N-1A/A 1 d507945dn1aa.htm N-1A/A N-1A/A
Table of Contents

Filed with the Securities and Exchange Commission on                     , 2018

1933 Act Registration File No. 333-216479

1940 Act File No. 811-23235

 

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM N-1A

AMENDMENT NO. 1

REGISTRATION STATEMENT

UNDER

   THE SECURITIES ACT OF 1933  
   Pre-Effective Amendment No. 1  
   Post-Effective Amendment No.  

and/or

REGISTRATION STATEMENT

UNDER

   THE INVESTMENT COMPANY ACT OF 1940  
   Pre-Effective Amendment No. 1  

(Check appropriate box or boxes.)

 

 

MORNINGSTAR FUNDS TRUST

(Exact Name of Registrant as Specified in Charter)

 

 

Morningstar Funds Trust

22 W. Washington Street

Chicago, IL 60602

(Address of Principal Executive Offices, including Zip Code)

Registrant’s Telephone Number, including Area Code: (312) 696-6000

 

Name and Address of Agent for Service

 

 

Patrick J. Maloney

Morningstar Funds Trust

22 W. Washington Street

Chicago, IL 60602

 

 

Copy to:

Eric S. Purple

Stradley Ronon Stevens & Young, LLP

1250 Connecticut Avenue N.W.

Suite 500

Washington, D.C. 20036

 

 

Approximate Date of Proposed Public Offering:

As soon as practicable after the effectiveness of this registration statement.

The Registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


Table of Contents

Subject to Completion—Dated ______, 2018

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

INSERT LOGO

MORNINGSTAR FUNDS TRUST

 

    Morningstar U.S. Equity Fund

   Ticker: MSTQX    

    Morningstar International Equity Fund

   Ticker: MSTFX    

    Morningstar Global Income Fund

   Ticker: MSTGX    

    Morningstar Total Return Bond Fund

   Ticker: MSTRX    

    Morningstar Municipal Bond Fund

   Ticker: MSTPX    

    Morningstar Defensive Bond Fund

   Ticker: MSTBX    

    Morningstar Multisector Bond Fund

   Ticker: MSTMX    

    Morningstar Unconstrained Allocation Fund

   Ticker: MSTSX    

    Morningstar Alternatives Fund

   Ticker: MSTVX    

PROSPECTUS

_______________, 2018

The Securities and Exchange Commission has not approved or disapproved these securities or passed upon the adequacy of this prospectus. Any representation to the contrary is a criminal offense.


Table of Contents

TABLE OF CONTENTS

 

SUMMARY SECTIONS

  

MORNINGSTAR U.S. EQUITY FUND

     1  

MORNINGSTAR INTERNATIONAL EQUITY FUND

     6  

MORNINGSTAR GLOBAL INCOME FUND

     11  

MORNINGSTAR TOTAL RETURN BOND FUND

     16  

MORNINGSTAR MUNICIPAL BOND FUND

     21  

MORNINGSTAR DEFENSIVE BOND FUND

     25  

MORNINGSTAR MULTISECTOR BOND FUND

     29  

MORNINGSTAR UNCONSTRAINED ALLOCATION FUND

     34  

MORNINGSTAR ALTERNATIVES FUND

     39  

STATEMENT OF SHAREHOLDER RIGHTS

     44  

ADDITIONAL INFORMATION ABOUT THE FUNDS’ INVESTMENT STRATEGIES AND RISKS

     44  

Additional Principal Investment Strategy Information

     44  

Additional Principal Risk Information

     45  

Exclusion from Regulation as a Commodity Pool Operator

     61  

PORTFOLIO HOLDINGS INFORMATION

     62  

MANAGEMENT OF THE FUNDS

     62  

Investment Adviser

     62  

Fund Expenses

     64  

Subadviser Evaluation and Selection

     65  

Subadvisers and Portfolio Managers

     66  

SHAREHOLDER INFORMATION

     81  

ACCOUNT AND TRANSACTION POLICIES

     82  

TOOLS TO COMBAT FREQUENT TRANSACTIONS

     83  

DIVIDENDS AND DISTRIBUTIONS

     84  

TAX CONSEQUENCES

     84  

PRIVACY NOTICE

     PN-1  

 

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Table of Contents

MORNINGSTAR U.S. EQUITY FUND

SUMMARY INFORMATION

Investment Objective

The Fund seeks long-term capital appreciation.

Fees and Expenses of the Fund

The following tables describe the fees and expenses that you may pay if you buy and hold shares of the Fund.

Shareholder Fees

(Fees paid directly from your investment)

 

Sales Charge (Load) Imposed on Purchases

     None  

Sales Charge (Load) Imposed on Reinvested Dividends

     None  

Redemption Fee

     None  

Exchange Fee

     None  

Account Service Fee

     None  

Annual Fund Operating Expenses

(Expenses that you pay each year as a percentage of the value of your investment)

 

Management Fees

     0.67

Distribution and/or Service (12b-1) Fees

     None  

Other Expenses(1)

  

Sub-accounting Fees(2)

     0.13

Other Operating Expenses

     0.10
  

 

 

 

Total Other Expenses

     0.23
  

 

 

 

Total Fund Annual Fund Operating Expenses

     0.90

Fee Waivers and Expense Reimbursement(3)

     -0.03
  

 

 

 

Total Annual Fund Operating Expenses After Fee Waivers and Expense Reimbursement(3)

     0.87
  

 

 

 

 

(1)  Other expenses are based on estimated amounts for the current fiscal year.
(2)  Represents fees assessed by various financial intermediaries and “mutual fund supermarkets” for providing certain account maintenance, record keeping, and transactional services with respect to Fund shares held by these intermediaries for their customers.
(3)  The adviser has agreed, through at least [____], 2019 [Date to be inserted will be at least one year from the date of this Prospectus], to waive all or a portion of its advisory fees and, if necessary, to assume certain other expenses (to the extent permitted by the Internal Revenue Code of 1986, as amended) to the extent necessary to ensure that the Fund’s Total Annual Fund Operating Expenses (excluding taxes, interest, brokerage commissions, trading costs, Acquired Fund Fees and Expenses, litigation expenses, and extraordinary expenses) do not exceed 0.87%. Under the agreement, the adviser may recoup waived fees and expenses it assumed for a three-year period under specified conditions.

Example

The example below can help you compare the cost of investing in the Fund with the cost of investing in other mutual funds. This example assumes that you invest $10,000 in the Fund for the time periods indicated and then sell all of your shares at the end of those periods. The example also assumes that your investment has a 5% return each year and that the Fund’s operating expenses remain the same. Although your actual costs may be higher or lower, based on these assumptions your costs would be:

 

1 Year      3 Years  
$ 89      $ 284  

 

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Portfolio Turnover

The Fund will pay transaction costs, such as commissions, when it buys and sells securities (or “turns over” its portfolio). A higher portfolio turnover rate may mean higher transaction costs and could result in higher taxes if you hold Fund shares in a taxable account. These costs, which are not reflected in annual fund operating expenses or in the example, affect the Fund’s performance. Because the Fund is new, no portfolio turnover statistics are available as of the date of this prospectus.

Principal Investment Strategies

In seeking long-term capital appreciation, the Fund will normally invest at least 80% of its assets in equity securities of U.S.-based companies, and may invest up to 100% of its assets in such securities. The Fund seeks to provide broad U.S. equity exposure across market capitalizations and investment styles and has the flexibility to invest in large-cap, mid-cap, and small-cap common stocks across the growth and value style spectrum. The Fund may also invest in real estate investment trusts (REITs) and non-U.S. companies. The Fund may invest in derivatives, including futures and forward foreign currency contracts, for risk management purposes or as part of its investment strategies.

Multimanager Approach

The Fund uses a multimanager approach, meaning the adviser, Morningstar Investment Management LLC (“Morningstar” or “adviser” or “we”), may allocate assets to one or more subadvisers, in addition to open- and closed-end investment companies, exchange traded funds (ETFs), and individual securities. Each subadviser acts independently from the others and uses its own investment style and process to select securities, within the constraints of the Fund’s investment objective, strategies, and restrictions. Morningstar is responsible for selecting the investment strategies and deciding what percent of assets to give to each subadviser, with the goal of maximizing return with a prudent level of risk for the strategy. Subject to the oversight of the board of trustees, Morningstar may change subadvisers and sell holdings at any time.

Principal Risks

You can lose money by investing in the Fund. The Fund can also underperform broad markets or other investments. The Fund’s principal risks include:

 

    Multimanager and subadviser selection risk – To a significant extent, the Fund’s performance depends on Morningstar’s skill in selecting subadvisers and each subadviser’s skill in selecting securities and executing its strategy. Subadviser strategies may occasionally be out of favor and subadvisers may underperform relative to their peers or benchmarks.

 

    Asset allocation risk – In an attempt to invest in areas that look most attractive on a valuation basis, the Fund may favor asset classes or market segments that cause the Fund to underperform its benchmark.

 

    Stock market/company risk – Stocks can be highly volatile and prices may fluctuate widely, which means you should expect a wide range of returns and could lose money, even over a long time period. Various economic, industry, regulatory, political or other factors can dramatically affect the stock market as a whole, certain industry sectors, and/or individual companies.

 

    Smaller companies risk – The stocks of small- or mid-sized companies may be subject to more abrupt or erratic market movements than stocks of larger, more established companies. Small companies may have limited product lines or financial resources, or may be dependent upon a small or inexperienced management group, and their securities may trade less frequently and in lower volume than the securities of larger companies, which could lead to higher transaction costs.

 

    REITs and other real estate companies risk – REIT and other real estate company securities are subject to, among other risks: declines in property values; defaults by mortgagors or other borrowers and tenants; increases in property taxes and other operating expenses; overbuilding in their sector of the real estate market; fluctuations in rental income; changes in interest rates; lack of availability of mortgage funds or financing; extended vacancies of properties, especially during economic downturns; changes in tax and regulatory requirements; losses due to environmental liabilities; or casualty or condemnation losses.

 

    Foreign securities risk – Securities of non-U.S. issuers may be less liquid, more volatile, and harder to value than U.S. securities. They may also be subject to political, economic, and regulatory risks, and market instability.

 

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    Investment company and ETF risk – An investment company, including an open- or closed-end mutual fund or ETF, in which the Fund invests may not achieve its investment objective or execute its investment strategies effectively, or a large purchase or redemption activity by shareholders might negatively affect the value of the shares. The Fund must also pay its pro rata portion of an investment company’s fees and expenses. Shares of ETFs trade on exchanges and may be bought and sold at market value. ETF shares may be thinly traded, making it difficult for the Fund to sell shares at a particular time or an anticipated price. ETF shares may also trade at a premium or discount to the net asset value of the ETF; at times, this premium or discount could be significant.

 

    Derivatives risk – A derivative is an instrument with a value based on the performance of an underlying currency, security, index, or other reference asset. Derivatives involve risks different from, or possibly greater than, the risks of investing in more traditional investments. Derivatives involve costs, may create leverage, and may be illiquid, volatile, or difficult to value. In addition, derivatives could cause losses if the counterparty to the transaction does not perform as promised. The investment results achieved by using derivatives may not match or fully offset changes in the value of the underlying currency, security, index, or other reference asset that the Fund was attempting to hedge or the investment opportunity it was trying to pursue.

Performance

Because the Fund has not yet started operations as of the date of this prospectus, we cannot yet report on its performance history. Once the Fund has been in operation for at least one calendar year, we will provide performance information for the Fund, as well as a comparison to a relevant market benchmark.

Fund Management

Morningstar is the investment adviser for the Fund and has overall supervisory responsibility for the general management and investment of the Fund’s portfolio. The Fund is managed in a multimanager structure. On behalf of Morningstar, the following persons have primary responsibility for the Fund and, subject to oversight by the board of trustees, are responsible for selecting and overseeing the subadvisers listed below.

 

Portfolio Manager

  

Position with Morningstar

  

Start Date with
the Fund

Morningstar Investment Management LLC

Daniel E. McNeela, CFA    Senior Portfolio Manager and
Co-Head of Target Risk Strategies
   Since Inception
Michael A. Stout, CFA    Portfolio Manager    Since Inception

Subadvisers and Portfolio Managers

Morningstar currently plans to allocate assets among the following subadvisers and may adjust these allocations at any time. The portfolio managers listed below are responsible for the day-to-day management of each subadviser’s allocated portion of the Fund’s portfolio:

 

Portfolio Manager

  

Position with Subadviser

  

Start Date with
the Fund

ClearBridge Investments, LLC

Peter J. Bourbeau    Managing Director and Portfolio Manager    Since Inception
Margaret B. Vitrano    Managing Director and Portfolio Manager    Since Inception

 

- 3 -


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Portfolio Manager

  

Position with Subadviser

  

Start Date with
the Fund

Diamond Hill Capital Management, Inc.

Christopher A. Welch, CFA    Co-Chief Investment Officer and Portfolio Manager    Since Inception
Christopher M. Bingaman, CFA    Chief Executive Officer, President, and Portfolio Manager    Since Inception
Jeanette M. Hubbard, CFA    Assistant Portfolio Manager    Since Inception

Levin Capital Strategies, L.P.

John (Jack) W. Murphy    Portfolio Manager and Senior Securities Analyst    Since Inception

Massachusetts Financial Services Company, d/b/a MFS Investment Management

Steven Gorham, CFA    Investment Officer and Portfolio Manager    Since Inception
Nevin Chitkara    Investment Officer and Portfolio Manager    Since Inception

Wasatch Advisors, Inc.

JB Taylor    Chief Executive Officer and Portfolio Manager    Since Inception
Paul S. Lambert    Portfolio Manager    Since Inception
Michael K. Valentine    Portfolio Manager    Since Inception

Westwood Management Corp.

Matthew R. Lockridge    Senior Vice President, Portfolio Manager, Research Analyst    Since Inception
William E. Costello, CFA    Senior Vice President, Portfolio Manager, Senior Research Analyst    Since Inception
Frederic G. Rowsey, CFA    Vice President, Portfolio Manager, Research Analyst    Since Inception

Purchase and Sale of Fund Shares

Fund shares are currently available only to investors participating in Morningstar Managed Portfolios, an investment advisory program sponsored by Morningstar Investment Services LLC, a wholly-owned subsidiary of the adviser, and also in programs sponsored by unaffiliated financial institutions that license the use of Morningstar Managed Portfolios in their own investment advisory program (collectively, Advisory Programs). There are no initial or subsequent minimum purchase amounts for the Fund. Orders to sell or “redeem” shares must be placed through the Advisory Program in which you participate and may trigger a purchase or sale of the Fund’s underlying investments. Fund shares may be purchased or redeemed on any day the New York Stock Exchange (NYSE) is open. At any time that an investor in the Fund ceases to be an eligible investor in the Fund, the entity managing the Advisory Program will direct the redemption of that investor’s Fund shares and no further purchases will be allowed.

 

- 4 -


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See the Purchase and Sale of Fund Shares section on page [    ] of this prospectus for more information.

Tax Information

The Fund’s distributions generally are taxable to you as ordinary income, capital gains, or some combination of both, unless you are investing through a tax-advantaged arrangement, such as a 401(k) plan or an IRA, in which case your distributions may be taxed as ordinary income when withdrawn from the tax-advantaged account.

 

- 5 -


Table of Contents

MORNINGSTAR INTERNATIONAL EQUITY FUND

SUMMARY INFORMATION

Investment Objective

The Fund seeks long-term capital appreciation.

Fees and Expenses of the Fund

The following tables describe the fees and expenses that you may pay if you buy and hold shares of the Fund.

Shareholder Fees

(Fees paid directly from your investment)

 

Sales Charge (Load) Imposed on Purchases

     None  

Sales Charge (Load) Imposed on Reinvested Dividends

     None  

Redemption Fee

     None  

Exchange Fee

     None  

Account Service Fee

     None  

Annual Fund Operating Expenses

(Expenses that you pay each year as a percentage of the value of your investment)

 

Management Fees

     0.83

Distribution and/or Service (12b-1) Fees

     None  

Other Expenses(1)

  

Sub-accounting Fees(2)

     0.13

Other Operating Expenses

     0.10
  

 

 

 

Total Other Expenses

     0.23
  

 

 

 

Total Fund Annual Fund Operating Expenses

     1.06

Fee Waivers and Expense Reimbursement(3)

     -0.05
  

 

 

 

Total Annual Fund Operating Expenses After Fee Waivers and Expense Reimbursement(3)

     1.01
  

 

 

 

 

(1) Other expenses are based on estimated amounts for the current fiscal year.
(2) Represents fees assessed by various financial intermediaries and “mutual fund supermarkets” for providing certain account maintenance, record keeping, and transactional services with respect to Fund shares held by these intermediaries for their customers.
(3) The adviser has agreed, through at least [                    ], 2019 [Date to be inserted will be at least one year from the date of this Prospectus], to waive all or a portion of its advisory fees and, if necessary, to assume certain other expenses (to the extent permitted by the Internal Revenue Code of 1986, as amended) to the extent necessary to ensure that the Fund’s Total Annual Fund Operating Expenses (excluding taxes, interest, brokerage commissions, trading costs, Acquired Fund Fees and Expenses, litigation expenses, and extraordinary expenses) do not exceed 1.01%. Under the agreement, the adviser may recoup waived fees and expenses it assumed for a three-year period under specified conditions.

Example

The example below can help you compare the cost of investing in the Fund with the cost of investing in other mutual funds. This example assumes that you invest $10,000 in the Fund for the time periods indicated and then sell all of your shares at the end of those periods. The example also assumes that your investment has a 5% return each year and that the Fund’s operating expenses remain the same. Although your actual costs may be higher or lower, based on these assumptions your costs would be:

 

1 Year      3 Years  
$ 103      $ 332  

 

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Portfolio Turnover

The Fund will pay transaction costs, such as commissions, when it buys and sells securities (or “turns over” its portfolio). A higher portfolio turnover rate may mean higher transaction costs and could result in higher taxes if you hold Fund shares in a taxable account. These costs, which are not reflected in annual fund operating expenses or in the example, affect the Fund’s performance. Because the Fund is new, no portfolio turnover statistics are available as of the date of this prospectus.

Principal Investment Strategies

In seeking long-term capital appreciation, the Fund will normally invest at least 80% of its assets in equity securities. Under normal circumstances, the Fund will invest approximately 80-100% of its assets in securities of issuers domiciled outside of the United States. The Fund may invest in developed and emerging markets and will typically invest in a minimum of 10 countries. The Fund seeks to provide broad international equity exposure across market capitalizations and investment styles and has the flexibility to invest in large-cap, mid-cap, and small-cap common stocks across the growth and value style spectrum. The Fund may also invest in derivatives, including futures and forward foreign currency contracts, for risk management purposes or as part of its investment strategies.

Multimanager Approach

The Fund uses a multimanager approach, meaning the adviser, Morningstar Investment Management LLC (“Morningstar” or “adviser” or “we”), may allocate assets to one or more subadvisers, in addition to open- and closed-end investment companies, exchange traded funds (ETFs), and individual securities. Each subadviser acts independently from the others and uses its own investment style and process to select securities, within the constraints of the Fund’s investment objective, strategies, and restrictions. Morningstar is responsible for selecting the investment strategies and deciding what percent of assets to give to each subadviser, with the goal of maximizing return with a prudent level of risk for the strategy. Subject to the oversight of the board of trustees, Morningstar may change subadvisers and sell holdings at any time.

Principal Risks

You can lose money by investing in the Fund. The Fund can also underperform broad markets or other investments. The Fund’s principal risks include:

 

    Multimanager and subadviser selection risk – To a significant extent, the Fund’s performance depends on Morningstar’s skill in selecting subadvisers and each subadviser’s skill in selecting securities and executing its strategy. Subadviser strategies may occasionally be out of favor and subadvisers may underperform relative to their peers or benchmarks.

 

    Asset allocation risk In an attempt to invest in areas that look most attractive on a valuation basis, the Fund may favor asset classes or market segments that cause the Fund to underperform its benchmark.

 

    Stock market/company risk – Stocks can be highly volatile and prices may fluctuate widely, which means you should expect a wide range of returns and could lose money, even over a long time period. Various economic, industry, regulatory, political or other factors can dramatically affect the stock market as a whole, certain industry sectors, and/or individual companies.

 

    Smaller companies risk – The stocks of small- or mid-sized companies may be subject to more abrupt or erratic market movements than stocks of larger, more established companies. Small companies may have limited product lines or financial resources, or may be dependent upon a small or inexperienced management group, and their securities may trade less frequently and in lower volume than the securities of larger companies, which could lead to higher transaction costs.

 

    Foreign securities risk – Securities of non-U.S. issuers may be less liquid, more volatile, and harder to value than U.S. securities. They may also be subject to political, economic and regulatory risks, and market instability.

 

    Emerging markets risk – Emerging market countries may have relatively unstable governments and economies based on only a few industries, which can cause greater instability. These countries are also more likely to experience higher levels of inflation, deflation, or currency devaluations, which could hurt their economies and securities markets.

 

    Geographic concentration risk – To the extent that the Fund invests a significant portion of its assets in a particular country, region or continent, economic, political, social and environmental conditions in such country, region or continent will have a greater effect on the Fund’s performance than they would in a more geographically diversified equity fund.

 

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    Currency risk – Because this Fund invests in foreign securities, changes in currency exchange rates could hurt performance. Morningstar or a subadviser may decide not to hedge, or may not be successful in hedging, its currency exposure.

 

    Investment company and ETF risk – An investment company, including an open- or closed-end mutual fund or ETF, in which the Fund invests may not achieve its investment objective or execute its investment strategies effectively, or a large purchase or redemption activity by shareholders might negatively affect the value of the shares. The Fund must also pay its pro rata portion of an investment company’s fees and expenses. Shares of ETFs trade on exchanges and may be bought and sold at market value. ETF shares may be thinly traded, making it difficult for the Fund to sell shares at a particular time or an anticipated price. ETF shares may also trade at a premium or discount to the net asset value of the ETF; at times, this premium or discount could be significant.

 

    Derivatives risk – A derivative is an instrument with a value based on the performance of an underlying currency, security, index, or other reference asset. Derivatives involve risks different from, or possibly greater than, the risks of investing in more traditional investments. Derivatives involve costs, may create leverage, and may be illiquid, volatile, or difficult to value. In addition, derivatives could cause losses if the counterparty to the transaction does not perform as promised. The investment results achieved by using derivatives may not match or fully offset changes in the value of the underlying currency, security, index, or other reference asset that the Fund was attempting to hedge or the investment opportunity it was trying to pursue.

Performance

Because the Fund has not yet started operations as of the date of this prospectus, we cannot yet report on its performance history. Once the Fund has been in operation for at least one calendar year, we will provide performance information for the Fund, as well as a comparison to a relevant market benchmark.

Fund Management

Morningstar is the investment adviser for the Fund and has overall supervisory responsibility for the general management and investment of the Fund’s portfolio. The Fund is managed in a multimanager structure. On behalf of Morningstar, the following persons have primary responsibility for the Fund and, subject to oversight by the board of trustees, are responsible for selecting and overseeing the subadvisers listed below.

 

Portfolio Manager

  

Position with Morningstar

  

Start Date with
the Fund

Morningstar Investment Management LLC

Daniel E. McNeela, CFA    Senior Portfolio Manager and
Co-Head of Target Risk Strategies
   Since Inception
Gareth P. Lyons    Portfolio Manager    Since Inception

 

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Table of Contents

Subadvisers and Portfolio Managers

Morningstar currently plans to allocate assets among the following subadvisers and may adjust these allocations at any time. The portfolio managers listed below are responsible for the day-to-day management of each subadviser’s allocated portion of the Fund’s portfolio:

 

Portfolio Manager

  

Position with Subadviser

  

Start Date with
the Fund

Harding Loevner LP

Ferrill D. Roll, CFA    Co-Chief Investment Officer, Co-Lead Portfolio Manager, Analyst    Since Inception
Alexander T. Walsh, CFA    Co-Lead Portfolio Manager, Analyst    Since Inception
Scott Crawshaw    Portfolio Manager, Analyst    Since Inception
Bryan C. Lloyd, CFA    Portfolio Manager, Analyst    Since Inception
Patrick C. Todd, CFA    Portfolio Manager, Analyst    Since Inception
Andrew H. West, CFA    Manager of Research, Portfolio Manager, Analyst    Since Inception

Harris Associates L.P.

David G. Herro, CFA    Deputy Chairman, Chief Investment Officer—International Equities, and Portfolio Manager    Since Inception
Michael L. Manelli, CFA    Vice President, Portfolio Manager, and International Investment Analyst    Since Inception

Lazard Asset Management LLC

James Donald, CFA    Managing Director, Portfolio Manager/Analyst, and Head of Emerging Markets    Since Inception
Rohit Chopra    Managing Director and Portfolio Manager/Analyst    Since Inception
Monika Shrestha    Director and Portfolio Manager/Analyst    Since Inception
John Reinsberg    Deputy Chairman, Head of International and Global Strategies    Since Inception

T. Rowe Price Associates, Inc.

Gonzalo Pángaro, CFA    Vice President and Portfolio Manager    Since Inception

Purchase and Sale of Fund Shares

Fund shares are currently available only to investors participating in Morningstar Managed Portfolios, an investment advisory program sponsored by Morningstar Investment Services LLC, a wholly-owned subsidiary of the adviser, and also in programs sponsored by unaffiliated financial institutions that license the use of Morningstar Managed Portfolios in their own investment advisory program (collectively, Advisory Programs). There are no initial or subsequent minimum purchase amounts for the Fund. Orders to sell or “redeem” shares must be placed through the Advisory Program in which you participate and may trigger a purchase or sale of the Fund’s underlying investments.

 

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Fund shares may be purchased or redeemed on any day the New York Stock Exchange (NYSE) is open. At any time that an investor in the Fund ceases to be an eligible investor in the Fund, the entity managing the Advisory Program will direct the redemption of that investor’s Fund shares and no further purchases will be allowed.

See the Purchase and Sale of Fund Shares section on page [    ] of this prospectus for more information.

Tax Information

The Fund’s distributions generally are taxable to you as ordinary income, capital gains, or some combination of both, unless you are investing through a tax-advantaged arrangement, such as a 401(k) plan or an IRA, in which case your distributions may be taxed as ordinary income when withdrawn from the tax-advantaged account.

 

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MORNINGSTAR GLOBAL INCOME FUND

SUMMARY INFORMATION

Investment Objective

The Fund seeks current income and long-term capital appreciation.

Fees and Expenses of the Fund

The following tables describe the fees and expenses that you may pay if you buy and hold shares of the Fund.

Shareholder Fees

(Fees paid directly from your investment)

 

Sales Charge (Load) Imposed on Purchases

     None  

Sales Charge (Load) Imposed on Reinvested Dividends

     None  

Redemption Fee

     None  

Exchange Fee

     None  

Account Service Fee

     None  

Annual Fund Operating Expenses

(Expenses that you pay each year as a percentage of the value of your investment)

 

Management Fees

     0.35

Distribution and/or Service (12b-1) Fees

     None  

Other Expenses (1)

  

Sub-accounting Fees (2)

     0.13

Other Operating Expenses

     0.20
  

 

 

 

Total Other Expenses

     0.33

Acquired Fund Fees and Expenses (3)

     0.30
  

 

 

 

Total Fund Annual Fund Operating Expenses

     0.98
  

 

 

 

 

(1)  Other expenses are based on estimated amounts for the current fiscal year.
(2)  Represents fees assessed by various financial intermediaries and “mutual fund supermarkets” for providing certain account maintenance, record keeping, and transactional services with respect to Fund shares held by these intermediaries for their customers.
(3)  Acquired Fund Fees and Expenses (AFFE) represent costs incurred indirectly by the Fund as a result of its ownership of shares of another investment company, such as open- or closed-end mutual funds, exchange traded funds (ETFs), and business development companies (BDCs). These are estimated for the current fiscal year.

Example

The example below can help you compare the cost of investing in the Fund with the cost of investing in other mutual funds. This example assumes that you invest $10,000 in the Fund for the time periods indicated and then sell all of your shares at the end of those periods. The example also assumes that your investment has a 5% return each year and that the Fund’s operating expenses remain the same. Although your actual costs may be higher or lower, based on these assumptions your costs would be:

 

1 Year      3 Years  
$ 100      $ 312  

Portfolio Turnover

The Fund will pay transaction costs, such as commissions, when it buys and sells securities (or “turns over” its portfolio). A higher portfolio turnover rate may mean higher transaction costs and could result in higher taxes if you hold Fund shares in a taxable account. These costs, which are not reflected in annual fund operating expenses or in the example, affect the Fund’s performance. Because the Fund is new, no portfolio turnover statistics are available as of the date of this prospectus.

 

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Principal Investment Strategies

In seeking current income and long-term capital appreciation, the Fund has significant flexibility and invests across asset classes and geographies, according to the portfolio management team’s assessment of their valuations, fundamental health, and income levels. Under normal circumstances, the Fund will invest at least 20% (or, if market conditions are unfavorable, at least 10%) of assets in securities of issuers domiciled outside of the United States and may invest up to 100% assets in such securities.

The Fund invests in income-generating equity securities, which may include common stocks, convertible securities, preferred stocks, real estate investment trusts (REITs), and master limited partnerships (MLPs). The fund may invest in companies of any size from any country, including emerging markets.

The Fund also invests in fixed-income securities of varying maturity, duration, and quality. These may include U.S. and non-U.S. corporate debt securities, U.S. and non-U.S. government debt securities, emerging-market debt securities, mortgage-backed and asset-backed securities, and floating-rate notes. The Fund may invest without limit in fixed-income securities that are rated below investment grade (commonly known as junk bonds) or, if unrated, are determined by the Fund’s subadviser(s) to be of comparable quality.

To meet its objective, the Fund may invest in exchange traded funds (ETFs), which could represent a significant percentage of assets. The Fund may also invest in derivatives, including options, futures, swaps, and forward foreign currency contracts, for risk management purposes or as part of its investment strategies.

Multimanager Approach

The Fund uses a multimanager approach, meaning the adviser, Morningstar Investment Management LLC (“Morningstar” or “adviser” or “we”), may allocate assets to one or more subadvisers, in addition to open- and closed-end investment companies, ETFs, and individual securities. Each subadviser acts independently from the others and uses its own investment style and process to select securities, within the constraints of the Fund’s investment objective, strategies, and restrictions. Morningstar is responsible for selecting the investment strategies and deciding what percent of assets to give to each subadviser, with the goal of maximizing return with a prudent level of risk for the strategy. Subject to the oversight of the board of trustees, Morningstar may change subadvisers and sell holdings at any time.

Principal Risks

You can lose money by investing in this Fund. The Fund can also underperform broad markets and other investments. The Fund’s principal risks include:

 

    Multimanager and subadviser selection risk – To a significant extent, the Fund’s performance depends on Morningstar’s skill in selecting subadvisers and each subadviser’s skill in selecting securities and executing its strategy. Subadviser strategies may occasionally be out of favor and subadvisers may underperform relative to their peers or benchmarks.

 

    Asset allocation risk – In an attempt to invest in areas that look most attractive on a valuation basis, the Fund may favor asset classes or market segments that cause the Fund to underperform its benchmark. Given the wide latitude with which the adviser manages this portfolio, you should expect this Fund to periodically underperform broad markets.

 

    Stock market/company risk – Stocks can be highly volatile and prices may fluctuate widely, which means you should expect a wide range of returns and could lose money, even over a long time period. Various economic, industry, regulatory, political or other factors can dramatically affect the stock market as a whole, certain industry sectors, and/or individual companies.

 

    Interest-rate risk – The value of fixed-income securities, as well as some income-oriented equity securities that pay dividends, will typically decline when interest rates rise.

 

    Credit risk – Issuers of fixed-income securities could default or be downgraded if they fail to make required payments of principal or interest.

 

    High-yield risk – High-yield securities and unrated securities of similar credit quality (commonly known as junk bonds) are subject to greater levels of credit and liquidity risks. High-yield securities are considered speculative with respect to the issuer’s continuing ability to make principal and interest payments.

 

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    Foreign securities risk –Securities of non-U.S. issuers may be less liquid, more volatile, and harder to value than U.S. securities. They may also be subject to political, economic, and regulatory risks, and market instability.

 

    Emerging markets risk – Emerging market countries may have relatively unstable governments and economies based on only a few industries, which can cause greater instability. These countries are also more likely to experience higher levels of inflation, deflation, or currency devaluations, which could hurt their economies and securities markets.

 

    Currency risk – Because this Fund invests in foreign securities, changes in currency exchange rates could hurt performance. Morningstar or a subadviser may decide not to hedge, or may not be successful in hedging, its currency exposure.

 

    Convertible securities risk – Convertible securities are generally debt securities or preferred stocks that may be converted into common stock. The value of a convertible security is influenced by changes in interest rates, with investment value declining as interest rates increase and increasing as interest rates decline. The credit standing of the issuer and other factors also may have an effect on the convertible security’s investment value.

 

    Preferred stock risk – Preferred stocks are equity securities that often pay dividends at a specific rate and have a preference over common stocks for dividend payments and liquidation of assets. Preferred stocks are subject to issuer-specific and market risks applicable generally to equity securities, however, unlike common stocks, participation in the growth of an issuer may be limited. The value of preferred stocks will usually react more strongly than bonds and other debt securities to actual or perceived changes in the company’s financial condition or prospects, and may be less liquid than common stocks.

 

    REITs and other real estate companies risk REIT and other real estate company securities are subject to, among other risks: declines in property values; defaults by mortgagors or other borrowers and tenants; increases in property taxes and other operating expenses; overbuilding in their sector of the real estate market; fluctuations in rental income; changes in interest rates; lack of availability of mortgage funds or financing; extended vacancies of properties, especially during economic downturns; changes in tax and regulatory requirements; losses due to environmental liabilities; or casualty or condemnation losses.

 

    Master limited partnership (MLP) risk – An MLP is a limited partnership, the interests of which are publicly traded on an exchange or in the OTC market. Investing in MLPs, which are subject to a variety of laws and regulations, involves risks related to the underlying assets of the MLPs and risks associated with pooled investment vehicles. MLPs holding credit-related investments are subject to interest-rate risk and credit risk, and MLPs that concentrate in a particular industry or geographic region are subject to the risks of those industries or regions. MLPs may have limited financial resources, their securities may trade infrequently and in limited volume, and they may be subject to more abrupt or erratic price movements than securities of larger or more broadly based companies.

 

    U.S. government securities risk – U.S. government obligations have different levels of credit support and, therefore, different degrees of credit risk. The U.S. government does not guarantee the market value of the securities it issues, so those values may fluctuate. Like most fixed-income securities, the prices of government securities typically fall when interest rates increase and rise when interest rates decline.

 

    Sovereign debt securities risk – Sovereign debt instruments are subject to the risk that a governmental entity may delay or refuse to pay interest or repay principal on its sovereign debt, due, for example, to cash flow problems, insufficient foreign currency reserves, political considerations, the relative size of the governmental entity’s debt position in relation to the economy, or the failure to put in place economic reforms required by the International Monetary Fund or other multilateral agencies.

 

    Mortgage-related and other asset-backed securities risk – Mortgage-related and asset-backed securities are typically subject to the same risks inherent to investing in fixed-income securities as well as extension risk and prepayment risk:

Extension Risk — Rising interest rates tend to extend the duration of mortgage-related securities, making them more sensitive to changes in interest rates. As a result, in a period of rising interest rates, if the Fund holds mortgage-related securities, it may exhibit additional volatility.

Prepayment Risk — When interest rates decline, the value of mortgage-related securities with prepayment features may not increase as much as other fixed-income securities because borrowers may pay off their mortgages sooner than expected. In addition, the potential impact of prepayment on the price of asset-backed and mortgage-backed securities may be difficult to predict and result in greater volatility.

 

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    Floating-rate notes risk – Floating-rate notes are subject to credit risk and interest-rate risk. The interest rate of a floating-rate note may be based on a known lending rate, such as a bank’s prime rate, and resets whenever that rate is adjusted. The interest rate on a variable-rate demand note is reset at specified intervals at a market rate. Some floating- and variable-rate securities may be callable by the issuer, meaning that they can be paid off before their maturity date and the proceeds may need to be invested in lower-yielding securities that reduce the Fund’s income.

 

    Investment company and ETF risk – An investment company, including an open- or closed-end mutual fund or ETF, in which the Fund invests may not achieve its investment objective or execute its investment strategies effectively, or a large purchase or redemption activity by shareholders might negatively affect the value of the shares. The Fund must also pay its pro rata portion of an investment company’s fees and expenses. Shares of ETFs trade on exchanges and may be bought and sold at market value. ETF shares may be thinly traded, making it difficult for the Fund to sell shares at a particular time or an anticipated price. ETF shares may also trade at a premium or discount to the net asset value of the ETF; at times, this premium or discount could be significant.

 

    Derivatives risk – A derivative is an instrument with a value based on the performance of an underlying currency, security, index, or other reference asset. Derivatives involve risks different from, or possibly greater than, the risks of investing in more traditional investments. Derivatives involve costs, may create leverage, and may be illiquid, volatile, or difficult to value. In addition, derivatives could cause losses if the counterparty to the transaction does not perform as promised. The investment results achieved by using derivatives may not match or fully offset changes in the value of the underlying currency, security, index, or other reference asset that the Fund was attempting to hedge or the investment opportunity it was trying to pursue.

Performance

Because the Fund has not yet started operations as of the date of this prospectus, we cannot yet report on its performance history. Once the Fund has been in operation for at least one calendar year, we will provide performance information for the Fund, as well as a comparison to a relevant market benchmark.

Fund Management

Morningstar is the investment adviser for the Fund and has overall supervisory responsibility for the general management and investment of the Fund’s portfolio. The Fund is managed in a multimanager structure. On behalf of Morningstar, the following persons have primary responsibility for the Fund and, subject to oversight by the board of trustees, are responsible for selecting and overseeing the subadviser listed below.

 

Portfolio Manager

  

Position with Morningstar

  

Start Date with
the Fund

Morningstar Investment Management LLC

     

Marta K. Norton, CFA

  

Portfolio Manager and

Head of U.S. Outcome-Based Strategies

   Since Inception

Michelle R. Ward, CFA

   Associate Portfolio Manager    Since Inception

 

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Subadviser and Portfolio Managers

Morningstar currently plans to allocate assets to the following subadviser and may adjust this allocation at any time. The portfolio managers listed below are responsible for the day-to-day management of the Fund’s portfolio:

 

Portfolio Manager

  

Position with Subadviser

  


Start Date with
the Fund

Schafer Cullen Capital Management

     

James P. Cullen

   Chairman, Chief Executive Officer, and Portfolio Manager    Since Inception

Rahul D. Sharma

   Executive Director and Portfolio Manager    Since Inception

Purchase and Sale of Fund Shares

Fund shares are currently available only to investors participating in Morningstar Managed Portfolios, an investment advisory program sponsored by Morningstar Investment Services LLC, a wholly-owned subsidiary of the adviser, and also in programs sponsored by unaffiliated financial institutions that license the use of Morningstar Managed Portfolios in their own investment advisory program (collectively, Advisory Programs). There are no initial or subsequent minimum purchase amounts for the Fund. Orders to sell or “redeem” shares must be placed through the Advisory Program in which you participate and may trigger a purchase or sale of the Fund’s underlying investments. Fund shares may be purchased or redeemed on any day the New York Stock Exchange (NYSE) is open. At any time that an investor in the Fund ceases to be an eligible investor in the Fund, the entity managing the Advisory Program will direct the redemption of that investor’s Fund shares and no further purchases will be allowed.

See the Purchase and Sale of Fund Shares section on page [    ] of this prospectus for more information.

Tax Information

The Fund’s distributions generally are taxable to you as ordinary income, capital gains, or some combination of both, unless you are investing through a tax-advantaged arrangement, such as a 401(k) plan or an IRA, in which case your distributions may be taxed as ordinary income when withdrawn from the tax-advantaged account.

 

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MORNINGSTAR TOTAL RETURN BOND FUND

SUMMARY INFORMATION

Investment Objective

The Fund seeks to maximize total return while also generating income and preserving capital.

Fees and Expenses of the Fund

The following tables describe the fees and expenses that you may pay if you buy and hold shares of the Fund.

Shareholder Fees

(Fees paid directly from your investment)

 

Sales Charge (Load) Imposed on Purchases

     None  

Sales Charge (Load) Imposed on Reinvested Dividends

     None  

Redemption Fee

     None  

Exchange Fee

     None  

Account Service Fee

     None  

Annual Fund Operating Expenses

(Expenses that you pay each year as a percentage of the value of your investment)

 

Management Fees

     0.44

Distribution and/or Service (12b-1) Fees

     None  

Other Expenses(1)

  

Sub-accounting Fees(2)

     0.13

Other Operating Expenses

     0.10
  

 

 

 

Total Other Expenses

     0.23

Acquired Fund Fees and Expenses(3)

     0.01
  

 

 

 

Total Fund Annual Fund Operating Expenses

     0.68

Fee Waivers and Expense Reimbursement(4)

     -0.12
  

 

 

 

Total Annual Fund Operating Expenses After Fee Waivers and Expense Reimbursement(4)

     0.56
  

 

 

 

 

(1) Other expenses are based on estimated amounts for the current fiscal year.
(2) Represents fees assessed by various financial intermediaries and “mutual fund supermarkets” for providing certain account maintenance, record keeping, and transactional services with respect to Fund shares held by these intermediaries for their customers.
(3) Acquired Fund Fees and Expenses (AFFE) represent costs incurred indirectly by the Fund as a result of its ownership of shares of another investment company, such as open- or closed-end mutual funds, exchange traded funds (ETFs), and business development companies (BDCs). These are estimated for the current fiscal year.
(4) The adviser has agreed, through at least [                    ], 2019 [Date to be inserted will be at least one year from the date of this Prospectus], to waive all or a portion of its advisory fees and, if necessary, to assume certain other expenses (to the extent permitted by the Internal Revenue Code of 1986, as amended) to the extent necessary to ensure that the Fund’s Total Annual Fund Operating Expenses (excluding taxes, interest, brokerage commissions, trading costs, Acquired Fund Fees and Expenses, litigation expenses, and extraordinary expenses) do not exceed 0.55%. Under the agreement, the adviser may recoup waived fees and expenses it assumed for a three-year period under specified conditions.

Example

The example below can help you compare the cost of investing in the Fund with the cost of investing in other mutual funds. This example assumes that you invest $10,000 in the Fund for the time periods indicated and then sell all of your shares at the end of those periods. The example also assumes that your investment has a 5% return each year and that the Fund’s operating expenses remain the same. Although your actual costs may be higher or lower, based on these assumptions your costs would be:

 

1 Year      3 Years  
$
57
 
   $ 205  

 

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Portfolio Turnover

The Fund will pay transaction costs, such as commissions, when it buys and sells securities (or “turns over” its portfolio). A higher portfolio turnover rate may mean higher transaction costs and could result in higher taxes if you hold Fund shares in a taxable account. These costs, which are not reflected in annual fund operating expenses or in the example, affect the Fund’s performance. Because the Fund is new, no portfolio turnover statistics are available as of the date of this prospectus.

Principal Investment Strategies

In seeking to maximize total return while also generating income and preserving capital, the Fund will normally invest at least 80% of its assets in debt securities (commonly referred to as “bonds”) of varying maturity, duration, and quality.

The Fund invests primarily in investment-grade fixed-income securities. These may include U.S. and non-U.S. investment-grade corporate debt securities, U.S. government debt securities including Treasury Inflation Protected Bond Securities and zero-coupon securities, non-U.S. government debt securities, emerging-market debt securities, and mortgage-backed and asset-backed securities. The Fund may also invest up to 20% of its assets in fixed-income securities that are rated below investment grade (commonly known as junk bonds), or if unrated, are determined by the Fund’s subadviser(s) to be of comparable quality.

In addition, the Fund may invest up to 15% of its assets in collateralized debt obligations (CDOs), of which 10% (as a percentage of the Fund’s assets) may be in collateralized loan obligations (CLOs). CDOs are types of asset-backed securities. CLOs are ordinarily issued by a trust or other special purpose entity and are typically collateralized by a pool of loans, which may include, among others, domestic and non-U.S. senior secured loans, senior unsecured loans, and subordinate corporate loans, including loans that may be rated below investment grade or equivalent unrated loans, held by such issuer.

The Fund may invest up to 20% of its assets in securities denominated in foreign currencies. The Fund may also invest in derivatives, including options, futures, swaps, and forward foreign currency contracts, for risk management purposes or as part of its investment strategies. The Fund may also enter into reverse repurchase agreements and dollar rolls.

Multimanager Approach

The Fund uses a multimanager approach, meaning the adviser, Morningstar Investment Management LLC (“Morningstar” or “adviser” or “we”), may allocate assets to one or more subadvisers, in addition to open- and closed-end investment companies, exchange traded funds (ETFs), and individual securities. Each subadviser acts independently from the others and uses its own investment style and process to select securities, within the constraints of the Fund’s investment objective, strategies, and restrictions. Morningstar is responsible for selecting the investment strategies and deciding what percent of assets to give to each subadviser, with the goal of maximizing return with a prudent level of risk for the strategy. Subject to the oversight of the board of trustees, Morningstar may change subadvisers and sell holdings at any time.

Principal Risks

This Fund is designed to offer a moderate level of risk, but you can lose money by investing in the Fund. The Fund can also underperform broad markets and other investments. The Fund’s principal risks include:

 

    Multimanager and subadviser selection risk – To a significant extent, the Fund’s performance depends on Morningstar’s skill in selecting subadvisers and each subadviser’s skill in selecting securities and executing its strategy. Subadviser strategies may occasionally be out of favor and subadvisers may underperform relative to their peers or benchmarks.

 

    Asset allocation risk – In an attempt to invest in areas that look most attractive on a valuation basis, the Fund may favor asset classes or market segments that cause the Fund to underperform its benchmark.

 

    Interest-rate risk –The value of fixed-income securities will typically decline when interest rates rise.

 

    Credit risk – Issuers of fixed-income securities could default or be downgraded if they fail to make required payments of principal or interest.

 

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    High-yield risk – High-yield securities and unrated securities of similar credit quality (commonly known as junk bonds) are subject to greater levels of credit and liquidity risks. High-yield securities are considered speculative with respect to the issuer’s continuing ability to make principal and interest payments.

