment grade category also may be
considered to possess some speculative characteristics by certain ratings
agencies.
The market values of high yield securities tend to reflect individual
developments of the issuer to a greater extent than do higher-quality
securities, which tend to react mainly to fluctuations in the general level
of interest rates. In addition, lower-quality debt securities tend to be
more sensitive to general economic conditions. Certain emerging market
governments that issue high yield securities in which the Fund may
invest are among the largest debtors to commercial banks, foreign
governments and supranational organizations, such as the World Bank,
and may not be able or willing to make principal and/or interest
payments as they come due.
Credit ratings and unrated securities
Rating agencies are private services that provide ratings of the credit
quality of debt obligations. Appendix A to this prospectus describes the
various ratings assigned to debt obligations by Moody’s, S&P and Fitch.
As noted in Appendix A, Moody’s, S&P and Fitch may modify their
ratings of securities to show relative standing within a rating category,
with the addition of numerical modifiers (1, 2 or 3) in the case of
Moody’s, and with the addition of a plus (+) or minus (-) sign in the case
of S&P and Fitch. Ratings assigned by a rating agency are not absolute
standards of credit quality and do not evaluate market risks. Rating
agencies may fail to make timely changes in credit ratings, and an
issuer’s current financial condition may be better or worse than a rating
indicates. The Fund will not necessarily sell a security when its rating is
reduced below its rating at the time of purchase. PIMCO does not rely
solely on credit ratings, and develops its own analysis of issuer credit
quality. The ratings of a debt security may change over time. Moody’s,
S&P and Fitch monitor and evaluate the ratings assigned to securities
on an ongoing basis. As a result, debt instruments held by the Fund
could receive a higher rating (which would tend to increase their value)
or a lower rating (which would tend to decrease their value) during the
period in which they are held by the Fund.
The Fund may purchase unrated securities (which are not rated by a
rating agency) if PIMCO determines, in its sole discretion, that the
security is of comparable quality to a rated security that the Fund may
purchase. In making determinations, PIMCO may take into account
different factors than those taken into account by rating agencies, and
PIMCO’s rating of a security may differ from the rating that a rating
agency may have given the same securities. Unrated securities may be
less liquid than comparable rated securities and involve the risk that a
portfolio manager may not accurately evaluate the security’s
comparative credit rating. Analysis of the creditworthiness of issuers of
high yield securities may be more complex than for issuers of
higher-quality fixed income securities. The Fund’s success in achieving its
investment objectives may depend more heavily on the portfolio
manager’s creditworthiness analysis than if the Fund invested
exclusively in higher-quality and higher-rated securities.
Zero-Coupon Bonds, Step-Ups and Payment-In-Kind Securities
Zero-coupon bonds pay interest only at maturity rather than at intervals
during the life of the security. Like zero-coupon bonds, “step up” bonds
pay no interest initially but eventually begin to pay a coupon rate prior
to maturity, which rate may increase at stated intervals during the life of
the security. PIKs are debt obligations that pay “interest” in the form of
other debt obligations, instead of in cash. Each of these instruments is
normally issued and traded at a deep discount from face value.
Zero-coupon bonds, step-ups and PIKs allow an issuer to avoid or delay
the need to generate cash to meet current interest payments and, as a
result, may involve greater credit risk than bonds that pay interest
currently or in cash. The Fund would be required to distribute the
income on these instruments as it accrues, even though the Fund will
not receive the income on a current basis or in cash. Thus, the Fund may
have to sell investments, including when it may not be advisable to do
so, to make income distributions to its shareholders.
Inflation-Indexed Bonds
Inflation-indexed bonds (other than municipal inflation-indexed bonds
and certain corporate inflation-indexed bonds) are fixed income
securities the principal value of which is periodically adjusted according
to the rate of inflation. If the index measuring inflation falls, the
principal value of inflation-indexed bonds (other than municipal
inflation-indexed bonds and certain corporate inflation-indexed bonds)
will be adjusted downward, and consequently the interest payable on
these securities (calculated with respect to a smaller principal amount)
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
36
PIMCO California Flexible Municipal Income Fund
will be reduced. Repayment of the original bond principal upon maturity
(as adjusted for inflation) is guaranteed in the case of Treasury Inflation
Protected Securities (“TIPS”). For bonds that do not provide a similar
guarantee, the adjusted principal value of the bond repaid at maturity
may be less than the original principal. TIPS may also be divided into
individual zero-coupon instruments for each coupon or principal
payment (known as “iSTRIPS”). An iSTRIP of the principal component of
a TIPS issue will retain the embedded deflation floor that will allow the
holder of the security to receive the greater of the original principal or
inflation-adjusted principal value at maturity. iSTRIPS may be less liquid
than conventional TIPS because they are a small component of the TIPS
market. Municipal inflation-indexed securities are municipal bonds that
pay coupons based on a fixed rate plus CPI. With regard to municipal
inflation-indexed bonds and certain corporate inflation-indexed bonds,
the inflation adjustment is typically reflected in the semi-annual coupon
payment. As a result, the principal value of municipal inflation-indexed
bonds and such corporate inflation-indexed bonds does not adjust
according to the rate of inflation. At the same time, the value of
municipal inflation-indexed securities and such corporate
inflation-indexed securities generally will not increase if the rate of
inflation decreases. Because municipal inflation-indexed securities and
corporate inflation-indexed securities are a small component of the
municipal bond and corporate bond markets, respectively, they may be
less liquid than conventional municipal and corporate bonds.
The value of inflation-indexed bonds is expected to change in response
to changes in real interest rates. Real interest rates are tied to the
relationship between nominal interest rates and the rate of inflation. If
nominal interest rates increase at a faster rate than inflation, real
interest rates may rise, leading to a decrease in value of
inflation-indexed bonds. Any increase in the principal amount of an
inflation-indexed bond will be considered taxable ordinary income, even
though investors do not receive their principal until maturity. See “Tax
Matters” in this prospectus and “Taxation” in the Statement of
Additional Information.
Variable- and Floating-Rate Securities
Variable- and floating-rate instruments are instruments that pay interest
at rates that adjust whenever a specified interest rate changes and/or
that reset on predetermined dates (such as the last day of a month or
calendar quarter). In addition to senior loans, variable- and floating-rate
instruments may include, without limitation, instruments such as
catastrophe and other event-linked bonds, bank capital securities,
unsecured
and/or secured loans (including, but not limited to,
bank
and/
or other syndicated loans and non-syndicated (private direct)
loans)
, corporate bonds, money market instruments and certain types of
mortgage-related and other asset-backed securities. Due to their
variable- or floating-rate features, these instruments will generally pay
higher levels of income in a rising interest rate environment and lower
levels of income as interest rates decline. For the same reason, the
market value of a variable- or floating-rate instrument is generally
expected to have less sensitivity to fluctuations in market interest rates
than a fixed-rate instrument, although the value of a variable- or
floating-rate instrument may nonetheless decline as interest rates rise
and due to other factors, such as changes in credit quality.
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 which is tied to another interest rate, such as a money-market index
or U.S.
Treasury bill rate. The interest rate on a floater resets periodically,
typically every six
months. Due to the interest rate reset feature, floaters
provide the Fund with a certain degree of protection against rises in
interest rates, although 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, in which the value of the investment position is
determined by changes in the difference between the prices or interest
rates, as the case may be, of the respective securities.
Inverse Floaters
An inverse floater is a type of debt instrument that bears a floating or
variable interest rate that moves in the opposite direction to interest
rates generally or the interest rate on another security or index. Changes
in interest rates generally, or the interest rate of the other security or
index, inversely affect the interest rate paid on the inverse floater, with
the result that the inverse floater’s price will be considerably more
volatile than that of a fixed-rate bond. The Fund may invest without
limitation in inverse floaters, which brokers typically create by depositing
an income-producing instrument, which may be a mortgage-related
asset, in a trust. The trust in turn issues a variable rate security and
inverse floaters. The interest rate for the variable rate security is typically
determined by an index or an auction process, while the inverse floater
holder receives the balance of the income from the underlying
income-producing instrument less an auction fee. The market prices of
inverse floaters may be highly sensitive to changes in interest rates and
prepayment rates on the underlying securities, and may decrease
significantly when interest rates increase or prepayment rates change. In
a transaction in which the Fund purchases an inverse floater from a
trust, and the underlying bond was held by the Fund prior to being
deposited into the trust, the Fund typically treats the transaction as a
secured borrowing for financial reporting purposes. As a result, for
financial reporting purposes, the Fund will generally incur a non-cash
interest expense with respect to interest paid by the trust on the
variable rate securities, and will recognize additional interest income in
an amount directly corresponding to the non-cash interest expense.
Therefore, the Fund’s NAV per Common Share and performance are not
affected by the non-cash interest expense. This accounting treatment
does not apply to inverse floaters acquired by the Fund when the Fund
did not previously own the underlying bond.
Derivatives
The Fund may, but is not required to, utilize various derivative strategies
(both long and short positions) for investment purposes, leveraging
purposes, or in an attempt to hedge against market, credit, interest rate,
currency and other risks in the portfolio. See “Use of Leverage.”
Generally, derivatives are financial contracts whose value depends
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| PIMCO California Flexible Municipal Income Fund
Prospectus
upon, or is derived from, the value of an underlying asset, reference rate
or index, and may relate to, among others, individual debt instruments,
interest rates, currencies or currency exchange rates, commodities and
related indexes. Examples of derivative instruments that the Fund may
use include, without limitation, futures and forward contracts (including
foreign currency exchange contracts), call and put options (including
options on futures contracts), credit default swaps, total return swaps,
basis swaps and other swap agreements. The Fund’s use of derivative
instruments involves risks different from, or possibly greater than, the
risks associated with investment directly in securities and other more
traditional investments. See “Principal Risks of the Fund—Derivatives
Risk.” Certain types of derivative instruments that the Fund may utilize
are described elsewhere in this section, including those described under
“Municipal Bonds—Tender Option Bonds,” “—Certain Interest Rate
Transactions,” and “—Credit Default Swaps” Please see “Investment
Objectives and Policies—Derivative Instruments” in the Statement of
Additional Information for additional information about these and other
derivative instruments that the Fund may use and the risks associated
with such instruments. There is no assurance that these derivative
strategies will be available at any time or that PIMCO will determine to
use them for the Fund or, if used, that the strategies will be successful. In
addition, the Fund may be subject to certain restrictions on its use of
derivative strategies imposed by guidelines of one or more rating
agencies that may issue ratings for any Preferred Shares issued by the
Fund.
Rule 144A Securities
The Fund may invest in securities that have not been registered for
public sale, but that are eligible for purchase and sale pursuant to
Rule 144A under the 1933 Act. Rule 144A permits certain qualified
institutional buyers, such as the Fund, to trade in privately placed
securities that have not been registered for sale under the 1933 Act.
Illiquid Investments
To the extent consistent with the applicable liquidity requirements for
interval funds under Rule 23c-3 of the Act, the Fund may invest without
limit in illiquid investments. PIMCO may be subject to significant delays
in disposing of illiquid investments, and other transaction costs that are
higher than those for transactions in liquid investments may entail
registration expenses and other transaction costs that are higher than
those for transactions in liquid investments. The term “illiquid
investments” for this purpose means any investment that the Fund
reasonably expects cannot be sold or disposed of in current market
conditions in seven calendar days or less without the sale or disposition
significantly changing the market value of the investment. Restricted
investments, i.e., investments subject to legal or contractual restrictions
on resale, may be illiquid. However, some restricted investments (such as
investments issued pursuant to Rule 144A under the 1933 Act, and
certain commercial paper) may be treated as liquid, although they may
be relatively less liquid than registered investments traded on
established secondary markets.
Other Investment Companies
The Fund may invest up to 5% of its total assets in securities of other
investment companies (including those advised by PIMCO), including
closed-end funds, exchange-traded funds and other open-end funds,
that invest primarily in municipal bonds and other municipal securities
of the types in which the Fund may invest directly. The Fund may invest
in certain money market funds and/or short-term bond funds (“Central
Funds”), to the extent permitted by the Act, the rules thereunder or
exemptive relief therefrom. The Central Funds are registered investment
companies created for use by certain registered investment companies
advised by PIMCO in connection with their cash management activities.
When investing in another investment company, the Fund generally will
consider such investment company's 80% policy for purposes of
determining whether to treat an investment therein towards the
Fund's 80% policy or, if the investment company does not have an 80%
policy, the Fund may consider the underlying investment company's
portfolio holdings and related information.
In general, under the Act, an investment company such as the Fund may
not (i) own more than 3% of the outstanding voting securities of any
one registered investment company, (ii) invest more than 5% of its total
assets in the securities of any single registered investment company or
(iii) invest more than 10% of its total assets in securities of other
registered investment companies.
The Fund may invest in other investment companies to gain broad
market or sector exposure or for cash management purposes, including
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 when PIMCO believes share prices of other
investment companies offer attractive values.
As a shareholder 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. In addition, the securities of
other investment companies may also be leveraged and will therefore
be subject to the same leverage risks described in this prospectus.
Regulatory changes adopted by the SEC concerning investments by
registered investment companies in the securities of other registered
investment companies may, among other things, limit investment
flexibility. This could adversely impact the Fund's investment strategies
and operations. The “Investment Objectives and Policies - Regulatory
Risk” section in the Statement of Additional Information discusses these
changes in further detail.
Foreign (Non-U.S.) Investments
The Fund may invest in instruments of corporate and other foreign
(non-U.S.) issuers, and in instruments traded principally outside of the
United States. The Fund may invest in sovereign and other debt
securities issued by foreign governments and their respective
sub-divisions, agencies or instrumentalities, government sponsored
enterprises and supranational government entities. Supranational
April 30, 2023
(as supplemented January
12, 2024)
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38
PIMCO California Flexible Municipal Income Fund
entities include international organizations that are organized or
supported by one or more government entities to promote economic
reconstruction or development and by international banking institutions
and related governmental agencies. As a holder of such debt securities,
the Fund may be requested to participate in the rescheduling of such
debt and to extend further loans to governmental entities. In addition,
there are generally no bankruptcy proceedings similar to those in the
United States by which defaulted foreign debt securities may be
collected. Investing in foreign securities involves special risks and
considerations not typically associated with investing in U.S. securities.
PIMCO generally considers an instrument to be economically tied to a
non-U.S. country if the issuer is a foreign (non-U.S.) government (or any
political subdivision, agency, authority or instrumentality of such
government), or if the issuer is organized under the laws of a
non-U.S. country. In the case of money market instruments, other than
commercial paper and certificates of deposits, such instruments will be
considered economically tied to a non-U.S. country if the issuer of such
money market instrument is organized under the laws of a
non-U.S. country. In the case of commercial paper and certificates of
deposit, such instruments will be considered economically tied to a
non-U.S. country if the “country of exposure” of such instrument is a
non-U.S. country, as determined by the criteria set forth below. With
respect to derivative instruments, PIMCO generally considers such
instruments to be economically tied to non-U.S. countries if the
underlying assets are foreign currencies (or baskets or indexes of such
currencies), or instruments or securities that are issued by foreign
governments or issuers organized under the laws of a non-U.S. country
(or if the underlying assets are money market instruments, other than
commercial paper and certificates of deposit, the issuer of such money
market instrument is organized under the laws of a non-U.S. country) or,
in the case of underlying assets that are commercial paper or certificates
of deposit, if the “country of exposure” of such money market
instrument is a non-U.S. country). A security’s “country of exposure” is
determined by PIMCO using certain factors provided by a third-party
analytical service provider. The factors are applied in order such that the
first factor to result in the assignment of a country determines the
“country of exposure.” Both the factors and the order in which they are
applied may change in the discretion of PIMCO. The current factors,
listed in the order in which they are applied, are: (i) if an asset-backed or
other collateralized security, the country in which the collateral backing
the security is located; (ii) the “country of risk” of the issuer; (iii) if the
security is guaranteed by the government of a country (or any political
subdivision, agency, authority or instrumentality of such government),
the country of the government or instrumentality providing the
guarantee; (iv) the “country of risk” of the issuer’s ultimate parent; or (v)
the country where the issuer is organized or incorporated under the
laws thereof. “Country of risk” is a separate four-part test determined
by the following factors, listed in order of importance: (i) management
location; (ii) country of primary listing; (iii) sales or revenue attributable
to the country; and (iv) reporting currency of the issuer. Further, where a
derivative instrument is exposed to an index, PIMCO generally considers
the derivative to be economically tied to each country represented by
the components of the underlying index pursuant to the criteria set forth
in the preceding sentence.
The Fund may invest in Brady Bonds, which are securities created
through the exchange of existing commercial bank loans to sovereign
entities for new obligations in connection with a debt restructuring.
Investments in Brady Bonds may be viewed as speculative. Brady Bonds
acquired by the Fund may be subject to restructuring arrangements or
to requests for new credit, which may cause the Fund to realize a loss of
interest or principal on any of its portfolio holdings.
The foreign securities in which the Fund may invest include without
limitation Eurodollar obligations and “Yankee Dollar” obligations.
Eurodollar obligations are U.S. dollar-denominated certificates of
deposit and time deposits issued outside the U.S. capital markets by
foreign branches of U.S. banks and by foreign banks. Yankee Dollar
obligations are U.S. dollar-denominated obligations issued in the
U.S. capital markets by foreign banks. Eurodollar and Yankee Dollar
obligations are generally subject to the same risks that apply to
domestic debt issues, notably credit risk, interest rate risk, market risk
and liquidity risk. Additionally, Eurodollar (and to a limited extent,
Yankee Dollar) obligations are subject to certain sovereign risks. One
such risk is the possibility that a sovereign country might prevent
capital, in the form of U.S. dollars, from flowing across its borders. Other
risks include adverse political and economic developments; the extent
and quality of government regulation of financial markets and
institutions; the imposition of foreign withholding or other taxes; market
disruptions, the possibility of security suspensions; the expropriation or
nationalization of foreign issuers or the imposition of sanctions or other
similar measures.
Short Sales
The Fund may make short sales of securities (i) to offset potential
declines in long positions in similar securities, (ii) to increase the
flexibility of the Fund, (iii) for investment return, (iv) as part of a risk
arbitrage strategy, and (v) as part of its overall portfolio management
strategies involving the use of derivative instruments. 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 or will
underperform relative to other securities held in the Fund’s portfolio.
When the Fund makes a short sale, 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 or maintain an arrangement with a broker to
borrow securities, and would often be obligated to pay over any accrued
interest and dividends on such borrowed securities.
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.
If the price of the security sold short increases between the time of the
short sale and the time that the Fund replaces the borrowed security,
the Fund will incur a loss; conversely, if the price declines, the Fund will
39 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
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.
The Fund may invest pursuant to a risk arbitrage strategy to take
advantage of a perceived relationship between the value of two
securities. Frequently, a risk arbitrage strategy involves the short sale of
a security.
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 will engage in short
selling to the extent permitted by the federal securities laws and rules
and interpretations thereunder. To the extent the Fund engages in short
selling in foreign (non-U.S.) jurisdictions, the Fund will do so to the
extent permitted by the laws and regulations of such jurisdiction.
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 Act
and rules and interpretations thereunder.
Certain Interest Rate Transactions
In order to reduce the interest rate risk inherent in the Fund’s underlying
investments and capital structure, the Fund may (but is not required to)
enter into interest rate swap transactions. Interest rate swaps involve
the exchange by the Fund with a counterparty of their respective
commitments to pay or receive interest, such as an exchange of fixed
rate payments for floating rate payments. These transactions generally
involve an agreement with the swap counterparty to pay a fixed or
variable rate payment in exchange for the counterparty paying the Fund
the other type of payment stream (i.e., variable or fixed). The payment
obligation would be based on the notional amount of the swap. Other
forms of interest rate swap agreements in which the Fund may invest
include without limitation interest rate caps, under which, in return for a
premium, one party agrees to make payments to the other to the extent
that interest rates exceed a specified rate, or “cap;” interest rate floors,
under which, in return for a premium, one party agrees to make
payments to the other to the extent that interest rates fall below a
specified rate, or “floor;” and interest rate “collars,” under which a
party sells a cap and purchases a floor or vice versa in an attempt to
protect itself against interest rate movements exceeding given minimum
or maximum levels. The Fund may (but is not required to) use interest
rate swap transactions with the intent to reduce or eliminate the risk
that an increase in short-term interest rates could pose for the
performance of the Fund’s Common Shares as a result of leverage, and
also may use these instruments for other hedging or investment
purposes. Any termination of an interest rate swap transaction could
result in a termination payment by or to the Fund.
Credit Default Swaps
The Fund may enter into credit default swaps for both investment and
risk management purposes, as well as to add leverage to the Fund’s
portfolio. A credit default swap may have as reference obligations one
or more securities that are not currently held by the Fund. The protection
“buyer” in a credit default swap is generally obligated to pay the
protection “seller” an upfront or a periodic stream of payments over the
term of the contract provided that no credit event, such as a default, on
a reference obligation has occurred. If a credit event occurs, the seller
generally must pay the buyer the “par value” (full notional value) of the
swap in exchange for an equal face amount of deliverable obligations of
the reference entity described in the swap, or the seller may be required
to deliver the related net cash amount, if the swap is cash settled.
Rather than exchange the bonds for par value, a single cash payment
may be due from the protection seller representing the difference
between the par value of the bonds and the current market value of the
bonds (which may be determined through an auction). Rather than
exchange the bonds for par value, a single cash payment may be due
from the protection seller representing the difference between the par
value of the bonds and the current market value of the bonds (which
may be determined through an auction). The Fund may be either the
buyer or seller in the transaction. If the Fund is a buyer and no credit
event occurs, the Fund may recover nothing if the swap is held through
its termination date. However, if a credit event occurs, the buyer
generally may elect to receive the full notional value of the swap from
the seller, who, in turn, generally will recover an amount significantly
lower than the equivalent face amount of the obligations of the
reference entity, whose value may have significantly decreased, through
(i) physical delivery of such obligations by the buyer, (ii) cash settlement
or (iii) an auction process. As a seller, the Fund generally receives an
upfront payment or a fixed rate of income throughout the term of the
swap provided that there is no credit event. As the seller, the Fund
would effectively add leverage to its portfolio because, in addition to its
total net assets, the Fund would be subject to investment exposure on
the notional amount of the swap.
The spread of a credit default swap is the annual amount the protection
buyer must pay the protection seller over the length of the contract,
expressed as a percentage of the notional amount. When spreads rise,
market perceived credit risk rises and when spreads fall, market
perceived credit risk falls. Wider credit spreads and decreasing market
values, when compared to the notional amount of the swap, represent a
deterioration of the referenced entity’s credit soundness and a greater
likelihood or risk of default or other credit event occurring as defined
under the terms of the agreement. For credit default swaps on
asset-backed securities and credit
indexes
, the quoted market prices and
resulting values, as well as the annual payment rate, serve as an
indication of the current status of the payment/performance risk.
Credit default swaps involve greater risks than if the Fund had invested
in the reference obligation directly since, in addition to general market
risks, credit default swaps are subject to leverage risk, illiquidity risk,
counterparty risk and credit risk, among other risks associated with
derivative instruments. A buyer generally also will lose its investment
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
40
PIMCO California Flexible Municipal Income Fund
and recover nothing should no credit event occur and the swap is held
to its termination date. If a credit event were to occur, the value of any
deliverable obligation received by the seller, coupled with the upfront or
periodic payments previously received, may be less than the full notional
value it pays to the buyer, resulting in a loss of value to the seller. The
Fund’s obligations under a credit default swap will be accrued daily
(offset against any amounts owing to the Fund).
When-Issued, Delayed Delivery and Forward Commitment
Transactions
The Fund may purchase or sell securities that it is eligible to purchase or
sell on a when-issued basis, may purchase or sell such securities for
delayed delivery and may make contracts to purchase or sell such
securities for a fixed price at a future date beyond normal settlement
time (forward commitments). When-issued transactions, delayed
delivery purchases and forward commitments involve a risk of loss if the
value of the securities declines prior to the settlement date. This risk is in
addition to the risk that the Fund’s other assets will decline in value.
Therefore, these transactions may result in a form of leverage and
increase the Fund’s overall investment exposure. Typically, no income
accrues on securities the Fund has committed to purchase prior to the
time delivery of the securities is made. 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 pay for
the securities, the Fund could suffer a loss. Additionally, when selling a
security on a when-issued, delayed delivery or forward commitment
basis without owning the security, the Fund will incur a loss if the
security’s price appreciates in value such that the security’s price is
above the agreed-upon price on the settlement date.
Repurchase Agreements
The Fund may enter into repurchase agreements in which the Fund
purchases a security from a bank or broker-dealer that agrees to
repurchase the security at the Fund’s cost plus interest within a specified
time. If the party agreeing to repurchase should default, the Fund will
seek to sell the securities which it holds. This could involve procedural
costs or delays in addition to a loss on the securities if their value should
fall below their repurchase price.
Lending of Portfolio Securities
For the purpose of achieving income, the Fund may lend its portfolio
securities to brokers, dealers or other financial institutions provided a
number of conditions are satisfied, including that the loan is fully
collateralized. See “Investment Objectives and Policies—Securities
Loans” in the Statement of Additional Information for details. When the
Fund lends portfolio securities, its investment performance will continue
to reflect changes in the value of the securities loaned. The Fund will
also receive a fee or interest on the collateral. Securities lending involves
the risk of loss of rights in the collateral or delay in recovery of the
collateral if the borrower fails to return the security loaned or becomes
insolvent, or the risk of loss due to the investment performance of the
collateral. The Fund may pay lending fees to the party arranging the
loan, which may be an affiliate of the Fund. See “Principal Risks of the
Fund—Securities Lending Risk.”
Portfolio Turnover
The length of time the Fund has held a particular security is not
generally a consideration in investment decisions. A change in the
securities held by the Fund is known as “portfolio turnover.” The Fund
may engage in frequent and active trading of portfolio securities to
achieve its investment objectives, particularly during periods of volatile
market movements. High portfolio turnover (e.g., over 100%) generally
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. Sales of
portfolio securities may also result in realization of taxable capital gains,
including short-term capital gains (which are generally treated as
ordinary income upon distribution in the form of dividends). The trading
costs and tax effects associated with portfolio turnover may adversely
affect the Fund’s performance.
Use of Leverage
The Fund currently
utilizes
leverage through its outstanding Preferred
Shares.
The Fund may also choose to add leverage
through the use of
tender option bonds
,
the issuance of additional
Preferred Shares
,
or
the
use of reverse repurchase agreements, selling credit default swaps,
dollar rolls/buy backs or borrowings, such as through bank loans or
commercial paper and/or other credit facilities. The Fund may also enter
into transactions other than those noted above that may give rise to a
form of leverage including, among others, futures and forward contracts
(including foreign currency exchange contracts), total return swaps and
other derivative transactions, loans of portfolio securities, short sales
and when-issued, delayed delivery and forward commitment
transactions.
The Fund
utilizes
certain kinds of leverage, including, without limitation,
tender option bonds, opportunistically and may choose to increase or
decrease, or eliminate entirely, its use of leverage over time and from
time to time based on PIMCO
’
s assessment of the yield curve
environment, interest rate trends, market conditions and other factors.
The Fund may also determine to increase its leverage through the
issuance of
additional
Preferred Shares
,
or
decrease the leverage
it
currently
maintains through
its
outstanding Preferred Shares through
Preferred Share
redemptions or tender offers
and
may or may not
determine to replace
such
leverage
. The Fund may issue
additional
Preferred Shares without the approval of
the
Common Shareholders. If
the Fund issues
additional
Preferred Shares in the future, all costs and
expenses relating to the issuance and ongoing maintenance of the
Preferred Shares will be borne by the Common Shareholders, and these
costs and expenses may be significant. Leveraging transactions pursued
by the Fund may increase its duration and sensitivity to interest rate
movements. The
Fund’
s net assets attributable to its Preferred Shares
and the net
proceeds the Fund obtains from the
issuance of additional
preferred shares
or the use of tender option bonds
or other forms of
leverage will be invested in accordance with the Fund
’
s investment
41 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
objectives and policies as described in this prospectus. So long as the
rate of return, net of applicable Fund expenses, on the debt obligations
and other investments purchased by the Fund exceeds the dividend
rates payable on the Preferred Shares together with the costs to the
Fund of
other
leverage it utilizes
, the investment of the Fund
’
s assets
attributable to leverage will generate more income than will be needed
to pay the costs of the leverage. If so, and all other things being equal,
the excess may be used to pay higher dividends to Common
Shareholders than if the Fund were not so leveraged.
The Fund is subject to the requirement under the Act that an investment
company satisfy an asset coverage requirement of 300% of its
indebtedness measured at the time the investment company incurs the
indebtedness. This means that at any given time the value of the Fund's
total indebtedness may not exceed one-third the value of its total assets
(including assets attributable to such leverage). The interests of persons
with whom the Fund enters into leverage arrangements will not
necessarily be aligned with the interests of the Fund's shareholders and
such persons will have claims on the Fund's assets that are senior to
those of the Fund's shareholders.
Under the Act, the Fund is not permitted to issue
preferred shares
unless, immediately after such issuance, the value of the Fund
’
s total net
assets (as defined below) is at least 200% of the liquidation value of
any outstanding Preferred Shares and the newly issued
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.
The Fund may enter into derivatives or other transactions that may
provide leverage (other than through the issuance of Preferred Shares or
bank borrowing). The Derivatives Rule regulates a registered investment
company's use of derivatives and certain other transactions that create
future payment and/or delivery obligations by the Fund. This new rule
became operative in August 2022. The Derivatives Rule prescribes
specific VaR leverage limits that apply to the Fund (although the Fund in
the future could qualify as a limited derivatives user (as defined in the
Derivatives Rule) and would therefore not be subject to all of the
requirements of the Derivatives Rule). VaR is an estimate of potential
losses on an instrument or portfolio over a specified time horizon and at
a given confidence level. The Fund may apply a relative VaR test or an
absolute VaR test (if the Fund's derivatives risk manager determines that
a designated reference portfolio would not provide an appropriate
reference portfolio for purposes of the relative VaR test). The limit under
the relative VaR test when a fund has outstanding preferred shares is
250% (or 200% when no preferred shares are outstanding) of the VaR
of a designated reference portfolio, which, very generally, may be a
designated unleveraged index or the Fund's securities portfolio
excluding derivatives. If applicable, the limit under the absolute VaR test
when the Fund has outstanding preferred shares is 25% (or 20% when
no preferred shares are outstanding) of the value of a fund's net assets.
The Derivatives Rule also generally requires the Fund to appoint a
derivatives risk manager, maintain a DRMP designed to identify, assess,
and reasonably manage the risks associated with transactions covered
by the rule, and abide by certain board and other reporting obligations
and recordkeeping requirements. With respect to reverse repurchase
agreements or other similar financing transactions in particular, the
Derivatives Rule permits a fund to enter into such transactions if the
fund either (i) complies with the asset coverage requirements of
Section 18 of the Act, and combines the aggregate amount of
indebtedness associated with all reverse repurchase agreements and
similar financing with the aggregate amount of any other senior
securities representing indebtedness when calculating the relevant asset
coverage ratio, or (ii) treats all reverse repurchase agreements and
similar financing transactions as derivatives transactions for all purposes
under the Derivatives Rule. The Fund has adopted procedures for
investing in derivatives and other transactions in compliance with the
Derivatives Rule. Compliance with the Derivatives Rule could adversely
affect the value or performance of the Fund. Limits or restrictions
applicable to the counterparties or issuers, as applicable, with which the
Fund may engage in derivative transactions could also limit or prevent
the Fund from using certain instruments.
Leveraging is a speculative technique and there are special risks and
costs involved. The Fund cannot assure you that its use of
Preferred
Shares and any other
forms of leverage (such as tender option bonds)
will be successful or result in a higher yield on your Common Shares.
When leverage is used, the net asset value of the Common Shares and
the yield to Common Shareholders will be more volatile. In addition,
dividends paid on
Preferred Shares (including
the
Preferred Shareholder
Gross-Up (as
described below)) and interest and other expenses borne
by the Fund with respect to its use of tender option bonds or other
forms of leverage are borne by the Common Shareholders (and not by
the holders of Preferred Shares
(“Preferred
Shareholders
”
)
)
and result in
a reduction of the net asset value of the Common Shares. In addition,
because the fees received by the Investment Manager are based on the
total managed assets of the Fund, which includes total assets of the
Fund (including assets attributable to any reverse repurchase
agreements, dollar rolls
, tender option bonds, borrowings and Preferred
Shares that may be outstanding, if any), the Investment Manager has a
financial incentive for the Fund to use certain forms of leverage (e.g.,
Preferred Shares and
tender option bonds
), which may create a conflict
of interest between the Investment Manager, on the one hand, and the
Common Shareholders, on the other hand.
The Fund
’s ability to utilize leverage may also be limited by asset
coverage requirements and other guidelines imposed by the terms of
the Preferred Shares
or
imposed by rating agencies that provide ratings
for the Preferred Shares
which
are
more restrictive than the limitations
imposed by the Act noted above.
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
42
PIMCO California Flexible Municipal Income Fund
Effects of Leverage
The following table is furnished in response to requirements of the SEC.
It is designed to illustrate the effects of leverage through the use of
senior securities, as that term is defined under Section 18 of the Act, 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%. The table below
assumes the
Fund’
s continued use
of Preferred Shares issued by the
Fund on January
12,
2024,
representing approximately 21.65
% of the
Fund
’
s total
average
managed assets
. The table below also assumes
that the Fund will
pay dividends on Preferred Shares at an estimated
annual effective Preferred Share dividend rate of 5.12
%
(
based on the
Preferred Share dividend rate under market conditions as of
December
31
,
2023,
and including
the amortization of Preferred Shares
offerings costs of $ 360,000 over the three-year term of the Preferred
Shares) and interest on tender option bonds
at an estimated annual
effective interest expense rate of 4.16
%
,
which is based on market
conditions
as of December 31,
2023
. Based on such estimates, the
annual return that the Fund
’
s portfolio must experience (net of
expenses) in order to cover the costs of the Fund
’
s leverage would be
1.23
%. The information below does not reflect the Fund
’
s potential use
of certain other forms of economic leverage achieved through the use of
other instruments or transactions not considered to be senior securities
under the Act, such as certain derivative instruments.
These assumed investment portfolio returns are hypothetical figures and
are not necessarily indicative of the investment portfolio returns
experienced or expected to be experienced by the Fund. Your actual
returns may be greater or less than those appearing below. In addition,
actual borrowing expenses associated with the use of tender option
bonds or
the issuance of
Preferred Shares by the Fund may vary
frequently and may be significantly higher or lower than the rate used
for the example below.
Assumed Portfolio Total Return (net of expenses) | (10.00)% | (5.00)% | 0.00% | 5.00% | 10.00% |
Common Shares Total Return | (14.91)% | (8.27)% | (1.64)% | 5.00% | 11.64% |
Common Shares Total Return is composed of two elements – the
distributions paid by the Fund to Common Shareholders (the amount of
which is largely determined by the net investment income of the Fund
after paying dividend payments on any Preferred Shares issued by the
Fund and expenses on any forms of leverage outstanding) and gains or
losses on the value of the securities and other instruments the Fund
owns. As required by SEC 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 income it receives on its investments is entirely offset by losses in
the value of those investments. This table reflects hypothetical
performance of the Fund's portfolio and not the actual performance of
the Fund's Common Shares, the value of which is determined by market
forces and other factors.
Should the Fund elect to add
additional
leverage, any benefits of such
leverage cannot be fully achieved until the proceeds resulting from the
use of such leverage have been received by the Fund and invested in
accordance with the Fund's investment objectives and policies. As noted
above, the Fund's willingness to use leverage, and the extent to which
leverage is used at any time, will depend on many factors, including,
among other things, PIMCO's assessment of the yield curve
environment, interest rate trends, market conditions and other factors.
Principal Risks of the Fund
The NAV of the Common Shares will fluctuate with and be affected by,
among other things, various principal risks of the Fund and its
investments which are summarized below.
New/Small Fund Risk
A new or smaller fund’s performance may not represent how the Fund is
expected to or may perform in the long term if and when it becomes
larger and has fully implemented its investment strategies. Investment
positions may have a disproportionate impact (negative or positive) on
performance in a new and smaller fund, such as the Fund. New and
smaller funds may also require a period of time before they are invested
in securities that meet their investment objectives and policies and
achieve a representative portfolio composition. Fund performance may
be lower or higher during this “ramp-up” period, and may also be more
volatile, than would be the case after the fund is fully invested. Similarly,
a new or smaller fund’s investment strategy may require a longer period
of time to show returns that are representative of the strategy. New
funds have limited performance histories for investors to evaluate and
new and smaller funds may not attract sufficient assets to achieve
investment and trading efficiencies. If a new or smaller fund were to fail
to successfully implement its investment strategies or achieve its
investment objectives, performance may be negatively impacted, and
any resulting liquidation could create negative transaction costs for the
fund and tax consequences for investors.
Interest Rate Risk
Interest rate risk is the risk that fixed income securities and other
instruments in the Fund’s portfolio will fluctuate in value because of a
change in interest rates. For example, as nominal interest rates rise, the
value of certain fixed income securities held by the Fund is likely to
decrease. A nominal interest rate can be described as the sum of a real
interest rate and an expected inflation rate. Interest rate changes can be
sudden and unpredictable, and the Fund may lose money as a result of
movements in interest rates. The Fund may not be able to effectively
hedge against changes in interest rates or may choose not to do so for
cost or other reasons.
A wide variety of factors can cause interest rates or yields of
U.S. Treasury securities (or yields of other types of bonds) to rise
including, but not limited to, central bank monetary policies, changing
inflation or real growth rates, general economic conditions, increasing
bond issuances or reduced market demand for low yielding investments.
Risks associated with rising interest rates are heightened under current
market conditions given that the U.S. Federal Reserve (the “Federal
43 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
Reserve”) has begun to raise interest rates from historically low levels
and has signaled an intention to continue to do so. Further, in market
environments where interest rates are rising, issuers may be less willing
or able to make principal and interest payments on fixed-income
investments when due.
Further, fixed income securities with longer durations tend to be more
sensitive to changes in interest rates, usually making them more volatile.
Duration is a measure used to determine the sensitivity of a security’s
price to changes in interest rates that incorporates a security’s yield,
coupon, final maturity and call features, among other characteristics.
Duration is useful primarily as a measure of the sensitivity of a fixed
income security’s market price to interest rate (i.e., yield) movements. All
other things remaining equal, for each one percentage point increase in
interest rates, the value of a portfolio of fixed income investments would
generally be expected to decline by one percent for every year of the
portfolio’s average duration above zero. For example, the value of a
portfolio of fixed income securities with an average duration of eight
years would generally be expected to decline by approximately 8% if
interest rates rose by one percentage point.
Variable and floating rate securities may decline in value if their interest
rates do not rise as much, or as quickly, as interest rates in general.
Conversely, floating rate securities will not generally increase in value if
interest rates decline. Inverse floating rate securities may decrease in
value if interest rates increase. Inverse floating rate securities may also
exhibit greater price volatility than a fixed rate obligation with similar
credit quality. When the Fund holds variable or floating rate securities, a
decrease (or, in the case of inverse floating rate securities, an increase)
in market interest rates will adversely affect the income received from
such securities and the NAV of the Fund’s shares.
During periods of very low or negative interest rates, the Fund may be
unable to maintain positive returns. Very low or negative interest rates
may magnify interest rate risk. Changing interest rates, including rates
that fall below zero, may have unpredictable effects on markets, may
result in heightened market volatility and may detract from Fund
performance to the extent the Fund is exposed to such interest rates.
Measures such as average duration may not accurately reflect the true
interest rate sensitivity of the Fund. This is especially the case if the Fund
consists of securities with widely varying durations. Therefore, if the
Fund has an average duration that suggests a certain level of interest
rate risk, the Fund may in fact be subject to greater interest rate risk
than the average would suggest. This risk is greater to the extent the
Fund uses leverage or derivatives in connection with the management
of the Fund.
Convexity is an additional measure used to understand a security’s or
the Fund’s interest rate sensitivity. Convexity measures the rate of
change of duration in response to changes in interest rates. With respect
to a security’s price, a larger convexity (positive or negative) may imply
more dramatic price changes in response to changing interest rates.
Convexity may be positive or negative. Negative convexity implies that
interest rate increases result in increased duration, meaning increased
sensitivity in prices in response to rising interest rates. Thus, securities
with negative convexity, which may include bonds with traditional call
features and certain mortgage-backed securities, may experience
greater losses in periods of rising interest rates. Accordingly, if the Fund
holds such securities, the Fund may be subject to a greater risk of losses
in periods of rising interest rates.
Rising interest rates may result in a decline in value of the Fund’s fixed
income investments and in periods of volatility. Further, while U.S. bond
markets have steadily grown over the past three decades, dealer
“market making” ability has remained relatively stagnant. As a result,
dealer inventories of certain types of bonds and similar instruments,
which provide a core indication of the ability of financial intermediaries
to “make markets,” are at or near historic lows in relation to market
size. Because market makers provide stability to a market through their
intermediary services, a significant reduction in dealer inventories could
potentially lead to decreased liquidity and increased volatility in the
fixed income markets. Such issues may be exacerbated during periods of
economic uncertainty. All of these factors, collectively and/or
individually, could cause the Fund to lose value.
Municipal Bond Risk
Investing in the municipal bond market involves the risks of investing in
debt securities generally and certain other risks. The amount of public
information available about the municipal bonds in which the Fund may
invest is generally less than that for corporate equities or bonds, and the
investment performance of the Fund’s investment in municipal bonds
may therefore be more dependent on the analytical abilities of PIMCO
than its investments in taxable bonds. The secondary market for
municipal bonds,
also tends to be less well developed or liquid than
many other securities markets, which may adversely affect the Fund’s
ability to sell municipal bonds at attractive prices
.
The ability of municipal issuers to make timely payments of interest and
principal may be diminished during general economic downturns, by
litigation, legislation or political events, or by the bankruptcy of the
issuer. Laws, referenda, ordinances or regulations enacted in the future
by Congress or state legislatures or the applicable governmental entity
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
also 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.
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 municipal bonds in a particular state or
geographic region.
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
44
PIMCO California Flexible Municipal Income Fund
The Fund may invest in trust certificates issued in tender option bond
programs. In these programs, a trust typically issues two classes of
certificates and uses the proceeds to purchase municipal securities
having relatively long maturities and bearing interest at a fixed interest
rate substantially higher than prevailing short-term tax-exempt rates.
There is a risk that the Fund will not be considered the owner of a
tender option bond for federal income tax purposes, and thus will not
be entitled to treat such interest as exempt from federal income tax.
Certain tender option bonds may be less liquid or may become less
liquid as a result of, among other things, a credit rating downgrade, a
payment default or a disqualification from tax-exempt status. The Fund’s
investment in the securities issued by a tender option bond trust may
involve greater risk and volatility than an investment in a fixed rate
bond, and the value of such securities may decrease significantly when
market interest rates increase. Tender option bond trusts could be
terminated due to market, credit or other events beyond the Fund’s
control, which could require the Fund to dispose of portfolio investments
at inopportune times and prices. The Fund may use a tender option
bond program as a way of achieving leverage in its portfolio, in which
case the Fund will be subject to leverage risk. The use of tender option
bonds
will impact the Fund's duration and cause the Fund to be subject
to increased duration and interest rate risk.
The Fund may invest in revenue bonds, which are typically issued to
fund a wide variety of capital projects including electric, gas, water and
sewer systems; highways, bridges and tunnels; port and airport facilities;
colleges and universities; and hospitals. Because the principal security
for a revenue bond is generally the net revenues derived from a
particular facility or group of facilities or, in some cases, from the
proceeds of a special excise or other specific revenue source
or annual
revenues or annual revenues
, there is no guarantee that the particular
project will generate enough revenue to pay its obligations, in which
case the Fund’s performance may be adversely affected.
The Fund may invest in taxable municipal bonds, such as Build America
Bonds. Build America Bonds are tax credit bonds created by the
American Recovery and Reinvestment Act of 2009, which authorized
state and local governments to issue Build America Bonds as taxable
bonds in 2009 and 2010, without volume limitations, to finance any
capital expenditures for which such issuers could otherwise issue
traditional tax-exempt bonds. The Fund’s investments in Build America
Bonds or similar taxable municipal bonds will result in taxable income
and the Fund may elect to pass through to Common Shareholders the
corresponding tax credits.
The
tax credits can generally be used to offset
federal income taxes and the alternative minimum tax, but such credits
are generally not refundable. Taxable municipal bonds involve similar
risks as tax-exempt municipal bonds, including credit and market risk.
See “Principal Risks of the Fund—Credit Risk” and “Principal Risks of
the Fund—Market Risk.”
The Fund may invest in participations in lease obligations or installment
purchase contract obligations of municipal authorities or entities.
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, which
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 the disposition or re-leasing of the property
might prove difficult.
Municipal securities are also subject to interest rate, credit, and liquidity
risk.
Interest Rate Risk
. The value of municipal securities, similar to
other fixed income securities, will likely drop as interest rates rise in
the general market. Conversely, when rates decline, bond prices
generally rise.
Credit Risk.
The risk that a borrower may be unable to make
interest or principal payments when they are due. Funds that invest in
municipal securities rely on the ability of the issuer to service its debt.
This subjects the Fund to credit risk in that the municipal issuer may
be fiscally unstable or exposed to large liabilities that could impair its
ability to honor its obligations. Municipal issuers with significant debt
service requirements, in the near-to mid-term; unrated issuers and
those with less capital and liquidity to absorb additional expenses
may be most at risk. To the extent the Fund invests in lower quality or
high yield municipal securities, it may be more sensitive to the
adverse credit events in the municipal market. The treatment of
municipalities in bankruptcy is more uncertain, and potentially more
adverse to debt holders, than for corporate issues.
Liquidity Risk
. The risk that investors may have difficulty finding a
buyer when they seek to sell, and therefore, may be forced to sell at a
discount to the market value. Liquidity may sometimes be impaired in
the municipal market and because the Fund primarily invests in
municipal securities, it may find it difficult to purchase or sell such
securities at opportune times. Liquidity can be impaired due to
interest rate concerns, credit events, or general supply and demand
imbalances. Depending on the particular issuer and current economic
conditions, municipal securities could be deemed more volatile
investments.
In addition to general municipal market risks, different municipal sectors
may face different risks. For instance, general obligation bonds are
secured by the full faith, credit, and taxing power of the municipality
issuing the obligation. As such, timely payment depends on the
municipality's ability to raise tax revenue and maintain a fiscally sound
budget. The timely payments may also be influenced by any unfunded
pension liabilities or other post-employee benefit plan liabilities.
Revenue bonds are secured by special tax revenues or other revenue
sources. If the specified revenues do not materialize, then the bonds
may not be repaid.
45 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
Private activity bonds are yet another type of municipal security.
Municipalities use private activity bonds to finance the development of
industrial facilities for use by private enterprise. Principal and interest
payments are to be made by the private enterprise benefiting from the
development, which means that the holder of the bond is exposed to
the risk that the private issuer may default on the bond.
Moral obligation bonds are usually issued by special purpose public
entities. If the public entity defaults, repayment becomes a “moral
obligation” instead of a legal one. The lack of a legally enforceable right
to payment in the event of default poses a special risk for a holder of
the bond because it has little or no ability to seek recourse in the event
of default.
In addition, a significant restructuring of federal income tax rates or
even serious discussion on the topic in Congress could cause municipal
bond prices to fall. The demand for municipal securities is strongly
influenced by the value of tax-exempt income to investors relative to
taxable income. Lower income tax rates potentially reduce the
advantage of owning municipal securities.
Similarly, changes to state or federal regulation tied to a specific sector,
such as the hospital sector, could have an impact on the revenue stream
for a given subset of the market.
Municipal notes are similar to general municipal debt obligations, but
they generally possess shorter terms. Municipal notes can be used to
provide interim financing and may not be repaid if anticipated revenues
are not realized.
Puerto Rico-Specific Risk
The Fund may be affected significantly by political, economic,
environmental, social, regulatory or restructuring developments affecting
the ability of Puerto Rican municipal issuers to pay interest or repay
principal. Certain issuers of Puerto Rico municipal bonds have
experienced serious financial difficulties in the past and reoccurrence of
these difficulties may impair the ability of certain Puerto Rico issuers to
pay principal or interest on their obligations. Provisions of the Puerto
Rico Constitution and Commonwealth laws, including a
federally-appointed oversight board to oversee the Commonwealth’s
financial operations, which limit the taxing and spending authority of
Puerto Rico governmental entities may impair the ability of Puerto Rico
issuers to pay principal and/or interest on their obligations. While Puerto
Rico’s economy is broad, it does have major concentrations in certain
industries, such as manufacturing and service, and may be sensitive to
economic problems affecting those industries. Future Puerto Rico
political and economic developments, constitutional amendments,
legislative measures, executive orders, administrative regulations,
litigation, debt restructuring, and voter initiatives as well as
environmental events, natural disasters, pandemics, epidemics or social
unrest could have an adverse effect on the debt obligations of Puerto
Rico issuers.
Municipal Project-Specific Risk
The Fund may be more sensitive to adverse economic, business or
political developments if it invests a substantial portion of its assets in
the bonds of specific projects (such as those relating to education,
health care, housing, transportation, and utilities), industrial
development bonds, or in general obligation bonds, particularly if there
is a large concentration from issuers in a single state. This is because the
value of municipal securities can be significantly affected by the
political, economic, legal, and legislative realities of the particular
issuer’s locality or municipal sector events. Similarly, changes to state or
federal regulation tied to a specific sector, such as the hospital sector,
could have an impact on the revenue stream for a given subset of the
market.
Municipal Project Housing-Related Risk
The Fund may invest in the bonds of projects focused on low-income,
affordable or other housing developments and businesses located in
low-income areas or invest in or originate loans that finance or are
generally related to such projects. There are significant risks associated
with the Fund’s investment in the bonds of these types of projects and
loans related to such projects. There may be federal, state and local
governmental regulatory restrictions on the operation, rental and
transfer of these projects, such as the requirement that the owners of
these affordable housing developments rent or sell certain residential
units to persons or families of low or moderate income and that the
amount of rent that may be charged for these units may be less than
market rates. These restrictions may adversely affect economic
performance relative to properties that are not subject to these
restrictions. There are also no assurances that a project owner will be
able to achieve and maintain sufficient rental income in order to pay all
operating expenses and maintenance and repair costs of such a project
and the debt service on the related bonds or loan on a timely basis. In
the event that a project owner is unable to pay all such costs, expenses
and debt service, a default on the related bonds or loan is likely to occur.
Loans and Other Indebtedness; Loan Participations and
Assignments Risk
Loan interests may take the form of (i) direct interests acquired during a
primary distribution or other purchase of a loan, (ii) loans originated by
the Fund or (iii) assignments of, novations of or participations in all or a
portion of a loan acquired in secondary markets. In addition to credit
risk and interest rate risk, the Fund’s exposure to loan interests may be
subject to additional risks. For example, purchasers of loans and other
forms of direct indebtedness depend primarily upon the
creditworthiness of the borrower for payment of principal and interest.
Loans are subject to the risk that scheduled interest or principal
payments will not be made in a timely manner or at all, either of which
may adversely affect the value of the loan. If the Fund does not receive
scheduled interest or principal payments on such indebtedness, the
Fund’s share price and yield could be adversely affected. Loans that are
fully secured may offer the Fund more protection than an unsecured
loan in the event of non-payment of scheduled interest or principal if
the Fund is able to access and monetize the collateral. However, the
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
46
PIMCO California Flexible Municipal Income Fund
collateral underlying a loan, if any, may be unavailable or insufficient to
satisfy a borrower’s obligation. If the Fund becomes owner, whole or in
part, of any collateral after a loan is foreclosed, the Fund may incur costs
associated with owning and/or monetizing its ownership of the
collateral.
Moreover, the purchaser of an assignment typically succeeds to all the
rights and obligations under the loan agreement with the same rights
and obligations as the assigning lender. Assignments may, however, be
arranged through private negotiations between potential assignees and
potential assignors, and the rights and obligations acquired by the
purchaser of an assignment may differ from, and be more limited than,
those held by the assigning lender.
In connection with purchasing loan participations, the Fund generally
will have no right to enforce compliance by the borrower with the terms
of the loan agreement relating to the loan, nor any rights of set-off
against the borrower, and the Fund may not directly benefit from any
collateral supporting the loan in which it has purchased the loan
participation. As a result, the Fund will be subject to the credit risk of
both the borrower and the lender that is selling the participation. In the
event of the insolvency of the lender selling a participation, the Fund
may be treated as a general creditor of the lender and may not benefit
from any set-off between the lender and the borrower. Certain loan
participations may be structured in a manner designed to prevent
purchasers of participations from being subject to the credit risk of the
lender, but even under such a structure, in the event of the lender’s
insolvency, the lender’s servicing of the participation may be delayed
and the assignability of the participation impaired.
The Fund may have difficulty disposing of loans and loan participations.
Because there is no liquid market for many such investments, the Fund
anticipates that such investments could be sold only to a limited number
of institutional investors. The lack of a liquid secondary market may have
an adverse impact on the value of such investments and the Fund’s
ability to dispose of particular loans and loan participations when that
would be desirable, including in response to a specific economic event
such as a deterioration in the creditworthiness of the borrower. The lack
of a liquid secondary market for loans and loan participations also may
make it more difficult for the Fund to assign a value to these securities
for purposes of valuing the Fund’s portfolio. Investments in loans may
include participations in bridge loans, which are loans taken out by
borrowers for a short period (typically less than one year) pending
arrangement of more permanent financing through, for example, the
issuance of bonds frequently high yield bonds issued for the purpose of
acquisitions.
To the extent the Fund invests in loans or originates loans, the Fund may
be subject to greater levels of credit risk, call risk, settlement risk and
liquidity risk. These instruments are considered predominantly
speculative with respect to an issuer’s continuing ability to make
principal and interest payments and may be more volatile than other
types of securities. The Fund may also be subject to greater levels of
liquidity risk than funds that do not invest in loans. In addition, the loans
in which the Fund invests may not be listed on any exchange and a
secondary market for such loans may be comparatively illiquid relative
to markets for other more liquid fixed income securities. Consequently,
transactions in loans may involve greater costs than transactions in
more actively traded securities. In connection with certain loan
transactions, transaction costs that are borne by the Fund may include
the expenses of third parties that are retained to assist with reviewing
and conducting diligence, negotiating, structuring and servicing a loan
transaction, and/or providing other services in connection therewith.
Furthermore, the Fund may incur such costs in connection with loan
transactions that are pursued by the Fund but not ultimately
consummated (so-called “broken deal costs”).
Restrictions on transfers in loan agreements, a lack of publicly available
information, irregular trading activity and wide bid/ask spreads, among
other factors, may, in certain circumstances, make loans more difficult to
sell at an advantageous time or price than other types of securities or
instruments. These factors may result in the Fund being unable to realize
full value for the loans and/or may result in the Fund not receiving the
proceeds from a sale of a loan for an extended period after such sale,
each of which could result in losses to the Fund. Some loans may have
extended trade settlement periods, including settlement periods of
greater than seven days, which may result in cash not being
immediately available to the Fund. If an issuer of a loan prepays or
redeems the loan prior to maturity, the Fund may have to reinvest the
proceeds in other loans or similar instruments that may pay lower
interest rates. Because of the risks involved in investing in loans, an
investment in the Fund should be considered speculative.
The Fund’s investments in subordinated and unsecured loans generally
are subject to similar risks as those associated with investments in
secured loans. Subordinated or unsecured loans are lower in priority of
payment to secured loans and are subject to the additional risk that the
cash flow of the borrower and property securing the loan or debt, if any,
may be insufficient to meet scheduled payments after giving effect to
the senior secured obligations of the borrower. This risk is generally
higher for subordinated unsecured loans or debt, which are not backed
by a security interest in any specific collateral. Subordinated and
unsecured loans generally have greater price volatility than secured
loans and may be less liquid. There is also a possibility that originators
will not be able to sell participations in subordinated or unsecured
loans, which would create greater credit risk exposure for the holders of
such loans. Subordinate and unsecured loans share the same risks as
other below investment grade securities.
There may be less readily available information about most loans and
the underlying borrowers than is the case for many other types of
securities. Loans may be issued by borrowers that are not subject to SEC
reporting requirements and therefore may not be required to file reports
with the SEC or may file reports that are not required to comply with
SEC form requirements. In addition, such borrowers may be subject to a
less stringent liability disclosure regime than companies subject to SEC
reporting requirements. Loans may not be considered “securities,” and
purchasers, such as the Fund, therefore may not be entitled to rely on
the anti-fraud protections of the federal securities laws. Because there is
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| PIMCO California Flexible Municipal Income Fund
Prospectus
limited public information available regarding loan investments, the
Fund is particularly dependent on the analytical abilities of the Fund’s
portfolio managers.
Economic exposure to loan interests through the use of derivative
transactions may involve greater risks than if the Fund had invested in
the loan interest directly during a primary distribution, through direct
originations or through assignments of, novations of or participations in
a loan acquired in secondary markets since, in addition to the risks
described above, certain derivative transactions may be subject to
leverage risk and greater illiquidity risk, counterparty risk, valuation risk
and other risks.
Loan Origination Risk
The Fund may invest in and/or originate loans, including, without
limitation, to, on behalf of, authorized by, sponsored by, and/or in
connection with a project for which authority and responsibility lies with
one or more U.S. states or territories, cities in a U.S. state or territory, or
political subdivisions, agencies, authorities or instrumentalities of such
states, territories or cities, which may be in the form of whole loans,
assignments, participations, secured and unsecured notes, senior and
second lien loans, mezzanine loans, bridge loans or similar investments,
including to borrowers that are unrated or have credit ratings that are
determined by one or more NRSROs and/ or PIMCO to be below
investment grade. This may include loans to public or private firms or
individuals, such as in connection with housing development projects.
The loans the Fund invests in or originates may vary in maturity and/or
duration. The Fund is not limited in the amount, size or type of loans it
may invest in and/or originate, including with respect to a single
borrower or with respect to borrowers that are determined to be below
investment grade, other than pursuant to any applicable law. The Fund’s
investment in or origination of loans may also be limited by the
requirements the Fund intends to observe under Subchapter M of the
Code in order to qualify as a RIC. The loans acquired by the Fund may be
of the type that count towards the Fund's 80% policy or they may be
loans that produce income that is subject to regular federal income tax
or California income tax. The Fund may subsequently offer such
investments for sale to third parties; provided, that there is no assurance
that the Fund will complete the sale of such an investment. If the Fund
is unable to sell, assign or successfully close transactions for the loans
that it originates, the Fund will be forced to hold its interest in such
loans for an indeterminate period of time. This could result in the Fund’s
investments having high exposure to certain borrowers. The Fund will be
responsible for the expenses associated with originating a loan
(whether or not consummated). This may include significant legal and
due diligence expenses, which will be indirectly borne by the Fund and
Common Shareholders.
Bridge loans are generally made with the expectation that the borrower
will be able to obtain permanent financing in the near future. Any delay
in obtaining permanent financing subjects the bridge loan investor to
increased risk. A borrower’s use of bridge loans also involves the risk
that the borrower may be unable to locate permanent financing to
replace the bridge loan, which may impair the borrower’s perceived
creditworthiness.
Loan origination and servicing companies are routinely involved in legal
proceedings concerning matters that arise in the ordinary course of their
business. In addition, a number of participants in the loan origination
and servicing industry (including control persons of industry
participants) have been the subject of regulatory actions by state
regulators, including state attorneys general, and by the federal
government. Governmental investigations, examinations or regulatory
actions, or private lawsuits, including purported class action lawsuits,
may adversely affect such companies’ financial results. To the extent the
Fund engages in origination and/or servicing directly, or has a financial
interest in, or is otherwise affiliated with, an origination or servicing
company, the Fund will be subject to enhanced risks of litigation,
regulatory actions and other proceedings. As a result, the Fund may be
required to pay legal fees, settlement costs, damages, penalties or other
charges, any or all of which could materially adversely affect the Fund
and its holdings.
California State-Specific Risk
The Fund invests a substantial portion of its assets in municipal bonds
issued by or on behalf of the State of California and its political
subdivisions, financing authorities and their agencies, and therefore may
be affected significantly by political, economic, regulatory, social,
environmental, or public health developments affecting the ability of
California tax exempt issuers to pay interest or repay principal. Certain
issuers of California municipal bonds have experienced serious financial
difficulties in the past and reoccurrence of these difficulties may impair
the ability of certain California issuers to pay principal or interest on
their obligations. Provisions of the California Constitution and State
statutes that limit the taxing and spending authority of California
governmental entities may impair the ability of California issuers to pay
principal and/or interest on their obligations. While California’s economy
is broad, it does have major concentrations in advanced technology,
aerospace and defense-related manufacturing, trade, entertainment,
real estate and financial services, and may be sensitive to economic
problems affecting those industries. Future California political and
economic developments, constitutional amendments, legislative
measures, executive orders, administrative regulations, litigation and
voter initiatives as well as environmental events, natural disasters,
pandemics, epidemics or social unrest
,
could have an adverse effect on
the debt obligations of California issuers.
New York State-Specific Risk
The Fund may invest in municipal bonds issued by or on behalf of the
State of New York and its political subdivisions, financing authorities
and their agencies, and therefore may be affected significantly by
political, economic or regulatory developments affecting the ability of
New York tax exempt issuers to pay interest or repay principal. Certain
issuers of New York municipal bonds have experienced serious financial
difficulties in the past and reoccurrence of these difficulties may impair
the ability of certain New York issuers to pay principal or interest on
their obligations. Provisions of the New York Constitution and State
statutes which limit the taxing and spending authority of New York
governmental entities may impair the ability of New York issuers to pay
April 30, 2023
(as supplemented January
12, 2024)
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Prospectus
48
PIMCO California Flexible Municipal Income Fund
principal and/or interest on their obligations. While New York’s economy
is broad, it does have major concentrations in certain industries, such as
financial services, and may be sensitive to economic problems affecting
those industries. Future New York political and economic developments,
constitutional amendments, legislative measures, executive orders,
administrative regulations, litigation and voter initiatives as well as
environmental events, natural disasters, pandemics, epidemics or social
unrest could have an adverse effect on the debt obligations of New York
issuers to pay principal or interest on their obligations. The financial
health of New York City affects that of the State, and when New York
City experiences financial difficulty it may have an adverse effect on
New York municipal bonds held by the Fund. The growth rate of
New York has at times been somewhat slower than the nation overall.
The economic and financial condition of New York also may be affected
by various financial, social, economic, environmental, political and
geopolitical factors.
Insurance Risk
The Fund may purchase municipal securities that are secured by
insurance, bank credit agreements or escrow accounts. The credit quality
of the companies that provide such credit enhancements will affect the
value of those securities. Certain significant providers of insurance for
municipal securities have incurred significant losses as a result of
exposure to sub-prime mortgages and other lower credit quality
investments that have experienced recent defaults or otherwise suffered
extreme credit deterioration. As a result, such losses reduced the
insurers’ capital and called into question their continued ability to
perform their obligations under such insurance if they are called upon to
do so in the future. If the insurer of a municipal security suffers a
downgrade in its credit rating or the market discounts the value of the
insurance provided by the insurer, the rating of the underlying municipal
security will be more relevant and the value of the municipal security
would more closely, if not entirely, reflect such rating. In such a case, the
value of insurance associated with a municipal security would decline
and may not add any value. The insurance feature of a municipal
security does not guarantee the full payment of principal and interest
through the life of an insured obligation, the market value of the insured
obligation or the net asset value of the common shares represented by
such insured obligation.
Inflation/Deflation Risk
Inflation risk is the risk that the value of assets or income from the
Fund’s investments will be worth less in the future as inflation decreases
the value of payments at future dates. As inflation increases, the real
value of the Fund’s portfolio could decline. Inflation has
increased and it
cannot be predicted
when,
if, or the degree to which
it may decline.
Deflation risk is the risk that prices throughout the economy decline
over time. Deflation may have an adverse effect on the creditworthiness
of issuers and may make issuer default more likely, which may result in a
decline in the value of the Fund’s portfolio and Common Shares.
Call Risk
Call risk refers to the possibility that an issuer may exercise its right to
redeem a fixed income security earlier than expected (a call). Issuers
may call outstanding securities prior to their maturity for a number of
reasons (
e.g.
, declining interest rates, changes in credit spreads and
improvements in the issuer’s credit quality). If an issuer calls a security in
which the Fund has invested, the Fund may not recoup the full amount
of its initial investment and may be forced to reinvest in lower-yielding
securities, securities with greater credit risks or securities with other, less
favorable features.
Credit Risk
The Fund could lose money if the issuer or guarantor of a fixed income
security (including a security purchased with securities lending
collateral), or the counterparty to a derivatives contract, repurchase
agreement or a loan of portfolio securities, is unable or unwilling, or is
perceived (whether by market participants, rating agencies, pricing
services or otherwise) as unable or unwilling, to make timely principal
and/or interest payments or to otherwise honor its obligations. The risk
that such issuer, guarantor or counterparty is less willing or able to do
so is heightened in market environments where interest rates are rising.
The downgrade of the credit of a security held by the Fund may
decrease its value. Measures such as average credit quality may not
accurately reflect the true credit risk of the Fund. This is especially the
case if the Fund consists of securities with widely varying credit ratings.
Securities are subject to varying degrees of credit risk, which are often
reflected in credit ratings. This risk is greater to the extent the Fund uses
leverage or derivatives in connection with the management of the Fund.
Municipal bonds are subject to the risk that litigation, legislation or
other political events, local business or economic conditions, or the
bankruptcy of the issuer could have a significant effect on an issuer’s
ability to make payments of principal and/or interest. Rising or high
interest rates may deteriorate the credit quality of an issuer or
counterparty, particularly if an issuer or counterparty faces challenges
rolling or refinancing its obligations.
Issuer Risk
The value of a security may decline for a number of reasons that directly
relate to the issuer, such as management performance, major litigation,
investigations or other controversies, changes in financial condition or
credit rating, changes in government regulations affecting the issuer or
its competitive environment and strategic initiatives such as mergers,
acquisitions or dispositions and the market response to any such
initiatives, financial leverage
,
reputation
or reduced demand for the
issuer’s goods or services, as well as the historical and prospective
earnings of the issuer and the value of its assets. A change in the
financial condition of a single issuer may affect
one or more other
issuers or
securities markets as a whole. These risks can apply to the
Common Shares issued by the Fund and to the issuers of securities and
other instruments in which the Fund invests.
49 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
Liquidity Risk
To the extent consistent with the applicable liquidity requirements for
interval funds under Rule 23c-3 of the Act, the Fund may invest without
limit in illiquid investments. Liquidity risk exists when particular
investments are difficult to purchase or sell. Illiquid investments are
investments that the Fund reasonably expects cannot be sold or
disposed of in current market conditions in seven calendar days or less
without the sale or disposition significantly changing the market value
of the investment. Illiquid investments may become harder to value,
especially in changing markets. The Fund’s investments in illiquid
investments may reduce the returns of the Fund because it may be
unable to sell the illiquid investments at an advantageous time or price
or possibly require the Fund to dispose of other investments at
unfavorable times or prices in order to satisfy its obligations, which
could prevent the Fund from taking advantage of other investment
opportunities. Additionally, the market for certain investments may
become illiquid under adverse market or economic conditions
independent of any specific adverse changes in the conditions of a
particular issuer. Bond markets have consistently grown over the past
three decades while the capacity for traditional dealer counterparties to
engage in fixed income trading has not kept pace and in some cases has
decreased. As a result, dealer inventories of corporate bonds, which
provide a core indication of the ability of financial intermediaries to
“make markets,” are at or near historic lows in relation to market size.
Because market makers seek to provide stability to a market through
their intermediary services, the significant reduction in dealer inventories
could potentially lead to decreased liquidity and increased volatility in
the fixed income markets. Such issues may be exacerbated during
periods of economic uncertainty.
In such cases, the Fund, due to limitations on investments in illiquid
investments and the difficulty in purchasing and selling such securities
or instruments, may be unable to achieve its desired level of exposure to
a certain sector. To the extent that the Fund invests in securities of
companies with smaller market capitalizations, foreign (non-U.S.)
securities, Rule 144A securities, illiquid sectors of fixed income
securities, derivatives or securities with substantial market and/or credit
risk, the Fund will tend to have greater exposure to liquidity risk.
Further, fixed income securities with longer durations until maturity face
heightened levels of liquidity risk as compared to fixed income securities
with shorter durations until maturity. The risks associated with illiquid
instruments may be particularly acute in situations in which the Fund’s
operations require cash (such as in connection with repurchase offers)
and could result in the Fund borrowing to meet its short-term needs or
incurring losses on the sale of illiquid instruments. See “Principal Risks
of the Fund —Repurchase Offers Risk.” It may also be the case that
other market participants may be attempting to liquidate fixed income
holdings at the same time as the Fund, causing increased supply in the
market and contributing to liquidity risk and downward pricing pressure.
See “Principal Risks of the Fund—Valuation Risk.”
Repurchase Offers Risk
As described under “Periodic Repurchase Offers” above, the Fund is an
“interval fund” and, in order to provide liquidity to shareholders, the
Fund, subject to applicable law, conducts quarterly repurchase offers of
the Fund’s outstanding Common Shares at NAV, subject to approval of
the Board. In each quarter, such repurchase offers will be for at least 5%
and not more than 25% of its outstanding Common Shares at NAV,
pursuant to Rule 23c-3 under the Act.
The Fund currently expects to conduct quarterly repurchase offers for
10% of its outstanding Common Shares under ordinary circumstances.
The Fund believes that these repurchase offers are generally beneficial
to the Fund’s shareholders, and repurchases generally will be funded
from available cash or sales of portfolio securities. However, repurchase
offers and the need to fund repurchase obligations may affect the ability
of the Fund to be fully invested or force the Fund to maintain a higher
percentage of its assets in liquid investments, which may harm the
Fund’s investment performance. Moreover, diminution in the size of the
Fund through repurchases may result in untimely sales of portfolio
securities (with associated imputed transaction costs, which may be
significant), and may limit the ability of the Fund to participate in new
investment opportunities or to achieve its investment objectives. The
Fund may accumulate cash by holding back (i.e., not reinvesting)
payments received in connection with the Fund’s investments. If at any
time cash and other liquid assets held by the Fund are not sufficient to
meet the Fund’s repurchase obligations, the Fund intends, if necessary,
to sell investments. To the extent the Fund employs investment leverage,
repurchases of Common Shares would compound the adverse effects of
leverage in a declining market. In addition, if the Fund borrows to
finance repurchases, interest on that borrowing will negatively affect
Common Shareholders who do not tender their Common Shares by
increasing the Fund’s expenses and reducing any net investment
income. If a repurchase offer is oversubscribed, the Fund may, but is not
required to, determine to increase the amount repurchased by up to 2%
of the Fund’s outstanding shares as of the date of the Repurchase
Request Deadline. In the event that the Fund determines not to
repurchase more than the repurchase offer amount, or if shareholders
tender more than the repurchase offer amount plus 2% of the Fund’s
outstanding shares as of the date of the Repurchase Request Deadline,
the Fund will repurchase the Common Shares tendered on a pro rata
basis, and shareholders will have to wait until the next repurchase offer
to make another repurchase request. As a result, shareholders may be
unable to liquidate all or a given percentage of their investment in the
Fund during a particular repurchase offer. Some shareholders, in
anticipation of proration, may tender more Common Shares than they
wish to have repurchased in a particular quarter, thereby increasing the
likelihood that proration will occur. A shareholder may be subject to
market and other risks, and the NAV of Common Shares tendered in a
repurchase offer may decline between the Repurchase Request Deadline
and the date on which the NAV for tendered Common Shares is
determined. In addition, the repurchase of Common Shares by the Fund
may be a taxable event to shareholders.
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
50
PIMCO California Flexible Municipal Income Fund
High Yield Securities Risk
To the extent that the Fund invests in high yield securities and unrated
securities of similar credit quality (commonly known as “high yield
securities” or “junk bonds”), the Fund may be subject to greater levels
of credit risk, call risk and liquidity risk than funds that do not invest in
such securities, which could have a negative effect on the NAV of the
Fund’s Common Shares or Common Share dividends. These securities
are considered predominantly speculative with respect to an issuer’s
continuing ability to make principal and interest payments, and may be
more volatile than other types of securities. An economic downturn or
individual corporate developments could adversely affect the market for
these securities and reduce the Fund’s ability to sell these securities at
an advantageous time or price. An economic downturn would generally
lead to a higher non-payment rate and, a high yield security may lose
significant market value before a default occurs. The Fund may purchase
distressed securities that are in default or the issuers of which are in
bankruptcy, which involve heightened risks.
High yield securities structured as zero-coupon bonds or pay-in-kind
securities tend to be especially volatile as they are particularly sensitive
to downward pricing pressures from rising interest rates or widening
spreads and may require the Fund to make taxable distributions of
imputed income without receiving the actual cash currency. Issuers of
high yield securities may have the right to “call” or redeem the issue
prior to maturity, which may result in the Fund having to reinvest the
proceeds in other high yield securities or similar instruments that may
pay lower interest rates. The Fund may also be subject to greater levels
of liquidity risk than funds that do not invest in high yield securities.
Consequently, transactions in high yield securities may involve greater
costs than transactions in more actively traded securities.
These factors may result in the Fund being unable to realize full value
for these securities and/or may result in the Fund not receiving the
proceeds from a sale of a high yield security for an extended period after
such sale, each of which could result in losses to the Fund. Because of
the risks involved in investing in high yield securities, an investment in
the Fund should be considered speculative.
To the extent the Fund focuses on below investment grade debt
obligations, PIMCO’s capabilities in analyzing credit quality and
associated risks will be particularly important, and there can be no
assurance that PIMCO will be successful in this regard. See “The Fund’s
Investment Objectives and Strategies—Portfolio Contents—High Yield
Securities” for additional information.
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 factors including, but
not limited to, PIMCO's assessment of the credit quality of the issuer of
such security, the price at which such security could be sold and the
rating, if any, assigned to such security by other rating agencies. Analysis
of creditworthiness may be more complex for issuers of high yield
securities than for issuers of higher quality debt securities.
Market Risk
The market price of securities owned by the Fund may go up or down,
sometimes rapidly or unpredictably. Securities may decline in value due
to factors affecting securities markets generally or particular industries
represented in the securities markets. The value of a security may decline
due to general market conditions that are not specifically related to a
particular company, such as real or perceived adverse economic
conditions, changes in the general outlook for corporate earnings,
changes in interest or currency rates, adverse changes to credit markets
or adverse investor sentiment generally. The value of a security may also
decline due to factors that affect a particular industry or industries, such
as labor shortages or increased production costs and competitive
conditions within an industry. During a general downturn in the
securities markets, multiple asset classes may decline in value
simultaneously. Equity securities generally have greater price volatility
than fixed income securities. Credit ratings downgrades may also
negatively affect securities held by the Fund. Even when markets
perform well, there is no assurance that the investments held by the
Fund will increase in value along with the broader market.
In addition, market risk includes the risk that geopolitical and other
events will disrupt the economy on a national or global level. For
instance, war, terrorism, social unrest, recessions, supply chain
disruptions, market manipulation, government defaults, government
shutdowns, political changes, diplomatic developments or the
imposition of sanctions and other similar measures, public health
emergencies (such as the spread of infectious diseases, pandemics and
epidemics) and natural/environmental disasters can all negatively
impact the securities markets, which could cause the Fund to lose value.
These events could reduce consumer demand or economic output, result
in market closures, travel restrictions or quarantines, and significantly
adversely impact the economy. The current contentious domestic
political environment, as well as political and diplomatic events within
the United States and abroad, such as presidential elections in the
U.S. or abroad or the U.S. government's inability at times to agree on a
long-term budget and deficit reduction plan, has in the past resulted,
and may in the future result, in a government shutdown or otherwise
adversely affect the U.S. regulatory landscape, the general market
environment and/or investor sentiment, which could have an adverse
impact on the Fund's investments and operations. Additional and/or
prolonged U.S. federal government shutdowns may affect investor and
consumer confidence and may adversely impact financial markets and
the broader economy, perhaps suddenly and to a significant degree.
Governmental and quasi-governmental authorities and regulators
throughout the world have previously responded to serious economic
disruptions with a variety of significant fiscal and monetary policy
changes, including but not limited to, direct capital infusions into
companies, new monetary programs and dramatically lower interest
rates. An unexpected or sudden reversal of these policies, or the
ineffectiveness of these policies, could increase volatility in securities
markets, which could adversely affect the Fund's investments. Any
market disruptions could also prevent the Fund from executing
advantageous investment decisions in a timely manner. Funds that have
focused their investments in a region enduring geopolitical market
51 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
disruption will face higher risks of loss, although the increasing
interconnectivity between global economies and financial markets can
lead to events or conditions in one country, region or financial market
adversely impacting a different country, region or financial market. Thus,
investors should closely monitor current market conditions to determine
whether the Fund meets their individual financial needs and tolerance
for risk.
Recently, there have been inflationary price movements. As such, fixed
income securities markets may experience heightened levels of interest
rate, volatility and liquidity risk. As discussed more under “Interest Rate
Risk,” the Federal Reserve has begun to raise interest rates from
historically low levels and has signaled an intention to continue to do
so. Any additional interest rate increases in the future could cause the
value of the Fund, that invests in fixed income securities to decrease.
Exchanges and securities markets may close early, close late or issue
trading halts on specific securities, which may result in, among other
things, the Fund being unable to buy or sell certain securities or financial
instruments at an advantageous time or accurately price its portfolio
investments.
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 municipal bonds at
attractive prices or value municipal bonds.
Management Risk
The Fund is subject to management risk because it is an actively
managed investment portfolio. PIMCO and each individual portfolio
manager will apply investment techniques and risk analysis in making
investment decisions for the Fund, but there can be no guarantee that
these decisions will produce the desired results. Certain securities or
other instruments in which the Fund seeks to invest may not be
available in the quantities desired. In addition, regulatory restrictions,
actual or potential conflicts of interest or other considerations may
cause PIMCO to restrict or prohibit participation in certain investments.
In such circumstances, PIMCO or the individual portfolio managers may
determine to purchase other securities or instruments as substitutes.
Such substitute securities or instruments may not perform as intended,
which could result in losses to the Fund. To the extent the Fund employs
strategies targeting perceived pricing inefficiencies, arbitrage strategies
or similar strategies, it is subject to the risk that the pricing or valuation
of the securities and instruments involved in such strategies may change
unexpectedly, which may result in reduced returns or losses to the Fund.
The Fund is also subject to the risk that deficiencies in the internal
systems or controls of PIMCO or another service provider will cause
losses for the Fund or hinder Fund operations. For example, trading
delays or errors (both human and systemic) could prevent the Fund from
purchasing a security expected to appreciate in value. Additionally,
actual or potential conflicts of interest, legislative, regulatory, or tax
restrictions, policies or developments may affect the investment
techniques available to PIMCO and each individual portfolio manager in
connection with managing the Fund and may also adversely affect the
ability of the Fund to achieve its investment objectives. There also can be
no assurance that all of the personnel of PIMCO will continue to be
associated with PIMCO for any length of time. The loss of services of one
or more key employees of PIMCO could have an adverse impact on the
Fund’s ability to realize its investment objectives.
In addition, the Fund may rely on various third-party sources to calculate
its NAV. As a result, the Fund is subject to certain operational risks
associated with reliance on service providers and service providers’ data
sources. In particular, errors or systems failures and other technological
issues may adversely impact the Fund’s calculations of its NAV, and such
NAV calculation issues may result in inaccurately calculated NAVs,
delays in NAV calculation and/or the inability to calculate NAVs over
extended periods. The Fund may be unable to recover any losses
associated with such failures.
Reinvestment Risk
Income from the Fund’s portfolio will decline if and when the Fund
invests the proceeds from matured, traded or called debt obligations at
market interest rates that are below the portfolio’s current earnings rate.
For instance, during periods of declining interest rates, an issuer of debt
obligations may exercise an option to redeem securities prior to
maturity, forcing the Fund to invest in lower-yielding securities. The Fund
also may choose to sell higher yielding portfolio securities and to
purchase lower yielding securities to achieve greater portfolio
diversification, because the portfolio managers believe the current
holdings are overvalued or for other investment-related reasons. A
decline in income received by the Fund from its investments is likely to
have a negative effect on dividend levels, NAV and/or overall return of
the Common Shares.
Leverage Risk
The Fund’s use of leverage (as described under “Use of Leverage” in the
body of this prospectus) creates the opportunity for increased Common
Share net income, but also creates special risks for Common
Shareholders. To the extent used, there is no assurance that the Fund’s
leveraging strategies will be successful. Leverage is a speculative
technique that may expose the Fund to greater risk and increased costs.
The Fund’s assets attributable to any outstanding Preferred Shares or
the net proceeds that the Fund obtains from its use of tender option
bonds, derivatives or other forms of leverage, if any, will be invested in
accordance with the Fund’s investment objectives and policies as
described in this prospectus. Dividends payable with respect to any
Preferred Shares outstanding and interest expense payable by the Fund
with respect to any tender option bonds, derivatives and other forms of
leverage will generally be based on shorter-term interest rates that
would be periodically reset. So long as the Fund’s portfolio investments
provide a higher rate of return (net of applicable Fund expenses) than
April 30, 2023
(as supplemented January
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52
PIMCO California Flexible Municipal Income Fund
the dividend rate on any Preferred Shares outstanding, including
the
Preferred Shareholder Gross-Up, and the interest expenses and other
costs to the Fund of such other leverage, the investment of the proceeds
thereof will generate more income than will be needed to pay the costs
of the leverage. If so, and all other things being equal, the excess may be
used to pay higher dividends to Common Shareholders than if the Fund
were not so leveraged. If, however, shorter-term interest rates rise
relative to the rate of return on the Fund’s portfolio, the interest and
other costs to the Fund of leverage (including interest expenses on
tender option bonds and the dividend rate on any outstanding Preferred
Shares, including
the
Preferred Shareholder Gross-Up) could exceed the
rate of return on the debt obligations and other investments held by the
Fund, thereby reducing return to Common Shareholders. In addition,
fees and expenses of any form of leverage used by the Fund will be
borne entirely by the Common Shareholders (and not by
Preferred
Shareholders, if any) and will reduce the investment return of the
Common Shares. Therefore, there can be no assurance that the Fund’s
use of leverage will result in a higher yield on the Common Shares, and
it may result in losses. In addition, any Preferred Shares issued by the
Fund are expected to pay cumulative dividends, which may tend to
increase leverage risk.
Leverage creates several major types of risks for Common Shareholders,
including:
◾
the likelihood of greater volatility of NAV of Common Shares, and
of the investment return to Common Shareholders, than a
comparable portfolio without leverage;
◾
the possibility either that Common Share dividends will fall if the
interest and other costs of leverage rise, or that dividends paid on
Common Shares will fluctuate because such costs vary over time;
and
◾
the effects of leverage in a declining market or a rising interest
rate environment, as leverage is likely to cause a greater decline in
the NAV of the Common Shares than if the Fund were not
leveraged.
In addition, the counterparties to the Fund’s leveraging transactions and
any Preferred Shareholders of the Fund will have complete priority over
the Fund’s Common Shareholders in the distribution of the Fund’s
assets.
In addition to tender option bonds and
Preferred Shares, the Fund may
engage in other transactions that may give rise to a form of leverage
including, among others loans of portfolio securities, short sales and
when-issued, delayed delivery and forward commitment transactions,
credit default swaps, reverse repurchases, or other derivatives. The
Fund
’
s use of such transactions gives rise to associated leverage risks
described above, and may adversely affect the Fund
’
s income,
distributions and total returns to Common Shareholders. The Fund may
offset derivatives positions against one another or against other assets
to manage effective market exposure resulting from derivatives in its
portfolio. To the extent that any offsetting positions do not behave in
relation to one another as expected, the Fund may perform as if it is
leveraged through use of these derivative strategies. See “Use of
Leverage.”
The Fund is
required to satisfy certain
regulatory and rating
asset
coverage requirements in connection with its use of Preferred Shares
.
Accordingly, any decline in the net asset value of the Fund
’
s investments
could result in the risk that the Fund will fail to meet its asset coverage
requirements for any such Preferred Shares or the risk of the Preferred
Shares being downgraded by a rating agency. In an extreme case, the
Fund
’
s current investment income might not be sufficient to meet the
dividend requirements on any Preferred Shares outstanding. In order to
address these types of events, the Fund might need to liquidate
investments in order to fund a redemption of some or all of
Preferred
Shares
.
Liquidations
at times of adverse economic conditions may result
in a loss to the Fund. At other times, these liquidations may result in
gain at the Fund level and thus in additional taxable distributions to
Common Shareholders. See “Tax Matters” for more information. Any
Preferred Shares, tender option bonds, loans of portfolio securities, short
sales and when-issued, delayed delivery and forward commitment
transactions, credit default swaps, reverse repurchases, or other
derivatives by the Fund or counterparties to the Fund
’
s other leveraging
transactions, if any, would have, seniority over the Fund
’
s Common
Shares.
When
the Fund issues Preferred Shares, the Fund
pays
(and the
Common Shareholders
bear) all costs and expenses relating to the
issuance and ongoing maintenance of Preferred Shares. In addition,
holders of any Preferred Shares issued by the Fund would have
complete priority over Common Shareholders in the distribution of the
Fund
’
s assets. Furthermore, Preferred Shareholders, voting separately as
a single class,
have the right to elect two members of the Board at all
times and to elect a majority of the trustees in the event two full years’
dividends on the Preferred Shares are unpaid, and
also have separate
class voting rights on certain matters. Accordingly, Preferred
Shareholders may have interests that differ from those of Common
Shareholders, and may at times have disproportionate influence over
the Fund
’
s affairs.
Because the fees received by the Investment Manager are based on the
average daily “total managed assets” of the Fund, which includes total
assets of the Fund (including assets attributable to any reverse
repurchase agreements, dollar rolls, tender option bonds, borrowings
and Preferred Shares that may be outstanding, if any), the Investment
Manager has a financial incentive for the Fund to use certain forms of
leverage (e.g., Preferred Shares and tender option bonds), which may
create a conflict of interest between the Investment Manager, on the
one hand, and the Common Shareholders, on the other hand.
Derivatives Risk
Derivatives and other similar instruments (referred to collectively as
“derivatives”) are financial contracts whose value depends on, or is
derived from, the value of an underlying asset, reference rate or index.
The Fund may, but is not required to, utilize a variety of derivative
instruments (both long and short positions) for investment or risk
management purposes. The Fund may use derivatives to gain exposure
to securities markets in which it may invest (e.g., pending investment of
the proceeds of this offering in individual securities, as well as on an
ongoing basis). The Fund may also use derivatives to add leverage to its
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portfolio. See “Principal Risks of the Fund —Leverage Risk.” Derivatives
transactions that the Fund may utilize include, but are not limited to,
purchases or sales of futures and forward contracts (including foreign
currency exchange contracts), call and put options, credit default swaps,
total return swaps, basis swaps and other swap agreements. The Fund
may also have exposure to derivatives, such as interest rate or
credit-default swaps, through investment in credit-linked trust
certificates and other securities issued by special purpose or structured
vehicles. The Fund may also use derivatives for leverage, in which case
their use would involve leveraging risk, and in some cases, may subject
the Fund to the potential for unlimited loss. The use of derivatives may
cause the Fund’s investment returns to be impacted by the performance
of securities the Fund does not own and result in the Fund’s total
investment exposure exceeding the value of its portfolio.
The Fund’s use of derivative instruments involves risks different from, or
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 (which may be heightened for highly-customized derivatives),
interest rate risk, market risk, leverage risk, counterparty (including
credit) risk, operational risk, legal risk, leveraging risk, counterparty risk,
tax risk and management risk, as well as risks arising from changes in
applicable requirements, risks arising from margin requirements and
risks arising from mispricing or valuation complexity. They also involve
the risk that changes in the value of a derivative may not correlate
perfectly with the underlying asset, rate or index. If the Fund invests in a
derivative instrument, the Fund could lose more than the amount
invested and derivatives may increase the volatility of the Fund,
especially in unusual or extreme market conditions. The Fund may be
required to hold additional cash or sell other investments in order to
obtain cash to close out a position and changes in the value of a
derivative may also create margin delivery or settlement payment
obligations for the Fund.
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 or that, if used, such strategies will be successful. In
addition, the Fund’s use of derivatives may increase or accelerate the
amount of taxes payable by Common Shareholders. See “Tax Matters.”
OTC derivatives are also subject to the risk that a counterparty to the
transaction will not fulfill its contractual obligations to the other party,
as many of the protections afforded to centrally-cleared derivatives
might not be available for OTC derivatives transactions. For derivatives
traded on an exchange or through a central counterparty, credit risk
resides with the Fund’s clearing broker, or the clearinghouse itself, rather
than with a counterparty in an OTC derivative transaction. The primary
credit risk on derivatives that are exchange-traded or traded through a
central clearing counterparty resides with the Fund’s clearing broker, or
the clearinghouse itself.
Participation in the markets for derivative instruments involves
investment risks and transaction costs to which the Fund may not be
subject absent the use of these strategies. The skills needed to
successfully execute derivative strategies may be different from those
needed for other types of transactions. If the Fund incorrectly forecasts
the value and/or creditworthiness of securities, currencies, interest rates,
counterparties or other economic factors involved in a derivative
transaction, the Fund might have been in a better position if the Fund
had not entered into such derivative transaction. In evaluating the risks
and contractual obligations associated with particular derivative
instruments, it is important to consider that certain derivative
transactions may be modified or terminated only by mutual consent of
the Fund and its counterparty. Therefore, it may not be possible for the
Fund to modify, terminate, or offset the Fund’s obligations or the Fund’s
exposure to the risks associated with a derivative transaction prior to its
scheduled termination or maturity date, which may create a possibility
of increased volatility and/or decreased liquidity to the Fund. Hedges are
sometimes subject to imperfect matching between the derivative and
the underlying instrument, and there can be no assurance that the
Fund’s hedging transactions will be effective. In such case, the Fund may
lose money.
Because the markets for certain derivative instruments (including
markets located in foreign countries) are relatively new and still
developing, appropriate derivative transactions may not be available in
all circumstances for risk management or other purposes. Upon the
expiration of a particular contract, the Fund may wish to retain the
Fund’s position in the derivative instrument by entering into a similar
contract, but may be unable to do so if the counterparty to the original
contract is unwilling to enter into the new contract and no other
appropriate counterparty can be found. When such markets are
unavailable, the Fund will be subject to increased liquidity and
investment risk.
When a derivative is used as a hedge against a position that the Fund
holds, any loss generated by the derivative generally should be
substantially offset by gains on the hedged investment, and vice versa.
Although hedging can reduce or eliminate losses, it can also reduce or
eliminate gains. Hedges are sometimes subject to imperfect matching
between the derivative and the underlying instrument, and there can be
no assurance that the Fund’s hedging transactions will be effective. In
such case, the Fund may lose money.
The regulation of the derivatives markets has increased over the past
several years, and additional future regulation of the derivatives markets
may make derivatives more costly, may limit the availability or reduce
the liquidity of derivatives, or may otherwise adversely affect the value
or performance of derivatives. Any such adverse future developments
could impair the effectiveness or raise the costs of the Fund’s derivative
transactions, impede the employment of the Fund’s derivatives
strategies, or adversely affect the Fund’s performance and cause the
Fund to lose value.
Credit Default Swaps Risk
Credit default swap agreements may involve greater risks than if the
Fund had invested in the reference obligation directly since, in addition
to general market risks, credit default swaps are subject to leverage risk,
illiquidity risk, counterparty risk and credit risk. A buyer generally also
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PIMCO California Flexible Municipal Income Fund
will lose its investment and recover nothing should no credit event occur
and the swap is held to its termination date. If a credit event were to
occur, the value of any deliverable obligation received by the seller (if
any), coupled with the upfront or periodic payments previously received,
may be less than the full notional value it pays to the buyer, resulting in
a loss of value to the seller. When the Fund acts as a seller of a credit
default swap, it is exposed to many of the same risks of leverage
described herein. As the seller, the Fund would receive a stream of
payments over the term of the swap agreement provided that no event
of default has occurred with respect to the referenced debt obligation
upon which the swap is based. The Fund would effectively add leverage
to its portfolio because,
if
a default occurs, the stream of payments may
stop and, in addition to its total net assets, the Fund would be subject to
investment exposure on the notional amount of the swap.
Although the Fund may seek to realize gains by selling credit default
swaps that increase in value, to realize gains on selling credit default
swaps, an active secondary market for such instruments must exist or
the Fund must otherwise be able to close out these transactions at
advantageous times. In addition to the risk of losses described above, if
no such secondary market exists or the Fund is otherwise unable to
close out these transactions at advantageous times, selling credit
default swaps may not be profitable for the Fund.
The market for credit default swaps has become more volatile as the
creditworthiness of certain counterparties has been questioned and/or
downgraded. The Fund will be subject to credit risk with respect to the
counterparties to the credit default swap contract (whether a clearing
corporation or another third party). If a counterparty’s credit becomes
significantly impaired, multiple requests for collateral posting in a short
period of time could increase the risk that the Fund may not receive
adequate collateral. The Fund may exit its obligations under a credit
default swap only by terminating the contract and paying applicable
breakage fees, or by entering into an offsetting credit default swap
position, which may cause the Fund to incur more losses.
Valuation Risk
Certain securities in which the Fund invests may be less liquid and more
difficult to value than other types of securities. Investments for which
market quotations are not readily available are valued at fair value as
determined in good faith pursuant to Rule 2a-5 under the Act. See
“How Fund Shares are Priced.” Fair value pricing may require subjective
determinations about the value of a security or other asset. As a result,
there can be no assurance that fair value pricing will result in
adjustments to the prices of securities or other assets, or that fair value
pricing will reflect actual market value, and it is possible that the fair
value determined for a security or other asset will be materially different
from quoted or published prices, from the prices used by others for the
same security or other asset and/or from the value that actually could be
or is realized upon the sale of that security or other asset.
Counterparty Risk
The Fund will be subject to credit risk with respect to the counterparties
to the derivative contracts and other instruments entered into by the
Fund or held by special purpose or structured vehicles in which the Fund
invests. In the event that the Fund enters into a derivative transaction
with a counterparty that subsequently becomes insolvent or becomes
the subject of a bankruptcy case, the derivative transaction may be
terminated in accordance with its terms and the Fund’s ability to realize
its rights under the derivative instrument and its ability to distribute the
proceeds could be adversely affected. If a counterparty becomes
bankrupt or otherwise fails to perform its obligations under a derivative
contract due to financial difficulties, the Fund may experience significant
delays in obtaining any recovery (including recovery of any collateral it
has provided to the counterparty) in a dissolution, assignment for the
benefit of creditors, liquidation, winding-up, bankruptcy, or other
analogous proceeding. In addition, in the event of the insolvency of a
counterparty to a derivative transaction, the derivative transaction
would typically be terminated at its fair market value. If the Fund is
owed this fair market value in the termination of the derivative
transaction and its claim is unsecured, the Fund will be treated as a
general creditor of such counterparty, and will not have any claim with
respect to any underlying security or asset. The Fund may obtain only a
limited recovery or may obtain no recovery in such circumstances. While
the Fund may seek to manage its counterparty risk by transacting with a
number of counterparties, concerns about the solvency of, or a default
by, one large market participant could lead to significant impairment of
liquidity and other adverse consequences for other counterparties.
Confidential Information Access Risk
In managing the Fund (and other PIMCO clients), PIMCO may from time
to time have the opportunity to receive Confidential Information about
the issuers of certain investments, including, without limitation, senior
floating rate loans, other loans and related investments being
considered for acquisition by the Fund or held in the Fund’s portfolio.
For example, an issuer of privately placed loans considered by the Fund
may offer to provide PIMCO with financial information and related
documentation regarding the issuer that is not publicly available.
Pursuant to applicable policies and procedures, PIMCO may (but is not
required to) seek to avoid receipt of Confidential Information from the
issuer so as to avoid possible restrictions on its ability to purchase and
sell investments on behalf of the Fund and other clients to which such
Confidential Information relates. In such circumstances, the Fund (and
other PIMCO clients) may be disadvantaged in comparison to other
investors, including with respect to the price the Fund pays or receives
when it buys or sells an investment. Further, PIMCO’s and the Fund’s
abilities to assess the desirability of proposed consents, waivers or
amendments with respect to certain investments may be compromised
if they are not privy to available Confidential Information. PIMCO may
also determine to receive such Confidential Information in certain
circumstances under its applicable policies and procedures. If PIMCO
intentionally or unintentionally comes into possession of Confidential
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Information, it may be unable, potentially for a substantial period of
time, to purchase or sell investments to which such Confidential
Information relates.
Private Placements Risk
A private placement involves the sale of securities that have not been
registered under the 1933 Act, or relevant provisions of applicable
non-U.S. law, to certain institutional and qualified individual purchasers,
such as the Fund. In addition to the general risks to which all securities
are subject, securities received in a private placement generally are
subject to strict restrictions on resale, and there may be no liquid
secondary market or ready purchaser for such securities. See “Principal
Risks of the Fund - Liquidity Risk.” Therefore, the Fund may be unable to
dispose of such securities when it desires to do so, or at the most
favorable time or price. Private placements may also raise valuation
risks. See “Principal Risks of the Fund - Valuation Risk.”
Privacy and Data Security Risk
The GLBA and other laws limit the disclosure of certain non-public
personal information about a consumer to non- affiliated third parties
and require financial institutions to disclose certain privacy policies and
practices with respect to information sharing with both affiliates and
non- affiliated third parties. Many states and a number of
non-U.S. jurisdictions have enacted privacy and data security laws
requiring safeguards on the privacy and security of consumers’
personally identifiable information. Other laws deal with obligations to
safeguard and dispose of private information in a manner designed to
avoid its dissemination. Privacy rules adopted by the U.S. Federal Trade
Commission and SEC implement GLBA and other requirements and
govern the disclosure of consumer financial information by certain
financial institutions, ranging from banks to private investment funds.
U.S. platforms following certain models generally are required to have
privacy policies that conform to these GLBA and other requirements. In
addition, such platforms typically have policies and procedures intended
to maintain platform participants’ personal information securely and
dispose of it properly. The Fund generally does not intend to obtain or
hold borrowers’ non-public personal information, and the Fund has
implemented procedures reasonably designed to prevent the disclosure
of borrowers’ non-public personal information to the Fund. However,
service providers to the Fund, including their custodians and the
platforms acting as loan servicers for the Fund, may obtain, hold or
process such information. The Fund cannot guarantee the security of
non-public personal information in the possession of such a service
provider and cannot guarantee that service providers have been and will
continue to comply with the GLBA, other data security and privacy laws
and any other related regulatory requirements. Violations of GLBA and
other laws could subject the Fund to litigation and/or fines, penalties or
other regulatory action, which, individually or in the aggregate, could
have an adverse effect on the Fund. The Fund may also face regulations
related to privacy and data security in the other jurisdictions in which
the Fund invests.
Regulatory Changes Risk
Financial entities, such as investment companies and investment
advisers, are generally subject to extensive government regulation and
intervention. Government regulation and/or intervention may change
the way the Fund is regulated, affect the expenses incurred directly by
the Fund and the value of its investments, and limit and/or preclude the
Fund’s ability to achieve its investment objectives. Government
regulation may change frequently and may have significant adverse
consequences. The Fund and the Investment Manager have historically
been eligible for exemptions from certain regulations. However, there is
no assurance that the Fund and the Investment Manager will continue
to be eligible for such exemptions.
Moreover, government regulation may have unpredictable and
unintended effects. Legislative or regulatory actions to address
perceived liquidity or other issues in fixed income markets generally, or
in particular markets such as the municipal securities market, may alter
or impair the Fund’s ability to pursue its investment objectives or utilize
certain investment strategies and techniques.
Actions by governmental entities may also impact certain instruments in
which the Fund invests and reduce market liquidity and resiliency. For
example, the Fund’s investments (including, but not limited to,
repurchase agreements, collateralized loan obligations and
mortgage-backed securities), payment obligations and financing terms
may rely in some fashion on LIBOR. For more information related to the
LIBOR transition, see “Principal Risks of the Fund – Regulatory Risk –
LIBOR.”
Also, nationalization, expropriation or confiscatory taxation, currency
blockage, market disruptions, political changes, security suspensions or,
diplomatic developments or the imposition of sanctions or other similar
measures could adversely affect the Fund's investments. In the event of
nationalization, expropriation or other confiscation, the Fund could lose
its entire investment. The type and severity of sanctions and other
similar measures, including counter sanctions and other retaliatory
actions, that may be imposed could vary broadly in scope, and their
impact is difficult to ascertain. These types of measures may include, but
are not limited to, banning a sanctioned country or certain persons or
entities associated with such country from global payment systems that
facilitate cross-border payments, restricting the settlement of securities
transactions by certain investors, and freezing the assets of particular
countries, entities or persons. The imposition of sanctions and other
similar measures could, among other things, result in a decline in the
value and/or liquidity of securities issued by the sanctioned country or
companies located in or economically tied to the sanctioned country,
downgrades in the credit ratings of the sanctioned country's securities
or those of companies located in or economically tied to the sanctioned
country, currency devaluation or volatility, and increased market
volatility and disruption in the sanctioned country and throughout the
world. Sanctions and other similar measures could directly or indirectly
limit or prevent
the
Fund from buying and selling securities (in the
sanctioned country and other markets), significantly delay or prevent the
settlement of securities transactions, and adversely impact the Fund's
liquidity and performance.
