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WO2009039395A1 - Procédé de création de panier pour un fonds indiciel négociable en bourse (etf) géré activement qui ne révèle pas tous les titres de fonds sous-jacents et société d'investissement qui investit dans des valeurs à revenus fixes et a des classes de fonds classiques et indiciels négociables en bourse avec des fréquences de paiement de dividendes différentes - Google Patents

Procédé de création de panier pour un fonds indiciel négociable en bourse (etf) géré activement qui ne révèle pas tous les titres de fonds sous-jacents et société d'investissement qui investit dans des valeurs à revenus fixes et a des classes de fonds classiques et indiciels négociables en bourse avec des fréquences de paiement de dividendes différentes Download PDF

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Publication number
WO2009039395A1
WO2009039395A1 PCT/US2008/077052 US2008077052W WO2009039395A1 WO 2009039395 A1 WO2009039395 A1 WO 2009039395A1 US 2008077052 W US2008077052 W US 2008077052W WO 2009039395 A1 WO2009039395 A1 WO 2009039395A1
Authority
WO
WIPO (PCT)
Prior art keywords
securities
fund
shares
investment company
etf
Prior art date
Application number
PCT/US2008/077052
Other languages
English (en)
Inventor
Kathryn J. Hyatt
Kenneth E. Volpert
Glenn H. Booraem
Original Assignee
The Vanguard Group, Inc.
Priority date (The priority date is an assumption and is not a legal conclusion. Google has not performed a legal analysis and makes no representation as to the accuracy of the date listed.)
Filing date
Publication date
Priority claimed from US11/858,668 external-priority patent/US7792725B2/en
Priority claimed from US11/955,854 external-priority patent/US7461027B1/en
Application filed by The Vanguard Group, Inc. filed Critical The Vanguard Group, Inc.
Publication of WO2009039395A1 publication Critical patent/WO2009039395A1/fr

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Classifications

    • G—PHYSICS
    • G06—COMPUTING; CALCULATING OR COUNTING
    • G06Q—INFORMATION AND COMMUNICATION TECHNOLOGY [ICT] SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES; SYSTEMS OR METHODS SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES, NOT OTHERWISE PROVIDED FOR
    • G06Q40/00—Finance; Insurance; Tax strategies; Processing of corporate or income taxes
    • G06Q40/06—Asset management; Financial planning or analysis
    • G—PHYSICS
    • G06—COMPUTING; CALCULATING OR COUNTING
    • G06Q—INFORMATION AND COMMUNICATION TECHNOLOGY [ICT] SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES; SYSTEMS OR METHODS SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES, NOT OTHERWISE PROVIDED FOR
    • G06Q40/00—Finance; Insurance; Tax strategies; Processing of corporate or income taxes
    • G06Q40/04—Trading; Exchange, e.g. stocks, commodities, derivatives or currency exchange

Definitions

  • Figure 1 shows a schematic block diagram of one preferred embodiment of the present invention.
  • Figure 2 shows a flowchart of an active bond ETF basket creation process in accordance with one preferred embodiment of the present invention.
  • FIG. 3 shows a flowchart of a dividend distribution process in accordance with one preferred embodiment of the present invention.
  • One preferred embodiment of the present invention provides methods and apparatus that administer an investment company.
  • the process operates as follows:
  • the investment company issues one or more classes of shares that are bought from and redeemed with the investment company at a net asset value. 2.
  • the investment company also issues one or more classes of shares that are listed for trading on a securities exchange and that are bought and sold in a secondary market at negotiated market prices.
  • One or more computers maintain information regarding portfolio holdings of the investment company and outstanding shares in the investment company. 4. Dividends are periodically declared at a first time interval for the outstanding shares that are bought from and redeemed with the investment company at a net asset value. The amount of dividends to declare is calculated from the information maintained in the one or more computers.
  • Dividends are periodically declared at a second time interval that is different from the first time interval for the outstanding shares that are exchange-traded. Again, the amount of dividends to declare is calculated from the information maintained in the one or more computers.
  • Another preferred embodiment of the present invention provides methods and apparatus that administer an actively managed investment company that invests assets in fixed income securities. The process operates as follows:
  • the investment company issues one or more classes of shares that are listed for trading on a securities exchange and that are bought and sold in a secondary market at negotiated market prices.
  • the investment company selects and holds a portfolio of fixed income securities that relate to a benchmark index.
  • the selection is made in an actively managed manner such that the duration range of the securities holdings is either longer than the duration of the benchmark index (also referred to herein as being “bullish”), close to the duration of the benchmark index (also referred to herein as being “neutral”), or shorter than the duration of the benchmark index (also referred to herein as being “bearish”).
  • the investment company defines a creation unit basket that has a duration that is equal to a midpoint of the duration range of the securities holdings of the investment company. 4. The investment company periodically publishes the creation unit basket to facilitate creation and redemption of the exchange-traded shares.
  • FIG. 1 shows a schematic block diagram of a system 10 in accordance with one preferred embodiment of the present invention.
  • the system 10 is similar to the system shown in Figure 1 of the '964 patent, except that the "VIPER shares" referred to in the '964 patent are now referred to as "ETF shares," and there are additional elements provided to facilitate the present inventive features.
  • the system 10 includes an investment company 12 (also, referred to interchangeably as “the Fund”), investors A, B and C (labeled as 14, 16 and 18, respectively), an authorized participant (also known as a "market maker" or
  • the investment company 12 includes a first processor 24 that records one or more classes of conventional shares issued by the investment company 12, a second processor 26 that records one or more classes of ETF shares issued by the investment company 12, a database 50 that stores information about the investment company's portfolio holdings (i.e., the pool of underlying securities), and a database 52 that stores information about dividend declarations for the multiple share classes (e.g., payment dates, ex- dividend dates, amounts of dividends paid).
  • the first processor 24 records one class of conventional shares issued by the investment company 12, such as a class of conventional shares that has a relatively small minimum investment of $1,000 or $3,000 ("investor shares").
  • the class of conventional shares could have a relatively large minimum investment, such as $10 million ("institutional shares").
  • the second processor 26 records one class of ETF shares issued by the investment company 12.
  • the investment company 12 also includes a database 28 for maintaining shareholder account data. For each shareholder of the investment company 12, the database 28 maintains a record of the amount of conventional shares. The database 28 also maintains a single account that tracks all of the outstanding ETF shares.
  • the investment company 12 further includes a portfolio trading and management computer 54, a portfolio management instruction computer 56 that receives instructions for execution from a portfolio manager (PM), and a database 58 that contains the current basket of securities used for creating and redeeming ETF shares.
  • PM portfolio manager
  • Investor A represents one or more investors who have purchased conventional investor shares in exchange for cash.
  • Investor B represents one or more investors who have purchased conventional institutional shares.
  • Investors who wish to purchase ETF shares in quantities smaller than a Creation Unit must purchase the shares on the secondary market through a broker. This process is represented by the investors C (labeled as 18), the brokers 20, the authorized participant 19, and the clearinghouse 22.
  • An authorized participant 19 is a financial entity that maintains firm bid and offer prices in a given security by standing ready to buy or sell round lots at publicly quoted prices.
  • an authorized participant is the member firm that makes a market in the stock and maintains the limit order book.
  • the authorized participant 19 purchases ETF shares in Creation Units from the investment company 12 which are settled through the clearinghouse 22.
  • the authorized participant 19 has a computer 37 for tracking its account data.
  • the clearinghouse 22 is the Depository Trust Company (DTC).
  • the DTC is a national clearinghouse for the settlement of trades in corporate and municipal securities and performs securities custody-related services for its participating banks and broker- dealers.
  • DTC is owned by members of the financial industry and by their representatives who are its users. The use of other clearinghouses is within the scope of the present invention.
  • each broker 34, 36 has a computer for tracking brokerage account data for its shareholders, labeled as elements 38 and 40, respectively.
  • Each broker 34, 36 may have many investors.
  • investor 42 (investor CIi) and investor 44 (investor Cl n ) have accounts with broker 34
  • investor 46 (investor Cni) and investor 48 (investor Cn n ) have accounts with broker 36.
  • the clearinghouse 22 has a record of all outstanding ETF shares issued by the investment company 12.
  • Fig. 1 shows only purchase transactions. Sell-type ETF transactions are performed by a reverse of the ETF purchase transactions.
  • the investment company could be an open-end fund (e.g., open-end mutual fund), a closed-end fund (e.g., closed-end mutual fund), or a UIT.
  • the ETF shares issued by the investment company are publicly listed and traded on a national stock exchange, such as the American Stock Exchange (AMEX).
  • AMEX American Stock Exchange
  • the investment company could have an investment objective of tracking a specific target index of securities (i.e., an index fund).
  • the investment company could be actively managed by an investment advisor in a manner that does not attempt to tightly track a target index.
  • ETF shares may be acquired in one of two different ways: (1) An investor may purchase ETF shares directly from the investment company 12 in exchange for a basket of securities of generally equivalent monetary value. Preferably, the direct purchase requires a purchase of a predetermined number of ETF shares, known as a "Creation Unit.” The account data is then updated to include the newly purchased shares.
  • a "Creation Unit” will preferably cost millions of dollars, and thus, Creation Units will be purchased primarily by institutional investors who have been pre-approved.
  • An investor may purchase ETF shares on the secondary market through a broker.
  • the account data of the investor, as maintained by the investor's broker, is then updated to reflect the new number of shares held by the investor.
  • ETF shares may be sold or redeemed in one of two different ways:
  • An investor may redeem ETF shares directly with the mutual fund in exchange for a basket of securities of generally equivalent monetary value.
  • a shareholder may sell ETF shares directly on the secondary market through a broker.
  • Figure 2 is a flowchart of an active bond ETF basket creation process. This process may be used in an investment company that invests most, substantially all, or all of its assets in fixed income securities, such as bonds. In one exemplary embodiment, the process in Figure 2 operates as follows:
  • the portfolio manager (PM) of the investment company 12 determines that there will be duration ranges for the Fund.
  • the PM determines what the boundaries of the duration ranges will be, vis-a-vis the duration of the Fund's benchmark or target index (e.g., the Bear range is -0.75 yrs to -0.375 yrs, the Neutral range is -0.375 yrs to +0.375 yrs, the Bull range is +0.375 yrs to +0.75 yrs).
  • the PM determines, based on experience, research and market conditions, which duration range the Fund should be in (considering future interest rate expectations).
  • the PM buys/sells underlying securities so that the Fund's duration range matches the PM's determination of which duration range the Fund should be in. 5.
  • the PM calculates the midpoint of the Fund's current duration range.
  • the PM selects the securities that will be included in the Basket and the extent of overlap between Basket securities and the Fund's actual underlying securities (e.g., target 50-75% for a Treasury inflation-protected securities (TIPS) fund, 40-50% for a non-TIPS Treasury bond fund).
  • TIPS Treasury inflation-protected securities
  • the PM establishes the respective weightings of the Basket securities, so that the duration of the Basket always matches the midpoint of the Fund's current duration range. -For example, regardless of whether the PM is currently taking a moderately Bullish, medium Bullish, or strongly Bullish position, the duration of the Basket will always match the midpoint of the Bullish range. Likewise, regardless of whether the PM is currently taking a moderately Bearish, medium Bearish, or strongly Bearish position, the duration of the Basket will always match the midpoint of the Bearish range. Likewise, regardless of whether the PM is currently taking a
  • the Fund's Creation Basket is published by a publication module 60 once each business day via any suitable electronic or print media. Although the Creation Basket is expected to sufficiently closely track each applicable Fund, each Fund's
  • Adviser preferably will not disclose intra-day changes in the Fund's investment portfolio to
  • the composition of the Creation Basket must very closely resemble the composition of the investment portfolio of each Fund in order that (i) the market value of the Creation Basket will closely track the same-day NAV of that Fund's ETF shares, and (ii) specialists and market makers will have sufficient information about that Fund to maintain reasonable spreads between the bid and offer prices of ETF shares. Because each Fund is actively managed, however, the Fund has a fiduciary responsibility to keep confidential the exact composition of the Funds and changes to the composition of the Funds so as to prevent front running and free riding. This duty of confidentiality prevents the production of a Creation Basket that exactly mirrors the full portfolio holdings of the Funds. That is, the Creation Basket should not reveal all of the Fund holdings. The Creation Basket described herein accomplishes this goal.
  • the desired level of tracking between the market value of the Creation Basket and the same-day NAV of the Funds is achieved by selecting the weightings of the securities in the Creation Basket according to two requirements.