 

    CDO risk – In addition to the typical risks associated with fixed-income securities and asset-backed securities, CDOs carry additional risks including, but not limited to: (i) the possibility that distributions from collateral securities will not be adequate to make interest or other payments; (ii) the risk that the collateral may default or decline in value or be downgraded, if rated by a nationally recognized statistical rating organization; (iii) the Fund may invest in tranches of CDOs that are subordinate to other tranches; (iv) the structure and complexity of the transaction and the legal documents could lead to disputes among investors regarding the characterization of proceeds; (v) the investment return achieved by the Fund could be significantly different than those predicted by financial models; (vi) the lack of a readily available secondary market for CDOs; (vii) the risk of forced “fire sale” liquidation due to technical defaults such as coverage test failures; and (viii) the CDO’s manager may perform poorly. In addition, investments in CDOs may be characterized by the Fund as illiquid securities.

 

    Foreign securities risk –Securities of non-U.S. issuers may be less liquid, more volatile, and harder to value than U.S. securities. They may also be subject to political, economic, and regulatory risks, and market instability.

 

    Emerging markets risk – Emerging market countries may have relatively unstable governments and economies based on only a few industries, which can cause greater instability. These countries are also more likely to experience higher levels of inflation, deflation, or currency devaluations, which could hurt their economies and securities markets.

 

    Currency risk – Because this Fund invests in foreign securities, changes in currency exchange rates could hurt performance. Morningstar or a subadviser may decide not to hedge, or may not be successful in hedging, its currency exposure.

 

    U.S. government securities risk – U.S. government obligations have different levels of credit support and, therefore, different degrees of credit risk. The U.S. government does not guarantee the market value of the securities it issues, so those values may fluctuate. Like most fixed-income securities, the prices of government securities typically fall when interest rates increase and rise when interest rates decline.

 

    Sovereign debt securities risk – Sovereign debt instruments are subject to the risk that a governmental entity may delay or refuse to pay interest or repay principal on its sovereign debt, due, for example, to cash flow problems, insufficient foreign currency reserves, political considerations, the relative size of the governmental entity’s debt position in relation to the economy, or the failure to put in place economic reforms required by the International Monetary Fund or other multilateral agencies.

 

    Mortgage-related and other asset-backed securities risk – Mortgage-related and asset-backed securities are typically subject to the same risks inherent to investing in fixed-income securities as well as extension risk and prepayment risk:

Extension Risk — Rising interest rates tend to extend the duration of mortgage-related securities, making them more sensitive to changes in interest rates. As a result, in a period of rising interest rates, if the Fund holds mortgage-related securities, it may exhibit additional volatility.

Prepayment Risk — When interest rates decline, the value of mortgage-related securities with prepayment features may not increase as much as other fixed-income securities because borrowers may pay off their mortgages sooner than expected. In addition, the potential impact of prepayment on the price of asset-backed and mortgage-backed securities may be difficult to predict and result in greater volatility.

 

    Reverse repurchase agreements risk – Reverse repurchase agreements involve the sale of securities held by the Fund with an agreement to repurchase the securities at an agreed-upon price, date and interest payment. Reverse repurchase agreements involve the risk that the other party may fail to return the securities in a timely manner or at all. The Fund could lose money if it is unable to recover the securities and the value of the collateral held by the Fund, including the value of the investments made with cash collateral, is less than the value of securities. These events could also trigger adverse tax consequences to the Fund.

 

    Dollar rolls risk – Dollar rolls involve the risk that the market value of the securities that the Fund is committed to buy may decline below the price of the securities the Fund has sold. These transactions may involve leverage.

 

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    Investment company and ETF risk – An investment company, including an open- or closed-end mutual fund or ETF, in which the Fund invests may not achieve its investment objective or execute its investment strategies effectively, or a large purchase or redemption activity by shareholders might negatively affect the value of the shares. The Fund must also pay its pro rata portion of an investment company’s fees and expenses. Shares of ETFs trade on exchanges and may be bought and sold at market value. ETF shares may be thinly traded, making it difficult for the Fund to sell shares at a particular time or an anticipated price. ETF shares may also trade at a premium or discount to the net asset value of the ETF; at times, this premium or discount could be significant.

 

    Derivatives risk – A derivative is an instrument with a value based on the performance of an underlying currency, security, index, or other reference asset. Derivatives involve risks different from, or possibly greater than, the risks of investing in more traditional investments. Derivatives involve costs, may create leverage, and may be illiquid, volatile, or difficult to value. In addition, derivatives could cause losses if the counterparty to the transaction does not perform as promised. The investment results achieved by using derivatives may not match or fully offset changes in the value of the underlying currency, security, index, or other reference asset that the Fund was attempting to hedge or the investment opportunity it was trying to pursue.

Performance

Because the Fund has not yet started operations as of the date of this prospectus, we cannot yet report on its performance history. Once the Fund has been in operation for at least one calendar year, we will provide performance information for the Fund, as well as a comparison to a relevant market benchmark.

Fund Management

Morningstar is the investment adviser for the Fund and has overall supervisory responsibility for the general management and investment of the Fund’s portfolio. The Fund is managed in a multimanager structure. On behalf of Morningstar, the following persons have primary responsibility for the Fund and, subject to oversight by the board of trustees, are responsible for selecting and overseeing the subadvisers listed below.

 

Portfolio Manager

  

Position with Morningstar

  

Start Date with
the Fund

Morningstar Investment Management LLC

     

Daniel E. McNeela, CFA

  

Senior Portfolio Manager and

Co-Head of Target Risk Strategies

   Since Inception

John P. McLaughlin, CFA

   Associate Portfolio Manager    Since Inception

Michelle R. Ward, CFA

   Associate Portfolio Manager    Since Inception

 

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Table of Contents

Subadvisers and Portfolio Managers

Morningstar currently plans to allocate assets among the following subadvisers and may adjust these allocations at any time. The portfolio managers listed below are responsible for the day-to-day management of each subadviser’s allocated portion of the Fund’s portfolio:

 

Portfolio Manager

  

Position with Subadviser

  

Start Date with
the Fund

BlackRock Financial Management, Inc.

  

Richard M. Rieder

   Global Chief Investment Officer, Managing Director, and Portfolio Manager    Since Inception

Robert J. Miller

   Managing Director and Portfolio Manager    Since Inception

David L. Rogal

   Director and Portfolio Manager    Since Inception

Western Asset Management Company

John L. Bellows, CFA

   Portfolio Manager and
Research Analyst
   Since Inception

S. Kenneth Leech

   Chief Investment Officer   

Since Inception

Mark S. Lindbloom

   Portfolio Manager    Since Inception

Frederick R. Marki, CFA

   Portfolio Manager    Since Inception

Julien A. Scholnick, CFA

   Portfolio Manager    Since Inception

Purchase and Sale of Fund Shares

Fund shares are currently available only to investors participating in Morningstar Managed Portfolios, an investment advisory program sponsored by Morningstar Investment Services LLC, a wholly-owned subsidiary of the adviser, and also in programs sponsored by unaffiliated financial institutions that license the use of Morningstar Managed Portfolios in their own investment advisory program (collectively, Advisory Programs). There are no initial or subsequent minimum purchase amounts for the Fund. Orders to sell or “redeem” shares must be placed through the Advisory Program in which you participate and may trigger a purchase or sale of the Fund’s underlying investments. Fund shares may be purchased or redeemed on any day the New York Stock Exchange (NYSE) is open. At any time that an investor in the Fund ceases to be an eligible investor in the Fund, the entity managing the Advisory Program will direct the redemption of that investor’s Fund shares and no further purchases will be allowed.

See the Purchase and Sale of Fund Shares section on page [    ] of this prospectus for more information.

Tax Information

The Fund’s distributions generally are taxable to you as ordinary income, capital gains, or some combination of both, unless you are investing through a tax-advantaged arrangement, such as a 401(k) plan or an IRA, in which case your distributions may be taxed as ordinary income when withdrawn from the tax-advantaged account.

 

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MORNINGSTAR MUNICIPAL BOND FUND

SUMMARY INFORMATION

Investment Objective

The Fund seeks income exempt from federal income taxes as well as capital preservation.

Fees and Expenses of the Fund

The following tables describe the fees and expenses that you may pay if you buy and hold shares of the Fund.

Shareholder Fees

(Fees paid directly from your investment)

 

Sales Charge (Load) Imposed on Purchases

     None  

Sales Charge (Load) Imposed on Reinvested Dividends

     None  

Redemption Fee

     None  

Exchange Fee

     None  

Account Service Fee

     None  

Annual Fund Operating Expenses

(Expenses that you pay each year as a percentage of the value of your investment)

 

Management Fees

     0.44

Distribution and/or Service (12b-1) Fees

     None  

Other Expenses(1)

  

Sub-accounting Fees(2)

     0.13

Other Operating Expenses

     0.14
  

 

 

 

Total Other Expenses

     0.27
  

 

 

 

Total Fund Annual Fund Operating Expenses

     0.71

Fee Waivers and Expense Reimbursement(3)

     -0.08
  

 

 

 

Total Annual Fund Operating Expenses After Fee Waivers and Expense Reimbursement(3)

     0.63
  

 

 

 

 

(1) Other expenses are based on estimated amounts for the current fiscal year.
(2) Represents fees assessed by various financial intermediaries and “mutual fund supermarkets” for providing certain account maintenance, record keeping, and transactional services with respect to Fund shares held by these intermediaries for their customers.
(3) The adviser has agreed, through at least [                    ], 2019 [Date to be inserted will be at least one year from the date of this Prospectus], to waive all or a portion of its advisory fees and, if necessary, to assume certain other expenses (to the extent permitted by the Internal Revenue Code of 1986, as amended) to the extent necessary to ensure that the Fund’s Total Annual Fund Operating Expenses (excluding taxes, interest, brokerage commissions, trading costs, Acquired Fund Fees and Expenses, litigation expenses, and extraordinary expenses) do not exceed 0.63%. Under the agreement, the adviser may recoup waived fees and expenses it assumed for a three-year period under specified conditions.

Example

The example below can help you compare the cost of investing in the Fund with the cost of investing in other mutual funds. This example assumes that you invest $10,000 in the Fund for the time periods indicated and then sell all of your shares at the end of those periods. The example also assumes that your investment has a 5% return each year and that the Fund’s operating expenses remain the same. Although your actual costs may be higher or lower, based on these assumptions your costs would be:

 

1 Year      3 Years  
$
64
 
   $ 219  

 

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Table of Contents

Portfolio Turnover

The Fund will pay transaction costs, such as commissions, when it buys and sells securities (or “turns over” its portfolio). A higher portfolio turnover rate may mean higher transaction costs and could result in higher taxes if you hold Fund shares in a taxable account. These costs, which are not reflected in annual fund operating expenses or in the example, affect the Fund’s performance. Because the Fund is new, no portfolio turnover statistics are available as of the date of this prospectus.

Principal Investment Strategies

In seeking income exempt from federal income taxes as well as capital preservation, the Fund will normally invest at least 80% of its assets in debt securities (commonly referred to as “bonds”) from municipal issuers within the United States or its territories.

The Fund’s dividends are generally exempt from federal income tax, although a portion may be an item of tax preference for purposes of the federal alternative minimum tax (“Tax Preference Item”). A portion of the dividends may also be exempt from state and local income taxes, depending on where you live. Under normal market conditions, the Fund is not considered an optimal investment for tax-advantaged retirement accounts, such as 401(k) plan accounts or individual retirement accounts, or for investors in low tax brackets, because such investors may not take advantage of the tax benefits of the Fund.

The Fund intends to invest primarily in investment-grade municipal securities, but may invest up to 35% of assets in high-yield fixed-income securities that are rated below investment grade (commonly known as junk bonds) or, if unrated, are determined by the Fund’s subadviser(s) to be of comparable quality. The Fund may also invest in derivatives, including options, futures, swaps, and inverse floating-rate debt instruments (inverse floaters), for risk management purposes or as part of its investment strategies.

Multimanager Approach

The Fund uses a multimanager approach, meaning the adviser, Morningstar Investment Management LLC (“Morningstar” or “adviser” or “we”), may allocate assets to one or more subadvisers, in addition to open- and closed-end investment companies, exchange traded funds (ETFs), and individual securities. Each subadviser acts independently from the others and uses its own investment style and process to select securities, within the constraints of the Fund’s investment objective, strategies, and restrictions. Morningstar is responsible for selecting the investment strategies and deciding what percent of assets to give to each subadviser, with the goal of maximizing return with a prudent level of risk for the strategy. Subject to the oversight of the board of trustees, Morningstar may change subadvisers and sell holdings at any time.

Principal Risks

You can lose money by investing in the Fund. The Fund can also underperform broad markets and other investments. The Fund’s principal risks include:

 

    Multimanager and subadviser selection risk – To a significant extent, the Fund’s performance depends on Morningstar’s skill in selecting subadvisers and each subadviser’s skill in selecting securities and executing its strategy. Subadviser strategies may occasionally be out of favor and subadvisers may underperform relative to their peers or benchmarks.

 

    Asset allocation risk – In an attempt to invest in areas that look most attractive on a valuation basis, the Fund may favor asset classes or market segments that cause the Fund to underperform its benchmark.

 

    Municipal securities risk – The municipal securities market could be significantly affected by negative political and legislative changes, as well as uncertainties related to taxation or the rights of municipal security holders. Changes in the financial health of a municipality may make it difficult for it to pay interest and principal when due.

 

    Interest-rate risk – The value of fixed-income securities will typically decline when interest rates rise.

 

    Credit risk – Issuers of fixed-income securities could default or be downgraded if they fail to make required payments of principal or interest.

 

    High-yield risk – High-yield securities and unrated securities of similar credit quality (commonly known as junk bonds) are subject to greater levels of credit and liquidity risks. High-yield securities are considered speculative with respect to the issuer’s continuing ability to make principal and interest payments.

 

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    Investment company and ETF risk – An investment company, including an open- or closed-end mutual fund or ETF, in which the Fund invests may not achieve its investment objective or execute its investment strategies effectively, or a large purchase or redemption activity by shareholders might negatively affect the value of the shares. The Fund must also pay its pro rata portion of an investment company’s fees and expenses. Shares of ETFs trade on exchanges and may be bought and sold at market value. ETF shares may be thinly traded, making it difficult for the Fund to sell shares at a particular time or an anticipated price. ETF shares may also trade at a premium or discount to the net asset value of the ETF; at times, this premium or discount could be significant.

 

    Derivatives risk – A derivative is an instrument with a value based on the performance of an underlying currency, security, index, or other reference asset. Derivatives involve risks different from, or possibly greater than, the risks of investing in more traditional investments. Derivatives involve costs, may create leverage, and may be illiquid, volatile, or difficult to value. In addition, derivatives could cause losses if the counterparty to the transaction does not perform as promised. The investment results achieved by using derivatives may not match or fully offset changes in the value of the underlying currency, security, index, or other reference asset that the Fund was attempting to hedge or the investment opportunity it was trying to pursue.

Performance

Because the Fund has not yet started operations as of the date of this prospectus, we cannot yet report on its performance history. Once the Fund has been in operation for at least one calendar year, we will provide performance information for the Fund, as well as a comparison to a relevant market benchmark.

Fund Management

Morningstar is the investment adviser for the Fund and has overall supervisory responsibility for the general management and investment of the Fund’s portfolio. The Fund is managed in a multimanager structure. On behalf of Morningstar, the following persons have primary responsibility for the Fund and, subject to oversight by the board of trustees, are responsible for selecting and overseeing the subadvisers listed below.

 

Portfolio Manager

  

Position with Morningstar

  

Start Date with
the Fund

Morningstar Investment Management LLC

     

Daniel E. McNeela, CFA

  

Senior Portfolio Manager and

Co-Head of Target Risk Strategies

   Since Inception

John P. McLaughlin, CFA

   Associate Portfolio Manager    Since Inception

Subadvisers and Portfolio Managers

Morningstar currently plans to allocate assets among the following subadvisers and may adjust these allocations at any time. The portfolio managers listed below are responsible for the day-to-day management of each subadviser’s allocated portion of the Fund’s portfolio:

 

Portfolio Manager

  

Position with Subadviser

  

Start Date with
the Fund

T. Rowe Price Associates, Inc.

     

Konstantine B. Mallas

   Portfolio Manager and Vice President    Since Inception

James M. Murphy, CFA

   Portfolio Manager and Vice President    Since Inception

 

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Portfolio Manager

  

Position with Subadviser

  

Start Date with
the Fund

Wells Capital Management Incorporated

Wendy S. Casetta

   Senior Portfolio Manager    Since Inception

Lyle J. Fitterer, CFA

   Co-Head of Global Fixed Income, Managing Director, Head of Municipal Fixed Income    Since Inception

Robert J. Miller

   Senior Portfolio Manager    Since Inception

Purchase and Sale of Fund Shares

Fund shares are currently available only to investors participating in Morningstar Managed Portfolios, an investment advisory program sponsored by Morningstar Investment Services LLC, a wholly-owned subsidiary of the adviser, and also in programs sponsored by unaffiliated financial institutions that license the use of Morningstar Managed Portfolios in their own investment advisory program (collectively, Advisory Programs). There are no initial or subsequent minimum purchase amounts for the Fund. Orders to sell or “redeem” shares must be placed through the Advisory Program in which you participate and may trigger a purchase or sale of the Fund’s underlying investments. Fund shares may be purchased or redeemed on any day the New York Stock Exchange (NYSE) is open. At any time that an investor in the Fund ceases to be an eligible investor in the Fund, the entity managing the Advisory Program will direct the redemption of that investor’s Fund shares and no further purchases will be allowed.

See the Purchase and Sale of Fund Shares section on page [    ] of this prospectus for more information.

Tax Information

The Fund’s distributions are generally exempt from federal income tax, although a portion may be an item of tax preference for purposes of the federal alternative minimum tax (Tax Preference Item); provided, however, that under legislation commonly known as the “Tax Cuts and Jobs Act,” corporations are no longer subject to the alternative minimum tax for taxable years of the corporation beginning after December 31, 2017. A portion of the distributions may also be exempt from state and local income taxes, depending on where you live. The Fund is not an appropriate investment for tax-advantaged retirement accounts, such as 401(k) plan accounts or individual retirement accounts, and may not be beneficial for investors in low tax brackets. The Fund may also make distributions that are taxable to you as ordinary income or capital gains.

 

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MORNINGSTAR DEFENSIVE BOND FUND

SUMMARY INFORMATION

Investment Objective

The Fund seeks capital preservation.

Fees and Expenses of the Fund

The following tables describe the fees and expenses that you may pay if you buy and hold shares of the Fund.

Shareholder Fees

(Fees paid directly from your investment)

 

Sales Charge (Load) Imposed on Purchases

     None  

Sales Charge (Load) Imposed on Reinvested Dividends

     None  

Redemption Fee

     None  

Exchange Fee

     None  

Account Service Fee

     None  

Annual Fund Operating Expenses

(Expenses that you pay each year as a percentage of the value of your investment)

 

Management Fees

     0.36

Distribution and/or Service (12b-1) Fees

     None  

Other Expenses(1)

  

Sub-accounting Fees(2)

     0.13

Other Operating Expenses

     0.28
  

 

 

 

Total Other Expenses

     0.41

Acquired Fund Fees and Expenses(3)

     0.06
  

 

 

 

Total Fund Annual Fund Operating Expenses

     0.83

Fee Waivers and Expense Reimbursement(4)

     -0.26
  

 

 

 

Total Annual Fund Operating Expenses After Fee Waivers and Expense Reimbursement(4)

     0.57
  

 

 

 

 

(1)  Other expenses are based on estimated amounts for the current fiscal year.
(2)  Represents fees assessed by various financial intermediaries and “mutual fund supermarkets” for providing certain account maintenance, record keeping, and transactional services with respect to Fund shares held by these intermediaries for their customers.
(3)  Acquired Fund Fees and Expenses (AFFE) represent costs incurred indirectly by the Fund as a result of its ownership of shares of another investment company, such as open- or closed-end mutual funds, exchange traded funds (ETFs), and business development companies (BDCs). These are estimated for the current fiscal year.
(4) The adviser has agreed, through at least [                    ], 2019 [Date to be inserted will be at least one year from the date of this Prospectus], to waive all or a portion of its advisory fees and, if necessary, to assume certain other expenses (to the extent permitted by the Internal Revenue Code of 1986, as amended) to the extent necessary to ensure that the Fund’s Total Annual Fund Operating Expenses (excluding taxes, interest, brokerage commissions, trading costs, Acquired Fund Fees and Expenses, litigation expenses, and extraordinary expenses) do not exceed 0.51%. Under the agreement, the adviser may recoup waived fees and expenses it assumed for a three-year period under specified conditions.

Example

The example below can help you compare the cost of investing in the Fund with the cost of investing in other mutual funds. This example assumes that you invest $10,000 in the Fund for the time periods indicated and then sell all of your shares at the end of those periods. The example also assumes that your investment has a 5% return each year and that the Fund’s operating expenses remain the same. Although your actual costs may be higher or lower, based on these assumptions your costs would be:

 

1 Year      3 Years  
$
58
 
   $ 239  

 

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Portfolio Turnover

The Fund will pay transaction costs, such as commissions, when it buys and sells securities (or “turns over” its portfolio). A higher portfolio turnover rate may mean higher transaction costs and could result in higher taxes if you hold Fund shares in a taxable account. These costs, which are not reflected in annual fund operating expenses or in the example, affect the Fund’s performance. Because the Fund is new, no portfolio turnover statistics are available as of the date of this prospectus.

Principal Investment Strategies

In seeking capital preservation, the Fund will normally invest at least 80% of its assets in a diversified portfolio of debt securities (commonly referred to as “bonds”) of varying maturity, duration, and quality. Under normal conditions, the Fund intends to pursue a defensive strategy of limiting its interest-rate sensitivity by maintaining a portfolio duration of three years or less.

The Fund invests primarily in short- and intermediate-term investment-grade fixed-income securities. These may include U.S. and non-U.S. investment-grade corporate debt securities, U.S. and non-U.S. government debt securities, and mortgage-backed and asset-backed securities. In most market environments, the fund will not invest more than 20% of assets in fixed-income securities that are rated below investment grade (commonly known as junk bonds), or if unrated, are determined by the Fund’s subadviser(s) to be of comparable quality.

In addition, the Fund may invest a significant portion of its assets in collateralized debt obligations (CDOs), including collateralized loan obligations (CLOs). CDOs are types of asset-backed securities. CLOs are ordinarily issued by a trust or other special purpose entity and are typically collateralized by a pool of loans, which may include, among others, domestic and non-U.S. senior secured loans, senior unsecured loans, and subordinate corporate loans, including loans that may be rated below investment grade or equivalent unrated loans, held by such issuer.

This Fund may also invest in exchange traded funds (ETFs), which could represent a significant percentage of assets.

Multimanager Approach

The Fund uses a multimanager approach, meaning the adviser, Morningstar Investment Management LLC (“Morningstar” or “adviser” or “we”), may allocate assets to one or more subadvisers, in addition to open- and closed-end investment companies, ETFs, and individual securities. Each subadviser acts independently from the others and uses its own investment style and process to select securities, within the constraints of the Fund’s investment objective, strategies, and restrictions. Morningstar is responsible for selecting the investment strategies and deciding what percent of assets to give to each subadviser, with the goal of maximizing return with a prudent level of risk for the strategy. Subject to the oversight of the board of trustees, Morningstar may change subadvisers and sell holdings at any time.

Principal Risks

This Fund is designed to offer a low level of risk, but you can lose money by investing in the Fund. The Fund can also underperform broad markets and other investments. The Fund’s principal risks include:

 

    Multimanager and subadviser selection risk – To a significant extent, the Fund’s performance depends on Morningstar’s skill in selecting subadvisers and each subadviser’s skill in selecting securities and executing its strategy. Subadviser strategies may occasionally be out of favor and subadvisers may underperform relative to their peers or benchmarks.

 

    Asset allocation risk – In an attempt to invest in areas that look most attractive on a valuation basis, the Fund may favor asset classes or market segments that cause the Fund to underperform its benchmark. Given the wide latitude with which the adviser manages this portfolio, you should expect this Fund to periodically underperform broad markets.

 

    Interest-rate risk – The value of fixed-income securities will typically decline when interest rates rise.

 

    Credit risk – Issuers of fixed-income securities could default or be downgraded if they fail to make required payments of principal or interest.

 

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    High-yield risk – High-yield securities and unrated securities of similar credit quality (commonly known as junk bonds) are subject to greater levels of credit and liquidity risks. High-yield securities are considered speculative with respect to the issuer’s continuing ability to make principal and interest payments.

 

    CDO risk – In addition to the typical risks associated with fixed-income securities and asset-backed securities, CDOs carry additional risks including, but not limited to: (i) the possibility that distributions from collateral securities will not be adequate to make interest or other payments; (ii) the risk that the collateral may default or decline in value or be downgraded, if rated by a nationally recognized statistical rating organization; (iii) the Fund may invest in tranches of CDOs that are subordinate to other tranches; (iv) the structure and complexity of the transaction and the legal documents could lead to disputes among investors regarding the characterization of proceeds; (v) the investment return achieved by the Fund could be significantly different than those predicted by financial models; (vi) the lack of a readily available secondary market for CDOs; (vii) the risk of forced “fire sale” liquidation due to technical defaults such as coverage test failures; and (viii) the CDO’s manager may perform poorly. In addition, investments in CDOs may be characterized by the Fund as illiquid securities.

 

    Foreign securities risk –Securities of non-U.S. issuers may be less liquid, more volatile, and harder to value than U.S. securities. They may also be subject to political, economic, regulatory, or market instability.

 

    U.S. government securities risk – U.S. government obligations have different levels of credit support and, therefore, different degrees of credit risk. The U.S. government does not guarantee the market value of the securities it issues, so those values may fluctuate. Like most fixed-income securities, the prices of government securities typically fall when interest rates increase and rise when interest rates decline.

 

    Sovereign debt securities risk – Sovereign debt instruments are subject to the risk that a governmental entity may delay or refuse to pay interest or repay principal on its sovereign debt, due, for example, to cash flow problems, insufficient foreign currency reserves, political considerations, the relative size of the governmental entity’s debt position in relation to the economy, or the failure to put in place economic reforms required by the International Monetary Fund or other multilateral agencies.

 

    Mortgage-related and other asset-backed securities risk – Mortgage-related and asset-backed securities are typically subject to the same risks inherent to investing in fixed-income securities as well as extension risk and prepayment risk:

Extension Risk — Rising interest rates tend to extend the duration of mortgage-related securities, making them more sensitive to changes in interest rates. As a result, in a period of rising interest rates, if the Fund holds mortgage-related securities, it may exhibit additional volatility.

Prepayment Risk — When interest rates decline, the value of mortgage-related securities with prepayment features may not increase as much as other fixed-income securities because borrowers may pay off their mortgages sooner than expected. In addition, the potential impact of prepayment on the price of asset-backed and mortgage-backed securities may be difficult to predict and result in greater volatility.

 

    Investment company and ETF risk – An investment company, including an open- or closed-end mutual fund or ETF, in which the Fund invests may not achieve its investment objective or execute its investment strategies effectively, or a large purchase or redemption activity by shareholders might negatively affect the value of the shares. The Fund must also pay its pro rata portion of an investment company’s fees and expenses. Shares of ETFs trade on exchanges and may be bought and sold at market value. ETF shares may be thinly traded, making it difficult for the Fund to sell shares at a particular time or an anticipated price. ETF shares may also trade at a premium or discount to the net asset value of the ETF; at times, this premium or discount could be significant.

Performance

Because the Fund has not yet started operations as of the date of this prospectus, we cannot yet report on its performance history. Once the Fund has been in operation for at least one calendar year, we will provide performance information for the Fund, as well as a comparison to a relevant market benchmark.

 

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Fund Management

Morningstar is the investment adviser for the Fund and has overall supervisory responsibility for the general management and investment of the Fund’s portfolio. The Fund is managed in a multimanager structure. On behalf of Morningstar, the following persons have primary responsibility for the Fund and, subject to oversight by the board of trustees, are responsible for selecting and overseeing the subadviser listed below.

 

Portfolio Manager

  

Position with Morningstar

  

Start Date with
the Fund

Morningstar Investment Management LLC

     

Marta K. Norton, CFA

  

Portfolio Manager and

Head of U.S. Outcome-Based Strategies

   Since Inception

Michelle R. Ward, CFA

   Associate Portfolio Manager    Since Inception

Subadviser and Portfolio Managers

Morningstar currently plans to allocate assets to the following subadviser and may adjust this allocation at any time. The portfolio managers listed below are responsible for the day-to-day management of the Fund’s portfolio:

 

Portfolio Manager

  

Position with Subadviser

  

Start Date with
the Fund

First Pacific Advisors, LLC

     

Thomas H. Atteberry, CFA

   Portfolio Manager and Partner    Since Inception

Abhijeet Patwardhan

   Portfolio Manager, Director of Research, and Partner    Since Inception

Purchase and Sale of Fund Shares

Fund shares are currently available only to investors participating in Morningstar Managed Portfolios, an investment advisory program sponsored by Morningstar Investment Services LLC, a wholly-owned subsidiary of the adviser, and also in programs sponsored by unaffiliated financial institutions that license the use of Morningstar Managed Portfolios in their own investment advisory program (collectively, Advisory Programs). There are no initial or subsequent minimum purchase amounts for the Fund. Orders to sell or “redeem” shares must be placed through the Advisory Program in which you participate and may trigger a purchase or sale of the Fund’s underlying investments. Fund shares may be purchased or redeemed on any day the New York Stock Exchange (NYSE) is open. At any time that an investor in the Fund ceases to be an eligible investor in the Fund, the entity managing the Advisory Program will direct the redemption of that investor’s Fund shares and no further purchases will be allowed.

See the Purchase and Sale of Fund Shares section on page [     ] of this prospectus for more information.

Tax Information

The Fund’s distributions generally are taxable to you as ordinary income, capital gains, or some combination of both, unless you are investing through a tax-advantaged arrangement, such as a 401(k) plan or an IRA, in which case your distributions may be taxed as ordinary income when withdrawn from the tax-advantaged account.

 

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MORNINGSTAR MULTISECTOR BOND FUND

SUMMARY INFORMATION

Investment Objective

The Fund seeks total return through a combination of current income and capital appreciation.

Fees and Expenses of the Fund

The following tables describe the fees and expenses that you may pay if you buy and hold shares of the Fund.

Shareholder Fees

(Fees paid directly from your investment)

 

Sales Charge (Load) Imposed on Purchases

     None  

Sales Charge (Load) Imposed on Reinvested Dividends

     None  

Redemption Fee

     None  

Exchange Fee

     None  

Account Service Fee

     None  

Annual Fund Operating Expenses

(Expenses that you pay each year as a percentage of the value of your investment)

 

Management Fees

     0.61

Distribution and/or Service (12b-1) Fees

     None  

Other Expenses (1)

  

Sub-accounting Fees (2)

     0.13

Other Operating Expenses

     0.13
  

 

 

 

Total Other Expenses

     0.26
  

 

 

 

Total Fund Annual Fund Operating Expenses

     0.87

Fee Waivers and Expense Reimbursement(3)

     -0.07
  

 

 

 

Total Annual Fund Operating Expenses After Fee Waivers and Expense Reimbursement(3)

     0.80
  

 

 

 

 

(1) Other expenses are based on estimated amounts for the current fiscal year.
(2) Represents fees assessed by various financial intermediaries and “mutual fund supermarkets” for providing certain account maintenance, record keeping, and transactional services with respect to Fund shares held by these intermediaries for their customers.
(3) The adviser has agreed, through at least [                    ], 2019 [Date to be inserted will be at least one year from the date of this Prospectus], to waive all or a portion of its advisory fees and, if necessary, to assume certain other expenses (to the extent permitted by the Internal Revenue Code of 1986, as amended) to the extent necessary to ensure that the Fund’s Total Annual Fund Operating Expenses (excluding taxes, interest, brokerage commissions, trading costs, Acquired Fund Fees and Expenses, litigation expenses, and extraordinary expenses) do not exceed 0.80%. Under the agreement, the adviser may recoup waived fees and expenses it assumed for a three-year period under specified conditions.

Example

The example below can help you compare the cost of investing in the Fund with the cost of investing in other mutual funds. This example assumes that you invest $10,000 in the Fund for the time periods indicated and then sell all of your shares at the end of those periods. The example also assumes that your investment has a 5% return each year and that the Fund’s operating expenses remain the same. Although your actual costs may be higher or lower, based on these assumptions your costs would be:

 

1 Year      3 Years  
$ 82      $ 271  

 

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Portfolio Turnover

The Fund will pay transaction costs, such as commissions, when it buys and sells securities (or “turns over” its portfolio). A higher portfolio turnover rate may mean higher transaction costs and could result in higher taxes if you hold Fund shares in a taxable account. These costs, which are not reflected in annual fund operating expenses or in the example, affect the Fund’s performance. Because the Fund is new, no portfolio turnover statistics are available as of the date of this prospectus.

Principal Investment Strategies

In seeking total return through a combination of current income and capital appreciation, the Fund will normally invest at least 80% of its assets in debt securities (commonly referred to as “bonds”) of varying maturity, duration, and quality across various sectors of the fixed-income market. These may include U.S. and non-U.S. corporate debt securities, U.S. and non-U.S. government debt securities, emerging-market debt securities, mortgage-backed and asset-backed securities, municipal securities, and floating-rate notes.

The fund may invest without limit in fixed-income securities that are rated below investment grade (commonly known as junk bonds), or if unrated, are determined by the Fund’s subadviser(s) to be of comparable quality. The Fund may invest without limit in securities denominated in foreign currencies and in U.S. dollar-denominated securities of foreign issuers.

The Fund may invest in securities acquired in a private placement, such as Rule 144A securities, as well as derivatives, including options, futures, swaps, and forward foreign currency contracts, for risk management purposes or as part of its investment strategies. Due to the opportunistic nature of its strategy, the Fund may also invest up to 20% of its assets in equity securities, including common stocks and convertible securities.

Multimanager Approach

The Fund uses a multimanager approach, meaning the adviser, Morningstar Investment Management LLC (“Morningstar” or “adviser” or “we”), may allocate assets to one or more subadvisers, in addition to open- and closed-end investment companies, exchange traded funds (ETFs), and individual securities. Each subadviser acts independently from the others and uses its own investment style and process to select securities, within the constraints of the Fund’s investment objective, strategies, and restrictions. Morningstar is responsible for selecting the investment strategies and deciding what percent of assets to give to each subadviser, with the goal of maximizing return with a prudent level of risk for the strategy. Subject to the oversight of the board of trustees, Morningstar may change subadvisers and sell holdings at any time.

Principal Risks

This Fund is designed to offer a high level of risk, and you can lose money by investing in the Fund. The Fund can also underperform broad markets and other investments. The Fund’s principal risks include:

 

    Multimanager and subadviser selection risk – To a significant extent, the Fund’s performance depends on Morningstar’s skill in selecting subadvisers and each subadviser’s skill in selecting securities and executing its strategy. Subadviser strategies may occasionally be out of favor and subadvisers may underperform relative to their peers or benchmarks.

 

    Asset allocation risk – In an attempt to invest in areas that look most attractive on a valuation basis, the Fund may favor asset classes or market segments that cause the Fund to underperform its benchmark.

 

    Interest-rate risk –The value of fixed-income securities will typically decline when interest rates rise.

 

    Credit risk – Issuers of fixed-income securities could default or be downgraded if they fail to make required payments of principal or interest.

 

    High-yield risk – High-yield securities and unrated securities of similar credit quality (commonly known as junk bonds) are subject to greater levels of credit and liquidity risks. High-yield securities are considered speculative with respect to the issuer’s continuing ability to make principal and interest payments.

 

    Foreign securities risk – Securities of non-U.S. issuers may be less liquid, more volatile, and harder to value than U.S. securities. They may also be subject to political, economic, and regulatory risks, and market instability.

 

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    Emerging markets risk – Emerging market countries may have relatively unstable governments and economies based on only a few industries, which can cause greater instability. These countries are also more likely to experience higher levels of inflation, deflation, or currency devaluations, which could hurt their economies and securities markets.

 

    Currency risk – Because this Fund invests in foreign securities, changes in currency exchange rates could hurt performance. Morningstar or a subadviser may decide not to hedge, or may not be successful in hedging, its currency exposure.

 

    Stock market/company risk – Stocks can be highly volatile and prices may fluctuate widely, which means you should expect a wide range of returns and could lose money, even over a long time period. Various economic, industry, regulatory, political or other factors can dramatically affect the stock market as a whole, certain industry sectors, and/or individual companies.

 

    U.S. government securities risk – U.S. government obligations have different levels of credit support and, therefore, different degrees of credit risk. The U.S. government does not guarantee the market value of the securities it issues, so those values may fluctuate. Like most fixed-income securities, the prices of government securities typically fall when interest rates increase and rise when interest rates decline.

 

    Sovereign debt securities risk – Sovereign debt instruments are subject to the risk that a governmental entity may delay or refuse to pay interest or repay principal on its sovereign debt, due, for example, to cash flow problems, insufficient foreign currency reserves, political considerations, the relative size of the governmental entity’s debt position in relation to the economy, or the failure to put in place economic reforms required by the International Monetary Fund or other multilateral agencies.

 

    Mortgage-related and other asset-backed securities risk – Mortgage-related and asset-backed securities are typically subject to the same risks inherent to investing in fixed-income securities as well as extension risk and prepayment risk:

Extension Risk — Rising interest rates tend to extend the duration of mortgage-related securities, making them more sensitive to changes in interest rates. As a result, in a period of rising interest rates, if the Fund holds mortgage-related securities, it may exhibit additional volatility.

Prepayment Risk — When interest rates decline, the value of mortgage-related securities with prepayment features may not increase as much as other fixed-income securities because borrowers may pay off their mortgages sooner than expected. In addition, the potential impact of prepayment on the price of asset-backed and mortgage-backed securities may be difficult to predict and result in greater volatility.

 

    Municipal securities risk – The municipal securities market could be significantly affected by negative political and legislative changes, as well as uncertainties related to taxation or the rights of municipal security holders. Changes in the financial health of a municipality may make it difficult for it to pay interest and principal when due.

 

    Floating-rate notes risk – Floating-rate notes are subject to credit risk and interest rate risk. The interest rate of a floating rate instrument may be based on a known lending rate, such as a bank’s prime rate, and is reset whenever such rate is adjusted. The interest rate on a variable rate demand note is reset at specified intervals at a market rate. Some floating- and variable-rate securities may be callable by the issuer, meaning that they can be paid off before their maturity date and the proceeds may be required to be invested in lower yielding securities that reduce the Fund’s income.

 

    Private placements risk – Securities that are purchased in private placements are subject to restrictions on resale as a matter of contract or under federal securities laws. Because there may be relatively few potential purchasers for these investments, especially under adverse circumstances, a Fund could find it more difficult to sell private placements at an advisable time or attractive price. Additionally, such securities may not be listed on an exchange and may have no active trading market. Accordingly, many private placement securities may be illiquid. At times, it may also be more difficult to determine the fair value of such securities for purposes of computing a Fund’s net asset value.

 

    Investment company and ETF risk – An investment company, including an open- or closed-end mutual fund or ETF, in which the Fund invests may not achieve its investment objective or execute its investment strategies effectively, or a large purchase or redemption activity by shareholders might negatively affect the value of the shares. The Fund must also pay its pro rata portion of an investment company’s fees and expenses. Shares of ETFs trade on exchanges and may be bought and sold at market value. ETF shares may be thinly traded, making it difficult for the Fund to sell shares at a particular time or an anticipated price. ETF shares may also trade at a premium or discount to the net asset value of the ETF; at times, this premium or discount could be significant.

 

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    Convertible securities risk – Convertible securities are generally debt securities or preferred stocks that may be converted into common stock. The value of a convertible security is influenced by changes in interest rates, with investment value declining as interest rates increase and increasing as interest rates decline. The credit standing of the issuer and other factors also may have an effect on the convertible security’s investment value.

 

    Derivatives risk – A derivative is an instrument with a value based on the performance of an underlying currency, security, index, or other reference asset. Derivatives involve risks different from, or possibly greater than, the risks of investing in more traditional investments. Derivatives involve costs, may create leverage, and may be illiquid, volatile, or difficult to value. In addition, derivatives could cause losses if the counterparty to the transaction does not perform as promised. The investment results achieved by using derivatives may not match or fully offset changes in the value of the underlying currency, security, index, or other reference asset that the Fund was attempting to hedge or the investment opportunity it was trying to pursue.

 

    Nondiversification risk –As a non-diversified fund, the Fund has a greater potential to realize losses if adverse events affect a particular issuer.

Performance

Because the Fund has not yet started operations as of the date of this prospectus, we cannot yet report on its performance history. Once the Fund has been in operation for at least one calendar year, we will provide performance information for the Fund, as well as a comparison to a relevant market benchmark.

Fund Management

Morningstar is the investment adviser for the Fund and has overall supervisory responsibility for the general management and investment of the Fund’s portfolio. The Fund is managed in a multimanager structure. On behalf of Morningstar, the following persons have primary responsibility for the Fund and, subject to oversight by the board of trustees, are responsible for selecting and overseeing the subadvisers listed below.

 

Portfolio Manager

  

Position with Morningstar

  

Start Date with
the Fund

Morningstar Investment Management LLC

  
Daniel E. McNeela, CFA   

Senior Portfolio Manager and

Co-Head of Target Risk Strategies

   Since Inception
John P. McLaughlin, CFA    Associate Portfolio Manager    Since Inception
Michelle R. Ward, CFA    Associate Portfolio Manager    Since Inception

 

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Subadvisers and Portfolio Managers

Morningstar currently plans to allocate assets among the following subadvisers and may adjust these allocations at any time. The portfolio managers listed below are responsible for the day-to-day management of each subadviser’s allocated portion of the Fund’s portfolio:

 

Portfolio Manager

  

Position with Subadviser

  

Start Date with
the Fund

Franklin Advisers, Inc.

     
Michael Hasenstab, PhD    Executive Vice President, Chief Investment Officer, and Portfolio Manager    Since Inception
Sonal Desai, PhD    Senior Vice President, Director of Research, and Portfolio Manager    Since Inception

Loomis, Sayles & Company, L.P.

Daniel J. Fuss, CFA, CIC    Vice Chairman and Executive Vice President    Since Inception
Matthew J. Eagan, CFA    Vice President and Portfolio Manager    Since Inception
Elaine M. Stokes    Vice President and Portfolio Manager    Since Inception

TCW Investment Management Company LLC

  
Penelope D. Foley    Group Managing Director    Since Inception
David I. Robbins    Group Managing Director    Since Inception
Alex Stanojevic    Managing Director    Since Inception

Purchase and Sale of Fund Shares

Fund shares are currently available only to investors participating in Morningstar Managed Portfolios, an investment advisory program sponsored by Morningstar Investment Services LLC, a wholly-owned subsidiary of the adviser, and also in programs sponsored by unaffiliated financial institutions that license the use of Morningstar Managed Portfolios in their own investment advisory program (collectively, Advisory Programs). There are no initial or subsequent minimum purchase amounts for the Fund. Orders to sell or “redeem” shares must be placed through the Advisory Program in which you participate and may trigger a purchase or sale of the Fund’s underlying investments. Fund shares may be purchased or redeemed on any day the New York Stock Exchange (NYSE) is open. At any time that an investor in the Fund ceases to be an eligible investor in the Fund, the entity managing the Advisory Program will direct the redemption of that investor’s Fund shares and no further purchases will be allowed.

See the Purchase and Sale of Fund Shares section on page [    ] of this prospectus for more information.

Tax Information

The Fund’s distributions generally are taxable to you as ordinary income, capital gains, or some combination of both, unless you are investing through a tax-advantaged arrangement, such as a 401(k) plan or an IRA, in which case your distributions may be taxed as ordinary income when withdrawn from the tax-advantaged account.

 

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MORNINGSTAR UNCONSTRAINED ALLOCATION FUND

SUMMARY INFORMATION

Investment Objective

The Fund seeks long-term capital appreciation over a full market cycle.

Fees and Expenses of the Fund

The following tables describe the fees and expenses that you may pay if you buy and hold shares of the Fund.

Shareholder Fees

(Fees paid directly from your investment)

 

Sales Charge (Load) Imposed on Purchases

     None  

Sales Charge (Load) Imposed on Reinvested Dividends

     None  

Redemption Fee

     None  

Exchange Fee

     None  

Account Service Fee

     None  

Annual Fund Operating Expenses

(Expenses that you pay each year as a percentage of the value of your investment)

 

Management Fees

     0.47

Distribution and/or Service (12b-1) Fees

     None  

Other Expenses (1)

  

Sub-accounting Fees (2)

     0.13

Other Operating Expenses

     0.32
  

 

 

 

Total Other Expenses

     0.45

Acquired Fund Fees and Expenses (3)

     0.20
  

 

 

 

Total Fund Annual Fund Operating Expenses

     1.12
  

 

 

 

 

(1) Other expenses are based on estimated amounts for the current fiscal year.
(2) Represents fees assessed by various financial intermediaries and “mutual fund supermarkets” for providing certain account maintenance, record keeping, and transactional services with respect to Fund shares held by these intermediaries for their customers.
(3) Acquired Fund Fees and Expenses (AFFE) represent costs incurred indirectly by the Fund as a result of its ownership of shares of another investment company, such as open- or closed-end mutual funds, exchange traded funds (ETFs), and business development companies (BDCs). These are estimated for the current fiscal year.

Example

The example below can help you compare the cost of investing in the Fund with the cost of investing in other mutual funds. This example assumes that you invest $10,000 in the Fund for the time periods indicated and then sell all of your shares at the end of those periods. The example also assumes that your investment has a 5% return each year and that the Fund’s operating expenses remain the same. Although your actual costs may be higher or lower, based on these assumptions your costs would be:

 

1 Year      3 Years  
$ 114      $ 356  

Portfolio Turnover

The Fund will pay transaction costs, such as commissions, when it buys and sells securities (or “turns over” its portfolio). A higher portfolio turnover rate may mean higher transaction costs and could result in higher taxes if you hold Fund shares in a taxable account. These costs, which are not reflected in annual fund operating expenses or in the example, affect the Fund’s performance. Because the Fund is new, no portfolio turnover statistics are available as of the date of this prospectus.

 

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Principal Investment Strategies

In seeking long-term capital appreciation over a full market cycle, the Fund has significant flexibility and invests across asset classes and geographies according to the portfolio management team’s assessment of their valuations and fundamental health.

The Fund invests in equity securities, which may include common stocks and real estate investment trusts (REITs). The Fund may invest in companies of any size from any country, including emerging markets.