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PIMCO California Flexible Municipal Income Fund
Regulatory Risk – LIBOR
Certain instruments in which the Fund may invest rely in some fashion
upon the London Interbank Offered Rate (“LIBOR”). LIBOR was
traditionally an average interest rate, determined by the ICE Benchmark
Administration, that banks charge one another for the use of short-term
money. On March 5, 2021, the Financial Conduct Authority (“FCA”), the
United Kingdom’s financial regulatory body and regulator of LIBOR,
publicly announced that all U.S. Dollar LIBOR settings will either cease
to be provided by any administrator or will no longer be representative
(i) immediately after December 31, 2021 for one-week and two-month
U.S. Dollar LIBOR settings and (ii) immediately after June 30, 2023 for
the remaining U.S. Dollar LIBOR settings. As of January 1, 2022, as a
result of supervisory guidance from U.S. regulators, U.S. regulated
entities have generally ceased entering into new LIBOR contracts with
limited exceptions. Publication of all Japanese yen and the one- and
six-month sterling LIBOR settings have ceased, and while publication of
the three-month Sterling LIBOR setting will continue through at least
the end of March 2024 on the basis of a changed methodology (known
as “synthetic LIBOR”), this rate has been designated by the FCA as
unrepresentative of the underlying market that it seeks to measure and
is solely available for use in legacy transactions. Certain bank-sponsored
committees in other jurisdictions, including Europe, the United Kingdom,
Japan and Switzerland, have selected alternative reference rates
denominated in other currencies. Although the transition process away
from LIBOR has become increasingly well-defined, any potential effects
of the transition away from LIBOR on the Fund or on certain instruments
in which the Fund invests can be difficult to ascertain, and may vary
depending on factors that include, but are not limited to: (i) existing
fallback or termination provisions in individual contracts and (ii)
whether, how, and when industry participants adopt new reference
rates for affected instruments. So-called “tough legacy” contracts have
LIBOR interest rate provisions with no fallback provisions contemplating
a permanent discontinuation of LIBOR, inadequate fallback provisions
or fallback provisions which may not effectively result in a transition
away from LIBOR prior to LIBOR’s planned replacement date. On
March 15, 2022, the Adjustable Interest Rate (LIBOR) Act was signed
into law. This law provides a statutory fallback mechanism on a
nationwide basis to replace LIBOR with a benchmark rate that is
selected by the Board of Governors of the Federal Reserve System based
on the Secured Overnight Financing Rate (“SOFR”) for tough legacy
contracts. On February 27, 2023, the Federal Reserve System’s final rule
in connection with this law became effective, establishing benchmark
replacements based on SOFR and Term SOFR (a forward-looking
measurement of market expectations of SOFR implied from certain
derivatives markets) for applicable tough legacy contracts governed by
U.S. law. In addition, the FCA has announced that it will require the
publication of synthetic LIBOR for the one-month, three-month and
six-month U.S. Dollar LIBOR settings after June 30, 2023 through at
least September 30, 2024. Certain of the Fund’s investments may
involve individual tough legacy contracts which may be subject to the
Adjustable Interest Rate (LIBOR) Act or synthetic LIBOR and no
assurances can be given that these measures will have the intended
effects. Moreover, certain aspects of the transition from LIBOR will rely
on the actions of third-party market participants, such as clearing
houses, trustees, administrative agents, asset servicers and certain
service providers; PIMCO cannot guarantee the performance of such
market participants and any failure on the part of such market
participants to manage their part of the LIBOR transition could impact
the Fund. The transition of investments from LIBOR to a replacement
rate as a result of amendment, application of existing fallbacks,
statutory requirements or otherwise may also result in a reduction in the
value of certain instruments held by the Fund or a reduction in the
effectiveness of related Fund transactions such as hedges. In addition,
an instrument’s transition to a replacement rate could result in
variations in the reported yields of the Fund that holds such instrument.
Any such effects of the transition away from LIBOR, as well as other
unforeseen effects, could result in losses to the Fund.
Other Investment Companies Risk
The Fund may invest up to 5% of its total assets in securities of other
investment companies (including those advised by PIMCO), including
closed-end funds, exchange-traded funds and other open-end funds,
that invest primarily in municipal bonds and other municipal securities
of the types in which the Fund may invest directly. As a shareholder 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 investment management fees and other expenses with
respect to the assets so invested. Common Shareholders would
therefore be subject to duplicative expenses to the extent the Fund
invests in other investment companies. In addition, these other
investment companies may utilize leverage, in which case an investment
would subject the Fund to additional risks associated with leverage. Due
to its own financial interest or other business considerations, the
Investment Manager may choose to invest a portion of the Fund’s assets
in investment companies sponsored or managed by the Investment
Manager or its related parties in lieu of investments by the Fund directly
in portfolio securities, or may choose to invest in such investment
companies over investment companies sponsored or managed by
others. Applicable law may limit the Fund’s ability to invest in other
investment companies. See “Principal Risks of the Fund – Leverage
Risk.”
Tax Risk
The Fund has elected to be treated as a RIC under the Code and intends
each year to qualify and be eligible to be treated as such, so that it
generally will not be subject to U.S. federal income tax on its net
investment income or net short-term or long-term capital gains that are
distributed (or deemed distributed, as described below) to shareholders.
In order to qualify and be eligible for such treatment, the Fund must
meet certain asset diversification tests, derive at least 90% of its gross
income for such year from certain types of qualifying income, and
distribute to its shareholders at least 90% of its “investment company
taxable income” as that term is defined in the Code (which includes,
among other things, dividends, taxable interest and the excess of any
net short-term capital gains over net long-term capital losses, as
reduced by certain deductible expenses).
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The Fund’s investment strategy will potentially be limited by its intention
to continue qualifying for treatment as a RIC and can limit the Fund’s
ability to continue qualifying as such. The tax treatment of certain of the
Fund’s investments under one or more of the qualification or
distribution tests applicable to RICs is uncertain. An adverse
determination or future guidance by the IRS or a change in law might
affect the Fund’s ability to qualify or be eligible for treatment as a RIC.
If, in any year, the Fund were to fail to qualify for treatment as a RIC
under the Code, and were ineligible to or did not otherwise cure such
failure, the Fund would be subject to tax on its taxable income at
corporate rates and, when such income is distributed, shareholders
would be subject to further tax on such distributions to the extent of the
Fund’s current or accumulated earnings and profits.
To qualify to pay exempt-interest dividends, which are treated as items
of interest excludable from gross income for federal income tax
purposes, at least 50% of the value of the total assets of the Fund must
consist of obligations exempt from federal income tax as of the close of
each quarter of the Fund’s taxable year. If the proportion of taxable
investments held by the Fund exceeds 50% of the Fund’s total assets as
of the close of any quarter of the Fund’s taxable year, the Fund will not
for that taxable year satisfy the general eligibility test that otherwise
permits it to pay exempt-interest dividends.
The value of the Fund’s investments and its net asset value may be
adversely affected by changes in tax rates and policies. Because interest
income from municipal securities is normally not subject to regular
federal income taxation, the attractiveness of municipal securities in
relation to other investment alternatives is affected by changes in
federal income tax rates or changes in the tax-exempt status of interest
income from municipal securities. Any proposed or actual changes in
such rates or exempt status, therefore, can significantly affect the
demand for and supply, liquidity and marketability of municipal
securities. This could in turn affect the Fund’s net asset value and ability
to acquire and dispose of municipal securities at desirable yield and
price levels. Additionally, the Fund is not a suitable investment for
individual retirement accounts, for other tax-exempt or tax-deferred
accounts or for investors who are not sensitive to the federal income tax
consequences of their investments.
Potential Conflicts of Interest Risk-Allocation of Investment
Opportunities
The Investment Manager and its affiliates are involved worldwide with a
broad spectrum of financial services and asset management activities
and may engage in the ordinary course of business in activities in which
its interests or the interests of its clients may conflict with those of the
Fund. The Investment Manager may provide investment management
services to other funds and discretionary managed accounts that follow
an investment program similar to that of the Fund. Subject to the
requirements of the Act, the Investment Manager intends to engage in
such activities and may receive compensation from third parties for its
services. The results of the Fund’s investment activities may differ from
those of the Fund’s affiliates, or another account managed by the
Investment Manager or its affiliates, and it is possible that the Fund
could sustain losses during periods in which one or more of the Fund’s
affiliates and/or other accounts managed by the Investment Manager or
its affiliates, including proprietary accounts, achieve profits on their
trading.
Distribution Rate Risk
The Fund’s distribution rates may be affected by numerous factors,
including but not limited to changes in realized and projected market
returns, fluctuations in market interest rates, Fund performance, and
other factors. There can be no assurance that a change in market
conditions or other factors will not result in a change in the Fund’s
distribution rate or that the rate will be sustainable in the future. For
instance, during periods of low or declining interest rates, the Fund’s
distributable income and dividend levels may decline for many reasons.
For example, the Fund may have to deploy uninvested assets (whether
from sales of Fund shares, proceeds from matured, traded or called debt
obligations or other sources) in new, lower yielding instruments.
Additionally, payments from certain instruments that may be held by the
Fund (such as variable and floating rate securities) may be negatively
impacted by declining interest rates, which may also lead to a decline in
the Fund’s distributable income and dividend levels.
Securities Lending Risk
For the purpose of achieving income, the Fund may lend its portfolio
securities to brokers, dealers, and other financial institutions provided a
number of conditions are satisfied, including that the loan is fully
collateralized. Please see “Investment Objectives and Policies—Loans of
Portfolio Securities” in the Statement of Additional Information for more
details. When the Fund lends portfolio securities, its investment
performance will continue to reflect changes in the value of the
securities loaned, and the Fund will also receive a fee or interest on the
collateral. Securities lending involves the risk of loss of rights in the
collateral or delay in recovery of the collateral if the borrower fails to
return the security loaned or becomes insolvent. The Fund may pay
lending fees to a party arranging the loan, which may be an affiliate of
the Fund. Cash collateral received by the Fund in securities lending
transactions may be invested in short-term liquid fixed income
instruments or in money market or short-term mutual funds, or similar
investment vehicles, including affiliated money market or short-term
mutual funds. The Fund bears the risk of such investments.
Portfolio Turnover Risk
The Investment Manager manages the Fund without regard generally to
restrictions on portfolio turnover. The use of futures contracts and other
derivative instruments with relatively short maturities may tend to
exaggerate the portfolio turnover rate for the Fund. Trading in fixed
income securities does not generally involve the payment of brokerage
commissions, but does involve indirect transaction costs. The use of
futures contracts and other derivative instruments may involve the
payment of commissions to futures commission merchants or other
intermediaries. Higher portfolio turnover involves correspondingly
greater expenses to the Fund, including brokerage commissions or
dealer mark-ups and other transaction costs on the sale of securities
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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. Such sales may result in realization of taxable
capital gains (including short-term capital gains, which are generally
taxed to shareholders at ordinary income tax rates when distributed net
of short-term capital losses and net long-term capital losses), and may
adversely impact the Fund’s after-tax returns. See “Tax Matters.”
Operational Risk
An investment in the Fund, like any fund, can involve operational risks
arising from factors such as processing errors, human errors, inadequate
or failed internal or external processes, failures in systems and
technology, changes in personnel and errors caused by third-party
service providers. The occurrence of any of these failures, errors or
breaches could result in a loss of information, regulatory scrutiny,
reputational damage or other events, any of which could have a
material adverse effect on the Fund. While the Fund seeks to minimize
such events through controls and oversight, there may still be failures
that could cause losses to the Fund.
Market Disruptions Risk
The Fund is subject to investment and operational risks associated with
financial, economic and other global market developments and
disruptions, including those arising from war, terrorism, market
manipulation, government interventions, defaults and shutdowns,
political changes or diplomatic developments, public health
emergencies (such as the spread of infectious diseases, pandemics and
epidemics) and natural/environmental disasters, which can all negatively
impact the securities markets, interest rates, auctions, secondary trading,
ratings, credit risk, inflation, deflation and other factors relating to the
Fund’s investments or the Investment Manager’s operations and the
value of an investment in the Fund, its distributions and its returns.
These events can also impair the technology and other operational
systems upon which the Fund’s service providers, including PIMCO as
the Fund’s investment adviser, rely, and could otherwise disrupt the
Fund’s service providers’ ability to fulfill their obligations to the Fund.
Cyber Security Risk
As the use of technology has become more prevalent in the course of
business, the Fund has become potentially more susceptible to
operational and information security risks resulting from breaches in
cyber security. A breach in cyber security refers to both intentional and
unintentional cyber events from outside threat actors or internal
resources that may, among other things, cause the Fund to lose
proprietary information, suffer data corruption and/or destruction or
lose operational capacity, result in the unauthorized release or other
misuse of confidential information, or otherwise disrupt normal business
operations. Cyber security breaches may involve unauthorized access to
the Fund’s digital information systems (e.g., through “hacking” or
malicious software coding), and may come from multiple sources,
including outside attacks such as denial-of-service attacks (i.e., efforts to
make network services unavailable to intended users) or cyber extortion,
including exfiltration of data held for ransom and/or “ransomware”
attacks that renders systems inoperable until ransom is paid, or insider
actions. In addition, cyber security breaches involving the Fund’s third
party service providers (including but not limited to advisers,
administrators, transfer agents, custodians, vendors, suppliers,
distributors and other third parties), trading counterparties or issuers in
which the Fund invests can also subject the Fund to many of the same
risks associated with direct cyber security breaches or extortion of
company data. Moreover, cyber security breaches involving trading
counterparties or issuers in which the Fund invests could adversely
impact such counterparties or issuers and cause the Fund’s investments
to lose value.
Cyber security failures or breaches may result in financial losses to the
Fund and its shareholders. These failures or breaches may also result in
disruptions to business operations, potentially resulting in financial
losses; interference with the Fund’s ability to calculate its NAV, process
shareholder transactions or otherwise transact business with
shareholders; impediments to trading; violations of applicable privacy
and other laws; regulatory fines; penalties; third party claims in
litigation; reputational damage; reimbursement or other compensation
costs; additional compliance and cyber security risk management costs
and other adverse consequences. In addition, substantial costs may be
incurred in order to prevent any cyber incidents in the future.
Like with operational risk in general, the Fund has established business
continuity plans and risk management systems designed to reduce the
risks associated with cyber security. However, there are inherent
limitations in these plans and systems, including that certain risks may
not have been identified, in large part because different or unknown
threats may emerge in the future. As such, there is no guarantee that
such efforts will succeed, especially because the Fund does not directly
control the cyber security systems of issuers in which the Fund may
invest, trading counterparties or third party service providers to the
Fund. Such entities have experienced cyber attacks and other attempts
to gain unauthorized access to systems from time to time, and there is
no guarantee that efforts to prevent or mitigate the effects of such
attacks or other attempts to gain unauthorized access will be successful.
There is also a risk that cyber security breaches may not be detected. The
Fund and its shareholders may suffer losses as a result of a cyber
security breach related to the Fund, its service providers, trading
counterparties or the issuers in which the Fund invests.
Non-Diversification Risk
Focusing investments in a small number of issuers increases risk. The
Fund is “non-diversified,” which means that the Fund may invest a
greater percentage of its assets in the securities of a single issuer (such
as bonds issued by a particular state) than funds that are “diversified.”
A fund that invests in a relatively small number of issuers is more
susceptible to risks associated with a single economic, political or
regulatory occurrence than a more diversified portfolio might be. Some
of those issuers also may present substantial credit or other risks.
Similarly, the Fund may be subject to increased economic, business or
political risk to the extent that it invests a substantial portion of its
assets in a particular currency, in a group of related industries, in a
particular issuer, in the bonds of similar projects or in a narrowly defined
59 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
geographic area outside the U.S. Notwithstanding the Fund’s status as a
“non-diversified” investment company under the Act, the Fund intends
to qualify as a RIC accorded special tax treatment under the Code,
which imposes its own diversification requirements.
Contingent Convertible Securities Risk
CoCos have no stated maturity, have fully discretionary coupons and are
typically issued in the form of subordinated debt instruments. CoCos
generally either convert into equity or have their principal written down
(including potentially to zero) upon the occurrence of certain triggering
events (“triggers”) linked to regulatory capital thresholds or regulatory
actions relating to the issuer’s continued viability. As a result, an
investment by the Fund in CoCos is subject to the risk that coupon (
i.e.
,
interest) payments may be cancelled by the issuer or a regulatory
authority in order to help the issuer absorb losses and the risk of total
loss. An investment by the Fund in CoCos is also subject to the risk that,
in the event of the liquidation, dissolution or winding-up of an issuer
prior to a trigger event, the Fund’s rights and claims will generally rank
junior to the claims of holders of the issuer’s other debt obligations and
CoCos may also be treated as junior to an issuer’s other obligations and
securities. In addition, if CoCos held by the Fund are converted into the
issuer’s underlying equity securities following a trigger event, the Fund’s
holding may be further subordinated due to the conversion from a debt
to equity instrument. Further, the value of an investment in CoCos is
unpredictable and will be influenced by many factors and risks,
including interest rate risk, credit risk, market risk and liquidity risk. An
investment by the Fund in CoCos may result in losses to the Fund.
Certain Affiliations
Certain broker-dealers may be considered to be affiliated persons of the
Fund and/or the Investment Manager due to their possible affiliations
with Allianz SE, the ultimate parent of the Investment Manager, or
another Allianz entity. Allianz Asset Management of America LP merged
with Allianz Asset Management
of America LLC
, with the latter being
the surviving entity, effective January 1, 2023. Following the merger,
Allianz Asset Management
of America LLC
is PIMCO LLC’s managing
member and direct parent entity. Absent an exemption from the SEC 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.
The Fund has received exemptive relief from the SEC that, to the extent
the Fund relies on such relief, permits it to (among other things)
co-invest with certain other persons, including certain affiliates of the
Investment Manager and certain public or private funds managed by the
Investment Manager and its affiliates, subject to certain terms and
conditions. The exemptive relief from the SEC with respect to
co-investments imposes extensive conditions on any co-investments
made in reliance on such relief.
Anti-Takeover Provisions
The Fund’s 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. See “Anti-Takeover and Other Provisions in the
Declaration of Trust and Bylaws.”
How the Fund Manages Risk
Hedging and Related Strategies
The Fund may (but is not required to) use various investment strategies
to attempt to hedge exposure to reduce the risk of price fluctuations of
its portfolio securities, the risk of loss, and to preserve capital.
Derivatives strategies and instruments that the Fund may use include:
financial futures contracts; short sales; other types of swap agreements
or options thereon; options on financial futures; and options based on
either an index 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 its hedging and related
transactions may be subject to one or more special U.S. federal income
tax rules that can affect the amount, timing and/or character of
distributions to Common Shareholders. For instance, many hedging
activities will be treated as capital gain and, if not offset by net realized
capital loss, will be distributed to shareholders in taxable distributions. If
effectively used, hedging strategies will offset in varying percentages
losses incurred on the Fund’s investments due to adverse interest rate
changes. There is no assurance that these hedging strategies will be
available at any time or that PIMCO will determine to use them for the
Fund or, if used, that the strategies will be successful. PIMCO may
determine not to engage in hedging strategies or to do so only in
unusual circumstances or market conditions. In addition, the Fund may
be subject to certain restrictions on its use of hedging strategies
imposed by guidelines of one or more ratings agencies that may issue
ratings on any Preferred Shares issued by the Fund.
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).
The Fund
also may attempt to reduce
leverage by redeeming or otherwise purchasing Preferred Shares or by
reducing any holdings in other instruments that create leverage. As
explained above under “Principal Risks of the Fund-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.
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
60
PIMCO California Flexible Municipal Income Fund
Investment Limitations
In addition, the Fund has adopted certain investment limitations
designed to limit investment risk. See “Investment Restrictions” in the
Statement of Additional Information for a description of these
limitations.
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Management of the Fund
Trustees and Officers
The business of the Fund is managed under the direction of the Fund’s Board including supervision of the duties performed by the Investment
Manager. The Board is currently composed of eight Trustees of the Fund (“Trustees”), six of whom are not “interested persons” of the Fund (as that
term is defined by Section 2(a)(19) of the Act). The Trustees meet periodically throughout the year to discuss and consider matters concerning the
Fund and to oversee the Fund’s activities, including its investment performance, compliance program and risks associated with its activities. 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
PIMCO serves as the investment manager for the Fund. Subject to the supervision of the Board, PIMCO is responsible for managing the investment
activities of the Fund and the Fund’s business affairs and other administrative matters.
PIMCO is located at 650 Newport Center Drive, Newport Beach, CA 92660. Organized in 1971, PIMCO provides investment management and
advisory services to private accounts of institutional and individual clients and to registered investment companies. PIMCO is a majority-owned
indirect subsidiary of Allianz SE, a publicly traded European insurance and financial services company. As of December 31, 2022, PIMCO had
approximately $1.74 trillion in assets under management.
PIMCO may retain affiliates to provide various administrative and other services required by the Fund.
Investment Management Agreement
Pursuant to an investment management agreement between the Investment Manager and the Fund (the “Investment Management Agreement”), the
Fund has agreed to pay the Investment Manager an annual fee, payable monthly, in an amount equal to 0.75% of the Fund’s “total managed
assets.” Total managed assets means the total assets of the Fund (including assets attributable to any reverse repurchase agreements, dollar rolls/
buy backs, tender option bonds, borrowings and Preferred Shares that may be outstanding, if any) minus accrued liabilities (other than liabilities
representing reverse repurchase agreements, dollar rolls/buy backs, tender option bonds and borrowings). For purposes of calculating “total managed
assets,” the liquidation preference of any Preferred Shares outstanding is not considered a liability. By way of clarification, with respect to any reverse
repurchase agreement or similar transaction, “total managed assets” includes any proceeds from the sale of an asset of the Fund to a counterparty in
such a transaction, in addition to the value of the underlying asset as of the relevant measuring date. Furthermore, to the extent applicable, assets
attributable to tender option bonds would be included as assets irrespective of whether or not they are included as assets for financial reporting
purposes. However, to the extent the Fund does not contribute municipal bonds to a tender option bond trust but holds residual interests issued by
such trust, the tender option bonds outstanding would not be included in the calculation of “total managed assets.” In addition, for purposes of
calculating “total managed assets,” the Fund’s derivative investments will be valued based on their market value.
Pursuant to the Investment Management Agreement, PIMCO shall provide to the Fund investment guidance and policy direction in connection with
the management of the Fund, including oral and written research, analysis, advice and statistical and economic data and information. In addition,
under the terms of the Investment Management Agreement, subject to the general supervision of the Board, PIMCO provides or causes to be
furnished all supervisory and administrative and other services reasonably necessary for the operation of the Fund under the unified management fee,
including but not limited to the supervision and coordination of matters relating to the operation of the Fund, including any necessary coordination
among the custodian, transfer agent, dividend disbursing agent, and recordkeeping agent (including pricing and valuation of the Fund), accountants,
attorneys, and other parties performing services or operational functions for the Fund; the provision of adequate personnel, office space,
communications facilities, and other facilities necessary for the effective supervision and administration of the Fund, as well as the services of a
sufficient number of persons competent to perform such supervisory and administrative and clerical functions as are necessary for compliance with
federal securities laws and other applicable laws; the maintenance of the books and records of the Fund; the preparation of all federal, state, local and
foreign tax returns and reports for the Fund; the preparation, filing and distribution of any proxy materials (except as provided below), periodic reports
to shareholders and other regulatory filings; the provision of administrative services to shareholders for the Fund including the maintenance of a
shareholder information telephone number, the provision of certain statistical information and performance of the Fund, an internet website (if
requested), and maintenance of privacy protection systems and procedures; the preparation and filing of such registration statements and other
documents with such authorities as may be required to register a new class of shares of the Fund; the taking of other such actions as may be required
by applicable law (including establishment and maintenance of a compliance program for the Fund); and the provision of administrative services to
shareholders as necessary, including: the maintenance of a shareholder call center; shareholder transaction processing; the provision of certain
statistical information and performance of the Fund; a web servicing platform and internet website; access by PIMCO representatives to databases to
assist with shareholder inquiries and reports; oversight of anti-money laundering monitoring systems and procedures; and processing of client
registration applications.
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
62
PIMCO California Flexible Municipal Income Fund
Under the Investment Management Agreement, PIMCO will pay all expenses incurred by it in connection with its obligations under the Investment
Management Agreement with respect to the Fund, with the exception of certain expenses that are assumed by the Fund pursuant to the Investment
Management Agreement. In addition, PIMCO is responsible for the following costs expenses: expenses of all audits by the Fund’s independent public
accountants; expenses of the Fund’s transfer agent, registrar, dividend disbursing agent, and recordkeeping agent; expenses and fees paid to agents
and intermediaries for sub-transfer agency, sub-accounting and other shareholder services on behalf of shareholders of Shares of the Fund (or Shares
of a particular Share class) held through omnibus and networked, record shareholder accounts (together, “Sub-Transfer Agency Expenses”), except
where Sub-Transfer Agency Expenses are paid pursuant to a Rule 12b-1 or similar plan adopted by the Board; expenses of the Fund’s custodial
services, including any recordkeeping services provided by the custodian; expenses of obtaining quotations for calculating the value of the Fund’s net
assets; expenses of maintaining the Fund’s tax records; certain expenses and fees, including legal fees, incident to meetings of the Fund’s
shareholders; certain expenses associated with the preparation, printing and distribution of the Fund’s prospectuses, notices and proxy statements,
press releases and reports to existing shareholders; certain expenses associated with the preparation and filing of registration statements and
updates thereto and reports with regulatory bodies; expenses associated with the maintenance of the Fund’s existence and qualification to do
business; expenses (including registration fees) of issuing, redeeming and repurchasing (including expenses associated with the Fund’s repurchases
pursuant to Rule 23c-3 under the Act); expenses associated with registering and qualifying for sale Common Shares with federal and state securities
authorities following the initial registration of its Common Shares under the 1933 Act (i.e., that are not organizational and offering expenses of the
Fund specified below) and following any registration of a new class of shares of the Fund subsequent to its initial registration; and the expense of
qualifying and listing existing Common Shares with any securities exchange or other trading system; the Fund’s ordinary legal fees, including the legal
fees that arise in the ordinary course of business for a Massachusetts business trust, registered as a closed-end management investment company
and, as applicable, that operates as an “interval fund” pursuant to Rule 23c-3 under the Act, or that is listed for trading with a securities exchange or
other trading system; costs of printing certificates representing Common Shares of the Fund, if any; the Fund’s pro rata portion of the fidelity bond
required by Section 17(g) of the Act, or other insurance premiums; and organizational and offering expenses, including registration (including share
registration) fees, legal, marketing, printing, accounting and other expenses, in connection with any registration of a new class of shares of the Fund
subsequent to its initial registration.
The Fund (and not PIMCO) is responsible for certain fees and expenses that are not covered by the unified management fee under the Investment
Management Agreement. These include salaries and other compensation or expenses, including travel expenses, of any of the Fund’s executive
officers and employees, if any, who are not officers, directors, shareholders, members, partners or employees of PIMCO or its subsidiaries or affiliates;
taxes and governmental fees, if any, levied against the Fund; brokerage fees and commissions, and other portfolio transaction expenses incurred by or
for the Fund (including, without limitation, fees and expenses of outside legal counsel or third-party consultants retained in connection with
reviewing, negotiating and structuring specialized loans and other investments made by the Fund, and any costs associated with originating loans,
asset securitizations, alternative lending-related strategies and so-called “broken-deal costs” (e.g., fees, costs, expenses and liabilities, including, for
example, due diligence-related fees, costs, expenses and liabilities, with respect to unconsummated investments)); expenses of the Fund’s securities
lending (if any), including any securities lending agent fees, as governed by a separate securities lending agreement; costs, including interest
expenses, of borrowing money or engaging in other types of leverage financing including, without limitation, through the use by the Fund of reverse
repurchase agreements, dollar rolls/buy backs, bank borrowings, credit facilities and tender option bonds; costs, including dividend and/or interest
expenses and other costs (including, without limitation, offering and related legal costs, fees to brokers, fees to auction agents, fees to transfer
agents, fees to ratings agencies and fees to auditors associated with satisfying ratings agency requirements for any Preferred Shares or other
securities issued by the Fund and other related requirements in the Fund’s organizational documents) associated with the Fund’s issuance, offering,
redemption and maintenance of any Preferred Shares, commercial paper or other instruments (such as the use of reverse repurchase agreements,
dollar rolls/buy backs, bank borrowings, credit facilities and tender option bonds) for the purpose of incurring leverage; fees and expenses of any
underlying funds or other pooled vehicles in which the Fund invests; dividend and interest expenses on short positions taken by the Fund; fees and
expenses, including travel expenses, and fees and expenses of legal counsel retained for their benefit, of Trustees who are not officers, employees,
partners, shareholders or members of PIMCO or its subsidiaries or affiliates; extraordinary expenses, including extraordinary legal expenses, as may
arise, including, without limitation, expenses incurred in connection with litigation, proceedings, other claims, and the legal obligations of the Fund to
indemnify its Trustees, officers, employees, shareholders, distributors, and agents with respect thereto; fees and expenses, including legal, printing and
mailing, solicitation and other fees and expenses associated with and incident to shareholder meetings and proxy solicitations involving contested
elections of Trustees, shareholder proposals or other non-routine matters that are not initiated or proposed by Fund management; organizational and
offering expenses of the Fund, including registration (including Share registration fees), legal, marketing, printing, accounting and other expenses,
associated with organizing the Fund in its state of jurisdiction and in connection with the initial registration of the Fund under the Act and the initial
registration of its Common Shares under the 1933 Act (i.e., through the effectiveness of the Fund’s initial registration statement on Form N-2) and
fees and expenses associated with seeking, applying for and obtaining formal exemptive, no-action and/or other relief from the SEC in connection
with the issuance of multiple share classes; except as otherwise provided as an expense of PIMCO, any expenses allocated or allocable to a specific
63 Prospectus
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Prospectus
class of Common Shares, including without limitation sub-transfer agency expenses and distribution and/or services fees paid pursuant to a
Rule 12b-1 or similar plan adopted by the Board for a particular share class; and expenses of the Fund which are capitalized in accordance with
generally accepted accounting principles.
PIMCO may earn a profit on the management fee paid by the Fund. Also, under the terms of the Investment Management Agreement, PIMCO, and
not Common Shareholders, would benefit from any price decreases in third-party services, including decreases resulting from an increase in net
assets.
Because the management fee received by PIMCO is based on the average daily total managed assets of the Fund, which includes total assets of the
Fund (including assets attributable to any reverse repurchase agreements, dollar rolls/buy backs, tender option bonds, borrowings and Preferred
Shares that may be outstanding, if any), PIMCO has a financial incentive for the Fund to utilize reverse repurchase agreements, dollar rolls/buy backs,
tender option bonds and borrowings or to issue Preferred Shares, which may create a conflict of interest between PIMCO, on the one hand, and
Common Shareholders, on the other hand.
A discussion of the basis for the Board’s approval of the Fund’s Investment Management Agreement is available in the Fund’s semi-annual report to
shareholders for the fiscal half-year ended June 30, 2022.
Expense Limitation Agreement
PIMCO has contractually agreed, through May 2, 2024, to waive its management fee, or reimburse the Fund, to the extent that organizational
expenses, pro rata share of expenses related to obtaining or maintaining a Legal Entity Identifier and pro rata Trustees’ fees exceed 0.10% of the
Fund’s average daily net assets. The Expense Limitation Agreement will automatically renew for one-year terms unless PIMCO provides written notice
to the Fund at least 30 days prior to the end of the then current term.
Under the Expense Limitation Agreement, in any month in which the investment management agreement is in effect, PIMCO is entitled to
reimbursement by the Fund of any portion of the management fee reduced as set forth above (the “Reimbursement Amount”) during the previous
thirty-six months, provided that such amount paid to PIMCO will not (1) together with any recoupment of organizational expenses, pro rata share of
expenses related to obtaining or maintaining a Legal Entity Identifier and pro rata trustee fees or management fees exceed 0.10% of average daily
net assets; (2) exceed the total Reimbursement Amount; or (3) include any amounts previously reimbursed to PIMCO. For the avoidance of doubt, any
reimbursement of PIMCO’s management fee pursuant to the Expense Limitation Agreement plus any recoupment of organizational expenses and pro
rata Trustees’ fees will not exceed the lesser of (i) the expense limit in effect at the time of waiver or reimbursement and (ii) the expense limit in effect
at the time of recoupment.
Fee Waiver Agreement
Pursuant to a Management Fee Waiver Agreement between the Fund and PIMCO, PIMCO has contractually agreed, through June 21, 2023, to waive
33% of the management fees it is entitled to receive from the Fund pursuant to the Investment Management Agreement (“Management Fee Waiver
Agreement”). PIMCO’s waiver of management fees under the Management Fee Waiver Agreement is applied first and independently of PIMCO’s
obligations under the Expense Limitation Agreement (such that amounts waived pursuant to the Management Fee Waiver Agreement shall not be
applied to reduce any waiver or reimbursement obligations PIMCO has under the Expense Limitation Agreement). PIMCO may not seek
reimbursement from the Fund with respect to the management fees waived pursuant to the Management Fee Waiver Agreement.
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
64
PIMCO California Flexible Municipal Income Fund
Portfolio Managers
The following individuals share primary responsibility for managing the Fund.
Portfolio Manager(s) | Since | Recent Professional Experience |
David Hammer | Inception of the Fund | Mr. Hammer is a Managing Director in the Newport Beach office and head of municipal bond portfolio management, with oversight of the firm’s municipal investment grade, high yield, taxable, and separately managed accounts. He is the lead portfolio manager on PIMCO’s municipal bond fund complex, including investment grade, high yield, state-specific, closed-end funds, and interval fund. Prior to rejoining PIMCO in 2015, he was a managing director at Morgan Stanley, where he was head of municipal trading, risk management, and research. He has investment experience since 2013 and holds an undergraduate degree from Syracuse University. |
Amit Arora | Inception of the Fund | Mr. Arora is an Executive Vice President and portfolio manager in the Newport Beach office and a member of the credit and liability-driven portfolio management teams. He manages credit portfolios focusing on investment grade and long credit. He was previously a senior member of PIMCO's global risk management team. Prior to joining PIMCO in 2009, he was an executive director, responsible for credit hybrids and exotics trading at J.P. Morgan. Mr. Arora was previously with Bear Stearns as a managing director on the structured credit trading desk, responsible for credit derivative products in investment grade and high yield credits. He has also worked on the foreign exchange Treasury desk at Citibank. He has investment experience since 1997 and holds an MBA from NYU Stern School of Business and a bachelor's degree in mechanical engineering from the Indian Institute of Technology (IIT Bombay). He is a Certified Financial Risk Manager (FRM). |
Kyle Christine | Inception of the Fund | Mr. Christine is a Senior Vice President and municipal bond portfolio manager in the Newport Beach office. He has previously served as a rotating member of PIMCO's Americas portfolio committee. Prior to joining PIMCO in 2017, he was an institutional high yield and taxable municipal bond trader at Morgan Stanley. He has investment and financial services experience since 2013 and holds an undergraduate degree from Union College (NY). |
Please see the Statement of Additional Information for additional information about other accounts managed by the portfolio managers, the portfolio
managers’ compensation and the portfolio managers’ ownership of shares of the Fund.
Control Persons
A control person is a person who owns, either directly or indirectly, beneficially more than 25% of the voting securities of a company. As of
December
28
, 2023, the Fund
could be deemed to be under the control of Allianz Fund Investments,
Inc.
It
is
anticipated that this party will eventually
no longer be a control person of
the Fund
over time,
due to
the continuous offering of the
Fund's
Common Shares
.
Please see “Securities Ownership” in the Fund's Statement of Additional Information for additional information on any control persons.
Additional Information
The Trustees are responsible generally for overseeing the management of the Fund. The Trustees authorize the Fund to enter into service agreements
with the Investment Manager, the Distributor and other service providers in order to provide, and in some cases authorize service providers to procure
through other parties, necessary or desirable services on behalf of the Fund. Shareholders are not intended to be third-party beneficiaries of such
service agreements.
Neither this prospectus, the Fund’s Statement of Additional Information, any contracts filed as exhibits to the Fund’s registration statement, nor any
other communications or disclosure documents from or on behalf of the Fund creates a contract between a shareholder of the Fund and the Fund, a
service provider to the Fund, and/or the Trustees or officers of the Fund. The Trustees may amend this prospectus, the Statement of Additional
Information, and any other contracts to which the Fund is a party, and interpret the investment objectives, policies, restrictions and contractual
65 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
provisions applicable to the Fund without shareholder input or approval, except in circumstances in which shareholder approval is specifically required
by law (such changes to fundamental investment policies) or where a shareholder approval requirement is specifically disclosed in this prospectus or
the Statement of Additional Information.
Plan of Distribution
PIMCO Investments LLC, an affiliate of PIMCO, is the principal underwriter and distributor of the Fund's Common Shares pursuant to a distribution
contract (the “Distribution Contract”) with the Fund. The Distributor, located at 1633 Broadway, New York, New York 10019, is a broker-dealer
registered with the SEC and is a member of the Financial Industry Regulatory Authority (“FINRA”). The Distributor is a wholly-owned subsidiary of
PIMCO and an indirect subsidiary of Allianz Asset Management. The Distributor does not participate in the distribution of non-PIMCO managed
registered fund products.
The Distributor acts as the distributor of Common Shares for the Fund on a best efforts basis, subject to various conditions, pursuant to the terms of
the Distribution Contract. The Distributor is not obligated to sell any specific amount of Common Shares of the Fund.
Common Shares of the Fund are continuously offered through the Distributor. As discussed below, the Fund may authorize one or more intermediaries
(e.g., broker-dealers and other financial firms) to receive orders on its behalf. The Common Shares will be offered at NAV per share (plus any
applicable sales load) calculated each regular business day. Please see “How Fund Shares are Priced” below.
The Fund and the Distributor have the sole right to accept orders to purchase Common Shares and reserve the right to reject any order in whole or in
part.
The Fund’s Common Shares are not listed for trading on any securities exchange. There is currently no secondary market for the Fund’s Common
Shares and the Fund does not anticipate that a secondary market will develop for its Common Shares. Investors should consider Common Shares of
the Fund to be an illiquid investment. Neither the Investment Manager nor the Distributor intends to make a market in the Fund’s Common Shares.
The Fund has agreed to indemnify the Distributor and certain of the Distributor's affiliates against certain liabilities, including certain liabilities arising
under the 1933 Act. To the extent consistent with applicable law, the Distributor has agreed to indemnify the Fund and each Trustee against certain
liabilities under the 1933 Act, as amended, and in connection with the services rendered to the Fund.
Share Classes
The Fund has adopted a Multi-Class Plan pursuant to Rule 18f-3 under the Act. Although the Fund is not an open-end investment company, it has
undertaken to comply with the terms of Rule 18f-3 as a condition of an exemptive order under the Act which permits it to have, among other things, a
multi-class structure and distribution and shareholder servicing fees. Under the Multi-Class Plan, shares of each class of the Fund represent an equal
pro rata interest in the Fund and, generally, have identical voting, dividend, liquidation, and other rights, preferences, powers, restrictions, limitations,
qualifications and terms and conditions, except that: (a) each class has a different designation; (b) each class of shares bears any class-specific
expenses; and (c) each class shall have separate voting rights on any matter submitted to shareholders in which the interests of one class differ from
the interests of any other class, and shall have exclusive voting rights on any matter submitted to shareholders that relates solely to that class.
The Fund currently has five separate classes of Common Shares: Institutional Class, Class A-1, Class A-2, Class A-3 and Class A-4. Each class of
Common Shares represents an investment in the same portfolio of investments, but each class has its own expense structure and arrangements for
shareholder services or distribution, which allows you to choose the class that best fits your situation and eligibility requirements.
◾
Institutional Class Common Shares are offered for investment to investors such as pension and profit sharing plans, employee benefit trusts,
endowments, foundations, corporations and individuals that can meet the minimum investment amount. Institutional Class Common Shares
may also be offered through certain financial firms that charge their customers transaction or other fees with respect to their customers'
investments in the Fund.
◾
Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares are not available for purchase directly from the Distributor and are primarily
offered and sold to retail investors by certain broker-dealers which are members of FINRA and which have agreements with the Distributor to
sell Class A-1, Class A-2, Class A-3 and/or Class A-4 Common Shares, but may be made available through other financial firms, including banks
and trust companies and to specified benefit plans (as defined below) and other retirement accounts.
Class A-1, Class A-2, Class A-3 and Class A-4 Distribution and Servicing Plans
The Fund has adopted separate Distribution and Servicing Plans for the Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares of the Fund.
Each Distribution and Servicing Plan operates in a manner consistent with Rule 12b-1 under the Act, which regulates the manner in which an
open-end investment company may directly or indirectly bear the expenses of distributing its shares. Although the Fund is not an open-end
investment company, it has undertaken to comply with the terms of Rule 12b-1 as a condition of an exemptive order under the Act which permits it to
have, among other things, a multi-class structure and distribution and shareholder servicing fees. Each Distribution and Servicing Plan permits the
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PIMCO California Flexible Municipal Income Fund
Fund to compensate the Distributor for providing or procuring through financial firms, distribution, administrative, recordkeeping, shareholder and/or
related services with respect to the Class A-1, Class A-2, Class A-3 or Class A-4 Common Shares, as applicable. Most or all of the distribution and/or
service fees are paid to financial firms through which Common Shareholders may purchase and/or hold Class A-1, Class A-2, Class A-3 and Class A-4
Common Shares, as applicable. Because these fees are paid out of the applicable share class’s assets on an ongoing basis, over time they will increase
the cost of an investment in Class A-1, Class A-2, Class A-3 or Class A-4 Common Shares and may cost you more than other types of sales charge.
The maximum annual rates at which the distribution and/or servicing fees may be paid under the Distribution and Servicing Plan for Class A-1
Common Shares (calculated as a percentage of the Fund’s average daily net assets attributable to the Class A-1 Common Shares) is 0.50%.
The maximum annual rates at which the distribution and/or servicing fees may be paid under the Distribution and Servicing Plan for Class A-2
Common Shares (calculated as a percentage of the Fund’s average daily net assets attributable to the Class A-2 Common Shares) is 0.50%.
The maximum annual rates at which the distribution and/or servicing fee may be paid under the Distribution and Servicing Plan for Class A-3
Common Shares (calculated as a percentage of the Fund’s average daily net assets attributable to the Class A-3 Common Shares) is 0.75%.
The maximum annual rates at which the distribution and/or servicing fee may be paid under the Distribution and Servicing Plan for Class A-4
Common Shares (calculated as a percentage of the Fund’s average daily net assets attributable to the Class A-4 Common Shares) is 0.75%.
Servicing Arrangements
The Fund’s Common Shares may be available through certain broker-dealers, banks, trust companies, insurance companies and other financial firms
that have entered into selling and/or arrangements with respect to the Fund. A financial firm is one that, in exchange for compensation, sells, among
other products, registered investment company shares (including the shares offered in this prospectus) or provides services for registered investment
company shareholders.
These financial firms provide varying investment products, programs, platforms and accounts, through which investors may purchase Common Shares
of the Fund. Selling and/or shareholder servicing arrangements typically include processing orders for shares, generating account and confirmation
statements, sub-accounting, account maintenance, tax reporting, collecting and posting distributions to investor accounts and disbursing cash
dividends as well as other investment or administrative services required for the particular firm’s products, programs, platform and accounts. These
financial firms may impose additional or different conditions than the Fund on purchases of Common Shares. They may also independently establish
and charge their customers or program participants transaction fees, account fees and other amounts in connection with purchases of Common
Shares in addition to any fees imposed by the Fund. These additional fees may vary and over time could increase the cost of an investment in the Fund
and lower investment returns. Each financial firm is responsible for transmitting to its customers and program participants a schedule of any such fees
and information regarding any additional or different conditions regarding purchases. Shareholders who are customers of these financial firms or
participants in programs serviced by them should contact the financial firm for information regarding these fees and conditions.
PIMCO and/or its affiliates may make payments to financial firms for the shareholder services provided. These payments are made out of PIMCO’s or
its affiliates’ resources, including the management fees paid to PIMCO under the Fund’s Investment Management Agreement. The actual services
provided by these firms, and the payments made for such services, vary from firm to firm and, in some instances, vary with respect to a single firm
according to investment channel. The payments are based on a fixed dollar amount for each account and position maintained by the financial firm
and/or a percentage of the value of shares held by investors through the firm. Please see the Statement of Additional Information for more
information.
These payments may be material to financial firms relative to other compensation paid by the Fund, PIMCO and/or its affiliates (as applicable) and
may be in addition to other fees and payments, such as distribution and/or service fees, revenue sharing or “shelf space” fees and event support,
other non-cash compensation and charitable contributions paid to or at the request of such firms (described below). Also, the payments may differ
depending on the share class or investment channel and may vary from amounts paid to the Fund’s transfer agent for providing similar services to
other accounts. PIMCO and/or its affiliates do not control these financial firms’ provision of the services for which they are receiving payments.
Other Payments to Financial Firms
Some or all of the sales charges, distribution fees and servicing fees described above are paid or “reallowed” to the financial firm, including their
financial professionals through which you purchase your shares.
Revenue Sharing/Marketing Support.
The Distributor or PIMCO (for purposes of this subsection only, collectively, “PIMCO”) makes payments
and provides other incentives to financial firms as compensation for services such as providing the Fund with “shelf space,” or a higher profile for the
financial firms’ financial professionals and their customers, placing the Fund on the financial firms’ preferred or recommended fund list, granting
PIMCO access to the financial firms’ financial professionals and furnishing marketing support and other specified services. These payments may be
significant to the financial firms.
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A number of factors are considered in determining the amount of these additional payments to financial firms. On some occasions, such payments
may be conditioned upon levels of sales, including the sale of a specified minimum dollar amount of the shares of the Fund and/or other funds
sponsored by PIMCO together or a particular class of shares, during a specified period of time. PIMCO also makes payments to one or more financial
firms based upon factors such as the amount of assets a financial firm’s clients have invested in the Fund and the quality of the financial firm’s
relationship with PIMCO and/or its affiliates.
The additional payments described above are made from PIMCO’s (or its affiliates’) own assets (and sometimes, therefore referred to as “revenue
sharing”) pursuant to agreements with financial firms and do not change the price paid by investors for the purchase of the Fund’s shares or the
amount the Fund will receive as proceeds from such sales. These payments may be made to financial firms (as selected by PIMCO) that have sold
significant amounts of shares of the Fund or other funds sponsored by PIMCO. In certain cases, the payments described in the preceding sentence
may be subject to minimum payment levels or vary based on the management fee or total expense ratio of the Fund. In lieu of payments pursuant to
the foregoing terms, PIMCO makes, in certain instances, payments of an agreed upon amount which normally will not exceed the amount that would
have been payable pursuant to the formula as of the effective date of the agreement.
Ticket Charges.
In addition to the payments described above, PIMCO makes payments to financial firms in connection with certain transaction fees
(also referred to as “ticket charges”) incurred by the financial firms.
Event Support; Other Non-Cash Compensation; Charitable Contributions.
In addition to the payments described above, PIMCO pays
and/or reimburses, at its own expense, financial firms’ sponsorship and/or attendance at conferences, seminars or informational meetings (which may
include events held through video technology, to the extent permitted by applicable regulation) (“event support”), provides financial firms or their
personnel with occasional tickets to events or other entertainment (which, in some instances, is held virtually), meals, and small gifts or pays or
provides reimbursement for reasonable travel and lodging expenses for attendees of PIMCO educational events (“other non-cash compensation”)
and makes charitable contributions to valid charitable organizations at the request of financial firms (“charitable contributions”) to the extent
permitted by applicable law, rules and regulations.
Visits; Training; Education.
In addition to the payments described above, wholesaler representatives and employees of PIMCO or its affiliates visit
financial firms on a regular basis to educate financial professionals and other personnel about the Fund and to encourage the sale or
recommendation of Fund shares to their clients. PIMCO may also provide (or compensate consultants or other third parties to provide) other relevant
training and education to a financial firm’s financial professionals and other personnel.
Platform Support; Consultant Services.
PIMCO also may make payments or reimbursements to financial firms or their affiliated companies,
which may be used for their platform development, maintenance, improvement and/or the availability of services including, but not limited to,
platform education and communications, relationship management support, development to support new or changing products, eligibility for
inclusion on sample fund line-ups, trading or order taking platforms and related infrastructure/technology and/or legal, risk management and
regulatory compliance infrastructure in support of investment-related products, programs and services (collectively, “platform support”). PIMCO may
also make payments to third party law firms or other service providers that provide certain due diligence services to financial firms with respect to the
Fund and/or PIMCO in connection with such financial firm determining whether to include the Fund on its platform. Subject to applicable law, PIMCO
and its affiliates may also provide investment advisory services to financial firms and their affiliates and may execute brokerage transactions on behalf
of the Fund with such financial firms’ affiliates. These financial firms or their affiliates may, in the ordinary course of their financial firm business,
recommend that their clients utilize PIMCO’s investment advisory services or invest in the Fund or in other products sponsored or distributed by
PIMCO or its affiliates. In addition, PIMCO may pay investment consultants or their affiliated companies for certain services including technology,
operations, tax, or audit consulting services and may pay such firms for PIMCO’s attendance at investment forums sponsored by such firms
(collectively, “consultant services”).
Data.
PIMCO also may make payments or reimbursements to financial firms or their affiliated companies for various studies, surveys, industry data,
research and information about, and contact information for, particular financial professionals who have sold, or may in the future sell, shares of the
Fund or other PIMCO-advised funds (i.e., “data”). Such payments may relate to the amount of assets a financial firm’s clients have invested in the
Fund or other PIMCO-advised funds.
Payments.
Payments for items including event support, platform support, data and consultant services (but not including certain account services),
as well as revenue sharing, are, in certain circumstances, bundled and allocated among these categories in PIMCO’s discretion. Portions of such
bundled payments allocated by PIMCO to revenue sharing shall remain subject to the percentage limitations on revenue sharing payments disclosed
above. The financial firms receiving such bundled payments may characterize or allocate the payments differently from PIMCO’s internal allocation. In
addition, payments made by PIMCO to a financial firm and allocated by PIMCO to a particular category of services can in some cases result in benefits
related to, or enhance the eligibility of, PIMCO or the Fund to receive, services provided by the financial firm that may be characterized or allocated to
one or more other categories of services. If investment advisers, distributors or affiliated persons of funds make payments and provide other incentives
in differing amounts, financial firms and their financial professionals may have financial incentives for recommending a particular fund over other
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PIMCO California Flexible Municipal Income Fund
funds. In addition, depending on the arrangements in place at any particular time, a financial firm and its financial professionals also may have a
financial incentive for recommending a particular share class over other share classes.
A shareholder who holds Fund Common Shares
through a financial firm should consult with the shareholder’s financial professional and review carefully any disclosure by the
financial firm as to its compensation received by the financial professional.
Although the Fund may use financial firms that sell Fund
Common Shares to effect transactions for the Fund’s portfolio, the Fund and PIMCO will not consider the sale of Fund Common Shares as a factor
when choosing financial firms to effect those transactions. For further details about payments made by PIMCO to financial firms, please see the
Statement of Additional Information.
Purchasing Shares
The following section provides basic information about how to purchase Common Shares of the Fund.
The Fund typically does not offer or sell its shares to non-U.S. residents. For purposes of this policy, a U.S. resident is defined as an account with (i) a
U.S. address of record and (ii) all account owners residing in the U.S. at the time of sale.
The Fund and the Distributor each reserves the right, in its sole discretion, to suspend the offering of shares of the Fund or to reject any purchase
order, in whole or in part, when, in the judgment of management, such suspension or rejection is in the best interests of the Fund.
In the interest of economy and convenience, certificates for shares will not be issued.
If you are eligible to buy Institutional Class Common Shares as well as Class A-1, Class A-2, Class A-3 or Class A-4 Common Shares, you should buy
Institutional Class Common Shares because Class A-2 and Class A-4 Common Shares may be subject to sales charges, and each of Class A-1,
Class A-2, Class A-3 and Class A-4 Common Shares will pay an annual distribution and/or service fee.
Individual shareholders who purchase Common Shares through financial intermediaries, pensions or profit sharing plans may not be eligible to hold
Common Shares outside of their respective plan or financial intermediary platform.
Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares.
Eligible investors may purchase Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares through their broker-dealer or other
financial firm. Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares are not available for purchase directly from the Distributor.
1.
Through your broker-dealer or other financial firm.
Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares are primarily offered
and sold to retail investors by certain broker-dealers that are members of FINRA and that have agreements with the Distributor to offer
Class A-1, Class A-2, Class A-3 and/or Class A-4 Common Shares, but may be made available through other financial firms, including banks
and trust companies and to specified benefit plans and other retirement accounts. Your broker-dealer or other financial firm may establish
higher or lower minimum investment requirements than the Fund and may also independently charge you transaction or other fees and
additional amounts (which may vary) in return for its services, which will reduce your return. Shares you purchase through your broker-dealer or
other financial firm will normally be held in your account with that firm and instructions for buying, selling, exchanging or transferring
Class A-1, Class A-2, Class A-3 or Class A-4 Common Shares must be submitted by your broker-dealer or other financial firm on your behalf.
Institutional Class Common Shares.
Eligible investors may purchase Institutional Class Common Shares in the following ways:
◾
Through your broker-dealer or other financial firm.
Institutional Class Common Shares may be offered through certain financial firms that charge their customers transaction or other fees with
respect to their customers’ investments in the Fund. Your broker-dealer or other financial firm may establish higher or lower minimum
investment requirements than the Fund and may also independently charge you transaction or other fees and additional amounts (which may
vary) in return for its services, which will reduce your return. Shares you purchase through your broker-dealer or other financial firm will normally
be held in your account with that firm. If you purchase shares through a broker-dealer or other financial firm, instructions for buying, selling,
exchanging or transferring Institutional Class Common Shares must be submitted by your financial firm or broker-dealer on your behalf.
◾
Through the Distributor.
You should discuss your investment with your financial advisor before you make a purchase to be sure the Fund is appropriate for you. Investors
who meet the minimum investment amount and wish to invest directly in Institutional Class Common Shares may obtain an Account
Application online at pimco.com
/forms
or by calling 844.312.2113. If you do not list a financial advisor and his/her brokerage firm on the
Account Application, the Distributor is designated as the broker of record, but solely for purposes of acting as your agent to purchase shares.
The completed Account Application may be submitted using the following methods:
Facsimile: 844.643.0432
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Overnight Mail:
PIMCO Interval Funds
430 W. 7th Street
Suite 219993
Kansas City, MO 64105-1407
Regular Mail:
PIMCO Interval Funds
P.O. Box 219993
Kansas City, MO 64121-9993
E-mail: pimcoaltprocessing@dstsystems.com
For inquiries, please call 844.312.2113.
Payment for the purchase of Common Shares may be made by check payable to the PIMCO Interval Funds and sent to the Regular Mail address
above; or by wiring federal funds to:
PIMCO Interval Funds
United Missouri Bank
928 Grand Blvd
Kansas City, MO 64106
ABA 101000695
DDA
9872291743
ACCT: Your PIMCO Account Number
FFC: Shareholder Name and Fund Identifier
Before wiring federal funds, the investor must provide order instructions to the transfer agent by facsimile at 844.643.0432 or by e-mail at
pimcoaltprocessing@dstsystems.com. In order to receive the current day’s NAV, order instructions must be received in good order prior to the close of
regular trading on the New York Stock Exchange (“NYSE”) (ordinarily 4:00 p.m., Eastern time) (“NYSE Close”). Instructions must include the name
and signature of an appropriate person designated on the Account Application (“Authorized Person”), account name, account number, name of the
Fund and dollar amount. Payments received without order instructions could result in a processing delay or a return of wire. Failure to send the
accompanying payment on the same day may result in the cancellation of the order.
An investor may place a purchase order for Common Shares without first wiring federal funds if the purchase amount is to be derived from an
advisory account managed by PIMCO or one of its affiliates, or from an account with a broker-dealer or other financial firm that has established a
processing relationship with the Fund on behalf of its customers
Investment Minimums
◾
Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares.
The following investment minimums apply for purchases of Class A-1,
Class A-2, Class A-3 and Class A-4 Common Shares:
Initial Investment | Subsequent Investments |
$2,500 per account | $50 |
◾
Institutional Class Common Shares.
The following investment minimums apply for purchases of Institutional Class Common Shares:
Initial Investment | Subsequent Investments |
$1 million per account | None |
The initial investment minimums may be higher or lower for certain financial firms that submit orders on behalf of their customers. The Fund or the
Distributor may lower or waive the minimum initial investment for certain classes of shares or categories of investors at their discretion. The minimum
initial investment may also be modified for the Trustees and certain employees and their extended family members of PIMCO and its affiliates. For
these purposes, “extended family members” shall include such person’s spouse or domestic partner, as recognized by applicable state law, children,
siblings, current brother/sister-in-laws, parents, and current father/mother-in-laws. Please see the Statement of Additional Information for details.
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PIMCO California Flexible Municipal Income Fund
◾
Additional Investments.
An investor may purchase additional Institutional Class Common Shares of the Fund at any time by sending a
facsimile or e-mail as outlined above. If you invest in Common Shares through a broker-dealer, contact your financial firm for information on
purchasing additional Common Shares.
◾
Other Purchase Information.
Purchases of the Fund’s Common Shares will be made in full and fractional shares.
Sales Charge - Class A-2 and Class A-4 Common Shares
This section includes important information about sales charge reduction programs available to investors in Class A-2 and/or Class A-4 Common
Shares of the Fund and describes information or records you may need to provide to the Distributor or your financial firm in order to be eligible for
sales charge reduction programs.
Unless you are eligible for a waiver, the public offering price you pay when you buy Class A-2 or Class A-4 Common Shares of the Fund is the NAV of
the shares plus an initial sales charge. The initial sales charge varies depending upon the size of your purchase, as set forth below. No sales charge is
imposed where Class A-2 or Class A-4 Common Shares are issued to you pursuant to the automatic reinvestment of income dividends or capital gains
distributions. For investors investing in Class A-2 or Class A-4 Common Shares of the Fund through a financial intermediary, it is the responsibility of
the financial intermediary to ensure that you obtain the proper “breakpoint” discount.
Because the offering price is calculated to two decimal places, the dollar amount of the sales charge as a percentage of the offering price and your
net amount invested for any particular purchase of Fund shares may be higher or lower depending on whether downward or upward rounding was
required during the calculation process.
Class A-2 and Class A-4 Common Shares are subject to a 3.00% maximum sales charge as a percentage of the offering price (3.09% as a percentage
of net amount invested).
Class A-2 Common Shares are subject to the following sales charge:
Your Investment | As a % of Public Offering Price | As a % of Net Amount Invested |
Less than $100,000 | 2.00% (1) | 2.04% (1) |
$100,000 - $249,999.99 | 1.00% | 1.01% |
$250,000 and over | 0.00% (2) | 0.00% (2) |
(1)
Although the Fund is permitted to charge a maximum sales charge of 3.00%, the Fund has elected to currently charge a maximum sales charge of 2.00%.
(2)
As shown, investors that purchase $250,000 or more of the Fund’s Class A-2 Common Shares will not pay any initial sales charge on the purchase. However, unless eligible for a
waiver, purchases of $250,000 or more of Class A-2 Common Shares will be subject to an early withdrawal charge of 1.00% if the shares are repurchased during the first 12 months
after their purchase. See “Early Withdrawal Charges - Class A-2 and Class A-4 Common Shares” and “Sales at Net Asset Value” below.
Class A-4 Common Shares are subject to the following sales charge:
Your Investment | As a % of Public Offering Price | As a % of Net Amount Invested |
Less than $100,000 | 2.00% (1) | 2.04% (1) |
$100,000 - $249,999.99 | 1.00% | 1.01% |
$250,000 and over | 0.00% (2) | 0.00% (2) |
(1)
Although the Fund is permitted to charge a maximum sales charge of 3.00%, the Fund has elected to currently charge a maximum sales charge of.2.00%.
(2)
As shown, investors that purchase $250,000 or more of the Fund’s Class A-4 Common Shares will not pay any initial sales charge on the purchase. However, unless eligible for a
waiver, purchases of $250,000 or more of Class A-4 Common Shares will be subject to an early withdrawal charge of 1.00% if the shares are repurchased during the first 12 months
after their purchase. See “Early Withdrawal Charges - Class A-2 and Class A-4 Common Shares” and “Sales at Net Asset Value” below.
Investors in the Fund may reduce or eliminate sales charges applicable to purchases of Class A-2 or Class A-4 shares through utilization of the
Combined Purchase Privilege, Right of Accumulation, Letter of Intent or Reinstatement Privilege. These programs will apply to purchases of closed-end
interval funds that PIMCO sponsors currently or in the future (collectively, “Eligible Funds”), which offer Class A-1, Class A-2, Class A-3 and/or
Class A-4 Common Shares. These programs are summarized below and described in the Statement of Additional Information. Eligible Funds do not
include any open-end funds sponsored by PIMCO.
Combined Purchase Privilege and Right of Accumulation (Breakpoints). A Qualifying Investor (as defined below) may qualify for a reduced sales
charge on Class A-2 or Class A-4 Common Shares at the breakpoint levels disclosed herein by combining concurrent purchases of the Class A-1,
Class A-2, Class A-3 and/or Class A-4 common shares of one or more Eligible Funds into a single purchase (the “Combined Purchase Privilege”). In
addition, a Qualifying Investor may obtain a reduced sales charge on Class A-2 or Class A-4 Common Shares by adding the purchase value of
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Class A-1, Class A-2, Class A-3 and/or Class A-4 common shares of an Eligible Fund with the current aggregate net asset value of all Class A-1,
Class A-2, Class A-3 and/or Class A-4 common shares of any Eligible Fund held by accounts for the benefit of such Qualifying Investor (the “Right of
Accumulation” or “Cumulative Quantity Discount”).
The term “Qualifying Investor” refers to:
1.
an individual, such individual’s spouse or domestic partner, as recognized by applicable state law, or such individual’s children under the age of
21 years (each a “family member”) (including family trust* accounts established by such a family member); or
2.
a trustee or other fiduciary for a single trust (except family trusts* noted above), estate or fiduciary account although more than one
beneficiary may be involved; or
3.
an employee benefit plan of a single employer.
*
For these purposes, a “family trust” is one in which a family member, as defined in section (1) above, or a direct lineal descendant(s) of such person is/are the beneficiary(ies), and such
person or another family member, direct lineal ancestor or sibling of such person is/are the trustee(s).
While a shareholder’s positions in Class A-1 and Class A-3 common shares of other Eligible Funds are accounted for with respect to reaching a
breakpoint level on purchases of Class A-2 or Class A-4 common shares of any Eligible Fund, because neither the Eligible Fund nor their Distributor
impose an initial sales charge on Class A-1 or Class A-3 common shares of other Eligible Funds, the Combined Purchase Privilege and Right of
Accumulation programs do not apply to that share class. Class A-1 and Class A-3 common shares of other Eligible Funds that count towards reaching
a breakpoint level on purchases of Class A-2 or Class A-4 common shares of any Eligible Fund through the Combined Purchase Privilege and Right of
Accumulation programs are still subject to transaction or other fees that may be charged by certain financial firms, as those programs do not impact
the imposition of such fees.
Letter of Intent. Investors may also obtain a reduced sales charge on purchases of Class A-2 and/or Class A-4 Common Shares of the Fund by means
of a written Letter of Intent which expresses an intent to invest not less than $250,000 within a period of 13 months in Class A-1, Class A-2,
Class A-3 and/or Class A-4 common shares of any Eligible Fund(s). The maximum intended investment allowable in a Letter of Intent is $250,000.
Each purchase of shares under a Letter of Intent will be made at the public offering price or prices applicable at the time of such purchase to a single
purchase of the dollar amount indicated in the Letter of Intent. The value of the investor’s account(s) linked to a Letter of Intent will be included at the
start date of the Letter of Intent. A Letter of Intent is not a binding obligation to purchase the full amount indicated. Shares purchased with the first
5% of the amount indicated in the Letter of Intent will be held in escrow (while remaining registered in your name) to secure payment of the higher
sales charges applicable to the shares actually purchased in the event the full intended amount is not purchased. If the full amount indicated is not
purchased, a sufficient amount of such escrowed shares will be involuntarily repurchased to pay the additional sales charge applicable to the amount
actually purchased, if necessary. Dividends on escrowed shares, whether paid in cash or reinvested in additional Eligible Fund shares, are not subject
to escrow. When the full amount indicated has been purchased, the escrow will be released. Repurchases during the Letter of Intent period will not
count against the shareholder.
In making computations concerning the amount purchased for purposes of a Letter of Intent, market appreciation in the value of the shareholder’s
Class A-1, Class A-2, Class A-3 and/or Class A-4 common shares of Eligible Funds will not be included.
◾
Method of Valuation of Accounts
. To determine whether a shareholder qualifies for a reduction in sales charge on a purchase of Class A-2
and/or Class A-4 Common Shares of the Fund, the public offering price of the shares is used for purchases relying on the Combined Purchase
Privilege or a Letter of Intent and the amount of the total current purchase (including any sales load) plus the NAV (at the close of business on
the day of the current purchase) of shares previously acquired is used for the Right of Accumulation (Cumulative Quality Discount).
Reinstatement Privilege
. A Class A-2 or Class A-4 shareholder who has caused any or all of his or her shares to be repurchased may reinvest all or
any portion of the repurchase proceeds in Class A-1, Class A-2, Class A-3 and/or Class A-4 common shares of any Eligible Fund at NAV without any
sales charge, provided that such reinvestment is made within 120 calendar days after the repurchase date. The limitations and restrictions of this
program are fully described in the Statement of Additional Information.
Sales at Net Asset Value.
In addition to the programs summarized above, Class A-2 and Class A-4 Common Shares, which are available for
purchase only through a broker-dealer or other financial firm, may be sold at NAV without an initial sales charge to certain types of accounts or
account holders, including: current or former Trustees, officers and employees of the Fund or PIMCO, and by directors, officers and current or former
employees of the Distributor or certain of PIMCO’s affiliates if the account was established while employed; purchases made through wrap accounts
or certain types of group omnibus plans sponsored by employers; professional or charitable organizations; investors engaging in certain transactions
related to IRAs or other qualified retirement plan accounts; retirement plans that are maintained or sponsored by financial firms, provided the
financial firms have entered into an agreement with the Distributor related to such plans; investors making certain purchases following the
announcement of a Fund or share class liquidation; and any other person for which the Distributor determines that there will be minimal cost borne
by the Distributor associated with the sale. Please see the Statement of Additional Information for additional details.
Exchanges.
Exchanges of Common Shares for Class A-2 or Class A-4 Common Shares of the Fund or Class A-2 and/or Class A-4 common shares of
other Eligible Funds, at the direction of a financial intermediary (as described under “Exchanging Shares” below) will not be subject to a sales charge.
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Early Withdrawal Charges - Class A-2 and Class A-4 Common Shares
Unless you are eligible for a waiver, as described under “Sales at Net Asset Value”, if you purchase $250,000 or more of Class A-2 or Class A-4
Common Shares (and, thus, pay no initial sales charge) of the Fund, you will be subject to a 1% early withdrawal charge (“EWC”) if your Class A-2 or
Class A-4 Common Shares are repurchased within 12 months of their purchase. The Class A-2 and Class A-4 EWCs do not apply if you are otherwise
eligible to purchase Class A-2 or Class A-4 Common Shares without an initial sales charge or are eligible for a waiver of the EWC.
How EWCs will be Calculated
An EWC is imposed on repurchases of Class A-2 and Class A-4 Common Shares on the amount of the repurchase which causes the current value of
your account for the particular class of Common Shares of the Fund to fall below the total dollar amount of your purchase payments subject to the
EWC.
The following rules apply under the method for calculating EWCs:
◾
Common Shares acquired through the reinvestment of dividends or capital gains distributions will be repurchased first and will not be subject
to any EWC.
◾
For the repurchase of all other Common Shares, the EWC will be based on either your original purchase price or the then current NAV of the
Common Shares being sold, whichever is lower. To illustrate this point, consider Common Shares purchased at an NAV of $10. If the Fund’s
NAV per Common Share at the time of repurchase is $12, the EWC will apply to the purchase price of $10. If the NAV per Common Share at the
time of repurchase is $8, the EWC will apply to the $8 current NAV per Common Share.
◾
EWCs will be deducted from the proceeds of your repurchase, not from amounts remaining in your account.
◾
In determining whether an EWC is payable, it is assumed that you will have repurchased first the lot of Common Shares which will incur the
lowest EWC.
Reductions and Waivers of Initial Sales Charges and EWCs
The initial sales charges and EWCs on Class A-2 or Class A-4 Common Shares may be reduced or waived under certain purchase arrangements and
for certain categories of investors. See “Sales at Net Asset Value” above for information on such reductions or waivers that may be applicable to
Class A-2 and Class A-4 initial sales charges.
EWCs on Class A-2 and Class A-4 Common Shares may be reduced or waived for repurchases where the shareholder can demonstrate hardship,
which shall be determined in the sole discretion of the Distributor, and there will be minimal cost borne by the Distributor associated with the
repurchase, which shall be determined in the sole discretion of the Distributor. In addition, investors will not be subject to EWCs for certain
transactions where the Distributor did not pay at the time of purchase the amount it normally would have to the broker-dealer.
Required Shareholder Information and Records.
In order for investors in Class A-2 or Class A-4 Common Shares of the Fund to take advantage of
sales charge reductions, an investor or his or her financial firm must notify the Fund that the investor qualifies for such a reduction. If the Fund is not
notified that the investor is eligible for these reductions, the Fund will be unable to ensure that the reduction is applied to the investor’s account. An
investor may have to provide certain information or records to his or her financial firm or the Fund to verify the investor’s eligibility for breakpoint
discounts or sales charge waivers.
An investor may be asked to provide information or records, including account statements, regarding shares of the Fund or other Eligible Funds held
in:
◾
any account of the investor at another financial firm; and
◾
accounts of Qualifying Investors at any financial firm.
Information Regarding State Escheatment Laws
Closed-end fund accounts can be considered abandoned property. States increasingly are looking at inactive closed-end fund accounts as possible
abandoned or unclaimed property. Under certain circumstances, the Fund may be legally obligated to escheat (or transfer) an investor's account to
the appropriate state's unclaimed property administrator. The Fund will not be liable to investors or their representatives for good faith compliance
with state unclaimed or abandoned property (escheatment) laws.
Escheatment laws vary by state, and states have different criteria for defining inactivity and abandoned property. Generally, a closed-end account may
be subject to “escheatment” (i.e., considered to be abandoned or unclaimed property) if the account owner has not initiated any activity in the
account or contacted the fund for an “inactivity period” as specified in applicable state laws. Typically, an investor's last known address of record
determines the state that has jurisdiction.
The process described above, and the application of state escheatment laws, may vary depending on how shareholders hold their shares in the Fund.
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Exchanging Shares
Exchanges Across Eligible Funds:
Subject to the terms and conditions below, shares of one class of common shares of other Eligible Funds may be
exchanged, at the shareholder’s option, for shares of the same class or another class of Common Shares of the Fund. Shareholders may also move
their investment in Common Shares of the Fund into shares of the same class or another class of common shares of other Eligible Funds in
conjunction with quarterly repurchases made by the Fund. In this case, rather than tendering shares for cash, the shareholder would elect to have the
dollar value of those Common Shares accepted for purchases of shares of the other Eligible Funds. Such exchanges for shares of other Eligible Funds
must occur in conjunction with quarterly repurchases made by the Fund and will be subject to those repurchase offer risks, such as the risk that
shareholders may be unable to liquidate all or a given percentage of their investment in the Fund during a particular repurchase offer, that are
described elsewhere in this prospectus. See “Principal Risks of the Fund - Repurchase Offers Risk.”
The total value of shares being exchanged into the Fund must at least equal the minimum investment requirement applicable to the relevant class of
Common Shares of the Fund, and the total value of shares being exchanged out of the Fund into other Eligible Funds must meet the minimum
investment requirements of those Eligible Funds, as applicable. Other than exchanges at the direction of a financial intermediary (as described below),
shares of the Fund or other Eligible Funds related to such exchanges will be subject to any sales charges, EWCs and/or waivers applicable to such
classes of shares.
Intra-Fund Exchanges: Shares of one class of the Fund may be exchanged at any time, at a shareholder’s option, directly for shares of another class of
the Fund (an “intra-fund exchange”), subject to the terms and conditions described below and provided that the shareholder for whom the intra-fund
exchange is being requested meets the eligibility requirements of the class into which such shareholder seeks to exchange. Additional information
regarding the eligibility requirements of different share classes, including investment minimums and intended distribution channels is described under
“Purchasing Shares” and “Investment Minimums” above.
Shares of one class of the Fund will be exchanged for shares of a different class of the Fund on the basis of their respective NAVs. Ongoing fees and
expenses incurred by a given share class will differ from those of other share classes, and a shareholder receiving new shares in an intra-fund
exchange may be subject to higher or lower total expenses following such exchange.
Financial Intermediary-Directed Exchanges: Financial intermediaries may, in connection with a change in a client’s account type, at the direction of a
client, or otherwise in accordance with a financial intermediary’s policies and procedures, direct the Fund on behalf of the intermediary’s clients to
exchange shares of one class of Common Shares of the Fund for shares of another class of Common Shares of the Fund, or exchange Common Shares
of the Fund for the same class or another class of common shares of another Eligible Fund. Any such exchange will not be subject to a sales charge.
Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares of the Fund are, however, subject to higher annual operating expenses than
Institutional Class Common Shares. See “Summary of Fund Expenses.” The Fund will only complete such an exchange at the direction of a financial
intermediary and without making inquiry as to whether the exchange is consistent with the particular intermediary’s policies and procedures or the
client’s account type and/or suitability criteria. An investor should contact his or her financial intermediary to learn more about the details of this
exchange feature and whether and under what circumstances it may apply in accordance with the investor’s arrangements with the particular
intermediary.
Shares Purchased or Held Through Financial Intermediaries
The Fund’s sales charge waivers and discounts disclosed in this prospectus are available for qualifying purchases and are generally available through
financial firms. The availability of sales charge waivers and discounts may depend on the particular financial intermediary or type of account through
which you purchase or hold Fund shares. There are currently no sales charge waivers, discounts and/or breakpoints available through any specific
financial intermediary required to be disclosed by the Fund. Any such sales charge waivers, discounts and/or breakpoints will be set forth in an
appendix to this prospectus.
While neither the Fund nor the Distributor impose an initial sales charge on Institutional Class, Class A-1 or Class A-3 Common Shares, if you buy
Institutional Class, Class A-1 or Class A-3 Common Shares through certain financial firms they may directly charge you transaction or other fees in
such amount as they may determine. Please consult your financial firm for additional information.
Signature Validation
When a signature validation is called for, a Medallion signature guarantee or Signature validation program (“SVP”) stamp may be required. A
Medallion signature guarantee is intended to provide signature validation for transactions considered financial in nature, and an SVP stamp is
intended to provide signature validation for transactions non-financial in nature. In certain situations, a notarized signature may be used instead of a
Medallion signature guarantee or an SVP stamp. A Medallion signature guarantee or SVP stamp may be obtained from a domestic bank or trust
company, broker, dealer, clearing agency, savings association or other financial institution which is participating in a Medallion program or SVP
recognized by the Securities Transfer Association. When a Medallion signature guarantee or SVP stamp is required, signature validations from
financial institutions which are not participating in one of these programs will not be accepted. Please note that financial institutions participating in
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a recognized Medallion program may still be ineligible to provide a signature validation for transactions of greater than a specified dollar amount. The
Fund may change the signature validation requirements from time to time upon notice to shareholders, which may be given by means of a new or
supplemented prospectus. Shareholders should contact the Fund for additional details regarding the Fund’s signature validation requirements.
In addition, corporations, trusts, and other institutional organizations are required to furnish evidence of the authority of the persons designated on
the Account Application to effect transactions for the organization.
Request for Multiple Copies of Shareholder Documents
To reduce expenses, it is intended that only one copy of the Fund's prospectus and each annual and semi-annual report, when available, will be
mailed to those addresses shared by two or more accounts. If you wish to receive individual copies of these documents and your shares are held
directly with the Fund, call the Fund at 844.312.2113. You will receive the additional copy within 30 days after receipt of your request by the Fund.
Alternatively, if your shares are held through a financial institution, please contact the financial institution directly.
Acceptance and Timing of Purchase Orders
Under normal circumstances, a purchase order received by the Fund or its designee prior to the NYSE Close, on a day the Fund is open for business,
together with payment made in one of the ways described above will be effected at that day’s NAV plus any applicable sales charge. An order
received after the NYSE Close will be effected at the NAV determined on the next business day. However, orders received by certain retirement plans
and other financial firms on a business day prior to the NYSE Close and communicated to the Fund or its designee prior to such time as agreed upon
by the Fund and financial firm will be effected at the NAV determined on the business day the order was received by the financial firm. The Fund is
“open for business” on each day the NYSE is open for trading, which excludes the following holidays: New Year’s Day, Martin Luther King, Jr. Day,
Presidents’ Day, Good Friday, Memorial Day, Juneteenth National Independence Day, Independence Day, Labor Day, Thanksgiving Day and Christmas
Day. On any day that regular trading on the NYSE closes earlier than scheduled, the Fund reserves the right to: (i) advance the time as of which the
NAV is calculated and, therefore, the time by which purchase orders must be received to receive that day’s NAV or (ii) accept purchase orders until,
and calculate its NAV as of, the normally scheduled NYSE Close. On any day that the NYSE is closed when it would normally be open for business, the
Fund may accept purchase orders until, and calculate its NAV as of, the normally scheduled close of regular trading on the NYSE or such other time
that the Fund may determine.
The Fund reserves the right to close if the primary trading markets of the Fund’s portfolio instruments are closed and the Fund’s management believes
that there is not an adequate market to meet purchase requests. On any business day when the Securities Industry and Financial Markets Association
(“SIFMA”) recommends that the securities markets close trading early, the Fund may close trading early. Purchase orders will be accepted only on
days which the Fund is open for business.
The Fund and the Distributor each reserves the right, in its sole discretion, to accept or reject any order for purchase of Fund Common Shares in whole
or in part
. The sale of Common Shares may be suspended during any period in which the NYSE is closed other than weekends or holidays, or if
permitted by the rules of the SEC, when trading on the NYSE is restricted or during an emergency which makes it impracticable for the Fund to
dispose of its securities or to determine fairly the value of its net assets, or during any other period as permitted by the SEC for the protection of
investors.
Verification of Identity and Compliance with Economic Sanctions and Anti-Money Laundering Laws
To help the federal government combat the funding of terrorism and money laundering activities, federal law generally requires all financial
institutions to obtain, verify and record information that identifies each person (and natural person beneficial owners, if applicable) that opens a new
account, and to determine whether such person’s (or natural person beneficial owner’s) name appears on government lists of known or suspected
terrorists and terrorist organizations. As a result, unless there is an applicable exception or exemption, the Fund must obtain the following information
for each person (or natural person beneficial owner, if applicable) that opens a new account:
1.
Name;
2.
Date of birth (for individuals);
3.
Residential or business street address; and
4.
Social security number, taxpayer identification number, or other identifying number.
Federal law prohibits the Fund and other financial institutions from opening a new account unless they receive the minimum
identifying information listed above, unless there is an applicable exception or exemption.
Individuals may also be asked for a copy of their driver’s license, passport or other identifying document in order to verify their identity. In addition, it
may be necessary to verify an individual’s identity by cross-referencing the identification information with a consumer report or other electronic
database. Additional information may be required to open accounts for corporations and other entities, and the Fund or its affiliates or agents may
request information about the investor’s source of funds and source of wealth before permitting investment in the Fund.
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After an account is opened, the Fund may restrict your ability to purchase additional Common Shares until your identity is verified and all other
requested information is provided to the Fund’s satisfaction. The Fund also may close or freeze your account and redeem your shares or take other
appropriate action if it is unable to verify your identity or obtain other requested information within a reasonable time at any point in the lifecycle of
the account.
The Fund and its affiliates are subject to various anti-money laundering laws in addition to those set forth above, as well as laws that restrict them
from dealing with entities, individuals, organizations and/or investments that are subject to applicable sanctions regimes. Each investor acknowledges
that (i) if the Fund or its affiliates or agents reasonably believes that such investor (or any of its underlying beneficial owners) is the subject or target
of relevant economic or trade sanctions program or has used proceeds of crime to fund their investment,
(ii) if
the investor fails to provide information
to the Fund or its affiliates or agents for purposes of assessing the Fund’s compliance with economic or trade sanctions or anti-money laundering
laws, or (iii) if
otherwise required by applicable law or regulation, the Fund or its affiliates or agents may, in their sole discretion, undertake
appropriate actions to ensure compliance with applicable law or regulations, including but not limited to freezing, segregating or redeeming such
investor’s subscription in the Fund and/or making disclosures to appropriate regulators. In this event, the affected investor shall have no claim against
the Fund or any of its affiliates or agents, for any form of damages that result from any of the aforementioned actions.
Periodic Repurchase Offers
The Fund is a closed-end interval fund and, to provide liquidity and the ability to receive NAV on a disposition of at least a portion of your Common
Shares, makes periodic offers to repurchase Common Shares. No shareholder will have the right to require the Fund to repurchase its Common
Shares, except as permitted by the Fund's interval structure. No public market for the Common Shares exists, and none is expected to develop in the
future. Consequently, shareholders generally will not be able to liquidate their investment other than as a result of repurchases of their Common
Shares by the Fund, and then only on a limited basis.
The Fund has adopted, pursuant to Rule 23c-3 under the Act, a fundamental policy, which cannot be changed without shareholder approval, requiring
the Fund to offer to repurchase at least 5% and up to 25% of its Common Shares at NAV on a regular schedule. Although the policy permits
repurchases of between 5% and 25% of the Fund’s outstanding Common Shares, for each quarterly repurchase offer, the Fund currently expects to
offer to repurchase 10% of the Fund’s outstanding Common Shares at NAV subject to approval of the Board. The schedule requires the Fund to make
repurchase offers every three months.
Repurchase Dates
The Fund will make quarterly repurchase offers. Subject to Board approval, Repurchase Request Deadlines are expected to occur each February, May,
August and November, and Repurchase Offer Notices are expected to be sent to shareholders each January, April, July and October preceding each
such Repurchase Request Deadline. As discussed below, the date on which the repurchase price for Common Shares is determined will occur no later
than the 14th day after the Repurchase Request Deadline (or the next business day, if the 14th day is not a business day). A repurchase schedule
setting forth each of these dates for the Fund’s current calendar year is available on the Fund’s website at www.pimco.com.
Repurchase Request Deadline
The date by which shareholders wishing to tender Common Shares for repurchase must respond to the repurchase offer will be no more than
fourteen days before the Repurchase Pricing Date (defined below). When a repurchase offer commences, the Fund sends, at least 21 days before the
Repurchase Request Deadline, written notice to each shareholder setting forth, among other things:
◾
The percentage of outstanding Common Shares that the Fund is offering to repurchase and how the Fund will purchase Common Shares on a
pro rata basis if the offer is oversubscribed.
◾
The date on which a shareholder's repurchase request is due.
◾
The date that will be used to determine the Fund's NAV applicable to the repurchase offer (the “Repurchase Pricing Date”).
◾
The date by which the Fund will pay to shareholders the proceeds from their Common Shares accepted for repurchase.
◾
The NAV of the Common Shares as of a date no more than seven days before the date of the written notice and the means by which
shareholders may ascertain the NAV.
◾
The procedures by which shareholders may tender their Common Shares and the right of shareholders to withdraw or modify their tenders
before the Repurchase Request Deadline.
◾
The circumstances in which the Fund may suspend or postpone the repurchase offer.
This notice may be included in a shareholder report or other Fund document. Shareholders that hold shares through a financial intermediary will need
to ask their financial intermediary to submit their repurchase requests and tender shares on their behalf. The Repurchase Request Deadline will be
strictly observed. If a shareholder’s repurchase request is not submitted to the Fund’s transfer agent in properly completed form by the Repurchase
Request Deadline, the shareholder will be unable to sell his or her shares to the Fund until a subsequent repurchase offer, and the shareholder’s
request for that offer must be resubmitted. If a shareholder’s Authorized Intermediary will submit his or her repurchase request, the shareholder
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should submit his or her request to the Authorized Intermediary in the form requested by the Authorized Intermediary sufficiently in advance of the
Repurchase Request Deadline to allow the Authorized Intermediary to submit the request to the Fund. If a shareholder’s Authorized Intermediary is
unable or fails to submit the shareholder’s request to the Fund in a timely manner, or if the shareholder fails to submit his or her request to the
shareholder’s Authorized Intermediary, the shareholder will be unable to sell his or her shares to the Fund until a subsequent repurchase offer, and
the shareholder’s request for that offer must be resubmitted.
Shareholders may withdraw or change a repurchase request with a proper instruction submitted in good form at any point before the Repurchase
Request Deadline.
Determination of Repurchase Price and Payment for Shares
The Repurchase Pricing Date will occur no later than the 14th day after the Repurchase Request Deadline (or the next business day, if the 14th day is
not a business day). The Fund expects to distribute payment to shareholders within three (3) business days after the Repurchase Pricing Date and will
distribute such payment no later than seven (7) calendar days after such date. The Fund's NAV per share may change materially between the date a
repurchase offer is mailed and the Repurchase Request Deadline, and it may also change materially between the Repurchase Request Deadline and
Repurchase Pricing Date. The method by which the Fund calculates NAV is discussed below under “How Fund Shares are Priced.” During the period
an offer to repurchase is open, shareholders may obtain the current NAV by visiting www.pimco.com or calling the Fund’s transfer agent at
844.312.2113.
Suspension or Postponement of Repurchase Offers
The Fund may suspend or postpone a repurchase offer in limited circumstances set forth in Rule 23c-3 under the Act, as described below, but only
with the approval of a majority of the Trustees, including a majority of Trustees who are not “interested persons” of the Fund, as defined in the Act.
The Fund may suspend or postpone a repurchase offer as may be permitted under Rule 23c-3, including (but not limited to): (1) if making or effecting
the repurchase offer would cause the Fund to lose its status as a RIC under Subchapter M of the Code; (2) for any period during which the NYSE or
any other market in which the securities owned by the Fund are principally traded is closed, other than customary weekend and holiday closings, or
during which trading in such market is restricted; (3) for any period during which an emergency exists as a result of which disposal by the Fund of
securities owned by it is not reasonably practicable, or during which it is not reasonably practicable for the Fund fairly to determine the value of its net
assets; or (4) for such other periods as the SEC may by order permit for the protection of shareholders of the Fund.
Oversubscribed Repurchase Offers
There is no minimum number of Common Shares that must be tendered before the Fund will honor repurchase requests. However, the Fund’s Trustees
set for each repurchase offer a maximum percentage of Common Shares that may be repurchased by the Fund, which is currently expected to be 10%
of the Fund’s outstanding Common Shares. In the event a repurchase offer by the Fund is oversubscribed, the Fund may repurchase, but is not
required to repurchase, additional Common Shares up to a maximum amount of 2% of the outstanding Common Shares of the Fund. If the Fund
determines not to repurchase additional Common Shares beyond the repurchase offer amount, or if shareholders tender an amount of Common
Shares greater than that which the Fund is entitled to repurchase, the Fund will repurchase the Common Shares tendered on a pro rata basis.
However, the foregoing will not prohibit the Fund from accepting all Common Shares tendered for repurchase by shareholders who own less than one
hundred (100) Common Shares and who tender all of their Common Shares, before prorating Common Shares tendered by other shareholders;
provided that if a shareholder holds his or her shares through an Authorized Intermediary, such shareholder's Authorized Intermediary may not be
willing or able to arrange for this treatment on the shareholder's behalf.
If any Common Shares that you wish to tender to the Fund are not repurchased because of proration, you will have to wait until the next repurchase
offer and resubmit a new repurchase request, and your repurchase request will not be given any priority over other shareholders’ requests. Thus, there
is a risk that the Fund may not purchase all of the Common Shares you wish to have repurchased in a given repurchase offer or in any subsequent
repurchase offer. In anticipation of the possibility of proration, some shareholders may tender more Common Shares than they wish to have
repurchased in a particular quarter, increasing the likelihood of proration.
There is no assurance that you will be able to tender your Common Shares when or in the amount that you desire.
Consequences of Repurchase Offers
From the time the Fund distributes or publishes each repurchase offer notification until the Repurchase Pricing Date for that offer, the Fund must
maintain liquid assets at least equal to the percentage of its Common Shares subject to the repurchase offer. For this purpose, “liquid assets” means
assets that may be sold or otherwise disposed of in the ordinary course of business, at approximately the price at which the Fund values them, within
the period between the Repurchase Request Deadline and the repurchase payment deadline, or which mature by the repurchase payment deadline.
The Fund is also permitted to borrow up to the maximum extent permitted under the Act to meet repurchase requests.
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If the Fund borrows to finance repurchases, interest on that borrowing will negatively affect shareholders who do not tender their Common Shares by
increasing the Fund's expenses and reducing any net investment income. There is no assurance that the Fund will be able sell a significant amount of
additional Common Shares so as to mitigate these effects.
These and other possible risks associated with the Fund’s repurchase offers are described under “Principal Risks of Investment in the
Fund-Repurchase Offers Risk” above. In addition, the repurchase of Common Shares by the Fund will be a taxable event to shareholders, potentially
even to those shareholders that do not participate in the repurchase. For a discussion of these tax consequences, see “Tax Matters” below and in the
Statement of Additional Information.
How Fund Shares are Priced
The NAV of the Fund’s Common Shares is determined by dividing the total value of the Fund’s portfolio investments and other assets, less any
liabilities, by the total number of shares outstanding.
On each day that the NYSE is open, the Fund’s Common Shares are ordinarily valued as of the NYSE Close. Information that becomes known to the
Fund or its agents after the time as of which NAV has been calculated on a particular day will not generally be used to retroactively adjust the price of
a security or the NAV determined earlier that day. If regular trading on the NYSE closes earlier than scheduled, the Fund may calculate its NAV as of
the earlier closing time or calculate its NAV as of the normally scheduled close of regular trading on the NYSE for that day. The Fund generally does
not calculate its NAV on days on which the NYSE is not open for business. If the NYSE is closed on a day it would normally be open for business, the
Fund may calculate its NAV as of the normally scheduled NYSE Close or such other time that the Fund may determine.
For purposes of calculating NAV, portfolio securities and other assets for which market quotations are readily available are valued at market value. A
market quotation is readily available only when that quotation is a quoted price (unadjusted) in active markets for identical investments that the Fund
can access at the measurement date, provided that a quotation will not be readily available if it is not reliable. Market value is generally determined
on the basis of official closing prices or the last reported sales prices. The Fund will normally use pricing data for domestic equity securities received
shortly after the NYSE Close and does not normally take into account trading, clearances or settlements that take place after the NYSE Close. A
foreign (non-U.S.) equity security traded on a foreign exchange or on more than one exchange is typically valued using pricing information from the
exchange considered by PIMCO to be the primary exchange. If market value pricing is used, a foreign (non-U.S.) equity security will be valued as of
the close of trading on the foreign exchange, or the NYSE Close, if the NYSE Close occurs before the end of trading on the foreign exchange.
Investments for which market quotations are not readily available are valued at fair value as determined in good faith pursuant to Rule 2a-5 under
the Act. As a general principle, the fair value of a security or other asset is the price that would be received to sell an asset or paid to transfer a liability
in an orderly transaction between market participants at the measurement date. Pursuant to Rule 2a-5, the Board has designated PIMCO as the
valuation designee (“Valuation Designee”) for each Fund to perform the fair value determination relating to all Fund investments. PIMCO may carry
out its designated responsibilities as Valuation Designee through various teams and committees. The Valuation Designee’s policies and procedures
govern the Valuation Designee’s selection and application of methodologies for determining and calculating the fair value of Fund investments. The
Valuation Designee may value Fund portfolio securities for which market quotations are not readily available and other Fund assets utilizing inputs
from pricing services, quotation reporting systems, valuation agents and other third-party sources (together, “Pricing Sources”).
Domestic and foreign (non-U.S.) fixed income securities, non-exchange-traded derivatives, and equity options are normally valued on the basis of
quotes obtained from brokers and dealers or Pricing Sources using data reflecting the earlier closing of the principal markets for those securities.
Prices obtained from Pricing Sources may be based on, among other things, information provided by market makers or estimates of market values
obtained from yield data relating to investments or securities with similar characteristics. Certain fixed income securities purchased on a
delayed-delivery basis are marked to market daily until settlement at the forward settlement date. Exchange-traded options, except equity options,
futures and options on futures are valued at the settlement price determined by the relevant exchange. Swap agreements are valued on the basis of
bid quotes obtained from brokers and dealers or market-based prices supplied by Pricing Sources. With respect to any portion of the Fund’s assets
that are invested in one or more open-end management investment companies (other than exchange-traded funds), a Fund’s NAV will be calculated
based on the NAVs of such investments.
If a foreign (non-U.S.) equity security’s value has materially changed after the close of the security’s primary exchange or principal market but before
the NYSE Close, the security may be valued at fair value. Foreign (non-U.S.) equity securities that do not trade when the NYSE is open are also valued
at fair value. With respect to foreign (non-U.S.) equity securities, the Fund may determine the fair value of investments based on information provided
by Pricing Sources, which may recommend fair value or adjustments with reference to other securities, indexes or assets. In considering whether fair
valuation is required and in determining fair values, the Valuation Designee may, among other things, consider significant events (which may be
considered to include changes in the value of U.S. securities or securities indexes) that occur after the close of the relevant market and before the
NYSE Close. The Fund may utilize modeling tools provided by third-party vendors to determine fair values of non-U.S. securities. For these purposes,
unless otherwise determined by the Valuation Designee, any movement in the applicable reference index or instrument (“zero trigger”) between the
April 30, 2023
(as supplemented January
12, 2024)
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PIMCO California Flexible Municipal Income Fund
earlier close of the applicable foreign market and the NYSE Close may be deemed to be a significant event, prompting the application of the pricing
model (effectively resulting in daily fair valuations.) Foreign (non-U.S.) exchanges may permit trading in foreign (non-U.S.) equity securities on days
when the Fund is not open for business, which may result in the Fund’s portfolio investments being affected when shareholders are unable to buy or
sell shares.
Investments valued in currencies other than the U.S. dollar are converted to the U.S. dollar using exchange rates obtained from Pricing Sources. As a
result, the value of such investments and, in turn, the NAV of the Fund’s shares may be affected by changes in the value of currencies in relation to
the U.S. dollar. The value of investments traded in markets outside the United States or denominated in currencies other than the U.S. dollar may be
affected significantly on a day that the Fund is not open for business. As a result, the value of the Fund’s foreign (non-U.S.) investments may change
at times when shareholders are unable to buy or sell shares and the value of such investments will be reflected in the Fund’s next calculated NAV.
Fair valuation may require subjective determinations about the value of a security. While the Fund’s and Valuation Designee’s policies and procedures
are intended to result in a calculation of the Fund’s NAV that fairly reflects security values as of the time of pricing, the Fund cannot ensure that fair
values accurately reflect the price that the Fund could obtain for a security if it were to dispose of that security as of the time of pricing (for instance,
in a forced or distressed sale). The prices used by the Fund may differ from the value that would be realized if the securities were sold.
Under certain circumstances, the per share NAV of a class of the Fund’s shares may be different from the per share NAV of another class of shares as
a result of the different daily expense accruals applicable to each class of shares.
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Distributions
The Fund currently intends to declare income dividends daily and
distribute them to Common Shareholders monthly, which may be at
rates that reflect the past and projected net income of the Fund. Subject
to applicable law, the Fund may fund a portion of its distributions with
gains from the sale of portfolio securities and other sources.
Distributions
can only be made from net investment income after paying
any accrued dividends to holders of the Preferred Shares. The dividend
rate that the Fund pays on its Common Shares may vary as portfolio and
market conditions change, and will depend on a number of factors,
including without limitation the amount of the Fund's undistributed net
investment income and net short- and long-term capital gains, as well
as dividends payable on any Preferred Shares issued by the Fund
(including any Preferred Share Gross-Up) and the costs of any other
leverage obtained by the Fund (including interest expenses on any
tender option bonds, reverse repurchase agreements, dollar rolls/buy
backs and borrowings). The rate of distributions on the Common Shares
and the Fund's dividend policy could change 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
(and other forms of leverage). For a discussion of factors that may cause
the Fund's income and capital gains (and therefore the dividend) to
vary, see “Principal Risks of the Fund.” The Fund intends to distribute
each year all of its net investment income and net short-term capital
gains. In addition, at least annually, the Fund intends to distribute net
realized long-term capital gains not previously distributed, if any. The
net investment income of the Fund consists of all income (other than
net short-term and long-term capital gains) less all expenses of the
Fund (after it pays accrued dividends on any outstanding Preferred
Shares). The Fund's distribution rates may be based, in part, on
projections as to annual cash available for distribution and, therefore,
the distributions paid by the Fund for any particular month may be more
or less than the amount of cash available to the Fund for distribution for
that monthly period.
The Fund may 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 NAV and,
correspondingly, distributions from undistributed net investment income
will be deducted from the Fund's NAV.
The Fund
’
s
Preferred Shares
pay dividend distributions at a stated
rate,
which rate
is
based generally on the assumption that such dividend
distributions will consist entirely of dividends that pass through the
character of exempt interest earned by the Fund and are therefore not
taxable to shareholders for regular federal and California income tax
purposes (“exempt-interest dividends”). IRS rules nonetheless require a
RIC having two or more classes of stock for U.S. federal income tax
purposes to characterize amounts distributed as dividends to each class
for the taxable year in accordance with their pro rata share of income or
gains of any type. Therefore,
the Fund might be required to characterize
a portion of dividends paid to Preferred Shareholders as ordinary
income or capital gain dividends. The terms of such Preferred Shares
provide further that, in the event less than the entire amount of any
particular dividend distribution paid pursuant to the stated rate were to
consist of “exempt-interest dividends” (i.e., if a portion of any particular
dividend were to derive from ordinary income or capital gain, including
short-term capital gain taxable as ordinary income when distributed),
the amount of such dividend would increase by an amount (a “Preferred
Shareholder Gross-Up”) such that the after-tax amount of such
dividend, as increased by the Preferred Shareholder Gross-Up, would
equal the total amount the holder of such Preferred Shares would have
received if the dividend at the stated rate had consisted entirely of
“exempt-interest dividends.” The Preferred Shareholder Gross-Up will
be calculated (i) without consideration being given to the time value of
money, (ii) assuming that no Preferred Shareholder is subject to the
federal alternative minimum tax, and (iii) assuming that the portion of
any dividend distribution (including the amount of any Preferred
Shareholder Gross-Up) that is not an exempt interest dividend would be
taxable (x), in the hands of the initial purchaser of the Preferred Shares
(or certain of its affiliates), at the maximum combined marginal regular
federal corporate income tax rate and California state tax rate (including
any surtax), and (y), in the hands of any other holder, at the greater of
(a) the maximum combined marginal regular federal individual income
tax rate (taking into account the 3.8% Medicare contribution tax on net
investment income) and California state tax rate (including any surtax)
applicable to ordinary income or net capital gain, as applicable, or (b)
the maximum combined marginal regular federal corporate income tax
rate and California state tax rate (including any surtax) applicable to
ordinary income or net capital gain, as applicable, in each case
disregarding the effect of any other state or local taxes. Any Preferred
Shareholder Gross-Up would reduce the amount that would otherwise
be distributable to Common Shareholders.
The tax treatment and characterization of the Fund’s distributions may
vary significantly from time to time because of the varied nature of the
Fund’s investments. If the Fund estimates that a portion of one of its
dividend distributions may be comprised of amounts from sources other
than net investment income in accordance with its internal policies,
accounting records and related accounting practices, the Fund will
notify shareholders of record of the estimated composition of such
distribution through a Section 19 Notice. For these purposes, the Fund
estimates the source or sources from which a distribution is paid, to the
close of the period as of which it is paid, in reference to its internal
accounting records and related accounting practices. If, based on such
accounting records and practices, it is estimated that a particular
distribution does not include capital gains or paid-in surplus or other
capital sources, a Section 19 Notice generally would not be issued. It is
important to note that differences exist between the Fund’s daily
internal accounting records and practices, the Fund’s financial
statements presented in accordance with U.S. GAAP, and recordkeeping
practices under income tax regulations. For instance, the Fund’s internal
accounting records and practices may take into account, among other
April 30, 2023
(as supplemented January
12, 2024)
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PIMCO California Flexible Municipal Income Fund
factors, tax-related characteristics of certain sources of distributions that
differ from treatment under U.S. GAAP. Examples of such differences
may include, among others, the treatment of paydowns on
mortgage-backed securities purchased at a discount and periodic
payments under interest rate swap contracts. Accordingly, among other
consequences, it is possible that the Fund may not issue a Section 19
Notice in situations where the Fund’s financial statements prepared
later and in accordance with U.S. GAAP and/or the final tax character of
those distributions might later report that the sources of those
distributions included capital gains and/or a return of capital.
The tax characterization of the Fund's distributions made in a taxable
year cannot finally be determined until at or after the end of the year. As
a result, there is a possibility that the Fund may make total distributions
during a taxable year in an amount that exceeds the Fund's net
investment income and net realized capital gains (as reduced by any
capital loss carryforwards) for the relevant year. For example, the Fund
may distribute amounts early in the year that are derived from
short-term capital gains, but incur net short-term capital losses later in
the year, thereby offsetting short-term capital gains out of which
distributions have already been made by the Fund. In such a situation,
the amount by which the Fund's total distributions exceed net
investment income and net realized capital gains would generally be
treated as a tax-free return of capital up to the amount of a
shareholder's tax basis in his or her Common Shares, with any amounts
exceeding such basis treated as gain from the sale of Common Shares.
In general terms, a return of capital would occur where a Fund
distribution (or portion thereof) represents a return of a portion of your
investment, rather than net income or capital gains generated from your
investment during a particular period. A return of capital is not taxable,
but it reduces a shareholder's tax basis in the Common Shares, thus
reducing any loss or increasing any gain on a subsequent taxable
disposition by the shareholder of the Common Shares. The Fund will
send shareholders detailed tax information with respect to the Fund's
distributions annually. See “Tax Matters.”
The Act currently limits the number of times the Fund may distribute
long-term capital gains in any tax year, which may increase the
variability of the Fund's distributions and result in certain distributions
being comprised more or less heavily than others of long-term capital
gains currently eligible for favorable income tax rates.
Unless a Common Shareholder elects to receive distributions in cash, all
distributions of Common Shareholders whose shares are registered with
the plan agent will be automatically reinvested in additional Common
Shares under the Plan. See “Dividend Reinvestment Plan.”
The Board may change the Fund's distribution policy and the amount or
timing of distributions, based on a number of factors, including the
amount of the Fund's undistributed net investment income and net
short- and long-term capital gains and historical and projected net
investment income and net short- and long-term capital gains.
Dividend Reinvestment Plan
Pursuant to the Plan, all Common Shareholders will have all dividends,
including any capital gain dividends, reinvested automatically in
additional Common Shares by SS&C Global Investor and Distribution
Solutions, 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.
Common Shares received under the Plan will be issued to you at their
NAV on the ex-dividend date; there is no sales or other charge for
reinvestment. You are free to withdraw from the Plan and elect to
receive cash at any time by giving written notice to the Plan Agent or by
contacting your broker or dealer, who will inform the Fund. Your request
must be received by the Fund at least ten days prior to the payment
date of the distribution to be effective for that dividend or capital gain
distribution.
The Plan Agent provides written confirmation of all transactions in the
shareholder accounts in the Plan, including information you may need
for tax records. Any proxy you receive will include all Common Shares
you have received under the Plan.
Automatically reinvested dividends and distributions are taxed in the
same manner as cash dividends and distributions. See “Tax Matters.”
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. If the Plan is amended to
include such service charges, the Plan Agent will include a notification
to registered Common Shareholders with the Plan Agent. Additional
information about the Plan may be obtained from the Plan Agent.
Description of Capital Structure and Shares
The following is a brief description of the capital structure of the Fund.
This description does not purport to be complete and is subject to and
qualified in its entirety by reference to the Declaration and the Fund’s
Bylaws, as amended and restated through the date hereof (the
“Bylaws”). The Declaration and Bylaws are each exhibits to the
registration statement of which this prospectus is a part.
The Fund is an unincorporated voluntary association with transferable
shares of beneficial interest (commonly referred to as a “Massachusetts
business trust”) established under the laws of The Commonwealth of
Massachusetts by the Declaration. The Declaration provides that the
Trustees of the Fund may authorize separate classes of shares of
beneficial interest. Preferred Shares
(such as the RVMTP Shares)
may be
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Prospectus
issued in one or more series, with such par value and with such rights as
determined by the Board, by action of the Board without the approval of
the Common Shareholders.
