Filed Pursuant to Rule 497(h)
File No. 333-100018
PROSPECTUS
[LOGO] AEW
3,750,000 SHARES
AEW REAL ESTATE INCOME FUND
COMMON SHARES
$15.00 PER SHARE
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INVESTMENT OBJECTIVES. AEW Real Estate Income Fund (the "Fund") is a
newly organized, non-diversified, closed-end management investment company.
. The Fund's primary investment objective is high current income; and
. The Fund's secondary investment objective is capital appreciation.
PORTFOLIO CONTENTS. Under normal market conditions, the Fund will invest
at least 90% of its total assets in income-producing common shares, preferred
shares, convertible preferred shares and debt securities issued by Real Estate
Companies (companies, including real estate investment trusts ("REITs"), that
generally derive at least 50% of their revenue from the ownership,
construction, financing, management or sale of commercial, industrial or
residential real estate, or have at least 50% of their assets invested in such
real estate). The Fund will, under normal market conditions, invest at least
80% of its total assets in income-producing equity securities issued by REITs.
The Fund may invest in non-investment grade fixed income securities, such as
non-investment grade debt securities (commonly known as "junk bonds") and
non-investment grade preferred and convertible preferred shares, although the
Fund will not invest in a non-investment grade fixed income security if, as a
result of such investment, more than 25% of the Fund's total assets would be
invested in such securities. There can be no assurance that the Fund will
achieve its investment objectives. For more information on the Fund's
investment strategies, see "Investment Objectives and Policies" and "Principal
Risks of the Fund."
NO PRIOR HISTORY. Because the Fund is newly organized, its common shares
have no history of public trading. The shares of closed-end investment
companies frequently trade at a discount from their net asset value. This risk
may be greater for investors expecting to sell their shares a relatively short
time after completion of the public offering. The Fund's common shares have
been approved for listing on the American Stock Exchange under the symbol "RIF."
INVESTING IN THE COMMON SHARES INVOLVES RISKS THAT ARE DESCRIBED IN
"PRINCIPAL RISKS OF THE FUND" BEGINNING ON PAGE 28 OF THIS PROSPECTUS.
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PER SHARE TOTAL
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Public offering price......... $15.00 $56,250,000
Sales load(1)................. $.675 $2,531,250
Estimated offering expenses(2) $ .03 $112,500
Proceeds to the Fund.......... $14.295 $53,606,250
(1)For a description of other compensation paid to the underwriters, see
"Underwriting."
(2)Total organizational expenses and offering costs are estimated to be
approximately $924,100. The investment manager has agreed to pay
organizational expenses and offering costs of the Fund (other than the
sales load) that exceed $0.03 per common share.
The underwriters may also purchase up to an additional 562,500 common
shares at the public offering price, less the sales load, within 45 days of the
date of this prospectus to cover over-allotments.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.
The common shares will be ready for delivery on or about November 29,
2002.
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MERRILL LYNCH & CO.
PRUDENTIAL SECURITIES LEGG MASON WOOD WALKER RBC CAPITAL MARKETS
INCORPORATED
ADVEST, INC. FERRIS, BAKER WATTS, J.J.B. HILLIARD, W.L. LYONS, INC.
INCORPORATED
MCDONALD INVESTMENTS INC. QUICK & REILLY, INC.
TD WATERHOUSE WEDBUSH MORGAN SECURITIES INC.
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The date of this prospectus is November 25, 2002.
(CONTINUED FROM PREVIOUS PAGE)
LEVERAGE. The Fund intends to use leverage by issuing preferred shares
representing approximately 35% of the Fund's capital after their issuance or,
alternatively, through issuing commercial paper or notes or through other
borrowings. Through leveraging, the Fund will seek to obtain a higher return
for holders of common shares than if the Fund did not use leverage. Leverage is
a speculative technique, and there are special risks and costs associated with
leveraging. There can be no assurance that a leveraging strategy will be
successful during any period in which it is employed. See "Use of
Leverage--Leverage Risks."
This prospectus sets forth concisely information about the Fund you
should know before investing. You should read the prospectus before deciding
whether to invest and retain it for future reference. A Statement of Additional
Information, dated November 25, 2002 (the "SAI"), containing additional
information about the Fund, has been filed with the Securities and Exchange
Commission and is incorporated by reference in its entirety into this
prospectus. You can review the table of contents of the SAI on page 50 of this
prospectus. You may request a free copy of the SAI by calling (800) 862-4863 or
by writing to the Fund. You may also obtain the SAI and other information
regarding the Fund on the Securities and Exchange Commission's web site
(HTTP://WWW.SEC.GOV).
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TABLE OF CONTENTS
PAGE
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Prospectus Summary................................................ 4
Summary of Fund Expenses.......................................... 17
The Fund.......................................................... 19
Use of Proceeds................................................... 19
Investment Objectives and Policies................................ 19
Use of Leverage................................................... 24
Interest Rate Transactions........................................ 27
Principal Risks of the Fund....................................... 28
Additional Risk Considerations.................................... 35
Management of the Fund............................................ 36
Net Asset Value................................................... 38
Dividends and Distributions....................................... 39
Closed-End Structure.............................................. 41
Possible Conversion to Open-End Status............................ 42
Repurchase of Shares.............................................. 42
Tax Matters....................................................... 42
Description of Shares............................................. 43
Certain Provisions in the Declaration of Trust.................... 45
Underwriting...................................................... 47
Custodian, Transfer Agent, Dividend Disbursing Agent and Registrar 49
Reports to Shareholders........................................... 49
Legal Matters..................................................... 49
Table of Contents of the Statement of Additional Information...... 50
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Please see page 51 for important privacy policy information.
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED OR INCORPORATED BY
REFERENCE IN THIS PROSPECTUS. THE FUND HAS NOT, AND THE UNDERWRITERS HAVE NOT,
AUTHORIZED ANY OTHER PERSON TO PROVIDE YOU WITH DIFFERENT INFORMATION. IF
ANYONE PROVIDES YOU WITH DIFFERENT OR INCONSISTENT INFORMATION, YOU SHOULD NOT
RELY ON IT. THE FUND IS NOT, AND THE UNDERWRITERS ARE NOT, MAKING AN OFFER TO
SELL THESE SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT
PERMITTED. YOU SHOULD ASSUME THAT THE INFORMATION IN THIS PROSPECTUS IS
ACCURATE ONLY AS OF THE DATE OF THIS PROSPECTUS. THE FUND'S BUSINESS, FINANCIAL
CONDITION AND PROSPECTS MAY HAVE CHANGED SINCE THAT DATE.
Until December 20, 2002 (25 days after the date of this prospectus), all
dealers that buy, sell or trade the common shares, whether or not participating
in this offering, may be required to deliver a prospectus. This is in addition
to the dealer's obligation to deliver a prospectus when acting as an
underwriter and with respect to its unsold allotments or subscriptions.
3
PROSPECTUS SUMMARY
THIS IS ONLY A SUMMARY. THIS SUMMARY MAY NOT CONTAIN ALL OF THE
INFORMATION THAT YOU SHOULD CONSIDER BEFORE INVESTING IN THE FUND'S COMMON
SHARES. YOU SHOULD REVIEW THE MORE DETAILED INFORMATION CONTAINED IN THIS
PROSPECTUS AND IN THE SAI, ESPECIALLY THE INFORMATION SET FORTH UNDER THE
HEADINGS "PRINCIPAL RISKS OF THE FUND" AND "ADDITIONAL RISK CONSIDERATIONS."
THE FUND.................. AEW Real Estate Income Fund (the "Fund") is a
newly organized, non-diversified, closed-end
management investment company.
THE OFFERING.............. The Fund is offering 3,750,000 common shares of
beneficial interest ("Common Shares") through a
group of underwriters led by Merrill Lynch,
Pierce, Fenner & Smith Incorporated ("Merrill
Lynch"). You must purchase at least 100 Common
Shares ($1,500). The Fund has granted the
underwriters an option to purchase up to 562,500
additional Common Shares to cover over-allotments.
The initial public offering price is $15.00 per
share. See "Underwriting." AEW Management and
Advisors, L.P. (the "Investment Manager") has
agreed to pay organizational expenses and offering
costs of the Fund (other than the sales load) that
exceed $0.03 per Common Share.
INVESTMENT OBJECTIVES
AND POLICIES.............. The Fund's primary investment objective is high
current income. Capital appreciation is a
secondary investment objective. There can be no
assurance that the Fund's investment objectives
will be achieved. The Fund's investment objectives
and certain investment policies are considered
fundamental and may not be changed without
shareholder approval. See "Investment Objectives
and Policies."
Under normal market conditions, the Fund will
invest at least 90% of its total assets in
income-producing common shares, preferred shares,
convertible preferred shares and debt securities
issued by Real Estate Companies, including real
estate investment trusts, or "REITs." A "Real
Estate Company" is a company that generally
derives at least 50% of its revenue from the
ownership, construction, financing, management or
sale of commercial, industrial or residential real
estate (or has at least 50% of its assets invested
in such real estate). As part of this policy, the
Fund may also invest in rights or warrants to
purchase income-producing common and preferred
shares of Real Estate Companies. Under normal
market conditions, the Investment Manager expects
to invest approximately 60% to 80% of the Fund's
total assets in common shares of Real Estate
Companies and approximately 20% to 40% of its
total assets in preferred shares, including
convertible preferred shares, issued by Real
Estate Companies. Under normal market conditions,
at least 80% of the Fund's total assets will be
invested in income-producing equity securities
issued by REITs. A significant portion of the
equity securities of the Real Estate Companies in
which the Fund invests are expected to trade on a
national securities exchange or in the
over-the-counter market. A REIT is a Real Estate
Company that pools investors' funds for investment
primarily in income-producing real estate or in
real estate-related loans
4
(such as mortgages) or other interests. REITs are
generally not taxed on income distributed to
shareholders provided they distribute to their
shareholders substantially all of their income and
otherwise comply with the requirements of the
Internal Revenue Code of 1986, as amended (the
"Code"). As a result, REITs generally pay
relatively high dividends (as compared to other
types of companies). The Fund intends to use these
REIT dividends in an effort to meet its primary
objective of high current income. The Fund will
primarily invest in Equity REITs, which invest the
majority of their assets directly in real property
and derive their income primarily from rents. The
Fund may invest up to 20% of its total assets in
U.S. Government obligations and debt securities,
including convertible debt securities, issued by
Real Estate Companies. The preferred shares,
convertible preferred shares and debt securities
in which the Fund may invest are sometimes
collectively referred to in this Prospectus as
"Fixed Income Securities." The Fund may invest in
Fixed Income Securities that are below investment
grade quality. A Fixed Income Security will be
considered to be investment grade if, at the time
of investment, such security has a rating of "BBB"
or higher by Standard & Poor's Ratings Services
("S&P") or "Baa" or higher by Moody's Investors
Service, Inc. ("Moody's") or an equivalent rating
by another nationally recognized statistical
rating agency or, if unrated, is judged to be of
comparable quality by the Investment Manager. The
Fund will not invest in a non-investment grade
Fixed Income Security if, as a result of such
investment, more than 25% of the Fund's total
assets would be invested in non-investment grade
Fixed Income Securities. The Fund may invest up to
10% of its total assets in securities of non-U.S.
issuers located in countries that are members of
the Organisation For Economic Co-operation and
Development. The Fund may invest in securities
that are illiquid so long as no more than 10% of
the total assets of the Fund (taken at market
value at the time of investment) would be invested
in such securities. The Fund will not invest more
than 15% of its total assets (taken at market
value at the time of investment) in the securities
of any one issuer other than the U.S. Government.
The Fund may invest in interest rate swap or
interest rate cap transactions in order to reduce
the interest rate risk inherent in the Fund's
underlying investments and capital structure. See
"Interest Rate Transactions." The Fund may also
purchase or sell futures or options on futures to
hedge interest rate risks. See "Investment
Objectives and Policies" and "Principal Risks of
the Fund."
In anticipation of or in response to adverse
market conditions, for cash management purposes,
or for defensive purposes, the Fund may
temporarily hold all or a portion of its assets in
cash, money market instruments, or bonds or other
debt securities. The Fund would be unable to
achieve its investment objectives if a substantial
portion of its assets consisted of such
instruments.
USE OF LEVERAGE........... Subject to market conditions and the receipt of
the highest credit rating on the Fund Preferred
Shares (defined below) from at least one
5
nationally recognized statistical rating agency
(e.g., AAA or Aaa), approximately one to three
months after completion of this offering, the Fund
intends to offer preferred shares of beneficial
interest ("Fund Preferred Shares") representing
approximately 35% of the Fund's capital after
their issuance. The issuance of Fund Preferred
Shares will leverage your investment in the Common
Shares. As an alternative to Fund Preferred
Shares, the Fund may incur leverage through the
issuance of commercial paper or notes or other
borrowings. Any Fund Preferred Shares or
borrowings will have seniority over the Common
Shares.
The use of leverage creates an opportunity for
increased Common Share net income, but also
creates special risks for holders of Common Shares
("Common Shareholders"). It is anticipated that
the Fund Preferred Shares will generally pay
dividends based on short-term rates, which will be
reset frequently. Borrowings may be at a fixed or
floating rate. The Fund may seek to protect itself
from the risk of increasing dividends or interest
expenses resulting from an increase in short-term
interest rates by entering into a swap or cap
transaction as to all or a portion of the Fund
Preferred Shares or any borrowings. See "Interest
Rate Transactions." As long as the rate of return,
net of applicable Fund expenses, on the Fund's
portfolio investments exceeds Fund Preferred Share
dividend rates, as reset periodically, interest on
any borrowings or the payment rate set by any
interest rate swap, the investment of the proceeds
of the Fund Preferred Shares or any borrowing will
generate more income than will be needed to pay
such dividends, interest rate or swap payment. If
so, the excess may be available to pay higher
dividends to Common Shareholders. If, however, the
dividends or interest rate on any borrowings, as
modified by any cap, or the payment rate set by
any interest rate swap, exceeds the rate of return
on the Fund's investment portfolio, the return to
Common Shareholders will be less than if the Fund
had not used leverage. Fund Preferred Shares are
expected to pay cumulative dividends, which may
tend to increase leverage risk.
The holders of Fund Preferred Shares, voting as a
separate class, will be entitled to elect two
members of the Board of Trustees of the Fund and,
in the event that the Fund fails to pay two full
years of accrued dividends on the Fund Preferred
Shares, the holders of the Fund Preferred Shares
will be entitled to elect a majority of the
members of the Board of Trustees. See "Use of
Leverage" and "Description of Shares--Fund
Preferred Shares."
There is no assurance that the Fund will utilize
leverage or that, if utilized, the Fund's
leveraging strategy will be successful. See "Use
of Leverage--Leverage Risk."
LEVERAGE RISK. Leverage creates two major types
of risks for Common Shareholders:
. The likelihood of greater volatility of net
asset value and market price of Common Shares
because changes in the value of the
6
Fund's portfolio (including changes in the
value of any interest rate swap, if
applicable) are borne entirely by the Common
Shareholders; and
. The possibility either that Common Share
income will fall if the dividend rate on the
Fund Preferred Shares or the interest rate on
any borrowings rises, or that Common Share
income will fluctuate because the dividend
rate on the Fund Preferred Shares or the
interest rate on any borrowings varies.
When the Fund is utilizing leverage, the fees paid
to the Investment Manager and its affiliates for
investment advisory, management and other services
will be higher than if the Fund did not utilize
leverage because the fees paid will be calculated
based on the Fund's managed assets (which include
the liquidation preference on any Fund Preferred
Shares and the principal amount of any borrowings
used for leverage). As a result, the Investment
Manager has a financial incentive for the Fund to
issue Fund Preferred Shares or to otherwise incur
leverage, which may create a conflict of interest.
INTEREST RATE TRANSACTIONS In order to reduce the interest rate risk inherent
in the Fund's underlying investments and capital
structure, the Fund may enter into interest rate
swap or cap transactions. The use of interest rate
swaps and caps is a highly specialized activity
that involves investment techniques and risks
different from those associated with ordinary
portfolio security transactions. Common
Shareholders will bear the risks and costs
associated with the Fund's use of interest rate
transactions. In an interest rate swap, the Fund
would agree to pay to the other party to the
interest rate swap (the "counterparty") a fixed
rate payment in exchange for the counterparty
agreeing to pay to the Fund a variable rate
payment that is intended to approximate the Fund's
variable rate payment obligation on the Fund
Preferred Shares or any variable rate borrowing.
The payment obligations would be based on the
notional amount of the swap. In an interest rate
cap, the Fund would pay a premium to the
counterparty to the interest rate cap and, to the
extent that a specified variable rate index
exceeds a predetermined fixed rate, would receive
from the counterparty payments of the difference
based on the notional amount of such cap.
Depending on the state of interest rates in
general, the Fund's use of interest rate swaps or
caps could enhance or decrease the net income of
the Common Shares. To the extent there is a
decline in interest rates, the value of the
interest rate swap or cap could decline, and this
could result in a decline in the net asset value
of the Common Shares. In addition, if the
counterparty to an interest rate swap or cap
defaults, the Fund would be obligated to make the
payments that it had intended to avoid. Depending
on whether the Fund would be entitled to receive
net payments from the counterparty on the swap or
cap, which in turn would depend on, among other
things, the general state of short-term interest
rates, such default could negatively impact the
performance of the Common Shares. In addition,
there is a risk that the Fund will not be able to
enter
7
into suitable interest rate swap or cap
transactions, or that the terms of an interest
rate swap or cap transaction will be less
favorable to the Fund than expected. Similarly, at
the time an interest rate swap or cap transaction
terminates, the Fund may not be able to obtain a
replacement transaction, or the terms of any
replacement transaction may not be as favorable to
the Fund. If these situations occur, they could
have a negative impact on the performance of the
Fund's Common Shares. If the Fund fails to
maintain the required 200% asset coverage of the
liquidation value of the outstanding Fund
Preferred Shares or if the Fund loses its expected
AAA/Aaa rating on the Fund Preferred Shares or
fails to maintain other covenants, the Fund may be
required to redeem some or all of the Fund
Preferred Shares. Similarly, the Fund could be
required to prepay the principal amount of any
borrowings. Such redemption or prepayment likely
would result in the Fund seeking to terminate
early all or a portion of any swap or cap
transaction. Early termination of a swap or cap
could result in a termination payment by the Fund.
The Fund does not intend to enter into interest
rate swap or cap transactions having a notional
amount that exceeds the outstanding amount of the
Fund's leverage. In addition to using swaps and
caps, the Fund may also purchase or sell futures
contracts or options on futures contracts in an
attempt to hedge interest rate risks. See "Use of
Leverage" and "Interest Rate Transactions" for
additional information.
PRINCIPAL RISKS OF THE FUND The Fund is a newly organized, non-diversified,
closed-end management investment company designed
primarily as a long-term investment and not as a
trading vehicle. The Fund is not intended to be a
complete investment program and, due to the
uncertainty inherent in all investments, there can
be no assurance that the Fund will achieve its
investment objectives.
The following paragraphs summarize the principal
risks to which the Fund and the Common Shares are
subject. For a more complete discussion of these
risks, see "Principal Risks of the Fund."
NO OPERATING HISTORY. As a newly organized
entity, the Fund has no operating history. See
"The Fund."
INVESTMENT RISK. An investment in the Fund is
subject to investment risk, including the possible
loss of the entire principal amount that you
invest.
ISSUER RISK. The value of an equity or debt
security may decline for a number of reasons that
directly relate to the Real Estate Company that
issues it, such as management performance,
financial leverage and reduced demand for the Real
Estate Company's properties and services.
MARKET RISK. Your investment in the Common Shares
represents an indirect investment in the REIT
shares and other securities of Real Estate
Companies owned by the Fund, a significant portion
of which
8
are expected to trade on a national securities
exchange or in the over-the-counter markets. The
value of these securities, like other investments
traded on securities markets, may move up or down,
sometimes rapidly and unpredictably. Preferred
shares and debt securities are generally more
sensitive to changes in interest rates than common
stocks. When interest rates rise, the market value
of preferred shares and debt securities generally
will fall. Your Common Shares at any point in time
may be worth less than what you invested, even
after taking into account the reinvestment of Fund
dividends and distributions. The Fund may utilize
leverage, which magnifies market risk. See "Use of
Leverage--Leverage Risks."
INTEREST RATE RISK. Interest rate risk is the
risk that fixed-income investments such as
preferred shares, U.S. Government obligations and
debt securities, and to a lesser extent
dividend-paying common stocks such as REIT common
shares, will decline in value because of changes
in interest rates. When interest rates rise, the
market value of such securities generally will
fall. The Fund's investment in such securities
means that the net asset value and market price of
Common Shares will tend to decline if market
interest rates rise. Also, during periods of
declining interest rates, many mortgages may be
refinanced, which may reduce the yield from
securities of Real Estate Companies that invest
primarily in loans secured by real estate and
generally derive their income primarily from
interest payments on mortgage loans. This risk is
commonly known as "prepayment risk." The Fund
intends to use leverage, which may tend to magnify
interest rate risk. See "Use of Leverage--Leverage
Risks." The Fund may use swaps, caps, futures
contracts and options on futures contracts to help
control interest rate risk. See "Investment
Objectives and Policies--Portfolio
Composition--Short Sales and Derivatives" and
"Interest Rate Transactions."
GENERAL REAL ESTATE RISKS. Because the Fund
concentrates its assets in the real estate
industry, your investment in the Fund will be
closely linked to the performance of the real
estate markets. Property values may fall due to
supply and demand disparities, increasing
vacancies or declining rents resulting from
economic, legal, cultural or technological
developments. Real Estate Company prices also may
drop because of the failure of borrowers to pay
their loans and poor management. Many Real Estate
Companies (including REITs) utilize leverage,
which increases investment risk and could
adversely affect a Real Estate Company's
operations and market value in periods of
unfavorable interest rate movements. In addition,
there are risks associated with particular sectors
of the real estate industry.
RETAIL PROPERTIES. Retail properties are affected
by the overall health of the national and relevant
local economy and may be adversely affected by the
growth of alternative forms of retailing,
bankruptcy, departure or cessation of operations
of a tenant, a shift in consumer demand due to
demographic changes, spending patterns and lease
terminations.
9
OFFICE PROPERTIES. Office properties are affected
by the overall health of the national and relevant
local economy, as well as by other factors such as
a downturn in the businesses operated by their
tenants, obsolescence, non-competitiveness and the
high capital expenditures needed to operate such
properties.
HOTEL PROPERTIES. The risks of hotel properties
include, among other things, the necessity of a
high level of continuing capital expenditures,
competition, increases in operating costs that may
not be offset by increases in revenues, dependence
on business and commercial travelers and tourism,
increases in fuel costs and other expenses of
travel, and adverse effects of general and local
economic conditions. Hotel properties tend to be
more sensitive to adverse economic conditions and
competition than many other commercial properties.
HEALTHCARE PROPERTIES. Healthcare properties and
healthcare providers are affected by several
significant factors, including federal, state and
local laws governing licenses, certification,
adequacy of care, pharmaceutical distribution,
rates, equipment, personnel and other factors
regarding operations; continued availability of
revenue from government reimbursement programs
(primarily Medicaid and Medicare) and from private
sector health insurance providers; and competition
on a local and regional basis. The failure of any
healthcare operator to comply with governmental
laws and regulations may affect its ability to
operate its facility or receive government
reimbursements.
MULTIFAMILY/RESIDENTIAL PROPERTIES. The value and
successful operation of a multifamily/residential
property may be affected by a number of factors
such as the location of the property, the ability
of the management team, the type of services
provided by the property, the level of mortgage
rates, the presence of competing properties,
adverse economic conditions in the locale, the
relocation of tenants to new properties with
better amenities, oversupply, and rent control
laws or other laws affecting such properties.
SELF-STORAGE PROPERTIES. The value and successful
operation of a self-storage property may be
affected by a number of factors, such as the
ability of the management team, the location of
the property, the presence of competing
properties, changes in traffic patterns, and
adverse effects of general and local economic
conditions.
INSURANCE RISK. Certain of the Real Estate
Companies in which the Fund invests may carry
comprehensive liability, fire, flood, earthquake
extended coverage and rental loss insurance with
various policy specifications, limits and
deductibles. Should any type of uninsured loss
occur (or if an insurer is unwilling or unable to
pay on a claim), the Real Estate Company could
lose its investment in, and anticipated profits
and cash flows from, a number of properties. Such
a loss would impact the Fund's investment
performance.
10
FINANCIAL LEVERAGE RISK. Real Estate Companies
may be highly leveraged and financial covenants
may affect the ability of Real Estate Companies to
operate effectively or pay dividends. If the
principal payments of a Real Estate Company's debt
cannot be refinanced, extended or paid with
proceeds from other capital transactions, such as
new equity capital, the Real Estate Company's cash
flow may not be sufficient to pay dividends or to
repay all maturing debt outstanding, which would
impact the Fund's investment performance.
ENVIRONMENTAL ISSUES. In connection with the
ownership (direct or indirect), operation,
management and development of real properties that
may contain hazardous or toxic substances, a Real
Estate Company may be considered an owner,
operator or responsible party of such properties
and, therefore, may be potentially liable for
removal or remediation costs as well as certain
other costs, including governmental fines and
liabilities for injuries to persons and property.
The existence of any such environmental liability
could have a material adverse effect on the
results of operations and cash flow of any such
Real Estate Company and, as a result, the net
asset value of the Common Shares or the amount
available to make distributions on shares of the
Fund could be reduced.
SMALLER COMPANIES. Even the larger Real Estate
Companies in the industry tend to be small to
medium-sized companies in relation to the equity
markets as a whole. Real Estate Company shares,
therefore, can be more volatile than, and perform
differently from, larger company stocks. There may
be less trading in a smaller company's stock,
which means that buy and sell transactions in that
stock could have a larger impact on the stock's
price than is the case with larger company stocks.
Further, smaller companies may have fewer business
lines; changes in any one line of business,
therefore, may have a greater impact on a smaller
company's stock price than is the case for a
larger company. Smaller company shares may also
perform differently in different cycles than
larger company shares. Accordingly, Real Estate
Company shares can be more volatile than--and at
times will perform differently from--large company
shares such as those found in the Dow Jones
Industrial Average.
As of September 30, 2002, the market
capitalization of REITs ranged in size from
approximately $5 million to approximately $11
billion.
TAX ISSUES. REITs are subject to a highly
technical and complex set of provisions in the
Code. It is possible that the Fund may invest in a
Real Estate Company that purports to be a REIT but
does not satisfy all of the conditions of REIT
status in any year. In some cases, the Real Estate
Company may still be able to qualify for REIT
status after payment of a penalty tax. Otherwise,
a Real Estate Company that fails to qualify for
REIT status would be subject to corporate-level
taxation. In either case, the return to the Fund
on its investment in such company would be
reduced. REITs could possibly fail to qualify for
tax free pass-through of income under the Code, or
to maintain their
11
exemptions from registration under the Investment
Company Act of 1940, as amended (the "1940 Act").
The above factors may also adversely affect the
Fund's investment in such a REIT. In the event of
a default by a borrower or lessee, the REIT may
experience delays in enforcing its rights as a
mortgagee or lessor and may incur substantial
costs associated with protecting its investments.
LOWER-RATED SECURITIES RISK. Lower-rated
preferred stock or debt securities, or equivalent
unrated securities, which are commonly known as
"junk bonds," generally involve greater volatility
of price and risk of loss of income and principal,
and may be more susceptible to real or perceived
adverse economic and competitive industry
conditions than higher grade securities. It is
reasonable to expect that any adverse economic
conditions could disrupt the market for
lower-rated securities, have an adverse impact on
the value of those securities, and adversely
affect the ability of the issuers of those
securities to repay principal and interest on
those securities.
INTEREST RATE TRANSACTIONS RISK. The Fund may
enter into a swap or cap transaction to attempt to
protect itself from increasing dividend or
interest expenses resulting from increasing
short-term interest rates. A decline in interest
rates may result in a decline in the value of the
swap or cap, which may result in a decline in the
net asset value of the Fund. A sudden and dramatic
decline in interest rates may result in a
significant decline in the net asset value of the
Fund. See "Interest Rate Transactions." These
transactions may also reduce the opportunity for
gain by offsetting any positive effect of
favorable movements in the hedged interest rates.
RISKS OF FUTURES AND OPTIONS ON FUTURES. The use
by the Fund of futures contracts and options on
futures contracts to hedge interest rate risks can
reduce the opportunity for gain by offsetting the
positive effect on favorable movements in the
hedged interest rates. The Fund could lose money
if the counterparty to a futures contract or
option on a futures contract is unwilling or
unable to honor its obligations to the Fund.
Furthermore, there is no assurance that a liquid
secondary market will exist for any particular
futures contract or option thereon at any
particular time. If the Fund were unable to
liquidate a futures contract or an option on a
futures contract position due to the absence of a
liquid secondary market or the imposition of price
limits, it could incur substantial losses. The
Fund would continue to be subject to market risk
and counterparty risk with respect to the position.
FOREIGN SECURITY RISK. The prices of foreign
securities may be affected by factors not present
with U.S. securities, including currency exchange
rates, political and economic conditions, less
stringent regulation and higher volatility. As a
result, many foreign securities may be less liquid
and more volatile than U.S. securities.
LIQUIDITY RISK. The Fund may invest in securities
that are illiquid so long as no more than 10% of
the total assets of the Fund (taken at market
value at the time of investment) would be invested
in such
12
securities. Illiquid securities are those that
cannot be disposed of within seven days in the
ordinary course of business at approximately the
amount at which the Fund has valued the
securities. Illiquid securities may trade at a
discount from comparable, more liquid investments,
and may be subject to wide fluctuations in market
value. Also, the Fund may not be able to dispose
of illiquid securities when that would be
beneficial at a favorable time or price.
RISKS OF WARRANTS AND RIGHTS. Warrants and rights
are subject to the same market risks as stocks,
but may be more volatile in price. An investment
in warrants or rights may be considered
speculative. The purchase of warrants or rights
involves the risk that the Fund could lose the
purchase value of a warrant or right if the right
to subscribe to additional shares is not exercised
prior to the warrant's or right's expiration.
Also, the purchase of warrants and rights involves
the risk that the effective price paid for the
warrant or right, added to the subscription price
of the related security, may exceed the subscribed
security's market price, such as when there is no
movement in the price of the underlying security
or when the market price of the underlying
security decreases.
INFLATION RISK. Inflation risk is the risk that
the value of assets or income from investments
will be worth less in the future as inflation
decreases the present value of future payments. As
inflation increases, the real value of the Common
Shares and distributions can decline and the
dividend payments on the Fund Preferred Shares, if
any, or interest payments on any borrowings may
increase, which would tend further to reduce
returns to Common Shareholders.
MARKET PRICE DISCOUNT FROM NET ASSET
VALUE. Shares of closed-end investment companies
frequently trade at a discount from their net
asset value. This characteristic is a risk
separate and distinct from the risk that net asset
value would decrease as a result of investment
activities and may be greater for investors
expecting to sell their shares a relatively short
time following completion of this offering. The
Fund cannot predict whether the Common Shares will
trade at, above or below net asset value. The
Common Shares are designed primarily for long-term
investors, and you should not view the Fund as a
vehicle for trading purposes.
ADDITIONAL RISK
CONSIDERATIONS.......... In addition to the principal risks summarized
above, the Fund and the Common Shares are also
subject to additional risks. See "Additional Risk
Considerations" for a more complete description of
the additional risks described below.
PORTFOLIO TURNOVER. The Fund may engage in
frequent and active portfolio trading when
considered appropriate, but it will not use short-
term trading as the primary means of achieving its
investment objectives. There are no limits on the
rate of portfolio turnover. A higher turnover rate
results in correspondingly greater brokerage
commissions and other transactional expenses,
which are borne by the Fund. High portfolio
turnover may result in the realization of net
short-
13
term capital gains by the Fund that, when
distributed to shareholders, will be taxable as
ordinary income.
NON-DIVERSIFIED STATUS. Because the Fund, as a
"non-diversified" investment company under the
1940 Act, can invest a greater portion of its
assets in obligations of a single issuer than, and
invest in a smaller number of individual issuers
than, a "diversified" fund, an investment in the
Fund presents greater risk to you than an
investment in a diversified company. The Fund will
be more susceptible than a diversified fund to
being adversely affected by any single corporate,
economic, political or regulatory occurrence. See
"Investment Objectives and Policies." To help
control this risk, the Fund will not invest more
than 15% of its total assets (taken at market
value at the time of investment) in the securities
of any one issuer other than the U.S. Government.
In addition, the Fund intends to diversify its
investments to the extent necessary to maintain
its status as a regulated investment company under
the Code. See "Taxation" in the SAI.
ANTI-TAKEOVER PROVISIONS. The Fund's Amended and
Restated Agreement and Declaration of Trust (the
"Declaration") includes provisions that could have
the effect of limiting the ability of other
entities or persons to acquire control of the Fund
or convert the Fund to open-end status. These
provisions may have the effect of depriving you of
an opportunity to sell your shares at a premium
over prevailing market prices. See "Certain
Provisions in Declaration of Trust."
RECENT DEVELOPMENTS. As a result of the terrorist
attacks on the World Trade Center and the Pentagon
on September 11, 2001, some of the U.S. securities
markets were closed for a four-day period. These
terrorist attacks and related events have led to
increased short-term market volatility and may
have long-term effects on U.S. and world economies
and markets. A similar disruption of the financial
markets could impact interest rates, auctions,
secondary trading, ratings, credit risk, inflation
and other factors relating to the Common Shares
and the Fund Preferred Shares.
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 the Investment
Manager's parent, CDC IXIS Asset Management North
America, L.P. Absent an exemption from the
Securities and Exchange Commission or other
regulatory relief, the Fund is generally precluded
from effecting certain principal transactions with
affiliated brokers, and its ability to purchase
securities being underwritten by an affiliated
broker or a syndicate including an affiliated
broker or to utilize affiliated brokers for agency
transactions is subject to regulatory and other
restrictions. This could limit the Fund's ability
to engage in securities transactions and take
advantage of market opportunities.
Given the risks described above, an investment in
the Fund may not be appropriate for all investors.
You should carefully consider your ability to
assume these risks before making an investment in
the Fund.
14
INVESTMENT MANAGER, ADMINISTRATOR
AND SUB-ADMINISTRATOR... AEW Management and Advisors, L.P. will be the
Fund's investment manager. The Investment Manager
is a real estate investment advisory firm that
provides investment management and related
services to institutional and retail investors.
Together with its affiliates operating under the
AEW name, the Investment Manager managed
approximately $6.9 billion of client capital as of
September 30, 2002. The Investment Manager is a
subsidiary of CDC IXIS Asset Management North
America, L.P., which, together with its
subsidiaries and affiliates in the U.S., Europe
and Asia, managed approximately $291 billion in
assets for institutions and individuals as of
September 30, 2002. An affiliate of the Investment
Manager, CDC IXIS Asset Management Services, Inc.
("CDC IXIS Services"), will have responsibility
for providing or procuring administrative services
for the Fund and assisting the Fund with
operational needs pursuant to an Administrative
Services Agreement. As permitted by the
Administrative Services Agreement, CDC IXIS
Services has entered into an agreement with
Investors Bank & Trust Company to perform certain
administrative functions subject to the
supervision of CDC IXIS Services (the
"Sub-Administration Agreement"). See "Management
of the Fund--Administrative Services and
Sub-Administration Agreements."