To meet its objective, the Fund may also invest in fixed-income securities of varying maturity, duration, and quality. These may include U.S. and non-U.S. corporate debt securities, U.S. government debt securities including Treasury Inflation Protected Bond Securities and zero-coupon securities, non-U.S. government debt securities, emerging-market debt securities, and mortgage-backed and asset-backed securities. The Fund may invest without limit in fixed-income securities that are rated below investment grade (commonly known as junk bonds) or, if unrated, are determined by the Fund’s subadviser(s) to be of comparable quality.

The Fund may invest in exchange traded funds (ETFs), which could represent a significant percentage of assets. The Fund may also invest in derivatives, including options, futures, swaps, and forward foreign currency contracts, for risk management purposes or as part of its investment strategies.

Multimanager Approach

The Fund uses a multimanager approach, meaning the adviser, Morningstar Investment Management LLC (“Morningstar” or “adviser” or “we”), may allocate assets to one or more subadvisers, in addition to open- and closed-end investment companies, ETFs, and individual securities. Each subadviser acts independently from the others and uses its own investment style and process to select securities, within the constraints of the Fund’s investment objective, strategies, and restrictions. Morningstar is responsible for selecting the investment strategies and deciding what percent of assets to give to each subadviser, with the goal of maximizing return with a prudent level of risk for the strategy. Subject to the oversight of the board of trustees, Morningstar may change subadvisers and sell holdings at any time.

Principal Risks

You can lose money by investing in this Fund. The Fund can also underperform broad markets and other investments. The Fund’s principal risks include:

 

    Multimanager and subadviser selection risk – To a significant extent, the Fund’s performance depends on Morningstar’s skill in selecting subadvisers and each subadviser’s skill in selecting securities and executing its strategy. Subadviser strategies may occasionally be out of favor and subadvisers may underperform relative to their peers or benchmarks.

 

    Asset allocation risk – In an attempt to invest in areas that look most attractive on a valuation basis, the Fund may favor asset classes or market segments that cause the Fund to underperform its benchmark. Given the wide latitude with which the adviser manages this portfolio, you should expect this Fund to periodically underperform broad markets.

 

    Stock market/company risk – Stocks can be highly volatile and prices may fluctuate widely, which means you should expect a wide range of returns and could lose money, even over a long time period. Various economic, industry, regulatory, political or other factors can dramatically affect the stock market as a whole, certain industry sectors, and/or individual companies.

 

    Interest-rate risk –The value of fixed-income securities, as well as some income-oriented equity securities that pay dividends, will typically decline when interest rates rise.

 

    Credit risk – Issuers of fixed-income securities could default or be downgraded if they fail to make required payments of principal or interest.

 

    High-yield risk – High-yield securities and unrated securities of similar credit quality (commonly known as junk bonds) are subject to greater levels of credit and liquidity risks. High-yield securities are considered speculative with respect to the issuer’s continuing ability to make principal and interest payments.

 

    Foreign securities risk – Securities of non-U.S. issuers may be less liquid, more volatile, and harder to value than U.S. securities. They may also be subject to political, economic, and regulatory risks, and market instability.

 

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    Emerging markets risk – Emerging market countries may have relatively unstable governments and economies based on only a few industries, which can cause greater instability. These countries are also more likely to experience higher levels of inflation, deflation, or currency devaluations, which could hurt their economies and securities markets.

 

    Currency risk – Because this Fund invests in foreign securities, changes in currency exchange rates could hurt performance. Morningstar or a subadviser may decide not to hedge, or may not be successful in hedging, its currency exposure.

 

    REITs and other real estate companies risk – REIT and other real estate company securities are subject to, among other risks: declines in property values; defaults by mortgagors or other borrowers and tenants; increases in property taxes and other operating expenses; overbuilding in their sector of the real estate market; fluctuations in rental income; changes in interest rates; lack of availability of mortgage funds or financing; extended vacancies of properties, especially during economic downturns; changes in tax and regulatory requirements; losses due to environmental liabilities; or casualty or condemnation losses.

 

    Derivatives risk – A derivative is an instrument with a value based on the performance of an underlying currency, security, index, or other reference asset. Derivatives involve risks different from, or possibly greater than, the risks of investing in more traditional investments. Derivatives involve costs, may create leverage, and may be illiquid, volatile, or difficult to value. In addition, derivatives could cause losses if the counterparty to the transaction does not perform as promised. The investment results achieved by using derivatives may not match or fully offset changes in the value of the underlying currency, security, index, or other reference asset that the Fund was attempting to hedge or the investment opportunity it was trying to pursue.

 

    U.S. government securities risk – U.S. government obligations have different levels of credit support and, therefore, different degrees of credit risk. The U.S. government does not guarantee the market value of the securities it issues, so those values may fluctuate. Like most fixed-income securities, the prices of government securities typically fall when interest rates increase and rise when interest rates decline.

 

    Sovereign debt securities risk – Sovereign debt instruments are subject to the risk that a governmental entity may delay or refuse to pay interest or repay principal on its sovereign debt, due, for example, to cash flow problems, insufficient foreign currency reserves, political considerations, the relative size of the governmental entity’s debt position in relation to the economy, or the failure to put in place economic reforms required by the International Monetary Fund or other multilateral agencies.

 

    Mortgage-related and other asset-backed securities risk – Mortgage-related and asset-backed securities are typically subject to the same risks inherent to investing in fixed-income securities as well as extension risk and prepayment risk:

Extension Risk — Rising interest rates tend to extend the duration of mortgage-related securities, making them more sensitive to changes in interest rates. As a result, in a period of rising interest rates, if the Fund holds mortgage-related securities, it may exhibit additional volatility.

Prepayment Risk — When interest rates decline, the value of mortgage-related securities with prepayment features may not increase as much as other fixed-income securities because borrowers may pay off their mortgages sooner than expected. In addition, the potential impact of prepayment on the price of asset-backed and mortgage-backed securities may be difficult to predict and result in greater volatility.

 

    Investment company and ETF risk – An investment company, including an open- or closed-end mutual fund or ETF, in which the Fund invests may not achieve its investment objective or execute its investment strategies effectively, or a large purchase or redemption activity by shareholders might negatively affect the value of the shares. The Fund must also pay its pro rata portion of an investment company’s fees and expenses. Shares of ETFs trade on exchanges and may be bought and sold at market value. ETF shares may be thinly traded, making it difficult for the Fund to sell shares at a particular time or an anticipated price. ETF shares may also trade at a premium or discount to the net asset value of the ETF; at times, this premium or discount could be significant.

Performance

Because the Fund has not yet started operations as of the date of this prospectus, we cannot yet report on its performance history. Once the Fund has been in operation for at least one calendar year, we will provide performance information for the Fund, as well as a comparison to a relevant market benchmark.

 

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Fund Management

Morningstar is the investment adviser for the Fund and has overall supervisory responsibility for the general management and investment of the Fund’s portfolio. The Fund is managed in a multimanager structure. On behalf of Morningstar, the following persons have primary responsibility for the Fund and, subject to oversight by the board of trustees, are responsible for selecting and overseeing the subadvisers listed below.

 

Portfolio Manager

  

Position with Morningstar

  

Start Date with
the Fund

Morningstar Investment Management LLC

  
Marta K. Norton, CFA   

Portfolio Manager and

Head of U.S. Outcome-Based Strategies

   Since Inception
Michelle R. Ward, CFA    Associate Portfolio Manager    Since Inception

Subadvisers and Portfolio Managers

Morningstar currently plans to allocate assets among the following subadvisers and may adjust these allocations at any time. The portfolio managers listed below are responsible for the day-to-day management of each subadviser’s allocated portion of the Fund’s portfolio:

 

Portfolio Manager

  

Position with Subadviser

  

Start Date with
the Fund

Brandywine Global Investment Management, LLC

  
David F. Hoffman, CFA    Managing Director and Portfolio Manager    Since Inception
Stephen S. Smith    Managing Director and Portfolio Manager    Since Inception
Jack P. McIntyre, CFA    Portfolio Manager    Since Inception
Anujeet Sareen, CFA    Portfolio Manager    Since Inception

Lazard Asset Management LLC

  
Bertrand Cliquet, CFA    Portfolio Manager/Analyst    Since Inception
Matthew Landy    Senior Vice President and Portfolio Manager/Analyst    Since Inception
John Mulquiney, CFA    Portfolio Manager/Analyst    Since Inception
Warryn Robertson    Portfolio Manager/Analyst    Since Inception

Purchase and Sale of Fund Shares

Fund shares are currently available only to investors participating in Morningstar Managed Portfolios, an investment advisory program sponsored by Morningstar Investment Services LLC, a wholly-owned subsidiary of the adviser, and also in programs sponsored by unaffiliated financial institutions that license the use of Morningstar Managed Portfolios in their own investment advisory program (collectively, Advisory Programs). There are no initial or subsequent minimum purchase amounts for the Fund. Orders to sell or “redeem” shares must be placed through the Advisory Program in which you participate and may trigger a purchase or sale of the Fund’s underlying investments.

 

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Fund shares may be purchased or redeemed on any day the New York Stock Exchange (NYSE) is open. At any time that an investor in the Fund ceases to be an eligible investor in the Fund, the entity managing the Advisory Program will direct the redemption of that investor’s Fund shares and no further purchases will be allowed.

See the Purchase and Sale of Fund Shares section on page [    ] of this prospectus for more information.

Tax Information

The Fund’s distributions generally are taxable to you as ordinary income, capital gains, or some combination of both, unless you are investing through a tax-advantaged arrangement, such as a 401(k) plan or an IRA, in which case your distributions may be taxed as ordinary income when withdrawn from the tax-advantaged account.

 

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MORNINGSTAR ALTERNATIVES FUND

SUMMARY INFORMATION

Investment Objective

The fund seeks long-term capital appreciation and low sensitivity to traditional U.S. asset classes.

Fees and Expenses of the Fund

The following tables describe the fees and expenses that you may pay if you buy and hold shares of the Fund.

Shareholder Fees

(Fees paid directly from your investment)

 

Sales Charge (Load) Imposed on Purchases

     None  

Sales Charge (Load) Imposed on Reinvested Dividends

     None  

Redemption Fee

     None  

Exchange Fee

     None  

Account Service Fee

     None  

Annual Fund Operating Expenses

(Expenses that you pay each year as a percentage of the value of your investment)

 

Management Fees

     0.85

Distribution and/or Service (12b-1) Fees

     None  

Other Expenses (1)

  

Sub-accounting Fees (2)

     0.13

Other Operating Expenses

     0.25
  

 

 

 

Total Other Expenses

     0.38

Acquired Fund Fees and Expenses (3)

     [0.01 %] 
  

 

 

 

Total Fund Annual Fund Operating Expenses

     [1.24 %] 
  

 

 

 

 

(1) Other expenses are based on estimated amounts for the current fiscal year.
(2) Represents fees assessed by various financial intermediaries and “mutual fund supermarkets” for providing certain account maintenance, record keeping, and transactional services with respect to Fund shares held by these intermediaries for their customers.
(3) Acquired Fund Fees and Expenses (AFFE) represent costs incurred indirectly by the Fund as a result of its ownership of shares of another investment company, such as open- or closed-end mutual funds, exchange traded funds (ETFs), and business development companies (BDCs). These are estimated for the current fiscal year.

Example

The example below can help you compare the cost of investing in the Fund with the cost of investing in other mutual funds. This example assumes that you invest $10,000 in the Fund for the time periods indicated and then sell all of your shares at the end of those periods. The example also assumes that your investment has a 5% return each year and that the Fund’s operating expenses remain the same. Although your actual costs may be higher or lower, based on these assumptions your costs would be:

 

1 Year      3 Years  
$ [126    $ [393

Portfolio Turnover

The Fund will pay transaction costs, such as commissions, when it buys and sells securities (or “turns over” its portfolio). A higher portfolio turnover rate may mean higher transaction costs and could result in higher taxes if you hold Fund shares in a taxable account. These costs, which are not reflected in annual fund operating expenses or in the example, affect the Fund’s performance. Because the Fund is new, no portfolio turnover statistics are available as of the date of this prospectus.

 

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Principal Investment Strategies

In seeking long-term capital appreciation and low sensitivity to traditional U.S. asset classes, the Fund allocates assets to strategies that provide alternative sources of return. In particular, the Fund has the latitude to invest in the following alternative strategies:

 

    Long-Short Equity, which combines long equity positions with short equity positions (selling borrowed securities). Since the strategy is both long and short, total net exposure is typically less than 100%.

 

    Convertible Arbitrage, which includes the purchase of convertible securities and the sale of the underlying common stock. These securities tend to be convertible bonds or convertible preferred stocks that may be converted into the stock of the same company.

 

    Merger Arbitrage, which seeks to profit from the successful completion of corporate organizations. The process typically involves purchasing shares of an announced acquisition target company at a discount to their expected value upon completion of the acquisition. Hedging strategies may be used to reduce market exposure and volatility.

 

    Credit Arbitrage, which seeks to exploit the mispricing of different classes of securities that are usually of the same company, and may include investments in investment-grade and/or non-investment-grade corporate debt (otherwise known as junk bonds), credit derivatives, loans, equities, credit index securities, and private debt.

 

    Global Macro, which establishes long (number of contracts bought exceeds number sold) with a short (number of contracts sold exceeds number bought) exposures around the globe to take advantage of what the subadviser believe to be attractive opportunities. This strategy may include investments in fixed-income and equity securities and a wide variety of derivative instruments. Such investments will likely have significant exposure to foreign investments and may be concentrated in a geographic region or country.

 

    Hedged Equity, which seeks to limit investment loss by creating a transaction that offsets an existing position in a contract that provides the right to buy or sell shares of a security at a specific price for a certain time. Specifically, this strategy attempts to reduce the systematic risk created by factors such as exposures to sectors, market-cap ranges, investment styles, currencies, and/or countries; the strategy strives to achieve this by matching short positions within each area against long positions. This strategy may be managed as beta-neutral, dollar-neutral, or sector-neutral in order to achieve low beta exposures to certain market indexes.

 

    Market Neutral, which attempts to significantly reduce the systematic risk created by factors such as exposures to sectors, market-cap ranges, investment styles, currencies, and/or countries. This strategy seeks to achieve this by matching short positions within each area against long positions, and the strategy may be managed as beta-neutral, dollar-neutral, or sector-neutral. In attempting to significantly reduce systematic risk, issue selection may be emphasized, with profits dependent on the ability to sell short and buy long the chosen securities.

 

    Nontraditional Bond, which pursues strategies that diverge in one or more ways from conventional practice in the broader bond-fund universe. In pursuing this strategy, the Fund may seek to avoid losses and produce returns uncorrelated with the overall bond market and may employ a variety of methods to achieve those aims, including investing tactically across a wide swath of individual sectors, including high-yield and foreign debt.

The Fund may invest in derivatives, including options, futures, swaps, and forward foreign currency contracts, for risk management purposes or as part of its investment strategies.

Multimanager Approach

The Fund uses a multimanager approach, meaning the adviser, Morningstar Investment Management LLC (“Morningstar” or “adviser” or “we”), may allocate assets to one or more subadvisers, in addition to open- and closed-end investment companies, ETFs, and individual securities. Each subadviser acts independently from the others and uses its own investment style and process to select securities, within the constraints of the Fund’s investment objective, strategies, and restrictions. Morningstar is responsible for selecting the investment strategies and deciding what percent of assets to give to each subadviser, with the goal of maximizing return with a prudent level of risk for the strategy. Subject to the oversight of the board of trustees, Morningstar may change subadvisers and sell holdings at any time.

 

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Principal Risks

You can lose money by investing in the Fund. The Fund can also underperform broad markets and other investments. The Fund’s principal risks include:

 

    Multimanager and subadviser selection risk – To a significant extent, the Fund’s performance depends on Morningstar’s skill in selecting subadvisers and each subadviser’s skill in selecting securities and executing its strategy. Subadviser strategies may occasionally be out of favor and subadvisers may underperform relative to their peers or benchmarks.

 

    Absolute return strategy risk In seeking low sensitivity to traditional U.S. asset classes, the Fund uses an absolute return strategy and a benchmark index of cash-like instruments. Unlike most equity funds, the Fund should not be expected to benefit from broad equity market returns, and unlike traditional bond funds, it may not generate current income or benefit when interest rates decline.

 

    Long/short strategy risk – While the fund may invest in long positions and short positions, there is the risk that the investments will not perform as expected and losses on one type of position could more than offset gains on the other, or the fund could lose money on both positions, if the portfolio managers judge the market incorrectly.

 

    Interest-rate risk –The value of fixed-income securities, as well as some income-oriented equity securities that pay dividends, will typically decline when interest rates rise.

 

    Credit risk – Issuers of fixed-income securities could default or be downgraded if they fail to make required payments of principal or interest.

 

    High-yield risk – High-yield securities and unrated securities of similar credit quality (commonly known as junk bonds) are subject to greater levels of credit and liquidity risks. High-yield securities are considered speculative with respect to the issuer’s continuing ability to make principal and interest payments.

 

    Foreign securities risk – Securities of non-U.S. issuers may be less liquid, more volatile, and harder to value than U.S. securities. They may also be subject to political, economic, and regulatory risks, and market instability.

 

    Emerging markets risk – Emerging market countries may have relatively unstable governments and economies based on only a few industries, which can cause greater instability. These countries are also more likely to experience higher levels of inflation, deflation, or currency devaluations, which could hurt their economies and securities markets.

 

    Currency risk – Because this Fund invests in foreign securities, changes in currency exchange rates could hurt performance. Morningstar or a subadviser may decide not to hedge, or may not be successful in hedging, its currency exposure.

 

    Convertible securities risk – Convertible securities are generally debt securities or preferred stocks that may be converted into common stock. The value of convertible securities may fall when interest rates rise and increase when interest rates fall. The credit standing of the issuer and other factors also may have an effect on the convertible security’s investment value.

 

    Preferred stock risk – Preferred stocks are equity securities that often pay dividends at a specific rate and have a preference over common stocks for dividend payments and liquidation of assets. Preferred stocks are subject to issuer-specific and market risks applicable generally to equity securities, however, unlike common stocks, participation in the growth of an issuer may be limited. The value of preferred stocks will usually react more strongly than bonds and other debt securities to actual or perceived changes in the company’s financial condition or prospects, and may be less liquid than common stocks.

 

    Short sales risk – Short sales involve selling a security the Fund does not own in anticipation that the security’s price will decline. To complete the transaction, the Fund must borrow the security to make delivery to the buyer. The Fund is then obligated to replace the security borrowed by purchasing the security at the market price at the time of replacement. Short sales are highly speculative and may subject the Fund to, at least theoretically, unlimited risk due to the fact that the value of the security underlying the short sale may appreciate indefinitely. Short sales also create leverage which increases the Fund’s exposure to the market. When the Fund is selling a security short, it must maintain a segregated account of cash or high-grade securities equal to the margin requirement. As a result, the Fund may maintain high levels of cash or other liquid assets (such as U.S. Treasury bills, money market accounts, repurchase agreements, certificates of deposit, high quality commercial paper and long equity positions) or may use borrowings for this cash. The need to maintain cash or other liquid assets in segregated accounts could limit the Fund’s ability to pursue other opportunities as they arise.

 

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    Derivatives risk – A derivative is an instrument with a value based on the performance of an underlying currency, security, index, or other reference asset. Derivatives involve risks different from, or possibly greater than, the risks of investing in more traditional investments. Derivatives involve costs, may create leverage, and may be illiquid, volatile, or difficult to value. In addition, derivatives could cause losses if the counterparty to the transaction does not perform as promised. The investment results achieved by using derivatives may not match or fully offset changes in the value of the underlying currency, security, index, or other reference asset that the Fund was attempting to hedge or the investment opportunity it was trying to pursue.

 

    Investment company and ETF risk – An investment company, including an open- or closed-end mutual fund or ETF, in which the Fund invests may not achieve its investment objective or execute its investment strategies effectively, or a large purchase or redemption activity by shareholders might negatively affect the value of the shares. The Fund must also pay its pro rata portion of an investment company’s fees and expenses. Shares of ETFs trade on exchanges and may be bought and sold at market value. ETF shares may be thinly traded, making it difficult for the Fund to sell shares at a particular time or an anticipated price. ETF shares may also trade at a premium or discount to the net asset value of the ETF; at times, this premium or discount could be significant.

Performance

Because the Fund has not yet started operations as of the date of this prospectus, we cannot yet report on its performance history. Once the Fund has been in operation for at least one calendar year, we will provide performance information for the Fund, as well as a comparison to a relevant market benchmark.

Fund Management

Morningstar is the investment adviser for the Fund and has overall supervisory responsibility for the general management and investment of the Fund’s portfolio. The Fund is managed in a multimanager structure. On behalf of Morningstar, the following persons have primary responsibility for the Fund and, subject to oversight by the board of trustees, are responsible for selecting and overseeing the subadvisers listed below.

 

Portfolio Manager

  

Position with Morningstar

  

Start Date with
the Fund

Morningstar Investment Management LLC

  
Marta K. Norton, CFA   

Portfolio Manager and

Head of U.S. Outcome-Based Strategies

   Since Inception
Michelle R. Ward, CFA    Associate Portfolio Manager    Since Inception

Subadvisers and Portfolio Managers

Morningstar currently plans to allocate assets among the following subadvisers and may adjust these allocations at any time. The portfolio managers listed below are responsible for the day-to-day management of each subadviser’s allocated portion of the Fund’s portfolio:

 

Portfolio Manager

  

Position with Subadviser

  

Start Date with
the Fund

SSI Investment Management

  
George M. Douglas, CFA    Chief Investment Officer, Principal, and Portfolio Manager    Since Inception
Alexander W. Volz    Portfolio Manager    Since Inception

 

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Portfolio Manager

  

Position with Subadviser

  

Start Date with
the Fund

Dagney M. Hollander    Portfolio Manager    Since Inception

Water Island Capital

     
John S. Orrico, CFA    Chief Investment Officer    Since Inception
Roger P. Foltynowicz, CFA, CAIA    Portfolio Manager    Since Inception
Todd W. Munn    Portfolio Manager    Since Inception

Purchase and Sale of Fund Shares

Fund shares are currently available only to investors participating in Morningstar Managed Portfolios, an investment advisory program sponsored by Morningstar Investment Services LLC, a wholly-owned subsidiary of the adviser, and also in programs sponsored by unaffiliated financial institutions that license the use of Morningstar Managed Portfolios in their own investment advisory program (collectively, Advisory Programs). There are no initial or subsequent minimum purchase amounts for the Fund. Orders to sell or “redeem” shares must be placed through the Advisory Program in which you participate and may trigger a purchase or sale of the Fund’s underlying investments. Fund shares may be purchased or redeemed on any day the New York Stock Exchange (NYSE) is open. At any time that an investor in the Fund ceases to be an eligible investor in the Fund, the entity managing the Advisory Program will direct the redemption of that investor’s Fund shares and no further purchases will be allowed.

See the Purchase and Sale of Fund Shares section on page [    ] of this prospectus for more information.

Tax Information

The Fund’s distributions generally are taxable to you as ordinary income, capital gains, or some combination of both, unless you are investing through a tax-advantaged arrangement, such as a 401(k) plan or an IRA, in which case your distributions may be taxed as ordinary income when withdrawn from the tax-advantaged account.

 

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STATEMENT OF SHAREHOLDER RIGHTS

When you buy shares in a mutual fund, you become a shareholder in an investment company. As an owner, you have certain rights and protections, chief among them an independent board of trustees, whose main role is to represent your interests. To get to know your board, please see the “Trustees and Executive Officers” section on page [    ] of the Statement of Additional Information.

ADDITIONAL INFORMATION ABOUT THE FUNDS’ INVESTMENT STRATEGIES AND RISKS

Additional Principal Investment Strategy Information

Certain Funds have a policy of investing, under normal circumstances, at least 80% of their respective assets in a particular type of investment as of the time of purchase. Except with respect to the Morningstar Municipal Bond Fund, these policies are non-fundamental and may be changed without shareholder approval. No change to a Fund’s 80% investment policy will be made without a minimum of 60 days advance notice being provided to the shareholders of the Fund. The 80% investment policy of the Morningstar Municipal Bond Fund is fundamental and may not be changed without shareholder approval. For purposes of a Fund’s 80% investment policy and other percentage thresholds set forth in the Funds’ prospectus, unless specifically noted otherwise, references to the Fund’s “assets” mean the Fund’s net assets plus borrowings for investment purposes, if any.

In addition to the description of each Fund’s principal investment strategies set forth in the summary section of the prospectus, the following discussion provides additional detail with respect to each Fund’s principal investment strategies and the types of instruments in which the Funds may invest. This information is supplemental to, and should be read in connection with, the strategy and risk discussion in each Fund’s summary.

Morningstar U.S. Equity Fund. The equity securities in which the Fund may invest include American depositary receipts (ADRs). The Fund may also invest up to 20% of its assets in fixed-income securities of varying maturity, duration and quality. Typically, such investments will be composed of short-duration, investment grade (or equivalent) securities and money market instruments. Certain of the Fund’s investments may be directly or indirectly linked to the performance of one or more commodities, and therefore subject to developments in the commodities markets. To facilitate the implementation of its investment strategy, the Fund may also use derivatives, including forward foreign currency contracts and futures, to enhance returns, to manage or adjust the Fund’s risk profile, to replace more traditional direct investments, or to obtain exposure to certain markets.

Morningstar International Equity Fund. The equity securities in which the Fund may invest include ADRs, global depositary receipts (GDRs), and real estate investment trusts (REITs). The Fund may invest in the securities of companies located in emerging and frontier markets. The Fund may also invest up to 20% of its assets in fixed-income securities of varying maturity, duration and quality. Typically, such investments will be composed of short-duration, investment grade (or equivalent) securities and money market instruments. Certain of the Fund’s investments may be directly or indirectly linked to the performance of one or more commodities, and therefore subject to developments in the commodities markets. To facilitate the implementation of its investment strategy, the Fund may also use derivatives, including forward foreign currency contracts and futures, to enhance returns, to manage or adjust the Fund’s risk profile, to replace more traditional direct investments, or to obtain exposure to certain markets.

Morningstar Global Income Fund. The income-generating equity securities in which the Fund may invest include ADRs and GDRs. The Fund may invest in the securities of companies located in emerging and frontier markets. Certain of the Fund’s investments may be directly or indirectly linked to the performance of one or more commodities, and therefore subject to developments in the commodities markets. To facilitate the implementation of its investment strategy, the Fund may also use derivatives, including forward foreign currency contracts and futures, to enhance returns, to manage or adjust the Fund’s risk profile, to replace more traditional direct investments, or to obtain exposure to certain markets.

Morningstar Total Return Bond Fund. The fixed-income securities in which the Fund may invest include securities of municipal issuers, corporate loans and floating-rate notes. The fund may also invest in common and preferred stock, convertible securities, dollar rolls, repurchase agreements, purchase and sale contracts, standby commitments, and when-issued and delayed-delivery securities. In addition, certain of the Fund’s investments may be directly or indirectly linked to the

 

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performance of one or more commodities, and therefore subject to developments in the commodities markets. To facilitate the implementation of its investment strategy, the Fund may also use derivatives, including options, futures, swaps, and forward foreign currency contracts, to enhance returns, to manage or adjust the Fund’s risk profile, to replace more traditional direct investments, or to obtain exposure to certain markets.

Morningstar Municipal Bond Fund. The fixed-income securities in which the Fund may invest include U.S. and non-U.S. government debt securities. The Fund may also invest in mortgage-backed and asset-backed securities, and structured products such as tobacco settlement securitization bonds (tobacco bonds). In addition, certain of the Fund’s investments may be directly or indirectly linked to the performance of one or more commodities, and therefore subject to developments in the commodities markets. To facilitate the implementation of its investment strategy, the Fund may also use derivatives, including forward foreign currency contracts, futures, and swaps, to enhance returns, to manage or adjust the Fund’s risk profile, to replace more traditional direct investments, or to obtain exposure to certain markets.

Morningstar Defensive Bond Fund. The fixed-income securities in which the Fund may invest include floating-rate notes. In addition, certain of the Fund’s investments may be directly or indirectly linked to the performance of one or more commodities, and therefore subject to developments in the commodities markets. To facilitate the implementation of its investment strategy, the Fund may also use derivatives, including forward foreign currency contracts and futures, to enhance returns, to manage or adjust the Fund’s risk profile, to replace more traditional direct investments, or to obtain exposure to certain markets.

Morningstar Multisector Bond Fund. The fixed-income securities in which the Fund may invest include corporate loans and securities of municipal issuers. The Fund may invest in equity securities including common and preferred stock of companies located in any country, including emerging and frontier markets. In addition, certain of the Fund’s investments may be directly or indirectly linked to the performance of one or more commodities, and therefore subject to developments in the commodities markets. To facilitate the implementation of its investment strategy, the Fund may also use derivatives, including options, futures, swaps, and forward foreign currency contracts, to enhance returns, to manage or adjust the Fund’s risk profile, to replace more traditional direct investments, or to obtain exposure to certain markets.

Morningstar Unconstrained Allocation Fund. The fixed-income securities in which the Fund may invest include floating-rate notes. The Fund may invest in equity securities of companies of any market capitalization located in any country, including emerging and frontier markets. The Fund may invest in ADRs and GDRs and convertible securities. The Fund may invest in the securities of companies located in emerging and frontier markets. Certain of the Fund’s investments may be directly or indirectly linked to the performance of one or more commodities, and therefore subject to developments in the commodities markets. To facilitate the implementation of its investment strategy, the Fund may also use derivatives, including options, futures, swaps, and forward foreign currency contracts, to enhance returns, to manage or adjust the Fund’s risk profile, to replace more traditional direct investments, or to obtain exposure to certain markets.

Morningstar Alternatives Fund. The fixed-income securities in which the Fund may invest include U.S. and non-U.S. government debt securities. The Fund may also invest in equity securities of companies of any market capitalization located in any country, including emerging and frontier markets. Certain of the Fund’s investments may be directly or indirectly linked to the performance of one or more commodities, and therefore subject to developments in the commodities markets. To facilitate the implementation of its investment strategy, the Fund may also use derivatives, including options, futures, swaps, and forward foreign currency contracts, to enhance returns, to manage or adjust the Fund’s risk profile, to replace more traditional direct investments, or to obtain exposure to certain markets.

Additional Principal Risk Information

The tables below provide additional information about the Funds’ principal investment risks. In addition to the investment risks deemed to be principal for a particular Fund, the Fund may be subject to additional, non-principal risks. For more information about the Funds’ non-principal investment strategies and risks, see the Funds’ Statement of Additional Information. The following risks are described in alphabetical order and not in order of importance or potential exposure.

 

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    Principal Risk

 

     Morningstar
U.S. Equity
Fund
   Morningstar
International
Equity Fund
   Morningstar
Global
Income
Fund
   Morningstar
Total Return
Bond Fund
   Morningstar
Municipal
Bond Fund

Absolute Return Strategy Risk

                        

Active Management Risk

                        

American Depositary Receipts (ADRs) Risk

                        

Asset Allocation Risk

                        

Changing Fixed-income Markets

                        

Collateralized Debt Obligations (CDOs) Risk

                        

Commodity-Linked Investment Risk

                        

Convertible Securities Risk

                        

Corporate Loan Risk

                        

Credit Risk

                        

Currency Risk

                        

Derivatives Risk

                        

Dollar Rolls Risk

                        

Emerging Markets Risk

                        

Floating-rate Notes Risk

                        

Foreign Securities Risk

                        

Forward Foreign Currency Contracts Risk

                        

Frontier Markets Risk

                        

Futures Contracts Risk

                        

Geographic Concentration Risk

                        

Global Depositary Receipts (GDRs) Risk

                        

High-yield Risk

                        

Interest-rate Risk

                        

Inverse Floater Risk

                        

Investment Company and ETF Risk

                        

Investment Strategy Risk

                        

Large-Cap Stock Risk

                        

Liquidity Risk

                        

Long/Short Strategy Risk

                        

Market Risk

                        

Master Limited Partnership (MLP) Risk

                        

Mortgage-Related and Other Asset-Backed Securities Risk

                        

Multimanager and Subadviser Selection Risk

                        

Municipal Securities Risk

                        

New Fund Risk

                        

Nondiversification Risk

                        

Options Risk

                        

Portfolio Turnover Risk

                        

Preferred Stock Risk

                        

Private Placements Risk

                        

Redemption Risk

                        

REITs and Other Real Estate Companies Risk

                        

Repurchase Agreements and Purchase and Sale Contracts Risk

                        

Reverse Repurchase Agreements Risk

                        

Short Sales Risk

                        

Smaller Companies Risk

                        

 

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    Principal Risk

 

     Morningstar
U.S. Equity
Fund
   Morningstar
International
Equity Fund
   Morningstar
Global
Income
Fund
   Morningstar
Total Return
Bond Fund
   Morningstar
Municipal
Bond Fund

Sovereign Debt Securities Risk

                        

Standby Commitments Risk

                        

Stock Market/Company Risk

                        

Swaps Risk

                        

U.S. Government Securities Risk

                        

Valuation Risk

                        

When-Issued and Delayed Delivery Securities Risk

                        

Tobacco Bonds Risk

                        

 

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    Principal Risk

 

     Morningstar
Defensive
Bond Fund
   Morningstar
Multisector
Bond Fund
   Morningstar
Unconstrained
Allocation
Fund
   Morningstar
Alternatives
Fund

Absolute Return Strategy Risk

                   

Active Management Risk

                   

American Depositary Receipts (ADRs) Risk

                   

Asset Allocation Risk

                   

Changing Fixed-income Markets

                   

Collateralized Debt Obligations (CDOs) Risk

                   

Commodity-Linked Investment Risk

                   

Convertible Securities Risk

                   

Corporate Loan Risk

                   

Credit Risk

                   

Currency Risk

                   

Derivatives Risk

                   

Dollar Rolls Risk

                   

Emerging Markets Risk

                   

Floating-rate Notes Risk

                   

Foreign Securities Risk

                   

Forward Foreign Currency Contracts Risk

                   

Frontier Markets Risk

                   

Futures Contracts Risk

                   

Geographic Concentration Risk

                   

Global Depositary Receipts (GDRs) Risk

                   

High-yield Risk

                   

Interest-rate Risk

                   

Inverse Floater Risk

                   

Investment Company and ETF Risk

                   

Investment Strategy Risk

                   

Large-Cap Stock Risk

                   

Liquidity Risk

                   

Long/Short Strategy Risk

                   

Market Risk

                   

Master Limited Partnership (MLP) Risk

                   

Mortgage-Related and Other Asset-Backed Securities Risk

                   

Multimanager and Subadviser Selection Risk

                   

Municipal Securities Risk

                   

New Fund Risk

                   

Nondiversification Risk

                   

Options Risk

                   

Portfolio Turnover Risk

                   

Preferred Stock Risk

                   

Private Placements Risk

                   

Redemption Risk

                   

REITs and Other Real Estate Companies Risk

                   

Repurchase Agreements and Purchase and Sale Contracts Risk

                   

Reverse Repurchase Agreement Risk

                   

Short Sales Risk

                   

Smaller Companies Risk

                   

Sovereign Debt Securities Risk

                   

Standby Commitments Risk

                   

 

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    Principal Risk

 

     Morningstar
Defensive
Bond Fund
   Morningstar
Multisector
Bond Fund
   Morningstar
Unconstrained
Allocation
Fund
   Morningstar
Alternatives
Fund

Stock Market/Company Risk

                   

Swaps Risk

                   

U.S. Government Securities Risk

                   

Valuation Risk

                   

When-Issued and Delayed Delivery Securities Risk

                   

Tobacco Bonds Risk

                   

 

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Absolute Return Strategy Risk – The Morningstar Alternatives Fund employs an “absolute return” investment approach, benchmarking itself to an index of cash instruments and seeking to achieve returns that are largely independent of broad movements in stocks and bonds. Unlike equity funds, the Fund should not be expected to benefit from general equity market returns. Different from fixed-income funds, the Fund may not generate current income and should not be expected to experience price appreciation as interest rates decline.

Active Management Risk. Each Fund is actively managed with discretion and may underperform market indexes or other mutual funds with similar investment objectives.

American Depositary Receipts Risk. The stocks of most foreign companies that trade in the U.S. markets are traded as American Depositary Receipts (ADRs). U.S. depositary banks issue these stocks. Each ADR represents one or more shares of foreign stock or a fraction of a share. The price of an ADR corresponds to the price of the foreign stock in its home market, adjusted to the ratio of the ADRs to foreign company shares. Therefore while purchasing a security on a U.S. exchange, the risks inherently associated with foreign investing still apply to ADRs.

Asset Allocation Risk. In an attempt to invest in areas that look most attractive on a valuation basis, the Fund may overweight asset classes or market segments that underperform relative to the broad market or other market segments.

Changing Fixed-income Markets. Following the financial crisis that began in 2007, the Board of Governors of the Federal Reserve System (the Federal Reserve) has attempted to support the U.S. economic recovery by keeping the federal funds rate at a low level. The Federal Reserve has begun raising the federal funds rate and may continue to do so. Increases in the federal funds rate may expose fixed-income and related markets to heightened volatility and may reduce liquidity for certain Fund investments, which could cause the value of the Fund’s investments and share price to decline. If a Fund invests in derivatives tied to fixed-income markets, the Fund may be more substantially exposed to these risks than a fund that does not invest in derivatives. To the extent a Fund experiences high redemptions because of these policy changes, the Fund may experience increased portfolio turnover, which will increase the costs the Fund incurs and may lower its performance. In addition, decreases in fixed-income dealer market-making capacity may persist in the future, potentially leading to decreased liquidity and increased volatility in the fixed-income markets.

Collateralized Debt Obligations (CDOs) Risk. In addition to the typical risks associated with fixed-income securities and asset-backed securities, CDOs carry additional risks including, but not limited to: (i) the possibility that distributions from collateral securities will not be adequate to make interest or other payments; (ii) the risk that the collateral may default or decline in value or be downgraded, if rated by a nationally recognized statistical rating organization; (iii) the Fund may invest in tranches of CDOs that are subordinate to other tranches; (iv) the structure and complexity of the transaction and the legal documents could lead to disputes among investors regarding the characterization of proceeds; (v) the investment return achieved by the Fund could be significantly different than those predicted by financial models; (vi) the lack of a readily available secondary market for CDOs; (vii) the risk of forced “fire sale” liquidation due to technical defaults such as coverage test failures; and (viii) the CDO’s manager may perform poorly. In addition, investments in CDOs may be characterized by the Fund as illiquid securities.

Commodity-Linked Investment Risk. A Fund’s investment in commodity-linked investments and other commodity/natural resource-related securities may subject the Fund to greater volatility than investments in traditional securities. The value of commodity-linked investments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity, such as drought, flood, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Commodity-linked investments may be hybrid instruments that can have substantial risk of loss with respect to both principal and interest. Commodity-linked investments may be more volatile and less liquid than the underlying commodity, instruments, or measures, are subject to the credit risks associated with the issuer, and their values may decline substantially if the issuer’s creditworthiness deteriorates. As a result, returns of commodity-linked investments may deviate significantly from the return of the underlying commodity, instruments, or measures.

 

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The tax treatment of commodity-linked derivative instruments may be adversely affected by changes in legislation, regulations or other legally binding authority. If, as a result of any such adverse action, the income of the Fund from certain commodity-linked derivatives was treated as non-qualifying income the Fund might fail to qualify as a regulated investment company and/or be subject to federal income tax at the Fund level. As a regulated investment company, the Fund must derive at least 90% of its gross income for each taxable year from sources treated as qualifying income under the Internal Revenue Code of 1986, as amended, including income from any financial instrument or position that constitutes a security under 2(a)(36) of the 1940 Act. In September 2016, the Internal Revenue Service announced that it will no longer issue private letter rulings on questions relating to the treatment of a corporation as a regulated investment company that require a determination of whether a financial instrument or position is a security under section 2(a)(36) of the 1940 Act. The IRS also revoked rulings issued to some funds regarding the treatment of commodity-linked notes held directly by such funds. Additionally, in September 2016, the Internal Revenue Service issued proposed regulations that would require the Subsidiary to distribute its “Subpart F” income (defined in Section 951 of the Code to include passive income such as income from commodity-linked derivatives) each year in order for the Fund to treat that income as qualifying income. Should the Internal Revenue Service issue guidance, or Congress enact legislation, that adversely affects the tax treatment of the Fund’s use of commodity-linked instruments or the Subsidiary (which guidance might be applied to the Fund retroactively), it could, among other consequences, limit the Fund’s ability to pursue its investment strategy.

Convertible Securities Risk. In general, a convertible security is subject to the risks of stocks, and its price may be as volatile as that of the underlying stock, when the underlying stock’s price is high relative to the conversion price and a convertible security is subject to the risks of debt securities, and is particularly sensitive to changes in interest rates, when the underlying stock’s price is low relative to the conversion price.

The value of a convertible security is influenced by changes in interest rates, with investment value declining as interest rates increase and increasing as interest rates decline. The credit standing of the issuer and other factors also may have an effect on the convertible security’s investment value.

Many convertible securities have credit ratings that are below investment grade and are subject to the same risks as an investment in lower-rated debt securities. The credit rating of a company’s convertible securities is generally lower than that of its non-convertible debt securities. Convertible securities are normally considered “junior” securities—that is, the company usually must pay interest on its non-convertible debt securities before it can make payments on its convertible securities. If the issuer stops paying interest or principal, convertible securities may become worthless and the Fund could lose its entire investment. To the extent the Fund invests in convertible securities issued by small- or mid-cap companies, it will be subject to the risks of investing in such companies. The securities of small- and mid-cap companies may fluctuate more widely in price than the market as a whole. There may also be less trading in small- or mid-cap securities, which means that buy and sell transactions in those securities could have a larger impact on a security’s price than is the case with large-cap securities.

Convertible securities generally have less potential for gain or loss than common stocks.

Corporate Loan Risk. Commercial banks and other financial institutions or institutional investors make corporate loans to companies that need capital to grow or restructure. Borrowers generally pay interest on corporate loans at rates that change in response to changes in market interest rates such as the London Interbank Offered Rate (LIBOR) or the prime rates of U.S. banks. As a result, the value of corporate loan investments is generally less exposed to the adverse effects of shifts in market interest rates than investments that pay a fixed rate of interest. However, because the trading market for certain corporate loans may be less developed than the secondary market for bonds and notes, a Fund may experience difficulties in selling its corporate loans. Transactions in corporate loans may settle on a delayed basis. As a result, the proceeds from the sale of corporate loans may not be readily available to make additional investments or to meet a Fund’s redemption obligations. To the extent the extended settlement process gives rise to short-term liquidity needs, a Fund may hold additional cash, sell investments or temporarily borrow from banks and other lenders. Leading financial institutions often act as agent for a broader group of lenders, generally referred to as a syndicate. The syndicate’s agent arranges the corporate loans, holds collateral and accepts payments of principal and interest. If the agent develops financial problems, a Fund may not recover its investment or recovery may be delayed. By investing in a corporate loan, a Fund may become a member of the syndicate. The market for corporate loans may be subject to irregular trading activity and wide bid/ask spreads. The corporate loans in which a Fund invests are subject to the risk of loss of principal and income. Although borrowers frequently provide collateral to secure repayment of these obligations they do not always do so. If they do provide collateral, the value of the collateral may not completely cover the borrower’s obligations at the time of a default. If a borrower

 

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files for protection from its creditors under the U.S. bankruptcy laws, these laws may limit the a rights to its collateral. In addition, the value of collateral may erode during a bankruptcy case. In the event of a bankruptcy, the holder of a corporate loan may not recover its principal, may experience a long delay in recovering its investment and may not receive interest during the delay.

Credit Risk. Credit risk is the risk that an issuer may fail or become less able to make payments when due. An issuer of a fixed-income security could be downgraded or default. If a Fund holds securities that have been downgraded, or that default on payment, the Fund’s performance could be negatively affected.

Currency Risk. Each Fund may invest in securities denominated in foreign currencies. Changes in currency exchange rates could adversely impact investment gains or add to investment losses. Currency exchange rates can be affected unpredictably by intervention, or failure to intervene, by U.S. or foreign governments or central banks or by currency controls or political developments in the U.S. or abroad. Although a Fund may attempt to hedge currency risk, the hedging instruments may not perform as expected and could produce losses. Suitable hedging instruments may not be available for all foreign currencies. A Fund is not required to hedge currency risk and may elect not to hedge currency risk even if suitable instruments are available.

Derivatives Risk. Certain Funds may invest in derivatives, which involve risks that are different from, and in some respects greater than, risks associated with more traditional investments, such as stock and bonds. Derivatives are instruments, such as options, futures, forward foreign currency contracts and swaps, whose value is derived from that of other assets, rates or indexes. Certain derivative instruments may be highly complex and highly volatile leading them to perform in unexpected ways. Derivatives may also create leverage which magnifies the impact of a decline or gain in the reference instrument underlying the derivative. The use of leverage by a Fund may cause the Fund to lose more than the amount it invests. Some derivatives may be thinly traded, which may make it difficult for a Fund to close its position in or sell the derivative at a particular time or at an anticipated price. In addition, changes in government regulation of derivatives could affect the character, timing, and amount of a Fund’s taxable income or gains. A Fund’s use of derivatives may be limited by the requirements for taxation of the Fund as a regulated investment company.

Many derivatives are traded on margin. Regulatory requirements and/or contractual undertakings may require a Fund to segregate cash or other liquid assets to be used for margin payments. Derivatives that have margin requirements involve the risk that if a Fund has insufficient cash or eligible margin securities to meet daily variation margin requirements, it may have to sell securities from its portfolio at a time when it may be disadvantageous to do so. A Fund may remain obligated to meet margin requirements until it is able to close its position. The need to provide margin or collateral and/or segregate assets could limit a Fund’s ability to pursue other opportunities as they arise.

Derivatives can be used for hedging (attempting to reduce risk by offsetting one investment position with another) or non-hedging purposes. Hedging with derivatives may increase expenses, and there is no guarantee that a hedging strategy will work. While hedging can reduce or eliminate losses, it can also reduce or eliminate gains. The use of derivatives for non-hedging purposes may be considered more speculative than other types of investments.

Derivative instruments are subject to counterparty risk, meaning that the party who issues the derivatives may experience a significant credit event and may be unwilling or unable to make timely settlement payments or otherwise honor its obligations. Changes in the value of a derivative may not correlate perfectly with the underlying asset, rate or index, and the Fund could lose more than the principal amount invested.