  • the first Creation Basket requirement specifies that the Creation Basket must be a representative sample of the securities comprising the investment portfolio of each Fund. This requirement ensures substantial identity between the Deposit Securities and the securities comprising the investment portfolio of the Funds, which will increase the degree of positive correlation of price movements between the Creation Basket and the Funds' ETF shares.
  • the second Creation Basket requirement specifies that the Duration and Yield Curve Slope Exposure of each Fund's Creation Basket must closely approximate the Duration and Yield Curve Slope Exposure of the investment portfolio of the corresponding Fund.
  • each Fund's Adviser assigns a rating of Bullish, Neutral or Bearish to the interest rate sensitivity of the Fund's investment portfolio.
  • a specific number is defined to be the midpoint of a range represented by that rating.
  • the weightings of the securities in the Creation Basket are selected such that the Duration of the Creation Basket is calculated to be approximately the same as the midpoint of the Duration range which is assigned to the Fund's investment portfolio.
  • Each Fund's Adviser also structures the securities which comprise the Creation Basket so that the Yield Curve Slope Exposure of the Creation Basket closely approximates the Yield Curve Slope Exposure of the corresponding Fund's investment portfolio.
  • the Creation Basket further has a breakeven inflation (BEI) exposure that is approximately matched to the BEI exposure of the securities holdings.
  • BEI breakeven inflation
  • the creation basket process may be implemented in an investment company that offers ETF shares as the only class of shares, or offers ETF shares as a class of shares in addition to one or more classes of conventional shares. If the creation basket process is implemented in an investment company that offers ETF shares as the only class of shares, the system of Figure 1 would not include the processor 24 that issues the conventional shares, the shareholder account data in the database 28 (since there would be no individual shareholder accounts to track), or the investors 14 and 16 who purchase and redeem conventional shares.
  • dividends are declared daily and paid monthly. As described in Appendix B, there are many reasons why it would not be practical for funds to declare dividends daily for an exchange-traded class of shares and why the dividend payment dates cannot be the same for conventional shares and exchange-traded shares. In one embodiment of the present invention, dividends are declared daily and paid monthly for conventional shares, but dividends are declared only monthly for the ETF share class(es) and paid several days later than the payment date for the conventional shares.
  • FIG 3 shows a flowchart of a dividend distribution process in accordance with one preferred embodiment of the present invention.
  • there are two classes of shares one conventional share class, such as the investor shares shown in Figure 1 , and one ETF share class.
  • the income earned on the portfolio is allocated daily among the share classes based on their relative net assets.
  • Appendices A and B are Applications for Exemptive Relief filed by The Vanguard Group, Inc. to permit stand-alone index funds that invest in fixed income securities (e.g., bonds) to issue exchange-traded shares and to actively manage the ETF share class.
  • Appendix A is directed toward an actively-managed TIPS fund and Appendix B is directed towards a more general Treasury index fund.
  • the fixed income securities may be funds that invest in corporate bonds, mortgage backed securities, international bonds, and the like.
  • the disclosed embodiments are investment companies that invest substantially all of their assets in fixed income securities, the scope of the invention includes "balanced fund" investment companies, wherein the fixed income portion of the balanced fund uses the inventive methods described above.
  • dividends are declared daily for conventional shares and monthly for the ETF share class(es).
  • other differing dividend declaration schedules are within the scope of the present invention.
  • the investment company has an investment objective of tracking a specific benchmark index of fixed income securities.
  • the investment objective is set by an investment advisor, such as in an actively managed investment company, as opposed to tracking a specific benchmark index.
  • the present invention may be implemented with any combination of hardware and software. If implemented as a computer-implemented apparatus, the present invention is implemented using means for performing all of the steps and functions described above.
  • the present invention can be included in an article of manufacture (e.g., one or more computer program products) having, for instance, computer useable media.
  • the media has encoded therein, for instance, computer readable program code means for providing and facilitating the mechanisms of the present invention.
  • the article of manufacture can be included as part of a computer system or sold separately.
  • the Prior Vanguard ETF Orders relate only to Vanguard stock index funds. This Application differs from the Prior Vanguard ETF Applications in that it seeks relief to permit an actively managed bond fund to issue a class of exchange-traded shares.
  • the Commission previously has issued relief permitting bond index funds to issue exchange-traded shares, but not as part of a multiple-class structure.
  • the Commission previously has sought public
  • Vanguard Index Funds et al.. File No. 812- 12094, Investment Company Act Release Nos. 24680 (Oct. 6, 2000) (notice), and 24789 (Dec. 12, 2000) (order).
  • the application related to the Original Vanguard ETF Order shall be referred to herein as the "Original Vanguard ETF Application.”
  • ETF is an abbreviation for "exchange-traded fund.”
  • ETF Shares interchangeably to refer to the class of exchange-traded shares issued by certain Vanguard funds as well as the exchange-traded shares issued by third-party ETFs.
  • the relief requested in this Application differs from non- Vanguard precedent in that Applicants are requesting relief from Sections 18(I)(I) and 18(i) of the Act to structure their ETFs as a separate share class of multiple-class funds.
  • Section 18(f)(l) prohibits a fund from issuing a class of senior security.
  • Section 18(i) provides that all shares of stock issued by a fund must have equal voting rights. See Part VI. C of this Application.
  • Vanguard Fixed Income Securities Funds (“Fixed Income Securities Funds” or “Trust”) was originally organized in 1972 as a Maryland corporation and was reorganized as a Delaware statutory trust in 1998.
  • the Trust is registered with the Commission as an open-end management investment company. It currently consists often separate investment portfolios, including, among others, Vanguard Inflation-Protected Securities Fund (the "Applicant Fund” or “Fund”), which is an actively managed bond fund that seeks to provide inflation protection and income consistent with investment in inflation-indexed securities.
  • the Applicant Fund invests at least 80% of its assets in inflation-indexed bonds issued by the U.S. government, its agencies and instrumentalities, and corporations, but it emphasizes securities backed by the full faith and credit of the U.S. government.
  • the Fund may invest in bonds of any maturity; however, its dollar- weighted average maturity is expected to be in a range of 7 to 20 years. All bonds purchased by the Fund will be rated investment-grade (in one of the four highest rating categories) or will be unrated bonds considered by the Fund's adviser to be investment-grade.
  • the Vanguard Group, Inc., adviser to the Fund (the "Adviser” or "VGI"), buys and sells securities based on its judgment about issuers, the prices of the securities, and other economic factors.
  • the Applicant Fund invests mainly in a diversified group of investment-grade, inflation-
  • Inflation-indexed securities are designed to provide a "real rate of return” — a return after adjusting for the impact of inflation.
  • an inflation- indexed security provides principal and interest payments that are adjusted over time to reflect a rise (inflation) or a drop (deflation) in the general price level.
  • Treasury Inflation- Protected Securities (“TIPS”) are securities issued by the U.S. Treasury whose principal and interest is increased or decreased based on changes in the Consumer Price Index (“CPI"). TIPS differ from nominal Treasuries, which are not adjusted to reflect the effect of inflation on investors' purchasing power.
  • the Fund's non-inflation-indexed holdings may include the following:
  • the Applicant Fund may invest in derivatives if the expected risks and rewards of the derivatives are consistent with the investment objective, policies, strategies, and risks of the Fund as disclosed in the Fund's prospectus.
  • the Adviser will not use derivatives to change the risks of the Fund as a whole as such risks are disclosed in the Fund's prospectus.
  • derivatives will be used only where they may help the Adviser:
  • the Fund's derivative investments may include fixed income futures contracts, fixed income options, interest rate swaps, total return swaps, credit default swaps, or other derivatives.
  • the investment objective of the Applicant Fund is to seek to provide inflation protection and income consistent with investment in inflation-indexed securities. While the Adviser uses the Lehman Brothers U.S. Treasury Inflation Notes Index (the "benchmark index") as a benchmark for the Fund's performance, the Fund's average maturity and mix of bonds may differ from those of the benchmark index. 8 This may occur, for example, when the Adviser sees an opportunity to enhance returns. The Adviser identifies return enhancement opportunities based on its expectation of future interest rates and inflation and its judgment concerning the comparative value of inflation-indexed securities and nominal securities. 9 The Adviser acts on these return enhancement opportunities by differentiating the characteristics and composition of the investment portfolio of the Fund from the characteristics and composition of the benchmark index.
  • the benchmark index includes all publicly issued, U.S. Treasury inflation-protected securities that have at least one year remaining to maturity, are rated investment grade and have $250 million or more of outstanding face value. In addition, the securities must be denominated in U.S. dollars and must be fixed rate and non-convertible.
  • the benchmark index is market capitalization weighted and the securities in the benchmark index are updated on the last calendar day of each month.
  • the Adviser identifies return enhancement opportunities is by comparing its own prediction of future interest rates and inflation to the interest rate and inflation levels that are implied by (i) the nominal securities that are eligible for investment by the Applicant Fund (e.g., fixed-principal Treasuries, agencies and corporates) and (ii) the inflation-indexed securities that comprise the benchmark index . 10
  • the Adviser implements its interest rate and inflation insights primarily by managing the Fund's duration, yield curve slope exposure and breakeven inflation (“BEI”) exposure consistent with the Adviser's prediction of future interest rates and inflation. Duration, yield curve slope exposure and BEI exposure measure the principal market forces that drive the performance of a portfolio of inflation- indexed securities. As explained further below, the Adviser's decision to differentiate the Fund from the benchmark index on the basis of these three measures will cause most of the performance variation between the Fund and the benchmark index.
  • BEI breakeven inflation
  • the prices of inflation-indexed securities and nominal securities reflect the forward-looking interest rate expectations of the market as a whole. Market expectations of future inflation are incorporated into the price of nominal securities, while principal and interest payments on inflation-indexed securities are adjusted to reflect the rate of inflation recently measured by an index. The Adviser may believe that future interest rates and inflation will differ from both market expectations and index levels, and may invest Fund assets accordingly.
  • the measure known as "duration" represents a bond's (or a bond fund's) market- value sensitivity to changes in yields - real or nominal. 11 If the duration of the Applicant Fund differs from the duration of the benchmark index, changes in interest rates will have a greater or lesser impact on the performance of the Fund than on the performance of the benchmark index. The Adviser actively manages the duration of the Fund within one of three ranges (bullish, neutral or bearish, versus the benchmark index) that best reflects its expectations regarding future interest rates. 12 The Adviser's use of Treasury futures contracts to alter the Fund's duration 13 would produce a secondary risk called "futures basis" risk, which measures the degree to which the price of a futures contract tracks the price of the underlying security. 14
  • Yield curve slope exposure describes the distribution of the portfolio holdings of the Applicant Fund along the yield curve. If the Fund has a different yield curve slope exposure than the benchmark index, non-parallel shifts in the yield curve will have a more or less favorable impact on the total return of the Fund than on the total return of the benchmark index.
  • the real duration is the percentage change in its market value associated with a 1% change in its real yield. Id.
  • Basis is the difference between the spot or cash price of a commodity and the price of the nearest futures contract for the same or a related commodity, while “basis risk” is the risk associated with an unexpected widening or narrowing of basis between the time a position is established and the time that it is lifted. See “The CFTC Glossary, A Guide to the Language of the Futures Industry", Office of External Affairs, Commodity Futures Trading Commission (Sept. 2005), reprinted at http://www.cftc.gov/files/opa/cftcglossary.pdf.
  • the total return of the Applicant Fund will differ from the total return of the benchmark index to the extent the Fund has different BEI exposures along the yield curve.
  • the Adviser identifies BEI return enhancement opportunities by comparing the relative value of inflation-indexed securities and nominal securities. The Adviser's comparative value judgments are implemented primarily by allocating more of the Fund's assets to the most attractive class of securities.
  • the Adviser could seek to exploit this opportunity by reducing the duration contribution (i.e., the amount of the investment portfolio's duration that comes from that security or security type) of the inflation-indexed securities in the Fund 17 and increasing the duration contribution of the nominal securities in the Fund. 18 Alternatively, if the Adviser believes that inflation-indexed securities are undervalued versus nominal securities, the Adviser could seek to exploit this opportunity by increasing the duration contribution of inflation-indexed securities in the Fund. 19
  • Adviser implements its judgments concerning fixed income securities is through differentiated issue selection.
  • “Issue selection” involves deciding, at each point along the yield curve, whether to purchase one issue of available securities instead of another based on the Adviser's perception of their relative value, taking into consideration auction supply and liquidity differentials, among other factors. Differences between the issue structure of the portfolio securities of the Applicant Fund and the securities that comprise the benchmark index will have a secondary impact on the degree to which the performance of the Fund differs (for better or worse) from the performance of the benchmark index.