FEES AND EXPENSES......... The Fund will pay the Investment Manager a monthly
fee computed at the annual rate of 0.80% of
average daily managed assets (which include the
liquidation preference of any Fund Preferred
Shares and the principal amount of any borrowings
used for leverage). The Investment Manager has
contractually agreed to waive a portion of its
investment management fees in the amount of 0.25%
of average daily managed assets for the first five
years of the Fund's operations (through November
29, 2007), and in declining amounts for each of
the four years thereafter (through November 29,
2011). See "Management of the Fund--Investment
Management Agreement."
Under the Administrative Services Agreement, the
Fund pays CDC IXIS Services a monthly
administration fee computed on the basis of the
average daily managed assets of the Fund at an
annual rate equal to 0.06% of the first $300
million in assets and 0.0575% of assets in excess
of $300 million, with a minimum annual fee of
$150,000. Under the Sub-Administration Agreement,
CDC IXIS Services (and not the Fund) pays
Investors Bank & Trust Company, the Fund's
sub-administrator, a monthly fee computed on the
basis of the managed assets of the Fund at an
annual rate equal to 0.015% of the first $300
million in assets and 0.012% thereafter. See
"Management of the Fund--Administrative Services
and Sub-Administration Agreements."
When the Fund is utilizing leverage, the fees paid
to the Investment Manager and its affiliates for
investment advisory, management and other services
will be higher than if the Fund did not utilize
leverage because the fees paid will be calculated
based on the Fund's managed assets, which include
the liquidation preference of any Fund Preferred
Shares and the principal amount of any borrowings
used for leverage.
15
As a result, the Investment Manager has a
financial incentive for the Fund to issue Fund
Preferred Shares or to otherwise incur leverage,
which may cause a conflict of interest. The Fund's
investment management fees and other expenses are
borne only by the Common Shareholders, and not by
holders of the Fund Preferred Shares. See "Use of
Leverage."
LISTING AND SYMBOL........ The Common Shares have been approved for listing
on the American Stock Exchange under the symbol
"RIF."
DIVIDENDS AND DISTRIBUTIONS Commencing with the Fund's first dividend, the
Fund intends to make regular monthly cash
distributions to Common Shareholders at a level
rate based on the projected performance of the
Fund, which rate may be adjusted from time to
time. The Fund's ability to maintain a level
dividend rate will depend on a number of factors,
including the stability of income received from
its investments and dividends payable on the Fund
Preferred Shares or interest payments on
borrowings. As portfolio and market conditions
change, the rate of dividends on the Common Shares
and the Fund's dividend policy will likely change.
Over time, the Fund will distribute all of its net
investment income (after payment of expenses,
dividends on any Fund Preferred Shares and
interest on any borrowings). In addition, at least
annually, the Fund intends to distribute net
capital gain and taxable ordinary income, if any,
to you so long as the net capital gain and taxable
ordinary income are not necessary to pay expenses
or to pay accrued dividends on, or redeem or
liquidate, any Fund Preferred Shares, or pay
interest on any borrowings. The Fund expects to
declare the initial monthly dividend on the Common
Shares within 45 days of the completion of this
offering and to pay the initial monthly dividend
within approximately 60 to 90 days after the
completion of this offering, depending on market
conditions. Following the completion of this
offering, the Fund intends to file an exemptive
application with the Securities and Exchange
Commission seeking an order under the 1940 Act
facilitating the implementation of a dividend
policy calling for monthly distributions of a
fixed percentage of its net asset value ("Managed
Dividend Policy"). If and when the Fund receives
the requested relief, the Fund may, subject to the
determination of its Board of Trustees, implement
a Managed Dividend Policy. See "Dividends and
Distributions."
DIVIDEND REINVESTMENT PLAN Unless you elect to receive distributions in cash,
you will receive distributions in additional
Common Shares purchased in the open market or
issued by the Fund through the Fund's Dividend
Reinvestment Plan. Shareholders whose Common
Shares are held in the name of a broker or nominee
should contact the broker or nominee to confirm
that the dividend reinvestment service is
available. See "Dividends and Distributions" and
"Tax Matters."
CUSTODIAN, TRANSFER
AGENT, DIVIDEND
DISBURSING AGENT AND
REGISTRAR............... Investors Bank & Trust Company will act as
custodian, and EquiServe Trust Company, N.A. and
its affiliate EquiServe, Inc. (together,
"EquiServe") will act as transfer agent,
dividend disbursing agent and registrar for the
Fund. See "Custodian, Transfer Agent, Dividend
Disbursing Agent and Registrar."
16
SUMMARY OF FUND EXPENSES
The following table assumes the issuance of Fund Preferred Shares in an
amount equal to 35% of the Fund's capital (after their issuance), and shows
Fund expenses as a percentage of net assets attributable to Common Shares.
Footnote 2 to the table also shows Fund expenses as a percentage of net assets
attributable to Common Shares, but assumes that no Fund Preferred Shares are
issued or outstanding (such as will be the case prior to the Fund's expected
issuance of Fund Preferred Shares).
SHAREHOLDER TRANSACTION EXPENSES
Sales Load Paid by You (as a percentage of offering price). 4.50%
Dividend Reinvestment Plan Fees............................ None(1)
PERCENTAGE OF NET ASSETS
ATTRIBUTABLE TO COMMON SHARES
(ASSUMING THE ISSUANCE OF
FUND PREFERRED SHARES) (2)(3)
-----------------------------
ANNUAL EXPENSES
Management Fees........... 1.22%
Other Expenses............ .99%//
-----
Total Annual Expenses..... 2.21%
Fee Waiver (Years 1-5)(4). (0.38)%(5)
-----
Net Annual Expenses(4).... 1.83%(5)
=====
--------
(1)You will pay brokerage charges if you direct the plan agent to sell your
Common Shares held in a dividend reinvestment account.
(2)The table presented in this footnote estimates what the Fund's annual
expenses would be stated as a percentage of the Fund's net assets
attributable to Common Shares but, unlike the table above, assumes that no
Fund Preferred Shares are issued or outstanding. This will be the case, for
instance, prior to the Fund's expected issuance of Fund Preferred Shares. In
accordance with these assumptions, the Fund's expenses would be estimated to
be as follows:
PERCENTAGE OF NET ASSETS
ATTRIBUTABLE TO COMMON SHARES
(ASSUMING NO FUND PREFERRED
SHARES ARE ISSUED OR
OUTSTANDING)
-----------------------------
ANNUAL EXPENSES
Management Fees........... .80%
Other Expenses............ .78%
----
Total Annual Expenses..... 1.58%
Fee Waiver (Years 1-5)(4). (.25)%(5)
----
Net Annual Expenses(4).... 1.33%(5)
====
(3)If the Fund offers Fund Preferred Shares, costs of that offering, estimated
to be approximately 2.1% of the total dollar amount of the Fund Preferred
Share offering, will be borne immediately by Common Shareholders and result
in a reduction of the net asset value of the Common Shares. Assuming the
issuance of Preferred Shares in an amount equal to 35% of the Fund's capital
(after their issuance), these offering costs are estimated to be
approximately $588,700 or $0.157 per Common Share (1.05% of the offering
price). These offering costs are not included among the expenses shown in
this table.
17
(FOOTNOTES CONTINUED FROM PREVIOUS PAGE)
(4)Year 1 represents the period from commencement of operations through
November 29, 2003.
(5)The Investment Manager has contractually agreed to waive a portion of its
investment management fees in the amount of 0.25% of average daily managed
assets (which include the liquidation preference of any Fund Preferred
Shares and the principal amount of any borrowings used for leverage) for the
first five years of the Fund's operations, 0.20% of average daily managed
assets in year six, 0.15% of average daily managed assets in year seven,
0.10% of average daily managed assets in year eight and 0.05% of average
daily managed assets in year nine. The Investment Manager has not agreed to
waive any portion of its fees beyond year nine of the Fund's operations.
Without the fee waiver, "Net Annual Expenses" would be estimated to be 2.21%
of average daily net assets attributable to Common Shares (assuming the
issuance of Fund Preferred Shares) and 1.58% of average daily net assets
attributable to Common Shares (assuming no Fund Preferred Shares are issued
or outstanding). The Investment Manager has also agreed to pay all
organizational expenses and offering costs (other than the sales load) that
exceed $0.03 per Common Share (0.20% of the offering price).
The purpose of the table above is to help you understand all fees and
expenses that you, as a Common Shareholder, would bear directly or indirectly.
The Other Expenses shown in the table and related footnotes are based on
estimated amounts for the Fund's first year of operations and assume that the
Fund issues approximately 3,750,000 Common Shares. If the Fund issues fewer
Common Shares, all other things being equal, these expenses as a percentage of
net assets would increase.
As required by relevant Securities and Exchange Commission regulations,
the following example illustrates the expenses (including the sales load of
$45, estimated offering expenses of this offering of $2.00 and the estimated
offering costs of issuing Fund Preferred Shares, assuming the Fund issues Fund
Preferred Shares representing 35% of the Fund's capital (after their issuance),
of $10.46) that you would pay on a $1,000 investment in Common Shares, assuming
(1) total net annual expenses of 1.83% of net assets attributable to Common
Shares (assuming the issuance of Fund Preferred Shares) in years 1 through 5,
increasing to 2.21% in year ten and (2) a 5% annual return(1).
1 YEAR 3 YEARS 5 YEARS 10 YEARS(2)
- ------ ------- ------- -----------
Total Expenses Incurred $75 $112 $151 $273
(1)THE EXAMPLE ABOVE SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE
EXPENSES. ACTUAL EXPENSES MAY BE HIGHER OR LOWER THAN THOSE SHOWN. The
example assumes that the estimated "Other Expenses" set forth in the Annual
Expenses table are accurate, that fees and expenses increase as described in
note 2 below, and that all dividends and distributions are reinvested at net
asset value. Actual expenses may be greater or less than those assumed.
Moreover, the Fund's actual rate of return may be greater or less than the
hypothetical 5% annual return shown in the example.
(2)Assumes waiver of management fees at the annual rate of 0.20% of the Fund's
average daily managed assets in year six, 0.15% in year seven, 0.10% in year
eight, and 0.05% in year nine. The Investment Manager has not agreed to
waive any portion of its fees beyond year nine of the Fund's operations. See
"Management of the Fund--Investment Management Agreement."
18
THE FUND
AEW Real Estate Income Fund is a newly organized, non-diversified,
closed-end management investment company. The Fund was organized as a
Massachusetts business trust on September 18, 2002 and is registered as an
investment company under the 1940 Act. As a newly-organized entity, the Fund
has no operating history. The Fund's principal office is located at 399
Boylston Street, Boston, Massachusetts 02116, and its telephone number is (800)
862-4863.
USE OF PROCEEDS
The net proceeds of the offering of Common Shares will be approximately
$53,606,250 (or $61,647,188 if the underwriters exercise the over-allotment
option in full) after payment of the estimated organizational and offering
costs and the sales load. The Investment Manager has agreed to pay the amount
by which the aggregate of all of the Fund's organizational expenses and
offering costs (other than the sales load) exceeds $0.03 per Common Share. The
Fund will invest the net proceeds of the offering in accordance with the Fund's
investment objectives and policies as stated below. It is presently anticipated
that the Fund will be able to invest substantially all of the net proceeds in
securities of Real Estate Companies that meet its investment objectives and
policies within three months after the completion of the offering. Pending such
investment, it is anticipated that the proceeds will be invested in U.S.
Government Securities or other high quality short-term securities.
INVESTMENT OBJECTIVES AND POLICIES
GENERAL
The Fund's primary investment objective is high current income. Capital
appreciation is the Fund's secondary investment objective. There can be no
assurance that the Fund will achieve its investment objectives. The Fund's
investment objectives are fundamental and may not be changed without the
approval of shareholders. Unless otherwise indicated, the Fund's investment
policies are not fundamental and may be changed by the Board of Trustees
without the approval of shareholders. The Fund has a policy of concentrating
its investments (investing 25% or more of its assets) in the U.S. real estate
industry and not in any other industry. This investment policy is considered
fundamental and may not be changed without the approval of a majority of the
Fund's outstanding voting securities, as defined in the 1940 Act. Under normal
market conditions, the Fund will invest at least 90% of its total assets in
income-producing common shares, preferred shares, convertible preferred shares
(preferred shares that, during certain periods or upon the happening of certain
events, may be converted into common shares) and debt securities issued by Real
Estate Companies, including real estate investment trusts, or "REITs." Under
normal market conditions, at least 80% of the Fund's total assets will be
invested in income-producing equity securities issued by REITs. A significant
portion of the equity securities of Real Estate Companies in which the Fund
invests are expected to trade on a national securities exchange or in the
over-the-counter markets. The Fund may invest up to 20% of its total assets in
U.S. Government obligations and debt securities, including convertible debt
securities, issued by Real Estate Companies. The preferred shares, convertible
preferred shares and debt securities in which the Fund may invest are sometimes
collectively referred to in this Prospectus as "Fixed Income Securities." The
Fund may invest in Fixed Income Securities that are below investment grade
quality, including securities that are unrated but judged to be of comparable
quality by the Investment Manager. A Fixed Income Security will be considered
to be investment grade if, at the time of investment, such security has a
rating of "BBB" or higher by S&P or "Baa" or higher by Moody's or an equivalent
rating by a nationally recognized statistical rating agency or, if unrated, is
judged to be of comparable quality by the Investment Manager. The Fund will not
invest in a non-investment grade Fixed Income Security if, as a result of such
investment, more than 25% of the Fund's total assets would be invested in
non-investment grade Fixed Income Securities. At least 90% of the Fund's total
assets will be invested in securities of U.S. issuers. The Fund may invest in
securities that are illiquid so long as no more than 10% of the total assets of
the Fund (taken at market value at the time of investment) would be invested in
such securities. The Fund may invest up to 10% of its total assets in
securities of non-U.S. issuers located in countries that are members of the
Organisation For Economic Co-operation and Development. The Fund will not
invest more than
19
15% of its total assets (taken at market value at the time of investment) in
the securities of any one issuer other than the U.S. Government, nor will it
invest directly in real estate or in securities of Real Estate Companies that
are controlled by the Investment Manager, CDC IXIS Asset Management North
America, L.P. or their respective affiliates.
In anticipation of or in response to adverse market conditions, for cash
management purposes or for defensive purposes, the Fund may temporarily hold
all or a portion of its assets in cash, money market instruments, or bonds or
other debt securities. The Fund would be unable to achieve its investment
objectives if a substantial portion of its assets consisted of such instruments.
The Fund will not enter into short sales or invest in derivatives, except
for interest rate hedging purposes as described in this prospectus. See "Use of
Leverage" and "Interest Rate Transactions."
INVESTMENT PHILOSOPHY
The Investment Manager employs a value-oriented investment strategy
designed to identify securities that are priced below what it believes is their
intrinsic value. The Investment Manager believes that ultimately the
performance of Real Estate Companies' securities is dependent upon the
performance of the underlying real estate assets and company management as well
as the overall influence of capital markets. Consequently, when selecting
securities for the Fund, the Investment Manager draws upon the combined
expertise of its real estate, research and securities professionals.
INVESTMENT PROCESS
When selecting investments for the Fund, the Investment Manager generally
considers the following factors that it believes help to identify those Real
Estate Companies whose securities represent the greatest value and income
and/or price appreciation potential:
VALUATION. The Investment Manager has developed a proprietary model to
assess the relative value of each security in the Fund's investment universe.
This model is designed to estimate what a Real Estate Company's anticipated
cash flows are worth to a security investor (a capital markets value) and to a
direct real estate investor (a real estate value). The model helps the
Investment Manager to identify securities that it believes trade at discounts
to either or both of these model values relative to similar securities. The
Investment Manager will generally sell a security once it is considered
overvalued or when the Investment Manager believes that there is greater
relative value in other securities in the Fund's investment universe.
PRICE. The Investment Manager examines the historic pricing of each Real
Estate Company in the Fund's universe of potential investments. Those
securities that have under-performed in price, either in absolute terms or
relative to the Fund's universe in general, are generally given greater weight
than those that have over-performed.
INCOME. The Investment Manager further evaluates Real Estate Companies
by analyzing their dividend yields as well as other factors that influence the
sustainability and growth of dividends. These factors include cash flow,
leverage and payout ratios.
CATALYSTS. When evaluating a security, the Investment Manager also seeks
to identify potential catalysts that, in its opinion, could cause the
marketplace to re-value the security in the near term. These catalysts can be
macroeconomic, market-driven or company-specific in nature.
In order to control risk, the Investment Manager will endeavor to
maintain a portfolio that is broadly diversified within the U.S. real estate
industry, with exposure to securities representing major property types and
geographic areas. However, the Investment Manager's stock selection disciplines
and fundamental real estate
20
market and property type analyses may lead the Investment Manager to overweight
or underweight particular property types and/or geographic regions from time to
time.
PORTFOLIO COMPOSITION
The Fund's portfolio will be composed principally of the following
investments. A more detailed description of the Fund's investment policies and
restrictions and more detailed information about the Fund's portfolio
investments are contained in the SAI.
REAL ESTATE COMPANIES. For purposes of these investment policies, a Real
Estate Company is one that:
. generally derives at least 50% of its revenues from the ownership,
construction, financing, management or sale of commercial,
industrial, or residential real estate; or
. has at least 50% of its assets invested in such real estate.
Under normal market conditions, the Fund will invest at least 90% of its
total assets in income-producing common shares, preferred shares, convertible
preferred shares (preferred shares that, during certain periods or upon the
happening of certain events, may be converted into common shares) and debt
securities issued by Real Estate Companies, including REITs. As part of this
policy, the Fund may also invest in rights or warrants to purchase
income-producing common and preferred shares of Real Estate Companies.
REAL ESTATE INVESTMENT TRUSTS. Under normal market conditions, at least
80% of the Fund's total assets will be invested in income-producing equity
securities issued by REITs. A REIT is a Real Estate Company that pools
investors' funds for investment primarily in income-producing real estate or in
real estate-related loans (such as mortgages) or other interests. A REIT is not
taxed on income distributed to shareholders if, among other things, it
distributes to its shareholders substantially all of its taxable income (other
than net capital gains) for each taxable year. As a result, REITs tend to pay
relatively higher dividends than other types of companies. The Fund intends to
use these REIT dividends in an effort to meet its primary objective of high
current income.
REITs can generally be classified as Equity REITs, Mortgage REITs and
Hybrid REITs. Equity REITs generally invest a majority of their assets in
income-producing real estate properties in order to generate cash flow from
rental income and gradual asset appreciation. The income-producing real estate
properties in which Equity REITs invest typically include properties such as
office buildings, retail and industrial facilities, hotels, apartment buildings
and healthcare facilities. Equity REITs can realize capital gains by selling
properties that have appreciated in value. Mortgage REITs invest the majority
of their assets in real estate mortgages and derive their income primarily from
interest payments on the mortgages. Hybrid REITs combine the characteristics of
both Equity REITs and Mortgage REITs. The Fund does not currently intend to
invest more than 10% of its total assets in Mortgage REITs or Hybrid REITs.
REITs can be listed and traded on national securities exchanges or can be
traded privately between individual owners. The Fund may invest in both
publicly and privately traded REITs.
PREFERRED SHARES. Preferred shares pay fixed or floating dividends to
investors, and have a "preference" over common stock in the payment of
dividends and the liquidation of a company's assets. This means that a company
must pay dividends on preferred shares before paying any dividends on its
common shares. Preferred shareholders usually have no right to vote for
corporate directors or on other matters. Under normal market conditions, the
Investment Manager expects to invest approximately 60% to 80% of the Fund's
total assets in common shares of Real Estate Companies and approximately 20% to
40% of its total assets in preferred shares, including convertible preferred
shares, issued by Real Estate Companies. The actual percentage of common,
preferred and convertible preferred shares, rights and warrants, U.S.
Government obligations and debt securities in the Fund's portfolio may vary
over time based on the Investment Manager's assessment of market conditions.
21
U.S. GOVERNMENT OBLIGATIONS. The Fund may invest in U.S. Government
obligations, provided that such investments, together with the Fund's
investments in debt securities (including convertible debt securities) do not
exceed 20% of the Fund's total assets, taken at market value at the time of
investment. Obligations issued or guaranteed by the U.S. Government, its
agencies and instrumentalities include bills, notes and bonds. Obligations of
certain agencies and instrumentalities of the U.S. Government are supported by
the full faith and credit of the U.S. Treasury; others are supported by the
right of the issuer to borrow from the Treasury; others are supported by the
discretionary authority of the U.S. Government to purchase the agency's
obligations; still others, though issued by an instrumentality chartered by the
U.S. Government, are supported only by the credit of the instrumentality. The
U.S. Government may choose not to provide financial support to U.S.
Government-sponsored agencies or instrumentalities if it is not legally
obligated to do so.
LOWER-RATED SECURITIES. The Fund may invest in non-investment grade
quality Fixed Income Securities. Non-investment grade quality Fixed Income
Securities are those that are not rated "Baa" or "BBB" or above by Moody's or
S&P (or a comparable rating by another nationally recognized statistical rating
agency) or, if unrated, are judged to be of comparable quality by the
Investment Manager. If a Fixed Income Security is rated differently by two or
more nationally recognized statistical rating agencies, the Investment Manager
may rely on the higher rating if it believes that rating to be more accurate.
The Fund will not invest in a non-investment grade Fixed Income Security if, as
a result of such investment, more than 25% of the Fund's total assets would be
invested in non-investment grade Fixed Income Securities. In the event that a
downgrade of one or more investment grade quality Fixed Income Securities
causes the Fund to exceed this 25% limit, the Investment Manager will
determine, in its discretion, whether to sell any non-investment grade Fixed
Income Securities to reduce the percentage to below 25% of the Fund's total
assets. It is possible, therefore, that the value of non-investment grade Fixed
Income Securities could exceed 25% of the Fund's total assets for an indefinite
period of time. The 25% restriction described above does not limit the Fund's
ability to invest in securities other than Fixed Income Securities (such as
common shares of Real Estate Companies). The Investment Manager will monitor
the credit quality of the issuers of the Fund's Fixed Income Securities.
Securities that are below investment grade quality are regarded as having
predominately speculative characteristics with respect to capacity to pay
interest and repay principal. Debt securities that are below investment grade
quality are commonly referred to as "junk bonds." The Fund may only invest in
non-investment grade securities that are rated "CCC" or higher by S&P or "Caa"
or higher by Moody's (or a comparable rating by another nationally recognized
statistical rating agency), or unrated securities judged to be of comparable
quality by the Investment Manager. The issuers of these securities may be in
default or have a currently identifiable vulnerability to default on their
payments of principal and interest, or may otherwise be subject to present
elements of danger with respect to payments of principal or interest. However,
the Fund may not invest in securities that are in default as to payment of
principal and interest at the time of investment. See "Principal Risks of the
Fund--Risks Of Investment In Lower-Rated Securities." For a description of
security ratings, see Appendix A to the SAI.
ILLIQUID SECURITIES. The Fund may invest in securities that are illiquid
so long as no more than 10% of the total assets of the Fund (taken at market
value at the time of investment) would be invested in such securities. The term
"illiquid securities" for these purposes means securities that cannot be
disposed of within seven days in the ordinary course of business at
approximately the amount at which the Fund has valued the securities. The above
limitation applies only at the time a security is purchased, and the Fund is
not required to dispose of securities if, due to market movements, greater than
10% of the Fund's total assets are invested in illiquid securities.
The Board of Trustees has delegated to the Investment Manager the
day-to-day determination of the illiquidity of any security held by the Fund,
although it has retained oversight and ultimate responsibility for such
determinations. Certain illiquid securities may require pricing at fair value
as determined in good faith under the supervision of the Board of Trustees. See
"Net Asset Value." The Investment Manager may be subject to significant delays
in disposing of illiquid securities held by the Fund, and transactions in
illiquid securities may
22
entail registration expenses and other transaction costs that are higher than
those for transactions in liquid securities. If adverse market conditions were
to develop during any such delay, the Fund might obtain a less favorable price
than that which prevailed when it decided to sell.
As discussed below under "Interest Rate Transactions," the Fund intends
to segregate cash or liquid securities with its custodian having a value at
least equal to the Fund's net payment obligations under any swap transaction,
as marked to market daily. The Fund will treat such amounts as illiquid for
purposes of its 10% limit on investments in illiquid securities.
SHORT SALES AND DERIVATIVES. The Fund will not enter into short sales or
invest in derivatives, except for interest rate hedging purposes as described
in this prospectus. See "Use of Leverage" and "Interest Rate Transactions."
The Fund will only enter into futures contracts to hedge interest rate
risks. A futures contract is a two party agreement to buy or sell a specified
amount of a specified security, such as a U.S. Treasury security, for a
specified price at a designated date, time and place. Brokerage fees are
incurred when a futures contract is bought or sold, and margin deposits must be
maintained at all times when a futures contract is outstanding. The Fund may
purchase and sell futures contracts as an offset against the effect of expected
changes in interest rates. The Fund will only enter into futures contracts that
are traded on domestic futures exchanges and are standardized as to maturity
date and underlying financial instrument.
The Fund will only purchase or sell options on futures contracts to hedge
interest rate risks. Options on futures contracts give the purchaser the right,
in return for the premium paid, to assume a position in a futures contract (a
long position if the option is a call and a short position if the option is a
put) at a specified exercise price at any time during the period of the option.
Upon exercise of the option, the delivery of the futures contract position by
the writer of the option to the holder of the option will be accompanied by
delivery of the accumulated balance in the writer's futures contract margin
account. If the Fund sells ("writes") options on futures contracts, it will
segregate cash or liquid securities in an amount necessary to cover its
obligations under the option, and will mark such amounts to market daily.
NON-PRINCIPAL INVESTMENT STRATEGIES
In addition to the investment strategies discussed above, the Fund may
also invest in other portfolio instruments or use other investment strategies,
including those listed below. For additional information about the Fund's
investments, please see the SAI.
WARRANTS AND RIGHTS. The Fund may invest in warrants or rights to
purchase income-producing common and preferred shares of Real Estate Companies.
Warrants are options to purchase equity securities at a specified price for a
specified period of time. Their prices do not necessarily move parallel to the
prices of the underlying securities. Rights are similar to warrants but
normally have a shorter duration and are typically distributed directly by the
issuer to shareholders. Rights and warrants generally have no voting rights,
receive no dividends and have no rights with respect to the assets of the
issuer.
TEMPORARY AND DEFENSIVE INVESTMENTS. In anticipation of or in response
to adverse market conditions, for cash management purposes or for defensive
purposes, the Fund may temporarily hold all or a portion of its assets in cash,
money market instruments, or bonds or other debt securities. The Fund would be
unable to achieve its investment objectives if a substantial portion of its
assets consisted of such instruments.
23
SECURITIES LENDING. The Fund may lend its portfolio securities
(generally to broker-dealers and other financial institutions) where such loans
are callable at any time and are continuously secured by segregated collateral
equal to no less than the market value, determined daily, of the loaned
securities. The Fund's net asset value would continue to reflect the value of
the loaned securities, and the Fund would continue to receive the income on the
loaned securities and would at the same time earn interest on the collateral or
on the investment of any cash collateral. The Fund presently intends to invest
such cash collateral in money market instruments listed below in "--Other
Investments." The Fund will not lend portfolio securities representing more
than one-third of its total assets. The Fund may pay lending fees to the party
arranging the loan.
Lending securities involves a risk of loss to the Fund if and to the
extent that the market value of the securities loaned increases and the
collateral is not increased accordingly. Securities lending also 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.
FUNDAMENTAL INVESTMENT POLICIES
The Fund has adopted certain fundamental investment policies designed to
limit investment risk and maintain portfolio diversification. These fundamental
investment policies may not be changed without the approval of the holders of a
majority of the outstanding Common Shares and, if issued, Fund Preferred
Shares, voting as a single class. A "majority of the outstanding" shares for
these purposes means (i) 67% or more of the shares present at a meeting, if the
holders of more than 50% of the shares outstanding are present or represented
by proxy, or (ii) more than 50% of the shares outstanding, whichever of (i) or
(ii) is less. The Fund may become subject to guidelines which are more limiting
than the investment restrictions set forth above or in the SAI in order to
obtain and maintain ratings from a rating agency on any Fund Preferred Shares
that it may issue. It is not currently anticipated that these guidelines will
materially impede the Investment Manager from managing the Fund's portfolio in
accordance with the Fund's investment objectives and policies. See "Investment
Objectives and Policies" and "Investment Restrictions" in the SAI for
information about these guidelines and a complete list of the fundamental
investment policies of the Fund. See "Description of Shares--Fund Preferred
Shares--Voting Rights" for additional information with respect to the voting
rights of holders of Fund Preferred Shares.
OTHER INVESTMENTS
The Fund's cash reserves, held to provide sufficient flexibility to take
advantage of new opportunities for investments and for other cash needs, will
be invested in money market instruments. Money market instruments in which the
Fund may invest its cash reserves will generally consist of obligations issued
or guaranteed by the U.S. Government, its agencies or instrumentalities,
repurchase agreements collateralized by such obligations, commercial paper and
shares of money market funds. Subject to certain restrictions contained in any
applicable exemptive order issued by the Securities and Exchange Commission,
these instruments may include investment companies such as money market funds
advised or subadvised by the Investment Manager or its affiliates. To the
extent the Fund purchases shares of a money market fund, the Fund will
indirectly bear its proportionate share of the advisory fees and other
operating expenses of such fund.
USE OF LEVERAGE
Subject to market conditions and the Fund's receipt of the highest credit
rating on the Fund Preferred Shares from at least one nationally recognized
statistical rating agency (e.g., AAA or Aaa), approximately one to three months
after the completion of the offering of the Common Shares, the Fund intends to
offer Fund Preferred Shares representing approximately 35% of the Fund's
capital immediately after their issuance. The issuance of Fund Preferred Shares
will leverage the Common Shares. As an alternative to issuing Fund Preferred
Shares, the Fund may leverage through the issuance of commercial paper or notes
or other borrowings. Any Fund Preferred Shares or borrowings will have
seniority over the Common Shares.
24
Under the 1940 Act, the Fund is not permitted to issue preferred shares
unless, immediately after the issuance, the value of the Fund's total assets
(less any liabilities not representing senior securities) is at least 200% of
the liquidation value of the outstanding preferred shares plus the aggregate
amount of any senior securities of the Fund representing indebtedness (I.E.,
such liquidation value plus the aggregate amount of any senior securities of
the Fund representing indebtedness may not exceed 50% of the Fund's total
assets less liabilities not representing senior securities). In addition, the
Fund is not permitted to declare any cash dividend or other distribution on its
Common Shares if, after giving effect to the distribution, the Fund does not
satisfy the above-referenced 200% asset coverage requirement. If Fund Preferred
Shares are issued, the Fund intends, to the extent possible, to purchase or
redeem Fund Preferred Shares from time to time to the extent necessary in order
to maintain asset coverage of any Fund Preferred Shares of at least 200%. If
the Fund has Fund Preferred Shares outstanding, two of the Fund's Trustees will
be elected by the holders of Fund Preferred Shares, voting separately as a
class. The remaining Trustees of the Fund will be elected by holders of Common
Shares and Fund Preferred Shares voting together as a single class. In the
event the Fund failed to pay dividends on Fund Preferred Shares for two years,
Fund Preferred Shareholders would be entitled to elect a majority of the
Trustees of the Fund. The failure to pay dividends or make distributions could
result in the Fund ceasing to qualify as a regulated investment company under
the Code, which could have a material adverse effect on the value of the Common
Shares. See "Description of Shares--Fund Preferred Shares."
Under the 1940 Act, the Fund generally is not permitted to borrow unless
immediately after the borrowing the value of the Fund's total assets less
liabilities not representing senior securities is at least 300% of the
principal amount of such borrowing (I.E., such principal amount may not exceed
33 1/3% of the Fund's total assets less liabilities not representing senior
securities). In addition, the Fund is not permitted to declare any cash
dividend or other distribution on its Common Shares if, at the time of such
declaration, the Fund does not satisfy the 300% asset coverage requirement. If
the Fund borrows, the Fund intends, to the extent possible, to prepay all or a
portion of the principal amount of the borrowing to the extent necessary in
order to maintain the required asset coverage. Failure to maintain certain
asset coverage requirements could result in an event of default and entitle the
debt holders to elect a majority of the Board of Trustees.
The Fund may be subject to certain restrictions imposed by either
guidelines of one or more rating agencies that may issue ratings for Fund
Preferred Shares or, if the Fund borrows from a lender, by the lender. These
guidelines may impose asset coverage or portfolio composition requirements that
are more stringent than those imposed on the Fund by the 1940 Act. It is not
anticipated that these covenants or guidelines will materially impede the
Investment Manager from managing the Fund's portfolio in accordance with the
Fund's investment objectives and policies. In addition to other considerations,
to the extent that the Fund believes that the covenants and guidelines required
by the rating agencies would materially impede its ability to meet its
investment objectives, or if the Fund is unable to obtain its desired rating on
the Fund Preferred Shares (expected to be AAA/Aaa), the Fund will not issue the
Fund Preferred Shares.
Assuming that the Fund Preferred Shares or borrowings will represent
approximately 35% of the Fund's capital and pay dividends or interest at an
annual average rate of 4.00%, the income generated by the Fund's portfolio (net
of estimated expenses) must exceed 1.36% in order to cover such dividend or
interest payments. Of course, these numbers are merely estimates, used for
illustration. Actual Fund Preferred Share dividend rates or interest rates on
borrowings may vary frequently and may be significantly higher or lower than
the rate estimated above.
The following table is furnished in response to requirements of the
Securities and Exchange Commission. It is designed to illustrate the effect of
leverage on Common Share total return, assuming investment portfolio total
returns (comprised of income and changes in the value of investments held in
the Fund's portfolio) of -10%, -5%, 0%, 5% and 10%. These assumed investment
portfolio returns are hypothetical figures and are not necessarily indicative
of the investment portfolio returns expected to be experienced by the Fund. The
table further reflects the issuance of Fund Preferred Shares or use of
borrowings representing 35% of the Fund's total capital (after their issuance)
and the Fund's currently projected annual Fund Preferred Share
25
dividend rate, borrowing interest rate or payment rate set by an interest rate
transaction of 4.00%. See "Use of Leverage--Leverage Risks." The table does not
reflect any offering costs of Common Shares or Fund Preferred Shares or
expenses attributable to any borrowings.
Assumed Portfolio Total Return (Net of
Expenses)........................... (10)% (5)% 0 % 5% 10%
Common Share Total Return............. (17.18)% (9.62)% (2.05)% 5.51% 13.08%
Common Share total return is composed of two elements--the Common Share
distributions paid by the Fund (the amount of which is largely determined by
the net investment income of the Fund after paying dividends on Fund Preferred
Shares or interest on borrowings) and gains or losses on the value of the
securities the Fund owns. As required by Securities and Exchange Commission
rules, the table assumes that the Fund is more likely to suffer capital losses
than to enjoy capital appreciation. For example, to assume a total return of
0%, the Fund must assume that the net investment income it receives on its
investments is entirely offset by losses in the value of those investments.
During the time in which the Fund is utilizing leverage, the fees paid to
the Investment Manager and its affiliates for investment advisory, management
and other services will be higher than if the Fund did not utilize leverage
because the fees paid will be calculated based on the Fund's managed assets,
which include the liquidation preference of any Fund Preferred Shares and the
principal amount of any borrowings used for leverage. In addition, fees and
expenses paid by the Fund are borne entirely by the Common Shareholders (and
not by holders of Fund Preferred Shares, if any). These include costs
associated with any offering of Fund Preferred Shares by the Fund (which costs
are estimated to be approximately 2.1% of the total dollar amount of a Fund
Preferred Share offering), which will be borne immediately by Common
Shareholders (as will the costs associated with any borrowings or other forms
of leverage utilized by the Fund) and result in a reduction of the net asset
value of the Common Shares.