The following table shows, for each class of authorized securities of the
Fund, the amount of (i) shares authorized and (ii) shares outstanding,
each as of
January
2
,
2024 (and as of January
12, 2054 for the Series
2054 RVMTP Shares)
:
(1) | (2) | (3) | (4) |
Title of Class | Amount Authorized | Amount Held by the Fund for its Account | Amount Outstanding Exclusive of Amount Shown Under Column (3) |
Institutional Class Common Shares | Unlimited | 0 | 8,050,872.81 |
Class A-1 Common Shares | Unlimited | 0 | 451,793.70 |
Series 2054 RVMTP Shares | Unlimited | 0 | 250 |
Common Shares
The Declaration authorizes the issuance
of
an unlimited number ofCommon Shares. The Common Shares will be issued with a par value of
$0.00001 per share. The Fund currently has five separate classes of
Common Shares: Institutional Class, Class A-1, Class A-2, Class A-3 and
Class A-4. An investment in any share class of the Fund represents an
investment in the same assets of the Fund. However, the ongoing fees
and expenses for each share class may be different. The fees and
expenses for the Fund are set forth in “Summary of Fund Expenses”
above. Certain share class details are set forth in “Plan of Distribution”
above.
Common Shareholders will be entitled to the payment of dividends and
other distributions when, as and if declared by the Board after payment
of preferential amounts payable to
holders of Preferred Shares
. All
Common Shares have equal rights to the payment of dividends and the
distribution of assets upon liquidation after payment of the preferential
amounts payable to
holders of Preferred Shares
. Common Shares will,
when issued, be fully paid and, subject to matters discussed in
“Anti-Takeover and Other Provisions in the Declaration of Trust and
Bylaws,” non-assessable, and will have no pre-emptive or conversion
rights or rights to cumulative voting. Upon liquidation of the Fund, after
paying or adequately providing for the payment of all liabilities of the
Fund and the liquidation preference with respect to any outstanding
Preferred Shares, and upon receipt of such releases, indemnities and
refunding agreements as they deem necessary for their protection, the
Trustees may distribute the remaining assets of the Fund among the
Fund’s Common Shareholders.
The Fund does not intend to hold annual meetings of shareholders. If
the Fund does hold a meeting of shareholders, Common Shares of the
Fund entitle their holders to one vote for each Common Share held;
however, separate votes are taken by each class of Common Shares on
matters affecting an individual class of Common Shares. Each fractional
share shall be entitled to a proportionate fractional vote, except as
otherwise provided by the Declaration, Bylaws, or required by applicable
law.
So long as
any Preferred Shares are outstanding,
holders of
Preferred Shares
will be able to elect two Trustees and vote as a
separate class on certain matters.
The Fund will send unaudited reports at least semiannually and audited
financial statements annually to all of its Common Shareholders.
The Common Shares are not, and are not expected to be, listed for
trading on any national securities exchange nor is there expected to be
any secondary trading market in the Common Shares.
Preferred Shares
The Declaration authorizes the issuance of an unlimited number of
preferred shares. Preferred shares may be issued in one or more classes
or series, with such par value and rights as determined by the Board, by
action of the Board without the approval of the Common Shareholders.
On January 12, 2024, the Fund issued 250 RVMTP Shares in a single
series of Remarketable Variable Rate MuniFund Term Preferred Shares,
Series 2054 (the “RVMTP Shares”). The RVMTP Shares have a par value
of $0.00001 per share and liquidation preference of $100,000 per
share. The RVMTP Shares have various rights that were approved by the
Board without the approval of the Common Shareholders, which are
specified in the Fund’s Bylaws. Certain rights, terms and conditions of
the RVMTP Shares are summarized below:
Distribution Preference.
Any Preferred Shares, including, without
limitation, the RVMTP Shares, have complete priority over the Common
Shares as to distribution of assets.
RVMTP Share Dividends.
The dividend rate paid on the RVMTP
Shares is also determined over the course of the Rate Period. The
dividends per share for the RVMTP Shares for a given Rate Period are
dependent on the RVMTP Share dividend rate (the “RVMTP Share
Dividend Rate”) for that Rate Period. The RVMTP Share Dividend Rate is
equal to (i) the sum of the Index Rate
1
plus (ii) the Applicable Spread
2
(including the “Spread Adjustment”
3
) plus (iii) the Failed Remarketing
Spread
4
. The dividend per RVMTP Share for the Rate Period is then
determined as described in the table below.
5
Dividend Rate | Rate Period Fraction | RVMTP Shares Liquidation Preference | Dividend | |||
Number of days in the Rate Period (or a part thereof) | ||||||
Dividend Rate | X | Divided by | X | 100,000 | = | Dividends per RVMTP Share |
Total number of days in the year |
(1)
The Index Rate is determined by reference to a weekly, high-grade index comprised of
seven-day, tax-exempt variable rate demand notes, generally the Securities Industry
and Financial Markets Association Municipal Swap Index.
(2)
The Applicable Spread for a Rate Period is a percentage per annum that is based on (i)
the long term rating most recently assigned by the applicable ratings agency to such
series of the RVMTP Shares, and (ii) the “Spread Adjustment.”
(3)
The “Spread Adjustment” means, (i) for the period from the closing date, January 12,
2024 to and including the date that is six months prior to the then current RVMTP
Early Term Redemption Date (as defined below) (“Rate Period Termination Date”), 0%,
and (ii) for the period after the Rate Period Termination Date, 2.00%.
April 30, 2023
(as supplemented January
12, 2024)
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PIMCO California Flexible Municipal Income Fund
(4)
The Failed Remarketing Spread with respect to a series of RVMTP Shares means (i) for
so long as two or more Failed Remarketings have not occurred, 0%, and (ii) following
the second occurrence of a Failed Remarketing, 0.25% (for Series 2050-B) multiplied
by the number of Failed Remarketings that have occurred after the first Failed
Remarketing. A “Failed Remarketing,” with respect to a series of RVMTP Shares, will
occur if any RVMTP Shares in such series subject to a Mandatory Tender Event due to
the Fund designating a Special Terms Period have not been either retained by the
holders or successfully remarketed by the Mandatory Tender Date (each as defined
below).
(5)
An increased RVMTP Share Dividend Rate could be triggered by the Fund’s failure to
comply with certain requirements relating to such series of the RVMTP Shares, certain
actions taken by the applicable ratings agency or certain determinations regarding the
tax status of such series of the RVMTP Shares made by a court or other applicable
governmental authority. The RVMTP Share Dividend Rate will in no event exceed 15%
per year.
RVMTP Special Terms Period.
The Fund, at its option, may
designate special terms applicable to all of the outstanding RVMTP
Shares in a series for a certain period (a “Special Terms Period”)
pursuant to a notice of special terms. Such special terms may differ from
those provided in the current governing documents of the RVMTP
Shares and may include, without limitation, changes to the RVMTP
Dividend Rate, dividend payment dates, redemption provisions
(including, without limitation, the RVMTP Term Redemption Date or the
RVMTP Early Term Redemption Date), required Effective Leverage Ratio,
and the Preferred Shareholder Gross-Up (each as defined below);
provided that such special terms do not affect the parity ranking of the
RVMTP Shares to any other class or series of Preferred Shares then
outstanding with respect to dividends or distribution of assets upon
dissolution, liquidation, or winding up of the affairs of the Fund. No
Special Terms Period with respect to a series of RVMTP Shares will
become effective unless certain conditions are satisfied, including that
all of the RVMTP Shares in such series are remarketed (except with
respect to any RVMTP Shares whose holders have elected to retain their
RVMTP Shares for the Special Terms Period). A Special Terms Period will
not become effective before the the 24-month anniversary of the date
of original issue of the RVMTP Shares.
Preferred Shareholder Gross-Up.
As noted above, RVMTP Shares
each pay dividend distributions at stated rates, which rates are based
generally on the assumption that such dividend distributions consist
entirely of “exempt-interest dividends” (as defined below under
“Taxes—Taxes on Portfolio Distributions”). The terms of the RVMTP
Shares provide further that, in the event less than the entire amount of
any particular dividend distribution paid pursuant to the stated rate
were to consist of “exempt-interest dividends” (i.e., if a portion of any
particular dividend were to derive from ordinary income or capital gain,
including short-term capital gain taxable as ordinary income when
distributed), the amount of such dividend would increase by an amount
(the “Preferred Shareholder Gross-Up”) such that the after-tax amount
of such dividend, as increased by the Preferred Shareholder Gross-Up,
would equal the total amount the holder of such RVMTP Shares would
have received if the dividend at the stated rate had consisted entirely of
“exempt-interest dividends.” The Preferred Shareholder Gross-Up is
calculated (i) without consideration being given to the time value of
money, (ii) assuming that no holder of RVMTP Shares is subject to the
federal alternative minimum tax, and (iii) assuming that the portion of
any dividend distribution (including the amount of the Preferred
Shareholder Gross-Up) that is not an exempt interest dividend would be
taxable (x), in the hands of the initial purchaser of the RVMTP Shares (or
certain of its affiliates), at the maximum marginal regular federal
corporate income tax rate, and (y) in the case of any other holder, at the
greater of (a) the maximum marginal regular federal individual income
tax rate (taking into account the 3.8% Medicare contribution tax on net
investment income) applicable to ordinary income or net capital gain, as
applicable, or (b) the maximum marginal regular federal corporate
income tax rate applicable to ordinary income or net capital gain, as
applicable, in each case disregarding the effect of any state or local
taxes.
Any Preferred Shareholder Gross-Up
will
reduce the amount that
would otherwise be distributable to Common Shareholders.
Liquidation Preference.
In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the affairs of the Fund,
holders
of RVMTP Shares are
entitled to receive a preferential liquidating
distribution (
equal
to
the original purchase price per share
of $100,000
plus accumulated and unpaid dividends thereon, whether or not earned
or declared) before any distribution of assets is made to Common
Shareholders.
Voting Rights.
Under the Act, Preferred Shares
(including, without
limitation, the RVMTP Shares)
are required to be voting shares and to
have equal voting rights with Common Shares. Except as otherwise
indicated in this prospectus or the Statement of Additional Information,
and except as otherwise required by applicable law, Preferred Shares
vote together with Common Shareholders as a single class.
In addition, holders of Preferred Shares, including RVMTP Shares, voting
as a separate class, are entitled to elect two of the Fund’s trustees. The
remaining trustees are elected by Common Shareholders and Preferred
Shareholders, 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, are entitled to elect a majority of the Fund’s trustees until all
dividends in arrears with respect to the Preferred Shares have been paid
or declared and set apart for payment. In order for the Fund to take
certain actions or enter into certain transactions, a separate class vote of
Preferred Shareholders is required, in addition to the single class vote of
the holders of Preferred Shares and Common Shares.
1940 Act Asset Coverage.
In accordance with the Fund’s governing
documents and the Act, the Fund is required to maintain certain asset
coverage with respect to all outstanding senior securities of the Fund
which are stocks for purposes of the Act, including the RVMTP Shares.
Under the Act, the Fund is not permitted to issue preferred shares
unless, immediately after such issuance, the value of the Fund’s total net
assets (as defined below) is at least 200% of the liquidation value of
any outstanding preferred shares and the newly issued 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 or pay common share dividends unless
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Prospectus
immediately thereafter the Fund has a minimum asset coverage ratio of
200% with respect to all outstanding senior securities of the Fund
which are stocks for purposes of the Act after deducting the amount of
such common share dividends.
In addition, under the terms of the RVMTP Shares, the Fund must
maintain an “asset coverage,” as defined for purposes of Section 18(h)
of the Act, of at least 225% with respect to all outstanding preferred
shares, including all previously issued outstanding preferred shares (or
such other asset coverage as may in the future be specified in or under
the Act or by rule, regulation or order of the SEC as the minimum asset
coverage for senior securities which are shares of stock of a closed-end
investment company).
Additional Investment Limitations.
Under the terms of purchase
agreements between the Fund and the initial investor in the RVMTP
Shares, the Fund is subject to various investment limitations. These
investment limitations are in addition to, and may be more restrictive
than, those to which the Fund is subject in accordance with its
investment objectives and policies as described herein and in the
Statement of Additional Information.
Effective Leverage Ratio Requirement.
In accordance with the
Bylaws, without the prior written consent of the holders of RVMTP
Shares, the Fund’s Effective Leverage Ratio may not exceed 45% (or
46% solely by reason of fluctuations in the market value of the Fund’s
portfolio securities) as of the close of business on any business day. If
the Fund fails to comply with any additional requirements relating to
the calculation of the Effective Leverage Ratio requirement applicable to
the RVMTP Shares and, in any such case, such failure is not cured as of
the close of business on the date that is ten business days following the
business day on which such non-compliance is first determined (the
“Effective Leverage Ratio Cure Date”), the Fund shall cause the
Effective Leverage Ratio to not exceed 45% (or 46% solely by reason of
fluctuations in the market value of the Fund’s portfolio securities), by (i)
not later than the close of business on the business day next following
the Effective Leverage Ratio Cure Date, engaging in transactions
involving or relating to any floating rate securities not owned by the
Fund and/or any inverse floating rate securities owned by the Fund,
including the purchase, sale or retirement thereof, (ii) to the extent
permitted by law, not later than the close of business on the second
business day next following the Effective Leverage Ratio Cure Date,
causing a notice of redemption to be issued for the redemption of a
sufficient number of Preferred Shares, in accordance with the terms of
the Preferred Shares, or (iii) engaging in any combination, in the Fund’s
discretion, of the actions contemplated by clauses (i) and (ii).
Issuance of Additional Preferred Shares.
So long as any RVMTP
Shares are outstanding, the Fund may, without the vote or consent of
the holders thereof, authorize, establish and create and issue and sell
shares of one or more series of Preferred Shares ranking on a parity with
RVMTP Shares as to the payment of dividends and the distribution of
assets upon dissolution, liquidation or the winding up of the affairs of
the Fund, in addition to then outstanding series of RVMTP Shares,
including additional series of RVMTP Shares, and authorize, issue and
sell additional shares of any such Series of Preferred Shares then
outstanding or so established or created, including additional series of
RVMTP Shares, in each case in accordance with applicable law, provided
that the Fund shall, immediately after giving effect to the issuance of
such Preferred Shares and to its receipt and application of the proceeds
thereof, including to the redemption of Preferred Shares with such
proceeds, have “asset coverage,” as defined for the purposes of
Section 18(h) of the Act, of at least 225% and an effective leverage
ratio not exceeding 45% (calculated according to the terms of the
section below entitled “Preferred Shares-Calculation of Effective
Leverage Ratio”).
Calculation of Effective Leverage Ratio.
For purposes of
determining whether the effective leverage requirement discussed
above is satisfied, the “Effective Leverage Ratio” on any date shall
mean the quotient of: (i) The sum of (A) the aggregate liquidation
preference of the Fund’s “senior securities” (as that term is defined in
the Act) that are stock for purposes of the Act, excluding, without
duplication, (1) any such senior securities for which the Fund has issued
a notice of redemption and either has delivered deposit securities or
sufficient securities or funds, (as applicable in accordance with the terms
of such senior securities) to the paying agent for such senior securities
or otherwise has adequate deposit securities or sufficient securities or
funds on hand for the purpose of such redemption (as applicable in
accordance with the terms of such senior securities) and (2) any such
senior securities that are to be redeemed with net proceeds from the
sale of the RVMTP Shares, for which the Fund has delivered deposit
securities or sufficient securities or funds (as applicable in accordance
with the terms of such senior securities) to the paying agent for such
senior securities or otherwise has adequate deposit securities or
sufficient securities or funds on hand (as applicable in accordance with
the terms of such senior securities) for the purpose of such redemption;
(B) the aggregate principal amount of the Fund’s “senior securities
representing indebtedness” (as that term is defined in the Act giving
effect to any interpretations thereof by the SEC or its staff); (C) the
aggregate principal amount of floating rate securities corresponding to
any associated residual floating rate securities not owned by the Fund
(less the aggregate principal amount of any such floating rate securities
owned by the Fund and corresponding to the associated residual
floating rate securities owned by the Fund); and (D) the aggregate
amount of the purchase price component payable for a repurchase
under reverse repurchase agreements entered into by the Fund; divided
by (ii) the sum of (A) the market value of the Fund’s total assets
(including amounts attributable to senior securities, but excluding any
assets consisting of deposit securities or funds referred to in clauses
(A)(1) and (A)(2) above), less the amount of the Fund’s accrued
liabilities (other than liabilities for the aggregate principal amount of
“senior securities representing indebtedness” (as that term is defined in
the Act, giving effect to any interpretations thereof by the SEC or its
staff), including floating rate securities), (B) the aggregate principal
amount of floating rate securities not owned by the Fund that
correspond to the associated inverse floating rate securities owned by
the Fund; and (C) the aggregate amount of the purchase price
component payable for a repurchase under reverse repurchase
agreements entered into by the Fund.
April 30, 2023
(as supplemented January
12, 2024)
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PIMCO California Flexible Municipal Income Fund
Ratings Agency Guidelines.
The Fund has obtained ratings for the
RVMTP Shares from Fitch. For so long as Fitch is rating the RVMTP
Shares, the Fund has agreed to adhere to separate guidelines and asset
coverage requirements specific to Fitch (“Fitch Preferred Shares Asset
Coverage”) as described in Fitch’s published Closed-End Funds and
Market Value Structures Rating Criteria (“Fitch Rating Criteria”). These
guidelines may be changed by Fitch, in its sole discretion, from time to
time. These guidelines impose asset coverage or portfolio composition
requirements that may be more stringent than those imposed on the
Fund by the Act.
Satisfaction of Fitch Preferred Shares Asset Coverage for the RVMTP
Shares requires that the Fund satisfy both a “Fitch Total
Overcollateralization Test” (“Fitch Total OC”) and a “Fitch Net Over
Collateralization Test” (“Fitch Net OC”, and together with Fitch Total
OC, the “Fitch OC Tests”), in each case to be consistent with the
then-current rating of the RVMTP Shares assigned by Fitch using the
calculations set forth in the Fitch Rating Criteria, including information
therein relating to diversification guidelines as applied to the Fund.
The Fund has agreed that it will adhere to the Fitch OC Tests as
described above as of the close of business on the last business day of
each month for so long as Fitch is rating the RVMTP Shares. If the Fund
fails to adhere to the Fitch OC Tests as described in the preceding
sentence, the Fund will cure such failure (including, without limitation,
by causing a notice of redemption to be issued for the redemption of a
sufficient number of the Fund’s Preferred Shares) within ten days
following the business day on which such failure is first determined.
Fitch may change its rating methodologies for evaluating and providing
ratings for shares of closed-end funds at any time and in its sole
discretion, perhaps substantially. Such a change could adversely affect
the ratings assigned to the Fund’s Preferred Shares, the dividend rates
paid thereon, and the expenses borne by the Fund’s Common
Shareholders.
Mandatory Redemptions.
The RVMTP Shares are subject to a
mandatory term redemption date of January 12, 2054, subject to the
Fund’s right to extend the term with the consent of the holders of the
RVMTP Shares (the “RVMTP Share Term Redemption Date”). There is no
assurance that the term of the RVMTP Shares will be extended.
In addition, with respect to each series of RVMTP Shares, a “Mandatory
Tender Event” will occur on each date that is (i) 20 business days before
each 42-month anniversary of the date of original issue of such series of
the RVMTP Shares, (ii) the date the Fund delivers a notice designating a
Special Terms Period, and (iii) 20 business days before the end of a
Special Terms Period (provided that no subsequent Terms Period is
designated). If any RVMTP Shares subject to a Mandatory Tender Event
upon a forty-two month anniversary of the date of original issue of the
RVMTP Shares or upon the end of a Special Terms Period (each, an
“RVMTP Early Term Redemption Date”) have not been either retained
by the holders or remarketed by the Mandatory Tender Date, the Fund
will redeem such RVMTP Shares on the RVMTP Early Term Redemption
Date.
1
The RVMTP Shares are also subject to mandatory redemption by the
Fund, in whole or in part, in certain circumstances, such as the failure by
the Fund to comply with asset coverage and/or effective leverage ratio
requirements described above (and the failure to cure any such failure
within the applicable cure period) or certain actions taken by the
applicable ratings agency.
Term Redemption and Early Term Redemption Liquidity
Account.
At least six months prior to the RVMTP Share Redemption
Date or the RVMTP Early Term Redemption Date (each, a ”Redemption
Date“), the Fund will maintain segregated assets of a minimum credit
rating quality with a market value equal to at least 110% of the
redemption price of all outstanding RVMTP Shares to be redeemed until
the redemption of all such outstanding RVMTP Shares, as applicable.
The Fund will include certain liquid and/or highly rated assets in an
amount equal to 20% of such segregated assets with five months
remaining to the Redemption Date, which amount will increase monthly
by 20% and reach 100% with one month remaining to the Redemption
Date.
Optional Redemption.
The Fund may redeem, in whole or from time
to time in part, the outstanding RVMTP Shares at a redemption price
per share equal to (i) the liquidation preference of the RVMTP Shares, as
applicable, plus (ii) an amount equal to all unpaid dividends and other
distributions on such RVMTP Shares, as applicable, accumulated from
and including the date of issuance to (but excluding) the date of
redemption (whether or not earned or declared by the Fund, but
without interest thereon) plus (iii) any applicable optional redemption
premium.
2
RVMTP Mandatory Tender.
Upon the occurrence of a Mandatory
Tender Event with respect to a series of RVMTP Shares, all RVMTP
Shares in such series will be subject to mandatory tender (subject to the
holders’ election to retain their RVMTP Shares) and the Fund will issue
or cause to be issued a notice of mandatory tender to the holders of
such RVMTP Shares for remarketing on the Mandatory Tender Date.
Common Share Repurchases.
In the event that the Fund notifies
JPMorgan that it will repurchase its common shares more frequently
than quarterly or repurchase more than 12% of its issued and
outstanding Common Shares in connection with a single repurchase
offer, the Fund must redeem all of the RVMTP Shares held by JPMorgan
in accordance with Section 2.6(c) of the RVMTP Statement (as defined
above) by the date of such common share repurchase if JPMorgan
requests such redemption in writing to the Fund within five (5) business
days after receiving such notice.
(1)
With respect to the Mandatory Tender Events described in clauses (i), (ii) and (iii)
above, the corresponding “Mandatory Tender Date” means, respectively: (i) the date
that is the 42 month anniversary of the date of original issue of such series of RVMTP
Share, (ii) the date on which the related Special Terms Period becomes effective, and
(iii) the last day of the related Special Terms Period (subject, in each case, to the
holders’ election to retain their RVMTP Shares).
(2)
If the Fund redeems RVMTP Shares prior to the first anniversary of its closing date, the
applicable optional redemption premium will be equal to the product of (i) the
Applicable Spread for such RVMTP share in effect on the date of the optional
redemption and (ii) the liquidation preference of such RVMTP Share and (iii) a fraction,
the numerator of which is the number of calendar days from and including from and
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| PIMCO California Flexible Municipal Income Fund
Prospectus
including the date of redemption to and excluding the first anniversary of the closing
date and the denominator of which is the actual number of calendar days from and
including January 12, 2024 to and excluding the first anniversary of the closing date. If
either (a) the optional redemption date for such RVMTP Share either occurs on or after
the first anniversary of the closing or (b) the Fund notifies JPMorgan Chase Bank, N.A.
(“JPMorgan”) that the optional redemption date has been called in connection with a
redemption of common shares as described in Section 6.20 of the Amended and
Restated Purchase Agreement, then zero. If fewer than all of the outstanding RVMTP
Shares of a Series are to be redeemed, the shares of such Series to be redeemed shall
be selected either (A) pro rata among the holders of such Series, (B) by lot, or (C) in
such other manner as the Board may determine to be fair and equitable.
Anti-Takeover and Other Provisions in the
Declaration of Trust and Bylaws
The Declaration and the Bylaws include 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.
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 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 and holders of at least
seventy-five percent (75%) of the Fund's shares to authorize certain
Fund transactions not in the ordinary course of business, including a
merger or consolidation or share exchange, any shareholder proposal as
to specific investment decisions made or to be with respect to the assets
of the Fund or issuance or transfer by the Fund of the Fund's shares
having an aggregate fair market value of $1,000,000 or more (except
as may be made pursuant to a public offering, the Fund's Plan or upon
exercise of any stock subscription rights), 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 Act). The Declaration also requires
the affirmative vote or consent of holders of at least seventy-five
percent (75%) 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 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 and By-Laws” 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 Bylaws,
certain of which are required by the Act.
The overall effect of these provisions is to render more difficult the
accomplishment of a merger or the assumption of control of the Fund
by a third party. These provisions also 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 objectives and policies. The Board
has considered the foregoing anti-takeover provisions and concluded
that they are in the best interests of the Fund and its shareholders,
including 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 Bylaws,
both of which are on file with the SEC.
Under Massachusetts law, shareholders could, in certain circumstances,
be held personally liable for the obligations of the Fund. However, the
Declaration contains an express disclaimer of shareholder liability for
debts or obligations of the Fund and requires that notice of such limited
liability be given in each agreement, obligation or instrument entered
into or executed by the Fund or the Trustees. The Declaration further
provides for indemnification out of the assets and property of the Fund
for all loss and expense of any shareholder held personally liable for the
obligations of the Fund. Thus, the risk of a shareholder incurring
financial loss on account of shareholder liability is limited to
circumstances in which the Fund would be unable to meet its
obligations. The Fund believes that the likelihood of such circumstances
is remote.
Forum for Adjudication of Disputes
The Bylaws provide that unless the Fund consents in writing to the
selection of an alternative forum, the sole and exclusive forum for (i) any
action or proceeding brought on behalf of the Fund or one or more of
the shareholders, (ii) any action asserting a claim of breach of a fiduciary
duty owed by any Trustee, officer, other employee of the Fund, or the
Fund's investment adviser to the Fund or the Fund's shareholders, (iii)
any action asserting a breach of contract by the Fund, by any Trustee,
officer or other employee of the Fund, or by the Fund's investment
adviser, (iv) any action asserting a claim arising pursuant to any
provision of the Massachusetts Business Corporation Act, Chapter 182
of the Massachusetts General Laws or the Declaration or the Bylaws, (v)
any action to interpret, apply, enforce or determine the validity of the
Declaration or the Bylaws or any agreement contemplated by any
provision of the Act, the Declaration or the Bylaws, or (vi) any action
asserting a claim governed by the internal affairs doctrine shall be
within the federal or state courts in the Commonwealth of
Massachusetts (each, a “Covered Action”).
The Bylaws further provide that if any Covered Action is filed in a court
other than in a federal or state court sitting within the Commonwealth
of Massachusetts (a “Foreign Action”) in the name of any shareholder,
such shareholder shall be deemed to have consented to (i) the personal
jurisdiction of the federal and state courts within The Commonwealth of
April 30, 2023
(as supplemented January
12, 2024)
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PIMCO California Flexible Municipal Income Fund
Massachusetts in connection with any action brought in any such courts
to enforce the preceding sentence (an “Enforcement Action”) and (ii)
having service of process made upon such shareholder in any such
Enforcement Action by service upon such shareholder's counsel in the
Foreign Action as agent for such shareholder.
Any person purchasing or otherwise acquiring or holding any interest in
shares of beneficial interest of the Fund will be (i) deemed to have
notice of and consented to the foregoing paragraph and (ii) deemed to
have waived any argument relating to the inconvenience of the forum
referenced above in connection with any action or proceeding described
in the foregoing paragraph.
This forum selection provision may limit a shareholder's ability to bring a
claim in a judicial forum that it finds favorable for disputes with
Trustees, officers or other agents of the Fund and its service providers,
which may discourage such lawsuits with respect to such claims and
increase the costs for a shareholder to pursue such claims. If a court
were to find the forum selection provision contained in the Bylaws to be
inapplicable or unenforceable in an action, the Fund may incur
additional costs associated with resolving such action in other
jurisdictions. This forum selection provision shall not apply to claims
made under federal securities laws. The enforceability of exclusive forum
provisions is questionable.
Derivative and Direct Claims of Shareholders
The Declaration contains provisions regarding derivative and direct
claims of shareholders. As used in the Declaration, a “direct”
shareholder claim refers to a claim based upon alleged violations of a
shareholder's individual rights independent of any harm to the Fund,
including a shareholder's voting rights under Article V of the Declaration
or Article 10 of the Bylaws, rights to receive a dividend payment as may
be declared from time to time, rights to inspect books and records, or
other similar rights personal to the shareholder and independent of any
harm to the Fund. Any other claim asserted by a shareholder, including
without limitation any claims purporting to be brought on behalf of the
Fund or involving any alleged harm to the Fund, are considered a
“derivative” claim.
A shareholder or group of shareholders may not bring or maintain any
court action, proceeding or claim on behalf of the Fund or any series or
class of shares without first making demand on the Trustees requesting
the Trustees to bring or maintain such action, proceeding or claim. Such
demand shall not be excused under any circumstances, including claims
of alleged interest on the part of the Trustees. The Trustees shall consider
such demand within 90 days of its receipt by the Fund. In their sole
discretion, the Trustees may submit the matter to a vote of shareholders
of the Fund or a series or class of shares, as appropriate. Any decision by
the Trustees to bring, maintain or settle (or not to bring, maintain or
settle) such court action, proceeding or claim, or to submit the matter to
a vote of shareholders shall be made by the Trustees in their business
judgment and shall be binding upon the shareholders and no suit,
proceeding or other action shall be commenced or maintained after a
decision to reject a demand. Any Trustee who is not an “interested
person” (within the meaning of Section 2(a)(19) of the Act) of the Fund
acting in connection with any demand or any proceeding relating to a
claim on behalf of or for the benefit of the Fund shall be deemed to be
independent and disinterested with respect to such demand, proceeding
or claim.
A shareholder or group of shareholders may not bring or maintain a
direct action or claim for monetary damages against the Fund or the
Trustees predicated upon an express or implied right of action under the
Declaration (excepting rights of action permitted under Section 36(b) of
the Act), nor shall any single shareholder, who is similarly situated to
one or more other shareholders with respect to the alleged injury, have
the right to bring such an action, unless such group of shareholders or
shareholder has obtained authorization from the Trustees to bring the
action. The requirement of authorization shall not be excused under any
circumstances, including claims of alleged interest on the part of the
Trustees. The Trustees shall consider such request within 90 days of its
receipt by the Fund. In their sole discretion, the Trustees may submit the
matter to a vote of shareholders of the Fund or series or class of shares,
as appropriate. Any decision by the Trustees to settle or to authorize (or
not to settle or to authorize) such court action, proceeding or claim, or
to submit the matter to a vote of shareholders, shall be made in their
business judgment and shall be binding on all shareholders.
Any person purchasing or otherwise acquiring or holding any interest in
shares of beneficial interest of the Fund will be deemed to have notice
of and consented to the foregoing provisions. These provisions may limit
a shareholder's ability to bring a claim against the Trustees, officers or
other agents of the Fund and its service providers, which may
discourage such lawsuits with respect to such claims.
These provisions in the Declaration regarding derivative and direct
claims of shareholders shall not apply to claims made under federal
securities laws.
Tax Matters
This section summarizes some of the U.S. federal income tax
consequences to U.S. persons of investing in the Fund; the
consequences under other tax laws and to non-U.S. shareholders may
differ. Shareholders should consult their tax advisors as to the possible
application of federal, state, local or non-U.S. income tax laws. This
summary is based on the Code, U.S. Treasury regulations, and other
applicable authority, all as of the date of this prospectus. These
authorities are subject to change by legislative or administrative action,
possibly with retroactive effect. Please see the Statement of Additional
Information for additional information regarding the tax aspects of
investing in the Fund.
Treatment as a Regulated Investment Company
The Fund has elected to be treated, and intends each year to qualify and
be eligible, to be treated, as a RIC under Subchapter M of the Code. A
RIC is not subject to U.S. federal income tax at the corporate level on
income and gains from investments that are distributed in a timely
manner to shareholders in the form of dividends. The Fund's failure to
qualify as a RIC would result in corporate-level taxation, thereby
reducing the return on your investment.
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Prospectus
As described under “Use of Leverage” above, if at any time when
Preferred Shares or other senior securities 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 U.S. federal income and excise tax on undistributed
income or gains and may, in certain circumstances, prevent the Fund
from qualifying for treatment as a RIC. The Fund may repurchase,
prepay, or otherwise retire Preferred Shares or other senior securities, as
applicable, in an effort to comply with the distribution requirement
applicable to RICs.
Taxes on Fund Distributions
A shareholder subject to U.S. federal income tax will generally be
subject to tax on Fund distributions. For U.S. federal income tax
purposes, Fund distributions will generally be taxable to a shareholder
as either ordinary income or capital gains. Fund dividends consisting of
distributions of investment income generally are taxable to shareholders
as ordinary income. The municipal bonds in which the Fund primarily
invests are generally issued by states, cities, or a political subdivision,
agency, authority or instrumentality of such state or city, the interest on
which is generally exempt from regular federal income tax, and Fund
distributions of such interest that the Fund properly reports to you as
”
exempt-interest dividends
“
will generally not be subject to regular
federal income tax. An investment in the Fund may result in liability for
federal alternative minimum tax for individuals.
Distributions of net investment income other than
”
exempt-interest
dividends
“
will generally be taxable to you as ordinary income. The
federal tax exemption for exempt-interest dividends from the Fund does
not necessarily result in the exemption of such dividends from state and
local taxes although the Fund intends to arrange its affairs so that a
portion of such distributions will be exempt from personal income taxes
in California. The Fund will seek to produce income that is generally
exempt from federal income tax and will not benefit investors in
tax-advantaged retirement plans or individuals not subject to federal
income tax. Further, the Fund will seek to produce income that is
generally exempt from California income tax and will not provide any
state tax benefit to individuals that are not subject to California income
tax.
Federal taxes on Fund distributions of capital gains are determined by
how long the Fund owned or is deemed to have owned the investments
that generated the capital gains, rather than how long a shareholder
has owned the shares. Distributions of net capital gains (that is, the
excess of net long-term capital gains over net short-term capital losses,
in each case determined with reference to any loss carryforwards) that
are properly reported by the Fund as capital gain dividends generally
will be treated as long-term capital gains includible in a shareholder's
net capital gains and taxed to individuals at reduced rates. The Fund
does not expect a significant portion of its distributions to be treated as
long-term capital gains. Distributions of net short-term capital gains in
excess of net long-term capital losses generally will be taxable to
shareholders as ordinary income. Distributions that the Fund properly
reports to you as
”
qualified dividend income
“
are taxable at the
reduced rates applicable to long-term capital gains provided that both
the individual shareholder and the Fund meet certain holding period
and other requirements.
The Code generally imposes a 3.8% Medicare contribution tax on the
“net investment income” of certain individuals, trusts and estates to the
extent their adjusted gross income exceeds certain threshold amounts.
Net investment income generally includes for this purpose dividends
(other than exempt-interest dividends) paid by the Fund, including any
capital gain dividends, and including net capital gains recognized on the
sale, redemption or exchange of shares of the Fund. Shareholders are
advised to consult their tax advisors regarding the possible implications
of this additional tax on their investment in the Fund.
The ultimate tax characterization of the Fund's distributions made in a
taxable year cannot be determined finally until after the end of that
taxable year. As a result, there is a possibility that the Fund may make
total distributions during a taxable year in an amount that exceeds the
Fund's current and accumulated earnings and profits. In that case, the
excess generally would be treated as return of capital and would reduce
a shareholder's tax basis in the applicable shares, with any amounts
exceeding such basis treated as gain from the sale of such shares. A
return of capital is not taxable, but it reduces a shareholder's tax basis
in the shares, thus reducing any loss or increasing any gain on a
subsequent taxable disposition by the shareholder of the Common
Shares.
Fund distributions are taxable to shareholders as described above 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).
The IRS currently requires a RIC that the IRS recognizes as having two or
more “classes” of stock for U.S. federal income tax purposes to allocate
to each such class proportionate amounts of each type of its income
(such as ordinary income and capital gains) based upon the percentage
of total dividends distributed to each class for the tax year. Accordingly,
if the Fund issues one or more series of Preferred Shares, the Fund will
allocate capital gain dividends for each tax year between and among its
Common Shares and each such series of its Preferred Shares in
proportion to the total dividends paid to each class with respect to such
tax year. Dividends qualifying and not qualifying for the dividends
received deduction, as qualified dividend income or as exempt-interest
dividends will similarly be allocated between and among Common
Shares and each series of Preferred Shares, as and when issued.
Certain Fund Investments
The Fund’s investments in certain debt instruments could cause the
Fund to recognize taxable income in excess of the cash generated by
such investments (which may require the Fund to liquidate other
investments in order to make required distributions).
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
this market discount will be included in the Fund’s ordinary income and
will be taxable to you as such when it is distributed.
April 30, 2023
(as supplemented January
12, 2024)
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PIMCO California Flexible Municipal Income Fund
Taxes When you Dispose of Your Common Shares
Any gain resulting from the disposition of Common Shares that is
treated as a sale or exchange for U.S. federal income tax purposes
generally will be taxable to shareholders as capital gains for U.S. federal
income tax purposes.
Shareholders who offer, and are able to sell all of the Common Shares
they hold or are deemed to hold in response to a repurchase offer (as
described above) generally will be treated as having sold their shares
and generally will recognize a capital gain or loss. In the case of
shareholders who tender or are able to sell fewer than all of their
shares, it is possible that any amounts that the shareholder receives in
such repurchase will be taxable as a dividend to such shareholder. In
addition, there is a risk that shareholders who do not tender any of their
shares for repurchase, or whose percentage interest in the Fund
otherwise increases as a result of the repurchase offer, will be treated
for U.S. federal income tax purposes as having received a taxable
dividend distribution as a result of their proportionate increase in the
ownership of the Fund. The Fund’s use of cash to repurchase shares
could adversely affect its ability to satisfy the distribution requirements
for treatment as a RIC. The Fund could also recognize income in
connection with its liquidation of portfolio securities to fund share
repurchases. Any such income would be taken into account in
determining whether such distribution requirements are satisfied.
Backup Withholding
The Fund is generally required to withhold and remit to the U.S. Treasury
a percentage of the taxable distributions and redemption proceeds paid
to any shareholder who fails to properly furnish the Fund with a correct
taxpayer identification number, who has under-reported dividend or
interest income, or who fails to certify to the Fund that he, she or it is
not subject to such withholding. The backup withholding rules may also
apply to distributions that are properly reported as exempt-interest
dividends.
General
The foregoing discussion relates solely to U.S. federal income tax laws.
Dividends and distributions also may be subject to state and local taxes.
Shareholders are urged to consult their tax advisors regarding specific
questions as to federal, state, local, and, where applicable, foreign taxes.
Foreign investors should consult their tax advisors concerning the tax
consequences of ownership of Common Shares of the Fund.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and related regulations currently in effect. For
the complete provisions, reference should be made to the pertinent
Code sections and regulations. The Code and regulations are subject to
change by legislative or administrative actions.
Please see “Taxation” in the Statement of Additional Information for
additional information regarding the tax aspects of investing in
Common Shares of the Fund.
Custodian and Transfer Agent
The primary custodian of the assets of the Fund is State Street Bank and
Trust Company. State Street Bank and Trust Company’s principal
business address is One Lincoln Street, Boston, MA 02111. The primary
custodian performs custodial and fund accounting services as well as
sub-administrative and compliance services on behalf of the Fund. UMB
Bank, n.a. also serves as a custodian of the Fund for the purpose of
processing investor subscriptions and repurchases. UMB Bank, n.a.’s
principal business address is 1010 Grand Boulevard, Kansas City, MO
64106.
SS&C Global Investor and Distribution Solutions, Inc.
,
430 W. 7th Street
STE 219024, Kansas City, Missouri 64105-1407,
serves as the Fund’s
transfer agent, registrar, dividend disbursement agent and shareholder
servicing agent, as well as agent for the Plan.
The Bank of New York Mellon, 240 Greenwich Street, New York,
New York 10286, serves as transfer agent, registrar, redemption and
paying agent and calculation agent with respect to the RVMTP Shares.
Independent Registered Public Accounting Firm
PwC serves as independent registered public accounting firm for the
Fund. PwC provides audit services, tax assistance and consultation in
connection with review of SEC and IRS filings.
Legal Matters
Certain legal matters will be passed on for the Fund by Ropes & Gray
LLP, 800 Boylston Street, Prudential Tower, Boston, Massachusetts
02199-3600.
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Prospectus
Appendix A
Description of Securities Ratings
The Fund’s investments may range in quality from securities rated in the
lowest category in which the Fund is permitted to invest to securities
rated in the highest category (as rated by Moody’s, Standard & Poor’s 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 fixed income securities:
High Quality Debt Securities
are those rated in one of the two highest
rating categories (the highest category for commercial paper) or, if
unrated, deemed comparable by PIMCO.
Investment Grade Debt Securities
are those rated in one of the four
highest rating categories, or, if unrated, deemed comparable by PIMCO.
Below Investment Grade High Yield Securities (“Junk Bonds”),
are
those rated lower than Baa by Moody’s, BBB by Standard & Poor’s or
Fitch, and comparable securities. They are deemed predominantly
speculative with respect to the issuer’s ability to repay principal and
interest.
The following is a description of Moody’s, Standard & Poor’s and Fitch’s
rating categories applicable to fixed income securities.
Moody
’
s Investors Service, Inc.
Global Long-Term Rating Scale
Ratings assigned on Moody’s global long-term rating scales are
forward-looking opinions of the relative credit risks of financial
obligations issued by non-financial corporates, financial institutions,
structured finance vehicles, project finance vehicles, and public sector
entities. Long-term ratings are assigned to issuers or obligations with an
original maturity of
eleven months
or more and reflect both on the
likelihood of a default or impairment on contractual financial
obligations and the expected financial loss suffered in the event of
default or impairment.
Aaa: Obligations rated Aaa are judged to be of the highest quality,
subject to the lowest level of credit risk.
Aa: Obligations rated Aa are judged to be of high quality and are
subject to very low credit risk.
A: Obligations rated A are judged to be upper-medium grade and are
subject to low credit risk.
Baa: Obligations rated Baa are judged to be medium-grade and subject
to moderate credit risk and as such may possess certain speculative
characteristics.
Ba: Obligations rated Ba are judged to be speculative and are subject to
substantial credit risk.
B: Obligations rated B are considered speculative and are subject to
high credit risk.
Caa: Obligations rated Caa are judged to be speculative of poor
standing and are subject to very high credit risk.
Ca: Obligations rated Ca are highly speculative and are likely in, or very
near, default, with some prospect of recovery of principal and interest.
C: Obligations rated C are the lowest rated and are typically in default,
with little prospect for recovery of principal or interest.
Moody
’
s appends numerical modifiers 1, 2, and 3 to each generic rating
classification from Aa through Caa. The modifier 1 indicates that the
obligation ranks in the higher end of its generic rating category; the
modifier 2 indicates a mid-range ranking; and the modifier 3 indicates a
ranking in the lower end of that generic rating category. Additionally, a
“(hyb)” indicator is appended to all ratings of hybrid securities issued by
banks, insurers, finance companies, and securities firms.*
* By their terms, hybrid securities allow for the omission of scheduled
dividends, interest, or principal payments, which can potentially result in
impairment if such an omission occurs. Hybrid securities may also be
subject to contractually allowable write-downs of principal that could
result in impairment. Together with the hybrid indicator, the long-term
obligation rating assigned to a hybrid security is an expression of the
relative credit risk associated with that security.
Medium-Term Note Program Ratings
Moody’s assigns provisional ratings to medium-term note (MTN) or
similar programs and definitive ratings to the individual debt securities
issued from them (referred to as drawdowns or notes).
MTN program ratings are intended to reflect the ratings likely to be
assigned to drawdowns issued from the program with the specified
priority of claim (
e.g.
,
senior or subordinated). To capture the contingent
nature of a program rating, Moody
’
s assigns provisional ratings to MTN
programs. A provisional rating is denoted by a (P) in front of the rating.
The rating assigned to a drawdown from a rated MTN or bank/deposit
note program is definitive in nature, and may differ from the program
rating if the drawdown is exposed to additional credit risks besides the
issuer
’
s default, such as links to the defaults of other issuers, or has
other structural features that warrant a different rating. In some
circumstances, no rating may be assigned to a drawdown.
Moody
’
s encourages market participants to contact Moody’s Ratings
Desks or visit www.moodys.com directly if they have questions
regarding ratings for specific notes issued under a medium-term note
program. Unrated notes issued under an MTN program may be assigned
an NR (not rated) symbol.
Global Short-Term Rating Scale
Ratings assigned on Moody’s global short-term rating scales are
forward-looking opinions of the relative credit risks of financial
obligations issued by non-financial corporates, financial institutions,
structured finance vehicles, project finance vehicles, and public sector
entities. Short-term ratings are assigned to obligations with an original
maturity of thirteen months or less and reflect both on the likelihood of
a default or impairment on contractual financial obligations and the
expected financial loss suffered in the event of default or impairment.
Moody’s employs the following designations to indicate the relative
repayment ability of rated issuers:
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PIMCO California Flexible Municipal Income Fund
P-1: Ratings of Prime-1 reflect a superior ability to repay short-term
obligations.
P-2: Ratings of Prime-2 reflect a strong ability to repay short-term
obligations.
P-3: Ratings of Prime-3 reflect an acceptable ability to repay short-term
obligations.
NP: Issuers (or supporting institutions) rated Not Prime do not fall within
any of the Prime rating categories.
National Scale Long-Term Ratings
Moody’s long-term National Scale Ratings (NSRs) are opinions of the
relative creditworthiness of issuers and financial obligations within a
particular country. NSRs are not designed to be compared among
countries; rather, they address relative credit risk within a given country.
Moody’s assigns national scale ratings in certain local capital markets in
which investors have found the global rating scale provides inadequate
differentiation among credits or is inconsistent with a rating scale
already in common use in the country.
In each specific country, the last two characters of the rating indicate
the country in which the issuer is located or the financial obligation was
issued (
e.g.,
Aaa.ke for Kenya).
Aaa.n: Issuers or issues rated Aaa.n demonstrate the strongest
creditworthiness relative to other domestic issuers and issuances.
Aa.n: Issuers or issues rated Aa.n demonstrate very strong
creditworthiness relative to other domestic issuers and issuances.
A.n: Issuers or issues rated A.n present above-average creditworthiness
relative to other domestic issuers and issuances.
Baa.n: Issuers or issues rated Baa.n represent average creditworthiness
relative to other domestic issuers and issuances.
Ba.n: Issuers or issues rated Ba.n demonstrate below-average
creditworthiness relative to other domestic issuers and issuances.
B.n: Issuers or issues rated B.n demonstrate weak creditworthiness
relative to other domestic issuers and issuances.
Caa.n: Issuers or issues rated Caa.n demonstrate very weak
creditworthiness relative to other domestic issuers and issuances.
Ca.n: Issuers or issues rated Ca.n demonstrate extremely weak
creditworthiness relative to other domestic issuers and issuances.
C.n: Issuers or issues rated C.n demonstrate the weakest
creditworthiness relative to other domestic issuers and issuances.
Moody’s appends numerical modifiers 1, 2, and 3 to each generic rating
classification from Aa through Caa. The modifier 1 indicates that the
obligation ranks in the higher end of its generic rating category; the
modifier 2 indicates a mid-range ranking; and the modifier 3 indicates a
ranking in the lower end of that generic rating category.
National Scale Short-Term Ratings
Moody’s short-term NSRs are opinions of the ability of issuers or
issuances in a given country, relative to other domestic issuers or
issuances, to repay debt obligations that have an original maturity not
exceeding thirteen months. Short-term NSRs in one country should not
be compared with short-term NSRs in another country, or with Moody’s
global ratings. There are four categories of short-term national scale
ratings, generically denoted N-1 through N-4 as defined below.
In each specific country, the first two letters indicate the country in
which the issuer is located (
e.g.
, KE-1 through KE-4 for Kenya).
N-1: N-1 issuers or issuances represent the strongest likelihood of
repayment of short-term
debt obligations relative to other domestic
issuers
or issuances
.
N-2: N-2 issuers or issuances represent an above average likelihood of
repayment of short-term
debt obligations relative to other domestic
issuers
or issuances
.
N-3: N-3 issuers or issuances represent an average likelihood of
repayment of short-term
debt obligations relative to other domestic
issuers
or issuances
.
N-4: N-4 issuers or issuances represent a below average likelihood of
repayment of short-term
debt obligations relative to other domestic
issuers
or issuances
.
The short-term rating symbols P-1.za, P-2.za, P-3.za and NP.za are used
in South Africa.
Short-Term Obligation Ratings
The Municipal Investment Grade (MIG) scale is used for US municipal
cash flow notes, bond anticipation notes and certain other short-term
obligations, which typically mature in three years or less. Under certain
circumstances, the MIG scale is used for bond anticipation notes with
maturities of up to five years.
MIG 1: This designation denotes superior credit quality. Excellent
protection is afforded by established cash flows, highly reliable liquidity
support, or demonstrated broad-based access to the market for
refinancing.
MIG 2: This designation denotes strong credit quality. Margins of
protection are ample, although not as large as in the preceding group.
MIG 3: This designation denotes acceptable credit quality. Liquidity and
cash-flow protection may be narrow, and market access for refinancing
is likely to be less well-established.
SG: This designation denotes speculative-grade credit quality. Debt
instruments in this category may lack sufficient margins of protection.
Demand Obligation Ratings
In the case of variable rate demand obligations (VRDOs), a
two-component rating is assigned. The components are a long-term
rating and a short-term demand obligation rating. The long-term rating
addresses the issuer’s ability to meet scheduled principal and interest
payments. The short-term demand obligation rating addresses the ability
of the issuer or the liquidity provider to make payments associated with
the purchase-price-upon-demand feature (“demand feature”) of the
VRDO. The short-term demand obligation rating uses the Variable
Municipal Investment Grade (VMIG) scale.
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VMIG 1: This designation denotes superior credit quality. Excellent
protection is afforded by the superior short-term credit strength of the
liquidity provider and structural and legal protections
.
VMIG 2: This designation denotes strong credit quality. Good protection
is afforded by the strong short-term credit strength of the liquidity
provider and structural and legal protections
.
VMIG 3: This designation denotes acceptable credit quality. Adequate
protection is afforded by the satisfactory short-term credit strength of
the liquidity provider and structural and legal protections
.
SG: This designation denotes speculative-grade credit quality. Demand
features rated in this category may be supported by a liquidity provider
that does not have a sufficiently strong short-term rating or may lack
the structural or legal protections
.
Standard & Poor’s Ratings Services
Long-Term Issue Credit Ratings
Issue credit ratings are based, in varying degrees, on S&P Global
Ratings
’
(“S&P”) analysis of the following considerations:
◾
Likelihood of payment
—
capacity and willingness of the obligor to
meet its financial commitments on an obligation in accordance
with the terms of the obligation;
◾
Nature and provisions of the financial obligation and the promise
S&P imputes; and
◾
Protection afforded by, and relative position of, the financial
obligation in the event of a bankruptcy, reorganization, or other
arrangement under the laws of bankruptcy and other laws
affecting creditors’ rights.
Issue ratings are an assessment of default risk, but may incorporate an
assessment of relative seniority or ultimate recovery in the event of
default. Junior obligations are typically rated lower than senior
obligations, to reflect lower priority in bankruptcy, as noted above. (Such
differentiation may apply when an entity has both senior and
subordinated obligations, secured and unsecured obligations, or
operating company and holding company obligations.)
Investment Grade
AAA: An obligation rated ‘AAA’ has the highest rating assigned by S&P.
The obligor’s capacity to meet its financial commitments on the
obligation is extremely strong.
AA: An obligation rated ‘AA’ differs from the highest-rated obligations
only to a small degree. The obligor’s capacity to meet its financial
commitments on the obligation is very strong.
A: An obligation rated ‘A’ is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than
obligations in higher-rated categories. However, the obligor’s capacity to
meet its financial commitments 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 weaken the obligor’s capacity to meet its financial
commitments on the obligation.
Speculative Grade
Obligations rated ‘BB’, ‘B’, ‘CCC’, ‘CC’, and ‘C’ are regarded as having
significant speculative characteristics. ‘BB’ indicates the least degree of
speculation and ‘C’ the highest. While such obligations will likely have
some quality and protective characteristics, these may be outweighed by
large uncertainties or major exposure 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 that
could lead to the obligor’s inadequate capacity to meet its financial
commitments 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 commitments on the obligation. Adverse business, financial,
or economic conditions will likely impair the obligor’s capacity or
willingness to meet its financial commitments 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 commitments 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 commitments on the obligation.
CC: An obligation rated ‘CC’ is currently highly vulnerable to
nonpayment. The ‘CC’ rating is used when a default has not yet
occurred, but S&P expects default to be a virtual certainty, regardless of
the anticipated time to default.
C: An obligation rated ‘C’ is currently highly vulnerable to nonpayment,
and the obligation is expected to have lower relative seniority or lower
ultimate recovery compared with obligations that are rated higher.
D: An obligation rated ‘D’ is in default or in breach of an imputed
promise. For non-hybrid capital instruments, the ‘D’ rating category is
used when payments on an obligation are not made on the date due,
unless S&P believes that such payments will be made within
the next
five business days in the absence of a stated grace period or within the
earlier of the stated grace period or
the next
30 calendar days. The ‘D’
rating also will be used upon the filing of a bankruptcy petition or the
taking of similar action and where default on an obligation is a virtual
certainty, for example due to automatic stay provisions. A rating on an
obligation is lowered to ‘D’ if it is subject to a distressed debt
restructuring.
NR: This indicates that a rating has not been assigned or is no longer
assigned.
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 rating categories.
April 30, 2023
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PIMCO California Flexible Municipal Income Fund
Short-Term Issue Credit Ratings
A-1: A short-term obligation rated ‘A-1’ is rated in the highest category
by S&P. The obligor’s capacity to meet its financial commitments 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 commitments on these obligations is extremely
strong.
A-2: A short-term obligation rated ‘A-2’ is somewhat more susceptible
to the adverse effects of changes in circumstances and economic
conditions than obligations in higher rating categories. However, the
obligor’s capacity to meet its financial commitments 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 weaken an obligor’s capacity to meet
its financial commitments on the obligation.
B: A short-term obligation rated ‘B’ is regarded as vulnerable and has
significant speculative characteristics. The obligor currently has the
capacity to meet its financial commitments; however, it faces major
ongoing uncertainties that could lead to the obligor’s inadequate
capacity to meet its financial commitments.
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 commitments
on the obligation.
D: A short-term obligation rated ‘D’ is in default or in breach of an
imputed promise. For non-hybrid capital instruments, the ‘D’ rating
category is used when payments on an obligation are not made on the
date due, unless S&P believes that such payments will be made within
any stated grace period. However, any stated grace period longer than
five business days will be treated as five business days. The ‘D’ rating
also will be used upon the filing of a bankruptcy petition or the taking
of a similar action and where default on an obligation is a virtual
certainty, for example due to automatic stay provisions. A rating on an
obligation is lowered to ‘D’ if it is subject to a distressed debt
restructuring.
Dual Ratings: Dual ratings may be assigned to debt issues that have a
put option or demand feature. The first component of the rating
addresses the likelihood of repayment of principal and interest as due,
and the second component of the rating addresses only the demand
feature. The first component of the rating can relate to either a
short-term or long-term transaction and accordingly use either
short-term or long-term rating symbols. The second component of the
rating relates to the put option and is assigned a short-term rating
symbol (for example, ‘AAA/A-1+‘ or ‘A-1+/ A-1’). With U.S. municipal
short-term demand debt, the U.S. municipal short-term note rating
symbols are used for the first component of the rating (for example,
‘SP-1+/A-1+‘).
Active Qualifiers
S&P uses the following qualifiers that limit the scope of a rating. The
structure of the transaction can require the use of a qualifier such as a
‘
p
’
qualifier, which indicates the rating addresses the principal portion of
the obligation only. A qualifier appears as a suffix and is part of the
rating.
L: Ratings qualified with
‘
L
’
apply only to amounts invested up to federal
deposit insurance limits.
p: This suffix is used for issues in which the credit factors, the terms, or
both, that determine the likelihood of receipt of payment of principal are
different from the credit factors, terms or both that determine the
likelihood of receipt of interest on the obligation. The ‘p’ suffix indicates
that the rating addresses the principal portion of the obligation only and
that the interest is not rated.
prelim: Preliminary ratings, with the
‘
prelim
’
suffix, may be assigned to
obligors or obligations, including financial programs, in the
circumstances described below. Assignment of a final rating is
conditional on the receipt by S&P of appropriate documentation. S&P
reserves the right not to issue a final rating. Moreover, if a final rating is
issued, it may differ from the preliminary rating.
◾
Preliminary ratings may be assigned to obligations, most
commonly structured and project finance issues, pending receipt
of final documentation and legal opinions.
◾
Preliminary ratings may be assigned to obligations that will likely
be issued upon the obligor
’
s emergence from bankruptcy or
similar reorganization, based on late-stage reorganization plans,
documentation
,
and discussions with the obligor. Preliminary
ratings may also be assigned to the obligors. These ratings
consider the anticipated general credit quality of the reorganized
or post-bankruptcy issuer as well as attributes of the anticipated
obligation(s).
◾
Preliminary ratings may be assigned to entities that are being
formed or that are in the process of being independently
established when, in S&P’s opinion, documentation is close to
final. Preliminary ratings may also be assigned to the obligations
of these entities.
◾
Preliminary ratings may be assigned when a previously unrated
entity is undergoing a well-formulated restructuring,
recapitalization, significant financing or other transformative
event, generally at the point that investor or lender commitments
are invited. The preliminary rating may be assigned to the entity
and to its proposed obligation(s). These preliminary ratings
consider the anticipated general credit quality of the obligor, as
well as attributes of the anticipated obligation(s), assuming
successful completion of the transformative event. Should the
transformative event not occur, S&P would likely withdraw these
preliminary ratings.
◾
A preliminary recovery rating may be assigned to an obligation
that has a preliminary issue credit rating.
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| PIMCO California Flexible Municipal Income Fund
Prospectus
t: This symbol indicates termination structures that are designed to
honor their contracts to full maturity or, should certain events occur, to
terminate and cash settle all their contracts before their final maturity
date.
cir: This symbol indicates a Counterparty Instrument Rating (CIR), which
is a forward-looking opinion about the creditworthiness of an issuer in a
securitization structure with respect to a specific financial obligation to
a counterparty (including interest rate swaps, currency swaps, and
liquidity facilities). The CIR is determined on an ultimate payment basis;
these opinions do not take into account timeliness of payment.
Inactive Qualifiers (no longer applied or outstanding)
*:This symbol indicated that the rating was contingent upon S&P receipt
of an executed copy of the escrow agreement or closing documentation
confirming investments and cash flows. Discontinued use in August
1998.
c: This qualifier was used to provide additional information to investors
that the bank may terminate its obligation to purchase tendered bonds
if the long-term credit rating of the issuer was lowered to below an
investment-grade level and/or the issuer’s bonds were deemed taxable.
Discontinued use in January 2001.
G: The letter ‘G’ followed the rating symbol when a fund’s portfolio
consisted primarily of direct U.S. government securities.
i: This suffix was used for issues in which the credit factors, terms, or
both that determine the likelihood of receipt of payment of interest are
different from the credit factors, terms, or both that determine the
likelihood of receipt of principal on the obligation. The 'i' suffix indicated
that the rating addressed the interest portion of the obligation only. The
'i' suffix was always used in conjunction with the 'p' suffix, which
addresses likelihood of receipt of principal. For example, a rated
obligation could have been assigned a rating of 'AAApNRi' indicating
that the principal portion was rated 'AAA' and the interest portion of
the obligation was not rated.
pi: This qualifier was used to indicate ratings that were based on an
analysis of an issuer’s published financial information, as well as
additional information in the public domain. Such ratings did not,
however, reflect in-depth meetings with an issuer’s management and
therefore, could have been based on less comprehensive information
than ratings without a ‘pi’ suffix. Discontinued use as of December 2014
and as of August 2015 for Lloyd’s Syndicate Assessments.
pr: The letters ‘pr’ indicate that the rating was provisional. A provisional
rating assumed the successful completion of a project financed by the
debt being rated and indicates that payment of debt service
requirements was largely or entirely dependent upon the successful,
timely completion of the project. This rating, however, while addressing
credit quality subsequent to completion of the project, made no
comment on the likelihood of or the risk of default upon failure of such
completion.
q: A ‘q’ subscript indicates that the rating is based solely on quantitative
analysis of publicly available information. Discontinued use in April
2001.
r: The ‘r’ modifier was assigned to securities containing extraordinary
risks, particularly market risks, that are not covered in the credit rating.
The absence of an ‘r’ modifier should not be taken as an indication that
an obligation would not exhibit extraordinary
noncredit
-
related risks.
S&P discontinued the use of the ‘r’ modifier for most obligations in June
2000 and for the balance of obligations (mainly structured finance
transactions) in November 2002.
Fitch Ratings
Long-Term Credit Ratings
Investment Grade
Rated entities in a number of sectors, including financial and
non-financial corporations, sovereigns, insurance companies and certain
sectors within public finance, are generally assigned Issuer Default
Ratings (“IDRs”). IDRs are also assigned to certain entities or
enterprises in global infrastructure, project finance, and public finance.
IDRs opine on an entity’s relative vulnerability to default (including by
way of a distressed debt exchange) on financial obligations. The
threshold default risk addressed by the IDR is generally that of the
financial obligations whose non-payment would best reflect the
uncured failure of that entity. As such, IDRs also address relative
vulnerability to bankruptcy, administrative receivership or similar
concepts.
In aggregate, IDRs provide an ordinal ranking of issuers based on the
agency’s view of their relative vulnerability to default, rather than a
prediction of a specific percentage likelihood of default.
AAA: Highest credit quality. ‘AAA’ ratings denote the lowest expectation
of default risk. They are assigned only in cases of exceptionally strong
capacity for payment of financial commitments. This capacity is highly
unlikely to be adversely affected by foreseeable events.
AA: Very high credit quality. ‘AA’ ratings denote expectations of very low
default risk. They indicate very strong capacity for payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.
A: High credit quality. ‘A’ ratings denote expectations of low default risk.
The capacity for payment of financial commitments is considered strong.
This capacity may, nevertheless, be more vulnerable to adverse business
or economic conditions than is the case for higher ratings.
BBB: Good credit quality. ‘BBB’ ratings indicate that expectations of
default risk are currently low. The capacity for payment of financial
commitments is considered adequate, but adverse business or economic
conditions are more likely to impair this capacity.
Speculative Grade
BB: Speculative. ‘BB’ ratings indicate an elevated vulnerability to default
risk, particularly in the event of adverse changes in business or
economic conditions over time; however, business or financial flexibility
exists that supports the servicing of financial commitments.
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B: Highly speculative. ‘B’ ratings indicate that material default risk is
present, but a limited margin of safety remains. Financial commitments
are currently being met
;
however, capacity for continued payment is
vulnerable to deterioration in the business and economic environment.
CCC: Substantial credit risk. Very low margin for safety. Default is a real
possibility.
CC: Very high levels of credit risk. Default of some kind appears
probable.
C: Near default.
A default or default-like process has begun, or the issuer is in standstill,
or for a closed funding vehicle, payment capacity is irrevocably impaired.
Conditions that are indicative of a ‘C’ category rating for an issuer
include:
a. the issuer has entered into a grace or cure period following
non-payment of a material financial obligation;
b. the issuer has entered into a temporary negotiated waiver or
standstill agreement following a payment default on a material financial
obligation;
c. the formal announcement by the issuer or their agent of a distressed
debt exchange;
d. a closed financing vehicle where payment capacity is irrevocably
impaired such that it is not expected to pay interest and/or principal in
full during the life of the transaction, but where no payment default is
imminent
RD: Restricted default. ‘RD’ ratings indicate an issuer that in Fitch
Ratings’ opinion has experienced an uncured payment default or
distressed debt exchange on a bond, loan or other material financial
obligation but
has not entered into bankruptcy filings, administration,
receivership, liquidation or other formal winding-up procedure, and
has
not otherwise ceased operating. This would include:
i. the selective payment default on a specific class or currency of debt;
ii. the uncured expiry of any applicable grace period, cure period or
default forbearance period following a payment default on a bank loan,
capital markets security or other material financial obligation;
iii. the extension of multiple waivers or forbearance periods upon a
payment default on one or more material financial obligations, either in
series or in parallel; ordinary execution of a distressed debt exchange on
one or more material financial obligations.
D: Default. ‘D’ ratings indicate an issuer that in Fitch Ratings’ opinion
has entered into bankruptcy filings, administration, receivership,
liquidation or other formal winding-up procedure or that has otherwise
ceased business. Default ratings are not assigned prospectively to
entities or their obligations; within this context, non-payment on an
instrument that contains a deferral feature or grace period will generally
not be considered a default until after the expiration of the deferral or
grace period, unless a default is otherwise driven by bankruptcy or other
similar circumstance, or by a distressed debt exchange.
The modifiers “+” or “-” may be appended to a rating to denote
relative status within major rating categories. For example, the rating
category ‘AA’ has three notch-specific rating levels (’AA+‘; ’AA’; ‘AA-’;
each a rating level). Such suffixes are not added to ‘AAA’ ratings and
ratings below the ‘CCC’ category.
Recovery Ratings
Recovery Ratings are assigned to selected individual securities and
obligations, most frequently for individual obligations of corporate
finance issuers with IDRs in speculative grade categories.
Among the factors that affect recovery rates for securities are the
collateral, the seniority relative to other obligations in the capital
structure (where appropriate), and the expected value of the company
or underlying collateral in distress.
The Recovery Rating scale is based on the expected relative recovery
characteristics of an obligation upon the curing of a default, emergence
from insolvency or following the liquidation or termination of the
obligor or its associated collateral.
Recovery Ratings are an ordinal scale and do not attempt to precisely
predict a given level of recovery. As a guideline in developing the rating
assessments, the agency employs broad theoretical recovery bands in its
ratings approach based on historical averages and analytical judgment,
but actual recoveries for a given security may deviate materially from
historical averages.
RR1:
Outstanding recovery prospects given default.
‘RR1’ rated
securities have characteristics consistent with securities historically
recovering 91%-100% of current principal and related interest.
RR2:
Superior recovery prospects given default.
‘RR2’ rated securities
have characteristics consistent with securities historically recovering
71%-90% of current principal and related interest.
RR3:
Good recovery prospects given default.
‘RR3’ rated securities have
characteristics consistent with securities historically recovering
51%-70% of current principal and related interest.
RR4:
Average recovery prospects given default.
‘RR4’ rated securities
have characteristics consistent with securities historically recovering
31%-50% of current principal and related interest.
RR5:
Below average recovery prospects given default.
‘RR5’ rated
securities have characteristics consistent with securities historically
recovering 11%-30% of current principal and related interest.
RR6:
Poor recovery prospects given default.
‘RR6’ rated securities have
characteristics consistent with securities historically recovering 0%-10%
of current principal and related interest.
Short-Term Credit Ratings
A short-term issuer or obligation rating is based in all cases on the
short-term vulnerability to default of the rated entity and relates to the
capacity to meet financial obligations in accordance with the
documentation governing the relevant obligation. Short-term deposit
ratings may be adjusted for loss severity. Short-Term Ratings are
assigned to obligations whose initial maturity is viewed as “short term”
based on market convention (a long-term rating can also be used to rate
A-6 Prospectus
| PIMCO California Flexible Municipal Income Fund
Prospectus
an issue with short maturity). Typically, this means up to 13 months for
corporate, sovereign, and structured obligations, and up to 36 months
for obligations in U.S. public finance markets.
F1:
Highest short-term credit quality.
Indicates the strongest intrinsic
capacity for timely payment of financial commitments; may have an
added “+” to denote any exceptionally strong credit feature.
F2:
Good short-term credit quality.
Good intrinsic capacity for timely
payment of financial commitments.
F3:
Fair short-term credit quality.
The intrinsic capacity for timely
payment of financial commitments is adequate.
B:
Speculative short-term credit quality.
Minimal capacity for timely
payment of financial commitments, plus heightened vulnerability to near
term adverse changes in financial and economic conditions.
C:
High short-term default risk.
Default is a real possibility.
RD:
Restricted default.
Indicates an entity that has defaulted on one or
more of its financial commitments, although it continues to meet other
financial obligations. Typically applicable to entity ratings only.
D:
Default.
Indicates a broad-based default event for an entity, or the
default of a short-term obligation.
April 30, 2023
(as supplemented January
12, 2024)
|
Prospectus
A-7
As permitted by regulations adopted by the Securities and Exchange Commission, paper copies of the Fund’s annual and semi-annual
shareholder reports
will no longer be
sent by mail, unless you specifically request paper copies
from the Fund or from your financial
intermediary, such as a broker-dealer or bank. Instead, the
shareholder reports will be
made available on
a
website,
and you will be
notified by mail each time a report is posted and provided with a website link to access the report.
Instructions for requesting paper
copies will be provided by the Fund or your financial intermediary. Paper copies of the Fund’s shareholder reports are required to be
provided free of charge by the Fund or financial intermediary.
PIF0004_011224
PIMCO CALIFORNIA FLEXIBLE MUNICIPAL INCOME FUND
Statement of Additional Information
April 30, 2023 (as supplemented January 12, 2024)
PIMCO California Flexible Municipal Income Fund (the “Fund”) is a non-diversified, closed-end management investment company that continuously offers its shares of beneficial interest, par value of $0.00001 per share (the “Common Shares”) and is operated as an “interval fund.” The Fund currently has five separate classes of Common Shares: Institutional Class, Class A-1, Class A-2, Class A-3 and Class A-4.
This Statement of Additional Information relating to the Common Shares of the Fund is not a prospectus, and should be read in conjunction with the Fund’s prospectus relating thereto dated April 30, 2023, as supplemented from time to time (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.
Pacific Investment Management Company LLC (“PIMCO” or the “Investment Manager”), 650 Newport Center Drive, Newport Beach, California 92660, is the investment manager to the Fund.
A copy of the Prospectus and annual report or semi-annual report for the Fund may be obtained free of charge at the telephone number and address listed below or by visiting www.pimco.com.
PIMCO California Flexible Municipal Income Fund
Regulatory Document Request
650 Newport Center Drive
Newport Beach, California 92660
Telephone: 844.312.2113
Regulatory Document Request
650 Newport Center Drive
Newport Beach, California 92660
Telephone: 844.312.2113
Capitalized terms used but not defined in this Statement of Additional Information have the meanings ascribed to them in the Prospectus.
THE FUND
The Fund is a non-diversified, closed-end management investment company that continuously offers its Common Shares and is operated as an “interval fund.” The Fund was formed on February 8, 2022 as a Massachusetts business trust and commenced investment operations on June 27, 2022. The Fund has five separate classes of Common Shares: Institutional Class, Class A-1, Class A-2, Class A-3 and Class A-4.
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives and general investment policies of the Fund are described in the Prospectus. Additional information concerning the characteristics of certain of the Fund’s investments, strategies and risks is set forth below. Unless a strategy or policy described below is specifically prohibited by the investment restrictions listed in the Prospectus, by the investment restrictions under “Investment Restrictions” in this Statement of Additional Information, or by applicable law, the Fund may engage in each of the practices described below. However, the Fund is not required to engage in any particular transaction or purchase any particular type of securities or investment even if to do so might benefit the Fund. Unless otherwise stated herein, all investment policies of the Fund may be changed by the Board of Trustees (the “Board”) without shareholder approval. In addition, the Fund may be subject to restrictions on its ability to utilize certain investments or investment techniques. Unless otherwise stated herein, these additional restrictions may be changed with the consent of the Board but without approval by or notice to shareholders.
High Yield Securities (“Junk Bonds”) and Securities of Distressed Companies
The Fund may invest without limit in debt instruments that are, at the time of purchase, rated below “investment grade” by at least one of Moody’s Investors Service, Inc. (“Moody’s”), S&P Global Ratings (“S&P”) or Fitch Ratings Inc. (“Fitch”), or unrated but determined by PIMCO to be of comparable quality. The Fund may also invest in defaulted securities and debtor-in-possession financings. A description of the ratings categories used is set forth in Appendix A to the Prospectus.
A security is considered to be below “investment grade” quality if it is either (1) not rated in one of the four highest rating categories by one of the nationally recognized statistical rating organizations (“NRSROs”) (i.e., rated Ba or below by Moody’s, BB or below by S&P or BB or below by Fitch) or (2) if unrated, determined by PIMCO to be of comparable quality to obligations so rated. Investments in securities rated below investment grade are described as “speculative” by Moody’s, S&P and Fitch.
Investment in lower rated corporate debt securities (“high yield” securities or “junk bonds”) and securities of distressed companies generally provides greater income and increased opportunity for capital appreciation than investments in higher quality securities, but it also typically entails greater price volatility and principal and income risk. Securities of distressed companies include both debt and equity securities. High yield securities and debt securities of distressed companies are regarded as predominantly speculative with respect to the issuer’s continuing ability to make timely principal and interest payments. Issuers of high yield and distressed company securities may be involved in restructurings or bankruptcy proceedings that may not be successful. Analysis of the creditworthiness of issuers of debt securities that are high yield or debt securities of distressed companies may be more complex than for issuers of higher quality debt.
High yield securities and debt securities of distressed companies may be more susceptible to real or perceived adverse economic and competitive industry conditions than investment grade securities. The prices of these securities have been found to be more sensitive to adverse economic downturns or individual corporate developments. A projection of an economic downturn, for example, could cause a decline in prices of high yield securities and debt securities of distressed companies because the advent of a recession could lessen the ability of a highly leveraged company to make principal and interest payments on its debt securities, and a high yield security may lose significant market value before a default occurs. If an issuer defaults, in addition to risking payment of all or a portion of interest and principal, the Fund, by investing in such securities, may incur additional expenses to seek recovery of their respective investments. In the case of securities structured as zero-coupon or pay-in-kind securities, 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 manage these risks through diversification, credit analysis and attention to current developments and trends in both the economy and financial markets.
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High yield and distressed company securities and securities of distressed companies may have the right to “call” or redeem the issue prior to maturity, which may result in the Fund having to reinvest the proceeds in other high yield securities that may pay lower interest rates. The Fund may also be subject to greater levels of liquidity risk than funds that do not invest in these securities. In addition, the high yield securities and securities of distressed companies in which the Fund invests may not be listed on any exchange and a secondary market for such securities may be comparatively less liquid relative to markets for other more liquid fixed-income securities. Consequently, transactions in high yield and distressed company securities may involve greater costs than transactions in more actively traded securities, which could adversely affect the price at which the Fund could sell a high yield or distressed company security, and could adversely affect the daily net asset value of the shares. A lack of publicly-available information, irregular trading activity and wide bid/ask spreads among other factors, may, in certain circumstances, make high yield debt more difficult to sell at an advantageous time or price than other types of securities or instruments. These factors may result in the Fund being unable to realize full value for these securities and/or may result in the Fund not receiving the proceeds from a sale of a high yield or distressed company security for an extended period after such sale, each of which could result in losses to the Fund. Because of the risks involved in investing in high yield securities and securities of distressed companies, an investment in the Fund should be considered speculative.
Analysis of the creditworthiness of issuers of high yield securities and distressed company securities may be more complex than for issuers of higher quality debt securities, and achievement of the Fund’s investment objectives may, to the extent of its investments in high yield and distressed company securities, depend more heavily on PIMCO’s creditworthiness analysis than would be the case if the Fund were investing in higher quality securities.
High yield securities structured as “zero-coupon” bonds or “payment-in-kind” securities (“PIKs”) tend to be especially volatile as they are particularly sensitive to downward pricing pressures from rising interest rates or widening spreads and may require the Fund to make taxable distributions of income greater than the total amount of cash interest the Fund has actually received. Even though such securities do not pay current interest in cash, the Fund nonetheless is required to accrue interest income on these investments and to distribute the interest income on a current basis. Thus, the Fund could be required at times to sell other investments in order to satisfy its distribution requirements (including when it is not advantageous to do so).
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. Lower liquidity in secondary markets could adversely affect the value of high yield/high risk securities held by the Fund. While lower rated securities typically are less sensitive to interest rate changes than higher rated securities, the market prices of high yield/high risk securities structured as zero coupon bonds or PIKs may be affected to a greater extent by interest rate changes. For instance. In addition, 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 and distressed company securities are less liquid than the market for other types of 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. PIMCO seeks to manage the risks of investing in all securities through diversification, in-depth analysis and attention to current market developments.
The use of credit ratings as the sole method of evaluating high yield securities and debt securities of distressed companies can involve certain risks. For example, credit ratings evaluate the safety of principal and interest payments of a debt security, not the market value risk of a security. 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 debt securities for the Fund, and develops its own independent analysis of issuer credit quality. If a credit rating agency changes the rating of a debt security held by the Fund, the Fund may retain the security.
Securities Lending
For the purpose of achieving income, the Fund may lend its portfolio securities to brokers, dealers, and other financial institutions provided a number of conditions are satisfied, including that the loan is fully collateralized. Please see “Investment Objectives and Policies-Loans of Portfolio Securities” in the Statement of Additional Information for more details. When the Fund lends portfolio securities, its investment performance will continue to reflect changes in the value of the securities loaned, and the Fund will also receive a fee or interest on the collateral.
2
Securities lending involves the risk of loss of rights in the collateral or delay in recovery of the collateral if the borrower fails to return the security loaned or becomes insolvent. The Fund may pay lending fees to a party arranging the loan, which may be an affiliate of the Fund. Cash collateral received by the Fund in securities lending transactions may be invested in short-term liquid fixed-income instruments or in money market or short-term mutual funds, or similar investment vehicles, including affiliated money market or short-term mutual funds. The Fund bears the risk of such investments.
Puerto Rico
Municipal obligations issued by the Commonwealth of Puerto Rico or its political subdivisions, agencies, instrumentalities, or public corporations may be affected by economic, market, political, environmental and social conditions in Puerto Rico. Puerto Rico currently is experiencing significant fiscal and economic challenges, including substantial debt service obligations, high levels of unemployment, underfunded public retirement systems, and persistent government budget deficits. These challenges may negatively affect the value of the Fund’s investments in Puerto Rico municipal securities. Major ratings agencies have downgraded the general obligation debt of Puerto Rico to below investment grade and continue to maintain a negative outlook for this debt, which increases the likelihood that the rating will be lowered further or discontinued. Puerto Rico has previously defaulted on its debt by failing to make full payment due on its outstanding bonds, and there can be no assurance that Puerto Rico will be able to satisfy its future debt obligations. Further downgrades or defaults may place additional strain on the Puerto Rican economy and may negatively affect the value, liquidity, and volatility of the Fund’s investments in Puerto Rico municipal securities. Legislation, including legislation that would allow Puerto Rico to restructure its municipal debt obligations, thus increasing the risk that Puerto Rico may never pay off municipal indebtedness, or may pay only a small fraction of the amount owed, could also impact the value of the Fund’s investments in Puerto Rico municipal securities.
These challenges and uncertainties have been exacerbated by recent natural disasters that have struck Puerto Rico. In September 2017, two successive hurricanes caused significant damage to Puerto Rico, and resulted in severe flooding and infrastructure damage, including damage to the Commonwealth’s water, power, and telecommunications infrastructure, and resulted in more than 1 million people losing power. Estimates suggest that the hurricanes caused more than $80 billion in damage, which led to additional strain on Puerto Rico’s economic situation. In late December 2019 and January 2020, a series of earthquakes caused an estimated $200 million in damage to Puerto Rico. The aftershocks from these earthquakes may continue for years, and it is not currently possible to predict the extent of the damage that could arise from any aftershocks. The length of time needed to rebuild Puerto Rico’s infrastructure is unclear, but could amount to years, during which the Commonwealth is likely to be in an uncertain economic state. The full extent of the negative impact of these (or future) natural disasters on Puerto Rico’s economy and foreign investment in Puerto Rico is difficult to estimate.
New York State
The Fund may invest in municipal bonds issued by or on behalf of the State of New York and its political subdivisions, financing authorities and their agencies, and therefore may be affected significantly by political, economic or regulatory developments affecting the ability of New York tax-exempt issuers to pay interest or repay principal. Certain issuers of New York municipal bonds have experienced serious financial difficulties in the past and reoccurrence of these difficulties may impair the ability of certain New York issuers to pay principal or interest on their obligations. Provisions of the New York Constitution and State statutes which limit the taxing and spending authority of New York governmental entities may impair the ability of New York issuers to pay principal and/or interest on their obligations. While New York’s economy is broad, it does have major concentrations in certain industries, such as financial services, and may be sensitive to economic problems affecting those industries. Future New York political and economic developments, constitutional amendments, legislative measures, executive orders, administrative regulations, litigation and voter initiatives as well as environmental events, natural disasters, pandemics, epidemics or social unrest could have an adverse effect on the debt obligations of New York issuers to pay principal or interest on their obligations. The financial health of New York City affects that of the State, and when New York City experiences financial difficulty it may have an adverse effect on New York municipal bonds held by the Fund. The growth rate of New York has at times been somewhat slower than the nation overall. The economic and financial condition of New York also may be affected by various financial, social, economic, environmental, political and geopolitical factors.
3
Mortgage-Related and Other Asset-Backed Securities
Mortgage-related securities are interests in pools of residential or commercial mortgage loans, including mortgage loans made by savings and loan institutions, mortgage bankers, commercial banks and others. Such mortgage loans may include reperforming loans (“RPLs”), which are loans that have previously been delinquent but are current at the time securitized. Pools of mortgage loans are assembled as securities for sale to investors by various governmental, government-related and private organizations. The Fund may invest in a variety of mortgage-related and other asset-backed securities (“ABS”) issued by government agencies or other governmental entities or by private originators or issuers.
The financial downturn of the late 2000s adversely affected the market for mortgage-related securities. The downturn saw dramatic declines in the housing market, with falling home prices and increasing foreclosures and unemployment, and significant asset write-downs by financial institutions. Between 2008 and 2009, the market for mortgage-related securities (and other ABS) was particularly adversely impacted by, among other factors, the failure of certain large financial institutions and the events leading to the conservatorship and the control by the U.S. Government of the Federal National Mortgage Association (“FNMA”) and the Federal Home Loan Mortgage Corporation (“FHLMC”), as described below. These events, coupled with the general economic downturn, resulted in a substantial level of uncertainty in the financial markets, particularly with respect to mortgage-related investments. There is no assurance that the U.S. Government would take similar or further action to support the mortgage-related securities industry, as it has in the past, should the economy experience another downturn. Further, any future government actions may significantly alter the manner in which the mortgage-related securities market functions. Each of these factors could ultimately increase the risk that the Fund could realize losses on mortgage-related securities.
The mortgage-related securities in which the Fund may invest include, without limitation, mortgage pass-through securities, collateralized mortgage obligations (“CMOs”), commercial or residential mortgage-backed securities, mortgage dollar rolls/buy backs, CMO residuals, stripped mortgage-backed securities (“SMBS”) and other securities that directly or indirectly represent a participation in, or are secured by and payable from, mortgage loans on real property. The Fund may also invest in other types of ABS, including collateralized debt obligations (“CDOs”), which include collateralized bond obligations (“CBOs”), collateralized loan obligations (“CLOs”) and other similarly structured securities. The mortgage-related securities in which the Fund may invest may pay variable or fixed rates of interest.
Through investments in mortgage-related securities, including those that are issued by private issuers, the Fund may have some exposure to subprime loans as well as to the mortgage and credit markets generally. Private issuers include commercial banks, savings associations, mortgage companies, investment banking firms, finance companies and special purpose finance entities (called “special purpose vehicles” or “SPVs”) and other entities that acquire and package mortgage loans for resale as mortgage-related securities.
Mortgage Pass-Through Securities. Mortgage pass-through securities are securities representing interests in “pools” of mortgage loans secured by residential or commercial real property. Interests in pools of mortgage-related securities differ from other forms of debt securities, which normally provide for periodic payment of interest in fixed or variable amounts with principal payments at maturity or specified call dates. Instead, these securities provide a monthly payment which consists of both interest and principal payments. In effect, these payments are a “pass-through” of the monthly payments made by the individual borrowers on their residential or commercial mortgage loans, net of any fees paid to the issuer or guarantor of such securities. Additional payments are caused by repayments of principal resulting from the sale of the underlying property, refinancing or foreclosure, net of fees or costs which may be incurred. Some mortgage-related securities (such as securities issued by the Government National Mortgage Association (“GNMA”)) are described as “modified pass-through.” These securities entitle the holder to receive all interest and principal payments owed on the mortgage pool, net of certain fees, at the scheduled payment dates regardless of whether or not the mortgagor actually makes the payment.
The rate of pre-payments on underlying mortgages will affect the price and volatility of a mortgage-related security, and may have the effect of shortening or extending the effective duration of the security relative to what was anticipated at the time of purchase. Early repayment of principal on some mortgage-related securities (arising from prepayments of principal due to the sale of the underlying property, refinancing, or foreclosure, net of fees and costs that may be incurred) may expose the Fund to a lower rate of return upon reinvestment of principal. Also, if a security subject to prepayment has been purchased at a premium, the value of the premium would be lost in the event of
4
prepayment. Like other fixed-income securities, when interest rates rise, the value of a mortgage-related security generally will decline; however, when interest rates are declining, the value of mortgage-related securities with prepayment features may not increase as much as other fixed-income securities. Adjustable rate mortgage-related and other ABS are also subject to some interest rate risk. For example, because interest rates on most adjustable rate mortgage- and other ABS only reset periodically (e.g., monthly or quarterly), changes in prevailing interest rates (and particularly sudden and significant changes) can be expected to cause some fluctuations in the market value of these securities, including declines in value as interest rates rise. In addition, to the extent that unanticipated rates of pre-payment on underlying mortgages increase the effective duration of a mortgage-related security, the volatility of such security can be expected to increase.
The residential mortgage market in the United States has experienced in the past, and could experience in the future, difficulties that may adversely affect the performance and market value of certain of the Fund’s mortgage-related investments. Delinquencies, defaults and losses on residential mortgage loans may increase substantially over certain periods. A decline in or flattening of housing values may exacerbate such delinquencies and losses on residential mortgages. Borrowers with adjustable rate mortgage loans are more sensitive to changes in interest rates, which affect their monthly mortgage payments, and may be unable to secure replacement mortgages at comparably low interest rates. As a result of the 2008 financial crisis, a number of residential mortgage loan originators experienced serious financial difficulties or bankruptcy. Owing largely to the foregoing, reduced investor demand for mortgage loans and mortgage-related securities and increased investor yield requirements caused limited liquidity in the secondary market for certain mortgage-related securities, which adversely affected the market value of mortgage-related securities. It is possible that such limited liquidity in such secondary markets could recur or worsen in the future.
Agency Mortgage-Related Securities. Payment of principal and interest on some mortgage pass-through securities (but not the market value of the securities themselves) may be guaranteed by the full faith and credit of the U.S. Government (in the case of securities guaranteed by GNMA) or guaranteed by agencies or instrumentalities of the U.S. Government (in the case of securities guaranteed by the FNMA or the FHLMC). The principal governmental guarantor of mortgage-related securities is GNMA. GNMA is a wholly-owned U.S. Government corporation within the U.S. Department of Housing and Urban Development (the “Department of Housing and Urban Development”). GNMA is authorized to guarantee, with the full faith and credit of the U.S. Government, the timely payment of principal and interest on securities issued by institutions approved by GNMA (such as savings and loan institutions, commercial banks and mortgage bankers) and backed by pools of mortgages insured by the Federal Housing Administration (the “FHA”), or guaranteed by the Department of Veterans Affairs (the “VA”).
Government-related guarantors (i.e., not backed by the full faith and credit of the U.S. Government) include FNMA and FHLMC. FNMA is a government-sponsored corporation. FNMA primarily purchases conventional (i.e., not insured or guaranteed by any government agency) residential mortgages from a list of approved seller/servicers, which includes state and federally chartered savings and loan associations, mutual savings banks, commercial banks, credit unions and mortgage bankers. Pass-through securities issued by FNMA are guaranteed as to timely payment of principal and interest by FNMA but are not backed by the full faith and credit of the U.S. Government. Instead, they are supported only by the discretionary authority of the U.S. Government to purchase the agency’s obligations.
FHLMC was created by Congress in 1970 for the purpose of increasing the availability of mortgage credit for residential housing. It is a government-sponsored corporation that issues participation certificates (“PCs”) which are pass-through securities, each representing an undivided interest in a pool of residential mortgages. FHLMC guarantees the timely payment of interest and ultimate collection of principal, but PCs are not backed by the full faith and credit of the U.S. Government. Instead, they are supported only by the discretionary authority of the U.S. Government to purchase the agency’s obligations.
FNMA and FHLMC also securitize RPLs. For example, in FNMA’s case, the RPLs are single-family, fixed rate reperforming loans that generally were previously placed in a mortgage-backed securities trust guaranteed by FNMA, purchased from the trust by FNMA and held as a distressed asset after four or more months of delinquency, and subsequently became current (i.e., performing) again. Such RPLs may have exited delinquency through efforts at reducing defaults (e.g., loan modification). In selecting RPLs for securitization, FNMA follows certain criteria related to length of time the loan has been performing, the type of loan (single-family, fixed rate), and the status of the loan as first lien, among other things. FNMA may include different loan structures and modification programs in the future.
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Since September 6, 2008, FNMA and FHLMC have operated under a conservatorship administered by the Federal Housing Finance Agency (“FHFA”). As the conservator, FHFA succeeded to all rights, titles, powers and privileges of FNMA and FHLMC and of any stockholder, officer or director of FNMA and FHLMC with respect to FNMA and FHLMC and the assets of FNMA and FHLMC. In connection with the conservatorship, the U.S. Department of the Treasury (the “U.S. Treasury”) entered into a Senior Preferred Stock Purchase Agreement to provide additional financing to FNMA and FHLMC.
FNMA and FHLMC continue to operate as going concerns while in conservatorship and each remains liable for all of its obligations, including its guaranty obligations, associated with its mortgage-backed securities. The Senior Preferred Stock Purchase Agreement is intended to enhance each of FNMA’s and FHLMC’s ability to meet its obligations. The FHFA has indicated that the conservatorship of each enterprise will end when the director of FHFA determines that FHFA’s plan to restore the enterprise to a safe and solvent condition has been completed.
Under the Federal Housing Finance Regulatory Reform Act of 2008 (the “Reform Act”), which was included as part of the Housing and Economic Recovery Act of 2008, FHFA, as conservator or receiver, has the power to repudiate any contract entered into by FNMA or FHLMC prior to FHFA’s appointment as conservator or receiver, as applicable, if FHFA determines, in its sole discretion, that performance of the contract is burdensome and that repudiation of the contract promotes the orderly administration of FNMA’s or FHLMC’s affairs. The Reform Act requires FHFA to exercise its right to repudiate any contract within a reasonable period of time after its appointment as conservator or receiver.
FHFA, in its capacity as conservator, has indicated that it has no intention to repudiate the guaranty obligations of FNMA or FHLMC because FHFA views repudiation as incompatible with the goals of the conservatorship. However, in the event that FHFA, as conservator or if it is later appointed as receiver for FNMA or FHLMC, were to repudiate any such guaranty obligation, the conservatorship or receivership estate, as applicable, would be liable for actual direct compensatory damages in accordance with the provisions of the Reform Act. Any such liability could be satisfied only to the extent of FNMA’s or FHLMC’s assets available therefor.
In the event of repudiation, the payments of interest to holders of FNMA or FHLMC mortgage-backed securities would be reduced if payments on the mortgage loans represented in the mortgage loan groups related to such mortgage-backed securities are not made by the borrowers or advanced by the servicer. Any actual direct compensatory damages for repudiating these guaranty obligations may not be sufficient to offset any shortfalls experienced by such mortgage-backed security holders.
Further, in its capacity as conservator or receiver, FHFA has the right to transfer or sell any asset or liability of FNMA or FHLMC without any approval, assignment or consent. Although FHFA has stated that it has no present intention to do so, if FHFA, as conservator or receiver, were to transfer any such guaranty obligation to another party, holders of FNMA or FHLMC mortgage-backed securities would have to rely on that party for satisfaction of the guaranty obligation and would be exposed to the credit risk of that party.
In addition, certain rights provided to holders of mortgage-backed securities issued by FNMA and FHLMC under the operative documents related to such securities may not be enforced against FHFA, or enforcement of such rights may be delayed, during the conservatorship or any future receivership. The operative documents for FNMA and FHLMC mortgage-backed securities may provide (or with respect to securities issued prior to the date of the appointment of the conservator may have provided) that upon the occurrence of an event of default on the part of FNMA or FHLMC, in its capacity as guarantor, which includes the appointment of a conservator or receiver, holders of such mortgage-backed securities have the right to replace FNMA or FHLMC as trustee if the requisite percentage of mortgage-backed securities holders consent. The Reform Act prevents mortgage-backed security holders from enforcing such rights if the event of default arises solely because a conservator or receiver has been appointed. The Reform Act also provides that no person may exercise any right or power to terminate, accelerate or declare an event of default under certain contracts to which FNMA or FHLMC is a party, or obtain possession of or exercise control over any property of FNMA or FHLMC, or affect any contractual rights of FNMA or FHLMC, without the approval of FHFA, as conservator or receiver, for a period of 45 or 90 days following the appointment of FHFA as conservator or receiver, respectively.
FHFA and the White House have made public statements regarding plans to consider ending the conservatorships of FNMA and FHLMC. In the event that FNMA and FHLMC are taken out of conservatorship, it is unclear how the
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capital structure of FNMA and FHLMC would be constructed and what effects, if any, there may be on FNMA’s and FHLMC’s creditworthiness and guarantees of certain mortgage-backed securities. It is also unclear whether the U.S. Treasury would continue to enforce its rights or perform its obligations under the Senior Preferred Stock Programs. Should FNMA’s and FHLMC’s conservatorship end, there could be an adverse impact on the value of their securities, which could cause losses to the Fund.
FNMA and FHMLC have entered into a joint initiative to develop and operate a common securitization platform for the issuance of a uniform mortgage-backed security (the “Single Security Initiative”) that aligns the characteristics of FNMA and FHLMC certificates. In June 2019, under the Single Security Initiative, FNMA and FHLMC started issuing uniform mortgage-backed securities in place of their current offerings of to-be-announced-eligible securities. The Single Security Initiative seeks to support the overall liquidity of the to-be-announced (“TBA”) market and aligns the characteristics of FNMA and FHLMC certificates. The long-term effects that the Single Security Initiative may have on the market for TBA and other mortgage-backed securities are uncertain.
Privately Issued Mortgage-Related (Non-Agency) Securities. Commercial banks, savings and loan institutions, private mortgage insurance companies, mortgage bankers and other secondary market issuers also create pass-through pools of conventional residential mortgage loans. Such issuers may be the originators and/or servicers of the underlying mortgage loans as well as the guarantors of the mortgage-related securities. Pools created by such non-governmental issuers generally offer a higher rate of interest than government and government-related pools because there are no direct or indirect government or agency guarantees of payments in the former pools.
However, timely payment of interest and principal of these pools may be supported by various forms of insurance or guarantees, including individual loan, title, pool and hazard insurance and letters of credit, which may be issued by governmental entities, private insurers or the mortgage poolers. The insurance and guarantees are issued by governmental entities, private insurers or the mortgage poolers. Such insurance and guarantees, and the creditworthiness of the issuers thereof, will be considered in determining whether a mortgage-related security meets the Fund’s investment quality standards. There can be no assurance that insurers or guarantors can meet their obligations under the insurance policies or guarantee arrangements. The Fund may buy mortgage-related securities without insurance or guarantees if, through an examination of the loan experience and practices of the originators/servicers and poolers, PIMCO determines that the securities meet the Fund’s quality standards. Securities issued by certain private organizations may not be readily marketable. Please refer to “Illiquid Investments” for further discussion of regulatory considerations and constraints relating to investment liquidity.
Privately issued mortgage-related securities are not subject to the same underwriting requirements for the underlying mortgages that are applicable to those mortgage-related securities that have a government or government-sponsored entity guarantee. As a result, the mortgage loans underlying privately issued mortgage-related securities may, and frequently do, have less favorable collateral, credit risk or other underwriting characteristics than government or government-sponsored mortgage-related securities and have wider variances in a number of terms including interest rate, term, size, purpose and borrower characteristics. Mortgage pools underlying privately issued mortgage-related securities more frequently include second mortgages, high loan-to-value ratio mortgages and manufactured housing loans, in addition to commercial mortgages and other types of mortgages where a government or government sponsored entity guarantee is not available. The coupon rates and maturities of the underlying mortgage loans in a privately-issued mortgage-related securities pool may vary to a greater extent than those included in a government guaranteed pool, and the pool may include subprime mortgage loans. Subprime loans are loans made to borrowers with weakened credit histories or with a lower capacity to make timely payments on their loans. For these reasons, the loans underlying these securities have had in many cases higher default rates than those loans that meet government underwriting requirements.
The risk of non-payment is greater for mortgage-related securities that are backed by loans that were originated under weak underwriting standards, including loans made to borrowers with limited means to make repayment. A level of risk exists for all loans, although, historically, the poorest performing loans have been those classified as subprime. Other types of privately issued mortgage-related securities, such as those classified as pay-option adjustable rate or Alt-A have also performed poorly. Even loans classified as prime have experienced higher levels of delinquencies and defaults. The substantial decline in real property values across the U.S. has exacerbated the level of losses that investors in privately issued mortgage-related securities have experienced. It is not certain when these trends may reverse. Market factors that may adversely affect mortgage loan repayment include adverse economic conditions, unemployment, a decline in the value of real property, or an increase in interest rates.
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Privately issued mortgage-related securities are not traded on an exchange and there may be a limited market for the securities, especially when there is a perceived weakness in the mortgage and real estate market sectors. Without an active trading market, mortgage-related securities held in the Fund’s portfolio may be particularly difficult to value because of the complexities involved in assessing the value of the underlying mortgage loans.
The Fund may purchase privately issued mortgage-related securities that are originated, packaged and serviced by third party entities. It is possible these third parties could have interests that are in conflict with the holders of mortgage-related securities, and such holders (such as the Fund) could have rights against the third parties or their affiliates. For example, if a loan originator, servicer or its affiliates engaged in negligence or willful misconduct in carrying out its duties, then a holder of the mortgage-related security could seek recourse against the originator/servicer or its affiliates, as applicable. Also, as a loan originator/servicer, the originator/servicer or its affiliates may make certain representations and warranties regarding the quality of the mortgages and properties underlying a mortgage-related security. If one or more of those representations or warranties is false, then the holders of the mortgage-related securities (such as the Fund) could trigger an obligation of the originator/servicer or its affiliates, as applicable, to repurchase the mortgages from the issuing trust.
Notwithstanding the foregoing, many of the third parties that are legally bound by trust and other documents have failed to perform their respective duties, as stipulated in such trust and other documents, and investors have had limited success in enforcing terms. To the extent third party entities involved with privately issued mortgage-related securities are involved in litigation relating to the securities, actions may be taken that are adverse to the interests of holders of the mortgage-related securities, including the Fund. For example, third parties may seek to withhold proceeds due to holders of the mortgage-related securities, including the Fund, to cover legal or related costs. Any such action could result in losses to the Fund.
The assets underlying mortgage-related securities may be represented by a portfolio of residential or commercial mortgages (including both whole mortgage loans and mortgage participation interests that may be senior or junior in terms of priority of repayment) or portfolios of mortgage pass-through securities issued or guaranteed by GNMA, FNMA or FHLMC. Mortgage loans underlying a mortgage-related security may in turn be insured or guaranteed by the FHA or the VA. In the case of privately issued mortgage-related securities whose underlying assets are neither U.S. Government securities nor U.S. Government-insured mortgages, to the extent that real properties securing such assets may be located in the same geographical region, the security may be subject to a greater risk of default than other comparable securities in the event of adverse economic, political or business developments that may affect such region and, ultimately, the ability of residential homeowners to make payments of principal and interest on the underlying mortgages.
PIMCO seeks to manage the portion of the Fund’s assets committed to privately issued mortgage-related securities in a manner consistent with the Fund’s investment objectives, policies and overall portfolio risk profile. In determining whether and how much to invest in privately issued mortgage-related securities, and how to allocate those assets, the Investment Manager will generally consider a number of factors. These include, but are not limited to: (1) the nature of the borrowers (e.g., residential vs. commercial); (2) the collateral loan type (e.g., for residential: First Lien - Jumbo/Prime, First Lien - Alt-A, First Lien - Subprime, First Lien - Pay-Option or Second Lien; for commercial: Conduit, Large Loan or Single Asset / Single Borrower); and (3) in the case of residential loans, whether they are fixed rate or adjustable mortgages. Each of these criteria can cause privately issued mortgage-related securities to have differing primary economic characteristics and distinguishable risk factors and performance characteristics.
Collateralized Mortgage Obligations (“CMOs”). A CMO is a debt obligation of a legal entity that is collateralized by mortgages and divided into classes. Similar to a bond, interest and prepaid principal is paid, in most cases, semi-annually or on a monthly basis. CMOs may be collateralized by whole mortgage loans or private mortgage bonds, but are more typically collateralized by portfolios of mortgage pass-through securities guaranteed by GNMA, FHLMC, or FNMA, and their income streams.
CMOs are structured into multiple classes, often referred to as “tranches,” with each class bearing a different stated maturity and entitled to a different schedule for payments of principal and interest, including prepayments. Actual maturity and average life will depend upon the pre-payment experience of the collateral. In the case of certain CMOs (known as “sequential pay” CMOs), payments of principal received from the pool of underlying mortgages, including prepayments, are applied to the classes of CMOs in the order of their respective final distribution dates.
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Thus, no payment of principal will be made to any class of sequential pay CMOs until all other classes having an earlier final distribution date have been paid in full.
In a typical CMO transaction, a corporation (“issuer”) issues multiple series (e.g., A, B, C, Z) of CMO bonds (“Bonds”). Proceeds of the Bond offering are used to purchase mortgages or mortgage pass-through certificates (“Collateral”). The Collateral is pledged to a third party trustee as security for the Bonds. Principal and interest payments from the Collateral are used to pay principal on the Bonds in the order A, B, C, Z. The Series A, B, and C Bonds all bear current interest. Interest on the Series Z Bond is accrued and added to principal and a like amount is paid as principal on the Series A, B, or C Bond currently being paid off. When the Series A, B, and C Bonds are paid in full, interest and principal on the Series Z Bond begins to be paid currently.
CMOs may be less liquid and may exhibit greater price volatility than other types of mortgage- or asset-backed securities.
As CMOs have evolved, some classes of CMO bonds have become more common. For example, the Fund may invest in parallel-pay and planned amortization class (“PAC”) CMOs and multi-class pass-through certificates. Parallel-pay CMOs and multi-class pass-through certificates are structured to provide payments of principal on each payment date to more than one class. These simultaneous payments are taken into account in calculating the stated maturity date or final distribution date of each class, which, as with other CMO and multi-class pass-through structures, must be retired by its stated maturity date or final distribution date but may be retired earlier. PACs generally require payments of a specified amount of principal on each payment date. PACs are parallel-pay CMOs with the required principal amount on such securities having the highest priority after interest has been paid to all classes. Any CMO or multi-class pass-through structure that includes PAC securities must also have support tranches-known as support bonds, companion bonds or non-PAC bonds-which lend or absorb principal cash flows to allow the PAC securities to maintain their stated maturities and final distribution dates within a range of actual prepayment experience. These support tranches are subject to a higher level of maturity risk compared to other mortgage-related securities, and usually provide a higher yield to compensate investors. If principal cash flows are received in amounts outside a pre-determined range such that the support bonds cannot lend or absorb sufficient cash flows to the PAC securities as intended, the PAC securities are subject to heightened maturity risk. Consistent with the Fund’s investment objectives and policies, PIMCO may invest in various tranches of CMO bonds, including support bonds.