  • B. The Vanguard Group. Inc.
  • VGI The Vanguard Group, Inc. is a Pennsylvania corporation that is wholly and jointly owned by 35 investment companies 20 that offer, in the aggregate, more than 140 distinct investment portfolios (each, a "Vanguard Fund"). This "mutual" ownership structure is unique in the mutual fund industry.
  • VGI is a registered investment adviser under the Investment Advisers Act of 1940 and a registered transfer agent under the Securities Exchange Act of 1934 ("Exchange Act").
  • VGI provides each of the Vanguard Funds, at cost, with corporate management, administrative, transfer agency, and (through Vanguard Marketing Corporation, a wholly-owned subsidiary) distribution services. It also provides advisory services, at cost, to certain of the Vanguard Funds, including the Applicant Fund. 21
  • the Trust's board of trustees may engage a party other than VGI to provide advisory services to the Applicant Fund. Any such advisers will be registered or exempt from registration under the Investment Advisers Act of 1940.
  • VGI vanguard Funds with furnishings and equipment. Pursuant to exemptive orders issued by the Commission in 1975 and 1981, each Vanguard Fund, including the Applicant Fund, pays its share of VGI' s total expenses pursuant to allocations approved by the board of trustees of each Vanguard Fund. 22 In addition, each Vanguard Fund bears its own direct expenses such as legal, auditing, and custodian fees.
  • VMC Vanguard Marketing Corporation
  • VGI Vanguard Marketing Corporation
  • VMC operates a retail brokerage business.
  • Creating an exchange-traded share class of the Applicant Fund is preferable to creating entirely new exchange-traded clone funds, for several reasons.
  • creating a separate fund would create additional overhead costs; a new share class can be created and offered with much less cost than creating and offering a new stand-alone fund.
  • assets invested in the Fund's ETF share class should provide additional economies of scale and opportunities for greater diversification to the Fund, which would not occur if ETF Shares were instead offered by a stand-alone fund.
  • a separate share class that attracts additional capital through in-kind contributions should also allow the Fund to better achieve its investment objective (due to lower investment costs and enhanced diversification) and may help the Fund outperform the benchmark index (for the same reasons).
  • the Applicant Fund's organizational documents permit it to issue shares of different classes.
  • the Fund currently offers the following classes of shares: Investor Shares, Admiral Shares, and Institutional Shares. Investor Shares are for the typical retail investor; they require a minimum investment of $3,000. Admiral Shares are for high-balance and/or long-tenured retail accounts; they require a minimum investment of $100,000, or $50,000 for those who have owned shares of the Fund for ten years and are registered users ofvanguard.com. Institutional Shares require a minimum investment of $5 million. Investor, Admiral and Institutional Shares are collectively referred to herein as "Conventional Shares.”
  • ETF Shares The exchange-traded class of shares is referred to herein as "ETF Shares.” 25 Except as set forth in Part VI. C. below, the Fund will comply in all respects with Rule 18f-3 under the Act, which permits an open-end investment company to issue more than one class of shares. The Fund will not issue ETF Shares until it amends its multiclass plan under Rule 18f-3(a) to permit the issuance of such shares.
  • the board of trustees of the Fund including a majority of the trustees who are not interested persons, as defined in Section 2(a)(19) of the Act ("Disinterested Trustees"), will determine that the allocation of distribution expenses among the classes of Conventional Shares and ETF Shares in accordance with the Multi-Class Distribution Formula (described in Part VLC.) is in the best interests of each share class and of the Fund as a whole. A similar determination will be made by the board of any Vanguard Fund
  • VPER Shares The exchange-traded class of shares of Vanguard Funds were previously referred to as "VIPER Shares” but are now referred to as "ETF Shares.”
  • the Fund will issue and redeem ETF Shares only in aggregations of a specified number ("Creation Units"). Purchasers of Creation Units will be able to separate the Creation Units into individual ETF Shares.
  • the actual number of ETF Shares in a Creation Unit will be based in part on the net asset value per share of the Fund and the dollar value initially established for the Fund's Creation Unit. It is expected that a Creation Unit will have an initial price of $7.5 million and that the number of ETF Shares in a Creation Unit will be 100,000 (although the number could be higher or lower). The initial value of an ETF Share is expected to be $75 per share.
  • the Fund seeks to provide inflation protection and income consistent with investment in inflation-indexed securities, based on the Adviser's judgment about issuers, the prices of the securities, and other economic factors. While the Adviser uses the Lehman Brothers U.S. Treasury Inflation Notes Index as a benchmark for the Fund's performance, the Fund's average maturity and mix of bonds may differ from those of the benchmark. This may occur, for example, when the Adviser sees an opportunity to enhance returns, as described above in Section ILA. Unlike all prior ETF proposals approved by the Commission - which involved index-based ETFs - the Applicants' proposal involves an actively managed ETF.
  • the Applicant Fund will list its ETF Shares on a domestic Exchange. 27
  • the Fund will comply with all applicable rules of the Exchange on which its ETF Shares are listed. Neither the Fund's Distributor nor any other entity will maintain a secondary market in individual ETF Shares.
  • the Exchange will designate one or more member firms to act as a specialist and maintain a market for the ETF Shares that trade on the Exchange (the "Exchange Specialist").
  • the Fund's ETF Shares will trade on the Exchange in a manner similar to currently available Vanguard ETF Shares, as well as hundreds of other exchange-traded funds.
  • ETF Shares Like the currently available ETF Shares, these ETF Shares will be registered in book- entry form only; the Applicant Fund will not issue individual share certificates for ETF Shares.
  • the Depository Trust Company (“DTC") or its nominee will be the record or registered owner of all outstanding ETF Shares. Beneficial ownership of ETF Shares will be shown on the records of DTC or a broker-dealer that is a participant in DTC (a "DTC Participant"). 28 Any retail investor wishing to own ETF Shares must do so through an account maintained by a broker- dealer that (i) is a DTC Participant or (ii) has a relationship with another broker-dealer that is a DTC Participant.
  • Beneficial owners of ETF Shares will receive all of the statements, notices, and reports required under the Act and other applicable laws. They will receive, for example, annual and semi-annual fund reports, written statements accompanying dividend payments, proxy statements, annual notifications detailing the tax status of fund distributions, Form 1099-DIVs, etc. Some of these documents will be provided to Beneficial Owners by their brokers, while others will be provided by the Applicant Fund through the brokers. This arrangement is identical to that of hundreds of other exchange-traded funds, and is similar to that used by funds whose shares are owned through mutual fund supermarket intermediaries.
  • the Applicant Fund will issue ETF Shares in Creation Unit-size aggregations to
  • DTC Participants include banks, trust companies, clearing companies, and other organizations.
  • the in-kind deposit will consist of a basket ("Basket") of securities ("Deposit Securities”) determined by the Adviser to closely resemble - but not replicate - the composition and characteristics, and closely track the expected performance, of the investment portfolio of the Fund. a. Minimum Basket Requirements
  • the Adviser will use a sophisticated computer program to sample the investment portfolio of the Fund and, based on that sample, structure a Basket that satisfies each of the following requirements (the "Minimum Basket Requirements").
  • the Basket will contain a representative sample of the inflation-indexed securities and nominal securities comprising the investment portfolio of the Fund.
  • An “Authorized Participant” is a broker-dealer that is a DTC Participant that has executed a "Participant
  • the Basket will be constructed to produce, at a one standard deviation level of confidence, an expected daily tracking error ("Expected Daily Tracking Error") between the daily total return of the Basket (as measured by its market value or "MV") and the daily total return of the Fund's ETF Shares (as measured by their net asset value per share or "NAV") that is no greater than ⁇ 3 basis points ("bps").
  • MV daily total return of the Basket
  • NAV net asset value per share
  • bps net asset value per share
  • composition and characteristics of the Basket will closely resemble the composition and characteristics of the investment portfolio of the Applicant Fund, the Applicants believe that (i) the daily total return of the Basket will closely track the daily total return of the ETF Shares and (ii) Exchange Specialists and market makers will have sufficient information about the Fund to maintain reasonable spreads between the bid and offer prices of ETF Shares. Furthermore, because the Adviser will ensure that the composition and characteristics of each Basket have a high statistical probability of causing the Expected Daily Tracking Error to be less than or equal to ⁇ 3 bps, Exchange Specialists and market makers will have added assurance that their arbitrage activities will be successful without having to widen spreads as protection from uncertainty. 30 Finally, the Applicants expect their proposal for once-per-day publication of the Basket (which is consistent with the practice of
  • the Adviser has back-tested its basket design methodology for the Applicant Fund over an eight year period (incorporating real- world interest rates, inflation and other bond market conditions) and determined that, at a one standard deviation level of confidence, the historic daily tracking error between the daily total return of the Basket and the daily total return of the ETF Shares ranges from 0.7 bps to 1.4 bps.
  • the Adviser also applied its methodology for the Fund on a forward-looking basis (with good faith assumptions about interest rates, inflation and other bond market conditions) and determined that, at a one standard deviation level of confidence, the predicted daily tracking error between the daily total return of the Basket and the daily total return of the ETF Shares ranges from 1.6 bps to 2.1 bps.
  • the Adviser and the Vanguard Funds maintain written policies and procedures that govern the disclosure of the portfolio holdings of a Vanguard Fund to any person, including any ongoing arrangement to disclose portfolio holdings to any person.
  • Those policies and procedures are designed to prevent the misuse of material nonpublic information concerning the portfolio holdings of the funds, and generally prohibit the portfolio holdings of the funds from being disclosed to any person other than specified affiliates or service providers, and then only for legitimate business purposes within the scope of such persons' official duties and responsibilities, and subject to such persons' continuing legal duty of confidentiality and legal duty not to trade on the basis of any material nonpublic information.
  • the Applicants propose to use a modified version of the same sophisticated computer program the Adviser has used to sample the target indexes tracked by the Vanguard Bond Index Funds since December 11, 1986.
  • the investment process the Adviser uses for these funds enables them to invest in a representative sample of bonds from their respective target indexes. That sample resembles the full target indexes in terms of characteristics such as maturity, credit quality, issuer type, and yield.
  • This approach has been highly successful, as demonstrated by the Vanguard Bond Index Funds' history of tracking tightly to their target indexes.
  • an investment adviser can construct a portfolio that is a subset of the component securities in the corresponding index, rather than a replication of the index.
  • the investment adviser also may acquire securities for the ETF portfolio that are not included in the corresponding index. While these ETFs still seek to track the performance of their respective indices, they have greater flexibility in accomplishing that goal.”); see also Original Vanguard ETF Order (permitting Total Stock Market ETF Shares and Extended Market ETF Shares to publish baskets that sample rather than replicate a target index).
  • the Adviser proposes to sample the investment portfolio of the Applicant Fund (which typically holds about 20 securities ) to generate a Basket of Deposit Securities which duplicate approximately 50% to 75% of the securities held in the investment portfolio.
  • the sampling techniques used to determine the Basket should not harm tracking.
  • Vanguard Total Stock Market ETFs and Vanguard Extended Market ETFs are the only two domestic Vanguard ETFs whose baskets sample rather than replicate a target index. Based on data for the six month period ending December 31 , 2006, the monthly tracking error figures for the two funds were +0.7 bps for Total Stock Market ETFs and +1.28 bps for Extended Market ETFs.
  • the Adviser expects this number to increase by approximately four (4) securities a year, based on expected increases in the number of securities included in the benchmark index.
  • the proposed size of the Basket of Deposit Securities for the Applicant Fund (approximately 10 to 15 securities) is similar to the size of the Baskets of Deposit Securities for similar index-based ETFs, such as the following (typical number of Deposit Securities in parentheses): iShares Lehman TIPS Bond Fund (17); iShares Lehman 1-3 Year Treasury Bond Fund (21); iShares Lehman 7-10 Year Treasury Bond Fund (10); and iShares Lehman 20+ Year Treasury Bond Fund (12).
  • the first Minimum Basket Requirement specifies that the Basket must contain a representative sample of the inflation-indexed securities and nominal securities comprising the investment portfolio of the Fund. This requirement ensures a significant overlap between the Deposit Securities and the securities comprising the investment portfolio of the Fund, which will increase
  • the second Minimum Basket Requirement specifies that the duration, yield curve slope exposure and BEI exposure of the Basket must closely approximate the duration, yield curve slope exposure and BEI exposure of the investment portfolio of the Fund. This ensures that the Basket and the investment portfolio of the Fund will have closely matched exposures to the principal market forces that drive the performance of a portfolio of inflation-indexed securities, which will further increase the degree of positive correlation of price movements between the Basket and the ETF Shares. Minimal Tracking Error.