The Fund may also borrow money as a temporary measure for extraordinary
or emergency purposes, including the payment of dividends and the settlement of
securities transactions that otherwise might require untimely dispositions of
Fund securities. Such borrowings are not considered leverage for purposes of
the restrictions set forth in this prospectus.
LEVERAGE RISKS
Utilization of leverage is a speculative investment technique and
involves certain risks to the Common Shareholders. There is no assurance that
the Fund will utilize leverage or that, if utilized, the Fund's leveraging
strategy will be successful.
Leverage creates two major types of risks for Common Shareholders:
. The likelihood of greater volatility of net asset value and market
price of Common Shares because changes in the value of the Fund's
portfolio (including changes in the value of any interest rate swap
or cap, if applicable) are borne entirely by the Common Shareholders;
and
. The possibility either that Common Share income will fall if the
dividend rate on the Fund Preferred Shares or the interest rate on
any borrowings rises, or that Common Share income will fluctuate
because the dividend rate on the Fund Preferred Shares or the
interest rate on any borrowings varies.
The use of leverage creates an opportunity for increased Common Share net
income, but also creates special risks for Common Shareholders. It is
anticipated that the Fund Preferred Shares will generally pay dividends based
on short-term rates, which will be reset frequently. Borrowings may be at a
fixed or floating rate. The Fund may seek to protect itself from the risk of
increasing dividends or interest expenses resulting from an increase in
short-term interest rates by entering into a swap or cap transaction as to all
or a portion of the Fund
26
Preferred Shares or any borrowings. See "Interest Rate Transactions." As long
as the rate of return, net of applicable Fund expenses, on the Fund's portfolio
investments exceeds Fund Preferred Share dividend rates, as reset periodically,
interest on any borrowings or the payment rate set by any interest rate swap,
the investment of the proceeds of the Fund Preferred Shares or any borrowing
will generate more income than will be needed to pay such dividends, interest
rate or swap payment. If so, the excess may be available to pay higher
dividends to Common Shareholders. If, however, the dividend or interest rate on
any borrowings, as modified by any cap, or the payment rate set by any interest
rate swap, approaches the net return on the Fund's portfolio investments, the
benefit of leverage to Common Shareholders will be reduced, and if such
dividend or interest rate exceeds the net return on the Fund's investment
portfolio, the return to Common Shareholders will be less than if
the Fund had not used leverage. Fund Preferred Shares are expected to pay
cumulative dividends, which may tend to increase leverage risk.
To the extent that the Fund is required or elects to redeem any Fund
Preferred Shares or prepay any borrowings, the Fund may need to liquidate
investments to fund such redemptions or prepayments. Liquidation at times of
adverse economic conditions may result in capital loss and reduce returns to
Common Shareholders. In addition, such redemption or prepayment would likely
result in the Fund seeking to terminate early all or a portion of any swap or
cap transaction. Early termination of the swap or cap could result in a
termination payment by the Fund. See "Interest Rate Transactions."
Although it is a condition to the issuance of any Fund Preferred Shares
that such Fund Preferred Shares be issued with the highest rating from at least
one nationally recognized statistical rating agency, such ratings will not
eliminate or mitigate the risk of investing in Common Shares. If the rating on
any Fund Preferred Shares is downgraded or withdrawn, the Fund would likely be
forced to redeem some or all Fund Preferred Shares, which could adversely
affect Common Shareholders as described above.
Unless and until Fund Preferred Shares are issued or borrowings for
leverage are made, the Common Shares will not be leveraged and the disclosure
regarding these strategies will not apply.
INTEREST RATE TRANSACTIONS
In order to reduce the interest rate risk inherent in the Fund's
investments and capital structure, the Fund may enter into interest rate swap
or cap transactions. The Fund would use interest rate swaps or caps only with
the intent to reduce or eliminate the risk that an increase in short-term
interest rates could have on Common Share net earnings as a result of leverage.
Interest rate swaps involve the Fund's agreement with the swap
counterparty to pay a fixed rate payment in exchange for the counterparty
paying the Fund a variable rate payment that is intended to approximate all or
a portion of the Fund's variable rate payment obligation on Fund Preferred
Shares or any variable rate borrowing. The payment obligation would be based on
the notional amount of the swap, which will not exceed the amount of the Fund's
leverage. The Fund intends to segregate cash or liquid securities having a
value at least equal to the Fund's net payment obligations under any swap
transaction, marked to market daily. The Fund will treat such amounts as
illiquid for purposes of its 10% limit on investments in illiquid securities.
The Fund may use an interest rate cap, which would require it to pay a
premium to the cap counterparty and would entitle it, to the extent that a
specified variable rate index exceeds a predetermined fixed rate, to receive
payment from the counterparty of the difference based on the notional amount.
The use of interest rate swaps and caps is a highly specialized activity
that involves investment techniques and risks different from those associated
with ordinary portfolio security transactions. Common Shareholders will bear
the risks and costs associated with the Fund's use of interest rate
transactions. Depending on the state of interest rates in general, the Fund's
use of interest rate instruments could enhance or harm the overall performance
of the Common Shares. To the extent there is a decline in interest rates, the
net amount
27
receivable by the Fund, if any, under the interest rate swap or cap could
decline, and this could thus result in a decline in the net asset value of the
Common Shares. In addition, if short-term interest rates are lower than the
Fund's fixed rate of payment on the interest rate swap, the swap will reduce
Common Share net earnings. If, on the other hand, short-term interest rates are
higher than the fixed rate of payment on the interest rate swap, the swap will
enhance Common Share net earnings. Buying interest rate caps could enhance the
performance of the Common Shares by providing a maximum leverage expense.
Buying interest rate caps could also decrease the net earnings of the Common
Shares in the event that the premium paid by the Fund to the counterparty
exceeds the additional amount of dividends on Fund Preferred Shares or interest
on borrowings that the Fund would have been required to pay had it not entered
into the cap agreement. The Fund has no current intention of entering into
swaps or caps other than as described in this prospectus. The Fund would not
enter into interest rate swap or cap transactions in an aggregate notional
amount that exceeds the outstanding amount of the Fund's leverage.
Interest rate swaps and caps do not involve the delivery of securities or
other underlying assets or principal. Accordingly, the risk of loss with
respect to interest rate swaps is limited to the net amount of interest
payments that the Fund is contractually obligated to make. If the counterparty
defaults, the Fund would not be able to use the anticipated net receipts under
the swap or cap to offset the dividend payments on Fund Preferred Shares or
interest payments on borrowings. Depending on whether the Fund would be
entitled to receive net payments from the counterparty on the swap or cap,
which in turn would depend on the general state of short-term interest rates at
that point in time, such a default could negatively impact the performance of
the Common Shares. The Fund will usually enter into swaps or caps on a net
basis; that is, the two payment streams will be netted out in a cash settlement
on the payment date or dates specified in the instrument, with the Fund
receiving or paying, as the case may be, only the net amount of the two
payments.
The Fund will not enter into an interest rate swap or cap transaction
with any counterparty that the Investment Manager believes does not have the
financial resources to honor its obligation under the interest rate swap or cap
transaction. Further, the Investment Manager will monitor the financial
stability of a counterparty to an interest rate swap or cap transaction in an
effort to protect the Fund's investments proactively. However, these measures
will not guarantee that the counterparty to a swap or cap transaction will not
default.
The Fund may not be able to enter into a suitable interest rate swap or
cap transaction when the Investment Manager believes such a transaction would
be appropriate, or the terms of the transaction may be less favorable then
expected. In addition, at the time the interest rate swap or cap transaction
reaches its scheduled termination date, there is a risk that the Fund will not
be able to obtain a replacement transaction or that the terms of the
replacement will not be as favorable as those of the expiring transaction. If
these situations occur, they could have a negative impact on the performance of
the Common Shares.
The Fund may choose or be required to redeem some or all Fund Preferred
Shares or prepay any borrowings. This redemption would likely result in the
Fund seeking to terminate early all or a portion of any swap or cap
transaction. Such early termination of a swap or cap could result in a
termination payment by the Fund. There may also be penalties associated with
early termination.
The Fund may also purchase and sell futures contracts and options on
futures contracts to hedge interest rate risk. See "Investment Objectives and
Policies--Portfolio Composition--Short Sales and Derivatives."
The Fund's ability to engage in interest rate transactions may be limited
by tax considerations.
PRINCIPAL RISKS OF THE FUND
The Fund is a newly organized, non-diversified, closed-end management
investment company designed primarily as a long-term investment and not as a
trading vehicle. The Fund is not intended to be a complete investment program
and, due to the uncertainty inherent in all investments, there can be no
assurance that the Fund will achieve its investment objectives.
28
NO OPERATING HISTORY
The Fund is a newly organized, non-diversified, closed-end management
investment company with no operating history.
INVESTMENT RISK
An investment in the Fund is subject to investment risk, including the
possible loss of the entire principal amount that you invest.
ISSUER RISK
The value of an equity or debt security may decline for a number of
reasons that directly relate to the Real Estate Company that issues it, such as
management performance, financial leverage and reduced demand for the Real
Estate Company's properties and services.
MARKET RISK
Your investment in the Common Shares represents an indirect investment in
the REIT shares and other securities of Real Estate Companies owned by the
Fund, a significant portion of which are expected to trade on a national
securities exchange or in the over-the-counter markets. The value of these
securities, like other investments traded on securities markets, may move up or
down, sometimes rapidly and unpredictably. Preferred shares and debt securities
are generally more sensitive to changes in interest rates than common stocks.
When interest rates rise, the market value of preferred shares and debt
securities generally will fall. Your Common Shares at any point in time may be
worth less than what you invested, even after taking into account the
reinvestment of Fund dividends and distributions. The Fund may utilize
leverage, which magnifies market risk. See "Use of Leverage--Leverage Risks."
INTEREST RATE RISK
Interest rate risk is the risk that fixed-income investments such as
preferred shares, U.S. Government obligations and debt securities, and to a
lesser extent dividend-paying common stocks such as REIT common shares, will
decline in value because of changes in interest rates. When interest rates
rise, the market value of such securities generally will fall. The Fund's
investment in such securities means that the net asset value and market price
of Common Shares will tend to decline if market interest rates rise. Also,
during periods of declining interest rates, many mortgages may be refinanced,
which may reduce the yield from securities of Real Estate Companies that invest
primarily in loans secured by real estate and generally derive their income
primarily from interest payments on mortgage loans. This risk is commonly known
as "prepayment risk." The Fund intends to use leverage, which may tend to
magnify interest rate risk. See "Principal Risks of the Fund--Leverage Risk."
The Fund may use swaps, caps, futures contracts and options on futures
contracts to help control interest rate risk. See "Investment Objectives and
Policies--Portfolio Composition--Short Sales and Derivatives" and "Interest
Rate Transactions."
GENERAL RISKS OF SECURITIES LINKED TO THE REAL ESTATE MARKET
The Fund will not invest in real estate directly, but will invest in real
estate indirectly by purchasing securities issued by Real Estate Companies,
including REITs. However, because of the Fund's policy of concentrating in the
securities of companies in the real estate industry, it is also subject to the
risks associated with the direct ownership of real estate. These risks include:
. declines in the value of real estate
. risks related to general and local economic conditions
29
. possible lack of availability of mortgage funds
. overbuilding
. extended vacancies of properties
. increased competition
. increases in property taxes and operating expenses
. changes in zoning laws
. losses due to costs resulting from the clean-up of environmental
problems
. liability to third parties for damages resulting from environmental
problems
. casualty or condemnation losses
. limitations on rents
. changes in neighborhood values and the appeal of properties to tenants
. changes in interest rates
Thus, the value of the Common Shares may change at different rates
compared to the value of shares of a registered investment company with
investments in a mix of different industries and will depend on the general
condition of the economy. An economic downturn could have a material adverse
effect on the real estate markets and on Real Estate Companies in which the
Fund invests, which in turn could result in the Fund not achieving its
investment objectives.
GENERAL REAL ESTATE RISKS. Real property investments are subject to
varying degrees of risk. The yields available from investments in real estate
depend on the amount of income and capital appreciation generated by the
related properties. Income and real estate values may also be adversely
affected by such factors as applicable laws (e.g., The Americans with
Disabilities Act and tax laws), supply and demand disparities, interest rate
levels, and the availability of financing. If the properties do not generate
sufficient income to meet operating expenses, including, where applicable, debt
service, ground lease payments, tenant improvements, third-party leasing
commissions and other capital expenditures, the income and ability of the Real
Estate Company to make payments of any dividends or interest and principal on
its securities will be adversely affected. In addition, real property may be
subject to the quality of credit extended and defaults by borrowers and
tenants. The performance of the economy in each of the regions in which the
real estate owned by the Real Estate Company is located affects occupancy,
market rental rates and expenses and, consequently, has an impact on the income
from such properties and their underlying values. The financial results of
major local employers also may have an impact on the cash flow and value of
certain properties. In addition, real estate investments are relatively
illiquid and, therefore, the ability of Real Estate Companies to vary their
portfolios promptly in response to changes in economic or other conditions is
limited. A Real Estate Company may also have joint venture investments in
certain of its properties, and consequently, its ability to control decisions
relating to such properties may be limited.
In addition to these risks, investments in real estate and Real Estate
Companies are also subject to risks that are specific to the investment sector
or type of property in which the Real Estate Companies are investing. Some of
these specific risks, which could have an adverse effect on the Fund's return,
are discussed below.
RETAIL PROPERTIES. Retail properties are affected by the overall health
of the national and relevant local economy. A retail property may be adversely
affected by the growth of alternative forms of retailing, bankruptcy, decline
in drawing power, departure or cessation of operations of an anchor tenant, a
shift in consumer demand due to demographic changes, and/or changes in consumer
preference (for example, to discount retailers) and spending patterns. A retail
property may also be adversely affected if a significant tenant ceases
operation at such
30
location, voluntarily or otherwise. Certain tenants at retail properties may be
entitled to terminate their leases if an anchor tenant ceases operations at
such property.
OFFICE PROPERTIES. Office properties are also affected by the overall
health of the national and relevant local economy. Office properties generally
require their owners to expend significant amounts for general capital
improvements, tenant improvements and costs of reletting space. In addition,
office properties that are not equipped to accommodate the needs of modern
businesses may become functionally obsolete and thus non-competitive. Office
properties may also be adversely affected if there is an economic decline in
the businesses operated by their tenants. The risks of such an adverse effect
are increased if the property revenue is dependent on a single tenant or if
there is a significant concentration of tenants in a particular business or
industry.
HOTEL PROPERTIES. The risks of hotel properties include, among other
things, the necessity of a high level of continuing capital expenditures to
keep necessary furniture, fixtures and equipment updated, competition from
other hotels, increases in operating costs (which increases may not necessarily
be offset in the future by increased room rates), dependence on business and
commercial travelers and tourism, increases in fuel costs and other expenses of
travel, changes to regulation of operating, liquor and other licenses, and
adverse effects of general and local economic conditions. Due to the fact that
hotel rooms are generally rented for short periods of time, hotel properties
tend to be more sensitive to adverse economic conditions and competition than
many other commercial properties.
Also, hotels may be operated pursuant to franchise, management and
operating agreements that may be terminable by the franchiser, the manager or
the operator. On the other hand, it may be difficult to terminate an
ineffective operator of a hotel property.
HEALTHCARE PROPERTIES. Healthcare properties and healthcare providers
are affected by several significant factors, including federal, state and local
laws governing licenses, certification, adequacy of care, pharmaceutical
distribution, rates, equipment, personnel and other factors regarding
operations; continued availability of revenue from government reimbursement
programs (primarily Medicaid and Medicare) and from private sector health
insurance providers; and competition in terms of appearance, reputation,
quality and cost of care with similar properties on a local and regional basis.
Governmental laws and regulations are subject to frequent and substantial
changes resulting from legislation, adoption of rules and regulations, and
administrative and judicial interpretations of existing law. Changes may also
be applied retroactively and the timing of such changes cannot be predicted.
The failure of any healthcare operator to comply with governmental laws and
regulations may affect its ability to operate its facility or receive
government reimbursement. In addition, in the event that a tenant is in default
on its lease, a new operator or purchaser at a foreclosure sale will have to
apply in its own right for all relevant licenses if such new operator does not
already hold such licenses. There can be no assurance that such new licenses
could be obtained, and consequently, there can be no assurance that any
healthcare property subject to foreclosure will be disposed of in a timely
manner.
MULTIFAMILY/RESIDENTIAL PROPERTIES. The value and successful operation
of a multifamily/residential property may be affected by a number of factors
such as the location of the property, the ability of management to provide
adequate maintenance and insurance, the types of services provided by the
property, the level of mortgage rates, presence of competing properties, the
relocation of tenants to new properties with better amenities, adverse economic
conditions in the locale, the amount of rent charged, and oversupply of units
due to new construction. In addition, multifamily properties may be subject to
rent control laws or other laws affecting such properties, which could impact
the cash flows of such properties.
SELF-STORAGE PROPERTIES. The value and successful operation of a
self-storage property may be affected by a number of factors, such as the
ability of the management team, the location of the property, the presence of
competing properties, changes in traffic patterns, and adverse effects of
general and local economic conditions.
31
INSURANCE ISSUES. Certain Real Estate Companies may, in connection with
the issuance of securities, have disclosed that they carry comprehensive
liability, fire, flood, extended coverage and rental loss insurance with policy
specifications, limits and deductibles customarily carried for similar
properties. However, such insurance is not uniform among Real Estate Companies.
Moreover, there are certain types of extraordinary losses that may be
uninsurable, or not insurable at economic rates. Certain properties may be
subject to catastrophic events, such as terrorism, earthquake activity, floods
or fires, for which insurance coverage cannot be economically obtained. Should
a property sustain damage as a result of a catastrophic event, even if the Real
Estate Company maintains appropriate insurance, the Real Estate Company may
incur substantial losses due to insurance deductibles, co-payments on insured
losses or uninsured losses. Should any type of uninsured loss occur (or if an
insurer is unwilling or unable to pay a claim), the Real Estate Company could
lose its investment in, and anticipated profits and cash flows from, a number
of properties, and the Fund's investment performance may be impacted as a
result.
FINANCIAL LEVERAGE RISK. Real Estate Companies may be highly leveraged
and financial covenants may affect the ability of Real Estate Companies to
operate effectively. Real Estate Companies are subject to risks normally
associated with debt financing. If the principal payments of a Real Estate
Company's debt cannot be refinanced, extended or paid with proceeds from other
capital transactions, such as new equity capital, the Real Estate Company's
cash flow may not be sufficient to make scheduled interest payments or to repay
principal.
In addition, a Real Estate Company's obligation to comply with financial
covenants, such as debt-to-asset ratios and secured debt-to-total asset ratios,
and other contractual obligations may restrict a Real Estate Company's range of
operating activity. A Real Estate Company, therefore, may be limited from
incurring additional indebtedness, selling its assets and engaging in mergers
or making acquisitions that may be beneficial to the operation of the Real
Estate Company.
ENVIRONMENTAL ISSUES. In connection with the ownership (direct or
indirect), operation, management and development of real properties that may
contain hazardous or toxic substances, a Real Estate Company may be considered
an owner or operator of such properties or as having arranged for the disposal
or treatment of hazardous or toxic substances and, therefore, may be
potentially liable for removal or remediation costs, as well as certain other
costs, including governmental fines and liabilities for injuries to persons and
property. The existence of any such environmental liability could have a
material adverse effect on the results of operations and cash flow of any such
Real Estate Company and, as a result, the net asset value of the Fund's Common
Shares or the amount available to make distributions on shares of the Fund
could be reduced.
SMALLER COMPANIES. Even the larger REITs in the industry tend to be
small to medium-sized companies in relation to the equity markets as a whole.
There may be less trading in a smaller company's stock, which means that buy
and sell transactions in that stock could have a larger impact on the stock's
price than is the case with larger company stocks. Smaller companies also may
have fewer lines of business, so that changes in any one line of business may
have a greater impact on a smaller company's stock price than is the case for a
larger company. Further, smaller company stocks may perform differently in
different cycles than larger company stocks. Accordingly, REIT shares can be
more volatile than--and at times will perform differently from--large company
stocks such as those found in the Dow Jones Industrial Average.
TAX ISSUES. REITs are subject to a highly technical and complex set of
provisions in the Code. It is possible that the Fund may invest in a Real
Estate Company that purports to be a REIT but does not satisfy all of the
conditions of REIT status in any year. In some cases, the Real Estate Company
may still be able to qualify for REIT status after payment of a penalty tax.
Otherwise, a Real Estate Company that fails to qualify for REIT status would be
subject to corporate-level taxation. In either case, the return to the Fund on
its investment in such company would be reduced. REITs could possibly fail to
qualify for tax free pass-through of income under the Code, or to maintain
their exemptions from registration under the 1940 Act. The above factors may
also adversely affect the Fund's investment in such a REIT. In the event of a
default by a borrower or lessee, the
32
REIT may experience delays in enforcing its rights as a mortgagee or lessor and
may incur substantial costs associated with protecting its investments.
LEVERAGE RISK
The Fund intends to use leverage by issuing Fund Preferred Shares
representing approximately 35% of the Fund's capital after their issuance or,
alternatively, through borrowing. Leverage is a speculative technique, and
there are special risks and costs associated with leveraging. For a more
detailed description of the risks associated with leverage, see "Use of
Leverage--Leverage Risks."
RISKS OF INVESTMENT IN LOWER-RATED SECURITIES
Lower-rated securities, also known as "junk bonds," may be considered
speculative with respect to the issuer's continuing ability to make principal
and interest payments. Analysis of the creditworthiness of issuers of
lower-rated securities may be more complex than for issuers of higher quality
debt securities, and the Fund's ability to achieve its investment objectives
may, to the extent the Fund invests in lower-rated securities, be more
dependent upon the Investment Manager's credit analysis than would be the case
if the Fund were investing in higher quality securities. The Fund may only
invest in non-investment grade securities that are rated "CCC" or higher by S&P
or "Caa" or higher by Moody's (or a comparable rating by another nationally
recognized statistical agency), or unrated securities judged to be of
comparable quality by the Investment Manager. The issuers of these securities
may be in default or have a currently identifiable vulnerability to default on
their payments of principal and interest, or may otherwise be subject to
present elements of danger with respect to payments of principal or interest.
However, the Fund will not invest in securities that are in default as to
payment of principal and interest at the time of purchase.
Lower-rated securities may be more susceptible to real or perceived
adverse economic and competitive industry conditions than higher grade
securities. The prices of lower-rated securities have been found to generally
be less sensitive to interest-rate changes than more highly rated investments,
but more sensitive to adverse economic downturns or individual corporate
developments. Yields on lower-rated securities will fluctuate. If the issuer of
lower-rated securities defaults, the Fund may incur additional expenses to seek
recovery.
The secondary markets in which lower-rated securities are traded may be
less liquid than the market for higher grade securities. A lack of liquidity in
the secondary trading markets could adversely affect the price at which the
Fund could sell a particular lower-rated security when necessary to meet
liquidity needs or in response to a specific economic event, such as a
deterioration in the creditworthiness of the issuer, and could adversely affect
and cause large fluctuations in the net asset value of the Fund's shares.
Adverse publicity and investor perceptions may decrease the values and
liquidity of high yield securities.
It is reasonable to expect that any adverse economic conditions could
disrupt the market for lower-rated securities, have an adverse impact on the
value of such securities, and adversely affect the ability of the issuers of
such securities to repay principal and pay interest thereon. New laws and
proposed new laws may adversely impact the market for lower-rated securities.
While securities carrying the fourth highest quality rating ("Baa" by
Moody's or "BBB" by S&P or an equivalent rating from another nationally
recognized statistical rating agency or, if unrated, judged to be of comparable
quality by the Investment Manager) are considered investment grade and are
viewed to have adequate capacity for payment of principal and interest,
investments in such securities involve a higher degree of risk than that
associated with investments in securities in the higher rating categories. Such
securities lack outstanding investment characteristics and, in fact, have
speculative characteristics as well. For example, changes in economic
conditions or other circumstances are more likely to lead to a weakened
capacity to make principal and interest payments than is the case with higher
rated securities.
33
INTEREST RATE TRANSACTIONS RISK
The Fund may enter into a swap or cap transaction to attempt to protect
itself from increasing dividend or interest expenses resulting from increasing
short-term interest rates. A decline in interest rates may result in a decline
in the value of the swap or cap, which may result in a decline in the net asset
value of the Fund. A sudden and dramatic decline in interest rates may result
in a significant decline in the net asset value of the Fund. See "Interest Rate
Transactions."
RISKS OF FUTURES AND OPTIONS ON FUTURES
The use by the Fund of futures contracts and options on futures contracts
to hedge interest rate risks involves special considerations and risks.
Successful use of hedging transactions depends upon the Investment Manager's
ability to predict correctly the direction of changes in interest rates. There
can be no assurance that any particular hedging strategy will succeed or that
appropriate hedging transactions will be available on the terms desired. There
might be imperfect correlation, or even no correlation, between the price
movements of a futures or option contract and the movements of the interest
rates being hedged. Such a lack of correlation might occur due to factors
unrelated to the interest rates being hedged, such as market liquidity and
speculative or other pressures on the markets in which the hedging instrument
is traded. Hedging strategies, if successful, can reduce risk of loss by wholly
or partially offsetting the negative effect of unfavorable movements in the
interest rates being hedged. However, hedging strategies can also reduce
opportunity for gain by offsetting the positive effect of favorable movements
in the hedged interest rates. The Fund could lose money if the counterparty to
a futures contract or option on a futures contract is unwilling or unable to
honor its obligations to the Fund. There is no assurance that a liquid
secondary market will exist for any particular futures contract or option
thereon at any particular time. If the Fund were unable to liquidate a futures
contract or an option on a futures contract position due to the absence of a
liquid secondary market or the imposition of price limits, it could incur
substantial losses. The Fund would continue to be subject to market risk and
counterparty risk with respect to the position. There is no assurance that the
Fund will use hedging transactions. For example, if the Fund determines that
the cost of hedging will exceed the potential benefit to the Fund, the Fund
will not enter into such transactions.
FOREIGN SECURITY RISK
The prices of foreign securities may be affected by factors not present
in U.S. markets. The dollar value of the Fund's foreign investments will be
affected by changes in the exchange rates between the dollar and the currencies
in which those investments are traded. The value of the Fund's foreign
investments may also be adversely affected by political and social instability
in their home countries and by changes in economic or taxation policies in
those countries. Foreign securities are also subject to the risks of
nationalization, expropriation or confiscatory taxation, currency blockage, and
adverse political changes or diplomatic developments.
Foreign companies generally are subject to less stringent regulations,
including financial and accounting controls, than are U.S. companies. As a
result, there generally is less publicly available information about foreign
companies than about U.S. companies. In addition, the securities markets of
other countries are smaller than U.S. securities markets. As a result, many
foreign securities may be less liquid and more volatile than U.S. securities.
LIQUIDITY RISK
The Fund may invest in securities that are illiquid so long as no more
than 10% of the total assets of the Fund (taken at market value at the time of
investment) would be invested in such securities. The term "illiquid
securities" for these purposes means securities that cannot be disposed of
within seven days in the ordinary course of business at approximately the
amount at which the Fund has valued the securities. Illiquid securities may
trade at a discount from comparable, more liquid investments, and may be
subject to wide fluctuations in market value. Also, the Fund may not be able to
dispose of illiquid securities when that would be beneficial at a favorable
time or price.
34
RISKS OF WARRANTS AND RIGHTS
Warrants and rights are subject to the same market risks as stocks, but
may be more volatile in price. Warrants and rights do not carry the right to
dividends or voting rights with respect to their underlying securities, and
they do not represent any rights in the assets of the issuer. An investment in
warrants or rights may be considered speculative. In addition, the value of a
warrant or right does not necessarily change with the value of the underlying
security, and a warrant or right ceases to have value if it is not exercised
prior to its expiration date. The purchase of warrants or rights involves the
risk that the Fund could lose the purchase value of a warrant or right if the
right to subscribe to additional shares is not exercised prior to the warrant's
or right's expiration. Also, the purchase of warrants and rights involves the
risk that the effective price paid for the warrant or right, added to the
subscription price of the related security, may exceed the subscribed
security's market price. This may occur, for example, when there is no movement
in the price of the underlying security or when the market price of the
underlying security decreases.
INFLATION RISK
Inflation risk is the risk that the value of assets or income from
investments will be worth less in the future as inflation decreases the present
value of future payments. As inflation increases, the real value of the Common
Shares and distributions can decline and the dividend payments on the Fund
Preferred Shares, if any, or interest payments on any borrowings may increase,
which would tend further to reduce returns to Common Shareholders.
MARKET PRICE DISCOUNT FROM NET ASSET VALUE
Shares of closed-end investment companies frequently trade at a discount
from their net asset value. This characteristic is a risk separate and distinct
from the risk that the Fund's net asset value could decrease as a result of the
Fund's investment activities and may be greater for investors expecting to sell
their shares a relatively short time following completion of this offering. The
net asset value of the Common Shares will be reduced immediately following the
offering by the payment of the sales load and certain offering costs. Whether
investors will realize gains or losses upon the sale of the Common Shares will
depend not upon the Fund's net asset value, but entirely upon whether the
market price of the Common Shares at the time of sale is above or below the
investor's purchase price for the Common Shares. Because the market price of
the Common Shares will be determined by factors such as relative supply of and
demand for Common Shares in the market, general market and economic conditions,
and other factors beyond the control of the Fund, the Fund cannot predict
whether the Common Shares will trade at below or above net asset value, or at
below or above the initial public offering price. The Common Shares are
designed primarily for long-term investors, and you should not view the Fund as
a vehicle for trading purposes.
ADDITIONAL RISK CONSIDERATIONS
PORTFOLIO TURNOVER
The Fund may engage in frequent and active portfolio trading when the
Investment Manager considers it to be appropriate, but the Fund will not use
short-term trading as the primary means of achieving its investment objectives.
Although the Fund cannot accurately predict its annual portfolio turnover rate,
it is not expected to exceed 100% under normal circumstances. However, there
are no limits on the rate of portfolio turnover, and investments may be sold
without regard to the length of time held when, in the opinion of the
Investment Manager, investment considerations warrant such action. A higher
turnover rate results in correspondingly greater brokerage commissions and
other transactional expenses that are borne by the Fund. High portfolio
turnover may result in the realization of net short-term capital gains by the
Fund that, when distributed to shareholders, will be taxable as ordinary
income. See "Tax Matters."
35
NON-DIVERSIFIED STATUS
Because the Fund, as a "non-diversified" investment company under the
1940 Act, can invest a greater portion of its assets in obligations of a single
issuer than, and invest in a smaller number of individual issuers than, a
"diversified" fund, an investment in the Fund presents greater risk to you than
an investment in a diversified company. The Fund will be more susceptible than
a diversified fund to being adversely affected by any single corporate,
economic, political or regulatory occurrence. See "Investment Objectives and
Policies." To help control this risk, the Fund will not invest more than 15% of
its total assets (taken at market value at the time of investment) in the
securities of any one issuer other than the U.S. Government. In addition, the
Fund intends to diversify its investments to the extent necessary to maintain
its status as a regulated investment company under the Code. See "Taxation" in
the SAI.
ANTI-TAKEOVER PROVISIONS
The Declaration includes provisions that may have the effect of limiting
the ability of other entities or persons to acquire control of the Fund or to
convert the Fund to open-end status. These provisions may also have the effect
of depriving shareholders of an opportunity to sell their shares at a premium
over prevailing market prices. See "Certain Provisions in the Declaration of
Trust."
RECENT DEVELOPMENTS
As a result of the terrorist attacks on the World Trade Center and the
Pentagon on September 11, 2001, some of the U.S. securities markets were closed
for a four-day period. These terrorist attacks and related events have led to
increased short-term market volatility and may have long-term effects on U.S.
and world economies and markets. A similar disruption of the financial markets
could impact interest rates, auctions, secondary trading, ratings, credit risk,
inflation and other factors relating to the Common Shares and the Fund
Preferred Shares.
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 CDC
IXIS Asset Management North America, L.P. Absent an exemption from the
Securities and Exchange Commission or other regulatory relief, the Fund is
generally precluded from effecting certain principal transactions with
affiliated brokers, and its ability to purchase securities being underwritten
by an affiliated broker or a syndicate including an affiliated broker or to
utilize affiliated brokers for agency transactions is subject to regulatory and
other restrictions. This could limit the Fund's ability to engage in securities
transactions and take advantage of market opportunities.
MANAGEMENT OF THE FUND
The business and affairs of the Fund are managed under the direction of
the Board of Trustees. Subject always to the investment objectives and policies
of the Fund and to the general supervision of the Trustees, the Investment
Manager is responsible for management of the Fund's investment portfolio. The
management of the Fund's day-to-day operations (other than investment
operations) is delegated to its officers and the Fund's administrator and
sub-administrator, subject always to the general supervision of the Trustees.
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 SAI.
INVESTMENT MANAGER
The Investment Manager has been retained to provide investment advice,
and, in general, to conduct the investment program of the Fund under the
overall supervision and control of the Trustees of the Fund. The
36
Investment Manager, which is registered as an investment adviser with the
Securities and Exchange Commission, is a real estate investment advisory firm
that provides investment management and related services to institutional and
retail investors. Together with its affiliates operating under the AEW name,
the Investment Manager managed approximately $6.9 billion of client capital as
of September 30, 2002. The Investment Manager is a subsidiary of (and therefore
may be deemed to be controlled by) CDC IXIS Asset Management North America,
L.P., which, together with its subsidiaries and affiliates in the U.S., Europe
and Asia, managed approximately $291 billion in assets for institutions and
individuals as of September 30, 2002. The Investment Manager's address is Two
Seaport Lane, World Trade Center East, Boston, Massachusetts 02210.
A team of professionals at the Investment Manager, working under the
Fund's portfolio manager, is primarily responsible for overseeing the
day-to-day operations of the Fund. That team is led by Matthew A. Troxell, who
serves as Portfolio Manager for the Fund. Mr. Troxell joined the Investment
Manager in 1994 as a Vice President and became a Principal of the firm in 1997.
He has 19 years of securities and portfolio management experience. Prior to
joining the Investment Manager, he was a Vice President and Assistant to the
President of Landmark Land Company and a Securities Analyst at A.G. Becker
Paribas. Mr. Troxell is a graduate of Tufts University (B.A.) and holds the
designation of Chartered Financial Analyst (CFA).
INVESTMENT MANAGEMENT AGREEMENT
Under its Investment Management Agreement with the Fund, the Investment
Manager furnishes a continuous investment program for the Fund's portfolio,
makes the day-to-day investment decisions for the Fund, and generally manages
the Fund's investments in accordance with the stated policies of the Fund,
subject to the general supervision of the Board of Trustees of the Fund. The
Investment Manager also performs certain administrative services for the Fund
and provides persons satisfactory to the Trustees of the Fund to serve as
officers of the Fund. Such officers, as well as certain other employees and
Trustees of the Fund, may be directors, officers, or employees of the
Investment Manager or its affiliates, including CDC IXIS Services.