CMOs that are issued or guaranteed by the U.S. Government or by any of its agencies or instrumentalities will be considered U.S. Government securities by the Fund, while other CMOs, even if collateralized by U.S. Government securities, will have the same status as other privately issued securities for purposes of applying the Fund’s diversification tests.
FHLMC Collateralized Mortgage Obligations. FHLMC CMOs are debt obligations of FHLMC issued in multiple classes having different maturity dates which are secured by the pledge of a pool of conventional mortgage loans purchased by FHLMC. Payments of principal and interest on the CMOs are made semi-annually, as opposed to monthly. The amount of principal payable on each semi-annual payment date is determined in accordance with FHLMC’s mandatory sinking fund schedule, which in turn, is equal to approximately 100% of FHA prepayment experience applied to the mortgage collateral pool. All sinking fund payments in the CMOs are allocated to the retirement of the individual classes of bonds in the order of their stated maturities. Payment of principal on the mortgage loans in the collateral pool in excess of the amount of FHLMC’s minimum sinking fund obligation for any payment date are paid to the holders of the CMOs as additional sinking fund payments. Because of the “pass-through” nature of all principal payments received on the collateral pool in excess of FHLMC’s minimum sinking fund requirement, the rate at which principal of the CMOs is actually repaid is likely to be such that each class of bonds will be retired in advance of its scheduled maturity date.
If collection of principal (including prepayments) on the mortgage loans during any semi-annual payment period is not sufficient to meet FHLMC’s minimum sinking fund obligation on the next sinking fund payment date, FHLMC agrees to make up the deficiency from its general funds.
Criteria for the mortgage loans in the pool backing the FHLMC CMOs are identical to those of FHLMC PCs. FHLMC has the right to substitute collateral in the event of delinquencies and/or defaults.
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Commercial Mortgage-Backed Securities. Commercial mortgage-backed securities include securities that reflect an interest in, and are secured by, mortgage loans on commercial real property. Many of the risks of investing in commercial mortgage-backed securities reflect the risks of investing in the real estate securing the underlying mortgage loans. These risks reflect the effects of local and other economic conditions on real estate markets, the ability of tenants to make loan payments, and the ability of a property to attract and retain tenants. Commercial mortgage-backed securities may be less liquid and exhibit greater price volatility than other types of mortgage- or asset-backed securities.
CMO Residuals. CMO residuals are mortgage securities issued by agencies or instrumentalities of the U.S. Government or by private originators of, or investors in, mortgage loans, including savings and loan associations, homebuilders, mortgage banks, commercial banks, investment banks and special purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs is applied first to make required payments of principal and interest on the CMOs and second to pay the related administrative expenses and any management fee of the issuer. The residual in a CMO structure generally represents the interest in any excess cash flow remaining after making the foregoing payments. Each payment of such excess cash flow to a holder of the related CMO residual represents income and/or a return of capital. The amount of residual cash flow resulting from a CMO will depend on, among other things, the characteristics of the mortgage assets, the coupon rate of each class of CMO, prevailing interest rates, the amount of administrative expenses and the pre-payment experience on the mortgage assets. In particular, the yield to maturity on CMO residuals is extremely sensitive to pre-payments on the related underlying mortgage assets, in the same manner as an interest-only (“IO”) class of SMBS. See “Stripped Mortgage-Backed Securities” below. In addition, if a series of a CMO includes a class that bears interest at an adjustable rate, the yield to maturity on the related CMO residual will also be extremely sensitive to changes in the level of the index upon which interest rate adjustments are based. As described below with respect to SMBS, in certain circumstances the Fund may fail to recoup fully its initial investment in a CMO residual.
CMO residuals are generally purchased and sold by institutional investors through several investment banking firms acting as brokers or dealers. Transactions in CMO residuals are generally completed only after careful review of the characteristics of the securities in question. In addition, CMO residuals may, or pursuant to an exemption therefrom, may not, have been registered under the Securities Act of 1933, as amended (the “1933 Act”). CMO residuals, whether or not registered under the 1933 Act, may be subject to certain restrictions on transferability. Please refer to “Illiquid Investments” for further discussion of regulatory considerations and constraints relating to investment liquidity.
Adjustable Rate Mortgage Backed Securities. Adjustable rate mortgage-backed securities (“ARMBSs”) have interest rates that reset at periodic intervals. Acquiring ARMBSs permits the Fund to participate in increases in prevailing current interest rates through periodic adjustments in the coupons of mortgages underlying the pool on which ARMBSs are based. Such ARMBSs generally have higher current yield and lower price fluctuations than is the case with more traditional fixed-income debt securities of comparable rating and maturity. In addition, when prepayments of principal are made on the underlying mortgages during periods of rising interest rates, the Fund can reinvest the proceeds of such prepayments at rates higher than those at which they were previously invested. Mortgages underlying most ARMBSs, however, have limits on the allowable annual or lifetime increases that can be made in the interest rate that the mortgagor pays. Therefore, if current interest rates rise above such limits over the period of the limitation, the Fund, when holding an ARMBS, does not benefit from further increases in interest rates. Moreover, when interest rates are in excess of coupon rates (i.e., the rates being paid by mortgagors) of the mortgages, ARMBSs behave more like fixed-income securities and less like adjustable rate securities and are subject to the risks associated with fixed-income securities. In addition, during periods of rising interest rates, increases in the coupon rate of adjustable rate mortgages generally lag current market interest rates slightly, thereby creating the potential for capital depreciation on such securities.
Stripped Mortgage-Backed Securities. SMBS are derivative multi-class mortgage securities. SMBS may be issued by agencies or instrumentalities of the U.S. Government, or by private originators of, or investors in, mortgage loans, including savings and loan associations, mortgage banks, commercial banks, investment banks and special purpose entities of the foregoing.
SMBS are usually structured with two classes that receive different proportions of the interest and principal distributions on a pool of mortgage assets. A common type of SMBS will have one class receiving some of the interest
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and most of the principal from the mortgage assets, while the other class will receive most of the interest and the remainder of the principal. In the most extreme case, one class will receive all of the interest (the “IO” class), while the other class will receive all of the principal (the principal-only or “PO” class). The yield to maturity on an IO class is extremely sensitive to the rate of principal payments (including prepayments) on the related underlying mortgage assets, and a rapid rate of principal payments may have a material adverse effect on the Fund’s yield to maturity from these securities. If the underlying mortgage assets experience greater than anticipated prepayments of principal, the Fund may fail to recoup some or all of its initial investment in these securities even if the security is in one of the highest rating categories.
Other Mortgage-Related Securities. Other mortgage-related securities include securities other than those described above that directly or indirectly represent a participation in, or are secured by and payable from, mortgage loans on real property, including mortgage dollar rolls/buy backs, CMO residuals or SMBS. Other mortgage-related securities may be equity or debt securities issued by agencies or instrumentalities of the U.S. Government or by private originators of, or investors in, mortgage loans, including savings and loan associations, homebuilders, mortgage banks, commercial banks, investment banks, partnerships, trusts and special purpose entities of the foregoing.
Mortgage-related securities include, among other things, securities that reflect an interest in reverse mortgages. In a reverse mortgage, a lender makes a loan to a homeowner based on the homeowner’s equity in his or her home. While a homeowner must be age 62 or older to qualify for a reverse mortgage, reverse mortgages may have no income restrictions. Repayment of the interest or principal for the loan is generally not required until the homeowner dies, sells the home, or ceases to use the home as his or her primary residence.
There are three general types of reverse mortgages: (1) single-purpose reverse mortgages, which are offered by certain state and local government agencies and nonprofit organizations; (2) federally-insured reverse mortgages, which are backed by the Department of Housing and Urban Development; and (3) proprietary reverse mortgages, which are privately offered loans. A mortgage-related security may be backed by a single type of reverse mortgage. Reverse mortgage-related securities include agency and privately issued mortgage-related securities. The principal government guarantor of reverse mortgage-related securities is GNMA.
Reverse mortgage-related securities may be subject to risks different than other types of mortgage-related securities due to the unique nature of the underlying loans. The date of repayment for such loans is uncertain and may occur sooner or later than anticipated. The timing of payments for the corresponding mortgage-related security may be uncertain. Because reverse mortgages are offered only to persons 62 and older and there may be no income restrictions, the loans may react differently than traditional home loans to market events. Additionally, there can be no assurance that service providers to reverse mortgage trusts (RMTs) will diligently and appropriately execute their duties with respect to servicing such trusts. As a result, investors (which may include the Fund) in notes issued by RMTs may be deprived of payments to which they are entitled. This could result in losses to the Fund. Investors, including the Fund, may determine to pursue negotiations or legal claims or otherwise seek compensation from RMT service providers in certain instances. This may involve the Fund incurring costs and expenses associated with such actions.
Asset-Backed Securities. The Fund may invest in, or have exposure to, ABS, which are securities that represent a participation in, or are secured by and payable from, a stream of payments generated by particular assets, most often a pool or pools of similar assets (e.g., trade receivables). ABS are created from many types of assets, including, but not limited to, auto loans, accounts receivable such as credit card receivables and hospital account receivables, home equity loans, student loans, boat loans, mobile home loans, recreational vehicle loans, manufactured housing loans, aircraft leases, computer leases and syndicated bank loans. The credit quality of these securities depends primarily upon the quality of the underlying assets and the level of credit support and/or enhancement provided. To protect ABS investors from the possibility that some borrowers could miss payments or even default on their loans, ABS include various forms of credit enhancement.
The underlying assets (e.g., loans) are subject to prepayments that shorten the securities’ weighted average maturity and may lower their return. If the credit support or enhancement is exhausted, losses or delays in payment may result if the required payments of principal and interest are not made. The value of these securities also may change because of changes in the market’s perception of the creditworthiness of the servicing agent for the pool, the originator of the pool, or the financial institution or trust providing the credit support or enhancement. Typically, there
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is no perfected security interest in the collateral that relates to the financial assets that support ABS. ABS have many of the same characteristics and risks as the mortgage backed securities described above.
The Fund may purchase or have exposure to commercial paper, including asset-backed commercial paper (“ABCP”), that is issued by structured investment vehicles or other conduits. These conduits may be sponsored by mortgage companies, investment banking firms, finance companies, hedge funds, private equity firms and special purpose finance entities. ABCP typically refers to a short-term debt security, the payment of which is supported by cash flows from underlying assets, or one or more liquidity or credit support providers, or both. Assets backing ABCP include credit card, car loan and other consumer receivables and home or commercial mortgages, including subprime mortgages. The repayment of ABCP issued by a conduit depends primarily on the cash collections received from the conduit’s underlying asset portfolio and the conduit’s ability to issue new ABCP. Therefore, there could be losses to the Fund if investing in ABCP in the event of credit or market value deterioration in the conduit’s underlying portfolio, mismatches in the timing of the cash flows of the underlying asset interests and the repayment obligations of maturing ABCP, or the conduit’s inability to issue new ABCP. To protect investors from these risks, ABCP programs may be structured with various protections, such as credit enhancement, liquidity support, and commercial paper stop-issuance and wind-down triggers. However, there can be no guarantee that these protections will be sufficient to prevent losses to investors in ABCP. Some ABCP programs provide for an extension of the maturity date of the ABCP if, on the related maturity date, the conduit is unable to access sufficient liquidity through the issue of additional ABCP. This may delay the sale of the underlying collateral and the Fund may incur a loss if the value of the collateral deteriorates during the extension period. Alternatively, if collateral for ABCP deteriorates in value, the collateral may be required to be sold at inopportune times or at prices insufficient to repay the principal and interest on the ABCP. ABCP programs may provide for the issuance of subordinated notes as an additional form of credit enhancement. The subordinated notes are typically of a lower credit quality and have a higher risk of default. To the extent the Fund purchases these subordinated notes, it will have a higher likelihood of loss than investors in the senior notes.
Some ABS, particularly home equity loan transactions, are subject to interest-rate risk and prepayment risk. A change in interest rates can affect the pace of payments on the underlying loans, which in turn, affects total return on the securities. ABS also carry credit or default risk. If many borrowers on the underlying loans default, losses could exceed the credit enhancement level and result in losses to investors in an ABS transaction. Additionally, the value of ABS is subject to risks associated with the servicers’ performance. In some circumstances, a servicer’s or originator’s mishandling of documentation related to the underlying collateral (e.g., failure to properly document a security interest in the underlying collateral) may affect the rights of the security holders in and to the underlying collateral. Finally, ABS have structure risk due to a unique characteristic known as early amortization, or early payout, risk. Built into the structure of most ABS are triggers for early payout, designed to protect investors from losses. These triggers are unique to each transaction and can include: a big rise in defaults on the underlying loans, a sharp drop in the credit enhancement level, or even the bankruptcy of the originator. Once early amortization begins, all incoming loan payments (after expenses are paid) are used to pay investors as quickly as possible based upon a predetermined priority of payment.
Several types of ABS have already been offered to investors, including Enhanced Equipment Trust Certificates (“EETCs”) and Certificates for Automobile Receivablessm (“CARSsm”).
EETCs are typically issued by specially-created trusts established by airlines, railroads, or other transportation corporations. The proceeds of EETCs are used to purchase equipment, such as airplanes, railroad cars, or other equipment, which in turn serve as collateral for the related issue of the EETCs. The equipment generally is leased by the airline, railroad or other corporation, which makes rental payments to provide the projected cash flow for payments to EETC holders. Holders of EETCs must look to the collateral securing the certificates, typically together with a guarantee provided by the lessee corporation or its parent company for the payment of lease obligations, in the case of default in the payment of principal and interest on the EETCs. However, because principal and interest payments on EETCs are funded in the ordinary course by the lessee corporation, the Fund treats EETCs as corporate bonds/obligations for purposes of compliance testing and related classifications.
CARSsm represent undivided fractional interests in a trust whose assets consist of a pool of motor vehicle retail installment sales contracts and security interests in the vehicles securing the contracts. Payments of principal and interest on CARSsm are passed through monthly to certificate holders, and are guaranteed up to certain amounts and for a certain time period by a letter of credit issued by a financial institution unaffiliated with the trustee or originator of the trust. An investor’s return on CARSsm may be affected by early prepayment of principal on the underlying vehicle
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sales contracts. If the letter of credit is exhausted, the trust may be prevented from realizing the full amount due on a sales contract because of state law requirements and restrictions relating to foreclosure sales of vehicles and the obtaining of deficiency judgments following such sales or because of depreciation, damage or loss of a vehicle, the application of federal and state bankruptcy and insolvency laws, or other factors. As a result, certificate holders may experience delays in payments or losses if the letter of credit is exhausted.
Consistent with the Fund’s investment objectives and policies, PIMCO also may invest in other types of ABS (such as credit card receivables or student loans). Other ABS may be collateralized by the fees earned by service providers. The value of ABS may be substantially dependent on the servicing of the underlying asset pools and are therefore subject to risks associated with the negligence by, or defalcation of, their servicers. In certain circumstances, the mishandling of related documentation may also affect the rights of the security holders in and to the underlying collateral. The insolvency of entities that generate receivables or that utilize the assets may result in added costs and delays in addition to losses associated with a decline in the value of the underlying assets.
Investors should note that Congress from time to time may consider actions that would limit or remove the explicit or implicit guarantee of the payment of principal and/or interest on many types of ABS. Any such action would likely adversely impact the value of such securities.
Collateralized Bond Obligations, Collateralized Loan Obligations and Other Collateralized Debt Obligations. The Fund may invest in each of CBOs, CLOs, other CDOs and other similarly structured securities. CBOs, CLOs and other CDOs are types of ABS. A CBO is a trust that is often backed by a diversified pool of high risk, below investment grade fixed-income securities. The collateral can be from many different types of fixed-income securities such as high-yield debt, residential privately issued mortgage-related securities, commercial privately issued mortgage-related securities, trust preferred securities and emerging market debt. A CLO is a trust typically collateralized by a pool of loans, which may include, among others, domestic and foreign senior secured loans, senior unsecured loans and subordinate corporate loans, including loans that may be rated below investment grade or equivalent unrated loans. Other CDOs are trusts backed by other types of assets representing obligations of various parties. CBOs, CLOs and other CDOs may charge management fees and administrative expenses.
For CBOs, CLOs and other CDOs, the cash flows from the trust are split into two or more portions, called tranches, varying in risk and yield. The riskiest portion is the “equity” tranche which bears the bulk of defaults from the bonds or loans in the trust and serves to protect the other, more senior tranches from default in all but the most severe circumstances. Since it is partially protected from defaults, a senior tranche from a CBO trust, CLO trust or trust of another CDO typically has higher ratings and lower yields than their underlying securities, and can be rated investment grade. Despite the protection from the equity tranche, CBO, CLO or other CDO tranches can experience substantial losses due to actual defaults, downgrades of the underlying collateral by rating agencies, forced liquidation of the collateral pool due to a failure of coverage tests, increased sensitivity to defaults due to collateral default and disappearance of protecting tranches, market anticipation of defaults, as well as aversion to CBO, CLO or other CDO securities as a class. Interest on certain tranches of a CDO may be paid in kind or deferred and capitalized (paid in the form of obligations of the same type rather than cash), which involves continued exposure to default risk with respect to such payments.
The risks of an investment in a CBO, CLO or other CDO depend largely on the type of the collateral securities and the class of the instrument in which the Fund invests. Normally, CBOs, CLOs and other CDOs are privately offered and sold, and thus, are not registered under the securities laws. As a result, investments in CBOs, CLOs and other CDOs may be characterized by the Fund as illiquid investments. However, an active dealer market may exist for CBOs, CLOs and other CDOs allowing them to qualify for Rule 144A transactions. Please refer to “Illiquid Investments” for further discussion of regulatory considerations and constraints relating to investment liquidity. In addition to the normal risks associated with fixed-income securities discussed elsewhere in this Statement of Additional Information and the Prospectus (e.g., prepayment risk, credit risk, liquidity risk, market risk, structural risk, legal risk and interest rate risk (which may be exacerbated if the interest rate payable on a structured financing changes based on multiples of changes in interest rates or inversely to changes in interest rates) and default risk), CBOs, CLOs and other CDOs carry additional risks including, but are not limited to: (i) the possibility that distributions from collateral securities will not be adequate to make interest or other payments; (ii) the quality of the collateral may decline in value or default; (iii) the risk that the Fund may invest in CBOs, CLOs or other CDOs that are subordinate to other classes; (iv) the complex structure of the security may not be fully understood at the time of investment and may produce disputes with the issuer or unexpected investment results; (v) the investment return achieved by the Fund
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could be significantly different than those predicted by financial models; (vi) the lack of a readily available secondary market for CDOs; (vii) risk of forced “fire sale” liquidation due to technical defaults such as coverage test failures; and (viii) the CDO’s manager may perform poorly.
Real Estate Assets and Related Derivatives
The Fund may generally gain exposure to the real estate sector by investing in real-estate linked derivatives, real estate investment trusts (“REITs”) and common, preferred and convertible securities of issuers in real estate-related industries. The Fund may also invest in loans or other investments secured by real estate (other than mortgage-backed securities) and may, as a result of default, foreclosure or otherwise, take possession of and hold real estate as a direct owner (see “Loans and Other Indebtedness; Loan Participations and Assignments” below). Each of these types of investments are subject, directly or indirectly, to risks associated with ownership of real estate, including changes in the general economic climate or local conditions (such as an oversupply of space or a reduction in demand for space), loss to casualty or condemnation, increases in property taxes and operating expenses, zoning law amendments, changes in interest rates, overbuilding and increased competition, including competition based on rental rates, variations in market value, changes in the financial condition of tenants, changes in operating costs, attractiveness and location of the properties, adverse changes in the real estate markets generally or in specific sectors of the real estate industry and possible environmental liabilities. Real estate-related investments may entail leverage and may be highly volatile.
REITs are pooled investment vehicles that own, and typically operate, income-producing real estate. If a REIT meets certain requirements, including distributing to shareholders substantially all of its taxable income (other than net capital gains), then it is generally not taxed on the income distributed to shareholders. REITs are subject to management fees and other expenses, and so the Fund would bear its proportionate share of the costs of the REITs’ operations if it invests in REITs. Dividends received by the Fund from a REIT generally will not constitute qualified dividend income. REITs may not provide complete tax information to the Fund until after the calendar year-end. Consequently, because of the delay, it may be necessary for the Fund to request permission from the Internal Revenue Service (“IRS”) to extend the deadline for issuance of Form 1099-DIV.
There are three general categories of REITs: Equity REITs, Mortgage REITs and Hybrid REITs. Equity REITs invest primarily in direct fee ownership or leasehold ownership of real property; they derive most of their income from rents. Mortgage REITs invest mostly in mortgages on real estate, which may secure construction, development or long-term loans, and the main source of their income is mortgage interest payments. Hybrid REITs hold both ownership and mortgage interests in real estate.
Along with the risks common to different types of real estate related securities, REITs, no matter the type, involve additional risk factors. These include poor performance by the REIT’s manager, changes to the tax laws, and failure by the REIT to qualify for favorable tax treatment under the Internal Revenue Code of 1986, as amended (the “Code”). Furthermore, REITs are not diversified and are heavily dependent on cash flow. Investments in REIT equity securities could require the Fund to accrue and distribute income not yet received by the Fund. On the other hand, investments in REIT equity securities can also result in the Fund’s receipt of cash in excess of the REIT’s earnings; if the Fund distributes such amounts, such distribution could constitute a return of capital to Fund shareholders for federal income tax purposes. In addition, some REITS have limited diversification because they invest in a limited number of properties, a narrow geographic area, or a single type of property. Also, the organizational documents of a REIT may contain provisions that make changes in control of the REIT difficult and time-consuming. Finally, private REITs are not traded on a national securities exchange. As such, these products are generally illiquid. This reduces the ability of the Fund to redeem its investment early. Private REITS are also generally harder to value and may bear higher fees than public REITs.
Some of the REITs in which the Fund may invest may be permitted to hold senior or residual interests in real estate mortgage investment conduits (“REMICs”) or debt or equity interests in taxable mortgage pools (“TMPs”). The Fund may also hold interests in “Re-REMICs”, which are interests in securitizations formed by the contribution of asset backed or other similar securities into a trust which then issues securities in various tranches. The Fund may participate in the creation of a Re-REMIC by contributing assets to the trust and receiving junior and/or senior securities in return. An interest in a Re-REMIC security may be riskier than the securities originally held by and contributed to the trust, and the holders of the Re-REMIC securities will bear the costs associated with the securitization.
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Foreign (Non-U.S.) Securities
Subject to the limitations set forth in the Prospectus, the Fund may invest in instruments of corporate and other foreign (non-U.S.) issuers, and in instruments traded principally outside of the United States. The Fund may invest in sovereign and other debt securities issued by foreign governments and their respective sub-divisions, agencies or instrumentalities, government sponsored enterprises and supranational government entities. The Fund may also invest directly in foreign currencies, including currencies of emerging market countries.
The foreign securities in which the Fund may invest include without limit Eurodollar obligations and “Yankee Dollar” obligations. Eurodollar obligations are U.S. dollar-denominated certificates of deposit and time deposits issued outside the U.S. capital markets by foreign branches of U.S. banks and by foreign banks. Yankee Dollar obligations are U.S. dollar-denominated obligations issued in the U.S. capital markets by foreign banks. Eurodollar and Yankee Dollar obligations are generally subject to the same risks that apply to domestic debt issues, notably credit risk, interest rate risk, market risk and liquidity risk. Additionally, Eurodollar (and to a limited extent, Yankee Dollar) obligations are subject to certain sovereign risks. One such risk is the possibility that a sovereign country might prevent capital, in the form of U.S. dollars, from flowing across its borders. Other risks include adverse political and economic developments; the extent and quality of government regulation of financial markets and institutions; the imposition of foreign withholding or other taxes; and the expropriation or nationalization of foreign issuers.
The Fund may also invest in American Depositary Receipts (“ADRs”), European Depositary Receipts (“EDRs”) or Global Depositary Receipts (“GDRs”). ADRs are U.S. dollar-denominated receipts issued generally by domestic banks and represent the deposit with the bank of a security of a non-U.S. issuer. EDRs are foreign currency-denominated receipts similar to ADRs and are issued and traded in Europe, and are publicly traded on exchanges or over-the-counter (“OTC”) in the United States. GDRs may be offered privately in the United States and also trade in public or private markets in other countries. ADRs, EDRs and GDRs may be issued as sponsored or unsponsored programs. In sponsored programs, an issuer has made arrangements to have its securities trade in the form of ADRs, EDRs or GDRs. In unsponsored programs, the issuer may not be directly involved in the creation of the program. Although regulatory requirements with respect to sponsored and unsponsored programs are generally similar, in some cases it may be easier to obtain financial information from an issuer that has participated in the creation of a sponsored program.
Investing in non-U.S. securities involves special risks and considerations not typically associated with investing in U.S. securities. These include: differences in accounting, auditing and financial reporting standards, generally higher commission rates on non-U.S. portfolio transactions, the possibility of expropriation or confiscatory taxation, adverse changes in investment or exchange control regulations (which may include suspension of the ability to transfer currency from a country), market disruption, the possibility of security suspensions, political instability which can affect U.S. investments in non-U.S. countries, the imposition of sanctions and other similar measures and potential restrictions on the flow of international capital. In addition, foreign securities and the Fund’s income in respect of those securities may be subject to foreign taxes, including taxes withheld from payments on those securities, which would reduce the Fund’s return on such securities. Non-U.S. securities often trade with less frequency and volume than domestic securities and therefore may exhibit greater price volatility. Changes in foreign exchange rates will affect the value of those securities that are denominated or quoted in currencies other than the U.S. dollar. The currencies of non-U.S. countries may experience significant declines against the U.S. dollar, and devaluation may occur subsequent to investments in these currencies by the Fund.
Investment in sovereign debt can involve a high degree of risk. The governmental entity that controls the repayment of sovereign debt may not be able or willing to repay the principal and/or interest when due in accordance with the terms of the debt. A governmental entity’s willingness or ability to repay principal and interest due in a timely manner may be affected by, among other factors, its cash flow situation, the extent of its foreign reserves, the availability of sufficient foreign exchange on the date a payment is due, the relative size of the debt service burden to the economy as a whole, the governmental entity’s policy toward the International Monetary Fund, and the political constraints to which a governmental entity may be subject. Governmental entities also may depend on expected disbursements from foreign governments, multilateral agencies and others to reduce principal and interest arrearages on their debt. The commitment on the part of these governments, agencies and others to make such disbursements may be conditioned on a governmental entity’s implementation of economic reforms and/or economic performance and the timely service of such debtor’s obligations. Failure to implement such reforms, achieve such levels of economic performance or repay principal or interest when due may result in the cancellation of such third parties’ commitments
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to lend funds to the governmental entity, which may further impair such debtor’s ability or willingness to service its debts in a timely manner. Consequently, governmental entities may default on their sovereign debt. Holders of sovereign debt (including the Fund) may be requested to participate in the rescheduling of such debt and to extend further loans to governmental entities. There is no bankruptcy proceeding by which sovereign debt on which governmental entities have defaulted may be collected in whole or in part.
The investments in foreign currency denominated debt obligations and hedging activities by the Fund will likely produce a difference between the Fund’s book income and its taxable income. This difference may cause a portion of the Fund’s income distributions to constitute returns of capital for tax purposes or require the Fund to make distributions exceeding book income to qualify as a regulated investment company (“RIC”) for U.S. federal tax purposes. The Fund’s investments in non-U.S. securities may increase or accelerate the amount of ordinary income recognized by shareholders. See “Taxation.”
Euro- and European Union-related risks. The global economic crisis brought several small economies in Europe to the brink of bankruptcy and many other economies into recession and weakened the banking and financial sectors of many European countries. For example, the governments of Greece, Spain, Portugal, and the Republic of Ireland have all experienced large public budget deficits, the effects of which are still yet unknown and may slow the overall recovery of the European economies from the global economic crisis. In addition, due to large public deficits, some European countries may be dependent on assistance from other European governments and institutions or other central banks or supranational agencies such as the International Monetary Fund. Assistance may be dependent on a country’s implementation of reforms or reaching a certain level of performance. Failure to reach those objectives or an insufficient level of assistance could result in a deep economic downturn which could significantly affect the value of a Fund’s European investments.
The national politics of European countries can be unpredictable and subject to influence by disruptive political groups or ideologies. The occurrence of conflicts, war or terrorist activities in Europe could have an adverse impact on financial markets. For example, Russia launched a large-scale invasion of Ukraine in February 2022. The extent, duration and impact of Russia’s military action in Ukraine, related sanctions and retaliatory actions are difficult to ascertain, but could be significant and have severe adverse effects on the region, including significant adverse effects on the regional, European, and global economies and the markets for certain securities and commodities, such as oil and natural gas, as well as other sectors.
The Economic and Monetary Union of the European Union (“EMU”) is comprised of the European Union (“EU”) members that have adopted the euro currency. By adopting the euro as its currency, a member state relinquishes control of its own monetary policies. As a result, European countries are significantly affected by fiscal and monetary policies implemented by the EMU and European Central Bank. The euro currency may not fully reflect the strengths and weaknesses of the various economies that comprise the EMU and Europe generally.
It is possible that one or more EMU member countries could abandon the euro and return to a national currency and/or that the euro will cease to exist as a single currency in its current form. The effects of such an abandonment or a country’s forced expulsion from the euro on that country, the rest of the EMU, and global markets are impossible to predict, but are likely to be negative. The exit of any country out of the euro may have an extremely destabilizing effect on other Eurozone countries and their economies and a negative effect on the global economy as a whole. Such an exit by one country may also increase the possibility that additional countries may exit the euro should they face similar financial difficulties. In addition, in the event of one or more countries’ exit from the euro, it may be difficult to value investments denominated in euros or in a replacement currency.
On January 31, 2020, the United Kingdom officially withdrew from the EU (commonly known as “Brexit”). Upon the United Kingdom’s withdrawal, the EU and the United Kingdom entered into a transition phase, which concluded on December 31, 2020. Negotiators representing the United Kingdom and EU came to a preliminary trade agreement that took effect on January 1, 2021, but many aspects of the United Kingdom-EU trade relationship remain subject to further negotiation. Uncertainties remain relating to certain aspects of the United Kingdom’s future economic, trading and legal relationships with the EU and with other countries. Due to political uncertainty, it is not possible to anticipate the form or nature of the future trading relationship between the United Kingdom and the EU. The UK, EU and broader global economy may experience substantial volatility in foreign exchange markets and a sustained weakness in the British pound’s exchange rate against the United States dollar, the euro and other currencies, which may impact Fund returns. Brexit may also destabilize some or all of the other EU member countries and/or the
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Eurozone. These developments could result in losses to the Fund, as there may be negative effects on the value of the Fund’s investments and/or on the Fund’s ability to enter into certain transactions or value certain investments, and these developments may make it more difficult for the Fund to exit certain investments at an advantageous time or price. Such events could result from, among other things, increased uncertainty and volatility in the United Kingdom, the EU and other financial markets; fluctuations in asset values; fluctuations in exchange rates; decreased liquidity of investments located, traded or listed within the United Kingdom, the EU or elsewhere; changes in the willingness or ability of financial and other counterparties to enter into transactions or the price and terms on which other counterparties are willing to transact; and/or changes in legal and regulatory regimes to which Fund investments are or become subject. Any of these events, as well as an exit or expulsion of an EU member state other than the United Kingdom from the EU, could negatively impact Fund returns.
Investments in Russia. The Fund may have investments in securities and instruments that are economically tied to Russia. In determining whether an instrument is economically tied to Russia, PIMCO uses the criteria for determining whether an instrument is economically tied to an emerging market country as set forth above under “Foreign Securities.” In addition to the risks listed above under “Foreign Securities,” investing in Russia presents additional risks. In particular, investments in Russia are subject to the risk that the United States and/or other countries may impose economic sanctions, export or import controls, or other similar measures. Other similar measures may include, but are not limited to, banning or expanding bans on Russia or certain persons or entities associated with Russia from global payment systems that facilitate cross-border payments, restricting the settlement of securities transactions by certain investors, and freezing Russian assets or those of particular countries, entities or persons with ties to Russia (e.g., Belarus). Such sanctions or other similar measures – which may impact companies in many sectors, including energy, financial services, technology, accounting, quantum computing, shipping, aviation, metals and mining, and defense, among others – and Russia’s countermeasures may negatively impact the Fund’s performance and/or ability to achieve its investment objective. For example, certain investments in Russian companies or instruments tied to Russian companies may be prohibited and/or existing investments may become illiquid (e.g., in the event that transacting in certain existing investments is prohibited, securities markets close, or market participants cease transacting in certain investments in light of geopolitical events, sanctions or related considerations), which could render any such securities held by a Fund unmarketable for an indefinite period of time and/or cause the Fund to sell other fund holdings at a disadvantageous time or price in order to meet shareholder redemptions. It is also possible that such sanctions, export and import controls, or similar measures may prevent U.S.-based entities that provide services to the Fund from transacting with Russian or Belarusian entities. Under such circumstances, the Fund may not receive payments due with respect to certain investments, such as the payments due in connection with the Fund’s holding of a fixed income security. In addition, such sanctions and other similar measures, and the Russian government’s response, could result in a downgrade of Russia’s credit rating or of securities of issuers located in or economically tied to Russia, devaluation of Russia’s currency and/or increased volatility with respect to Russian securities and the ruble. More generally, investments in Russian securities are highly speculative and involve significant risks and special considerations not typically associated with investments in the securities markets of the U.S. and most other developed countries. Over the past century, Russia has experienced political, social and economic turbulence and has endured decades of communist rule under which tens of millions of its citizens were collectivized into state agricultural and industrial enterprises. Since the collapse of the Soviet Union, Russia’s government has been faced with the daunting task of stabilizing its domestic economy, while transforming it into a modern and efficient structure able to compete in international markets and respond to the needs of its citizens. However, to date, many of the country’s economic reform initiatives have floundered. In this environment, there is always the risk that the nation’s government will abandon the current program of economic reform and replace it with radically different political and economic policies that would be detrimental to the interests of foreign investors, a risk that has been at least partially realized in connection with Russia’s countersanctions. Further changes could entail a return to a centrally planned economy and nationalization of private enterprises similar to what existed under the old Soviet Union.
Russia has attempted, and may attempt in the future, to assert its influence in the region surrounding it through economic or military measures. For example, in February 2022, Russia launched a large-scale invasion of Ukraine and has been the subject of economic sanctions and import and export controls imposed by countries throughout the world, including the United States. Such measures have had and may continue to have an adverse effect on the Russian, Belarusian and Ukrainian economies, which may, in turn, negatively impact the Fund. Moreover, disruptions caused by Russian military action or other actions (including cyberattacks, espionage or other asymmetric measures) or resulting actual or threatened responses to such activity may impact Russia’s economy and Russian and other issuers of securities in which the Fund is invested. Such resulting actual or threatened responses may include, but are not limited to, purchasing and financing restrictions, withdrawal of financial intermediaries, boycotts or changes in consumer or
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purchaser preferences, sanctions, export or import controls, tariffs or cyberattacks on the Russian government, Russian companies or Russian individuals, including politicians. Any actions by Russia made in response to such sanctions or retaliatory measures could further impair the value and liquidity of Fund investments. Sanctions and other similar measures have resulted in defaults on debt obligations by certain corporate issuers and the Russian Federation that could lead to cross-defaults or cross-accelerations on other obligations of these issuers.
Poor accounting standards, inept management, pervasive corruption, insider trading and crime, and inadequate regulatory protection for the rights of investors all pose a significant risk, particularly to foreign investors. In addition, there is the risk that the Russian tax system will not be reformed to prevent inconsistent, retroactive, and/or exorbitant taxation, or, in the alternative, the risk that a reformed tax system may result in the inconsistent and unpredictable enforcement of the new tax laws. Investments in Russia may be subject to the risk of nationalization or expropriation of assets. Regional armed conflict and its collateral economic and market effects may also pose risks for investments in Russia.
Compared to most national securities markets, the Russian securities market suffers from a variety of problems not encountered in more developed markets. There is little long-term historical data on the Russian securities market because it is relatively new and a substantial proportion of securities transactions in Russia are privately negotiated outside of stock exchanges. The inexperience of the Russian securities market and the limited volume of trading in securities in the market may make obtaining accurate prices on portfolio securities from independent sources more difficult than in more developed markets. Additionally, because of less stringent auditing and financial reporting standards than apply to U.S. companies, there may be little reliable corporate information available to investors. As a result, it may be difficult to assess the value or prospects of an investment in Russian companies. Securities of Russian companies also may experience greater price volatility than securities of U.S. companies. These issues can be magnified as a result of sanctions and other similar measures that may be imposed and the Russian government's response.
Because of the recent formation of the Russian securities market as well as the underdeveloped state of the banking and telecommunications systems, settlement, clearing and registration of securities transactions are subject to significant risks. Prior to the implementation of the National Settlement Depository (“NSD”), a recognized central securities depository, there was no central registration system for equity share registration in Russia and registration was carried out by either the issuers themselves or by registrars located throughout Russia. Title to Russian equities held through the NSD is now based on the records of the NSD and not the registrars. Although the implementation of the NSD has enhanced the efficiency and transparency of the Russian securities market, issues resulting in loss still can occur. In addition, sanctions by the European Union against the NSD, as well as the potential for sanctions by other governments, could make it more difficult to conduct or confirm transactions involving Russian securities. Ownership of securities issued by Russian companies that are not held through depositories such as the NSD may be defined according to entries in the company’s share register and normally evidenced by extracts from the register or by formal share certificates. These services may be carried out by the companies themselves or by registrars located throughout Russia. In such cases, the risk is increased that the Fund could lose ownership rights through fraud, negligence, or even mere oversight. While the Fund will endeavor to ensure that its interest continues to be appropriately recorded either itself or through a custodian or other agent by inspecting the share register and by obtaining extracts of share registers through regular confirmations, these extracts have no legal enforceability and it is possible that subsequent illegal amendment or other fraudulent act may deprive the Fund of its ownership rights or improperly dilute its interests. In addition, while applicable Russian regulations impose liability on registrars for losses resulting from their errors, it may be difficult for the Fund to enforce any rights it may have against the registrar or issuer of the securities in the event of loss of share registration. Furthermore, significant delays or problems may occur in registering the transfer of securities, which could cause the Fund to incur losses due to a counterparty’s failure to pay for securities the Fund has delivered or the Fund’s inability to complete its contractual obligations because of theft or other reasons.
In addition, issuers and registrars are still prominent in the validation and approval of documentation requirements for corporate action processing in Russia. Because the documentation requirements and approval criteria vary between registrars and issuers, there remain unclear and inconsistent market standards in the Russian market with respect to the completion and submission of corporate action elections. In addition, sanctions or Russian countermeasures may prohibit or limit the Fund’s ability to participate in corporate actions, and therefore require the Fund to forego voting on or receiving funds that would otherwise be beneficial to the Fund. To the extent that the Fund suffers a loss relating to title or corporate actions relating to its portfolio securities, it may be difficult for the Fund to
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enforce its rights or otherwise remedy the loss. Russian securities laws may not recognize foreign nominee accounts held with a custodian bank, and therefore the custodian may be considered the ultimate owner of securities they hold for their clients. T also may experience difficulty in obtaining and/or enforcing judgments in Russia.
The Russian economy is heavily dependent upon the export of a range of commodities including most industrial metals, forestry products, oil, and gas. Accordingly, it is strongly affected by international commodity prices and is particularly vulnerable to any weakening in global demand for these products, and to sanctions or other actions that may be directed at the Russian economy as a whole or at Russian oil, natural gas, metals or timber industries.
Foreign investors also face a high degree of currency risk when investing in Russian securities and a lack of available currency hedging instruments. In addition, Russia has implemented certain capital controls on foreign portfolio investments and there is the risk that the Russian government will impose additional capital controls on foreign portfolio investments. Such capital controls may prevent the sale of a portfolio of foreign assets and the repatriation of investment income and capital.
Emerging Market Securities
The Fund may invest in securities that are economically tied to an emerging market country. PIMCO generally considers an instrument to be economically tied to an emerging market country if: the issuer is organized under the laws of an emerging market country; the currency of settlement of the security is a currency of an emerging market country; the security is guaranteed by the government of an emerging market country (or any political subdivision, agency, authority or instrumentality of such government); for an asset-backed or other collateralized security, the country in which the collateral backing the security is located is an emerging market country; or the security’s “country of exposure” is an emerging market country, as determined by the criteria set forth below.
With respect to derivative instruments, PIMCO generally considers such instruments to be economically tied to emerging market countries if the underlying assets are currencies of emerging market countries (or baskets or indexes of such currencies), or instruments or securities that are issued or guaranteed by governments of emerging market countries or by entities organized under the laws of emerging market countries or if an instrument’s “country of exposure” is an emerging market country. A security’s “country of exposure” is determined by PIMCO using certain factors provided by a third-party analytical service provider. The factors are applied in order such that the first factor to result in the assignment of a country determines the “country of exposure.” Both the factors and the order in which they are applied may change in the discretion of PIMCO. The current factors, listed in the order in which they are applied, are: (i) if an asset-backed or other collateralized security, the country in which the collateral backing the security is located, (ii) the “country of risk” of the issuer, (iii) if the security is guaranteed by the government of a country (or any political subdivision, agency, authority or instrumentality of such government), the country of the government or instrumentality providing the guarantee, (iv) the “country of risk” of the issuer’s ultimate parent, or (v) the country where the issuer is organized or incorporated under the laws thereof. “Country of risk” is a separate four-part test determined by the following factors, listed in order of importance: (i) management location, (ii) country of primary listing, (iii) sales or revenue attributable to the country, and (iv) reporting currency of the issuer. PIMCO has broad discretion to identify countries that it considers to qualify as emerging markets. In exercising such discretion, PIMCO identifies countries as emerging markets consistent with the strategic objectives of the Fund. For example, the Fund may consider a country to be an emerging market country based on a number of factors including, but not limited to, if the country is classified as an emerging or developing economy by any supranational organization such as the World Bank or the United Nations, or related entities, or if the country is considered an emerging market country for purposes of constructing emerging markets indices. In some cases, this approach may result in PIMCO identifying a particular country as an emerging market with respect to the Fund, that may not be identified as an emerging market with respect to other funds managed by PIMCO.
The risks of investing in non-U.S. securities are particularly high when the issuers are tied economically to countries with developing or “emerging market” economies. Countries with “emerging market” economies are those with securities markets that are, in the opinion of PIMCO, less sophisticated than more developed markets in terms of participation by investors, analyst coverage, liquidity and regulation. Investing in emerging market countries involves certain risks not typically associated with investing in U.S. securities, and imposes risks greater than, or in addition to, risks of investing in non-U.S., developed countries. These risks include: greater risks of nationalization or expropriation of assets or confiscatory taxation; currency devaluations and other currency exchange rate fluctuations; greater social, economic and political uncertainty and instability (including the risk of war); more substantial
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government involvement in the economy; less government supervision and regulation of the securities markets and participants in those markets; controls on foreign investment and limitations on repatriation of invested capital and on the Fund’s ability to exchange local currencies for U.S. dollars; unavailability of currency hedging techniques in certain emerging market countries; the fact that companies in emerging market countries may be smaller, less seasoned and newly organized companies; the difference in, or lack of, auditing and financial reporting standards, which may result in unavailability of material information about issuers; the risk that it may be more difficult to obtain and/or enforce a judgment in a court outside the United States; the imposition of sanctions or other similar measures; and greater price volatility, substantially less liquidity and significantly smaller market capitalization of securities markets. In addition, a number of emerging market countries restrict, to various degrees, foreign investment in securities, and high rates of inflation and rapid fluctuations in inflation rates have had, and may continue to have, negative effects on the economies and securities markets of certain emerging market countries. Also, any change in the leadership or politics of emerging market countries, or the countries that exercise a significant influence over those countries, may halt the expansion of or reverse the liberalization of foreign investment policies now occurring and adversely affect existing investment opportunities.
Emerging market countries typically have less established legal, accounting and financial reporting systems than those in more developed markets, which may reduce the scope or quality of financial information available to investors. Governments in emerging market countries are often less stable and more likely to take extra-legal action with respect to companies, industries, assets, or foreign ownership than those in more developed markets. Moreover, it can be more difficult for investors to bring litigation or enforce judgments against issuers in emerging markets or for U.S. regulators to bring enforcement actions against such issuers.
Nationalization, expropriation or confiscatory taxation, currency blockage, political changes or diplomatic developments, including the imposition of sanctions or other similar measures, could adversely affect the Fund’s investments in a foreign country. In the event of nationalization, expropriation or other confiscation, the Fund could lose its entire investment in that country. Adverse conditions in a certain region can adversely affect securities of other countries whose economies appear to be unrelated. To the extent the Fund invests in emerging market securities that are economically tied to a particular region, country or group of countries, the Fund may be more sensitive to adverse political or social events affecting that region, country or group of countries. Economic, business, political, or social instability may affect emerging market securities differently, and often more severely, than developed market securities
The Fund may also invest in Brady Bonds. Brady Bonds are securities created through the exchange of existing commercial bank loans to sovereign entities for new obligations in connection with debt restructurings under a debt restructuring plan introduced by former U.S. Secretary of the Treasury, Nicholas F. Brady (the “Brady Plan”). Brady Plan debt restructurings have been implemented in a number of countries, including: Argentina, Bolivia, Brazil, Bulgaria, Costa Rica, the Dominican Republic, Ecuador, Jordan, Mexico, Niger, Nigeria, Panama, Peru, the Philippines, Poland, Uruguay, and Venezuela. Beginning in the early 2000s, certain countries began retiring their Brady Bonds, including Brazil, Colombia, Mexico, the Philippines and Venezuela.
Brady Bonds may be collateralized or uncollateralized, are issued in various currencies (primarily the U.S. dollar) and are actively traded in the OTC secondary market. Brady Bonds are not considered to be U.S. government securities. U.S. dollar-denominated, collateralized Brady Bonds, which may be fixed rate par bonds or floating rate discount bonds, are generally collateralized in full as to principal by U.S. Treasury zero coupon bonds having the same maturity as the Brady Bonds. Interest payments on these Brady Bonds generally are collateralized on a one-year or longer rolling-forward basis by cash or securities in an amount that, in the case of fixed rate bonds, is equal to at least one year of interest payments or, in the case of floating rate bonds, initially is equal to at least one year’s interest payments based on the applicable interest rate at that time and is adjusted at regular intervals thereafter. Certain Brady Bonds are entitled to “value recovery payments” in certain circumstances, which in effect constitute supplemental interest payments but generally are not collateralized. Brady Bonds are often viewed as having three or four valuation components: (i) the collateralized repayment of principal at final maturity; (ii) the collateralized interest payments; (iii) the uncollateralized interest payments; and (iv) any uncollateralized repayment of principal at maturity (these uncollateralized amounts constitute the “residual risk”).
Brady Bonds involve various risk factors including residual risk and the history of defaults with respect to commercial bank loans by public and private entities of countries issuing Brady Bonds. There can be no assurance that Brady Bonds in which the Fund may invest will not be subject to restructuring arrangements or to requests for new credit, which may cause the Fund to suffer a loss of interest or principal on any of its holdings.
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Foreign Currency Transactions
The Fund may purchase and sell foreign currency options and foreign currency futures contracts and related options (see “Derivative Instruments”), and may engage in foreign currency transactions either on a spot (cash) basis at the rate prevailing in the currency exchange market at the time or through forward currency contracts (“forwards”). The Fund may engage in these transactions in order to attempt to protect against uncertainty in the level of future foreign exchange rates in the purchase and sale of securities. The Fund also may also use foreign currency options, foreign currency forward contracts, foreign currency futures and foreign currency spot transactions to increase exposure to a foreign currency or to shift exposure to foreign currency fluctuations from one currency to another. Since some foreign exchange transactions for the Fund are directed to the Fund’s custodian for execution, execution of such transactions may be better or worse than comparable transactions effected by other intermediaries.
A forward involves an obligation to purchase or sell a certain amount of a specific currency at a future date, which may be three business days or more from the date of the contract agreed upon by the parties, at a price set at the time of the contract. These contracts may be bought or sold to protect the Fund against a possible loss resulting from an adverse change in the relationship between foreign currencies and the U.S. dollar or to increase exposure to a particular foreign currency. Although, when used for hedging, forwards are intended to minimize the risk of loss due to a decline in the value of the hedged currencies, at the same time, they tend to limit any potential gain which might result should the value of such currencies increase. Forwards are subject to the risks discussed under “Derivative Instruments” below. Forwards are used primarily to adjust the foreign exchange exposure of the Fund with a view to protecting the outlook, and the Fund might be expected to enter into such contracts under the following circumstances:
Lock In. When PIMCO desires to lock in the U.S. dollar price on the purchase or sale of a security denominated in a foreign currency.
Cross Hedge. If a particular currency is expected to decrease against another currency, the Fund may sell the currency expected to decrease and purchase a currency which is expected to increase against the currency sold in an amount approximately equal to some or all of the Fund’s portfolio holdings denominated in the currency sold.
Direct Hedge. If PIMCO wants to eliminate substantially all of the risk of owning a particular currency, and/or if PIMCO thinks that the Fund can benefit from price appreciation in a given country’s bonds but does not want to hold the currency, it may employ a direct hedge back into the U.S. dollar. In either case, the Fund would enter into a forward contract to sell the currency in which a portfolio security is denominated and purchase U.S. dollars at an exchange rate established at the time it initiated the contract. The cost of the direct hedge transaction may offset most, if not all, of the yield advantage offered by the foreign security, but the Fund would hope to benefit from an increase (if any) in the value of the bond.
Proxy Hedge. The Fund might choose to use a proxy hedge, which may be less costly than a direct hedge. In this case, the Fund, having purchased a security, will sell a currency whose value is believed to be closely linked to the currency in which the security is denominated. Interest rates prevailing in the country whose currency was sold would be expected to be closer to those in the United States and lower than those of securities denominated in the currency of the original holding. This type of hedging entails greater risk than a direct hedge because it is dependent on a stable relationship between the two currencies paired as proxies and the relationships can be very unstable at times.
Costs of Hedging. When the Fund purchases a foreign (non-U.S.) bond with a higher interest rate than is available on U.S. bonds of a similar maturity, the additional yield on the foreign (non-U.S.) bond could be substantially reduced or lost if the Fund were to enter into a direct hedge by selling the foreign currency and purchasing the U.S. dollar. This is what is known as the “cost” of hedging. Proxy hedging attempts to reduce this cost through an indirect hedge back to the U.S. dollar.
It is important to note that hedging costs are treated as capital transactions and are not, therefore, deducted from the Fund’s dividend distribution and are not reflected in its yield. Instead such costs will, over time, be reflected in the Fund’s net asset value per share.
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The Fund may enter into foreign currency transactions as a substitute for cash investments and for other investment purposes not involving hedging, including, without limitation, to exchange payments received in a foreign currency into U.S. dollars or in anticipation of settling a transaction that requires the Fund to deliver a foreign currency.
The forecasting of currency market movement is extremely difficult, and whether any hedging strategy will be successful is highly uncertain. Moreover, it is impossible to forecast with precision the market value of portfolio securities at the expiration of a foreign currency forward contract. Accordingly, the Fund may be required to buy or sell additional currency on the spot market (and bear the expense of such transaction) if PIMCO’s predictions regarding the movement of foreign currency or securities markets prove inaccurate. Also, foreign currency transactions, like currency exchange rates, can be affected unpredictably by intervention (or the failure to intervene) by U.S. or foreign governments or central banks, or by currency controls or political developments. Such events may prevent or restrict the Fund’s ability to enter into foreign currency transactions, force the Fund to exit a foreign currency transaction at a disadvantageous time or price or result in penalties for the Fund, any of which may result in a loss to the Fund. In addition, the use of cross-hedging transactions may involve special risks, and may leave the Fund in a less advantageous position than if such a hedge had not been established. Because foreign currency forward contracts are privately negotiated transactions, there can be no assurance that the Fund will have the flexibility to roll-over a foreign currency forward contract upon its expiration if it desires to do so. Additionally, there can be no assurance that the other party to the contract will perform its services thereunder. Under definitions adopted by the Commodity Futures Trading Commission (“CFTC”) and the Securities and Exchange Commission (“SEC”), many non-deliverable foreign currency forwards are considered swaps for certain purposes, including the determination of whether such instruments need to be exchange-traded and centrally cleared as discussed further in “Risks of Potential Government Regulation of Derivatives” and “Additional Risk Factors in Cleared Derivatives Transactions.” These changes are expected to reduce counterparty risk as compared to bi-laterally negotiated contracts.
The Fund may hold a portion of its assets in bank deposits denominated in foreign currencies, so as to facilitate investment in foreign securities as well as to protect against currency fluctuations and the need to convert such assets into U.S. dollars (thereby also reducing transaction costs). To the extent these monies are converted back into U.S. dollars, the value of the assets so maintained will be affected favorably or unfavorably by changes in foreign currency exchange rates and exchange control regulations.
Tax Consequences of Hedging. Under applicable tax law, the Fund may be required to limit its gains from hedging in foreign currency forwards, futures, and options. Although the Fund is expected to comply with such limits, the extent to which these limits apply is subject to tax regulations as yet unissued. Hedging also may result in the application of the mark-to-market and straddle provisions of the Code. Those provisions could result in an increase (or decrease) in the amount of taxable dividends paid by the Fund and could affect whether dividends paid by the Fund are classified as capital gains or ordinary income.
Foreign Currency Exchange-Related Securities
Foreign Currency Warrants. Foreign currency warrants such as Currency Exchange Warrants™ are warrants which entitle the holder to receive from their issuer an amount of cash (generally, for warrants issued in the United States, in U.S. dollars) which is calculated pursuant to a predetermined formula and based on the exchange rate between a specified foreign currency and the U.S. dollar as of the exercise date of the warrant. Foreign currency warrants generally are exercisable upon their issuance and expire as of a specified date and time. Foreign currency warrants have been issued in connection with U.S. dollar-denominated debt offerings by major corporate issuers in an attempt to reduce the foreign currency exchange risk which, from the point of view of prospective purchasers of the securities, is inherent in the international fixed-income marketplace. Foreign currency warrants may attempt to reduce the foreign exchange risk assumed by purchasers of a security by, for example, providing for a supplemental payment in the event that the U.S. dollar depreciates against the value of a major foreign currency such as the Japanese yen or the euro. The formula used to determine the amount payable upon exercise of a foreign currency warrant may make the warrant worthless unless the applicable foreign currency exchange rate moves in a particular direction (e.g., unless the U.S. dollar appreciates or depreciates against the particular foreign currency to which the warrant is linked or indexed). Foreign currency warrants are severable from the debt obligations with which they may be offered, and may be listed on exchanges. Foreign currency warrants may be exercisable only in certain minimum amounts, and an investor wishing to exercise warrants who possesses less than the minimum number required for exercise may be required either to sell the warrants or to purchase additional warrants, thereby incurring additional transaction costs. In
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the case of any exercise of warrants, there may be a time delay between the time a holder of warrants gives instructions to exercise and the time the exchange rate relating to exercise is determined, during which time the exchange rate could change significantly, thereby affecting both the market and cash settlement values of the warrants being exercised. The expiration date of the warrants may be accelerated if the warrants should be delisted from an exchange or if their trading should be suspended permanently, which would result in the loss of any remaining “time value” of the warrants (i.e., the difference between the current market value and the exercise value of the warrants), and, in the case the warrants were “out-of-the-money,” in a total loss of the purchase price of the warrants. Warrants are generally unsecured obligations of their issuers and are not standardized foreign currency options issued by the Options Clearing Corporation (“OCC”). Unlike foreign currency options issued by OCC, the terms of foreign exchange warrants generally will not be amended in the event of governmental or regulatory actions affecting exchange rates or in the event of the imposition of other regulatory controls affecting the international currency markets. The initial public offering price of foreign currency warrants is generally considerably in excess of the price that a commercial user of foreign currencies might pay in the interbank market for a comparable option involving significantly larger amounts of foreign currencies. Foreign currency warrants are subject to significant foreign exchange risk, including risks arising from complex political or economic factors.
Principal Exchange Rate Linked Securities. Principal exchange rate linked securities (“PERLs”) are debt obligations the principal on which is payable at maturity in an amount that may vary based on the exchange rate between the U.S. dollar and a particular foreign currency at or about that time. The return on “standard” PERLs is enhanced if the foreign currency to which the security is linked appreciates against the U.S. dollar, and is adversely affected by increases in the foreign exchange value of the U.S. dollar; “reverse” PERLs are like “standard” securities, except that their return is enhanced by increases in the value of the U.S. dollar and adversely impacted by increases in the value of foreign currency. Interest payments on the securities are generally made in U.S. dollars at rates that reflect the degree of foreign currency risk assumed or given up by the purchaser of the notes (i.e., at relatively higher interest rates if the purchaser has assumed some of the foreign exchange risk, or relatively lower interest rates if the issuer has assumed some of the foreign exchange risk, based on the expectations of the current market). PERLs may in limited cases be subject to acceleration of maturity (generally, not without the consent of the holders of the securities), which may have an adverse impact on the value of the principal payment to be made at maturity.
Performance Indexed Paper. Performance indexed paper (“PIPs”) is U.S. dollar-denominated commercial paper the yield of which is linked to certain foreign exchange rate movements. The yield to the investor on “PIPs” is established at maturity as a function of spot exchange rates between the U.S. dollar and a designated currency as of or about that time (generally, the index maturity two days prior to maturity). The yield to the investor will be within a range stipulated at the time of purchase of the obligation, generally with a guaranteed minimum rate of return that is below, and a potential maximum rate of return that is above, market yields on U.S. dollar-denominated commercial paper, with both the minimum and maximum rates of return on the investment corresponding to the minimum and maximum values of the spot exchange rate two business days prior to maturity.
U.S. Government Securities
U.S. Government securities are obligations of, and, in certain cases, guaranteed by, the U.S. Government, its agencies or instrumentalities. The U.S. Government does not guarantee the net asset value of the Fund’s shares. U.S. Government securities are subject to market and interest rate risk, and may be subject to varying degrees of credit risk. Forward contracts that are not required to “cash settle” may be treated as such for asset segregation or “earmarking” purposes when the Fund has entered into a contractual arrangement with its counterparty to require the trade to be closed out prior to any potential settlement date involving a delivery obligation. Some U.S. Government securities, such as Treasury bills, notes and bonds, and securities guaranteed by GNMA, are supported by the full faith and credit of the United States; others, such as those of the Federal Home Loan Banks, are supported by the right of the issuer to borrow from the U.S. Treasury; others, such as those of the FNMA, are supported by the discretionary authority of the U.S. Government to purchase the agency’s obligations; and still others, such as securities issued by members of the Farm Credit System, are supported only by the credit of the agency, instrumentality or corporation. U.S. Government securities may include zero coupon securities, which do not distribute interest on a current basis and tend to be subject to greater risk than interest-paying securities of similar maturities.
Securities issued by U.S. Government agencies or GSEs may not be guaranteed by the U.S. Treasury. GNMA, a wholly owned U.S. Government corporation, is authorized to guarantee, with the full faith and credit of the U.S. Government, the timely payment of principal and interest on securities issued by institutions approved by GNMA and backed by pools of mortgages insured by the FHA or guaranteed by the VA. Government-related guarantors (i.e.,
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not backed by the full faith and credit of the U.S. Government) include the FNMA and the FHLMC. Pass-through securities issued by FNMA are guaranteed as to timely payment of principal and interest by FNMA but are not backed by the full faith and credit of the U.S. Government. FHLMC guarantees the timely payment of interest and ultimate collection of principal, but its PCs are not backed by the full faith and credit of the U.S. Government.
U.S. Government securities include securities that have no coupons, or have been stripped of their unmatured interest coupons, individual interest coupons from such securities that trade separately, and evidence of receipt of such securities. Such securities may pay no cash income, and are purchased at a deep discount from their value at maturity. Because interest on zero coupon securities is not distributed on a current basis but is, in effect, compounded, zero coupon securities tend to be subject to greater risk than interest-paying securities of similar maturities. Custodial receipts issued in connection with so-called trademark zero coupon securities, such as Certificate of Accrual on Treasury Securities (“CATs”) and treasury investment growth receipts (“TIGRs”), are not issued by the U.S. Treasury, and are therefore not U.S. Government securities, although the underlying bond represented by such receipt is a debt obligation of the U.S. Treasury. Other zero coupon Treasury securities (e.g., Separate trading of registered interest and principal of securities (“STRIPs”) and coupons under book-entry safekeeping (“CUBEs”)) are direct obligations of the U.S. Government.
Municipal Securities
The Fund will invest, under normal circumstances, at least 80% of its net assets (plus any borrowings for investment purposes) in a portfolio of municipal bonds and other municipal securities, the interest from which, in the opinion of bond counsel for the issuer at the time of issuance (or on the basis of other authority believed by PIMCO to be reliable), is exempt from federal and California income tax (i.e., excluded from gross income for income tax purposes but not necessarily exempt from the alternative minimum tax or from the income taxes of any other state or of a local government) (the “80% policy”). California municipal bonds generally are issued by or on behalf of the State of California and its political subdivisions, financing authorities and their agencies. Within the 80% policy, the Fund may invest in debt securities of an issuer located outside of California whose interest is, in the opinion of bond counsel for the issuer at the time of issuance, exempt from federal and California income tax. By concentrating its investments in California municipal securities, the Fund will be subject to California State-Specific Risk, among other risks. The Fund’s 80% policy is a fundamental policy, which may not be changed without the approval of the holders of a majority of the Fund’s outstanding Common Shares and Preferred Shares (as defined below) voting together as a single class, and of the holders of a majority of the outstanding Preferred Shares voting as a separate class.
Municipal securities include debt obligations issued by governmental entities to obtain funds for various public purposes, including the construction of a wide range of public facilities, the refunding of outstanding obligations, the payment of general operating expenses, and the extension of loans to public institutions and facilities. Municipal securities can be classified into two principal categories, including “general obligation” bonds and other securities and “revenue” bonds and other securities. General obligation bonds are secured by the issuer’s full faith, credit and taxing power for the payment of principal and interest. Revenue securities 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 tax or other specific revenue source, such as the user of the facility being financed. Municipal securities also may include “moral obligation” securities, which normally are issued by special purpose public authorities. If the issuer of moral obligation securities is unable to meet its debt service obligations from current revenues, it may draw on a reserve fund, the restoration of which is a moral commitment but not a legal obligation of the governmental entity that created the special purpose public authority. Municipal securities may be structured as fixed-, variable- or floating-rate obligations or as zero-coupon, PIKs and step-coupon securities and may be privately placed or publicly offered.
Municipal securities may include municipal bonds, municipal notes and municipal leases. Municipal bonds are debt obligations of a governmental entity that obligate the municipality to pay the holder a specified sum of money at specified intervals and to repay the principal amount of the loan at maturity.
The Fund may invest in instruments, or participations in instruments, issued in connection with lease obligations or installment purchase contract obligations of municipalities (“municipal lease obligations”). Although municipal lease obligations do not constitute general obligations of the issuing municipality, a lease obligation may be backed by the municipality’s covenant to budget for, appropriate funds for and make the payments due under the lease obligation. However, certain municipal lease obligations contain “non-appropriation” clauses, which provide that the municipality has no obligation to make lease or installment purchase payments in future years unless money is appropriated for such
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purpose in the relevant years. In deciding whether to purchase a lease obligation for the Fund, PIMCO will generally 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. Municipal lease obligations may be less readily marketable than other municipal securities.
Projects financed with certificates of participation generally are not subject to state constitutional debt limitations or other statutory requirements that may apply to other municipal securities. Payments by the public entity on the obligation underlying the certificates are derived from available revenue sources. That revenue might be diverted to the funding of other municipal service projects. Payments of interest and/or principal with respect to the certificates are not guaranteed and do not constitute an obligation of a state or any of its political subdivisions.
Municipal leases may also be subject to “abatement risk.” The leases underlying certain municipal lease obligations may state that lease payments are subject to partial or full abatement. That abatement might occur, for example, if material damage to or destruction of the leased property interferes with the lessee’s use of the property. However, in some cases that risk might be reduced by insurance covering the leased property, or by the use of credit enhancements such as letters of credit to back lease payments, or perhaps by the lessee’s maintenance of reserve monies for lease payments. While the obligation might be secured by the lease, it might be difficult to dispose of that property in case of a default.
Municipal notes may be issued by governmental entities and other tax-exempt issuers in order to finance short-term cash needs or, occasionally, to finance construction. Most municipal notes are general obligations of the issuing entity payable from taxes or designated revenues expected to be received within the relevant fiscal period. Municipal notes generally have maturities of one year or less. Municipal notes can be subdivided into two sub-categories: (i) municipal commercial paper and (ii) municipal demand obligations. Municipal commercial paper typically consists of very short-term unsecured negotiable promissory notes that are sold, for example, to meet seasonal working capital or interim construction financing needs of a governmental entity or agency. While these obligations are intended to be paid from general revenues or refinanced with long-term debt, they frequently are backed by letters of credit, lending agreements, note repurchase agreements or other credit facility agreements offered by banks or institutions.
Municipal demand obligations can be subdivided into two general types: variable rate demand notes and master demand obligations. Variable rate demand notes are tax-exempt municipal obligations or participation interests that provide for a periodic adjustment in the interest rate paid on the notes. They permit the holder to demand payment of the notes, or to demand purchase of the notes at a purchase price equal to the unpaid principal balance, plus accrued interest either directly by the issuer or by drawing on a bank letter of credit or guaranty issued with respect to such note. The issuer of the municipal obligation may have a corresponding right to prepay at its discretion the outstanding principal of the note plus accrued interest upon notice comparable to that required for the holder to demand payment. The variable rate demand notes in which the Fund may invest are payable, or are subject to purchase, on demand usually on notice of seven calendar days or less. The terms of the notes generally provide that interest rates are adjustable at intervals ranging from daily to six months.
Master demand obligations are tax-exempt municipal obligations that provide for a periodic adjustment in the interest rate paid and permit daily changes in the amount borrowed. The interest on such obligations is, in the opinion of counsel for the borrower, excluded from gross income for federal income tax purposes (but not necessarily for AMT purposes). Although there is no secondary market for master demand obligations, such obligations are considered by the Fund to be liquid because they are payable upon demand.
Investing in municipal securities is subject to certain risks. There are variations in the quality of municipal securities, both within a particular classification and between classifications, and the rates of return on municipal securities can depend 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. The ratings of NRSROs represent their opinions as to the quality of municipal securities. It should be emphasized, however, that these ratings are general and are not absolute standards of quality, and municipal securities with the same maturity, interest rate, and rating may have different rates of return while municipal securities of the same maturity and interest rate with different ratings may have the same rate of return.
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The payment of principal and interest on most municipal securities purchased by the Fund will depend upon the ability of the issuers to meet their obligations. An issuer’s obligations under its municipal securities are subject to the provisions of bankruptcy, insolvency, and other laws affecting the rights and remedies of creditors, such as the United States Bankruptcy Code. The power or ability of an issuer to meet its obligations for the payment of interest on and principal of its municipal securities may be materially adversely affected by litigation or other conditions.
There are particular considerations and risks relevant to investing in a portfolio of a single state’s municipal securities, such as the greater risk of the concentration of portfolio holdings. Each state’s municipal securities may include, in addition to securities issued by the relevant state and its political subdivisions, agencies, authorities and instrumentalities, securities issued by the governments of Guam, Puerto Rico or the U.S. Virgin Islands. These securities may be subject to different risks than municipal securities issued by the relevant state and its political subdivisions, agencies, authorities and instrumentalities.
The Fund ordinarily purchases municipal securities whose interest, in the opinion of bond counsel, is excluded from gross income for federal income tax purposes and California income taxes. The opinion of bond counsel may assert that such interest is not an item of tax preference for the purposes of the AMT or is exempt from certain other state or local taxes. There is no assurance that the applicable taxing authority will agree with this opinion. In the event, for example, the IRS determines that an issuer does not comply with relevant tax requirements, interest payments from a security could become federally taxable, possibly retroactively to the date the security was issued. As a shareholder of the Fund, you may be required to file an amended tax return as a result, reporting such income as taxable.
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. Specifically, California and New York municipal bonds generally are issued by or on behalf of the State of California and New York, respectively, and their political subdivisions and financing authorities, and local governments. 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 or annual revenues. Limited obligation bonds are payable only from the revenues derived from a particular facility or class of facilities or, in some cases, from the proceeds of a special excise or other specific revenue source. Tax-exempt private activity bonds and industrial development bonds generally are also revenue bonds and thus are not payable from the issuer’s general revenues. The credit and quality of private activity bonds and industrial development bonds are usually related to the credit of the 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 does not expect to be eligible to pass through to shareholders the tax-exempt character of interest earned on municipal bonds. The Fund may be more sensitive to adverse economic, business or political developments if it invests a substantial portion of its assets in industrial development bonds.
The Fund may invest in pre-refunded municipal bonds. Pre-refunded municipal bonds are tax-exempt bonds that have been refunded to a call date prior to the final maturity of principal, or, in the case of pre-refunded municipal bonds commonly referred to as “escrowed-to-maturity bonds,” to the final maturity of principal, and remain outstanding in the municipal market. The payment of principal and interest of the pre-refunded municipal bonds held by the Fund is funded from securities in a designated escrow account that holds U.S. Treasury securities or other obligations of the U.S. Government (including its agencies and instrumentalities (“Agency Securities”)). As the payment of principal and interest is generated from securities held in an escrow account established by the municipality and an independent escrow agent, the pledge of the municipality has been fulfilled and the original pledge of revenue by the municipality is no longer in place. Pre-refunded and/or escrowed to maturity municipal bonds may bear an investment grade rating (for example, if re-rated by a rating service or, if not re-rated, determined by PIMCO to be of comparable quality) because they are backed by U.S. Treasury securities, Agency Securities or other investment grade securities. For the avoidance of any doubt, PIMCO’s determination of an issue’s credit rating will generally be used for compliance with the Fund’s investment parameters when an issue either loses its rating or is not re-rated upon pre-refunding. The escrow account securities pledged to pay the principal and interest of the pre-refunded municipal bond do not guarantee the price movement of the bond before maturity. Issuers of municipal bonds refund in advance of maturity the outstanding higher cost debt and issue new, lower cost debt, placing the proceeds of the lower cost issuance into an escrow account to pre-refund the older, higher cost debt. Investments in pre-refunded municipal bonds held by the Fund may subject the Fund to interest rate risk, market risk and credit risk.
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In addition, while a secondary market exists for pre-refunded municipal bonds, if the Fund sells pre-refunded municipal bonds prior to maturity, the price received may be more or less than the original cost, depending on market conditions at the time of sale. To the extent permitted by the SEC and the IRS, the Fund’s investment in pre-refunded municipal bonds backed by U.S. Treasury and Agency securities in the manner described above, will, for purposes of diversification tests applicable to the Fund, be considered an investment in the respective U.S. Treasury and Agency securities.
Under the Code, certain limited obligation bonds are considered “private activity bonds” and interest paid on such bonds is treated as an item of tax preference for purposes of calculating federal AMT liability.
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.
The Fund may invest in taxable municipal bonds, such as Build America Bonds. Build America Bonds are tax credit bonds created by the American Recovery and Reinvestment Act of 2009, which authorizes state and local governments to issue Build America Bonds as taxable bonds in 2009 and 2010, without volume limitations, to finance any capital expenditures for which such issuers could otherwise issue traditional tax-exempt bonds. State and local governments may receive a direct federal subsidy payment for a portion of their borrowing costs on Build America Bonds equal to 35% of the total coupon interest paid to investors (or 45% in the case of Recovery Zone Economic Development Bonds). The state or local government issuer can elect to either take the federal subsidy or pass the 35% tax credit along to bondholders. The Fund’s investments in Build America Bonds or similar taxable municipal bonds will result in taxable income and the Fund may elect to pass through to holders of the Fund’s Common Shares (“Common Shareholders”) any corresponding tax credits. Such tax credits can generally be used to offset federal income taxes and the AMT, but such credits are generally not refundable. Build America Bonds or similar taxable municipal bonds involve similar risks as tax-exempt municipal bonds, including credit and market risk. They are intended to assist state and local governments in financing capital projects at lower borrowing costs and are likely to attract a broader group of investors than tax-exempt municipal bonds. Although Build America Bonds were only authorized for issuance during 2009 and 2010, the program may have resulted in reduced issuance of tax-exempt municipal bonds during the same period.
The Build America Bond program expired on December 31, 2010, at which point no further issuance of new Build America Bonds was permitted. As of the date of this Statement of Additional Information, there is no indication that Congress will renew the program to permit issuance of new Build America Bonds.
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.
Certain Risks of Investing in Municipal Bonds. Economic downturns and budgetary constraints have made municipal bonds more susceptible to downgrade, default and bankruptcy. In addition, difficulties in the municipal bond markets could result in increased illiquidity, volatility and credit risk, and a decrease in the number of municipal bond investment opportunities. The value of municipal bonds may also be affected by uncertainties involving the taxation of municipal bonds or the rights of municipal bond holders in the event of a bankruptcy. Proposals to restrict or eliminate the federal income tax exemption for interest on municipal bonds are introduced before Congress from time to time. These legal uncertainties could affect the municipal bond market generally, certain specific segments of the market, or the relative credit quality of particular securities.
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
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PIMCO’s evaluation of the issuer or cash needs resulting from repurchase requests for the Fund’s shares. 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.
Additionally, municipal bonds rated below investment grade (i.e., high yield municipal bonds) may not be as liquid as higher-rated municipal bonds. Reduced liquidity in the secondary market may have an adverse impact on the market price of a municipal bond and on the Fund’s ability to sell a municipal bond in response to changes or anticipated changes in economic conditions or to meet the Fund’s cash needs. Reduced liquidity may also make it more difficult to obtain market quotations based on actual trades for purposes of valuing the Fund’s portfolio. For more information on high yield securities please see “High Yield Securities (“Junk Bonds”) and Securities of Distressed Companies” above.
Prices and yields on municipal bonds are dependent on a variety of factors, including general money-market conditions, the financial condition of the issuer, general conditions of the municipal bond market, the size of a particular offering, the maturity of the obligation and the rating of the issue. A number of these factors, including the ratings of particular issues, are subject to change from time to time. Information about the financial condition of an issuer of municipal bonds may not be as extensive as that which is made available by corporations whose securities are publicly traded.
The perceived increased likelihood of default among issuers of municipal bonds has resulted in constrained illiquidity, increased price volatility and credit downgrades of issuers of municipal bonds. Local and national market forces - such as declines in real estate prices and general business activity - may result in decreasing tax bases, fluctuations in interest rates, and increasing construction costs, all of which could reduce the ability of certain issuers of municipal bonds to repay their obligations. Certain issuers of municipal bonds have also been unable to obtain additional financing through, or must pay higher interest rates on, new issues, which may reduce revenues available for issuers of municipal bonds to pay existing obligations. In addition, events have demonstrated that the lack of disclosure rules in this area can make it difficult for investors to obtain reliable information on the obligations underlying municipal bonds. Adverse developments in the municipal bond market may negatively affect the value of all or a substantial portion of the Fund’s holdings in municipal bonds.
From time to time, proposals have been introduced before Congress for the purpose of restricting or eliminating the federal income tax exemption for interest on certain types of municipal bonds. Additionally, certain other proposals have been introduced that would have the effect of taxing a portion of exempt interest and/or reducing the tax benefits of receiving exempt interest. It can be expected that similar proposals may be introduced in the future. As a result of any such future legislation, the availability of such municipal bonds for investment by the Fund and the value of such municipal bonds held by the Fund may be affected. In addition, it is possible that events occurring after the date of a municipal bond’s issuance, or after the Fund’s acquisition of such obligation, may result in a determination that the interest paid on that obligation is taxable, in certain cases retroactively.
Obligations of issuers of municipal bonds are subject to the provisions of bankruptcy, insolvency and other laws 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.
In particular, to the extent that the Fund invests a significant portion of its assets in municipal bonds issued by California and New York issuers, the Fund may be subject to the risks inherent in concentrating investment in a particular state or region. The following summarizes information drawn from official statements, and other public documents available relating to issues potentially affecting securities offerings of issuers domiciled in the states of California and New York. Neither the Fund nor PIMCO have independently verified the information, but have no reason to believe that it is substantially different.
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California. To the extent the Fund invests in municipal bonds issued by California issuers, it may be particularly affected by political, economic, regulatory, social, environmental, or public health developments affecting the ability of California tax-exempt issuers to pay interest or repay principal.
Provisions of the California Constitution and State statutes that limit the taxing and spending authority of California governmental entities may impair the ability of California governmental issuers to maintain debt service on their obligations. Future California political and economic developments, constitutional amendments, legislative measures, executive orders, administrative regulations, litigation and voter initiatives as well as environmental events, natural disasters, pandemics, epidemics, or social unrest could have an adverse effect on the debt obligations of California issuers. The information set forth below constitutes only a brief summary of a number of complex factors that may impact issuers of California municipal bonds. The information is derived from sources that are generally available to investors, including information promulgated by the State’s Department of Finance, the State’s Treasurer’s Office, and the Legislative Analyst’s Office. The information is intended to give a recent historical description and is not intended to indicate future or continuing trends in the financial or other positions of California. Such information has not been independently verified by the Fund, and the Fund assumes no responsibility for the completeness or accuracy of such information. It should be noted that the financial strength of local California issuers and the creditworthiness of obligations issued by local California issuers are not directly related to the financial strength of the State or the creditworthiness of obligations issued by the State, and there is no obligation on the part of the State to make payment on such local obligations in the event of default.
Certain debt obligations held by the Fund may be obligations of issuers that rely in whole or in substantial part on California state government revenues for the continuance of their operations and payment of their obligations. Whether and to what extent the California Legislature will continue to appropriate a portion of the State’s General Fund to counties, cities and their various entities, which depend upon State government appropriations, is not entirely certain. To the extent local entities do not receive money from the State government to pay for their operations and services, their ability to pay debt service on obligations held by the Fund may be impaired.
Certain tax-exempt securities in which the Fund may invest may be obligations payable solely from the revenues of specific institutions, or may be secured by specific properties, which are subject to provisions of California law that could adversely affect the holders of such obligations. For example, the revenues of California health care institutions may be subject to state laws, and California law limits the remedies of a creditor secured by a mortgage or deed of trust on real property.
California’s economy, the largest state economy in the United States and one of the largest and most diverse in the world, has major components in high technology, trade, entertainment, manufacturing, government, tourism, construction and services, and may be sensitive to economic factors affecting those industries.
California’s fiscal health has improved since the severe recession ended in 2009, which caused large budget deficits. California’s General Fund budget has achieved structural balance for the last several fiscal years. In recent years, the State has paid off billions of dollars of budgetary borrowings, debts and deferrals that were accumulated to balance budgets during the most recent recession and years prior. However, California’s General Fund was adversely impacted by the health-related and economic impacts of the COVID-19 pandemic. Efforts to respond to and mitigate the spread of COVID-19 have had a negative impact on the California and national economies. Additionally, it is projected that California will face an operating deficit in fiscal year 2023-24 due to an anticipated reduction in revenues, and that the State will face operating deficits in each fiscal year through 2026-27.
To help address the public health and economic impact of COVID-19, the federal government passed the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), which provided for approximately $2.2 trillion in disaster relief. Among other things, the CARES Act established the Coronavirus Relief Fund, of which California received approximately $9.5 billion. In March 2021, the American Rescue Plan was signed into law, which provided an additional $350 billion in emergency funding for state, local, territorial, and Tribal governments. California was allocated approximately $27 billion in American Rescue Plan funding. In addition, in February 2021, the Governor signed an economic relief package totaling $7.6 billion into law, which was funded primarily by the State’s General Fund.
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A failure by California to meet its debt obligations could lead to a significant decline in the value, liquidity, and marketability of Fund investments. The current economic environment, including prolonged inflation and rising interest rates, also may negatively affect the economy of the State.
California’s economy is one of the largest in the world. The unemployment rate in California grew to a peak of 16.1% in April 2020, but had fallen to 4.1% as of December 2022. The State’s unemployment rate was above the national average of 3.5% in December 2022.
The budget for fiscal year 2022-2023 (“2022-23 Enacted Budget”) was enacted on June 27, 2022. The 2022-23 Enacted Budget projects General Fund revenues and transfers to be approximately $219.7 billion (a decrease of 3.2% compared with revised estimates for fiscal year 2021-22). Against these revenues and transfers, the 2022-23 Enacted Budget provides for General Fund expenditures of approximately $234.4 billion (an increase of 3.5% compared with revised estimates for fiscal year 2021-2022). The 2022-23 Enacted Budget projects that the State will begin fiscal year 2022-23 with a surplus of $22.5 billion.
The Governor released his proposed budget for fiscal year 2023-24 on January 10, 2023 (“2023-24 Governor’s Budget”). The 2023-24 Governor’s Budget projects that General Fund revenues and transfers will be $210.2 billion (an increase of 0.6% compared to revised estimates for fiscal year 2022-2023) and expenditures will be $223.6 billion (a decrease of 6.9% compared to revised estimates for fiscal year 2022-2023). The 2023-24 Governor’s Budget projects a $22.5 billion budget gap in fiscal year 2023-24. In response to the projected budget gap, the 2023-24 Governor’s Budget includes $13.6 billion in spending reductions, delays, and trigger restoration.
According to the Legislative Analyst’s Office (“LAO”), California’s nonpartisan fiscal and policy advisor, the State is projected to face operating deficits in fiscal years 2023-24, attributed in part to reduced revenues primarily as a result of declines in withholding and capital gains taxes, through 2026-27. The LAO notes that the deficit for fiscal year 2023-24 is manageable and, in light of its position that the State presently faces a heightened risk of recession, it generally agrees with the Governor’s proposed approach to manage the deficit primarily through spending-related solutions, including spending delays and reductions, instead of using the State’s reserves to close the deficit. However, the LAO notes that deficits in future years may be larger than those predicted in the Governor’s proposed budget and recommends that the legislature avoid enacting budgets that plan for future operating deficits. Specifically, the LAO recommends that the State legislature consider additional spending reductions to address the deficits.
Moody’s, S&P and Fitch assign ratings to California’s long-term general obligation bonds, which represent their opinions as to the quality of the municipal bonds they rate. As of March 31, 2023, California’s general obligation bonds were assigned ratings of Aa2, AA- and AA by Moody’s, S&P and Fitch, respectively. The ratings agencies continue to monitor the State’s budget deliberations closely to determine whether to alter the ratings. It should be recognized that these ratings are not an absolute standard of quality, but rather general indicators. Such ratings reflect only the view of the originating rating agencies, from which an explanation of the significance of such ratings may be obtained. There is no assurance that a particular rating will continue for any given period of time or that any such rating will not be revised downward or withdrawn entirely if, in the judgment of the agency establishing the rating, circumstances so warrant. A downward revision or withdrawal of such ratings, or either of them, may affect the market price of the State municipal obligations in which the Fund invests.
The State is a party to numerous legal proceedings, many of which normally occur in governmental operations and which, if decided against the State, might require the State to make significant future expenditures or impair future revenue sources. Constitutional and statutory amendments as well as budget developments may affect the ability of California issuers to pay interest and principal on their obligations. The overall effect may depend upon whether a particular California tax-exempt security is a general or limited obligation bond and on the type of security provided for the bond. It is possible that measures affecting the taxing or spending authority of California or its political subdivisions may be approved or enacted in the future.
Additionally, California is prone to natural disasters and climate events, including earthquakes, wildfires, mudslides, floods and droughts. Such events have, in the past, resulted in significant disruptions to the California economy and required substantial expenditures from the state government. California lies within an active geologic region that is subject to major seismic activity, which could result in increased frequency and severity of earthquakes. In the recent past, California has experienced prolonged droughts and wildfire activity. There can be no guarantee that future natural disasters and climate events will not have a significant detrimental effect on the State. The specific
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timing of natural disasters and climate events, and the severity of their impact on the State, is unpredictable and could be significant. The State is limited in its ability to mitigate the fiscal impact of natural disasters and climate events on the State budget, and there can be no assurance that current or any future measures will be effective.
New York. To the extent the Fund invests in municipal bonds issued by New York issuers, it may be particularly affected by political, economic or regulatory developments affecting the ability of New York tax-exempt issuers to pay interest or repay principal. Investors should be aware that certain issuers of New York tax-exempt securities have at times experienced serious financial difficulties. A reoccurrence of these difficulties may impair the ability of certain New York issuers to maintain debt service on their obligations. The following information provides only a brief summary of the complex factors affecting the financial situation in New York (as used in this section, the “State” or “New York”) and is derived from sources that are generally available to investors, including the New York State Division of the Budget and the New York City Office of Management and Budget. The information is intended to give a recent historical description and is not intended to indicate future or continuing trends in the financial or other positions of New York. Such information has not been independently verified by the Fund, and the Fund assumes no responsibility for the completeness or accuracy of such information. It should be noted that the creditworthiness of obligations issued by local New York issuers may be unrelated to the creditworthiness of obligations issued by New York City (as used in this section, the “City” or “New York City”) and State agencies, and that there is no obligation on the part of New York State to make payment on such local obligations in the event of default.
Relative to other states, New York has for many years imposed a very high state and local tax burden on residents. The burden of state and local taxation, in combination with the many other causes of regional economic dislocation, has contributed to the decisions of some businesses and individuals to relocate outside of, or not locate within, New York. The economic and financial condition of the State also may be affected by various financial, social, economic, environmental, political, and geopolitical factors as well as natural disasters, epidemics, pandemics, and social unrest. For example, the securities industry is more central to New York’s economy than to the national economy, therefore any significant decline in stock market performance could adversely affect the State’s income and employment levels. Furthermore, such financial, social, economic, environmental, political, and geopolitical factors can be very complex, may vary from year to year and can be the result of actions taken not only by the State and its agencies and instrumentalities, but also by entities, such as the Federal government, that are not under the control of the State.
The fiscal stability of New York is related to the fiscal stability of the State’s municipalities, its agencies and authorities (which generally finance, construct and operate revenue-producing public benefit facilities). This is due in part to the fact that agencies, authorities and local governments in financial trouble often seek State financial assistance. In the event that New York City or any of its agencies or authorities suffers serious financial difficulty, then the ability of the State, New York City, and the State’s political subdivisions, agencies and authorities to obtain financing in the public credit markets, and the market price of outstanding New York tax-exempt securities, may be adversely affected.
State actions affecting the level of receipts and disbursements, the relative strength of the State and regional economies and actions of the Federal government may create budget gaps for the State. Moreover, even an ostensibly balanced budget may still contain several financial risks. These risks include the impact of broad economic factors, additional spending needs, revenues that may not materialize and proposals to reduce spending or raise revenues that have been previously rejected by the Legislature. To address a potential imbalance in any given fiscal year, the State would be required to take actions to increase receipts and/or reduce disbursements as it enacts the budget for that year. Under the State Constitution, the Governor is required to propose a balanced budget each year. There can be no assurance, however, that the Legislature will enact such proposals or that the State’s actions will be sufficient to preserve budgetary balance in a given fiscal year or to align recurring receipts and disbursements in future fiscal years. The fiscal stability of the State is related to the fiscal stability of its public authorities. Authorities have various responsibilities, including those that finance, construct and/or operate revenue-producing public facilities. Authorities may issue bonds and notes within the amounts and restrictions set forth in their respective legislative authorization.
Authorities are generally supported by revenues generated by the projects financed or operated, such as tolls charged for use of highways, bridges or tunnels; charges for electric power, electric and gas utility services; rentals charged for housing units and charges for occupancy at medical care facilities. Since the State has no actual or contingent liability for the payment of this type of public authority indebtedness, it is not classified as either State-supported debt or State-related debt. Some authorities, however, receive monies from State appropriations to pay
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for the operating costs of certain programs. In addition, State legislation authorizes several financing techniques for authorities. Also, there are statutory arrangements providing for State local assistance payments otherwise payable to localities, to be made under certain circumstances directly to the authorities, in order to secure the payment of debt service on their revenue bonds and notes. Although the State has no obligation to provide additional assistance to localities whose local assistance payments have been paid to authorities under these arrangements, if local assistance payments are diverted the affected localities could seek additional State assistance.
Over the near and long term, New York and New York City may face economic problems. New York City accounts for a large portion of the State’s population and personal income, and New York City’s financial health affects the State in numerous ways. New York City continues to require significant financial assistance from the State and depends on State aid to both enable it to balance its budget and to meet its cash requirements. The State could also be affected by the ability of the City to market its securities successfully in the public credit markets.
New York was adversely impacted by the health-related and economic effects of the COVID-19 pandemic. Efforts to respond to and mitigate the spread of COVID-19 have had a negative impact on the New York and national economies and triggered volatility in the markets.
To help address the public health and economic impact of COVID-19, the federal government passed the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), which provided for approximately $2.2 trillion in disaster relief. Among other things, the CARES Act established the Coronavirus Relief Fund, of which New York received approximately $5.1 billion. In March 2021, the American Rescue Plan was signed into law, which provided an additional $350 billion in emergency funding for state, local, territorial, and Tribal governments. New York was allocated approximately $12.7 billion in American Rescue Plan funds. The rate and level at which the State and the federal government took on new debt could have a negative impact on their fiscal health, which could lead to prolonged challenges. A failure by New York to meet its debt obligations could lead to a significant decline in the value, liquidity, and marketability of Fund investments. The current economic environment, including prolonged inflation and rising interest rates, also may negatively affect the economy of the State.
The budget for fiscal year 2022-23 (“2022-23 Enacted Budget”) was adopted on April 9, 2022. The 2022-23 Enacted Budget forecasted total revenues of approximately $98.4 billion, which represents an increase of $2.0 billion from fiscal year 2021-22. The 2022-23 Enacted Budget projected personal income tax revenues of approximately $64.4 billion (an increase of $4.8 billion from fiscal year 2021-22), consumption and use tax revenues of approximately $16.0 billion (an increase of $1.6 billion from fiscal year 2021-22), and business tax receipts of approximately $9.8 billion (an increase of $1.3 billion from fiscal year 2021-22). Against these revenues, the 2022-23 Enacted Budget provides for approximately $96.1 billion in expenditures, which represents an increase of $7.2 billion from fiscal year 2021-22. State agency operations expenditures are also expected to total $21.7 billion, an increase of $934 million from fiscal year 2021-22. The 2022-23 Enacted Budget projects that the closing balance of the General Fund at the end of fiscal year 2022-23 will be approximately $25.3 billion, a decrease of $7.8 billion from fiscal year 2021-22.
In March 2023, the Governor submitted her amended proposed budget to the state legislature (“2023-24 Governor’s Budget”). The 2023-24 Governor’s Budget projects $103.7 billion in revenue, an annual increase of $3.4 billion from fiscal year 2022-23. These receipts are expected to consist of $66.7 billion in personal income tax revenues (a decrease of $3.4 billion from fiscal year 2022-23), $18.4 billion in consumption/use tax receipts (an increase of $1.2 billion from fiscal year 2022-23), and $8.8 billion in business tax revenue (a decrease of $1.4 billion from fiscal year 2022-23). Against these revenues, the 2023-24 Governor’s Budget calls for $106.9 billion in expenditures, an increase of $12.4 billion from fiscal year 2022-23.
New York is prone to natural disasters and climate events, including hurricanes. Such events have, in the past, resulted in significant disruptions to the New York economy and required substantial expenditures from the state government.
The State’s economy continues to face significant risks, including, but not limited to, the effects of: national and international events; climate change, extreme weather events and other natural disasters; pandemics; instability in the Eurozone and eastern Europe; major terrorist events; hostilities or war; social unrest; changes in international trade policies, consumer confidence, oil supplies and oil prices; cyber security attacks; Federal statutory and regulatory
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changes concerning financial sector activities; changes concerning financial sector bonus payouts; and shifts in monetary policy affecting interest rates and the financial markets.
New York’s unemployment rate reached its peak of 16.5% in May 2020 but had fallen to 4.1% as of December 2022. The State’s unemployment rate was above the national average of 3.5% in December 2022.
New York City is the largest city in the U.S., and has a complex, varied and aging infrastructure. The City has more school buildings, firehouses, health facilities, community colleges, roads and bridges, libraries, and police precincts than any other city in the country. Notably, New York City was the center of New York’s initial COVID-19 outbreak in 2020, which had an adverse impact on the City’s financial health.
New York City’s general debt limit, as provided in the New York State Constitution, is 10% of the five-year rolling average of the full value of taxable City real property. As of June 30, 2022, the City’s total debt-incurring power under the general debt limit was approximately $127.35 billion, and the net debt-incurring power was approximately $41.51 billion. The City’s general obligation debt outstanding was approximately $38.85 billion as of June 30, 2022. After including contract and other liability and adjusting for appropriations, the City’s indebtedness that is counted toward the debt limit totaled approximately $88.39 billion as of June 30, 2022.
In addition to general obligation bonds, the City maintains several additional credits, including bonds issued by the New York City Transitional Finance Authority (“NYCTFA”) and Tobacco Settlement Asset Securitization Corporation (“TSASC”). At the end of fiscal year 2022, NYCTFA debt backed by personal income tax revenues accounted for approximately $43.67 billion of debt. In July 2009, the State Legislature granted NYCTFA the authority to issue additional debt up to $13.5 billion for general capital purposes. The City exhausted the $13.5 billion bonding limit in fiscal year 2007. In July 2009, the State Legislature authorized TFA to issue debt beyond the $13.5 billion limit. However, this additional borrowing is subject to the City’s general debt limit. Thus, additional borrowing above the $13.5 billion limit is secured by personal income tax revenues and counted under the City’s general debt limit. In addition to this capacity, the NYCTFA is authorized to issue up to $9.4 billion of Building Aid Revenue Bonds for education purposes. As of June 30, 2022, excluding amortization, approximately $8.15 billion of these bonds have been issued. Debt service for these bonds is supported by building aid payments the City receives from the State. At the end of fiscal year 2022, TSASC debt totaled approximately $996 million.
As of March 31, 2023, New York State’s general obligation bonds are rated AA+, Aa1, and AA+ by S&P, Moody’s and Fitch, respectively. As of March 31, 2023, New York City’s general obligation debt was rated AA, Aa2, and AA by S&P, Moody’s, and Fitch, respectively. Such ratings reflect only the view of the originating rating agencies, from which an explanation of the significance of such ratings may be obtained. There is no assurance that a particular rating will continue for any given period of time or that any such rating will not be revised downward or withdrawn entirely if, in the judgment of the agency originally establishing the rating, circumstances so warrant. A downward revision or withdrawal of such ratings, or either of them, may have an effect on the market price of the State municipal obligations in which the Fund invests.
Puerto Rico. Because the Fund may invest in municipal securities issued by Puerto Rico (as used in this section, the “Commonwealth” or “Puerto Rico”), it may be particularly affected by political, economic, environmental, social, regulatory or restructuring developments affecting the ability of Puerto Rican municipal issuers to pay interest or repay principal. As a result of the ongoing financial challenges faced by Puerto Rico, the Commonwealth’s economic circumstances may change negatively and more rapidly than usual, and the Commonwealth may be less able to maintain up-to-date information for the public.
Beginning in 2006, the Commonwealth began to face significant budget shortfalls and endured continuous economic decline through 2018. On June 30, 2016, the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”) was signed into law by President Obama. PROMESA established a federally-appointed oversight board (the “Oversight Board”) to oversee the Commonwealth’s financial operations and allows the Commonwealth and its instrumentalities, with approval of the Oversight Board, to file cases to restructure debt and other obligations in a “Title III” proceeding. Title III incorporates many provisions of the federal Bankruptcy Code and incorporates legal mechanisms for a litigation stay and restructuring of pension and debt obligations, among other provisions. Title III petitions were filed for, among others, the Commonwealth, the Puerto Rico Sales Tax Financing Corporation, and the Puerto Rico Electric Power Authority, three of the largest issuers of Commonwealth debt. The Oversight Board is required by law to remain in place until, based on audited financials, four consecutive fiscal years have ended with
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balanced operations and Puerto Rico has demonstrated affordable market access to short-term and long-term credit markets at reasonable interest rates.
The Commonwealth has been in bankruptcy proceedings for approximately five years. However, in the first quarter of 2022, the central government of Puerto Rico executed a debt exchange and exited bankruptcy, which impacted a majority of Puerto Rico’s outstanding debt. A debt adjustment plan (the “Plan”) was approved by Puerto Rico’s bankruptcy court in January 2022, and the debt exchange became effective in March 2022. Puerto Rico’s direct debt obligations were reduced from $34.3 billion to $7.4 billion, and its annual debt service was reduced from $4.2 billion to $1.15 billion.
The Plan requires that Puerto Rico adopt debt management policies in order to ensure that debt service does not become unmanageable. The policies dictate, among other things, that debt proceeds may only be used to fund capital projects and that debt to cover deficits will no longer be acceptable. Future debt refundings are required to result in cash flow savings each fiscal year and may not raise principal. Additionally, new debt is required to begin amortizing within two years and may not have a maturity greater than 30 years.
The Plan has substantially reduced the outstanding debt obligations of Puerto Rico and certain of its instrumentalities, but there can be no assurances that Puerto Rico will be able to negotiate settlements with respect to its remaining outstanding debt and Title III proceedings. In addition, the composition of the Oversight Board has changed significantly in recent years, and there can be no guarantee that the members of the Oversight Board will approve future restructuring agreements with other creditors.
The budget process will continue to require the Oversight Board, the governor of Puerto Rico, and Puerto Rico’s Legislative Assembly to develop a budget that complies with the fiscal plan developed by the Oversight Board and the governor of Puerto Rico. The 2022 fiscal plan was certified by the Oversight Board on January 27, 2022 (“2022 Fiscal Plan”). The 2022 Fiscal Plan contemplated approximately $84 billion in federal disaster relief to address damage caused by recent natural disasters and COVID-19. Apart from federal aid, the 2022 Fiscal Plan projected General Fund revenues of approximately $12.7 billion.
On June 30, 2022, the budget for fiscal year 2023 was certified. The fiscal year 2023 budget provides for General Fund expenditures of approximately $12.4 billion. Allocations in the fiscal year 2023 budget to education, health care, and economic development were approximately $2.5 billion, $1.4 billion, and $43.4 million, respectively.
The Commonwealth’s budget is impacted by extensive unfunded pension obligations related to its retirement systems, which include the Employees Retirement System, the Teachers Retirement System, and the Judiciary Retirement System. The Commonwealth’s pension systems operate on a “pay-as-you-go” basis, and the General Fund has assumed any payments that the pension systems could not make. As a result, the Commonwealth may have fewer resources for other priorities, including payments on its outstanding debt obligations. Alternatively, the Commonwealth may be forced to raise revenue or issue additional debt. Either outcome could increase pressure on the Commonwealth’s budget, which could have an adverse impact on the Fund’s investments in Puerto Rico.
Investors should be aware that Puerto Rico relies heavily on transfers from the federal government related to specific programs and activities in the Commonwealth. These transfers include, among others, entitlements for previously performed services, or those resulting from contributions to programs such as Social Security, Veterans’ Benefits, Medicare and U.S. Civil Service retirement pensions, as well as grants such as Nutritional Assistance Program grants and Pell Grant scholarships for higher education. There is considerable uncertainty about which federal policy changes may be enacted in the coming years and the economic impact of those changes. Due to the Commonwealth’s dependence on federal transfers, any actions that reduce or alter these transfers may cause increased fiscal stress in Puerto Rico, which may have a negative impact on the value of the Commonwealth’s municipal securities.
There can be no assurances that the Commonwealth will not continue to face severe fiscal stress or that such circumstances will not become even more difficult in the future. Furthermore, there can be no guarantee that future developments will not have a materially adverse impact on the Commonwealth’s finances. Any further deterioration in the Commonwealth’s financial condition may have a negative effect on the payment of principal and interest, as well as the marketability, liquidity or value of the securities issued by the Commonwealth, which could reduce the performance of the Fund.
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Since PROMESA was enacted, there have been various legal proceedings initiated by creditors of Puerto Rico and other constituencies. These groups asserted a number of complex legal claims that questioned the efficacy and validity of PROMESA, calling into question the validity of Oversight Board appointments. The U.S. Supreme Court ultimately decided that the appointment of the members to the Oversight Board was valid. In addition, certain Title III proceedings remain ongoing and certain Plans of Adjustment remain subject to judicial attack. The Commonwealth, its officials and employees are named as defendants in legal proceedings that occur in the normal course of governmental operations. Some of these proceedings involve claims for substantial amounts, which if decided against the Commonwealth might require the Commonwealth to make significant future expenditures or substantially impair future revenue sources. Because of the prospective nature of these proceedings, it is not presently possible to predict the ultimate outcome of such proceedings, estimate the potential impact on the ability of the Commonwealth to pay debt service costs on its obligations, or determine what impact, if any, such proceedings may have on the Fund’s investments.
In September 2017, two successive hurricanes — Irma and Maria — caused severe damage to Puerto Rico. The Commonwealth’s infrastructure was severely damaged by high winds and substantial flooding, including damage to the Commonwealth’s water, power, and telecommunications infrastructure, and resulted in more than 1 million people losing power. In late December 2019 and January 2020, a series of earthquakes, including a magnitude 6.4 earthquake—the strongest to hit the island in more than a century—caused an estimated $200 million in damage. The aftershocks from these earthquakes may continue for years, and it is not currently possible to predict the extent of the damage that could arise from any aftershocks. The full extent of the natural disasters’ impact on Puerto Rico’s economy and foreign investment in Puerto Rico is difficult to estimate, but is expected to have substantially adverse effects on Puerto Rico’s economy. In addition to diverting funds to relief and recovery efforts, Puerto Rico is expected to lose substantial revenue as a result of decreased tourism and general business operations. There can be no assurances that Puerto Rico will receive the necessary aid to rebuild from the damage caused by the hurricanes or earthquakes or that future catastrophic weather events or natural disasters will not cause similar damage.
In addition, the Commonwealth was significantly impacted by COVID-19. Efforts to respond to and mitigate the spread of COVID-19 had a negative impact on the Commonwealth and national economies. In March 2020, the Oversight Board authorized the Commonwealth to implement a $787 million relief package to fight the pandemic and its economic impacts, of which $500 million was incremental new spending made available through a special appropriation. Any reduction in the Commonwealth’s revenues as a result of the pandemic could have a negative ability on the Commonwealth to meet its debt service obligations, including with respect to debt held by the Fund. Further, Congress passed the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) in March 2020, which provided for approximately $2.2 trillion in disaster relief. Among other things, the CARES Act established the Coronavirus Relief Fund, from which Puerto Rico received $2.2 billion. In March 2021, the American Rescue Plan was signed into law, which provided an additional $350 billion in emergency funding for state, local, territorial, and Tribal governments, including $4.5 billion specifically for relief to U.S. territories. The rate and level at which the federal government and the Commonwealth took on new debt could have a negative impact on their fiscal health, which could lead to prolonged challenges. A failure by Puerto Rico to meet its debt obligations could lead to a significant decline in the value, liquidity, and marketability of Fund investments.