  • the third Minimum Basket Requirement specifies that the Basket must be expected to produce, at a one standard deviation level of confidence, an Expected Daily Tracking Error between the daily total return of the Basket and the daily total return of the ETF Shares that is no greater than ⁇ 3 bps. This measure is the "gold standard" for determining the reliability of the Basket as a proxy for the Fund's investment portfolio prior to actual trading.
  • the Applicants have taken several steps to eliminate the possibility of predatory trading practices and avoid conflicts of interest involving the Adviser.
  • the Adviser's proprietary basket design methodology deliberately restricts the amount of information market participants receive about the composition and characteristics of the investment portfolio of the Fund.
  • the Basket will only duplicate approximately 50% to 75% of the securities held by the Fund, and will not include any of the futures contracts or other derivatives comprising the investment portfolio.
  • the duration of the Basket will only closely approximate, and will rarely (and only by chance) exactly equal, the duration of the investment portfolio.
  • the composition and characteristics of the Basket will always modestly diverge from the current composition and characteristics of the Fund's investment portfolio, and the Expected Daily Tracking Error will fall within a range of ⁇ 3 bps.
  • the Adviser developed its basket design methodology in light of the concerns the Commission expressed in the Concept Release over the liquidity of the securities in the investment portfolio of an actively managed ETF.
  • the Adviser considered the fact that the Applicant Fund invests at least 80% of its assets in inflation-indexed bonds issued by the U.S. government, its agencies and instrumentalities, and corporations, with an emphasis on U.S.
  • Non-Treasury inflation-indexed securities are very rare and comprise an immaterial portion of the market value of inflation-indexed securities
  • the prospectus permits the Applicant Fund, as a secondary investment strategy, to invest up to 15% of its net assets in illiquid securities.
  • the Fund should not be denied the latitude that index-based ETFs and other open-end investment companies currently have to invest in securities that are not registered under Section 12 of the Exchange Act, or securities that are part of an "unsold allotment" within the meaning of Section 4(3)(C) of the Securities Act, to the extent such investments are not prohibited by the investment objective, policies, strategies or limitations of the Fund or applicable law.
  • the Adviser believes it is important for the Fund to maintain its current ability to make opportunistic investments in illiquid, restricted and similar securities that are not included within the benchmark index, because such securities may offer the opportunity for greater diversification, better pricing and higher returns.
  • the Commission's staff has acknowledged that allowing mutual funds to invest in illiquid securities helps to remove unnecessary barriers to capital formation and to facilitate access to the capital markets by small businesses in a manner consistent with the public interest and the protection of investment company shareholders. 51
  • the Fund will impose a Transaction Fee on Authorized Participants who deposit cash in lieu of illiquid, unregistered or unsold allotment securities in order to offset the transaction costs to the Fund of buying those particular Deposit Securities, as well as to protect the existing shareholders of the Fund from the dilutive effect of the transaction costs (primarily custodial costs) that the Fund incurs when Authorized Participants purchase Creation Units.
  • the Applicants' novel basket design methodology, including satisfaction of the Minimum Basket Requirements, will provide sufficient information about the composition and characteristics of the investment portfolio of the Fund, including its illiquid, unregistered or unsold allotment securities, to enable Exchange Specialists and market makers to maintain reasonable spreads between the bid and offer prices of ETF Shares, and therefore cause the market price of ETF Shares to closely track NAV.
  • the Applicant Fund will issue ETF Shares only in Creation Unit-size aggregations to Authorized Participants, and only in exchange for an in-kind deposit of securities, together with a deposit of a specified cash payment described more fully below.
  • the in-kind deposit will consist of a Basket of Deposit Securities (duplicating approximately 50% to 75% of the securities held in the Fund's investment portfolio) determined by the Adviser to closely resemble the composition and characteristics, and closely track the expected performance, of the investment portfolio of the Fund.
  • the identities and amounts of the Deposit Securities will be determined by the Adviser and made available to Authorized Participants.
  • the Fund can minimize brokerage expenses and other transaction costs. 53
  • the Applicant Fund will offer and sell Creation Unit-size aggregations of ETF Shares through the Distributor on a continuous basis at the NAV per share next determined after receipt of an order in proper form. 54
  • the NAV of ETF Shares like Conventional Shares, will be determined as of the close of regular trading on the New York Stock Exchange ("NYSE") on each day that the NYSE is open.
  • the Applicant Fund reserves the right, in its sole discretion, to allow a purchaser to substitute cash for some or all of the Deposit Securities. See infra Part III. C.3.
  • NAV is calculated each business day as of the close of regular trading on the New York Stock Exchange, generally 4 p.m., Eastern time.
  • ETF Shares will be listed on an Exchange and traded in the secondary market in the same manner as other equity securities.
  • the price of ETF Shares trading on the secondary market will be based on a current bid/offer market. No secondary sales will be made to brokers or dealers at a concession by the Distributor or by the Applicant Fund. Purchases and sales of ETF Shares in the secondary market - which will not involve the Applicant Fund - will be subject to customary brokerage commissions and charges.
  • ETF Shares by means of bids and offers on an Exchange in the secondary market is not novel.
  • ETF Shares trade using this method, and this is also the method employed by iShares, SPDRs, MidCap SPDRs, DIAMONDS, Nasdaq- 100 Trust Shares, Select Sector SPDRs, and other ETFs.
  • the price at which ETF Shares of the Applicant Fund trade will be disciplined by arbitrage opportunities created by the ability to purchase or redeem Creation Units at NAV, which should ensure that ETF Shares similarly do not trade at a material premium or discount in relation to NAV.
  • ETF Shares in Creation Unit-size aggregations
  • the Applicant Fund will accept purchase orders only on days that the NYSE is open.
  • the purchase of a Creation Unit will operate as follows. Once a purchase order has been placed with the Distributor, the Distributor will inform the Adviser and the Applicant Fund's custodian ("Custodian"). The Authorized Participant will deliver to the Custodian, on behalf of itself or the Beneficial Owner, the relevant Deposit Securities and any required cash, with appropriate adjustments as determined by the Fund.
  • the Distributor will transmit all purchase orders to the Applicant Fund.
  • the Fund may reject any order that is not in proper form.
  • DTC will instruct the Fund to initiate "delivery" of the appropriate number of ETF Shares to the book entry account specified by the purchaser. 55
  • the Custodian will then notify the Adviser and the Distributor.
  • the Distributor will furnish an ETF Shares Prospectus (as defined in Part III. J.) and a confirmation order to those placing purchase orders.
  • the Authorized Participants that purchase Creation Units from the Applicant Fund must make an in-kind deposit of Deposit Securities together with an amount of cash specified by the Adviser (the "Purchase Balancing Amount"), plus the applicable Transaction Fee (as defined in Part III. F. below).
  • the Deposit Securities and the Purchase Balancing Amount collectively are referred to as the "Creation Deposit.”
  • the Purchase Balancing Amount is a cash payment designed to ensure that the NAV of a Creation Deposit is identical to the NAV of the Creation Unit it is used to purchase.
  • the Purchase Balancing Amount is an amount equal to the
  • Creation Units may be issued to an Authorized Participant notwithstanding the fact that the corresponding Deposit Securities have not been received in part or in whole, in reliance on the Authorized Participant's undertaking to deliver the missing Deposit Securities as soon as possible, which undertaking shall be secured by the Authorized Participant's delivery and maintenance of collateral.
  • the Authorized Participant Agreement will permit the Applicant Fund to buy the missing Deposit Securities at any time and will subject the Authorized Participant to liability for any shortfall between the cost to the Fund of purchasing the securities and the value of the collateral.
  • SAI Statement of Additional Information
  • the Applicant Fund reserves the right to permit or require an Authorized Purchaser to substitute an amount of cash (referred to as a "cash in lieu" amount) or a different security to replace any prescribed Deposit Security. 57 Substitution might be permitted or required, for example, because one or more Deposit Securities may be unavailable, may not be available in the quantity needed to make a Creation Deposit, or may not be eligible for trading by an Authorized Participant (or the investor on whose behalf the Authorized Participant is acting). Substitution also may be permitted or required if one or more Deposit Securities are illiquid, unregistered or unsold allotment securities. In addition, substitution may be permitted or required because the Creation Deposit will not include any of the derivatives that are included in the Fund's investment portfolio.
  • the investment portfolio of the Fund and the contents of the Basket will be comprised primarily of liquid TIPS and nominal Treasuries, trading costs incurred by the Fund to acquire any Deposit Security or derivative not part of a Creation Deposit are expected to be immaterial.
  • the Adviser may adjust the relevant Transaction Fee to ensure that the Fund collects the extra expense from the purchaser.
  • the Adviser will make available through DTC or the Distributor or the National Securities Clearing Corporation ("NSCC”) on each business day, prior to the opening of trading
  • the Purchase Balancing Amount will be a negative number, in which case the Purchase Balancing Amount will be paid by the Applicant Fund to the purchaser, rather than vice-versa.
  • the Applicant Fund may require a purchasing investor to purchase a Creation Unit entirely for cash.
  • the Adviser might prefer to receive cash rather than in-kind bonds so that it has liquid resources on hand to make the necessary purchases.
  • Adviser also will make available information about the previous day's Purchase Balancing Amount. If the Expected Daily Tracking Error for a Basket is likely to exceed ⁇ 3 bps, the Adviser will make the Expected Daily Tracking Error for the Basket available to Authorized Participants together with the identities and amounts of the related Deposit Securities.
  • the consolidated tape will show the market price of ETF Shares only; it will not show the price (i.e., the NAV) of Conventional Shares.
  • the HV of an ETF Share will be calculated as follows: First, the market value of a Creation Deposit will be established based on the previous night's closing price of each Deposit Security plus the previous night's Purchase Balancing Amount. Then, throughout the day at 15-second intervals, the approximate market value of a Creation Deposit will be recalculated based on the then-current market price of each Deposit Security (determined by third party pricing services) plus the previous night's Purchase Balancing Amount. The valuations of the Creation Deposit throughout the day will be compared against the previous night's value to determine the percentage change in the value of the Creation Deposit. This percentage will then be applied against the previous night's closing NAV to obtain the current HV of an ETF Share.
  • the IIV will be calculated by an independent third party and will be updated throughout the trading day to reflect changing bond prices, as well as mortgage TBA prices, using prices from independent third-party pricing sources. Information about the intra-day and closing prices for the Deposit Securities and Redemption Securities of the Fund will be readily available to the marketplace. 62
  • ETF Shares can be purchased from the Applicant Fund only in Creation-Unit size aggregations
  • ETF Shares similarly may be redeemed only if tendered in Creation Unit-size aggregations (except in the event the Fund or the ETF Share class is liquidated).
  • a redemption request must be submitted by the cut-off times discussed above in Part III.C.2.
  • intra-day bond prices that form the basis of the Applicant Fund's HV calculation.
  • intra-day prices for treasury securities, agency securities, and mortgage TBAs are available from Bloomberg and Tradeweb.
  • Intra-day prices for corporate bonds are available from the Trade Reporting and Compliance Engine (commonly known as "TRACE").
  • intra-day prices for each of these securities are available by subscription or otherwise to clients of major U.S. bond dealers.
  • Closing bond prices are readily available from published or other public sources, such as TRACE, or on-line client-based information services provided by Bloomberg, Tradeweb, various bond dealers, and other pricing services commonly used by bond mutual funds.
  • Redemption Securities a Basket of securities
  • the Adviser will use the same process to determine the Redemption Securities as it uses to determine the Deposit Securities.
  • the Adviser will use sophisticated computer program to sample the investment portfolio of the Fund and structure a Basket that satisfies each of the Minimum Basket Requirements. As it does for Deposit Securities, the Adviser will make available through NSCC on each business day prior to the opening of trading a list of the names and number of each Redemption Security for the Fund.
  • the Adviser will make the Expected Daily Tracking Error for the Basket available to Authorized Participants together with the identities and amounts of the related Deposit Securities.
  • the Redemption Securities received by a redeeming Authorized Participant typically, but not always, will be the same as the Deposit Securities required of Authorized Participants purchasing Creation Units on the same day.
  • the redeeming Authorized Participant will either receive from or pay to the Fund a cash amount equal to the difference ("Redemption Balancing Amount").