Under recent financial reforms, certain types of derivatives (i.e., certain swaps) are, and others are expected to eventually be, required to be cleared through a central counterparty. Central clearing is designed to reduce counterparty risk and increase liquidity compared to over-the-counter (OTC) derivatives, but it does not eliminate those risks entirely and may involve additional costs and risks not involved with OTC derivatives. With swaps that are cleared through a central counterparty, there is also a risk of loss by a Fund of its initial and variation margin deposits in the event of bankruptcy of a futures commission merchant with which the Fund has an open position, or the central counterparty in a swap contract. The regulation of swaps, as well as other derivatives, is a rapidly changing area of law and is subject to modification by government and judicial action. It is not possible to predict fully the effects of current or future regulation. New requirements, even if not directly applicable to the Funds, may increase the cost of a Fund’s investments and cost of doing business.

 

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Dollar Rolls Risk. A dollar roll transaction involves a sale by a Fund of a mortgage-backed or other security concurrently with an agreement by the Fund to repurchase a similar security at a later date at an agreed-upon price. Dollar roll transactions involve the risk that the market value of the securities a Fund is required to purchase may decline below the agreed upon repurchase price of those securities. If the broker-dealer to whom a Fund sells securities becomes insolvent, the Fund’s right to purchase or repurchase securities may be restricted. Successful use of mortgage dollar rolls may depend upon the adviser’s or a subadviser’s ability to correctly predict interest rates and prepayments. There is no assurance that dollar rolls can be successfully employed.

Emerging Markets Risk. Each fund may invest in emerging market countries. The securities markets of emerging market countries may have lower trading volume, be less liquid, be subject to greater price volatility, have smaller market capitalizations, have less government regulation, and not be subject to as extensive and frequent accounting, financial and other reporting requirements as the securities markets of more developed countries.

Emerging market countries may have relatively unstable governments and economies based on only a few industries, which may cause greater instability. The value of emerging market securities will likely be particularly sensitive to changes in the economies of such countries. These countries are also more likely to experience higher levels of inflation, deflation or currency devaluations, which could hurt their economies and securities markets.

Unanticipated political or social developments may result in sudden and significant investment losses. Investing in emerging market countries involves greater risk of loss due to expropriation, nationalization, confiscation of assets and property or the imposition of restrictions on foreign investments and on repatriation of capital.

Settlement and clearance procedures in emerging countries are frequently less developed and reliable than those in the United States and may involve a Fund’s delivery of securities before receipt of payment for their sale. Settlement, clearance or registration problems may make it more difficult for a Fund to value its portfolio securities and could cause the Fund to miss attractive investment opportunities, to have a portion of its assets uninvested or to incur losses due to the failure of a counterparty to pay for securities the Fund has delivered or the Fund’s inability to complete its contractual obligations because of theft or other reasons.

Rising interest rates, combined with widening credit spreads, could negatively impact the value of emerging market debt and increase funding costs for foreign issuers. In such a scenario, foreign issuers might not be able to service their debt obligations, the market for emerging market debt could suffer from reduced liquidity, and any investing Fund could lose money.

Foreign Securities Risk. A Fund may invest in foreign securities. Risks associated with investing in foreign securities include fluctuations in the exchange rates of foreign currencies that may affect the U.S. dollar value of a security, the possibility of substantial price volatility as a result of political and economic instability in the foreign country, less public information about issuers of securities, different securities regulation, different accounting, auditing and financial reporting standards and less liquidity than in U.S. markets. Shareholder rights under the laws of some foreign countries may not be as favorable as U.S. laws. Thus, a shareholder may have more difficulty in asserting its rights or enforcing a judgment against a foreign company than a shareholder of a comparable U.S. company. In addition, settlement and clearance procedures in certain foreign markets may result in delays in payment for, or delivery of, securities not typically associated with settlement and clearance of U.S. investments.

Forward Foreign Currency Contracts Risk. A forward foreign currency contract is an obligation to buy or sell a particular currency in exchange for another currency, which may be U.S. dollars, at a specified price at a future date. Forward foreign currency contracts are typically individually negotiated and privately traded by currency traders and their customers in the interbank market. A Fund may not fully benefit from, or may lose money on, forward foreign currency transactions if changes in currency exchange rates do not occur as anticipated or do not correspond accurately to changes in the value of the Fund’s holdings.

 

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A Fund’s ability to use forward foreign currency transactions successfully depends on a number of factors, including the forward foreign currency transactions being available at attractive prices, the availability of liquid markets and the ability of the portfolio managers to accurately predict the direction of changes in currency exchange rates. Currency exchange rates may be volatile and may be affected by, among other factors, the general economics of a country, the actions of U.S. and foreign governments or central banks, the imposition of currency controls and speculation. Currency transactions are also subject to the risk that the other party in the transaction will default its contractual obligation, which would deprive a Fund of unrealized profits or force a Fund to cover its commitments for purchase or sale of a currency, if any, at the current market price. If a Fund enters into a forward foreign currency contract, its custodian will segregate liquid assets of the Fund having a value equal to the Fund’s commitment under such forward contract from day to day, except to the extent that the Fund’s forward contract obligation is covered by liquid portfolio securities denominated in, or whose value is tied to, the currency underlying the forward contract.

Frontier Markets Risk. Frontier market countries are countries that have smaller economies or less developed capital markets than traditional emerging markets. Frontier countries tend to have relatively low gross national product per capita compared to the larger traditionally-recognized emerging markets. The frontier emerging market countries include the least developed countries even by emerging markets standards. The risks of investments in frontier emerging market countries include all the risks described above for investment in foreign securities and emerging markets, although these risks are magnified in the case of frontier countries.

Futures Contracts Risk. A futures contract is a standard binding agreement to buy or sell a specified quantity of an underlying reference asset, such as a specific security, currency, commodity or index, at a specified price at a specified later date. Investments in futures contracts and options on futures contracts may increase volatility and be subject to additional market, active management, interest, currency, and counterparty risk. A fund may be subject to additional risks, such as liquidity risk, if the contract cannot be closed when desired.

Futures contracts provide for the future sale by one party and purchase by another of a specific asset at a specific time and price. An option on a futures contract gives the purchaser the right, in exchange for a premium, to assume a position in a futures contract at a specified exercise price during the term of the option. Futures and forward contracts are subject to counterparty risk, meaning that the party who issues the derivatives may experience a significant credit event and may be unwilling or unable to make timely settlement payments or otherwise honor its obligations.

Geographic Concentration Risk. To the extent that the Fund invests a significant portion of its assets in a particular country, region or continent, economic, political, social and environmental conditions in such country, region or continent will have a greater effect on the Fund’s performance than they would in a more geographically diversified equity fund. Similarly, if so concentrated, the Fund’s performance may be more volatile than the performance of a more geographically diversified fund.

Global Depositary Receipts Risk. GDRs are receipts issued by either a U.S. or non-U.S. banking institution evidencing its ownership of the underlying foreign securities and are often denominated in U.S. dollars. Each GDR represents one or more shares of foreign stock or a fraction of a share. The price of a GDR corresponds to the price of the foreign stock in its home market, adjusted to the ratio of the GDRs to foreign company shares. Therefore, the risks inherently associated with foreign investing still apply to GDRs.

High-yield Risk. High-yield securities are considered primarily speculative with respect to the issuer’s continuing ability to make principal and interest payments. High-yield securities and unrated securities of similar credit quality (commonly known as junk bonds) are subject to greater levels of credit and liquidity risks. Changes in general economic conditions, changes in the financial condition of the issuer, and changes in interest rates may adversely impact the value of high-yield securities.

High-yield securities are less liquid than investment grade securities and may be difficult to price or sell, particularly in times of negative sentiment toward high-yield securities. Issuers of high-yield securities may have a larger amount of outstanding debt relative to their assets than issuers of investment grade securities have. Periods of economic downturn or rising interest rates may cause the issuers of high-yield securities to experience financial distress, which could adversely impact their ability to make timely payments of principal and interest and could increase the possibility of default. The market value and liquidity of high-yield securities may be impacted negatively by adverse publicity and investor perceptions, whether or not based on fundamental analysis, especially in a market characterized by low trade volume.

Interest Rate Risk. In general, the value of fixed-income securities, as well as some income-oriented equity securities that pay dividends, will typically decline when interest rates rise.

 

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Inverse Floater Risk. The interest rate of an inverse floater resets in the opposite direction from the market rate of interest on a security or interest to which it is related. An inverse floater may be considered to be leveraged to the extent that its interest rate varies by a magnitude that exceeds the magnitude of the change in the index rate of interest, and is subject to many of the same risks as derivatives. The higher degree of leverage inherent in inverse floaters is associated with greater volatility in their market values. Certain of these investments may be illiquid. The absence of an active secondary market with respect to these investments could make it difficult for a Fund to dispose of a variable or floating-rate note if the issuer defaulted on its payment obligation or during periods that a Fund is not entitled to exercise its demand rights, and a Fund could, for these or other reasons, suffer a loss with respect to such instruments.

Investment Company and ETF Risk. An investment company, including an open- or closed-end mutual fund or ETF, in which a Fund invests may not achieve its investment objective or execute its investment strategies effectively, or a large purchase or redemption activity by shareholders of such an investment company might negatively affect the value of the investment company’s shares. The performance of an investment company or ETF that is actively managed will depend on its adviser’s ability to select profitable investments. An investment company of ETF that is passively managed may not accurately track its underlying index or the index may perform poorly. Additionally, a passively managed investment company or ETF may not be permitted to take defensive positions during periods of market decline or sell poorly performing securities. A Fund must also pay its pro rata portion of an investment company’s fees and expenses. Market movements or economic factors may constrain the liquidity of an investment company’s portfolio and compromise its ability to meet redemption requests. This could cause the value of a Fund’s investment in another investment company to decline.

Shares of ETFs trade on exchanges such as the New York Stock Exchange and may be bought and sold at market value. ETF shares may be thinly traded, making it difficult for a Fund to sell shares at a particular time or an anticipated price. ETF shares may also trade at a premium or discount to the net asset value of the ETF. At times, this premium or discount may be significant.

Investment Strategy Risk. There is no assurance each Fund’s investment objective will be achieved. Investment decisions may not produce the expected results. The value of a Fund may decline, and a Fund may underperform other funds with similar objectives and strategies.

Large Cap Stock Risk. Large-capitalization stocks as a group could fall out of favor with the market, causing the Fund to underperform investments that focus solely on small- or medium-capitalization stocks. Large cap companies may trail the returns of the overall stock market. Historically, large cap stocks tend to go through cycles of doing better — or worse — than the stock market in general and these periods may last as long as several years.

Liquidity Risk. Liquidity risk exists when particular investments are difficult to purchase or sell. Low trading volume, a lack of a market maker, or contractual or legal restrictions may limit or prevent a Fund from selling securities or closing derivative positions at desirable times or prices. Low levels of liquidity in particular investments may force a Fund to sell a security at a price that is lower than the Fund anticipated and may cause the Fund to lose money.

Long/Short Strategy Risk. While the fund may invest in long positions and short positions, there is the risk that the investments will not perform as expected and losses on one type of position could more than offset gains on the other, or the fund could lose money on both positions, if the portfolio managers judge the market incorrectly.

Market Risk. The overall market may perform poorly or the returns from the securities in which the Fund invests may underperform returns from the general securities markets or other types of investments. Turbulence or uncertainty in the financial markets may negatively affect issuers, which could have a negative effect on a Fund. The overall stock market may also be adversely affected by policy changes by the U.S. Government, Federal Reserve, or other government actors. A Fund’s NAV may decline over short periods due to short-term market movements and over longer periods during extended market downturns.

Master Limited Partnership (MLP) Risk. An MLP is a limited partnership, the interests of which are publicly traded on an exchange or in the OTC market. Many MLPs operate pipelines that transport commodities such as crude oil, natural gas and petroleum. The income of such MLPs correlates to the volume of the commodities transported, not their price.

 

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Investments in securities issued by MLPs involve risks that differ from traditional investments in common stock. Holders of MLP units generally have more limited control rights and limited rights to vote on matters affecting the MLP than holders of a corporation’s common stock. MLPs are controlled by a general partner which may have conflicts of interest and limited fiduciary duties to the MLP. Although investors in an MLP normally would not be liable for debts of the MLP beyond the amount of their investment, they may not be shielded from liability to the same extent as shareholders of a corporation.

MLPs are subject to various federal, state and local environmental laws and health and safety laws as well as laws and regulations specific to their particular activities. These laws and regulations address: health and safety standards for the operation of facilities, transportation systems and the handling of materials; air and water pollution requirements and standards; solid waste disposal requirements; land reclamation requirements; and requirements relating to the handling and disposition of hazardous materials. MLPs are subject to the costs of compliance with such laws applicable to them, and changes in such laws and regulations may adversely affect their results of operations.

Investing in MLPs involves certain risks related to investing in the underlying assets of the MLPs and risks associated with pooled investment vehicles. MLPs holding credit-related investments are subject to interest rate risk and the risk of default on payment obligations by debt issuers. MLPs that concentrate in a particular industry or a particular geographic region are subject to risks associated with such industry or region. Investments held by MLPs may be relatively illiquid, limiting the MLPs’ ability to vary their portfolios promptly in response to changes in economic or other conditions. MLPs may have limited financial resources, their securities may trade infrequently and in limited volume, and they may be subject to more abrupt or erratic price movements than securities of larger or more broadly based companies.

Distributions from an MLP may consist in part of a return of the amount originally invested, which would not be taxable to the extent the distributions do not exceed the investor’s adjusted basis in its MLP interest. These reductions in a Fund’s adjusted tax basis in the MLP securities will increase the amount of gain (or decrease the amount of loss) recognized by the Fund on a subsequent sale of the securities.

Mortgage-related and Other Asset-backed Securities Risk. Mortgage-related and asset-backed securities are subject to extension risk and prepayment risk:

 

    Extension Risk — Rising interest rates tend to extend the duration of mortgage-related securities, making them more sensitive to changes in interest rates. As a result, in a period of rising interest rates, if the Fund holds mortgage-related securities, it may exhibit additional volatility.

 

    Prepayment Risk — When interest rates decline, the value of mortgage-related securities with prepayment features may not increase as much as other fixed-income securities because borrowers may pay off their mortgages sooner than expected. In addition, the potential impact of prepayment on the price of asset-backed and mortgage-backed securities may be difficult to predict and result in greater volatility.

Multimanager and Subadviser Selection Risk. To a significant extent, each Fund’s performance will depend on Morningstar’s skill in selecting subadvisers and each subadviser’s skill in selecting securities and executing its strategy. Subadviser strategies may occasionally be out of favor and subadvisers may underperform relative to their peers or benchmarks. In addition, because portions of each Fund’s assets are managed by different subadvisers using different styles, a Fund could experience overlapping securities transactions. Certain subadvisers may be purchasing securities at the same time other subadvisers may be selling those same securities, which may lead to higher transaction expenses compared to Funds using a single investment management style.

Municipal Securities Risk. The municipal securities market could be significantly affected by adverse political and legislative changes, as well as uncertainties related to taxation or the rights of municipal security holders. Changes in the financial health of a municipality may make it difficult for it to pay interest and principal when due. In addition, changes in the financial condition of one or more individual municipal issuers or insurers of municipal issuers can

 

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affect the overall municipal securities market. Changes in market conditions may directly impact the liquidity and valuation of municipal securities, which may, in turn, adversely affect the yield and value of the Fund’s municipal securities investments. Declines in real estate prices and general business activity may reduce the tax revenues of state and local governments.

In the case of insured municipal securities, insurance supports the commitment that interest payments on a municipal security will be made on time and the principal will be repaid when the security matures. Insurance does not, however, protect a Fund or its shareholders against losses caused by declines in a municipal security’s market value. The Portfolio Managers generally look to the credit quality of the issuer of a municipal security to determine whether the security meets a Fund’s quality restrictions, even if the security is covered by insurance. However, a downgrade in the claims-paying ability of an insurer of a municipal security could have an adverse effect on the market value of the security.

In recent periods an increasing number of municipal issuers have defaulted on obligations, been downgraded, or started insolvency proceedings. Financial difficulties of municipal issuers may continue or get worse. Because many municipal securities are issued to finance similar types of projects, especially those related to education, health care, housing, transportation, and utilities, conditions in those sectors can affect the overall municipal securities market. Municipal securities backed by current or anticipated revenues from a specific project or specific asset (so-called “private activity bonds”) may be adversely impacted by declines in revenue from the project or asset. Declines in general business activity could affect the economic viability of facilities that are the sole source of revenue to support private activity bonds. To the extent that a Fund invests in private activity bonds, a part of its dividends will be a Tax Preference Item.

Generally, a Fund purchases municipal securities the interest on which, in the opinion of counsel to the issuer, is exempt from federal income tax. There is no guarantee that such an opinion will be correct, and there is no assurance that the Internal Revenue Service will agree with such an opinion. Municipal securities generally must meet certain regulatory and statutory requirements to distribute interest that is exempt from federal income tax. If any municipal security held by the Fund fails to meet such requirements, the interest received by the Fund from such security and distributed to shareholders would be taxable. In addition, there could be changes in applicable tax laws or tax treatments that reduce or eliminate the current federal income tax exemption on municipal securities or otherwise adversely affect the current federal or state status of municipal securities.

The Fund may not be able to sell a municipal security in a timely manner at a desired price. The secondary market for certain municipal bonds tends to be less developed and less liquid than many other bond markets. Reduced liquidity in the bond markets can result from a number of events, such as limited trading activity, reductions in bond inventory, and rapid or unexpected changes in interest rates. Less liquid markets could lead to greater price volatility and limit the fund’s ability to sell a holding at a suitable price.

New Fund Risk. Each Fund is new and has no operating history, and there can be no assurance that a Fund will grow to or maintain an economically viable size.

Nondiversification Risk. The Morningstar Multisector Bond Fund is a non-diversified investment company, which means that more of its assets may be invested, directly or indirectly, in the securities of a single issuer than a diversified investment company. This may make the value of the Fund’s shares more susceptible to certain risks than shares of a diversified investment company. As a non-diversified fund, the Fund has a greater potential to realize losses upon the occurrence of adverse events affecting a particular issuer.

Options Risk. The use of options involves investment strategies and risks different from those associated with ordinary portfolio securities transactions. If the Portfolio Managers apply a strategy at an inappropriate time or judge market conditions or trends incorrectly, the use of options may lower a Fund’s return. There can be no guarantee that the use of options will increase a Fund’s return or income. In addition, there may be an imperfect correlation between the movement in prices of options and the securities underlying them and there may at times not be a liquid secondary market for various options. Government legislation or regulation could affect the use of derivatives and could limit a Fund’s ability to pursue its investment strategies.

 

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When a Fund writes a covered call option, it assumes the risk that it will have to sell the underlying security at an exercise price that may be lower than the market price of the security, and it gives up the opportunity to profit from a price increase in the underlying security above the exercise price. If a call option that a Fund has written is exercised, the Fund will experience a gain or loss from the sale of the underlying security. If a call option that a Fund has written expires unexercised, the Fund will experience a gain in the amount of the premium it received; however, that gain may be offset by a decline in the market value of the underlying security during the option period.

When a Fund writes a put option, it assumes the risk that it will have to purchase the underlying security at an exercise price that may be higher than the market price of the security. If the market price of the underlying security declines, a Fund would expect to suffer a loss. However, the premium a Fund received for writing the put should offset a portion of the decline.

Each Fund’s ability to close out its position as a purchaser or seller of an OTC or exchange-listed put or call option is dependent, in part, upon the liquidity of the option market. There are significant differences between the securities and options markets that could result in an imperfect correlation among these markets, causing a given transaction not to achieve its objectives. A Fund’s ability to utilize options successfully will depend on the ability of the Fund’s investment adviser to predict pertinent market movements, which cannot be assured.

Portfolio Turnover Risk. A Fund may engage in active and frequent trading of its portfolio securities. Such a strategy often involves higher transaction costs, including brokerage commissions and dealer mark-ups, and may increase the amount of capital gains (in particular, short-term gains) realized by a Fund. Shareholders may pay tax on such capital gains. These effects of higher than normal portfolio turnover may adversely affect Fund performance.

Preferred Stock Risk. Preferred stocks are equity securities that often pay dividends at a specific rate and have a preference over common stocks for dividend payments and liquidation of assets. Preferred stocks are subject to issuer-specific and market risks applicable generally to equity securities, however, unlike common stocks, participation in the growth of an issuer may be limited. Distributions on preferred stocks are generally payable at the discretion of the issuer’s board of directors, after the company makes required payments to holders of its bonds and other debt securities. For this reason, the value of preferred stock will usually react more strongly than bonds and other debt securities to actual or perceived changes in the company’s financial condition or prospects. Preferred stock of smaller companies may be more vulnerable to adverse developments than preferred stock of larger companies. Preferred stocks may be less liquid than common stocks. Preferred stocks may include provisions that permit the issuer, at its discretion, to defer or omit distributions for a stated period without any adverse consequences to the issuer. Preferred shareholders may have certain rights if distributions are not paid but generally have no legal recourse against the issuer and may suffer a loss of value if distributions are not paid. Generally, preferred shareholders have no voting rights with respect to the issuer unless distributions to preferred shareholders have not been paid for a stated period, at which time the preferred shareholders may elect a number of directors to the issuer’s board. Generally, once all the distributions have been paid to preferred shareholders, the preferred shareholders no longer have voting rights.

Private Placements Risk. A Fund may invest in securities that are purchased in private placements and, accordingly, are subject to restrictions on resale as a matter of contract or under federal securities laws. Because there may be relatively few potential purchasers for such investments, especially under adverse market or economic conditions or in the event of adverse changes in the financial condition of the issuer, a Fund could find it more difficult to sell such securities when a subadviser believes it advisable to do so or may be able to sell such securities only at prices lower than if such securities were more widely held. At times, it may also be more difficult to determine the fair value of such securities for purposes of computing a Fund’s net asset value.

The absence of a trading market can make it difficult to ascertain a market value for illiquid investments. Disposing of illiquid investments may involve time-consuming negotiation and legal expenses, and it may be difficult or impossible for a Fund to sell them promptly at an acceptable price. A Fund may have to bear the extra expense of registering such securities for resale and the risk of substantial delay in effecting such registration. In addition, market quotations are less readily available. The judgment of a subadviser may at times play a greater role in valuing these securities than in the case of publicly traded securities.

 

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Redemption Risk. A Fund may experience losses when selling securities to meet redemption requests. This risk is greater for larger redemption requests or redemption requests during poor market conditions. Redemption risk may increase if a Fund must sell illiquid securities to meet redemption requests. Heavy redemptions may hurt the Fund’s performance.

REITs and Other Real Estate Companies Risk. REIT and other real estate company securities are subject to, among other risks: declines in property values; defaults by mortgagors or other borrowers and tenants; increases in property taxes and other operating expenses; overbuilding in their sector of the real estate market; fluctuations in rental income; changes in interest rates; lack of availability of mortgage funds or financing; extended vacancies of properties, especially during economic downturns; changes in tax and regulatory requirements; losses due to environmental liabilities; or casualty or condemnation losses. REITs also are dependent upon the skills of their managers and are subject to heavy cash flow dependency or self-liquidation. Domestic REITs could be adversely affected by failure to qualify for tax-free “pass-through” of net income and gains under the Internal Revenue Code of 1986, as amended (the Code), or to maintain their exemption from registration under the Investment Company Act of 1940, as amended. The value of REIT common shares may decline when interest rates rise. During periods of high interest rates, REITs and other real estate companies may lose appeal for investors who may be able to obtain higher yields from other income-producing investments. High interest rates may also mean that financing for property purchases and improvements is more costly and difficult to obtain.

Most equity REITs receive a flow of income from property rentals, which, after covering their expenses, they pay to their shareholders in the form of dividends. Equity REITs may be affected by changes in the value of the underlying property they own, while mortgage REITs may be affected by the quality of any credit they extend.

REIT and other real estate company securities tend to be small- to mid-cap securities and are subject to the risks of investing in small- to mid-cap securities. Some of the REIT securities in which a Fund invests may be preferred stock, which receives preference in the payment of dividends.

Repurchase Agreements and Purchase and Sale Contracts Risk. If the other party to a repurchase agreement or purchase and sale contract defaults on its obligation under the agreement, the Fund may suffer delays and incur costs or lose money in exercising its rights under the agreement. If the seller fails to repurchase the security in either situation and the market value of the security declines, the Fund may lose money.

Reverse Repurchase Agreements Risk. Reverse repurchase agreements involve the sale of securities held by a Fund with an agreement to repurchase the securities at an agreed-upon price, date and interest payment. Reverse repurchase agreements involve the risk that the other party may fail to return the securities in a timely manner or at all. A Fund could lose money if it is unable to recover the securities and the value of the collateral held by the Fund, including the value of the investments made with cash collateral, is less than the value of securities. These events could also trigger adverse tax consequences to the Fund.

Short Sales Risk. Short sales involve selling a security a Fund does not own in anticipation that the security’s price will decline. To complete the transaction, a Fund must borrow the security to make delivery to the buyer. A Fund is then obligated to replace the security borrowed by purchasing the security at the market price at the time of replacement. The price at such time may be higher or lower than the price at which the security was sold by a Fund. Short sales are highly speculative and may subject a Fund to, at least theoretically, unlimited risk due to the fact that the value of the security underlying the short sale may appreciate indefinitely.

Because a Fund may invest the proceeds of a short sale, another effect of short selling on the Fund is similar to the effect of leverage, in that it amplifies changes in the Fund’s net asset value since it increases the exposure of the Fund to the market and may increase losses and the volatility of returns.

A Fund may not always be able to close out a short position at a favorable time or price. A lender may request that borrowed securities be returned to it on short notice, and a Fund may have to buy the borrowed securities at an unfavorable price, which will potentially reduce or eliminate any gain or cause a loss to the Fund.

 

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When a Fund is selling a security short, it must maintain a segregated account of cash or high-grade securities equal to the margin requirement. As a result, a Fund may maintain high levels of cash or other liquid assets (such as U.S. Treasury bills, money market accounts, repurchase agreements, certificates of deposit, high quality commercial paper and long equity positions) or may use borrowings for this cash. The need to maintain cash or other liquid assets in segregated accounts could limit a Fund’s ability to pursue other opportunities as they arise.

Smaller Companies Risk. The stocks of small- or mid-sized companies may be subject to more abrupt or erratic market movements than stocks of larger, more established companies. Small companies may have limited product lines or financial resources, or may be dependent upon a small or inexperienced management group, and their securities may trade less frequently and in lower volume than the securities of larger companies, which could lead to higher transaction costs.

Sovereign Debt Securities Risk. Sovereign debt instruments are subject to the risk that a governmental entity may delay or refuse to pay interest or repay principal on its sovereign debt, due, for example, to cash flow problems, insufficient foreign currency reserves, political considerations, the relative size of the governmental entity’s debt position in relation to the economy, or the failure to put in place economic reforms required by the International Monetary Fund or other multilateral agencies. If a governmental entity defaults, it may ask for more time in which to pay or for further loans. There is no legal process for collecting sovereign debt that a government does not pay nor are there bankruptcy proceedings through which all or part of the sovereign debt that a governmental entity has not repaid may be collected.

Standby Commitments Risk. Standby commitment agreements involve the risk that the security the Fund buys will lose value prior to its delivery to the Fund and will no longer be worth what the Fund has agreed to pay for it. These agreements also involve the risk that if the security goes up in value, the counterparty will decide not to issue the security. In this case, the Fund loses both the investment opportunity for the assets it set aside to pay for the security and any gain in the security’s price.

Stock Market/Company Risk. Stocks can be highly volatile and prices may fluctuate widely, which means you should expect a wide range of returns and could lose money, even over a long time period. Various economic, industry, regulatory, political or other factors can dramatically affect the stock market as a whole, certain industry sectors, and/or individual companies.

Swaps Risk. A swap is an agreement that obligates two parties to exchange on specified dates series of cash flows that are calculated by reference to changes in a specified rate or the value of an underlying asset. The use of swaps is a highly specialized activity which involves investment techniques, risk analyses and tax planning different from those associated with ordinary portfolio securities transactions. Although certain swaps have been designated for mandatory central clearing, swaps are still privately negotiated instruments featuring a high degree of customization. Some swaps may be complex and valued subjectively. Swaps also may be subject to pricing or “basis” risk, which exists when a particular swap becomes extraordinarily expensive relative to historical prices or the price of corresponding cash market instruments. Because swaps often involve leverage, their use can significantly magnify the effect of price movements of the underlying securities or reference measures, disproportionately increasing the Fund’s losses and reducing the Fund’s opportunities for gains. At present, there are few central exchanges or markets for certain swap transactions. Therefore, such swaps may be less liquid than exchange- traded swaps or instruments. In addition, if a swap counterparty defaults on its obligations under the contract, a Fund could sustain significant losses.

Tobacco Bonds Risk. Tobacco bonds are securitizations backed by annual payments from tobacco companies arising out of a master settlement agreement reached in 1998 between the tobacco companies and various states, territories and municipalities. The performance of tobacco bonds may depend to a greater extent on, the overall condition of the tobacco settlement sector. Tobacco settlement revenue bonds are generally neither general nor legal obligations of a state or any of its political subdivisions and neither the full faith and credit nor the taxing power nor any other assets or revenues of a state or of any political subdivision will be pledged to the payment of any such bonds. In addition, tobacco companies’ profits from the sale of tobacco products are inherently variable and difficult to estimate. There can be no guarantee that tobacco companies will earn enough revenues to cover the payments due under tobacco bonds. The revenues of tobacco companies may be adversely affected by the adoption of new legislation and/or by litigation.

 

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U.S. Government Securities Risk. U.S. government obligations have different levels of credit support and, therefore, different degrees of credit risk. Treasury securities and some other securities issued by agencies and instrumentalities of the U.S. government are supported by the full faith and credit of the United States, but others are neither insured nor guaranteed by the U.S. government and, instead, may be supported only by the credit of the issuer or by the right of the issuer to borrow from the U.S. Department of the Treasury. The Treasury has the authority to provide financial support to these debt obligations, but no assurance can be given that the U.S. government will do so.

Valuation Risk. The price a Fund could receive upon the sale of any particular portfolio investment may differ from the Fund’s valuation of the investment, particularly for securities that trade in thin or volatile markets or that are valued using a fair valuation methodology or a price provided by an independent pricing service. As a result, the price received upon the sale of an investment may be less than the value ascribed by a Fund, and the Fund could realize a greater than expected loss or lesser than expected gain upon the sale of the investment. Pricing services that value fixed-income securities generally utilize a range of market-based and security-specific inputs and assumptions, as well as considerations about general market conditions, to establish a price. Pricing services generally value fixed-income securities assuming orderly transactions of an institutional round lot size, but may be held or transactions may be conducted in such securities in smaller, odd lot sizes. Odd lots often trade at lower prices than institutional round lots. A Fund’s ability to value its investments may also be impacted by technological issues and/or errors by pricing services or other third-party service providers.

When-Issued and Delayed-Delivery Securities Risk. When-issued and delayed delivery securities and forward commitments involve the risk that the security the Fund buys will lose value prior to its delivery. There also is the risk that the security will not be issued or that the other party to the transaction will not meet its obligation. If this occurs, the Fund may lose both the investment opportunity for the assets it set aside to pay for the security and any gain in the security’s price.

Exclusion from Regulation as a Commodity Pool Operator

[Morningstar has claimed an exclusion from the definition of commodity pool operator under the Commodity Exchange Act (CEA) and the rules of the Commodity Futures Trading Commission (CFTC) with respect to the Funds. Morningstar is therefore not subject to registration or regulation as a commodity pool operator under the CEA with respect to the Funds. The Funds are not intended as vehicles for trading in the futures, commodity options or swaps markets. In addition, Morningstar is relying upon a related exclusion from the definition of commodity trading advisor under the CEA and the rules of the CFTC. The Funds are not intended as a vehicle for trading in the commodity futures, commodity options or swaps markets. The CFTC has neither reviewed nor approved the Advisor’s reliance on these exclusions, or the Funds, their investment strategies or prospectus, or this SAI.][Rule 4.5 status pending final confirmation.]

 

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PORTFOLIO HOLDINGS INFORMATION

A complete description of the Funds’ policies and procedures regarding disclosure of the Fund’s portfolio holdings is available in the Fund’s SAI and on the Fund’s website at www.                .com.

MANAGEMENT OF THE FUNDS

Investment Adviser

Morningstar, located at 22 W Washington Street, Chicago, IL 60602, serves as investment adviser to the Funds under an investment advisory agreement (the Advisory Agreement) with Morningstar Funds Trust (the Trust), on behalf of each Fund. Morningstar is registered as an investment adviser with the U.S. Securities and Exchange Commission (the SEC) and was formed on September 20, 1999 in Delaware.

As the Funds’ adviser, Morningstar has overall supervisory responsibility for the general management and investment of each Fund’s securities portfolio, and subject to review and approval by the Board, sets each Fund’s overall investment strategies. Morningstar is also responsible for the oversight and evaluation of each Fund’s subadvisers. The following portfolio managers are primarily responsible for the day-to-day management of the Funds:

 

    Daniel E. McNeela, CFA (Morningstar U.S. Equity Fund, Morningstar International Equity Fund, Morningstar Total Return Bond Fund, Morningstar Municipal Bond Fund, and Morningstar Multisector Bond Fund)—Dan McNeela is a senior portfolio manager and co-head of target risk strategies with Morningstar’s Investment Management group. McNeela is focused on portfolio construction, asset allocation, and manager due diligence. Along with the other comanagers of the Funds, he is responsible for subadviser selection and oversight, allocating the Funds’ assets to the subadvisers and any ETFs that are selected, constructing the portfolios to achieve desired asset class exposures including any residual cash, in addition to other portfolio management responsibilities. Prior to joining the investment management group in 2006, McNeela was associate director of mutual fund analysis for Morningstar, Inc. McNeela served as the editor of Morningstar’s flagship newsletter, Morningstar Mutual Funds and appeared before House and Senate subcommittees to testify as an investor advocate regarding the effectiveness of 529 college savings plans. He joined Morningstar in 2000 as a fund analyst with the individual investor group, specializing in domestic equity funds, with subspecialties in real estate and long-short funds and was the lead analyst on funds offered by Janus, Putnam, Royce and Goldman Sachs. Prior to Morningstar, he held a number of corporate finance positions at Scott Foresman, a leading educational publisher. McNeela holds a BS in Finance from Indiana University and an MBA from the from the University of Illinois. McNeela has served as a portfolio manager for the Funds since their inception.

 

    Marta K. Norton, CFA (Morningstar Global Income Fund, Morningstar Defensive Bond Fund, Morningstar Unconstrained Allocation Fund, and Morningstar Alternatives Fund)—Marta Norton is a portfolio manager for Morningstar’s Investment Management group. She leads the group’s U.S. outcome-based strategies team, which focuses on inflation-plus, cash-plus, and income investment strategies. Along with the other comanagers of the Funds, she is responsible for subadviser selection and oversight, allocating the Funds’ assets to the subadvisers and any ETFs that are selected, constructing the portfolios to achieve desired asset class exposures including any residual cash, in addition to other portfolio management responsibilities. Previously, Norton was an investment manager for Morningstar Investment Services, where she managed asset allocation, income, and absolute return strategies. Prior to joining the investment management group in 2008, she was a senior mutual fund analyst for Morningstar, Inc. and led Morningstar’s 529 college-savings-plan coverage. Before joining Morningstar in 2005, Norton was an economist for the Bureau of Labor Statistics and a research analyst for LECG, LLC. Norton holds a BA from Wheaton College. Norton has served as a portfolio manager for the Funds since their inception.

 

   

Gareth P. Lyons (Morningstar International Equity Fund)—Gareth Lyons is a portfolio manager on the active asset allocation team in Morningstar’s Investment Management group. In this role, Lyons is responsible for manager assessment and selection as well as portfolio construction for multi-manager portfolios and models. Along with the other comanager of the Fund, he is responsible for subadviser

 

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selection and oversight, allocating the Fund’s assets to the subadvisers and any ETFs that are selected, constructing the portfolio to achieve desired asset class exposures including any residual cash, in addition to other portfolio management responsibilities. Prior to joining the investment management group in 2017, Lyons was director with Morningstar Investment Management’s manager selection team, overseeing manager research and selection for retirement-focused clients. Lyons joined Morningstar, Inc. as a mutual fund analyst in 2003, specializing in international and domestic equity funds. Prior to joining the firm, Lyons was an equity analyst and portfolio manager with DHK Trading, LLC, and before that, he was an equity analyst with UBS Global Asset Management. Lyons holds a BA in English and Economics (with honors) from University College Dublin, Ireland. Lyons has served as a portfolio manager for the Fund since its inception.

 

    Michael A. Stout, CFA (Morningstar U.S. Equity Fund)—Mike Stout is a portfolio manager within Morningstar’s Investment Management group, specializing in domestic equity. Along with the other comanager of the Fund, he is responsible for subadviser selection and oversight, allocating the Fund’s assets to the subadvisers and any ETFs that are selected, constructing the portfolios to achieve desired asset class exposures including any residual cash, in addition to other portfolio management responsibilities. Prior to joining the investment management group in 1998 as a founding member, Stout was senior analyst and editor of fund research. Before that, he was a research analyst covering open-end funds. He began his career at Morningstar in 1993 as a research analyst covering closed-end funds. Before joining Morningstar, Stout was an investment broker with A.G. Edwards & Sons and previously a captain in the United States Air Force. He holds a BA in music from The Ohio State University and an MBA from the University of Texas at San Antonio. Stout has served as a portfolio manager for the Fund since its inception.

 

    John P. McLaughlin, CFA (Morningstar Total Return Bond Fund, Morningstar Municipal Bond Fund, and Morningstar Multisector Bond Fund)—John McLaughlin is an associate portfolio manager for Morningstar’s Investment Management group. McLaughlin focuses on portfolio construction, asset allocation, and investment due diligence. McLaughlin is also a member of Investment Management’s Global Asset Allocation team focusing on global credit in addition to Americas’ fixed-income research. Along with the other comanagers of the Funds, he is responsible for subadviser selection and oversight, allocating the Funds’ assets to the subadvisers and any ETFs that are selected, constructing the portfolios to achieve desired asset class exposures including any residual cash, in addition to other portfolio management responsibilities. Prior to joining Morningstar in 2014, McLaughlin worked at RVK, Inc where he advised large sovereign wealth funds and pension plans on asset allocation, asset class structure, and manager selection. Prior to RVK, McLaughlin worked for Russell Investments where he managed custom derivative overlay portfolios for institutional investors globally. McLaughlin holds a BA in Finance from Seattle University graduating with high honors. McLaughlin has served as a portfolio manager for the Funds since their inception.

 

    Michelle R. Ward, CFA (Morningstar Global Income Fund, Morningstar Total Return Bond Fund, Morningstar Defensive Bond Fund, Morningstar Multisector Bond Fund, Morningstar Unconstrained Allocation Fund, and Morningstar Alternatives Fund)—Michelle Ward is an associate portfolio manager for Morningstar’s Investment Management group. Ward focuses on portfolio construction, fixed-income asset class research, and investment due diligence and is a member of the U.S. outcome-based strategies team, which focuses on inflation-plus, cash-plus, and income investment strategies. Along with the other comanagers of the Funds, she is responsible for subadviser selection and oversight, allocating the Funds’ assets to the subadvisers and any ETFs that are selected, constructing the portfolios to achieve desired asset class exposures including any residual cash, in addition to other portfolio management responsibilities. Prior to joining the investment management group in 2014, Ward was a senior analyst and team lead covering active strategies on Morningstar, Inc.’s manager research team. Her focus was on fixed-income and real return strategies. Before joining Morningstar in 2012, Ward was a research analyst for Ellwood Associates, an institutional investment consulting firm, where she was a member of a consulting team on a variety of plan types and served as a member of the firm’s fixed-income and real asset manager research teams. Ward holds a BA in Economics from the University of Michigan. Ward has served as a portfolio manager for the Funds since their inception.

 

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The SAI provides additional information about the portfolio managers’ compensation, other accounts managed by the portfolio managers, and their ownership of securities in each Fund.

Under the Advisory Agreement, Morningstar is entitled to receive an annual management fee calculated daily and payable monthly equal to the following percentage of a Fund’s average daily net assets:

 

FUND

   MANAGEMENT FEE  

Morningstar U.S. Equity Fund

     0.67

Morningstar International Equity Fund

     0.83

Morningstar Global Income Fund

     0.35

Morningstar Total Return Bond Fund

     0.44

Morningstar Municipal Bond Fund

     0.44

Morningstar Defensive Bond Fund

     0.36

Morningstar Multisector Bond Fund

     0.61

Morningstar Unconstrained Allocation Fund

     0.47

Morningstar Alternatives Fund

     0.85

Morningstar has agreed, through at least [                    ], 2019 [Date to be inserted will be at least one year from the date of this Prospectus], to waive all or a portion of its advisory fees and, if necessary, to assume certain other expenses (to the extent permitted by the Internal Revenue Code of 1986, as amended) to the extent necessary to ensure that each Fund’s Total Annual Fund Operating Expenses (excluding taxes, interest, brokerage commissions, trading costs, acquired fund fees and expenses, litigation expenses, and extraordinary expenses) do not exceed the expense caps set forth below.

 

FUND

   EXPENSE CAP  

Morningstar U.S. Equity Fund

     0.87

Morningstar International Equity Fund

     1.01

Morningstar Global Income Fund

     0.89

Morningstar Total Return Bond Fund

     0.55

Morningstar Municipal Bond Fund

     0.63

Morningstar Defensive Bond Fund

     0.51

Morningstar Multisector Bond Fund

     0.80

Morningstar Unconstrained Allocation Fund

     1.00

Morningstar Alternatives Fund

     1.29

Subject to approval by the Board, the Funds have agreed to reimburse the adviser for any waived fees or expenses assumed for a Fund in later periods; provided, however, that the repayment shall be payable only to the extent that it (1) can be made during the three years after the end of the calendar month in which the adviser waived fees or assumed expenses for the Fund, and (2) can be repaid without causing the Fund’s Total Annual Fund Operating Expenses (excluding taxes, interest, brokerage commissions, trading costs, acquired fund fees and expenses, litigation expenses, and extraordinary expenses) of the Fund to exceed any applicable expense limitation that was in place for the Fund at the time of the waiver and/or assumption of expenses.

Details about the Board’s considerations in approving each Fund’s Advisory Agreement will be available in the Funds’ semi-annual report to shareholders for the period ending October 31, 2018.

Fund Expenses

In addition to the advisory fees discussed above, each Fund incurs other expenses such as custodian, transfer agency, interest, acquired fund fees and expenses, and other customary Fund expenses. (Acquired fund fees and expenses are indirect fees that each Fund incurs from investing in the shares of other investment companies.)

 

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Subadviser Evaluation and Selection

Morningstar is responsible for hiring, terminating, and replacing subadvisers, subject to Board approval. Before hiring a subadviser, we perform due diligence on the subadviser, including (but not limited to), quantitative and qualitative analysis of the subadviser’s investment process, risk management, and historical performance. Morningstar’s goal is to hire subadvisers who it believes are skilled and have distinguished themselves through consistent and superior performance. Generally, we select subadvisers who we believe will be able to add value through security selection or allocations to securities, markets, or strategies. Morningstar is responsible for the general supervision of the subadvisers as well as allocating each Fund’s assets among the subadvisers and rebalancing the portfolio as necessary from time to time.

More on Multistyle Management: The investment methods used by the subadvisers in selecting securities for each Fund vary. The allocation of each Fund’s portfolio managed by one subadviser will, under normal circumstances, differ from the allocations managed by the other subadvisers with respect to portfolio composition, turnover, issuer capitalization, and issuer financial condition. Because selections are made independently by each subadviser, it is possible that a security held by one portfolio allocation may also be held by other portfolio allocations of the Fund or that several subadvisers may simultaneously favor the same industry.

Morningstar is responsible for establishing the target allocation of Fund assets to each subadviser and may adjust the target allocations at its discretion. Market performance may result in allocation drift among the subadvisers of a Fund. Morningstar is also responsible for periodically reallocating the portfolio among the subadvisers, the timing and degree of which will be determined by Morningstar. Each subadviser independently selects the brokers and dealers to execute transactions for the allocation of the Fund being managed by that subadviser. A subadviser may occasionally hold more than the specified maximum number of holdings in its portfolio, which may be the result of an involuntary spin-off by one of the companies held in the portfolio, the payment of a stock dividend or split in a separate class of stock, or an overlap in selling a portfolio security while simultaneously adding a new security.

At times, allocation adjustments among subadvisers may be considered tactical with over- or under-allocations to certain subadvisers based on Morningstar’s assessment of the risk and return potential of each subadviser’s strategy. Subadviser allocations are also influenced by each subadviser’s historical returns and volatility, which are assessed by examining the performance of strategies managed by the subadvisers in other accounts that Morningstar believes to be similar to those that will be used for a Fund. Morningstar has analyzed the individual and combined performance of the subadvisers in a variety of investment environments.

If a subadviser ceases to manage an allocation of a Fund’s portfolio, Morningstar will select a replacement subadviser or allocate the assets among the remaining subadvisers. The securities that were held in the departing subadviser’s allocation of the Fund’s portfolio may be allocated to and retained by another subadviser of the Fund or will be liquidated in an orderly manner, taking into account various factors, which may include but are not limited to the market for the security and the potential tax consequences. Morningstar may also add additional subadvisers to increase Fund diversification or capacity. Absent exemptive relief, any new subadviser must be first be approved by the respective Funds’ shareholders.

Pursuant to the SEC exemptive order described below, Morningstar will act as the manager of managers of each Fund and be responsible for the investment performance of each Fund, since it will allocate the Fund’s assets to the subadvisers and recommends hiring or changing subadvisers to the board of trustees. The “manager of managers” structure enables the Fund to operate with greater efficiency by not incurring the expense and delays associated with obtaining shareholder approval of subadvisory agreements. The structure does not permit investment advisory fees paid by each Fund to be increased or to change Morningstar’s obligations under the Advisory Agreement, including Morningstar’s responsibility to monitor and oversee subadvisory services furnished to each Fund, without shareholder approval. Furthermore, any subadvisory agreements with affiliates of a Fund or Morningstar will require shareholder approval.