As of the date of this SAI, S&P, Moody’s and Fitch each have withdrawn their unenhanced ratings of Puerto Rico’s general obligation debt. The withdrawals reflect only the views of the respective rating agency, an explanation of which may be obtained from each such rating agency. There is no assurance that the withdrawals will continue for any given period of time or that they will not be reversed by the rating agency if, in the judgment of such rating agency, circumstances so warrant. A downward revision or withdrawal of a general obligation bond rating may have an adverse effect on the market prices of the securities issued by the Commonwealth and its political subdivisions, instrumentalities, and authorities.
Tender Option Bonds. The Fund may invest in trust certificates issued in tender option bond (“TOB”) programs. In a TOB transaction, a tender option bond trust (“TOB Trust”) issues floating rate certificates (“TOB Floater”) and residual interest certificates (“TOB Residual”) and utilizes the proceeds of such issuance to purchase a fixed-rate municipal bond (“Fixed Rate Bond”) that either is owned or identified by the Fund. The TOB Floater is generally issued to third party investors (typically a money market fund) and the TOB Residual is generally issued to the Fund, which sold or identified the Fixed Rate Bond. The TOB Trust divides the income stream provided by the Fixed Rate Bond to create two securities, the TOB Floater, which is a short-term security, and the TOB Residual, which is a longer-term security. The interest rates payable on the TOB Residual issued to the Fund bear an inverse relationship to
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the interest rate on the TOB Floater. The interest rate on the TOB Floater is reset by a remarketing process typically every 7 to 35 days. After income is paid on the TOB Floater at current rates, the residual income from the Fixed Rate Bond goes to the TOB Residual. Therefore, rising short-term rates result in lower income for the TOB Residual, and vice versa. In the case of a TOB Trust that utilizes the cash received (less transaction expenses) from the issuance of the TOB Floater and TOB Residual to purchase the Fixed Rate Bond from the Fund, the Fund may then invest the cash received in additional securities, generating leverage for the Fund. Other PIMCO-managed accounts may also contribute municipal bonds to a TOB Trust into which the Fund has contributed Fixed Rate Bonds. If multiple PIMCO-managed accounts participate in the same TOB Trust, the economic rights and obligations under the TOB Residual will be shared among the funds ratably in proportion to their participation in the TOB Trust.
The TOB Residual may be more volatile and less liquid than other municipal bonds of comparable maturity. In most circumstances the TOB Residual holder bears substantially all of the underlying Fixed Rate Bond’s downside investment risk and also benefits from any appreciation in the value of the underlying Fixed Rate Bond. Investments in a TOB Residual typically will involve greater risk than investments in Fixed Rate Bonds.
A TOB Residual held by the Fund provides the Fund with the right to: (1) cause the holders of the TOB Floater to tender their notes at par, and (2) cause the sale of the Fixed-Rate Bond held by the TOB Trust, thereby collapsing the TOB Trust. TOB Trusts are generally supported by a liquidity facility provided by a third party bank or other financial institution (the “Liquidity Provider”) that provides for the purchase of TOB Floaters that cannot be remarketed. The holders of the TOB Floaters have the right to tender their certificates in exchange for payment of par plus accrued interest on a periodic basis (typically weekly) or on the occurrence of certain mandatory tender events. The tendered TOB Floaters are remarketed by a remarketing agent, which is typically an affiliated entity of the Liquidity Provider. If the TOB Floaters cannot be remarketed, the TOB Floaters are purchased by the TOB Trust either from the proceeds of a loan from the Liquidity Provider or from a liquidation of the Fixed Rate Bond.
The TOB Trust may also be collapsed without the consent of the Fund, as the TOB Residual holder, upon the occurrence of certain “tender option termination events” (or “TOTEs”) as defined in the TOB Trust agreements. Such termination events typically include the bankruptcy or default of the municipal bond, a substantial downgrade in credit quality of the municipal bond, or a judgment or ruling that interest on the Fixed Rate Bond is subject to federal income taxation. Upon the occurrence of a termination event, the TOB Trust would generally be liquidated in full with the proceeds typically applied first to any accrued fees owed to the trustee, remarketing agent and liquidity provider, and then to the holders of the TOB Floater up to par plus accrued interest owed on the TOB Floater and a portion of gain share, if any, with the balance paid out to the TOB Residual holder. In the case of a mandatory termination event (“MTE”), after the payment of fees, the TOB Floater holders would be paid before the TOB Residual holders (i.e., the Fund). In contrast, in the case of a TOTE, after payment of fees, the TOB Floater holders and the TOB Residual holders would be paid pro rata in proportion to the respective face values of their certificates. If there are insufficient proceeds from the liquidation of the TOB Trust, the party that would bear the losses would depend upon whether the Fund holds a non-recourse TOBs Residual or a recourse TOBs Residual. If the Fund holds a non-recourse TOBs Residual, the Liquidity Provider or holders of the TOBs Floaters would bear the losses on those securities and there would be no recourse to the Fund’s assets. If the Fund holds a recourse TOBs Residual, the Fund (and, indirectly, holders of the Fund’s Common Shares) would typically bear the losses. In particular, if the Fund holds a recourse TOBs Residual, it will typically have entered into an agreement pursuant to which the Fund would be required to pay to the Liquidity Provider the difference between the purchase price of any TOBs Floaters put to the Liquidity Provider by holders of the TOBs Floaters and the proceeds realized from the remarketing of those TOBs Floaters or the sale of the assets in the TOBs Issuer. The Fund may invest in both non-recourse and recourse TOBs Residuals to leverage its portfolio.
In December 2013, regulators finalized rules implementing Section 619 (the “Volcker Rule”) and Section 941 (the “Risk Retention Rules”) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). Both the Volcker Rule and the Risk Retention Rules apply to tender option bond programs and place restrictions on the way certain sponsors may participate in tender option bond programs. Specifically, the Volcker Rule generally prohibits banking entities from engaging in proprietary trading or from acquiring or retaining an ownership interest in, or sponsoring, a hedge fund or private equity fund (“covered fund”), subject to certain exemptions and limitations. Tender option bond programs generally are considered to be covered funds under the Volcker Rule, and, thus, may not be sponsored by a banking entity absent an applicable exemption. The Volcker Rule does not provide for any exemption that would allow banking entities to sponsor tender option bonds in the same manner as they did prior to the Volcker Rule’s compliance date, which was July 21, 2017.
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The Risk Retention Rules took effect in December 2016 and require the sponsor to a TOB Trust to retain at least five percent of the credit risk of the underlying assets supporting the TOB Trust’s municipal bonds. The Risk Retention Rules may adversely affect the Fund’s ability to engage in TOB Trust transactions or increase the costs of such transactions in certain circumstances.
Under the new TOB Trust structure, the Liquidity Provider or remarketing agent will no longer purchase the tendered TOB Floaters, even in the event of failed remarketing. This may increase the likelihood that a TOB Trust will need to be collapsed and liquidated in order to purchase the tendered TOB Floaters. The TOB Trust may draw upon a loan from the Liquidity Provider to purchase the tendered TOB Floaters. Any loans made by the Liquidity Provider will be secured by the purchased TOB Floaters held by the TOB Trust and will be subject to an interest rate agreed with the Liquidity Provider.
Corporate Debt Securities
The Fund may invest in corporate debt securities of U.S. issuers and foreign issuers, and/or it may hold its assets in these securities for cash management purposes. The investment return of corporate debt securities reflects interest earnings and changes in the market value of the security. The market value of a corporate debt obligation may generally be expected to rise and fall inversely with interest rates generally. There also exists the risk that the issuers of the securities may not be able to meet their obligations on interest or principal payments at the time called for by an instrument. The Fund’s investments in U.S. dollar or foreign currency-denominated corporate debt securities of domestic or foreign issuers are limited to corporate debt securities (corporate bonds, debentures, notes and other similar corporate debt instruments, including convertible securities) which meet the minimum ratings criteria set forth for the Fund, or, if unrated, are in PIMCO’s opinion comparable in quality to corporate debt securities in which the Fund may invest. Corporate income-producing securities may include forms of preferred or preference stock.
The rate of interest on a corporate debt security may be fixed, floating or variable, and may vary inversely with respect to a reference rate. The rate of return or return of principal on some debt obligations may be linked or indexed to the level of exchange rates between the U.S. dollar and a foreign currency or currencies. Corporate debt securities may be acquired with warrants attached.
Securities rated Baa and BBB are the lowest which are considered “investment grade” obligations. Moody’s describes securities rated Baa as “judged to be medium-grade and subject to moderate credit risk and as such may possess certain speculative characteristics.” S&P describes securities rated BBB as exhibiting adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to weaken the obligor’s capacity to meet its financial commitments on the obligation. Fitch describes securities rated BBB as having good credit quality with current low expectations of default. The capacity for payment of financial commitments is considered adequate, but adverse business or economic conditions are more likely to impair this capacity.” For a discussion of securities rated below investment grade, see “High Yield Securities (“Junk Bonds”) and Securities of Distressed Companies.”
Commercial Paper
Commercial paper represents short-term unsecured promissory notes issued in bearer form by corporations such as banks or bank holding companies and finance companies. The Fund may invest in commercial paper of any credit quality consistent with the Fund’s investment objectives and policies, including unrated commercial paper. See Appendix A to the Prospectus for a description of the ratings assigned by Moody’s, S&P and Fitch to commercial paper. The rate of return on commercial paper may be linked or indexed to the level of exchange rates between the U.S. dollar and a foreign currency or currencies.
Convertible Securities
The Fund may invest in convertible securities, which may offer higher income than the common stocks into which they are convertible. A convertible security is a bond, debenture, note, preferred security, or other security that entitles the holder to acquire common stock or other equity securities of the same or a different issuer. A convertible security generally entitles the holder to receive interest paid or accrued until the convertible security matures or is redeemed, converted or exchanged. Before conversion, convertible securities have characteristics similar to non-convertible debt securities or preferred securities, as applicable. Convertible securities rank senior to common
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stock in a corporation’s capital structure and, therefore, generally entail less risk than the corporation’s common stock, although the extent to which such risk is reduced depends in large measure upon the degree to which the convertible security sells above its value as a fixed-income security. Convertible securities are subordinate in rank to any senior debt obligations of the issuer, and, therefore, an issuer’s convertible securities entail more risk than its debt obligations. Convertible securities generally offer lower interest or dividend yields than non-convertible debt securities of similar credit quality because of the potential for capital appreciation. In addition, convertible securities are often lower-rated securities.
Because of the conversion feature, the price of the convertible security will normally fluctuate in some proportion to changes in the price of the underlying asset, and as such is subject to risks relating to the activities of the issuer and/or general market and economic conditions. The income component of a convertible security may tend to cushion the security against declines in the price of the underlying asset. However, the income component of convertible securities causes fluctuations based upon changes in interest rates and the credit quality of the issuer.
If the convertible security’s “conversion value,” which is the market value of the underlying common stock that would be obtained upon the conversion of the convertible security, is substantially below the “investment value,” which is the value of a convertible security viewed without regard to its conversion feature (i.e., strictly on the basis of its yield), the price of the convertible security is governed principally by its investment value. If the conversion value of a convertible security increases to a point that approximates or exceeds its investment value, the value of the security will be principally influenced by its conversion value. A convertible security will sell at a premium over its conversion value to the extent investors place value on the right to acquire the underlying common stock while holding an income-producing security.
A convertible security may be subject to redemption at the option of the issuer at a predetermined price. If a convertible security held by the Fund is called for redemption, the Fund would be required to permit the issuer to redeem the security and convert it to underlying common stock, or would sell the convertible security to a third party, which may have an adverse effect on the Fund’s ability to achieve its investment objectives. The Fund generally would invest in convertible securities for their favorable price characteristics and total return potential and would normally not exercise an option to convert unless the security is called or conversion is forced.
The Fund may invest in so-called “synthetic convertible securities,” which are composed of two or more different securities whose investment characteristics, taken together, resemble those of convertible securities. A third party or PIMCO may create a “synthetic” convertible security by combining separate securities that possess the two principal characteristics of a traditional convertible security, i.e., an income-producing security (“income-producing component”) and the right to acquire an equity security (“convertible component”). The income-producing component is achieved by investing in non-convertible, income-producing securities such as bonds, preferred securities and money market instruments, which may be represented by derivative instruments. The convertible component is achieved by investing in securities or instruments such as warrants or options to buy common stock at a certain exercise price, or options on a stock index. Unlike a traditional convertible security, which is a single security having a single market value, a synthetic convertible comprises two or more separate securities, each with its own market value. Therefore, the “market value” of a synthetic convertible security is the sum of the values of its income-producing component and its convertible component. For this reason, the values of a synthetic convertible security and a traditional convertible security may respond differently to market fluctuations.
More flexibility is possible in the assembly of a synthetic convertible security than in the purchase of a convertible security. Although synthetic convertible securities may be selected where the two components are issued by a single issuer, thus making the synthetic convertible security similar to the traditional convertible security, the character of a synthetic convertible security allows the combination of components representing distinct issuers, when PIMCO believes that such a combination may better achieve the Fund’s investment objectives. A synthetic convertible security also is a more flexible investment in that its two components may be purchased separately. For example, the Fund may purchase a warrant for inclusion in a synthetic convertible security but temporarily hold short-term investments while postponing the purchase of a corresponding bond pending development of more favorable market conditions.
A holder of a synthetic convertible security faces the risk of a decline in the price of the security or the level of the index or security involved in the convertible component, causing a decline in the value of the security or instrument, such as a call option or warrant purchased to create the synthetic convertible security. Should the price of
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the stock fall below the exercise price and remain there throughout the exercise period, the entire amount paid for the call option or warrant would be lost. Because a synthetic convertible security includes the income-producing component as well, the holder of a synthetic convertible security also faces the risk that interest rates will rise, causing a decline in the value of the income-producing component.
The Fund also may purchase synthetic convertible securities created by other parties, including convertible structured notes. Convertible structured notes are income-producing debentures linked to equity, and are typically issued by investment banks. Convertible structured notes have the attributes of a convertible security; however, the investment bank that issues the convertible note, rather than the issuer of the underlying common stock into which the note is convertible, assumes credit risk associated with the underlying investment, and the Fund in turn assumes credit risk associated with the convertible note.
Contingent Convertible Instruments. Contingent convertible securities (“CoCos”) are a form of hybrid debt security that are intended to either convert into equity or have their principal written down (including potentially to zero) upon the occurrence of certain “triggers.” The triggers are generally linked to regulatory capital thresholds or regulatory actions calling into question the issuing banking institution’s continued viability as a going-concern. CoCos’ unique equity conversion or principal write-down features are tailored to the issuing banking institution and its regulatory requirements.
Some additional risks associated with CoCos include, but are not limited to:
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Loss absorption risk. CoCos have fully discretionary coupons. This means coupons can potentially be cancelled at the banking institution’s discretion or at the request of the relevant regulatory authority in order to help the bank absorb losses.
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Subordinated instruments. CoCos will, in the majority of circumstances, be issued in the form of subordinated debt instruments in order to provide the appropriate regulatory capital treatment prior to a conversion. Accordingly, in the event of liquidation, dissolution or winding-up of an issuer prior to a conversion having occurred, the rights and claims of the holders of the CoCos, such as the Portfolios, against the issuer in respect of or arising under the terms of the CoCos shall generally rank junior to the claims of all holders of unsubordinated obligations of the issuer and may also become junior to other obligations and securities of the issuer. In addition, if the CoCos are converted into the issuer’s underlying equity securities following a conversion event (i.e., a “trigger”), each holder will be subordinated due to their conversion from being the holder of a debt instrument to being the holder of an equity instrument.
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Market value will fluctuate based on unpredictable factors. The value of CoCos is unpredictable and will be influenced by many factors including, without limitation: (i) the creditworthiness of the issuer and/or fluctuations in such issuer’s applicable capital ratios; (ii) supply and demand for the CoCos; (iii) general market conditions and available liquidity; and (iv) economic, financial and political events that affect the issuer, its particular market or the financial markets in general.
Equity Securities
Subject to the Fund’s investment policies, the Fund may hold common stocks and other equity securities from time to time, including without limitation those it has received through the conversion of a convertible security held by the Fund or in connection with the restructuring of a debt security. The market price of common stocks and other equity securities may go up or down, sometimes rapidly or unpredictably. Equity securities may decline in value due to factors affecting equity securities markets generally, particular industries represented in those markets, or the issuer itself. The values of equity securities may decline due to general market conditions that are not specifically related to a particular company, such as real or perceived adverse economic conditions, changes in the general outlook for corporate earnings, changes in interest or currency rates or adverse investor sentiment generally. They may also decline due to factors that affect a particular industry or industries, such as labor shortages or increased production costs and competitive conditions within an industry. Equity securities generally have greater price volatility than fixed-income securities. These risks are generally magnified in the case of equity investments in distressed companies.
Different types of equity securities provide different voting and dividend rights and priority in the event of the bankruptcy and/or insolvency of the issuer. In addition to common stock, equity securities may include preferred securities, convertible securities and warrants, which are discussed elsewhere in the Prospectus and this Statement of Additional Information. Equity securities other than common stock are subject to many of the same risks as common
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stock, although possibly to different degrees. The risks of equity securities are generally magnified in the case of equity investments in distressed companies.
Preferred Securities
Preferred securities represent an equity interest in a company that generally entitles the holder to receive, in preference to the holders of other stocks such as common stocks, dividends and a fixed share of the proceeds resulting from a liquidation of the company. Some preferred securities also entitle their holders to receive additional liquidation proceeds on the same basis as holders of a company’s common stock, and thus also represent an ownership interest in that company. Preferred securities are subject to issuer-specific and market risks applicable generally to equity securities. In addition, a company’s preferred securities generally pay dividends only after the company makes required payments to holders of its bonds and other debt. For this reason, the value of preferred securities will usually react more strongly than bonds and other debt to actual or perceived changes in the company’s financial condition or prospects. Preferred securities of smaller companies may be more vulnerable to adverse developments than preferred securities of larger companies.
The value of a company’s preferred securities may fall as a result of factors relating directly to that company’s products or services. A preferred security’s value may also fall because of factors affecting not just the company, but companies in the same industry or in a number of different industries, such as increases in production costs.
The value of preferred securities may also be affected by changes in financial markets that are relatively unrelated to the company or its industry, such as changes in interest rates or currency exchange rates. In addition, a company’s preferred securities generally pay dividends only after the company makes required payments to holders of its bonds and other debt. For this reason, the value of preferred securities will usually react more strongly than bonds and other debt to actual or perceived changes in the company’s financial condition or prospects. Preferred securities of smaller companies may be more vulnerable to adverse developments than those of larger companies.
Adjustable Rate and Auction Preferred Securities. Typically, the dividend rate on an adjustable rate preferred security is determined prospectively each quarter by applying an adjustment formula established at the time of issuance of the security. Although adjustment formulas vary among issues, they typically involve a fixed premium or discount relative to rates on specified debt securities issued by the U.S. Treasury. Typically, an adjustment formula will provide for a fixed premium or discount adjustment relative to the highest base yield of three specified U.S. Treasury securities: the 90-day Treasury bill, the 10-year Treasury note and the 20-year Treasury bond. The premium or discount adjustment to be added to or subtracted from this highest U.S. Treasury base rate yield is fixed at the time of issue and cannot be changed without the approval of the holders of the security. The dividend rate on another type of preferred security in which the Fund may invest, commonly known as auction preferred securities, is adjusted at intervals that may be more frequent than quarterly, such as every 7 or 49 days, based on bids submitted by holders and prospective purchasers of such securities and may be subject to stated maximum and minimum dividend rates. The issues of most adjustable rate and auction preferred securities currently outstanding are perpetual, but are redeemable after a specified date, or upon notice, at the option of the issuer. Certain issues supported by the credit of a high-rated financial institution provide for mandatory redemption prior to expiration of the credit arrangement. No redemption can occur if full cumulative dividends are not paid. Although the dividend rates on adjustable and auction preferred securities are generally adjusted or reset frequently, the market values of these preferred securities may still fluctuate in response to changes in interest rates. Market values of adjustable preferred securities also may substantially fluctuate if interest rates increase or decrease once the maximum or minimum dividend rate for a particular security is approached. Auctions for U.S. auction preferred securities have failed since early 2008, and the dividend rates payable on such preferred securities since that time typically have been paid at their maximum applicable rate (typically a function of a reference rate of interest). PIMCO expects that auction preferred securities will continue to pay dividends at their maximum applicable rate for the foreseeable future and cannot predict whether or when the auction markets for auction preferred securities may resume normal functioning.
Fixed Rate Preferred Securities. Some fixed rate preferred securities in which the Fund may invest, known as perpetual preferred securities, offer a fixed return with no maturity date. Because they never mature, perpetual preferred securities act like long-term bonds and can be more volatile than and more sensitive to changes in interest rates than other types of preferred securities that have a maturity date. The Fund may also invest in sinking fund preferred securities. These preferred securities also offer a fixed return, but have a maturity date and are retired or
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redeemed on a predetermined schedule. The shorter duration of sinking fund preferred securities makes them perform somewhat like intermediate-term bonds and they typically have lower yields than perpetual preferred securities.
Bank Obligations
The Fund may invest in bank capital securities of both non-U.S. (foreign) and U.S. issuers. Bank capital securities are issued by banks to help fulfill their regulatory capital requirements. There are three common types of bank capital: Lower Tier II, Upper Tier II and Tier I. Bank capital is generally, but not always, of investment grade quality. Upper Tier II securities are commonly thought of as hybrids of debt and preferred securities. Upper Tier II securities are often perpetual (with no maturity date), callable and have a cumulative interest deferral feature. This means that under certain conditions, the issuer bank can withhold payment of interest until a later date. However, such deferred interest payments generally earn interest. Tier I securities often take the form of trust preferred securities.
Bank obligations in which the Fund may invest include, without limitation, certificates of deposit, bankers’ acceptances and fixed time deposits. Certificates of deposit are negotiable certificates issued against funds deposited in a commercial bank for a definite period of time and that earn a specified return. Bankers’ acceptances are negotiable drafts or bills of exchange, normally drawn by an importer or exporter to pay for specific merchandise, which are “accepted” by a bank, meaning, in effect, that the bank unconditionally agrees to pay the face value of the instrument on maturity. Fixed time deposits are bank obligations payable at a stated maturity date and bearing interest at a fixed rate. Fixed time deposits may be withdrawn on demand by the investor, but may be subject to early withdrawal penalties which vary depending upon market conditions and the remaining maturity of the obligation. There are generally no contractual restrictions on the right to transfer a beneficial interest in a fixed time deposit to a third party, although there is generally no market for such deposits.
The activities of U.S. banks and most foreign banks are subject to comprehensive regulations which, in the case of U.S. regulations, have undergone substantial changes in the past decade and are currently subject to legislative and regulatory scrutiny. The enactment of new legislation or regulations, as well as changes in interpretation and enforcement of current laws, may affect the manner of operations and profitability of U.S. and foreign banks. Significant developments in the U.S. banking industry have included increased competition from other types of financial institutions, increased acquisition activity and geographic expansion. Banks may be particularly susceptible to certain economic factors, such as interest rate changes and adverse developments in the market for real estate. Fiscal and monetary policy and general economic cycles can affect the availability and cost of funds, loan demand and asset quality and thereby impact the earnings and financial conditions of banks.
U.S. and global markets recently have experienced increased volatility, including as a result of the recent failures of certain U.S. and non-U.S. banks, which could be harmful to the Fund and issuers in which they invest. For example, if a bank at which a Fund or issuer has an account fails, any cash or other assets in bank or custody accounts, which may be substantial in size, could be temporarily inaccessible or permanently lost by the Fund or issuer. If a bank that provides a subscription line credit facility, asset-based facility, other credit facility and/or other services to an issuer or to a fund fails, the issuer or fund could be unable to draw funds under its credit facilities or obtain replacement credit facilities or other services from other lending institutions with similar terms.
Issuers in which the Fund may invest can be affected by volatility in the banking sector. Even if banks used by issuers in which the Fund invests remain solvent, continued volatility in the banking sector could contribute to, cause or intensify an economic recession, increase the costs of capital and banking services or result in the issuers being unable to obtain or refinance indebtedness at all or on as favorable terms as could otherwise have been obtained. Conditions in the banking sector are evolving, and the scope of any potential impacts to the Fund and issuers, both from market conditions and also potential legislative or regulatory responses, are uncertain. Such conditions and responses, as well as a changing interest rate environment, can contribute to decreased market liquidity and erode the value of certain holdings, including those of U.S. and non-U.S. banks. Continued market volatility and uncertainty and/or a downturn in market and economic and financial conditions, as a result of developments in the banking industry or otherwise (including as a result of delayed access to cash or credit facilities), could have an adverse impact on the Fund and issuers in which they invest.
Obligations of foreign banks involve somewhat different investment risks than those affecting obligations of U.S. banks, including the possibilities that their liquidity could be impaired because of future political and economic developments, that their obligations may be less marketable than comparable obligations of U.S. banks, that a foreign
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jurisdiction might impose withholding or other taxes on interest income payable on those obligations, that foreign deposits may be seized or nationalized, that foreign governmental restrictions such as exchange controls may be adopted which might adversely affect the payment of principal and interest on those obligations and that the selection of those obligations may be more difficult because there may be less publicly available information concerning foreign banks and the accounting, auditing and financial reporting standards, practices and requirements applicable to foreign banks may differ from those applicable to U.S. banks. Foreign banks are not generally subject to examination by any U.S. government agency or instrumentality.
Loans and Other Indebtedness; Loan Participations and Assignments
The Fund may purchase indebtedness and participations in commercial loans, as well as interests and/or servicing or similar rights in such loans. Such instruments may be secured or unsecured and may be newly-originated (and may be specifically designed for the Fund). Indebtedness is different from traditional debt securities in that debt securities are part of a large issue of securities to the public whereas indebtedness may not be a security and may represent a specific commercial loan to a borrower. Loan participations typically represent direct participation, together with other parties, in a loan to a corporate borrower, and generally are offered by banks or other financial institutions or lending syndicates. The Fund may participate in such syndications, or can buy part of a loan, becoming a part lender. When purchasing indebtedness and loan participations, the Fund assumes the credit risk associated with the corporate borrower and may assume the credit risk associated with an interposed bank or other financial intermediary. The indebtedness and loan participations that the Fund may acquire may not be rated by any NRSROs.
A loan is often administered by an agent bank acting as agent for all holders. The agent bank administers the terms of the loan, as specified in the loan agreement. In addition, the agent bank is normally responsible for the collection of principal and interest payments from the corporate borrower and the apportionment of these payments to the credit of all institutions which are parties to the loan agreement. Unless, under the terms of the loan or other indebtedness, the Fund has direct recourse against the corporate borrower, the Fund may have to rely on the agent bank or other financial intermediary to apply appropriate credit remedies against a corporate borrower.
A financial institution’s employment as agent bank might be terminated in the event that it fails to observe a requisite standard of care or becomes insolvent. A successor agent bank would generally be appointed to replace the terminated agent bank, and assets held by the agent bank under the loan agreement should remain available to holders of such indebtedness. However, if assets held by the agent bank for the benefit of the Fund were determined to be subject to the claims of the agent bank’s general creditors, the Fund might incur certain costs and delays in realizing payment on a loan or loan participation and could suffer a loss of principal and/or interest. In situations involving other interposed financial institutions (e.g., an insurance company or governmental agency) similar risks may arise.
Purchasers of loans and other forms of direct indebtedness depend primarily upon the creditworthiness of the corporate borrower for payment of principal and interest. If the Fund does not receive scheduled interest or principal payments on such indebtedness, the Fund’s share price and yield could be adversely affected. Loans that are fully secured offer the Fund more protection than an unsecured loan in the event of non-payment of scheduled interest or principal. However, there is no assurance that the liquidation of collateral from a secured loan would satisfy the corporate borrower’s obligation, or that the collateral can be liquidated. In the event of the bankruptcy of a borrower, the Fund could experience delays or limitations in its ability to realize the benefits of any collateral securing a loan.
The Fund may acquire loan participations with credit quality comparable to that of issuers of its securities investments. Indebtedness of companies whose creditworthiness is poor involves substantially greater risks, and may be highly speculative. Some companies may never pay off their indebtedness, or may pay only a small fraction of the amount owed. Consequently, when acquiring indebtedness of companies with poor credit, the Fund bears a substantial risk of losing the entire amount of the instrument acquired. The Fund may make purchases of indebtedness and loan participations to achieve income and/or capital appreciation.
The Fund limits the amount of its total assets that it will invest in issuers within the same industry. For purposes of these limits, the Fund generally will treat the corporate borrower as the “issuer” of indebtedness held by the Fund. In the case of loan participations where a bank or other lending institution serves as a financial intermediary between the Fund and the corporate borrower, if the participation does not shift to the Fund the direct debtor-creditor relationship with the corporate borrower, SEC interpretations require the Fund to treat both the lending bank or other lending institution and the corporate borrower as “issuers.” Treating a financial intermediary as an issuer of
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indebtedness may restrict the Fund’s ability to invest in indebtedness related to a single financial intermediary, or a group of intermediaries engaged in the same industry, even if the underlying borrowers represent many different companies and industries.
Loans and other types of direct indebtedness (which the Fund may invest in or otherwise gain exposure to) may not be readily marketable and may be subject to restrictions on resale. In some cases, negotiations involved in disposing of indebtedness may require weeks to complete. Consequently, some indebtedness may be difficult or impossible to dispose of readily at what the Investment Manager believes to be a fair price. In addition, valuation of illiquid indebtedness involves a greater degree of judgment in determining the Fund’s net asset value than if that value were based on available market quotations, and could result in significant variations in the Fund’s daily share price. At the same time, some loan interests are traded among certain financial institutions and accordingly may be deemed liquid. As the market for different types of indebtedness develops, the liquidity of these instruments is expected to improve. Investments in loan participations are considered to be debt obligations for purposes of the Fund’s investment restriction relating to the lending of funds or assets.
In purchasing loans, the Fund will compete with a broad spectrum of lenders. Increased competition for, or a diminishment in the available supply of, qualifying loans could result in lower yields on and/or less advantageous terms of such loans, which could reduce Fund performance.
Investments in loans through a purchase of a loan or a direct assignment of a financial institution’s interests with respect to a loan may involve additional risks to the Fund. The purchaser of an assignment typically succeeds to all the rights and obligations under the loan agreement with the same rights and obligations as the assigning lender. Assignments may, however, be arranged through private negotiations between potential assignees and potential assignors, and the rights and obligations acquired by the purchaser of an assignment may differ from, and be more limited than, those held by the assigning lender. For example, if a loan is foreclosed, the Fund could become owner, in whole or in part, of any collateral, which could include, among other assets, real estate or other real or personal property, and would bear the costs and liabilities associated with owning and holding or disposing of the collateral (see “Real Estate Assets and Related Derivatives” above). In addition, it is conceivable that under emerging legal theories of lender liability, the Fund could be held liable as co-lender. It is unclear whether loans and other forms of direct indebtedness offer securities law protections against fraud and misrepresentation. In the absence of definitive regulatory guidance, the Fund relies on the Investment Manager’s research in an attempt to avoid situations where fraud or misrepresentation could adversely affect the Fund.
The Fund may make, participate in or acquire debtor-in-possession financings (commonly known as “DIP financings”). DIP financings are arranged when an entity seeks the protections of the bankruptcy court under Chapter 11 of the U.S. Bankruptcy Code. These financings allow the entity to continue its business operations while reorganizing under Chapter 11. Such financings constitute senior liens on unencumbered security (i.e., security not subject to other creditors’ claims). There is a risk that the entity will not emerge from Chapter 11 and be forced to liquidate its assets under Chapter 7 of the U.S. Bankruptcy Code. In the event of liquidation, the Fund’s only recourse will be against the property securing the DIP financing.
Investments in loans may include unfunded loan commitments, which are contractual obligations for future funding. Unfunded loan commitments may include revolving credit facilities, which may obligate the Fund to supply additional cash to the borrower on demand. Unfunded loan commitments represent a future obligation in full, even though a percentage of the committed amount may not be utilized by the borrower. When investing in a loan participation, the Fund has the right to receive payments of principal, interest and any fees to which it is entitled only from the agent selling the loan agreement and only upon receipt of payments by the agent from the borrower. The Fund may receive a commitment fee based on the undrawn portion of the underlying line of credit portion of a loan. In certain circumstances, the Fund may receive a penalty fee upon the prepayment of a loan by a borrower. Fees earned or paid are recorded as a component of interest income or interest expense, respectively, on the Consolidated Statement of Operations.
Some lending platforms (or their affiliates) may attempt to take advantage of policies in certain states that allow lenders to make loans at advantageous interest rates by incorporating choice of law provisions into loan agreements that hold that the agreements are to be governed by the laws of those lender-friendly states. In the event that a borrower or state regulator successfully invalidates such choice-of-law clause, platforms (of their affiliates) may not be able to collect some or all of the interest and principal due on such loans; such loans may not be found to be
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enforceable or the platforms (or their affiliates) could become subject to penalties and damages. Other platforms may engage in arrangements with funding banks where the platform assists the bank in originating loans that are funded by the bank. In some cases, the loans are sold to the platforms and the platforms as assignees of the bank under applicable law and precedent utilize the bank’s rate and fee exportation authority. At least one federal circuit court has cast doubt upon this theory and other litigation challenges the ability of assignees to utilize a bank’s exportation authority as an assignee of the bank’s loans.
Loan Origination
The Fund may invest in and/or originate loans, including, without limitation, to, on behalf of, authorized by, sponsored by, and/or in connection with a project for which authority and responsibility lies with one or more U.S. states or territories, cities in a U.S. state or territory, or political subdivisions, agencies, authorities or instrumentalities of such states, territories or cities, which may be in the form of whole loans, assignments, participations, secured and unsecured notes, senior and second lien loans, mezzanine loans, bridge loans or similar investments, including to borrowers that are unrated or have credit ratings that are determined by one or more NRSROs and/or PIMCO to be below investment grade. This may include loans to public or private firms or individuals, such as in connection with housing development projects. The loans the Fund invests in or originates may vary in maturity and/or duration. The Fund is not limited in the amount, size or type of loans it may invest in and/or originate, including with respect to a single borrower or with respect to borrowers that are determined to be below investment grade, other than pursuant to any applicable law. The Fund's investment in or origination of loans may also be limited by the requirements the Fund intends to observe under Subchapter M of the Code in order to qualify as a regulated investment company. The loans acquired by the Fund may be of the type that count towards the Fund’s 80% policy or they may be loans that produce income that is subject to regular federal income tax. The Fund may subsequently offer such investments for sale to third parties; provided, that there is no assurance that the Fund will complete the sale of such an investment. If the Fund is unable to sell, assign or successfully close transactions for the loans that it originates, the Fund will be forced to hold its interest in such loans for an indeterminate period of time. This could result in the Fund’s investments having high exposure to certain borrowers. The Fund will be responsible for the expenses associated with originating a loan (whether or not consummated). This may include significant legal and due diligence expenses, which will be indirectly borne by the Fund and Common Shareholders.
Bridge loans are generally made with the expectation that the borrower will be able to obtain permanent financing in the near future. Any delay in obtaining permanent financing subjects the bridge loan investor to increased risk. A borrower’s use of bridge loans also involves the risk that the borrower may be unable to locate permanent financing to replace the bridge loan, which may impair the borrower’s perceived creditworthiness.
Loan origination and servicing companies are routinely involved in legal proceedings concerning matters that arise in the ordinary course of their business. In addition, a number of participants in the loan origination and servicing industry (including control persons of industry participants) have been the subject of regulatory actions by state regulators, including state attorneys general, and by the federal government. Governmental investigations, examinations or regulatory actions, or private lawsuits, including purported class action lawsuits, may adversely affect such companies’ financial results. To the extent the Fund engages in origination and/or servicing directly, or has a financial interest in, or is otherwise affiliated with, an origination or servicing company, the Fund will be subject to enhanced risks of litigation, regulatory actions and other proceedings. As a result, the Fund may be required to pay legal fees, settlement costs, damages, penalties or other charges, any or all of which could materially adversely affect the Fund and its holdings.
Senior Loans
To the extent the Fund invests in senior loans, including bank loans, the Fund may be subject to greater levels of credit risk, call (or “prepayment”) risk, settlement risk and liquidity risk, than funds that do not invest in such investments. These instruments are considered predominantly speculative with respect to an issuer’s continuing ability to make principal and interest payments, and may be more volatile than other types of investments. An economic downturn or individual corporate developments could adversely affect the market for these instruments and reduce the Fund’s ability to sell these instruments at an advantageous time or price. An economic downturn would generally lead to a higher non-payment rate and, a senior loan may lose significant market value before a default occurs. In addition, the senior loans in which the Fund invests may not be listed on any exchange and a secondary market for such loans may be less liquid than markets for other investments. Consequently, transactions in senior loans may involve greater
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costs than transactions in more actively traded securities. Restrictions on transfers in loan agreements, a lack of publicly-available information, irregular trading activity and wide bid/ask spreads among other factors, may, in certain circumstances, make senior loans difficult to value accurately or sell at an advantageous time or price than other types of securities or instruments. These factors may result in the Fund being unable to realize full value for the senior loans and/or may result in the Fund not receiving the proceeds from a sale of a senior loan for an extended period after such sale, each of which could result in losses to the Fund. Senior loans may have extended trade settlement periods, which may result in sale proceeds not being immediately available to the Fund. As a result, transactions in senior loans that settle on a delayed basis may limit the Fund’s ability to make additional investments or satisfy the Fund’s repurchase obligations. The Fund may seek to satisfy any short-term liquidity needs resulting from an extended trade settlement process by, among other things, selling portfolio assets, holding additional cash or entering into temporary borrowing arrangements with banks and other potential funding sources. If an issuer of a senior loan prepays or redeems the loan prior to maturity, the Fund may have to reinvest the proceeds in other senior loans or similar instruments that may pay lower interest rates. Senior loans may not be considered securities under the federal securities laws. In such circumstances, fewer legal protections may be available with respect to the Fund’s investment in senior loans. In particular, if a senior loan is not considered a security under the federal securities laws, certain legal protections normally available to securities investors under the federal securities laws, such as those against fraud and misrepresentation, may not be available. Senior loans in which the Fund invests may be collateralized, although the loans may not be fully collateralized and the collateral may be unavailable or insufficient to meet the obligations of the borrower. The Fund may have limited rights to exercise remedies against such collateral or a borrower, and loan agreements may impose certain procedures that delay receipt of the proceeds of collateral or require the Fund to act collectively with other creditors to exercise its rights with respect to a senior loan. Because of the risks involved in investing in senior loans, an investment in the Fund that invests in such instruments should be considered speculative.
Senior loans that are covenant-lite obligations contain fewer maintenance covenants than other types of loans, or no maintenance covenants, and may not include terms that allow the lender to monitor the performance of the borrower and declare a default if certain criteria are breached. Covenant-lite obligations may carry more risk than traditional loans as they allow borrowers to engage in activities that would otherwise be difficult or impossible under a covenant-heavy loan agreement. In the event of default, covenant-lite obligations may exhibit diminished recovery values as the lender may not have the opportunity to negotiate with the borrower prior to default. The Fund may have a greater risk of loss on investments in covenant-lite obligations as compared to investments in traditional loans.
Secondary trades of senior loans may have extended settlement periods. Any settlement of a secondary market purchase of senior loans in the ordinary course, on a settlement date beyond the period expected by loan market participants (i.e., T+7 for par/near par loans and T+20 for distressed loans, in other words more than seven or twenty business days beyond the trade date, respectively) is subject to the “delayed compensation” rules prescribed by the Loan Syndications and Trading Association (“LSTA”) and addressed in the LSTA’s standard loan documentation for par/near par trades and for distressed trades. “Delayed compensation” is a pricing adjustment comprised of certain interest and fees, which is payable between the parties to a secondary loan trade. The LSTA introduced a requirements-based rules program in order to incentivize shorter settlement times for secondary transactions and discourage certain delay tactics that create friction in the loan syndications market by, among other things, mandating that the buyer of a senior loan satisfy certain “basic requirements” as prescribed by the LSTA no later than T+5 in order for the buyer to receive the benefit of interest and other fees accruing on the purchased loan from and after T+7 for par/near par loans (for distressed trades, T+20) until the settlement date, subject to certain specific exceptions. These “basic requirements” generally require a buyer to execute the required trade documentation and to be, and remain, financially able to settle the trade no later than T+7 for par/near par loans (and T+20 for distressed trades). In addition, buyers are required to fund the purchase price for a secondary trade upon receiving notice from the agent of the effectiveness of the trade in the agent’s loan register. The Fund, as a buyer of a senior loan in the secondary market, would need to meet these “basic requirements” or risk forfeiting all or some portion of the interest and other fees accruing on the loan from and after T+7 for par/near par loans (for distressed trades, T+20) until the settlement date. The “delayed compensation” mechanism does not mitigate the other risks of delayed settlement or other risks associated with investments in senior loans.
Investors should be aware that the Fund’s investment in a senior loan may result in the Fund or PIMCO receiving information about the issuer that may be deemed material, non-public information. Under such circumstances, the Fund’s investment opportunities may be limited, as trading in securities of such issuer may be restricted. Additionally, PIMCO may seek to avoid receiving material, non-public information about issuers of senior loans. As a result,
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PIMCO may forgo certain investment opportunities or be disadvantaged as compared to other investors that do not restrict information that they receive from senior loan issuers.
Delayed Funding Loans and Revolving Credit Facilities
The Fund may also enter into, or acquire participations in, delayed funding loans and revolving credit facilities. Delayed funding loans and revolving credit facilities are borrowing arrangements in which the lender agrees to make loans up to a maximum amount upon demand by the borrower during a specified term. A revolving credit facility differs from a delayed funding loan in that as the borrower repays the loan, an amount equal to the repayment may be borrowed again during the term of the revolving credit facility. Delayed funding loans and revolving credit facilities usually provide for floating or variable rates of interest. These commitments may have the effect of requiring the Fund to increase its investment in an issuer at a time when it might not otherwise decide to do so (including at a time when the issuer’s financial condition makes it unlikely that such amounts will be repaid).
The Fund may invest in delayed funding loans and revolving credit facilities with credit quality comparable to that of issuers of its securities investments. Delayed funding loans and revolving credit facilities may be subject to restrictions on transfer, and only limited opportunities may exist to resell such instruments. As a result, the Fund may be unable to sell such investments at an opportune time or may have to resell them at less than fair market value. For a further discussion of the risks involved in investing in loan participations and other forms of direct indebtedness see “Loans and Other Indebtedness; Loan Participations and Assignments.” Participation interests in revolving credit facilities will be subject to the limitations discussed in “Loans and Other Indebtedness; Loan Participations and Assignments.” Delayed funding loans and revolving credit facilities are considered to be debt obligations for purposes of the Fund’s investment restriction relating to the lending of funds or assets by the Fund.
Zero-Coupon Bonds, Step-Ups and Payment-In-Kind Securities
The Fund may invest directly or indirectly in zero-coupon securities, “step-ups” and PIKs. 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. PIKs are debt obligations that pay “interest” in the form of other debt obligations instead of cash. Each of these instruments is normally issued and traded at a deep discount from face value. The amount of the discount varies depending on such factors as the time remaining until maturity of the securities, prevailing interest rates, the liquidity of the security and the perceived credit quality of the issuer. The market prices of zero-coupon bonds, step-ups and PIKs generally are more volatile than the market prices of debt instruments that pay interest currently and in cash and are likely to respond to changes in interest rates to a greater degree than do other types of securities having similar maturities and credit quality.
In order to satisfy a requirement for qualification as a regulated investment company under the 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 (“OID”) accrued on zero-coupon bonds, step-ups and PIKs. Because the Fund will not, on a current basis, receive cash payments from the issuer of these securities in respect of any accrued OID, in some years, the Fund may have to sell other portfolio holdings in order to obtain cash to satisfy the distribution requirements under the Code even though investment considerations might otherwise make it undesirable for the Fund to sell securities at such time. Under many market conditions, investments in zero-coupon bonds, step-ups and PIKs may be illiquid, making it difficult for the Fund to dispose of them or determine their current value.
Variable and Floating Rate Debt 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, including Senior Loans (described in more detail above). Variable and floating rate securities are securities that pay interest at rates that adjust whenever a specified interest rate changes, float at a fixed margin above a generally recognized base lending rate and/or reset or are redetermined (e.g.,
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pursuant to an auction) on specified dates (such as the last day of a month or calendar quarter). These instruments may include, without limitation, variable-rate preferred securities, bank loans, money market instruments and certain types of mortgage-backed and other ABS. Due to their variable- or floating-rate features, these instruments will generally pay higher levels of income in a rising interest rate environment and lower levels of income as interest rates decline. For the same reason, the market value of a variable- or floating-rate instrument is generally expected to have less sensitivity to fluctuations in market interest rates than a fixed-rate instrument, although the value of a floating-rate instrument may nonetheless decline as interest rates rise and due to other factors, such as changes in credit quality.
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 which is tied to another interest rate, such as a money-market index or U.S. 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 rises in 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 securities or currencies 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 without limit 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 floater may exhibit greater price volatility than a fixed rate obligation of similar credit quality. See “Mortgage-Related and Other Asset-Backed Securities” above. The Fund’s investments in variable- and floating-rate securities may require the Fund to accrue and distribute income not yet received. As a result, in order to generate cash to make the requisite distributions, the Fund may be required to sell securities in its portfolio that it would otherwise have continued to hold. See “Taxation.”
The Fund may invest in residual interest bonds. The term “residual interest bonds” generally includes tender option bond trust residual interest certificates and instruments designed to receive residual interest payments or other excess cash flows from collateral pools once other interest holders and expenses have been paid.
Inflation-Indexed Bonds
The Fund may invest in inflation-indexed bonds. Inflation-indexed bonds are fixed-income securities whose principal value is periodically adjusted according to the rate of inflation. Two structures are common. The U.S. Treasury and some other issuers use a structure that accrues inflation into the principal value of the bond. Many other issuers pay out the Consumer Price Index accruals as part of a semiannual coupon.
Inflation-indexed securities issued by the U.S. Treasury have maturities of approximately five, ten or thirty years, although it is possible that securities with other maturities will be issued in the future. The U.S. Treasury securities pay interest on a semi-annual basis equal to a fixed percentage of the inflation-adjusted principal amount. For example, if the Fund purchased an inflation-indexed bond with a par value of $1,000 and a 3% real rate of return coupon (payable 1.5% semi-annually), and the rate of inflation over the first six months was 1%, the mid-year par value of the bond would be $1,010 and the first semi-annual interest payment would be $15.15 ($1,010 times 1.5%). If inflation during the second half of the year resulted in the whole year’s inflation equaling 3%, the end-of-year par value of the bond would be $1,030 and the second semi-annual interest payment would be $15.45 ($1,030 times 1.5%).
If the periodic adjustment rate measuring inflation falls, the principal value of inflation-indexed bonds will be adjusted downward, and consequently the interest payable on these securities (calculated with respect to a smaller principal amount) will be reduced. Repayment of the original bond principal upon maturity (as adjusted for inflation) is guaranteed in the case of a U.S. Treasury inflation-indexed bond, even during a period of deflation, although the inflation-adjusted principal received could be less than the inflation-adjusted principal that had accrued to the bond at the time of purchase. However, the current market value of the bonds is not guaranteed and will fluctuate. The Fund also may invest in other inflation-related bonds which may or may not provide a similar guarantee. If a guarantee of principal is not provided, the adjusted principal value of the bond repaid at maturity may be less than the original principal.
The value of inflation-indexed bonds is expected to change in response to changes in real interest rates. Real interest rates in turn are tied to the relationship between nominal interest rates and the rate of inflation. Therefore, if
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inflation were to rise at a faster rate than nominal interest rates, real interest rates might decline, leading to an increase in value of inflation-indexed bonds. In contrast, if nominal interest rates increase at a faster rate than inflation, real interest rates might rise, leading to a decrease in value of inflation-indexed bonds.
While these securities are expected to provide protection from long-term inflationary trends, short-term increases in inflation may lead to a decline in value. If interest rates rise due to reasons other than inflation (for example, due to changes in currency exchange rates), investors in these securities may not be protected to the extent that the increase is not reflected in the bond’s inflation measure.
The periodic adjustment of U.S. inflation-indexed bonds is tied to the Consumer Price Index for All Urban Consumers (“CPI-U”), which is not seasonally adjusted and which is calculated monthly by the U.S. Bureau of Labor Statistics. The CPI-U is a measurement of changes in the cost of living, made up of components such as housing, food, transportation and energy. Inflation-indexed bonds issued by a foreign (non-U.S.) government are generally adjusted to reflect a comparable inflation index calculated by that government. There can be no assurance that the CPI-U or any foreign (non-U.S.) inflation index will accurately measure the real rate of inflation in the prices of goods and services. Moreover, there can be no assurance that the rate of inflation in a foreign (non-U.S.) country will be correlated to the rate of inflation in the United States.
Any increase in the principal amount of an inflation-indexed bond will be considered taxable ordinary income, even though investors do not receive their principal until maturity. As a result, in order to generate cash to make the requisite distributions, the Fund may be required to sell securities in its portfolio that it would otherwise have continued to hold. See “Taxation.”
Event-Linked Bonds
The Fund may obtain event-linked exposure by investing in “event-linked bonds,” or “event-linked swaps,” or by implementing “event-linked strategies.” Event-linked exposure results in gains that typically are contingent on the non-occurrence of a specific “trigger” event, such as a hurricane, earthquake or other physical or weather-related phenomena. Some event-linked bonds are commonly referred to as “catastrophe bonds.” They may be issued by government agencies, insurance companies, reinsurers, special purpose corporations or other on-shore or off-shore entities (such special purpose entities are created to accomplish a narrow and well-defined objective, such as the issuance of a note in connection with a reinsurance transaction). If a trigger event causes losses exceeding a specific amount in the geographic region and time period specified in a bond, the Fund may lose a portion or all of its principal invested in the bond. If no trigger event occurs, the Fund will recover its principal plus interest. For some event-linked bonds, the trigger event or losses may be based on company-wide losses, index-portfolio losses, industry indices or readings of scientific instruments rather than specified actual losses. Often the event-linked bonds provide for extensions of maturity that are mandatory, or optional at the discretion of the issuer, in order to process and audit loss claims in those cases where a trigger event has, or possibly has, occurred. An extension of maturity may increase volatility. In addition to the specified trigger events, event-linked bonds also may expose the Fund to certain unanticipated risks including but not limited to issuer risk, credit risk, counterparty risk, adverse regulatory or jurisdictional interpretations and adverse tax consequences.
Event-linked bonds are a relatively new type of financial instrument. As such, there is no significant trading history for many of these securities, and there can be no assurance that a liquid market in these instruments will develop. Lack of a liquid market may impose the risk of higher transaction costs and the possibility that the Fund may be forced to liquidate positions when it would not be advantageous to do so. Event-linked bonds are typically rated, and the Fund will only invest in event-linked bonds that meet the credit quality requirements for the Fund.
Commodities
The Fund may purchase or sell derivatives, securities or other instruments that provide exposure to commodities. The Fund’s investments in commodities-related instruments may subject the Fund to greater volatility than investments in traditional securities. The value of commodity-related instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. An unexpected surplus of a commodity caused by one of the aforementioned factors, for example, may cause a significant decrease in the value of the commodity (and a decrease in the value of any
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investments directly correlated to the commodity). Conversely, an unexpected shortage of a commodity caused by one of the aforementioned factors may cause a significant increase in the value of the commodity (and a decrease in the value of any investments inversely correlated to that commodity). The commodity markets are subject to temporary distortions and other disruptions due to, among other factors, lack of liquidity, the participation of speculators, and government regulation and other actions.
The Fund may focus its commodity-related investments in a particular sector of the commodities market (such as gold, oil, metal, carbon or agricultural products). As a result, to the extent the Fund focuses its investments in a particular sector of the commodities market, the Fund may be more susceptible to risks associated with those sectors, including the risk of loss due to adverse economic, business or political developments affecting a particular sector. See “Derivative Instruments” below for a more detailed discussion of risks related to commodities, including additional discussion of commodity-related derivative instruments.
Derivative Instruments
In pursuing its investment objectives, the Fund may, to the extent permitted by its investment objectives and policies, purchase and sell (write) both put options and call options on securities, swap agreements, recovery locks, securities indexes, commodity indexes and foreign currencies, and enter into interest rate, foreign currency, index and commodity futures contracts and purchase and sell options on such futures contracts (“futures options”) for hedging purposes, to seek to replicate the composition and performance of a particular index, or as part of its overall investment strategies. The Fund also may purchase and sell foreign currency options for purposes of increasing exposure to a foreign currency or to shift exposure to foreign currency fluctuations from one currency to another. The Fund also may enter into swap agreements with respect to interest rates, commodities, indexes of securities or commodities and, to the extent it may invest in foreign currency-denominated securities, may enter into swap agreements with respect to foreign currencies. The Fund may invest in structured notes and enter into transactions involving other similar instruments as discussed herein. All of these transactions are referred to collectively herein as “derivatives”. If other types of financial instruments, including other types of options, futures contracts, or futures options are traded in the future, the Fund also may use those instruments, provided that their use is consistent with the Fund’s investment objectives.
The value of some derivative instruments in which the Fund invests 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 additional, unforeseen risks, including the risk of loss.
The Fund might not employ any of the strategies described herein, and no assurance can be given that any strategy used will succeed. Like most other investments, derivatives are subject to the risk that the market value of the instrument will change in a way detrimental to the Fund's interest. If PIMCO incorrectly forecasts interest rates, market values or other economic factors in using 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 derivatives 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. Because many derivatives have a leverage component, adverse changes in the value or level of the underlying asset, reference rate or index could result in a loss substantially greater than the amount invested in the derivative itself. The use of certain derivatives involves the risk that a loss may be sustained as a result of the failure of another party (usually referred to as a “counterparty”) to make required payments or otherwise comply with the contract's terms. Counterparty risk also includes the risks of having concentrated exposure to a counterparty. Using derivatives is also subject to operational and legal risks. Operational risk generally refers to risk related to potential operational issues, including documentation issues, settlement issues, systems failures, inadequate controls, and human error. Legal risk generally refers to insufficient documentation, insufficient capacity or authority of counterparty, or legality or enforceability of a contract. 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. This is due in part to liquidity risk which refers 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 and the possible inability of the Fund to close out or to liquidate its derivatives positions. Liquidity risk also refers to the risk that the Fund may be required to hold additional cash or sell
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other investments in order to obtain cash to close out derivatives or meet the liquidity demands that derivatives can create to make payments of margin, collateral, or settlement payments to counterparties. The Fund may have to sell a security at a disadvantageous time or price to meet such obligations. In addition, the Fund’s use of such instruments may cause the Fund to realize higher amounts of short-term capital gains (generally taxed upon distribution at ordinary income tax rates) than if it had not used such instruments. If the Fund gains exposure to an asset class using derivative instruments backed by a collateral portfolio of fixed-income instruments, changes in the value of the fixed-income instruments may result in greater or lesser exposure to that asset class than would have resulted from a direct investment in securities comprising that asset class. The Fund may invest in derivatives to the extent permitted by the Investment Company Act of 1940, as amended (the “Act”), and rules and interpretations thereunder and other federal securities laws.
Participation in the markets for derivative instruments involves investment risks and transaction costs to which the Fund may not be subject absent the use of these strategies. The skills needed to successfully execute derivative strategies may be different from those needed for other types of transactions. If the Fund incorrectly forecasts the value and/or creditworthiness of securities, currencies, interest rates, counterparties or other economic factors involved in a derivative transaction, the Fund might have been in a better position if the Fund had not entered into such derivative transaction. In evaluating the risks and contractual obligations associated with particular derivative instruments, it is important to consider that certain derivative transactions may be modified or terminated only by mutual consent of the Fund and its counterparty and certain derivative transactions may be terminated by the counterparty or the Fund, as the case may be, upon the occurrence of certain Fund-related or counterparty-related events, which may result in losses or gains to the Fund based on the market value of the derivative transactions entered into between the Fund and the counterparty. In addition, such early terminations may result in taxable events and accelerate gain or loss recognition for tax purposes. It may not be possible for the Fund to modify, terminate, or offset the Fund’s obligations or the Fund’s exposure to the risks associated with a derivative transaction prior to its termination or maturity date, which may create a possibility of increased volatility and/or decreased liquidity to the Fund. Upon the expiration or termination of a particular contract, the Fund may wish to retain the Fund’s position in the derivative instrument by entering into a similar contract, but may be unable to do so if the counterparty to the original contract is unwilling or unable to enter into the new contract and no other appropriate counterparty can be found, which could cause the Fund not to be able to maintain certain desired investment exposures or not to be able to hedge other investment positions or risks, which could cause losses to the Fund. Furthermore, after such an expiration or termination of a particular contract, the Fund may have fewer counterparties with which to engage in additional derivative transactions, which could lead to potentially greater counterparty risk exposure to one or more counterparties and which could increase the cost of entering into certain derivatives. In such cases, the Fund may lose money.
The Fund may engage in investment strategies, including the use of derivatives, to, among other things, generate current, distributable income, even if such strategies could potentially result in declines in the Fund’s net asset value. The Fund’s income and gain-generating strategies, including certain derivatives strategies, may generate current taxable income and gains sufficient to support distributions even in situations when the Fund has experienced losses due to, for example, adverse changes in the broad U.S. or non-U.S. equity markets or the Fund’s debt investments, or arising from its use of derivatives. Consequently, shareholders may receive distributions subject to tax at ordinary income rates at a time when their investment in the Fund has declined in value, which may be economically similar to a taxable return of capital.
The tax treatment of certain derivatives may be open to different interpretations. Any recharacterization of payments made or received by the Fund pursuant to derivatives potentially could affect the amount, timing or characterization of Fund distributions. In addition, the tax treatment of such investment strategies may be changed by regulation or otherwise.
Options on Securities and Indexes. The Fund may purchase and sell both put and call options on equity, fixed-income or other securities (including securities to be purchased in when-issued, delayed delivery and forward commitment transactions)or indexes in standardized contracts traded on foreign or domestic securities exchanges, boards of trade, or similar entities, or quoted on the National Association of Securities Dealers Automated Quotations (“NASDAQ”) System or on an OTC market, and agreements, sometimes called cash puts, which may accompany the purchase of a new issue of bonds from a dealer.
An option on a security (or 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
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the option (or the cash value of an option that is on an index or cash settled) at a specified exercise price, often at any time during the term of the option for American options or only at expiration for European options. The writer of an option on a security that requires physical delivery has the obligation upon exercise of the option to deliver the underlying security upon payment of the exercise price (in the case of a call) or to pay the exercise price upon delivery of the underlying security (in the case of a put). Certain put options written by the Fund, which counterparties may use as a source of liquidity, may be structured to have an exercise price that is less than the market value of the underlying securities that would be received by the Fund. Upon exercise, the writer of an option on an index or a cash-settled option on a security is obligated to pay the difference between the cash value of the index and the exercise price multiplied by the specified multiplier for the option. (An index is designed to reflect features of a particular financial or securities market, a specific group of financial instruments or securities, or certain economic indicators.)
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 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 ask prices.
The Fund may write straddles consisting of a combination of a call and a put written on the same underlying security.
Risks Associated with Options on Securities and Indexes. There are several risks associated with transactions in options on securities and on indexes. For example, there are significant differences between the securities and options markets that could result in an imperfect correlation between these markets, causing a given transaction not to achieve its 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.
The writer of an American option often 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. To the extent the Fund writes a put option, the Fund has assumed the obligation during the option period to purchase the underlying investment from the put buyer at the option’s exercise price if the put buyer exercises its option, regardless of whether the value of the underlying investment falls below the exercise price. This means that the Fund that writes a put option may be required to take delivery of the underlying investment and make payment for such investment at the exercise price. This may result in losses to the Fund and may result in the Fund holding the underlying investment for some period of time when it is disadvantageous to do so. 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
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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 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. 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.
To the extent that the Fund writes a call option on a security it holds in its portfolio, the Fund 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 during the option period, but, as long as its obligation under such call option continues, has retained the risk of loss should the price of the underlying security decline.
Foreign Currency Options. To the extent the Fund invests in foreign currency-denominated securities, it may buy or sell put and call options on foreign currencies. In addition, the Fund may buy or sell put and call options on foreign currencies either on exchanges or in the OTC market. A put option on a foreign currency gives the purchaser of the option the right to sell a foreign currency at the exercise price until the option expires. A call option on a foreign currency gives the purchaser of the option the right to purchase the currency at the exercise price until the option expires. Currency options traded on U.S. or other exchanges may be subject to position limits which may limit the ability of the Fund to reduce foreign currency risk using such options. OTC options differ from exchange-traded options in that they are bilateral contracts with price and other terms negotiated between buyer and seller, and generally do not have as much market liquidity as exchange-traded options. Under definitions adopted by the CFTC and SEC, many foreign currency options are considered swaps for certain purposes, including determination of whether such instruments need to be exchange-traded and centrally cleared as discussed further in “Risks of Potential Government Regulation of Derivatives.”
Futures Contracts and Options on Futures Contracts. A futures contract is an agreement to buy or sell a security or other asset for a set price on a future date. These contracts are traded on exchanges, so that, in most cases, a party can close out its position on the exchange for cash, without delivering the underlying security or other underlying asset. An option on a futures contract gives the holder of the option the right to buy or sell a position in a futures contract from or to the writer of the option, at a specified price and on or before a specified expiration date. The Fund may invest in futures contracts and options thereon (“futures options”) with respect to, but not limited to, interest rates, commodities, and security or commodity indexes. To the extent that the Fund may invest in foreign currency-denominated securities, it also may invest in foreign currency futures contracts and options thereon.
An interest rate, commodity, foreign currency or index futures contract provides for the future sale or purchase of a specified quantity of a financial instrument, commodity, foreign currency or the cash value of an index at a specified price and time. A futures contract on an index is an agreement pursuant to which a party agrees to pay or receive an amount of cash equal to the difference between the value of the index at the close of the last trading day of the contract and the price at which the index contract was originally written. Although the value of an index might be a function of the value of certain specified securities, no physical delivery of these securities is made.
A public market exists in futures contracts covering a number of indexes as well as financial instruments and foreign currencies, including, but not limited to: the S&P 500; the S&P Midcap 400; the Nikkei 225; the Markit CDX credit index; the iTraxx credit index; U.S. Treasury bonds; U.S. Treasury notes; U.S. Treasury bills; 90-day commercial paper; bank certificates of deposit; Eurodollar certificates of deposit; the Australian dollar; the Canadian dollar; the British pound; the Japanese yen; the Swiss franc; the Mexican peso; and certain multinational currencies, such as the euro. It is expected that other futures contracts will be developed and traded in the future. Certain futures contracts on indexes, financial instruments or foreign currencies may represent new investment products that lack performance track records.
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The Fund also may invest in commodity futures contracts and options thereon. A commodity futures contract is an agreement to buy or sell a commodity, such as an energy, agricultural, metal or carbon commodity at a later date at a price and quantity agreed-upon when the contract is bought or sold.
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. 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.
Limitations on Use of Futures and Futures Options. When a purchase or sale of a futures contract is made by the Fund, the Fund is required to deposit with its custodian a specified amount of assets determined to be liquid by PIMCO (“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. Margin requirements on foreign exchanges may be different than U.S. exchanges. The initial margin is in the nature of a performance bond or good faith deposit on the futures contract which is returned to the Fund upon termination of the contract, assuming all contractual obligations have been satisfied. The Fund expects to earn interest income on its initial margin deposits. A futures contract held by the Fund is valued daily at the official settlement price of the exchange on which it is traded. Each day the Fund pays or receives cash, called “variation margin,” equal to the daily change in value of the futures contract. This process is known as “marking to market.” Variation margin does not represent a borrowing or loan by the Fund but is instead a settlement between the Fund and the broker of the amount one would owe the other if the futures contract expired. In computing daily net asset value, the Fund will mark to market its open futures positions.
The Fund is also required to deposit and maintain margin with respect to put and call options on futures contracts written by it. Such margin deposits will vary depending on the nature of the underlying futures contract (and the related initial margin requirements), the current market value of the option, and other futures positions held by the Fund. Customer account agreements and related addenda govern cleared derivatives transactions such as futures, options on futures, and cleared OTC derivatives. Such transactions require posting of initial margin as determined by each relevant clearing agency which is segregated in an account at a futures commission merchant (“FCM”) registered with the CFTC. In the United States, counterparty risk may be reduced as creditors of an FCM cannot have a claim to Fund assets in the segregated account. Portability of exposure reduces risk to the Fund. Variation margin, or changes in market value, are generally exchanged daily, but may not be netted between futures and cleared OTC derivatives unless the parties have agreed to a separate arrangement in respect of portfolio margining.
Although some futures contracts call for making or taking delivery of the underlying securities or commodities, generally these obligations are closed out prior to delivery by offsetting purchases or sales of matching futures contracts (same exchange, underlying security or index, and delivery month). Closing out a futures contract sale is effected by purchasing an offsetting futures contract for the same aggregate amount of the specific type of financial instrument or commodity with the same delivery date. 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. Any transaction costs must also be included in these calculations.
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.
Commodity Pool Operators and Commodity Trading Advisors. The CFTC has adopted regulations that subject registered investment companies and their investment advisers to regulation by the CFTC if the registered investment company invests more than a prescribed level of its liquidation value in commodity futures, options on futures commodities or commodity futures, swaps, or other financial instruments regulated under the Commodity Exchange Act of 1936, as amended (“CEA”) and the rules thereunder (“commodity interests”), or if the fund markets itself as providing investment exposure to such instruments. As of the date of this Statement of Additional Information, pursuant to CFTC Rule 4.5, PIMCO has claimed an exclusion from the definition of commodity pool operator
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(“CPO”) under the CEA with respect to the Fund, and is therefore not subject to registration or regulation as a CPO with respect to the Fund. To remain eligible for this exclusion the Fund must comply with certain limitations, including limits on its ability to use any commodity interests and limits on the manner in which the Fund holds out its use of such commodity interests. These limitations may restrict the Fund’s ability to pursue its investment strategy, increase the costs of implementing its strategy, increase expenses of the Fund, and/or adversely affect the Fund’s total return.
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 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 U.S. Government securities. 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 or a futures option position, and that 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.
Risks Associated with Commodity Futures Contracts. There are several additional risks associated with transactions in commodity futures contracts, including but not limited to:
Storage. Unlike the financial futures markets, in the commodity futures markets there are costs of physical storage associated with purchasing the underlying commodity. The price of the commodity futures contract will reflect the storage costs of purchasing the physical commodity, including the time value of money invested in the physical commodity. To the extent that the storage costs for an underlying commodity change while the Fund is invested in futures contracts on that commodity, the value of the futures contract may change proportionately.
Reinvestment. In the commodity futures markets, producers of the underlying commodity may decide to hedge the price risk of selling the commodity by selling futures contracts today to lock in the price of the commodity at delivery tomorrow. In order to induce speculators to purchase the other side of the same futures contract, the commodity producer generally must sell the futures contract at a lower price than the expected future spot price. Conversely, if most hedgers in the futures market are purchasing futures contracts to hedge against a rise in prices, then speculators will only sell the other side of the futures contract at a higher futures price than the expected future spot price of the commodity. The changing nature of the hedgers and speculators in the commodity markets will influence whether
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futures prices are above or below the expected future spot price, which can have significant implications for the Fund. If the nature of hedgers and speculators in futures markets has shifted when it is time for the Fund to reinvest the proceeds of a maturing contract in a new futures contract, the Fund might reinvest at higher or lower futures prices, or choose to pursue other investments.
Other Economic Factors. The commodities which underlie commodity futures contracts may be subject to additional economic and non-economic variables, such as drought, floods, weather, livestock disease, embargoes, tariffs, and international economic, political and regulatory developments. These factors may have a larger impact on commodity prices and commodity-linked instruments, including futures contracts, than on traditional securities. Certain commodities are also subject to limited pricing flexibility because of supply and demand factors. Others are subject to broad price fluctuations as a result of the volatility of the prices for certain raw materials and the instability of supplies of other materials. These additional variables may create additional investment risks which subject the Fund’s investments to greater volatility than investments in traditional securities.
Additional Risks of Options on Securities, Futures Contracts, Options on Futures Contracts and Forward Currency Exchange Contracts and Options Thereon. Options on securities, futures contracts, options on futures contracts, forward currency exchange contracts and options on forward currency exchange contracts may be traded on foreign (non-U.S.) exchanges. Such transactions may not be regulated as effectively as similar transactions in the United States; may not involve a clearing mechanism and related guarantees; and are subject to the risk of governmental actions affecting trading in, or the prices of, foreign (non-U.S.) securities. The value of such positions also could be adversely affected by: (i) other complex foreign (non-U.S.) political, legal and economic factors; (ii) lesser availability than in the United States of data on which to make trading decisions; (iii) delays in the Fund’s ability to act upon economic events occurring in foreign (non-U.S.) markets during non-business hours in the United States; (iv) the imposition of different exercise and settlement terms and procedures and margin requirements than in the United States; and (v) lesser trading volume.
Swap Agreements and Options on Swap Agreements. The Fund may engage in swap transactions, including, but not limited to, swap agreements on interest rates, security or commodity indexes, specific securities and commodities, and credit and event-linked swaps. To the extent the Fund may invest in foreign (non-U.S.) currency-denominated securities, it also may invest in currency exchange rate swap agreements. The Fund also may enter into options on swap agreements (“swaptions”).
The Fund may enter into swap transactions for any legal purpose consistent with its investment objectives and policies, such as attempting to obtain or preserve a particular return or spread at a lower cost than obtaining a return or spread through purchases and/or sales of instruments in other markets, to protect against currency fluctuations, as a duration management technique, to protect against any increase in the price of securities the Fund anticipates purchasing at a later date, or to gain exposure to certain markets in a more cost efficient manner.
OTC swap agreements are bilateral contracts entered into primarily by institutional investors for periods ranging from a few weeks to more than one year. In a standard OTC swap transaction, two parties agree to exchange the returns (or differentials in rates of return) earned or realized on particular predetermined investments or instruments. 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 change in value of a particular dollar amount invested at a particular interest rate, in a particular foreign (non-U.S.) currency, or in a “basket” of securities or commodities representing a particular index. A “quanto” or “differential” swap combines both an interest rate and a currency transaction. Certain swap agreements, such as interest rate swaps, are traded on exchanges and cleared through central clearing counterparties. Other forms of swap agreements include interest rate caps, under which, in return for a premium, one party agrees to make payments to the other to the extent that interest rates exceed a specified rate, or “cap”; interest rate floors, under which, in return for a premium, one party agrees to make payments to the other to the extent that interest rates fall below a specified rate, or “floor”; and interest rate collars, under which a party sells a cap and purchases a floor or vice versa in an attempt to protect itself against interest rate movements exceeding given minimum or maximum levels. A total return swap agreement is a contract in which one party agrees to make periodic payments to another party based on the change in market value of underlying assets, which may include a single stock, a basket of stocks, or a stock index during the specified period, in return for periodic payments based on a fixed or variable interest rate or the total return from other underlying assets. Consistent with the Fund’s investment objectives and general investment policies, the Fund may invest in commodity swap agreements. For example, an investment in a commodity swap agreement may involve the exchange of floating-rate interest payments for the total return on a commodity index. In a total return
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commodity swap, the Fund will receive the price appreciation of a commodity index, a portion of the index, or a single commodity in exchange for paying an agreed-upon fee. If the commodity swap is for one period, the Fund may pay a fixed fee, established at the outset of the swap. However, if the term of the commodity swap is more than one period, with interim swap payments, the Fund may pay an adjustable or floating fee. With a “floating” rate, the fee may be pegged to a base rate and is adjusted each period. Therefore, if interest rates increase over the term of the swap contract, the Fund may be required to pay a higher fee at each swap reset date.
The Fund also may enter into combinations of swap agreements in order to achieve certain economic results. For example, the Fund may enter into two swap transactions, one of which offsets the other for a period of time. After the offsetting swap transaction expires, the Fund would be left with the economic exposure provided by the remaining swap transaction. The intent of such an arrangement would be to lock in certain terms of the remaining swap transaction that the Fund may wish to gain exposure to in the future without having that exposure during the period the offsetting swap is in place.
The Fund also may enter into swaptions. A swaption is a contract that gives a counterparty the right (but not the obligation) in return for payment of a premium, 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.
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.
The Fund also may enter into forward volatility agreements, also known as volatility swaps. In a volatility swap, the counterparties agree to make payments in connection with changes in the volatility (i.e., the magnitude of change over a specified period of time) of an underlying reference instrument, such as a currency, rate, index, security or other financial instrument. Volatility swaps permit the parties to attempt to hedge volatility risk and/or take positions on the projected future volatility of an underlying reference instrument. For example, the Fund may enter into a volatility swap in order to take the position that the reference instrument’s volatility will increase over a particular period of time. If the reference instrument’s volatility does increase over the specified time, the Fund will receive a payment from its counterparty based upon the amount by which the reference instrument’s realized volatility level exceeds a volatility level agreed upon by the parties. If the reference instrument’s volatility does not increase over the specified time, the Fund will make a payment to the counterparty based upon the amount by which the reference instrument’s realized volatility level falls below the volatility level agreed upon by the parties. Payments on a volatility swap will be greater if they are based upon the mathematical square of volatility (i.e., the measured volatility multiplied by itself, which is referred to as “variance”). This type of a volatility swap is frequently referred to as a variance swap. The Fund may potentially engage in variance swaps.
Most types of swap agreements entered into by the Fund will 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 also may enter into OTC and cleared credit default swap agreements. A credit default swap agreement may reference one or more debt securities or obligations that are not currently held by the Fund. The protection “buyer” in an OTC credit default swap contract is generally obligated to pay the protection “seller” an upfront or a periodic stream of payments over the term of the contract until a credit event, such as a default, on a reference obligation has occurred. If a credit event occurs, the seller generally must pay the buyer the “par value” (full notional value) of the swap in exchange for an equal face amount of deliverable obligations of the reference entity described in the swap, or the seller may be required to deliver the related net cash amount if the swap is cash settled. The Fund may be either the buyer or seller in the transaction. If the Fund is a buyer and no credit event occurs, the Fund may recover nothing if the swap is held through its termination date. However, if a credit event occurs, the buyer may receive the full notional value of the swap in exchange for an equal face amount of deliverable obligations of the reference entity whose value may have significantly decreased.
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As a seller, the Fund generally receives an upfront payment or a fixed rate of income throughout the term of the swap provided that there is no credit event. As the seller, the Fund would effectively add leverage to its portfolio because, in addition to its total net assets, the Fund would be subject to investment exposure on the notional amount of the swap.
The spread of a credit default swap is the annual amount the protection buyer must pay the protection seller over the length of the contract, expressed as a percentage of the notional amount. When spreads rise, market-perceived credit risk rises and when spreads fall, market-perceived credit risk falls. Wider credit spreads and decreasing market values, when compared to the notional amount of the swap, represent a deterioration of the credit soundness of the issuer of the reference obligation and a greater likelihood or risk of default or other credit event occurring as defined under the terms of the agreement. For credit default swap agreements on asset-based securities and credit indices, the quoted market prices and resulting values, as well as the annual payment rate, serve as an indication of the current status of the payment/performance risk.
Credit default swap agreements sold by the Fund may involve greater risks than if the Fund had invested in the reference obligation directly since, in addition to general market risks, credit default swaps are subject to illiquidity risk, counterparty risk (with respect to OTC credit default swaps) and credit risk. The Fund will enter into uncleared credit default swap agreements only with counterparties that meet certain standards of creditworthiness. A buyer generally also will lose its investment and recover nothing should no credit event occur and the swap is held to its termination date. If a credit event were to occur, the value of any deliverable obligation received by the seller, coupled with the upfront or periodic payments previously received, may be less than the full notional value it pays to the buyer, resulting in a loss of value to the seller. In addition, there may be disputes between the buyer and seller of a credit default swap agreement or within the swaps market as a whole as to whether a credit event has occurred or what the payment should be. Such disputes could result in litigation or other delays, and the outcome could be adverse for the buyer or seller.
The Fund’s obligations under a credit default swap agreement will be accrued daily (offset against any amounts owing to the Fund).
The Dodd-Frank Act and related regulatory developments require the clearing and exchange-trading of certain standardized OTC derivative instruments that the CFTC and SEC have defined as “swaps.” The CFTC has implemented mandatory exchange-trading and clearing requirements under the Dodd-Frank Act and the CFTC continues to approve contracts for central clearing. Uncleared swaps are subject to certain margin requirements that mandate the posting and collection of minimum margin amounts on certain uncleared swaps transactions, which may result in the Fund and its counterparties posting higher margin amounts for uncleared swaps than would otherwise be the case. These amounts beyond coverage of daily exposure, if any, may (or if required by law, will) be segregated with a third-party custodian. To the extent the Fund is required by regulation to post additional collateral beyond coverage of daily exposure, it could potentially incur costs, including in procuring eligible assets to meet collateral requirements, associated with such posting. PIMCO will continue to monitor developments in this area, particularly to the extent regulatory changes affect the Fund’s ability to enter into swap agreements.
Whether the Fund’s use of swap agreements or swaptions will be successful in furthering its investment objectives will depend on PIMCO’s ability to predict correctly whether certain types of investments are likely to produce greater returns than other investments. 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 OTC swap agreements only with counterparties that meet certain standards of creditworthiness. Certain restrictions imposed on the Fund by the Code may limit the Fund’s ability to use swap agreements. The swaps market is subject to increasing regulations, in both U.S. and non-U.S. markets. It is possible that developments in the swaps market, including additional government regulation, could adversely affect the Fund’s ability to terminate existing swap agreements or to realize amounts to be received under such agreements.
Swaps are highly specialized instruments that require investment techniques, risk analyses, and tax planning different from those associated with traditional investments. The use of a swap requires an understanding not only of the reference asset, reference rate, or index but also of the swap itself, without the benefit of observing the performance of the swap under all possible market conditions. Because OTC swap agreements are bilateral contracts that may be subject to contractual restrictions on transferability and termination and because they may have remaining
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terms of greater than seven days, swap agreements may be considered to be illiquid and subject to regulatory limitations on investments in illiquid investments. Please refer to “Illiquid Investments” for further discussion of regulatory considerations and constraints relating to investment liquidity. To the extent that a swap is not liquid, it may not be possible to initiate a transaction or liquidate a position at an advantageous time or price, which may result in significant losses.
Like most other investments, swap agreements are subject to the risk that the market value of the instrument will change in a way detrimental to the Fund’s interest. The Fund bears the risk that PIMCO will not accurately forecast future market trends or the values of assets, reference rates, indexes, or other economic factors in establishing swap positions for the Fund. If PIMCO attempts to use a swap as a hedge against, or as a substitute for, a portfolio investment, the Fund will be exposed to the risk that the swap will have or will develop imperfect or no correlation with the portfolio investment. This could cause substantial losses for the Fund. While hedging strategies involving swap 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 other Fund investments. Many swaps are complex and often valued subjectively.
The Fund also may enter into recovery locks. A recovery lock is an agreement between two parties that provides for a fixed payment by one party and the delivery of a reference obligation, typically a bond, by the other party upon the occurrence of a credit event, such as a default, by the issuer of the reference obligation. Recovery locks are used to “lock in” a recovery amount on the reference obligation at the time the parties enter into the agreement. In contrast to a credit default swap where the final settlement amount may be dependent on the market price for the reference obligation upon the credit event, a recovery lock fixes the settlement amount in advance and is not dependent on the market price of the reference obligation at the time of the credit event. Unlike certain other types of derivatives, recovery locks generally do not involve upfront or periodic cash payments by either of the parties. Instead, payment and settlement occurs after there has been a credit event. If a credit event does not occur prior to the termination date of a recovery lock, the agreement terminates and no payments are made by either party. The Fund may enter into a recovery lock to purchase or sell a reference obligation upon the occurrence of a credit event.
Recovery locks are subject to the risk that PIMCO will not accurately forecast the value of a reference obligation upon the occurrence of a credit event. For example, if the Fund enters into a recovery lock and agrees to deliver a reference obligation in exchange for a fixed payment upon the occurrence of a credit event, the value of the reference obligation or eventual recovery on the reference obligation following the credit event may be greater than the fixed payment made by the counterparty to the Fund. If this occurs, the Fund will incur a loss on the transaction. In addition to general market risks, recovery locks are subject to illiquidity risk, counterparty risk and credit risk. The market for recovery locks is relatively new and is smaller and less liquid than the market for credit default swaps and other derivatives. Elements of judgment may play a role in determining the value of a recovery lock. It may not be possible to enter into a recovery lock at an advantageous time or price. The Fund will only enter into recovery locks with counterparties that meet certain standards of creditworthiness.
Correlation Risk. In certain cases, the value of derivatives may not correlate perfectly, or at all, with the value of the assets, reference rates or indexes they are designed to closely track. There are a number of factors which may prevent the Fund, or derivatives or other strategies used by the Fund, from achieving desired correlation with an index. These may include, but are not limited to: (i) the impact of portfolio fees, expenses and transaction costs, including borrowing and brokerage costs/bid-ask spreads, which are not reflected in index returns; (ii) differences in the timing of daily calculations of the value of an index and the timing of the valuation of derivatives, securities and other assets held by the Fund and the determination of the net asset value of Fund shares; (iii) disruptions or illiquidity in the markets for derivative instruments or securities in which the Fund invests; (iv) the Fund having exposure to or holding less than all of the securities in the underlying index and/or having exposure to or holding securities not included in the underlying index; (v) large or unexpected movements of assets into and out of a portfolio (due to share purchases or redemptions, for example), potentially resulting in the portfolio being over- or under-exposed to the index; (vi) the impact of accounting standards or changes thereto; (vii) changes to the applicable index that are not disseminated in advance; (viii) a possible need to conform the Fund’s portfolio holdings to comply with investment restrictions or policies or regulatory or tax law requirements; and (ix) fluctuations in currency exchange rates.
Structured Notes. Structured notes are derivative debt instruments, the interest rate or principal of which is determined by an unrelated indicator (for example, a currency, security, commodity or index thereof). The terms of the instrument may be “structured” by the purchaser and the borrower issuing the note. Indexed securities may include
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structured notes as well as securities other than debt securities, the interest rate or principal of which is determined by an unrelated indicator. The value of these notes will rise or fall in response to changes in the unrelated indicator. These notes expose the Fund economically to movements in the prices of the unrelated indicator. Indexed securities may include a multiplier that multiplies the indexed element by a specified factor and, therefore, the value of such securities may be very volatile. The terms of structured notes and indexed securities may provide that in certain circumstances no principal is due at maturity, which may result in a loss of invested capital. Structured notes and indexed securities may be positively or negatively indexed, so that appreciation of the unrelated indicator may produce an increase or a decrease in the interest rate or the value of the structured note or indexed security at maturity may be calculated as a specified multiple of the change in the value of the unrelated indicator. Therefore, the value of such notes and securities may be very volatile. These notes also are subject to similar risks that in general affect the values of debt securities, such as credit, market and interest rate risks. Structured notes and indexed securities may entail a greater degree of market risk than other types of debt securities because the investor also bears the risk of the unrelated indicator. Structured notes or indexed securities also may be more volatile, relatively less liquid, and more difficult to accurately price than less complex securities and instruments or more traditional debt securities. To the extent the Fund invests in these notes and securities, however, PIMCO analyzes these notes and securities in its overall assessment of the effective duration of the Fund’s holdings in an effort to monitor the Fund’s interest rate risk. At the maturity of the note, the Fund may receive more or less principal that it originally invested. The Fund might receive interest payments on the note that are more or less than the stated coupon interest payments. Certain issuers of structured products may be deemed to be investment companies as defined in the Act. As a result, the Fund’s investments in these structured products may be subject to limits applicable to investments in investment companies and may be subject to restrictions contained in the Act.
Risks of Potential Government Regulation of Derivatives. It is possible that additional government regulation of various types of derivative instruments, including futures, options and swap agreements, and regulation of certain market participants’ use of the same, may limit or prevent the Fund from using such instruments as a part of its investment strategy, and could ultimately prevent the Fund from being able to achieve its investment objectives. It is impossible to fully predict the effects of past, present or future legislation and regulation by multiple regulators in this area, but the effects could be substantial and adverse. It is possible that legislative and regulatory activity could limit or restrict the ability of the Fund to use certain instruments as a part of its investment strategy. Limits or restrictions applicable to the counterparties or issuers, as applicable, with which the Fund engages in derivative transactions could also limit or prevent the Fund from using certain instruments.
There is a possibility of future regulatory changes altering, perhaps to a material extent, the nature of an investment in the Fund or the ability of the Fund to continue to implement its investment strategies. The futures, options and swaps markets are subject to comprehensive statutes, regulations, and margin requirements. In addition, the SEC, CFTC and the exchanges are authorized to take extraordinary actions in the event of a market emergency, including, for example, the implementation or reduction of speculative position limits, the implementation of higher margin requirements, the establishment of daily price limits and the suspension of trading.
The regulation of futures, options and swaps transactions in the United States is a changing area of law and is subject to modification by government and judicial action. The CFTC and various exchanges have rules limiting the maximum net long or short positions which any person or group may own, hold or control in any given futures contract or option on such futures contract. PIMCO will need to consider whether the exposure created under these contracts might exceed the applicable limits in managing the Fund, and the limits may constrain the ability of the Fund to use such contracts. In addition, the CFTC in October 2020 adopted amendments to its position limits rules that establish certain new and amended position limits for 25 specified physical commodity futures and related options contracts traded on exchanges, other futures contracts and related options directly or indirectly linked to such 25 specified contracts, and any OTC transactions that are economically equivalent to the 25 specified contracts. PIMCO will need to consider whether the exposure created under these contracts might exceed the new and amended limits in anticipation of the applicable compliance dates, and the limits may constrain the ability of the Fund to use such contracts. The amendments also modify the bona fide hedging exemption for which certain swap dealers are currently eligible, which could limit the amount of speculative OTC transaction capacity each such swap dealer would have available for the Fund prior to the applicable compliance date.
In particular, the Dodd-Frank Act sets forth a legislative framework for OTC derivatives, including financial instruments, such as swaps, in which the Fund may invest. Title VII of the Dodd-Frank Act makes broad changes to
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the OTC derivatives market, grants significant authority to the SEC and the CFTC to regulate OTC derivatives and market participants, and requires clearing and exchange trading of many OTC derivatives transactions.
Provisions in the Dodd-Frank Act include capital and margin requirements and the mandatory use of clearinghouse mechanisms for many OTC derivative transactions. The CFTC, SEC and other federal regulators have adopted the rules and regulations enacting the provisions of the Dodd-Frank Act. However, swap dealers, major market participants and swap counterparties are experiencing, and will continue to experience, new and additional regulations, requirements, compliance burdens and associated costs. The Dodd-Frank Act and the rules promulgated thereunder may negatively impact the Fund’s ability to meet its investment objectives either through limits or requirements imposed on it or upon its counterparties. In particular, new position limits imposed on the Fund or its counterparties may impact its ability to invest in futures, options and swaps in a manner that efficiently meets its investment objectives. New requirements, even if not directly applicable to the Fund, including margin requirements, changes to the CFTC speculative position limits regime and mandatory clearing, discussed further below in “Additional Risk Factors in Cleared Derivatives Transactions,” may increase the cost of the Fund’s investments and cost of doing business, which could adversely affect investors.
Additional Risk Factors in Cleared Derivatives Transactions. Some types of swaps (including interest rate swaps and credit default index swaps on North American and European indices) are required to be centrally cleared, and additional types of swaps may be required to be centrally cleared in the future. In a cleared derivatives transaction, the Fund’s counterparty is a clearing house, rather than a bank or broker. Since the Fund is not a member of clearing houses and only members of a clearing house can participate directly in the clearing house, the Fund will hold cleared derivatives through accounts at clearing members. In cleared derivatives transactions, the Fund will make payments (including margin payments) to and receive payments from a clearing house through its accounts at clearing members. Clearing members guarantee performance of their clients’ obligations to the clearing house.
In many ways, centrally cleared derivative arrangements are less favorable to registered funds than bilateral arrangements. For example, the Fund may be required to provide greater amounts of margin for cleared derivatives transactions than for bilateral derivatives transactions. Also, in contrast to bilateral derivatives transactions, following a period of notice to the Fund, a clearing member generally can require termination of existing cleared derivatives transactions at any time or increases in margin requirements above the margin that the clearing member required at the beginning of a transaction. Clearing houses also have broad rights to increase margin requirements for existing transactions or to terminate transactions at any time. Any increase in margin requirements or termination by the clearing member or the clearing house could interfere with the ability of the Fund to pursue its investment strategy. Further, any increase in margin requirements by a clearing member could also expose the Fund to greater credit risk to its clearing member, because margin for cleared derivatives transactions in excess of clearing house margin requirements typically is held by the clearing member. Also, the Fund is subject to risk if it enters into a derivatives transaction that is required to be cleared (or that PIMCO expects to be cleared), and no clearing member is willing or able to clear the transaction on the Fund’s behalf. While the documentation in place between the Fund and its clearing members generally provides that the clearing members will accept for clearing all transactions submitted for clearing that are within credit limits (specified in advance) for the Fund, the Fund is still subject to the risk that no clearing member will be willing or able to clear a transaction. In those cases, the transaction might have to be terminated, and the Fund could lose some or all of the benefit of the transaction, including loss of an increase in the value of the transaction and/or loss of hedging protection offered by the transaction. In addition, the documentation governing the relationship between the Fund and the clearing members is developed by the clearing members and generally is less favorable to the Fund than typical bilateral derivatives documentation. For example, this documentation generally includes a one-way indemnity by the Fund in favor of the clearing member, indemnifying the clearing member against losses it incurs in connection with acting as the Fund’s clearing member, and the documentation typically does not give the Fund any rights to exercise remedies if the clearing member defaults or becomes insolvent.
Some types of cleared derivatives are required to be executed on an exchange or on a swap execution facility (a “SEF”). A SEF is a trading platform where multiple market participants can execute derivatives by accepting bids and offers made by multiple other participants in the platform. This execution requirement may make it more difficult and costly for funds, such as the Fund, to enter into highly tailored or customized transactions. Trading swaps on a SEF may offer certain advantages over traditional bilateral OTC trading, such as ease of execution, price transparency, increased liquidity and/or favorable pricing. Execution through a SEF is not, however, without additional costs and risks, as parties are required to comply with SEF and CFTC rules and regulations, including disclosure and recordkeeping obligations, and SEF rights of inspection, among others. SEFs typically charge fees, and if the Fund
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executes derivatives on a SEF through a broker intermediary, the intermediary may impose fees as well. The Fund also may be required to indemnify a SEF, or a broker intermediary who executes swaps on a SEF on the Fund’s behalf, against any losses or costs that may be incurred as a result of the Fund’s transactions on the SEF. In addition, the Fund may be subject to execution risk if it enters into a derivatives transaction that is required to be cleared, and no clearing member is willing to clear the transaction on the Fund’s behalf. In that case, the transaction might have to be terminated, and the Fund could lose some or all of the benefit of any increase in the value of the transaction after the time of the trade.
These and other new rules and regulations could, among other things, further restrict the Fund’s ability to engage in, or increase the cost to the Fund of, derivatives transactions, for example, by making some types of derivatives no longer available to the Fund, increasing margin or capital requirements, or otherwise limiting liquidity or increasing transaction costs. These regulations are relatively new and evolving, so their potential impact on the Fund and the financial system are not yet known. While the new regulations and the central clearing of some derivatives transactions are designed to reduce systemic risk (i.e., the risk that the interdependence of large derivatives dealers could cause a number of those dealers to suffer liquidity, solvency or other challenges simultaneously), there is no assurance that the new clearing mechanisms will achieve that result, and in the meantime, as noted above, central clearing will expose the Fund to new kinds of risks and costs.
A Note on Commodity-Linked Derivatives. The Fund may seek to gain exposure to the commodity markets by investing in commodity-linked derivative instruments, swap transactions, or index-linked or commodity linked structured notes.
The value of a commodity-linked derivative investment generally is based upon the price movements of a physical commodity (such as energy, mineral, or agricultural products), a commodity futures contract or commodity index, or other economic variable based upon changes in the value of commodities or the commodities markets. See “Swap Agreements and Options on Swap Agreements” above for further detail about swap transactions.
Further, the Fund may invest in derivative debt instruments with principal and/or coupon payments linked to the value of commodities, commodity futures contracts or the performance of commodity indices. These are “commodity-linked” or “index-linked” notes, and are sometimes referred to as “structured notes” because the terms of the debt instrument may be structured by the issuer of the note and the purchaser of the note. See “Structured Notes” above for further discussion of these notes.
The Fund’s investments in commodity-linked instruments may bear on or be limited by the Fund’s intention to qualify as a regulated investment company under the Code. See “Taxation.”
Leverage and Borrowing
The Fund currently utilizes leverage through its outstanding Remarketable Variable Rate MuniFund Term Preferred Shares (“RVMTP Shares” and, together with any other preferred shares the Fund may have outstanding, “Preferred Shares”). The Fund may also choose to add leverage through the use of TOBs, the issuance of additional Preferred Shares, or the use of reverse repurchase agreements, credit default swaps, dollar rolls/buy backs or borrowings, such as through bank loans or commercial paper and/or other credit facilities. Information regarding the terms and features of the Preferred Shares is provided under “Description of Capital Structure and Shares” in the Prospectus. The Fund may also enter into transactions other than those noted above that may give rise to a form of leverage including, among others, futures and forward contracts (including foreign currency exchange contracts), total return swaps and other derivative transactions, loans of portfolio securities, short sales and when-issued, delayed delivery and forward commitment transactions.
The Fund may utilize certain kinds of leverage, including, without limitation, TOBs, opportunistically and may choose to increase or decrease, or eliminate entirely, its use of leverage over time and from time to time based on PIMCO’s assessment of the yield curve environment, interest rate trends, market conditions and other factors. The Fund may also determine to increase its leverage through the issuance of additional Preferred Shares, or decrease the leverage it currently maintains through its outstanding Preferred Shares through Preferred Share redemptions or tender offers and may or may not determine to replace such leverage. The Fund’s Board may authorize the issuance of additional Preferred Shares without the approval of Common Shareholders. If the Fund issues additional Preferred Shares in the future, all costs and expenses relating to the issuance and ongoing maintenance of the Preferred Shares
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60 will be borne by the Common Shareholders, and these costs and expenses may be significant. Leveraging transactions pursued by the Fund may increase its duration and sensitivity to interest rate movements. The Fund’s net assets attributable to its Preferred Shares and the net proceeds the Fund obtains from the issuance of additional preferred shares or the use of TOBs or other forms of leverage will be invested in accordance with the Fund’s investment objectives and policies as described in the Prospectus. So long as the rate of return, net of applicable Fund expenses, on the debt obligations and other investments purchased by the Fund exceeds the dividend rates payable on the Preferred Shares together with the costs to the Fund of other leverage it utilizes, the investment of the Fund’s assets attributable to leverage will generate more income than will be needed to pay the costs of the leverage. If so, and all other things being equal, the excess may be used to pay higher dividends to Common Shareholders than if the Fund were not so leveraged.
The Fund’s use of derivatives and other similar instruments is generally subject to a value-at-risk leverage limit, derivatives risk management program, and reporting requirements under Rule 18f-4 unless the Fund qualifies as “limited derivatives user” as defined in the rule or the Fund’s use of such an instrument satisfies the conditions of certain exemptions under the rule.
The use of these forms of leverage increases the volatility of the Fund’s investment portfolio and could result in larger losses to Common Shareholders than if these strategies were not used. See “Principal Risks of the Fund—Leverage Risk” in the Prospectus. To the extent that the Fund engages in borrowings, it may prepay a portion of the principal amount of the borrowing to the extent necessary in order to maintain the required asset coverage. Failure to maintain asset coverage requirements could result in an event of default.
The Fund’s ability to utilize leverage is also limited by asset coverage requirements and other guidelines imposed by the terms of the Preferred Shares and imposed by rating agencies that provide ratings for the Preferred Shares (currently, Fitch), which are more restrictive than the limitations imposed by the Act noted above. Please see “Description of Capital Structure and Shares-Preferred Shares.”
Leveraging is a speculative technique and there are special risks and costs involved. The Fund cannot assure you that its use of Preferred Shares and any other forms of leverage (such as TOBs) will be successful or result in a higher yield on your Common Shares. When leverage is used, the net asset value of the Common Shares and the yield to Common Shareholders will be more volatile. See “Principal Risks of the Fund—Leverage Risk” in the Prospectus. In addition, dividends paid on Preferred Shares (including the Preferred Shareholder Gross-Up (as described below)) and interest and other expenses borne by the Fund with respect to its use of TOBs or other forms of leverage are borne by the Common Shareholders (and not by the holders of Preferred Shares (“Preferred Shareholders”)) and result in a reduction of the net asset value of the Common Shares. In addition, because the fees received by the Investment Manager are based on the Fund’s “total managed assets,” which includes total assets of the Fund (including assets attributable to any reverse repurchase agreements, dollar rolls/buy backs, TOBs, borrowings and Preferred Shares that may be outstanding, if any), the Investment Manager has a financial incentive for the Fund to use certain forms of leverage (e.g., Preferred Shares and TOBs), which may create a conflict of interest between the Investment Manager, on the one hand, and the Common Shareholders, on the other hand. For purposes of calculating “total managed assets,” the Fund’s derivatives will be valued based on their market value. The transactions discussed herein can be subject to the risks discussed under “Derivative Instruments” above, in addition to the risks discussed in this section. Please see “Use of Leverage,” “Principal Risks of the Fund—Leverage Risk for additional information regarding leverage and related risks. In addition, dividend, interest and other costs and expenses borne by the Fund with respect to its use of reverse repurchase agreements, borrowings or any other forms of leverage are borne by the Common Shareholders and result in a reduction of the net asset value of the Common Shares. 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 portfolio securities held by the Fund.
Reverse Repurchase Agreements
The Fund may enter into reverse repurchase agreements and economically similar transactions. A reverse repurchase agreement involves the sale of a portfolio-eligible security by the Fund to another party, such as a bank or broker-dealer, coupled with its agreement to repurchase the instrument at a specified time and price. Under a reverse repurchase agreement, the Fund continues to receive any principal and interest payments on the underlying security during the term of the agreement. However, reverse repurchase agreements involve the risk that the market value of
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securities retained by the Fund may decline below the repurchase price of the securities sold by the Fund which it is obligated to repurchase. With respect to reverse repurchase agreements in which banks are counterparties, the Fund may treat such transactions as bank borrowings, which would be subject to the Fund’s limitations on borrowings. Such treatment would, among other things, restrict the aggregate of such transaction (plus any other borrowings) to one-third of the Fund’s total assets. Such transactions also can be subject to the risks discussed under “Derivative Instruments” above, in addition to the risks discussed in this section.
The Fund also may effect simultaneous purchase and sale transactions that are known as “sale-buybacks.” A sale-buyback is similar to a reverse repurchase agreement, except that in a sale-buyback, the counterparty that purchases the security is entitled to receive any principal or interest payments made on the underlying security pending settlement of the Fund’s repurchase of the underlying security.
Mortgage Dollar Rolls/Buy Backs
A mortgage dollar roll/buy back is similar to a reverse repurchase agreement in certain respects. In a “dollar roll” or “buy back” transaction, the Fund sells a mortgage-related security, such as a security issued by GNMA, to a dealer and simultaneously agrees to repurchase a similar security (but not the same security) in the future at a predetermined price. A “dollar roll/buy back” can be viewed, like a reverse repurchase agreement, as a collateralized borrowing in which the Fund pledges a mortgage-related security to a dealer to obtain cash. Unlike in the case of reverse repurchase agreements, the dealer with which the Fund enters into a dollar roll/buy back transaction is not obligated to return the same securities as those originally sold by the Fund, but only securities which are “substantially identical.” To be considered “substantially identical,” the securities returned to the Fund generally must: (1) be collateralized by the same types of underlying mortgages; (2) be issued by the same agency and be part of the same program; (3) have a similar original stated maturity; (4) have identical net coupon rates; (5) have similar market yields (and therefore price); and (6) satisfy “good delivery” requirements, meaning that the aggregate principal amounts of the securities delivered and received back must be within a specified percentage of the initial amount delivered.
It is possible that changing government regulation may affect the Fund’s use of these strategies. Changes in regulatory requirements concerning margin for certain types of financing transactions, such as repurchase agreements, reverse repurchase agreements, and securities lending and borrowing, could impact the Fund’s ability to utilize these investment strategies and techniques.
Repurchase Agreements
For the purposes of maintaining liquidity and achieving income, the Fund may enter into repurchase agreements with domestic commercial banks or registered broker-dealers. A repurchase agreement is a contract under which the Fund would acquire a security for a relatively short period (usually not more than one week) subject to the obligation of the seller to repurchase and the Fund to resell such security at a fixed time and price (representing the Fund’s cost plus interest). In the case of repurchase agreements with broker-dealers, the value of the underlying securities (or collateral) will be at least equal at all times to the total amount of the repurchase obligation, including the interest factor. The Fund bears a risk of loss in the event that the other party to a repurchase agreement defaults on its obligations and the Fund is delayed or prevented from exercising its rights to dispose of the collateral securities. This risk includes the risk of procedural costs or delays in addition to a loss on the securities if their value should fall below their repurchase price. PIMCO will monitor the creditworthiness of the counterparties.
Credit-Linked Trust Certificates
The Fund may invest in credit-linked trust certificates, which are investments in a limited purpose trust or other vehicle which, in turn, invests in a basket of derivative instruments, such as credit default swaps, total return swaps, basis swaps, interest rate swaps and other derivative transactions or securities, in order to provide exposure to the high yield or another debt securities market. For instance, the Fund may invest in credit-linked trust certificates as a cash management tool in order to gain exposure to the high yield markets and/or to remain fully invested when more traditional income-producing securities are not available, including during the period when the net proceeds of this offering and any future offering are being invested.
Like an investment in a bond, investments in these credit-linked trust certificates represent the right to receive periodic income payments (in the form of distributions) and payment of principal at the end of the term of the
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certificate. However, these payments are conditioned on the Fund’s receipt of payments from, and the Fund’s potential obligations to, the counterparties to the derivative instruments and other securities in which the trust invests. For instance, the trust may sell one or more credit default swaps, under which the trust would receive a stream of payments over the term of the swap agreements provided that no event of default has occurred with respect to the referenced debt obligation upon which the swap is based. If a default occurs, the stream of payments may stop and the trust would be obligated to pay to the counterparty the par (or other agreed upon value) of the referenced debt obligation. This, in turn, would reduce the amount of income and principal that the Fund would receive as an investor in the trust. Please see “Derivative Instruments-Swap Agreements and Options on Swap Agreements” in this Statement of Additional Information for additional information about credit default swaps. The Fund’s investments in these instruments are indirectly subject to the risks associated with derivative instruments, including, among others, credit risk, default or similar event risk, counterparty risk, interest rate risk, leverage risk and management risk. It is expected that the trusts which issue credit-linked trust certificates will constitute “private” investment companies, exempt from registration under the Act. Therefore, the certificates will be subject to the risks described under “Other Investment Companies,” and will not be subject to applicable investment limitations and other regulation imposed by the Act (although the Fund will remain subject to such limitations and regulation, including with respect to its investments in the certificates). Although the trusts are typically private investment companies, they generally are not actively managed such as a “hedge fund” might be. It is also expected that the certificates will be exempt from registration under the 1933 Act. Accordingly, there may be no established trading market for the certificates and they may constitute illiquid investments. See “Principal Risks of the Fund-Liquidity Risk” in the Prospectus. If market quotations are not readily available for the certificates, they will be valued by the Fund at fair value as determined by the Board or persons acting at its direction. See “How Fund Shares are Priced” in the Prospectus.