  • Deposit and Redemption Securities could differ. For example, if ABC bond were replacing XYZ bond in the Applicant Fund's investment portfolio at the close of today's trading session, today's prescribed Deposit Securities might include ABC but not XYZ, while today's prescribed Redemption Securities might include XYZ but not ABC. Having the flexibility to prescribe different baskets for creation and redemption promotes efficient portfolio management and lowers the fund's trading costs, and thus is in the best interests of the Fund's shareholders.
  • the Applicant Fund has the right to make redemption payments in cash, in kind, or a combination of each, provided that the value of its redemption payments equals the NAV of the ETF Shares tendered for redemption.
  • the Fund may nonetheless accept the redemption request in reliance on the Authorized Participant's undertaking to deliver the missing ETF Shares as soon as possible, which undertaking shall be secured by the Authorized Participant's delivery and maintenance of collateral.
  • the Authorized Participant Agreement will permit the Fund to buy the missing ETF Shares at any time and will subject the Authorized Participant to liability for any shortfall between the cost to the Fund of purchasing the ETF Shares and the value of the collateral.
  • the SAI may contain further details relating to such collateral procedures.
  • the Applicants currently contemplate that Creation Units of the Fund will be redeemed principally in kind, except in certain circumstances.
  • the Fund may make redemptions partly in cash in lieu of transferring one or more Redemption Securities to a redeeming Authorized Participant if the Fund determines, in its discretion, that such alternative is warranted due to unusual circumstances. This could happen, for example, if the redeeming Authorized Participant is unable, by law or policy, to own a particular Redemption Security.
  • a redeeming Authorized Participant may be an investment banking firm or broker-dealer restricted from
  • Redemptions in which cash is substituted for one or more Redemption Securities may be assessed a higher Transaction Fee to offset the transaction cost to the fund of selling those particular Redemption Securities.
  • the Applicant Fund will impose a "Transaction Fee" on Authorized Participants that purchase or redeem Creation Units.
  • the purpose of the Transaction Fee is to protect the existing shareholders of the Fund from the dilutive effect of the administrative costs (primarily custodial costs) that the Fund incurs when investors purchase or redeem Creation Units.
  • the maximum Transaction Fees will be fully disclosed in the ETF Shares Prospectus (as defined in Part MJ.) for the Fund.
  • the ETF Shares will settle through DTC.
  • the Custodian will monitor the movement of the Deposit Securities and will instruct the movement of the ETF Shares only upon validation that the Deposit Securities have settled correctly or that required collateral is in place.
  • creation transactions will settle as follows. On settlement date (T + 3) an Authorized Participant will transfer to the Custodian: (i) Deposit Securities that are U.S. government and mortgage-backed securities using the Fedwire System, (ii) Deposit Securities that are corporate and non-corporate fixed income securities (other than U.S. government and
  • the Applicant Fund permits an in-kind purchaser to deposit cash in lieu of depositing one or more Deposit Securities, the purchaser may be assessed a higher Transaction Fee to offset the transaction cost to the Applicant Fund of buying those particular Deposit Securities.
  • the Custodian will notify the Distributor and the Adviser.
  • the Applicant Fund will issue Creation Unit-size aggregations of ETF Shares and the Custodian will deliver the ETF Shares to the Authorized Participant through DTC.
  • DTC will then credit the Authorized Participant's DTC account.
  • the Applicant Fund similarly will be protected from failure to receive Creation Unit aggregations of ETF Shares because the Custodian will not effect the Fund's side of the transaction (the delivery of Redemption Securities and the Redemption Balancing Amount) until the Custodian has received confirmation of receipt of the Authorized Participant's incoming Creation Unit-size aggregation of ETF Shares.
  • the Applicant Fund plan to settle transactions in all fixed income instruments, cash, and ETF Shares on the same T + 3 settlement cycle.
  • the Applicant Fund will not make the DTC book-entry Dividend Reinvestment Service (the "Service") available for use by Beneficial Owners for reinvestment of their cash proceeds, but certain individual brokers may make the Service available to their clients. 67
  • the SAI will inform investors of this fact and direct interested investors to contact such investor's broker to ascertain the availability and a description of the Service through such broker.
  • the SAI will also caution interested Beneficial Owners that they should note that each broker may require
  • the Applicant Fund declares and distributes dividends on a quarterly basis (March, June, September and
  • ETF Shares acquired pursuant to the Service will be held by the Beneficial Owners in the same manner, and subject to the same terms and conditions, as original ownership of ETF Shares.
  • ETF Shares will include both institutional investors and retail investors interested in owning a unitary security that represents an interest in a basket of inflation-indexed securities and that can be bought and sold on an intra- day or short-term basis.
  • ETF Shares will be offered through their own prospectus (the "ETF Shares Prospectus"), separate from the prospectus that covers the Conventional Shares (the "Conventional Shares Prospectus”).
  • VMC operates a retail brokerage business know as "Vanguard Brokerage Services" or "VBS.”
  • VBS may purchase and sell ETF Shares of the Fund, other Vanguard Funds or other ETFs on behalf of its brokerage customers in the normal course of its retail brokerage business. Those transactions will be made by VMC in its capacity as a retail broker (operating as VBS) and will not be made in its capacity as the principal underwriter of the Vanguard Funds (operating as the Distributor).
  • Applicants will arrange for dealers selling ETF Shares in the secondary market to provide purchasers with either a prospectus or a Product Description that describes, in plain English, the Fund (e.g., investment objective, primary investment strategies, primary investment risks and total annual operating expenses), the ETF Shares it issues and the fact that the Fund is actively managed.
  • the Fund e.g., investment objective, primary investment strategies, primary investment risks and total annual operating expenses
  • ETF Shares Prospectus is intended for Authorized Participants dealing directly with the Applicant Fund, while the Product Description is intended for investors purchasing on the secondary market, the two documents will be tailored to meet the information needs of their particular audiences. Each document will disclose that the Fund is actively managed. 70 The ETF Shares Prospectus will make clear that ETF Shares may be bought from the Fund only in Creation Unit-size aggregations and redeemed with the Fund only if tendered in Creation Unit-size aggregations (except in the event the Fund or ETF Share class is liquidated),
  • dealer as defined in Section 2(a)( 12) of the Securities Act includes both a dealer effecting transactions for its own account and a broker effecting transactions for the accounts of others.
  • the Fund should not be required to deliver its prospectus to investors purchasing from or through dealers in the secondary market in order to communicate its investment strategy or fundamental policies because the Product Description will describe, in plain English, the Fund (e.g., its investment objective, primary investment strategies and risks and total annual operating expenses), the ETF Shares it issues and the fact that the Fund is actively managed.
  • the ETF Shares Prospectus also will disclose certain legal risks that are unique to Authorized Participants purchasing Creation Units from the Applicant Fund. Because new ETF Shares may be issued on an ongoing basis, a "distribution" of ETF Shares could be occurring at any time.
  • the ETF Shares Prospectus will caution broker-dealers and others that some activities on their part, depending on the circumstances, may result in their being deemed participants in the distribution in a manner that could render them statutory underwriters and subject them to the prospectus delivery and liability provisions of the Securities Act.
  • a broker-dealer firm and/or its client may be deemed a statutory underwriter if it purchases Creation Units from the Fund, breaks them down into the constituent ETF Shares, and sells those Shares directly to customers, or if it chooses to couple the creation of a supply of new ETF Shares with an active selling effort involving solicitation of secondary market demand for ETF Shares.
  • the ETF Shares Prospectus will state that whether a person is an underwriter depends upon all of the facts and circumstances pertaining to that person's activities.
  • ETF Shares Prospectus also will caution dealers who are not “underwriters” but are participating in a distribution (as contrasted to ordinary secondary trading transactions), and thus dealing with ETF Shares that are part of an "unsold allotment" within the meaning of Section 4(3)(C) of the Securities Act, that they would be unable to take advantage of the prospectus delivery exemption provided by Section 4(3) of the Securities Act.
  • the Product Description will provide a plain English overview of the Applicant Fund, including its investment objective and investment strategies, the fact that the Fund is actively managed, the identity of the Adviser, the material risks of investing in the Fund, and the composition and frequency of distributions. It also will provide a brief, plain English description of the salient aspects of ETF Shares, including: the manner in which ETF Shares can be bought and sold; and risks specific to ETF Shares, including application of trading halt procedures, and the actions, if any, that would be taken by the Fund if its ETF Shares are delisted. The Product Description also will clearly disclose, among other things, that ETF Shares are not redeemable individually, and that an investor selling ETF Shares on the secondary market may incur brokerage commissions when selling the Shares and may receive less than the NAV of the Shares.
  • the Product Description is not intended to substitute for a full prospectus.
  • the Product Description will indicate that an ETF Shares Prospectus and SAI about the Applicant Fund may be obtained, without charge, from the investor's broker or from the Distributor. Other than identifying said website, the Product Description will not contain information that is not also in the ETF Shares Prospectus.
  • the Distributor will coordinate the production and distribution of Product Descriptions to broker-dealers. It will be the responsibility of the broker-dealers to ensure that a Product Description is provided to each secondary market purchaser of ETF Shares. This same practice is used today for ETFs in the market.
  • the SAI will include more detailed information about ETF Shares, including the details of purchasing and redeeming Creation Units. The Applicants do not intend to have different SAIs for different share classes.
  • the first potential new regulatory concern the Commission raised in the Concept Release relates to Section l(b)(3) of the Act, which states that the public interest and the interest of investors are adversely affected when investment companies issue securities containing inequitable or discriminatory provisions.
  • the Commission observed that one potential difference between the existing index-based ETFs and an actively managed ETF is that, in the latter case, significant deviations could develop between the market price and the NAV of the ETF shares.
  • the Commission also observed that it might be possible that, during any particular time, the NAV of an actively managed ETF could be increasing while the market price of its shares could be falling, and vice versa.
  • the Deposit Securities will consist of a Basket of securities determined by the Adviser to closely resemble the composition and characteristics, and closely track the expected performance, of the investment portfolio of the Fund.
  • the Adviser will use a sophisticated computer program to sample the investment portfolio of the Fund and structure a Basket that satisfies each of the Minimum Basket Requirements.
  • the Fund stands ready to sell and redeem Creation Units from any Authorized Participant under the terms and conditions described in this Application, which are substantially identical to the terms and conditions under which Creation Units of index-based ETFs are bought and sold every day under existing Commission exemptive orders.
  • the Adviser manipulate the intra-day pricing of ETF Shares in the Fund, or Creation Unit transactions, by aggressively or selectively trading nominal U.S. government and agency securities.
  • the Adviser's basket construction methodology was precisely engineered to maximize tight tracking of ETF Share prices and daily NAV, and could not be simultaneously used to manipulate the prices of Deposit Securities.
  • the U.S. government and agency securities market, as well as the TIPS sector is simply too liquid, deep and competitive for the Adviser (through its trading activities for the Fund) or any other Vanguard affiliate contemplated by Section l(b)(2) of the Act to take self-serving actions or other actions favoring the interests of persons other than shareholders of the Fund.
  • the Adviser has no conflicts of interest or other issues arising under Section 1 (b)(2) in managing the Applicant Fund or in facilitating its issuance of ETF Shares.
  • Source Lehman Brothers: www.LehmanLive.com. U.S. TIPS Index (December 31 , 2006).
  • the proposal may improve the Applicant Fund's performance and allow it to realize additional economies of scale, without adding volatility.
  • the ability of the Fund to effect may improve the Applicant Fund's performance and allow it to realize additional economies of scale, without adding volatility.
  • the Fund's ETF Shares will have the same appeal as index-based ETFs for individual investors who seek a long-term investment for asset allocation purposes.
  • the Fund's ETF Shares will have the same appeal as index-based ETFs for individual investors who desire to trade frequently as part of market timing investment strategies. Just like index-based ETFs, the ETF Shares could be purchased and sold in the secondary market at a known price anytime during the trading day, could be purchased on margin, and can be sold short.
  • the Applicant Fund's ETF Shares should appeal to institutional investors for the same variety of reasons that shares in index-based ETFs are appealing.
  • the Fund's ETF Shares should have strong appeal with institutional money managers and mutual funds that currently use shares of index-based ETFs as a temporary means of keeping cash invested in the bond markets during transitions in investment strategy or management.
  • the Applicant Fund's ETF Shares should be equally as attractive as shares in index- based ETFs for those investors who value low-cost and tax efficient investment vehicles. Despite the fact that the Fund is actively managed, its Convention Shares' expense ratios are low. 77 Although the Applicants have not determined the pricing for the ETF Shares, they are expected to be priced at or below Admiral Shares (11 bps), which would compare favorably with the 20 bps expense ratio of the iShares Lehman TIPS Bond Fund. 78 The extremely low expense ratio expected for the Fund's ETF Shares is almost entirely attributable to the unique "at-cost" arrangement that exists for the Vanguard Funds.