Multimanager Exemptive Order: As referenced above, the Trust, on behalf of the Funds, and Morningstar have obtained an exemptive order from the SEC, which permits Morningstar, subject to certain conditions, to select new subadvisers with the approval of the Board but without obtaining shareholder approval. The order also permits Morningstar to change the terms of agreements with the subadvisers or to continue the employment of a subadviser after an event that would otherwise cause the automatic termination of services. The order will also permit the Funds to disclose subadvisers’ fees only in the aggregate in its registration statement. This arrangement has been approved by the Board of trustees and the Fund’s initial shareholder. Shareholders will be notified of any changes made to subadvisers or material changes to subadvisory agreements within 90 days of the change.

 

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Subadvisers and Portfolio Managers

Morningstar has entered into a subadvisory agreement with each subadviser. Morningstar compensates each Fund’s subadvisers out of the investment advisory fees it receives from the Fund. Each subadviser makes investment decisions for the assets it has been allocated to manage. Morningstar oversees the subadvisers for compliance with each Fund’s investment objective, policies, strategies and restrictions, and monitors each subadviser’s adherence to its investment style. The board of trustees supervises Morningstar and the subadvisers, establishes policies that they must follow in their management activities, and oversees the hiring, termination and replacement of subadvisers recommended by Morningstar.

A discussion regarding the basis of the board of trustees’ approval of the investment subadvisory agreements between Morningstar and the respective subadvisers will be available in the Funds’ semi-annual report to shareholders for the period ending October 31, 2018.

The following provides additional information about each subadviser and the portfolio managers who are responsible for the day-to-day management of each subadviser’s allocation. The SAI provides additional information about the portfolio managers’ compensation, other accounts managed by the portfolio managers, and their ownership of securities in each Fund.

The Subadvisers

MORNINGSTAR U.S. EQUITY FUND

Morningstar has currently selected six subadvisers for the Morningstar U.S. Equity Fund, each to cover a specific investment mandate, as outlined in the table below. Additional information on each subadviser and its portfolio managers follows.

 

Subadviser

  

Investment Mandate

ClearBridge Investments, LLC    Large-Cap Growth
Diamond Hill Capital Management, Inc.    Mid-Cap Value
Levin Capital Strategies, L.P.    Large-Cap Blend
MFS Investment Management    Large-Cap Value
Wasatch Advisors, Inc.    Small-/Mid-Cap Growth
Westwood Management Corp.    Small-Cap Value/Blend

ClearBridge Investments, LLC (ClearBridge), 620 Eighth Avenue, New York, NY 10018, serves as a subadviser to the Fund under a subadvisory agreement (the ClearBridge Subadvisory Agreement) with Morningstar on behalf of the Fund. ClearBridge has been registered with the SEC as an investment adviser since 2005. ClearBridge is a wholly-owned subsidiary of Legg Mason, Inc., a publicly traded global asset management company headquartered in Baltimore, MD. As of December 31, 2017, ClearBridge’s total assets under management (including assets under management of ClearBridge, LLC, an affiliate of ClearBridge) were approximately $137.0 billion. This includes $16.8 billion for which ClearBridge provides non-discretionary investment models to managed account sponsors. The following portfolio managers are primarily responsible for the day-to-day management of ClearBridge’s allocated portion of the Fund’s portfolio:

 

    Peter J. Bourbeau—Peter Bourbeau is a managing director and portfolio manager of ClearBridge and has 27 years of investment industry experience. He joined the subadviser or its predecessor in 1991. Previously, Bourbeau was a director of Citigroup Global Markets Inc. (CGMI) and served as a portfolio manager at Smith Barney Asset Management (SBAM). A graduate of the University of Florida, Bourbeau obtained his MBA from Fordham University. Bourbeau has served as a portfolio manager for the Fund since its inception.

 

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    Margaret B. Vitrano—Margaret Vitrano is a managing director and portfolio manager for ClearBridge and has 22 years of investment industry experience. She joined a ClearBridge predecessor organization in 1997. From 2006-2009, Vitrano served on the firm’s 401(k) Investment Committee, which is responsible for choosing and overseeing investments for the firm’s employee retirement plan. Prior to her role at ClearBridge, Vitrano was a research analyst for the consumer discretionary sector at Citigroup. Vitrano earned an MBA from the Wharton School at the University of Pennsylvania and a BA in Public Policy Studies and Art History from Duke University. Vitrano has served as a portfolio manager for the Fund since its inception.

Diamond Hill Capital Management, Inc. (Diamond Hill), 325 John H. McConnell Boulevard, Suite 200, Columbus, OH 43215, serves as a subadviser to the Fund under a subadvisory agreement (the Diamond Hill Subadvisory Agreement) with Morningstar on behalf of the Fund. Diamond Hill has been registered with the SEC as an investment adviser since 1988. Diamond Hill is a wholly-owned subsidiary of Diamond Hill Investment Group, Inc., a publicly traded company. As of December 31, 2017, Diamond Hill had approximately $22.3 billion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of Diamond Hill’s allocated portion of the Fund’s portfolio:

 

    Christopher A. Welch, CFA—Chris Welch serves as co-chief investment officer and portfolio manager for Diamond Hill. He joined Diamond Hill in 2005. From 2004 to 2005, Welch was a portfolio manager with Fiduciary Trust Company International. From 2002 to 2004, Welch was a private investor. From 1995 to 2002, he was a portfolio manager and senior equity analyst for Nationwide Insurance and affiliates. Welch has a BA in Economics from Yale University (summa cum laude). Welch has served as a portfolio manager for the Fund since its inception.

 

    Christopher M. Bingaman, CFA—Chris Bingaman serves as chief executive officer, president, and portfolio manager for Diamond Hill. He joined Diamond Hill in 2001. From 1997 to March 2001, Bingaman was a Senior Equity Analyst for Nationwide Insurance and affiliates. In 1997, he was an equity analyst for Dillon Capital Management, an investment advisory firm. From 1990 to 1997, Bingaman held various positions with Fifth Third Bank, First Chicago NBD, and NBD Bank. Bingaman has a BA in Finance from Hillsdale College (cum laude) and an MBA from the University of Notre Dame. Bingaman has served as a portfolio manager for the Fund since its inception.

 

    Jeannette M. Hubbard, CFA—Jenny Hubbard serves as an assistant portfolio manager for Diamond Hill. She joined Diamond Hill in 2007. From 2003 to 2006, Hubbard was a member of the Global Securitization Strategy Group at ABN Amro/LaSalle Bank. From 2001 to 2003, she was a senior equity research analyst at Avondale Partners, LLC. From 2000 to 2001, Hubbard was a vice president of Underwriting at The School Company, LLC. From 1996 to 2000, she was an analyst and assistant treasurer at Prologis Trust. Hubbard has a BA in English with an emphasis in Economics from the University of Colorado and an MA in International Economic Development Policy from Stanford University. Hubbard has served as a portfolio manager for the Fund since its inception.

Levin Capital Strategies, L.P. (Levin Capital), 595 Madison Avenue, 17th Floor, New York, NY 10022, serves as a subadviser to the Fund under a subadvisory agreement (the Levin Capital Subadvisory Agreement) with Morningstar on behalf of the Fund. Levin Capital is registered as an investment adviser with the SEC and was founded in 2005. John A. Levin controls LCS through Levin Capital Strategies, G.P., LLC, where John A. Levin is the managing member. As of December 31, 2017, Levin Capital had approximately $7.3 billion in assets under management. The following portfolio manager is primarily responsible for the day-to-day management of Levin Capital’s allocated portion of the Fund’s portfolio:

 

    John (Jack) W. Murphy—Jack Murphy is a portfolio manager and senior securities analyst for Levin Capital Strategies, L.P. Prior to joining the firm, Murphy was a portfolio manager for the long-only investment team of John A. Levin & Co., Inc. He was at Prudential Securities (1991-1995) and worked at Bain & Co. (1988-1991). Murphy earned a BS from Bryant College and an MBA from Northeastern University. Murphy has served as a portfolio manager for the Fund since its inception.

 

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Massachusetts Financial Services Company, d/b/a MFS Investment Management (MFS), 111 Huntington Avenue, Boston, MA 02199, serves as a subadviser to the Fund under a subadvisory agreement (the MFS Subadvisory Agreement) with Morningstar on behalf of the Fund. MFS is registered as an investment adviser with the SEC and was founded in 1924. MFS is an indirect, majority owned subsidiary of Sun Life Financial Inc., a diversified financial services company. As of December 31, 2017, MFS had approximately $491 billion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of MFS’s allocated portion of the Fund’s portfolio:

 

    Steven Gorham, CFA—Steve Gorham serves as an investment officer and portfolio manager for MFS. He also serves on the Global Equity Management Team. Gorham joined MFS in 1989. He earned a BS from the University of New Hampshire and an MBA from Boston College. Gorham has served as a portfolio manager for the Fund since its inception.

 

    Nevin Chitkara—Nevin Chitkara serves as an investment officer and equity portfolio manager for MFS. He joined MFS in 1997. Chitkara earned a BS from Boston University (magna cum laude) and an MBA from the Massachusetts Institute of Technology. Chitkara has served as a portfolio manager for the Fund since its inception.

Wasatch Advisors, Inc. (Wasatch Advisors), 505 Wakara Way, 3rd Floor, Salt Lake City, UT 84111, serves as a subadviser to the Fund under a subadvisory agreement (the Wasatch Advisors Subadvisory Agreement) with Morningstar on behalf of the Fund. Wasatch Advisors is registered as an investment adviser with the SEC and was founded in 1975. Wasatch Advisors is 100% employee owned with over 25 shareholders and no one employee owning 25% or more of the firm. As of December 31, 2017, Wasatch Advisors had approximately $16.6 billion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of Wasatch Advisors’ allocated portion of the Fund’s portfolio:

 

    JB Taylor—JB Taylor is chief executive officer of Wasatch Advisors and a member of its board of directors. He has been the lead portfolio manager for the Wasatch Small Cap Core Growth and Wasatch Small Cap Growth portfolios since 2000 and 2016, respectively. In addition, he is a portfolio manager for the Wasatch Global Small Cap portfolios. Taylor joined Wasatch Advisors as a research analyst in 1996, working on Wasatch Micro Cap Growth portfolios. He began working on Wasatch Small Cap Core Growth portfolios as a senior research analyst in 1999. Taylor graduated from Stanford University, earning a BS in Industrial Engineering. Taylor has served as a portfolio manager for the Fund since its inception.

 

    Paul S. Lambert—Paul Lambert has been a portfolio manager for Wasatch Small Cap Core Growth portfolios since 2005. He has also been a portfolio manager for Wasatch Small Cap Ultra Growth portfolios since 2012. He joined Wasatch Advisors as a research analyst in 2000, working on Wasatch Small Cap Value portfolios. He began working on Wasatch Small Cap Core Growth portfolios as a senior research analyst in 2003. Prior to joining Wasatch Advisors, Lambert worked for Fidelity Investments. Lambert graduated from the University of Utah, earning a BS in Finance. Lambert has served as a portfolio manager for the Fund since its inception.

 

    Michael K. Valentine—Mike Valentine has been a portfolio manager for Wasatch Small Cap Core Growth portfolios since 2017. He joined Wasatch Advisors in 2016. Since entering the asset-management business in 2005, he has covered various sectors including health care, technology, and basic materials across all market caps and geographies. Prior to joining Wasatch Advisors, Valentine was a portfolio manager at Point72 in Boston where he led a team of analysts and managed a long/short fund focused on the technology and telecom sectors. Prior to Point72, he worked from 2005 to 2012 as an analyst and a portfolio manager at Fidelity Investments in Boston where he developed a technology-sector strategy for a group of diversified funds in addition to managing long-only sector portfolios. Valentine holds a BA in Computer Science from Amherst College. Valentine has served as a portfolio manager for the Fund since its inception.

 

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Westwood Management Corp. (Westwood), 200 Crescent Court, Suite 1200, Dallas, TX 75201, serves as a subadviser to the Fund under a subadvisory agreement (the Westwood Subadvisory Agreement) with Morningstar on behalf of the Fund. Westwood is registered as an investment adviser with the SEC and was founded in 1983. Westwood is a wholly-owned subsidiary of Westwood Holdings Group, Inc., a publicly traded company. As of December 31, 2017, Westwood had approximately $19.3 billion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of Westwood’s allocated portion of the Fund’s portfolio:

 

    Matthew R. Lockridge—Matthew Lockridge joined Westwood in 2010, serves as a portfolio manager and is responsible for investment research in the consumer discretionary and staples sectors. He is also a member of the consumer/health care research group. Lockridge earned his MBA with a concentration in Finance and Accounting from the University of Chicago, Graduate School of Business and his BBA in Finance from Southern Methodist University. Lockridge has served as a portfolio manager for the Fund since its inception.

 

 

    William E. Costello, CFA—William Costello joined Westwood in 2010 and serves as a portfolio manager. He is also responsible for investment research within the energy and utilities sectors and is a member of the energy/utilities research group. Costello earned an MBA from Boston University and a BA in Economics from Marietta College. He is a member of the CFA Institute, the Boston Security Analysts Society, and the National Association of Petroleum Investment Analysts. Costello has served as a portfolio manager for the Fund since its inception.

 

    Frederic G. Rowsey, CFA—Frederic Rowsey joined Westwood in 2010, serves as a portfolio manager and is responsible for investment research in the consumer discretionary sector. He is also a member of the consumer/health care research group. Previously, he served as a research associate, assisting with research in the consumer discretionary, consumer staples, health care and energy sectors. Rowsey graduated from Harvard University with a BA in Economics and a secondary degree in Psychology. Rowsey is a member of the CFA Institute and the CFA Society of Dallas-Fort Worth. Rowsey has served as a portfolio manager for the Fund since its inception.

MORNINGSTAR INTERNATIONAL EQUITY FUND

Morningstar has currently selected four subadvisers for the Morningstar International Equity Fund, each to cover a specific investment mandate, as outlined in the table below. Additional information on each subadviser and its portfolio managers follows.

 

Subadviser

  

Investment Mandate

Harding Loevner LP    Foreign Large-Cap
Harris Associates L.P.    Foreign Large-Cap
Lazard Asset Management LLC    Diversified Emerging Markets
T. Rowe Price Associates, Inc.    Diversified Emerging Markets

Harding Loevner LP (Harding Loevner), 400 Crossing Boulevard, Fourth Floor, Bridgewater, NJ 08807, serves as a subadviser to the Fund under a subadvisory agreement (the Harding Loevner Subadvisory Agreement) with Morningstar on behalf of the Fund. Harding Loevner is registered as an investment adviser with the SEC and was founded in 1989. Harding Loevner is a Delaware limited partnership that operates independently of Affiliated Managers Group, Inc., a publicly-traded company, which owns Harding Loevner’s general partner and an interest of approximately 63% as of December 31, 2017. Harding Loevner’s key employees own the remaining interests. As of December 31, 2017, Harding Loevner had approximately $62.4 billion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of Harding Loevner’s allocated portion of the Fund’s portfolio:

 

   

Ferrill D. Roll, CFA—Ferrill Roll is a co-chief investment officer, a co-lead portfolio manager of both the Global Equity strategy and the International Equity strategy, and a financial analyst. Roll is a partner of the firm and has more than 35 years of industry experience. He joined Harding Loevner in 1996. Roll has extensive experience across a wide range of international markets, including serving as portfolio manager and general partner of Cesar Montemayor Capital, L.P., a global investment partnership investing in fixed-income, currency, and equity markets. He also worked in international equity sales at First Boston and

 

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Barings Securities. Roll began his career at JP Morgan, where he established the currency options trading department and advised corporate clients on foreign exchange markets. He graduated from Stanford University with a BA in Economics. Roll has served as a portfolio manager for the Fund since its inception.

 

    Alexander T. Walsh, CFA—Alec Walsh is a co-lead portfolio manager of the International Equity strategy and a health care analyst. He joined Harding Loevner in 1994 and is a partner of the firm. Walsh has more than 35 years of industry experience, beginning his career in money market trading and operations for J. Henry Schroder Bank & Trust. He later joined Merrill Lynch as an account executive and then PaineWebber as First Vice President, where he built an institutional equity clientele comprising Fortune 100 accounts and investment advisers. Walsh is a graduate of McGill University with a BA in North American Studies. Walsh has served as a portfolio manager for the Fund since its inception.

 

    Scott Crawshaw—Scott Crawshaw is a portfolio manager of the Emerging Markets Equity, International Equity, and Global Equity strategies and an analyst of emerging markets companies. He is a partner of the firm and has more than 20 years of industry experience. Before joining Harding Loevner in 2014, he worked for 10 years as a senior portfolio manager and research analyst of emerging markets equities for Russell Investments based in London. He also worked at ISIS Asset Management as a fund manager for global emerging market equities and at Bacon and Woodrow in its London Investment Division. Crawshaw graduated from the University of Bristol with a BS in Mathematics. Crawshaw has served as a portfolio manager for the Fund since its inception.

 

    Bryan C. Lloyd, CFA—Bryan Lloyd is a portfolio manager of the International Equity strategy and a financials analyst. He is a partner of the firm and has more than 20 years of industry experience. He joined Harding Loevner in 2011 after seven years at Calamos Asset Management. While at Calamos, Bryan served as vice president/senior analyst of financial services and prior to that held the position of research analyst. From 1999–2003, he worked at Credit Suisse First Boston as an associate in equity research. Earlier in his career, he served as a credit analyst at ABN AMRO Bank and as a financial analyst at M&T Bank. He is a graduate of Lafayette College with a BA in Mathematics and Economics. Lloyd has served as a portfolio manager for the Fund since its inception.

 

    Patrick C. Todd, CFA—Patrick Todd is a portfolio manager of the International Equity strategy and a health care and real estate analyst. Todd joined Harding Loevner in 2012 and is a partner of the firm. He has more than 10 years of industry experience. Todd previously worked at Gabelli & Company as a research analyst, Ironbound Capital as a research analyst, and Merrill Lynch Investment Managers as a portfolio specialist. Todd holds a BA in Biochemical Sciences from Harvard University and an MBA in Applied Value Investing from Columbia Business School. Todd has served as a portfolio manager for the Fund since its inception.

 

    Andrew H. West, CFA—Andrew West is the manager of research, a portfolio manager of the International Equity, International Equity Research, Global Equity Research, and Emerging Markets Equity Research strategies, and a consumer discretionary and industrials analyst. As manager of research, West is responsible for monitoring and supporting the quality and consistency of analyst output. He is a partner of the firm and has more than 25 years of industry experience. Prior to joining Harding Loevner in 2006, West worked at Standard & Poor’s Equity Research, Veitia & Associates, and International Assets Advisory Corp. West holds a BS in Business Administration/Finance from the University of Central Florida and an MBA in Finance and International Business from the New York University Leonard N. Stern School of Business. West has served as a portfolio manager for the Fund since its inception.

Harris Associates L.P. (Harris Associates), 111 S. Wacker Drive, Suite 4600, Chicago, IL 60606, serves as a subadviser to the Fund under a subadvisory agreement (the Harris Associates Subadvisory Agreement) with Morningstar on behalf of the Fund. Harris Associates is registered as an investment adviser with the SEC and was founded in 1976. Harris Associates is a limited partnership with Harris Associates, Inc. as its general partner. Harris Associates and its general partner are indirect subsidiaries of Natixis Investment Managers, L.P. which is an indirect subsidiary of Natixis Investment Managers, an international asset management group based in Paris, France. As of December 31, 2017, Harris Associates had approximately $140.4 billion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of Harris Associates’ allocated portion of the Fund’s portfolio:

 

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    David G. Herro, CFA—David Herro is deputy chairman, chief investment officer of International Equities, and a portfolio manager at Harris. Prior to joining Harris in 1992, Herro worked as a portfolio manager for The Principal Financial Group from 1986 to 1989 and as a portfolio manager for The State of Wisconsin Investment Board from 1989 to 1992. He received a BS from the University of Wisconsin-Platteville and a Master of Arts from the University of Wisconsin-Milwaukee. Herro has served as a portfolio manager for the Fund since its inception.

 

    Michael L. Manelli, CFA—Michael Manelli is a vice president, a portfolio manager, and an international investment analyst at Harris. Prior to joining Harris in 2005, Manelli was a research associate/analyst at Morgan Stanley from 2001 to 2005. He received a BBA from the University of Iowa. Manelli has served as a portfolio manager for the Fund since its inception.

Lazard Asset Management LLC (Lazard), 30 Rockefeller Plaza, New York, NY 10112, serves as a subadviser to the Fund under a subadvisory agreement (the Lazard Subadvisory Agreement” with Morningstar on behalf of the Fund. Lazard is registered as an investment adviser with the SEC and was founded in 1970. Lazard is a wholly-owned subsidiary of Lazard Frères & Co. LLC, a New York limited liability company with one member, Lazard Group LLC, a Delaware limited liability company. As of December 31, 2017, Lazard had approximately $222.4 billion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of Lazard’s allocated portion of the Fund’s portfolio:

 

    James Donald, CFA—James Donald is a managing director, head of Emerging Markets, and portfolio manager/analyst on the Emerging Markets Equity team. He is also a member of the International Equity Select with the Emerging Markets team. Since joining Lazard in 1996, Donald has been instrumental in developing and coordinating the emerging markets activities at Lazard. He began working in the investment field in 1983. Prior to joining Lazard, Donald was a portfolio manager with Mercury Asset Management. He has a BA (Hons) in history from the University of Western Ontario. James is a board member of EMpower, a charity of investment professionals focused on adolescents, healthcare, and women’s issues in emerging markets countries, as well as a member of the 20-20 Investments Association, an investor group that is focused on emerging markets. Donald has served as a portfolio manager for the Fund since its inception.

 

    Rohit Chopra—Rohit Chopra is a portfolio manager/analyst on the Emerging Markets Equity team, focusing on consumer and telecommunications research and analysis. He began working in the investment field in 1996. Prior to joining the Firm in 1999, Chopra was with Financial Resources Group, Deutsche Bank, and Morgan Stanley. He has a BS in Finance and Information Systems from New York University and also studied at the London School of Economics and Political Science. Chopra has been accepted as a Young Global Leader (YGL) in 2016 by the World Economic Forum, which engages the top political, business, and other leaders of society to shape the global future. Chopra has served as a portfolio manager for the Fund since its inception.

 

    Monika Shrestha—Monika Shrestha is a portfolio manager/analyst on the Emerging Markets Equity team, responsible for research coverage of companies in the financials sector. She began working in the investment field in 1997. Prior to joining Lazard in 2003, Shrestha was a principal at Waterview Advisors and a Corporate Finance Analyst with Salomon Smith Barney. She has an MBA from Harvard Business School, a BSE in Computer Science and Engineering, and a BS in Economics (with a concentration in Finance) from the University of Pennsylvania. Shrestha has served as a portfolio manager for the Fund since its inception.

 

   

John Reinsberg—John Reinsberg is deputy chairman of Lazard Asset Management LLC and head of International and Global Strategies. He is also a portfolio manager/analyst on the Global Equity and International Equity portfolio teams. He began working in the investment field in 1981. Prior to joining Lazard in 1992, Reinsberg was Executive Vice President with General Electric Investment Corporation and

 

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Trustee of the General Electric Pension Trust. He was also previously with Jardine Matheson (Hong Kong) and Hill & Knowlton, Inc. Reinsberg has an MBA from Columbia University and a BA from the University of Pennsylvania. He is an Overseer of the University of Pennsylvania School of Arts and Sciences, Chairman of the University of Pennsylvania Huntsman Program Advisory Board, a Trustee of the NPR Foundation (National Public Radio), a Member of the board of Directors of the Alliance for Cancer Gene Therapy, and a Member of the Board of Directors of the U.S. Institute (Institutional Investor). Reinsberg has served as a portfolio manager for the Fund since its inception.

T. Rowe Price Associates, Inc. (T. Rowe Price), 100 East Pratt Street, Baltimore, MD 21202, serves as a subadviser to the Fund under a subadvisory agreement (the T. Rowe Price Subadvisory Agreement) with Morningstar on behalf of the Fund. T. Rowe Price is registered as an investment adviser with the SEC and was founded in 1937. T. Rowe Price is a wholly owned subsidiary of T. Rowe Price Group, Inc., which was formed in 2000 as the publicly traded parent holding company of T. Rowe Price and its affiliated entities. As of December 31, 2017, T. Rowe Price had approximately $991.1 billion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of T. Rowe Price’s allocated portion of the Fund’s portfolio:

 

    Gonzalo Pángaro, CFA—Gonzalo Pángaro is a vice president and portfolio manager for T. Rowe Price International. He joined the firm in 1998 and his investment experience dates from 1991. During the past five years, Pángaro has served as a portfolio manager. He earned a master’s degree in finance from CEMA University (Centro de Estudios Macroeconomics de la Argentina), and a bachelor’s degree in business administration from the Argentine Catholic University. He is also fluent in Spanish, English and Portuguese. Pángaro has served as a portfolio manager for the Fund since its inception.

MORNINGSTAR GLOBAL INCOME FUND

Morningstar has currently selected one subadviser for the Morningstar Global Income Fund, to cover the investment mandate outlined in the table below. Additional information on the subadviser and its portfolio managers follows.

 

Subadviser

  

Investment Mandate

Schafer Cullen Capital Management, Inc.    World Stock

Schafer Cullen Capital Management, Inc. (Schafer Cullen), 645 Fifth Avenue, New York, NY 10022, serves as a subadviser to the Fund under a subadvisory agreement (the Schafer Cullen Subadvisory Agreement) with Morningstar on behalf of the Fund. Schafer Cullen is registered as an investment adviser with the SEC and was founded in 1983. Schafer Cullen is currently owned by James P. Cullen, who owns a 51% interest, and the Cullen 2011 Descendants’ Trust, which owns a 49% interest. As of December 31, 2017 Schafer Cullen had approximately $21.7 billion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of Schafer Cullen’s allocated portion of the Fund’s portfolio:

 

    James P. Cullen—James Cullen, the chairman, chief executive officer and controlling member of Schafer Cullen Capital Management, Inc., has been co-portfolio manager of the Schafer Cullen Global Equity High Dividend Fund since the Fund’s inception on April 1, 2018. He is also a founder of Cullen Capital Management LLC, a registered investment adviser, and has been its chairman and chief executive officer since May 2000. Prior to founding Schafer Cullen, Cullen was a vice president at Donaldson, Lufkin & Jenrette. Prior to Donaldson, he co-managed the New York Research, which specialized in low P/E research. Cullen began his career at Merrill Lynch in 1965 and later worked for the research firm Spencer Trask & Company. Cullen spent four years as a Navy Officer on the aircraft carrier USS Essex after receiving a BS in Finance from Seton Hall University. Cullen has served as a portfolio manager for the Fund since its inception.

 

    Rahul D. Sharma—Rahul Sharma has served as a co-portfolio manager for the Schafer Cullen Global Equity High Dividend Fund since it commenced operations on April 1, 2018. Sharma currently serves as portfolio manager and executive director at Schafer Cullen Capital Management, Inc. and has worked there since May 2000. Prior to joining Schafer Cullen, he worked in small business management. Sharma received his BS in Mathematics from the College of William and Mary in 1994. Sharma has served as a portfolio manager for the Fund since its inception.

 

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MORNINGSTAR TOTAL RETURN BOND FUND

Morningstar has currently selected two subadvisers for the Morningstar Total Return Bond Fund, each to cover a specific investment mandate, as outlined in the table below. Additional information on each subadviser and its portfolio managers follows.

 

Subadviser

  

Investment Mandate

BlackRock Financial Management, Inc.    Core Plus Bond
Western Asset Management Company    Core Bond

BlackRock Financial Management, Inc. (BlackRock), 55 East 52nd Street, New York, NY 10055, serves as a subadviser to the Fund under a subadvisory agreement (the BlackRock Subadvisory Agreement) with Morningstar on behalf of the Fund. BlackRock is registered as an investment adviser with the SEC and was founded in 1988. BlackRock is a wholly-owned subsidiary of BlackRock, Inc., a publicly traded company. As of December 31, 2017, BlackRock had approximately $6.28 trillion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of BlackRock’s allocated portion of the Fund’s portfolio:

 

    Richard M. Rieder—Rick Rieder managing director, is BlackRock’s global chief investment officer of fixed income, co-head of BlackRock, Inc.’s Global Fixed Income Platform, member of the Global Operating Committee, and Chairman of the BlackRock, Inc. firmwide Investment Council. He has been a managing director of BlackRock, Inc. since 2009. Rieder was president and chief executive officer of R3 Capital Partners from 2008 to 2009 and managing director of Lehman Brothers from 1994 to 2008. Rieder earned a BBA degree in finance from Emory University and an MBA degree from The Wharton School of the University of Pennsylvania. Rieder has served as a portfolio manager for the Fund since its inception.

 

    Robert J. Miller—Bob Miller has been a managing director of BlackRock, Inc. since 2011. Prior to that, Miller was a co-founder and partner at the Round Table Investment Management Company, a multi-strategy, research-based investment company, where he managed a global macro strategy. Previously, he spent 20 years at Bank of America, where he served in a variety of roles, including managing director from 1999 to 2007. Miller earned a BA in economics from Davidson College. Miller has served as a portfolio manager for the Fund since its inception.

 

    David L. Rogal—David Rogal has been a director of BlackRock, Inc. since 2014. Rogal began his career at BlackRock in 2006 as an analyst in the Financial Institutions Group and served as a vice president from 2011 to 2013. Rogal earned a BA, Phi Beta Kappa, in economics and genetics from Cornell University in 2006. Rogal has served as a portfolio manager for the Fund since its inception.

Western Asset Management Company (Western), 385 East Colorado Boulevard, Pasadena, CA 91101, serves as a subadviser to the Fund under a subadvisory agreement (the Western Subadvisory Agreement) with Morningstar on behalf of the Fund. Western is registered as an investment adviser with the SEC and was founded in 1971. Western is a wholly-owned subsidiary of Legg Mason, Inc., a publicly traded asset management company. As of December 31, 2017, Western had approximately $442.2 billion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of Western’s allocated portion of the Fund’s portfolio:

 

    John L. Bellows, PhD, CFA—John Bellows is a portfolio manager and research analyst with Western Asset. Prior to joining the firm in 2012, Bellows served at the U.S. Department of the Treasury, most recently as the Acting Assistant Secretary for Economic Policy. At Western Asset, he is a member of the US Broad Strategy Committee and the Global Investment Strategy Committee. Bellows holds a BA in Economics from Dartmouth College, where he graduated magna cum laude, and a PhD in Economics from the University of California, Berkeley. Bellows has served as a portfolio manager for the Fund since its inception.

 

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    S. Kenneth Leech—Ken Leech is the chief investment officer of Western Asset. He joined the firm in 1990. Leech leads the Global Portfolio, US Broad Portfolio and Macro Opportunities Teams. From 2002–2004, he served as a member of the Treasury Borrowing Advisory Committee. Leech is a graduate of the University of Pennsylvania’s Wharton School. In his four years, he received three degrees: a BA, a BS and an MBA, graduating summa cum laude. Leech has served as a portfolio manager for the Fund since its inception.

 

    Mark S. Lindbloom—Mark Lindbloom has more than 40 years of experience and is currently a portfolio manager at Western Asset, where he has worked since 2005. Prior to his time at Western Asset, Lindbloom was a portfolio manager at Citigroup Asset Management and at Brown Brothers Harriman & Company. He has also worked as an Analyst at New York Life Insurance. Lindbloom holds an MBA from Pace University and BS degree from Rider University. Lindbloom has served as a portfolio manager for the Fund since its inception.

 

 

    Frederick R. Marki, CFA—Frederick Marki is a portfolio manager with Western Asset and has more than 34 years of experience. Prior to joining the firm in 2005, Marki was senior portfolio manager with Citigroup Asset Management, portfolio manager with UBS, and vice president with Merrill Lynch. He began his career as an assistant economist at the Federal Reserve Bank of New York. Marki holds a BS from the Massachusetts Institute of Technology. Marki has served as a portfolio manager for the Fund since its inception.

 

    Julien A. Scholnick, CFA—Julien Scholnick is a portfolio Manager with Western Asset and has more than 21 years of experience. Prior to joining the firm in 2003, Scholnick served as an associate in the Private Client Group with Salomon Smith Barney, as a senior analyst with Digital Coast Partners, and as a senior analyst with Arthur Andersen, LLP. Scholnick holds a BA from from the University of California, Los Angeles, and an MBA from Cornell University. Scholnick has served as a portfolio manager for the Fund since its inception.

MORNINGSTAR MUNICIPAL BOND FUND

Morningstar has currently selected two subadvisers for the Morningstar Municipal Bond Fund, each to cover a specific investment mandate or mandates, as outlined in the table below. Additional information on each subadviser and its portfolio managers follows.

 

Subadviser

  

Investment Mandate(s)

T. Rowe Price Associates, Inc.    Municipal Bond
Wells Capital Management, Inc.   

Intermediate-Term Municipal Bond

Short-Term Municipal Bond

T. Rowe Price Associates, Inc. (T. Rowe Price), 100 East Pratt Street, Baltimore, MD 21202, serves as a subadviser to the Fund under a subadvisory agreement (the T. Rowe Price Subadvisory Agreement) with Morningstar on behalf of the Fund. T. Rowe Price is registered as an investment adviser with the SEC and was founded in 1937. T. Rowe Price is a wholly owned subsidiary of T. Rowe Price Group, Inc., which was formed in 2000 as the publicly traded parent holding company of T. Rowe Price and its affiliated entities. As of December 31, 2017, T. Rowe Price had approximately $991.1 billion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of T. Rowe Price’s allocated portion of the Fund’s portfolio:

 

    Konstantine B. Mallas—Dino Mallas is a vice president and portfolio manager for T. Rowe Price. He joined T. Rowe Price in 1986 and his investment experience dates from 1990. During the past five years, Mallas has served as a portfolio manager. He earned a BS from American University and an MBA from Loyola University Maryland. Mallas has served as a portfolio manager for the Fund since its inception.

 

    James M. Murphy, CFA—Jim Murphy is a vice president and portfolio manager for T. Rowe Price. He joined the firm in 2000 and his investment experience dates from 1993. During the past five years, Murphy has served as a portfolio manager. He received a BS in finance from the University of Delaware and an MBA in finance from Seton Hall University. He also is a trustee of the T. Rowe Price Foundation and a trustee of Severn School. Murphy has served as a portfolio manager for the Fund since its inception.

 

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Wells Capital Management, Inc. (WellsCap), 525 Market St., San Francisco, CA 94105, serves as a subadviser to the Fund under a subadvisory agreement (the WellsCap Subadvisory Agreement) with Morningstar on behalf of the Fund. WellsCap is incorporated in California and is an SEC registered investment adviser. WellsCap is a directly and wholly-owned subsidiary of Wells Fargo Asset Management Holdings, LLC, which is an indirect wholly-owned subsidiary of Wells Fargo & Company (Wells Fargo), a diversified financial services company. As of December 31, 2017, WellsCap had approximately $389.6 billion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of WellsCap’s allocated portion of the Fund’s portfolio:

 

    Wendy S. Casetta—Wendy Casetta is a senior portfolio manager for the Wells Fargo Asset Management (WFAM) Municipal Fixed Income team. She joined the firm from Strong Capital Management, where she held a similar position. Prior to joining Strong, Casetta was a fixed-income trader and investment associate at Barnett Capital Advisors in Jacksonville, FL. She began her investment industry career in 1993 as a registered representative at the Nicholas Company in Milwaukee, WI. Casetta earned a bachelor’s degree in finance from the University of Wisconsin, Oshkosh, and an MBA from the University of North Florida, Jacksonville. Casetta has served as a portfolio manager for the Fund since its inception.

 

    Lyle J. Fitterer, CFA—Lyle Fitterer serves as the co-head of Global Fixed Income and head of the Municipal Fixed Income team at Wells Fargo Asset Management (WFAM), where he manages portfolio teams focused on municipal fixed-income strategies. In 2017, Fitterer was named co-head of the WFAM global fixed-income business, where he works to oversee the global fixed-income teams and to seamlessly deliver global fixed-income solutions to meet client needs. From mid-2005 to early 2009, Fitterer served as head of the WFAM Customized Fixed Income team, which manages taxable longer duration strategies. He joined the firm in 2005 from Strong Capital Management, where he was appointed director of Strong’s Municipal Fixed Income team. Prior to that, he served in a variety of other roles with the firm, including managing director of Strong’s Institutional Client Services team, where he was responsible for overseeing institutional and intermediary sales. Fitterer was also a member of the Strong Taxable Fixed Income team, initially as an analyst and trader and then as a portfolio manager specializing in mortgage- and asset-backed securities. He began his investment career in 1989 and holds a bachelor’s degree in accounting from the University of North Dakota. He is also a Certified Public Accountant. Fitterer has served as a portfolio manager for the Fund since its inception.

 

    Robert J. Miller—Robert Miller is a senior portfolio manager for the Wells Fargo Asset Management (WFAM) Municipal Fixed Income team, where he manages both mutual funds and separate accounts. Prior to joining WFAM in 2008, Miller worked for American Century Investments for 10 years where he was part of team managing the firm’s municipal bond portfolios. He had direct responsibility for the firm’s national intermediate- and long-term investment grade strategies. In addition, he managed several other state-specific funds for the firm. He also served as a member of its analytical team. Earlier, Miller spent eight years in New York as a municipal bond analyst with Moody’s Investors Service where he served as an analyst in the States and High Profile Ratings Group as well as the Airport Credit Group, the Southeast Regional Ratings Group, and the Mid-Atlantic Regional Ratings Group. He also founded a small venture capital firm and served as a consultant with Black and Veatch and KPMG Peat Marwick, where he specialized in conducting financial feasibility studies in support of large infrastructure projects. Miller earned a bachelor’s degree in business administration with a concentration in finance from San Jose State University and a master’s degree in business administration from the Leonard N. Stern School of Business at New York University.

 

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MORNINGSTAR DEFENSIVE BOND FUND

Morningstar has currently selected one subadviser for the Morningstar Defensive Bond Fund, to cover the specific investment mandate shown in the table below. Additional information on the subadviser and its portfolio managers follows.

 

Subadviser

  

Investment Mandates

First Pacific Advisors, LLC

  

Nontraditional Bond

First Pacific Advisors, LLC (First Pacific), 11601 Wilshire Boulevard, Suite 1200, Los Angeles, CA 90025, serves as a subadviser to the Fund under a subadvisory agreement (the First Pacific Subadvisory Agreement) with Morningstar on behalf of the Fund. First Pacific is registered as an investment adviser with the SEC and was founded in 2004. The firm’s owners are its Managing Partners, J. Richard Atwood, and Steven T. Romick, and nine other Partners as follows: Arik A. Ahitov, Thomas H. Atteberry, Dennis M. Bryan, J. Mark Hancock, Mark Landecker, Ryan Leggio, Nico Y. Mizrahi, Abhijeet Patwardhan, and Brian A. Selmo. As of December 31, 2017, First Pacific had approximately $33.7 billion in assets under management on a discretionary basis. As of that same date, First Pacific also managed approximately $3.7 million in assets for Unified Managed Account overlay programs on a non-discretionary basis. The following portfolio managers are primarily responsible for the day-to-day management of First Pacific’s allocated portion of the Fund’s portfolio:

 

    Thomas H. Atteberry, CFATom Atteberry joined the FPA in 1997. He serves as portfolio manager for the FPA New Income, Inc. and Source Capital, Inc. Prior to joining FPA, Atteberry served as chief fixed-income strategist of Fifth Third Bank and chief investment officer of Mercantile Bank in Joplin, MO. He earned a bachelor’s degree in Business Administration from Texas Christian University. Atteberry has served as a portfolio manager for the Fund since its inception.

 

    Abhijeet PatwardhanAbhi Patwardhan joined FPA in 2010. He serves as portfolio manager and director of research for the FPA New Income, Inc. and portfolio manager for Source Capital, Inc. Prior to joining FPA, Patwardhan was an investment analyst at Reservoir Capital Group and D.B. Zwirn & Co. and an investment banking analyst at UBS Warburg and Donaldson, Lufkin & Jenrette. He earned a bachelor’s degree in Economics and an MBA from the Wharton School of the University of Pennsylvania. Patwardhan has served as a portfolio manager for the Fund since its inception.

MORNINGSTAR MULTISECTOR BOND FUND

Morningstar has currently selected three subadvisers for the Morningstar Multisector Bond Fund, each to cover a specific investment mandate, as outlined in the table below. Additional information on each subadviser and its portfolio managers follows.

 

Subadviser

  

Investment Mandate

Franklin Advisers, Inc.    World Bond
Loomis, Sayles & Company, L.P.    High-Yield Bond
TCW Investment Management Company LLC    Emerging Markets Bond

Franklin Advisers, Inc. (Franklin), One Franklin Parkway, San Mateo, California 94403, serves as a subadviser to the Fund under a subadvisory agreement (the Franklin Subadvisory Agreement) with Morningstar on behalf of the Fund. Franklin is registered as an investment adviser with the SEC and was founded in 1985. Franklin is a wholly-owned subsidiary of Franklin Resources, Inc., a publicly traded holding company that, together with its various subsidiaries, is referred to as Franklin Templeton Investments, a global investment management organization offering investment services. As of December 31, 2017, Franklin had approximately $753.8 billion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of Franklin’s allocated portion of the Fund’s portfolio:

 

    Michael Hasenstab, PhDMichael Hasenstab is executive vice president and chief investment officer for Templeton Global Macro, which conducts in-depth global macroeconomic analysis covering thematic topics, regional and country analysis, and interest rate, currency and sovereign credit market outlooks. Hasenstab also serves as economic advisor to the CEO of Franklin Resources, Inc. Hasenstab initially joined Franklin Templeton Investments in July 1995, After a leave of absence to obtain his doctor of philosophy (PhD) degree, he rejoined the company in April 2001. He has worked and traveled extensively abroad, with a special focus on Asia. Hasenstab holds a PhD in economics from the Asia Pacific School of Economics and Management at Australian National University, a master’s degree in economics of development from the Australian National University, and a BA in international relations/political economy from Carleton College in the United States. Hasenstab has served as a portfolio manager for the Fund since its inception.

 

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    Sonal Desai, PhDSonal Desai is a senior vice president and director of research for Templeton Global Macro. Desai is a portfolio manager for a number of funds, including Templeton Global Bond Fund and Templeton Global Total Return Fund. Desai joined Franklin Templeton Investments in 2009 from Thames River Capital in London. She started her career in 1994 as an assistant professor of economics at the University of Pittsburgh, and then worked for more than six years at the International Monetary Fund in Washington, DC. Following this, she joined the private financial sector and worked for about five years as director and senior economist for Dresdner Kleinwort Wasserstein in London. Desai holds a PhD in economics from Northwestern University and a BA in economics from Delhi University. Desai has served as a portfolio manager for the Fund since its inception.

Loomis, Sayles & Company, L.P. (Loomis Sayles), One Financial Center, Boston, MA 02111, serves as a subadviser to the Fund under a subadvisory agreement (the Loomis Sayles Subadvisory Agreement) with Morningstar on behalf of the Fund. Loomi, Sayles is registered as an investment adviser with the SEC and was founded in 1926. Loomis Sayles is an indirect subsidiary of Natixis Investment Managers, L.P. which is an indirect subsidiary of Natixis Investment Managers, an international asset management group based in Paris, France. As of December 31, 2017, Loomis Sayles had approximately $268.1 billion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of Loomis Sayles’ allocated portion of the Fund’s portfolio:

 

    Daniel J. Fuss, CFA, CICDaniel Fuss is vice chairman and executive vice president of Loomis Sayles. He began his investment career in 1958 and joined Loomis Sayles in 1976. Fuss earned a BS and an MBA from Marquette University and has more than 59 years of investment experience. Fuss has served as a portfolio manager for the Fund since its inception.

 

    Matthew J. Eagan, CFAMatthew Eagan, vice president of Loomis Sayles, began his investment career in 1989 and joined Loomis Sayles in 1997. He earned a BA from Northeastern University and an MBA from Boston University and has more than 27 years of investment experience. Eagan has served as a portfolio manager for the Fund since its inception.

 

    Elaine M. StokesElaine Stokes, vice president of Loomis Sayles, began her investment career in 1987 and joined Loomis Sayles in 1988. She earned a BS from St. Michael’s College and has more than 30 years of investment experience. Stokes has served as a portfolio manager for the Fund since its inception.

TCW Investment Management Company LLC (TCW), 865 South Figueroa Street, Suite 2100, Los Angeles, CA 90017, serves as a subadviser to the Fund under a subadvisory agreement (the TCW Subadvisory Agreement) with Morningstar on behalf of the Fund. TCW is registered as an investment adviser with the SEC and has been since 1987. TCW is wholly-owned by The TCW Group, Inc., a Nevada corporation (TCW Group). In February 2013, TCW management and private investment funds affiliated with alternative asset manager The Carlyle Group (together with such affiliates, “Carlyle”) acquired TCW Group. On December 27, 2017 Nippon Life Insurance Company acquired a 24.75% minority stake in TCW Group from Carlyle. As a result of the transaction, TCW management and employees have increased their ownership in the firm to approximately 44.07% and Carlyle maintains a 31.18% interest in TCW Group. As of December 31, 2017, TCW had approximately $204.6 billion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of TCW’s allocated portion of the Fund’s portfolio:

 

    Penelope D. FoleyPenelope Foley is a portfolio manager for TCW Emerging Markets Group. Prior to joining TCW in 1990, she was a senior vice president of Drexel Burnham Lambert, where she was involved in the management of DBL Americas Development Association, LP, and in the provision of investment and merchant banking services in Latin America. Before Drexel, she was a vice president in Citicorp’s Investment Bank and was responsible for Euro securities, project finance and private placements in Latin America and Canada. Previously, she was an associate in the Corporate Finance Department at Lehman Brothers. Foley attended Northwestern University and holds a BA from Hollins College. Foley has served as a portfolio manager for the Fund since its inception.

 

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    David I. RobbinsDavid Robbins is a portfolio manager for TCW Emerging Markets Group. Prior to joining TCW in 2000, Robbins was with Lehman Brothers, where he was responsible for global emerging markets trading in the Fixed Income division. Prior to that, he worked at Morgan Stanley from 1983-1997 where he was head of Emerging Markets Trading. Robbins received a BA in Economics and History from Swarthmore College. Robbins has served as a portfolio manager for the Fund since its inception.

 

 

    Alex StanojevicAlex Stanojevic is a portfolio manager for the TCW Emerging Markets Group. Prior to this, he served as the team’s head trader, where he was responsible for trading emerging markets fixed-income assets and determining relative value opportunities in the investable universe. Stanojevic joined TCW in 2005 from Coast Asset Management LP, where he was responsible for interest-rate derivatives transactions, trade modeling, research, and performance reporting. Stanojevic received his BS in Finance from the California State University Long Beach (magna cum laude), and an MBA from Loyola Marymount University, Los Angeles. Stanojevic has served as a portfolio manager for the Fund since its inception.