For its services under the Investment Management Agreement, the Fund pays
the Investment Manager a monthly management fee computed at the annual rate of
..80% of the average daily managed assets of the Fund. "Managed assets" means
the net asset value of the Common Shares plus the liquidation preference of any
Fund Preferred Shares and the principal amount of any borrowings used for
leverage. In addition to the monthly management fee, the Fund pays all other
costs and expenses of its operations, including compensation of its independent
Trustees, custodian, administrator, transfer agency and dividend disbursing
expenses, legal fees, expenses of independent auditors, expenses associated
with interest rate transactions (including, to the extent approved by the Board
of Trustees from time to time, the fees of third parties that may assist in the
structuring and negotiation of interest rate transactions), expenses of
repurchasing shares, expenses of issuing any Fund Preferred Shares, listing
expenses, trading, brokerage and other investment expenses, interest expense,
expenses of preparing, printing and distributing shareholder reports, notices,
proxy statements and reports to governmental agencies, and taxes, if any. The
organizational expenses and offering costs of the Fund that are not paid by the
Investment Manager will be netted against paid-in capital in the Fund's initial
fiscal year. The Investment Manager has contractually agreed to waive a portion
of its investment management fees in the amount of 0.25% of average daily
managed assets (which include the liquidation preference of any Fund Preferred
Shares and the principal amount of any borrowings used for leverage) for the
first five years of the Fund's operations, 0.20% of average daily managed
assets in year six, 0.15% of average daily managed assets in year seven, 0.10%
of daily managed assets in year eight and 0.05% of average daily managed assets
in year nine. The Investment Manager has not agreed to waive any portion of its
fees beyond year nine of the Fund's operations. See "Summary of Fund Expenses."
When the Fund is utilizing leverage, the fees paid to the Investment Manager
and its affiliates for investment advisory, management and other services will
be higher than if the Fund did not utilize leverage because the fees paid will
be calculated based on the Fund's managed assets, which include the liquidation
preference of any Fund Preferred Shares and the principal amount of any
borrowings used for leverage. As a result, the Investment Manager has a
financial incentive for the Fund to issue Fund Preferred Shares or to otherwise
incur leverage, which may create a conflict of interest. See "Use of Leverage."
37
ADMINISTRATIVE SERVICES AND SUB-ADMINISTRATION AGREEMENTS
Under its Administrative Services Agreement with the Fund, CDC IXIS
Services provides certain administrative and accounting functions for the Fund,
including providing or procuring administrative services necessary for the
operations of the Fund, furnishing office space and facilities required for
conducting the business of the Fund and providing persons satisfactory to the
Trustees of the Fund to serve as officers of the Fund.
As permitted by the Administrative Services Agreement and with the
approval of the Board of Trustees of the Fund, CDC IXIS Services has entered
into the Sub-Administration Agreement with Investors Bank & Trust Company, as
sub-administrator. Under the Sub-Administration Agreement, Investors Bank &
Trust Company has assumed responsibility for certain fund administration
services, subject to the supervision of CDC IXIS Services.
Under the Administrative Services Agreement, the Fund pays CDC IXIS
Services a monthly administration fee computed on the basis of the average
daily managed assets of the Fund at an annual rate equal to 0.06% of the first
$300 million in assets and 0.0575% of assets in excess of $300 million, with a
minimum annual fee of $150,000. Under the Sub-Administration Agreement, CDC
IXIS Services (and not the Fund) pays Investors Bank & Trust Company a monthly
fee computed on the basis of the managed assets of the Fund at an annual rate
equal to 0.015% of the first $300 million in assets and 0.012% thereafter.
Investors Bank & Trust Company serves as the Fund's custodian and EquiServe has
been retained to serve as the Fund's transfer agent, dividend disbursing agent
and registrar. See "Custodian, Transfer Agent, Dividend Disbursing Agent and
Registrar."
MARKETING AGENT
CDC IXIS Asset Management Advisors Group (the "Advisors Group"), an
affiliate of the Investment Manager, will act as marketing agent for the Fund
in connection with the offering of the Common Shares by preparing marketing
materials and providing distribution support during the offering. The Advisors
Group has agreed, pursuant to an agreement with the Investment Manager, (i) to
reimburse the Investment Manager for one-half of the amount by which the
aggregate of all of the Fund's organizational expenses and offering costs
(other than the sales load) exceeds $0.03 per Common Share and (ii) to bear a
portion of any ongoing asset-based fees to be paid by the Investment Manager to
the underwriters (other than Merrill Lynch) in connection with the offering in
the amount of 21.8% of such fees in years one and two of the Fund's operations
and in declining amounts for each of the four years thereafter. As payment for
these services, the Investment Manager (and not the Fund) has agreed to pay the
Advisors Group a fee at the annual rate of 0.12% of net assets for years one
and two of the Fund's operations, 0.08% of net assets for years three and four,
and 0.05% of net assets in years five and six. The Investment Manager has not
agreed to pay any fees to the Advisors Group (and the Advisors Group has not
agreed to bear any portion of any asset-based fees payable by the Investment
Manager) beyond year six of the Fund's operations. The Advisors Group and the
Investment Manager, both of which are subsidiaries of CDC IXIS Asset Management
North America, L.P., may agree to change or eliminate these payments at any
time.
NET ASSET VALUE
The Fund determines the net asset value of its Common Shares on each day
the New York Stock Exchange is open for business at the close of regular
trading (normally 4:00 p.m. Eastern time). Domestic debt securities and
non-U.S. securities are normally priced using data reflecting the earlier
closing of the principal markets for those securities. Information that becomes
known to the Fund or its agent after the Fund's net asset value has been
calculated on a particular day will not be used to adjust retroactively the
price of a security or the Fund's net asset value determined earlier that day.
The Fund determines net asset value per Common Share by dividing the
value of the Fund's securities, cash and other assets (including interest
accrued but not collected) less all its liabilities (including accrued
38
expenses, the liquidation preference of the Fund Preferred Shares and dividends
payable) by the total number of Common Shares outstanding. The Fund values
portfolio securities for which market quotations are readily available at
market value. The Fund's short-term investments are valued at amortized cost
when the security has 60 days or less to maturity.
In unusual circumstances, instead of valuing securities in the usual
manner, the Fund may value securities at fair value as determined in good faith
by the Board of Trustees or persons acting pursuant to procedures approved by
the Board, generally based on recommendations provided by the Investment
Manager or CDC IXIS Services. Fair valuation may also be required due to
material events that occur after the close of the relevant market but prior to
the close of the New York Stock Exchange. The effect of using fair value
pricing is that the Common Shares' net asset value will be subject to the
judgment of the Board of Trustees or its designee instead of being determined
by the market.
Any swap transaction that the Fund enters into may, depending on the
applicable interest rate environment, have a positive or negative value for
purposes of calculating net asset value. Any cap transaction that the Fund
enters into may, depending on the applicable interest rate environment, have no
value or a positive value. In addition, accrued payments to the Fund under such
transactions will be assets of the Fund and accrued payments by the Fund will
be liabilities of the Fund.
DIVIDENDS AND DISTRIBUTIONS
LEVEL RATE DIVIDEND POLICY
Subject to the determination of the Board of Trustees to implement a
Managed Dividend Policy, as discussed below, commencing with the Fund's first
dividend, the Fund intends to make regular monthly cash distributions to Common
Shareholders at a level rate based on the projected performance of the Fund,
which rate may be adjusted from time to time ("Level Rate Dividend Policy").
Distributions can only be made from net investment income after paying accrued
dividends on Fund Preferred Shares, if any, and interest and required principal
payments on borrowings, if any, as well as making any required payments on any
interest rate transactions. The Fund's ability to maintain a Level Rate
Dividend Policy will depend on a number of factors, including the stability of
income received from its investments and dividends payable on Fund Preferred
Shares and interest and required principal payments on borrowings, if any. Over
time, the Fund intends to distribute all of its net investment income (after
payment of expenses, dividends on any Fund Preferred Shares and interest on any
borrowings). At least annually, the Fund intends to distribute all of its net
capital gain and ordinary taxable income after paying expenses and paying any
accrued dividends on, or redeeming or liquidating, any Fund Preferred Shares,
if any, or making interest and required principal payments on borrowings, if
any. Initial distributions to Common Shareholders are expected to be declared
approximately 45 days, and paid approximately 60 to 90 days, from the
completion of this offering, depending upon market conditions. The net income
of the Fund consists of all interest income accrued on portfolio assets less
all expenses of the Fund. Expenses of the Fund are accrued each day. In
addition, the Fund currently expects that a portion of its distributions will
consist of amounts in excess of investment company taxable income and net
capital gain derived from the non-taxable components of the cash flow from the
real estate underlying the Fund's portfolio investments. It is possible that
amounts distributed to the Fund from Real Estate Companies would be
recharacterized as a return of capital, in which case amounts distributed to
Fund shareholders may also be recharacterized as a return of capital. To permit
the Fund to maintain a more stable monthly distribution, the Fund will
initially distribute less than the entire amount of net investment income
earned in a particular period. The undistributed net investment income would be
available to supplement future distributions. As a result, the distributions
paid by the Fund for any particular monthly period may be more or less than the
amount of net investment income actually earned by the Fund during the period.
Undistributed net investment income will be added to the Fund's net asset value
and, correspondingly, distributions from undistributed net investment income
will be deducted from the Fund's net asset value. See "Tax Matters."
39
MANAGED DIVIDEND POLICY
Following the completion of this offering, the Fund intends to file an
exemptive application with the Securities and Exchange Commission seeking an
order under the 1940 Act facilitating the implementation of a Managed Dividend
Policy. If and when the Fund receives the requested relief, the Fund may,
subject to the determination of its Board of Trustees, implement a Managed
Dividend Policy. Under a Managed Dividend Policy, the Fund would intend to
distribute a monthly fixed percentage of net asset value to Common
Shareholders. As with the Level Dividend Rate Policy, distributions would be
made only after paying expenses and paying dividends on Fund Preferred Shares,
if any, and interest and required principal payments on borrowings, if any.
Under a Managed Dividend Policy, if, for any monthly distribution, net
investment income and net realized capital gain were less than the amount of
the distribution, the difference would be distributed from the Fund's assets.
It is possible that amounts distributed to the Fund from Real Estate Companies
would be recharacterized as a return of capital, in which case amounts
distributed to Fund shareholders may also be recharacterized as a return of
capital. The Fund's final distribution for each calendar year would include any
remaining net investment income and net realized capital gain undistributed
during the year. Pursuant to the requirements of the 1940 Act and other
applicable laws, a notice would accompany each monthly distribution with
respect to the estimated source of the distribution made. In the event the Fund
distributed in any calendar year amounts in excess of net investment income and
net realized capital gain (such excess, the "Excess"), such distribution would
decrease the Fund's total assets and, therefore, have the likely effect of
increasing the Fund's expense ratio. There is a risk that the Fund would not
eventually realize capital gains in an amount corresponding to a distribution
of the Excess. In addition, in order to make such distributions, the Fund may
have to sell a portion of its investment portfolio at a time when independent
investment judgment might not dictate such action. There is no guarantee that
the Fund will receive an exemptive order facilitating the implementation of a
Managed Dividend Policy or, if received, that the Fund will determine to
implement a Managed Dividend Policy. The Board of Trustees reserves the right
to change the dividend policy from time to time.
DIVIDEND REINVESTMENT PLAN
The Fund has a Dividend Reinvestment Plan (the "Plan") commonly referred
to as an "opt-out" plan. Each Common Shareholder will have all distributions of
dividends and capital gains automatically reinvested in additional Common
Shares by EquiServe, as agent for shareholders pursuant to the Plan (the "Plan
Agent"), unless they elect to receive cash. The Plan Agent will either (i)
effect purchases of Common Shares under the Plan in the open market or (ii)
distribute newly issued Common Shares of the Fund. Shareholders who elect not
to participate in the Plan will receive all distributions in cash paid by check
mailed directly to the shareholder of record (or if the shares are held in
street or other nominee name, then to the nominee) by the Plan Agent, as
dividend disbursing agent. Shareholders whose Common Shares are held in the
name of a broker or nominee should contact the broker or nominee to determine
whether and how they may participate in the Plan.
The Plan Agent serves as agent for the shareholders in administering the
Plan. After the Fund declares a dividend or makes a capital gain distribution,
the Plan Agent will, as agent for the participants, either (i) receive the cash
payment and use it to buy Common Shares in the open market, on the American
Stock Exchange or elsewhere, for the participants' accounts or (ii) distribute
newly issued Common Shares of the Fund on behalf of the participants. The Plan
Agent will receive cash from the Fund with which to buy Common Shares in the
open market if, on the determination date, the net asset value per share
exceeds the market price per share plus estimated brokerage commissions on that
date. The Plan Agent will receive the dividend or distribution in newly issued
Common Shares of the Fund if, on the determination date, the market price per
share plus estimated brokerage commissions equals or exceeds the net asset
value per share of the Fund on that date. The number of shares to be issued
will be computed at a per share rate equal to the greater of (i) the net asset
value or (ii) 95% of the closing market price per share on the payment date.
Participants in the Plan may withdraw from the Plan upon written notice
to the Plan Agent. Such withdrawal will be effective immediately if received
not less than ten days prior to a distribution record date; otherwise, it will
be effective for all subsequent dividend record dates. When a participant
withdraws from the
40
Plan or upon termination of the Plan as provided below, certificates for whole
Common Shares credited to his or her account under the Plan will be issued and
a cash payment will be made for any fraction of a Common Share credited to such
account. In the alternative, upon receipt of the participant's instructions,
Common Shares will be sold and the proceeds sent to the participant less
brokerage commissions and any applicable taxes.
The Plan Agent maintains each shareholder's account in the Plan and
furnishes confirmations of all acquisitions made for the participant. Common
Shares in the account of each Plan participant will be held by the Plan Agent
on behalf of the participant. Proxy material relating to shareholders' meetings
of the Fund will include those shares purchased as well as shares held pursuant
to the Plan.
In the case of shareholders, such as banks, brokers or nominees, which
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 shareholders as representing the total amount
registered in the record shareholder's name and held for the account of
beneficial owners who are participants in the Plan.
The Plan Agent's fees for the handling of reinvestment of dividends and
other distributions will be paid by the Fund. Each participant will pay a pro
rata share of brokerage commissions incurred with respect to the Plan Agent's
open market purchases in connection with the reinvestment of distributions.
There are no other charges to participants for reinvesting dividends or capital
gain distributions; however, the Fund reserves the right to amend the Plan to
include a service charge payable by the participants.
The automatic reinvestment of dividends and other distributions will not
relieve participants of any income tax that may be payable or required to be
withheld on such dividends or distributions. See "Tax Matters."
The Fund and the Plan Agent reserve the right to amend or terminate the
Plan. All correspondence concerning the Plan should be directed to the Plan
Agent by telephone at (800) 730-6001.
CLOSED-END STRUCTURE
The Fund is a closed-end management investment company (commonly referred
to as a closed-end fund). Closed-end funds differ from open-end investment
companies (which are generally referred to as mutual funds) in that closed-end
funds generally list their shares for trading on a stock exchange and do not
redeem their shares at the request of the shareholder. This means that, if you
wish to sell your shares of a closed-end fund, you must trade them on the
market like any other stock at the prevailing market price at that time.
Shareholders of an open-end investment company may require the company to
redeem their shares at any time (except in certain circumstances as authorized
by or permitted under the 1940 Act) at their net asset value, less any
redemption charge that might be in effect at the time of redemption. In order
to avoid maintaining large cash positions or liquidating favorable investments
to meet redemptions, open-end investment companies typically engage in a
continuous offering of their shares. Open-end investment companies are thus
subject to periodic asset in-flows and out-flows that can complicate portfolio
management. By comparison, closed-end funds are generally better able to stay
fully invested in securities that are consistent with their investment
objectives, and also have greater flexibility to make certain types of
investments and use certain investment strategies such as financial leverage
and investments in illiquid securities.
Shares of closed-end funds frequently trade at a discount to their net
asset value. Because of this possibility and the recognition that any such
discount may not be in the best interest of shareholders, the Fund's Board of
Trustees might consider from time to time repurchases of Fund shares in the
open market or in private transactions, tender offers for shares at net asset
value or other programs intended to reduce the discount. The Fund cannot
guarantee or assure, however, that the Fund's Board will engage in any of these
actions. Nor is there any guarantee or assurance that such actions, if
undertaken, would result in shares trading at a price equal or close to net
asset value per share. See "Repurchase of Shares." The Board of Trustees might
also consider
41
converting the Fund to an open-end investment company, which would also require
a vote of the shareholders of the Fund. See "Certain Provisions in the
Declaration of Trust."
POSSIBLE CONVERSION TO OPEN-END STATUS
Subject to the voting and other provisions in the Declaration, the Fund
may be converted to an open-end investment company at any time by a vote of the
outstanding shares. See "Certain Provisions in the Declaration of Trust" for a
discussion of the shareholder and Trustee approval requirements applicable to
conversion of the Fund to an open-end investment company. If the Fund converted
to an open-end investment company, it would be required to redeem all Fund
Preferred Shares then outstanding (requiring in turn that it liquidate a
portion of its investment portfolio) and the Fund's Common Shares would likely
no longer be listed on the American Stock Exchange. Conversion to open-end
status could also require the Fund to modify certain investment restrictions
and policies. The Board of Trustees may at any time propose conversion of the
Fund to open-end status, depending upon its judgment regarding the advisability
of such action in light of circumstances then prevailing. However, the Fund
cannot assure you that the Board of Trustees will decide to take or propose
such a conversion.
REPURCHASE OF SHARES
Shares of closed-end investment companies often trade at a discount to
net asset value, and the Fund's shares may also trade at a discount to their
net asset value, although it is possible that they may trade at a premium above
net asset value. The market price of the Fund's shares will be determined by
such factors as dividend levels (which are in turn affected by the return on
the Fund's portfolio and expenses), relative demand for and supply of shares in
the market, the Fund's net asset value, call protection, dividend stability,
general market and economic conditions and other factors beyond the control of
the Fund. Although Common Shareholders will not have the right to redeem their
shares, the Fund may take action to repurchase shares in the open market or in
private transactions or make tender offers for its shares at net asset value.
The Fund cannot assure you that the Board of Trustees will decide to take or
propose any of these actions, or that share repurchases or tender offers, if
undertaken, will reduce market discount. For more information, see "Repurchase
of Shares; Conversion to Open-End Fund" in the SAI. Repurchase of the Common
Shares may have the effect of reducing any market discount to net asset value.
There is no assurance that, if action is undertaken to repurchase or
tender for Common Shares, such action will result in the Common Shares trading
at a price which approximates their net asset value. Although share repurchases
and tenders could have a favorable effect on the market price of the Common
Shares, you should be aware that the acquisition of Common Shares by the Fund
will decrease the total assets of the Fund and, therefore, will have the effect
of increasing the Fund's expense ratio and may adversely affect the ability of
the Fund to achieve its investment objectives. To the extent the Fund may need
to liquidate investments to fund repurchases of shares, this may result in
portfolio turnover, which will result in additional expenses being borne by the
Fund, including brokerage commissions or dealer mark-ups and other transaction
costs on the sale of securities and reinvestment in other securities. Portfolio
turnover could give rise to a greater amount of taxable capital gains. The
Board of Trustees would typically consider the following factors to be relevant
to a potential decision to repurchase shares: the extent and duration of the
discount, the liquidity of the Fund's portfolio, the impact (including the
expense) of any action on the Fund or its shareholders and market
considerations. Any share repurchases or tender offers will be made in
accordance with the requirements of the Securities Exchange Act of 1934, as
amended, and the 1940 Act.
TAX MATTERS
The following brief tax discussion assumes you are a U.S. shareholder and
that you hold your shares as a capital asset. For more detailed information
regarding the tax consequences of investing in the Fund, please see the SAI.
The Fund intends to qualify each year for treatment as a regulated investment
company under the
42
provisions of Subchapter M of the Code. If the Fund so qualifies and
distributes each year to its shareholders at least 90% of the sum of its
"investment company taxable income" (generally, its taxable net income and the
excess, if any, of its net short-term capital gain over net long-term capital
losses) and its net tax-exempt income for such year, the Fund will not be
required to pay federal income taxes on any income it distributes to
shareholders in the form of dividends (including capital gain dividends) to
shareholders. Such distributions, however, will generally be taxable to you as
a shareholder of the Fund when received.
For federal income tax purposes, distributions paid to you out of the
Fund's "investment company taxable income" will be taxable to you as ordinary
income to the extent of the Fund's earnings and profits. Taxes on distributions
of capital gains are determined by how long the Fund owned the investments that
generated them, rather than by how long you have held your Fund shares.
Distributions are taxable to you even if they are paid from income or gains
earned by the Fund before your investment (and thus were included in the price
you paid). Distributions of gains from investments that the Fund owned for more
than one year that are designated by the Fund as capital gain dividends will be
taxable as capital gains. Distributions of gains from investments that the Fund
owned for one year or less will be taxable as ordinary income. The Fund intends
to distribute to its shareholders, at least annually, substantially all of its
investment company taxable income and net capital gain. A distribution of an
amount in excess of the Fund's current and accumulated earnings and profits is
treated as a non-taxable return of capital that reduces your tax basis in your
Common Shares; any such distributions in excess of your basis are treated as
gain from a sale of your shares. The tax treatment of your dividends and
distributions will be the same regardless of whether they were paid to you in
cash or reinvested in additional Common Shares. Shareholders not subject to tax
on their income will generally not be required to pay tax on amounts
distributed to them.
A dividend paid to you in January of a year generally is deemed to have
been paid by the Fund on December 31 of the preceding calendar year if it is
declared by the Fund in October, November or December with a record date in
such a month. Each year, the Fund will notify you of the tax status of
dividends and other distributions.
If you sell your Common Shares, or have shares repurchased by the Fund,
you may realize a capital gain or loss in an amount equal to the difference
between the amount realized and your adjusted tax basis in the shares sold,
which gain or loss will be long-term or short-term depending generally on your
holding period for the shares.
The Fund may be required to withhold U.S. federal income tax from all
taxable distributions payable if you:
. fail to provide the Fund with your correct taxpayer identification
number (TIN);
. fail to certify to the Fund that you are a United States person and
are not subject to such withholding; or
. have been notified by the Internal Revenue Service that you are
subject to backup withholding.
It is not expected that investors will be subject to the alternative
minimum tax as a result of an investment in the Fund. Fund distributions may be
subject to state and local taxes. You should consult with your own tax adviser
regarding the particular consequences of investing in the Fund.
DESCRIPTION OF SHARES
COMMON SHARES
The Declaration authorizes the issuance of an unlimited number of Common
Shares, $.00001 par value per share. The Common Shares have no preemptive,
conversion, exchange or redemption rights. Each share has equal voting,
dividend, distribution and liquidation rights. The Common Shares will, when
issued, be fully paid
43
and, subject to the matters discussed in "Certain Provisions in the Declaration
of Trust," nonassessable. Common Shareholders are entitled to one vote per
share, and fractional shares will be entitled to a proportionate fractional
vote. Whenever Fund Preferred Shares or borrowings are outstanding, Common
Shareholders will not be entitled to receive any distributions from the Fund
unless all accrued dividends on the Fund Preferred Shares and interest and
principal payments on borrowings have been paid, and unless the applicable
asset coverage requirements under the 1940 Act would be satisfied after giving
effect to the distribution. See "--Fund Preferred Shares" below. The Common
Shares have been approved for listing on the American Stock Exchange under the
symbol "RIF." Under the rules of the American Stock Exchange currently
applicable to listed companies, the Fund will be required to hold a meeting of
shareholders annually. The foregoing description and the descriptions below
under "Fund Preferred Shares" and "Certain Provisions in the Declaration of
Trust" and above under "Possible Conversion to Open-End Status" are subject to
the provisions contained in the Fund's Declaration and Bylaws.
FUND PREFERRED SHARES
The Declaration authorizes the issuance of an unlimited number of
Preferred Shares. The Preferred Shares may be issued in one or more classes or
series, with such par value and rights as determined by the Board of Trustees,
by action of the Board of Trustees without the approval of the Common
Shareholders.
The Fund's Board of Trustees has indicated its intention to authorize an
offering of Fund Preferred Shares (representing approximately 35% of the Fund's
capital immediately after the time the Fund Preferred Shares are issued)
approximately one to three months after completion of the offering of Common
Shares. Any such decision is subject to market conditions, to the Fund's
receipt of the highest credit rating on the Fund Preferred Shares from at least
one nationally recognized statistical rating agency (e.g., AAA or Aaa) and to
the Board's continuing belief that leveraging the Fund's capital structure
through the issuance of Fund Preferred Shares is likely to achieve the benefits
to the Common Shareholders described in this prospectus. The Board of Trustees
has indicated that the preference on distribution, liquidation preference, and
redemption provisions of the Fund Preferred Shares will likely be as stated
below.
LIMITED ISSUANCE OF FUND PREFERRED SHARES. Under the 1940 Act, the Fund
could issue Fund Preferred Shares with an aggregate liquidation value of up to
one-half of the value of the Fund's total assets less liabilities not
representing senior securities, measured immediately after issuance of the Fund
Preferred Shares. "Liquidation value" means the original purchase price of the
shares being liquidated plus any accrued and unpaid dividends. In addition, the
Fund is not permitted to declare any cash dividend or other distribution on its
Common Shares unless the liquidation value of the Fund Preferred Shares is less
than one-half of the value of the Fund's total assets less liabilities not
representing senior securities (determined after deducting the amount of such
dividend or distribution) immediately after the distribution. If the Fund sells
all the Common Shares and Fund Preferred Shares discussed in this prospectus,
the liquidation value of the Fund Preferred Shares is expected to be
approximately 35% of the value of the Fund's capital measured immediately after
issuance. The Fund intends to purchase or redeem Fund Preferred Shares, if
necessary, to keep that fraction below one-half.
DISTRIBUTION PREFERENCE. The Fund Preferred Shares will have complete
priority over the Common Shares as to distribution of assets.
LIQUIDATION PREFERENCE. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the affairs of the Fund, holders of
Fund Preferred Shares will be entitled to receive a preferential liquidating
distribution (expected to equal the original purchase price per share plus
accumulated and unpaid dividends thereon, whether or not earned or declared)
before any distribution of assets is made to Common Shareholders.
VOTING RIGHTS. Fund Preferred Shares are required to be voting shares.
Except as otherwise provided in the Fund's Declaration or Bylaws and except as
otherwise required by applicable law, holders of Fund Preferred
44
Shares will vote together with Common Shareholders as a single class. In order
for the Fund to take certain actions or enter into certain transactions, a
separate class vote of holders of Fund Preferred Shares will be required, in
addition to the combined single class vote of the holders of Fund Preferred
Shares and Common Shares.
Holders of Fund Preferred Shares, voting as a separate class, will be
entitled to elect two of the Fund's Trustees. The remaining Trustees will be
elected by Common Shareholders and holders of Fund Preferred Shares, voting
together as a single class. In the event that two full years of accrued
dividends are unpaid on the Fund Preferred Shares, the holders of all
outstanding Fund Preferred Shares, voting as a separate class, will be entitled
to elect a majority of the Fund's Trustees until all dividends in arrears have
been paid or otherwise provided for by the Fund. In order for the Fund to take
certain actions or enter into certain transactions, a separate class vote of
holders of Fund Preferred Shares will be required, in addition to the combined
single class vote of the holders of Fund Preferred Shares and Common Shares.
REDEMPTION, PURCHASE AND SALE OF FUND PREFERRED SHARES. The terms of the
Fund Preferred Shares may provide that they are redeemable at certain times, in
whole or in part, at the original purchase price per share plus accumulated
dividends. The terms may also state that the Fund may tender for or purchase
Fund Preferred Shares and resell any shares so tendered. Any redemption or
purchase of Fund Preferred Shares by the Fund will reduce the leverage
applicable to Common Shares, while any resale of shares by the Fund will
increase such leverage. See "Use of Leverage."
The discussion above describes the Board of Trustees' present intention
with respect to a possible offering of Fund Preferred Shares. If the Board of
Trustees determines to authorize such an offering, the terms of the Fund
Preferred Shares may be the same as, or different from, the terms described
above, subject to applicable law and the Fund's Declaration and Bylaws. In
addition, any rating agency rating the Fund Preferred Shares may require terms
in addition to, or different from, those described above.
See "Description of Shares" in the SAI for a more detailed summary of the
terms of the Fund's shares.
As of the date of this prospectus, the Investment Manager owned of record
and beneficially 7,000 Common Shares, constituting 100% of the outstanding
shares of the Fund, and thus, until the public offering of the Common Shares is
completed, will control the Fund.
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST
The Declaration includes provisions that could limit the ability of other
entities or persons to acquire control of the Fund or to convert the Fund to
open-end status. The Fund's Trustees are divided into three classes. At each
annual meeting of shareholders, the term of one class will expire and each
Trustee elected to that class will hold office for a term of three years. The
classification of the Board of Trustees in this manner could delay for an
additional year the replacement of a majority of the Board of Trustees. In
addition, the Declaration provides that a Trustee may be removed only for cause
and only (i) by action of at least seventy-five percent (75%) of the
outstanding shares of the classes or series of shares entitled to vote for the
election of such Trustee, or (ii) by at least seventy-five percent (75%) of the
remaining Trustees.
As described below, the Declaration grants special approval rights with
respect to certain matters to members of the Board who qualify as "Continuing
Trustees," which term means a Trustee who either (i) has been a member of the
Board for a period of at least thirty-six months (or since immediately after
the initial registered public offering of the Fund's Common Shares, if less
than thirty-six months) or (ii) was nominated to serve as a member of the Board
of Trustees by a majority of the Continuing Trustees then members of the Board.
The Declaration requires the affirmative vote or consent of at least
seventy-five percent (75%) of the Board of Trustees and holders of at least
seventy-five percent (75%) of the Fund's shares (including Common
45
Shares and Fund Preferred Shares) to authorize certain Fund transactions not in
the ordinary course of business, including a merger or consolidation, or
certain sales, or transfers, of Fund assets, unless the transaction is
authorized by both a majority of the Trustees and seventy-five percent (75%) of
the Continuing Trustees (in which case no shareholder authorization would be
required by the Declaration, but may be required in certain cases under the
1940 Act). The Declaration also requires the affirmative vote or consent of
holders of at least seventy-five percent (75%) of each class of the Fund's
shares entitled to vote on the matter to authorize a conversion of the Fund
from a closed-end to an open-end investment company, unless the conversion is
authorized by both a majority of the Trustees and seventy-five percent (75%) of
the Continuing Trustees (in which case shareholders would have only the minimum
voting rights required by the 1940 Act with respect to the conversion). Also,
the Declaration provides that, subject to the terms of any Fund Preferred
Shares that may be set forth in the Bylaws, 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 Declaration also
requires the approval of both a majority of the Trustees and seventy-five
percent (75%) of the Continuing Trustees for certain extraordinary
distributions from the Fund to shareholders. The voting provisions discussed in
this section are more restrictive than those required under the 1940 Act and
Massachusetts law. See "Certain Provisions in the Declaration of Trust" in the
SAI 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 as the Trustees may
consider necessary or desirable.
The overall effect of these provisions is to render more difficult the
accomplishment of a merger or the assumption of control by a third party. They
provide, however, the advantage of potentially requiring persons seeking
control of the Fund to negotiate with its management regarding the price to be
paid and facilitating the continuity of the Fund's investment objective and
policies. The provisions of the Declaration described above could have the
effect of depriving the Common Shareholders of opportunities to sell their
Common Shares at a premium over the then current market price of the Common
Shares by discouraging a third party from seeking to obtain control of the Fund
in a tender offer or similar transaction. The Board of Trustees of the Fund has
considered the foregoing anti-takeover provisions and concluded that they are
in the best interests of the Fund and its Common Shareholders.
The foregoing is intended only as a summary and is qualified in its
entirety by reference to the full text of the Declaration and the Fund's
Bylaws, both of which are on file with the Securities and Exchange Commission.
Under Massachusetts law, shareholders could, in certain circumstances, be
held personally liable for the obligations of the Fund. However, the
Declaration contains an express disclaimer of shareholder liability for debts
or obligations of the Fund and requires that notice of such limited liability
be given in each note, bond, contract, instrument, certificate or undertaking
made or issued by the Trustees or any officer or officers of the Fund. The
Declaration further provides for indemnification by the Fund for all loss and
expense of any shareholder or former shareholder held personally liable on
account of being or having been a shareholder 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.
46
UNDERWRITING
Subject to the terms and conditions stated in the purchase agreement
dated November 25, 2002, each underwriter named below has severally agreed to
purchase, and the Fund has agreed to sell to such underwriter, the number of
Common Shares set forth opposite the name of such underwriter.
NUMBER OF
UNDERWRITER COMMON SHARES
----------- -------------
Merrill Lynch, Pierce, Fenner & Smith
Incorporated....................... 490,000
Prudential Securities Incorporated.......... 350,000
Advest, Inc................................. 250,000
Legg Mason Wood Walker, Incorporated........ 250,000
Quick & Reilly, Inc......................... 250,000
RBC Dain Rauscher Inc....................... 185,000
Ferris, Baker Watts, Incorporated........... 185,000
J.J.B. Hilliard, W.L. Lyons, Inc............ 185,000
McDonald Investments Inc., a KeyCorp Company 185,000
TD Waterhouse Investor Services, Inc........ 185,000
Wedbush Morgan Securities Inc............... 185,000
U.S. Bancorp Piper Jaffray Inc.............. 100,000
Wachovia Securities, Inc.................... 100,000
William Blair & Company, L.L.C.............. 50,000
Brean Murray & Co., Inc..................... 50,000
C.E. Unterberg, Towbin...................... 50,000
Crowell, Weedon & Co........................ 50,000
D.A. Davidson & Co.......................... 50,000
Fahnestock & Co. Inc........................ 50,000
Johnston, Lemon & Co. Incorporated.......... 50,000
Morgan Keegan & Company, Inc................ 50,000
Parker/Hunter Incorporated.................. 50,000
Stephens Inc................................ 50,000
Stifel, Nicolaus & Company, Incorporated.... 50,000
Utendahl Capital Partners, L.P.............. 50,000
Gilford Securities Incorporated............. 25,000
Howe Barnes Investments, Inc................ 25,000
Mesirow Financial, Inc...................... 25,000
NatCity Investments, Inc.................... 25,000
Nutmeg Securities, Ltd...................... 25,000
Pacific Crest Securities, Inc............... 25,000
SWS Securities, Inc......................... 25,000
Sands Brothers & Co., Ltd................... 25,000
Sterling Financial Investment Group, Inc.... 25,000
Torrey Pines Securities..................... 25,000
---------
Total.............................. 3,750,000
=========
The purchase agreement provides that the obligations of the underwriters
to purchase the shares included in this offering are subject to the approval of
certain legal matters by counsel and to certain other conditions. The
underwriters are obligated to purchase all the Common Shares sold under the
purchase agreement if any of the Common Shares are purchased. In the purchase
agreement, the Fund and the Investment Manager have agreed to indemnify the
underwriters against certain liabilities, including liabilities arising under
the Securities Act of 1933, or to contribute payments the underwriters may be
required to make for any of those liabilities.
47
The underwriters propose to initially offer some of the Common Shares
directly to the public at the public offering price set forth on the cover page
of this prospectus and some of the Common Shares to certain dealers at the
public offering price less a concession not in excess of $.45 per share. The
sales load investors in the Fund will pay of $.675 per share is equal to 4.5%
of the initial offering price. The underwriters may allow, and the dealers may
reallow, a discount not in excess of $.10 per share on sales to other dealers.
After the initial public offering, the public offering price, concession and
discount may be changed. Investors must pay for any Common Shares purchased on
or before November 29, 2002.
The following table shows the public offering price, sales load and
proceeds before expenses to the Fund. The information assumes either no
exercise or full exercise by the underwriters of their over-allotment option.