  • This expense ratio differential is due to the reduced portfolio management, shareholder recordkeeping, and service expenses that apply to ETF Shares as compared to Conventional Shares.
  • investors who purchase and sell ETF Shares in secondary market transactions pay brokerage commissions in connection with those transactions, which can represent an additional cost to investors that will not be reflected in the expense ratio of ETF Shares.
  • the ETF structure will allow the Applicant Fund to avoid more capital gains than currently and to an extent should rival the capital gains avoidance rate of index-based fixed
  • the Fund's expense ratios vary by share class: Investor Shares (20 bps); Admiral Shares (11 bps) and Institutional Shares (8 bps).
  • the Fund is expected to have the same opportunities to avoid realizing capital gains.
  • ETF Shares The Applicant Fund's introduction of ETF Shares will be beneficial to investors and will have no detrimental effects.
  • the issuance of ETF Shares would not cause investors to be confused about the actively managed nature of the Fund because investors who deal directly with the Fund for ETF Shares will receive an ETF Shares Prospectus, and the Applicants will arrange for dealers selling the Fund's ETF Shares in the secondary market to provide purchasers with a Product Description that describes, in plain English, the Fund and its ETF Shares.
  • Vanguard Total Stock Market ETF and Vanguard Extended Market ETF (inception dates May 24, 2001 and December 27, 2001, respectively).
  • the Bid- Ask Price of Total Stock Market ETF Shares has been within 10 bps of NAV on more than 92% of trading days and within 25 bps on more than 99% of trading days.
  • the Bid-Ask Price of Extended Market ETF Shares has been within 10 bps of NAV on more than 80% of trading days and within 25 bps on more than 95% of trading days.
  • the Bid-Ask Price and NAV rarely differ by more than 10 basis points (95% of the time) and typically the difference is far less. 80
  • the Bid-Ask Price and NAV of newer Vanguard ETFs are within 25 bps 99% of the time.
  • the Adviser has back-tested its basket design methodology for the Applicant Fund over an eight year period (incorporating real- world interest rates, inflation and other bond market conditions) and determined that, at a one standard deviation level of confidence, the back-tested daily tracking error between the daily total return of the Basket and the daily total return of the ETF Shares is predicted to range from 0.7 bps to 1.4 bps.
  • the Adviser also applied its methodology on a forward-looking basis (with good faith assumptions about interest rates, inflation and other bond market conditions) and determined that, at a one standard deviation level of confidence, the predicted daily tracking error between the daily total return of the Basket and the daily total return of the ETF Shares ranges from 1.6 bps to 2.1 bps.
  • These hypothetical tracking error statistics are substantially better than the Adviser's Expected Daily Tracking Error of ⁇ 3 bps.
  • the expected and the tested daily tracking error statistics for the Fund's ETF Shares are low in absolute terms, even when compared with the zero bps tracking error that would exist if the Basket exactly replicated the portfolio holdings of the Fund.
  • the Applicants believe their proposal represents a reasonable trade-off between competing interests.
  • the similarities between the Basket and the investment portfolio of the Fund will be great enough to ensure that the daily total return of the Basket will closely track the daily total return of the ETF Shares.
  • the differences between the Basket and the investment portfolio of the Fund are substantial enough to eliminate the possibility of predatory trading
  • the Adviser's expected and tested tracking error measures are important not only because they are low in magnitude, but also because they are low (and ideally immaterial) relative to the trading spreads that prevail in the ETF marketplace.
  • the expected and tested tracking error measures for the Applicant Fund's ETF Shares are significantly less than the historic spread between the market price and the NAV of the ETF Shares of current iShares ETFs, as demonstrated in the following table 84 In other words, the tracking error caused by the differences between the Basket and the investment portfolio of the Fund is likely to be lost within the noise of normal ETF trading activity
  • Section 6(c) the Applicants request an exemption from Sections 18(f)(l) and 18(i). This exemption will permit the Applicant Fund to utilize a multi-class structure.
  • Section 24(d) Pursuant to Section 6(c), the Applicants request an exemption from Section 24(d). This exemption will permit dealers to sell ETF Shares in the secondary market unaccompanied by a statutory prospectus when prospectus delivery is not required by the Securities Act.
  • Section 17(a) of the Act This exemption will permit certain affiliated persons of the Applicant Fund to buy securities from and sell securities to the Fund in connection with the in-kind purchase and redemption of the Fund's ETF Shares.
  • Section 5(a)(l) defines an "open-end" management investment company as a "management company which is offering for sale or has outstanding any redeemable security of which it is the issuer."
  • Relief was sought from Section 5(a)(l) because each fund applicant issued only one class of shares; if the shares issued were considered not to be redeemable, the fund could not meet the definition of, and thus could not operate as, an open-end company.
  • the Applicant Fund does not require relief from Section 5(a)(l) because it already has redeemable shares (the Conventional Shares) outstanding.
  • a management investment company that has any redeemable securities outstanding is, according to Section 5(a)(l), an open-end company.
  • this Application differs from the Prior Vanguard ETF Applications in that it seeks relief to permit an actively managed fund to issue a class of exchange-traded shares.
  • Section 6(c) provides a means for the Commission to respond to developments in the financial markets not specifically contemplated when the Act was passed or subsequently amended. 86 It permits the Commission to grant exemptions from particular provisions of the Act that would inhibit the development of new and innovative investment products, like the proposed ETF Shares. Section 6(c) provides as follows:
  • the Commission, . . . by order upon application, may conditionally or unconditionally exempt any person, security, or transaction, or any class or classes of persons, securities, or transactions, from any provision or provisions of [the Investment Company Act] or of any rule or regulation thereunder, if and to the extent that such exemption is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of [the Act].
  • ETF Shares could be viewed as satisfying the Section 2(a)(32) definition of a redeemable security.
  • ETF Shares are securities "under the terms of which" a holder may receive his proportionate share of the issuing fund's current net assets.
  • the unusual aspect of ETF Shares is that holders of such shares are entitled to redeem only when the shares are tendered in a Creation Unit bundle constituting a large number of individual shares.
  • ETF Shares will not be individually redeemable, the Applicants expect that the redeemability of Creation Units will attract arbitrage activity that will cause the market price of ETF Shares to remain close to the NAV of ETF Shares.
  • Section 18(f)(l) of the Act provides that "it shall be unlawful for any registered open-end investment company to issue any class of senior security or to sell any senior security of which it is the issuer," with exceptions not here relevant.
  • the term "senior security” is defined in Section 18(g) to mean "any stock of a class having priority over any other class as to distribution of assets or payment of dividends.”
  • Section 18(i) provides that every share of stock issued by an open-end investment company "shall be a voting stock and have equal voting rights with every other outstanding voting stock.”
  • the SEC generally takes the position that certain material differences in the rights accorded to, or expenses paid by, different shareholders of the same investment company raise senior security issues under Section 18. Since holders of Conventional Shares and ETF Shares will pay different expenses and have different redemption, trading, and voting rights, the Applicants are requesting relief from Sections 18(f)(l) and 18(i).
  • Rule 18f-3 allows open-end investment companies to issue multiple classes of shares representing interests in the same portfolio subject to certain provisions intended to prevent investor confusion, assure fair expense allocation and voting rights, and prevent conflicts of interest among classes.
  • the Applicants represent that their proposal complies substantially with the provisions of Rule 18f-3 and that, to the extent it does not comply, the noncompliance does not implicate any of the abuses or concerns that Section 18 was designed to prevent.
  • VMCs expenses be allocated among the Vanguard Funds according to a formula (the "Distribution Formula") based 50% on a fund's average month-end net assets during the preceding quarter relative to the average month-end net assets of the other Vanguard Funds, and 50% based on the fund's sales of new shares relative to the sales of new shares of the other Vanguard Funds during the preceding 24 months.
  • the Distribution Formula includes a ceiling so that no fund's payment (expressed as a percentage of its assets) exceeds 125% of the average expenses of the funds as a group (expressed as a percentage of the group's total assets). In addition, no fund may pay more than 0.2% of its average month-end net assets for distribution.
  • the Funds' Service Agreement was amended to include the Distribution Formula.
  • Each class of the Applicant Fund currently has different shareholder servicing arrangements and pays all of the expenses of its particular shareholder servicing arrangement. That will continue to be the case assuming the Fund is permitted to issue a class of ETF Shares.
  • ETF Shares could be considered to have a distribution arrangement different from that of Conventional Shares. 89 If that were the case, then the ETF Shares, to comply with paragraph (a)(l)(i) of Rule 18f-3, would have to bear all distribution costs that are attributable directly to them and not bear any distribution costs attributable directly to other classes or to funds that do not have a class of ETF Shares. Distribution for all of the Vanguard Funds is handled by VMC. Before any Vanguard Fund issued ETF Shares, VMC allocated distribution expenses among the Vanguard Funds using the Distribution Formula described above, with each class of a multi-class fund treated as if it were a separate fund (the "Multi-Class Distribution Formula").
  • ETF Shares can only be purchased with a Basket of securities by or through Authorized Participants, while the three classes of Conventional Shares can be purchased for cash by any investor who meets the investment minimum.
  • the original Distribution Formula was adopted after years of discussion with the Commission and a series of administrative hearings.
  • the Commission expressly approved the original Distribution Formula as part of the 1981 order, and it represents a fundamental feature of Vanguard's mutual, internally managed fund structure.
  • the Multi-Class Distribution Formula was based on the same fundamental premise as the original Distribution Formula - that all Vanguard shareholders benefit when additional shareholders invest in Vanguard Funds, and therefore that a portion of the cost incurred in distributing new shares (whether shares of a new fund or shares of a new class) should be borne by all Vanguard shareholders.
  • the Multi-Class Distribution Formula has been approved by the boards of the Vanguard Funds and has a proven history. It is fundamental to the Vanguard structure and, in the Applicants' view, is the fairest and most appropriate way to allocate distribution expenses.
  • the board of each Vanguard Fund annually reviews and approves the Applicant Fund's continued participation in arrangements for the payment of marketing and distribution expenses, including the Multi-Class Distribution Formula.
  • Vanguard Fund or class as a result of allocating distribution expenses to the ETF Share class in accordance with the Multi-Class Distribution Formula rather than in accordance with Rule 18f-3.
  • the Applicants will maintain records for at least six years, the first two in an easily accessible place, documenting the amount of money expended on advertising the ETF Shares. These records are subject to examination by the SEC and its staff.
  • ETF Shares prospectus The cover and summary page of the ETF Shares prospectus will include disclosure that the ETF Shares are listed on an Exchange and are not individually redeemable.
  • Vanguard ETFs will not be marketed as a mutual fund investment.
  • Marketing materials may refer to Vanguard ETFs as an interest in an investment company or fund, but will not make reference to an "open-end fund” or “mutual fund” 94 except to compare or contrast the ETF Shares with conventional mutual funds.
  • Vanguard ETFs are not a mutual fund product.
  • VMC will not market Conventional Shares and ETF Shares in the same advertisement or marketing material without appropriate disclosure explaining the relevant features of each class, and highlighting the differences between the classes.
  • ETF Shares are not redeemable with the Applicant Fund other than in Creation Unit aggregations;
  • ETF Shares, other than in Creation Unit aggregations may be sold only through a broker, and the selling shareholder may have to pay brokerage commissions in connection with the sale; and
  • the selling shareholder may receive less than net asset value in connection with the sale of ETF Shares.
  • VMC publishes materials comparing and contrasting Conventional Shares and ETF Shares, we expect those materials to explain the relevant features of each class and highlight the differences between the two classes.
  • the materials also may present Vanguard's view of which share class is most appropriate for which types of investors.
  • ETF Shares may be compared and contrasted generally to traditional mutual fund shares, while in other the cases ETF Shares of the Applicant Fund may be compared and contrasted to its Conventional Shares.
  • VMC has printed and website disclosure providing plain English disclosure about Vanguard ETFs and how they differ from traditional mutual funds.
  • No registered investment company shall sell any redeemable security issued by it to any person except to or through a principal underwriter for distribution or at a current public offering price described in the prospectus, and, if such class of security is being currently offered to the public by or through an underwriter, no principal underwriter of such security and no dealer shall sell any such security to any person except a dealer, a principal underwriter, or the issuer, except at a current public offering price described in the prospectus.
  • No registered investment company issuing any redeemable security, no person designated in such issuer's prospectus as authorized to consummate transactions in any such security, and no principal underwriter of, or dealer in, any such security shall sell, redeem, or repurchase any such security except at a price based on the current net asset value of such security which is next computed after receipt of a tender of such security for redemption or of an order to purchase or sell such security.