MORNINGSTAR UNCONSTRAINED ALLOCATION FUND

Morningstar has currently selected two subadvisers for the Morningstar Unconstrained Allocation Fund, each to cover a specific investment mandate, as outlined in the table below. Additional information on each subadviser and its portfolio managers follows.

 

Subadviser

  

Investment Mandate

Brandywine Global Investment Management, LLC    World Bond
Lazard Asset Management LLC    World Stock

Brandywine Global Investment Management, LLC (Brandywine), 2929 Arch Street, Suite 800, Philadelphia, PA 19104, serves as a subadviser to the Fund under a subadvisory agreement (the Brandywine Subadvisory Agreement) with Morningstar on behalf of the Fund. Brandywine is registered as an investment adviser with the SEC and was founded in 1986. Brandywine is a wholly-owned subsidiary of Legg Mason, Inc., a publicly traded asset management company. As of December 31, 2017, Brandywine had approximately $75.5 billion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of Brandywine’s allocated portion of the Fund’s portfolio:

 

    David F. Hoffman, CFADavid Hoffman is co-lead portfolio manager for the firm’s Global Fixed Income and related strategies. He joined the firm in 1995. Previously, Hoffman was president of Hoffman Capital, a global financial futures investment firm (1991 -1995); head of fixed-income investments at Columbus Circle Investors (1983-1990); senior vice president and portfolio manager at INA Capital Management (1979-1982), and fixed-income portfolio manager at Provident National Bank (1975-1979). Hoffman earned a BA in Art History from Williams College. He is a member of the firm’s Executive Board, currently serving as the board’s chair. Hoffman has served as a portfolio manager for the Fund since its inception.

 

    Stephen S. SmithSteve Smith is co-lead portfolio manager for the firm’s Global Fixed Income and related strategies. He is a member of the firm’s Executive Board. He joined the firm in 1991 to diversify the firm’s investment strategies and start the global fixed-income product. Previously, Smith was with Mitchell Hutchins Asset Management, Inc. as managing director of taxable fixed income (1988-1991); Provident Capital Management, Inc. as senior vice president overseeing taxable fixed income (1984-1988); Munsch & Smith Management as a founding partner (1980-1984) and First Pennsylvania Bank as vice president and portfolio manager in the fixed income division (1976-1980). Smith earned a BS in Economics and Business Administration from Xavier University, where he is currently chair of the university’s investment and plant & building committees, a member of the executive committee, and serves on the board of trustees. Smith is also a member of the board of trustees at the Winterthur Museum & Country Estate, a nonprofit, educational institution. Smith has served as a portfolio manager for the Fund since its inception.

 

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    Jack P. McIntyre, CFAJack McIntyre is a portfolio manager for the firm’s Global Fixed Income and related strategies. He joined the firm in 1998. Previously, he held positions as market strategist with McCarthy, Crisanti & Maffei, Inc. (1995-1998); senior fixed-income analyst with Technical Data, a division of Thomson Financial Services (1992-1995); quantitative associate with Brown Brothers Harriman & Co. (1990), and investment analyst with the Public Employee Retirement Administration of Massachusetts (1987-1989). McIntyre earned an MBA in Finance from the Leonard N. Stern Graduate School of Business at New York University and a BBA in Finance from the University of Massachusetts, Amherst. McIntyre has served as a portfolio manager for the Fund since its inception.

 

    Anujeet Sareen, CFAAnujeet Sareen is a portfolio manager for the firm’s Global Fixed Income and related strategies. Prior to joining the firm in 2016, Sareen was a managing director of global fixed income and a global macro strategist, as well as chair of the Currency Strategy Group at Wellington Management in Boston. Over his 22-year career at Wellington (1994-2016), he held a variety of roles while cultivating extensive fixed income and currency management experience. Sareen earned a BA in Computer Science from Brown University. Sareen has served as a portfolio manager for the Fund since its inception.

Lazard Asset Management LLC (Lazard), 30 Rockefeller Plaza, New York, NY 10112, serves as a subadviser to the Fund under a subadvisory agreement (the Lazard Subadvisory Agreement” with Morningstar on behalf of the Fund. Lazard is registered as an investment adviser with the SEC and was founded in 1970. Lazard is a wholly-owned subsidiary of Lazard Frères & Co. LLC, a New York limited liability company with one member, Lazard Group LLC, a Delaware limited liability company. As of December 31, 2017, Lazard had approximately $222.4 billion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of Lazard’s allocated portion of the Fund’s portfolio:

 

    Bertrand Cliquet, CFA—Bertrand Cliquet is a portfolio manager/analyst on the Lazard Global Listed Infrastructure and Global Equity Franchise teams. He joined Lazard in 2004 as a European utility analyst, before becoming a founding member of the Lazard Global Listed infrastructure strategy in 2005. Prior to joining Lazard, Cliquet was a utility analyst at Goldman Sachs International in London and a merger and acquisition analyst at Deutsche Bank. He has been working in the investment field since 1999. He attained a business degree from HEC in Paris, with a major in Finance. Cliquet was awarded the Prize of the “Club Finance International” and the Prize of the HEC Foundation for his thesis on “The deregulation of the European electricity market and its consequences for electricity prices and the strategic positioning of energy companies.” Bertrand is fluent in both French and German. Cliquet has served as a portfolio manager for the Fund since its inception.

 

    Matthew LandyMatthew Landy is a portfolio manager/analyst on the Global Listed Infrastructure and Global Equity Franchise teams. He began working in the investment field in 1995. Prior to joining Lazard in 2006, Landy worked in the private equity industry where he was involved in early stage venture capital in Europe and management buy-out investing in Australia. Previously he was an equity analyst with Tyndall Investment Management covering stocks in the consumer staples, consumer discretionary, and industrial sectors. Landy has a BCom and a BA from Monash University in Melbourne, Australia. Landy has served as a portfolio manager for the Fund since its inception.

 

    John Mulquiney, CFAJohn Mulquiney is a portfolio manager/analyst on the Global Listed Infrastructure and Global Equity Franchise teams. He has been working in the investment field since 1997. Prior to joining Lazard in August 2005, Mulquiney worked at Tyndall Australia where he covered stocks in various sectors including financials, consumer discretionary, healthcare, and materials. Mulquiney was also in the Asset and Infrastructure Group at Macquarie Bank, where he undertook transactions and developed valuation models for airports, electricity generators, rail projects, and health infrastructure. Most recently, he spent four years at Nanyang Ventures, an early expansion venture capital fund. Mulquiney holds a PhD from the Australian National University, and a BA (Hons) from Sydney University. Mulquiney has served as a portfolio manager for the Fund since its inception.

 

    Warryn RobertsonWarryn Robertson is a portfolio manager/analyst on the Global Listed Infrastructure, Global Equity Franchise, and Australian Equity teams. He has been working in the investment field since 1992. Prior to joining Lazard in April 2001, Robertson was an associate director at Capital Partners. Previously, He worked at PriceWaterhouseCoopers Corporate Finance. Robertson holds an MBA from the Melbourne Business School (Melbourne University) and a BCom, University of Canberra. Robertson has served as a portfolio manager for the Fund since its inception.

 

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MORNINGSTAR ALTERNATIVES FUND

Morningstar has currently selected two subadvisers for the Morningstar Alternatives Fund, each to cover a specific investment mandate, as outlined in the table below. Additional information on each subadviser and its portfolio managers follows.

 

Subadviser

  

Investment Mandate

SSI Investment Management, Inc.    Market Neutral
Water Island Capital, LLC    Market Neutral

SSI Investment Management, Inc. (SSI), 9440 Santa Monica Boulevard, 8th Floor, Beverly Hills, CA 90210, serves as a subadviser to the Fund under a subadvisory agreement (the SSI Subadvisory Agreement) with Morningstar on behalf of the Fund. SSI is registered as an investment adviser with the SEC and was founded in 1973. Amy Jo Gottfurcht, SSI’s Chairman and Chief Executive Officer, and John D. Gottfurcht, SSI’s President, are SSI’s controlling shareholders. George M. Douglas is SSI’s Chief Investment Officer and a material shareholder. As of December 31, 2017, SSI had approximately $1.6 billion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of SSI’s allocated portion of the Fund’s portfolio:

 

    George M. Douglas, CFAGeorge Douglas is chief investment officer and principal of SSI. He is currently a portfolio manager of the Hedged Convertible strategies and oversees SSI’s quantitative research process. He is also a member of SSI’s executive committee. Douglas has more than 40 years of experience in quantitative equity research and portfolio management and has served as SSI’s chief investment officer for 23 years. Prior to joining SSI, George was director of Quantitative Equity Investments and portfolio manager at CS First Boston Asset Management. He received a BS in Mathematics, MS in Statistics, and MBA from the University of Wisconsin. Douglas has served as a portfolio manager for the Fund since its inception.

 

    Alexander W. VolzAlex Volz is a portfolio manager at SSI. He oversees the daily management of the Hedged Convertible investment portfolios and is responsible for analyzing convertible arbitrage opportunities, trading and daily re-setting of hedge ratios. Volz has 21 years of industry experience, and has been with SSI for 15 years. Prior to joining SSI, Volz was a junior partner at Southern Trading Partners in Atlanta, GA. He received a BA in Economics from Vanderbilt University. Volz has served as a portfolio manager for the Fund since its inception.

 

    Dagney M. HollanderDagney Hollander is a portfolio manager at SSI and oversees the daily management of the Hedged Convertible investment portfolios. She has more than 16 years of industry experience as a trading assistant, analyst and portfolio manager. She received a BS in Finance, summa cum laude, from California State University, Northridge. She is a CFA Level III Candidate. Hollander has served as a portfolio manager for the Fund since its inception.

Water Island Capital, LLC (Water Island), 41 Madison Avenue, 42nd Floor, New York, NY 10010, serves as a subadviser to the Fund under a subadvisory agreement (the Water Island Subadvisory Agreement) with Morningstar on behalf of the Fund. Water Island is registered as an investment adviser with the SEC and was founded in 2000. Water Island’s majority owner is John Orrico. As of December 31, 2017, Water Island had approximately $2.6 billion in assets under management. The following portfolio managers are primarily responsible for the day-to-day management of Water Island’s allocated portion of the Fund’s portfolio:

 

    John S. Orrico, CFAJohn Orrico formed Water Island Capital in 2000 and serves as chief investment officer of the firm, leading the investment team. He is a portfolio manager on the Arbitrage Fund. Prior to forming Water Island Capital, Orrico joined Gruss & Co in 1994, focusing on merger arbitrage and special situations. He has worked in the securities industry since joining Morgan Stanley in 1982, beginning in corporate finance, with additional experience in institutional equity trading, equity research analysis and portfolio management. Orrico received a BA from Georgetown University. Orrico has served as a portfolio manager for the Fund since its inception.

 

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    Roger P. Foltynowicz, CFA, CAIARoger Foltynowicz joined Water Island Capital in 2003 and currently serves as portfolio manager on the merger arbitrage strategy. He has been a portfolio manager for the Arbitrage Fund since January 2005 and a portfolio manager for the Arbitrage Event-Driven Fund since inception in October 2010. Prior to joining Water Island Capital, Foltynowicz worked for Jacobs Engineering as project accountant and also played professional baseball for the Cincinnati Reds organization. Foltynowicz received an MS from Pace Graduate School of Business and a BA from Presbyterian College. He also achieved the Chartered Alternative Investment Analyst designation in addition to the CFA designation. Foltynowicz has served as a portfolio manager for the Fund since its inception.

 

    Todd W. MunnTodd Munn joined Water Island Capital in 2003 and currently serves as portfolio manager on the merger arbitrage strategy. He has been a portfolio manager for the Arbitrage Fund since January 2005 and a portfolio manager for the Arbitrage Event-Driven Fund since inception in October 2010. Munn has worked in the securities industry since 1993, having worked at Lipper & Company and Bear Stearns & Company prior to joining Water Island Capital. Munn received an MBA from Fordham Graduate School of Business and a BA from Gettysburg College. Munn has served as a portfolio manager for the Fund since its inception.

SHAREHOLDER INFORMATION

Pricing of Fund Shares

Each Fund’s share price, or NAV, is determined as of the close of regular session trading on the NYSE (normally 4:00 p.m. Eastern Time) each day that the NYSE is open, in accordance with Rule 22c-1 of the 1940 Act. The NYSE is regularly closed on New Year’s Day, Martin Luther King, Jr. Day, Presidents Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving, and Christmas.

The NAV per share for each class of each Fund’s shares is calculated by dividing the pro rata share of the value of all of the securities and other assets of the Fund allocable to that class of Fund shares, less the liabilities allocable to that class, by the number of shares of the class outstanding. When shares are purchased or sold, the order is processed at the next NAV that is calculated on a day when the NYSE is open for trading, after receiving a purchase or sale order. Because the Funds may invest in securities that are primarily listed on foreign exchanges and trade on days when the Funds do not price their shares, a Fund’s NAV may change on days when shareholders will not be able to purchase or redeem the Fund’s shares. If shares are purchased or sold through an intermediary, it is the responsibility of that intermediary to transmit those orders to the Funds’ transfer agent so such orders will be received in a timely manner.

A purchase or sale order typically is accepted when the Funds’ transfer agent or an intermediary has received a completed application or appropriate instruction along with the intended investment, if applicable, and any other required documentation.

More information about the valuation of the Funds’ holdings can be found in the SAI.

Fair Value Pricing

If market or broker-dealer quotations are unavailable or deemed unreliable for a security or if a security’s value may have been materially affected by events occurring after the close of a securities market on which the security principally trades but before a Fund calculates its NAV, the Fund may, in accordance with procedures adopted by the board of trustees, employ “fair value” pricing of securities. Fair value determinations are made in good faith in accordance with Board-approved procedures. Generally, the fair value of a portfolio security or other asset shall be the amount that the owner of the security or asset might reasonably expect to receive upon its sale under current market conditions. Attempts to determine the fair value of securities introduce an element of subjectivity to the pricing of securities. This fair value may be higher or lower than any available market price or quotation for such security and, because this process necessarily depends upon judgment, this value also may vary from valuations

 

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determined by other funds using their own valuation procedures. While each Fund’s use of fair value pricing is intended to result in calculation of an NAV that fairly reflects security values as of the time of pricing, a Fund cannot guarantee that any fair value price will, in fact, approximate the amount the Fund would actually realize upon the sale of the securities in question. If a reliable market quotation becomes available for a security formerly valued through fair valuation techniques, a Fund would compare the new market quotation to the fair value price to evaluate the effectiveness of its fair valuation procedures. If any significant discrepancies are found, a Fund may adjust its fair valuation procedures.

Purchase and Sale of Fund Shares

Fund shares are currently available only to investors participating in Morningstar Managed Portfolios, an investment advisory program sponsored by Morningstar Investment Services LLC, a wholly-owned subsidiary of the adviser, and also in programs sponsored by unaffiliated financial institutions that license the use of Morningstar Managed Portfolios in their own investment advisory program (collectively, Advisory Programs). There are no initial or subsequent minimum purchase amounts for the Funds. Orders to sell or “redeem” shares must be placed through the Advisory Program in which you participate and may trigger a purchase or sale of the Fund’s underlying investments. Fund shares may be purchased or redeemed on any day the New York Stock Exchange (NYSE) is open. At any time that an investor in the Fund ceases to be an eligible investor in the Fund, the entity managing the Advisory Program will direct the redemption of that investor’s Fund’s shares and no further purchases will be allowed.

Investors may be charged a fee if they effect transactions through a broker or agent. The Funds have authorized one or more brokers to receive on their behalf purchase and redemption orders. Such brokers are authorized to designate other intermediaries to receive purchase and redemption orders on a Fund’s behalf. A Fund will be deemed to have received a purchase or redemption order when an authorized broker or, if applicable, a broker’s authorized designee, receives the order. Customer orders will be priced at the Fund’s NAV next computed after they are received by an authorized broker or the broker’s authorized designee.

Morningstar Investment Services reserves the right to reject purchase orders or to stop offering Fund shares without notice. No order will be accepted, unless accepted by Morningstar Investment Services. The Fund does not issue share certificates. [Trustees of the Trust may also purchase shares as determined by Morningstar.]

USA PATRIOT Act. The USA PATRIOT Act of 2001 requires financial institutions, including each Fund, the adviser, Morningstar Investment Services, and custodians to adopt certain policies and programs to prevent money laundering activities, including procedures to verify the identity of customers opening new accounts. When setting up an account, you will be required to supply your custodian with your full name, date of birth, social security number and permanent street address. Mailing addresses containing only a P.O. Box will not be accepted. Until such verification is made, Morningstar Investment Services may temporarily limit any security purchases, including in the Funds. In addition, your custodian may close an account if it is unable to verify a shareholder’s identity. As required by law, your custodian may employ various procedures, such as comparing the information to fraud databases or requesting additional information or documentation from you, to ensure that the information supplied by you is correct. Corporate, trust and other entity accounts require further documentation.

If your custodian does not have a reasonable belief of the identity of an account holder, the account will be rejected or the account holder will not be allowed to perform a transaction in the account until such information is received. Each Fund also reserves the right to close the account within five business days if clarifying information/documentation is not received. Accounts may only be opened by persons with a valid social security number or tax identification number and permanent U.S. street address. Any exceptions are reviewed on a case-by-case basis.

ACCOUNT AND TRANSACTION POLICIES

Payment of Redemption Proceeds. Proceeds will generally be sent no later than seven calendar days after a Fund receives your redemption request. Each Fund may suspend your right to redeem your shares if the NYSE restricts trading, the SEC declares an emergency, or for other reasons. More information about redeeming shares and the circumstances under which redemptions may be suspended is in the SAI.

 

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Redemption proceeds will remain within your brokerage account unless you instruct otherwise. A Fund will not be responsible for interest lost on redemption amounts due to lost or misdirected mail. If the proceeds of redemption are requested to be sent to an address other than the address of record, or if the address of record has been changed within 15 days of the redemption request, the request must be in writing with your signature guaranteed.

Each Fund generally pays sale (redemption) proceeds in cash. However, under unusual conditions that make the payment of cash unwise and for the protection of a Fund’s remaining shareholders, a Fund might pay all or part of your redemption proceeds in securities with a market value equal to the redemption price (redemption in kind). It is unlikely that your shares would ever be redeemed in kind, but if they were, you would have to pay transaction costs to sell the securities distributed to you, as well as taxes on any capital gains from the sale as with any redemption. In addition, you would continue to be subject to the risks of any market fluctuation in the value of the securities you receive in kind until they are sold.

Electronic Delivery. It is each Fund’s policy to deliver documents electronically whenever possible. You may choose to receive Fund documents electronically rather than hard copy by signing up for e-delivery for your account with [                ] at www.[                ].com.

Unclaimed Property. Your mutual fund account may be transferred to your state of residence if no activity occurs within your account during the “inactivity period” specified in your state’s abandoned property laws.

TOOLS TO COMBAT FREQUENT TRANSACTIONS

[Frequent purchases and redemptions of Fund shares may interfere with the efficient management of a Fund’s portfolio by its portfolio managers, increase portfolio transaction costs, and have a negative effect on the Funds’ long-term shareholders. For example, in order to handle large flows of cash into and out of a Fund, the portfolio manager may need to allocate more assets to cash or other short-term investments or sell securities, rather than maintaining full investment in securities selected to achieve the Fund’s investment objective. Frequent trading may cause a Fund to sell securities at less favorable prices. Transaction costs, such as brokerage commissions and market spreads, can detract from a Fund’s performance. In addition, the return received by long-term shareholders may be reduced when trades by other shareholders are made in an effort to take advantage of certain pricing discrepancies, when, for example, it is believed that a Fund’s share price, which is determined at the close of the NYSE on each trading day, does not accurately reflect the value of the Fund’s portfolio securities.

Because of the potential harm to a Fund and its long-term shareholders, the board has approved policies and procedures that are intended to discourage and prevent excessive trading and market timing abuses through the use of various surveillance and other techniques. Under these policies and procedures, each Fund may limit additional purchases of Fund shares by shareholders whom Morningstar reasonably believes to be engaged in these excessive trading activities. The intent of the policies and procedures is not to inhibit legitimate strategies, such as asset allocation, dollar cost averaging, or similar activities that may nonetheless result in frequent trading of Fund shares. For this reason, the board has not adopted any specific restrictions on purchases and sales of Fund shares, but each Fund reserves the right to reject any purchase of Fund shares with or without prior notice to the account holder. In cases where surveillance of a particular account establishes what Morningstar reasonably believes to be actual market timing activity, a Fund will seek to block future purchases and exchanges of Fund shares by that account. Where surveillance of a particular account indicates activity that Morningstar reasonably believes could be either excessive or for legitimate purposes, each Fund may seek to block future purchases and exchanges of Fund shares by that account or permit the account holder to justify the activity. Although these policies are designed to deter frequent trading, none of these measures alone nor all of them taken together eliminate the possibility that frequent trading in the Fund will occur.

The policies apply to any account, whether an individual account or accounts with financial intermediaries, such as investment advisers, introducing brokers and retirement plan administrators, commonly called omnibus accounts, where the intermediary holds Fund shares for a number of its customers in one account. Each Fund and its service providers will use reasonable efforts to work with financial intermediaries to identify excessive short-term trading in omnibus accounts that may be detrimental to a Fund. However, there can be no assurance that the monitoring of omnibus account level trading will enable a Fund to identify or prevent all such trading by a financial intermediary’s customers.]

 

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DIVIDENDS AND DISTRIBUTIONS

Each Fund expects to declare and distribute all of its net investment income, if any, to shareholders as dividends at least:

 

    monthly, in the case of the Morningstar Total Return Bond Fund, Morningstar Municipal Bond Fund, and Morningstar Multisector Bond Fund;

 

    quarterly, in the case of the Morningstar Global Income Fund and Morningstar Defensive Bond Fund; or

 

    annually, in the case of the Morningstar U.S. Equity Fund, Morningstar International Equity Fund, Morningstar Unconstrained Allocation Fund and Morningstar Alternatives Fund.

Each Fund will distribute net realized capital gains, if any, at least annually, usually in December. Each Fund may make an additional payment of dividends or other distributions if it deems it to be desirable or necessary at other times during any year.

The amount of any distribution will vary, and there is no guarantee a Fund will pay either an income dividend or a capital gains distribution.

Distributions will be reinvested in shares of the Funds, unless otherwise directed by the shareholder. Generally, distributions within taxable accounts are taxable events for shareholders whether the distributions are received in cash or reinvested.

TAX CONSEQUENCES

Each Fund will elect and intends to qualify to be taxed as a regulated investment company (RIC) under Subchapter M of the Code. As a regulated investment company, each Fund will not be subject to federal income tax if it distributes its income as required by the tax law and satisfies certain other requirements that are described in the SAI.

Each Fund generally intends to operate in a manner such that it will not be liable for federal income or excise taxes.

You generally will be taxed on a Fund’s distributions, regardless of whether you reinvest them or receive them in cash. A Fund’s distributions of net investment income (including short-term capital gain) are taxable to you as ordinary income. A Fund’s distributions of long-term capital gain, if any, are taxable to you as long-term capital gain, regardless of how long you have held your shares. Distributions also may be subject to certain state and local taxes. Some Fund distributions also may include nontaxable returns of capital. Return of capital distributions reduce your tax basis in your Fund shares and are treated as gain from the sale of the shares to the extent your basis would be reduced below zero.

A portion of a Fund’s distributions may be treated as “qualified dividend income,” taxable to individuals at 0%, 15%, 20%, or 25% depending on the nature of the capital gain and the shareholder’s taxable income. A distribution is treated as qualified dividend income to the extent that a Fund receives dividend income from taxable domestic corporations and certain qualified foreign corporations, provided that certain holding period and other requirements are met by the Fund and the shareholder. To the extent a Fund’s distributions are attributable to other sources, such as interest or capital gains, the distributions are not treated as qualified dividend income. A Fund’s distributions of dividends that it receives from REITs and certain foreign corporations generally do not constitute “qualified dividend income.”

Distributions of capital gain and distributions of net investment income reduce the NAV of a Fund’s shares by the amount of the distribution. If you purchase shares before these distributions, you are taxed on the distribution even though the distribution represents a return of your investment.

 

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The sale or exchange of Fund shares is a taxable transaction for federal income tax purposes. You will recognize a gain or loss on such transactions equal to the difference, if any, between the amount of your net sales proceeds and your tax basis in the Fund shares. Such gain or loss will be capital gain or loss if you held your Fund shares as capital assets. Any capital gain or loss will generally be treated as long-term capital gain or loss if you held the Fund shares for more than one year at the time of the sale or exchange, and otherwise as short-term capital gain. Any capital loss arising from the sale or exchange of shares held for six months or less, however, will be treated as long-term capital loss to the extent of the amount of net long-term capital gain distributions with respect to those shares.

Each Fund may be required to withhold federal income tax at the federal backup withholding rate on all taxable distributions and redemption proceeds otherwise payable to you if you fail to provide a Fund with your correct taxpayer identification number or to make required certifications, or if you have been notified by the IRS that you are subject to backup withholding. Backup withholding is not an additional tax. Rather, any amounts withheld may be credited against your federal income tax liability, so long as you provide the required information or certification. Investment income received by a Fund from sources within foreign countries may be subject to foreign income taxes withheld at the source.

After December 31 of each year, a Fund will mail you reports containing information about the income tax classification of distributions paid during the year. Distributions declared in October, November or December to shareholders of record on a specified date in such a month, but paid in January, are taxable as if they were paid in December.

For further information about the tax effects of investing in the Fund, including state and local tax matters, please see the SAI and consult your tax adviser.

FINANCIAL HIGHLIGHTS

Financial highlights are not available at this time because the Fund has not started operations before the date of this prospectus.

 

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PRIVACY NOTICE

This information is not part of the prospectus

[TO BE INSERTED]

 

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Morningstar Funds Trust

You can find more information about the Funds in the following documents:

Statement of Additional Information (SAI): The SAI provides additional details about the investments and techniques of each Fund and certain other additional information. A current SAI is on file with the SEC and is herein incorporated into this prospectus by reference. It is legally considered a part of this prospectus.

Annual/Semi-Annual Reports: Additional information about each Fund’s investments will be available in the Fund’s annual and semi-annual reports to shareholders. Each Fund’s annual report will contain a discussion of market conditions and investment strategies that significantly affected the Fund’s performance during the Fund’s first fiscal year.

You can obtain free copies of these documents, request other information, and discuss your questions about the Fund by contacting the Fund at:

Morningstar Funds Trust

[                 ]

22 W. Washington Street

Chicago, IL 60602

1-  -  -

www.             .com

You can review and copy information including the Funds’ reports and SAI at the Public Reference Room of the SEC, 100 “F” Street N.E. Washington, D.C. 20549-1520. You can obtain information on the operation of the Public Reference Room by calling (202) 551-8090. Shareholder reports and other information about each Fund are also available:

 

    Free of charge from the Fund’s website at www.                    .com.

 

    Free of charge from the SEC’s EDGAR database on the SEC’s website at http://www.sec.gov.

 

    For a fee, by writing to the Public Reference Section of the SEC, Washington, D.C. 20549-1520.

 

    For a fee, by e-mail request to publicinfo@sec.gov.

(The Trust’s SEC Investment Company Act file number is 811- 23235.)


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Subject to Completion—Dated                 , 2018

The information in this Statement of Additional Information is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This Statement of Additional Information is not an offer to sell these securities and is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

STATEMENT OF ADDITIONAL INFORMATION

                         , 2018

MORNINGSTAR FUNDS TRUST

 

Morningstar U.S. Equity Fund

   Ticker: MSTQX

Morningstar International Equity Fund

   Ticker: MSTFX

Morningstar Global Income Fund

   Ticker: MSTGX

Morningstar Total Return Bond Fund

   Ticker: MSTRX

Morningstar Municipal Bond Fund

   Ticker: MSTPX

Morningstar Defensive Bond Fund

   Ticker: MSTBX

Morningstar Multisector Bond Fund

   Ticker: MSTMX

Morningstar Unconstrained Allocation Fund

   Ticker: MSTSX

Morningstar Alternatives Fund

   Ticker: MSTVX

22 W. Washington Street

Chicago, IL 60602

1.800.  .

www.             .com

This Statement of Additional Information (SAI) is not a prospectus and it should be read in conjunction with the prospectus for the above-listed series of the Morningstar Funds Trust (collectively, the “Funds”), dated             , 2018, advised by Morningstar Investment Management LLC (“Morningstar” or “adviser” or “we”). Copies of the Fund’s prospectus are available at www.             .com or by calling the above number. Morningstar has retained certain investment managers as subadvisers, each responsible for portfolio management of a portion of each Fund’s total assets.


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TABLE OF CONTENTS

 

THE TRUST

     1  

INVESTMENT STRATEGIES, POLICIES, AND RISKS

     1  

INVESTMENT RESTRICTIONS

     34  

PORTFOLIO TURNOVER

     37  

PORTFOLIO HOLDINGS INFORMATION

     37  

STATEMENT OF SHAREHOLDER RIGHTS

     38  

TRUSTEES AND EXECUTIVE OFFICERS

     38  

PROXY VOTING POLICIES

     44  

CONTROL PERSONS, PRINCIPAL SHAREHOLDERS

     44  

THE FUND’S INVESTMENT TEAM

     44  

SERVICE PROVIDERS

     76  

EXECUTION OF PORTFOLIO TRANSACTIONS AND BROKERAGE

     77  

CAPITAL STOCK

     77  

DETERMINATION OF NET ASSET VALUE

     78  

ANTI-MONEY LAUNDERING PROGRAM

     79  

REDEMPTIONS IN-KIND

     79  

DISTRIBUTIONS AND TAX INFORMATION

     79  

DISTRIBUTOR

     84  

FINANCIAL STATEMENTS

     84  

APPENDIX A

     A-1  

APPENDIX B

     B-1  


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THE TRUST

The Trust is a Delaware statutory trust organized under the laws of the State of Delaware on March 1, 2017, and is registered with the Securities and Exchange Commission (the SEC) as an open-end management investment company under the Investment Company Act of 1940, as amended (the 1940 Act). The Trust’s Agreement and Declaration of Trust (the Declaration of Trust) permits the Trust’s board of trustees to issue an unlimited number of full and fractional shares of beneficial interest, without par value, which may be issued in any number of series. The Trust may also issue separate classes of shares of any series. Currently, the Trust consists of nine series. The board may from time to time issue other series (and multiple classes of such series), the assets and liabilities of which will be separate and distinct from any other series.

All of the Funds, except for the Morningstar Multisector Bond Fund, are classified and operate as diversified funds under the 1940 Act. The Morningstar Multisector Bond Fund is classified as non-diversified. Under the 1940 Act, a diversified fund is a fund that meets the following requirements: at least 75% of the value of its total assets is represented by cash and cash items (including receivables), government securities, securities of other investment companies, and other securities for the purposes of this calculation limited in respect of any one issuer to an amount not greater in value than 5% of the value of the total assets of such management company and to not more than 10% of the outstanding voting securities of such issuer. A Fund may not change its diversification classification to become non-diversified without the approval of the holders of a majority of the Fund’s outstanding voting securities.

As used in this SAI, “a majority of a Fund’s outstanding voting securities” means the lesser of (1) 67% of the shares of beneficial interest of the Fund represented at a meeting at which more than 50% of the outstanding shares are present, or (2) more than 50% of the outstanding shares of beneficial interest of the Fund.

The Morningstar Multisector Bond Fund is classified as non-diversified under the 1940 Act. This means that, pursuant to the 1940 Act, there is no restriction as to how much the Fund may invest in the securities of any one issuer. However, to qualify for tax treatment as a regulated investment company under the Internal Revenue Code, as amended (the Code), the Morningstar Multisector Bond Fund (like all of the Funds) intends to comply, as of the end of each taxable quarter, with certain diversification requirements imposed by the Code. Pursuant to these requirements, at the end of each taxable quarter, the Morningstar Multisector Bond Fund, among other things, will not have investments in the securities of any one issuer (other than U.S. government securities or securities of other regulated investment companies) of more than 25% of the value of the Fund’s total assets. In addition, with respect to 50% of the Morningstar Multisector Bond Fund’s total assets, no investment can exceed 5% of the Fund’s total assets or 10% of the outstanding voting securities of the issuer.

As a non-diversified investment company, the Morningstar Multisector Bond Fund may be subject to greater risks than diversified investment companies because of the larger impact of fluctuation in the values of securities of fewer issuers.

Each Fund has not started operations as of the date of this SAI.

The Funds’ prospectus and this SAI are a part of the Trust’s registration statement filed with the SEC. Copies of the complete registration statement may be obtained from the SEC upon payment of the prescribed fee or may be accessed free of charge at the SEC’s website at sec.gov.

INVESTMENT STRATEGIES, POLICIES, AND RISKS

Equity Securities

Equity securities include common and preferred stocks, warrants, rights, and depository receipts. An investment in the equity securities of a company represents a proportionate ownership interest in that company. Therefore, a Fund participates in the financial success or failure of any company in which it has an equity interest.

Equity investments are subject to greater fluctuations in market value than other asset classes as a result of such factors as the issuer’s business performance, investor perceptions, stock market trends, and general economic conditions. Equity securities rank lower than bonds and other debt instruments in a company’s capital structure in terms of priority for corporate income and liquidation payments. See the prospectus for additional information regarding equity investments and their risks.

 

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All investments in equity securities are subject to market risks that may cause their prices to fluctuate over time. Historically, the equity markets have moved in cycles, and the value of the Funds’ securities may fluctuate substantially from day to day. Owning an equity security can also subject a Fund to the risk that the issuer may discontinue paying dividends.

To the extent a Fund invests in the equity securities of small- or medium-sized companies, it will be exposed to the risks of small- and medium-sized companies. Such companies may have narrower markets for their goods and/or services and may have more limited managerial and financial resources than larger, more established companies. Furthermore, such companies may have limited product lines, or services, markets, or financial resources, or may depend on a small management group. In addition, because these stocks may not be well-known to the investing public, may not have significant institutional ownership, and are typically followed by fewer third-party analysts, there will normally be less publicly available information on these securities compared with the securities of larger companies. Adverse publicity and investor perceptions, can also decrease the value and liquidity of securities held by a Fund. As a result, their performance can be more volatile and they face greater risk of business failure, which could increase the Fund’s volatility.

Common Stock. Common stocks represent a proportionate ownership share of a company, and its value is based on the success of the company’s business, any income paid to stockholders, the value of its assets, and general market conditions. In addition to the general risks set forth above, investments in common stocks are subject to risks related to their ranking in the capital structure. If a company in which a Fund invests is liquidated, the holders of preferred stock and creditors will be paid in full before any payments are made to holders of common stock. It is possible that all assets of a liquidated company will be exhausted before any payments are made to a Fund.

Preferred Stock. Preferred stocks are equity securities that often pay dividends at a specific rate and have a preference over common stocks for dividend payments and liquidation of assets. A preferred stock has characteristics of both a bond and common stock. It can offer the higher yield of a bond and has priority over common stock in equity ownership but does not have the seniority of a bond. Unlike common stock, a preferred stock’s participation in the issuer’s growth may be limited. Although the dividend is set at a fixed annual rate, it is subject to the risk that the dividend can be changed or omitted by the issuer.

Equity-linked Investments. Equity-linked investments are subject to the same risks as direct investments in securities of the underlying investment. If the underlying investment decreases in value, the value of the equity-linked investment will decrease; however, the performance of such investments may not correlate exactly to the performance of the underlying investment that they seek to replicate. Equity-linked investments are also subject to counterparty risk, which is the risk that the issuer of such investment — which is different from the issuer of the underlying investment — may be unwilling or unable to fulfill its obligations. There is no guarantee that a liquid market will exist or that the counterparty or issuer of such investments will be willing to repurchase them when a Fund wishes to sell them.

Convertible Securities and Warrants

Convertible securities are securities (such as debt securities or preferred stock) that may be converted into or exchanged for a specified amount of common stock of the same or different issuer within a particular period of time at a specified price or formula. Convertible securities also include corporate bonds, notes, and preferred stock. A convertible security entitles the holder to receive interest paid or accrued on debt or dividends paid on preferred stock until the convertible stock matures or is redeemed, converted or exchanged. While no investment is without some risk, investments in convertible securities generally entail less risk than an issuer’s common stock. However, any reduction in risk depends in large measure upon the degree to which the convertible security sells above its value as a fixed-income security. In addition to the general risks associated with equity securities discussed above, the market value of convertible securities is also affected by prevailing interest rates, the credit quality of the issuer, and any call provisions. While convertible securities generally offer lower interest or dividend yields than nonconvertible debt securities of similar quality, they do enable the investor to benefit from increases in the market price of the underlying common stock.

 

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Warrants and similar rights are instruments that give a Fund the right to purchase certain securities from an issuer at a specific price (the strike price) for a limited period of time. The strike price of warrants typically is much lower than the current market price of the underlying securities, yet they are subject to similar price fluctuations. As a result, warrants may be more volatile investments than the underlying securities and may offer greater potential for capital appreciation as well as capital loss. Warrants do not entitle a holder to dividends or voting rights with respect to the underlying securities and do not represent any rights in the assets of the issuing company. Also, the value of the warrant does not necessarily change with the value of the underlying securities and a warrant ceases to have value if it is not exercised before the expiration date. These factors can make warrants more speculative than other types of investments.

Other Corporate Debt Securities

The Funds may invest in non-convertible debt securities of foreign and domestic companies over a cross-section of industries. The debt securities in which a Fund may invest will be of varying maturities and may include corporate bonds, debentures, notes and other similar corporate debt instruments. The value of a longer-term debt security fluctuates more widely in response to changes in interest rates than do shorter-term debt securities.

Cash Position

When Morningstar or one of the fund’s subadvisers believes that market conditions are unfavorable, or if a subadviser is otherwise unable to locate attractive investment opportunities, a Fund’s holdings in cash or similar investments may increase. Cash or similar investments generally are a residual – they represent the assets that remain after a portfolio manager has committed available assets to desirable investment opportunities. However, a Fund’s adviser or subadviser may also temporarily increase the Fund’s cash position to protect its assets or maintain liquidity. Partly because each of the subadvisers acts independently of other subadvisers, the cash positions of a Fund may vary significantly.

If a Fund’s investments in cash or similar investments increase, it may not participate in market advances or declines to the same extent that it would if the Fund remained more fully invested in stocks or bonds.

Risks of Investing in Debt Securities

There are a number of risks generally associated with an investment in debt securities (including convertible securities). Yields on short-, intermediate-, and long-term securities depend on a variety of factors, including the general condition of the money and bond markets, the size of a particular offering, the maturity of the obligation, and the rating of the issue.

Debt securities with longer maturities tend to produce higher yields and are generally subject to potentially greater capital appreciation and depreciation than obligations with short maturities and lower yields. The market prices of debt securities usually vary, depending upon available yields. An increase in interest rates will generally reduce the value of such portfolio investments, and a decline in interest rates will generally increase the value of such portfolio investments. The ability of a Fund to achieve its investment objective also depends on the continuing ability of the issuers of the debt securities in which the Fund invests to meet their obligations for the payment of interest and principal when due.

Taxes. A Fund may purchase debt securities (such as zero coupon or pay-in-kind securities) that contain an original issue discount. The gradual increase in price of these securities to offset the original issue discount as earned income by a Fund and therefore is subject to the distribution requirements applicable to regulated investment companies under Subchapter M of the Code. Because the original issue discount earned by a Fund in a taxable year may not be represented by cash income, the Fund may have to dispose of other securities and use the proceeds to make distributions to shareholders.

Risks of Investing in Lower-Rated Debt Securities

Sensitivity to Interest Rate and Economic Changes. The economy and interest rates affect lower-rated debt securities differently from other securities. For example, the prices of lower-rated bonds have often been found to be less sensitive to interest rate changes than higher-rated investments, but more sensitive to adverse economic changes or individual corporate developments. Also, during an economic downturn or substantial period of rising interest rates, highly leveraged issuers may experience financial stress which would adversely affect their ability to service their principal and interest obligations, to meet projected business goals, and to obtain additional financing. If the issuer of a bond defaults, a Fund may incur additional expenses to seek recovery. In addition, periods of economic uncertainty and changes can be expected to result in increased volatility of market prices of lower-rated bonds and a Fund’s asset values.

 

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Payment Expectations. Lower-rated bonds present certain risks based on payment expectations. For example, lower-rated bonds may contain redemption and call provisions. If an issuer exercises these provisions in a declining interest rate market, a Fund would have to replace the security with a lower yielding security, resulting in a decreased return for investors. Conversely, a lower-rated bond’s value will decrease in a rising interest rate market, as will the value of a Fund’s assets. If a Fund experiences unexpected net redemptions, it may be forced to sell its lower-rated bonds without regard to their investment merits, thereby decreasing the asset base upon which a Fund’s expenses can be spread and possibly reducing the Fund’s rate of return.

Liquidity and Valuation. To the extent that there is no established retail secondary market, there may be thin trading of lower-rated bonds, and this may impact a subadviser’s ability to accurately value lower-rated bonds and a Fund’s assets and hinder the Fund’s ability to dispose of the bonds. Adverse publicity and investor perceptions, whether or not based on fundamental analysis, may decrease the values and liquidity of lower-rated bonds, especially in a thinly traded market.

Credit Ratings. Credit ratings evaluate the safety of principal and interest payments, not the market value risk of lower-rated bonds. Also, since credit rating agencies may fail to timely change the credit ratings to reflect subsequent events, a subadviser must monitor the issuers of lower-rated bonds in a Fund’s portfolio to determine if the issuers will have sufficient cash flow and profits to meet required principal and interest payments, and to assure the bonds’ liquidity so the Fund can meet redemption requests. A Fund will not necessarily dispose of a portfolio security when its rating has been changed.

Risks of Investing in Distressed Companies

From time to time, a Fund may purchase the direct indebtedness of various companies (Indebtedness), or participation interests in Indebtedness (Participations), including Indebtedness and Participations of reorganizing companies. Indebtedness can be distinguished from traditional debt securities in that debt securities are part of a large issue of securities to the general public which is typically registered with a securities registration organization, such as the SEC, and which is held by a large group of investors. Indebtedness may not be a security, but rather, may represent a specific commercial loan or portion of a loan which has been given to a company by a financial institution such as a bank or insurance company. The company is typically obligated to repay such commercial loan over a specified time period. By purchasing the Indebtedness of companies, a Fund in effect steps into the shoes of the financial institution which made the loan to the company before its restructuring or refinancing. Indebtedness purchased by a Fund may be in the form of loans, notes or bonds.

The length of time remaining until maturity on the Indebtedness is one factor the subadvisers consider in purchasing a particular Indebtedness. Indebtedness which represents a specific Indebtedness of the company to a bank, is not considered to be a security issued by the bank selling it. A Fund may purchase loans from national and state chartered banks as well as foreign banks, and they normally invest in the Indebtedness of a company which has the highest priority in terms of payment by the company, although on occasion lower priority Indebtedness also may be acquired.

Participations represent fractional interests in a company’s Indebtedness. The financial institutions that typically make Participations available are banks or insurance companies, governmental institutions, such as the Resolution Trust Corporation, the Federal Deposit Insurance Corporation or the Pension Benefit Guaranty Corporation, or certain organizations such as the World Bank, which are known as “supranational organizations.” Supranational organizations are entities established or financially supported by the national governments of one or more countries to promote reconstruction or development. Indebtedness and Participations may be illiquid as described below

Illiquid Securities

A Fund may not invest more than 15% of the value of its net assets in securities that are illiquid. Morningstar and subadvisers will monitor the amount of illiquid securities in a Fund, under the supervision of the board, to ensure compliance with this investment restriction.

 

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Historically, illiquid securities have included securities subject to contractual or legal restrictions on resale because they have not been registered under the Securities Act of 1933, as amended (the Securities Act), securities which are otherwise not readily marketable and repurchase agreements having a maturity of longer than seven days. Limitations on resale may have an adverse effect on the marketability of the securities, and a Fund might be unable to sell restricted or other illiquid securities promptly or at reasonable prices and might thereby experience difficulty satisfying redemption requests within seven days. Because of their illiquid nature, illiquid securities may need to be priced at fair value as determined in good faith pursuant to procedures approved by the Trust’s Board. Despite such good faith efforts to determine fair value prices, a Fund’s illiquid securities are subject to the risk that the security’s fair value price may differ from the actual price that the Fund may ultimately realize upon its sale or disposition.

In recent years, however, a large institutional market has developed for certain securities that are not registered under the Securities Act, including repurchase agreements, commercial paper, foreign securities, municipal securities and corporate bonds and notes. Institutional investors depend on an efficient institutional market in which the unregistered security can be readily resold or on an issuer’s ability to honor a demand for repayment. The fact that there are contractual or legal restrictions on resale to the general public or to certain institutions may not be indicative of the liquidity of such investments. If such securities are subject to purchase by institutional buyers in accordance with Rule 144A promulgated by the Commission under the Securities Act, a subadviser, pursuant to procedures adopted by the Trust’s board of trustees, may determine that such securities are not illiquid securities notwithstanding their legal or contractual restrictions on resale.

Exchange-Traded Funds and Other Registered Investment Companies

A Fund may invest in exchange-traded funds (ETFs), which are a type of index fund bought and sold on a securities exchange. An ETF trades like common stock and represents a fixed portfolio of securities designed to track a particular market index. A Fund could purchase an ETF to temporarily gain exposure to a portion of the U.S. or a foreign market while awaiting purchase of underlying securities. The risks of owning an ETF generally reflect the risks of owning the underlying securities they are designed to track, although lack of liquidity in an ETF could result in it being more volatile and ETFs have management fees that increase their costs. ETFs are also subject to other risks, including the risk that their prices may not correlate perfectly with changes in the underlying index and the risk of possible trading halts due to market conditions or other reasons that, in the view of the exchange upon which an ETF trades, would make trading in the ETF inadvisable. An exchange-traded sector fund may also be adversely affected by the performance of that specific sector or group of industries on which it is based. Investments in ETFs are generally subject to limits in the 1940 Act on investments in other investment companies, subject to certain exceptions.