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. These transactions may be known as to-be-announced (“TBA”) transactions.
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 other party to a transaction fails to deliver the securities, the Fund could miss a favorable price or yield opportunity. 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 pay for the securities, the Fund could suffer a loss. Additionally, when selling a security on a when-issued, delayed delivery, or forward commitment basis without owning the security, the Fund will incur a loss if the security’s price appreciates in value such that the security’s price is above the agreed-upon price on the settlement date.
The Fund may dispose of or renegotiate a transaction after it is entered into, and may purchase or sell when-issued, delayed delivery or forward commitment securities before the settlement date, 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.
The Fund may purchase or sell securities, including mortgage-backed securities, in the TBA market. A TBA purchase commitment is a security that is purchased or sold for a fixed price and the underlying securities are announced at a future date. Financial Industry Regulatory Authority (“FINRA”) rules include mandatory margin requirements for the TBA market that may require the Fund to post collateral in connection with its TBA transactions. There is no similar requirement applicable to the Fund’s TBA counterparties. The required collateralization of TBA trades could increase the cost of TBA transactions to the Fund and impose added operational complexity. Such transactions also can be subject to the risks discussed under “Derivative Instruments” above.
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Common Stocks
Common stock generally takes the form of shares in a corporation. The value of a company’s stock may fall as a result of factors directly relating to that company, such as decisions made by its management or lower demand for the company’s products or services. A stock’s value also may fall because of factors affecting not just the company, but also companies in the same industry or in a number of different industries, such as increases in production costs. The value of a company’s stock also may be affected by changes in financial markets that are relatively unrelated to the company or its industry, such as changes in interest rates or currency exchange rates. In addition, a company’s stock generally pays dividends only after the company invests in its own business and makes required payments to holders of its bonds, other debt and preferred securities. For this reason, the value of a company’s stock will usually react more strongly than its bonds, other debt and preferred securities to actual or perceived changes in the company’s financial condition or prospects. Stocks of smaller companies may be more vulnerable to adverse developments than those of larger companies. Stocks of companies that the portfolio managers believe are fast-growing may trade at a higher multiple of current earnings than other stocks. The value of such stocks may be more sensitive to changes in current or expected earnings than the values of other stocks.
Short Sales
The Fund may make short sales of securities: (i) to offset potential declines in long positions in similar securities; (ii) to increase the flexibility of the Fund; (iii) for investment return; (iv) as part of a risk arbitrage strategy; and (v) as part of its overall portfolio management strategies involving the use of derivative instruments. 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 or will underperform relative to other securities held in the Fund’s portfolio.
When the Fund makes a short sale, it will often 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. In connection with short sales of securities, the Fund may pay a fee to borrow securities or maintain an arrangement with a broker to borrow 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 that 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. If the Fund engages in short sales as part of a hedging strategy, 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.
The Fund may invest pursuant to a risk arbitrage strategy to take advantage of a perceived relationship between the value of two securities. Frequently, a risk arbitrage strategy involves the short sale of a security.
The Fund will engage in short selling to the extent permitted by the federal securities laws and rules and interpretations thereunder. To the extent the Fund engages in short selling in foreign (non-U.S.) jurisdictions, the Fund will do so to the extent permitted by the laws and regulations of such jurisdiction.
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 Act and rules and interpretations thereunder. Such transactions also can be subject to the risks discussed under “Derivative Instruments” above.
Illiquid Investments
To the extent consistent with the applicable liquidity requirements for interval funds under Rule 23c-3 of the Act, the Fund may invest without limit in illiquid investments. PIMCO may be subject to significant delays in disposing of illiquid investments, and transactions in illiquid investments may entail registration expenses and other transaction costs that are higher than those for transactions in liquid investments. The term “illiquid investments” for this purpose means any investment that the Fund reasonably expects cannot be sold or disposed of in current market conditions in seven calendar days or less without the sale or disposition significantly changing the market value of the investment.
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Rule 144A Securities
In addition to the Fund’s investments in privately placed and unregistered securities, the Fund may also invest in securities sold pursuant to Rule 144A under the 1933 Act. Such securities are commonly known as “144A securities” and may only be resold under certain circumstances to other institutional buyers. 144A securities frequently trade in an active secondary market. As a result of the resale restrictions on 144A securities, there is a greater risk that they will become illiquid than securities registered with the SEC. Please refer to “Illiquid Investments” for further discussion of regulatory considerations and constraints relating to investment liquidity.
Other Investment Companies
The Fund may also invest up to 5% of its total assets in securities of other investment companies (including those advised by PIMCO), including closed-end funds, exchange-traded funds and other open-end funds, that invest primarily in municipal bonds and other municipal securities of the types in which the Fund may invest directly. The Fund may invest in certain money market funds and/or short-term bond funds (“Central Funds”), to the extent permitted by the Act, the rules thereunder or exemptive relief therefrom. The Central Funds are registered investment companies created for use by certain registered investment companies advised by PIMCO in connection with their cash management activities. The Fund treats its investments in other investment companies that invest primarily in types of securities in which the Fund may invest directly as investments in such types of securities for purposes of the Fund’s investment policies (e.g., the Fund’s investment in an investment company that invests primarily in debt securities will be treated by the Fund as an investment in a debt security).
In general, under the Act, an investment company such as the Fund may not (i) own more than 3% of the outstanding voting securities of any one registered investment company, (ii) invest more than 5% of its total assets in the securities of any single registered investment company or (iii) invest more than 10% of its total assets in securities of other registered investment companies (the “3-5-10% Limitations”). On October 7, 2020, the SEC adopted Rule 12d1-4 under the Act which, subject to certain conditions, provides an exemption to permit acquiring funds to invest in the securities of other registered investment companies in excess of the 3-5-10% Limitations. In connection with the rule, the SEC rescinded Rule 12d1-2 under the Act and most fund of funds exemptive orders.
The Fund may invest in other investment companies to gain broad market or sector exposure or for cash management purposes, including 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 when PIMCO believes share prices of other investment companies offer attractive values.
As a shareholder 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. 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.
Private Placements
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. Please refer to “Illiquid Investments” for further discussion of regulatory considerations and constraints relating to investment liquidity.
Fund Operations
Operational Risk. An investment in the Fund, like any fund, can involve operational risks arising from factors such as processing errors, human errors, inadequate or failed internal or external processes, failures in systems and technology, changes in personnel and errors caused by third-party service providers. The occurrence of any of these failures, errors or breaches could result in a loss of information, regulatory scrutiny, reputational damage or other events, any of which could have a material adverse effect on the Fund. While the Fund seeks to minimize such events through controls and oversight, there may still be failures that could cause losses to the Fund.
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Market Disruptions Risk. The Fund is subject to investment and operational risks associated with financial, economic and other global market developments and disruptions, including those arising from war, terrorism, market manipulation, government interventions, defaults and shutdowns, political changes or diplomatic developments, public health emergencies (such as the spread of infectious diseases, pandemics and epidemics) and natural/environmental disasters, which can all negatively impact the securities markets and cause the Fund to lose value. These events can also impair the technology and other operational systems upon which the Fund’s service providers, including PIMCO as the Fund’s investment adviser, rely, and could otherwise disrupt the Fund’s service providers’ ability to fulfill their obligations to the Fund.
A widespread health crisis, such as a global pandemic, could cause substantial market volatility, exchange trading suspensions or restrictions and closures of securities exchanges and businesses. Such a health care crisis could also impact the ability to complete redemptions, and adversely impact investments held by the Fund. For example, the outbreak of COVID-19, a respiratory disease caused by a novel coronavirus, caused volatility, severe market dislocations and liquidity constraints in many markets, including markets for the securities the Fund holds. The transmission of COVID-19 and efforts to contain its spread resulted in travel restrictions and disruptions, closed international borders, enhanced health screenings at ports of entry and elsewhere, disruption of and delays in healthcare service preparation and delivery, quarantines, event and service cancellations or interruptions, disruptions to business operations (including staff furloughs and reductions) and supply chains, and a reduction in consumer and business spending, as well as general economic concern and uncertainty . These disruptions led to instability in the market-place, including equity and debt market losses and overall volatility, and the jobs market. The impact of COVID-19, and other infectious illness outbreaks, epidemics or pandemics that may arise in the future, could adversely affect the economies of many nations or the entire global economy, the financial well-being and performance of individual issuers, borrowers and sectors and the health of the markets generally in potentially significant and unforeseen ways. In addition, the impact of infectious illnesses, such as COVID-19, in emerging market countries may be greater due to generally less established healthcare systems. Public health crises may exacerbate other pre-existing political, social and economic risks in certain countries or globally.
The foregoing could lead to a significant economic downturn or recession, increased market volatility, a greater number of market closures, higher default rates and adverse effects on the values and liquidity of securities or other assets. Such impacts, which may vary across asset classes, may adversely affect the performance of the Fund. In certain cases, an exchange or market may close or issue trading halts on specific securities or even the entire market, which may result in the Fund being, among other things, unable to buy or sell certain securities or financial instruments or to accurately price their investments.
Cyber Security Risk. As the use of technology has become more prevalent in the course of business, the Fund has become potentially more susceptible to operational and information security risks resulting from breaches in cyber security. A breach in cyber security refers to both intentional and unintentional cyber events from outside threat actors or internal resources that may, among other things, cause the Fund to lose proprietary information, suffer data corruption and/or destruction or lose operational capacity, result in the unauthorized release or other misuse of confidential information, or otherwise disrupt normal business operations. Cyber security breaches may involve unauthorized access to the Fund’s digital information systems (e.g., through “hacking” or malicious software coding) and may come from multiple sources, including outside attacks such as denial-of-service attacks (i.e., efforts to make network services unavailable to intended users) or cyber extortion, including exfiltration of data held for ransom and/or “ransomware” attacks that renders systems inoperable until ransom is paid, or insider actions). In addition, cyber security breaches involving the Fund’s third party service providers (including but not limited to advisers, administrators, transfer agents, custodians, vendors, suppliers, distributors and other third parties), trading counterparties or issuers in which the Fund invests can also subject the Fund to many of the same risks associated with direct cyber security breaches or extortion of company data. Moreover, cyber security breaches involving trading counterparties or issuers in which the Fund invests could adversely impact such counterparties or issuers and cause the Fund’s investment to lose value. Cyber security failures or breaches may result in financial losses to the Fund and its shareholders. These failures or breaches may also result in disruptions to business operations, potentially resulting in financial losses; interference with the Fund’s ability to calculate its NAV, process shareholder transactions or otherwise transact business with shareholders; impediments to trading; violations of applicable privacy and other laws; regulatory fines; penalties; third party claims in litigation; reputational damage; reimbursement or other compensation costs; additional compliance costs and cyber security risk management costs and other adverse consequences. In addition, substantial costs may be incurred in order to prevent any cyber incidents in the future.
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Like with operational risk in general, the Fund has established risk management systems and business continuity plans designed to reduce the risks associated with cyber security. However, there are inherent limitations in these plans and systems, including that certain risks may not have been identified, in large part because different or unknown threats may emerge in the future. As such, there is no guarantee that such efforts will succeed, especially because the Fund does not directly control the cyber security systems of issuers in which the Fund may invest, trading counterparties or third party service providers to the Fund. Such entities have experienced cyber attacks and other attempts to gain unauthorized access to systems from time to time, and there is no guarantee that efforts to prevent or mitigate the effects of such attacks or other attempts to gain unauthorized access will be successful. There is also a risk that cyber security breaches may not be detected. The Fund and its shareholders may suffer losses as a result of a cyber security breach related to the Fund, its service providers, trading counterparties or the issuers in which the Fund invests.
Portfolio Turnover
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. Trading in fixed-income securities does not generally involve the payment of brokerage commissions, but does involve indirect transaction costs. Trading in equity securities involves the payment of brokerage commissions, which are transaction costs paid by the Fund. The use of futures contracts may involve the payment of commissions to FCMs. 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. Such sales may result in realization of taxable capital gains (including short-term capital gains which generally would be taxed at ordinary income tax rates when distributed to shareholders). See “Taxation.”
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 and any short sales that the Fund does not intend to maintain for more than one year. Proceeds from short sales and assets used to cover short positions undertaken are included in the amounts of securities sold and purchased, respectively, during the year.
For the fiscal period ended December 31, 2022, the Fund’s portfolio turnover rate was 53%.
Warrants to Purchase Securities
The Fund may invest in or acquire warrants to purchase equity or fixed-income securities. Warrants are instruments that give the holder the right, but not the obligation, to buy a security directly from an issuer at a specific price for a specific period of time. Changes in the value of a warrant do not necessarily correspond to changes in the value of its underlying security. The price of a warrant may be more volatile than the price of its underlying security, and a warrant may offer greater potential for capital appreciation as well as capital loss. Warrants do not entitle a holder to dividends or voting rights with respect to the underlying security, do not represent any rights in the assets of the issuing company and are subject to the risk that the issuer-counterparty may fail to honor its obligations. A warrant ceases to have value if it is not exercised prior to its expiration date. These factors can make warrants more speculative than other types of investments. Bonds with warrants attached to purchase equity securities have many characteristics of convertible bonds and their prices may, to some degree, reflect the performance of the underlying stock. Bonds also may be issued with warrants attached to purchase additional fixed-income securities at the same coupon rate. A decline in interest rates would permit the Fund to buy additional bonds at the favorable rate or to sell the warrants at a profit. If interest rates rise, the warrants would generally expire with no value. The Fund may from time to time use non-standard warrants, including low exercise price warrants or low exercise price options (“LEPOs”), to gain exposure to issuers in certain countries. LEPOs are different from standard warrants in that they do not give their holders the right to receive a security of the issuer upon exercise. Rather, LEPOs pay the holder the difference in price of the underlying security between the date the LEPO was purchased and the date it is sold. Additionally, LEPOs entail the same risks as other OTC derivatives, including the risks that the counterparty or issuer of the LEPO may not be able to fulfill its obligations, that the holder and counterparty or issuer may disagree as to the meaning or application of contractual terms, or that the instrument may not perform as expected. Furthermore, while LEPOs may be listed on
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an exchange, there is no guarantee that a liquid market will exist or that the counterparty or issuer of a LEPO will be willing to repurchase such instrument when the Fund wishes to sell it.
Loans of Portfolio Securities
Subject to certain conditions described in the Prospectus and below, the Fund may make secured loans of its portfolio securities to brokers, dealers and other financial institutions amounting to no more than one-third of its total assets. The risks in lending portfolio securities, as with other extensions of credit, include possible delay in recovery of the securities or possible loss of rights in the collateral should the borrowers (which typically include broker-dealers and other financial services companies) fail financially. However, such loans will be made only to borrowers that are believed by PIMCO to be of satisfactory credit standing. Securities loans are made to broker-dealers pursuant to agreements requiring that loans be continuously secured by collateral consisting of U.S. Government securities, cash or cash equivalents (negotiable certificates of deposit, bankers’ acceptances or letters of credit) maintained on a daily mark-to-market basis in an amount at least equal at all times to the market value of the securities lent. The borrower pays to the Fund, as the lender, an amount equal to any dividends or interest received on the securities lent.
The Fund may invest only the cash collateral received in interest-bearing, short-term securities or receive a fee from the borrower. In the case of cash collateral, the Fund typically pays a rebate to the lender. Although voting rights or rights to consent with respect to the loaned securities pass to the borrower, the Fund, as the lender, retains the right to call the loans and obtain the return of the securities loaned at any time on reasonable notice, and it will do so in order that the securities may be voted by the Fund if the holders of such securities are asked to vote upon or consent to matters materially affecting the investment. The Fund may also call such loans in order to sell the securities involved. The Fund’s performance will continue to reflect changes in the value of the securities loaned and will also reflect the receipt of either interest, through investment of cash collateral by the Fund in permissible investments, or a fee, if the collateral is U.S. Government securities.
Government Intervention Risk
Governmental and quasi-governmental authorities and regulators throughout the world have in the past responded to major economic disruptions with a variety of significant fiscal and monetary policy changes, including but not limited to, direct capital infusions into companies and financial markets, economic relief and similar packages and changes to interest rates. There can be no guarantee that any such measures taken in the past or in connection with future events (within the United States or other affected countries throughout the world) will be sufficient to have their intended effect. In addition, an unexpected or quick reversal of such measures could cause market downturns, disruptions, volatility and inflation, which could adversely affect the Fund’s investments.
In addition, federal, state, and other governments, their regulatory agencies, or self-regulatory organizations may take actions that affect the regulation of the instruments in which the Fund invests, or the issuers of such instruments, in ways that are unforeseeable. Legislation or regulation may also change the way in which the Fund itself is regulated. Such legislation or regulation could limit or preclude the Fund’s ability to achieve its investment objectives. Also, while such legislation or regulations are intended to strengthen markets, systems, and public finances, they could affect fund expenses and the value of fund investments in unpredictable ways.
During periods when interest rates are low (or negative), the Fund’s yield (or total return) may also be low and fall below zero. Very low or negative interest rates may heighten interest rate risk. The Fund may be subject to heightened levels of interest rate risk because the U.S. Federal Reserve (the “Federal Reserve”) has raised interest rates from historically low levels and has signaled an intention to continue to do so. To the extent the Federal Reserve continues to raise interest rates, there is a risk that rates across the financial system may rise. Changing interest rates may have unpredictable effects on markets, may result in heightened market volatility and may detract from Fund performance to the extent the Fund is exposed to such interest rates and/or volatility.
Governments or their agencies may also acquire distressed assets from financial institutions and acquire ownership interests in those institutions. Such a program may have positive or negative effects on the liquidity, valuation and performance of the Fund’s portfolio holdings. Furthermore, volatile financial markets can expose the Fund to greater market and liquidity risk and potential difficulty in valuing portfolio instruments held by the Fund. The Fund has established procedures to assess the liquidity of portfolio holdings and to value instruments for which market
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prices may not be readily available. PIMCO will monitor developments and seek to manage the Fund in a manner consistent with achieving the Fund’s investment objectives, but there can be no assurance that it will be successful in doing so.
The value of the Fund’s holdings is also generally subject to the risk of future local, national, or global economic disturbances based on unknown weaknesses in the markets in which the Fund invests. In the event of such a disturbance, issuers of securities held by the Fund may experience significant declines in the value of their assets and even cease operations, or may receive government assistance accompanied by increased restrictions on their business operations or other government intervention. In addition, it is not certain that the U.S. Government will intervene in response to a future market disturbance and the effect of any such future intervention cannot be predicted. It is difficult for issuers to prepare for the impact of future financial downturns, although companies can seek to identify and manage future uncertainties through risk management programs.
Quantitative Investing Risk
PIMCO employs and/or relies on algorithms, models or other systems in connection with many of its investment activities, including research, forecasting, selection, optimization, order routing, execution, and allocation processes (together, “Systems”). These Systems, which may be employed together and operate without human intervention, rely heavily on the use of proprietary and nonproprietary data, software, hardware, and intellectual property, including data, software and hardware that may be licensed or otherwise obtained from third parties. The use of such Systems has inherent limitations and risks. Although PIMCO seeks to develop and use Systems appropriately and effectively, there can be no assurance that it will successfully do so. The Systems are extremely complex and may involve the use of financial, economic, econometric and statistical theories, research and modeling and related translation into computer code. Errors may occur in the design, writing, testing, monitoring, and/or implementation of Systems, including in the manner in which Systems function together. The effectiveness of Systems may diminish over time, including as a result of market changes and changes in the behavior of market participants. The quality of the resulting analysis, investment selections, portfolio construction, asset allocations, proposed trades, risk management, allocations of investment opportunities and trading strategies depends on a number of factors including the accuracy and quality of data inputs into the Systems, including through automated and manual integration of completed transactions, the mathematical and analytical assumptions and underpinnings of the Systems' coding, the accuracy in translating those analytics into program code or interpreting the output of a System by another System in order to facilitate a transaction, change in market conditions, the successful integration of the various Systems into the portfolio selection and trading process and whether actual market events correspond to one or more assumptions underlying the Systems. Accordingly, Systems are subject to errors and/or mistakes (“System Incidents”) that may adversely impact the Fund. For example, System Incidents may result in Systems performing in a manner other than as intended, including, but not limited to, failure to achieve desired performance or investment objectives, execution of unanticipated trades or failure or delays in executing intended trades, failure to properly allocate trades, failure to properly gather and organize available data, or failure to identify hedging or other risk management opportunities or targets, all of which may adversely impact the Fund.
PIMCO relies on quantitative models, data, and trading algorithms supplied by third parties for certain funds. Such models, data and algorithms are used to construct sets of transactions and investments, to implement investment decisions, and to provide risk management insights. When the third-party models, data or algorithms prove to be incorrect or incomplete, any decisions or investments made in reliance thereon expose applicable funds to additional risks. For example, PIMCO does not have the same insight or access into the construction, coding or testing of the algorithms, and PIMCO and applicable funds will be exposed to systems, cyber security and other risks associated with the third party models, data or algorithms. For these reasons, and subject to PIMCO satisfying its standard of care, PIMCO generally will not compensate applicable funds for any losses associated with third-party models, data, or algorithms, and applicable funds will bear all such losses. PIMCO, subject to satisfying its standard of care, generally does not expect to disclose certain such events to applicable funds.
The Systems rely heavily on appropriate data inputs and it is impossible and impracticable to factor all relevant, available data into the Systems. PIMCO will use its discretion to determine what data to gather and what subset of data the Systems utilize. In addition, due to the automated nature of gathering data, the volume and depth of data available, the complexity and often manual nature of data cleaning, and the fact that the data may come from third-party sources, it is inevitable that not all desired and/or relevant data will be available to, or processed by, PIMCO at all times. Where incorrect or incomplete data is available, PIMCO may, and often will, continue to generate forecasts and make
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investment decisions based on the data available. Additionally, PIMCO may determine that certain available data, while potentially useful in generating forecasts and/or making investment decisions, is not cost effective to gather due to, among other factors, the technology costs or third-party vendor costs and, in such cases, PIMCO will not utilize such data. PIMCO has full discretion to select the data it utilizes, and may elect to use or may refrain from using any specific data or type of data in the Systems. The data used in the development of use of Systems may not be the most accurate data available or free of errors. Further, if incorrect market or other data are entered into an otherwise properly functioning System, the System's resulting output, including proposed trades or investment recommendations, may be inconsistent with the underlying investment strategy. Even if data is input correctly, prices anticipated by the data through the Systems may differ substantially from market prices, especially for financial instruments with complex characteristics, such as derivatives, in which the Fund may invest. Most Systems require continual monitoring and enhancements, and there is no guarantee that such monitoring and enhancements will be successful or that Systems will operate as intended. The successful deployment of the investment strategy, the portfolio construction process and/or the trading process could be severely compromised by software or hardware malfunctions, viruses, glitches, connectivity loss, system crashes or various other System Incidents, including, in particular, where multiple Systems contribute to the process, in particular where there is no human intervention (e.g., where one System develops a potential recommended signal or possible trade and another System interprets or optimizes that recommended signal or possible trade to facilitate a trade order, another System routes and executes that trade order, and another System allocates the completed trade, and where this process runs again in reliance on the preceding automated transaction). System Incidents may be difficult to detect and PIMCO may not immediately or ever detect certain System Incidents, which may have an increasing impact on the Fund over time. PIMCO has adopted policies and procedures that it believes are reasonably designed to prevent, detect, escalate and remediate System Incidents. PIMCO will address System Incidents in accordance with this policy but there is no guarantee that measures taken to address a System Incident will be successful.
PIMCO has policies and procedures that address identification and correction of errors that may occur in connection with PIMCO's management of the Fund and other client accounts (“Trade Errors”). PIMCO generally does not classify System Incidents to be Trade Errors and applicable funds generally will bear all losses associated with System Incidents, subject to PIMCO satisfying its standard of care. Further, PIMCO generally does not expect to disclose System Incidents to the Fund.
Regulatory Matters
Financial entities, such as investment companies and investment advisers, are generally subject to extensive government regulation and intervention. Government regulation and/or intervention may change the way the Fund is regulated, affect the expenses incurred directly by the Fund and the value of its investments, and limit and/or preclude the Fund’s ability to achieve its investment objectives. Government regulation may change frequently and may have significant adverse consequences. Moreover, government regulation may have unpredictable and unintended effects.
Actions by governmental entities may also impact certain instruments in which the Fund invests. For example, certain instruments in which the Fund may invest rely in some fashion upon the London Interbank Offered Rate (“LIBOR”). LIBOR was traditionally an average interest rate, determined by the ICE Benchmark Administration, that banks charge one another for the use of short-term money. On March 5, 2021, the Financial Conduct Authority (“FCA”), the United Kingdom’s financial regulatory body and regulator of LIBOR, publicly announced that all U.S. Dollar LIBOR settings will either cease to be provided by any administrator or will no longer be representative (i) immediately after December 31, 2021 for one-week and two-month U.S. Dollar LIBOR settings and (ii) immediately after June 30, 2023 for the remaining U.S. Dollar LIBOR settings. As of January 1, 2022, as a result of supervisory guidance from U.S. regulators, U.S. regulated entities have generally ceased entering into new LIBOR contracts with limited exceptions. Publication of all Japanese yen and the one- and six-month sterling LIBOR settings have ceased, and while publication of the three-month Sterling LIBOR setting will continue through at least the end of March 2024 on the basis of a changed methodology (known as “synthetic LIBOR”), this rate has been designated by the FCA as unrepresentative of the underlying market that it seeks to measure and is solely available for use in legacy transactions. Certain bank-sponsored committees in other jurisdictions, including Europe, the United Kingdom, Japan and Switzerland, have selected alternative reference rates denominated in other currencies. Although the transition process away from LIBOR has become increasingly well-defined, any potential effects of the transition away from LIBOR on the Fund or on certain instruments in which the Fund invests can be difficult to ascertain, and may vary depending on factors that include, but are not limited to: (i) existing fallback or termination provisions in individual contracts and (ii) whether, how, and when industry participants adopt new reference rates for affected instruments. So-called “tough
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legacy” contracts have LIBOR interest rate provisions with no fallback provisions contemplating a permanent discontinuation of LIBOR, inadequate fallback provisions or fallback provisions which may not effectively result in a transition away from LIBOR prior to LIBOR’s planned replacement date. On March 15, 2022, the Adjustable Interest Rate (LIBOR) Act was signed into law. This law provides a statutory fallback mechanism on a nationwide basis to replace LIBOR with a benchmark rate that is selected by the Board of Governors of the Federal Reserve System based on the Secured Overnight Financing Rate (“SOFR”) for tough legacy contracts. On February 27, 2023, the Federal Reserve System’s final rule in connection with this law became effective, establishing benchmark replacements based on SOFR and Term SOFR (a forward-looking measurement of market expectations of SOFR inferred from certain derivatives markets) for applicable tough legacy contracts governed by U.S. law. In addition, the FCA has announced that it will require the publication of synthetic LIBOR for the one-month, three-month and six-month U.S. Dollar LIBOR settings after June 30, 2023 through at least September 30, 2024. Certain of the Fund’s investments may involve individual tough legacy contracts which may be subject to the Adjustable Interest Rate (LIBOR) Act or synthetic LIBOR and no assurances can be given that these measures will have the intended effects. Moreover, certain aspects of the transition from LIBOR will rely on the actions of third-party market participants, such as clearing houses, trustees, administrative agents, asset servicers and certain service providers; PIMCO cannot guarantee the performance of such market participants and any failure on the part of such market participants to manage their part of the LIBOR transition could impact the Fund. The transition of investments from LIBOR to a replacement rate as a result of amendment, application of existing fallbacks, statutory requirements or otherwise may also result in a reduction in the value of certain instruments held by the Fund or a reduction in the effectiveness of related Fund transactions such as hedges. In addition, an instrument’s transition to a replacement rate could result in variations in the reported yields of the Fund that holds such instrument. Any such effects of the transition away from LIBOR, as well as other unforeseen effects, could result in losses to the Fund.
Any such effects of the transition away from LIBOR, as well as other unforeseen effects, could result in losses to the Fund. Additionally, alteration of the terms of a debt instrument or a modification of the terms of other types of contracts to replace LIBOR or another interbank offered rate (“IBOR”) with a new reference rate could result in a taxable exchange and the realization of income and gain/loss for U.S. federal income tax purposes. The IRS has issued final regulations regarding the tax consequences of the transition from IBOR to a new reference rate in debt instruments and non-debt contracts. Under the final regulations, alteration or modification of the terms of a debt instrument to replace an operative rate that uses a discontinued IBOR with a qualified rate (as defined in the final regulations) including true up payments equalizing the fair market value of contracts before and after such IBOR transition, to add a qualified rate as a fallback rate to a contract whose operative rate uses a discontinued IBOR or to replace a fallback rate that uses a discontinued IBOR with a qualified rate would not be taxable. The IRS may provide additional guidance, with potential retroactive effect.
In October 2020, the SEC adopted a final rule related to the use of derivatives, reverse repurchase agreements and certain other transactions by registered investment companies. The Fund’s trading of derivatives and other transactions that create future payment or delivery obligations is subject to value-at-risk (“VaR”) leverage limits and derivatives risk management program and reporting requirements. Generally, these requirements apply unless the Fund satisfies a “limited derivatives users” exception that is included in the final rule. Under the rule, when a fund trades reverse repurchase agreements or similar financing transactions, including certain tender option bonds, it needs to aggregate the amount of indebtedness associated with the reverse repurchase agreements or similar financing transactions with the aggregate amount of any other senior securities representing indebtedness when calculating a fund’s asset coverage ratio or treat all such transactions as derivatives transactions. Reverse repurchase agreements or similar financing transactions aggregated with other indebtedness do not need to be included in the calculation of whether the Fund satisfies the limited derivatives users exception, but for funds subject to the VaR testing requirement, reverse repurchase agreements and similar financing transactions must be included for purposes of such testing whether treated as derivatives transactions or not. The SEC also provided guidance in connection with the rule regarding the use of securities lending collateral that may limit the Fund’s securities lending activities. In addition, under the final rule, a fund is permitted to invest in a security on a when-issued or forward-settling basis, or with a non-standard settlement cycle, and the transaction will be deemed not to involve a senior security (as defined under Section 18(g) of the Act), provided that, (i) the Fund intends to physically settle the transaction and (ii) the transaction will settle within 35 days of its trade date (the “Delayed-Settlement Securities Provision”). A fund may otherwise engage in when-issued, forward-settling and non-standard settlement cycle securities transactions that do not meet the conditions of the Delayed-Settlement Securities Provision so long as the Fund treats any such transaction as a “derivatives transaction” for purposes of compliance with the rule. Furthermore, under the rule, the Fund is permitted to enter into an unfunded commitment agreement, and such unfunded commitment agreement will not be subject to the asset coverage
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requirements under the Act, if the Fund reasonably believes, at the time it enters into such agreement, that it will have sufficient cash and cash equivalents to meet its obligations with respect to all such agreements as they come due.
These requirements may limit the ability of the Fund to use derivatives, reverse repurchase agreements and similar financing transactions, when-issued, delayed delivery and forward commitment transactions, and unfunded commitment agreements as part of its investment strategies. These requirements may increase the cost of the Fund’s investments and cost of doing business, which could adversely affect investors. PIMCO cannot predict the effects of these requirements on the Fund. PIMCO intends to monitor developments and seek to manage the Fund in a manner consistent with achieving the Fund’s investment objectives, but there can be no assurance that it will be successful in doing so.
In October 2020, the SEC adopted certain regulatory changes and took other actions related to the ability of registered investment companies to invest in other registered investment companies. These changes, which are now in effect, include, among other things, the adoption of Rule 12d1-4 under the Act (the “Fund of Funds Rule”), the rescission of Rule 12d1-2 under the Act, and the withdrawal of certain related exemptive relief and no-action assurances. Such changes could adversely impact the investment strategies and operations of the Fund and Underlying PIMCO Funds, as well as funds serving as underlying funds of Affiliated Funds of Funds or third-party funds of funds.
In December 2020, the SEC adopted a rule addressing fair valuation of fund investments. The new rule sets forth requirements for good faith determinations of fair value as well as for the performance of fair value determinations, including related oversight and reporting obligations. The new rule also defines “readily available market quotations” for purposes of the definition of “value” under the Act, and the SEC noted that this definition will apply in all contexts under the Act.
In May 2022, the SEC proposed amendments to a current rule governing fund naming conventions. In general, the current rule requires funds with certain types of names to adopt a policy to invest at least 80% of their assets in the type of investment suggested by the name. The proposed amendments would expand the scope of the current rule in a number of ways that would result in an expansion of the types of fund names that would require the fund to adopt an 80% investment policy under the rule. Additionally, the proposed amendments would modify the circumstances under which a fund may deviate from its 80% investment policy and address the use and valuation of derivatives instruments for purposes of the rule. The proposal’s impact on the Fund will not be known unless and until any final rulemaking is adopted.
In May 2022, the SEC proposed a framework that would require certain registered funds (such as the Fund) to disclose their environmental, social, and governance (“ESG”) investing practices. Among other things, the proposed requirements would mandate that funds meeting three pre-defined classifications (i.e., integrated, ESG focused and/or impact funds) provide prospectus and shareholder report disclosure related to the ESG factors, criteria and processes used in managing the fund. The proposal’s impact on the Fund will not be known unless and until any final rulemaking is adopted.
In October 2022, the SEC adopted changes to the mutual fund and ETF shareholder report and registration statement disclosure requirements and the registered fund advertising rules, which will change the disclosures provided to shareholders.
In November 2022, the SEC proposed rule amendments which, among other things, would require funds to adopt swing pricing in order to mitigate dilution of shareholders’ interests in a fund by requiring the adjustment of fund net asset value per share to pass on costs stemming from shareholder purchase or redemption activity. In addition, the proposed rule would amend the liquidity rule framework. The proposal’s impact on the Fund will not be known unless and until any final rulemaking is adopted.
In November 2022, the SEC adopted amendments to Form N-PX under the Act to improve the utility to investors of proxy voting information reported by mutual funds, ETFs and certain other funds. The rule amendments will expand the scope of funds’ Form N-PX reporting obligations, subject managers to Form N-PX reporting obligations for “Say on Pay” votes, enhance Form N-PX disclosures, permit joint reporting by funds, managers and affiliated managers on Form N-PX, and require website availability of fund proxy voting records. The amendments will become effective on July 1, 2024. Funds and managers will be required to file their first reports covering the period from July 1, 2023 to June 30, 2024 on amended Form N-PX by August 31, 2024.
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During periods when interest rates are low (or negative), the Fund’s yield (or total return) may also be low and fall below zero. Very low or negative interest rates may heighten interest rate risk. The Fund may be subject to heightened levels of interest rate risk because the U.S. Federal Reserve (the “Federal Reserve”) has raised interest rates from historically low levels and has signaled an intention to continue to do so. To the extent the Federal Reserve continues to raise interest rates, there is a risk that rates across the financial system may rise. Changing interest rates may have unpredictable effects on markets, may result in heightened market volatility and may detract from Fund performance to the extent the Fund is exposed to such interest rates and/or volatility.
In addition, regulatory actions or actions taken by law enforcement entities in the United States or outside of the United States may also adversely affect the Fund’s investments. For example, assets that become subject to sanctions or that are involved in illegal activities such as money laundering or kleptocracy, may be seized, subject to forfeiture, frozen or otherwise become unmarketable, will lose value or become worthless and consequently adversely affect the Fund’s value. Actions such as geographical targeting orders for, or new rulemaking related to, real estate investments issued by FinCEN may also lengthen the settlement process, make a real estate asset less liquid and harder to sell, and/or increase costs associated with these portfolio investments.
CSDR Related Risk
The European Union has adopted a settlement discipline regime under Regulation (EU) No 909/2014 and the Settlement Discipline RTS as they may be modified from time to time (“CSDR”), which will have phased compliance dates. It aims to reduce the number of settlement fails that occur in EEA central securities depositories (“CSDs”) and address settlement fails where they occur. The key elements of the regime are: (i) mandatory buy-ins – if a settlement fail continues for a specified period of time after the intended settlement date, a buy-in process must be initiated to effect the settlement; (ii) cash penalties - EEA CSDs are required to impose cash penalties on participants that cause settlement fails and distribute these to receiving participants; and (iii) allocations and confirmations – EEA investment firms are required to take measures to prevent settlement fails, including putting in place arrangements with their professional clients to communicate securities allocations and transaction confirmations.
These requirements apply to transactions in transferable securities (e.g., shares and bonds), money market instruments, units in funds and emission allowances that are to be settled via an EEA CSD and, in the case of cash penalties and buy-in requirements only, are admitted to trading or traded on an EEA trading venue or cleared by an EEA central counterparty.
The implementation of the CSDR settlement discipline regime for funds that enter into in-scope transactions may result in increased operational and compliance costs being borne directly or indirectly by the Fund. CSDR may also affect liquidity and increase trading costs associated with relevant securities. If in-scope transactions are subject to additional expenses and penalties as a consequence of the CSDR settlement discipline regime, such expenses and penalties may be charged to the Fund depending upon their characterization under the Fund’s Investment Management Agreement.
Participation on Creditors Committees
Generally, when the Fund holds bonds or other similar fixed-income securities of an issuer, the Fund becomes a creditor of the issuer. If the Fund is a creditor of an issuer, it may be subject to challenges related to the securities that it holds, either in connection with the bankruptcy of the issuer or in connection with another action brought by other creditors of the issuer, shareholders of the issuer or the issuer itself. Although under no obligation to do so, PIMCO, as investment adviser to the Fund, may from time to time have an opportunity to consider, on behalf of the Fund and other similarly situated clients, negotiating or otherwise participating in the restructuring of the Fund’s portfolio investment or the issuer of such investment. PIMCO, in its judgment and discretion and based on the considerations deemed by PIMCO to be relevant, may believe that it is in the best interests of the Fund to negotiate or otherwise participate in such restructuring. Accordingly, and subject to applicable procedures approved by the Board, the Fund may from time to time participate on committees formed by creditors to negotiate with the management of financially troubled issuers of securities held by the Fund. Such participation may subject the Fund to expenses such as legal fees and may make the Fund an “insider” of the issuer for purposes of the federal securities laws, and therefore may restrict the Fund’s ability to trade in or acquire additional positions in a particular security when it might otherwise desire to do so. Participation by the Fund on such committees also may expose the Fund to potential liabilities under the federal bankruptcy laws or other laws governing the rights of creditors and debtors. Similarly, subject to the above-mentioned
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procedures, PIMCO may actively participate in bankruptcy court and related proceedings on behalf of the Fund in order to protect the Fund’s interests in connection with a restructuring transaction, and PIMCO may cause the Fund to enter into an agreement reasonably indemnifying third parties or advancing from the Fund’s assets any legal fees or other costs to third parties, including parties involved in or assisting the Fund with a restructuring transaction, such as trustees, servicers and other third parties. Further, PIMCO has the authority, subject to the above-mentioned procedures, to represent the Fund on creditors’ committees (or similar committees) or otherwise in connection with the restructuring of an issuer’s debt and generally with respect to challenges related to the securities held by the Fund relating to the bankruptcy of an issuer or in connection with another action brought by other creditors of the issuer, shareholders of the issuer or the issuer itself.
Temporary Defensive Strategies
Upon PIMCO’s recommendation, for temporary defensive purposes, the Fund may invest up to 100% of its net assets in investment grade debt securities, including high quality, short-term debt instruments, credit-linked trust certificates and/or index futures contracts or similar derivative instruments. Such investments may prevent the Fund from achieving its investment objectives.
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 Fund’s 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:
1.
Concentrate its investments in a particular industry, as that term is used in the Act and as interpreted, modified or otherwise permitted by regulatory authority having jurisdiction, from time to time;
2.
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 that invest in real estate, or interests therein.
3.
Purchase or sell commodities or commodities contracts or oil, gas or mineral programs. This restriction shall not prohibit the Fund, subject to restrictions described in the Prospectus and elsewhere in this Statement of Additional Information, from purchasing, selling or entering into futures contracts, options on futures contracts, forward contracts, or any interest rate, securities-related or other derivative instrument, including swap agreements and other derivative instruments, subject to compliance with any applicable provisions of the federal securities or commodities laws.
4.
Borrow money or issue any senior security, except to the extent permitted under the Act and as interpreted, modified, or otherwise permitted from time to time by regulatory authority having jurisdiction.
5.
Make loans, except to the extent permitted under the Act, as interpreted, modified, or otherwise permitted from time to time by regulatory authority having jurisdiction.
6.
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.
The Fund will invest, under normal circumstances, at least 80% of its net assets (plus any borrowings for investment purposes) in a portfolio of municipal bonds and other municipal securities, the interest from which, in the opinion of bond counsel for the issuer at the time of issuance (or on the basis of other authority believed by PIMCO to be reliable), is exempt from federal income tax and California income tax (i.e., excluded from gross income for income tax purposes but not necessarily exempt from the alternative minimum tax or from the income taxes of any other state or of a local government) (the “80% policy”). California municipal bonds generally are issued by or on behalf of the State of California and its political subdivisions, financing authorities and their agencies. Within the 80% policy, the Fund may invest in debt securities of an issuer located outside of California whose interest is, in the opinion of bond counsel for the issuer at the time of issuance, exempt from federal and California income tax. By concentrating its investments in California municipal securities, the Fund will be subject to California State-Specific Risk, among other risks. The Fund's 80% policy is a fundamental policy, which may not be changed without the approval of the holders of a majority of the Fund's 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.
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In addition, the Fund has adopted the following fundamental policies with respect to repurchase offers, which may not be changed without the approval of the holders of a majority of the Fund’s 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.
The Fund will make quarterly repurchase offers pursuant to Rule 23c-3 under the Act, as it may be amended from time to time.
b.
The Fund will repurchase shares that are tendered by a specific date (the “Repurchase Request Deadline”), which will be established by the Board (the “Board” or “Board of Trustees”) in accordance with Rule 23c-3, as amended from time to time. Rule 23c-3 requires the Repurchase Request Deadline to be no less than 21 and no more than 42 days after the Fund sends notification to shareholders of the repurchase offer.
c.
There will be a maximum fourteen (14) calendar day period (or the next business day if the 14th calendar day is not a business day) between the Repurchase Request Deadline and the date on which the Fund’s net asset value (“NAV”) applicable to the repurchase offer is determined (the “Repurchase Pricing Date”).
Other Information Regarding Investment Restrictions
Subject to the Fund’s self-imposed limitations, if any, as they may be amended from time to time, the Fund interprets its policies with respect to leverage and borrowing, issuing senior securities and lending to permit such activities as may be lawful for the Fund, to the full extent permitted by the Act or by exemption from the provisions therefrom pursuant to exemptive order of the SEC.
Currently, under the Act, the Fund may generally not lend money or property to any person, directly or indirectly, if such person controls or is under common control with the Fund, except for a loan from the Fund to a company that owns all of the outstanding securities of the Fund, except directors’ and qualifying shares.
The phrase “shareholder approval,” as used in the Prospectus and this Statement of Information, and the phrase a “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 apply only at the time of investment. Any subsequent change in the percentage of the Fund’s assets invested in certain securities or other instruments resulting from market fluctuations or other changes in the Fund’s total assets, will not require the Fund to dispose of an investment.
Under the Fund’s policy in paragraph (2) above in “Fundamental Investment Restrictions,” where the Fund purchases a loan or other security secured by real estate or interests therein, in the event of a subsequent default, foreclosure, or similar event, the Fund may take possession of and hold the underlying real estate in accordance with its rights under the initial security and subsequently sell or otherwise dispose of such real estate.
Under the Act, a “senior security” does not include any promissory note or evidence of indebtedness where such loan is for temporary purposes only and in an amount not exceeding 5% of the value of the total assets of the issuer at the time the loan is made. A loan is presumed to be for temporary purposes if it is repaid within sixty days and is not extended or renewed.
To the extent the Fund covers its commitment under a derivative instrument by the designation of assets determined by the Investment Manager to be liquid, equal in value to the amount of the Fund’s commitment, such instrument will not be considered a “senior security” for purposes of the Fund’s limitations on borrowings or the Fund’s issuance of Preferred Shares.
Pursuant to policies adopted by the Fund’s Board, purchased OTC options and the assets used as cover for OTC options written by the Fund may be treated as liquid. Please refer to “Illiquid Investments” for a further discussion of investment liquidity. It is noted that, while regulatory guidance indicates that assets used for cover may be considered “encumbered,” the liquidity classification of assets used for cover is not affected by their status as being used for cover.
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For purposes of applying the terms of the Fund’s policy in paragraph (1) above (the “industry concentration policy”), the Fund would be deemed to “concentrate” in a particular industry if it invested more than 25% of its total assets in that industry. For purposes of the industry concentration policy, PIMCO will, on behalf of the Fund, make reasonable determinations as to the appropriate industry classification to assign to each security or instrument in which the Fund invests. The definition of what constitutes a particular “industry” is an evolving one, particularly for industries or sectors within industries that are new or are undergoing rapid development. Some securities could reasonably fall within more than one industry category. 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). For purposes of the industry concentration policy, a foreign government is considered to be an industry, although currency positions are not considered to be an investment in a foreign government for these purposes. Mortgage-related or asset-backed securities that are issued or guaranteed as to principal or interest by the U.S. Government or its agencies or instrumentalities are not subject to the Fund’s industry concentration policy, by virtue of the exclusion from that test available to all U.S. Government securities. Similarly, tax-exempt municipal bonds issued by states, municipalities and other political subdivisions, agencies, authorities and instrumentalities of states and multi-state agencies and authorities are not subject to the Fund’s industry concentration policy.
To the extent that an underlying investment company in which the Fund invests has adopted a policy to concentrate its investments in a particular industry, the Fund will, to the extent applicable, take such underlying investment company’s concentration policy into consideration for purposes of the Fund’s own industry concentration policy.
For purposes of its investment policies and restrictions, with the exception of the Fund’s 80% policy to invest, under normal circumstances, at least 80% of its net assets (plus any borrowings for investment purposes) in a portfolio of municipal bonds and other municipal securities, the interest from which, in the opinion of bond counsel for the issuer at the time of issuance (or on the basis of other authority believed by PIMCO to be reliable) is exempt from federal income tax and California income tax (i.e., excluded from gross income for income tax purposes but not necessarily exempt from the alternative minimum tax or from the income taxes of any other state or of a local government) (the “80% policy”), the Fund may value derivative instruments at market value, notional value or full exposure value (i.e., the sum of the notional amount for the contract plus the market value), or any combination of the foregoing (e.g., notional value for purposes of calculating the numerator and market value for purposes of calculating the denominator for compliance with a particular policy or restriction). For example, the Fund may value credit default swaps at full exposure value for purposes of any quality guidelines because such value in general better reflects the Fund’s actual economic exposure during the term of the credit default swap agreement. As a result, the Fund may, at times, have notional exposure to an asset class (before netting) that is greater or lesser than the stated limit or restriction noted in the Fund’s Prospectus. In this context, both the notional amount and the market value may be positive or negative depending on whether the Fund is selling or buying protection through the credit default swap. For purposes of the Fund’s 80% policy, the Fund values its derivative instruments based on their market value. The manner in which certain securities or other instruments are valued by the Fund for purposes of applying investment policies and restrictions may differ from the manner in which those investments are valued by other types of investors.
From time to time, the Fund may voluntarily participate in actions (for example, rights offerings, conversion privileges, exchange offers, credit event settlements, etc.) including, but not limited to, where the issuer or counterparty offers securities or instruments to holders or counterparties, such as the Fund, and the acquisition is determined to be beneficial to Fund shareholders (“Voluntary Action”). Notwithstanding any percentage investment limitation listed under this “Investment Restrictions” section or any percentage investment limitation of the Act or rules thereunder, if the Fund has the opportunity to acquire a permitted security or instrument through a Voluntary Action, and the Fund will exceed a percentage investment limitation following the acquisition, it will not constitute a violation if, prior to the receipt of the securities or instruments and after announcement of the offering, the Fund sells an offsetting amount of assets that are subject to the investment limitation in question at least equal to the value of the securities or instruments to be acquired.
Unless otherwise indicated, all percentage limitations on Fund investments (as stated throughout this Statement of Additional Information or in the Prospectus) that are not: (i) specifically included in this “Investment Restrictions” section; or (ii) imposed by the Act, rules thereunder, the Code or related regulations (the “Elective Investment Restrictions”), will apply only at the time of investment unless the acquisition is a Voluntary Action. The percentage limitations and absolute prohibitions with respect to Elective Investment Restrictions are not applicable to the Fund’s acquisition of securities or instruments through a Voluntary Action.
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The Fund may engage in roll-timing strategies where the Fund seeks to extend the expiration or maturity of a position, such as a forward contract, futures contract or to-be-announced (“TBA”) transaction, on an underlying asset by closing out the position before expiration and contemporaneously opening a new position with respect to the same underlying asset that has substantially similar terms except for a later expiration date. Such “rolls” enable the Fund to maintain continuous investment exposure to an underlying asset beyond the expiration of the initial position without delivery of the underlying asset. Similarly, as certain standardized swap agreements transition from OTC trading to mandatory exchange-trading and clearing due to the implementation of Dodd-Frank Act regulatory requirements, the Fund may “roll” an existing OTC swap agreement by closing out the position before expiration and contemporaneously entering into a new exchange-traded and cleared swap agreement on the same underlying asset with substantially similar terms except for a later expiration date. These types of new positions opened contemporaneous with the closing of an existing position on the same underlying asset with substantially similar terms are collectively referred to as “Roll Transactions.” Elective Investment Restrictions (defined in the preceding paragraph), which normally apply at the time of investment, do not apply to Roll Transactions (although Elective Investment Restrictions will apply to the Fund’s entry into the initial position). In addition and notwithstanding the foregoing, for purposes of this policy, those Non-Fundamental Investment Restrictions that are considered Elective Investment Restrictions for purposes of the policy on Voluntary Actions (described in the preceding paragraph) are also Elective Investment Restrictions for purposes of this policy on Roll Transactions. The Fund will test for compliance with Elective Investment Restrictions at the time of the Fund’s initial entry into a position, but the percentage limitations and absolute prohibitions set forth in the Elective Investment Restrictions are not applicable to the Fund’s subsequent acquisition of securities or instruments through a Roll Transaction.
MANAGEMENT OF THE FUND
Trustees and Officers
The business of the Fund is managed under the direction of the Board. Subject to the provisions of the Fund’s Amended and Restated Agreement and Declaration of Trust, as may be amended from time to time (the “Declaration”), its Bylaws, as may be amended from time to time (the “Bylaws”) and Massachusetts law, the Trustees have all powers necessary and convenient to carry out their responsibilities, including the election and removal of the Fund’s officers.
Board Leadership Structure. The Board consists of eight Trustees, six of whom are not “interested persons” (within the meaning of Section 2(a)(19) of the Act) of the Fund or of the Investment Manager (the “Independent Trustees”), which represents 75% of the Trustees that are Independent Trustees. An Independent Trustee serves as Chair of the Board and is selected by a vote of the majority of the Independent Trustees. The Chair of the Board presides at meetings of the Board, acts as a liaison with service providers, officers, attorneys and other Trustees generally between meetings, and performs such other functions as may be requested by the Board from time to time.
The Board meets regularly four times each year to discuss and consider matters concerning the Fund, and also holds special meetings to address matters arising between regular meetings. The Independent Trustees regularly meet outside the presence of management and are advised by independent legal counsel.
The Board has established five standing Committees to facilitate the Trustees’ oversight of the management of the Fund: the Audit Oversight Committee, the Governance and Nominating Committee, the Valuation Oversight Committee, the Contracts Committee and the Performance Committee. The functions and role of each Committee are described below under “Committees of the Board of Trustees.” The membership of each Committee (other than the Performance Committee) consists of only the Independent Trustees. The Performance Committee consists of all the Trustees. The Independent Trustees believe that participation on each Committee allows them to participate in the full range of the Board’s oversight duties.
The Board reviews its leadership structure periodically and has determined that this leadership structure, including an Independent Chair, a supermajority of Independent Trustees and Committee membership limited to Independent Trustees (with the exception of the Performance Committee), is appropriate in light of the characteristics and circumstances of the Fund. In reaching this conclusion, the Board considered, among other things, the predominant role of PIMCO in the day-to-day management of Fund affairs, the extent to which the work of the Board is conducted through the Committees, the number of funds in the fund complex overseen by Board members, the variety of asset classes those funds include, the assets of the Fund and other funds in the fund complex and the
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management, and other service arrangements of the Fund and such other funds. The Board also believes that its structure, including the presence of two Trustees who are or have been executives with PIMCO or PIMCO-affiliated entities, facilitates an efficient flow of information concerning the management of the Fund to the Independent Trustees.
Risk Oversight. The Fund has retained PIMCO to provide investment advisory services and administrative services. Accordingly, PIMCO is immediately responsible for the management of risks that may arise from Fund investments and operations. Some employees of PIMCO serve as the Fund’s officers, including the Fund’s principal executive officer and principal financial and accounting officer, chief compliance officer and chief legal officer. PIMCO and the Fund’s other service providers have adopted policies, processes and procedures to identify, assess and manage different types of risks associated with the Fund’s activities. The Board oversees the performance of these functions by PIMCO and the Fund’s other service providers, both directly and through the Committee structure it has established. The Board receives from PIMCO a wide range of reports, both on a regular and as-needed basis, relating to the Fund’s activities and to the actual and potential risks of the Fund. These include reports on investment and market risks, custody and valuation of Fund assets, compliance with applicable laws, and the Fund’s financial accounting and reporting. The Board also regularly will receive, from the Fund’s principal underwriter, reports regarding distribution, sales and marketing of the Fund’s shares. In addition, the Board meets periodically with the individual portfolio managers of the Fund or their delegates to receive reports regarding the portfolio management of the Fund and its performance, including its investment risks. In the course of these meetings and discussions with PIMCO, the Board has emphasized the importance of PIMCO maintaining vigorous risk management programs and procedures with respect to the Fund.
In addition, the Board has appointed a Chief Compliance Officer (“CCO”). The CCO oversees the development of compliance policies and procedures that are reasonably designed to minimize the risk of violations of the federal securities laws (“Compliance Policies”). The CCO reports directly to the Independent Trustees, interacts with individuals within PIMCO’s organization, and provides presentations to the Board at its quarterly meetings and an annual report on the application of the Compliance Policies. The Board periodically discusses relevant risks affecting the Fund with the CCO at these meetings. The Board has approved the Compliance Policies and reviews the CCO’s reports. Further, the Board annually reviews the sufficiency of the Compliance Policies, as well as the appointment and compensation of the CCO.
The Board recognizes that the reports it receives concerning risk management matters are, by their nature, typically summaries of the relevant information. Moreover, the Board recognizes that not all risks that may affect the Fund can be identified in advance; that it may not be practical or cost-effective to eliminate or mitigate certain risks; that it may be necessary to bear certain risks (such as investment-related risks) in seeking to achieve the Fund’s investment objectives; and that the processes, procedures and controls employed to address certain risks may be limited in their effectiveness.
The Trustees and officers of the Fund, their year of birth, the positions they hold with the Fund, their term of office and length of time served, a description of their principal occupations during the past five years, the number of portfolios in the Fund Complex (as defined below) that the Trustee oversees and any other public company directorships held by the Trustee are listed in the two tables immediately following. Except as shown, each Trustee’s and officer’s principal occupation and business experience for the last five years have been with the employer(s) indicated, although in some cases the Trustee may have held different positions with such employer(s).
The charts below identify the Trustees and executive officers of the Fund. Unless otherwise indicated, the address of all persons below is c/o Pacific Investment Management Company LLC, 1633 Broadway, New York, New York 10019.
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Independent Trustees(1)
Name, Address and Year of Birth | Position(s) Held with the Fund | Term of Office and Length of Time Served(2) | Principal Occupation(s) During the Past 5 Years | Number of Portfolios in Fund Complex Overseen by Trustee(3) | Other Directorships Held by Trustee During the Past 5 Years |
Deborah A. DeCotis 1952 | Chair of the Board, Trustee | Since inception | Advisory Director, Morgan Stanley & Co., Inc. (since 1996); Member, Circle Financial Group (since 2009); Member, Council on Foreign Relations (since 2013); Trustee, Smith College (since 2017); Director, Watford Re (since 2017); and Director, Cadre Inc., a manufacturer of safety equipment (since 2022). Formerly, Co-Chair Special Projects Committee, Memorial Sloan Kettering (2005-2015); Trustee, Stanford University (2010- 2015); Principal, LaLoop LLC, a retail accessories company (1999-2014); Director, Helena Rubenstein Foundation (1997-2010); and Director, Armor Holdings (2002-2010). | 30 | Trustee, Allianz Funds (2011-2021); Trustee, Virtus Funds (2021-Present) |
Sarah E. Cogan 1956 | Trustee | Since inception | Retired Partner, Simpson Thacher & Bartlett LLP (law firm)(1989-2018); Director, Girl Scouts of Greater New York, Inc. (since 2016); and Trustee, Natural Resources Defense Council, Inc. (since 2013). | 30 | Trustee, Allianz Funds (2019-2021); Trustee, Virtus Funds (2021-Present) |
Joseph B. Kittredge, Jr. 1954 | Trustee | Since inception | Trustee (since 2019) and Governance Committee (since 2020), Vermont Law School (since 2019); Director and Treasurer, Center for Reproductive Rights (since 2015). Formerly, Director (2013-2020) and Chair (2018-2020), ACLU of Massachusetts; General Counsel, Grantham, Mayo, Van Otterloo & Co. LLC (2005-2018) and Partner (2007-2018); President, GMO Trust (institutional mutual funds) (2009-2018); Chief Executive Officer, GMO Trust (2009-2015); President and Chief Executive Officer, GMO Series Trust (platform based mutual funds) (2011-2013). | 30 | Trustee, GMO Trust (2010-2018); Chairman of the Board of Trustees, GMO Series Trust (2011-2018) |
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Name, Address and Year of Birth | Position(s) Held with the Fund | Term of Office and Length of Time Served(2) | Principal Occupation(s) During the Past 5 Years | Number of Portfolios in Fund Complex Overseen by Trustee(3) | Other Directorships Held by Trustee During the Past 5 Years |
Kathleen A. McCartney(4) 1955 | Trustee | Since July 2022 | President, Smith College (since 2013); Director (since 2013) and President (since 2020), Five Colleges, Inc., consortium of liberal arts colleges and universities (since 2013). Formerly, Director, American Council on Education Board of Directors, (2015-2019); Director, Consortium on Financing Higher Education Board of Directors (2015-2019); Director, edX Board of Directors, online course provider (2012-2013); Director, Bellwether Education Partners Board, national nonprofit organization (2010-2013); Dean, Harvard Graduate School of Education (2006-2013); Trustee, Tufts University (2007-2013). | 30 | None |
Alan Rappaport 1953 | Trustee | Since inception | Director, Victory Capital Holdings, Inc., an asset management firm (since 2013). Formerly, Adjunct Professor, New York University Stern School of Business (2011-2020); Lecturer, Stanford University Graduate School of Business (2013-2020); Advisory Director (formerly Vice Chairman), Roundtable Investment Partners (2009-2018); Member of Board of Overseers, NYU Langone Medical Center (2015-2016); Trustee, American Museum of Natural History (2005-2015); Trustee, NYU Langone Medical Center (2007-2015); and Vice Chairman (formerly, Chairman and President), U.S. Trust (formerly, Private Bank of Bank of America, the predecessor entity of U.S. Trust) (2001-2008). | 30 | Trustee, Allianz Funds (2010-2021); Trustee, Virtus Closed-End Funds (2021-Present) |
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Name, Address and Year of Birth | Position(s) Held with the Fund | Term of Office and Length of Time Served(2) | Principal Occupation(s) During the Past 5 Years | Number of Portfolios in Fund Complex Overseen by Trustee(3) | Other Directorships Held by Trustee During the Past 5 Years |
E. Grace Vandecruze 1963 | Trustee | Since inception | Founder and Managing Director, Grace Global Capital LLC, a strategic advisory firm to the insurance industry (since 2006); Director, The Doctors Company, a medical malpractice insurance company (since 2020); Director, Link Logistics REIT, a real estate company (since 2021); Director and Member of the Investment & Risk Committee, Resolution Life Group Holdings, a global life insurance group (since 2021); Director, Wharton Graduate Executive Board; Chief Financial Officer, ShoulderUp Technology Acquisition Corp, a special purpose acquisition company (since 2021); and Director, Blackstone Private Equity Strategies Fund (since 2022). Formerly, Director, Resolution Holdings (2015-2019); Director and Member of the Audit Committee and the Wealth Solutions Advisory Committee, M Financial Group, a life insurance company (2015-2021); Chief Financial Officer, Athena Technology Acquisition Corp. a special purpose acquisition company (2021-2022); and Director, SBLI USA, a life insurance company (2015-2018). | 30 | None |
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Interested Trustees
Name, Address and Year of Birth | Position(s) Held with the Fund | Term of Office and Length of Time Served(2) | Principal Occupation(s) During the Past 5 Years | Number of Portfolios in Fund Complex Overseen by Trustee(3) | Other Directorships Held by Trustee During the Past 5 Years |
David N. Fisher(5) 1968 650 Newport Center Drive, Newport Beach, CA 92660 | Trustee | Since inception. | Managing Director and Co-Head of U.S. Global Wealth Management Strategic Accounts, PIMCO (since 2021); Director, Court Appointed Special Advocates (CASA) of Orange County, a non-profit organization (since 2015). Formerly, Managing Director and Head of Traditional Product Strategies, PIMCO (2015-2021); Global Bond Strategist, PIMCO (2008-2015); and Managing Director and Head of Global Fixed Income, HSBC Global Asset Management (2005-2008). | 30 | None |
Libby D. Cantrill(5)(6) 1977 650 Newport Center Drive, Newport Beach, CA 92660 | Trustee | Since April 2023 | Managing Director, Head of Public Policy, PIMCO (since 2007); Institutional Account Manager, PIMCO (2007-2010); Legislative Aide, House of Representatives (2003-2005); Investment Banking Analyst, Morgan Stanley (2000-2003). | 27 | Covenant House New York (2021-Present); Securities Industry and Financial Markets Association (2022-Present) |
1.
“Independent Trustees” are those Trustees who are not “interested persons” of the Fund (as defined in Section 2(a)(19) of the Act).
2.
Under the Fund’s Declaration, a Trustee serves during the continued lifetime of the Fund until he or she dies, resigns or is removed, or, if sooner, until the election and qualification of his or her successor.
3.
The Term “Fund Complex” as used herein includes the Fund and any other registered investment company (i) that holds itself out to investors as a related company for purposes of investment and investor services; or (ii) for which PIMCO or an affiliate of PIMCO serves as primary investment adviser.
4.
Ms. McCartney was appointed as a Trustee of the Fund effective July 1, 2022.
5.
Ms. Cantrill and Mr. Fisher are “interested persons” of the Fund, as defined in Section 2(a)(19) of the Act, due to their affiliation with PIMCO and its affiliates.
6.
Ms. Cantrill was appointed as a Trustee of the Fund effective April 30, 2023.
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Officers
Name, Address and Year of Birth | Position(s) Held with Fund | Term of Office and Length of Time Served+ | Principal Occupation(s) During the Past 5 Years |
Eric D. Johnson1 1970 | President | Since inception | Executive Vice President and Head of Funds Business Group Americas, PIMCO. President, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series, PIMCO Equity Series VIT, PIMCO Managed Accounts Trust, PIMCO-Sponsored Interval Funds, PIMCO-Sponsored Closed-End Funds and PIMCO Flexible Real Estate Income Fund. |
Keisha Audain Pressley2 1975 | Chief Compliance Officer | Since inception | Executive Vice President and Deputy Chief Compliance Officer, PIMCO. Chief Compliance Officer, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series, PIMCO Equity Series VIT, PIMCO Managed Accounts Trust, PIMCO-Sponsored Interval Funds, PIMCO-Sponsored Closed-End Funds, PIMCO Flexible Real Estate Income Fund and PIMCO Capital Solutions BDC Corp. |
Ryan G. Leshaw1 1980 | Chief Legal Officer | Since inception | Executive Vice President and Senior Counsel, PIMCO. Chief Legal Officer, PIMCO Managed Accounts Trust, PIMCO-Sponsored Interval Funds, PIMCO-Sponsored Closed-End Funds, PIMCO Flexible Real Estate Income Fund and PIMCO Capital Solutions BDC Corp. Chief Legal Officer and Secretary, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series and PIMCO Equity Series VIT. Formerly, Associate, Willkie Farr & Gallagher LLP. |
Joshua D. Ratner2 1976 | Senior Vice President | Since inception | Executive Vice President and Head of Americas Operations, PIMCO. Senior Vice President, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series, PIMCO Equity Series VIT, PIMCO Managed Accounts Trust, PIMCO-Sponsored Interval Funds and PIMCO-Sponsored Closed-End Funds. |
84
Name, Address and Year of Birth | Position(s) Held with Fund | Term of Office and Length of Time Served+ | Principal Occupation(s) During the Past 5 Years |
Peter G. Strelow1 1970 | Senior Vice President | Since inception | Managing Director and Co-Chief Operating Officer, PIMCO. Senior Vice President, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series, PIMCO Equity Series VIT, PIMCO Managed Accounts Trust, PIMCO-Sponsored Interval Funds and PIMCO-Sponsored Closed-End Funds. Formerly, Chief Administrative Officer, PIMCO. |
Wu-Kwan Kit1 1981 | Vice President, Senior Counsel and Secretary | Since inception | Senior Vice President and Senior Counsel, PIMCO. Vice President, Senior Counsel and Secretary, PIMCO Managed Accounts Trust, PIMCO-Sponsored Interval Funds, PIMCO-Sponsored Closed-End Funds, PIMCO Flexible Real Estate Income Fund and PIMCO Capital Solutions BDC Corp. Assistant Secretary, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series and PIMCO Equity Series VIT. Formerly, Assistant General Counsel, VanEck Associates Corp. |
Douglas B. Burrill2 1980 | Vice President | Since August 2022 | Senior Vice President, PIMCO. Vice President, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series, PIMCO Equity Series VIT, PIMCO Managed Accounts Trust, PIMCO-Sponsored Interval Funds, PIMCO-Sponsored Closed-End Funds, PIMCO Flexible Real Estate Income Fund and PIMCO Capital Solutions BDC Corp. |
Elizabeth A. Duggan1 1964 | Vice President | Since inception | Executive Vice President, PIMCO. Vice President, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series, PIMCO Equity Series VIT, PIMCO Managed Accounts Trust, PIMCO-Sponsored Interval Funds, PIMCO-Sponsored Closed-End Funds, PIMCO Flexible Real Estate Income Fund and PIMCO Capital Solutions BDC Corp. |
85
Name, Address and Year of Birth | Position(s) Held with Fund | Term of Office and Length of Time Served+ | Principal Occupation(s) During the Past 5 Years |
Jason R. Duran1 1977 | Vice President | Since March 2023 | Vice President, PIMCO. Vice President, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series, PIMCO Equity Series VIT, PIMCO Managed Accounts Trust, PIMCO-Sponsored Interval Funds and PIMCO-Sponsored Closed-End Funds. |
Mark A. Jelic11981 | Vice President | Since inception | Senior Vice President, PIMCO. Vice President, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series, PIMCO Equity Series VIT, PIMCO Managed Accounts Trust, PIMCO-Sponsored Interval Funds, PIMCO-Sponsored Closed-End Funds, PIMCO Flexible Real Estate Income Fund and PIMCO Capital Solutions BDC Corp. |
Kenneth W. Lee1 1972 | Vice President | Since August 2022 | Senior Vice President, PIMCO. Vice President, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series, PIMCO Equity Series VIT, PIMCO Managed Accounts Trust, PIMCO-Sponsored Interval Funds, PIMCO-Sponsored Closed-End Funds, PIMCO Flexible Real Estate Income Fund and PIMCO Capital Solutions BDC Corp. |
Greg J. Mason3 1980 | Vice President | Since March 2023 | Senior Vice President, PIMCO. Vice President, PIMCO Managed Accounts Trust, PIMCO-Sponsored Interval Funds, PIMCO-Sponsored Closed-End Funds and PIMCO Flexible Real Estate Income Fund. |
Brian J. Pittluck1 1977 | Vice President | Since inception | Senior Vice President, PIMCO. Vice President, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series, PIMCO Equity Series VIT, PIMCO Managed Accounts Trust, PIMCO-Sponsored Interval Funds, PIMCO-Sponsored Closed-End Funds, PIMCO Flexible Real Estate Income Fund and PIMCO Capital Solutions BDC Corp. |
86
Name, Address and Year of Birth | Position(s) Held with Fund | Term of Office and Length of Time Served+ | Principal Occupation(s) During the Past 5 Years |
Keith A. Werber1 1973 | Vice President | Since August 2022 | Executive Vice President, PIMCO. Vice President, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series, PIMCO Equity Series VIT, PIMCO Managed Accounts Trust, PIMCO-Sponsored Interval Funds, PIMCO-Sponsored Closed-End Funds, PIMCO Flexible Real Estate Income Fund and PIMCO Capital Solutions BDC Corp. |
Bijal Y. Parikh1 1978 | Treasurer | Since inception | Senior Vice President, PIMCO. Treasurer, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series, PIMCO Equity Series VIT, PIMCO Managed Accounts Trust, PIMCO-Sponsored Interval Funds, PIMCO-Sponsored Closed-End Funds and PIMCO Flexible Real Estate Income Fund. |
Brandon T. Evans1 1982 | Deputy Treasurer | Since inception | Senior Vice President, PIMCO. Deputy Treasurer, PIMCO Managed Accounts Trust, PIMCO-Sponsored Interval Funds and PIMCO-Sponsored Closed-End Funds. Assistant Treasurer, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series, PIMCO Equity Series VIT and PIMCO Flexible Real Estate Income Fund. |
Erik C. Brown3 1967 | Assistant Treasurer | Since inception | Executive Vice President, PIMCO. Assistant Treasurer, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series, PIMCO Equity Series VIT, PIMCO Managed Accounts Trust, PIMCO-Sponsored Interval Funds, PIMCO-Sponsored Closed-End Funds, PIMCO Flexible Real Estate Income Fund and PIMCO Capital Solutions BDC Corp. |
87
Name, Address and Year of Birth | Position(s) Held with Fund | Term of Office and Length of Time Served+ | Principal Occupation(s) During the Past 5 Years |
Maria M. Golota2 1983 | Assistant Treasurer | Since February 2023 | Vice President, PIMCO. Assistant Treasurer, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series, PIMCO Equity Series VIT, PIMCO Managed Accounts Trust, PIMCO-Sponsored Interval Funds, PIMCO-Sponsored Closed-End Funds and PIMCO Flexible Real Estate Income Fund. |
1
The address of these officers is Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, California 92660.
2
The address of these officers is Pacific Investment Management Company LLC, 1633 Broadway, New York, New York 10019.
3
The address of these officers is Pacific Investment Management Company LLC, 401 Congress Ave., Austin, Texas 78701.
+
Under the Fund’s Bylaws, an officer serves until his or her successor is elected or qualified, or until he or she sooner dies, resigns, is removed or becomes disqualified. Officers hold office at the pleasure of the Trustees.
Each of the Fund’s executive officers is an “interested person” of the Fund (as defined in Section 2(a)(19) of the Act) as a result of his or her position(s) set forth in the table above.
Trustee Qualifications
The Board has determined that each Trustee is qualified to serve as such based on several factors (none of which alone is decisive). Each Trustee is knowledgeable about the Fund’s business and service provider arrangements, in part because he or she serves as trustee or director to a number of other investment companies advised by PIMCO and/or its affiliates with similar arrangements to that of the Fund, or has had significant experience in the investment management and/or financial services industries. Among the factors the Board considers when concluding that an individual is qualified to serve on the Board were the following: (i) the individual’s business and professional experience and accomplishments; (ii) the individual’s ability to work effectively with other members of the Board; (iii) the individual’s prior experience, if any, serving on the boards of public companies (including, where relevant, other investment companies) and other complex enterprises and organizations; and (iv) how the individual’s skills, experiences and attributes would contribute to an appropriate mix of relevant skills and experience on the Board.
In respect of each current Trustee, the individual’s substantial professional accomplishments and prior experience, including, in some cases, in fields related to the operations of the Fund, were a significant factor in the determination by the Board that the individual is qualified to serve as a Trustee of the Fund. The following is a summary of various qualifications, experiences and skills of each Trustee (in addition to business experience during the past five years set forth in the table above) that contributed to the Board’s conclusion that an individual is qualified to serve on the Board. References to qualifications, experiences and skills are not intended to hold out the Board or individual Trustees as having any special expertise or experience, and shall not impose any greater responsibility or liability on any such person or on the Board by reason thereof.
Libby D. Cantrill — Ms. Cantrill has substantial experience in the investment management industry. Ms. Cantrill has 18 years of investment experience and is the Head of Public Policy and is a managing director in PIMCO's portfolio management group. In her role, she analyzes policy and political risk for the firm's Investment Committee and leads U.S. policymaker engagement and policy strategy for the firm. She also works closely with PIMCO's Global Advisory Board and has served as a rotating member of the firm's Executive Committee. Ms. Cantrill is a Chartered Financial Analyst charterholder.
Sarah E. Cogan — Ms. Cogan has substantial legal experience in the investment management industry, having served as a partner at a large international law firm in the corporate department for over 25 years and as former head of the registered funds practice. She has extensive experience in oversight of investment company boards through her
88
experience as counsel to the Independent Trustees of certain PIMCO-Managed Funds and as counsel to other independent trustees, investment companies and asset management firms.
Deborah A. DeCotis — Ms. DeCotis has substantial senior executive experience in the investment banking industry, having served as a Managing Director for Morgan Stanley. She has extensive board experience and experience in oversight of investment management functions through her experience as a former Director of the Helena Rubenstein Foundation, Stanford Graduate School of Business and Armor Holdings.
David N. Fisher — Mr. Fisher has substantial executive experience in the investment management industry. Mr. Fisher is a Managing Director and Co-Head of U.S. Global Wealth Management Strategic Accounts at PIMCO. In this role, he helps oversee relationships with key distribution partners and develop the firm’s growth strategy across wealth management channels. Prior to taking on this position, Mr. Fisher was Head of Traditional Product Strategies at PIMCO, where he oversaw teams of product strategists covering core and non-core fixed-income strategies as well as the firm’s suite of equity strategies, was a Global Bond Strategist at PIMCO, and has managed PIMCO’s Total Return Strategy. Because of his familiarity with PIMCO and its affiliates, Mr. Fisher serves as an important information resource for the Independent Trustees and as a facilitator of communication with PIMCO.
Joseph B. Kittredge, Jr. — Mr. Kittredge has substantial experience in the investment management industry, having served for thirteen years as General Counsel to Grantham, Mayo, Van Otterloo & Co. LLC, the adviser to the GMO mutual fund complex, and as a Trustee and senior officer for funds in the GMO complex. Previously, he was a partner at a large international law firm. Mr. Kittredge has extensive experience in asset management regulation and has provided legal advice to investment company boards, registered funds and their sponsors with respect to a broad range of financial, legal, tax, regulatory and other issues. He also serves as the Audit Oversight Committee’s Chair and has been determined by the Board to be an “audit committee financial expert.”
Kathleen A. McCartney — Ms. McCartney has substantial board experience, having served on a number of nonprofit boards, as trustee of Tufts University, director of the American Council on Education, director of the Consortium on Financing Higher Education, founding board member of edX, and director of the Bellwether Education Partners board. She also has substantial senior executive experience as the President of Smith College and director of Five Colleges, Inc.
Alan Rappaport — Mr. Rappaport has substantial senior executive experience in the financial services industry. He formerly served as Chairman and President of the Private Bank of Bank of America and as Vice Chairman of U.S. Trust and as an Advisory Director of an investment firm.
E. Grace Vandecruze — Ms. Vandecruze has substantial senior executive experience in the financial services industry. She is Founder and Managing Director of Grace Global Capital LLC, a strategic advisory firm to the insurance industry (since 2006). She has extensive board experience and experience in oversight of investment management and insurance company functions through her experience as a Director and Member of the Audit Committee and the Wealth Solutions Advisory Committee, M Financial Group, a life insurance company (2015-2021), a Director of The Doctors Company, a medical malpractice insurance company (since 2020) and a Director and Member of the Investment & Risk Committee, Resolution Life Group Holdings, a global life insurance group (since 2021).
Committees of the Board of Trustees
Audit Oversight Committee. The Board has established an Audit Oversight Committee, in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), currently consisting of Messrs. Kittredge and Rappaport and Mses. Cogan, DeCotis, McCartney and Vandecruze, each of whom is an Independent Trustee. Mr. Kittredge is the current Chair of the Fund’s Audit Oversight Committee.
The Audit Oversight Committee provides oversight with respect to the internal and external accounting and auditing procedures of the Fund and, among other things, determines the selection of an independent registered public accounting firm for the Fund and considers the scope of the audit, approves all audit and permitted non- audit services proposed to be performed by those auditors on behalf of the Fund and approves non-audit services to be performed by the auditors for certain affiliates, including PIMCO and entities in a control relationship with PIMCO that provide services to the Fund where the engagement relates directly to the operations and financial reporting of the Fund. The
89
Audit Oversight Committee considers the possible effect of those services on the independence of the Fund’s independent registered public accounting firm. During the period ended December 31, 2022, the Audit Oversight Committee met five times.
Governance and Nominating Committee. The Board has established a Governance and Nominating Committee composed solely of Independent Trustees, currently consisting of Messrs. Kittredge and Rappaport and Mses. Cogan, DeCotis, McCartney and Vandecruze. Ms. DeCotis is the current Chair of the Governance and Nominating Committee. The primary purposes and responsibilities of the Governance and Nominating Committee are: (i) advising and making recommendations to the Board on matters concerning Board governance and related Trustee practices, and (ii) the screening and nomination of candidates for election to the Board as Independent Trustees.
The responsibilities of the Governance and Nominating Committee include considering and making recommendations to the Fund’s Board regarding: (1) governance, retirement and other policies, procedures and practices relating to the Board and the Trustees; (2) in consultation with the Chair of the Board, matters concerning the functions and duties of the Trustees and committees of the Board; (3) the size of the Board and, in consultation with the Chair of the Board, the Board’s committees and their composition; and (4) Board and committee meeting procedures. The Committee will also periodically review and recommend for approval by the Board the structure and levels of compensation and any related benefits to be paid or provided by the Fund to the Independent Trustees for their services on the Board and any committees on the Board.
The Governance and Nominating Committee is responsible for reviewing and recommending qualified candidates to the Board in the event that a position is vacated or created or when Trustees are to be re-elected. During the period ended December 31, 2022, the Governance and Nominating Committee met four times.
Qualifications, Evaluation and Identification of Trustee Nominees. The Governance and Nominating Committee of the Fund requires that Trustee candidates have a college degree or equivalent business experience. When evaluating candidates, the Governance and Nominating Committee may take into account a wide variety of factors including, but not limited to: (i) availability and commitment of a candidate to attend meetings and perform his or her responsibilities on the Board, (ii) relevant industry and related experience, (iii) educational background, (iv) ability, judgment and expertise and (v) overall diversity of the Board’s composition. The process of identifying nominees involves the consideration of candidates recommended by one or more of the following sources: (i) the Fund’s current Trustees, (ii) the Fund’s officers, (iii) the Fund’s investment adviser, (iv) the Fund’s shareholders and (v) any other source the Committee deems to be appropriate. The Governance and Nominating Committee may, but is not required to, retain a third-party search firm at the Fund’s expense to identify potential candidates.
Consideration of Candidates Recommended by Shareholders. The Governance and Nominating Committee will review and consider nominees recommended by shareholders to serve as Trustees, provided that the recommending shareholder follows the “Procedures for Shareholders to Submit Nominee Candidates”, which are set forth as Appendix A to the Fund’s Governance and Nominating Committee Charter and attached as Appendix A to this Statement of Additional Information. Among other requirements, these procedures provide that the recommending shareholder must submit any recommendation in writing to the Fund, to the attention of the Fund’s Secretary, at the address of the principal executive offices of the Fund. Once each quarter, if any shareholder recommendations have been received by the Secretary during the quarter, the Secretary will inform the Committee of the new shareholder recommendations. Because the Fund does not hold annual or other regular meetings of shareholders for the purpose of electing Trustees, the Committee will accept shareholder recommendations on a continuous basis. Any recommendation must include certain biographical and other information regarding the candidate and the recommending shareholder, and must include a written and signed consent of the candidate to be named as a nominee and to serve as a Trustee if elected. The foregoing description of the requirements is only a summary. Please refer to Appendix A to the Governance and Nominating Committee Charter, which is attached to this Statement of Additional Information as Appendix A for details.
The Governance and Nominating Committee has full discretion to reject nominees recommended by shareholders, and there is no assurance that any such person properly recommended and considered by the Committee will be nominated for election to the Board.
Diversity. The Governance and Nominating Committee takes diversity of a particular nominee and overall diversity of the Board into account when considering and evaluating nominees for Trustee. The Board has adopted a
90
diversity policy and, when considering a nominee’s and the Board’s diversity, the Committee generally considers the manner in which each nominee’s professional experience, education, expertise in matters that are relevant to the oversight of the Fund (e.g., investment management, distribution, accounting, trading, compliance, legal), general leadership experience, and life experience are complementary and, as a whole, contribute to the ability of the Board to oversee the Fund.
Valuation Oversight Committee. The Board has established a Valuation Oversight Committee, currently consisting of Messrs. Kittredge and Rappaport and Mses. Cogan, DeCotis, McCartney and Vandecruze. Ms. Vandecruze is the current Chair of the Valuation Oversight Committee. The Valuation Oversight Committee has been delegated responsibility by the Board for overseeing determination of the fair value of the Fund’s portfolio securities and other assets. The Valuation Oversight Committee reviews and approves procedures for the fair valuation of the Fund’s portfolio securities and periodically reviews reports and assessments provided by the Investment Manager pursuant to the Fund’s valuation procedures and the Investment Manager’s pricing policy. With respect to the fair valuation of portfolio securities for which market quotations are not readily available, the Investment Manager has been designated as “Valuation Designee” for the Fund in accordance with Rule 2a-5 under the Act. The Fund’s Valuation Oversight Committee reports to the Board periodically as to the Committee’s activities and oversight of the Investment Manager’s administration of the Fund’s valuation procedures and the Valuation Designee’s carrying out of its responsibilities under Rule 2a-5. During the period ended December 31, 2022, the Valuation and Oversight Committee met five times.
Contracts Committee. The Board has established a Contracts Committee, currently consisting of Messrs. Kittredge and Rappaport and Mses. Cogan, DeCotis, McCartney and Vandecruze. Ms. Cogan is the current Chair of the Fund’s Contracts Committee. The Contracts Committee meets as the Board deems necessary to review the performance of, and the reasonableness of the fees paid to, as applicable, the Fund’s investment adviser(s) and any sub-adviser(s), administrators(s) and principal underwriters(s) and to make recommendations to the Board regarding the approval and continuance of the Fund’s contractual arrangements for investment advisory, sub-advisory, administrative and distribution services, as applicable. The Contracts Committee also may review and evaluate the terms of other contracts or amendments thereto with the Fund’s other major service providers at the Board’s request. During the period ended December 31, 2022, the Contracts Committee met four times.
Performance Committee. The Board has established a Performance Committee, currently consisting of Messrs. Kittredge, Rappaport and Fisher and Mses. Cantrill, Cogan, DeCotis, McCartney and Vandecruze. Mr. Rappaport is the current Chair of the Performance Committee. The Performance Committee’s responsibilities include reviewing the performance of the Fund and any changes in investment philosophy, approach and personnel of the Investment Manager. During the period ended December 31, 2022, the Performance Committee met four times.
Securities Ownership
For each Trustee, the following table discloses the dollar range of equity securities in the Fund beneficially owned by the Trustee and, on an aggregate basis, in any registered investment companies overseen by the Trustee within the Fund’s family of investment companies as of December 31, 2022:
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Name of Trustee | Dollar Range of Equity Securities in the Fund | Aggregate Dollar Range of Equity Securities in All Registered Investment Companies Overseen by Trustee in Family of Investment Companies* |
Independent Trustees | ||
Sarah E. Cogan | None | Over $100,000 |
Deborah A. DeCotis | None | Over $100,000 |
Joseph B. Kittredge, Jr. | None | $50,001 – 100,000 |
Kathleen A. McCartney** | None | None |
Alan Rappaport | None | Over $100,000 |
E. Grace Vandecruze | None | None |
Interested Trustees | ||
Libby D. Cantrill*** | None | None |
David N. Fisher | None | Over $100,000 |
John C. Maney**** | None | Over $100,000 |
*
The term “Family of Investment Companies” as used herein includes the Fund and the following registered investment companies: PIMCO Municipal Income Fund, PIMCO California Municipal Income Fund, PIMCO New York Municipal Income Fund, PIMCO Municipal Income Fund II, PIMCO California Municipal Income Fund II, PIMCO New York Municipal Income Fund II, PIMCO Municipal Income Fund III, PIMCO California Municipal Income Fund III, PIMCO New York Municipal Income Fund III, PIMCO Dynamic Income Fund, PIMCO Corporate & Income Opportunity Fund, PIMCO Corporate & Income Strategy Fund, PCM Fund, Inc., PIMCO Access Income Fund, PIMCO Dynamic Income Opportunities Fund, PIMCO High Income Fund, PIMCO Income Strategy Fund, PIMCO Income Strategy Fund II, PIMCO Global StocksPLUS®& Income Fund, PIMCO Strategic Income Fund, Inc., PIMCO Energy and Tactical Credit Opportunities Fund, PIMCO Flexible Emerging Markets Income Fund, PIMCO California Flexible Municipal Income Fund, PIMCO Flexible Municipal Income Fund, PIMCO Flexible Credit Income Fund and each series of PIMCO Managed Accounts Trust.
**
Ms. McCartney was appointed as a Trustee of the Fund effective July 1, 2022.
***
Ms. Cantrill was appointed as a Trustee of the Fund, effective April 30, 2023.
****
Mr. Maney retired from the Board, effective April 30, 2023.
To the Fund’s knowledge, 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, 2022 by Independent Trustees and their immediate family members:
Name of Trustee | Name of Owners and Relations to Trustee | Company | Title of Class | Value of Securities | Percent of Class |
Sarah E. Cogan | None | N/A | N/A | N/A | N/A |
Deborah A. DeCotis | None | N/A | N/A | N/A | N/A |
Joseph B. Kittredge, Jr. | None | N/A | N/A | N/A | N/A |
Kathleen A. McCartney* | None | N/A | N/A | N/A | N/A |
Alan Rappaport | None | N/A | N/A | N/A | N/A |
E. Grace Vandecruze | None | N/A | N/A | N/A | N/A |
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*
Ms. McCartney was appointed as a Trustee of the Fund effective July 1, 2022.
As of November 30, 2023, the Fund’s officers and Trustees as a group owned less than 1% of the outstanding Common Shares.
Except as noted below in the table, to the Fund’s knowledge, no persons own of record 5% or more of any class of the Fund’s shares, and no person is reflected on the books and records of the Fund as owning beneficially 5% or more of the outstanding shares of any class of the Fund as of December 29, 2023.
Name/Address of Shareholder | Share Class | Percentage of Class |
CHARLES SCHWAB & CO INC SPECIAL CUSTODY A/C FBO CUSTOMERS ATTN MUTUAL FUNDS 211 MAIN ST SAN FRANCISCO, CA 94105-1905(1) | Institutional | 39.72% |
ALLIANZ FUND INVESTMENTS INC 1633 BROADWAY, NEW YORK, NY 10019(1) | Institutional | 32.76% |
YASHWANTH NELAPATI PLEDGED TO ML LENDER 2400 DIAMOND ST SAN FRANCISCO CA 94131-2610(1) | Class A-1 | 39.12% |
ISAAC & JANE KIM TTEES U/A DTD XX/XX/XXXX BY ISAAC KIM ET AL PLEDGED TO ML LENDER 1838 VALPARAISO AVE MENLO PARK CA 94025-6031 | Class A-1 | 11.38% |
JOERG A ROHDE TTEE MRS ANGELA W A ROHDE TTEE U/A DTD XX/XX/XXXX BY JOERG A ROHDE ET AL 546 W SANTA INEZ AVE HILLSBOROUGH CA 94010-6868 | Class A-1 | 8.05% |
BENJAMIN REKHI TTEE U/A DTD XX/XX/XXXX BY KANWAL S REKHI ET AL PLEDGED TO ML LENDER 1929 6TH ST APT 4 SANTA MONICA CA 90405-1241 | Class A-1 | 5.76% |
(1)
Individual/entity owned 25% or more of the outstanding shares of beneficial interest of the Fund, and therefore may be presumed to “control” the Fund, as that term is defined in the Act. A control person may be able to determine the outcome of a matter put to a shareholder vote. It is anticipated that these parties will eventually no longer be control persons of the Fund over time, due to the continuous offering of the Fund’s Common Shares.
Trustees’ Compensation
Each of the Independent Trustees serves as a trustee of PIMCO Municipal Income Fund, PIMCO California Municipal Income Fund, PIMCO New York Municipal Income Fund, PIMCO Municipal Income Fund II, PIMCO California Municipal Income Fund II, PIMCO New York Municipal Income Fund II, PIMCO Municipal Income Fund III, PIMCO California Municipal Income Fund III, PIMCO New York Municipal Income Fund III, PIMCO Access Income Fund, PIMCO Corporate & Income Strategy Fund, PIMCO Corporate & Income Opportunity Fund, PIMCO Dynamic Income Fund, PIMCO Dynamic Income Opportunities Fund, PIMCO High Income Fund, PIMCO Income Strategy Fund, PIMCO Income Strategy Fund II, PIMCO Global StocksPLUS® & Income Fund, PIMCO Energy and Tactical Credit Opportunities Fund, PCM Fund, Inc. and PIMCO Strategic Income Fund, Inc., each a closed-end management investment company for which PIMCO serves as investment manager (together, the “PIMCO Closed-End Funds”), as well as PIMCO Flexible Emerging Markets Income Fund, PIMCO Flexible Credit Income Fund, PIMCO California Flexible Municipal Income Fund and PIMCO Flexible Municipal Income Fund, each a closed-end management investment company that is operated as an “interval fund” for which the Investment Manager serves as investment manager (the “PIMCO Interval Funds”) and PIMCO Managed Accounts Trust (“PMAT”), an open-end investment management company with multiple series for which PIMCO serves as investment adviser and administrator (together with the PIMCO Closed-End Funds and the PIMCO Interval Funds, the “PIMCO-Managed Funds”).
Each Independent Trustee receives annual compensation of $250,000 for his or her service on the Boards of the PIMCO-Managed Funds, payable quarterly. The Independent Chair of the Boards receives an additional $75,000 per year, payable quarterly. The Audit Oversight Committee Chair receives an additional $35,000 annually,
93
payable quarterly. The Performance Committee Chair and the Valuation Oversight Committee Chair each receive an additional $10,000 annually, payable quarterly. The Contracts Committee Chair receives an additional $25,000 annually, payable quarterly. Trustees are also reimbursed for meeting-related expenses.
Each Trustee’s compensation for his or her service as a Trustee on the Boards of the PIMCO-Managed Funds and other costs in connection with joint meetings of such Funds are allocated among the PIMCO-Managed Funds, as applicable, on the basis of fixed percentages as among PMAT, the PIMCO Interval Funds and the PIMCO Closed-End Funds. Trustee compensation and other costs are then further allocated pro rata among the individual funds within each grouping based on each such fund’s relative net assets.
The Fund has no employees. The Fund’s officers and Interested Trustees (Ms. Cantrill and Mr. Fisher) are compensated by PIMCO or its affiliates, as applicable.
The Trustees do not currently receive any pension or retirement benefits from the Fund or the Fund Complex (see below).
The following table sets forth information regarding the compensation received by the Independent Trustees for the fiscal year ended December 31, 2022. For the calendar year ended December 31, 2022, the Independent Trustees received the compensation set forth in the table below for serving as trustees of the funds in the same Fund Complex as the Fund. Each officer and each Trustee who is a director, officer, partner, member or employee of the Investment Manager, or of any entity controlling, controlled by or under common control with the Investment Manager, including any Interested Trustee, serves without any compensation from the Fund.
Name of Trustee | Aggregate compensation from the Fund for the Fiscal Year Ended December 31, 2022*# | Pension or Retirement Benefits Accrued as Part of Fund Expenses | Estimated Annual Benefits Upon Retirement | Total Compensation from the Fund Complex Paid to the Trustees for the Calendar Year Ended December 31, 2022** |
Sarah E. Cogan | $204 | N/A | N/A | $275,000 |
Deborah A. DeCotis | $241 | N/A | N/A | $325,000 |
Joseph B. Kittredge, Jr. | $212 | N/A | N/A | $285,000 |
Kathleen A. McCartney*** | $186 | N/A | N/A | $125,000 |
William B. Ogden, IV**** | $193 | N/A | N/A | $260,000 |
Alan Rappaport | $193 | N/A | N/A | $260,000 |
E. Grace Vandecruze | $186 | N/A | N/A | $250,000 |
*
Since the Fund has not completed its first full year since organization, compensation is based upon payments made by the Fund during the fiscal period ended December 31, 2022.
#
Ms. Cantrill and Mr. Fisher are interested Persons of the Fund and do not receive compensation from the Fund for their services as Trustees.
**
The Term “Fund Complex” as used herein includes the Fund and any other registered investment company (i) that holds itself out to investors as a related company for purposes of investment and investor services; or (ii) for which PIMCO or an affiliate of PIMCO serves as primary investment adviser.
***
Ms. McCartney became a Trustee of the Fund effective July 1, 2022.
****
Mr. Ogden retired from the Board effective December 31, 2022.
Codes of Ethics
The Fund, PIMCO and PIMCO Investments LLC, the Fund’s principal underwriter, have each adopted a code of ethics under Rule 17j-1 of the Act. These codes permit personnel subject to the codes to invest in securities, including securities that may be purchased or held by the Fund. The codes of ethics are available on the EDGAR Database on
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the SEC’s Internet site at http://www.sec.gov, and copies may be obtained, after paying a duplicating fee, by electronic request at the following email address: publicinfo@sec.gov.
Investment Manager
PIMCO, a Delaware limited liability company, serves as investment manager to the Fund pursuant to an investment management agreement (the “Investment Management Agreement”) between PIMCO and the Fund. PIMCO is located at 650 Newport Center Drive, Newport Beach, California 92660. As of September 30, 2023, PIMCO had approximately $1.74 trillion in assets under management and $1.37 trillion in third party assets under management.
PIMCO is a majority owned subsidiary of Allianz Asset Management of America LLC (“Allianz Asset Management”) with a minority interest held by Allianz Asset Management U.S. Holding II LLC, each, a Delaware limited liability company, and by certain current and former officers of PIMCO. Allianz Asset Management was organized as a limited liability company under Delaware law in 2000. Allianz Asset Management of America LP (“AAM LP”) merged with Allianz Asset Management, with the latter being the surviving entity, effective January 1, 2023. Following the merger, Allianz Asset Management is PIMCO LLC’s managing member and direct parent entity. Through various holding company structures, Allianz Asset Management is majority owned by Allianz SE. Allianz SE is a European based, multinational insurance and financial services holding company and a publicly traded German company.
The management and operational oversight of Allianz Asset Management are carried out by its Management Board, the sole member of which is currently Tucker J. Fitzpatrick.
As of the date of this Statement of Additional Information, there are no significant institutional shareholders of Allianz SE. Absent an SEC exemption or other regulatory relief, the Fund generally is precluded from effecting principal transactions with brokers that are deemed to be affiliated persons of the Fund or PIMCO, and the Fund’s 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 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.
Legal Proceedings. On May 17, 2022, Allianz Global Investors U.S. LLC (“AGI U.S.”) pleaded guilty in connection with the proceeding United States of America v. Allianz Global Investors U.S. LLC. AGI U.S. is an indirect subsidiary of Allianz SE. The conduct resulting in the matter described above occurred entirely within AGI U.S. and did not involve PIMCO or the Distributor, or any personnel of PIMCO or the Distributor. Nevertheless, because of the disqualifying conduct of AGI U.S., their affiliate, PIMCO would have been disqualified from serving as the investment adviser, and the Distributor would have been disqualified from serving as the principal underwriter, to the Fund in the absence of SEC exemptive relief. PIMCO and the Distributor have received exemptive relief from the SEC to permit them to continue serving as investment adviser and principal underwriter for U.S.-registered investment companies, including the Fund.
Investment Management Agreement
The Fund pays for the advisory and supervisory and administrative services it requires under what is essentially an all-in fee structure (the “unified management fee”).
PIMCO, subject to the supervision of the Board, is responsible for providing investment guidance and policy direction in connection with the management of the Fund, including oral and written research, analysis, advice, and statistical and economic data and information. Consistent with the investment objectives, policies and restrictions applicable to the Fund, PIMCO determines the securities and other assets to be purchased or sold by the Fund and determines what portion, consistent with any applicable investment restrictions, shall be invested in securities or other assets, and what portion, if any, should be held uninvested. Under the Investment Management Agreement, the Fund has the benefit of the investment analysis and research, the review of current economic conditions and trends and the consideration of long-range investment policy generally available to investment advisory clients of PIMCO.
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Under the terms of the Investment Management Agreement, PIMCO is obligated to manage the Fund in accordance with applicable laws and regulations. PIMCO’s investment advisory services to the Fund are not exclusive under the terms of the Investment Management Agreement. PIMCO is free to, and does, render investment advisory services to others.
In addition, under the terms of the Investment Management Agreement, subject to the general supervision of the Board, PIMCO provides or causes to be furnished all supervisory and administrative and other services reasonably necessary for the operation of the Fund under the unified management fee, including but not limited to the supervision and coordination of matters relating to the operation of the Fund, including any necessary coordination among the custodian, transfer agent, dividend disbursing agent, and recordkeeping agent (including pricing and valuation of the Fund), accountants, attorneys, and other parties performing services or operational functions for the Fund; the provision of adequate personnel, office space, communications facilities, and other facilities necessary for the effective supervision and administration of the Fund, as well as the services of a sufficient number of persons competent to perform such supervisory and administrative and clerical functions as are necessary for compliance with federal securities laws and other applicable laws; the maintenance of the books and records of the Fund; the preparation of all federal, state, local and foreign tax returns and reports for the Fund; the preparation, filing and distribution of any proxy materials (except as provided below), periodic reports to shareholders and other regulatory filings; the provision of administrative services to shareholders for the Fund including the maintenance of a shareholder information telephone number, the provision of certain statistical information and performance of the Fund, an internet website (if requested), and maintenance of privacy protection systems and procedures; the preparation and filing of such registration statements and other documents with such authorities as may be required to register a new class of shares of the Fund; the taking of other such actions as may be required by applicable law (including establishment and maintenance of a compliance program for the Fund); and the provision of administrative services to shareholders as necessary, including: the maintenance of a shareholder call center; shareholder transaction processing; the provision of certain statistical information and performance of the Fund; a web servicing platform and internet website; access by PIMCO representatives to databases to assist with shareholder inquiries and reports; oversight of anti-money laundering monitoring systems and procedures; repurchase fee application and monitoring systems (if applicable); and processing of client registration applications.
Under the Investment Management Agreement, PIMCO will pay all expenses incurred by it in connection with its obligations under the Investment Management Agreement with respect to the Fund, with the exception of certain expenses that are assumed by the Fund pursuant to the Investment Management Agreement. In addition, PIMCO is responsible for the following costs expenses: expenses of all audits by the Fund’s independent public accountants; expenses of the Fund’s transfer agent, registrar, dividend disbursing agent, and recordkeeping agent; expenses and fees paid to agents and intermediaries for sub-transfer agency, sub-accounting and other shareholder services on behalf of shareholders of Shares of the Fund (or Shares of a particular Share class) held through omnibus and networked, record shareholder accounts (together, “Sub-Transfer Agency Expenses”), except where Sub-Transfer Agency Expenses are paid pursuant to a Rule 12b-1 or similar plan adopted by the Board; expenses of the Fund’s custodial services, including any recordkeeping services provided by the custodian; expenses of obtaining quotations for calculating the value of the Fund’s net assets; expenses of maintaining the Fund’s tax records; certain expenses and fees, including legal fees, incident to meetings of the Fund’s shareholders; certain expenses associated with the preparation, printing and distribution of the Fund’s prospectuses, notices and proxy statements, press releases and reports to existing shareholders; certain expenses associated with the preparation and filing of registration statements and updates thereto and reports with regulatory bodies; expenses associated with the maintenance of the Fund’s existence and qualification to do business; expenses (including registration fees) of issuing, redeeming and repurchasing (including expenses associated with the Fund’s repurchases pursuant to Rule 23c-3 under the Act); expenses associated with registering and qualifying for sale Common Shares with federal and state securities authorities following the initial registration of its Common Shares under the 1933 Act (i.e., that are not organizational and offering expenses of the Fund specified below) and following any registration of a new class of shares of the Fund subsequent to its initial registration; and the expense of qualifying and listing existing Common Shares with any securities exchange or other trading system; the Fund’s ordinary legal fees, including the legal fees that arise in the ordinary course of business for a Massachusetts business trust, registered as a closed-end management investment company and, as applicable, that operates as an “interval fund” pursuant to Rule 23c-3 under the Act, or that is listed for trading with a securities exchange or other trading system; costs of printing certificates representing Common Shares of the Fund, if any; the Fund’s pro rata portion of the fidelity bond required by Section 17(g) of the Act, or other insurance premiums; and organizational and
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offering expenses, including registration (including share registration) fees, legal, marketing, printing, accounting and other expenses, in connection with any registration of a new class of shares of the Fund subsequent to its initial registration.