  • Section 22(d) and Rule 22c- 1 were designed to prevent. While there is little legislative history regarding Section 22(d), that section appears to have been intended (i) to prevent dilution caused by certain riskless-trading schemes by principal underwriters and contract dealers, (ii) to prevent unjust discrimination or preferential treatment among buyers resulting from sales at different prices, and (iii) to ensure an orderly distribution system of shares by contract dealers by eliminating price competition from non-contract dealers who could offer investors shares at less than the published sales price and who could pay investors a little more than the published redemption price. 97 Rule 22c- 1 was intended to eliminate the riskless trading that Section 22(d) mitigated, but did not eliminate.
  • Section 22(d) preventing the disruption of orderly markets - Applicants assert that the proposed distribution system will be orderly. There will be no “contract” vs. "non-contract” dealers. All dealers trading ETF Shares will be on an equal footing. The presence of the Exchange Specialist also helps to provide an orderly market. Arbitrage activity will ensure that the difference between the market price and NAV of ETF Shares remains narrow. Finally, to the extent Section 22(d) was designed to avoid disruption in the distribution system, it was designed to protect investment companies and their selling group dealers, not members of the investing public. The Applicants have the right to waive that protection, and wish to do so.
  • Section 24(d) makes unavailable to transactions involving redeemable securities the dealer transaction exemption from the prospectus delivery requirement of the Securities Act. Thus, absent an exemption from Section 24(d), dealers
  • Section 5(b)(2) of the Securities Act requires that a statutory prospectus accompany or precede every sale of a security.
  • Section 4(3) of the Securities Act exempts certain dealer 100 transactions from the prospectus delivery requirements of Section 5
  • Section 24(d) of the Investment Company Act disallows that exemption for transactions in redeemable securities issued by a unit investment trust or open-end investment company if any other security is currently being offered or sold by the issuer.
  • the Applicants seek relief from Section 24(d) to the extent necessary to allow sales of ETF Shares by dealers in the secondary market unaccompanied by a prospectus (except during the first 25 days after ETF Shares are first offered to the public, for the reasons described below in Part VI.E.3).
  • the Applicants emphasize that they are not seeking relief from the prospectus delivery requirement for non-secondary market transactions, such as transactions in which an investor purchases ETF Shares from the issuer or an underwriter. 101
  • dealer includes both a dealer effecting trades for its own account and a broker effecting trades for the accounts of others. See Securities Act ⁇ 2(a)(12).
  • prospectus delivery is not required in certain instances, including purchases of ETF Shares by an investor who has previously been delivered a prospectus (until such prospectus is supplemented or otherwise updated) and unsolicited brokers' transactions in ETF Shares (pursuant to Section 4(4) of the Securities Act). Also, under Securities Act Rule 153, the prospectus delivery obligation owed to an Exchange member in connection with a sale on the Exchange is satisfied by the fact that the ETF Share prospectus and the SAI are each available at the Exchange upon request.
  • NMIA National Securities Markets Improvement Act of 1996
  • the National Securities Markets Improvement Act of 1996 (“NSMIA”) directs the Commission, whenever engaged in rulemaking under the Securities Act, the Exchange Act and the Investment Company Act, to consider whether the proposed action "will promote efficiency, competition and capital formation," in addition to investor protection.
  • 102 Although the Applicants are not seeking a rulemaking in this instance, we believe it would be appropriate for the Staff of the Division of Investment Management and the Commission to consider the standards articulated in NSMIA in evaluating this request for an exemption from Section 24(d). The Applicants believe the exemption is appropriate in the public interest because, in addition to being fully consistent with the Commission's mandate to protect investors, it will promote efficiency, competition and capital formation.
  • ETF Shares will be listed on an Exchange.
  • the Commission previously has determined that Exchange listing affects the prospectus delivery requirements applicable to a particular security.
  • Rule 174(d) under the Securities Act shortens, from 90 days to 25 days after the offering date, the period during which dealers must deliver a prospectus to secondary market purchasers if the security (like ETF Shares) is listed on a national securities exchange as of the offering date. According to the Commission release adopting Rule 174(d):
  • ETF Shares Investors interested in the Fund can obtain its prospectus, SAI, Form N-SAR, and Annual and Semi-Annual Reports sent to shareholders.
  • ETF Shares will be listed on an Exchange, prospective investors will have access to information about the product over and above what is normally available about an open-end fund security.
  • Information regarding market price and volume will be continually available (i) on a real-time basis throughout the day on brokers' computer screens and other electronic services, such as Quotron and Bloomberg, and (ii) on a 20-minute delayed basis free on numerous internet websites. The previous day's price and volume information will be published daily on numerous websites and in the financial section of many newspapers.
  • the Applicants expect that, like the ETF Shares currently trading on the American Stock Exchange, ETF Shares of the Fund will be followed by stock market and mutual fund professionals, who will offer their analyses of why investors should purchase, avoid, hold, or sell ETF Shares.
  • Section 17(a) of the Act Pursuant to Sections 6(c) and 17(b), the Applicants request an exemption from Section 17(a) of the Act.
  • the exemption will allow persons who are affiliates of the Fund by virtue of owning 5% or more, or more than 25%, of the Fund's outstanding securities (or affiliated persons of such affiliated persons that are not otherwise affiliated persons of the fund) to effect purchases and redemptions of Creation Units in kind.
  • Section 17(a)(l) of the Act makes it unlawful for any affiliated person of a registered investment company, 1 7 acting as principal, knowingly to sell any security or other property to such registered company (with certain exceptions not here relevant).
  • Section 17(a)(2) of the Act makes it unlawful for any affiliated person, acting as principal, knowingly to purchase any security or other property from such registered company (with one exception not here relevant).
  • Section 2(a)(3)(A) and (C) of the Act define "affiliated person," respectively, as any person who owns 5% or more of an issuer's outstanding voting securities and any person who controls the fund.
  • Section 2(a)(9) of the Act provides that a control relationship will be presumed where a person owns 25% or more of another person's voting securities.
  • NASD Rule 4420(j) which imposes on NASD members a similar requirement relating to delivery of Product Descriptions.
  • the term "affiliated person” shall include a second tier affiliated person.
  • Section 17(b) of the Act provides that the Commission will grant an exemption from the provisions of Section 17(a) if evidence establishes that the terms of the proposed transaction are reasonable and fair and do not involve overreaching on the part of any person concerned, that the proposed transaction is consistent with the policy of each registered investment company concerned, and that the proposed transaction is consistent with the general purposes of the Act.
  • Section 17(b) may authorize the Commission to exempt from Section 17(a) only a one-time transaction, and that relief for a series of ongoing transactions, such as the ongoing sale and redemption of Creation Units, requires an exemption under Section 6(c) of the Act as well.
  • Relief from Section 17(a) is requested under Section 6(c) as well as under Section 17(b).
  • ETF Shares Prospectus and the Product Description will clearly disclose that, for purposes of the Act, ETF Shares are issued by the Applicant Fund and that the acquisition of ETF Shares by investment companies is subject to the restrictions of Section 12(d)(l) of the Act.
  • the ETF Shares of the Applicant Fund will not be advertised or marketed as shares of an open-end investment company or mutual fund.
  • the ETF Shares Prospectus of the Applicant Fund will prominently disclose that (i) ETF Shares are not individually redeemable, (ii) holders of ETF Shares may acquire the shares from the Applicant Fund and tender the shares for redemption to the Applicant Fund in Creation Unit aggregations only and (iii) the Applicant Fund is actively managed.
  • Any advertising material that describes the purchase or sale of Creation Units or refers to redeemability will prominently disclose that (i) ETF Shares are not individually redeemable, (ii) holders of ETF Shares may acquire the shares from the Applicant Fund and tender the shares for redemption to the Applicant Fund in Creation Unit aggregations only and (iii) the Applicant Fund is actively managed.
  • the board of trustees of the Applicant Fund including a majority of Disinterested Trustees, must determine, for the Applicant Fund, that the allocation of distribution expenses among the classes of Conventional Shares and ETF Shares in accordance with the Multi-Class Distribution Formula is in the best interests of each class and of the Applicant Fund as a whole.
  • the Applicant Fund will preserve for a period of not less than six years from the date of a board determination, the first two years in an easily accessible place, a record of the determination and the basis and information upon which the determination was made. This record will be subject to examination by the SEC and its staff.
  • the Applicants' website which is and will be publicly accessible at no charge, will contain the following information, on a per ETF Share basis, for the Applicant Fund: (a) the prior business day's closing NAV and the Bid-Ask Price, and a calculation of the premium or discount of the Bid- Ask Price in relation to the closing NAV; and (b) data for a period covering at least the four previous calendar quarters (or the life of the Fund, if shorter) indicating how frequently the Applicant Fund's ETF Shares traded at a premium or discount to NAV based on the Bid-Ask Price and closing NAV, and the magnitude of such premiums and discounts.
  • the Product Description for the Applicant Fund will state that Applicants' website has information about the premiums and discounts at which the Applicant Fund's ETF Shares have traded.
  • the ETF Shares Prospectus and annual report will include, for the Applicant Fund: (a) the information listed in condition 8(b), (i) in the case of the ETF Shares Prospectus, for the most recently completed calendar year (and the most recently completed quarter or quarters, as applicable), and (ii) in the case of the annual report, for no less than the immediately preceding five fiscal years (or the life of the Applicant Fund, if shorter); and (b) the cumulative total return
  • Applicants request an order that would permit an existing and actively managed open-end investment company to issue a new class of shares with limited redeemability.
  • the requested order would permit secondary market transactions in the shares of the new class at negotiated prices on a national securities exchange and would allow dealers to sell the shares to secondary market purchasers unaccompanied by a prospectus, when prospectus delivery is not required by the Securities Act of 1933.
  • the requested order also would permit certain affiliated persons of the company to deposit securities into, and receive securities from, the company in connection with the purchase and redemption of aggregations of shares of the new classes.
  • VCI Vanguard Fixed Income Securities Funds
  • VMC Vanguard Marketing Corporation
  • Hearing or Notification of Hearing An order granting the requested relief will be issued unless the Commission orders a hearing.
  • Interested persons may request a hearing by writing to the Commission's Secretary and serving applicants with a copy of the request, personally or by mail.
  • Hearing requests should be received by the Commission by 5:30 p.m. on [DATE] and should be accompanied by proof of service on applicants, in the form of an affidavit or, for lawyers, a certificate of service.
  • Hearing requests should state the nature of the writer's interest, the reason for the request, and the issues contested. Persons who wish to be notified of a hearing may request notification of a hearing by writing to the Commission's Secretary.
  • ETF Shares a class of shares
  • Exchange national securities exchange
  • ETF Shares would provide an outlet for tactical traders, who could trade in and out of the ETF Shares without disrupting management of the Applicant Fund's portfolio or forcing the Applicant Fund to incur additional transaction costs.
  • VGI is a Pennsylvania corporation that is wholly and jointly owned by 35 investment companies that offer, in the aggregate, more than 140 distinct investment portfolios (the "Vanguard Funds"). VGI is registered as an investment adviser under the Investment Advisers Act of 1940 and as a transfer agent under the Securities Exchange Act of 1934 ("Exchange Act"). VGI provides each Vanguard Fund (including the Applicant Fund) with corporate management, administrative, and transfer agency services at cost. VGI also provides advisory services at cost to certain Vanguard Funds, including the Applicant Fund. VMC is a wholly owned subsidiary of VGI and is registered as a broker-dealer under the Exchange Act. VMC provides all distribution and marketing services at cost to the Vanguard Funds, including the Applicant Fund.
  • Fixed Income Securities Funds is an open-end management investment company registered under the Act and organized as a Delaware statutory trust. Fixed Income Securities Funds offers ten separate investment portfolios, including, among others, Vanguard Inflation- Protected Securities Fund (the "Applicant Fund” or “Fund”). The Applicant Fund is an actively managed bond fund that seeks to provide inflation protection and income consistent with
  • the Applicant Fund invests at least 80% of its assets in inflation-indexed bonds issued by the U.S. government, its agencies and instrumentalities, and corporations, but it emphasizes securities backed by the full faith and credit of the U.S. government.
  • the Fund may invest in bonds of any maturity; however, its dollar- weighted average maturity is expected to be in a range of 7 to 20 years. All bonds purchased by the Fund will be rated investment-grade (in one of the four highest rating categories) or will be unrated bonds considered by the Adviser to be investment-grade.