PER WITHOUT
SHARE OPTION WITH OPTION
----- ----------- -----------
Public offering price...... $15.00 $56,250,000 $64,687,500
Sales load................. $.675 $2,531,250 $2,910,937
Estimated offering expenses $.03 $112,500 $129,375
Proceeds to the Fund....... $14.295 $53,606,250 $61,647,188
The expenses of the offering are estimated at $924,100 ($927,800 if the
underwriters' option described below is exercised in full) and are payable by
the Fund. The Fund has agreed to pay Merrill Lynch $0.005 per common share as a
partial reimbursement of expenses incurred in connection with the offering. The
Investment Manager has agreed to pay the amount by which the aggregate of all
of the Fund's organizational expenses and offering costs (other than the sales
load) exceeds $0.03 per Common Share.
The Fund has granted the underwriters an option to purchase up to 562,500
additional Common Shares at the public offering price, less the sales load,
within 45 days from the date of this prospectus to cover over-allotments. If
the underwriters exercise this option, each will be obligated, subject to
conditions contained in the purchase agreement, to purchase a number of
additional shares proportionate to that underwriter's initial amount reflected
in the above table.
Until the distribution of the Common Shares is complete, Securities and
Exchange Commission rules may limit underwriters and selling group members from
bidding for and purchasing the Common Shares. However, the representatives may
engage in transactions that stabilize the price of the Common Shares, such as
bids or purchases to peg, fix or maintain that price.
If the underwriters create a short position in the Common Shares in
connection with the offering (I.E., if they sell more Common Shares than are
listed on the cover of this prospectus), the representatives may reduce that
short position by purchasing Common Shares in the open market. The
representatives may also elect to reduce any short position by exercising all
or part of the over-allotment option described above. The underwriters also may
impose a penalty bid, whereby selling concessions allowed to syndicate members
or other broker-dealers in respect of the Common Shares sold in this offering
for their account may be reclaimed by the syndicate if such Common Shares are
repurchased by the syndicate in stabilizing or covering transactions. Purchases
of the Common Shares to stabilize their price or to reduce a short position may
cause the price of the Common Shares to be higher than it might be in the
absence of such purchases.
Neither the Fund nor any of the underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transaction
described above may have on the price of the Common Shares. In addition,
neither the Fund nor any of the underwriters makes any representation that the
representatives will engage in these transactions or that these transactions,
once commenced, will not be discontinued without notice.
The Fund has agreed not to offer or sell any additional Common Shares
(other than Common Shares issued in connection with the Plan) for a period of
180 days after the date of the purchase agreement without the prior written
consent of the underwriters, except for the sale of the Common Shares to the
underwriters pursuant to the purchase agreement.
48
The Fund anticipates that the underwriters may from time to time act as
brokers or dealers in executing the Fund's portfolio transactions after they
have ceased to be underwriters. The underwriters are active underwriters of,
and dealers in, securities and act as market makers in a number of such
securities, and therefore can be expected to engage in portfolio transactions
with the Fund.
The Investment Manager has also agreed to pay from its own assets
additional compensation to Merrill Lynch. This additional compensation will be
payable quarterly at the annual rate of .10% of the Fund's managed assets
during the continuance of the Investment Management Agreement or other advisory
agreement between the Investment Manager and the Fund. The total amount of
these additional payments will not exceed 4.5% of the total price to the public
of the Common Shares sold in this offering; provided, that in determining when
the maximum additional compensation amount has been paid, the value of each of
the quarterly payments shall be discounted at the annual rate of 10% to the
closing date of this offering. Merrill Lynch has agreed to provide certain
after-market support services to the Investment Manager designed to maintain
the visibility of the Fund on an ongoing basis and to provide relevant
information, studies or reports regarding the Fund and the closed-end
investment company industry.
The address of Merrill Lynch is 4 World Financial Center, New York,
New York 10080.
CUSTODIAN, TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND REGISTRAR
Investors Bank & Trust Company, whose principal business address is
200 Clarendon Street, Boston, Massachusetts 02116, has been retained to act as
custodian of the Fund's investments, and EquiServe, whose principal business
address is 150 Royall Street, Canton, Massachusetts 02021, has been retained to
serve as the Fund's transfer and dividend disbursing agent and registrar.
Neither Investors Bank & Trust Company nor EquiServe has any part in deciding
the Fund's investment policies or which securities are to be purchased or sold
for the Fund's portfolio.
REPORTS TO SHAREHOLDERS
The Fund will send unaudited semi-annual and audited annual reports to
its shareholders, including a list of investments held.
LEGAL MATTERS
The validity of the shares offered hereby is being passed on for the Fund
by Ropes & Gray, Boston, Massachusetts, and certain other legal matters will be
passed on for the underwriters by Clifford Chance US LLP, New York, New York.
Clifford Chance US LLP may rely as to certain matters of Massachusetts law on
the opinion of Ropes & Gray.
49
TABLE OF CONTENTS OF THE
STATEMENT OF ADDITIONAL INFORMATION
Investment Objectives and Policies....................... 3
Investment Restrictions.................................. 14
Management of the Fund................................... 16
Investment Advisory and Other Services................... 22
Portfolio Transactions and Brokerage..................... 26
Determination of Net Asset Value......................... 28
Description of Shares.................................... 29
Certain Provisions in the Declaration of Trust........... 32
Repurchase of Shares; Conversion to Open-End Fund........ 34
Taxation................................................. 36
Performance-Related and Comparative and Other Information 43
Counsel and Independent Accountants...................... 47
Additional Information................................... 47
Report of Independent Accountants........................ 49
Financial Statements..................................... 50
Appendix A--Ratings of Investments....................... A-1
50
CDC IXIS ASSET MANAGEMENT SERVICES, INC.
AEW REAL ESTATE INCOME FUND
NOTICE OF PRIVACY POLICIES AND PRACTICES
CDC IXIS/1/ is dedicated to protecting the confidentiality of any nonpublic
personal information provided by our customers/2/. We understand the trust that
our customers place in us and are committed to earning that trust well into the
future.
TYPES OF INFORMATION GATHERED
CDC IXIS collects personal information on applications, forms, documents,
transaction histories and correspondence (electronic, written and telephonic)
with customers. Through our web sites we gather information about visitors and
their needs submitted through answers to surveys, data input to calculators and
information entered onto forms. This information includes but is not limited to
name, postal address, e-mail address and social security number. Much of the
data collected is statistical in nature and is not generally attributable to
any specific customer.
INFORMATION SHARED
It is the position of CDC IXIS that the information we collect, as described
above, may be shared with its corporate affiliates in the financial services
industry in order to enhance and improve customer communications, services, and
products designed to meet our customers' needs. CDC IXIS does not disclose any
nonpublic information about current or former customers to any unaffiliated
third party except as permitted by law, or at the specific request of the
customer. However, we may disclose some or all of the above information to
affiliated and unaffiliated companies that perform marketing and other services
(such as preparing and mailing prospectuses, reports and account statements,
conducting research on client satisfaction, and gathering votes for shareholder
proxies) on our or the Funds' behalf or to other financial institutions with
whom we have joint marketing agreements.
POLICIES AND PRACTICES
Only those CDC IXIS employees that have a business need for personally
identifiable data about our customers are given access to that information. CDC
IXIS maintains physical, electronic, and procedural safeguards that comply with
federal standards to protect your nonpublic personal information.
--------
/1/ For purposes of this notice CDC IXIS includes AEW Real Estate Income Fund
and CDC IXIS Asset Management Services, Inc.
/2/ For purposes of this notice, the terms CUSTOMER or CUSTOMERS include both
shareholders of AEW Real Estate Income Fund and individuals who provide
nonpublic personal information, but do not invest in the Fund.
51
================================================================================
3,750,000 SHARES
AEW REAL ESTATE INCOME FUND
COMMON SHARES
$15.00 PER SHARE
-----------------
PROSPECTUS
-----------------
MERRILL LYNCH & CO.
PRUDENTIAL SECURITIES
LEGG MASON WOOD WALKER
INCORPORATED
RBC CAPITAL MARKETS
ADVEST, INC.
FERRIS, BAKER WATTS,
INCORPORATED
J.J.B. HILLIARD, W.L. LYONS, INC.
MCDONALD INVESTMENTS INC.
QUICK & REILLY, INC.
TD WATERHOUSE
WEDBUSH MORGAN SECURITIES INC.
NOVEMBER 25, 2002
CEAEW15-1002
================================================================================
Filed Pursuant to Rule 497(h)
File No. 333-100018
AEW REAL ESTATE INCOME FUND
399 Boylston Street
Boston, Massachusetts 02116
(800) 862-4863
STATEMENT OF ADDITIONAL INFORMATION
November 25, 2002
AEW Real Estate Income Fund (the "Fund") is a newly organized,
non-diversified, closed-end management investment company organized as a
Massachusetts business trust on September 18, 2002.
This Statement of Additional Information relating to the common shares
("Common Shares") of the Fund is not a prospectus, but should be read in
conjunction with the prospectus of the Fund, dated November 25, 2002, 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. This Statement of Additional
Information is incorporated by reference in its entirety into the Prospectus.
Copies of the Statement of Additional Information and Prospectus may be obtained
free of charge by writing or calling the address or phone number shown above.
You may also obtain a copy of the Prospectus on the web site
(http://www.sec.gov) of the Securities and Exchange Commission ("SEC").
Capitalized terms used but not defined herein have the same meanings ascribed to
them in the Prospectus.
TABLE OF CONTENTS
INVESTMENT OBJECTIVES AND POLICIES....................................... 3
INVESTMENT RESTRICTIONS.................................................. 14
MANAGEMENT OF THE FUND................................................... 16
INVESTMENT ADVISORY AND OTHER SERVICES................................... 21
PORTFOLIO TRANSACTIONS AND BROKERAGE..................................... 26
DETERMINATION OF NET ASSET VALUE......................................... 28
DESCRIPTION OF SHARES.................................................... 29
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST........................... 32
REPURCHASE OF SHARES; CONVERSION TO OPEN-END FUND........................ 34
TAXATION................................................................. 36
PERFORMANCE-RELATED AND COMPARATIVE AND OTHER INFORMATION................ 43
COUNSEL AND INDEPENDENT ACCOUNTANTS...................................... 47
ADDITIONAL INFORMATION................................................... 47
REPORT OF INDEPENDENT ACCOUNTANTS........................................ 48
FINANCIAL STATEMENTS..................................................... 49
APPENDIX A............................................................... A-1
-2-
INVESTMENT OBJECTIVES AND POLICIES
Additional Information Regarding Fund Investments
The following descriptions supplement the descriptions of the principal
investment objectives, strategies and risks set forth in the Prospectus. Except
as specifically provided herein, the Fund's investment policies are not
fundamental and may be changed by the Board of Trustees of the Fund without the
approval of the shareholders.
Investments In Real Estate Companies And Real Estate Investment Trusts
Under normal market conditions, the Fund will invest at least 90% of
its total assets in income-producing common shares, preferred shares,
convertible preferred shares (preferred shares that, during certain periods or
upon the happening of certain events, may be converted into common shares) and
debt securities issued by real estate companies, including real estate
investment trusts ("REITs"). For purposes of the Fund's investment policies, a
"Real Estate Company" is one that generally derives at least 50% of its revenues
from the ownership, construction, financing, management or sale of commercial,
industrial, or residential real estate; or has at least 50% of its assets
invested in such real estate. Under normal market conditions, at least 80% of
the Fund's total assets will be invested in income-producing equity securities
issued by REITs. It is the Fund's fundamental policy to concentrate its
investments in the U.S. real estate industry (including REITs) and not in any
other industry.
Lower-Rated Securities
Under rating agency guidelines, medium- and lower-rated securities and
comparable unrated securities will likely have some quality and protective
characteristics that are outweighed by large uncertainties or major risk
exposures to adverse conditions. Medium- and lower-rated securities may have
poor prospects of ever attaining any real investment standing, may have a
current identifiable vulnerability to default, may be unlikely to have the
capacity to pay interest and repay principal when due in the event of adverse
business, financial or economic conditions, and/or may be likely to be in
default or not current in the payment of interest or principal. Such securities
are considered speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligations.
Accordingly, it is possible that these types of factors could reduce the value
of securities held by the Fund, with a commensurate effect on the value of the
Fund's shares.
Changes by recognized rating services in their ratings of any
fixed-income security and in the ability of an issuer to make payments of
interest and principal may also affect the value of these investments. A
description of the ratings of certain rating agencies is set forth in Appendix
A. The ratings generally represent the opinions of those organizations as to the
quality of the securities that they rate. Such ratings, however, are relative
and subjective, are not absolute standards of quality, are subject to change and
do not evaluate the market risk or liquidity of the securities. Ratings of a
non-U.S. debt instrument, to the extent that those ratings are undertaken, are
related to evaluations of the country in which the issuer of the instrument is
located. Ratings generally take into account the currency in which a non-U.S.
debt instrument is denominated.
-3-
The secondary markets for lower-rated securities are generally not as
liquid as the secondary markets for higher rated securities. The secondary
markets for lower-rated securities are concentrated in relatively few market
makers and participants in the market are generally institutional investors,
including insurance companies, banks, other financial institutions and mutual
funds. In addition, the trading volume for lower-rated securities is generally
lower than that for higher-rated securities and the secondary markets could
contract under adverse market or economic conditions independent of any specific
adverse changes in the condition of a particular issuer. These factors may have
an adverse effect on the ability of the Fund to dispose of particular portfolio
investments, may adversely affect the Fund's net asset value per share and may
limit the ability of the Fund to obtain accurate market quotations for purposes
of valuing securities and calculating net asset value. If the Fund is not able
to obtain precise or accurate market quotations for a particular security, it
will become more difficult to value its portfolio securities, and a greater
degree of judgment may be necessary in making such valuations. Less liquid
secondary markets may also affect the ability of the Fund to sell securities at
their fair value. If the secondary markets for lower-rated securities contract
due to adverse economic conditions or for other reasons, certain liquid
securities in the Fund's portfolio may become illiquid and the proportion of the
Fund's assets invested in illiquid securities may significantly increase.
Prices for lower-rated securities may be affected by legislative and
regulatory developments to a greater extent than higher-rated securities. These
laws could adversely affect the Fund's net asset value and investment practices,
the secondary market for lower-rated securities, the financial condition of
issuers of these securities and the value of outstanding lower-rated securities.
For example, federal legislation requiring the divestiture by federally insured
savings and loan associations of their investments in lower-rated bonds and
limiting the deductibility of interest by certain corporate issuers of
lower-rated bonds adversely affected the market in the past.
While the market values of securities rated below investment grade and
comparable unrated securities tend to react less to fluctuations in interest
rate levels than do those of higher-rated securities, the values of certain of
these securities also tend to be more sensitive to individual corporate
developments and changes in economic conditions than higher rated securities. In
addition, such securities present a higher degree of credit risk. Issuers of
these securities are often highly leveraged and may not have more traditional
methods of financing available to them, so that their ability to service their
debt obligations during an economic downturn or during sustained periods of
rising interest rates may be impaired. The risk of loss due to default by such
issuers is significantly greater than with investment grade securities because
such securities generally are unsecured and subordinated to the prior payment of
senior indebtedness. The Fund also may incur additional expenses to the extent
that it is required to seek recovery upon a default in the payment of principal
or interest on its portfolio holdings.
The Fund may only invest in non-investment grade securities that are
rated CCC or higher by Standard & Poor's Ratings Services ("S&P") or Caa or
higher by Moody's Investors Service, Inc. ("Moody's") (or a comparable rating by
another nationally recognized statistical rating agency), or unrated securities
determined to be of comparable quality by the Investment Manager. The issuers of
these securities may be in default or have a currently identifiable
vulnerability to default on their payments of principal and interest, or may
otherwise be subject to present
-4-
elements of danger with respect to payments of principal or interest. The Fund
will not invest in securities that are in default as to payment of principal and
interest at the time of purchase.
Swap Agreements
The Fund may enter into interest rate swap or cap transactions for
purposes of attempting to reduce or eliminate the impact that an increase in
short-term interest rates could have on the Fund's investments and capital
structure. Swap transactions are two-party contracts entered into primarily by
institutional investors for periods ranging from a few weeks to more than one
year. In a standard "swap" transaction, two parties agree to exchange the
returns (or differentials in rates of return) earned or realized on particular
predetermined investments or instruments. The gross returns to be exchanged or
"swapped" between the parties are calculated with respect to a "notional
amount," i.e., the return on or increase in value of a particular dollar amount
invested at a particular interest rate or in a "basket" of securities
representing a particular index. Commonly used swap transactions include: (i)
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"; (ii) 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 level, or "floor"; and (iii) 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 "notional amount" of the swap transaction is only a fictitious
basis on which to calculate the obligations that the parties to a swap
transaction have agreed to exchange. Most swap transactions entered into by the
Fund would calculate the obligations on a "net basis." Consequently, the Fund's
obligations (or rights) under a swap transaction will generally be equal only to
the net amount to be paid or received under the transaction based on the
relative values of the positions held by each party to the transaction (the "net
amount"). Obligations under a swap transaction will be accrued daily (offset
against amounts owing to the Fund) and any accrued but unpaid net amounts owed
to a swap counterparty will be covered by segregating liquid assets. The Fund
will not enter into a swap transaction with any single party if the net amount
owed to or to be received under existing contracts with that party would exceed
5% of the Fund's total assets.
Common Shareholders will bear the risks and costs of swaps, caps or
other interest rate transactions entered into by the Fund.
Foreign Securities
The Fund may invest up to 10% of its total assets in the securities of
non-U.S. issuers located in countries that are members of the Organisation For
Economic Co-operation and Development.
Investors should recognize that investing in the securities of foreign
issuers involves special considerations which are not typically associated with
investing in the securities of U.S. issuers. Investments in securities of
foreign issuers may involve risks arising from differences between U.S. and
foreign securities markets, including less volume, much greater price volatility
-5-
in and illiquidity of certain foreign securities markets, different trading and
settlement practices and less (or different) governmental supervision and
regulation, from changes in currency exchange rates, from high and volatile
rates of inflation, from economic, social and political conditions and, as with
domestic multinational corporations, from fluctuating interest rates.
Other investment risks include the possible imposition of foreign
withholding taxes on certain amounts of the Fund's income, the possible seizure
or nationalization of foreign assets and the possible establishment of exchange
controls, expropriation, confiscatory taxation, other foreign governmental laws
or restrictions which might affect adversely payments due on securities held by
the Fund, the lack of extensive operating experience of eligible foreign
sub-custodians and legal limitations on the ability of the Fund to recover
assets held in custody by a foreign sub-custodian or depository in the event of
the sub-custodian's or depository's bankruptcy or other event adversely
affecting such sub-custodian or depository.
In addition, there may be less publicly-available information about a
foreign issuer than about a U.S. issuer, and foreign issuers may not be subject
to the same accounting, auditing and financial record-keeping standards and
requirements as U.S. issuers. In particular, the assets and profits appearing on
the financial statements of a foreign issuer may not reflect its financial
position or results of operations in the way they would be reflected had the
financial statements been prepared in accordance with U.S. generally accepted
accounting principles. In addition, for an issuer that keeps accounting records
in local currency, inflation accounting rules may require, for both tax and
accounting purposes, that certain assets and liabilities be restated on the
issuer's balance sheet in order to express items in terms of currency of
constant purchasing power. Inflation accounting may indirectly generate losses
or profits. Consequently, financial data may be materially affected by
restatements for inflation and may not accurately reflect the real condition of
those issuers and securities markets. Finally, in the event of a default in any
such foreign obligations, it may be more difficult for the Fund to obtain or
enforce a judgment against the issuers of such obligations.
There generally is less governmental supervision and regulation of
exchanges, brokers and issuers in foreign countries than there is in the United
States. For example, in some jurisdictions there may be no comparable provisions
under certain foreign laws to insider trading and similar investor protection
securities laws that apply with respect to securities transactions consummated
in the United States. Further, brokerage commissions and other transaction costs
on foreign securities exchanges generally are higher than in the United States.
The manner in which foreign investors may invest in companies in
certain foreign countries, as well as limitations on such investments, also may
have an adverse impact on the operations of the Fund. For example, the Fund may
be required in some countries to invest initially through a local broker or
other entity and then have the purchased shares re-registered in the name of the
Fund. Re-registration may be costly and may in some instances not occur on a
timely basis, resulting in a delay during which the Fund may be denied certain
of its rights as an investor.
Foreign markets have different clearance and settlement procedures, and
in certain markets there have been times when settlements have failed to keep
pace with the volume of securities transactions, making it difficult to conduct
such transactions. Further, satisfactory
-6-
custodial services for investment securities may not be available in some
countries having smaller capital markets, which may result in the Fund
incurring additional costs and delays in transporting such securities outside
such countries. Delays in settlement or other problems could result in periods
when assets of the Fund are uninvested and no return is earned thereon. The
inability of the Fund to make intended security purchases due to settlement
problems or the risk of intermediary counterparty failures could cause the Fund
to forego attractive investment opportunities. The inability to dispose of a
portfolio security due to settlement problems could result either in losses to
the Fund due to subsequent declines in the value of such portfolio security or,
if the Fund has entered into a contract to sell the security, could result in
possible liability to the purchaser.
Rules adopted under the Investment Company Act of 1940, as amended (the
"1940 Act"), permit the Fund to maintain its foreign securities and cash in the
custody of certain eligible non-U.S. banks and securities depositories. Certain
banks in foreign countries may not be "eligible sub-custodians," as defined in
the 1940 Act, for the Fund, in which event the Fund may be precluded from
purchasing securities in certain foreign countries in which it otherwise would
invest or may incur additional costs and delays in providing transportation and
custody services for such securities outside of such countries. The Fund may
encounter difficulties in effecting, on a timely basis, portfolio transactions
with respect to any securities of issuers held outside their countries. Other
banks that are eligible foreign sub-custodians may be recently organized or
otherwise lack extensive operating experience. In addition, in certain countries
there may be legal restrictions or limitations on the ability of the Fund to
recover assets held in custody by foreign sub-custodians in the event of the
bankruptcy of the sub-custodian.
Illiquid Securities
The Fund may invest in securities that are illiquid so long as no more
than 10% of the total assets of the Fund (taken at market value at the time of
investment) would be invested in such securities. The above limitation applies
only at the time a security is purchased, and the Fund is not required to
dispose of securities if, due to market movements, greater than 10% of the
Fund's total assets are invested in illiquid securities. The term "illiquid
securities" for these purposes means securities that cannot be disposed of
within seven days in the ordinary course of business at approximately the amount
at which the Fund has valued the securities. The staff of the SEC is presently
of the view that repurchase agreements maturing in more than seven days are
subject to this restriction. Until that position is revised, modified or
rescinded, the Fund will conduct its operations in a manner consistent with this
view. This limitation on investment in illiquid securities does not apply to
certain restricted securities, including securities issued pursuant to Rule 144A
under the Securities Act of 1933 and certain commercial paper, that AEW
Management and Advisors, L.P. (the "Investment Manager") has determined to be
liquid under procedures approved by the Board of Trustees.
The Board of Trustees has delegated to the Investment Manager the
day-to-day determination of the illiquidity of any security held by the Fund,
although it has retained oversight and ultimate responsibility for such
determinations. Certain illiquid securities may require pricing at fair value as
determined in good faith under the supervision of the Board of Trustees. See
"Determination of Net Asset Value." The Investment Manager may be subject to
significant delays in disposing of illiquid securities held by the Fund, and
transactions in illiquid
-7-
securities may entail registration expenses and other transaction costs that
are higher than those for transactions in liquid securities. If adverse
market conditions were to develop during any such delay, the Fund might obtain a
less favorable price than that which prevailed when it decided to sell.
As discussed in the Prospectus under "Interest Rate Transactions," the
Fund intends to segregate cash or liquid securities with its custodian having a
value at least equal to the Fund's net payment obligations under any swap
transaction, as marked to market daily. The Fund will treat such amounts as
illiquid for purposes of its 10% limit on investments in illiquid securities.
Other Investment Companies
The Fund may invest in securities of open- or closed-end investment
companies that invest primarily in investments of the types in which the Fund
may invest directly. The Fund may invest in other investment companies either
during periods when it has large amounts of uninvested cash, such as the period
shortly after the Fund receives the proceeds of the offering of its Common
Shares or the planned offering of its preferred shares of beneficial interest
("Fund Preferred Shares"), during periods when there is a shortage of
attractive, real estate-related investments available in the market, to gain
exposure to foreign markets, when the Investment Manager believes share prices
of other investment companies offer attractive values or when it believes such
investments are attractive investment opportunities. The Fund may invest in
investment companies that are advised by the Investment Manager or its
affiliates (including affiliated money market and short-term bond funds) to the
extent permitted by applicable law and/or pursuant to exemptive relief from the
SEC. As a stockholder in an investment company, the Fund will bear its ratable
share of that investment company's expenses and Fund shareholders would remain
subject to payment of the Fund's management fees with respect to assets so
invested. Holders of Common Shares ("Common Shareholders") would therefore be
subject to duplicative expenses to the extent the Fund invests in other
investment companies. The Investment Manager will take expenses into account
when evaluating the investment merits of an investment in an investment company
relative to other investments. In addition, the securities of other investment
companies may also be leveraged and will therefore be subject to the same
leverage risks described in the Prospectus and herein. As described in the
Prospectus in the section entitled "Use of Leverage--Leverage Risks," the net
asset value and market value of leveraged shares will be more volatile and the
yield to shareholders will tend to fluctuate more than the yield generated by
unleveraged shares.
U.S. Government Securities
U.S. Government securities are obligations of, or guaranteed by, the
U.S. Government, its agencies or instrumentalities. The U.S. Government does not
guarantee the net asset value of the Fund's shares. Some U.S. Government
securities, such as Treasury bills, notes and bonds, and securities guaranteed
by the Government National Mortgage Association, 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 Federal National Mortgage Association,
are supported by the discretionary authority of the U.S. Government to purchase
the agency's obligations; and still others, such as those of the Student Loan
Marketing Association, are supported only by the credit of the instrumentality.
No assurance can be given that the U.S. Government will provide financial
support to U.S.
-8-
Government-sponsored instrumentalities if it is not obligated to do so by law.
U.S. Government securities include securities that have no coupons, or have been
stripped of their unmatured interest coupons, individual interest coupons from
such securities that trade separately and evidences of receipt of such
securities. Such securities may pay no cash income, and are purchased at a deep
discount from their value at maturity. Custodial receipts issued in connection
with so-called trademark zero-coupon securities, such as CATs and TIGRs, are not
issued by the U.S. Treasury, and are therefore not U.S. Government securities,
although the underlying bond represented by such receipt is a debt obligation of
the U.S. Treasury. Other zero-coupon Treasury securities (e.g., STRIPs and
CUBEs) are direct obligations of the U.S. Government.
Corporate Bonds
The Fund may invest in a wide variety of debt obligations of varying
maturities issued by U.S. and foreign corporations and other business entities,
including REITs. Bonds are fixed or variable rate debt obligations, including
bills, notes, debentures and similar instruments and securities. Bonds generally
are used by corporations and other issuers to borrow money from investors. The
issuer pays the investor a fixed or variable rate of interest and normally must
repay the amount borrowed on or before maturity. Certain bonds are "perpetual"
in that they have no maturity date. The Fund will invest in U.S.
dollar-denominated corporate bonds and may also invest in bonds denominated in
foreign currencies in accordance with the Fund's investment objectives and
policies as described in the Prospectus. The Fund has the flexibility to invest
in corporate bonds that are below investment grade quality. See "- Lower-Rated
Securities" above.
Many bonds, especially those issued at high interest rates, provide
that the issuer may repay them early. Issuers often exercise this right when
interest rates decline. Accordingly, holders of securities that may be called or
prepaid may not benefit fully from the increase in value that other fixed income
securities experience when rates decline. Furthermore, the Fund reinvests the
proceeds of the payoff at current yields, which typically are lower than those
paid by the security that was paid off.
Convertible Securities
The Fund may invest in convertible securities. A convertible debt
security is a bond, debenture, note, or other security that entitles the holder
to acquire common stock or other equity securities of the same or a different
issuer. Similarly, certain classes of preferred stock are convertible, meaning
the preferred stock is convertible into shares of common stock of the issuer. A
convertible security generally entitles the holder to receive interest or
dividends paid or accrued until the convertible security matures or is redeemed,
converted or exchanged. By holding a convertible security, the Fund can receive
a steady stream of interest payments or dividends and still have the option to
convert the security to common stock.
As a fixed income security, a convertible debt or equity security tends
to increase in market value when interest rates decline and to decrease in value
when interest rates rise. While convertible securities generally offer lower
interest or dividend yields than non-convertible
-9-
securities of similar quality, their value tends to increase as the market value
of the underlying stock increases and to decrease when the value of the
underlying stock decreases.
Convertible securities generally rank senior to common stock in a
corporation's capital structure and, therefore, generally entail less risk than
the corporation's common stock. 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.
The Fund may also 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. For example, the Fund may purchase a non-convertible debt security
and a warrant or option. The synthetic convertible differs from the true
convertible security in several respects. Unlike a true convertible security,
which is a single security having a unitary market value, a synthetic
convertible comprises two or more separate securities, each with its own market
value. Therefore, the "market value" of a synthetic convertible is the sum of
the values of its fixed income component and its convertible component. For this
reason, the values of a synthetic convertible and a true convertible security
may respond differently to market fluctuations.
Short Sales
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. The Fund will not enter into short sales except for interest rate
hedging purposes as described in the Prospectus.
When the Fund makes a short sale on a security, it must borrow the
security sold short and deliver it to the broker-dealer through which it made
the short sale as collateral for its obligation to deliver the security upon
conclusion of the sale. The Fund may have to pay a fee to borrow particular
securities and is often obligated to pay over any accrued interest and dividends
on such borrowed securities.
If the price of the security sold short increases between the time of
the short sale and the time the Fund replaces the borrowed security, the Fund
will incur a loss; conversely, if the price declines, the Fund will realize a
capital gain. Any gain will be decreased, and any loss increased, by the
transaction costs described above. The successful use of short selling may be
adversely affected by imperfect correlation between movements in the price of
the security sold short and the securities being hedged.
To the extent that the Fund engages in short sales, it will provide
collateral to the broker-dealer. A short sale is "against the box" to the extent
that the Fund contemporaneously owns, or has the right to obtain at no added
cost, securities identical to those sold short. The Fund may also engage in
so-called "naked" short sales (i.e., short sales that are not "against the
box"), in which case the Fund's losses could theoretically be unlimited, in
cases where the Fund is unable for whatever reason to close out its short
position.
-10-
Derivative Instruments
The Fund may invest in derivatives for interest rate hedging purposes as
described in the Prospectus. The Fund may purchase and sell (write) both put
options and call options on securities, swap agreements, and securities indexes,
and enter into interest rate and index futures contracts and purchase and sell
options on such futures contracts ("futures options") for these purposes. The
Fund may also use other types of instruments that are currently available or
that may be introduced in the future, including other types of options, futures
contracts or futures options, provided that their use is consistent with the
Fund's investment objectives.
The value of some derivative instruments in which the Fund may invest may
be particularly sensitive to changes in prevailing interest rates, and, like the
other investments of the Fund, the ability of the Fund to utilize these
instruments successfully may depend in part upon the ability of the Investment
Manager to forecast interest rates and other economic factors correctly. If the
Investment Manager incorrectly forecasts such factors and has taken positions in
derivative instruments contrary to prevailing market trends, the Fund could be
exposed to the risk of loss.
The Fund might not employ any derivatives, and no assurance can be given
that any strategy used will succeed. If the Investment Manager incorrectly
forecasts interest rates, market values or other economic factors in utilizing a
derivatives strategy for the Fund, the Fund might have been in a better position
if it had not entered into the transaction at all. Also, suitable derivative
transactions may not be available in all circumstances. The use of these
strategies involves certain special risks, including a possible imperfect
correlation, or even no correlation, between price movements of derivative
instruments and price movements of related investments. While some strategies
involving derivative instruments can reduce the risk of loss, they can also
reduce the opportunity for gain or even result in losses by offsetting favorable
price movements in related investments or otherwise, due to the possible
inability of the Fund to purchase or sell a portfolio security at a time that
otherwise would be favorable or the possible need to sell a portfolio security
at a disadvantageous time because the Fund is required to maintain asset
coverage or offsetting positions in connection with transactions in derivative
instruments and due to the possible inability of the Fund to close out or to
liquidate its derivatives positions.
Short-Term Investments and Borrowings
In anticipation of or in response to adverse market conditions, for cash
management purposes, or for defensive purposes, the Fund may invest up to 100%
of its net assets in cash equivalents and short-term fixed-income securities.
The Fund would be unable to achieve its investment objectives if a substantial
portion of its assets consisted of such investments. Short-term fixed income
investments include, without limitation, the following:
(1) U.S. government securities, including bills, notes and bonds differing
as to maturity and rates of interest that are either issued or guaranteed by the
U.S. Treasury or by U.S. government agencies or instrumentalities. U.S.
government agency securities include securities issued by (a) the Federal
Housing Administration, Farmers Home Administration, Export-Import Bank of the
United States, Small Business Administration and the Government National
-11-
Mortgage Association, whose securities are supported by the full faith and
credit of the United States; (b) the Federal Home Loan Banks, Federal
Intermediate Credit Banks, and the Tennessee Valley Authority, whose securities
are supported by the right of the agency to borrow from the U.S. Treasury; (c)
the Federal National Mortgage Association, whose securities are supported by the
discretionary authority of the U.S. Government to purchase certain obligations
of the agency or instrumentality; and (d) the Student Loan Marketing
Association, whose securities are supported only by its credit. While the U.S.
Government provides financial support to such U.S. government-sponsored agencies
or instrumentalities, no assurance can be given that it always will do so since
it is not so obligated by law. The U.S. Government, its agencies and
instrumentalities do not guarantee the market value of their securities.
Consequently, the value of such securities may fluctuate.
(2) Certificates of Deposit issued against funds deposited in a bank or a
savings and loan association. Such certificates are for a definite period of
time, earn a specified rate of return, and are normally negotiable. The issuer
of a certificate of deposit agrees to pay the amount deposited plus interest to
the bearer of the certificate on the date specified thereon. Under current FDIC
regulations, the maximum insurance payable as to any one certificate of deposit
is $100,000; therefore, certificates of deposit purchased by the Fund may not be
fully insured.
(3) Repurchase agreements, which involve purchases of debt securities. At
the time the Fund purchases securities pursuant to a repurchase agreement, it
simultaneously agrees to resell and redeliver such securities to the seller, who
also simultaneously agrees to buy back the securities at a fixed price and time.
This assures a predetermined yield for the Fund during its holding period, since
the resale price is always greater than the purchase price and reflects an
agreed-upon market rate. Such actions afford an opportunity for the Fund to
invest temporarily available cash. The Fund may enter into repurchase agreements
only with respect to obligations of the U.S. Government, its agencies or
instrumentalities; certificates of deposit; or bankers' acceptances in which the
Fund may invest. Repurchase agreements may be considered loans to the seller,
collateralized by the underlying securities. The risk to the Fund is limited to
the ability of the seller to pay the agreed-upon sum on the repurchase date; in
the event of default, the repurchase agreement provides that the Fund is
entitled to sell the underlying collateral. If the value of the collateral
declines after the agreement is entered into, and if the seller defaults under a
repurchase agreement when the value of the underlying collateral is less than
the repurchase price, the Fund could incur a loss of both principal and
interest. The Investment Manager monitors the value of the collateral at the
time the action is entered into and at all times during the term of the
repurchase agreement. The Investment Manager does so in an effort to determine
that the value of the collateral always equals or exceeds the agreed-upon
repurchase price to be paid to the Fund. If the seller were to be subject to a
federal bankruptcy proceeding, the ability of the Fund to liquidate the
collateral could be delayed or impaired because of certain provisions of the
bankruptcy laws.