The Fund (and not PIMCO) is responsible for certain fees and expenses that are not covered by the unified management fee under the Investment Management Agreement. These include salaries and other compensation or expenses, including travel expenses, of any of the Fund’s executive officers and employees, if any, who are not officers, directors, shareholders, members, partners or employees of PIMCO or its subsidiaries or affiliates; taxes and governmental fees, if any, levied against the Fund; brokerage fees and commissions, and other portfolio transaction expenses incurred by or for the Fund (including, without limitation, fees and expenses of outside legal counsel or third-party consultants retained in connection with reviewing, negotiating and structuring specialized loans and other investments made by the Fund, and any costs associated with originating loans, asset securitizations, alternative lending-related strategies and so-called “broken-deal costs” (e.g., fees, costs, expenses and liabilities, including, for example, due diligence-related fees, costs, expenses and liabilities, with respect to unconsummated investments)); expenses of the Fund’s securities lending (if any), including any securities lending agent fees, as governed by a separate securities lending agreement; costs, including interest expenses, of borrowing money or engaging in other types of leverage financing including, without limitation, through the use by the Fund of reverse repurchase agreements, dollar rolls/buy backs, bank borrowings, credit facilities and tender option bonds; costs, including dividend and/or interest expenses and other costs (including, without limitation, offering and related legal costs, fees to brokers, fees to auction agents, fees to transfer agents, fees to ratings agencies and fees to auditors associated with satisfying ratings agency requirements for preferred shares or other securities issued by the Fund and other related requirements in the Fund’s organizational documents) associated with the Fund’s issuance, offering, redemption and maintenance of any Preferred Shares, commercial paper or other instruments (such as the use of reverse repurchase agreements, dollar rolls/buy backs, bank borrowings, credit facilities and tender option bonds) for the purpose of incurring leverage; fees and expenses of any underlying funds or other pooled vehicles in which the Fund invests; dividend and interest expenses on short positions taken by the Fund; fees and expenses, including travel expenses, and fees and expenses of legal counsel retained for their benefit, of Trustees who are not officers, employees, partners, shareholders or members of PIMCO or its subsidiaries or affiliates; extraordinary expenses, including extraordinary legal expenses, as may arise, including, without limitation, expenses incurred in connection with litigation, proceedings, other claims, and the legal obligations of the Fund to indemnify its Trustees, officers, employees, shareholders, distributors, and agents with respect thereto; fees and expenses, including legal, printing and mailing, solicitation and other fees and expenses associated with and incident to shareholder meetings and proxy solicitations involving contested elections of Trustees, shareholder proposals or other non-routine matters that are not initiated or proposed by Fund management; organizational and offering expenses of the Fund, including registration (including Share registration fees), legal, marketing, printing, accounting and other expenses, associated with organizing the Fund in its state of jurisdiction and in connection with the initial registration of the Fund under the Act and the initial registration of its Common Shares under the 1933 Act (i.e., through the effectiveness of the Fund’s initial registration statement on Form N-2) and fees and expenses associated with seeking, applying for and obtaining formal exemptive, no-action and/or other relief from the SEC in connection with the issuance of multiple share classes; except as otherwise provided as an expense of PIMCO, any expenses allocated or allocable to a specific class of Common Shares, including without limitation sub-transfer agency expenses and distribution and/or service fees paid pursuant to a Rule 12b-1 or similar plan adopted by the Board for a particular share class; and expenses of the Fund which are capitalized in accordance with generally accepted accounting principles.
PIMCO may earn a profit on the management fee paid by the Fund. Also, under the terms of the Investment Management Agreement, PIMCO, and not Common Shareholders, would benefit from any price decreases in third-party services, including decreases resulting from an increase in net assets.
The Investment Management Agreement was initially approved by the Trustees of the Fund (including all of the Trustees who are not “interested persons” of the Fund) on March 25, 2022 at a meeting held for such purpose. A discussion regarding the basis for the Board’s initial approval of the Fund’s Investment Management Agreement is available in the Fund’s semi-annual report to shareholders for the period ended June 30, 2022. The Investment Management Agreement will remain in full force and effect, unless sooner terminated by the Fund, for an initial two year period and shall continue thereafter on an annual basis provided that such continuance is specifically approved at least annually (i) by the vote of a majority of the outstanding voting securities of the Fund or by the Fund’s Board; and (ii) by the vote, cast in person at a meeting called for such purpose, of a majority of the Fund’s Independent Trustees. It can also be terminated with respect to the Fund at any time, without payment of any penalty by a vote of a majority
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of the outstanding voting securities of the Fund or by a vote of a majority of the Fund’s entire Board on 60 days’ written notice to PIMCO, or by PIMCO on 60 days’ written notice to the Fund. Additionally, the Investment Management Agreement will terminate automatically in the event of its assignment. The Investment Management Agreement may not be materially amended with respect to the Fund without a vote of a majority of the outstanding voting securities of the Fund.
Pursuant to the Investment Management Agreement, the Fund has agreed to pay PIMCO an annual management fee, payable on a monthly basis, at the annual rate of 0.75% of the Fund’s average daily total managed assets. “Total managed assets” means the total assets of the Fund (including assets attributable to any reverse repurchase agreements, dollar rolls/buy backs, tender option bonds, borrowings and Preferred Shares that may be outstanding) minus accrued liabilities (other than liabilities representing reverse repurchase agreements, dollar rolls/buy backs, tender option bonds and borrowings). For purposes of calculating “total managed assets,” the liquidation preference of any Preferred Shares outstanding is not considered a liability. By way of clarification, with respect to any reverse repurchase agreement or similar transaction, “total managed assets” includes any proceeds from the sale of an asset of the Fund to a counterparty in such a transaction, in addition to the value of the underlying asset as of the relevant measuring date. Furthermore, to the extent applicable, assets attributable to tender option bonds would be included as assets irrespective of whether or not they are included as assets for financial reporting purposes. However, to the extent the Fund does not contribute municipal bonds to a tender option bond trust but holds residual interests issued by such trust, the tender option bonds outstanding would not be included in the calculation of “total managed assets.” In addition, for purposes of calculating “total managed assets,” the Fund’s derivative investments will be valued based on their market value. All fees and expenses are accrued daily and deducted before payment of dividends to investors.
Because the management fee received by PIMCO is based on the average daily total managed assets of the Fund, which includes total assets of the Fund (including assets attributable to any reverse repurchase agreements, dollar rolls/buy backs, tender option bonds, borrowings and Preferred Shares that may be outstanding), PIMCO has a financial incentive for the Fund to utilize reverse repurchase agreements, dollar rolls/buy backs, tender option bonds and borrowings or to issue Preferred Shares, which may create a conflict of interest between PIMCO, on the one hand, and Common Shareholders, on the other hand.
The Investment Management Agreement provides that neither PIMCO nor its members, officers, directors or employees shall be subject to any liability for, or any damages, expenses or losses incurred in connection with, any act or omission or mistake in judgment connected with or arising out of any services rendered under the Investment Management Agreement, except by reason of willful misfeasance, bad faith or gross negligence in performance of PIMCO’s duties, or by reason of reckless disregard of PIMCO’s obligations and duties under the Investment Management Agreement.
In rendering investment advisory services to the Fund, PIMCO may use the resources of one or more foreign (non-U.S.) affiliates that are not registered under the Investment Advisers Act of 1940, as amended (the “Advisers Act”) (the “PIMCO Overseas Affiliates”), to provide portfolio management, research and trading services to the Fund under the Memorandums of Understanding (“MOUs”). Each of the PIMCO Overseas Affiliates are Participating Affiliates of PIMCO as that term is used in relief granted by the staff of the SEC allowing U.S. registered advisers to use investment advisory and trading resources of unregistered advisory affiliates subject to the regulatory supervision of the registered adviser. Each PIMCO Overseas Affiliate and any of their respective employees who provide services to the Funds are considered under the MOUs to be “associated persons” of PIMCO as that term is defined in the Advisers Act for purposes of PIMCO’s required supervision.
Pursuant to the Investment Management Agreement, the Fund paid the Investment Manager the following amounts for the fiscal year ended December 31, 2022:
Fiscal Year | Management Fee Paid by Fund |
December 31, 2022* | $125,824 |
*
The Fund commenced operations on June 27, 2022. Information provided reflects the “stub” period from June 27, 2022, through the Fund’s fiscal year end of December 31, 2022.
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Expense Limitation Agreement
PIMCO has contractually agreed, through May 2, 2024, to waive its management fee, or reimburse the Fund, to the extent that organizational and offering expenses, the payment of expenses associated with obtaining or maintaining a Legal Entity Identifier, and/or payment of the Fund’s pro rata Trustees’ fees exceed 0.10% of the Fund’s net assets (the “Expense Limit”). Under an expense limitation agreement, in any month in which the investment management agreement is in effect, PIMCO is entitled to reimbursement by the Fund of any portion of the management fee reduced as set forth above (the “Reimbursement Amount”) during the previous thirty-six months, provided that such amount paid to PIMCO will not: (1) together with any recoupment of organizational and offering expenses, the payment of expenses associated with obtaining or maintaining a Legal Entity Identifier, and pro rata Trustees’ fees exceed 0.10% of average net assets; (2) exceed the total Reimbursement Amount; or (3) include any amounts previously reimbursed to PIMCO. For the avoidance of doubt, any reimbursement of PIMCO’s management fee pursuant to the expense limitation agreement plus any recoupment of organizational expenses and pro rata Trustees’ fees will not exceed the lesser of (i) the expense limit in effect at the time of wavier or reimbursement and (ii) the expense limit in effect at the time of recoupment. This expense limitation agreement will automatically renew for one-year terms unless PIMCO provides written notice to the Fund at least 30 days prior to the end of the then current term.
Fee Waiver Agreement
Pursuant to a Management Fee Waiver Agreement between the Fund and PIMCO, PIMCO has contractually agreed, through June 21, 2023, to waive 33% of the management fees it is entitled to receive from the Fund pursuant to the Investment Management Agreement (“Management Fee Waiver Agreement”).
PIMCO’s waiver of management fees under the Management Fee Waiver Agreement is applied first and independently of PIMCO’s obligations under the Expense Limitation Agreement (such that amounts waived pursuant to the Management Fee Waiver Agreement shall not be applied to reduce any waiver or reimbursement obligations PIMCO has under the Expense Limitation Agreement). PIMCO may not seek reimbursement from the Fund with respect to the management fees waived pursuant to the Management Fee Waiver Agreement.
The Management Fee Waiver Agreement will continue through the date set forth above, at which time it will terminate unless otherwise agreed to in writing by the parties.
Management Fees Waived and Recouped
For the fiscal year ended December 31, 2022, the following amounts of management fees were waived and recouped by PIMCO:
Fiscal Year | Management Fees Waived | Previously Waived Management Fees Recouped |
December 31, 2022* | $120,248 | $2,570 |
*
The Fund commenced operations on June 27, 2022. Information provided reflects the “stub” period from June 27, 2022, through the Fund’s fiscal year end of December 31, 2022.
In addition, the Management Fee Waiver Agreement will terminate upon termination of the Investment Management Agreement, or it may be terminated by the Fund, without payment of any penalty, upon notice to PIMCO at its principal place of business.
Portfolio Managers
Other Accounts Managed. The portfolio managers who are jointly and primarily responsible for the day-to-day management of the Fund also manage the other registered investment companies, other pooled investment vehicles and/or other accounts indicated below. The following table identifies, as of December 31, 2022: (i) the number of other registered investment companies, pooled investment vehicles and other accounts managed by the portfolio managers (exclusive of the Fund); and (ii) the total assets of such other companies, vehicles and accounts, and the number and total assets of such companies, vehicles and accounts with respect to which the management fee is based on performance.
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Total Number of Other Accounts | Total Assets of All Other Accounts (in $millions) | Number of Other Accounts Paying a Performance Fee | Total Assets of Other Accounts Paying a Performance Fee (in $millions) | |
David Hammer | ||||
Registered Investment Companies | 28 | $12,530.10 | 0 | $0.00 |
Other Pooled Investment Vehicles | 8 | $31,220.35 | 0 | $0.00 |
Other Accounts | 163 | $12,882.61 | 0 | $0.00 |
Amit Arora | ||||
Registered Investment Companies | 5 | $15,920.20 | 0 | $0.00 |
Other Pooled Investment Vehicles | 8 | $1,859.60 | 0 | $0.00 |
Other Accounts | 141 | $22,503.07 | 1 | $375.45 |
Kyle Christine | ||||
Registered Investment Companies | 1 | $53.12 | 0 | $0.00 |
Other Pooled Investment Vehicles | 0 | $0.00 | 0 | $0.00 |
Other Accounts | 4 | $55,772.35 | 0 | $0.00 |
Conflicts of Interest
From time to time, potential and actual conflicts of interest may arise between a portfolio manager’s management of the investments of the Fund, on the one hand, and the management of other accounts, on the other. Potential and actual conflicts of interest may also arise as a result of PIMCO’s other business activities and PIMCO’s possession of material non-public information (“MNPI”) about an issuer. Other accounts managed by a portfolio manager might have similar investment objectives or strategies as the Fund, track the same index the Fund tracks or otherwise hold, purchase, or sell securities that are eligible to be held, purchased or sold by the Fund. The other accounts might also have different investment objectives or strategies than the Fund. Investors should be aware that investments made by the Fund and the results achieved by the Fund at any given time are not expected to be the same as those made by other funds for which PIMCO acts as investment adviser, including funds with names, investment objectives and policies, and/or portfolio management teams, similar to the Fund. This may be attributable to a wide variety of factors, including, but not limited to, the use of a different strategy or portfolio management team, when a particular fund commenced operations or the size of a particular fund, in each case as compared to other similar funds. Potential and actual conflicts of interest may also arise as a result of PIMCO serving as investment adviser to accounts that invest in the Fund or to accounts in which the Fund invests. In this case, such conflicts of interest could in theory give rise to incentives for PIMCO to, among other things, vote proxies, purchase or redeem shares of the underlying account, or take other actions with respect to the underlying account, in a manner beneficial to the investing account and/or PIMCO but detrimental to the underlying account. Such conflicts of interest could similarly in theory give rise to incentives for PIMCO to, among other things, vote proxies or purchase or redeem shares of the underlying account, or take other actions with respect to the underlying account, in a manner beneficial to the underlying account and/or PIMCO and that may or may not be detrimental to the investing account. For example, even if there is a fee waiver or reimbursement in place relating to the Fund's investment in an underlying account, or relating to an investing account's investment in the Fund, this will not necessarily eliminate all conflicts of interest, as PIMCO could nevertheless have a financial incentive to favor investments in PIMCO-affiliated funds and managers (for example, to increase the assets under management of PIMCO or a fund, product or line of business, or otherwise provide support to, certain funds, products or lines of business), which could also impact the manner in which certain transaction fees are set. Conversely, PIMCO’s duties to the Fund, as well as regulatory or other limitations applicable to the Fund, may affect the courses of action available to PIMCO-advised accounts (including the Fund) that invest in the Fund in a manner that is detrimental to such investing accounts. In addition, regulatory restrictions, actual or potential conflicts of interest or other considerations may cause PIMCO to restrict or prohibit participation in certain investments.
Because PIMCO is affiliated with Allianz SE, a large multi-national financial institution (together with its affiliates, “Allianz”), conflicts similar to those described below may occur between the Fund or other accounts managed by PIMCO and PIMCO’s affiliates or accounts managed by those affiliates. Those affiliates (or their clients), which generally operate autonomously from PIMCO, may take actions that are adverse to the Fund or other accounts managed by PIMCO. In many cases, PIMCO will not be in a position to mitigate those actions or address those
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conflicts, which could adversely affect the performance of the Fund or other accounts managed by PIMCO (each, a “Client,” and collectively, the “Clients”). In addition, because certain Clients are affiliates of PIMCO or have investors who are affiliates or employees of PIMCO, PIMCO may have incentives to resolve conflicts of interest in favor of these Clients over other Clients.
Knowledge and Timing of Fund Trades. A potential conflict of interest may arise as a result of a portfolio manager’s day-to-day management of the Fund. Because of their positions with the Fund, the portfolio managers know the size, timing and possible market impact of the Fund’s trades. It is theoretically possible that the portfolio managers could use this information to the advantage of other accounts they manage and to the possible detriment of the Fund.
Cross Trades. A potential conflict of interest may arise in instances where the Fund buys an instrument from a Client or sells an instrument to a Client (each, a “cross trade”). Such conflicts of interest may arise, among other reasons, as a result of PIMCO representing the interests of both the buying party and the selling party in the cross trade or because the price at which the instrument is bought or sold through a cross trade may not be as favorable as the price that might have been obtained had the trade been executed in the open market. PIMCO effects cross trades when appropriate pursuant to procedures adopted under applicable rules and SEC guidance. Among other things, such procedures require that the cross trade is consistent with the respective investment policies and investment restrictions of both parties and is in the best interests of both the buying and selling accounts.
Investment Opportunities. A potential conflict of interest may arise as a result of the portfolio manager’s management of a number of accounts with varying investment guidelines. Often, an investment opportunity may be suitable for one or more Clients, but may not be available in sufficient quantities for all accounts to participate fully. In addition, regulatory issues applicable to PIMCO or the Funds or other accounts may result in the Funds not receiving securities that may otherwise be appropriate for them. Similarly, there may be limited opportunity to sell an investment held by the Fund and another Client. In addition, regulatory issues applicable to PIMCO or the Fund or other accounts may result in the Fund not receiving securities that may otherwise be appropriate for it. Similarly, there may be limited opportunity to sell an investment held by the Fund and another Client. PIMCO has adopted policies and procedures reasonably designed to allocate investment opportunities on a fair and equitable basis over time. In addition, regulatory issues applicable to PIMCO or one or more Clients may result in certain Clients, not receiving securities that may otherwise be appropriate for them.
PIMCO seeks to allocate orders across eligible Client accounts with similar investment guidelines and investment styles fairly and equitably, taking into consideration relevant factors including, among others, applicable investment restrictions and guidelines, including regulatory restrictions; Client account-specific investment objectives, restrictions and other Client instructions, as applicable; risk tolerances; amounts of available cash; the need to rebalance a Client account’s portfolio (e.g., due to investor contributions and redemptions); whether the allocation would result in a Client account receiving a trivial amount or an amount below the established minimum quantity; regulatory requirements; the origin of the investment; the bases for an issuer’s allocation to PIMCO; and other Client account-specific factors. As part of PIMCO’s trade allocation process, portions of new fixed income investment opportunities are distributed among Client account categories where the relevant portfolio managers seek to participate in the investment. Those portions are then further allocated among the Client accounts within such categories pursuant to PIMCO’s trade allocation policy. Portfolio managers managing quantitative strategies and specialized accounts, such as those focused on international securities, mortgage-backed securities, bank loans, or other specialized asset classes, will likely receive an increased distribution of new fixed income investment opportunities where the investment involves a quantitative strategy or specialized asset class that matches the investment objective or focus of the Client account category. PIMCO seeks to allocate fixed income investments to Client accounts with the general purpose of maintaining consistent concentrations across similar accounts and achieving, as nearly as possible, portfolio characteristic parity among such accounts. Client accounts furthest from achieving portfolio characteristic parity typically receive priority in allocations. With respect to an order to buy or sell an equity security in the secondary market, PIMCO seeks to allocate the order across Client accounts with similar investment guidelines and investment styles fairly and equitably over time, taking into consideration the relevant factors discussed above.
Any particular allocation decision among Client accounts may be more or less advantageous to any one Client or group of Clients, and certain allocations will, to the extent consistent with PIMCO’s fiduciary obligations, deviate from a pro rata basis among Clients in order to address for example, differences in legal, tax, regulatory, risk management, concentration, exposure, Client guideline limitations and/or mandate or strategy considerations for the relevant Clients. PIMCO may determine that an investment opportunity or particular purchases or sales are appropriate for one or more
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Clients, but not appropriate for other Clients, or are appropriate or suitable for, or available to, Clients but in different sizes, terms, or timing than is appropriate or suitable for other Clients. For example, some Clients have higher risk tolerances than other Clients, such as private funds, which, in turn, allows PIMCO to allocate a wider variety and/or greater percentage of certain types of investments (which may or may not outperform other types of investments) to such Clients. Further, the respective risk tolerances of different types of Clients may change over time as market conditions change. Those Clients receiving an increased allocation as a result of the effect of their respective risk tolerance may be Clients that pay higher investment management fees or that pay incentive fees. In addition, certain Client account categories focusing on certain types of investments or asset classes will be given priority in new issue distribution and allocation with respect to the investments or asset classes that are the focus of their investment mandate. PIMCO may also take into account the bases for an issuer’s allocation to PIMCO, for example, by giving priority allocations to Client accounts holding existing positions in the issuer’s debt if the issuer’s allocation to PIMCO is based on such holdings. PIMCO also may determine not to allocate to or purchase or sell for certain Clients all investments for which all Clients may be eligible. Legal, contractual, or regulatory issues and/or related expenses applicable to PIMCO or one or more Clients may result in certain Clients not receiving securities that may otherwise be appropriate for them or may result in PIMCO selling securities out of Client accounts even if it might otherwise be beneficial to continue to hold them. Additional factors that are taken into account in the distribution and allocation of investment opportunities to Client accounts include, without limitation: ability to utilize leverage and risk tolerance of the Client account; the amount of discretion and trade authority given to PIMCO by the Client; availability of other similar investment opportunities; the Client account’s investment horizon and objectives; hedging, cash and liquidity needs of the portfolio; minimum increments and lot sizes; and underlying benchmark factors. Given all of the foregoing factors, the amount, timing, structuring, or terms of an investment by a Client, including the Fund, may differ from, and performance may be lower than, investments and performance of other Clients, including those that may provide greater fees or other compensation (including performance-based fees or allocations) to PIMCO. PIMCO has also adopted additional procedures to complement the general trade allocation policy that are designed to address potential conflicts of interest due to the side-by-side management of the Fund and certain pooled investment vehicles, including investment opportunity allocation issues.
From time to time, PIMCO may take an investment position or action for one or more Clients that may be different from, or inconsistent with, an action or position taken for one or more other Clients having similar or differing investment objectives. These positions and actions may adversely impact, or in some instances may benefit, one or more affected Clients (including Clients that are PIMCO affiliates) in which PIMCO has an interest, or which pays PIMCO higher fees or a performance fee. For example, a Client may buy a security and another Client may establish a short position in that same security. The subsequent short sale may result in a decrease in the price of the security that the other Client holds. Similarly, transactions or investments by one or more Clients may have the effect of diluting or otherwise disadvantaging the values, prices or investment strategies of another Client.
When PIMCO implements for one Client a portfolio decision or strategy ahead of, or contemporaneously with, similar portfolio decisions or strategies of another Client, market impact, liquidity constraints or other factors could result in one or more Clients receiving less favorable trading results, the costs of implementing such portfolio decisions or strategies could be increased or such Clients could otherwise be disadvantaged. On the other hand, potential conflicts may also arise because portfolio decisions regarding a Client may benefit other Clients. For example, the sale of a long position or establishment of a short position for a Client may decrease the price of the same security sold short by (and therefore benefit) other Clients, and the purchase of a security or covering of a short position in a security for a Client may increase the price of the same security held by (and therefore benefit) other Clients.
Under certain circumstances, a Client may invest in a transaction in which one or more other Clients are expected to participate, or already have made or will seek to make, an investment. In addition, to the extent permitted by applicable law, a Client may also engage in investment transactions that may result in other Clients being relieved of obligations, or that may cause other Clients to divest certain investments (e.g., a Client may make a loan to, or directly or indirectly acquire securities or indebtedness of, a company that uses the proceeds to refinance or reorganize its 105 capital structure, which could result in repayment of debt held by another Client). Such Clients (or groups of Clients) may have conflicting interests and objectives in connection with such investments, including with respect to views on the operations or activities of the issuer involved, the targeted returns from the investment and the timeframe for, and method of, exiting the investment. When making such investments, PIMCO may do so in a way that favors one Client over another Client, even if both Clients are investing in the same security at the same time. Certain Clients may invest on a “parallel” basis (i.e., proportionately in all transactions at substantially the same time and on substantially the
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same terms and conditions). In addition, other accounts may expect to invest in many of the same types of investments as another account. However, there may be investments in which one or more of such accounts does not invest (or invests on different terms or on a non-pro rata basis) due to factors such as legal, tax, regulatory, business, contractual or other similar considerations or due to the provisions of a Client’s governing documents. Decisions as to the allocation of investment opportunities among such Clients present numerous conflicts of interest, which may not be resolved in a manner that is favorable to a Client’s interests. To the extent an investment is not allocated pro rata among such entities, a Client could incur a disproportionate amount of income or loss related to such investment relative to such other Client.
In addition, Clients may invest alongside one another in the same underlying investments or otherwise pursuant to a substantially similar investment strategy as one or more other Clients. In such cases, certain Clients may have preferential liquidity and information rights relative to other Clients holding the same investments, with the result that such Clients will be able to withdraw/redeem their interests in underlying investments in priority to Clients who may have more limited access to information or more restrictive withdrawal/redemption rights. Clients with more limited information rights or more restrictive liquidity may therefore be adversely affected in the event of a downturn in the markets.
Further, potential conflicts may be inherent in PIMCO’s use of multiple strategies. For example, conflicts will arise in cases where different Clients invest in different parts of an issuer’s capital structure, including circumstances in which one or more Clients may own private securities or obligations of an issuer and other Clients may own or seek to acquire private securities of the same issuer. For example, a Client may acquire a loan, loan participation or a loan assignment of a particular borrower in which one or more other Clients have an equity investment, or may invest in senior debt obligations of an issuer for one Client and junior debt obligations or equity of the same issuer for another Client.
PIMCO may also, for example, direct a Client to invest in a tranche of a structured finance vehicle, such as a CLO or CDO, where PIMCO is also, at the same or different time, directing another Client to make investments in a different tranche of the same vehicle, which tranche’s interests may be adverse to other tranches. PIMCO may also cause a Client to purchase from, or sell assets to, an entity, such as a structured finance vehicle, in which other Clients may have an interest, potentially in a manner that will have an adverse effect on the other Clients. There may also be conflicts where, for example, a Client holds certain debt or equity securities of an issuer, and that same issuer has issued other debt, equity or other instruments that are owned by other Clients or by an entity, such as a structured finance vehicle, in which other Clients have an interest.
In each of the situations described above, PIMCO may take actions with respect to the assets held by one Client that are adverse to the other Clients, for example, by foreclosing on loans, by putting an issuer into default, or by exercising rights to purchase or sell to an issuer, causing an issuer to take actions adverse to certain classes of securities, or otherwise. In negotiating the terms and conditions of any such investments, or any subsequent amendments or waivers or taking any other actions, PIMCO may find that the interests of a Client and the interests of one or more other Clients could conflict. In these situations, decisions over items such as whether to make the investment or take an action, proxy voting, corporate reorganization, how to exit an investment, or bankruptcy or similar matters (including, for example, whether to trigger an event of default or the terms of any workout) may result in conflicts of interest. Similarly, if an issuer in which a Client and one or more other Clients directly or indirectly hold different classes of securities (or other assets, instruments or obligations issued by such issuer or underlying investments of such issuer) encounters financial problems, decisions over the terms of any workout will raise conflicts of interests (including, for example, conflicts over proposed waivers and amendments to debt covenants). For example, a debt holder may be better served by a liquidation of the issuer in which it may be paid in full, whereas an equity or junior bond holder might prefer a reorganization that holds the potential to create value for the equity holders. In some cases PIMCO may refrain from taking certain actions or making certain investments on behalf of Clients in order to avoid or mitigate certain conflicts of interest or to prevent adverse regulatory or other effects on PIMCO, or may sell investments for certain Clients (in each case potentially disadvantaging the Clients on whose behalf the actions are not taken, investments not made, or investments sold). In other cases, PIMCO may not refrain from taking actions or making investments on behalf of certain Clients that have the potential to disadvantage other Clients. In addition, PIMCO may take actions or refrain from taking actions in order to mitigate legal risks to PIMCO or its affiliates or its Clients even if disadvantageous to a Client’s account. Moreover, a Client may invest in a transaction in which one or more other Clients are expected to participate, or already have made or will seek to make, an investment.
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Additionally, certain conflicts may exist with respect to portfolio managers who make investment decisions on behalf of several different types of Clients. Such portfolio managers may have an incentive to allocate trades, time or resources to certain Clients, including those Clients who pay higher investment management fees or that pay incentive fees or allocations, over other Clients. These conflicts may be heightened with respect to portfolio managers who are eligible to receive a performance allocation under certain circumstances as part of their compensation.
From time to time, PIMCO personnel may come into possession of MNPI which, if disclosed, might affect an investor’s decision to buy, sell or hold a security. Should a PIMCO employee come into possession of MNPI with respect to an issuer, he or she generally will be prohibited from communicating such information to, or using such information for the benefit of, Clients, which could limit the ability of Clients to buy, sell or hold certain investments, thereby limiting the investment opportunities or exit strategies available to Clients. In addition, holdings in the securities or other instruments of an issuer by PIMCO or its affiliates may affect the ability of a Client to make certain acquisitions of or enter into certain transactions with such issuer. PIMCO has no obligation or responsibility to disclose such information to, or use such information for the benefit of, any person (including Clients).
PIMCO maintains one or more restricted lists of companies whose securities are subject to certain trading prohibitions due to PIMCO’s business activities. PIMCO may restrict trading in an issuer’s securities if the issuer is on a restricted list or if PIMCO has MNPI about that issuer. In some situations, PIMCO may restrict Clients from trading in a particular issuer’s securities in order to allow PIMCO to receive MNPI on behalf of other Clients. A Client may be unable to buy or sell certain securities until the restriction is lifted, which could disadvantage the Client. PIMCO may also be restricted from making (or divesting of) investments in respect of some Clients but not others. In some cases PIMCO may not initiate or recommend certain types of transactions, or may otherwise restrict or limit its advice relating to certain securities if a security is restricted due to MNPI or if PIMCO is seeking to limit receipt of MNPI.
PIMCO may conduct litigation or engage in other legal actions on behalf of one or more Clients. In such cases, Clients may be required to bear certain fees, costs, expenses and liabilities associated with the litigation. Other Clients that are or were investors in, or otherwise involved with, the subject investments may or may not (depending on the circumstances) be parties to such litigation actions, with the result that certain Clients may participate in litigation actions in which not all Clients with similar investments may participate, and such nonparticipating Clients may benefit from the results of such litigation actions without bearing or otherwise being subject to the associated fees, costs, expenses and liabilities. PIMCO, for example, typically does not pursue legal claims on behalf of its separate accounts. Furthermore, in certain situations, litigation or other legal actions pursued by PIMCO on behalf of a Client may be brought against or be otherwise adverse to a portfolio company or other investment held by a Client.
Co-Investments. The 1940 Act imposes significant limits on co-investment with affiliates of the Fund. The Fund has received exemptive relief from the SEC that, to the extent the Fund relies on such relief, permits it to (among other things) co-invest with certain other persons, including certain affiliates of the Investment Manager and certain public or private funds managed by the Investment Manager and its affiliates, subject to certain terms and conditions. Co-investment transactions may give rise to conflicts of interest or perceived conflicts of interest among the Fund and its affiliates. The exemptive relief from the SEC with respect to co-investments imposes extensive conditions on any co-investments made in reliance on such relief that may limit or restrict the Fund’s ability to participate in an investment or participate in an investment to a lesser extent. An inability to receive the desired allocation to potential investments may affect the Fund’s ability to achieve the desired investment returns. In the event investment opportunities are allocated among the Fund and its affiliates pursuant to co-investment exemptive relief, the Fund may not be able to structure its investment portfolio in the manner desired. Although PIMCO will endeavor to allocate investment opportunities in a fair and equitable manner, the Fund will generally not be permitted to co-invest in any issuer in which a fund managed by PIMCO or any of its downstream affiliates (other than the Fund and its downstream affiliates) currently has an investment. However, the Fund would be able to co-invest with funds managed by PIMCO or any of its downstream affiliates, subject to compliance with existing regulatory guidance, applicable regulations and its allocation procedures. Pursuant to co-investment exemptive relief, the Fund will be able to invest in opportunities in which PIMCO and/or its affiliates has an investment, and PIMCO and/or its affiliates will be able to invest in opportunities in which the Fund has made an investment. From time to time, the Fund and its affiliates may make investments at different levels of an issuer’s capital structure or otherwise in different classes of an issuer’s securities. Such investments inherently give rise to conflicts of interest or perceived conflicts of interest between or among the various classes of securities that may be held by such entities. PIMCO has adopted procedures governing the co-investment in securities acquired in private placements with certain clients of PIMCO.
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The foregoing is not a complete list of conflicts to which PIMCO or Clients may be subject. PIMCO seeks to review conflicts on a case-by-case basis as they arise. Any review will take into consideration the interests of the relevant Clients, the circumstances giving rise to the conflict, applicable PIMCO policies and procedures, and applicable laws. Clients (and investors in the Fund) should be aware that conflicts will not necessarily be resolved in favor of their interests and may in fact be resolved in a manner adverse to their interests. PIMCO will attempt to resolve such matters fairly, but even so, matters may be resolved in favor of other Clients which pay PIMCO higher fees or performance fees or in which PIMCO or its affiliates have a significant proprietary interest. There can be no assurance that any actual or potential conflicts of interest will not result in a particular Client or group of Clients receiving less favorable investment terms in or returns from certain investments than if such conflicts of interest did not exist.
Conflicts like those described above may also occur between Clients, on the one hand, and PIMCO or its affiliates, on the other. These conflicts will not always be resolved in favor of the Client. In addition, because PIMCO is affiliated with Allianz, a large multi-national financial institution, conflicts similar to those described above may occur between clients of PIMCO and PIMCO’s affiliates or accounts managed by those affiliates. Those affiliates (or their clients), which generally operate autonomously from PIMCO, may take actions that are adverse to PIMCO’s Clients. In many cases, PIMCO will have limited or no ability to mitigate those actions or address those conflicts, which could adversely affect Client performance. In addition, certain regulatory or internal restrictions may prohibit PIMCO from using certain brokers or investing in certain companies (even if such companies are not affiliated with Allianz) because of the applicability of certain laws and regulations or internal Allianz policies applicable to PIMCO, Allianz SE or their affiliates. An account’s willingness to negotiate terms or take actions with respect to an investment may also be, directly or indirectly, constrained or otherwise impacted to the extent Allianz SE, PIMCO, and/or their affiliates, directors, partners, managers, members, officers or personnel are also invested therein or otherwise have a connection to the subject investment (e.g., serving as a trustee or board member thereof).
Performance Fees. A portfolio manager may advise certain accounts with respect to which the advisory fee is based entirely or partially on performance. Performance fee arrangements may create a conflict of interest for the portfolio manager in that the portfolio manager may have an incentive to allocate the investment opportunities that he or she believes might be the most profitable to such other accounts instead of allocating them to the Fund. PIMCO has adopted policies and procedures reasonably designed to allocate investment opportunities between the Fund and such other accounts on a fair and equitable basis over time.
Certain service providers to the Fund are expected to be owned by or otherwise related to or affiliated with a Client, and in certain cases, such service providers are expected to be, or are owned by, employed by, or otherwise related to, PIMCO, Allianz SE, their affiliates and/or their respective employees, consultants and other personnel. PIMCO may, in its sole discretion, determine to provide, or engage or recommend an affiliate of PIMCO to provide, certain services to the Fund, instead of engaging or recommending one or more third parties to provide such services. Subject to the governance requirements of a particular fund and applicable law, PIMCO or its affiliates, as applicable, will receive compensation in connection with the provision of such services. As a result, PIMCO faces a conflict of interest when selecting or recommending service providers for the Fund. Fees paid to an affiliated service provider will be determined in PIMCO’s commercially reasonable discretion, taking into account the relevant facts and circumstances, and consistent with PIMCO’s responsibilities. Although PIMCO has adopted various policies and procedures intended to mitigate or otherwise manage conflicts of interest with respect to affiliated service providers, there can be no guarantee that such policies and procedures (which may be modified or terminated at any time in PIMCO’s sole discretion) will be successful.
Portfolio Manager Compensation
PIMCO and its affiliates’ approach to compensation seeks to provide professionals with a compensation process that is driven by values of collaboration, openness, responsibility and excellence.
Generally, compensation packages consist of three components. The compensation program for portfolio managers is designed to align with clients’ interests, emphasizing each portfolio manager’s ability to generate long-term investment success for clients, among other factors. A portfolio manager’s compensation is not based solely on the performance of the Fund or any other account managed by that portfolio manager:
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Base Salary – Base salary is determined based on core job responsibilities, positions/levels and market factors. Base salary levels are reviewed annually, when there is a significant change in job responsibilities or position, or when there is a significant change in market levels.
Variable Compensation – In addition to a base salary, portfolio managers have a variable component of their compensation, which is based on a combination of individual and company performance and includes both qualitative and quantitative factors. The following non-exhaustive list of qualitative and quantitative factors is considered when determining total compensation for portfolio managers:
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Performance measured over a variety of longer- and shorter-term periods, including 5-year, 4-year, 3-year, 2-year and 1-year dollar-weighted and account-weighted, pre-tax total and risk-adjusted investment performance as judged against the applicable benchmarks (which may include internal investment performance-related benchmarks) for each account managed by a portfolio manager (including the Fund) and relative to applicable industry peer groups; and
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Amount and nature of assets managed by the portfolio manager.
The variable compensation component of an employee’s compensation may include a deferred component. The deferred portion will generally be subject to vesting and may appreciate or depreciate based on the performance of PIMCO and/or its affiliates. PIMCO’s Long-Term Incentive Plan provides participants with deferred cash awards that appreciate or depreciate based on PIMCO’s operating earnings over a rolling three-year period.
Portfolio managers who are Managing Directors of PIMCO receive compensation from a non-qualified profit sharing plan consisting of a portion of PIMCO’s net profits. Portfolio managers who are Managing Directors receive an amount determined by the Compensation Committee, based upon an individual’s overall contribution to the firm.
Securities Ownership
The following table discloses the dollar range of equity securities beneficially owned by the portfolio managers of the Fund. The information is as of December 31, 2022.
Name of Portfolio Manager | Dollar Range of Equity Securities in the Fund |
David Hammer | None |
Amit Arora | None |
Kyle Christine | None |
Proxy Voting Policies and Procedures
PIMCO has adopted written proxy voting policies and procedures (“Proxy Policy”) as required by Rule 206(4)6 under the Advisers Act. The Fund has adopted the Proxy Policy of PIMCO when voting proxies on its behalf.
Policy Statement: The Proxy Policy is intended to foster PIMCO’s compliance with its fiduciary obligations and applicable law; the policy applies to any voting or consent rights with respect to securities held in accounts over which PIMCO has discretionary voting authority. The Proxy Policy is designed in a manner reasonably expected to ensure that voting and consent rights are exercised in the best interests of PIMCO’s clients.
Overview: PIMCO has adopted a written Proxy Policy as required by Rule 206(4)-6 under the Advisers Act. Proxies generally describe corporate action-consent rights (relative to fixed-income securities) and proxy voting ballots (relative to fixed-income or equity securities) as determined by the issuer or custodian. As a general matter, when PIMCO has proxy voting authority, PIMCO has a fiduciary obligation to monitor corporate events and to take appropriate action on client proxies that come to its attention. Each proxy is voted on a case-by-case basis, taking into account relevant facts and circumstances. When considering client proxies, PIMCO may determine not to vote a proxy in limited circumstances.
Equity Securities. The term “equity securities” means common and preferred stock, including common and preferred shares issued by investment companies; it does not include debt securities convertible into equity securities. PIMCO has retained an Industry Service Provider (“ISP”) to provide research and voting recommendations for proxies
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relating to equity securities in accordance with the ISP’s guidelines. By following the guidelines of an independent third party, PIMCO seeks to mitigate potential conflicts of interest PIMCO may have with respect to proxies covered by the ISP. PIMCO will follow the recommendations of the ISP unless: (i) the ISP does not provide a voting recommendation; or (ii) a portfolio manager or analyst decides to override the ISP’s voting recommendation. In either such case as described above, the Legal and Compliance department will review the proxy to determine whether an actual or potential conflict of interest exists. When the ISP does not provide a voting recommendation, the relevant portfolio manager or analyst will make a determination regarding how, or if, the proxy will be voted by completing required documentation.
Fixed-Income Securities. Fixed-income securities can be processed as proxy ballots or corporate action-consents at the discretion of the issuer/custodian. Voting or consent rights shall not include matters which are primarily decisions to buy or sell investments, such as tender offers, exchange offers, conversions, put options, redemptions, and Dutch auctions. When processed as proxy ballots, the ISP generally does not provide a voting recommendation and their role is limited to election processing and recordkeeping. In such instances, any elections would follow the standard process discussed above for equity securities. When processed as corporate action-consents, the Legal and Compliance department will review all election forms to determine whether an actual or potential conflict of interest exists with respect to the portfolio manager’s or analyst’s consent election. PIMCO’s Credit Research and Portfolio Management Groups are responsible for issuing recommendations on how to vote proxy ballots and corporation action-consents with respect to fixed-income securities.
Resolution of Potential and Identified Conflicts of Interest. The Proxy Policy permits PIMCO to seek to resolve material conflicts of interest by pursuing any one of several courses of action. With respect to material conflicts of interest between PIMCO and a client account, the Proxy Policy permits PIMCO to either: (i) convene a working group to assess and resolve the conflict (the “Proxy Working Group”); or (ii) vote in accordance with protocols previously established by the Proxy Policy, the Proxy Working Group and/or other relevant procedures approved by PIMCO’s Legal and Compliance department or PIMCO’s Conflict Committee with respect to specific types of conflicts.
PIMCO will supervise and periodically review its proxy voting activities and the implementation of the Proxy Policy. PIMCO’s Proxy Policy, and information about how PIMCO voted a client’s proxies, is available upon request.
ISP Oversight. Consistent with its fiduciary obligations, PIMCO will perform periodic due diligence and oversight of ISPs engaged to provide PIMCO with proxy voting research and recommendations. PIMCO’s due diligence and oversight process includes, but is not limited to, the evaluation of: the ISP’s capacity and competency to provide proxy voting research and recommendations including the adequacy and quality of the ISP’s operational infrastructure as it relates to its process for seeking timely input from issuers and its voting methodologies and the ISP’s compliance program.
Information about how PIMCO voted the Fund’s proxies for the most recent twelve-month period ended June 30th (Form N-PX) will be available no later than the following August 31st, without charge, upon request, by calling the Fund at (844) 312-2113, and on the SEC’s website at http://www.sec.gov.
DISTRIBUTION OF FUND SHARES
PIMCO Investments LLC (the “Distributor”) serves as the principal underwriter in the continuous public offering of the Fund’s shares pursuant to a distribution contract (“Distribution Contract”) with the Fund, which is subject to annual approval by the Board. The Distributor is a wholly-owned subsidiary of PIMCO and an indirect subsidiary of Allianz Asset Management. The Distributor does not participate in the distribution of non-PIMCO managed registered fund products. As noted in further detail below, under a separate marketing services agreement between PIMCO and the Distributor, PIMCO compensates the Distributor for providing various marketing services for the Fund. Furthermore, representatives of the Distributor (“Account Managers and Associates”) may also be employees or associated persons of PIMCO. Because of these affiliations with PIMCO, the interests of the Distributor may conflict with the interests of Fund investors.
As noted above, PIMCO pays the Distributor a fee for marketing and related services pursuant to a Marketing Services Agreement between PIMCO and the Distributor. These payments are made to the Distributor from PIMCO’s profits and are in addition to the revenue the Distributor earns under its Distribution Contract with the Fund. The fee is payable on a monthly basis at a current annual rate of 0.20 percent of gross fund sales in the month (“gross fund sales” includes the aggregate gross dollar value of sales of the Fund and certain other PIMCO-managed funds during the
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applicable month, with certain exclusions). In addition, pursuant to the Marketing Services Agreement, PIMCO pays the Distributor a fee at the annual rate of 0.10 percent of the average daily net asset value of the shares of the Fund, and certain other PIMCO-managed funds.
The Distributor, located at 1633 Broadway, New York, NY 10019, is a broker-dealer registered with the SEC and is a member of FINRA. All account inquiries should be mailed to the Fund’s transfer agent, and should not be mailed to the Distributor.
The Distribution Contract will continue in effect with respect to the Fund for successive one-year periods, provided that each such continuance is specifically approved: (i) by the vote of a majority of the Trustees who are not interested persons of the Fund (as defined in the Act) and who have no direct or indirect financial interest in the Distribution Contract or the Investment Management Agreement; and (ii) by the vote of a majority of the entire Board cast in person at a meeting called for that purpose.
The Distributor acts as the distributor of Common Shares for the Fund on a best efforts basis, subject to various conditions, pursuant to the terms of the Distribution Contract. The Distributor is not obligated to sell any specific amount of Common Shares of the Fund.
The Fund generally does not offer or sell its shares outside of the United States, except to certain investors in approved jurisdictions and in conformity with local legal requirements.
Account Managers’ and Associates’ Compensation
Compensation for the Account Managers and Associates discussed in this section has four main components: base pay, quarterly incentive compensation, an annual bonus, and certain special bonuses/commissions.
Base Pay. All Account Managers and Associates receive some amount of base pay — a predetermined and fixed annual salary paid in bi-weekly installments. From time to time, the Distributor reviews the minimum base salary to confirm it is consistent with a reasonable wage and that there is an appropriate ratio between base salary and the other three compensation components.
Quarterly Incentive Compensation. Account Managers and Associates are eligible to receive quarterly incentive payments for the sale of certain products, including mutual funds, ETFs, interval funds, private funds and retail separately managed accounts (i.e., wrap accounts). Account Managers and Associates do not receive higher compensation for selling fund classes with distribution fees, for sales at approved firms. Additionally, Account Managers and Associates receive the same incentive compensation for products utilizing the same investment strategy (i.e., Total Return, Short Term, etc.). Account Managers and Associates employed by the Distributor are eligible to receive compensation, ascending by product categorization, with respect to sales of the following: Base/Core, Diversifiers, Strategic, Active ETFs and Alternative Strategies (each as defined from time-to-time by the Distributor) which can be adjusted based on achievement of goals and net flows. The Distributor only distributes investment products managed by PIMCO, and accordingly Account Managers and Associates compensation does not distinguish between proprietary and non-proprietary products. The Distributor reserves the right to determine the amount of compensation payable to Account Managers and Associates in its sole discretion.
Annual Bonus. Account Managers and Associates are eligible to receive an annual bonus. The annual bonus is determined through numerous factors, including a manager’s assessment that takes into consideration the Account Manager’s or Associate’s job and sales performance, both in absolute terms and relative to other Account Managers and Associates, as applicable, as well as PIMCO’s and the Distributor’s performance. The Distributor may use various metrics to assess or compare the job performance of Account Managers and Associates. Such metrics generally are indicative of the Account Manager’s or Associate’s success in the areas of, among others, financial professional satisfaction and the Account Manager’s or Associate’s product knowledge, responsiveness, and effectiveness. Annual bonuses may form a significant part of an Account Manager’s or Associate’s overall compensation. Additional information regarding annual bonuses is included under “Potential Conflicts of Interest” below.
Other Compensation. From time to time Account Managers and Associates may receive special bonuses, including monthly bonuses, or other rewards in connection with the Distributor’s incentive programs that reward
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certain performance-related metrics. Account Managers and Associates may receive commissions from the sale of other products, including closed-end funds, whose commission rates may be higher than those product types noted above.
Potential Conflicts of Interest
As described above, Account Managers and Associates are eligible to receive compensation, in addition to their base pay, which could represent a significant portion of an Account Manager’s and Associate’s compensation. A factor that is evaluated in determining such compensation is the Account Manager’s or Associate’s success in marketing and selling products distributed by the Distributor. Account Managers and Associates may have a financial incentive to offer certain types of products to you, and the offering of such products may be considered, among other factors, in the assessment of an Account Manager’s or Associate’s performance.
As described above, Account Managers and Associates who offer certain products may receive compensation as a direct or indirect result of your selection of those products, which could represent a significant portion of an Account Manager’s or Associate’s compensation; an Account Manager’s quarterly bonus could be reduced depending on the size of a transaction or transactions and the compensation of the Account Manager’s net sales for the year to date period. This compensation may be more than what the Account Manager or Associate would receive if you had selected other products. Therefore, Account Managers and Associates may have a financial incentive to offer certain products. For example, Alternatives Strategies offer higher compensation than Active ETFs, which offer higher compensation than Strategic Strategies, and so on, as noted above. Under policies applicable to all Account Managers and Associates, no Account Manager or Associate is permitted to promote, recommend, or solicit the sale of one product over another solely because that product will provide higher revenue or compensation to the Account Manager or Associate, the Distributor or PIMCO. Please review all product materials and disclosures before selecting an investment product.
Multi-Class Plan
The Fund has adopted a Multi-Class Plan pursuant to Rule 18f-3 under the Act. Although the Fund is not an open-end investment company, it has undertaken to comply with the terms of Rule 18f-3 as a condition of an exemptive order under the Act which permits it to have, among other things, a multi-class structure and distribution and/or shareholder servicing fees. Under the Multi-Class Plan, shares of each class of the Fund represent an equal pro rata interest in the Fund and, generally, have identical voting, dividend, liquidation, and other rights, preferences, powers, restrictions, limitations, qualifications and terms and conditions, except that: (a) each class has a different designation; (b) each class of shares bears any class-specific expenses; and (c) each class shall have separate voting rights on any matter submitted to shareholders in which the interests of one class differ from the interests of any other class, and shall have exclusive voting rights on any matter submitted to shareholders that relates solely to that class.
The Fund currently has five separate classes of Common Shares: Institutional Class, Class A-1, Class A-2, Class A-3 and Class A-4. Each class of Common Shares represents an investment in the same portfolio of investments, but each class has its own expense structure and arrangements for shareholder services or distribution, which allows you to choose the class that best fits your situation and eligibility requirements.
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Institutional Class Common Shares are offered for investment to investors such as pension and profit sharing plans, employee benefit trusts, endowments, foundations, corporations, pooled investment vehicles and other entities operating as “feeder funds,” and high net worth individuals that can meet the minimum investment amount. Institutional Class Common Shares also may be offered through certain financial firms that charge their customers transaction or other fees with respect to the customer’s investment in the Fund.
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Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares are not available for purchase directly from the Distributor. Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares are primarily offered and sold to retail investors by broker-dealers which are members of FINRA and which have agreements with the Distributor, but may be made available through other financial firms, including banks and trust companies and to specified benefit plans (as defined below) and other retirement accounts.
Financial firms may provide or arrange for the provision of some or all of the shareholder servicing, account maintenance and other services required by specified benefit plan accounts and their participants, for which fees or expenses may be charged in addition to those described in the Prospectus and Statement of Additional Information.
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The Fund has agreed to indemnify the Distributor and certain of the Distributor’s affiliates against certain liabilities, including certain liabilities arising under the 1933 Act. To the extent consistent with applicable law, the Distributor has agreed to indemnify the Fund and each Trustee against certain liabilities under the 1933 Act and in connection with the services rendered to the Fund.
Class A-1, Class A-2, Class A-3 and Class A-4 Distribution and Servicing Plans
The Fund has adopted separate Distribution and Servicing Plans for the Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares of the Fund. Each Distribution and Servicing Plan operates in a manner consistent with Rule 12b-1 under the Act, which regulates the manner in which an open-end investment company may directly or indirectly bear the expenses of distributing its shares. Although the Fund is not an open-end investment company, it has undertaken to comply with the terms of Rule 12b-1 as a condition of an exemptive order under the Act which permits it to have, among other things, a multi-class structure and distribution and/or shareholder servicing fees. Each Distribution and Servicing Plan permits the Fund to compensate the Distributor for providing or procuring through financial firms, distribution, administrative, recordkeeping, shareholder and/or related services with respect to the Class A-1, Class A-2, Class A-3 or Class A-4 Common Shares, as applicable. Most or all of the distribution and/or service fees are paid to financial firms through which Common Shareholders may purchase and/or hold Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares, as applicable.
Because these fees are paid out of the applicable share class’s assets on an ongoing basis, over time they will increase the cost of an investment in Class A-1, Class A-2, Class A-3 or Class A-4 Common Shares and may cost you more than other sales charges.
The maximum annual rates at which the distribution and/or servicing fee may be paid under the Distribution and Servicing Plan for Class A-1 Common Shares (calculated as a percentage of the Fund’s average daily net assets attributable to the Class A-1 Common Shares) is 0.50%.
The maximum annual rates at which the distribution and/or servicing fee may be paid under the Distribution and Servicing Plan for Class A-2 Common Shares (calculated as a percentage of the Fund’s average daily net assets attributable to the Class A-2 Common Shares) is 0.50%.
The maximum annual rates at which the distribution and/or servicing fee may be paid under the Distribution and Servicing Plan for Class A-3 Common Shares (calculated as a percentage of the Fund’s average daily net assets attributable to the Class A-3 Common Shares) is 0.75%.
The maximum annual rates at which the distribution and/or servicing fee may be paid under the Distribution and Servicing Plan for Class A-4 Common Shares (calculated as a percentage of the Fund’s average daily net assets attributable to the Class A-4 Common Shares) is 0.75%.
The fee payable pursuant to each Distribution and Servicing Plan may be used by the Distributor to provide or procure distribution services and shareholder services in respect of Class A-1, Class A-2, Class A-3 and Class A-4 Shares, as applicable (either directly or by procuring through other entities, including various financial services firms such as broker-dealers and registered investment advisors (“Service Organizations”)). Distribution services include some or all of the following services and facilities in connection with direct purchases by shareholders or in connection with products, programs or accounts offered by such Service Organizations: (i) facilities for placing orders directly for the purchase of the Fund’s shares; (ii) advertising with respect to the Fund’s Class A-1, Class A-2, Class A-3 or Class A-4 shares; (iii) providing information about the Fund; (iv) providing facilities to answer questions from prospective investors about the Fund; (v) receiving and answering correspondence, including requests for prospectuses and statements of additional information; (vi) preparing, printing and delivering prospectuses and shareholder reports to prospective shareholders; (vii) assisting investors in applying to purchase Class A-1, Class A-2, Class A-3 or Class A-4 shares and selecting dividend and other account options.
Shareholder services may include, but are not limited to, the following functions: (i) receiving, aggregating and processing shareholder orders; (ii) furnishing shareholder sub-accounting; (iii) providing and maintaining elective shareholder services such as check writing and wire transfer services; (iv) providing and maintaining pre-authorized investment plans; (v) communicating periodically with shareholders; (vi) acting as the sole shareholder of record and nominee for shareholders; (vii) maintaining accounting records for shareholders; (viii) answering questions and
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handling correspondence from shareholders about their accounts; (ix) issuing confirmations for transactions by shareholders; (x) performing similar account administrative services; (xi) providing such shareholder communications and recordkeeping services as may be required for any program for which a Service Organization is a sponsor that relies on Rule 3a-4 under the Act; (xii) and providing such other similar services as may reasonably be requested to the extent a Service Organization is permitted to do so under applicable statutes, rules, or regulations. The distribution and/or servicing fee may be spent by the Distributor for the services rendered to Class A-1, Class A-2, Class A-3 and Class A-4 shareholders as set forth above, but will generally not be spent by the Distributor on recordkeeping charges, accounting expenses, transfer costs or custodian fees.
In accordance with Rule 12b-1 under the Act, none of Distribution and Servicing Plans may be amended to increase materially the costs which the applicable class of shareholders may bear under the applicable Plan without approval of a majority of the outstanding Class A-1, Class A-2, Class A-3 or Class A-4 Common Shares, as applicable, and by vote of a majority of both: (i) the Trustees of the Fund; and (ii) those Trustees who are not “interested persons” of the Fund (as defined in the Act) and who have no direct or indirect financial interest in the operation of any of the Distribution and Servicing Plans or any agreements related to them (the “12b-1 Plan Trustees”), cast at a meeting called for the purpose of voting on the Plan and any related amendments. The Plan may not take effect until approved by a vote of a majority of both: (i) the Trustees of the Fund; and (ii) the 12b-1 Plan Trustees. Each Plan shall continue in effect so long as such continuance is specifically approved at least annually by the Trustees and the 12b-1Plan Trustees. Each Plan may be terminated at any time, without penalty, by vote of a majority of the 12b-1 Plan Trustees or by a vote of a majority of the outstanding Class A-1, Class A-2, Class A-3 or Class A-4 Common Shares of the Fund. Pursuant to each Plan, the Board will be provided with quarterly reports of amounts expended under the Plan and the purpose for which such expenditures were made.
FINRA rules limit the amount of distribution fees that may be paid by registered investment companies out of their assets as a percentage of total new gross sales. “Service fees,” defined to mean fees paid for providing shareholder services or the maintenance of accounts (but not transfer agency or sub-account services), are not subject to these limits on distribution fees. Some portion of the fees paid pursuant to each Distribution Plan may qualify as “service fees” (or fees for ministerial, recordkeeping or administrative activities) and therefore will not be limited by FINRA rules which limit distribution fees as a percentage of total new gross sales. However, FINRA rules limit service fees to 0.25% of a fund’s average annual net assets.
For the fiscal period ended December 31, 2022, the Fund did not pay the Distributor pursuant to the Distribution and Servicing Plan for Class A-1 shares, as the class launched on January 31, 2023. For the fiscal period ended December 31, 2022, the Fund did not pay the Distributor pursuant to the Distribution and Servicing Plan for Class A-2, Class A-3 and Class A-4 shares, as the share classes have not launched.
Additional Payments to Financial Firms
Revenue Sharing/Marketing Support. The Distributor or PIMCO (for purposes of this subsection only, collectively, “PIMCO”) makes payments and provides other incentives to financial firms as compensation for services such as providing the Fund with “shelf space,” or a higher profile for the financial firms’ financial professionals and their customers, placing the Fund on financial firms’ preferred or recommended fund list or otherwise identifying the Fund as being part of a complex to be accorded a higher degree of marketing support than complexes whose distributor or investment adviser is not making such payments, granting PIMCO access to the financial firms’ financial professionals (including through the firms’ intranet websites or other proprietary communications systems and channels) in order to promote the Fund, promotions in communications with financial firms’ customers such as in the firms’ internet websites or in customer newsletters, providing assistance in training and educating the financial firms’ personnel, and furnishing marketing support and other specified services. The actual services provided, and the payments made for such services, vary from firm to firm. These payments may be significant to the financial firms.
A number of factors are considered in determining the amount of these additional payments to financial firms. On some occasions, such payments may be conditioned upon levels of sales, including the sale of a specified minimum dollar amount of the shares of the Fund and/or other funds sponsored by PIMCO together or a particular class of shares, during a specified period of time. PIMCO also makes payments to one or more financial firms based upon factors such as the amount of assets a financial firm’s clients have invested in the Fund and the quality of the financial firm’s relationship with PIMCO and/or its affiliates.
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The additional payments described above are made from PIMCO’s (or its affiliates) own assets (and sometimes, therefore referred to as “revenue sharing”) pursuant to agreements with financial firms and do not change the price paid by investors for the purchase of the Fund’s shares or the amount the Fund will receive as proceeds from such sales. These payments may be made to financial firms (as selected by PIMCO) that have sold significant amounts of shares of the Fund or other PIMCO-sponsored funds. In certain cases, the payments described above may be subject to minimum payment levels or vary based on the management fee or total expense ratio of the relevant Fund(s) which normally will not exceed the amount that would have been payable pursuant to the formula as of the effective date of the agreement.
Ticket Charges. In addition to the payments described above, PIMCO makes payments to financial firms in connection with certain transaction fees (also referred to as “ticket charges”) incurred by the financial firms.
Event Support; Other Non-Cash Compensation; Charitable Contributions. In addition to the payments described above, PIMCO pays and/or reimburses, at its own expense, financial firms’ sponsorship and/or attendance at conferences, elite performer gatherings, seminars or informational meetings (which may include events held through video technology, to the extent permitted by applicable regulation (“event support”), provides financial firms or their personnel with occasional tickets to events or other entertainment (which in some instances is held virtually), meals and small gifts or pays or provides reimbursement for reasonable travel and lodging expenses for attendees of PIMCO educational events (“other non-cash compensation”), and makes charitable contributions to valid charitable organizations at the request of financial firms (“charitable contributions”) to the extent permitted by applicable law, rules and regulations.
Visits; Training; Education. In addition to the payments described above, wholesaler representatives and employees of PIMCO or its affiliates visit financial firms on a regular basis to educate financial professionals and other personnel about the Fund and to encourage the sale or recommendation of Fund shares to their clients. PIMCO may also provide (or compensate consultants or other third parties to provide) other relevant training and education to a financial firm’s financial professionals and other personnel.
Platform Support; Consultant Services. PIMCO also may make payments or reimbursements to financial firms or their affiliated companies, which may be used for their platform development, maintenance, improvement and/or the availability of services including, but not limited to, platform education and communications, relationship management support, development to support new or changing products, eligibility for inclusion on sample fund line-ups, trading or order taking platforms and related infrastructure/technology and/or legal, risk management and regulatory compliance infrastructure in support of investment-related products, programs and services (collectively, “platform support”). PIMCO may also make payments to third party law firms or other service providers that provide certain due diligence services to financial firms with respect to the Fund and/or PIMCO in connection with such financial firm determining whether to include the Fund on its platform. Such payments typically relate to the amount of assets a financial firm’s clients have invested in the Fund or other PIMCO-advised funds. In certain instances, platform support payments are made for the purpose of supporting services provided by a financial firm’s servicing of shareholder accounts, including, but not limited to, handling toll free telephone inquiries, processing shareholder communications, and providing information to shareholders on their investments. In addition, PIMCO may also pay for the cost of third party product trainings on behalf of, and/or for the benefit of, third party financial firms which market PIMCO interval funds.
Subject to applicable law, PIMCO and its affiliates may also provide investment advisory services to financial firms and their affiliates and may execute brokerage transactions on behalf of the Fund with such financial firms’ affiliates. These financial firms or their affiliates may, in the ordinary course of their financial firm business, recommend that their clients utilize PIMCO’s investment advisory services or invest in the funds or in other products sponsored or distributed by PIMCO or its affiliates.
Although platform support payments are not primarily intended to compensate financial firms for distribution of Fund shares or to encourage the sale of Fund shares, these payments may provide an additional incentive to certain financial firms to actively promote the sale of Fund shares and retain positions in the Fund in anticipation of increasing or retaining platform support payments. In addition, PIMCO may pay financial firms or their affiliated companies for certain services including technology, operations, tax, or audit consulting services and may pay such firms for PIMCO’s attendance at investment forums sponsored by such firms (collectively, “consultant services”). Such arrangements do not impact the amount of the management fee charged by PIMCO to the Fund.
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Data. PIMCO also may make payments or reimbursements to financial firms or their affiliated companies for various studies, surveys, industry data, research and information about, and contact information for, particular financial professionals who have sold, or may in the future sell, shares of the Fund or other PIMCO-advised funds (i.e., “data”). Such payments may relate to the amount of assets a financial firm’s clients have invested in the Fund or other PIMCO-advised funds.
Payments. Payments for items including event support, platform support, data and consultant services (but not including certain account services discussed below), as well as revenue sharing, are, in certain circumstances, bundled and allocated among these categories in PIMCO’s discretion. Portions of such bundled payments allocated by PIMCO to revenue sharing shall remain subject to the percentage limitations on revenue sharing payments disclosed above. The financial firms receiving such bundled payments may characterize or allocate the payments differently from PIMCO’s internal allocation. In addition, payments made by PIMCO to a financial firm and allocated by PIMCO to a particular category of services can in some cases result in benefits related to, or enhance the eligibility of PIMCO or the Fund to receive, services provided by the financial firm that may be characterized or allocated to one or more other categories of services.
As of March 31, 2023, PIMCO anticipates that the firms that will receive the additional payments for marketing support for the Fund, shelf space or other services as described above include the following firms. Also included in the list below are firms with which PIMCO has an agreement pertaining to services that PIMCO categorizes as “account services,” as described below, where such agreement calls for the financial firm to be identified.
Cambridge Investment Research Advisors, Inc.
Carson Wealth Management
Charles Schwab & Co., Inc.
Commonwealth Financial Network
Dynasty Financial
FSC Securities Corporation
LPL Financial LLC
Merrill Lynch, Pierce, Fenner & Smith, Incorporated
MML Investors Services, LLC
Rockefeller Financial LLC
Royal Alliance Associates
SagePoint Financial, Inc.
Securities America, Inc.
Triad Advisors, Inc.
UBS Financial Services, Inc.
Woodbury Financial Services, Inc.
PIMCO expects that additional firms may be added to this list from time to time or may receive one-time payments without anticipation of receiving future additional payments.
Subject to applicable law, PIMCO and its affiliates may also provide investment advisory services to financial firms and their affiliates and may execute brokerage transactions on behalf of the Fund with such financial firms’ affiliates. These financial firms or their affiliates may, in the ordinary course of their financial firm business, recommend that their clients utilize PIMCO’s investment advisory services or invest in the Fund or in other products sponsored or distributed by PIMCO or its affiliates.
Account Services. In addition to the payments, reimbursements and incentives described above, further amounts are, in certain circumstances, paid by PIMCO to financial firms for providing services with respect to shareholders holding Fund shares in nominee or street name, including, but not limited to, the following services: providing explanations and answering inquiries regarding the Fund and shareholder accounts; providing recordkeeping and other administrative services, including preparing record date shareholder lists for proxy solicitation; maintaining records of and facilitating purchases by shareholders of shares of the Fund; maintaining records of and facilitating repurchases of Common Shares by the Fund, including in connection with the Fund’s quarterly repurchase offers or other repurchases described in the Fund’s prospectus and elsewhere in this Statement of Additional Information; processing and mailing transaction confirmations, periodic statements, prospectuses, shareholder reports, shareholder notices and other SEC-required communications to shareholders; providing periodic statements to certain benefit plans and participants in such plans of the Fund held for the benefit of each participant in the plan; processing, collecting and posting distributions to their accounts; issuing and mailing dividend checks to shareholders who have selected cash distributions; assisting in the establishment and maintenance of shareholder accounts; providing account designations, addresses and other information; capturing and processing tax data; establishing and maintaining automated investment plans and shareholder account registrations; providing sub-accounting services; providing recordkeeping services related to shareholder purchase and Fund repurchase transactions, including providing such information as may be necessary to assure compliance with applicable blue sky requirements; and performing similar administrative services as requested by PIMCO to the extent that the firm is permitted by applicable statute, rule or regulation to provide such
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information or services. The actual services provided, and the payments made for such services, vary from firm to firm and, in some instances, vary with respect to a single firm according to investment channel. Such services may be referred to under a variety of descriptions, including sub-accounting, sub-transfer agency, administrative or shareholder services.
For these services, PIMCO pays an annual fee based on a per annum percentage of the value of the assets in the relevant accounts or annual per account charges. These payments are made out of PIMCO’s own resources. Such resources may include the management fees paid to PIMCO under the Fund’s Investment Management Agreement. Additionally, although these payments are made out of PIMCO’s own resources, in some cases the levels of such payments may vary by share class of the Fund in relation to advisory fees, total annual operating expenses or other payments made by the applicable share class to PIMCO; additionally, in some cases, the levels of such payments varies across and within share classes of the Fund in relation to investment channel and may differ from the amounts paid by PIMCO with respect to other PIMCO-sponsored funds for which the financial firm provides shareholder services. In addition, PIMCO may pay financial firms a flat fee by Fund or share class to cover certain set-up costs. These payments, taken together in the aggregate, may be material to financial firms relative to other compensation paid by the Fund and/or PIMCO and may be in addition to any (a) distribution and/or servicing (12b-1) fees; (b) marketing support, revenue sharing, platform support or “shelf space” fees; and (c) event support, other non-cash compensation and charitable contributions disclosed above and paid to or at the request of such financial firms or their personnel. The additional servicing payments and set-up fees described above may differ depending on the share class or investment channel and may vary from amounts paid to the Fund’s transfer agent for providing similar services to other accounts.
If investment advisers, distributors or affiliated persons of funds make payments and provide other incentives in differing amounts, financial firms and their financial professionals may have financial incentives for recommending a particular fund over other funds. Some platform arrangements also may entitle PIMCO or its affiliates to ancillary benefits such as reduced fees to attend a financial firm’s event or conference or elimination of one-time setup fees, such as CUSIP charges that financial firms otherwise may charge. In addition, depending on the arrangements in place at any particular time, a financial firm and its financial professionals also may have a financial incentive for recommending a particular share class over other share classes or may favor a particular investment channel over other such channels. Because financial firms may be paid varying amounts per class for sub-accounting and related recordkeeping services, the service requirements of which also may vary by class, this may create an additional incentive for financial firms and their financial professionals to favor one fund complex over another or one fund class over another. You should review carefully any disclosure by the financial firm or plan recordkeepers as to its compensation.
In certain circumstances, PIMCO or its affiliates may pay or reimburse financial firms for distribution and/or shareholder services out of PIMCO’s or its affiliates’ own assets when the Distributor does not receive associated distribution and/or service (12b-1) fees from the Fund. These payments and reimbursements may be made from profits received by PIMCO or its affiliates from other fees paid by the Fund. Such activities by PIMCO or its affiliates may provide incentives to financial firms to purchase or market shares of the Fund. Additionally, these activities and arrangements may give PIMCO or its affiliates additional access to sales representatives of such financial firms, which may increase sales of Fund shares. The payments described in this paragraph may be significant to payors and payees.
Purchasing Shares
The following section provides basic information about how to purchase Common Shares of the Fund. The Fund typically does not offer or sell its shares to non-U.S. residents. For purposes of this policy, a U.S. resident is defined as an account with (i) a U.S. address of record and (ii) all account owners residing in the U.S. at the time of sale.
The Fund and the Distributor each reserve the right, in its sole discretion, to suspend the offering of shares of the Fund or to reject any purchase order, in whole or in part, when, in the judgment of management, such suspension or rejection is in the best interests of the Fund or for other reasons such as compliance with anti-money laundering or sanctions obligations and requirements.
In the interest of economy and convenience, certificates for shares will not be issued.
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Purchases of Fund shares are discussed under the “Plan of Distribution - Purchasing Shares” section of the Prospectus, and that information is incorporated herein by reference.
If you are eligible to buy Institutional Class Common Shares as well as Class A-1, Class A-2, Class A-3 or Class A-4 Common Shares, you should buy Institutional Class Common Shares because Class A-2 and Class A-4 Common Shares may be subject to sales charges, and each of Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares will pay an annual distribution and/or service fee.
Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares. Eligible investors may purchase Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares through their broker-dealer or other financial firm. Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares are not available for purchase directly from the Distributor.
Through your broker-dealer or other financial firm. Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares are primarily offered and sold to retail investors by certain broker-dealers that are members of FINRA and that have agreements with the Distributor to offer Class A-1, Class A-2, Class A-3 and/or Class A-4 Common Shares, but may be made available through other financial firms, including banks and trust companies and to specified benefit plans and other retirement accounts. Your broker-dealer or other financial firm may establish higher or lower minimum investment requirements than the Fund and may also independently charge you transaction or other fees and additional amounts (which may vary) in return for its services, which will reduce your return. Shares you purchase through your broker-dealer or other financial firm will normally be held in your account with that firm and instructions for buying, selling, exchanging or transferring Class A-1, Class A-2, Class A-3 or Class A-4 Common Shares must be submitted by your broker-dealer or other financial firm on your behalf.
Institutional Class Common Shares. Eligible investors may purchase Institutional Class Common Shares in the following ways:
Through your broker-dealer or other financial firm. Institutional Class Common Shares may be offered through certain financial firms that charge their customers transaction or other fees with respect to their customers’ investments in the Fund. Your broker-dealer or other financial firm may establish higher or lower minimum investment requirements than the Fund and may also independently charge you transaction or other fees and additional amounts (which may vary) in return for its services, which will reduce your return. Shares you purchase through your broker-dealer or other financial firm will normally be held in your account with that firm. If you purchase shares through a broker-dealer or other financial firm, instructions for buying, selling, exchanging or transferring Institutional Class Common Shares must be submitted by your financial firm or broker-dealer on your behalf.
Through the Distributor. You should discuss your investment with your financial advisor before you make a purchase to be sure the Fund is appropriate for you. Individual investors who meet the minimum investment amount and wish to invest directly in Institutional Class Common Shares may obtain an Account Application online at pimco.com or by calling 844.312.2113. If you do not list a financial advisor and his/her brokerage firm on the Account Application, the Distributor is designated as the broker of record, but solely for purposes of acting as your agent to purchase shares.
The completed Account Application may be submitted using the following methods:
Facsimile: | |
844.643.0432 | |
Overnight Mail: PIMCO Interval Funds C/O SS&C Global Investor & Distribution Solutions, Inc. 430 W. 7th Street Suite 219993 Kansas City, MO 64105-1407 | RegularMail: PIMCO Interval Funds P.O. Box 219993 Kansas City, MO 64121-9993 |
E-mail: | |
pimcoaltprocessing@dstsystems.com |
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For inquiries, please call 844.312.2113.
Payment for the purchase of Common Shares may be made by check payable to the PIMCO Interval Funds and sent to the Regular Mail address above; or by wiring federal funds to:
PIMCO Interval Funds
United Missouri Bank
928 Grand Blvd
Kansas City, MO 64106
ABA 101000695
DDA 98-7229-174-3
ACCT: Your PIMCO Account Number
United Missouri Bank
928 Grand Blvd
Kansas City, MO 64106
ABA 101000695
DDA 98-7229-174-3
ACCT: Your PIMCO Account Number
FFC: Shareholder Name and Fund Identifier
Before wiring federal funds, the investor must provide order instructions to the transfer agent by facsimile at 844.643.0432 or by e-mail at pimcoaltprocessing@dstsystems.com. In order to receive the current day’s NAV, order instructions must be received in good order prior to the close of regular trading on the New York Stock Exchange (“NYSE”) (ordinarily 4:00 p.m., Eastern time) (“NYSE Close”). Instructions must include the name and signature of an appropriate person designated on the Account Application (“Authorized Person”), account name, account number, name of the Fund and dollar amount. Payments received without order instructions could result in a processing delay or a return of wire. Failure to send the accompanying payment on the same day may result in the cancellation of the order.
An investor may place a purchase order for Common Shares without first wiring federal funds if the purchase amount is to be derived from an advisory account managed by PIMCO or one of its affiliates, or from an account with a broker-dealer or other financial firm that has established a processing relationship with the Fund on behalf of its customers.
Investment Minimums
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Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares. The following investment minimums apply for purchases of Class A-1, Class A-2, Class A-3 and Class A-4 Common Shares:
Initial Investment | Subsequent Investments |
$2,500 per account | $50 |
•
Institutional Class Common Shares. The following investment minimums apply for purchases of Institutional Class Common Shares:
Initial Investment | Subsequent Investments |
$1 million per account | None |
The initial investment minimums may be higher or lower for certain financial firms that submit orders on behalf of their customers. The Fund or the Distributor may lower or waive the initial investment minimums for certain classes of shares or categories of investors at their discretion. The minimum initial investment may also be modified for the Trustees and certain employees and their extended family members of PIMCO and its affiliates. For these purposes, “extended family members” shall include such person’s spouse or domestic partner, as recognized by applicable state law, children, siblings, current brother/sister-in-laws, parents, and current father/mother-in-laws.
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Additional Investments. An investor may purchase additional Institutional Class Common Shares of the Fund at any time by sending a facsimile or e-mail as outlined above. If you invest in Common Shares through a broker-dealer, contact your financial firm for information on purchasing additional Common Shares.
•
Other Purchase Information. Purchases of the Fund’s Common Shares will be made in full and fractional shares.
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Sales Charge - Class A-2 and Class A-4 Common Shares
This section includes important information about sales charge reduction programs available to investors in Class A-2 and/or Class A-4 Common Shares of the Fund and describes information or records you may need to provide to the Distributor or your financial firm in order to be eligible for sales charge reduction programs.
Unless you are eligible for a waiver, the public offering price you pay when you buy Class A-2 or Class A-4 Common Shares of the Fund is the NAV of the shares plus an initial sales charge. The initial sales charge varies depending upon the size of your purchase, as set forth below. No sales charge is imposed where Class A-2 or Class A-4 Common Shares are issued to you pursuant to the automatic reinvestment of income dividends or capital gains distributions. For investors investing in Class A-2 or Class A-4 Common Shares of the Fund through a financial intermediary, it is the responsibility of the financial intermediary to ensure that you obtain the proper “breakpoint” discount.
The Fund may sell its Class A-2 and Class A-4 Common Shares at NAV without an initial sales charge to certain categories of investors, including current or retired officers, trustees, directors or employees of the Fund, PIMCO or the Distributor. The Fund believes that this arrangement encourages those persons to invest in the Fund, which further aligns the interest of the Fund and those persons. See “Sales at Net Asset Value” below for more information.
Because the offering price is calculated to two decimal places, the dollar amount of the sales charge as a percentage of the offering price and your net amount invested for any particular purchase of Fund shares may be higher or lower depending on whether downward or upward rounding was required during the calculation process.
Class A-2 Common Shares are subject to a 3.00% maximum sales charge as a percentage of the offering price (3.09% as a percentage of net amount invested).
Class A-2 Common Shares are subject to the following sales charge:
Your Investment | As a % of Public Offering Price | As a % of Net Amount Invested | Discount or commission to dealers as % of public offering price |
Less than $100,000 | 2.00%1 | 2.04%1 | 2.00% |
$100,000 – $249,999.99 | 1.00% | 1.01% | 1.00% |
$250,000 and over | 0.00%2 | 0.00%2 | 0.00% |
1
Although the Fund is permitted to charge a maximum sales charge of 3.00%, the Fund has elected to currently charge a maximum sales charge of 2.00%.
2
As shown, investors that purchase $250,000 or more of the Fund’s Class A-2 Common Shares will not pay any initial sales charge on the purchase. However, except with regard to purchases described below under “Sales at Net Asset Value”, purchases of $250,000 or more of Class A-2 Common Shares will be subject to an early withdrawal charge of 1.00% if the Common Shares are repurchased during the first 12 months after their purchase. The Distributor will pay a commission of 1.00% to dealers that sell amounts of $250,000 or more of Class A-2 Common Shares. See “Early Withdrawal Charges - Class A-2 and Class A-4 Common Shares” below.
Class A-4 Common Shares are subject to a 3.00% maximum sales charge as a percentage of the offering price (3.09% as a percentage of net amount invested).
Class A-4 Common Shares are subject to the following sales charge:
Your Investment | As a % of Public Offering Price | As a % of Net Amount Invested | Discount or commission to dealers as % of public offering price |
Less than $100,000 | 2.00%1 | 2.04%1 | 2.00% |
$100,000 – $249,999.99 | 1.00% | 1.01% | 1.00% |
$250,000 and over | 0.00%2 | 0.00%2 | 0.00% |
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1
Although the Fund is permitted to charge a maximum sales charge of 3.00%, the Fund has elected to currently charge a maximum sales charge of 2.00%.
2
As shown, investors that purchase $250,000 or more of the Fund’s Class A-4 Common Shares will not pay any initial sales charge on the purchase. However, except with regard to purchases described below under “Sales at Net Asset Value”, purchases of $250,000 or more of Class A-4 Common Shares will be subject to an early withdrawal charge of 1.00% if the Common Shares are repurchased during the first 12 months after their purchase. The Distributor will pay a commission of 1.00% to dealers that sell amounts of $250,000 or more of Class A-4 Common Shares. See “Early Withdrawal Charges - Class A-2 and Class A-4 Common Shares” below.
Investors in the Fund may reduce or eliminate sales charges applicable to purchases of Class A-2 or Class A-4 Common Shares through utilization of the Combined Purchase Privilege, Right of Accumulation, Letter of Intent or Reinstatement Privilege. These programs (described below) will apply to purchases of other closed-end interval funds that PIMCO sponsors currently or in the future (collectively, “Eligible Funds”), which offer Class A-1, Class A-2, Class A-3 and/or Class A-4 common shares. Eligible Funds do not include open-end funds sponsored by PIMCO.
Combined Purchase Privilege and Right of Accumulation (Breakpoints). A Qualifying Investor (as defined below) may qualify for a reduced sales charge on Class A-2 or Class A-4 Common Shares at the breakpoint levels disclosed herein by combining concurrent purchases of the Class A-1, Class A-2, Class A-3 and/or Class A-4 common shares of one or more Eligible Funds into a single purchase (the “Combined Purchase Privilege”). In addition, a Qualifying Investor may obtain a reduced sales charge on Class A-2 or Class A-4 Common Shares by adding the purchase value of Class A-1, Class A-2, Class A-3 and/or Class A-4 common shares of an Eligible Fund with the current aggregate net asset value of all Class A-1, Class A-2, Class A-3 and/or Class A-4 common shares of any Eligible Fund held by accounts for the benefit of such Qualifying Investor (the “Right of Accumulation” or “Cumulative Quantity Discount”).
The term “Qualifying Investor” refers to:
•
an individual, such individual’s spouse or domestic partner, as recognized by applicable state law, or such individual’s children under the age of 21 years (each a “family member”) (including family trust* accounts established by such a family member); or
•
a trustee or other fiduciary for a single trust (except family trusts* noted above), estate or fiduciary account although more than one beneficiary may be involved; or
•
an employee benefit plan of a single employer.
*
For these purposes, a “family trust” is one in which a family member, as defined in section (1) above, or a direct lineal descendant(s) of such person is/are the beneficiary(ies), and such person or another family member, direct lineal ancestor or sibling of such person is/are the trustee(s).
While a shareholder's positions in Class A-1 and Class A-3 common shares of other Eligible Funds are accounted for with respect to reaching a breakpoint level on purchases of Class A-2 or Class A-4 common shares of any Eligible Fund, because neither the Eligible Funds nor their distributor impose an initial sales charge on Class A-1 or Class A-3 common shares of other Eligible Funds, the Combined Purchase Privilege and Right of Accumulation programs do not apply to these share classes. Class A-1 or Class A-3 common shares of other Eligible Funds that count towards reaching a breakpoint level on purchases of Class A-2 or Class A-4 common shares of any Eligible Fund through the Combined Purchase Privilege and Right of Accumulation programs are still subject to transaction or other fees that may be charged by certain financial firms, as those programs do not impact the imposition of such fees.
Letter of Intent. Investors may also obtain a reduced sales charge on purchases of Class A-2 and/or Class A-4 Common Shares of the Fund by means of a written Letter of Intent which expresses an intent to invest not less than $250,000 within a period of 13 months in Class A-1, Class A-2, Class A-3 and/or Class A-4 common shares of any Eligible Fund(s). The maximum intended investment allowable in a Letter of Intent is $250,000. Each purchase of shares under a Letter of Intent will be made at the public offering price or prices applicable at the time of such purchase to a single purchase of the dollar amount indicated in the Letter of Intent. The value of the investor’s account(s) linked to a Letter of Intent will be included at the start date of the Letter of Intent. A Letter of Intent is not a binding obligation to purchase the full amount indicated. Shares purchased with the first 5% of the amount indicated in
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the Letter of Intent will be held in escrow (while remaining registered in your name) to secure payment of the higher sales charges applicable to the shares actually purchased in the event the full intended amount is not purchased. If the full amount indicated is not purchased, a sufficient amount of such escrowed shares will be involuntarily repurchased to pay the additional sales charge applicable to the amount actually purchased, if necessary. Dividends on escrowed shares, whether paid in cash or reinvested in additional Eligible Fund shares, are not subject to escrow. When the full amount indicated has been purchased, the escrow will be released. Repurchases during the Letter of Intent period will not count against the shareholder.
In making computations concerning the amount purchased for purposes of a Letter of Intent, market appreciation in the value of the shareholder’s Class A-1, Class A-2, Class A-3 and/or Class A-4 common shares of Eligible Funds will not be included.
Method of Valuation of Accounts. To determine whether a shareholder qualifies for a reduction in sales charge on a purchase of Class A-2 and/or Class A-4 Common Shares of the Fund, the public offering price of the shares is used for purchases relying on the Combined Purchase Privilege or a Letter of Intent and the amount of the total current purchase (including any sales load) plus the NAV (at the close of business on the day of the current purchase) of shares previously acquired is used for the Right of Accumulation.
Reinstatement Privilege. A Class A-2 or Class A-4 shareholder who has caused any or all of his or her shares to be repurchased may reinvest all or any portion of the repurchase proceeds in Class A-1, Class A-2, Class A-3 and/or Class A-4 common shares of any Eligible Fund at net asset value without any sales charge, provided that such reinvestment is made within 120 calendar days after the repurchase date. Shares are sold to a reinvesting shareholder at the net asset value next determined. See “How Fund Shares are Priced” in the Prospectus. A reinstatement pursuant to this privilege will not cancel the repurchase transaction and, consequently, any gain or loss so realized may be recognized for federal tax purposes except that no loss may be recognized to the extent that the proceeds are reinvested in shares of the same Fund within 30 days. The reinstatement privilege may be utilized by a shareholder only once per year per account (per 365 days), irrespective of the number of shares repurchased, except that the privilege may be utilized without limit in connection with transactions whose sole purpose is to transfer a shareholder’s interest in the Fund to his or her Individual Retirement Account or other qualified retirement plan account (if applicable). An investor may exercise the reinstatement privilege by written request sent to the Fund or to the investor’s financial firm. Investors who were not assessed a sales charge upon the purchase of their shares may not utilize the reinstatement privilege with respect to reinvestment of such shares following their repurchase.
Sales at Net Asset Value.
In addition to the programs summarized above, Class A-2 or Class A-4 Common Shares, which are available for purchase only through a broker-dealer or other financial firm, may be sold at NAV without an initial sales charge to:
(i)
current, retired, or former officers, trustees, directors or employees of the Fund (including accounts established for former employees or extended family of former employees established while employed), PIMCO Funds, PIMCO Equity Series, Allianz Funds, or Allianz Funds Multi-Strategy Trust, Allianz, Allianz Global Investors U.S. LLC, PIMCO or the Distributor, other affiliates of Allianz Global Investors U.S. LLC and funds advised or sub-advised by any such affiliates, in any case at the discretion of PIMCO or the Distributor; their spouse or domestic partner, as recognized by applicable state law, children, siblings, current brother/sister-in-laws, parents, and current father/mother-in-laws (“extended family”), or family trust account for their benefit, or any trust, profit-sharing or pension plan for the benefit of any such person;
(ii)
current registered representatives and other full-time employees of broker-dealers that have selling agreements with the Distributor or such persons’ spouse or domestic partner, as recognized by applicable state law, children under 21, and family trust accounts;
(iii)
trustees or other fiduciaries purchasing shares through certain group omnibus plans (such as 401(k), 403(b), Health Savings Accounts, 457, Profit Sharing/Keogh, Money Purchase Pension and Defined Benefit; not including individual participant directed accounts (i.e., accounts listed in the Fund’s records as for the benefit of a named individual), SEP-IRAs, SIMPLE IRAs, SARSEP IRAs and 403(b)7 custodial accounts) sponsored by employers, professional organizations or associations, or charitable organizations that qualify for 501(c)(3) status under the Internal Revenue Code;
(iv)
investors rolling over assets from specified benefit plans to IRAs or other qualified retirement plan accounts if such assets were invested in the Fund at the time of distribution;
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(v)
participants investing through accounts known as “wrap accounts” established with broker-dealers approved by the Distributor where such broker-dealers are paid a single, inclusive fee for brokerage and investment management services;
(vi)
client accounts of broker-dealers or registered investment advisers affiliated with such broker-dealers that use Class A-2 or Class A-4 Common Shares in particular investment products or programs or in particular situations in which the broker-dealer will make Class A-2 or Class A-4 Common Shares available for purchase at NAV (e.g., through self-directed brokerage service platforms or investment advisory programs);
(vii)
accounts for which the company that serves as trustee or custodian either (a) is affiliated with PIMCO or (b) has a specific agreement to serve as trustee or custodian of the account with the Distributor;
(viii)
investors following the public announcement of the Board’s approval of a plan of liquidation for the Fund or for another share class of the Fund until the liquidation date;
(ix)
investors making an exchange from a taxable account invested in a PIMCO Interval Fund to the Fund held in an IRA or other qualified retirement plan account for the purpose of making a contribution to the IRA or other qualified retirement plan account;
(x)
investors exchanging proceeds of required minimum distributions from an IRA or other qualified retirement plan account invested in a PIMCO Interval Fund to a taxable account invested in the Fund;
(xi)
investors acquiring Class A-2 or Class A-4 Common Shares as a result of any automatic conversion of their shares of another class of the Fund into Class A-2 or Class A-4 Common Shares; and
(xii)
any other person if the Distributor anticipates that there will be minimal cost borne by the Distributor associated with the sale. . What qualifies as “minimal cost” borne by the Distributor will be determined in the sole discretion of the Distributor but will be applied uniformly to all shareholders seeking a waiver for which there will be such minimal cost.
The Distributor will only pay Rule 12b-1 fees and will not pay any initial commission or other fees to broker-dealers upon the sale of Class A-2 or Class A-4 Common Shares to the purchasers described in sub-paragraphs (i) through (xii) above. In addition, the Distributor will only pay distribution and/or service fees and will not pay any initial commission or other fees to broker-dealers upon the sale of Class A-2 and Class A-4 Common Shares of the Fund following the public announcement of the Board's approval of a plan of liquidation for the Fund.
Exchanges
Shares of one class of the Fund or one class of common shares of other Eligible Funds may be exchanged for shares of the same class or another class of Common Shares of the Fund without a sales charge. The Fund will only complete an exchange at the direction of a financial intermediary. Contact your financial intermediary to learn more about the details of this exchange feature. See “Exchanging Shares” below for additional information.
Early Withdrawal Charges - Class A-2 and Class A-4 Common Shares
Unless you are eligible for a waiver, if you purchase $250,000 or more of Class A-2 or Class A-4 Common Shares (and, thus, pay no initial sales charge) of the Fund, you will be subject to a 1% early withdrawal charge (“EWC”) if your Class A-2 or Class A-4 Common Shares are repurchased within 12 months of their purchase. If the financial firm through which you purchased your Common Shares does not receive any upfront commission from the Distributor at the time of purchase, you will not be subject to an EWC upon repurchase. The Class A-2 and Class A-4 EWCs do not apply if you are otherwise eligible to purchase Class A-2 or Class A-4 Common Shares without an initial sales charge or are eligible for a waiver of the EWC.
How EWCs will be Calculated
An EWC is imposed on repurchases of Class A-2 or Class A-4 Common Shares on the amount of the repurchase which causes the current value of your account for the particular class of Common Shares of the Fund to fall below the total dollar amount of your purchase payments on which you paid no initial sales charge as a result of reaching a breakpoint on the initial purchase and have not been held 12 months.
The following rules apply under the method for calculating EWCs:
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•
Common Shares acquired through the reinvestment of dividends or capital gains distributions will be repurchased first and will not be subject to any EWC.
•
For the repurchase of all other Common Shares, the EWC will be based on either your original purchase price or the then current NAV of the Common Shares being sold, whichever is lower. To illustrate this point, consider Common Shares purchased at an NAV of $10. If the Fund's NAV per Common Share at the time of repurchase is $12, the EWC will apply to the purchase price of $10. If the NAV per Common Share at the time of repurchase is $8, the EWC will apply to the $8 current NAV per Common Share.
•
EWCs will be deducted from the proceeds of your repurchase, not from amounts remaining in your account.
In determining whether an EWC is payable, it is assumed that you will have repurchased first the lot of Common Shares which will incur the lowest EWC.
Reductions and Waivers of Initial Sales Charges and EWCs
The initial sales charges and EWCs on Class A-2 Common Shares may be reduced or waived under certain purchase arrangements and for certain categories of investors. See “Sales Charge - Class A-2 and Class A-4 Common Shares” above for information on Class A-2 and Class A-4 initial sales charges.
EWCs on Class A-2 or Class A-4 Common Shares may be reduced or waived for:
(i) any partial or complete repurchase following death or permanent and total disability (as defined in Section 22(e) of the Internal Revenue Code) of an individual holding shares for his or her own account and/or as the last survivor of a joint tenancy arrangement (this provision, however, does not cover the death or disability of an individual holding shares in a fiduciary capacity or as a nominee or agent, nor does it cover the death or disability of the owners, trustees or beneficiaries of a legal entity) provided the repurchase is requested within one year of the death or initial determination of disability and provided the death or disability occurs after the purchase of the shares;
(ii) repurchases by current or former Trustees, officers and employees of the Fund or any of the PIMCO Interval Funds, and by directors, officers and current or former employees of the Distributor, Allianz, Allianz Global Fund Management or PIMCO if the account was established while employed;
(iii) repurchases of shares of the Fund if it is combined with another Eligible Fund, investment company, or personal holding company by virtue of a merger, acquisition or other similar reorganization transaction;
(iv) repurchases where the shareholder can demonstrate hardship;
(v) repurchases where there will be minimal cost borne by the Distributor associated with the repurchase;
(vi) an intra-fund exchange of shares of one class of Common Shares of the Fund for shares of another class of Common Shares of the Fund, or exchange Common Shares of the Fund for the same class or another class of common shares of another Eligible Fund where the initial shares were purchased at NAV and no commission was paid;
(vii) repurchases following the public announcement of the Board’s approval of a plan of liquidation for the Fund or for another share class of the Fund.
What qualifies as “hardship” and “minimal cost” borne by the Distributor will be determined in the sole discretion of the Distributor. The Distributor follows how IRS regulations classify “hardship” – a financial hardship may occur when an individual has an immediate and heavy financial need and the money to be withdrawn from the shareholder’s account is necessary to meet that need. The Distributor generally determines an EWC waiver or reduction to be of “minimal cost” where the shareholder can demonstrate that the repurchase triggering the EWC was inadvertently executed during the period subject to the EWC and substantially all of the EWC period has lapsed.
The Fund may require documentation prior to waiver of the EWC for any class, including distribution letters, certification by plan administrators, applicable tax forms, death certificates, physicians’ certificates (e.g., with respect to disabilities), etc. In addition, investors will not be subject to EWCs for certain transactions where the Distributor did not pay at the time of purchase the amount it normally would have to the broker-dealer.
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Required Shareholder Information and Records
In order for investors in Class A-2 or Class A-4 Common Shares of the Fund to take advantage of sales charge reductions, an investor or his or her financial firm must notify the Fund that the investor qualifies for such a reduction. If the Fund is not notified that the investor is eligible for these reductions, the Fund will be unable to ensure that the reduction is applied to the investor’s account. An investor may have to provide certain information or records to his or her financial firm or the Fund to verify the investor’s eligibility for breakpoint discounts or sales charge waivers. An investor may be asked to provide information or records, including account statements, regarding shares of the Fund or other Eligible Funds held in:
•
any account of the investor at another financial firm; and
•
accounts of Qualifying Investors at any financial firm.
Exchanging Shares
Exchanges Across Eligible Funds: Subject to the terms and conditions below, shares of one class of common shares of other Eligible Funds may be exchanged, at the shareholder’s option, for shares of the same class or another class of Common Shares of the Fund. Shareholders may also move their investment in Common Shares of the Fund into shares of the same class or another class of common shares of other Eligible Funds in conjunction with quarterly repurchases made by the Fund. In this case, rather than tendering shares for cash, the shareholder would elect to have the dollar value of those Common Shares accepted for purchases of shares of the other Eligible Funds. Such exchanges for shares of other Eligible Funds must occur in conjunction with quarterly repurchases made by the Fund and will be subject to those repurchase offer risks, such as the risk that shareholders may be unable to liquidate all or a given percentage of their investment in the Fund during a particular repurchase offer, that are described in the Prospectus. See “Principal Risks of the Fund - Repurchase Offers Risk.”
The total value of shares being exchanged into the Fund must at least equal the minimum investment requirement applicable to the relevant class of Common Shares of the Fund, and the total value of shares being exchanged out of the Fund into other Eligible Funds must meet the minimum investment requirements of those Eligible Funds, as applicable. Other than exchanges at the direction of a financial intermediary (as described below), shares of the Fund or other Eligible Funds related to such exchanges will be subject to any sales charges, EWCs and/or waivers applicable to such classes of shares.
Intra-Fund Exchanges: Common Shares of one class of the Fund may be exchanged at any time, at a shareholder’s option, directly for shares of another class of the Fund (an “intra-fund exchange”), subject to the terms and conditions described below and provided that the shareholder for whom the intra-fund exchange is being requested meets the eligibility requirements of the class into which such shareholder seeks to exchange. Additional information regarding the eligibility requirements of different share classes, including investment minimums and intended distribution channels is described under “Purchasing Shares” and “Investment Minimums” above.
Common Shares of one class of the Fund will be exchanged for shares of a different class of the Fund on the basis of their respective NAVs. Ongoing fees and expenses incurred by a given share class will differ from those of other share classes, and a shareholder receiving new shares in an intra-fund exchange may be subject to higher or lower total expenses following such exchange.
Financial Intermediary-Directed Exchanges: Financial intermediaries may, in connection with a change in a client’s account type, at the direction of a client, or otherwise in accordance with a financial intermediary’s policies and procedures, direct the Fund on behalf of the intermediary’s clients to exchange shares of one class of Common Shares of the Fund for shares of another class of Common Shares of the Fund, or exchange Common Shares of the Fund for the same class or another class of common shares of another Eligible Fund. Any such exchange will not be subject to any sales charges or EWCs. Class A-1 Common Shares of the Fund are, however, subject to higher annual operating expenses than Institutional Class Common Shares. See “Summary of Fund Expenses” in the Prospectus. The Fund will only complete such an exchange at the direction of a financial intermediary and without making inquiry as to whether the exchange is consistent with the particular intermediary’s policies and procedures or the client’s account type and/or suitability criteria. An investor should contact his or her financial intermediary to learn more about the details of this exchange feature and whether and under what circumstances it may apply in accordance with the investor’s arrangements with the particular intermediary.
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Shares Purchased or Held Through Financial Intermediaries
The availability of sales charge waivers and discounts may depend on the particular financial intermediary or type of account through which you purchase or hold Fund shares. The Fund’s sales charge waivers and discounts disclosed above are available for qualifying purchases and are generally available through financial firms unless otherwise specified in Appendix B (Financial Firm-Specific Sales Charge Waivers and Discounts) to the Prospectus.
The sales charge waivers, discounts and/or breakpoints available through certain other financial intermediaries are set forth in Appendix B to the Prospectus, and may differ from those available for purchases made directly from the Distributor or certain other financial firms. Please contact your financial firm for more information regarding applicable sales charge waivers, discounts and/or breakpoints available to you and the financial firm’s related policies and procedures.
While neither the Fund nor the Distributor impose an initial sales charge on Institutional Class, Class A-1 or Class A-3 Common Shares, if you buy Institutional Class, Class A-1 or Class A-3 Common Shares through certain financial firms they may directly charge you transaction or other fees in such amount as they may determine. Please consult your financial firm for additional information.
Additional Information about Purchases. Shares may be purchased at a price equal to their net asset value per share, plus any applicable sales charge, next determined after receipt of an order. Under normal circumstances, all purchase orders received by the Fund or its designee prior to the NYSE Close on a regular business day are processed at that day’s offering price. However, orders received by the Fund or its designee after the offering price is determined that day from financial firms or certain retirement plans will receive such offering price if the orders were received by the financial firm or retirement plan from its customer or participant prior to such offering price determination and were transmitted to and received by the Fund or its designee prior to such time as agreed upon by the Distributor or Investment Manager in accordance with an agreement or as allowed by applicable law. Purchase orders will be accepted only on days on which the Fund is open for business. If a purchase order is received on a day when the Fund is not open for business, it will be processed on the next succeeding day the Fund is open for business (according to the succeeding day’s net asset value). The Fund is “open for business” on each day the NYSE is open for trading, which excludes the following holidays: New Year’s Day, Martin Luther King, Jr. Day, Presidents’ Day, Good Friday, Memorial Day, Juneteenth National Independence Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. On any day that regular trading on the NYSE closes earlier than scheduled, the Fund reserves the right to: (i) advance the time as of which the NAV is calculated and, therefore, the time by which purchase orders must be received to receive that day’s NAV or (ii) accept purchase orders until, and calculate its NAV as of, the normally scheduled NYSE Close. On any day that the NYSE is closed when it would normally be open for business, the Fund may accept purchase orders until, and calculate its NAV as of, the normally scheduled close of regular trading on the NYSE or such other time that the Fund may determine.
The Fund reserves the right to close if the primary trading markets of the Fund’s portfolio instruments are closed and the Fund’s management believes that there is not an adequate market to meet purchase requests. On any business day when the Securities Industry and Financial Markets Association recommends that the securities markets close trading early, the Fund may close trading early.
Broker-dealers and other financial firms are obligated to transmit purchase orders promptly. The Fund and the Distributor each reserves the right, in its sole discretion, to accept or reject any order for purchase of Fund shares. The sale of shares may be suspended on any day on which the NYSE is closed and, if permitted by the rules of the SEC, when trading on the NYSE is restricted or during an emergency that makes it impracticable for the Fund to dispose of its securities or to determine fairly the value of its net assets, or during any other period as permitted by the SEC for the protection of investors.
Signature Validation. When a signature validation is called for, a Medallion signature guarantee or Signature validation program (“SVP”) stamp may be required. A Medallion signature guarantee is intended to provide signature validation for transactions considered financial in nature, and an SVP stamp is intended to provide signature validation for transactions non-financial in nature. In certain situations, a notarized signature may be used instead of a Medallion signature guarantee or an SVP stamp. A Medallion signature guarantee or SVP stamp may be obtained from a domestic bank or trust company, broker, dealer, clearing agency, savings association or other financial institution which is participating in a Medallion program or Signature validation program recognized by the Securities Transfer Association. When a Medallion signature guarantee or SVP stamp is required, signature validations from financial
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institutions which are not participating in one of these programs will not be accepted. Please note that financial institutions participating in a recognized Medallion program may still be ineligible to provide a signature validation for transactions of greater than a specified dollar amount. The Fund may change the signature validation requirements from time to time upon notice to shareholders, which may be given by means of a new or supplemented prospectus. Shareholders should contact the Fund for additional details regarding the Fund’s signature validation requirements.
Account Registration and Privilege Changes. Changes in registration or account privileges may be made in writing. Signature validation may be required. See “Signature Validation” above. All correspondence must include the account number and may be submitted using the following methods:
Facsimile: | |
844.643.0432 | |
Overnight Mail: | Regular Mail: |
PIMCO Interval Funds | PIMCO Interval Funds |
C/O SS&C Global Investor & Distribution Solutions, Inc. | P.O. Box 219993 |
430 W. 7th Street | Kansas City, MO 64121-9993 |
Suite 219993 | |
Kansas City, MO 64105-1407 | |
Email: | |
pimcoaltprocessing@dstsystems.com |
For inquiries, please call 844.312.2113.
If you invest through a broker-dealer, contact your financial firm for information on changes in registration or account privileges.
Information for Shares of the Fund. Broker-dealers and other financial intermediaries provide varying arrangements for their clients to purchase Fund shares. Some may establish higher or lower minimum investment requirements than set forth above. Firms may arrange with their clients for other investment or administrative services and may independently establish and charge transaction or other fees and/or other additional amounts to their clients for such services, which charges would reduce clients’ return. Firms also may hold Fund shares in nominee or street name as agent for and on behalf of their customers. In such instances, the Fund’s transfer agent will have no information with respect to or control over accounts of specific shareholders. Such shareholders may obtain access to their accounts and information about their accounts only from their broker. In addition, certain privileges with respect to the purchase and redemption of shares or the reinvestment of dividends may not be available through such firms. Some firms may participate in a program allowing them access to their clients’ accounts for servicing including, without limitation, transfers of registration and dividend payee changes; and may perform functions such as generation of confirmation statements and disbursement of cash dividends.
Request for Multiple Copies of Shareholder Documents
To reduce expenses, it is intended that only one copy of the Prospectus and each annual and semi-annual report or notice of availability, when available, will be mailed to those addresses shared by two or more accounts. If you wish to receive individual copies of these documents and your shares are held in the Fund’s account, call the Fund at 844.312.2113. You will receive the additional copy within 30 days after receipt of your request by the Fund. Alternatively, if your shares are held through a financial institution, please contact the financial institution.