Despite the possibility of greater fees and expenses, investments in other investment companies may nonetheless be attractive for several reasons, especially in connection with foreign investments. Because of restrictions on direct investment by U.S. entities in certain countries, investing indirectly in such countries (by purchasing shares of another fund that is permitted to invest in such countries) may be the most practical and efficient way for the Fund to invest in such countries. In other cases, when a portfolio manager desires to make only a relatively small investment in a particular country, investing through another fund that holds a diversified portfolio in that country may be more effective than investing directly in issuers in that country.

The 1940 Act generally prohibits the Fund from investing more than 5% of the value of its total assets in any one investment company or more than 10% of the value of its total assets in investment companies as a group, and also restricts its investment in any investment company to 3% of the voting securities of such investment company. There are exceptions, however, to these limitations pursuant to various rules promulgated by the SEC. Additionally, the Funds and certain underlying investment companies in which they may invest (including, but not limited to, ETFs) have obtained exemptive orders from the SEC that each permit a Fund to acquire securities of other investment companies in excess of the percentage limitations of the 1940 Act.

Each Fund may invest in other investment companies, including those managed by Morningstar or a subadviser, to the extent permitted by any rule or regulation of the SEC or any order or interpretation thereunder.

 

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Money Market Mutual Funds. A Fund may under certain circumstances invest a portion of its assets in money market funds. However, an investment in a money market mutual fund will involve payment by the Fund of its pro rata share of advisory and administrative fees charged by such fund.

Short-Term Investments

A Fund may invest in any of the following short-term securities and instruments:

Bank Obligations. Obligations including certificates of deposit, fixed time deposits and bankers’ acceptances, commercial paper and other debt obligations of banks subject to regulation by the U.S. Government and having total assets of $1 billion or more, and instruments secured by such obligations, not including obligations of foreign branches of domestic banks except as permitted below.

Certificates of Deposit, Bankers Acceptances and Time Deposits. A Fund may hold certificates of deposit, bankers’ acceptances and time deposits. Certificates of deposit are negotiable certificates issued against funds deposited in a commercial bank for a definite period of time and earning a specified return. Bankers’ acceptances are negotiable drafts or bills of exchange, normally drawn by an importer or exporter to pay for specific merchandise, which are “accepted” by a bank, meaning in effect that the bank unconditionally agrees to pay the face value of the instrument on maturity.

Obligations of Savings Institutions. Certificates of deposit of savings banks and savings and loan associations, having total assets of $1 billion or more (investments in savings institutions above $100,000 in principal amount are not protected by federal deposit insurance).

Fully Insured Certificates of Deposit. Certificates of deposit of banks and savings institutions, having total assets of less than $1 billion, if the principal amount of the obligation is insured by the Bank Insurance Fund or the Savings Association Insurance Fund (each of which is administered by the Federal Deposit Insurance Corporation), limited to $250,000 principal amount per certificate and to 15% or less of a Fund’s net assets in all such obligations and in all illiquid assets, in the aggregate.

Commercial Paper and Short-Term Notes. Each Fund may invest a portion of its assets in commercial paper and short-term notes. Commercial paper consists of unsecured promissory notes issued by corporations. Commercial paper and short-term notes will normally have maturities of less than nine months and fixed rates of return, although such instruments may have maturities of up to one year.

Commercial paper and short-term notes will consist of issues rated at the time of purchase “A-2” or higher by Standard & Poor’s® Ratings Group, “Prime-1” or “Prime-2” by Moody’s Investors Service, Inc.©, or similarly rated by another nationally recognized statistical rating organization or, if unrated, will be determined by the adviser to be of comparable quality. These rating symbols are described in Appendix A.

Other Short-Term Obligations. Debt securities initially issued with a remaining maturity of 397 days or less and that have a short-term rating within ratings categories of at least A-1 by S&P or P-1 by Moody’s.

Municipal Securities

A Fund may invest in municipal securities. Municipal securities are issued by the states, territories and possessions of the United States, their political subdivisions (such as cities, counties and towns) and various authorities (such as public housing or redevelopment authorities), instrumentalities, public corporations and special districts (such as water, sewer or sanitary districts) of the states, territories, and possessions of the United States or their political subdivisions. In addition, municipal securities include securities issued by or on behalf of public authorities to finance various privately operated facilities, such as industrial development bonds, that are backed only by the assets and revenues of the non-governmental user (such as hospitals and airports).

Municipal securities are issued to obtain funds for a variety of public purposes, including general financing for state and local governments, or financing for specific projects or public facilities. Municipal securities are classified as general obligation or revenue bonds or notes. General obligation securities are secured by the issuer’s pledge of its full faith, credit and taxing power for the payment of principal and interest. Revenue securities are payable from

 

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revenue derived from a particular facility, class of facilities, or the proceeds of a special excise tax or other specific revenue source, but not from the issuer’s general taxing power. Private activity bonds and industrial revenue bonds do not carry the pledge of the credit of the issuing municipality, but generally are guaranteed by the corporate entity on whose behalf they are issued.

Municipal leases are entered into by state and local governments and authorities to acquire equipment and facilities such as fire and sanitation vehicles, telecommunications equipment, and other assets. Municipal leases (which normally provide for title to the leased assets to pass eventually to the government issuer) have evolved as a means for governmental issuers to acquire property and equipment without meeting the constitutional and statutory requirements for the issuance of debt. The debt-issuance limitations of many state constitutions and statutes are deemed to be inapplicable because of the inclusion in many leases or contracts of “non-appropriation” clauses that provide that the governmental issuer has no obligation to make future payments under the lease or contract unless money is appropriated for such purpose by the appropriate legislative body on a yearly or other periodic basis.

Tender Option Bonds

A Fund may invest in tender option bond (TOB) programs, a type of synthetic municipal bond instrument that allows the purchaser to receive a variable rate of tax-exempt income from a trust entity that holds long-term municipal bonds. These types of instruments involve the deposit into a trust or custodial account of one or more long-term tax-exempt bonds or notes (Underlying Bonds), and the sale of certificates evidencing interests in the trust or custodial account to investors such as an Underlying Fund. The trustee or custodian receives the long-term fixed rate interest payments on the Underlying Bonds, and pays certificate holders fixed rates or short-term floating or variable interest rates which are reset periodically. A TOB provides a certificate holder with the conditional right to sell its certificate to the sponsor or some designated third party at specified intervals and receive the par value of the certificate plus accrued interest (a demand feature). A “fixed rate trust certificate” evidences an interest in a trust entitling a certificate holder to fixed future interest and/or principal payments on the Underlying Bonds. A “variable rate trust certificate” evidences an interest in a trust entitling the certificate holder to receive variable rate interest based on prevailing short-term interest rates and also typically provides the certificate holder with the conditional demand feature (the right to tender its certificate at par value plus accrued interest under certain conditions).

All TOBs purchased by a Fund must meet the minimum quality standards for the Fund as disclosed in the purchasing Fund’s prospectus. In selecting TOB instruments for the Funds, Morningstar or a Fund’s subadviser(s) will consider the creditworthiness of the issuer of the Underlying Bond, the sponsor and the party providing certificate holders with a conditional right to sell their certificates at stated times and prices (a demand feature).

Typically, a certificate holder cannot exercise the demand feature until the occurrence of certain conditions, such as where the issuer of the Underlying Bond defaults on interest payments. Moreover, because TOB instruments involve a trust or custodial account and a third party conditional demand feature, they involve complexities and potential risks that may not be present where a municipal security is owned directly.

The tax-exempt character of the interest paid to certificate holders is based on the assumption that the holders have an ownership interest in the Underlying Bonds; however, the IRS has not issued a ruling addressing this issue. In the event the IRS issues an adverse ruling or successfully litigates this issue, it is possible that the interest paid to an Underlying Fund on certain TOB instruments would be deemed to be taxable. The Underlying Funds rely on opinions of special tax counsel on this ownership question and opinions of bond counsel regarding the tax-exempt character of interest paid on the Underlying Bonds.

U.S. and Foreign Government Obligations

A Fund may invest in U.S. Government obligations including Treasury bills, certificates of indebtedness, notes and bonds, and issues of such entities as the Government National Mortgage Association (GNMA), Export-Import Bank of the United States, Tennessee Valley Authority, Resolution Funding Corporation, Farmers Home Administration, Federal Home Loan Banks, Federal Intermediate Credit Banks, Federal Farm Credit Banks, Federal Land Banks, Federal Housing Administration, Federal National Mortgage Association (FNMA), Federal Home Loan Mortgage Corporation (FHLMC), and the Student Loan Marketing Association (SLMA).

 

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Some of these obligations, such as those of the GNMA, are supported by the full faith and credit of the U.S. Treasury; others, such as those of the Export-Import Bank of United States, are supported by the right of the issuer to borrow from the Treasury; others, such as those of the FNMA, are supported by the discretionary authority of the U.S. Government to purchase the agency’s obligations; still others, such as those of the SLMA, are supported only by the credit of the instrumentality. No assurance can be given that the U.S. Government would provide financial support to U.S. Government-sponsored instrumentalities if it is not obligated to do so by law.

A Fund may invest in sovereign debt obligations of foreign countries. A sovereign debtor’s willingness or ability to repay principal and interest in a timely manner may be affected by a number of factors, including its cash flow situation, the extent of its foreign reserves, the availability of sufficient foreign exchange on the date a payment is due, the relative size of the debt service burden to the economy as a whole, the sovereign debtor’s policy toward principal international lenders and the political constraints to which it may be subject. A government could default on its sovereign debt obligations. This risk of default is higher in emerging markets. Such sovereign debtors also may be dependent on expected disbursements from foreign governments, multilateral agencies and other entities abroad to reduce principal and interest arrearages on their debt. The commitments on the part of these governments, agencies and others to make such disbursements may be conditioned on a sovereign debtor’s implementation of economic reforms and/or economic performance and the timely service of such debtor’s obligations. Failure to meet such conditions could result in the cancellation of such third parties’ commitments to lend funds to the sovereign debtor, which may further impair such debtor’s ability or willingness to service its debt in a timely manner.

Floating-Rate and Variable-Rate Demand Notes

A Fund may purchase taxable or tax-exempt floating-rate and variable-rate demand notes for short-term cash management or other investment purposes. Floating-rate and variable-rate demand notes and bonds may have a stated maturity in excess of one year, but may have features that permit a holder to demand payment of principal plus accrued interest upon a specified number of days’ notice. Frequently, such obligations are secured by letters of credit or other credit support arrangements provided by banks. The issuer has a corresponding right, after a given period, to prepay in its discretion the outstanding principal of the obligation plus accrued interest upon a specific number of days’ notice to the holders. The interest rate of a floating-rate instrument may be based on a known lending rate, such as a bank’s prime rate, and is reset whenever such rate is adjusted. The interest rate on a variable-rate demand note is reset at specified intervals at a market rate.

Inverse Floaters

An inverse floater is a type of instrument that bears a floating or variable interest rate that moves in the opposite direction to interest rates generally or the interest rate on another security or index. Inverse floaters are typically created by a broker depositing an income-producing instrument, which may be a mortgage-backed security, in a trust. The trust in turn issues a variable-rate security and inverse floaters. The interest rate for the variable-rate security is typically determined by an index or an auction process, while the inverse floater holder receives the balance of the income from the underlying income-producing instrument less an auction fee. Because inverse floaters may be considered to be leveraged, including if their interest rates vary by a magnitude that exceeds the magnitude of the change in a reference rate of interest (typically a short-term interest rate) the market prices of inverse floaters may be highly sensitive to changes in interest rates and in prepayment rates on the underlying securities, and may decrease significantly when interest rates increase or prepayment rates change. The returns on inverse floaters may be leveraged, increasing substantially the volatility and interest-rate sensitivity.

Zero-Coupon and Payment-in-Kind Bonds

A Fund may invest without limit in so-called zero-coupon bonds and payment-in-kind bonds. Zero-coupon bonds are issued at a significant discount from their principal amount in lieu of paying interest periodically. Payment-in-kind bonds allow the issuer, at its option, to make current interest payments on the bonds either in cash or in additional bonds. Because zero-coupon and payment-in-kind bonds do not pay current interest in cash, their value is subject to greater fluctuation in response to changes in market interest rates than bonds that pay interest currently. Both zero-coupon and payment-in-kind bonds allow an issuer to avoid the need to generate cash to meet current interest payments. Accordingly, such bonds may involve greater credit risks than bonds paying interest currently in cash. A Fund is required to accrue interest income on such investments and to distribute such amounts at least annually to shareholders even though the investments do not make any current interest payments. Thus, it may be necessary at times for the Fund to liquidate other investments to satisfy its distribution requirements under the Code.

 

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Foreign Securities

A Fund may invest in securities issued by foreign governments and corporations, including emerging and frontier market securities, that are U.S. dollar denominated obligations. A Fund may invest in securities issued by foreign companies or governmental authorities either directly or through depository receipts or ETFs (generally referred to as “foreign securities”). Investing in foreign securities involves more risk than investing in U.S. securities. Changes in the value of foreign currencies can significantly affect the value of a foreign security held by a Fund, irrespective of developments relating to the issuer. In addition, the values of foreign securities may be affected by changes in exchange control regulations and fluctuations in the relative rates of exchange between the currencies of different nations, as well as by economic and political developments. Other risks involved in investing in foreign securities include the following: there may be less publicly available information about foreign companies comparable to the reports and ratings that are published about companies in the United States; foreign companies are not generally subject to uniform accounting, auditing and financial reporting standards and requirements comparable to those applicable to U.S. companies; some foreign stock markets have substantially less volume than U.S. markets, and securities of some foreign companies are less liquid and more volatile than securities of comparable U.S. companies; there may be less government supervision and regulation of foreign stock exchanges, brokers and listed companies than exist in the United States; and there may be the possibility of expropriation or confiscatory taxation, political or social instability or diplomatic developments which could affect assets of a Fund held in foreign countries. Investments in foreign government debt obligations also involve special risks. The issuer of the debt may be unable or unwilling to pay interest or repay principal when due in accordance with the terms of such debt, and a Fund may have limited legal resources in the event of default. Political conditions, especially a sovereign entity’s willingness to meet the terms of its debt obligations, are of considerable significance.

Foreign Securities Traded in the United States. A Fund may own foreign equity or debt securities that are traded in the United States and denominated in United States dollars. They also may be issued originally in the United States. For example, some foreign companies raise capital by selling dollar-denominated bonds to institutional investors in the United States. Such bonds have all of the risks associated with foreign securities traded in foreign markets, except for the risks of foreign securities markets. There may be a thin trading market for foreign securities that are traded in the United States, and in some cases such securities may be illiquid, since such securities may be restricted and traded principally among institutional investors.

Foreign Securities Traded in Foreign Markets. A Fund may invest in foreign securities that are traded in foreign securities markets. In addition to the general risks of foreign investments discussed above, securities that are traded in foreign markets present special risks, including higher brokerage costs, potentially thinner trading markets, extended settlement periods and the risks of holding securities with foreign sub-custodians and securities depositories. A Fund may also engage in foreign currency futures contracts, foreign currency forward contracts, and foreign currency exchange contracts. See “Foreign Currency” below for a description of such investments. The Funds may also invest some or all of their excess cash in deposit accounts with foreign banks.

Securities of Emerging Market Issuers. A Fund may invest in the securities of issuers in less developed foreign countries including countries whose economies or securities markets are not yet highly developed (emerging markets). Emerging markets are nations with below investment grade credit ratings and social or business activity in the process of rapid growth and industrialization. There are special risks associated with investing in emerging markets in addition to those described above. These special risks include, among others, greater political uncertainties, an economy’s dependence on revenues from particular commodities or on international aid or development assistance, currency transfer restrictions, a limited number of potential buyers for such securities and delays and disruptions in securities settlement procedures.

Securities of Frontier Market Issuers. A Fund may invest in the securities of issuers in frontier markets. There are special risks associated with investing in emerging markets in addition to those described above. Frontier market countries are countries that have smaller economies or less developed capital markets than traditional emerging markets. Frontier countries tend to have relatively low gross national product per capita compared to the larger traditionally-recognized emerging markets. The frontier emerging market countries include the least developed countries even by emerging markets standards. The risks of investments in frontier emerging market countries include all the risks described above for investment in foreign securities and emerging markets, although these risks are magnified in the case of frontier countries.

 

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Depositary Receipts

Many securities of foreign issuers are represented by American Depositary Receipts (ADRs), Global Depositary Receipts (GDRs), and European Depositary Receipts (EDRs) (collectively, depositary receipts). Generally, depositary receipts in registered form are designed for use in the U.S. securities market and depositary receipts in bearer form are designed for use in securities markets outside the U.S.

ADRs evidence ownership of, and represent the right to receive, securities of foreign issuers deposited in a domestic bank or trust company or a foreign correspondent bank. Prices of ADRs are quoted in U.S. dollars, and ADRs are traded in the U.S. on exchanges or over-the-counter (OTC). While ADRs do not eliminate all the risks associated with foreign investments, by investing in ADRs rather than directly in the stock of foreign issuers, a Fund will avoid currency and certain foreign market trading risks during the settlement period for either purchases or sales. In general, there is a large, liquid market in the U.S. for ADRs quoted on a national securities exchange. The information available for ADRs is subject to the accounting, auditing and financial reporting standards of the U.S. market or exchange on which they are traded, which standards are generally more uniform and more exacting than those to which many foreign issuers may be subject.

EDRs and GDRs are typically issued by foreign banks or trust companies and evidence ownership of underlying securities issued by either a foreign or a U.S. corporation. EDRs and GDRs may not necessarily be denominated in the same currency as the underlying securities into which they may be converted. The underlying shares are held in trust by a custodian bank or similar financial institution in the issuer’s home country. If the issuer’s home country does not have developed financial markets, a Fund could be exposed to the credit risk of the custodian or financial institution and greater market risk. The depository bank may not have physical custody of the underlying securities at all times and may charge fees for various services, including forwarding dividends and interest, and processing corporate actions. A Fund would be expected to pay a share of the additional fees, which it would not pay if investing directly in the foreign securities. A Fund may experience delays in receiving its dividend and interest payments or exercising rights as a shareholder.

Depositary receipts may reduce some but not eliminate all the risks inherent in investing in the securities of foreign issuers. Depositary receipts are still subject to the political and economic risks of the underlying issuer’s country and are still subject to foreign currency exchange risk. Depositary receipts will be issued under sponsored or unsponsored programs. In sponsored programs, an issuer has made arrangements to have its securities traded in the form of depositary receipts. In unsponsored programs, the issuer may not be directly involved in the creation of the program. Although regulatory requirements with respect to sponsored and unsponsored programs are generally similar, in some cases it may be easier to obtain financial information about an issuer that has participated in the creation of a sponsored program. There may be an increased possibility of untimely responses to certain corporate actions of the issuer, such as stock splits and rights offerings, in an unsponsored program. Accordingly, there may be less information available regarding issuers of securities underlying unsponsored programs and there may not be a correlation between this information and the market value of the depositary receipts. If a Fund’s investment depends on obligations being met by the arranger as well as the issuer of an unsponsored program, the Fund will be exposed to additional credit risk.

Asset-Backed, Mortgage-Related and Mortgage-Backed Securities

Mortgage-backed securities, including CMOs and certain stripped mortgage-backed securities, represent a participation in, or are secured by, mortgage loans. Asset-backed securities are structured like mortgage-backed securities, but instead of mortgage loans or interests in mortgage loans, the underlying assets may include such items as motor vehicle installment sales or installment loan contracts, leases of various types of real and personal property, receivables from credit card agreements, company receivables or other assets. The cash flow generated by the underlying assets is applied to make required payments on the securities and to pay related administrative expenses. The amount of residual cash flow resulting from a particular issue of asset-backed or mortgage-backed securities depends on, among other things, the characteristics of the underlying assets, the coupon rates on the securities, prevailing interest rates, the amount of administrative expenses and the actual prepayment experience on the underlying assets. A Fund may each invest in any such instruments or variations as may be developed, to the extent consistent with its investment objectives and policies and applicable regulatory requirements. In general, the collateral supporting asset-backed securities is of a shorter maturity than mortgage loans and is likely to experience substantial prepayments.

 

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Mortgage-backed securities have yield and maturity characteristics corresponding to the underlying assets. Unlike traditional debt securities, which may pay a fixed rate of interest until maturity, when the entire principal amount comes due, payments on certain mortgage-backed securities include both interest and a partial repayment of principal. Besides the scheduled repayment of principal, repayments of principal may result from the voluntary prepayment, refinancing or foreclosure of the underlying mortgage loans. If property owners make unscheduled prepayments of their mortgage loans, these prepayments will result in early payment of the applicable mortgage-backed securities. In that event a Fund may be unable to invest the proceeds from the early payment of the mortgage-backed securities in an investment that provides as high a yield as the mortgage-backed securities. Consequently, early payment associated with mortgage-backed securities may cause these securities to experience significantly greater price and yield volatility than that experienced by traditional fixed-income securities. The occurrence of mortgage prepayments is affected by factors including the level of interest rates, general economic conditions, the location and age of the mortgage and other social and demographic conditions. During periods of falling interest rates, the rate of mortgage prepayments tends to increase, thereby tending to decrease the life of mortgage-backed securities. During periods of rising interest rates, the rate of mortgage prepayments usually decreases, thereby tending to increase the life of mortgage-backed securities. If the life of a mortgage-backed security is inaccurately predicted, the Fund may not be able to realize the rate of return it expected.

Adjustable rate mortgage securities (ARMs), like traditional mortgage-backed securities, are interests in pools of mortgage loans that provide investors with payments consisting of both principal and interest as mortgage loans in the underlying mortgage pool are paid off by the borrowers. Unlike fixed-rate mortgage-backed securities, ARMs are collateralized by or represent interests in mortgage loans with variable rates of interest. These interest rates are reset at periodic intervals, usually by reference to an interest rate index or market interest rate. Although the rate adjustment feature may act as a buffer to reduce sharp changes in the value of adjustable rate securities, these securities are still subject to changes in value based on, among other things, changes in market interest rates or changes in the issuer’s creditworthiness. Because the interest rates are reset only periodically, changes in the interest rate on ARMs may lag changes in prevailing market interest rates. Also, some ARMs (or the underlying mortgages) are subject to caps or floors that limit the maximum change in the interest rate during a specified period or over the life of the security. As a result, changes in the interest rate on an ARM may not fully reflect changes in prevailing market interest rates during certain periods.

A Fund may also invest in hybrid ARMs, whose underlying mortgages combine fixed-rate and adjustable rate features.

Mortgage-backed and asset-backed securities are less effective than other types of securities as a means of locking in attractive long-term interest rates. One reason is the need to reinvest prepayments of principal; another is the possibility of significant unscheduled prepayments resulting from declines in interest rates. These prepayments would have to be reinvested at lower rates. The automatic interest rate adjustment feature of mortgages underlying ARMs likewise reduces the ability to lock-in attractive rates. As a result, mortgage-backed and asset-backed securities may have less potential for capital appreciation during periods of declining interest rates than other securities of comparable maturities, although they may have a similar risk of decline in market value during periods of rising interest rates. Prepayments may also significantly shorten the effective maturities of these securities, especially during periods of declining interest rates. Conversely, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to a greater risk of decline in market value in response to rising interest rates than traditional debt securities, and, therefore, potentially increasing the volatility of a Fund.

At times, some mortgage-backed and asset-backed securities will have higher than market interest rates and therefore will be purchased at a premium above their par value. Prepayments may cause losses on securities purchased at a premium.

CMOs may be issued by a U.S. Government agency or instrumentality or by a private issuer. Although payment of the principal of, and interest on, the underlying collateral securing privately issued CMOs may be guaranteed by the U.S. Government or its agencies or instrumentalities, these CMOs represent obligations solely of the private issuer and are not insured or guaranteed by the U.S. Government, its agencies or instrumentalities or any other person or entity.

 

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Prepayments could cause early retirement of CMOs. CMOs are designed to reduce the risk of prepayment for certain investors by issuing multiple classes of securities, each having different maturities, interest rates and payment schedules, and with the principal and interest on the underlying mortgages allocated among the several classes in various ways. Payment of interest or principal on some classes or series of CMOs may be subject to contingencies or some classes or series may bear some or all of the risk of default on the underlying mortgages. CMOs of different classes or series are generally retired in sequence as the underlying mortgage loans in the mortgage pool are repaid. If enough mortgages are repaid ahead of schedule, the classes or series of a CMO with the earliest maturities generally will be retired before their maturities. Thus, the early retirement of particular classes or series of a CMO would have the same effect as the prepayment of mortgages underlying other mortgage-backed securities. Conversely, slower than anticipated prepayments can extend the effective maturities of CMOs, subjecting them to a greater risk of decline in market value in response to rising interest rates than traditional debt securities, and, therefore, potentially increasing their volatility.

Prepayments could result in losses on stripped mortgage-backed securities. Stripped mortgage-backed securities are usually structured with two classes that receive different portions of the interest and principal distributions on a pool of mortgage loans. The yield to maturity on an interest only or “IO” class of stripped mortgage-backed securities is extremely sensitive not only to changes in prevailing interest rates but also to the rate of principal payments (including prepayments) on the underlying assets. A rapid rate of principal prepayments may have a measurable adverse effect on the Fund’s yield to maturity to the extent it invests in Ios. If the assets underlying the IO experience greater than anticipated prepayments of principal, a Fund may fail to recoup fully its initial investment in these securities. Principal only or “Pos” tend to increase in value if prepayments are greater than anticipated and decline if prepayments are slower than anticipated. The secondary market for stripped mortgage-backed securities may be more volatile and less liquid than that for other mortgage-backed securities, potentially limiting a Fund’s ability to buy or sell those securities at any particular time.

Subprime mortgage loans, which typically are made to less creditworthy borrowers, have a higher risk of default than conventional mortgage loans. Therefore, mortgage-backed securities backed by subprime mortgage loans may suffer significantly greater declines in value due to defaults or the increased risk of default.

The risks associated with other asset-backed securities (including in particular the risks of issuer default and of early prepayment) are generally similar to those described above for CMOs. In addition, because asset-backed securities generally do not have the benefit of a security interest in the underlying assets comparable to a mortgage, asset-backed securities present certain additional risks that are not present with mortgage-backed securities. The ability of an issuer of asset-backed securities to enforce its security interest in the underlying assets may be limited. For example, revolving credit receivables are generally unsecured and the debtors on such receivables are entitled to the protection of a number of state and federal consumer credit laws, many of which give debtors the right to set-off certain amounts owed, thereby reducing the balance due. Automobile receivables generally are secured, but by automobiles, rather than by real property.

Asset-backed securities may be collateralized by the fees earned by service providers. The values of asset-backed securities may be substantially dependent on the servicing of the underlying asset and are therefore subject to risks associated with the negligence or malfeasance by their servicers and to the credit risk of their servicers. In certain circumstances, the mishandling of related documentation may also affect the rights of the security holders in and to the underlying collateral. The insolvency of entities that generate receivables or that utilize the assets may result in added costs and delays in addition to losses associated with a decline in the value of the underlying assets. For the purposes of a Fund’s concentration policy, asset-backed securities will be classified in a consistent manner deemed reasonable by the Fund.

Collateralized bond obligations (CBOs), collateralized loan obligations (CLOs), and other CDOs. A CBO is a trust which is often backed by a pool of high risk, below investment grade fixed-income securities, such as high-yield bonds, privately issued mortgage-related securities, commercial mortgage-related securities, trust preferred securities, or emerging market debt. A CLO is a trust typically backed by a pool of loans, which may include senior secured loans, senior unsecured loans, and subordinate corporate loans, including loans that may be below investment grade. Other CDOs are trusts backed by other types of assets. The assets backing a CBO, CLO, or CDO trust may be referred to as “the collateral.” CBOs, CLOs and other CDOs may charge management fees and administrative expenses. The cash flows from the trust are split into two or more portions, called tranches, varying in

 

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risk and yield. Senior tranches can often be rated investment grade. CBO, CLO or other CDO tranches can experience substantial losses due to defaults, deterioration of protecting tranches, market participants’ perception of credit risk, as well as aversion to these securities generally. The risks of an investment in a CBO, CLO or other CDO often depend on the collateral securities and the particular tranche in which the Fund invests. These securities are often privately offered and not registered under securities laws. In addition to the normal risks associated with fixed-income securities (e.g., interest rate risk and credit risk), CBOs, CLOs and other CDOs carry additional risks including the possibility that distributions from collateral securities will not be adequate to make interest or other payments, the possibility that the quality of the collateral may decline in value or default, the risk that a Fund may invest in CBOs, CLOs or other CDOs that are subordinate to other tranches, as well as risks related to the complexity of the security and its structure.

Federal, state and local government officials and representatives as well as certain private parties have proposed actions to assist homeowners who own or occupy property subject to mortgages. Certain of those proposals involve actions that would affect the mortgages that underlie or relate to certain mortgage-related securities, including securities or other instruments which a Fund may hold or in which they may invest. Some of those proposals include, among other things, lowering or forgiving principal balances; forbearing, lowering or eliminating interest payments; or utilizing eminent domain powers to seize mortgages, potentially for below market compensation. The prospective or actual implementation of one or more of these proposals may significantly and adversely affect the value and liquidity of securities held by a Fund and could cause the Fund’s net asset value to decline, potentially significantly. Tremendous uncertainty remains in the market concerning the resolution of these issues; the range of proposals and the potential implications of any implemented solution is impossible to predict.

Collateralized Mortgage Obligations (CMOs) and Multiclass Pass-Through Securities. CMOs are debt obligations collateralized by mortgage loans or mortgage pass-through securities. CMOs may be collateralized by Government National Mortgage Association (Ginnie Mae), Federal National Mortgage Association (Fannie Mae), or Federal Home Loan Mortgage Corporation (Freddie Mac) certificates, but also may be collateralized by whole loans or private mortgage pass-through securities (such collateral is collectively hereinafter referred to as “Mortgage Assets”). Mortgage Assets may be collateralized by commercial or residential uses. Multiclass pass-through securities are equity interests in a trust composed of Mortgage Assets. Payments of principal of and interest on the Mortgage Assets, and any reinvestment income thereon, may require a Fund to pay debt service on the CMOs or make scheduled distributions on the multiclass pass-through securities. CMOs may be issued by Federal Agencies, or by private originators of, or investors in, mortgage loans, including savings and loan associations, mortgage banks, commercial banks, investment banks and special purpose subsidiaries of the foregoing. The issuer of a series of mortgage pass-through securities may elect to be treated as a Real Estate Mortgage Investment Conduit (REMIC). REMICs include governmental and/or private entities that issue a fixed pool of mortgages secured by an interest in real property. REMICs are similar to CMOs in that they issue multiple classes of securities, but unlike CMOs, which are required to be structured as debt securities, REMICs may be structured as indirect ownership interests in the underlying assets of the REMICs themselves. Although CMOs and REMICs differ in certain respects, characteristics of CMOs described below apply in most cases to REMICs, as well.

In a CMO, a series of bonds or certificates is issued in multiple classes. Each class of CMOs, often referred to as a tranche, is issued at a specific fixed or floating coupon rate and has a stated maturity or final distribution date. Principal prepayments on the Mortgage Assets may cause the CMOs to be retired substantially earlier than their stated maturities or final distribution dates. Interest is paid or accrues on all classes of the CMOs on a monthly, quarterly or semiannual basis. Certain CMOs may have variable or floating interest rates and others may be stripped mortgage securities. For more information on stripped mortgage securities, see “Stripped Mortgage Securities” below.

The principal of and interest on the Mortgage Assets may be allocated among the several classes of a CMO series in a number of different ways. Generally, the purpose of the allocation of the cash flow of a CMO to the various classes is to obtain a more predictable cash flow to certain of the individual tranches than exists with the underlying collateral of the CMO. As a general rule, the more predictable the cash flow is on a CMO tranche, the lower the anticipated yield will be on that tranche at the time of issuance relative to prevailing market yields on other mortgage-backed securities. As part of the process of creating more predictable cash flows on most of the tranches in a series of CMOs, one or more tranches generally must be created that absorb most of the volatility in the cash flows on the underlying mortgage loans. The yields on these tranches are generally higher than prevailing market yields on mortgage-backed securities with similar maturities. As a result of the uncertainty of the cash flows of these tranches, the market prices of and yield on these tranches generally are more volatile.

 

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CMO Residuals. CMO residuals are mortgage securities issued by agencies or instrumentalities of the U.S. Government or by private originators of, or investors in, mortgage loans, including savings and loan associations, homebuilders, mortgage banks, commercial banks, investment banks and special purpose entities of the foregoing. The cash flow generated by the mortgage assets underlying a series of a CMO is applied first to make required payments of principal and interest on the securities or certificates issued by the CMO and second to pay the related administrative expenses and any management fee of the issuer. The residual in a CMO structure generally represents the interest in any excess cash flow remaining after making the foregoing payments. The amount of residual cash flow resulting from a CMO will depend on, among other things, the characteristics of the mortgage assets, the coupon rate of each class of CMO, prevailing interest rates, the amount of administrative expenses and the pre-payment experience on the mortgage assets. The yield to maturity on CMO residuals is extremely sensitive to pre-payments on the related underlying mortgage assets. In addition, if a series of a CMO includes a class that bears interest at an adjustable rate, the yield to maturity on the related CMO residual will be extremely sensitive to changes in the level of the index upon which interest rate adjustments are based. The Fund may fail to recoup fully its initial investment in a CMO residual. CMO residuals may or, pursuant to an exemption therefrom, may not have been registered under the Securities Act. CMO residuals, whether or not registered under the Securities Act, may be subject to certain restrictions on transferability, and may be deemed “illiquid.”

Government Mortgage Pass-Through Securities. A Fund may invest in mortgage pass-through securities representing participation interests in pools of residential mortgage loans purchased from individual lenders by an agency, instrumentality or sponsored corporation of the United States government (Federal Agency) or originated by private lenders and guaranteed, to the extent provided in such securities, by a Federal Agency. Such securities, which are ownership interests in the underlying mortgage loans, differ from conventional debt securities, which provide for periodic payment of interest in fixed amounts (usually semiannually) and principal payments at payments (not necessarily in fixed amounts) that are a pass-through of the monthly interest and principal payments (including any prepayments) made by the individual borrowers on the pooled mortgage loans, net of any fees paid to the guarantor of such securities and the servicer of the underlying mortgage loans.

The government mortgage pass-through securities in which a Fund may invest include those issued or guaranteed by Ginnie Mae, Fannie Mae and Freddie Mac. Ginnie Mae certificates are direct obligations of the U.S. Government and, as such, are backed by the full faith and credit of the United States. Fannie Mae is a federally chartered, privately owned corporation and Freddie Mac is a corporate instrumentality of the United States. Fannie Mae and Freddie Mac certificates are not backed by the full faith and credit of the United States but the issuing agency or instrumentality has the right to borrow, to meet its obligations, from an existing line of credit with the U.S. Treasury. The U.S. Treasury has no legal obligation to provide such line of credit and may choose not to do so.

Certificates for these types of mortgage-backed securities evidence an interest in a specific pool of mortgages. These certificates are, in most cases, modified pass-through instruments, wherein the issuing agency guarantees the payment of principal and interest on mortgages underlying the certificates, whether or not such amounts are collected by the issuer on the underlying mortgages.

The Housing and Economic Recovery Act of 2008 (HERA) authorized the Secretary of the Treasury to support Fannie Mae, Freddie Mac, and the Federal Home Loan Banks (FHLBs) (collectively, the “GSEs”) by purchasing obligations and other securities from those government-sponsored enterprises. HERA gave the Secretary of the Treasury broad authority to determine the conditions and amounts of such purchases.

On September 6, 2008, the Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac into conservatorship. As the conservator, FHFA succeeded to all rights, titles, powers and privileges of Fannie Mae and Freddie Mac and of any stockholder, officer or director of Fannie Mae and Freddie Mac with respect to Fannie Mae and Freddie Mac and the assets of Fannie Mae and Freddie Mac. FHFA selected a new chief executive officer and chairman of the board of directors for Fannie Mae and Freddie Mac.

 

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In connection with the conservatorship, the U.S. Treasury, exercising powers granted to it under HERA, entered into a Senior Preferred Stock Purchase Agreement (SPA) with each of Fannie Mae and Freddie Mac pursuant to which the U.S. Treasury will purchase up to an aggregate of $100 billion of each of Fannie Mae and Freddie Mac to maintain a positive net worth in each enterprise. This agreement contains various covenants that severely limit each enterprise’s operations. In exchange for entering into these agreements, the U.S. Treasury received $1 billion of each enterprise’s senior preferred stock and warrants to purchase 79.9% of each enterprise’s common stock. On February 18, 2009, the U.S. Treasury announced that it was doubling the size of its commitment to each enterprise under the Senior Preferred Stock Program to $200 billion. The U.S. Treasury’s obligations under the Senior Preferred Stock Program are for an indefinite period of time for a maximum amount of $200 billion per enterprise. On December 24, 2009, the U.S. Treasury announced further amendments to the SPAs which included additional financial support for each GSE through the end of 2012 and changes to the limits on their retained mortgage portfolios. Although legislation has been enacted to support certain GSEs, including the FHLBs, Freddie Mac and Fannie Mae, there is no assurance that GSE obligations will be satisfied in full, or that such obligations will not decrease in value or default. It is difficult, if not impossible, to predict the future political, regulatory or economic changes that could impact the GSEs and the values of their related securities or obligations.

Fannie Mae and Freddie Mac are continuing to operate as going concerns while in conservatorship and each remain liable for all of its obligations, including its guaranty obligations, associated with its mortgage-backed securities. The SPA is intended to enhance each of Fannie Mae’s and Freddie Mac’s ability to meet its obligations.

Under the Federal Housing Finance Regulatory Reform Act of 2008 (the Reform Act), which was included as part of Housing and Economic Recovery Act of 2008, FHFA, as conservator or receiver, has the power to repudiate any contract entered into by Fannie Mae or Freddie Mac before FHFA’s appointment as conservator or receiver, as applicable, if FHFA determines, in its sole discretion, that performance of the contract is burdensome and that repudiation of the contract promotes the orderly administration of Fannie Mae’s or Freddie Mac’s affairs. The Reform Act requires FHFA to exercise its right to repudiate any contract within a reasonable period of time after its appointment as conservator or receiver.

FHFA, in its capacity as conservator, has indicated that it has no intention to repudiate the guaranty obligations of Fannie Mae or Freddie Mac because FHFA views repudiation as incompatible with the goals of the conservatorship. However, if FHFA, as conservator or if it is later appointed as receiver for Fannie Mae or Freddie Mac, were to repudiate any such guaranty obligation, the conservatorship or receivership estate, as applicable, would be liable for actual direct compensatory damages in accordance with the provisions of the Reform Act. Any such liability could be satisfied only to the extent of Fannie Mae’s or Freddie Mac’s available assets. The future financial performance of Fannie Mae and Freddie Mac is heavily dependent on the performance of the U.S. housing market.

In the event of repudiation, the payments of interest to holders of Fannie Mae, or Freddie Mac mortgage-backed securities would be reduced if payments on the mortgage loans represented in the mortgage loan groups related to such mortgage-backed securities are not made by the borrowers or advanced by the servicer. Any actual direct compensatory damages for repudiating these guaranty obligations may not be sufficient to offset any shortfalls experienced by such mortgage-backed security holders.

Further, in its capacity as conservator or receiver, FHFA has the right to transfer or sell any asset or liability of Fannie Mae or Freddie Mac without any approval, assignment or consent. Although FHFA has stated that it has no present intention to do so, if FHFA, as conservator or receiver, were to transfer any such guaranty obligation to another party, holders of Fannie Mae or Freddie Mac mortgage-backed securities would have to rely on that party for satisfaction of the guaranty obligation and would be exposed to the credit risk of that party.

In addition, certain rights provided to holders of mortgage-backed securities issued by Fannie Mae and Freddie Mac under the operative documents related to such securities may not be enforced against FHFA, or enforcement of such rights may be delayed, during the conservatorship or any future receivership. The operative documents for Fannie Mae and Freddie Mac mortgage-backed securities may provide (or with respect to securities issued before the date of the appointment of the conservator may have provided) that upon the occurrence of an event of default on the part of Fannie Mae or Freddie Mac, in its capacity as guarantor, which includes the appointment of a conservator or receiver, holders of such mortgage-backed securities have the right to replace Fannie Mae or Freddie Mac as trustee if the requisite percentage of mortgage-backed security holders consent. The Reform Act prevents mortgage-backed

 

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security holders from enforcing such rights if the event of default arises solely because a conservator or receiver has been appointed. The Reform Act also provides that no person may exercise any right or power to terminate, accelerate or declare an event of default under certain contracts to which Fannie Mae or Freddie Mac is a party, or obtain possession of or exercise control over any property of Fannie Mae or Freddie Mac, or affect any contractual rights of Fannie Mae or Freddie Mac, without the approval of FHFA, as conservator or receiver, for a period of 45 or 90 days following the appointment of FHFA as conservator or receiver, respectively.

Private Mortgage Pass-Through Securities. Private mortgage pass-through securities are structured similarly to the Ginnie Mae, Fannie Mae and Freddie Mac mortgage pass-through securities and are issued by United States and foreign private issuers such as originators of and investors in mortgage loans, including savings and loan associations, mortgage banks, commercial banks, investment banks and special purpose subsidiaries of the foregoing. These securities usually are backed by a pool of conventional fixed rate or adjustable rate mortgage loans. Private mortgage pass-through securities typically are not guaranteed by an entity having the credit status of Ginnie Mae, Fannie Mae and Freddie Mac, and are subject to greater complexity and risk of loss.

Mortgage Assets often consist of a pool of assets representing the obligations of a number of different parties. There are usually fewer properties in a pool of assets backing commercial mortgage-backed securities than in a pool of assets backing residential mortgage-backed securities hence they may be more sensitive to the performance of fewer Mortgage Assets. To lessen the effect of failures by obligors on underlying assets to make payments, those securities may contain elements of credit support, which fall into two categories: (i) liquidity protection and (ii) protection against losses resulting from ultimate default by an obligor on the underlying assets. Liquidity protection refers to the provision of advances, generally by the entity administering the pool of assets, to ensure that the receipt of payments on the underlying pool occurs in a timely fashion. Protection against losses resulting from default ensures ultimate payment of the obligations on at least a portion of the assets in the pool. This protection may be provided through guarantees, insurance policies or letters of credit obtained by the issuer or sponsor from third parties, through various means of structuring the transaction or through a combination of such approaches. The degree of credit support provided for each issue is generally based on historical information respecting the level of credit risk associated with the underlying assets. Delinquencies or losses in excess of those anticipated could adversely affect the return on an investment in a security.

Stripped Mortgage Securities. Stripped mortgage securities may be issued by Federal Agencies, or by private originators of, or investors in, mortgage loans, including savings and loan associations, mortgage banks, commercial banks, investment banks and special purpose subsidiaries of the foregoing. Stripped mortgage securities not issued by Federal Agencies will be treated by a Fund as illiquid securities so long as the staff of the SEC maintains its position that such securities are illiquid. Stripped mortgage securities issued by Federal Agencies generally will be treated by the Fund as liquid securities under procedures adopted by the Fund and approved by the Fund’s Board.

Stripped mortgage securities usually are structured with two classes that receive different proportions of the interest and principal distribution of a pool of mortgage assets. A common type of stripped mortgage security will have one class receiving some of the interest and most of the principal from the mortgage assets, while the other class will receive most of the interest and the remainder of the principal. In the most extreme case, one class will receive all of the interest (the interest-only or “IO” class), while the other class will receive all of the principal (the principal-only or “PO” class). PO classes generate income through the accretion of the deep discount at which such securities are purchased, and, while PO classes do not receive periodic payments of interest, they receive monthly payments associated with scheduled amortization and principal prepayment from the mortgage assets underlying the PO class. The yield to maturity on a PO or an IO class security is extremely sensitive to the rate of principal payments (including prepayments) on the related underlying mortgage assets. A slower than expected rate of principal payments may have an adverse effect on a PO class security’s yield to maturity. If the underlying mortgage assets experience slower than anticipated principal repayment, a Fund may fail to fully recoup its initial investment in these securities. Conversely, a rapid rate of principal payments may have a material adverse effect on an IO class security’s yield to maturity. If the underlying mortgage assets experience greater than anticipated prepayments or principal, the Fund may fail to fully recoup its initial investment in these securities.

A Fund may purchase stripped mortgage securities for income, or for hedging purposes to protect the Fund’s portfolio against interest rate fluctuations. For example, since an IO class will tend to increase in value as interest rates rise, it may be used to hedge against a decrease in value of other fixed-income securities in a rising interest rate environment.

 

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Mortgage Dollar Rolls. A Fund may enter into mortgage dollar rolls with a bank or a broker-dealer. A mortgage dollar roll is a transaction in which a Fund sells mortgage-related securities for immediate settlement and simultaneously purchases the same type of securities for forward settlement at a discount. While a Fund begins accruing interest on the newly purchased securities from the purchase or trade date, it is able to invest the proceeds from the sale of its previously owned securities, which will be used to pay for the new securities. The use of mortgage dollar rolls is a speculative technique involving leverage and can have an economic effect similar to borrowing money for investment purposes.

Real Estate Investment Trusts (REITs). A Fund may invest in REITs. REITs are pooled investment vehicles that invest primarily in either real estate or real estate related loans. Like Regulated Investment Companies (RICs) such as the Fund, REITs are not taxed on income distributed to shareholders provided that they comply with certain requirements under the Code. A Fund will indirectly bear its proportionate share of any expenses paid by REITs in which it invests in addition to the Fund’s own expenses.

REITs involve certain unique risks in addition to those risks associated with investing in the real estate industry in general (such as possible declines in the value of real estate, lack of availability of mortgage funds, or extended vacancies of property). REITs are generally classified as equity REITs, mortgage REITs or a combination of equity and mortgage REITs. Equity REITs invest the majority of their assets directly in real property and derive income primarily from the collection of rents. Equity REITs can also 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 income from the collection of interest payments. Equity REITs may be affected by changes in the value of the underlying property owned by the REITs, while mortgage REITs may be affected by the risk of borrower default. REITs, and mortgage REITs in particular, are also subject to interest rate risk. REITs are dependent upon their operators’ management skills, are generally not diversified (except to the extent the Code requires), and are subject to heavy cash flow dependency and the risk of default by borrowers. REITs are also subject to the possibility of failing to qualify for tax-free pass-through of income under the Code or failing to maintain their exemptions from registration under the 1940 Act. REITs may have limited financial resources, may trade less frequently and in a limited volume, and may be subject to more abrupt or erratic price movements than more widely held securities.