(4) Commercial paper, which consists of short-term unsecured promissory
notes, including variable rate master demand notes issued by corporations to
finance their current operations. Investments in commercial paper will be
limited to commercial paper rated in the highest categories by a major rating
agency and which mature within one year of the date of purchase or carry a
variable or floating rate of interest. Master demand notes are direct lending
arrangements between the Fund and a corporation. There is no secondary market
for such notes.
-12-
However, they are redeemable by the Fund at any time. The Investment Manager
will consider the financial condition of the corporation (e.g., earning power,
cash flow, and other liquidity measures) and will continuously monitor the
corporation's ability to meet all of its financial obligations, because the
Fund's liquidity might be impaired if the corporation were unable to pay
principal and interest on demand.
(5) Shares of other investment companies that in turn invest in short-term
investments, such as money market mutual funds. Subject to certain restrictions
contained in any applicable exemptive order issued by the SEC, these investments
may include investment companies such as money market funds advised or
subadvised by the Investment Manager or its affiliates.
The Fund may borrow money for temporary administrative purposes. Subject to
the terms of any applicable exemptive relief granted by the SEC, the Fund may
borrow for such purposes from other investment companies advised by the
Investment Manager or its affiliates in an inter-fund loan program. In such a
program, the Fund and affiliated funds would be permitted to lend and borrow
money for certain temporary purposes directly to and from one another.
Participation in such an inter-fund lending program would be voluntary for both
borrowing and lending funds, and the Fund would participate in an inter-fund
loan program only if the Board of Trustees determined that doing so would
benefit the Fund. Should the Fund participate in such an inter-fund lending
program, the Board of Trustees would establish procedures for the operation of
the program by the Investment Manager or an affiliate.
Portfolio Turnover
The Fund may engage in frequent and active portfolio trading when the
Investment Manager considers it to be appropriate, but the Fund will not use
short-term trading as the primary means of achieving its investment objectives.
Although the Fund cannot accurately predict its annual portfolio turnover rate,
it is not expected to exceed 100% under normal circumstances. However, there are
no limits on the rate of portfolio turnover, and investments may be sold without
regard to the length of time held when, in the opinion of the Investment
Manager, investment considerations warrant such action. A higher turnover rate
results in correspondingly greater brokerage commissions and other transactional
expenses that are borne by the Fund. High portfolio turnover may result in the
increased realization of net short-term capital gains by the Fund that, when
distributed to shareholders, will be taxable as ordinary income. See "Taxation."
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 CDC
IXIS Asset Management North America, L.P. 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 regulatory and other restrictions. This could limit the Fund's
ability to engage in securities transactions and take advantage of market
opportunities.
-13-
Other Investments; New Securities And Other Investment Techniques.
Although the Fund invests primarily in the securities of Real Estate
Companies, it may from time to time also invest in equity or debt securities of
issuers in other industries. Such investments may be subject to different or
additional risks, including, among others, the risk that market prices of equity
securities may rise and fall rapidly and unpredictably and the risk that debt
securities may lose value when interest rates rise.
New types of securities and other investment and hedging practices are
developed from time to time. The Investment Manager expects, consistent with the
Fund's investment objectives and policies, to invest in such new types of
securities and to engage in such new types of investment practices if the
Investment Manager believes that these investments and investment techniques may
assist the Fund in achieving its investment objectives. In addition, the
Investment Manager may use investment techniques and instruments that are not
specifically described herein.
INVESTMENT RESTRICTIONS
The investment objectives and the general investment policies and
investment techniques of the Fund are described in the Prospectus. The Fund's
investment objectives are fundamental, and the Fund has also adopted the
following investment restrictions as fundamental policies. The Fund's investment
objectives and the following investment restrictions may not be changed without
the approval of the holders of a majority of the outstanding shares (as defined
in the 1940 Act) of the Fund.
Under these policies:
(1) The Fund may not make short sales of securities or maintain a short
position or purchase securities on margin, except that the Fund may obtain
short-term credits as necessary for the clearance of security transactions, and
the Fund may make any short sales or maintain any short positions where the
short sales or short positions would not constitute "senior securities" under
the 1940 Act.
(2) The Fund may borrow money to the maximum extent permitted by law,
including without limitation (i) borrowing from banks or entering into reverse
repurchase agreements, or employing similar investment techniques, and pledging
its assets in connection therewith, and (ii) entering into reverse repurchase
agreements and transactions in options, futures, options on futures, and forward
foreign currency contracts.
(3) The Fund may not make loans, except that the Fund may purchase or hold
debt instruments in accordance with its investment objectives and policies. This
restriction does not apply to repurchase agreements or loans of portfolio
securities.
(4) The Fund may not act as an underwriter of securities of other issuers
except that, in the disposition of portfolio securities, it may be deemed to be
an underwriter under the federal securities laws.
-14-
(5) The Fund may not purchase or sell real estate, although it may purchase
securities of real estate investment trusts, issuers which deal in real estate,
securities which are secured by interests in real estate, and securities which
represent interests in real estate, and it may acquire and dispose of real
estate or interests in real estate acquired through the exercise of its rights
as a holder of debt obligations secured by real estate or interests therein.
(6) The Fund may not purchase or sell commodities, except that the Fund may
purchase and sell futures contracts and options, may enter into foreign exchange
contracts and may enter into swap agreements and other financial transactions
not requiring the delivery of physical commodities.
(7) The Fund may not issue senior securities, except for permitted
borrowings or as otherwise permitted under the 1940 Act.
In addition to these investment restrictions, the Fund will make
investments that will result in the concentration (as that term may be defined
by or interpreted under the 1940 Act and the rules and regulations thereunder)
of its investments in the securities of issuers primarily engaged in the real
estate industry (including real estate investment trusts) and not in any other
industry. This restriction does not apply to U.S. Government Securities. For
purposes of this restriction, telephone, gas and electric public utilities are
each regarded as separate industries and finance companies whose financing
activities are related primarily to the activities of their parent companies are
classified in the industry of their parents. For purposes of this restriction
with regard to bank obligations, bank obligations are considered to be one
industry, and asset-backed securities are not considered to be bank obligations.
This policy may not be changed without the approval of the holders of a
"majority of the outstanding shares" (as defined in the 1940 Act) of the Fund.
In addition to the fundamental investment policies identified as such
above, the Fund has adopted, among others, the following non-fundamental
investment policy. Under normal market conditions, the Fund will invest at least
90% of its total assets in common shares, preferred shares, convertible
preferred shares and debt securities issued by Real Estate Companies (as defined
in this Statement of Additional Information) ("Basket Investments"). The Board
of Trustees of the Fund may change the preceding policy without shareholder
approval. However, so long as it is required by applicable law, the Fund will
not change the policy in order to reduce below 80% the portion of its net assets
(plus any borrowings for investment purposes) that the Fund will invest, under
normal market conditions, in Basket Investments unless it provides shareholders
with at least 60 days' written notice of such change.
The percentages and percentage limitations set forth above or in the
Prospectus, other than with respect to restriction (2) pertaining to borrowing,
will apply at the time of the purchase of a security and shall not be considered
violated unless an excess or deficiency occurs or exists immediately after and
as a result of a purchase of such security. Restrictions (1) and (7) shall be
interpreted based upon no-action letters and other pronouncements of the SEC or
its staff. Under current pronouncements, certain Fund positions are excluded
from the definition of "senior security" so long as the Fund maintains adequate
cover, segregation of assets or otherwise.
-15-
The Fund intends to apply for ratings for its Fund Preferred Shares (if
issued) from one or more nationally recognized statistical rating agencies. In
order to obtain and maintain the required ratings, the Fund may be required to
comply with investment quality, diversification and other guidelines established
by such rating agencies. Such guidelines will likely be more restrictive than
the restrictions set forth above. The Fund does not anticipate that such
guidelines would have a material adverse effect on Common Shareholders or the
Fund's ability to achieve its investment objectives. The Fund presently
anticipates that any Fund Preferred Shares that it may issue would be initially
given the highest rating (i.e., AAA/Aaa) by at least one nationally recognized
statistical rating agency, but no assurance can be given that such rating(s)
will be obtained or that the Fund Preferred Shares will be issued. Rating
agencies receive fees in connection with their ratings issuances. In addition to
other considerations, to the extent that the Fund believes that the covenants
and guidelines required by the rating agencies would materially impede its
ability to meet its investment objectives, or if the Fund is unable to obtain
its desired rating on the Fund Preferred Shares (expected to be AAA/Aaa), the
Fund will not issue the Fund Preferred Shares.
MANAGEMENT OF THE FUND
The Fund is governed by a Board of Trustees, which is responsible for
generally overseeing the conduct of Fund business and for protecting the
interests of shareholders. Subject to the provisions of the Fund's Amended and
Restated Agreement and Declaration of Trust, its Amended and Restated Bylaws and
Massachusetts law, the Trustees have all power necessary and convenient to carry
out this responsibility, including the election and removal of the Fund's
officers. The Trustees meet periodically throughout the year to oversee the
Fund's activities, review contractual arrangements with companies that provide
services to the Fund and review the Fund's performance.
The table below provides certain information regarding the Trustees and
officers of the Fund. For purposes of this table and for purposes of this
Statement, the term "Independent Trustee" means those Trustees who are not
"interested persons" (as defined in the 1940 Act) of the Fund and, when
applicable, who have no direct or indirect financial interest in the approval of
a matter being voted on by the Board of Trustees. For purposes of this Statement
of Additional Information, the term "Interested Trustee" means those Trustees
who are "interested persons" of the Fund and, when applicable, who have a direct
or indirect financial interest in the approval of a matter being voted on by the
Board of Trustees.
---------------------------------------------------------------------------------------------------------------------------
Term of Number of
Office and Portfolios
Position(s) Length of Principal Occupation(s) in Fund
Held with Time During Past Complex
Name, Age and Address Fund Served 5 Years Overseen Other Directorships Held
--------------------- ---- ------ ------- -------- ------------------------
---------------------------------------------------------------------------------------------------------------------------
INDEPENDENT TRUSTEES
---------------------------------------------------------------------------------------------------------------------------
Graham T. Allison, Jr. (62) Trustee Term Douglas Dillon Professor 28 Director, Taubman Centers, Inc.
399 Boylston Street Contract expires and Director for the Board Member, USEC Inc.
Boston, MA 02116 Review and in 2003* Belfer Center of Science
Governance and International
Affairs, John F. Kennedy
---------------------------------------------------------------------------------------------------------------------------
-16-
---------------------------------------------------------------------------------------------------------------------------
Term of Number of
Office and Portfolios
Position(s) Length of Principal Occupation(s) in Fund
Held with Time During Past Complex
Name, Age and Address Fund Served 5 Years Overseen Other Directorships Held
--------------------- ---- ------ ------- -------- ------------------------
---------------------------------------------------------------------------------------------------------------------------
Committee Since School of Government,
Member inception Harvard University
(October
2002)
---------------------------------------------------------------------------------------------------------------------------
Daniel M. Cain (57) Trustee Term President and CEO, Cain 28 Trustee, Universal Health
452 Fifth Avenue Chairman expires Brothers & Company, Realty Income Trust
New York, NY 10018 of the in 2004* Incorporated (investment Director, eBenX, Inc.
Audit banking) Director, PASC
Committee Since
inception
(October
2002)
---------------------------------------------------------------------------------------------------------------------------
Kenneth J. Cowan (70) Trustee Term Retired 28 None
399 Boylston Street Chairman expires
Boston, MA 02116 of the in 2004*
Contract
Review and Since
Governance inception
Committee (October
2002)
---------------------------------------------------------------------------------------------------------------------------
Richard Darman (59) Trustee Term Partner, The Carlyle 28 Director, Frontier
Contract expires Group (investments); Ventures Corporation
399 Boylston Street Review and in 2003* Professor, John F. Director, Neptune
Boston, MA 02116 Governance Kennedy School of Communications Corporation
Committee Since Government, Harvard Director, Enumerate
Member inception University Solutions, Inc.
(October Director, AES Corp.
2002)
---------------------------------------------------------------------------------------------------------------------------
Sandra O. Moose (60) Trustee Term Senior Vice President 28 Director, Verizon
Exchange Place Audit expires and Director, The Boston Communications
Boston, MA 02109 Committee in 2005* Consulting Group, Inc. Director, Rohm and Haas
Member (management Company
Since consulting)
inception
(October
2002)
---------------------------------------------------------------------------------------------------------------------------
John A. Shane (69) Trustee Term President, Palmer 28 Director, Eastern Bank
200 Unicorn Park Drive Audit expires Service Corporation Corporation; Director,
Woburn, MA 01801 Committee in 2005* (venture capital Gensym Corporation;
Member organization) Director, Overland
Since Storage, Inc.
inception
(October
2002)
---------------------------------------------------------------------------------------------------------------------------
Pendleton P. White (71) Trustee Term Retired 28 None
6 Breckenridge Lane Contract expires
Savannah, GA 31411 Review and in 2003*
Governance
Committee Since
Member inception
(October
2002)
---------------------------------------------------------------------------------------------------------------------------
INTERESTED TRUSTEES
---------------------------------------------------------------------------------------------------------------------------
John T. Hailer** (41) President Term as President and Chief 28 None
399 Boylston Street and Chief Trustee Executive Officer, CDC
Boston, MA 02116 Executive expires IXIS Asset Management
Officer in 2004* Distributors, L.P.;
Director and Executive
Trustee Since Vice President of CDC
inception IXIS Asset Management
(October Distribution Corporation
2002) ("CDC IXIS Distribution
Corporation");
President and Chief
Executive Officer
---------------------------------------------------------------------------------------------------------------------------
-17-
---------------------------------------------------------------------------------------------------------------------------
Term of Number of
Office and Portfolios
Position(s) Length of Principal Occupation(s) in Fund
Held with Time During Past Complex
Name, Age and Address Fund Served 5 Years Overseen Other Directorships Held
--------------------- ---- ------ ------- -------- ------------------------
---------------------------------------------------------------------------------------------------------------------------
of CDC IXIS Asset
Management Advisers, L.P.
("CDC IXIS Advisers");
formerly, Senior Vice
President, Fidelity
Investments
---------------------------------------------------------------------------------------------------------------------------
Peter S. Voss*** (55) Chairman Term Director, President and 28 Trustee, Harris Associates
399 Boylston Street of the expires Chief Executive Officer, Investment Trust****
Boston, MA 02116 Board in 2005* CDC IXIS Asset
Since Management North
Trustee inception America, L.P.
(October
2002)
---------------------------------------------------------------------------------------------------------------------------
OFFICERS
---------------------------------------------------------------------------------------------------------------------------
James J. Finnegan (42) Chief Not AEW Management and N/A N/A
399 Boylston Street Operating Applicable Advisors, L.P., -
Boston, MA 02116 Officer General Counsel,
(October Managing Director, Vice
2002) President and Clerk,
December 1996 to present;
AEW Capital Management,
L.P. - General Counsel and
Principal, January 2000 to
present, Assistant General
Counsel and Vice
President, December 1996
to January 2000; AEW
Advisors, Inc. - Managing
Director and Vice
President, December 1996
to Present; AEW Investment
Group, Inc. - Vice
President and Assistant
Clerk, December, 1996 to
Present; AEW Real Estate
Advisors, Inc . - Vice
President and Assistant
Clerk, December 1996 to
Present; Aldrich, Eastman
& Waltch, L.P. - Assistant
General Counsel and Vice
President, October 1994 to
December, 1996; Capital
Management Resources, L.P.
- General Counsel and Vice
President, July 1993 to
October 1994
---------------------------------------------------------------------------------------------------------------------------
Mark E. Bradley Treasurer Not Senior Vice President N/A N/A
(42) Applicable and Deputy Treasurer,
399 Boylston Street CDC IXIS Asset
Boston, MA 02116 Since Management Services,
inception Inc.; Vice President and
(October Assistant Treasurer, MFS
2002) Investment Management,
1997-2002; Vice President,
Putnam Investments, 1994
to 1997; Senior Tax
Manager, Ernst & Young
LLP, 1985 to 1994
---------------------------------------------------------------------------------------------------------------------------
John E. Pelletier (38) Secretary Not Senior Vice President, N/A N/A
399 Boylston Street and Clerk Applicable General Counsel,
Boston, MA 02116 Secretary and Clerk, CDC
Since IXIS Distribution
inception Corporation; Senior Vice
(October President, General
2002) Counsel, Secretary and
Clerk, CDC IXIS Asset
Management Distributors,
L.P.; Senior Vice
President, General
Counsel, Secretary and
Clerk, CDC IXIS Asset
Management Advisers,
L.P.; Executive Vice
President,
---------------------------------------------------------------------------------------------------------------------------
-18-
---------------------------------------------------------------------------------------------------------------------------
Term of Number of
Office and Portfolios
Position(s) Length of Principal Occupation(s) in Fund
Held with Time During Past Complex
Name, Age and Address Fund Served 5 Years Overseen Other Directorships Held
--------------------- ---- ------ ------- -------- ------------------------
---------------------------------------------------------------------------------------------------------------------------
General Counsel, Secretary,
Clerk, and Director, CDC
IXIS Asset Management
Services, Inc.;
formerly, Senior Vice
President and General
Counsel, Funds
Distributor, Inc.;
formerly, Vice President
and General Counsel,
Boston Institutional
Group; formerly, Senior
Vice President and
General Counsel,
Financial Research
Corporation
---------------------------------------------------------------------------------------------------------------------------
*Subject to a Trustee's earlier retirement, resignation, disqualification or
removal from the Board. The current retirement age is 72.
**Mr. Hailer is an "interested person" of the Fund because he holds the
following positions with affiliated persons of the Fund: President and Chief
Executive Officer of CDC IXIS Asset Management Distributors, L.P.; Director and
Executive Vice President of CDC IXIS Distribution Corporation; and President and
Chief Executive Officer of CDC IXIS Advisers.
***Mr. Voss is an "interested person" of the Fund because he holds the following
positions with affiliated persons of the Fund: Director of CDC IXIS Asset
Management Services, Inc.; Director of CDC IXIS Distribution Corporation;
Director, President and Chief Executive Officer of CDC IXIS Asset Management
North America, L.P.; Director of AEW Capital Management, Inc.; Director of
Harris Associates, Inc.; Director of Jurika & Voyles, Inc.; Director of Loomis,
Sayles & Company, Inc.; Director of Reich & Tang Asset Management Inc.; Director
of Westpeak Investment Advisors, Inc.; and Director of Vaughan, Nelson,
Scarborough & McCullough, Inc.
****As of September 30, 2002, Harris Associates Investment Trust had seven
series that were overseen by its Board of Trustees.
Each Trustee of the Fund also serves as a trustee for CDC Nvest Funds Trust
I, II and III, CDC Nvest Companies Trust I, CDC Nvest Cash Management
Trust-Money Market Series and CDC Nvest Tax Exempt Money Market Trust
(collectively, the "CDC Nvest Trusts"), each of which is advised by affiliates
of the Investment Manager. Previous positions during the past five years with
CDC IXIS Asset Management Distributors, L.P. or CDC IXIS Advisers are omitted,
if not materially different from a trustee's or officer's current position with
such entity.
In accordance with the Fund's staggered board (see "Anti-Takeover and Other
Provisions in the Declaration of Trust"), the Common Shareholders of the Fund
will elect Trustees to fill the vacancies of Trustees whose terms expire at each
annual meeting of Common Shareholders. While any Fund Preferred Shares are
outstanding, holders of the Fund Preferred Shares, voting as a separate class,
will elect two Trustees and the remaining Trustees shall be elected by Common
Shareholders and holders of Fund Preferred Shares, voting together as a single
class, in each case in accordance with the Fund's staggered board structure.
Holders of the Fund Preferred Shares will be entitled to elect a majority of the
Fund's Trustees under certain circumstances.
The following table states the dollar range of equity securities
beneficially owned by each Trustee in the Fund and, on an aggregate basis, in
any registered investment companies overseen by the Trustees in the Fund's
"family of investment companies," which includes CDC Nvest
-19-
AEW Real Estate Fund (a series of CDC Nvest Companies Trust I), an open-end
investment company that is managed by the Investment Manager.
------------------------------------------------------------------------------------------------------
Aggregate Dollar Range of Equity
Securities in All Funds Overseen by
Dollar Range of Equity Trustee in Family of Investment
Name of Trustee/1/ Securities in the Fund Companies
--------------- ---------------------- ---------
------------------------------------------------------------------------------------------------------
INDEPENDENT TRUSTEE
------------------------------------------------------------------------------------------------------
Kenneth J. Cowan None $10,001 - $50,000
------------------------------------------------------------------------------------------------------
INTERESTED TRUSTEE
------------------------------------------------------------------------------------------------------
Peter S. Voss None Over $100,000
------------------------------------------------------------------------------------------------------
(1) Except as disclosed above, no Trustee of the Fund owns securities of the
Fund or CDC Nvest AEW Real Estate Fund. Information about ownership is shown as
of December 31, 2001 for the CDC Nvest AEW Real Estate fund. Because the Fund is
newly organized, information about ownership of its securities is shown as of
November 22, 2002.
Standing Board Committees
The Contract Review and Governance Committee of the Fund is comprised
solely of Independent Trustees and considers matters relating to advisory,
subadvisory and distribution arrangements, potential conflicts of interest
between the Investment Manager and the Fund, and governance matters relating to
the Fund.
The Audit Committee of the Fund is comprised solely of Independent
Trustees and considers matters relating to the scope and results of the Fund's
audits and serves as a forum in which the independent accountants can raise any
issues or problems identified in the audit with the Board of Trustees. This
Committee also reviews and monitors compliance with stated investment objectives
and policies, SEC and Treasury regulations as well as operational issues
relating to the transfer agent, administrator, sub-administrator and custodian.
Each Committee of the Board has held one meeting to date.
Trustee Fees
The Fund pays no compensation to its officers or to its Interested
Trustees. Each other Trustee of the Fund receives a fee of $2,000 annually for
serving as a Trustee of the Fund, and a fee of $375 and related expenses for
each meeting of the Board of Trustees attended. Each Committee member receives a
fee of $2,000 annually for Committee service, and will also receive a meeting
fee of $200 for each additional meeting after the first four meetings of a
Committee during a given year. In addition, the Chairpersons of the Contract
Review and Governance and Audit Committees each receive an additional fee of
$1,000 per year.
During the year ended December 31, 2001 (the fiscal year ended January
31, 2002, for CDC Nvest Companies Trust I), the Trustees of the Fund received
the amounts set forth in the following table for serving as trustees of the CDC
Nvest Trusts. The table also includes amounts expected to be paid to the
Trustees by the Fund for service as Trustees during the partial fiscal year
ended January 31, 2003.
-20-
Estimated
Compensation Pension or Total
from the Fund Retirement Estimated Compensation
for the Fiscal Benefits Annual from the
Year Ending Accrued as Benefits CDC Nvest
January 31, Part of Fund Upon Trusts and the
Name of Trustee 2003* Expenses* Retirement* Fund*+
--------------- ---- --------- ----------- ------
INDEPENDENT
-----------
Graham T. Allison, Jr. $2,000 $0 $0 $66,264
Daniel M. Cain $2,687 $0 $0 $70,998
Kenneth J. Cowan $2,687 $0 $0 $70,786
Richard Darman $2,375 $0 $0 $66,639
Sandra O. Moose $2,000 $0 $0 $66,265
John A. Shane $2,375 $0 $0 $66,640
Pendleton P. White $2,375 $0 $0 $66,640
INTERESTED
----------
Peter S. Voss $ 0 $0 $0 $ 0
John T. Hailer $ 0 $0 $0 $ 0
-----------------------------------------
*Since the Fund has not completed its first full fiscal year,
compensation is estimated based upon future payments to be made by the Fund
during the current fiscal year.
+Total Compensation represents amounts paid during 2001 (during the
fiscal year ended January 31, 2002, for CDC Nvest Companies Trust I) to a
trustee for serving on the board of trustees of 6 trusts with a total of 27
funds as of December 31, 2001, as well as estimated amounts to be paid by the
Fund during the current fiscal year. Amounts include payments deferred by
Trustees for 2001 (for the year ended January 31, 2002, for CDC Nvest Companies
Trust I).
The Fund provides no pension or retirement benefits to its Trustees.
Shareholders
As of November 22, 2002, the following person owned of record the
number of Common Shares noted below, representing the indicated percentage of
the Fund's outstanding shares as of such date.
-----------------------------------------------------------------------------------------
Shareholder Number of Percentage of the Fund's
Common Fund's Outstanding
Shares as of November 22, 2002
-----------------------------------------------------------------------------------------
AEW Management and Advisors, L.P. 7,000 100%
-----------------------------------------------------------------------------------------
INVESTMENT ADVISORY AND OTHER SERVICES
The Investment Manager
-21-
The Investment Manager has been retained to provide investment advice,
and, in general, to conduct the investment program of the Fund under the overall
supervision and control of the Trustees of the Fund. The Investment Manager is a
real estate investment advisory firm that provides investment management and
related services to institutional and retail investors. The Investment Manager
employs 180 investment professionals in offices located in Boston, Los Angeles,
Washington, DC, and London and utilizes the resources of a dedicated in-house
research group in place since 1988. Together with its affiliates operating under
the AEW name, the Investment Manager managed approximately $6.9 billion of
client capital as of September 30, 2002 (approximately $7.0 billion as of June
30, 2002), including the assets of some of the nation's leading public and
private pension funds, union retirement funds, and university endowments. The
Investment Manager managed approximately $2.1 billion in REIT securities as of
September 30, 2002 ($1.7 billion as of June 30, 2002). The Investment Manager's
address is Two Seaport Lane, World Trade Center East, Boston, Massachusetts
02210.
The Investment Manager is a registered investment adviser whose origins
date back to 1981. The Investment Manager is a limited partnership that is a
controlled affiliate of AEW Capital Management, L.P., which in turn is a
wholly-owned subsidiary of CDC IXIS Asset Management Holdings, LLC ("CDC IXIS
Holdings"), which in turn is a wholly-owned subsidiary of CDC IXIS Asset
Management North America, L.P. ("CDC IXIS North America"). CDC IXIS North
America owns the entire limited partnership interest in the Investment Manager.
CDC IXIS North America, together with its subsidiaries and affiliates in the
U.S., Europe and Asia, managed approximately $291 billion in assets for
institutions and individuals as of September 30, 2002 (approximately
$310 billion as of June 30, 2002).
Pursuant to the Investment Management Agreement, the Investment Manager
furnishes a continuous investment program for the Fund's portfolio, makes the
day-to-day investment decisions for the Fund, executes the purchase and sale
orders for the portfolio transactions of the Fund and generally manages the
Fund's investments in accordance with the stated policies of the Fund, subject
to the general supervision of the Board of Trustees of the Fund.
Under the Investment Management Agreement, the Fund pays the Investment
Manager a monthly management fee computed at the annual rate of .80% of the
average daily value of the managed assets (which include the liquidation
preference on any Preferred Shares and the principal amount on any borrowings
used for leverage) of the Fund, subject to certain fee waivers described in the
Prospectus. During the time in which the Fund is utilizing leverage, the fees
paid to the Investment Manager and its affiliates for investment management,
administrative and other services will be higher than if the Fund did not
utilize leverage because the fees paid will be calculated based on the Fund's
managed assets, which include the liquidation preference of any Fund Preferred
Shares and the principal amount of any borrowings used for leverage. Only the
Fund's Common Shareholders bear the Fund's fees and expenses.
Trustee Approval of the Investment Management Agreement
The Board of Trustees approved the Investment Management Agreement at a
meeting held on October 10, 2002. As noted above, each Trustee also serves as a
trustee for the CDC Nvest Funds, including the CDC Nvest AEW Real Estate Fund,
an open-end investment company managed by the Investment Manager that
principally invests in the securities of real estate companies. As a result, the
Trustees, in their collective years of service as trustees of such
-22-
funds, have gained significant knowledge regarding matters such as the fees and
expenses of investment companies; the services generally provided by investment
advisors to an investment company; the benefits of the advisory relationship to
an investment advisor; and the operations and prior performance of the
Investment Manager.
In connection with their meeting, the Trustees met with representatives
of the Investment Manager, including investment advisory personnel, and reviewed
materials specifically relating to the Investment Management Agreement,
including materials prepared by Fund counsel and counsel to the Independent
Trustees. In considering the Investment Management Agreement, the Board of
Trustees, including the Independent Trustees, did not identify any single factor
as determinative. Matters considered by the Board of Trustees, including the
Independent Trustees, in connection with its approval of the Investment
Management Agreement included the following:
. the economic outlook and the general investment outlook in the
markets in which the Fund proposes to invest, as well as the
investment performance of a peer group of funds (including other
funds advised by the Investment Manager) and the performance of
an appropriate index.
. the Investment Manager's investment philosophy and process,
operational stability and financial condition, as well as the
size and experience of the Investment Manager's investment staff.
. the expected quality of the Investment Manager's services with
respect to compliance with the Fund's investment policies and
restrictions and its policies on personal securities
transactions.
. the nature, quality, and extent of services to be performed by
the Investment Manager pursuant to the Investment Management
Agreement.
. the Fund's expected expense ratio and the expense ratios of a
peer group of funds. They also considered (i) the Investment
Manager's agreement to waive a portion of its investment
management fees and the financial impact on the Investment
Manager of such waiver, and (ii) the amount and nature of fees
paid by shareholders, including the fact that the Investment
Manager has agreed to pay organizational expenses and offering
costs of the Fund (other than the sales load) that exceed $0.03
per Common Share. For these purposes, the Trustees took into
account not only the fees paid by the Fund, but also so-called
"fallout benefits" to the Investment Manager, such as the
engagement of CDC IXIS Asset Management Services, Inc., an
affiliate of the Investment Manager, to provide administrative
services to the Fund, and the expected benefits of research made
available to the Investment Manager by reason of brokerage
commissions generated by the Fund's securities transactions. In
evaluating the Fund's investment management fees, the Trustees
also took into
-23-
account the demands, complexity and expected quality of the
investment management of the Fund. The Trustees also noted the
fact that, because the advisory fees paid to the Investment
Manager (as well as the fees paid to CDC IXIS Asset Management
Services, Inc.) by the Fund are based on the Fund's managed
assets, which include the liquidation preference on any Fund
Preferred Shares and the principal amount of any borrowings used
for leverage, the Investment Manager has a financial incentive
for the Fund to issue Fund Preferred Shares and use other forms
of leverage, which may create a conflict of interest between the
Investment Manager and the Fund's shareholders.
. the level of profits expected to be realized by the Investment
Manager and its affiliates in connection with the operation of
the Fund. In this respect, the Trustees considered certain
ongoing commissions that are expected to be paid by the
Investment Manager out of its own assets to the underwriters for
the offering of the Common Shares and the Investment Manager's
agreement to waive a portion of its investment management fees.
. whether there is potential for realization of any economies of
scale with respect to the management of the Fund and whether the
Fund will appropriately benefit from such economies of scale.
Based on their evaluation of all factors that they deemed to be
material, including, but not limited to, those factors described above, and
assisted by the advice of independent counsel, the Trustees, including the
Independent Trustees, concluded that the proposed investment management fee
structure was fair and reasonable, and that approval of the Investment
Management Agreement was in the best interest of the Fund and its shareholders.
Administrative Services
Pursuant to an Administrative Services Agreement between the Fund and
CDC IXIS Asset Management Services, Inc. ("CDC IXIS Services"), an affiliate of
the Investment Manager, CDC IXIS Services also performs or arranges for the
performance of certain administrative and accounting functions for the Fund,
including: (i) providing persons satisfactory to the Trustees of the Fund to
serve as officers and, in that capacity, manage the daily operations of the
Fund; (ii) processing the payment of expenses for the Fund; (iii) supervising
the preparation of periodic reports to the Fund's shareholders; (iv) preparing
materials for Fund Board and Committee meetings; (v) supervising the pricing of
the Fund's investment portfolio and the publication of the net asset value of
the Fund's shares, earnings reports and other financial data; (vi) monitoring
relationships with organizations providing services to the Fund, including the
custodian, transfer agent and printers; (vii) supervising compliance by the Fund
with record-keeping requirements under the 1940 Act and regulations thereunder,
maintaining books and records for the Fund (other than those maintained by the
Investment Manager, custodian and/or transfer agent) and preparing and filing of
tax reports other than the Fund's income tax returns; and (viii) providing
executive, clerical and secretarial help needed to carry out these
responsibilities.
-24-
Under the terms of the Administrative Services Agreement, the Fund pays CDC
IXIS Services a monthly administration fee computed on the basis of the average
daily managed assets of the Fund at an annual rate equal to 0.06% of the first
$300 million in assets and 0.0575% of assets in excess of $300 million, with a
minimum annual fee of $150,000.
In accordance with the terms of the Administrative Services Agreement and
with the approval of the Fund's Board of Trustees, CDC IXIS Services has
retained Investors Bank & Trust Company as sub-administrator under a
sub-administration agreement (the "Sub-Administration Agreement"). Under the
Sub-Administration Agreement, Investors Bank & Trust Company has assumed
responsibility for performing certain of the foregoing administrative functions,
including (i) determining, together with the Fund's custodian, the Fund's net
asset value and preparing these figures for publication; (ii) maintaining
certain of the Fund's books and records that are not maintained by the
Investment Manager, CDC IXIS Services, the custodian or transfer agent; (iii)
preparing financial information for the Fund's income tax returns, proxy
statements, shareholder reports, and SEC filings; and (iv) responding to
shareholder inquiries.
Under the terms of the Sub-Administration Agreement, CDC IXIS Services (and
not the Fund) pays Investors Bank & Trust Company a monthly sub-administration
fee computed on the basis of the managed assets of the Fund at an annual rate
equal to 0.015% of the first $300 million in managed assets and 0.012%
thereafter. As discussed below under "Custodian and Transfer and Dividend
Disbursing Agent," Investors Bank & Trust Company is also the Fund's custodian.
The personnel acting as officers of the Fund are employees or officers of
the Investment Manager, CDC IXIS Services or their affiliates. The Fund does not
pay for services performed by officers of the Investment Manager, CDC IXIS
Services or their affiliates, other than amounts payable under the Investment
Management and Administrative Services Agreements.
Marketing Agent
CDC IXIS Asset Management Advisors Group (the "Advisors Group"), an
affiliate of the Investment Manager, will act as marketing agent for the Fund in
connection with the offering of the Common Shares by preparing marketing
materials and providing distribution support during the offering. The Advisors
Group has agreed, pursuant to an agreement with the Investment Manager, (i) to
reimburse the Investment Manager for one-half of the amount by which the
aggregate of all of the Fund's organizational expenses and offering costs (other
than the sales load) exceeds $0.03 per Common Share and (ii) to bear a portion
of any ongoing asset-based fees to be paid by the Investment Manager to the
underwriters (other than Merrill Lynch, Pierce, Fenner & Smith Incorporated) in
connection with the offering in the amount of 21.8% of such fees in years one
and two of the Fund's operations and in declining amounts for each of the four
years thereafter. As payment for these services, the Investment Manager (and not
the Fund) has agreed to pay the Advisors Group a fee at the annual rate of 0.12%
of net assets for years one and two of the Fund's operations, 0.08% of net
assets for years three and four, and 0.05% of net assets in years five and six.
The Investment Manager has not agreed to pay any fees to the Advisors Group (and
the Advisor's Group has not agreed to bear any portion of any asset-based fees
payable by the Investment Manager) beyond year six of the Fund's operations.
The Advisors Group and the Investment Manager, both of which are subsidiaries
of CDC IXIS Asset Management North America, L.P., may agree to change or
eliminate these payments at any time.