REPURCHASE OF COMMON SHARES
In order to provide some liquidity to shareholders, the Fund makes quarterly offers to repurchase between 5% and 25% of its outstanding Common Shares at net asset value. Although the policy permits repurchases of between 5% and 25% of the Fund’s outstanding Common Shares, for each quarterly repurchase offer, the Fund currently expects to offer to repurchase 10% of the Fund’s outstanding Common Shares at NAV, subject to approval of the Board. Notices of each quarterly repurchase offer are sent to shareholders at least 21 days before the “Repurchase Request Deadline”
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(i.e., the date by which shareholders can tender their Common Shares in response to a repurchase offer). The Fund determines the NAV applicable to repurchases no later than the 14 days after the Repurchase Request Deadline (or the next business day, if the 14th day is not a business day) (the “Repurchase Pricing Date”). The Fund expects to distribute payment to shareholders within three business days after the Repurchase Pricing Date and will distribute such payment no later than seven (7) calendar days after such date. The Fund’s Common Shares are not listed on any securities exchange, and the Fund anticipates that no secondary market will develop for its Common Shares. Investors should consider Common Shares of the Fund to be an illiquid investment. Accordingly, you may not be able to sell Common Shares when and/or in the amount that you desire. Thus, Common Shares are appropriate only as a long-term investment. In addition, the Fund’s repurchase offers may subject the Fund and shareholders to special risks.
The section entitled “Periodic Repurchase Offers” in the Prospectus discusses the type and timing of notice for repurchase offers, the effects of oversubscribed repurchase offers, the determination of the repurchase price, payment by the Fund for Common Shares tendered in a repurchase offer, the effect of repurchase policies on the liquidity of the Fund, the consequences of repurchase offers and other details regarding the repurchase offers, including associated risks. The Fund’s fundamental policies with respect to repurchase offers are discussed in “Investment Restrictions” in this Statement of Additional Information.
See “Principal Risks of the Fund - Repurchase Offers Risk” in the Prospectus for a description of the risks associated with the Fund’s repurchase offers. In addition, the repurchase of Common Shares by the Fund will be a taxable event to shareholders. For a discussion of these tax consequences, see “Taxation” below.
In addition to the Fund’s policy to make periodic repurchase offers as described above, the Board may consider additional repurchases 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 (described below). The Fund cannot assure you that its Board will decide to take or propose any of these actions.
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 and gains. Any share repurchase, tender offer or borrowing that might be approved by the Board would have to comply with the Act and the rules and regulations thereunder and other applicable law.
Notwithstanding the foregoing, at any time when the Fund’s RVMTP Shares are outstanding, the Fund may not purchase, redeem or otherwise acquire for consideration any of its Common Shares unless and only if: (i) immediately after such transaction, the Fund would satisfy the asset coverage with respect to the RVMTP Shares required by the Fund’s Bylaws and the Act; (ii) full cumulative dividends on the Preferred Shares on or prior to the date of the transaction have been declared and paid (or have been declared and sufficient funds for the payment thereof have been deposited with the paying agent for the RVMTP Shares); and (iii) the Fund has deposited sufficient deposit securities with respect to the Preferred Shares to be redeemed for which a notice of redemption has been given or was required pursuant to the Fund’s Bylaws.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Investment Decisions and Portfolio Transactions
Investment decisions for the Fund and for the other investment advisory clients of PIMCO are made with a view to achieving their respective investment objectives. 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 also may be appropriate for other clients served by 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, including accounts in which PIMCO, its affiliates and its employees may have a financial interest. If a purchase or sale of securities consistent with the investment policies of the Fund and one or more of these clients served by PIMCO is considered at or about the same time, transactions in such securities will be allocated among the Fund and other clients pursuant to PIMCO’s trade allocation policy, as applicable, that is designed to ensure that all accounts, including the Fund, are treated fairly, equitably, and in a non-preferential manner, such that allocations are not based upon fee structure or portfolio manager preference. PIMCO may acquire on behalf of its clients (including the Fund) securities or other financial instruments providing exposure to different aspects of the capital and debt structure of an issuer, including
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without limitation those that relate to senior and junior/subordinate obligations of such issuer. In certain circumstances, the interests of those clients exposed to one portion of the issuer’s capital and debt structure may diverge from those clients exposed to a different portion of the issuer’s capital and debt structure. PIMCO may advise some clients or take actions for them in their best interests with respect to their exposures to an issuer’s capital and debt structure that may diverge from the interests of other clients with different exposures to the same issuer’s capital and debt structure.
PIMCO may aggregate orders for the Fund with simultaneous transactions entered into on behalf of its other clients when, in its reasonable judgment, aggregation may result in an overall economic benefit to the Fund and the other clients in terms of pricing, brokerage commissions or other expenses. When feasible, PIMCO allocates trades prior to execution. When pre-execution allocation is not feasible, PIMCO promptly allocates trades following established and objective procedures. Allocations generally are made at or about the time of execution and before the end of the trading day. As a result, one account may receive a price for a particular transaction that is different from the price received by another account for a similar transaction on the same day. In general, trades are allocated among portfolio managers on a pro rata basis (to the extent a portfolio manager decides to participate fully in the trade), for further allocation by each portfolio manager among that manager’s eligible accounts. In allocating trades among accounts, portfolio managers generally consider a number of factors, including, but not limited to, each account’s deviation (in terms of risk exposure and/or performance characteristics) from a relevant model portfolio, each account’s investment objectives, restrictions and guidelines, its risk exposure, its available cash, and its existing holdings of similar securities. Once trades are allocated, they may be reallocated only in unusual circumstances due to recognition of specific account restrictions. In some cases, PIMCO may sell a security on behalf of a client, including the Fund, to a broker-dealer that thereafter may be purchased for the accounts of one or more other clients, including the Fund, from that or another broker-dealer. PIMCO have adopted procedures they believe are reasonably designed to obtain the best execution for the transactions by each account.
Where applicable, PIMCO considers relevant ESG factors in its investment research process with the goal of enhancing risk-adjusted returns. Integrating relevant factors into the evaluation process does not mean that ESG related information is the sole or primary consideration for an investment decision. PIMCO's portfolio managers and analyst teams consider a variety of factors including the materiality of those factors to make investment decisions. Where material, ESG factors can be important considerations when evaluating long-term investment opportunities and risks for asset classes, where applicable. The materiality of ESG considerations to investment decisions typically varies across asset classes, strategies, products and valuations.
Brokerage and Research Services
There is generally no stated commission in the case of fixed-income securities, which are often traded in the OTC 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. Transactions in foreign securities generally involve the payment of fixed brokerage commissions, which are generally higher than those in the United States. Transactions in fixed-income securities on certain foreign exchanges may involve commission payments.
PIMCO places all orders for the purchase and sale of portfolio securities, options, futures contracts, swap agreements and other instruments for the Fund and buys and sells such securities, options, futures, swap agreements and other instruments for the Fund through a substantial number of brokers and dealers. In so doing, PIMCO uses its best efforts to obtain for the Fund the best execution available, except to the extent it may be permitted to pay higher brokerage commissions as described below. In seeking best 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. Changes in the aggregate amount of brokerage commissions paid by the Fund from year-to-year may be attributable to changes in the asset size of the Fund, the volume of the portfolio transactions effected by the Fund, the types of instruments in which the Fund invests, or the rates negotiated by PIMCO on behalf of the Fund. Although the Fund may use financial firms that sell Fund shares to
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effect transactions for the Fund’s portfolio, neither the Fund nor PIMCO will consider the sale of Fund shares as a factor when choosing financial firms to effect those transactions.
Brokerage Commissions Paid
For the fiscal year ended December 31, 2022, the following amounts of brokerage commissions were paid by the Fund:
Fiscal Year | Brokerage Commissions Paid |
12/31/2022* | $3 |
*
The Fund commenced operations on June 27, 2022. Information provided reflects the “stub” period from June 27, 2022, through the Fund’s fiscal year end of December 31, 2022.
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 and brokerage products and services (together, “services”) from broker-dealers that 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 also may receive research or research related credits from brokers that are generated from underwriting commissions when purchasing new issues of fixed-income 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 and services related to the execution of securities transactions. 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. Conversely, research and brokerage services provided to the Fund by broker-dealers in connection with trades executed on behalf of other clients of PIMCO may be useful to PIMCO in managing the Fund, although not all of these services may be necessarily useful and of value to PIMCO in managing such other clients.
In reliance on the “safe harbor” provided by Section 28(e) of the Exchange Act, as amended, PIMCO may cause the Fund to pay broker-dealers which provide them with “brokerage and research services” (as defined in the Exchange Act) an amount of 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 if PIMCO determines in good faith that the commission is reasonable in relation to the value of the brokerage and research services provided by the broker-dealer viewed in terms of either a particular transaction or PIMCO’s overall responsibilities to the advisory accounts for which PIMCO exercises investment discretion.
PIMCO may place orders for the purchase and sale of exchanged-listed portfolio securities with a broker-dealer that is an affiliate of PIMCO where, in the judgment of PIMCO, such firm will be able to obtain a price and execution at least as favorable as other qualified broker-dealers.
Pursuant to rules of the SEC, a broker-dealer that is an affiliate of PIMCO may receive and retain compensation for effecting portfolio transactions for the Fund on a national securities exchange of which the broker-dealer is a member if the transaction is “executed” on the floor of the exchange by another broker which is not an “associated person” of the affiliated broker-dealer, and if there is in effect a written contract between PIMCO and the Fund expressly permitting the affiliated broker-dealer to receive and retain such compensation.
SEC rules further require that commissions paid to such an affiliated broker dealer, or PIMCO by the Fund on exchange transactions not exceed “usual and customary brokerage commissions.” The rules define “usual and customary” commissions to include amounts which are “reasonable and fair compared to the commission, fee or other
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remuneration received or to be received by other brokers in connection with comparable transactions involving similar securities being purchased or sold on a securities exchange during a comparable period of time.”
The Fund did not pay any commissions to affiliated brokers in the fiscal years ended December 31, 2022.
Holdings of Securities of the Fund’s Regular Brokers and Dealers
The following table lists the regular brokers or dealers of the Fund whose securities the Fund acquired during the fiscal year ended December 31, 2022, as well as the Fund’s holdings in such brokers or dealers as of December 31, 2022.
Broker or Dealer | Value of Securities Held by the Fund as of December 31, 2022* ($000) |
JPMorgan Chase & Co. | $213 |
*
The Fund commenced operations on June 27, 2022. Information provided reflects the “stub” period from June 27, 2022, through the Fund’s fiscal year end of December 31, 2022.
DISTRIBUTIONS
See “Distributions” in the Prospectus for information relating to distributions to Fund shareholders.
DESCRIPTION OF CAPITAL STRUCTURE AND SHARES
The following is a brief description of the capital structure of the Fund. This description does not purport to be complete and is subject to and qualified in its entirety by reference to the Declaration and the Fund’s Bylaws, as amended and restated through the date hereof (the “Bylaws”). The Declaration and Bylaws are each exhibits to the registration statement of which this Statement of Additional Information is a part.
The Fund is an unincorporated voluntary association with transferable shares of beneficial interest (commonly referred to as a “Massachusetts business trust”) established under the laws of The Commonwealth of Massachusetts by the Declaration. The Declaration provides that the Trustees of the Fund may authorize separate classes of shares of beneficial interest. Preferred Shares (such as the RVMTP Shares) may be issued in one or more series, with such par value and with such rights as determined by the Board, by action of the Board without the approval of the Common Shareholders.
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. The Fund currently has five separate classes of Common Shares: Institutional Class, Class A-1, Class A-2, Class A-3 and Class A-4. An investment in any share class of the Fund represents an investment in the same assets of the Fund. However, the ongoing fees and expenses for each share class may be different. The fees and expenses for the Fund are set forth in “Summary of Fund Expenses” above. Certain share class details are set forth in “Plan of Distribution” above.
Common Shareholders will be entitled to the payment of dividends and other distributions when, as and if declared by the Board after payment of preferential amounts payable to holders of Preferred Shares. All Common Shares have equal rights to the payment of dividends and the distribution of assets upon liquidation after payment of the preferential amounts payable to holders of Preferred Shares. Common Shares will, when issued, be fully paid and, subject to matters discussed in “Anti-Takeover and Other Provisions in the Declaration of Trust and Bylaws,” non-assessable, and will have no pre-emptive or conversion rights or rights to cumulative voting. Upon liquidation of the Fund, after paying or adequately providing for the payment of all liabilities of the Fund and the liquidation preference with respect to any outstanding Preferred Shares, and upon receipt of such releases, indemnities and refunding agreements as they deem necessary for their protection, the Trustees may distribute the remaining assets of the Fund among the Fund’s Common Shareholders.
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The Fund does not intend to hold annual meetings of shareholders. If the Fund does hold a meeting of shareholders, Common Shares of the Fund entitle their holders to one vote for each Common Share held; however, separate votes are taken by each class of Common Shares on matters affecting an individual class of Common Shares. Each fractional share shall be entitled to a proportionate fractional vote, except as otherwise provided by the Declaration, Bylaws, or required by applicable law. So long as any Preferred Shares are outstanding, holders of Preferred Shares will be able to elect two Trustees and vote as a separate class on certain matters.
The Fund will send unaudited reports at least semiannually and audited financial statements annually to all of its Common Shareholders.
The Common Shares are not, and are not expected to be, listed for trading on any national securities exchange nor is there expected to be any secondary trading market in the Common Shares.
Preferred Shares
The Declaration authorizes the issuance of an unlimited number of preferred shares. Preferred shares may be issued in one or more classes or series, with such par value and rights as determined by the Board, by action of the Board without the approval of the Common Shareholders.
On January 12, 2024, the Fund issued 250 RVMTP Shares in a single series of Remarketable Variable Rate MuniFund Term Preferred Shares, Series 2054 (the “RVMTP Shares”). The RVMTP Shares have a par value of $0.00001 per share and liquidation preference of $100,000 per share. The RVMTP Shares have various rights that were approved by the Board without the approval of the Common Shareholders, which are specified in the Fund’s Bylaws. Certain rights, terms and conditions are summarized below:
Distribution Preference. Any Preferred Shares, including, without limitation, the RVMTP Shares, have complete priority over the Common Shares as to distribution of assets.
RVMTP Share Dividends. The dividend rate paid on the RVMTP Shares is also determined over the course of the Rate Period. The dividends per share for the RVMTP Shares for a given Rate Period are dependent on the RVMTP Share dividend rate (the “RVMTP Share Dividend Rate”) for that Rate Period. The RVMTP Share Dividend Rate is equal to (i) the sum of the Index Rate1 plus (ii) the Applicable Spread2 (including the “Spread Adjustment”3) plus (iii) the Failed Remarketing Spread4. The dividend per RVMTP Share for the Rate Period is then determined as described in the table below.5
Dividend Rate | Rate Period Fraction | RVMTP Shares Liquidation Preference | Dividend | |||
Dividend Rate | X | Number of days in the Rate Period (or a part thereof) | X | 100,000 | = | Dividends per RVMTP Share |
Divided by Total number of days in the year |
1
The Index Rate is determined by reference to a weekly, high-grade index comprised of seven-day, tax-exempt variable rate demand notes, generally the Securities Industry and Financial Markets Association Municipal Swap Index.
2
The Applicable Spread for a Rate Period is a percentage per annum that is based on (i) the long term rating most recently assigned by the applicable ratings agency to such series of the RVMTP Shares, and (ii) the “Spread Adjustment.”
3
The “Spread Adjustment” means, (i) for the period from the closing date, January 12, 2024 to and including the date that is six months prior to the then current RVMTP Early Term Redemption Date (as defined below) (“Rate Period Termination Date”), 0%, and (ii) for the period after the Rate Period Termination Date, 2.00%.
4
The Failed Remarketing Spread with respect to a series of RVMTP Shares means (i) for so long as two or more Failed Remarketings have not occurred, 0%, and (ii) following the second occurrence of a Failed Remarketing, 0.25% (for Series 2050-B) multiplied by the number of Failed Remarketings that have occurred after the first Failed Remarketing. A “Failed Remarketing,” with respect to a series of RVMTP Shares, will occur if any RVMTP Shares in such series subject to a Mandatory Tender Event due to the Fund designating a
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Special Terms Period have not been either retained by the holders or successfully remarketed by the Mandatory Tender Date (each as defined below).
5
An increased RVMTP Share Dividend Rate could be triggered by the Fund’s failure to comply with certain requirements relating to such series of the RVMTP Shares, certain actions taken by the applicable ratings agency or certain determinations regarding the tax status of such series of the RVMTP Shares made by a court or other applicable governmental authority. The RVMTP Share Dividend Rate will in no event exceed 15% per year.
Preferred Shareholder Gross-Up. As noted above, RVMTP Shares each pay dividend distributions at stated rates, which rates are based generally on the assumption that such dividend distributions consist entirely of “exempt-interest dividends” (as defined below under “Taxation—Exempt-Interest Dividends”). The terms of the RVMTP Shares provide further that, in the event less than the entire amount of any particular dividend distribution paid pursuant to the stated rate were to consist of “exempt-interest dividends” (i.e., if a portion of any particular dividend were to derive from ordinary income or capital gain, including short-term capital gain taxable as ordinary income when distributed), the amount of such dividend would increase by an amount (the “Preferred Shareholder Gross-Up”) such that the after-tax amount of such dividend, as increased by the Preferred Shareholder Gross-Up, would equal the total amount the holder of such RVMTP Shares would have received if the dividend at the stated rate had consisted entirely of “exempt-interest dividends.” The Preferred Shareholder Gross-Up is calculated (i) without consideration being given to the time value of money, (ii) assuming that no holder of RVMTP Shares is subject to the federal alternative minimum tax, and (iii) assuming that the portion of any dividend distribution (including the amount of the Preferred Shareholder Gross-Up) that is not an exempt interest dividend would be taxable (x), in the hands of the initial purchaser of the RVMTP Shares (or certain of its affiliates), at the maximum marginal regular federal corporate income tax rate, and (y) in the case of any other holder, at the greater of (a) the maximum marginal regular federal individual income tax rate (taking into account the 3.8% Medicare contribution tax on net investment income) applicable to ordinary income or net capital gain, as applicable, or (b) the maximum marginal regular federal corporate income tax rate applicable to ordinary income or net capital gain, as applicable, in each case disregarding the effect of any state or local taxes. Any Preferred Shareholder Gross-Up will reduce the amount that would otherwise be distributable to Common Shareholders.
Liquidation Preference. In the event of any voluntary or involuntary liquidation, dissolution or winding up of the affairs of the Fund, holders of RVMTP Shares are entitled to receive a preferential liquidating distribution (equal to the original purchase price per share of $100,000 plus accumulated and unpaid dividends thereon, whether or not earned or declared) before any distribution of assets is made to Common Shareholders.
Voting Rights. Under the Act, Preferred Shares (including, without limitation, the RVMTP Shares) are required to be voting shares and to have equal voting rights with Common Shares. Except as otherwise indicated in the Prospectus or this Statement of Additional Information, and except as otherwise required by applicable law, Preferred Shares vote together with Common Shareholders as a single class.
In addition, holders of Preferred Shares, including RVMTP Shares, voting as a separate class, are entitled to elect two of the Fund’s trustees. The remaining trustees are elected by Common Shareholders and Preferred Shareholders, 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, are entitled to elect a majority of the Fund’s trustees until all dividends in arrears with respect to the Preferred Shares have been paid or declared and set apart for payment. In order for the Fund to take certain actions or enter into certain transactions, a separate class vote of Preferred Shareholders is required, in addition to the single class vote of the holders of Preferred Shares and Common Shares.
1940 Act Asset Coverage. In accordance with the Fund’s governing documents and the Act, the Fund is required to maintain certain asset coverage with respect to all outstanding senior securities of the Fund which are stocks for purposes of the Act, including the RVMTP Shares.
Under the Act, the Fund is not permitted to issue preferred shares unless, immediately after such issuance, the value of the Fund’s total net assets (as defined below) is at least 200% of the liquidation value of any outstanding preferred shares and the newly issued 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 or
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pay common share dividends unless immediately thereafter the Fund has a minimum asset coverage ratio of 200% with respect to all outstanding senior securities of the Fund which are stocks for purposes of the Act after deducting the amount of such common share dividends.
In addition, under the terms of the RVMTP Shares, the Fund must maintain an “asset coverage,” as defined for purposes of Section 18(h) of the Act, of at least 225% with respect to all outstanding preferred shares, including all previously issued outstanding preferred shares (or such other asset coverage as may in the future be specified in or under the Act or by rule, regulation or order of the United States Securities and Exchange Commission as the minimum asset coverage for senior securities which are shares of stock of a closed-end investment company).
Additional Investment Limitations. Under the terms of purchase agreements between the Fund and the initial investor in the RVMTP Shares, the Fund is subject to various investment limitations. These investment limitations are in addition to, and may be more restrictive than, those to which the Fund is subject in accordance with its investment objectives and policies as described herein and in the Prospectus.
Effective Leverage Ratio Requirement. In accordance with the Bylaws, without the prior written consent of the holders of RVMTP Shares, the Fund’s Effective Leverage Ratio may not exceed 45% (or 46% solely by reason of fluctuations in the market value of the Fund’s portfolio securities) as of the close of business on any business day. If the Fund fails to comply with any additional requirements relating to the calculation of the Effective Leverage Ratio requirement applicable to the RVMTP Shares and, in any such case, such failure is not cured as of the close of business on the date that is ten business days following the business day on which such non-compliance is first determined (the “Effective Leverage Ratio Cure Date”), the Fund shall cause the Effective Leverage Ratio to not exceed 45% (or 46% solely by reason of fluctuations in the market value of the Fund’s portfolio securities), by (i) not later than the close of business on the business day next following the Effective Leverage Ratio Cure Date, engaging in transactions involving or relating to any floating rate securities not owned by the Fund and/or any inverse floating rate securities owned by the Fund, including the purchase, sale or retirement thereof, (ii) to the extent permitted by law, not later than the close of business on the second business day next following the Effective Leverage Ratio Cure Date, causing a notice of redemption to be issued for the redemption of a sufficient number of Preferred Shares, in accordance with the terms of the Preferred Shares, or (iii) engaging in any combination, in the Fund’s discretion, of the actions contemplated by clauses (i) and (ii).
Issuance of Additional Preferred Shares. So long as any RVMTP Shares are outstanding, the Fund may, without the vote or consent of the holders thereof, authorize, establish and create and issue and sell shares of one or more series of Preferred Shares ranking on a parity with RVMTP Shares as to the payment of dividends and the distribution of assets upon dissolution, liquidation or the winding up of the affairs of the Fund, in addition to then outstanding series of RVMTP Shares, including additional series of RVMTP Shares, and authorize, issue and sell additional shares of any such Series of Preferred Shares then outstanding or so established or created, including additional series of RVMTP Shares, in each case in accordance with applicable law, provided that the Fund shall, immediately after giving effect to the issuance of such Preferred Shares and to its receipt and application of the proceeds thereof, including to the redemption of Preferred Shares with such proceeds, have “asset coverage,” as defined for the purposes of Section 18(h) of the Act, of at least 225% and an effective leverage ratio not exceeding 45% (calculated according to the terms of the section below entitled “Preferred Shares-Calculation of Effective Leverage Ratio”).
Calculation of Effective Leverage Ratio.
For purposes of determining whether the effective leverage requirement discussed above is satisfied, the “Effective Leverage Ratio” on any date shall mean the quotient of:
(i)
The sum of (A) the aggregate liquidation preference of the Fund’s “senior securities” (as that term is defined in the Act) that are stock for purposes of the Act, excluding, without duplication, (1) any such senior securities for which the Fund has issued a notice of redemption and either has delivered deposit securities or sufficient securities or funds, (as applicable in accordance with the terms of such senior securities) to the paying agent for such senior securities or otherwise has adequate deposit securities or sufficient securities or funds on hand for the purpose of such redemption (as applicable in accordance with the terms of such senior securities) and (2) any such senior securities that are to be redeemed with net proceeds from the sale of the RVMTP Shares, for which the Fund has delivered deposit securities or sufficient securities or funds (as applicable in accordance with the terms of such senior
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securities) to the paying agent for such senior securities or otherwise has adequate deposit securities or sufficient securities or funds on hand (as applicable in accordance with the terms of such senior securities) for the purpose of such redemption; (B) the aggregate principal amount of the Fund’s “senior securities representing indebtedness” (as that term is defined in the Act giving effect to any interpretations thereof by the SEC or its staff); (C) the aggregate principal amount of floating rate securities corresponding to any associated residual floating rate securities not owned by the Fund (less the aggregate principal amount of any such floating rate securities owned by the Fund and corresponding to the associated residual floating rate securities owned by the Fund); and (D) the aggregate amount of the purchase price component payable for a repurchase under reverse repurchase agreements entered into by the Fund; divided by
(ii)
The sum of (A) the market value of the Fund’s total assets (including amounts attributable to senior securities, but excluding any assets consisting of deposit securities or funds referred to in clauses (A)(1) and (A)(2) above), less the amount of the Fund’s accrued liabilities (other than liabilities for the aggregate principal amount of “senior securities representing indebtedness” (as that term is defined in the Act, giving effect to any interpretations thereof by the SEC or its staff), including floating rate securities), (B) the aggregate principal amount of floating rate securities not owned by the Fund that correspond to the associated inverse floating rate securities owned by the Fund; and (C) the aggregate amount of the purchase price component payable for a repurchase under reverse repurchase agreements entered into by the Fund.
Ratings Agency Guidelines. The Fund has obtained ratings for the RVMTP Shares from Fitch. For so long as Fitch is rating the RVMTP Shares, the Fund has agreed to adhere to separate guidelines and asset coverage requirements specific to Fitch (“Fitch Preferred Shares Asset Coverage”) as described in Fitch’s published Closed-End Funds and Market Value Structures Rating Criteria (“Fitch Rating Criteria”). These guidelines may be changed by Fitch, in its sole discretion, from time to time. These guidelines impose asset coverage or portfolio composition requirements that may be more stringent than those imposed on the Fund by the Act.
Satisfaction of Fitch Preferred Shares Asset Coverage for the RVMTP Shares requires that the Fund satisfy both a “Fitch Total Overcollateralization Test” (“Fitch Total OC”) and a “Fitch Net Over Collateralization Test” (“Fitch Net OC”, and together with Fitch Total OC, the “Fitch OC Tests”), in each case to be consistent with the then-current rating of the RVMTP Shares assigned by Fitch using the calculations set forth in the Fitch Rating Criteria, including information therein relating to diversification guidelines as applied to the Fund. The Fund will use the calculations set forth in any updates to or subsequent version of the Fitch Rating Criteria formally adopted by Fitch with respect to the ratings of outstanding remarketable variable rate munifund preferred shares issued by registered closed-end funds within a reasonable time from the date of such adoption.
The Fund has agreed that it will adhere to the Fitch OC Tests as described above as of the close of business on the last business day of each month for so long as Fitch is rating the RVMTP Shares. If the Fund fails to adhere to the Fitch OC Tests as described in the preceding sentence, the Fund will cure such failure (including, without limitation, by causing a notice of redemption to be issued for the redemption of a sufficient number of the Fund’s Preferred Shares) within ten days following the business day on which such failure is first determined.
Fitch may change its rating methodologies for evaluating and providing ratings for shares of closed-end funds at any time and in its sole discretion, perhaps substantially. Such a change could adversely affect the ratings assigned to the Fund’s Preferred Shares, the dividend rates paid thereon, and the expenses borne by the Fund’s Common Shareholders.
Mandatory Redemptions. The RVMTP Shares are subject to a mandatory term redemption date of January 12, 2054, subject to the Fund’s right to extend the term with the consent of the holders of the RVMTP Shares (the “RVMTP Share Term Redemption Date”). There is no assurance that the term of the RVMTP Shares will be extended.
In addition, with respect to each series of RVMTP Shares, a “Mandatory Tender Event” will occur on each date that is (i) 20 business days before each 42-month anniversary of the date of original issue of such series of the RVMTP Shares, (ii) the date the Fund delivers a notice designating a Special Terms Period, and (iii) 20 business days before the end of a Special Terms Period (provided that no subsequent Terms Period is designated). If any RVMTP Shares subject to a Mandatory Tender Event upon a forty-two month anniversary of the date of original issue of the RVMTP Shares or upon the end of a Special Terms Period (each, an “RVMTP Early Term Redemption Date”) have not been either
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retained by the holders or remarketed by the Mandatory Tender Date, the Fund will redeem such RVMTP Shares on the RVMTP Early Term Redemption Date.1
1
With respect to the Mandatory Tender Events described in clauses (i), (ii) and (iii) above, the corresponding “Mandatory Tender Date” means, respectively: (i) the date that is the 42 month anniversary of the date of original issue of such series of RVMTP Share, (ii) the date on which the related Special Terms Period becomes effective, and (iii) the last day of the related Special Terms Period (subject, in each case, to the holders’ election to retain their RVMTP Shares.
The RVMTP Shares are also subject to mandatory redemption by the Fund, in whole or in part, in certain circumstances, such as the failure by the Fund to comply with asset coverage and/or effective leverage ratio requirements described above (and the failure to cure any such failure within the applicable cure period) or certain actions taken by the applicable ratings agency.
Term Redemption and Early Term Redemption Liquidity Account. At least six months prior to the RVMTP Share Redemption Date or the RVMTP Early Term Redemption Date (each, a “Redemption Date”), the Fund will maintain segregated assets of a minimum credit rating quality with a market value equal to at least 110% of the redemption price of all outstanding RVMTP Shares to be redeemed until the redemption of all such outstanding RVMTP Shares, as applicable. The Fund will include certain liquid and/or highly rated assets in an amount equal to 20% of such segregated assets with five months remaining to the Redemption Date, which amount will increase monthly by 20% and reach 100% with one month remaining to the Redemption Date.
Optional Redemption. The Fund may redeem, in whole or from time to time in part, the outstanding RVMTP Shares at a redemption price per share equal to (i) the liquidation preference of the RVMTP Shares, as applicable, plus (ii) an amount equal to all unpaid dividends and other distributions on such RVMTP Shares, as applicable, accumulated from and including the date of issuance to (but excluding) the date of redemption (whether or not earned or declared by the Fund, but without interest thereon) plus (iii) any applicable optional redemption premium.2
2
If the Fund redeems RVMTP Shares prior to the first anniversary of its closing date, the applicable optional redemption premium will be equal to the product of (i) the Applicable Spread for such RVMTP share in effect on the date of the optional redemption and (ii) the liquidation preference of such RVMTP Share and (iii) a fraction, the numerator of which is the number of calendar days from and including the date of redemption to and excluding the first anniversary of the closing date and the denominator of which is the actual number of calendar days from and including January 12, 2024 to and excluding the first anniversary of the closing date. If either (a) the optional redemption date for such RVMTP Share either occurs on or after the first anniversary of the closing or (b) the Fund notifies JPMorgan Chase Bank, N.A. (“JPMorgan”) that the optional redemption date has been called in connection with a redemption of common shares as described in Section 6.20 of the Amended and Restated Purchase Agreement, then zero. If fewer than all of the outstanding RVMTP Shares of a Series are to be redeemed, the shares of such Series to be redeemed shall be selected either (A) pro rata among the holders of such Series, (B) by lot, or (C) in such other manner as the Board may determine to be fair and equitable.
RVMTP Mandatory Tender. Upon the occurrence of a Mandatory Tender Event with respect to a series of RVMTP Shares, all RVMTP Shares in such series will be subject to mandatory tender (subject to the holders’ election to retain their RVMTP Shares) and the Fund will issue or cause to be issued a notice of mandatory tender to the holders of such RVMTP Shares for remarketing on the Mandatory Tender Date.
Common Share Repurchases. In the event that the Fund notifies JPMorgan that it will repurchase its common shares more frequently than quarterly or repurchase more than 12% of its issued and outstanding Common Shares in connection with a single repurchase offer, the Fund must redeem all of the RVMTP Shares held by JPMorgan in accordance with Section 2.6(c) of the RVMTP Statement (as defined above) by the date of such common share repurchase if JPMorgan requests such redemption in writing to the Fund within five (5) business days after receiving such notice.
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ANTI-TAKEOVER AND OTHER PROVISIONS IN THE DECLARATION OF TRUST AND BYLAWS
Anti-Takeover Provisions
The Declaration and the Bylaws include 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.
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 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 and holders of at least seventy-five percent (75%) of the Fund’s shares to authorize certain Fund transactions not in the ordinary course of business, including a merger or consolidation or share exchange, any shareholder proposal as to specific investment decisions made or to be with respect to the assets of the Fund or issuance or transfer by the Fund of the Fund’s shares having an aggregate fair market value of $1,000,000 or more (except as may be made pursuant to a public offering, the Fund’s dividend reinvestment plan or upon exercise of any stock subscription rights), 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 Act). The Declaration also requires the affirmative vote or consent of holders of at least seventy-five percent (75%) 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 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.
The Trustees may from time to time grant other voting rights to shareholders with respect to these and other matters in the Bylaws, certain of which are required by the Act.
The overall effect of these provisions is to render more difficult the accomplishment of a merger or the assumption of control of the Fund by a third party. These provisions also 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 objectives and policies. The Board has considered the foregoing anti-takeover provisions and concluded that they are in the best interests of the Fund and its shareholders, including 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 Bylaws, both of which are on file with the SEC.
Shareholder Liability
Under Massachusetts law, shareholders could, in certain circumstances, be held personally liable for the obligations of the Fund. However, the Declaration contains an express disclaimer of shareholder liability for debts or obligations of the Fund and requires that notice of such limited liability be given in each agreement, obligation or instrument entered into or executed by the Fund or the Trustees. The Declaration further provides for indemnification out of the assets and property of the Fund for all loss and expense of any shareholder held personally liable for the obligations of the Fund. Thus, the risk of a shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which the Fund would be unable to meet its obligations. The Fund believes that the likelihood of such circumstances is remote.
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. The Declaration provides further that a Trustee or
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officer shall be liable for his or her own willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of the office of Trustee or officer, and for nothing else, and shall not be liable for errors of judgment or mistakes of fact or law. No provision of the Declaration, however, shall limit or eliminate any duty under the federal securities laws (including any fiduciary duties of loyalty and care) that a Trustee or officer owes to the Fund with respect to claims asserted under the federal securities laws.
Forum for Adjudication of Disputes
The Bylaws provide that unless the Fund consents in writing to the selection of an alternative forum, the sole and exclusive forum for (i) any action or proceeding brought on behalf of the Fund or one or more of the shareholders, (ii) any action asserting a claim of breach of a fiduciary duty owed by any Trustee, officer, other employee of the Fund, or the Fund's investment adviser to the Fund or the Fund's shareholders, (iii) any action asserting a breach of contract by the Fund, by any Trustee, officer or other employee of the Fund, or by the Fund's investment adviser, (iv) any action asserting a claim arising pursuant to any provision of the Massachusetts Business Corporation Act, Chapter 182 of the Massachusetts General Laws or the Declaration or the Bylaws, (v) any action to interpret, apply, enforce or determine the validity of the Declaration or the Bylaws or any agreement contemplated by any provision of the Act, the Declaration or the Bylaws, or (vi) any action asserting a claim governed by the internal affairs doctrine shall be within the federal or state courts in the Commonwealth of Massachusetts (each, a “Covered Action”).
The Bylaws further provide that if any Covered Action is filed in a court other than in a federal or state court sitting within the Commonwealth of Massachusetts (a “Foreign Action”) in the name of any shareholder, such shareholder shall be deemed to have consented to (i) the personal jurisdiction of the federal and state courts within The Commonwealth of Massachusetts in connection with any action brought in any such courts to enforce the preceding sentence (an “Enforcement Action”) and (ii) having service of process made upon such shareholder in any such Enforcement Action by service upon such shareholder's counsel in the Foreign Action as agent for such shareholder.
Any person purchasing or otherwise acquiring or holding any interest in shares of beneficial interest of the Fund will be (i) deemed to have notice of and consented to the foregoing paragraph and (ii) deemed to have waived any argument relating to the inconvenience of the forum referenced above in connection with any action or proceeding described in the foregoing paragraph.
This forum selection provision may limit a shareholder's ability to bring a claim in a judicial forum that it finds favorable for disputes with Trustees, officers or other agents of the Fund and its service providers, which may discourage such lawsuits with respect to such claims and increase the costs for a shareholder to pursue such claims. If a court were to find the forum selection provision contained in the Bylaws to be inapplicable or unenforceable in an action, the Fund may incur additional costs associated with resolving such action in other jurisdictions. This forum selection provision shall not apply to claims made under federal securities laws. The enforceability of exclusive forum provisions is questionable.
Derivative and Direct Claims of Shareholders
The Declaration contains provisions regarding derivative and direct claims of shareholders. As used in the Declaration, a “direct” shareholder claim refers to a claim based upon alleged violations of a shareholder's individual rights independent of any harm to the Fund, including a shareholder's voting rights under Article V of the Declaration or Article 10 of the Bylaws, rights to receive a dividend payment as may be declared from time to time, rights to inspect books and records, or other similar rights personal to the shareholder and independent of any harm to the Fund. Any other claim asserted by a shareholder, including without limitation any claims purporting to be brought on behalf of the Fund or involving any alleged harm to the Fund, are considered a “derivative” claim.
A shareholder or group of shareholders may not bring or maintain any court action, proceeding or claim on behalf of the Fund or any series or class of shares without first making demand on the Trustees requesting the Trustees to bring or maintain such action, proceeding or claim. Such demand shall not be excused under any circumstances, including claims of alleged interest on the part of the Trustees. The Trustees shall consider such demand within 90 days of its receipt by the Fund. In their sole discretion, the Trustees may submit the matter to a vote of shareholders of the Fund or a series or class of shares, as appropriate. Any decision by the Trustees to bring, maintain or settle (or not to bring, maintain or settle) such court action, proceeding or claim, or to submit the matter to a vote of shareholders shall be made by the Trustees in their business judgment and shall be binding upon the shareholders and
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no suit, proceeding or other action shall be commenced or maintained after a decision to reject a demand. Any Trustee who is not an “interested person” (within the meaning of Section 2(a)(19) of the Act) of the Fund acting in connection with any demand or any proceeding relating to a claim on behalf of or for the benefit of the Fund shall be deemed to be independent and disinterested with respect to such demand, proceeding or claim.
A shareholder or group of shareholders may not bring or maintain a direct action or claim for monetary damages against the Fund or the Trustees predicated upon an express or implied right of action under the Declaration (excepting rights of action permitted under Section 36(b) of the Act), nor shall any single shareholder, who is similarly situated to one or more other shareholders with respect to the alleged injury, have the right to bring such an action, unless such group of shareholders or shareholder has obtained authorization from the Trustees to bring the action. The requirement of authorization shall not be excused under any circumstances, including claims of alleged interest on the part of the Trustees. The Trustees shall consider such request within 90 days of its receipt by the Fund. In their sole discretion, the Trustees may submit the matter to a vote of shareholders of the Fund or series or class of shares, as appropriate. Any decision by the Trustees to settle or to authorize (or not to settle or to authorize) such court action, proceeding or claim, or to submit the matter to a vote of shareholders, shall be made in their business judgment and shall be binding on all shareholders.
Any person purchasing or otherwise acquiring or holding any interest in shares of beneficial interest of the Fund will be deemed to have notice of and consented to the foregoing provisions. These provisions may limit a shareholder's ability to bring a claim against the Trustees, officers or other agents of the Fund and its service providers, which may discourage such lawsuits with respect to such claims.
These provisions in the Declaration regarding derivative and direct claims of shareholders shall not apply to claims made under federal securities laws.
CONVERSION TO OPEN-END FUND
The Fund’s Board may also from time to time consider submitting to the Fund’s shareholders 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 would consider all factors then relevant, including the size of the Fund, the extent to which shareholders have adequate liquidity through repurchase offers, 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 dividend charges on any 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 and seventy-five percent (75%) of the Continuing Trustees (as defined above under “Anti-Takeover and Other Provisions in the Declaration of Trust and Bylaws — Anti-Takeover Provisions”). This seventy-five percent (75%) shareholder approval requirement is higher than is required under the 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 Act would be necessary to authorize the conversion. Currently, the Act would require approval of the holders of a “majority of the outstanding” Common Shares and 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 were to convert to an open-end investment company, it would be required to redeem all Preferred Shares then outstanding (requiring in turn that it liquidate a portion of its investment portfolio).
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 Act) at their net asset value, less such redemption charge, if any, as might be in effect at the time of redemption, whereas the Fund currently makes only quarterly offers to repurchase its Common Shares (typically 5% per quarter), and shareholders do not have the right to otherwise have shares redeemed. Open-end companies are thus subject to more frequent periodic out-flows that can complicate portfolio management in comparison to the Fund. As described above, the Fund, like an open-end company, intends to engage in a continuous offering of its shares.
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NET ASSET VALUE
Net asset value is determined as indicated under “How Fund Shares Are Priced” in the Prospectus. The Fund’s net asset value will not be determined on the following holidays: New Year’s Day, Martin Luther King, Jr. Day, Presidents’ Day, Good Friday, Memorial Day, Juneteenth National Independence Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
TAXATION
The following discussion of U.S. federal income tax consequences of investment in Common Shares of the Fund is based on the Code, U.S. Treasury regulations, and other applicable authority, as of the date of this Statement of Additional Information. 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 U.S. federal income tax considerations generally applicable to investments in Common Shares of the Fund. This summary does not purport to be a complete description of the U.S. federal income tax considerations applicable to an investment in Common Shares of the Fund. There may be other tax considerations applicable to particular shareholders. For example, except as otherwise specifically noted herein, we have not described certain tax considerations that may be relevant to certain types of holders subject to special treatment under the U.S. federal income tax laws, including shareholders subject to the U.S. federal AMT, insurance companies, tax-exempt organizations, pension plans and trusts, regulated investment companies, dealers in securities, shareholders holding Common Shares through tax-advantaged accounts (such as 401(k) plans or individual retirement accounts), financial institutions, shareholders holding Common Shares as part of a hedge, straddle, or conversion transaction, entities that are not organized under the laws of the United States or a political subdivision thereof, and persons who are neither citizens nor residents of the United States. This summary assumes that investors hold Common Shares as capital assets (within the meaning of the Code). Shareholders should consult their own tax advisors regarding their particular situation and the possible application of U.S. federal, state, local, non-U.S. or other tax laws, and any proposed tax law changes.
Taxation of the Fund
The Fund has elected and intends each year to qualify and be eligible to be treated as a regulated investment company under Subchapter M of the Code. In order to qualify for the special tax treatment accorded regulated investment companies and their shareholders, the Fund must, among other things: (a) derive at least 90% of its gross income for each taxable year from (i) dividends, interest, payments with respect to certain securities loans, and gains from the sale or other disposition of stock, securities or foreign currencies, or other income (including but not limited to gains from options, futures, or forward contracts) derived with respect to its business of investing in such stock, securities, or currencies and (ii) net income derived from interests in “qualified publicly traded partnerships” (as defined below); (b) diversify its holdings so that, at the end of each quarter of the Fund’s taxable year, (i) at least 50% of the value of the Fund’s total assets consists of 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, including through corporations in which the Fund owns a 20% or more voting stock interest, (x) 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 that the Fund controls and that are engaged in the same, similar, or related trades or businesses, or (y) in the securities of one or more qualified publicly traded partnerships (as defined below); and (c) distribute with respect to each taxable year at least 90% of the sum of its investment company taxable income (as that term is defined in the Code without regard to the deduction for dividends paid—generally, taxable ordinary income and the excess, if any, of net short-term capital gains over net long-term capital losses) and any net tax-exempt interest income for such year.
In general, for purposes of the 90% gross income requirement described in paragraph (a) above, income derived from a partnership will be treated as qualifying income only to the extent such income is attributable to items of income of the partnership that would be qualifying income if realized directly by the regulated investment company. However, 100% of the net income derived from an interest in a “qualified publicly traded partnership” (a partnership (x) the interests in which are traded on an established securities market or are readily tradable on a secondary market or the substantial equivalent thereof and (y) that derives less than 90% of its income from the qualifying income described in paragraph (a)(i) above) will be treated as qualifying income. In general, such entities will be treated as partnerships for U.S. federal income tax purposes because they meet the passive income requirement under Code
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section 7704(c)(2). In addition, although in general the passive loss rules of the Code do not apply to regulated investment companies, such rules do apply to a regulated investment company with respect to items attributable to an interest in a qualified publicly traded partnership.
For purposes of the diversification test in (b) above, the term “outstanding voting securities of such issuer” will include the equity securities of a qualified publicly traded partnership. Also, for purposes of the diversification test in (b) above, the identification of the issuer (or, in some cases, issuers) of a particular Fund investment can depend on the terms and conditions of that investment. In some cases, identification of the issuer (or issuers) is uncertain under current law, and an adverse determination or future guidance by the IRS with respect to issuer identification for a particular type of investment may adversely affect the Fund’s ability to meet the diversification test in (b) above.
If the Fund qualifies as a regulated investment company that is accorded special tax treatment, the Fund will not be subject to U.S. federal income tax on income or gains distributed in a timely manner to Common Shareholders in the form of dividends (including Capital Gain Dividends, as defined below). If the Fund were to fail to meet the income, diversification, or distribution tests described above, the Fund could in some cases cure such failure, including by paying a Fund-level tax, paying interest, making additional distributions, or disposing of certain assets. If the Fund were ineligible to or otherwise did not cure such failure for any year, or were otherwise to fail to qualify as a regulated investment company accorded special tax treatment for such 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 Common Shareholders as ordinary income. Some portions of such distributions may be eligible for the dividends-received deduction in the case of corporate shareholders and may be eligible to be treated as “qualified dividend income” in the case of shareholders taxed as individuals, provided, in both cases, that the shareholder meets certain holding period and other requirements in respect of the Fund’s Common Shares (as described below). In addition, the Fund could be required to recognize unrealized gains, pay substantial taxes and interest and make substantial distributions before re-qualifying as a regulated investment company that is accorded special tax treatment.
The Fund intends to distribute to its shareholders, at least annually, all or substantially all of its investment company taxable income (computed without regard to the dividends-paid deduction), its net tax-exempt income (if any) and its net capital gain (that is, the excess of net long-term capital gain over net short-term capital loss, in each case determined with reference to any loss carryforwards). Any taxable income including any net capital gain retained by the Fund will be subject to tax at the Fund level at regular corporate rates. In the case of net capital gain, the Fund is permitted to designate the retained amount as undistributed capital gain in a timely notice to its shareholders who would then, in turn, (i) be required to include in income for U.S. federal income tax purposes, as long-term capital gain, their share of such undistributed amount, and (ii) be entitled to credit their proportionate shares of the tax paid by the Fund on such undistributed amount against their U.S. federal income tax liabilities, if any, and to claim refunds on a properly filed U.S. tax return to the extent the credit exceeds such liabilities. If the Fund makes this designation, for U.S. federal income tax purposes, the tax basis of Common Shares owned by a shareholder of the Fund will be increased by an amount equal to the difference between the amount of undistributed capital gains included in the shareholder’s gross income under clause (i) of the preceding sentence and the tax deemed paid by the shareholder under clause (ii) of the preceding sentence. The Fund is not required to, and there can be no assurance that the Fund will, make this designation if it retains all or a portion of its net capital gain in a taxable year.
As described under “Use of Leverage” in the Prospectus, if at any time when Preferred Shares or other senior securities 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 U.S. federal income and excise 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 repurchase, prepay, or otherwise retire Preferred Shares or other senior securities, as applicable, in an effort to comply with the distribution requirement applicable to regulated investment companies.
Capital losses in excess of capital gains (“net capital losses”) are not permitted to be deducted against the Fund’s net investment income. Instead, potentially subject to certain limitations, the Fund may carry net capital losses from any taxable year forward to subsequent taxable years to offset capital gains, if any, realized during such subsequent taxable years. Capital loss carryforwards are reduced to the extent they offset current-year net realized capital gains, whether the Fund retains or distributes such gains. If the Fund incurs or has incurred net capital losses, those losses will be carried forward to one or more subsequent taxable years without expiration. Any such carryforward losses will
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retain their character as short-term or long-term. The Fund’s available capital loss carryforwards, if any, will be set forth in its annual shareholder report for each fiscal year.
In determining its net capital gain, including in connection with determining the amount available to support a Capital Gain Dividend (as defined below), its taxable income and its earnings and profits, a regulated investment company generally may elect to treat part or all of any post-October capital loss (defined as any net capital loss attributable to the portion, if any, of the taxable year after October 31 or, if there is no such loss, the net long-term capital loss or net short-term capital loss attributable to such portion of the taxable year) or late-year ordinary loss (generally, the sum of its (i) net ordinary loss from the sale, exchange or other taxable disposition of property, attributable to the portion, if any, of the taxable year after October 31, and its (ii) other net ordinary loss attributable to the portion, if any, of the taxable year after December 31) as if incurred in the succeeding taxable year.
If the Fund were to fail to distribute in a calendar year at least an amount equal to the sum of 98% of its ordinary income for such year and 98.2% of its capital gain net income recognized for the one-year period ending on October 31 of such year (or November 30 or December 31 of that year if the Fund is permitted to elect and so elects), plus any such amounts retained from the prior year, the Fund would be subject to a nondeductible 4% excise tax on the undistributed amounts. For purposes of the required excise tax distribution, a regulated investment company’s ordinary gains and losses from the sale, exchange, or other taxable disposition of property that would otherwise be taken into account after October 31 (or November 30 of that year if the regulated investment company makes the election described above) generally are treated as arising on January 1 of the following calendar year; in the case of a regulated investment company with a December 31 year end that makes the election described above, no such gains or losses will be so treated. Also, for these purposes, the Fund will be treated as having distributed any amount on which it is subject to corporate income tax for the taxable year ending within the calendar year. The Fund intends generally to make distributions sufficient to avoid imposition of the 4% excise tax, although there can be no assurance that it will be able to or will do so.
Fund Distributions
The Fund intends to declare income dividends daily and distribute them to Common Shareholders monthly. Unless a shareholder elects otherwise, all distributions will be automatically reinvested in additional Common Shares of the Fund pursuant to the Fund’s Dividend Reinvestment Plan (the “Plan”). A shareholder whose distributions are reinvested in Common Shares under the Plan will be treated for U.S. federal income tax purposes as having received an amount in distribution equal to the fair market value of the Common Shares issued to the shareholder, which amount will also be equal to the net asset value of such shares. For U.S. federal income tax purposes, all distributions are generally taxable in the manner described below, whether a shareholder takes them in cash or they are reinvested pursuant to the Plan in additional shares of the Fund.
For U.S. federal income tax purposes, distributions of investment income other than exempt-interest dividends (described below) are generally taxable as ordinary income. Taxes on distributions of capital gains are determined by how long the Fund owned (or is deemed to have owned) the investments that generated the gains, rather than how long a shareholder has owned his or her Common Shares. In general, the Fund will recognize long-term capital gain or loss on investments it has owned (or is deemed to have owned) for more than one year, and short-term capital gain or loss on investments it has owned (or is deemed to have owned) for one year or less. Tax rules can alter the Fund’s holding period in investments and thereby affect the tax treatment of gain or loss in respect of such investments. Distributions of net capital gain that are properly reported by the Fund as capital gain dividends (“Capital Gain Dividends”) will be taxable to shareholders as long-term capital gains includible in net capital gain and taxed to individuals at reduced rates relative to ordinary income. Distributions of net short-term capital gain (as reduced by any net long-term capital loss for the taxable year) will be taxable to shareholders as ordinary income. The IRS and the Department of the Treasury have issued regulations that impose special rules in respect of Capital Gain Dividends received through partnership interests constituting “applicable partnership interests” under Section 1061 of the Code.
Distributions of investment income reported by the Fund as “qualified dividend income” received by an individual will be taxed at the reduced rates applicable to net capital gain. In order for some portion of the dividends received by the Fund shareholder to be qualified dividend income, the Fund must meet holding period and other requirements with respect to some portion of the dividend-paying stocks in its portfolio and the shareholder must meet holding period and other requirements with respect to the Fund’s shares. In general, a dividend will not be treated as qualified dividend income (at either the Fund or shareholder level) (1) if the dividend is received with respect to any
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share of stock held for fewer than 61 days during the 121-day period beginning on the date which is 60 days before the date on which such share becomes ex-dividend with respect to such dividend (or, in the case of certain preferred securities, 91 days during the 181-day period beginning 90 days before such date), (2) to the extent that the recipient is under an obligation (whether pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property, (3) if the recipient elects to have the dividend income treated as investment income for purposes of the limitation on deductibility of investment interest, or (4) if the dividend is received from a foreign corporation that is (a) not eligible for the benefits of a comprehensive income tax treaty with the United States (with the exception of dividends paid on stock of such a foreign corporation readily tradable on an established securities market in the United States) or (b) treated as a passive foreign investment company.
In general, distributions of investment income reported by the Fund as derived from qualified dividend income will be treated as qualified dividend income by a shareholder taxed as an individual provided the shareholder meets the holding period and other requirements described above with respect to the Fund’s shares.
In general, dividends of net investment income received by corporate shareholders of the Fund will qualify for the dividends-received deduction generally available to corporations only to the extent of the amount of eligible dividends received by the Fund from domestic corporations for the taxable year if certain holding period and other requirements are met at both the shareholder and Fund levels. The Fund does not expect a significant portion of distributions to be eligible for the dividends-received deduction.
Distributions by the Fund to its shareholders that the Fund properly reports as “section 199A dividends,” as defined and subject to certain conditions described below, are treated as qualified REIT dividends in the hands of non-corporate shareholders. Non-corporate shareholders are permitted a federal income tax deduction equal to 20% of qualified REIT dividends received by them, subject to certain limitations. Very generally, a “section 199A dividend” is any dividend or portion thereof that is attributable to certain dividends received by a regulated investment company from REITs, to the extent such dividends are properly reported as such by the regulated investment company in a written notice to its shareholders. A section 199A dividend is treated as a qualified REIT dividend only if the shareholder receiving such dividend holds the dividend-paying regulated investment company shares for at least 46 days of the 91-day period beginning 45 days before the shares become ex-dividend, and is not under an obligation to make related payments with respect to a position in substantially similar or related property. The Fund is permitted to report such part of its dividends as section 199A dividends as are eligible, but is not required to do so.
Any distribution of income that is attributable to (i) income received by the Fund in lieu of dividends with respect to securities on loan pursuant to a securities lending transaction or (ii) dividend income received by the Fund on securities it temporarily purchased from a counterparty pursuant to a repurchase agreement that is treated for U.S. federal income tax purposes as a loan by the Fund, will not constitute qualified dividend income to non-corporate shareholders and will not be eligible for the dividends-received deduction for corporate shareholders. Similarly, any distribution of income that is attributable to (i) income received by the Fund in lieu of tax-exempt interest with respect to securities on loan or (ii) tax-exempt interest received by the Fund on tax-exempt securities it temporarily purchased from a counterparty pursuant to a repurchase agreement that is treated for U.S. federal income tax purposes as a loan by the Fund, will not constitute an exempt-interest dividend to shareholders.
The IRS currently requires a regulated investment company that the IRS recognizes as having two or more “classes” of stock for U.S. federal income tax purposes to allocate to each such class proportionate amounts of each type of its income (such as ordinary income and capital gains) based upon the percentage of total dividends distributed to each class for the tax year. Accordingly, if the Fund issues one or more series of Preferred Shares, the Fund will allocate Capital Gain Dividends for each tax year between and among its Common Shares and each such series of its Preferred Shares in proportion to the total dividends paid to each class with respect to such tax year, and in a manner intended to comply with both applicable IRS rules and SEC requirements regarding the frequency of distributions of capital gains. Dividends qualifying for the dividends received deduction, as qualified dividend income or as exempt-interest dividends will be allocated between and among Common Shares and each such series of Preferred Shares separately from dividends that do not so qualify, in each case in proportion to the total dividends paid to each share class for the Fund’s tax year.
The Code generally imposes a 3.8% Medicare contribution tax on the net investment income of certain individuals, trusts and estates to the extent their income exceeds certain threshold amounts. For these purposes, “net investment income” generally includes, among other things, (i) distributions paid by the Fund of net investment
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income (other than exempt-interest dividends, described below) and capital gains as described above, and (ii) any net gain from the sale, exchange or other taxable disposition of Fund shares. Common Shareholders are advised to consult their tax advisors regarding the possible implications of this additional tax on their investment in the Fund.
If, in and with respect to any taxable year, the Fund makes a distribution in excess of its current and accumulated “earnings and profits,” the excess distribution will be treated as a return of capital to the extent of a shareholder’s tax basis in his or her Common Shares, and thereafter as capital gain. A return of capital is not taxable, but it reduces a shareholder’s basis in his or her shares, thus reducing any loss or increasing any gain on a subsequent taxable disposition by the shareholder of such shares. If the Fund issues one or more series of Preferred Shares, where one or more such distributions occur in and with respect to any taxable year of the Fund, the available earnings and profits will be allocated first to the distributions made to the holders of such Preferred Shares, and only thereafter to distributions made to Common Shareholders. In such case, the Preferred Shareholders will receive a disproportionate share of the distributions, if any, treated as dividends, and the holders of the Common Shares will receive a disproportionate share of the distributions, if any, treated as a return of capital.
A distribution by the Fund will be treated as paid on December 31 of any calendar year if it is declared by the Fund in October, November or December with a record date in such a month and paid by the Fund during January of the following calendar year. Such distributions will be taxable to shareholders in the calendar year in which the distributions are declared, rather than the calendar year in which the distributions are received.
As required by federal law, detailed federal tax information with respect to each calendar year will be furnished to shareholders early in the succeeding year. Dividends and distributions on Common Shares are generally subject to U.S. 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 Common Shares purchased at a time when the Fund’s net asset value reflects unrealized gains or income or gains that are realized but not yet distributed. Such realized income and gains may be required to be distributed even when the Fund’s net asset value also reflects unrealized losses.
If the Fund holds, directly or indirectly, one or more Build America Bonds issued before January 1, 2011, or other tax credit bonds issued on or before December 31, 2017, on one or more applicable dates during a taxable year, it is possible that the Fund will elect to permit its shareholders to claim a tax credit on their income tax returns equal to each shareholder’s proportionate share of tax credits from the applicable bonds that otherwise would be allowed to the Fund. In such a case, a shareholder will be deemed to receive a distribution of money with respect to its Fund shares equal to the shareholder’s proportionate share of the amount of such credits and be allowed a credit against the shareholder’s U.S. federal income tax liability equal to the amount of such deemed distribution, subject to certain limitations imposed by the Code on the credits involved. Even if the Fund is eligible to pass through tax credits to shareholders, the Fund may choose not to do so.
If for any taxable year the Fund were not a “publicly offered” regulated investment company within the meaning of Code Section 67(c)(2)(B), certain of the Fund’s direct and indirect expenses would be subject to special “pass-through” rules. Very generally, pursuant to Treasury Department regulations, expenses of a regulated investment company that is not “publicly offered,” except those specific to its status as a regulated investment company or separate entity (e.g., registration fees or transfer agency fees), are subject to special “pass-through” rules. These expenses (which include direct and certain indirect advisory fees) are treated as additional dividends to certain Fund shareholders (generally including other regulated investment companies that are not “publicly offered,” individuals and entities that compute their taxable income in the same manner as an individual) and, under current law, are not deductible by those shareholders that are individuals (or entities that compute their taxable income in the same manner as an individual).
Exempt-Interest Dividends
The Fund will be qualified to pay exempt-interest dividends to its shareholders if, at the close of each quarter of the Fund’s taxable year, at least 50% of the total value of the Fund’s assets consists of obligations the interest on which is exempt from federal income tax under Section 103(a) of the Code. Distributions that the Fund reports as exempt-interest dividends are treated as interest excludable from shareholders’ gross income for federal income tax purposes but may be taxable for federal AMT purposes and for state and local purposes.
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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 IRS 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.
A shareholder who receives Social Security or railroad retirement benefits should consult his or her tax adviser to determine what effect, if any, an investment in the Fund may have on the federal taxation of such benefits. Exempt-interest dividends generally are included in income for purposes of determining the amount of benefits that are taxable.
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” of the facilities financed by such obligations or bonds or who are “related persons” of such substantial users.
The Fund will notify its shareholders in a written statement of the portion of distributions for the taxable year that constitutes exempt-interest dividends.
Exempt-interest dividends may be taxable for purposes of the federal AMT. For individual shareholders, exempt-interest dividends that are derived from interest on private activity bonds that are issued after August 7, 1986 (other than a “qualified 501(c)(3) bond,” as such term is defined in the Code) generally must be included in an individual’s tax base for purposes of calculating the shareholder’s liability for U.S. federal AMT.
In order for the Fund to distribute exempt-interest dividends for purposes of the California personal income tax, at least 50% of the value of the Fund’s total assets at the end of each quarter of each taxable year must consist of California state or local obligations and/or U.S. federal obligations, the interest from which is exempt from California personal income taxation. If the Fund qualifies to distribute exempt-interest dividends and reports these distributions as such to Fund shareholders, all distributions of the Fund attributable to interest income earned on such California state or local obligations and/or U.S. federal obligations for the taxable year of the Fund will be exempt from California personal income tax.
Sales, Exchanges or Repurchases of Shares
The sale, exchange or repurchase of Fund shares may give rise to a gain or loss. In general, any gain or loss realized upon a taxable disposition of Fund shares treated as a sale or exchange for U.S. federal income tax purposes will be treated as long-term capital gain or loss if the shares have been held for more than 12 months. Otherwise, such gain or loss on the taxable disposition of Fund shares will be treated as short-term capital gain or loss. However, any loss realized upon a taxable disposition of Fund shares held for six months or less (i) will be treated as long-term, rather than short-term, to the extent of any long-term capital gain distributions received (or deemed received) by the shareholder with respect to the shares and (ii) generally will be disallowed to the extent of any exempt-interest dividends 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 under the Code’s “wash sale” rule if other substantially identical shares of the Fund are purchased within 30 days before or after the disposition. In such a case, the basis of the newly purchased shares will be adjusted to reflect the disallowed loss.
A repurchase by the Fund of a shareholder’s shares pursuant to a repurchase offer (as described in the Prospectus) generally will be treated as a sale or exchange of the shares by a shareholder provided that (i) the shareholder tenders, and the Fund repurchases, all of such shareholder’s shares (and such shareholder does not hold and is not deemed to hold any Preferred Shares), thereby reducing the shareholder’s percentage ownership of the Fund, whether directly or by attribution under Section 318 of the Code, to 0%, (ii) the shareholder meets numerical safe harbors under the Code with respect to percentage voting interest and reduction in ownership of the Fund following completion of the repurchase offer, or (iii) the repurchase offer otherwise results in a “meaningful reduction” of the shareholder’s ownership percentage interest in the Fund, which determination depends on a particular shareholder’s facts and circumstances.
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If a tendering shareholder’s proportionate ownership of the Fund (determined after applying the ownership attribution rules under Section 318 of the Code) is not reduced to the extent required under the tests described above, such shareholder will be deemed to receive a distribution from the Fund under Section 301 of the Code with respect to the shares held (or deemed held under Section 318 of the Code) by the shareholder after the repurchase offer (a “Section 301 distribution”). The amount of this distribution will equal the price paid by the Fund to such shareholder for the shares sold, and will be taxable as a dividend, i.e., as ordinary income, to the extent of the Fund’s current or accumulated earnings and profits allocable to such distribution, with the excess treated as a return of capital reducing the shareholder’s tax basis in the shares held after the repurchase offer, and thereafter as capital gain. In the event a repurchase is treated as a Section 301 distribution, any Fund shares held by a shareholder after a repurchase offer will be subject to basis adjustments in accordance with the provisions of the Code.
Provided that no tendering shareholder is treated as receiving a Section 301 distribution as a result of selling shares pursuant to a particular repurchase offer, shareholders who do not sell shares pursuant to that repurchase offer will not realize constructive distributions on their shares as a result of other shareholders selling shares in the repurchase offer. In the event that any tendering shareholder is deemed to receive a Section 301 distribution, it is possible that shareholders whose proportionate ownership of the Fund increases as a result of that repurchase offer, including shareholders who do not tender any shares, will be deemed to receive a constructive distribution under Section 305(c) of the Code in an amount equal to the increase in their percentage ownership of the Fund as a result of the repurchase offer. Such constructive distribution will be treated as a dividend to the extent of current or accumulated earnings and profits allocable to it.
Use of the Fund’s cash to repurchase shares may adversely affect the Fund’s ability to satisfy the distribution requirements for treatment as a regulated investment company described above. The Fund may also recognize income in connection with the sale of portfolio securities to fund share purchases, in which case the Fund would take any such income into account in determining whether such distribution requirements have been satisfied.
The foregoing discussion does not address the tax treatment of tendering shareholders who do not hold their shares as a capital asset. Such shareholders should consult their own tax advisors on the specific tax consequences to them of participating or not participating in the repurchase offer.
Issuer Deductibility of Interest
A portion of the interest paid or accrued on certain high-yield discount obligations owned by the Fund may not, and interest paid on debt obligations, if any, that are considered for tax purposes to be payable in the equity of the issuer or a related party will not, be deductible to the issuer.
This may affect the cash flow of the issuer. If a portion of the interest paid or accrued on certain high-yield discount obligations is not deductible, that portion will be treated as a dividend paid by the issuer for purposes of the corporate dividends received deduction. In such cases, if the issuer of the high-yield discount obligations is a domestic corporation, dividend payments by the Fund may be eligible for the dividends-received deduction to the extent attributable to the deemed dividend portion of such accrued interest.
Original Issue Discount, Payment-in-Kind Securities, Market Discount, Preferred Securities and Commodity-Linked Notes
Some debt obligations with a fixed maturity date of more than one year from the date of issuance (and zero-coupon debt obligations with a fixed maturity date of more than one year from the date of issuance) will be treated as debt obligations that are issued originally at a discount. Generally, the amount of the original issue discount (“OID”) is treated as interest income and is included in the Fund’s income and required to be distributed over the term of the debt obligation, even though payment of that amount is not received until a later time, upon partial or full repayment or disposition of the debt obligation. Increases in the principal amount of an inflation-indexed bond will generally be treated as OID.
Some debt obligations with a fixed maturity date of more than one year from the date of issuance that are acquired by the Fund in the secondary market may be treated as having “market discount.” Very generally, market discount is the excess of the stated redemption price of a debt obligation (or in the case of an obligation issued with OID, its “revised issue price”) over the purchase price of such obligation. Generally, (i) any gain recognized on the
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disposition of, and any partial payment of principal on, a debt obligation having market discount is treated as ordinary income to the extent the gain, or principal payment, does not exceed the “accrued market discount” on such debt obligation, (ii) alternatively, the Fund may elect to accrue market discount currently, in which case the Fund will be required to include the accrued market discount on such debt obligations in the Fund’s income (as ordinary income) and thus distribute it over the term of the debt obligations, even though payment of that amount is not received until a later time, upon partial or full repayment or disposition of the debt obligations, and (iii) the rate at which the market discount accrues, and thus is included in the Fund’s income, will depend upon which of the permitted accrual methods the Fund elects. The Fund reserves the right to revoke such an election at any time pursuant to applicable IRS procedures. In the case of higher-risk securities, the amount of market discount may be unclear. See “Higher-Risk Securities.”
From time to time, a substantial portion of the Fund’s investments in loans and other debt obligations could be treated as having OID and/or market discount, which, in some cases could be significant. To generate sufficient cash to make the requisite distributions, the Fund may be required to sell securities in its portfolio (including when it is not advantageous to do so) that it otherwise would have continued to hold.
A portion of the OID accrued on certain high yield discount obligations may not be deductible to the issuer and will instead be treated as a dividend paid by the issuer for purposes of the dividends-received deduction. In such cases, if the issuer of the high yield discount obligations is a domestic corporation, dividend payments by the Fund may be eligible for the dividends-received deduction to the extent attributable to the deemed dividend portion of such OID.
Some debt obligations with a fixed maturity date of one year or less from the date of issuance may be treated as having OID or, in certain cases, “acquisition discount” (very generally, the excess of the stated redemption price over the purchase price). The Fund will be required to include the OID or acquisition discount in income (as ordinary income) and thus distribute it over the term of the debt obligation, even though payment of that amount is not received until a later time, upon partial or full repayment or disposition of the debt obligation. The rate at which OID or acquisition discount accrues, and thus is included in the Fund’s income, will depend upon which of the permitted accrual methods the Fund elects.
Some preferred securities may include provisions that permit the issuer, at its discretion, to defer the payment of distributions for a stated period without any adverse consequences to the issuer. If the Fund owns a preferred security that is deferring the payment of its distributions, the Fund may be required to report income for U.S. federal income tax purposes to the extent of any such deferred distributions even though the Fund has not yet actually received the cash distribution.
In addition, pay-in-kind obligations will, and commodity-linked notes may, give rise to income that is required to be distributed and is taxable even though the Fund receives no interest payment in cash on the security during the year.
If the Fund holds the foregoing kinds of obligations, or other obligations subject to special rules under the Code, the Fund may be required to pay out as an income distribution each year an amount which is greater than the total amount of cash interest the Fund actually received. Such distributions may be made from the cash assets of the Fund or by disposition of portfolio securities, if necessary (including when it is not advantageous to do so). The Fund may realize gains or losses from such dispositions, including short-term capital gains taxable as ordinary income. In the event the Fund realizes net capital gains from such transactions, its shareholders may receive a larger capital gain distribution than they might otherwise receive in the absence of such transactions.
Higher-Risk Securities
The Fund may invest in debt obligations that are in the lowest rating categories or are unrated, including debt obligations of issuers not currently paying interest or who are in default. Investments in debt obligations that are at risk of or in default present special tax issues for the Fund. Tax rules are not entirely clear about issues such as whether or to what extent the Fund should recognize market discount on a debt obligation, when the Fund may cease to accrue interest, OID or market discount, when and to what extent the Fund may take deductions for bad debts or worthless securities and how the Fund should allocate payments received on obligations in default between principal and income. These and other related issues will be addressed by the Fund when, as and if it invests in such securities, in order to seek to ensure that it distributes sufficient income to preserve its status as a regulated investment company and does not become subject to federal income or excise tax.
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Securities Purchased at a Premium
Very generally, where the Fund purchases a bond at a price that exceeds the redemption price at maturity (i.e., at a premium), the Fund may elect to amortize the premium over the remaining term of the bond which election would apply to all bonds (other than bonds the interest on which is excludible from gross income for U.S. federal income tax purposes) held by the Fund. In the case of a taxable bond, if the Fund makes such election, which election is irrevocable without consent of the IRS, the Fund reduces the current taxable income from the bond by the amortized premium and reduces its tax basis in the bond by the amount of such offset; upon the disposition or maturity of such bonds, the Fund is permitted to deduct any remaining premium allocable to a prior period. If the Fund does not elect to take bond premium into account currently, it will recognize a capital loss when the bond matures. In the case of a tax-exempt bond, tax rules require the Fund to reduce its tax basis by the amount of amortized premium.
Catastrophe Bonds
The proper tax treatment of income or loss realized by the retirement or sale of certain catastrophe bonds is unclear. The Fund will report such income or loss as capital or ordinary income or loss in a manner consistent with any IRS position on the subject following the publication of such a position.
Loan Origination
Income and gains from certain of the Fund’s activities, including fees received in connection with the origination of loans, may not constitute qualifying income to a regulated investment company for purposes of the 90% gross income test described above. If the Fund were to treat income or gain from a particular investment or activity as qualifying income and the income or gain were later determined not to constitute qualifying income and, together with any other nonqualifying income, caused the Fund’s nonqualifying income to exceed 10% of its gross income in any taxable year, the Fund would fail to qualify as a regulated investment company unless it is eligible to and does pay a tax at the Fund level.
Passive Foreign Investment Companies
Equity investments by the Fund in certain “passive foreign investment companies” (“PFICs”) could subject the Fund to a U.S. federal income tax (including interest charges) on distributions received from the PFIC or on proceeds received from the disposition of shares in the PFIC. This tax cannot be eliminated by making distributions to Fund shareholders. However, the Fund may elect to treat a PFIC as a “qualified electing fund” (i.e., make a “QEF election”), in which case the Fund will be required to include its share of the company’s income and net capital gains annually, regardless of whether it receives any distribution from the company. Under proposed U.S. Treasury regulations, any such income or net capital gain of the PFIC that is required to be included in the Fund’s gross income is qualifying income to the extent derived with respect to the Fund’s business of investing in stock, securities or currencies. The Fund also may make an election to mark the gains (and to a limited extent losses) in such holdings “to the market” as though it had sold and repurchased its holdings in those PFICs on the last day of the Fund’s taxable year. Such gains and losses are treated as ordinary income and loss. The QEF and mark-to-market elections may accelerate the recognition of income (without the receipt of cash) and increase the amount required to be distributed by the Fund to avoid taxation. Making either of these elections therefore may require the Fund to sell other investments (including when it is not advantageous to do so) to meet its distribution requirement, which also may accelerate the recognition of gain and affect the Fund’s total return. Because it is not always possible to identify a foreign corporation as a PFIC, the Fund may incur the tax and interest charges described above in some instances. Dividends paid by PFICs will not be eligible to be treated as “qualified dividend income.”
Certain Investments in REITs
Any investment by the Fund in equity securities of REITs may result in the Fund’s receipt of cash in excess of the REIT’s earnings; if the Fund distributes these amounts, these distributions could constitute a return of capital to Fund shareholders for U.S. federal income tax purposes. Investments in REIT equity securities also may require the Fund to accrue and to distribute income not yet received. To generate sufficient cash to make the requisite distributions, the Fund may be required to sell securities in its portfolio (including when it is not advantageous to do so) that it otherwise would have continued to hold. Dividends received by the Fund from a REIT generally will not constitute qualified dividend income.
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Distributions by the Fund to its shareholders that the Fund properly reports as “section 199A dividends,” as defined and subject to certain conditions described below, are treated as qualified REIT dividends in the hands of non-corporate shareholders. Non-corporate shareholders are permitted a federal income tax deduction equal to 20% of qualified REIT dividends received by them, subject to certain limitations. Very generally, a “section 199A dividend” is any dividend or portion thereof that is attributable to certain dividends received by a regulated investment company from REITs, to the extent such dividends are properly reported as such by the regulated investment company in a written notice to its shareholders. A section 199A dividend is treated as a qualified REIT dividend only if the shareholder receiving such dividend holds the dividend-paying regulated investment company shares for at least 46 days of the 91-day period beginning 45 days before the shares become ex-dividend, and is not under an obligation to make related payments with respect to a position in substantially similar or related property. The Fund is permitted to report such part of its dividends as section 199A dividends as are eligible, but is not required to do so.
Foreign Currency Transactions
The Fund’s transactions in foreign currencies, foreign currency-denominated debt obligations and certain foreign currency options, futures contracts and forward contracts (and similar instruments) may give rise to ordinary income or loss to the extent such income or loss results from fluctuations in the value of the foreign currency concerned. Any such net gains could require a larger dividend toward the end of the calendar year. Any such net losses will generally reduce and potentially require the recharacterization of prior ordinary income distributions and may accelerate Fund distributions to shareholders and increase the distributions taxed to shareholders as ordinary income. Any net ordinary losses so created cannot be carried forward by the Fund to offset income or gains earned in subsequent taxable years.
Options, Futures, and Forward Contracts, Swap Agreements, and other Derivatives
In general, option premiums received by the Fund are not immediately included in the income of the Fund. Instead, the premiums are recognized when the option contract expires, the option is exercised by the holder, or the Fund transfers or otherwise terminates the option (e.g. through a closing transaction). If a call option written by the Fund is exercised and the Fund sells or delivers the underlying stock, the Fund generally will recognize capital gain or loss equal to (a) the sum of the strike price and the option premium received by the Fund minus (b) the Fund’s basis in the stock. Such gain or loss generally will be short-term or long-term depending upon the holding period of the underlying stock. If securities are purchased by the Fund pursuant to the exercise of a put option written by it, the Fund will generally subtract the premium received for purposes of computing its cost basis in the stock purchased. Gain or loss arising in respect of a termination of the Fund’s obligation under an option other than through the exercise of the option will be short-term capital gain or loss depending on whether the premium income received by the Fund is greater or less than the amount paid by the Fund (if any) in terminating the transaction. Thus, for example, if an option written by the Fund expires unexercised, the Fund generally will recognize short-term capital gain equal to the premium received.
The Fund’s options activities may include transactions constituting straddles for U.S. federal income tax purposes, that is, that trigger the U.S. federal income tax straddle rules contained primarily in Section 1092 of the Code. Such straddles include, for example, positions in a particular security, or an index of securities, and one or more options that offset the former position, including options that are “covered” by the Fund’s long position in the subject security. Very generally, where applicable, Section 1092 requires (i) that losses be deferred on positions deemed to be offsetting positions with respect to “substantially similar or related property” to the extent of unrealized gain in the latter, and (ii) that the holding period of such a straddle position that has not already been held for the long-term holding period be terminated and begin anew once the position is no longer part of a straddle. Options on single stocks that are not “deep in the money” may constitute qualified covered calls, which generally are not subject to the straddle rules; the holding period on stock underlying qualified covered calls that are “in the money” although not “deep in the money” will be suspended during the period that such calls are outstanding. Thus, the straddle rules and the rules governing qualified covered calls could cause gains that would otherwise constitute long-term capital gains to be treated as short-term capital gains, and distributions that would otherwise constitute “qualified dividend income” or qualify for the dividends-received deduction to fail to satisfy the holding period requirements and therefore to be taxed as ordinary income or to fail to qualify for the dividends received deduction, as the case may be.
The tax treatment of certain positions entered into by the Fund, including regulated futures contracts, certain foreign currency positions and certain listed non-equity options, will be governed by section 1256 of the Code (“section 1256 contracts”). Gains or losses on section 1256 contracts generally are considered 60% long-term and 40%
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short-term capital gains or losses (“60/40”), although certain foreign currency gains and losses from such contracts may be treated as ordinary in character. Also, section 1256 contracts held by the Fund at the end of each taxable year (and, for purposes of the 4% excise tax, on certain other dates as prescribed under the Code) are “marked to market” with the result that unrealized gains or losses are treated as though they were realized and the resulting gain or loss is treated as ordinary or 60/40 gain or loss, as applicable.
Derivatives, Hedging, and Other Transactions
In addition to the special rules described above in respect of futures and options transactions, the Fund’s transactions in other derivatives instruments (e.g., forward contracts and swap agreements), as well as any of its hedging, short sale, securities loan or similar transactions may be subject to one or more special tax rules (e.g., notional principal contract, straddle, constructive sale, straddle, wash sale and short sale rules). These rules may affect whether gains and losses recognized by the Fund are treated as ordinary or capital, accelerate the recognition of income or gains to the Fund, defer losses to the Fund, and cause adjustments in the holding periods of the Fund’s securities, thereby affecting, among other things, whether capital gains and losses are treated as short-term or long-term. These rules could, therefore, affect the amount, timing and/or character of distributions to shareholders.
Because these and other tax rules applicable to these types of transactions are in some cases uncertain under current law, an adverse determination or future guidance by the IRS with respect to these rules (which determination or guidance could be retroactive) may affect whether the Fund has made sufficient distributions, and otherwise satisfied the relevant requirements, to maintain its qualification as a regulated investment company and avoid a Fund-level tax.
Commodities and Commodity-Linked Instruments
The Fund’s investments in commodities and commodity-linked instruments, if any, will potentially be limited by the Fund’s intention to qualify as a regulated investment company, and will potentially limit the Fund’s ability to so qualify. Income and gains from commodities and certain commodity-linked instruments do not constitute qualifying income to a regulated investment company for purposes of the 90% gross income test described above. In addition, the tax treatment of some other commodity-linked instruments in which the Fund might invest is not certain, in particular with respect to whether income or gains from such instruments constitute qualifying income to a regulated investment company. If the Fund were to treat income or gain from a particular instrument as qualifying income and the income or gain were later determined not to constitute qualifying income, and, together with any other nonqualifying income, caused the Fund’s nonqualifying income to exceed 10% of its gross income in any taxable year, the Fund would fail to qualify as a regulated investment company unless it is eligible to and does pay a tax at the Fund level.
Book-Tax Differences
Certain of the Fund’s investments in derivative instruments and foreign currency-denominated instruments, and any of the Fund’s transactions in foreign currencies and hedging activities, are likely to produce a difference between its book income and the sum of its taxable income and net tax-exempt income (if any). If such a difference arises, and the Fund’s book income is less than the sum of its taxable income and net tax-exempt income (if any), the Fund could be required to make distributions exceeding book income to qualify as a regulated investment company that is accorded special tax treatment and to avoid an entity-level tax. In the alternative, if the Fund’s book income exceeds the sum of its taxable income (including realized capital gains) and net tax-exempt income, the distribution (if any) of such excess generally will be treated as (i) a dividend to the extent of the Fund’s remaining earnings and profits (including earnings and profits arising from tax-exempt income), (ii) thereafter, as a return of capital to the extent of the recipient’s basis in its shares, and (iii) thereafter as gain from the sale or exchange of a capital asset.
Short Sales
If the Fund participates in a short sale and, on the date of such short sale, the Fund either (i) does not hold securities substantially identical to those sold short or (ii) has held such substantially identical securities for one year or less, the character of gain or loss realized on such a short sale generally will be short-term. If the Fund participates in a short sale and, on the date of such short sale, the Fund has held substantially identical securities for more than one year, the character of gain realized on such short sale will be determined by reference to the Fund’s holding period in the property actually used to close the short sale; the character of loss realized on such short sale generally will be long term, regardless of the holding period of the securities actually used to close such short sale. Because net short-term
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capital gain (after reduction by any long-term capital loss) is generally taxed at ordinary income rates, the Fund’s short sale transactions can increase the percentage of the Fund’s gains that are taxable to shareholders as ordinary income.
Mortgage-Related Securities
The Fund may invest directly or indirectly in REMICs (including by investing in residual interests in CMOs with respect to which an election to be treated as a REMIC is in effect) or equity interests in TMPs. Under a notice issued by the IRS in October 2006 and U.S. Treasury regulations that have yet to be issued but may apply retroactively, a portion of the Fund’s income (including income allocated to the Fund from a REIT or other pass-through entity) that is attributable to a residual interest in a REMIC or an equity interest in a TMP — referred to in the Code as an “excess inclusion”— will be subject to U.S. federal income tax in all events. This notice also provides, and the regulations are expected to provide, that excess inclusion income of a regulated investment company, such as the Fund, will be allocated to shareholders of the regulated investment company in proportion to the dividends received by such shareholders, with the same consequences as if the shareholders held the related interest directly. As a result, the Fund may not be a suitable investment for charitable remainder trusts (“CRTs”), as noted below.
In general, excess inclusion income allocated to shareholders (i) cannot be offset by net operating losses (subject to a limited exception for certain thrift institutions), (ii) will constitute unrelated business taxable income (“UBTI”) to entities (including a qualified pension plan, an individual retirement account, a 401(k) plan, a Keogh plan or other tax-exempt entity) subject to tax on UBTI, thereby potentially requiring such an entity that is allocated excess inclusion income and otherwise might not be required to file a U.S. federal income tax return, to file such a tax return and pay tax on such income, and (iii) in the case of a non-U.S. shareholder, will not qualify for any reduction in U.S. federal withholding tax. A shareholder will be subject to U.S. federal income tax on such inclusions notwithstanding any exemption from such income tax otherwise available under the Code.
Non-U.S. Taxation
Income, proceeds and gains received by the Fund from sources within foreign countries may be subject to withholding and other taxes imposed by such countries, which will reduce the return on those investments. Tax treaties between certain countries and the United States may reduce or eliminate such taxes.
If, at the close of its taxable year, more than 50% of the value of the Fund’s total assets consists of the securities of foreign corporations, including for this purpose foreign governments, the Fund will be permitted to make an election under the Code that will allow shareholders a deduction or credit for foreign taxes paid by the Fund. In such a case, shareholders will include in gross income from foreign sources their pro rata shares of such taxes. A shareholder’s ability to claim an offsetting foreign tax credit or deduction in respect of such foreign taxes is subject to certain limitations imposed by the Code, which may result in the shareholder’s not receiving a full credit or deduction (if any) for the amount of such taxes. Shareholders who do not itemize on their U.S. federal income tax returns may claim a credit (but not a deduction) for such foreign taxes. If the Fund does not qualify for or chooses not to make such an election, shareholders will not be entitled separately to claim a credit or deduction for U.S. federal income tax purposes with respect to foreign taxes paid by the Fund; in that case the foreign tax will nonetheless reduce the Fund’s taxable income. Even if the Fund elects to pass through to its shareholders foreign tax credits or deductions, tax-exempt shareholders and those who invest in the Fund through tax-advantaged accounts (including those who invest through individual retirement accounts or other tax-advantaged retirement plans), will not benefit from any such tax credit or deduction. Shareholders generally are not expected to be entitled to claim a credit or deduction with respect to foreign taxes incurred by the Fund. This will decrease the Fund’s yield on securities subject to such taxes.
Tax-Exempt Shareholders
Income of a regulated investment company that would be UBTI if earned directly by a tax-exempt entity will not generally be attributed as UBTI to a tax-exempt shareholder of the regulated investment company. Notwithstanding this “blocking” effect, a tax-exempt shareholder could realize UBTI by virtue of its investment in the Fund if shares in the Fund constitute debt-financed property in the hands of the tax-exempt shareholder within the meaning of Code Section 514(b). A tax-exempt shareholder may also recognize UBTI if the Fund recognizes “excess inclusion income” derived from direct or indirect investments in residual interests in REMICs or equity interests in TMPs as described above, if the amount of such income recognized by the Fund exceeds the Fund’s investment company taxable income (after taking into account deductions for dividends paid by the Fund).
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In addition, special tax consequences apply to CRTs that invest in regulated investment companies that invest directly or indirectly in residual interests in REMICs or equity interests in TMPs. Under legislation enacted in December 2006, if a CRT, as defined in Section 664 of the Code, realizes any UBTI for a taxable year, a 100% excise tax is imposed on such UBTI. Under IRS guidance issued in October 2006, a CRT will not recognize UBTI solely as a result of investing in a regulated investment company that recognizes “excess inclusion income.” Rather, if at any time during any taxable year a CRT (or one of certain other tax-exempt shareholders, such as the United States, a state or political subdivision, or an agency or instrumentality thereof, and certain energy cooperatives) is a record holder of a share in a regulated investment company that recognizes “excess inclusion income,” then the regulated investment company will be subject to a tax on that portion of its “excess inclusion income” for the taxable year that is allocable to such shareholders at the highest federal corporate income tax rate. The extent to which this IRS guidance remains applicable in light of the December 2006 legislation is unclear. To the extent permitted under the Act, the Fund may elect to specially allocate any such tax to the applicable CRT, or other shareholder, and thus reduce such shareholder’s distributions for the year by the amount of the tax that relates to such shareholder’s interest in the Fund. CRTs and other tax-exempt shareholders are urged to consult their tax advisors concerning the consequences of investing in the Fund.
Non-U.S. Shareholders
Distributions by the Fund to shareholders that are not “United States persons” within the meaning of the Code (“foreign shareholders”) properly reported by the Fund as (1) Capital Gain Dividends, (2) short-term capital gain dividends, (3) interest-related dividends, each as defined and subject to certain conditions described below, or (4) exempt-interest dividends generally are not subject to withholding of U.S. federal income tax (except that exempt-interest dividends may be subject to backup withholding).
In general, the Code defines (1) “short-term capital gain dividends” as distributions of net short-term capital gains in excess of net long-term capital losses and (2) “interest-related dividends” as distributions from U.S. source interest income of types similar to those not subject to U.S. federal income tax if earned directly by an individual foreign shareholder, in each case to the extent such distributions are properly reported as such by the Fund in a written notice to shareholders. The exceptions to withholding for Capital Gain Dividends and short-term capital gain dividends do not apply to (A) distributions to an individual foreign shareholder who is present in the United States for a period or periods aggregating 183 days or more during the year of the distribution and (B) distributions attributable to gain that is effectively connected with the conduct by the foreign shareholder of a trade or business within the United States under special rules regarding the disposition of U.S. real property interests as described below. If the Fund invests in a regulated investment company that pays such distributions to the Fund, such distributions retain their character as not subject to withholding if properly reported when paid by the Fund to foreign shareholders. The exception to withholding for interest-related dividends does not apply to distributions to a foreign shareholder (A) that has not provided a satisfactory statement that the beneficial owner is not a United States person, (B) to the extent that the dividend is attributable to certain interest on an obligation if the foreign shareholder is the issuer or is a 10% shareholder of the issuer, (C) that is within certain foreign countries that have inadequate information exchange with the United States, or (D) to the extent the dividend is attributable to interest paid by a person that is a related person of the foreign shareholder and the foreign shareholder is a controlled foreign corporation.
The Fund is permitted to report such part of its dividends as interest-related or short-term capital gain dividends as are eligible, but is not required to do so. In the case of shares held through an intermediary, the intermediary may withhold even if the Fund reports all or a portion of a payment as an interest-related or short-term capital gain dividend to shareholders.
Foreign shareholders should contact their intermediaries regarding the application of withholding rules to their accounts.
Distributions by the Fund to foreign shareholders other than Capital Gain Dividends, short-term capital gain dividends, interest-related dividends, and exempt-interest dividends (e.g., dividends attributable to dividend and foreign-source interest income or to short-term capital gains or U.S. source interest income to which the exception from withholding described above does not apply) are generally subject to withholding of U.S. federal income tax at a rate of 30% (or lower applicable treaty rate).
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A foreign shareholder is not, in general, subject to U.S. federal income tax on gains (and is not allowed a deduction for losses) realized on the sale of shares of the Fund unless (i) such gain is effectively connected with the conduct by the foreign shareholder of a trade or business within the United States, (ii) in the case of a foreign shareholder that is an individual, the shareholder is present in the United States for a period or periods aggregating 183 days or more during the year of the sale and certain other conditions are met, or (iii) the special rules relating to gain attributable to the sale or exchange of “U.S. real property interests” (“USRPIs”) apply to the foreign shareholder’s sale of shares of the Fund (as described below).
Foreign shareholders with respect to whom income from the Fund is effectively connected with a trade or business conducted by the foreign shareholder within the United States will in general be subject to U.S. federal income tax on the income derived from the Fund at the graduated rates applicable to U.S. citizens, residents or domestic corporations, whether such income is received in cash or reinvested in shares of the Fund and, in the case of a foreign corporation, may also be subject to a branch profits tax. If a foreign shareholder is eligible for the benefits of a tax treaty, any effectively connected income or gain will generally be subject to U.S. federal income tax on a net basis only if it is also attributable to a permanent establishment maintained by the shareholder in the United States. More generally, foreign shareholders who are residents in a country with an income tax treaty with the United States may obtain different tax results than those described herein and are urged to consult their tax advisors.
Special rules would apply if the Fund were a qualified investment entity (“QIE”) because it is either a “U.S. real property holding corporation” (“USRPHC”) or would be a USRPHC but for the operation of certain exceptions to the definition thereof. Very generally, a USRPHC is a domestic corporation that holds USRPIs the fair market value of which equals or exceeds 50% of the sum of the fair market values of the corporation’s USRPIs, interests in real property located outside the United States, and other trade or business assets. USRPIs are generally defined as any interest in U.S. real property and any interest (other than solely as a creditor) in a USRPHC or, very generally, an entity that has been a USRPHC in the last five years. A regulated investment company that holds, directly or indirectly, significant interests in REITs may be a USRPHC. Interests in domestically controlled QIEs, including REITs and regulated investment companies that are QIEs, not-greater-than-10% interests in publicly traded classes of stock in REITs and not-greater-than-5% interests in publicly traded classes of stock in regulated investment companies generally are not USRPIs, but these exceptions do not apply for purposes of determining whether the Fund is a QIE. Furthermore, the U.S. Treasury and the IRS have issued proposed regulations that, if finalized, would change the rules relating to determining whether a QIE is domestically controlled.
If an interest in the Fund were a USRPI, the Fund would be required to withhold U.S. tax on the proceeds of a share repurchase by a greater-than-5% foreign shareholder or any foreign shareholder if shares of the Fund are not considered regularly traded on an established securities market, in which case such foreign shareholder generally would also be required to file a U.S. tax return and pay any additional taxes due in connection with the repurchase.
If the Fund were a QIE, under a special “look-through” rule, any distributions by the Fund to a foreign shareholder (including, in certain cases, distributions made by the Fund in redemption of its shares) attributable directly or indirectly to (i) distributions received by the Fund from a lower-tier regulated investment company or REIT that the Fund is required to treat as USRPI gain in its hands, or (ii) gains realized by the Fund on the disposition of USRPIs would retain their character as gains realized from USRPIs in the hands of the Fund’s foreign shareholders, and would be subject to U.S. withholding tax. In addition, such distributions could result in the foreign shareholder being required to file a U.S. tax return and pay tax on the distributions at regular U.S. federal income tax rates. The consequences to a foreign shareholder, including the rate of such withholding and character of such distributions (e.g., as ordinary income or USRPI gain), would vary depending upon the extent of the foreign shareholder’s current and past ownership of the Fund.
The Fund generally does not expect that it will be a QIE. Foreign shareholders should consult their tax advisers and, if holding shares through intermediaries, their intermediaries, concerning the application of these rules to their investment in the Fund.
Foreign shareholders also may be subject to “wash sale” rules to prevent the avoidance of the tax-filing and -payment obligations discussed above through the sale and repurchase of Fund shares.
In order for a foreign shareholder to qualify for any exemptions from withholding described above or for lower withholding tax rates under income tax treaties, or to establish an exemption from backup withholding, a foreign
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shareholder must comply with special certification and filing requirements relating to its non-U.S. status (including, in general, furnishing an IRS Form W-8BEN, W-8BEN-E or substitute form). Foreign shareholders should consult their tax advisors in this regard.
Special rules (including withholding and reporting requirements) apply to foreign partnerships and those holding Fund shares through foreign partnerships. Additional considerations may apply to foreign trusts and estates. Investors holding Fund shares through foreign entities should consult their tax advisers about their particular situation.
A foreign shareholder may be subject to state and local tax and to the U.S. federal estate tax in addition to the U.S. federal income tax referred to above.
A beneficial holder of shares who is a non-U.S. person may be subject to state and local tax and to the U.S. federal estate tax in addition to the U.S. federal tax on income referred to above.
Backup Withholding
The Fund is generally required to withhold and remit to the U.S. Treasury a percentage of taxable distributions and redemption proceeds, if any, paid to any individual shareholder who fails to properly furnish the Fund with a correct taxpayer identification number, 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 rules may also apply to distributions that are properly reported as exempt-interest dividends. Backup withholding is not an additional tax. Any amounts withheld may be credited against the shareholder’s U.S. federal income tax liability, provided the appropriate information is furnished to the IRS.
Tax Shelter Reporting Regulations
Under U.S. Treasury regulations, if a shareholder recognizes a loss of $2 million or more for an individual shareholder or $10 million or more for a corporate shareholder, the shareholder must file with the IRS a disclosure statement on IRS Form 8886. Direct shareholders of portfolio securities are in many cases excepted from this reporting requirement, but under current guidance, shareholders of a regulated investment company are not excepted. Future guidance may extend the current exception from this reporting requirement to shareholders of most or all regulated investment companies. The fact that a loss is reportable under these regulations does not affect the legal determination of whether the taxpayer’s treatment of the loss is proper. Shareholders should consult their tax advisors to determine the applicability of these regulations in light of their individual circumstances.
Other Reporting and Withholding Requirements
Sections 1471-1474 of the Code and the U.S. Treasury and IRS guidance issued thereunder (collectively, “FATCA”) generally require the Fund to obtain information sufficient to identify the status of each of its shareholders under FATCA or under an applicable intergovernmental agreement (an “IGA”) between the United States and a foreign government. If a shareholder fails to provide the requested information or otherwise fails to comply with FATCA or an IGA, the Fund may be required to withhold under FATCA at a rate of 30% with respect to that shareholder on ordinary dividends. The IRS and the U.S. Treasury have issued proposed regulations providing that these withholding rules will not apply to the gross proceeds of share repurchases or Capital Gain Dividends the Fund pays. If a payment by the Fund is subject to FATCA withholding, the Fund is required to withhold even if such payment would otherwise be exempt from withholding under the rules applicable to foreign shareholders described above (e.g., short-term capital gain dividends and interest-related dividends).
Shareholders that are U.S. persons and own, directly or indirectly, more than 50% of the Fund could be required to report annually their “financial interest” in the Fund’s foreign financial accounts, if any, on FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR). Shareholders should consult a tax advisor, and persons investing in the Fund through an intermediary should contact their intermediary, regarding the applicability to them of this reporting requirement.
Each prospective investor is urged to consult its tax adviser regarding the applicability of FATCA and any other reporting requirements with respect to the prospective investor’s own situation, including investments through an intermediary.
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Shares Purchased Through Tax-Qualified Plans
Special tax rules apply to investments through defined contribution plans and other tax-qualified plans. Shareholders should consult their tax advisers to determine the suitability of shares of the Fund as an investment through such plans and the precise effect of an investment on their particular tax situation.
PERFORMANCE RELATED AND COMPARATIVE INFORMATION
The Fund may quote certain performance-related information and may compare certain aspects of its portfolio and structure to other substantially similar closed-end funds as categorized by Broadridge Financial Solutions, Inc. (“Broadridge”), 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 and Broadridge, which the Fund believes to be generally accurate.
The Fund, in its advertisements, may refer to pending legislation from time to time and the possible effect of such legislation on investors, investment strategy and related matters. At any time in the future, yields and total return may be higher or lower than past yields and there can be no assurance that any historical results will continue.
Past performance is not indicative of future results. At the time Common Shareholders redeem their shares, they may be worth more or less than their original investment.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSEMENT AGENT
State Street Bank and Trust Company serves as the primary custodian for assets of the Fund. State Street Bank and Trust Company’s principal business address is One Lincoln Street, Boston, MA 02111. The primary custodian performs custodial and fund accounting services. UMB Bank, n.a. also serves as a custodian of the Fund for the purpose of processing investor subscriptions and repurchases. UMB Bank, n.a.’s principal business address is 1010 Grand Boulevard, Kansas City, MO 64106.
SS&C Global Investor & Distribution Solutions, Inc., 430 W. 7th Street STE 219024, Kansas City, Missouri 64105-1407, serves as the transfer agent and dividend disbursement agent for the Common Shares, as well as agent relating to the Dividend Reinvestment Plan for the Common Shares.
The Bank of New York Mellon, 240 Greenwich Street, New York, New York 10286, serves as transfer agent, registrar, redemption and paying agent and calculation agent with respect to the RVMTP Shares.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
PricewaterhouseCoopers LLP (“PwC”), 1100 Walnut Street, Suite 1300, Kansas City, MO 64106, serves as the independent registered public accounting firm for the Fund. PwC provides audit services, tax assistance and other audit related services to the Fund.
COUNSEL
Ropes & Gray LLP, Prudential Tower, 800 Boylston Street, Boston, Massachusetts 02199, passes upon certain legal matters in connection with shares offered by the Fund, and also acts as counsel to the Fund.
REGISTRATION STATEMENT
A Registration Statement on Form N-2, including any amendments thereto (the “Registration Statement”), relating to the Common Shares of the Fund offered hereby, has been filed by the Fund with the SEC, Washington, D.C. The Prospectus and this Statement of Additional Information are parts of, but 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 Common Shares offered or to be offered hereby, reference is made to the Fund’s Registration Statement. Statements contained in the Prospectus and this Statement of Additional Information as to the contents of any contract or other document referred to are not necessarily complete and in each instance reference is made to the
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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.
FINANCIAL STATEMENTS
The Fund’s audited financial statements appearing in the Fund’s annual shareholder report for the period ended December 31, 2022, are incorporated by reference in this Statement of Additional Information and have been so incorporated in reliance upon the report of PwC, independent registered public accounting firm for the Fund, whose report is included in such annual shareholder report.
The annual shareholder report is available upon request and without charge by writing to the Fund at c/o Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, California 92660.
PIF004SAI_011224
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Appendix A – PROCEDURES FOR SHAREHOLDERS TO SUBMIT NOMINEE CANDIDATES
(Appendix A to the Fund’s Governance and Nominating Committee Charter)
A shareholder of a Fund must follow the following procedures in order to submit properly a nominee recommendation for the Committee’s consideration.
1.
The shareholder must submit any such recommendation (a “Shareholder Recommendation”) in writing to a Fund, to the attention of the Secretary, at the address of the principal executive offices of the Fund. Once each quarter, if any Shareholder Recommendations have been received by the Secretary during the quarter, the Secretary will inform the Committee of the new Shareholder Recommendations. Because the Fund does not hold annual or other regular meetings of shareholders for the purpose of electing Trustees, the Committee will accept Shareholder Recommendations on a continuous basis.
2.
All Shareholder Recommendations properly submitted to a Fund will be held by the Secretary until such time as (i) the Committee convenes to consider candidates to fill Board vacancies or newly created Board positions (a “Trustee Consideration Meeting”) or (ii) the Committee instructs the Secretary to discard a Shareholder Recommendation following a Trustee Consideration Meeting or an Interim Evaluation (as defined below).
3.
At a Trustee Consideration Meeting, the Committee will consider each Shareholder Recommendation then held by the Secretary. Following a Trustee Consideration Meeting, the Committee may instruct the Secretary to discard any or all of the Shareholder Recommendations currently held by the Secretary.
4.
The Committee may, in its discretion and at any time, convene to conduct an evaluation of validly submitted Shareholder Recommendations (each such meeting, an “Interim Evaluation”) for the purpose of determining which Shareholder Recommendations will be considered at the next Trustee Consideration Meeting. Following an Interim Evaluation, the Committee may instruct the Secretary to discard any or all of the Shareholder Recommendations currently held by the Secretary.
5.
The Shareholder Recommendation must include: (i) a statement in writing setting forth (A) the name, date of birth, business address, residence address and nationality of the person recommended by the shareholder (the “candidate”); (B) the number of shares of (and class, if any) of the Fund(s) owned of record or beneficially by the candidate, as reported to such shareholder by the candidate; (C) any other information regarding the candidate called for with respect to director nominees by paragraphs (a), (d), (e) and (f) of Item 401 of Regulation S-K or paragraph (b) of Item 22 of Rule 14a-101 (Schedule 14A) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), adopted by the Securities and Exchange Commission (or the corresponding provisions of any regulation or rule subsequently adopted by the Securities and Exchange Commission or any successor agency applicable to the Trust); (D) any other information regarding the candidate that would be required to be disclosed if the candidate were a nominee in a proxy statement or other filing required to be made in connection with the election of Trustees or directors pursuant to Section 14 of the Exchange Act and the rules and regulations promulgated thereunder; and (E) whether the recommending shareholder believes that the candidate is or will be an “interested person” of the Fund (as defined in the Investment Company Act of 1940, as amended) and, if not an “interested person,” information regarding the candidate that will be sufficient for the Fund to make such determination; (ii) the written and signed consent of the candidate to be named as a nominee and to serve as a Trustee if elected; (iii) the recommending shareholder’s name as it appears on the Fund’s books; (iv) the number of shares of (and class, if any) of the Fund(s) owned beneficially and of record by the recommending shareholder; and (v) a description of all arrangements or understandings between the recommending shareholder and the candidate and any other person or persons (including their names) pursuant to which the recommendation is being made by the recommending shareholder. In addition, the Committee may require the candidate to furnish such other information as it may reasonably require or deem necessary to determine the eligibility of such candidate to serve on the Board or to satisfy applicable law.
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