A Fund’s investment in a REIT may result in the Fund making distributions that constitute a return of capital to Fund shareholders for federal income tax purposes or may require the Fund to accrue and distribute income not yet received. In addition, distributions attributable to REITs made by a Fund to Fund shareholders will not qualify for the corporate dividends-received deduction, or, generally, for treatment as qualified dividend income.

Forward Commitments and Dollar Rolls. A Fund may enter into contracts to purchase mortgage securities for a fixed price at a future date beyond customary settlement time (forward commitments) if the Fund sets aside on its books liquid assets in an amount sufficient to meet the purchase price, or if the Fund enters into offsetting contracts for the forward sale of other securities it owns. In the case of to-be-announced (TBA) mortgage purchase commitments, the unit price and the estimated principal amount are established when a Fund enters into a contract, with the actual principal amount being within a specified range of the estimate. TBA mortgages shall not exceed 20% of a Fund’s net assets. For these obligations, a Fund will segregate or earmark liquid assets in an amount sufficient to cover its obligations. Forward commitments may be considered securities in themselves and involve a risk of loss if the value of the security to be purchased declines before the settlement date, which risk is in addition to the risk of decline in the value of a Fund’s other assets. Where such purchases are made through dealers, a Fund relies on the dealer to consummate the sale. The dealer’s failure to do so may result in the loss to a Fund of an advantageous yield or price. Although a Fund will generally enter into forward commitments with the intention of acquiring securities for its portfolio, the Fund may dispose of a commitment before settlement if a subadviser deems it appropriate to do so. A Fund may realize short-term profits or losses upon the sale of forward commitments.

A Fund may enter into TBA sale commitments to hedge its portfolio positions or to sell securities it owns under delayed delivery arrangements. Proceeds of TBA sale commitments are not received until the contractual settlement date. Unsettled TBA sale commitments are valued at current market value of the underlying securities. If the TBA sale commitment is closed through the acquisition of an offsetting purchase commitment, a Fund realizes a gain or loss on the commitment without regard to any unrealized gain or loss on the underlying security. If a Fund delivers securities under the commitment, the Fund realizes a gain or loss from the sale of the securities based upon the unit price established at the date the commitment was entered into.

 

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A Fund may enter into mortgage dollar roll transactions (generally using TBAs) in which it sells a fixed-income security for delivery in the current month and simultaneously contracts to purchase similar securities (for example, same type, coupon and maturity) at an agreed upon future time. By engaging in a dollar roll transaction, a Fund foregoes principal and interest paid on the security that is sold but receives the difference between the current sales price and the forward price for the future purchase. A Fund would also be able to earn interest on the proceeds of the sale before they are reinvested. A Fund accounts for dollar rolls as purchases and sales. Dollar rolls may be used to create investment leverage and may increase a Fund’s risk and volatility.

The obligation to purchase securities on a specified future date involves the risk that the market value of the securities that a Fund is obligated to purchase may decline below the purchase price. In addition, in the event the other party to the transaction files for bankruptcy, becomes insolvent or defaults on its obligation, a Fund may be adversely affected.

Inflation-Protected Securities

A Fund may invest in U.S. Treasury Inflation Protected Securities (U.S. TIPS), which are fixed-income securities issued by the U.S. Department of Treasury, the principal amounts of which are adjusted daily based upon changes in the rate of inflation. A Fund may also invest in other inflation-protected securities issued by non-U.S. governments or by private issuers. U.S. TIPS pay interest on a semi-annual basis, equal to a fixed percentage of the inflation-adjusted principal amount. The interest rate on these bonds is fixed at issuance, but over the life of the bond this interest may be paid on an increasing or decreasing principal value that has been adjusted for inflation.

Repayment of the original bond principal upon maturity (as adjusted for inflation) is guaranteed for U.S. TIPS, even during a period of deflation. However, because the principal amount of U.S. TIPS would be adjusted downward during a period of deflation, a Fund will be subject to deflation risk with respect to its investments in these securities. In addition, the current market value of the bonds is not guaranteed and will fluctuate. If a Fund purchases in the secondary market U.S. TIPS whose principal values have been adjusted upward due to inflation since issuance, a Fund may experience a loss if there is a subsequent period of deflation. A Fund may also invest in other inflation-related bonds which may or may not provide a guarantee of principal. If a guarantee of principal is not provided, the adjusted principal value of the bond repaid at maturity may be less than the original principal amount.

The periodic adjustment of U.S. TIPS is currently tied to the CPI-U, which is calculated by the U.S. Department of Treasury. The CPI-U is a measurement of changes in the cost of living, made up of components such as housing, food, transportation and energy. Inflation-protected bonds issued by a non-U.S. government are generally adjusted to reflect a comparable inflation index, calculated by that government. There can be no assurance that the CPI-U or any non-U.S. inflation index will accurately measure the real rate of inflation in the prices of goods and services. If interest rates rise due to reasons other than inflation (for example, due to changes in currency exchange rates), investors in these securities may not be protected to the extent that the increase is not reflected in the bond’s inflation measure. In addition, there can be no assurance that the rate of inflation in a non-U.S. country will be correlated to the rate of inflation in the United States.

In general, the value of inflation-protected bonds is expected to fluctuate in response to changes in real interest rates, which are in turn tied to the relationship between nominal interest rates and the rate of inflation. Therefore, if inflation were to rise at a faster rate than nominal interest rates, real interest rates might decline, leading to an increase in value of inflation-protected bonds. In contrast, if nominal interest rates increased at a faster rate than inflation, real interest rates might rise, leading to a decrease in value of inflation-protected bonds. If inflation is lower than expected during the period a Fund holds the security, the Fund may earn less on the security than on a conventional bond. Any increase in principal value is taxable in the year the increase occurs, even though holders do not receive cash representing the increase at that time. As a result, if a Fund invests in inflation-protected securities, it could be required at times to liquidate other investments, including when it is not advantageous to do so, to satisfy its distribution requirements as a RIC and to eliminate any fund-level income tax liability under the Code.

 

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Initial Public Offerings

A Fund may purchase debt securities in initial public offerings (IPOs). These securities, which are often issued by unseasoned companies, may be subject to many of the same risks of investing in companies with smaller market capitalizations. Securities issued in IPOs have no trading history, and information about the companies may be available for very limited periods. Securities issued in an IPO frequently are very volatile in price, and a Fund may hold securities purchased in an IPO for a very short period of time. As a result, a Fund’s investments in IPOs may increase portfolio turnover, which increases brokerage and administrative costs and may result in taxable distributions to shareholders.

At any particular time or from time to time a Fund may not be able to invest in securities issued in IPOs, or invest to the extent desired because, for example, only a small portion (if any) of the securities being offered in an IPO may be made available to the Fund. In addition, under certain market conditions a relatively small number of companies may issue securities in IPOs.

Private Investments

Private Placement and Restricted Securities. A Fund may invest in securities that are purchased in private placements and, accordingly, are subject to restrictions on resale as a matter of contract or under federal securities laws. Because there may be relatively few potential purchasers for such investments, especially under adverse market or economic conditions or in the event of adverse changes in the financial condition of the issuer, a Fund could find it more difficult to sell such securities when a subadviser believes it advisable to do so or may be able to sell such securities only at prices lower than if such securities were more widely held. At times, it may also be more difficult to determine the fair value of such securities for purposes of computing a Fund’s net asset value.

While such private placements may offer attractive opportunities for investment not otherwise available on the open market, the securities so purchased are often restricted securities, i.e., securities which cannot be sold to the public without registration under the Securities Act or the availability of an exemption from registration (such as Rules 144 or 144A), or which are not readily marketable because they are subject to other legal or contractual delays in or restrictions on resale.

The absence of a trading market can make it difficult to ascertain a market value for illiquid investments. Disposing of illiquid investments may involve time-consuming negotiation and legal expenses, and it may be difficult or impossible for a Fund to sell them promptly at an acceptable price. A Fund may have to bear the extra expense of registering such securities for resale and the risk of substantial delay in effecting such registration. In addition, market quotations are less readily available. The judgment of a subadviser may at times play a greater role in valuing these securities than in the case of publicly traded securities.

Generally speaking, restricted securities may be sold only to qualified institutional buyers, or in a privately negotiated transaction to a limited number of purchasers, or in limited quantities after they have been held for a specified period of time and other conditions are met pursuant to an exemption from registration, or in a public offering for which a registration statement is in effect under the Securities Act. A Fund may be deemed to be an underwriter for purposes of the Securities Act when selling restricted securities to the public, and in such event the Fund may be liable to purchasers of such securities if the registration statement prepared by the issuer, or the Prospectuses forming a part of it, is materially inaccurate or misleading.

Redeemable Securities. Certain securities held by a Fund may permit the issuer at its option to call or redeem its securities. If an issuer were to redeem securities held by a Fund during a time of declining interest rates, the Fund may not be able to reinvest the proceeds in securities providing the same investment return as the securities redeemed.

Hybrid Securities

A Fund may acquire hybrid securities. A third party or subadviser may create a hybrid security by combining an income-producing debt security (income producing component) and the right to receive payment based on the change in the price of an equity security (equity component). The income-producing component is achieved by investing in non-convertible, income-producing securities such as bonds, preferred stocks and money market instruments, which may be represented by derivative instruments. The equity component is achieved by investing in securities or instruments such as cash-settled warrants to receive a payment based on whether the price of a common stock surpasses a certain exercise price. A hybrid security comprises two or more separate securities, each with its own market value. Therefore, the market value of a hybrid security is the sum of the values of its income-producing component and its equity component.

 

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Structured Investments. A structured investment is a security having a return tied to an underlying index or other security or asset class. Structured investments generally are individually negotiated agreements and may be traded OTC. Structured investments are organized and operated to restructure the investment characteristics of the underlying security. This restructuring involves the deposit with or purchase by an entity, such as a corporation or trust, or specified instruments (such as commercial bank loans) and the issuance by that entity or one or more classes of securities (structured securities”) backed by, or representing interests in, the underlying instruments. The cash flow on the underlying instruments may be apportioned among the newly issued structured securities to create securities with different investment characteristics, such as varying maturities, payment priorities and interest rate provisions, and the extent of such payments made with respect to structured securities is dependent on the extent of the cash flow on the underlying instruments. Because structured securities typically involve no credit enhancement, their credit risk generally will be equivalent to that of the underlying instruments. Investments in structured securities are generally of a class of structured securities that is either subordinated or unsubordinated to the right of payment of another class. Subordinated structured securities typically have higher yields and present greater risks than unsubordinated structured securities. Structured securities are typically sold in private placement transactions, and there currently is no active trading market for structured securities. Investments in government and government-related and restructured debt instruments are subject to special risks, including the inability or unwillingness to repay principal and interest, requests to reschedule or restructure outstanding debt and requests to extend additional loan amounts.

Borrowing and Other Forms of Leverage

A Fund has no present intent to do so, but may borrow money to the extent permitted by its investment policies and restrictions and applicable law. When a Fund borrows money or otherwise leverages its portfolio, the value of an investment in the Fund will be more volatile and other investment risks will tend to be compounded. This is because leverage tends to exaggerate the effect of any increase or decrease in the value of a Fund’s holdings. In addition to borrowing money from banks, a Fund may engage in certain other investment transactions that may be viewed as forms of financial leverage — for example, entering into reverse repurchase agreement and dollar rolls, investing collateral from loans of portfolio securities, entering into when-issued, delayed-delivery, or forward commitment transactions, or using derivatives such as swaps, futures, and forwards.

Repurchase Agreements. A Fund may enter into reverse repurchase agreements, although it has no present intent to do so. Under such agreements, the seller of the security agrees to repurchase it at a mutually agreed upon time and price. The repurchase price may be higher than the purchase price, the difference being income to the Fund, or the purchase and repurchase prices may be the same, with interest at a stated rate due to the Fund together with the repurchase price on repurchase. In either case, the income to the Fund is unrelated to the interest rate on the security itself. The Fund will generally enter into repurchase agreements of short durations, from overnight to one week, although the underlying securities generally have longer maturities. A Fund may not enter into a repurchase agreement with more than seven days to maturity if, as a result, more than 15% of the value of its net assets would be invested in illiquid securities, including such repurchase agreements.

It is not clear whether a court would consider the security acquired by a Fund subject to a repurchase agreement as being owned by the Fund or as being collateral for a loan by the Fund to the seller. In the event of the commencement of bankruptcy or insolvency proceedings with respect to the seller of the security before its repurchase under a repurchase agreement, a Fund may encounter delays and incur costs before being able to sell the security. Delays may involve loss of interest or a decline in price of the security. If a court characterizes the transaction as a loan, and a Fund has not perfected a security interest in the security, the Fund may be required to return the security to the seller’s estate and be treated as an unsecured creditor of the seller. As an unsecured creditor, a Fund would be at risk of losing some or all of the principal and income involved in the transaction. As with any unsecured debt instrument purchased for the Fund, Morningstar or the subadviser seeks to minimize the risk of loss through repurchase agreements by analyzing the creditworthiness of the other party, in this case the seller of the security.

 

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Apart from the risk of bankruptcy or insolvency proceedings, there is also the risk that the seller may fail to repurchase the security. However, a Fund will always receive as collateral for any repurchase agreement to which it is a party securities acceptable to it, the market value of which is equal to at least 102% of the amount invested by the Fund plus accrued interest, and the Fund will make payment against such securities only upon physical delivery or evidence of book entry transfer to the account of its custodian. If the market value of the security subject to the repurchase agreement becomes less than the repurchase price (including interest), the Fund will direct the seller of the security to deliver additional securities so that the market value of all securities subject to the repurchase agreement will equal or exceed the repurchase price. It is possible that a Fund will be unsuccessful in seeking to impose on the seller a contractual obligation to deliver additional securities.

The acquisition of a repurchase agreement may be deemed to be an acquisition of the underlying securities as long as the obligation of the seller to repurchase the securities is collateralized fully.

Derivatives

Some of the instruments in which a Fund may invest may be referred to as “derivatives,” because their value “derives” from the value of an underlying asset, reference rate, index or other market factor. These instruments include options, futures contracts, forward contracts, swap agreements and similar instruments. The market value of derivative instruments and securities sometimes may be more volatile than those of other instruments and each type of derivative instrument may have its own special risks.

Certain derivative instruments may expose a Fund to the credit risk of its counterparty. In the event the counterparty to such a derivative instrument becomes insolvent, a Fund potentially could lose all or a large portion of its investment in the derivative instrument.

Derivative instruments may be used for “hedging,” which means that they may be used when the adviser or a subadviser seeks to protect a Fund’s investments from a decline in value resulting from changes to interest rates, market prices, currency fluctuations, or other market factors. Derivative instruments may also be used for other purposes, including to seek to increase liquidity, provide efficient portfolio management, broaden investment opportunities (including taking short or negative positions), implement a tax or cash management strategy, gain exposure to a particular security or segment of the market, modify the effective duration of a Fund’s portfolio investments and/or enhance total return. However derivative instruments are used, their successful use is not assured and will depend upon, among other factors, the adviser’s or subadviser’s ability to gauge relevant market movements.

Investing for hedging purposes or to increase a Fund’s return may result in certain additional transaction costs that may reduce the Fund’s performance. In addition, when used for hedging purposes, no assurance can be given that each derivative position will achieve a close correlation with the security or currency that is the subject of the hedge, or that a particular derivative position will be available when sought by the subadviser. While hedging strategies involving derivatives can reduce the risk of loss, they can also reduce the opportunity for gain or even result in losses by offsetting favorable price movements in other Fund investments. Use of derivatives and other forms of leverage by a Fund may require the Fund to liquidate portfolio positions when it may not be advantageous to do so to satisfy its obligations or to meet segregation requirements. Increases and decreases in the value of a Fund’s portfolio may be magnified when the Fund uses leverage. Certain derivatives may create a risk of loss greater than the amount invested.

Forward Contracts. A Fund may invest in forward contracts for speculative or hedging purposes. A forward contract involves a negotiated obligation to purchase or sell a specific asset at a future date (with or without delivery required), which may be any fixed number of days from the date of the contract agreed upon by the parties, at a price set at the time of the contract. Risks associated with forwards include: (i) there may be an imperfect correlation between the movement in prices of forward contracts and the securities underlying them; (ii) there may not be a liquid market for forwards; and (iii) forwards may be difficult to accurately value. Forwards are also subject to credit risk, liquidity risk and leverage risk, each of which is further described elsewhere in this section.

 

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Forward Foreign Currency Contracts. A forward foreign currency contract is an obligation to purchase or sell a specific non-U.S. currency in exchange for another currency, which may be U.S. dollars, at an agreed exchange rate (price) at a future date. Currency forwards are typically individually negotiated and privately traded by currency traders and their customers in the interbank market. A forward foreign currency contract will tend to reduce or eliminate exposure to the currency that is sold, and increase exposure to the currency that is purchased, similar to when a Fund sells a security denominated in one currency and purchases a security denominated in another currency.

At the maturity of a forward foreign currency contract, a Fund may either exchange the currencies specified at the maturity of a forward foreign currency contract or, prior to maturity, the Fund may enter into a closing transaction involving the purchase or sale of an offsetting contract. Closing transactions with respect to forward foreign currency contract are usually effected with the counterparty to the original forward contract. A Fund may also enter into forward foreign currency contracts that do not provide for physical settlement of the two currencies but instead provide for settlement by a single cash payment calculated as the difference between the agreed upon exchange rate and the spot rate at settlement based upon an agreed upon notional amount (non-deliverable forwards).

Under definitions adopted by the Commodity Futures Trading Commission (CFTC) and SEC, non-deliverable forwards are considered swaps, and therefore are included in the definition of “commodity interests.” Although non-deliverable forwards have historically been traded in the OTC market, as swaps they may in the future be required to be centrally cleared and traded on public facilities. Forward foreign currency contracts that qualify as deliverable forwards are not regulated as swaps for most purposes, and are not included in the definition of “commodity interests.” However these forwards are subject to some requirements applicable to swaps, including reporting to swap data repositories, documentation requirements, and business conduct rules applicable to swap dealers.

CFTC regulation of forward foreign currency contracts, especially non-deliverable forwards, may restrict a Fund’s ability to use these instruments in the manner described above or subject the adviser to CFTC registration and regulation as a CPO.

The successful use of these transactions will usually depend on the adviser’s or a subadviser’s ability to accurately forecast currency exchange rate movements. Should exchange rates move in an unexpected manner, a Fund may not achieve the anticipated benefits of the transaction, or it may realize losses. In addition, these techniques could result in a loss if the counterparty to the transaction does not perform as promised, including because of the counterparty’s bankruptcy or insolvency. In unusual or extreme market conditions, a counterparty’s creditworthiness and ability to perform may deteriorate rapidly, and the availability of suitable replacement counterparties may become limited. Moreover, investors should bear in mind that the Funds are not obligated to actively engage in hedging or other currency transactions. For example, a Fund may not have attempted to hedge its exposure to a particular foreign currency at a time when doing so might have avoided a loss.

Forward foreign currency contracts may limit potential gain from a positive change in the relationship between the U.S. dollar and foreign currencies. Unanticipated changes in currency prices may result in poorer overall performance for a Fund than if it had not engaged in such contracts. Moreover, there may be an imperfect correlation between a Fund’s portfolio holdings of securities denominated in a particular currency and the currencies bought or sold in the forward foreign currency contract entered into by the Fund. This imperfect correlation may cause a Fund to sustain losses that will prevent the Fund from achieving a complete hedge or expose the Fund to risk of foreign exchange loss.

Futures Contracts. A Fund may enter into futures contracts. Generally, a futures contract is a standard binding agreement to buy or sell a specified quantity of an underlying reference instrument, such as a specific security, rate, currency or commodity, at a specified price at a specified later date. Each Fund may purchase or sell interest rate futures for the purpose of hedging some or all of the value of its portfolio securities against changes in prevailing interest rates or to manage its duration or effective maturity. If the adviser or a subadviser anticipates that interest rates may rise and, concomitantly, the price of certain of its portfolio securities may fall, a Fund may sell futures contracts. If declining interest rates are anticipated, a Fund may purchase futures contracts to protect against a potential increase in the price of securities the Fund intends to purchase. Subsequently, appropriate securities may be purchased by a Fund in an orderly fashion; as securities are purchased, corresponding futures positions would be terminated by offsetting sales of contracts.

 

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When a Fund enters into a futures contract, it must deliver to an account controlled by a futures commission merchant a futures commission merchant (FCM) an amount referred to as “initial margin” that is typically calculated as an amount equal to the volatility in market value of a contract over a fixed period. Initial margin requirements are determined by the respective exchanges on which the futures contracts are traded and the FCM. Thereafter, a “variation margin” amount may be required to be paid by the Fund or received by the Fund in accordance with margin controls set for such accounts, depending upon changes in the marked-to-market value of the futures contract. The account is marked-to-market daily and the variation margin is monitored by the Fund’s investment manager and custodian on a daily basis. When the futures contract is closed out, if the Fund has a loss equal to or greater than the margin amount, the margin amount is paid to the FCM along with any loss in excess of the margin amount. If the Fund has a loss of less than the margin amount, the excess margin is returned to the Fund. If the Fund has a gain, the full margin amount and the amount of the gain is paid to the Fund.

A Fund’s use of futures contracts is subject to the risks associated with derivative instruments generally. In addition, if the adviser’s or a subadviser’s judgment about the general direction of interest rates or markets is wrong, a Fund’s overall performance may be poorer than if no financial futures contracts had been entered into. For example, in some cases, securities called for by a financial futures contract may not have been issued at the time the contract was written. In addition, the market prices of financial futures contracts may be affected by certain factors.

There is a risk of loss by the Fund of the initial and variation margin deposits in the event of bankruptcy of the FCM with which the Fund has an open position in a futures contract. The assets of a Fund may not be fully protected in the event of the bankruptcy of the FCM or central counterparty because the Fund might be limited to recovering only a pro rata share of all available funds and margin segregated on behalf of an FCM’s customers. If an FCM does not provide accurate reporting, a Fund is also subject to the risk that the FCM could use the Fund’s assets, which are held in an omnibus account with assets belonging to the FCM’s other customers, to satisfy its own financial obligations or the payment obligations of another customer to the central counterparty.

The risk of loss in trading financial futures can be substantial due to the low margin deposits required and the extremely high degree of leverage involved in futures pricing. Relatively small price movements in a financial futures contract could have an immediate and substantial impact, which may be favorable or unfavorable to a Fund. It is possible for a price-related loss to exceed the amount of a Fund’s margin deposit.

Each Fund will incur brokerage fees in connection with its futures transactions. In addition, while futures contracts will be purchased and sold to reduce certain risks, those transactions themselves entail certain other risks. Thus, while a Fund may benefit from the use of futures, unanticipated changes in interest rates or stock price movements may result in a poorer overall performance for the Fund than if it had not entered into any futures contracts. Moreover, in the event of an imperfect correlation between the futures position and the portfolio position that is intended to be protected, the desired protection may not be obtained and the Fund may be exposed to risk of loss.

Although some financial futures contracts by their terms call for the actual delivery or acquisition of securities at expiration, in most cases the contractual commitment is closed out before expiration. The offsetting of a contractual obligation is accomplished by purchasing (or selling as the case may be) on a commodities or futures exchange an identical financial futures contract calling for delivery in the same month. Such a transaction, if effected through a member of an exchange, cancels the obligation to make or take delivery of the securities. A Fund will incur brokerage fees when it purchases or sells financial futures contracts, and will be required to maintain margin deposits. If a liquid secondary market does not exist when a Fund wishes to close out a financial futures contract, it will not be able to do so and will continue to be required to make daily cash payments of variation margin in the event of adverse price movements. There is no assurance that the Fund will be able to enter into closing transactions.

The CFTC and the various exchanges have established limits referred to as “speculative position limits” on the maximum net long or net short position that any person, such as a Fund, may hold or control in a particular futures contract. Trading limits are also imposed on the maximum number of contracts that any person may trade on a particular trading day. An exchange may order the liquidation of positions found to be in violation of these limits and it may impose other sanctions or restrictions. The regulation of futures, as well as other derivatives, is a rapidly changing area of law.

Futures exchanges may also limit the amount of fluctuation permitted in certain futures contract prices during a single trading day. This daily limit establishes the maximum amount that the price of a futures contract may vary either up or down from the previous day’s settlement price. Once the daily limit has been reached in a futures

 

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contract subject to the limit, no more trades may be made on that day at a price beyond that limit. The daily limit governs only price movements during a particular trading day and does not limit potential losses because the limit may prevent the liquidation of unfavorable positions. For example, futures prices have occasionally moved to the daily limit for several consecutive trading days with little or no trading, thereby preventing prompt liquidation of positions and subjecting some holders of futures contracts to substantial losses.

Interest Rate or Financial Futures Contracts. A Fund may invest in interest rate or financial futures contracts. Bond prices are established in both the cash market and the futures market. In the cash market, bonds are purchased and sold with payment for the full purchase price of the bond being made in cash, generally within five business days after the trade. In the futures market, a contract is made to purchase or sell a bond in the future for a set price on a certain date. Historically, the prices for bonds established in the futures markets have generally tended to move in the aggregate in concert with cash market prices, and the prices have maintained fairly predictable relationships.

The sale of an interest rate or financial futures contract by a Fund would create an obligation by the Fund, as seller, to deliver the specific type of financial instrument called for in the contract at a specific future time for a specified price. A futures contract purchased by a Fund would create an obligation by the Fund, as purchaser, to take delivery of the specific type of financial instrument at a specific future time at a specific price. The specific securities delivered or taken, respectively, at settlement date, would not be determined until at or near that date. The determination would be in accordance with the rules of the exchange on which the futures contract sale or purchase was made.

Although interest rate or financial futures contracts by their terms call for actual delivery or acceptance of securities, in most cases the contracts are closed out before the settlement date without delivery of securities. Closing out of a futures contract sale is effected by a Fund’s entering into a futures contract purchase for the same aggregate amount of the specific type of financial instrument and the same delivery date. If the price in the sale exceeds the price in the offsetting purchase, a Fund is paid the difference and thus realizes a gain. If the offsetting purchase price exceeds the sale price, a Fund pays the difference and realizes a loss. Similarly, the closing out of a futures contract purchase is effected by a Fund’s entering into a futures contract sale. If the offsetting sale price exceeds the purchase price, a Fund realizes a gain, and if the purchase price exceeds the offsetting sale price, the Fund realizes a loss.

A Fund will deal only in standardized contracts on recognized exchanges. The exchange typically guarantees performance under contract provisions through a clearing corporation, a nonprofit organization managed by the exchange membership. Domestic interest rate futures contracts are traded in an auction environment on the floors of several exchanges — principally, the Chicago Board of Trade and the Chicago Mercantile Exchange. A public market now exists in domestic futures contracts covering various financial instruments including long-term United States Treasury bonds and notes, GNMA modified pass-through mortgage-backed securities, three-month United States Treasury bills, and 90-day commercial paper. A Fund may trade in any futures contract for which there exists a public market, including, without limitation, the foregoing instruments. International interest rate futures contracts are traded on the London International Financial Futures Exchange, the Singapore International Monetary Exchange, the Sydney Futures Exchange Limited and the Tokyo Stock Exchange. Engaging in futures contracts on international exchanges may involve additional risks, including varying regulatory standards and supervision, fewer laws to protect investors, greater counterparty risk, greater transaction costs, greater volatility, and less liquidity, which could make it difficult for a fund to transact.

Options on futures contracts. Options on futures contracts trade on the same contract markets as the underlying futures contract. When a Fund buys an option, it pays a premium for the right, but does not have the obligation, to purchase (call) or sell (put) a futures contract at a set price (called the exercise price). The purchase of a call or put option on a futures contract, whereby a Fund has the right to purchase or sell, respectively, a particular futures contract, is similar in some respects to the purchase of a call or put option on an individual security or currency. Depending on the premium paid for the option compared to either the price of the futures contract upon which it is based or the price of the underlying reference instrument, the option may be less risky than direct ownership of the futures contract or the underlying reference instrument.

The seller (writer) of an option becomes contractually obligated to take the opposite futures position if the buyer of the option exercises its rights to the futures position specified in the option. In return for the premium paid by the buyer, the seller assumes the risk of taking a possibly adverse futures position. In addition, the seller will be required to post and maintain initial and variation margin with the FCM. One goal of selling (writing) options on futures may be to receive the premium paid by the option buyer.

 

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A Fund’s use of options on futures contracts is subject to the risks related to derivative instruments generally. In addition, the amount of risk the Fund assumes when it purchases an option on a futures contract is the premium paid for the option plus related transaction costs. The purchase of an option also entails the risk that changes in the value of the underlying futures contract will not be fully reflected in the value of the option purchased. The seller (writer) of an option on a futures contract is subject to the risk of having to take a possibly adverse futures position if the purchaser of the option exercises its rights. If the seller were required to take such a position, it could bear substantial losses. An option writer has potentially unlimited economic risk because its potential loss, except to the extent offset by the premium received, is equal to the amount the option is “in-the-money” at the expiration date. A call option is in-the-money if the value of the underlying futures contract exceeds the exercise price of the option. A put option is in-the-money if the exercise price of the option exceeds the value of the underlying futures contract.

Options. A Fund may purchase and sell call and put options. An option is a contract that gives the purchaser of the option, in return for the premium paid, the right to buy an underlying reference instrument, such as a specified security, currency, index, or other instrument, from the writer of the option (in the case of a call option), or to sell a specified reference instrument to the writer of the option (in the case of a put option) at a designated price during the term of the option. The premium paid by the buyer of an option will reflect, among other things, the relationship of the exercise price to the market price and the volatility of the underlying reference instrument, the remaining term of the option, supply, demand, interest rates and/or currency exchange rates. An American style put or call option may be exercised at any time during the option period while a European style put or call option may be exercised only upon expiration or during a fixed period prior thereto. Put and call options are traded on national securities exchanges and in the OTC market.

As the buyer of a call option, a Fund has a right to buy the underlying reference instrument (e.g., a currency or security) at the exercise price at any time during the option period (for American style options). The Fund may enter into closing sale transactions with respect to call options, exercise them, or permit them to expire. Unless the price of the underlying reference instrument changes sufficiently, a call option purchased by the Fund may expire without any value to the Fund, in which case the Fund would experience a loss to the extent of the premium paid for the option plus related transaction costs.

As the buyer of a put option, a Fund has the right to sell the underlying reference instrument at the exercise price at any time during the option period (for American style options). Like a call option, the Fund may enter into closing sale transactions with respect to put options, exercise them or permit them to expire. If a put option is not terminated in a closing sale transaction when it has remaining value, and if the market price of the underlying reference instrument remains equal to or greater than the exercise price during the life of the put option, the buyer would not make any gain upon exercise of the option and would experience a loss to the extent of the premium paid for the option plus related transaction costs. In order for the purchase of a put option to be profitable, the market price of the underlying reference instrument must decline sufficiently below the exercise price to cover the premium and transaction costs.

Writing options may permit the writer to generate additional income in the form of the premium received for writing the option. The writer of an option may have no control over when the underlying reference instruments must be sold (in the case of a call option) or purchased (in the case of a put option) because the writer may be notified of exercise at any time prior to the expiration of the option (for American style options). In general, though, options are infrequently exercised prior to expiration. Whether or not an option expires unexercised, the writer retains the amount of the premium. Writing “covered” call options means that the writer owns the underlying reference instrument that is subject to the call option. Call options may also be written on reference instruments that the writer does not own.

If a call option written by a Fund expires unexercised, the Fund will realize a gain in the amount of the premium received. If the market price of the underlying reference instrument decreases, the call option will not be exercised and the Fund will be able to use the amount of the premium received to hedge against the loss in value of the underlying reference instrument. The exercise price of a call option will be chosen based upon the expected price movement of the underlying reference instrument. The exercise price of a call option may be below, equal to (at-the-money), or above the current value of the underlying reference instrument at the time the option is written.

 

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As the writer of a put option, a Fund has a risk of loss should the underlying reference instrument decline in value. If the value of the underlying reference instrument declines below the exercise price of the put option and the put option is exercised, the Fund, as the writer of the put option, will be required to buy the instrument at the exercise price, which will exceed the market value of the underlying reference instrument at that time. The Fund will incur a loss to the extent that the current market value of the underlying reference instrument is less than the exercise price of the put option. However, the loss will be offset in part by the premium received from the buyer of the put. If a put option written by the Fund expires unexercised, the Fund will realize a gain in the amount of the premium received.

Options involve certain risks, including general risks related to derivative instruments. There can be no assurance that a liquid secondary market on an exchange will exist for any particular option, or at any particular time, and the Fund may have difficulty effecting closing transactions in particular options. Therefore, the Fund would have to exercise the options it purchased in order to realize any profit, thus taking or making delivery of the underlying reference instrument when not desired. The Fund could then incur transaction costs upon the sale of the underlying reference instruments. Similarly, when the Fund cannot effect a closing transaction with respect to a put option it wrote, and the buyer exercises, the Fund would be required to take delivery and would incur transaction costs upon the sale of the underlying reference instruments purchased. If the Fund, as a covered call option writer, is unable to effect a closing purchase transaction in a secondary market, it will not be able to sell the underlying reference instrument until the option expires, it delivers the underlying instrument upon exercise, or it segregates enough liquid assets to purchase the underlying reference instrument at the marked-to-market price during the term of the option. When trading options on non-U.S. exchanges or in the OTC market, many of the protections afforded to exchange participants will not be available. For example, there may be no daily price fluctuation limits, and adverse market movements could therefore continue to an unlimited extent over an indefinite period of time.

The effectiveness of an options strategy for hedging depends on the degree to which price movements in the underlying reference instruments correlate with price movements in the relevant portion of the Fund’s portfolio that is being hedged. In addition, the Fund bears the risk that the prices of its portfolio investments will not move in the same amount as the option it has purchased or sold for hedging purposes, or that there may be a negative correlation that would result in a loss on both the investments and the option. If the investment manager is not successful in using options in managing the Fund’s investments, the Fund’s performance will be worse than if the investment manager did not employ such strategies.

Swaps. A Fund may enter into a swap agreement. Generally, swap agreements are contracts between a Fund and another party (the swap counterparty) involving the exchange of payments on specified terms over periods ranging from a few days to multiple years. A swap agreement may be negotiated bilaterally and traded OTC between the two parties (for an uncleared swap) or, in some instances, must be transacted through an FCM and cleared through a clearinghouse that serves as a central counterparty (for a cleared swap). In a basic swap transaction, a Fund agrees with the swap counterparty to exchange the returns (or differentials in rates of return) and/or cash flows earned or realized on a particular “notional amount” or value of predetermined underlying reference instruments. The notional amount is the set dollar or other value selected by the parties to use as the basis on which to calculate the obligations that the parties to a swap agreement have agreed to exchange. The parties typically do not actually exchange the notional amount. Instead they agree to exchange the returns that would be earned or realized if the notional amount were invested in given investments or at given interest rates.

The use of swap transactions is a highly specialized activity, which involves investment techniques and risks different from those associated with ordinary portfolio securities transactions. Whether a Fund will be successful in using swap agreements to achieve its investment goal depends on the ability of the investment manager correctly to predict which types of investments are likely to produce greater returns. If the investment manager, in using swap agreements, is incorrect in its forecasts of market values, interest rates, inflation, currency exchange rates or other applicable factors, the investment performance of the Fund will be less than its performance would have been if it had not used the swap agreements.

 

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During the term of an uncleared swap, a Fund will be required to pledge to the swap counterparty, from time to time, an amount of cash and/or other assets equal to the total net amount (if any) that would be payable by the Fund to the counterparty if all outstanding swaps between the parties were terminated on the date in question, including any early termination payments (variation margin). Periodically, changes in the amount pledged are made to recognize changes in value of the contract resulting from, among other things, interest on the notional value of the contract, market value changes in the underlying investment, and/or dividends paid by the issuer of the underlying instrument. Likewise, the counterparty will be required to pledge cash or other assets to cover its obligations to the Fund. However, the amount pledged may not always be equal to or more than the amount due to the other party. Therefore, if a counterparty defaults in its obligations to the Fund, the amount pledged by the counterparty and available to the Fund may not be sufficient to cover all the amounts due to the Fund and the Fund may sustain a loss.

In an uncleared swap, a Fund is subject to the risk that its counterparty will be unable or will refuse to perform under such agreement, including because of the counterparty’s bankruptcy or insolvency. The Fund risks the loss of the accrued but unpaid amounts under a swap agreement, which could be substantial, in the event of a default, insolvency or bankruptcy by a swap counterparty. In such an event, the Fund will have contractual remedies pursuant to the swap agreements, but bankruptcy and insolvency laws could affect the Fund’s rights as a creditor. If the counterparty’s creditworthiness declines, the value of a swap agreement would likely decline, potentially resulting in losses. The Fund’s investment manager will only approve a swap agreement counterparty for the Fund if the investment manager deems the counterparty to be creditworthy under the Fund’s Counterparty Credit Review Standards, adopted and reviewed annually by the Fund’s board. However, in unusual or extreme market conditions, a counterparty’s creditworthiness and ability to perform may deteriorate rapidly, and the availability of suitable replacement counterparties may become limited.

Certain standardized swaps are subject to mandatory central clearing and exchange-trading. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act) and implementing rules will ultimately require the clearing and exchange-trading of many swaps. Mandatory exchange-trading and clearing will occur on a phased-in basis based on the type of market participant, CFTC approval of contracts for central clearing and public trading facilities making such cleared swaps available to trade. To date, the CFTC has designated only certain of the most common types of credit default index swaps and interest rate swaps as subject to mandatory clearing and certain public trading facilities have made certain of those cleared swaps available to trade, but it is expected that additional categories of swaps will in the future be designated as subject to mandatory clearing and trade execution requirements. Central clearing is intended to reduce counterparty credit risk and increase liquidity, but central clearing does not eliminate these risks and may involve additional costs and risks not involved with uncleared swaps.

In a cleared swap, the Fund’s ultimate counterparty is a central clearinghouse rather than a brokerage firm, bank or other financial institution. Cleared swaps are submitted for clearing through each party’s FCM, which must be a member of the clearinghouse that serves as the central counterparty. Transactions executed on a swap execution facility (SEF) may increase market transparency and liquidity but may require a market participant to incur increased expenses to access the same types of swaps that it has used in the past. When the Fund enters into a cleared swap, it must deliver to the central counterparty (via the FCM) an amount referred to as “initial margin.” Initial margin requirements are determined by the central counterparty, and are typically calculated as an amount equal to the volatility in market value of the cleared swap over a fixed period, but an FCM may require additional initial margin above the amount required by the central counterparty. During the term of the swap agreement, a “variation margin” amount may also be required to be paid by the Fund or may be received by the Fund in accordance with margin controls set for such accounts. If the value of the Fund’s cleared swap declines, the Fund will be required to make additional “variation margin” payments to the FCM to settle the change in value. Conversely, if the market value of the Fund’s position increases, the FCM will post additional “variation margin” to the Fund’s account. At the conclusion of the term of the swap agreement, if the Fund has a loss equal to or greater than the margin amount, the margin amount is paid to the FCM along with any loss in excess of the margin amount. If the Fund has a loss of less than the margin amount, the excess margin is returned to the Fund. If the Fund has a gain, the full margin amount and the amount of the gain is paid to the Fund.

As noted above, central clearing is designed to reduce counterparty credit risk and increase liquidity compared to uncleared swaps because central clearing interposes the central clearinghouse as the counterparty to each participant’s swap, but it does not eliminate those risks completely and may involve additional costs and risks not involved with uncleared swaps. There is also a risk of loss by the Fund of the initial and variation margin deposits in the event of bankruptcy of the FCM with which the Fund has an open position, or the central counterparty in a swap

 

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contract. The assets of the Fund may not be fully protected in the event of the bankruptcy of the FCM or central counterparty because the Fund might be limited to recovering only a pro rata share of all available funds and margin segregated on behalf of an FCM’s customers. If the FCM does not provide accurate reporting, the Fund is also subject to the risk that the FCM could use the Fund’s assets, which are held in an omnibus account with assets belonging to the FCM’s other customers, to satisfy its own financial obligations or the payment obligations of another customer to the central counterparty. Credit risk of cleared swap participants is concentrated in a few clearinghouses, and the consequences of insolvency of a clearinghouse are not clear.

With cleared swaps, the Fund may not be able to obtain terms as favorable as it would be able to negotiate for a bilateral, uncleared swap. In addition, an FCM may unilaterally amend the terms of its agreement with the Fund, which may include the imposition of position limits or additional margin requirements with respect to the Fund’s investment in certain types of swaps. Central counterparties and FCMs can require termination of existing cleared swap transactions upon the occurrence of certain events, and can also require increases in margin above the margin that is required at the initiation of the swap agreement.

Finally, the Fund is subject to the risk that, after entering into a cleared swap with an executing broker, no FCM or central counterparty is willing or able to clear the transaction. In such an event, the Fund may be required to break the trade and make an early termination payment to the executing broker.

Interest Rate and Total Return Swap Agreements. For temporary defensive purposes only, a Fund may purchase interest rate swaps. A Fund may use interest rate swaps to increase or decrease exposure to a particular interest rate or rates, which may result in the Fund experiencing a gain or loss depending on whether the interest rates increased or decreased during the term of the agreement. For temporary, defensive purposes only, a Fund may also engage in total return swaps, in which payments made by the Fund or the counterparty are based on the total return of a particular reference asset or assets (such as a fixed-income security, a combination of securities, or an index). The value of a Fund’s swap positions would increase or decrease depending on the changes in value of the underlying rates, currency values, volatility or other indexes or measures. Caps and floors have an effect similar to buying or writing options. Depending on how they are used, swap agreements may increase or decrease the overall volatility of the Fund’s investments and its share price. A Fund’s ability to engage in certain swap transactions may be limited by tax considerations.

A Fund’s ability to realize a profit from such transactions will depend on the ability of the financial institutions with which it enters into the transactions to meet their obligations to the Fund. If a counterparty’s creditworthiness declines, the value of the agreement would be likely to decline, potentially resulting in losses. If a default occurs by the other party to such transaction, a Fund will have contractual remedies pursuant to the agreements related to the transaction, which may be limited by applicable law in the case of a counterparty’s insolvency. Under certain circumstances, suitable transactions may not be available to a Fund, or the Fund may be unable to close out its position under such transactions at the same time, or at the same price, as if it had purchased comparable publicly traded securities. Swaps carry counterparty risks that cannot be fully anticipated. Also, because swap transactions typically involve a contract between the two parties, such swap investments can be extremely illiquid, as it is uncertain as to whether another counterparty would wish to take assignment of the rights under the swap contract at a price acceptable to a Fund.

Credit Default Swaps. For temporary defensive purposes only, a Fund may purchase credit default swaps. A credit default swap is an agreement between a Fund and a counterparty that enables the Fund to buy or sell protection against a credit event related to a particular issuer. One party, acting as a protection buyer, makes periodic payments, which may be based on, among other things, a fixed or floating rate of interest, to the other party, a protection seller, in exchange for a promise by the protection seller to make a payment to the protection buyer if a negative credit event (such as a delinquent payment or default) occurs with respect to a referenced bond or group of bonds. Credit default swaps may also be structured based on the debt of a basket of issuers, rather than a single issuer, and may be customized with respect to the default event that triggers purchase or other factors, or defaults by a particular combination of issuers within the basket, may trigger a payment obligation). As a credit protection seller in a credit default swap contract, a Fund would be required to pay the par (or other agreed-upon) value of a referenced debt obligation to the counterparty following certain negative credit events as to a specified third-party debtor, such as default by a U.S. or non-U.S. corporate issuer on its debt obligations. In return for its obligation, a Fund would receive from the counterparty a periodic stream of payments, which may be based on, among other things, a fixed or

 

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floating rate of interest, over the term of the contract provided that no event of default has occurred. If no default occurs, a Fund would keep the stream of payments, and would have no payment obligations to the counterparty. A Fund may sell credit protection to earn additional income and/or to take a synthetic long position in the underlying security or basket of securities.

A Fund may enter into credit default swap contracts as protection buyer to hedge against the risk of default on the debt of a particular issuer or basket of issuers or attempt to profit from a deterioration or perceived deterioration in the creditworthiness of the particular issuer(s) (also known as buying credit protection). This would involve the risk that the investment may expire worthless and would only generate gain in the event of an actual default by the issuer(s) of the underlying obligation(s) (or, as applicable, a credit downgrade or other indication of financial instability). It would also involve the risk that the seller may fail to satisfy its payment obligations to a Fund. The purchase of credit default swaps involves costs, which will reduce a Fund’s return.

Credit default swaps involve a number of special risks. A protection seller may have to pay out amounts following a negative credit event greater than the value of the reference obligation delivered to it by its counterparty and the amount of periodic payments previously received by it from the counterparty. When a Fund acts as a seller of a credit default swap, it is exposed to, among other things, leverage risk because if an event of default occurs the seller must pay the buyer the full notional value of the reference obligation. Each party to a credit default swap is subject to the credit risk of its counterparty (the risk that its counterparty may be unwilling or unable to perform its obligations on the swap as they come due). The value of the credit default swap to each party will change based on changes in the actual or perceived creditworthiness of the underlying issuer.

A protection buyer may lose its investment and recover nothing should an event of default not occur. A Fund may seek to realize gains on its credit default swap positions, or limit losses on its positions, by selling those positions in the secondary market. There can be no assurance that a liquid secondary market will exist at any given time for any particular credit default swap or for credit default swaps generally.

The market for credit default swaps has become more volatile in recent years as the creditworthiness of certain counterparties has been questioned and/or downgraded. The parties to a credit default swap may be required to post collateral to each other. If a Fund posts initial or periodic collateral to its counterparty, it may not be able to recover that collateral from the counterparty in accordance with the terms of the swap. In addition, if the Fund receives collateral from its counterparty, it may be delayed or prevented from realizing on the collateral in the event of the insolvency or bankruptcy of the counterparty. A Fund may exit its obligations under a credit default swap only by terminating the contract and paying applicable breakage fees, or by entering into an offsetting credit default swap position, which may cause the Fund to incur more losses.

Developing government regulation of derivatives. The Dodd-Frank Act and related regulatory developments have imposed comprehensive new regulatory requirements on swaps and swap market participants. The regulatory framework includes: (1) registration and regulation of swap dealers and major swap participants; (2) requiring central clearing and execution of standardized swaps; (3) imposing margin requirements on swap transactions; (4) regulating and monitoring swap transactions through position limits and large trader reporting requirements; and (5) imposing record keeping and centralized and public reporting requirements, on an anonymous basis, for most swaps. The CF