-25-
Custodian And Transfer And Dividend Disbursing Agent
Investors Bank & Trust Company, which has its principal business office at
200 Clarendon Street, Boston, Massachusetts 02116, has been retained to act as
custodian of the Fund's investments and EquiServe Trust Company, N.A. and
EquiServe, Inc. (together, "EquiServe"), which have a principal business office
at 150 Royall Street, Canton, Massachusetts 02021-1031, have been retained to
act as the Fund's transfer and dividend disbursing agent. Neither Investors Bank
& Trust Company nor EquiServe has any part in deciding the Fund's investment
policies or which securities are to be purchased or sold for the Fund's
portfolio.
CDC IXIS Services remains responsible for monitoring and overseeing the
performance by Investors Bank & Trust Company and EquiServe, as
sub-administrator and custodian and transfer and disbursing agent, respectively,
of their obligations to the Fund under their respective agreements with the
Fund, subject to the overall authority of the Fund's Board of Trustees.
Code Of Ethics
The Fund and the Investment Manager have adopted Codes of Ethics pursuant
to Rule 17j-1 under the 1940 Act. The Codes of Ethics permit employees to invest
in securities for their own accounts, under certain circumstances, including
securities that may be purchased or held by the Fund. Text-only versions of the
codes of ethics may be viewed online or downloaded from the EDGAR Database on
the SEC's internet web site at www.sec.gov. You may also review and copy those
documents by visiting the SEC's Public Reference Room in Washington, DC.
Information on the operation of the Public Reference Room may be obtained by
calling the SEC at 202-942-8090. In addition, copies of the Codes of Ethics may
be obtained, after mailing the appropriate duplicating fee, by writing to the
SEC's Public Reference Section, 450 5th Street, N.W., Washington, DC 20549-0102
or by e-mail request at publicinfo@sec.gov.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to policies established by the Board and the oversight of the
Investment Manager, the Investment Manager is primarily responsible for the
Fund's portfolio decisions and the placing of the Fund's portfolio transactions.
Fixed-income securities, certain short-term securities and certain equities
normally will be purchased or sold from or to issuers directly or to dealers
serving as market makers for the securities at a net price, which may include
dealer spreads and underwriting commissions. Equity securities may also be
purchased or sold through brokers who will be paid a commission.
The general policy of the Fund in selecting brokers and dealers is to
obtain the best results taking into account factors such as the general
execution and operational facilities of the broker or dealer, the type and size
of the transaction involved, the creditworthiness of the broker or dealer, the
stability of the broker or dealer, execution and settlement capabilities, time
required to negotiate and execute the trade, research services and the
Investment Manager's arrangements related thereto (as described below), overall
performance, the dealer's risk in positioning the securities involved, and the
broker's commissions and dealer's spread or mark-
-26-
up. While the Investment Manager generally seeks the best price in placing its
orders, the Fund may not necessarily be paying the lowest price available.
Notwithstanding the above, in compliance with Section 28(e) of the
Securities Exchange Act of 1934, as amended, the Investment Manager may select
brokers who charge a commission in excess of that charged by other brokers if
the Investment Manager determines in good faith that the commission to be
charged is reasonable in relation to the brokerage and research services
provided to the Investment Manager by such brokers. Research services generally
consist of research or statistical reports or oral advice from brokers and
dealers regarding particular companies, industries or general economic
conditions. The Investment Manager may also have arrangements with brokers
pursuant to which such brokers provide research services to the Investment
Manager in exchange for a certain volume of brokerage transactions to be
executed by such broker. While the payment of higher commissions increases the
Fund's costs, the Investment Manager does not believe that the receipt of such
brokerage and research services significantly reduces its expenses as the
Investment Manager. Arrangements for the receipt of research services from
brokers may create conflicts of interest.
Research services furnished to the Investment Manager by brokers who effect
securities transactions for the Fund may be used by the Investment Manager in
servicing other investment companies and accounts which it manages. Similarly,
research services furnished to the Investment Manager by brokers who effect
securities transactions for other investment companies and accounts which the
Investment Manager manages may be used by the Investment Manager in servicing
the Fund. Not all of these research services are used by the Investment Manager
in managing any particular account, including the Fund.
Under the 1940 Act, "affiliated persons" of the Fund are prohibited from
dealing with it as a principal in the purchase and sale of securities unless an
exemptive order allowing such transactions is obtained from the SEC. However,
the Fund may purchase securities from underwriting syndicates of which the
Investment Manager or any of its affiliates (as defined in the 1940 Act) is a
member under certain conditions, in accordance with Rule 10f-3 promulgated under
the 1940 Act. See "Investment Objectives and Policies - Certain Affiliations."
The Fund contemplates that, consistent with the policy of obtaining the
best net results, brokerage transactions may be conducted through "affiliated
broker/dealers," as defined in the 1940 Act. The Board of Trustees has adopted
procedures in accordance with Rule 17e-1 promulgated under the 1940 Act to
ensure that all brokerage commissions paid to such affiliates are reasonable and
fair in the context of the market in which such affiliates operate. Any such
compensation will be paid in accordance with applicable SEC regulations.
Investment decisions for the Fund are made independently from those of
other funds or accounts managed by the Investment Manager. Such other funds or
accounts may also invest in the same securities as the Fund. If those funds or
accounts are prepared to invest in, or desire to dispose of, the same security
at the same time as the Fund, however, transactions in such securities will be
made, insofar as feasible, for the respective funds and accounts in a manner
deemed equitable to all. In some cases, this procedure may adversely affect the
size of the position obtained for or disposed of by the Fund or the price paid
or received by the Fund. In
-27-
addition, because of different investment objectives, a particular security may
be purchased for one or more funds or accounts when one or more funds or
accounts are selling the same security.
DETERMINATION OF NET ASSET VALUE
The method for determining the net asset value per Common Share is
summarized in the Prospectus.
The total net asset value of the Common Shares (the excess of the assets of
the Fund over the Fund's liabilities) is determined at the close of regular
trading (normally 4:00 p.m. Eastern time) on each day that the New York Stock
Exchange (the "Exchange") is open for trading. In addition, in the Investment
Manager's discretion, the Fund's shares may be priced on a day the Exchange is
closed for trading if the Investment Manager in its discretion determines that
it is advisable to do so based primarily upon factors such as whether (i) there
has been enough trading in that Fund's portfolio securities to affect materially
the net asset value of the Fund's shares and (ii) whether in the Investment
Manager's view sufficient information (e.g., prices reported by pricing
services) is available for the Fund's shares to be priced. The Fund does not
expect to price its shares on the following holidays: New Year's Day, Martin
Luther King Day, Presidents' Day, Good Friday, Memorial Day, Independence Day,
Labor Day, Thanksgiving Day and Christmas Day. Securities listed on a national
securities exchange or on the NASDAQ National Market System are valued at their
last sale price, or, if there is no reported sale during the day, the last
reported bid price estimated by a broker. Unlisted securities traded in the
over-the-counter market are valued at the last reported bid price in the
over-the-counter market or on the basis of yield equivalents as obtained from
one or more dealers that make a market in the securities. U.S. government
securities are traded in the over-the-counter market. Options, interest rate
futures and options thereon that are traded on exchanges are valued at their
last sale price as of the close of such exchanges. Securities for which current
market quotations are not readily available and all other assets are taken at
fair value as determined in good faith by the Board of Trustees, although the
actual calculations may be made by persons acting pursuant to procedures
approved by the Board.
Generally, trading in foreign government securities and other fixed-income
securities, as well as trading in equity securities in markets outside the
United States, is substantially completed each day at various times prior to the
close of the Exchange. Securities traded on a foreign exchange will be valued at
their last sale price (or the last reported bid price, if there is no reported
sale during the day), on the exchange on which they principally trade, as of the
close of regular trading on such exchange, except for securities traded on the
London Stock Exchange ("British Equities"). British Equities will be valued at
the mean between the last bid and last asked prices on the London Stock
Exchange. The value of other securities principally traded outside the United
States will be computed as of the completion of substantial trading for the day
on the markets on which such securities principally trade. Securities
principally traded outside the United States will generally be valued several
hours before the close of regular trading on the Exchange, generally 4:00 p.m.
Eastern time, when the Fund computes the net asset value of its Common Shares.
Occasionally, events affecting the value of securities principally traded
outside the United States may occur between the completion of substantial
trading of such securities for the day and the close of the Exchange, which
events will not be reflected in the computation of the Fund's net asset value.
If, in the determination of the Board of Trustees or persons acting at
-28-
their direction, events materially affecting the value of the Fund's securities
occur during such period, then these securities will be valued at their fair
value as determined in good faith by or in accordance with procedures approved
by the Fund's Trustees. The effect of fair value pricing is that securities may
not be priced on the basis of quotations from the primary market in which they
are traded, but rather may be priced by another method that the Board of
Trustees believes accurately reflects fair value.
DESCRIPTION OF SHARES
Common Shares
The Fund's Declaration authorizes the issuance of an unlimited number of
Common Shares, par value $0.00001 per share. All Common Shares of the Fund have
equal rights as to the payment of dividends and the distribution of assets upon
liquidation of the Fund. The Common Shares will, when issued, be fully paid and,
subject to matters discussed in "Certain Provisions in the Declaration of Trust
- Shareholder Liability" below, non-assessable, and will have no pre-emptive or
conversion rights or rights to cumulative voting. At any time when the Fund
Preferred Shares are outstanding, Common Shareholders will not be entitled to
receive any distributions from the Fund unless all accrued dividends on Fund
Preferred Shares have been paid, asset coverage (as defined in the 1940 Act)
with respect to Fund Preferred Shares and certain forms of indebtedness would be
at least 200% and 300%, respectively, after giving effect to such distributions,
and other requirements imposed by any rating agencies rating any Fund Preferred
Shares issued by the Fund have been met. See "-Fund Preferred Shares" below.
The Common Shares have been approved for listing on the American Stock
Exchange under the symbol "RIF." Under the rules of the American Stock Exchange
currently applicable to listed companies, the Fund will be required to hold a
meeting of shareholders annually.
Shares of closed-end investment companies may frequently trade at prices
lower than net asset value. Shares of closed-end investment companies like the
Fund that invest primarily in securities of real estate companies have during
some periods traded at prices higher than net asset value and during other
periods traded at prices lower than net asset value. There can be no assurance
that the Common Shares or shares of other similar funds will trade at a price
higher than net asset value in the future. Net asset value will be reduced
immediately following the offering of the Common Shares after payment of the
sales load and organizational and offering expenses. Whether investors will
realize gains or losses upon the sale of Common Shares will depend entirely upon
whether the market price of the Common Shares at the time of sale is above or
below the original purchase price for the shares. Since the market price of the
Fund's Common Shares will be determined by factors beyond the control of the
Fund, the Fund cannot predict whether the Common Shares will trade at, below, or
above net asset value or at, below or above the initial public offering price.
Accordingly, the Common Shares are designed primarily for long-term investors,
and investors in the Common Shares should not view the Fund as a vehicle for
trading purposes. See "Repurchase of Shares; Conversion to Open-End Fund."
-29-
Fund Preferred Shares
The Declaration authorizes the issuance of an unlimited number of Fund
Preferred Shares. The Fund Preferred Shares may be issued in one or more classes
or series, with such par value, preferences, voting powers, terms of redemption,
and special rights and privileges as determined by the Board of Trustees of the
Fund, by action of the Board of Trustees without the approval of the Common
Shareholders.
The Fund's Board of Trustees has indicated its intention to authorize an
offering of Fund Preferred Shares (representing approximately 35% of the Fund's
capital immediately after the time the Fund Preferred Shares are issued)
approximately one to three months after completion of the offering of Common
Shares. The offering of the Fund Preferred Shares is subject to several
conditions, including general market conditions, the Fund's receipt of the
highest credit rating on the Fund Preferred Shares from at least one nationally
recognized statistical rating agency (e.g., AAA or Aaa) and the Board's
continuing belief that leveraging the Fund's capital structure through the
issuance of Fund Preferred Shares is likely to achieve the benefits to the
Common Shareholders described in the Prospectus. Although the terms of the Fund
Preferred Shares, including their dividend rate, voting rights, liquidation
preference and redemption provisions, will be determined by the Board of
Trustees (subject to applicable law and the Declaration) if and when it
authorizes a Fund Preferred Shares offering, it is likely that the initial
series of Fund Preferred Shares would likely pay cumulative dividends at
relatively short-term periods, by providing for the periodic (weekly and/or
monthly) redetermination of the dividend rate through an auction or similar
process. The liquidation preference, preference on distribution, voting rights
and redemption provisions of the Fund Preferred Shares are expected to be as
stated below.
Limited Issuance of Fund Preferred Shares. Under the 1940 Act, the Fund
could issue Fund Preferred Shares with an aggregate liquidation value of up to
one-half of the value of the Fund's total assets less all liabilities and
indebtedness not representing senior securities (as defined in the 1940 Act)
("Asset Coverage Assets"), measured immediately after issuance of the Fund
Preferred Shares. "Liquidation value" means the original purchase price of the
shares being liquidated plus any accrued and unpaid dividends. In addition, the
Fund would not be permitted to declare any cash dividend or other distribution
on its Common Shares unless the liquidation value of the Fund Preferred Shares
is no more than one-half of the value of the Fund's Asset Coverage Assets
(determined after deducting the amount of such dividend or distribution)
immediately after the distribution. It is currently anticipated that the
liquidation value of the Fund Preferred Shares will be approximately 35% of the
value of the Fund's capital, measured immediately after the issuance of the Fund
Preferred Shares. The Fund intends to purchase or redeem Fund Preferred Shares,
if necessary, to maintain applicable asset coverage requirements.
Distribution Preference. The Fund Preferred Shares have complete priority
over the Common Shares as to distribution of assets.
Liquidation Preference. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the affairs of the Fund, holders of
Fund Preferred Shares will be entitled to receive a preferential liquidating
distribution (expected to equal the original purchase
-30-
price per share plus accumulated and unpaid dividends thereon, whether or not
earned or declared) before any distribution of assets is made to Common
Shareholders. After payment of the full amount of the liquidating distribution
to which they are entitled, holders of Fund Preferred Shares will not be
entitled to any further participation in any distribution of assets by the Fund.
A consolidation or merger of the Fund with or into any Massachusetts business
trust or other entity or a sale of all or substantially all of, or any part of,
the assets of the Fund shall not be deemed to be a liquidation, dissolution or
winding up of the Fund.
Voting Rights. In connection with any issuance of Fund Preferred Shares,
the Fund must comply with Section 18(i) of the 1940 Act, which requires, among
other things, that Fund Preferred Shares be voting shares. Except as otherwise
provided in the Declaration or the Fund's Bylaws or otherwise required by
applicable law, holders of Fund Preferred Shares will vote together with Common
Shareholders as a single class.
In connection with the election of the Fund's Trustees, holders of Fund
Preferred Shares, voting as a separate class, will also be entitled to elect two
of the Fund's Trustees, and the remaining Trustees shall be elected by Common
Shareholders and holders of Fund Preferred Shares, voting together as a single
class. In addition, if at any time dividends on the Fund's outstanding Fund
Preferred Shares shall be unpaid in an amount equal to two full years' dividends
thereon, the holders of all outstanding Fund Preferred Shares, voting as a
separate class, will be entitled to elect a majority of the Fund's Trustees
until all dividends in arrears have been paid or declared and otherwise provided
for by the Fund.
The affirmative vote of the holders of a majority (as defined in the 1940
Act) of the outstanding Fund Preferred Shares, voting as a separate class, shall
be required to (1) adopt any plan of reorganization that would adversely affect
the Fund Preferred Shares, or (2) approve any action requiring a vote of
security holders under Section 13(a) of the 1940 Act, including, among other
things, the conversion of the Fund from a closed-end to an open-end company or
changes in the investment restrictions described as fundamental policies under
"Investment Restrictions." The class vote of holders of Fund Preferred Shares
described above shall in each case be in addition to any separate vote of the
requisite percentage of Common Shares and Fund Preferred Shares necessary to
authorize the action in question.
The foregoing voting provisions will not apply with respect to the Fund
Preferred Shares if, at or prior to the time when a vote is required, such
shares shall have been (1) redeemed or (2) called for redemption and sufficient
funds shall have been set aside to effect such redemption.
Redemption, Purchase and Sale of Fund Preferred Shares by the Fund. The
terms of the Fund Preferred Shares may provide that they are redeemable at
certain times, in whole or in part, at the original purchase price per share
plus accumulated dividends, that the Fund may tender for or purchase Fund
Preferred Shares and that the Fund may subsequently resell any shares so
tendered for or purchased. Any redemption or purchase of Fund Preferred Shares
by the Fund will reduce the leverage applicable to Common Shares, while any
resale of shares by the Fund will increase such leverage.
The discussion above describes the Fund's Board of Trustees' present
intention with respect to a possible offering of Fund Preferred Shares. If the
Board of Trustees determines to
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authorize such an offering, the terms of the Fund Preferred Shares may be the
same as, or different from, the terms described above, subject to applicable law
and the Declaration.
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST
Shareholder Liability
Under Massachusetts law, shareholders could, under certain circumstances,
be held personally liable for the obligations of the Fund. However, the Fund's
Amended and Restated Agreement and Declaration of Trust (the "Declaration")
contains an express disclaimer of shareholder liability for acts or obligations
of the Fund and requires that notice of such disclaimer be given in each note,
bond, contract, instrument, certificate or undertaking made or issued by the
Trustees or any officer or officers of the Fund. The Declaration also provides
for indemnification by the Fund for all loss and expense of any shareholder or
former shareholder held personally liable on account of being or having been a
shareholder of the Fund. Thus, the risk of a shareholder incurring financial
loss on account of shareholder liability is limited to circumstances in which
such disclaimer is inoperative or the Fund is unable to meet its obligations,
and thus should be considered remote.
Anti-Takeover Provisions
As described below, the Declaration includes provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund or to change the composition of its Board of Trustees, and could
have the effect of depriving shareholders of opportunities to sell their shares
at a premium over prevailing market prices by discouraging a third party from
seeking to obtain control of the Fund.
The Fund's Trustees are divided into three classes (Class I, Class II and
Class III), having initial terms of one, two and three years, respectively. At
each annual meeting of shareholders, the term of one class will expire and each
Trustee elected to that class will hold office for a term of three years. The
classification of the Board of Trustees in this manner could delay for an
additional year the replacement of a majority of the Board of Trustees. In
addition, subject to any voting powers of Common Shareholders or the holders of
Fund Preferred Shares, the Declaration provides that a Trustee may be removed
only for "cause" (as defined below) and only (i) by action of at least
seventy-five percent (75%) of the outstanding shares of the classes or series of
shares entitled to vote for the election of such Trustee, at a meeting called
for such purpose, or (ii) by a written instrument signed by at least
seventy-five percent (75%) of the remaining Trustees specifying the date when
such removal shall become effective. "Cause" for these purposes means willful
misconduct, dishonesty or fraud on the part of the Trustee in the conduct of his
or her office or such Trustee being convicted of a felony.
Except as provided in the next paragraph, the affirmative vote or consent
of at least seventy-five percent (75%) of the Board of Trustees and at least
seventy-five percent (75%) of the shares of the Fund outstanding and entitled to
vote thereon are required to authorize any of the following transactions (each a
"Material Transaction"): (1) a merger, consolidation or share exchange of the
Fund or any series or class of shares of the Fund with or into any other person
or company, or of any such person or company with or into the Fund or any such
series or class of shares; (2) the issuance or transfer by the Fund or any
series or class of shares (in one or a series
-32-
of transactions in any twelve-month period) of any securities issued by the Fund
or such series or class to any other person or entity for cash, securities or
other property (or combination thereof) having an aggregate fair market value of
$1,000,000 or more, excluding sales of securities of the Fund or such series or
class in connection with a public offering, issuances of securities of the Fund
or such series or class pursuant to a dividend reinvestment plan adopted by the
Fund, issuances of securities of the Fund or such series or class upon the
exercise of any stock subscription rights distributed by the Fund and issuances
of securities of the Fund or a series or class to all shareholders of the Fund
or such series or class on a pro rata basis; (3) a sale, lease, exchange,
mortgage, pledge, transfer or other disposition by the Fund or any series or
class of shares (in one or a series of transactions in any twelve-month period)
to or with any person of any assets of the Fund or such series or class having
an aggregate fair market value of $1,000,000 or more, except for transactions in
securities effected by the Fund or such series or class in the ordinary course
of its business or (4) any shareholder proposal as to specific investment
decisions made or to be made with respect to the assets of the Fund or a series
or class of shares. The same affirmative votes are required with respect to any
shareholder proposal as to specific investment decisions made or to be made with
respect to the Fund's assets or the assets of any series or class of shares of
the Fund.
Notwithstanding the approval requirements specified in the preceding
paragraph, the Declaration requires no vote or consent of the Fund's
shareholders to authorize a Material Transaction if the transaction is approved
by a vote of both a majority of the Board of Trustees and seventy-five percent
(75%) of the Continuing Trustees (as defined below), so long as all other
conditions and requirements, if any, provided for in the Fund's Bylaws and
applicable law (including any shareholder voting rights under the 1940 Act) have
been satisfied.
In addition, the Declaration provides that, subject to the voting power of
one or more classes of shares as set forth in the Bylaws, the Fund may be
terminated at any time by vote or consent of at least seventy-five percent (75%)
of the Fund's shares entitled to vote or, alternatively, by vote or consent of
both a majority of the Board of Trustees and seventy-five percent (75%) of the
Continuing Trustees (as defined below). A vote of both a majority of the Board
of Trustees and seventy-five percent (75%) of the Continuing Trustees (as
defined below) is required for distributions to the Fund's shareholders (in one
or a series of distributions) during any twelve-month period of any property (in
cash, shares or otherwise) with an aggregate fair market value in excess of 125%
of the income and gains (accrued or realized) of the Fund during such
twelve-month period.
In certain circumstances, the Declaration also imposes shareholder voting
requirements that are more demanding than those required under the 1940 Act in
order to authorize a conversion of the Fund from a closed-end to an open-end
investment company. See "Possible Conversion to Open-End Status" and "Certain
Provisions in the Declaration of Trust" in the Prospectus.
The Trustees may from time to time grant other voting rights to
shareholders with respect to these and other matters as the Trustees may
consider necessary or desirable.
As noted, the voting provisions described above could have the effect of
depriving Common Shareholders of an opportunity to sell their Common Shares at a
premium over
-33-
prevailing market prices by discouraging a third party from seeking to obtain
control of the Fund in a tender offer or similar transaction. In the view of the
Fund's Board of Trustees, however, these provisions offer several possible
advantages, including: (1) requiring persons seeking control of the Fund to
negotiate with its management regarding the price to be paid for the amount of
Common Shares required to obtain control; (2) promoting continuity and
stability; and (3) enhancing the Fund's ability to pursue long-term strategies
that are consistent with its investment objectives and management policies. The
Board of Trustees has determined that the voting requirements described above,
which are generally greater than the minimum requirements under the 1940 Act,
are in the best interests of the Fund's Common Shareholders generally.
A "Continuing Trustee," as used in the discussion above, is any member of
the Fund's Board of Trustees who either (i) has been a member of the Board for a
period of at least thirty-six months (or since immediately after the initial
registered public offering of the Fund's Common Shares, if less than thirty-six
months) or (ii) was nominated to serve as a member of the Board of Trustees by a
majority of the Continuing Trustees then members of the Board.
The foregoing is intended only as a summary and is qualified in its
entirety by reference to the full text of the Declaration and the Fund's Bylaws,
both of which have been filed as exhibits to the Fund's registration statement
on file with the SEC.
Liability of Trustees
The Declaration provides that the obligations of the Fund are not binding
upon the Trustees of the Fund individually, but only upon the assets and
property of the Fund, and that the Trustees shall not be liable for errors of
judgment or mistakes of fact or law. Nothing in the Declaration, however,
protects a Trustee against any liability to which he or she would otherwise be
subject by reason of willful misfeasance, bad faith, gross negligence or
reckless disregard of the duties involved in the conduct of his or her office.
REPURCHASE OF SHARES; CONVERSION TO OPEN-END FUND
The Fund is a closed-end investment company and as such its shareholders
will not have the right to cause the Fund to redeem their shares. Instead, the
Fund's shares will trade in the open market at a price that will be a function
of several factors, including dividend levels (which are in turn affected by
expenses), net asset value, call protection, price, dividend stability, relative
demand for and supply of such shares in the market, general market and economic
conditions and other factors beyond the control of the Fund. Shares of
closed-end investment companies frequently trade at prices lower than net asset
value. They sometimes also trade at a premium to net asset value. The Fund's
Board of Trustees regularly monitors the relationship between the market price
and net asset value of the Common Shares. If the Common Shares were to trade at
a substantial discount to net asset value for an extended period of time, the
Fund's Board may consider action that might be taken to reduce or eliminate any
material discount from net asset value in respect of shares, which may include
the repurchase of such shares in the open market or in private transactions, the
making of a tender offer for such shares at net asset value, the conversion of
the Fund to an open-end investment company, or other programs intended to reduce
the discount. The Board of Trustees currently considers the
-34-
following factors to be relevant to a consideration of any of the actions noted
above: the extent and duration of the discount, the liquidity of the Fund's
portfolio, the impact of any action on the Fund or its shareholders and general
market considerations. The Board of Trustees may decide not to take any of these
actions. The Fund has no present intention to repurchase its Common Shares and
generally would do so only in the circumstances described in this section.
Notwithstanding the foregoing, at any time when Fund Preferred Shares are
outstanding, the Fund may not purchase, redeem or otherwise acquire any of its
Common Shares unless (1) all accrued dividends on Fund Preferred Shares have
been paid and (2) at the time of such purchase, redemption or acquisition, the
net asset value of the Fund's portfolio (determined after deducting the
acquisition price of the Common Shares) is at least 200% of the liquidation
value of the outstanding Fund Preferred Shares (expected to equal the original
purchase price per share plus any accrued and unpaid dividends thereon).
Subject to its investment limitations, the Fund may borrow or use the
accumulation of cash to finance 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 income. Any share repurchase, tender offer or borrowing
that might be approved by the Board of Trustees would have to comply with the
Securities Exchange Act of 1934, as amended, and the 1940 Act and the rules and
regulations under each of those Acts.
The Fund's Board of Trustees may also from time to time consider submitting
to the holders of the shares of beneficial interest of the Fund a proposal to
convert the Fund to an open-end investment company. In determining whether to
exercise its sole discretion to submit this issue to shareholders, the Board of
Trustees would consider all factors then relevant, including the relationship of
the market price of the Common Shares to net asset value, the extent to which
the Fund's capital structure is leveraged and the possibility of re-leveraging,
the spread, if any, between the yields on securities in the Fund's portfolio and
interest and dividend charges on Fund Preferred Shares or other forms of
leverage and general market and economic conditions.
The Declaration requires the affirmative vote or consent of holders of at
least seventy-five percent (75%) of each class of the Fund's shares entitled to
vote on the matter to authorize a conversion of the Fund from a closed-end to an
open-end investment company, unless the conversion is authorized by both a
majority of the Board of Trustees and seventy-five percent (75%) of the
Continuing Trustees (as defined above under "Certain Provisions in the
Declaration of Trust--Anti-Takeover Provisions"). This seventy-five percent
(75%) shareholder approval requirement is higher than is required under the 1940
Act. In the event that a conversion is approved by the Trustees and the
Continuing Trustees as described above, the minimum shareholder vote required
under the 1940 Act would be necessary to authorize the conversion. Currently,
the 1940 Act would require approval of the holders of a "majority of the
outstanding" Common Shares and, if issued, Fund Preferred Shares, voting
together as a single class, and the holders of a "majority of the outstanding"
Fund Preferred Shares voting as a separate class, in order to authorize a
conversion.
The Fund anticipates that it would not charge any sales or redemption fees
upon conversion to an open-end fund. The Fund also currently anticipates that
after any such conversion, shareholder redemptions would generally be made in
cash. However, if the Fund were to meet shareholder redemptions "in kind"
through the distributions of securities, shareholders would bear the risks of
holding such securities directly and would bear any brokerage costs or other
transactional expenses in connection with the sale of such securities.
If the Fund converted to an open-end company, it would be required to
redeem all Preferred Shares then outstanding (requiring in turn that it
liquidate a portion of its investment
-35-
portfolio), and the Fund's Common Shares likely would no longer be listed on the
American Stock Exchange. Shareholders of an open-end investment company may
require the company to redeem their shares on any business day (except in
certain circumstances as authorized by or under the 1940 Act) at their net asset
value, less such redemption charge, if any, as might be in effect at the time of
redemption. In order to avoid maintaining large cash positions or liquidating
favorable investments to meet redemptions, open-end companies typically engage
in a continuous offering of their shares. Open-end companies are thus subject to
periodic asset in-flows and out-flows that can complicate portfolio management.
The repurchase by the Fund of its shares at prices below net asset value
will result in an increase in the net asset value of those shares that remain
outstanding. However, there can be no assurance that share repurchases or
tenders at or below net asset value will result in the Fund's shares trading at
a price equal to their net asset value. Nevertheless, the fact that the shares
may be the subject of repurchase or tender offers at net asset value from time
to time, or that the Fund may be converted to an open-end investment company,
may reduce any spread between market price and net asset value that might
otherwise exist.
In addition, a purchase by the Fund of its Common Shares will decrease the
Fund's total assets, which would likely have the effect of increasing the Fund's
expense ratio. Any purchase by the Fund of its Common Shares at a time when Fund
Preferred Shares are outstanding will increase the leverage applicable to the
outstanding Common Shares then remaining.
Before deciding whether to take any action if the Fund's Common Shares
trade below net asset value, the Board of Trustees would consider all relevant
factors, including the extent and duration of the discount, the liquidity of the
Fund's portfolio, the impact (including the expense) of any action that might be
taken on the Fund or its shareholders and market considerations. Based on these
considerations, even if the Fund's shares should trade at a discount, the Board
of Trustees may determine that, in the interest of the Fund and its
shareholders, no action should be taken.
TAXATION
Set forth below is a discussion of certain U.S. federal income tax issues
concerning the Fund and the purchase, ownership and disposition of Fund shares.
This discussion does not purport to be complete or to deal with all aspects of
federal income taxation that may be relevant to shareholders in light of their
particular circumstances. This discussion is based upon present provisions of
the Internal Revenue Code of 1986, as amended (the "Code"), the regulations
promulgated thereunder, and judicial and administrative ruling authorities, all
of which are subject to change, which change may be retroactive. Prospective
investors should consult their own tax advisers with regard to the federal tax
consequences of the purchase, ownership, or disposition of Fund shares, as well
as the tax consequences arising under the laws of any state, foreign country, or
other taxing jurisdiction.
Taxation of the Fund
The Fund intends to elect to be treated as, and to qualify annually as, a
regulated investment company under Subchapter M of the Code.
-36-
To qualify for the favorable U.S. federal income tax treatment generally
accorded to regulated investment companies, the Fund must, among other things,
(a) derive in each taxable year at least 90% of its gross income from dividends,
interest, payments with respect to securities loans and gains from the sale or
other disposition of stock, securities or foreign currencies or other income
derived with respect to its business of investing in such stock, securities or
currencies; (b) diversify its holdings so that, at end of each quarter of the
taxable year, (i) at least 50% of the market value of the Fund's assets is
represented by cash and cash items (including receivables), U.S. Government
securities, the securities of other regulated investment companies and other
securities, with such other securities of any one issuer limited for the
purposes of this calculation to an amount not greater than 5% of the value of
the Fund's total assets and not greater than 10% of the outstanding voting
securities of such issuer, and (ii) not more than 25% of the value of its total
assets is invested in the securities (other than U.S. Government securities or
the securities of other regulated investment companies) of a single issuer, or
two or more issuers which the Fund controls and are engaged in the same, similar
or related trades or businesses; and (c) distribute at least 90% of the sum of
its investment company taxable income (as that term is defined in the Code, but
without regard to the deduction for dividends paid) and net tax-exempt interest
each taxable year.
As a regulated investment company that is accorded special tax treatment,
the Fund generally will not be subject to U.S. federal income tax on its
investment company taxable income (which includes, among other items, dividends,
interest and net short-term capital gain in excess of net long-term capital
loss) and net capital gain (the excess of net long-term capital gain over net
short-term capital loss), if any, that it distributes to shareholders. The Fund
intends to distribute to its shareholders, at least annually, all or
substantially all of its investment company taxable income and net capital gain.
However, if the Fund retains any net capital gain or any investment company
taxable income, it will be subject to tax at regular corporate rates on the
amount retained. If the Fund retains any net capital gain, it may designate the
retained amount as undistributed capital gains in a notice to its shareholders
who, if subject to federal income tax on long-term capital gains, (i) will be
required to include in income for federal income tax purposes, as long-term
capital gain, their share of such undistributed amount, and (ii) will be
entitled to credit their proportionate shares of the tax paid by the Fund on
such undistributed amount against their federal income tax liabilities, if any,
and to claim refunds to the extent the credit exceeds such liabilities. For
federal income tax purposes the tax basis of shares owned by a shareholder of
the Fund will be increased by an amount equal under current law to the
difference between the amount of undistributed capital gains included in the
shareholder's gross income and the tax deemed paid by the shareholder under
clause (ii) of the preceding sentence.
If the Fund fails to distribute in a calendar year an amount equal to the
sum of (1) at least 98% of its ordinary income (not taking into account any
capital gains or losses) for the calendar year, (2) at least 98% of its capital
gains in excess of its capital losses (adjusted for certain ordinary losses) for
the one-year period ending on October 31 of the calendar year, and (3) any
ordinary income and capital gains for previous years that was not distributed
during those years, the Fund will be subject to a 4% excise tax on the
undistributed amount. A distribution will be treated as paid on December 31 of
the current 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
-37-
distributions are received. To prevent application of the excise tax, the Fund
intends to make its distributions in accordance with the calendar year
distribution requirement.
If the Fund failed to qualify as a regulated investment company or failed
to satisfy the 90% distribution requirement in any taxable year, the Fund would
be subject to tax on its taxable income at corporate rates (even if such income
were distributed to its shareholders), and all distributions out of earnings and
profits (including distributions of net capital gain) would be taxed to
shareholders as ordinary income. In addition, the Fund could be required to
recognize unrealized gains, pay substantial taxes and interest and make
substantial distributions before requalifying as a regulated investment company
that is accorded special tax treatment.
Distributions
Dividends paid out of the Fund's current and accumulated earnings and
profits will, except in the case of capital gain dividends described below, be
taxable to a U.S. shareholder as ordinary income to the extent of the Fund's
earnings and profits, whether paid in cash or reinvested in additional shares.
Although such dividends generally will not qualify for the dividends received
deduction available to corporations under Section 243 of the Code, if a portion
of the Fund's income consists of qualifying dividends paid by U.S. corporations
(other than REITs), a portion of the dividends paid by the Fund to corporate
shareholders may be eligible for the corporate dividends received deduction.
Distributions of net capital gain (the excess of net long-term capital gain over
net short-term capital loss), if any, properly designated as capital gain
dividends are taxable to a shareholder as long-term capital gains, regardless of
how long the shareholder has held Fund shares. A distribution of an amount in
excess of the Fund's current and accumulated earnings and profits will be
treated by a shareholder as a return of capital which is applied against and
reduces the shareholder's basis in his or her shares. A return of capital is not
taxable, but it reduces a shareholder's tax basis in his or her shares, thus
reducing any loss or increasing any gain on a subsequent taxable disposition by
the shareholder of his or her shares. To the extent that the amount of any such
distribution exceeds the shareholder's basis in his or her shares, the excess
will be treated by the shareholder as gain from a sale or exchange of the
shares.
Dividends and distribution on the Fund's shares are generally subject to
federal income tax as described herein to the extent they do not exceed the
Fund's realized income and gains, even though such dividends and distributions
may economically represent a return of a particular shareholder's investment.
Such distributions are likely to occur in respect of shares purchased at a time
when the Fund's net asset value reflects gains that are either unrealized, or
realized but not distributed. Such realized gains may be required to be
distributed even when the Fund's net asset value also reflects unrealized
losses. Distributions are taxable to a shareholder even if they are paid from
income or gains earned by the Fund prior to the shareholder's investment (and
thus included in the price paid by the shareholders).
The Internal Revenue Service ("IRS") currently requires that a regulated
investment company that has two or more classes of stock allocate to each such
class proportionate amounts of each type of its income (such as ordinary income
and capital gains) based upon the percentage of total dividends paid out of
earnings or profits to each class for the tax year. Accordingly, the Fund
intends each year to allocate capital gain dividends between its Common Shares
and Fund
-38-
Preferred Shares in proportion to the total dividends paid out of earnings or
profits to each class with respect to such tax year. Dividends qualifying and
not qualifying for the dividends received deduction will similarly be allocated
between and among these classes.
Distributions will be treated in the manner described above regardless of
whether such distributions are paid in cash or in additional shares of the Fund.
A shareholder whose distributions are reinvested in shares will be treated as
having received a dividend equal to the fair market value of the new shares
issued to the shareholder or the amount of cash allocated to the shareholder for
the purchase of shares on its behalf.
Shareholders will be notified annually as to the U.S. federal tax status of
distributions.
Sale Or Exchange Of Fund Shares
Upon the sale, exchange or redemption of shares of the Fund which a
shareholder holds as a capital asset, such shareholder may realize a capital
gain or loss which will be long-term or short-term, depending upon the
shareholder's holding period for the shares. Generally, a shareholder's gain or
loss will be a long-term gain or loss if the shares have been held for more than
one year.
However, all or a portion of any loss realized upon a taxable disposition
of Fund shares will be disallowed to the extent the shares disposed of are
replaced (including through reinvestment of dividends) within a period of 61
days beginning 30 days before and ending 30 days after the disposition. In such
a case, the basis of the newly purchased shares acquired will be adjusted to
reflect the disallowed loss. Any loss realized by a shareholder on a taxable
disposition of Fund shares held by the shareholder for six months or less will
be treated as a long-term capital loss to the extent of any distributions of net
capital gain received by the shareholder (or amounts credited as undistributed
capital gains) with respect to such shares.
From time to time, the Fund may make a tender offer for its Common Shares.
It is expected that the terms of any such offer will require a tendering
shareholder to tender all Common Shares and dispose of all Fund Preferred Shares
held, or considered under certain attribution rules of the Code to be held, by
such shareholder. Shareholders who tender all Common Shares and dispose of all
Fund Preferred Shares held, or considered to be held, by them will be treated as
having sold their shares and generally will realize a capital gain or loss. If a
shareholder tenders fewer than all of its Common Shares, or retains a
substantial portion of its Fund Preferred Shares, such shareholder may be
treated as having received a taxable dividend upon the tender of its Common
Shares. In such a case there is a risk that non-tendering shareholders will be
treated as having received taxable distributions from the Fund. Likewise, if the
Fund redeems some but not all of the Fund Preferred Shares held by a holder of
Fund Preferred Shares (a "Preferred Shareholder") and such shareholder is
treated as having received a taxable dividend upon such redemption, there is a
risk that Common Shareholders and non-redeeming Preferred Shareholders will be
treated as having received taxable distributions from the Fund. To the extent
that the Fund recognizes net gains on the liquidation of portfolio securities to
meet such tenders of Common Shares, the Fund will be required to make additional
distributions to its Common Shareholders.
-39-
Nature Of Fund's Investments
Certain of the Fund's investment practices are subject to special and
complex federal income tax provisions that may, among other things, (i)
disallow, suspend or otherwise limit the allowance of certain losses or
deductions, (ii) convert lower taxed long-term capital gain into higher taxed
short-term capital gain or ordinary income, (iii) convert an ordinary loss or a
deduction into a capital loss (the deductibility of which is more limited), (iv)
cause the Fund to recognize income or gain without a corresponding receipt of
cash, (v) adversely affect the time as to when a purchase or sale of stock or
securities is deemed to occur and (vi) adversely alter the characterization of
certain complex financial transactions. The Fund will monitor its transactions
and may make certain tax elections in order to mitigate the effect of these
provisions.
Original Issue Discount Securities and Payment-in-Kind Securities
The Fund may acquire debt obligations that are treated as issued originally
at a discount or having acquisition discount. Current federal tax law requires a
regulated investment company that holds a U.S. Treasury or other fixed income
zero-coupon security to accrue as income each year a portion of the discount at
which the security was issued, even though the holder receives no interest
payment in cash on the security during the year. In addition, payment-in-kind
securities will give rise to income which is required to be distributed and is
taxable even though the Fund holding the security receives no interest payment
in cash on the security during the year. Generally, the amount of the discount
is treated as interest income and is included in income over the term of the
debt security, even though payment of that amount is not received until a later
time, usually when the debt security matures. A portion of the original issue
discount includable in income with respect to certain high-yield corporate debt
obligations (including certain payment-in-kind securities) may be treated as a
dividend for certain U.S. federal income tax purposes. With respect to certain
short-term debt obligations, the Fund may make one or more elections which could
affect the character and timing of recognition of income.
Some of the debt obligations (with a fixed maturity date of more than one
year from the date of issuance) that may be acquired by the Fund in the
secondary market may be treated as having market discount. Generally, any gain
recognized on the disposition of, and any partial payment of principal on, a
debt security having market discount is treated as ordinary income to the extent
the gain, or principal payment, does not exceed the "accrued market discount" on
such debt security. Market discount generally accrues in equal daily
installments. The Fund may make one or more of the elections applicable to debt
obligations having market discount, which could affect the character and timing
of recognition of income.
If the Fund holds the foregoing kinds of securities, it may be required to
pay out as an income distribution each year an amount which is greater than the
total amount of cash interest the Fund actually received. Such distributions may
be made from the cash assets of the Fund or by liquidation of portfolio
securities, if necessary. The Fund may realize gains or losses from such
liquidations. In the event the Fund realizes net capital gains from such
transactions, its shareholders may receive a larger capital gain distribution
than they would in the absence of such transactions.
Investment In Real Estate Investment Trusts
-40-
If the Fund invests in REITs that hold residual interests in real estate
mortgage investment conduits ("REMICs"), a portion of the Fund's income from a
REIT that is attributable to the REIT's residual interest in a REMIC (referred
to in the Code as an "excess inclusion") will be subject to federal income tax
in all events. Excess inclusion income of a regulated investment company, such
as the Fund, will be allocated to shareholders of the regulated investment
company in proportion to the dividends received by such shareholders, with the
same consequences as if the shareholders held the related REMIC residual
interest directly. In general, excess inclusion income allocated to shareholders
(i) cannot be offset by net operating losses (subject to a limited exception for
certain thrift institutions), (ii) will constitute unrelated business taxable
income to entities (including a qualified pension plan, an individual retirement
account, a 401(k) plan, a Keogh plan or other tax-exempt entity) subject to tax
on unrelated business income, thereby potentially requiring such an entity that
is allocated excess inclusion income, and otherwise might not be required to
file a tax return, to file a tax return and pay tax on such income, and (iii) in
the case of a foreign shareholder, will not qualify for any reduction in U.S.
federal withholding tax. In addition, if at any time during any taxable year a
"disqualified organization" (as defined in the Code) is a record holder of a
share in a regulated investment company, then the regulated investment company
will be subject to a tax equal to that portion of its excess inclusion income
for the taxable year that is allocable to the disqualified organization,
multiplied by the highest federal income tax rate imposed on corporations. The
Investment Manager does not intend on behalf of the Fund to invest in REITs, a
substantial portion of the assets of which consists of residual interests in
REMICs.
Foreign Shareholders
U.S. taxation of a shareholder who, as to the United States, is a
nonresident alien individual, a foreign trust or estate, a foreign corporation
or foreign partnership ("foreign shareholder") depends on whether the income of
the Fund is "effectively connected" with a U.S. trade or business carried on by
the shareholder.
Income Not Effectively Connected. If the income from the Fund is not
"effectively connected" with a U.S. trade or business carried on by the foreign
shareholder, distributions of investment company taxable income will be subject
to a U.S. tax of 30% (or lower treaty rate, except in the case of any excess
inclusion income allocated to the shareholder (see "Taxation--Investment in Real
Estate Investment Trusts" above)), which tax is generally withheld from such
distributions.
Capital gain dividends and any amounts retained by the Fund which are
designated as undistributed capital gains will not be subject to U.S. tax at the
rate of 30% (or lower treaty rate) unless the foreign shareholder is a
nonresident alien individual and is physically present in the United States for
more than 182 days during the taxable year and meets certain other requirements.
However, this 30% tax on capital gains of nonresident alien individuals who are
physically present in the United States for more than the 182 day period only
applies in exceptional cases because any individual present in the United States
for more than 182 days during the taxable year is generally treated as a
resident for U.S. income tax purposes; in that case, he or she would be subject
to U.S. income tax on his or her worldwide income at the graduated rates
applicable to U.S. citizens, rather than the 30% U.S. tax. In the case of a
foreign shareholder who is a nonresident alien individual, the Fund may be
required to withhold U.S.
-41-
income tax on distributions of net capital gain unless the foreign shareholder
certifies his or her non-U.S. status under penalties of perjury or otherwise
establishes an exemption. See "Taxation-Backup Withholding," below. Any gain
that a foreign shareholder realizes upon the sale or exchange of such
shareholder's shares of the Fund will ordinarily be exempt from U.S. tax unless
(i) in the case of a shareholder that is a nonresident alien individual, the
gain is U.S. source income and such shareholder is physically present in the
United States for more than 182 days during the taxable year and meets certain
other requirements, or (ii) at any time during the shorter of the period during
which the foreign shareholder held shares of the Fund and the five year period
ending on the date of the disposition of those shares, the Fund was a "U.S. real
property holding corporation" and the foreign shareholder held more than 5% of
the shares of the Fund, in which event the gain would be taxed in the same
manner as for a U.S. shareholder as discussed above and a 10% U.S. withholding
tax would be imposed on the amount realized on the disposition of such shares to
be credited against the foreign shareholder's U.S. income tax liability on such
disposition. A corporation is a "U.S. real property holding corporation" if the
fair market value of its U.S. real property interests equals or exceeds 50% of
the fair market value of such interests plus its interests in real property
located outside the United States plus any other assets used or held for use in
a business. In the case of the Fund, "U.S. real property interests" include
interests in stock in U.S. real property holding corporations (other than an
interest in stock of a REIT controlled by U.S. persons at all times during the
five-year period prior to the disposition and holdings of 5% or less in the
stock of publicly traded U.S. real property holding corporations) and certain
participating debt securities.
Income Effectively Connected. If the income from the Fund is "effectively
connected" with a U.S. trade or business carried on by a foreign shareholder,
then distributions of investment company taxable income and capital gain
dividends, any amounts retained by the Fund which are designated as
undistributed capital gains and any gains realized upon the sale or exchange of
shares of the Fund will be subject to U.S. income tax at the graduated rates
applicable to U.S. citizens, residents and domestic corporations. Foreign
corporate shareholders may also be subject to the branch profits tax imposed by
the Code.
The tax consequences to a foreign shareholder entitled to claim the
benefits of an applicable tax treaty may differ from those described herein.
Foreign shareholders are advised to consult their own tax advisers with respect
to the particular tax consequences to them of an investment in the Fund.
Backup Withholding
The Fund generally is required to withhold U.S. federal income tax on all
taxable distributions and redemption proceeds payable to any non-corporate
shareholder who fails to provide the Fund with a correct taxpayer identification
number (TIN) or to make required certifications to the Fund that he or she is
not subject to withholding, or who has been notified by the IRS that he or she
is subject to backup withholding. Pursuant to tax legislation enacted in 2001,
the backup withholding tax rate will be (i) 30% for amounts paid during 2002 and
2003, (ii) 29% for amounts paid during 2004 and 2005, and (iii) 28% for amounts
paid during 2006 through 2010. This legislation will expire and the backup
withholding rate will be 31% for amounts paid after December 31, 2010, unless
Congress enacts tax legislation providing otherwise.
-42-
In order for a foreign shareholder to qualify for exemption from the backup
withholding tax rates and for reduced withholding tax rates under income tax
treaties, the foreign shareholder must comply with special certification and
filing requirements. Foreign shareholders in the Fund should consult their tax
advisers in this regard.
Corporate shareholders and certain other shareholders specified in the Code
generally are exempt from such backup withholding. Backup withholding is not an
additional tax. Any amounts withheld may be credited against the shareholder's
U.S. federal income tax liability.
Other Taxation
Fund shareholders may be subject to state, local and foreign taxes on their
Fund distributions. Shareholders are advised to consult their own tax advisers
with respect to the particular tax consequences to them of an investment in the
Fund.
PERFORMANCE-RELATED AND COMPARATIVE AND OTHER INFORMATION
From time to time, the Fund may quote the Fund's total return, aggregate
total return or yield in advertisements or in reports and other communications
to shareholders. The Fund's performance will vary depending upon market
conditions, the composition of its portfolio and its operating expenses.
Consequently, any given performance quotation should not be considered
representative of the Fund's performance in the future. In addition, because
performance will fluctuate, it may not provide a basis for comparing an
investment in the Fund with certain bank deposits or other investments that pay
a fixed yield for a stated period of time. Investors comparing the Fund's
performance with that of other investment companies should give consideration to
the quality and maturity of the respective investment companies' portfolio
securities.
From time to time, the Fund and/or the Investment Manager may report to
shareholders or to the public in advertisements concerning the performance of
the Investment Manager or on the comparative performance or standing of the
Investment Manager in relation to other money managers. The Investment Manager
also may provide current or prospective private account clients, in connection
with standardized performance information for the Fund, performance information
for the Fund gross and/or net of fees and expenses for the purpose of assisting
such clients in evaluating similar performance information provided by other
investment managers or institutions. Comparative information may be compiled or
provided by independent ratings services or by news organizations. Any
performance information, whether related to the Fund or the Investment Manager,
should be considered in light of the Fund's investment objectives and policies,
characteristics and quality of the Fund, and the market conditions during the
time period indicated, and should not be considered to be representative of what
may be achieved in the future. Performance information for the Fund may be
compared to various unmanaged indexes.
The Fund may quote certain performance-related information and may compare
certain aspects of its portfolio and structure to other substantially similar
closed-end funds as categorized by Lipper, Inc. ("Lipper"), Morningstar Inc. or
other independent services. Comparison of the Fund to an alternative investment
should be made with consideration of differences in features and expected
performance. The Fund may obtain data from sources or
-43-
reporting services, such as Bloomberg Financial ("Bloomberg") and Lipper, that
the Fund believes to be generally accurate.
Past performance is not indicative of future results. At the time common
shareholders sell their shares, they may be worth more or less than their
original investment.
Benefits of Investing in Real Estate and REITs
REITs historically have paid higher dividends than other income-producing
securities (see Graph A).
Graph A
------------------------------------------------------------------------------
Average annual income, 10/1/92-9/30/02
------------------------------------------------------------------------------
------------------------------------------------------------------------------
10% ----------------------------------------------------------------
----------------------------------------------------------------
------------------------------------------------------------------------------
8% ----------------------------------------------------------------
7.22% -------------------------------------------------------
------------------------------------------------- 7.01% --------------------
6% ----------------------------------------------------------------
----------------------------------------------------------------
------------------------------------------------------------------- 4.41%
4% ----------------------------------------------------------------
----------------------------------------------------------------
------------------------------------------------------------------------------
2% ----------------------------------------------------------------
------------------- 1.96% -------------------------------------
------------------------------------------------------------------------------
REITS STOCKS BONDS CASH
------------------------------------------------------------------------------
Dividends from real estate securities have historically outpaced consumer
inflation. The enhanced return potential of REITs has historically translated
into solid performance relative to other asset classes (see Graph B).
Graph B
-----------------------------------------------------------------------------
Average annual total return, 10/1/92-9/30/02
-----------------------------------------------------------------------------
-----------------------------------------------------------------------------
15% ---------------------------------------------------------------
---------------------------------------------------------------
-----------------------------------------------------------------------------
12% ---------------------------------------------------------------
10.90% ------------------------------------------------------
-----------------------------------------------------------------------------
9% ---------------------------------------------------------------
------------------ 8.99% --------------------------------------
---------------------------------- 7.37% ----------------------
-----------------------------------------------------------------------------
6% ---------------------------------------------------------------
---------------------------------------------------------------
----------------------------------------------------------------- 4.41%
3% ---------------------------------------------------------------
---------------------------------------------------------------
-----------------------------------------------------------------------------
REITS STOCKS BONDS CASH
-----------------------------------------------------------------------------
-44-
Real estate securities tend to experience less fluctuation than the stock
market. Since many REITs are backed by underlying tangible assets, they may hold
their value during inflationary times. Real estate may offer investors a new
asset class, an alternative to stocks, bonds and cash, with added
diversification benefits and a combination of growth and income potential. Real
estate securities historically have demonstrated a low correlation to other
investments, i.e., they tend to react differently to various market conditions
(see Graph C). In addition, real estate securities have tended to experience
less volatility than the broader stock market.
Graph C
--------------------------------------------------------------------------------
Correlation to real estate, 10/1/92-9/30/02
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
1.0
--------------------------------------------------------------------------------
1.0
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
0.8
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
0.6
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
0.4 .29
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
0.2 .07
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
.05
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
REITS STOCKS BONDS CASH
--------------------------------------------------------------------------------
The charts set forth above are presented for illustrative purposes only and do
not represent or predict the Fund's return. The Fund may invest in securities
other than REITs, and may invest in types of REITs different from those whose
returns are depicted in the charts. Investors should keep in mind that several
material differences exist between the indexes shown on these pages. REITs are
represented by the NAREIT Equity Index, which is composed solely of real estate
investment trusts (REITs). REITs must concentrate their holdings in real estate
investments. Stocks are represented by the S&P 500 Index, which is composed of
the common stocks of 500 publicly traded large companies and is not restricted
to any one sector or industry. Bonds are represented by the Lehman Brothers
Aggregate Bond Index, which contains investment-grade fixed-rate debt issues
with maturities of at least one year. Cash is represented by U.S. Treasury
bills, as reported by the United States Department of the Treasury. It is not
possible to invest directly in any index. The charts above show information for
only one time period. If different time periods were shown, the comparisons
might be less favorable.
Fund's Approach to Investing
The Fund has adopted a value-oriented approach to investing in real
estate, seeking to identify undervalued or mispriced securities and to detect
potential catalysts that could cause the marketplace to revalue the security in
the near-term. The Investment Manager generally sells securities it has acquired
once it believes that the stock has become overvalued compared to its peers, no
further catalysts exist that would cause the stock price to rise in value, the
Investment Manager has identified other securities that offer more promising
risk-adjusted opportunities, or the stock has reached a price that the
Investment Manager deems to be greater than its intrinsic value. The Investment
Manager's investment process incorporates in-depth research with hands
-45-
on real estate and capital markets expertise. The Fund will invest across a
variety of property types and geographic regions. The Fund is geared towards
investors who have a tolerance for risk, are seeking the potential for high
current income, combined with the potential for long-term capital appreciation
and could benefit from additional portfolio diversification.
The Investment Manager examines investment opportunities from two
complementary perspectives. "The Main Street perspective" analyzes what an
investor would pay to buy the company's underlying real estate assets, while
"The Wall Street perspective" evaluates what an investor would pay to buy the
company's securities. The Investment Manager's management system is designed to
bring Main Street and Wall Street closer together by applying both traditional
real estate valuation measures and financial analytical techniques.
In reports or other communications to shareholders of the Fund or in
advertising materials, the Fund may compare its performance with that of (i)
other investment companies listed in the rankings prepared by Lipper Analytical
Services, Inc., publications such as Barrons, Business Week, Forbes, Fortune,
Institutional Investor, Kiplinger's Personal Finance, Money, Morningstar Mutual
Fund Values, The New York Times, The Wall Street Journal and USA Today or other
industry or financial publications or (ii) the Standard and Poor's Index of 500
Stocks, the Dow Jones Industrial Average, Dow Jones Utility Index, the National
Association of Real Estate Investment ("NAREIT") Trusts Equity REIT Index, the
Salomon Brothers Broad Investment Grade Bond Index (BIG), Morgan Stanley Capital
International Europe Australasia Far East (MSCI EAFE) Index, the NASDAQ
Composite Index, and other relevant indices and industry publications. The Fund
may also compare the historical volatility of its portfolio to the volatility of
such indices during the same time periods. (Volatility is a generally accepted
barometer of the market risk associated with a portfolio of securities and is
generally measured in comparison to the stock market as a whole--the beta--or in
absolute terms--the standard deviation.)
Returns are historical and include change in share price and
reinvestment of dividends and capital gains. REITs are represented by the NAREIT
Equity REIT Index, an unmanaged portfolio representing the Equity REIT market.
This is not the Fund's performance and the Fund will not seek to replicate any
index. You cannot invest directly in an index. There is no guarantee that Fund
performance will equal or exceed Equity REIT Index performance. The Standard and
Poor's 500 Composite Index ("S&P 500") is an unmanaged index of 500 large
capitalization, publicly traded stocks representing a variety of industries. The
NASDAQ Composite Index is a broad based capitalization weighted index of all
NASDAQ national market and small-cap stocks. International Index, represented by
the MSCI EAFE (Morgan Stanley Capital International Europe Australasia Far East)
Index, is a market value-weighted average of the performance of more than 900
securities listed on the stock exchanges of countries in Europe, Australasia and
the Far East. Bonds, represented by the Salomon Brothers Broad Investment Grade
Bond Index (BIG), is designed to cover the investment grade universe of bonds
issued in the United States. The BIG index includes institutionally traded U.S.
Treasury, Government-sponsored (U.S. agency and supranational), mortgage and
corporate securities, and provides a reliable and fair benchmark for the
investment grade bond portfolio manager. The Dow Jones Utilities Average is a
price-weighted average of 15 utility companies that are listed on the New York
Stock Exchange and are involved in the production of electrical energy.
Correlation coefficients are based on monthly return data. Treasury securities
are backed by the
-46-
full faith and credit of the U.S. Government, while real estate securities are
not. Past performance is no guarantee of future results.
The underwriters propose to initially offer some of the Common Shares
directly to the public at the public offering price set forth on the cover page
of this prospectus and some of the Common Shares to certain dealers at the
public offering price less a concession not in excess of $.45 per share (3.0% of
the initial offering price).
COUNSEL AND INDEPENDENT ACCOUNTANTS
Ropes & Gray serves as counsel to the Fund, and is located at One
International Place, Boston, Massachusetts 02110. PricewaterhouseCoopers LLP,
located at 160 Federal Street, Boston, Massachusetts 02110, has been appointed
as independent accountants for the Fund. The statement of assets and liabilities
of the Fund as of November 8, 2002 and the statement of operations of the Fund
for the one day then ended included in this Statement of Additional Information
have been so included in reliance on the report of PricewaterhouseCoopers LLP,
independent accountants, given on the authority of the firm as experts in
auditing and accounting.
ADDITIONAL INFORMATION
A Registration Statement on Form N-2, including amendments thereto,
relating to the shares offered hereby has been filed by the Fund with the SEC,
Washington, DC. The Prospectus and this Statement of Additional Information do
not contain all the information set forth in the Registration Statement,
including any exhibits and schedules thereto. For further information with
respect to the Fund and the shares offered hereby, reference is made to the
Registration Statement. Statements contained in the Prospectus and this
Statement of Additional Information as to the contents of any contract or other
document referred to are not necessarily complete and in each instance reference
is made to the copy of such contract or other document filed as an exhibit to
the Registration Statement, each such statement being qualified in all respects
by such reference. You may also review and copy the Registration Statement by
visiting the SEC's Public Reference Room in Washington, DC. Information on the
operation of the Public Reference Room may be obtained by calling the SEC at
202-942-8090. In addition, copies of the Registration Statement may be obtained,
after mailing the appropriate duplicating fee, by writing to the SEC's Public
Reference Section, 450 5th Street, N.W., Washington, DC 20549-0102 or by e-mail
request at publicinfo@sec.gov.
-47-
REPORT OF INDEPENDENT ACCOUNTANTS
To the Trustees and Shareholder of AEW Real Estate Income Fund
In our opinion, the accompanying statement of assets and liabilities and the
related statement of operations present fairly, in all material respects, the
financial position of AEW Real Estate Income Fund (the "Fund") at November 8,
2002, and the results of its operations for the period indicated, in conformity
with accounting principles generally accepted in the United States of America.
These financial statements are the responsibility of the Fund's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these financial statements in accordance
with auditing standards generally accepted in the United States of America,
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Boston, Massachusetts
November 8, 2002
FINANCIAL STATEMENTS
AEW REAL ESTATE INCOME FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF NOVEMBER 8, 2002
ASSETS
Cash $100,275
Deferred Offering Costs 264,900
Receivable from Advisor 35,100
--------
Total Assets $400,275
LIABILITIES
Accrued Offering Costs $264,900
Payable for Organization Expense 35,100
--------
Total Liabilities $300,000
Net assets applicable to 7,000 Shares of $0.00001 par
value common shares outstanding $100,275
Net asset value per common share outstanding $ 14.325
STATEMENT OF OPERATIONS
ONE DAY ENDED NOVEMBER 8, 2002
Income 0
Expenses
Organization Expense 35,100
Less: Expense Reimbursement (35,100)
-------
Total Expenses 0
Net Investment Income 0
=======
NOTES TO FINANCIAL STATEMENTS
November 8, 2002
NOTE 1 - ORGANIZATION
AEW Real Estate Income Fund (the "Fund") was organized as a Massachusetts
business trust on September 18, 2002 and is registered under the Investment
Company Act of 1940, as amended, as a non-diversified, closed-end management
investment company. On November 8, 2002, AEW Management and Advisors, L.P., (the
"Advisor") purchased 7,000 common shares of beneficial interest, par value
$0.00001 per share ("Common Shares") for $100,275. The Fund has had no
operations other than organizational matters and the issuance and sale of 7,000
shares of common stock to the Advisor. The Fund's primary investment objective
is high current income. The proceeds of the initial common shares sold in the
Fund were invested in cash.
The Fund is authorized by its Amended and Restated Agreement and Declaration of
Trust to issue an unlimited number of common shares and preferred shares of
beneficial interest ("Fund Preferred shares"). The Fund Preferred shares may be
issued in one or more series, with such par value and rights as determined by
the Board of Trustees without the approval of the common Shareholders.
The Advisor has agreed to reimburse all organization expenses (approximately
$35,100) and pay all offering costs (other than sales load) that exceed $.03 per
common share. Such offering costs will be netted against paid-in-capital.
NOTE 2: ACCOUNTING POLICIES
The preparation of the financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of income and expenses
during the reporting period. Actual results could differ from these estimates.
Federal Income Taxes
The Fund intends to meet the requirements of the Internal Revenue Code
applicable to regulated investment companies, and to distribute to its
shareholders substantially all of its net investment income and any net
realized capital gains, at least annually. Accordingly, no provision for federal
tax has been made.
NOTE 3: INVESTMENT MANAGEMENT AGREEMENT
AEW Management and Advisors, L.P. will be the Fund's Adviser. The Fund has
entered into an Investment Management Agreement with the Adviser, under which
the Adviser will provide general investment advisory and administrative services
for the Fund. For providing these services, facilities and for bearing the
related expenses, the Adviser will receive a fee from the Fund, accrued daily
and paid monthly, at an annual rate equal to .80% of the average daily managed
assets. Managed asset value is the net asset value of the Common Shares plus the
liquidation preference of any Fund Preferred Shares and the principal amount of
any borrowings used for leverage.
In addition to the reimbursement and waiver of organization and offering costs
discussed in Note 1, the Adviser has contractually agreed with the Fund to waive
a portion of its fees in the amount of .25% of average daily managed assets for
the first five years of the Fund's operations, .20% of average daily managed
assets in year six, .15% of average daily managed assets in year seven, .10% of
average daily managed assets in year eight and .05% of average daily managed
assets in year nine. The Adviser will not reimburse the Fund for any portion of
its fees beyond year nine of the agreement.
-50-
APPENDIX A
RATINGS OF INVESTMENTS
Description of certain ratings assigned by S&P and Moody's:
S&P
LONG-TERM
"AAA"--An obligation rated "AAA" has the highest rating assigned by S&P.
The obligor's capacity to meet its financial commitment on the obligation is
extremely strong.
"AA"--An obligation rated "AA" differs from the highest rated obligations
only in small degree. The obligor's capacity to meet its financial commitment on
the obligation is very strong.
"A"--An obligation rated "A" is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than obligations in
higher rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
"BBB"--An obligation rated "BBB" exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation.
"BB," "B," "CCC," "CC," and "C"--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 exposures to adverse
conditions.
"BB"--An obligation rated "BB" is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
"B"--An obligation rated "B" is more vulnerable to nonpayment than
obligations rated "BB," but the obligor currently has the capacity to meet its
financial commitment on the obligation. Adverse business, financial, or economic
conditions will likely impair the obligor's capacity or willingness to meet its
financial commitment on the obligation.
"CCC"--An obligation rated "CCC" is currently vulnerable to nonpayment, and
is dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation.
"CC"--An obligation rated "CC" is currently highly vulnerable to
nonpayment.
A-1
"C"--A subordinated debt or preferred stock obligation rated "C" is
currently highly vulnerable to nonpayment. The "C" rating may be used to cover a
situation where a bankruptcy petition has been filed or similar action taken,
but payments on this obligation are being continued. A "C" also will be assigned
to a preferred stock issue in arrears on dividends or sinking fund payments, but
that is currently paying.
"D"--An obligation rated "D" is in payment default. The "D" rating category
is used when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period. The "D" rating also will be used upon the
filing of a bankruptcy petition or the taking of a similar action if payments on
an obligation are jeopardized.
"r"--The symbol "r" is attached to the ratings of instruments with
significant noncredit risks. It highlights risks to principal or volatility of
expected returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe prepayment risk--such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
"N.R."--The designation "N.R." indicates that no rating has been requested,
that there is insufficient information on which to base a rating, or that S&P
does not rate a particular obligation as a matter of policy.
Note: The ratings from "AA" to "CCC" may be modified by the addition of a
plus (+) or minus ( - ) sign designation to show relative standing within the
major rating categories.
SHORT-TERM
"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 commitment on the
obligation is strong. Within this category, certain obligations are given a plus
sign (+) designation. This indicates that the obligor's capacity to meet its
financial commitment on these obligations is extremely strong.
"A-2"--A short-term obligation rated "A-2" is somewhat more susceptible to
the adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity to meet
its financial commitment on the obligation is satisfactory.
"A-3"--A short-term obligation rated "A-3" exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
"B"--A short-term obligation rated "B" is regarded as having significant
speculative characteristics. The obligor currently has the capacity to meet its
financial commitment on the obligation; however, it faces major ongoing
uncertainties which could lead to the obligor's inadequate capacity to meet is
financial commitment on the obligation.
A-2
"C"--A short-term obligation rated "C" is currently vulnerable to
nonpayment and is dependent upon favorable business, financial, and economic
conditions for the obligor to meet its financial commitment on the obligation.
"D"--A short-term obligation rated "D" is in payment default. The "D"
rating category is used when payments on an obligation are not made on the date
due even if the applicable grace period has not expired, unless S&P believes
that such payments will be made during such grace period. The "D" rating also
will be used upon the filing of a bankruptcy petition or the taking of a similar
action if payments on an obligation are jeopardized.
MOODY'S
LONG-TERM
"Aaa"--Bonds rated "Aaa" are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
"Aa"--Bonds rated "Aa" are judged to be of high quality by all standards.
Together with the "Aaa" group they comprise what are generally known as
high-grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in "Aaa" securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risk appear somewhat larger than the "Aaa"
securities.
"A"--Bonds rated "A" possess many favorable investment attributes and are
to be considered as upper-medium-grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment some time in the future.
"Baa"--Bonds rated "Baa" are considered as medium-grade obligations (i.e.,
they are neither highly protected nor poorly secured). Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
"Ba"--Bonds rated "Ba" are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate, and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
"B"--Bonds rated "B" generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
A-3
"Caa"--Bonds rated "Caa" are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
"Ca"--Bonds rated "Ca" represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
"C"--Bonds rated "C" are the lowest rated class of bonds, and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Note: Moody's applies numerical modifiers 1, 2, and 3 in 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.
PREFERRED STOCK
Because of the fundamental differences between preferred stocks and bonds,
Moody's employs a variation of our familiar bond rating symbols in the quality
ranking of preferred stock.
These symbols, presented below, are designed to avoid comparison with bond
quality in absolute terms. It should always be borne in mind that preferred
stock occupies a junior position to bonds within a particular capital structure
and that these securities are rated within the universe of preferred stocks.
"aaa"--An issue rated "aaa" is considered to be a top-quality preferred
stock. This rating indicates good asset protection and the least risk of
dividend impairment within the universe of preferred stocks.
"aa"--An issue rated "aa" is considered a high-grade preferred stock. This
rating indicates that there is a reasonable assurance the earnings and asset
protection will remain relatively well maintained in the foreseeable future.
"a"--An issue rated "a" is considered to be an upper-medium-grade preferred
stock. While risks are judged to be somewhat greater than in the "aaa" and "aa"
classifications, earnings and asset protection are, nevertheless, expected to be
maintained at adequate levels.
"baa"--An issue rated "baa" is considered to be a medium-grade preferred
stock, neither highly protected nor poorly secured. Earnings and asset
protection appear adequate at present, but may be questionable over any great
length of time.
"ba"--An issue rated "ba" is considered to have speculative elements. Its
future cannot be considered well assured. Earnings and asset protection may be
very moderate and not well safeguarded during adverse periods. Uncertainty of
position characterizes preferred stocks in this class.
"b"--An issue rated "b" generally lacks the characteristics of a desirable
investment. Assurance of dividend payments and maintenance of other terms of the
issue over any long period of time may be small.
A-4
"caa"--An issue rated "caa" is likely to be in arrears on dividend
payments. This rating designation does not purport to indicate the future status
of payments.
"ca"--An issue rated "ca" is speculative in a high degree and is likely to
be in arrears on dividends with little likelihood of eventual payments.
"c"--This is the lowest-rated class of preferred or preference stock.
Issues so rated can thus be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Note: As in the case of bond ratings, Moody's applies to preferred stock
ratings the numerical modifiers 1, 2, and 3 in rating classifications "aa"
through "b". The modifier 1 indicates that the security ranks in the higher end
of its generic rating category; the modifier 2 indicates a mid-range ranking;
and the modifier 3 indicates that the issue ranks in the lower end of its
generic rating category.
PRIME RATING SYSTEM (SHORT-TERM)
Issuers rated Prime-1 (or supporting institutions) have a superior ability
for repayment of senior short-term debt obligations. Prime-1 repayment ability
will often be evidenced by many of the following characteristics:
Leading market positions in well-established industries.
High rates of return on funds employed.
Conservative capitalization structure with moderate reliance on debt and
ample asset protection.
Broad margins in earnings coverage of fixed financial charges and high
internal cash generation.
Well-established access to a range of financial markets and assured sources
of alternate liquidity.
Issuers rated Prime-2 (or supporting institutions) have a strong ability
for repayment of senior short-term debt obligations. This will normally be
evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term obligations. The effect of industry
characteristics and market compositions may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt protection
measurements and may require relatively high financial leverage. Adequate
alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
A-5