  • the Adviser buys and sells securities based on its judgment about issuers, the prices of the securities, and other economic factors.
  • the Applicant Fund invests mainly in a diversified group of investment-grade, inflation- indexed bonds, but up to 20% of the Fund's assets may be invested in holdings that are not inflation-indexed. The Fund typically will make such investments when inflation-indexed bonds are less attractive.
  • the Fund's non-inflation-indexed holdings may include the following: (i) corporate debt obligations; (ii) bonds issued by the U.S.
  • the Applicant Fund may invest in derivatives if the expected risks and rewards of the derivatives are consistent with the investment objective, policies, strategies, and risks of the Fund as disclosed in the Fund's prospectus.
  • the Adviser will not use derivatives to change the risks of the Fund as a whole as such risks are disclosed in the Fund's prospectus.
  • derivatives will be used only where they may help the Adviser: (i) invest in eligible asset classes with greater efficiency and lower cost than is possible through direct investment; (ii) add value when these instruments are attractively priced; or (iii) adjust the Fund's sensitivity to changes in interest rates.
  • the Fund's derivative investments may include fixed income futures contracts, fixed income options, interest rate swaps, total return swaps, credit default swaps, or other derivatives.
  • the investment objective of the Applicant Fund is to seek to provide inflation protection and income consistent with investment in inflation-indexed securities. While the Adviser uses the Lehman Brothers U.S. Treasury Inflation Notes Index (the "benchmark index") as a benchmark for the Fund's performance, the Fund's average maturity and mix of bonds may differ from those of the benchmark index. This may occur, for example, when the Adviser sees an opportunity to enhance returns.
  • the Adviser identifies return enhancement opportunities based on its expectation of future interest rates and inflation and its judgment concerning the comparative value of inflation-indexed securities and nominal securities. The Adviser acts on these return enhancement opportunities by differentiating the characteristics and composition of
  • the first way the Adviser identifies return enhancement opportunities is by comparing its own prediction of future interest rates and inflation to the interest rate and inflation levels that are implied by (i) the nominal securities that are eligible for investment by the Applicant Fund (e.g., fixed-principal Treasuries, agencies and corporates) and (ii) the inflation- indexed securities that comprise the benchmark index.
  • the Adviser implements its interest rate and inflation insights primarily by managing the Fund's duration, yield curve slope exposure and breakeven inflation (“BEI”) exposure consistent with the Adviser's prediction of future interest rates and inflation. Duration, yield curve slope exposure and BEI exposure measure the principal market forces that drive the performance of a portfolio of inflation-indexed securities. The Adviser's decision to differentiate the Fund from the benchmark index on the basis of these three measures will cause most of the performance variation between the Fund and the benchmark index.
  • BEI breakeven inflation
  • Issue selection involves deciding, at each point along the yield curve, whether to purchase one issue of available securities instead of another based on the Adviser's perception of their relative value, taking into consideration auction supply and liquidity differentials, among other factors. Differences between the issue structure of the portfolio securities of the Applicant Fund and the securities that comprise the benchmark index will have a secondary impact on the degree to which the performance of the Fund differs (for better or worse) from the performance of the benchmark index.
  • the Fund will issue and redeem ETF Shares in aggregations of 100,000 shares ("Creation Units"). It is expected that a Creation Unit will have an initial price of $7.5 million.
  • Creation Units may be purchased only by or through an "Authorized Participant," which is a Depository Trust Company ("DTC") participant that has executed a participation agreement with VMC. Creation Units will be issued in exchange for an in-kind deposit of securities and cash.
  • An investor wishing to purchase a Creation Unit from an Applicant Fund will have to transfer to the Fund a "Portfolio Deposit” consisting of (i) a basket of securities (“Basket”) that (a) duplicates approximately 50% to 75% of the securities held in the Fund's investment portfolio (“Deposit Securities”) and (b) satisfies three Minimum Basket Requirements (defined below), and (ii) a cash payment (“Balancing Amount”) to equalize any difference between (a) the aggregate market value per Creation Unit of the Deposit Securities and (b) the net asset value (“NAV”) per Creation Unit of the Fund.
  • Authorized Participant is a Depository Trust Company (“DTC") participant that has executed a participation agreement with VMC.
  • Creation Units will be issued in exchange
  • the Fund reserves the right to permit or require the substitution of an amount of cash or a different security to replace any Deposit Security in certain circumstances.
  • Cash or a different security might be substituted for a particular Deposit Security if, for example, one or more Deposit Securities is unavailable, is not available in the quantity needed, or is not eligible for trading by the Authorized Participant (or the investor on whose behalf the Authorized Participant is acting).
  • the Basket will be comprised of Deposit Securities that have been determined by the Adviser to closely resemble the composition and characteristics, and closely track the
  • the first Minimum Basket Requirement specifies that the Basket must contain a representative sample of the inflation- indexed securities and nominal securities comprising the investment portfolio of the Fund. The Applicants state that this requirement ensures a significant overlap between the Deposit Securities and the securities comprising the investment portfolio of the Fund, which will increase the degree of positive correlation of price movements between the Basket and the Fund's ETF Shares.
  • the second Minimum Basket Requirement specifies that the duration, yield curve slope exposure and BEI exposure of the Basket must closely approximate the duration, yield curve slope exposure and BEI exposure of the investment portfolio of the Fund. The Applicants state that this ensures that the Basket and the investment portfolio of the Fund will have closely matched exposures to the principal market forces that drive the performance of a portfolio of inflation-indexed securities, which will further increase the degree of positive correlation of price movements between the Basket and the Fund's ETF Shares.
  • the third Minimum Basket Requirement specifies that the Basket must be expected to produce, at a one standard deviation level of confidence, an expected daily tracking error ("Expected Daily Tracking Error") between the market value ("MV") of the Basket and the daily total return of the ETF Shares that is no greater than ⁇ 3 bps. This means that there is a 2/3 likelihood (one standard deviation) that the daily total return of the Basket will be within 3 bps of the daily total return of the ETF Shares. At a two standard deviation level of confidence, which translates to a 95% likelihood, the daily total return of the Basket will be within 6 bps of the daily total return of the ETF Shares.
  • this measure is the "gold standard" for determining the reliability of the Basket as a proxy for the Fund's investment portfolio prior to actual trading. Because the Adviser will ensure that the composition and characteristics of each Basket have a high statistical probability of causing the Expected Daily Tracking Error to be less than or equal to ⁇ 3 bps, Exchange Specialists and market makers will have added assurance that their arbitrage activities will be successful without having to widen spreads protection from uncertainty. The Applicants state that in the unlikely event that the Expected Daily Tracking Error for a Basket is likely to exceed ⁇ 3 bps, the Adviser will make the Expected Daily Tracking Error for the Basket available to Authorized Participants. According to the Applicants, this will allow Exchange Specialists and market makers to precisely calculate the likely success of their arbitrage activities, and thereby minimize the extent to which spreads widen beyond normal levels.
  • the Adviser has back-tested its basket design methodology over an eight year period (incorporating real-world interest rates, inflation and other bond market conditions) and determined that, at a one standard deviation level of confidence, the historic daily tracking error between the NAV of the Basket and the same-day NAV of the Applicant Fund's ETF Shares ranges from 0.7 bps to 1.4 bps.
  • the Applicants state that the Adviser also applied its methodology on a forward-looking basis (with good faith assumptions about interest rates,
  • the predicted daily tracking error for the Fund ranges from 1.6 bps to 2.1 bps.
  • these hypothetical tracking error statistics are substantially better than the Adviser's target daily tracking error of ⁇ 3 bps and easily fall within the range of, and compare favorably with, historic tracking error statistics for existing index-based ETFs.
  • the Applicants also observe that the Adviser's predicted and expected tracking error measures are important not only because they are low in magnitude, but also because they are low relative to the trading spreads that prevail in the ETF marketplace.
  • the Adviser developed its basket design methodology in light of the concerns the Commission expressed in the Concept Release over the liquidity of the securities in the investment portfolio of an actively managed ETF.
  • the Adviser considered the fact that the Applicant Fund invests at least 80% of its assets in inflation-indexed bonds issued by the U.S. government, its agencies and instrumentalities, and corporations, with an emphasis on U.S. government and agency securities.
  • the Adviser also considered the fact that the Fund has invested exclusively in U.S. government and agency securities since the Fund commenced operations. Because the Fund's portfolio securities are, as a practical matter, limited to TIPS and nominal U.S. government and agency securities, the Deposit Securities comprising each Basket will be among the most liquid securities in the United States.
  • the Adviser believes it is important for the Fund to maintain its current ability to make opportunistic investments in illiquid, restricted and similar securities that are not included within the benchmark index, because such securities may offer the opportunity for greater diversification, better pricing and higher returns.
  • the Commission's staff has acknowledged that allowing mutual funds to invest in illiquid securities helps to remove unnecessary barriers to capital formation and to facilitate access to the capital markets by small businesses in a manner consistent with the public interest and the protection of investment company shareholders.
  • the Fund will impose a Transaction Fee (defined below) on investors who deposit cash in lieu of the illiquid, unregistered or unsold allotment securities held in the Fund's investment portfolio in order to offset the transaction costs to the Fund of buying those particular Deposit Securities, as well as to protect the existing shareholders of the Fund from the dilutive effect of the transaction costs (primarily custodial costs) that the Fund incurs when Authorized Participants (defined below) purchase Creation Units.
  • Applicants believe that permitting cash purchases and redemptions of Creation Units in lieu of illiquid, unregistered or unsold allotment securities will have no material adverse effect on the arbitrage process.
  • the Applicants' novel basket design methodology including satisfaction of the Minimum Basket Requirements, will provide sufficient information about the composition and characteristics of the investment portfolio of the Fund, including its illiquid, unregistered or unsold allotment securities, to enable Exchange Specialists and market makers to maintain reasonable spreads between the bid and offer prices of ETF Shares, and therefore cause the market price of ETF Shares to closely track NAV.
  • ETF Shares will not be individually redeemable. ETF Shares will only be redeemable in Creation Unit-size aggregations through the Fund. To redeem, an investor will have to accumulate enough ETF Shares to constitute a Creation Unit.
  • An investor redeeming a Creation Unit generally will receive (i) a portfolio of securities ("Redemption Securities") that may or may not be the same as the Deposit Securities required of Authorized Participants purchasing Creation Units on the same day, and (ii) a cash payment that generally will be the same as that day's Balancing Amount. A redeeming investor will pay a Transaction Fee to recover the Fund's transaction costs.
  • VGI will make available through VMC, DTC, or the National Securities Clearing Corporation, for the Applicant Fund, (i) the list of the Deposit Securities and the required amount of each Deposit Security to be included in that day's creation basket; and (ii) the list of the Redemption Securities and the amount of each Redemption Security to be included in that day's redemption
  • VGI also will make available on a daily basis information about the previous day's Balancing Amount.
  • the Applicants expect that (i) the Exchange will disseminate continuously throughout the trading day, through the facilities of the consolidated tape, the market value of an ETF Share, and (ii) the Exchange or other market information provider (such as Bloomberg), every 15 seconds throughout the trading day, separately from the consolidated tape, will disseminate a calculation of the approximate NAV of an ETF Share (the "Intra-day Indicative Value" or "HV"). Comparing these two figures will help an investor determine whether, and estimate to what extent, the Fund's ETF Shares are selling at a premium or a discount to NAV.
  • Transaction Fee An Authorized Participant that purchases or redeems a Creation Unit from the Fund will be charged a fee ("Transaction Fee") to protect existing shareholders of the Fund from the dilutive effect of the transaction costs that the Fund incur when investors purchase or redeem Creation Units. Transaction Fees will differ for the Fund depending on the transaction expenses related to the Fund's portfolio securities.
  • Each purchaser of a Creation Unit will receive a prospectus for the ETF Shares ("ETF Shares Prospectus") that contains full disclosure of the maximum Transaction Fee.
  • ETF Shares Prospectus The Fund's Conventional Shares are covered by a separate prospectus (“Conventional Shares Prospectus").
  • VMC Authorized Participants wishing to purchase Creation Units will place orders with VMC, which will be responsible for transmitting the orders to the Applicant Fund. VMC will maintain a record of Creation Unit purchases and will send out an ETF Shares Prospectus and a confirmation to those placing purchase orders whose orders have been accepted by the Fund.
  • ETF Shares will be listed on an Exchange and traded in the secondary market in the same manner as other equity securities.
  • the Exchange will designate one or more member firms, known as "Exchange Specialists," to maintain a market in ETF Shares.
  • the price of ETF Shares traded on the secondary market will be based on a current bid/offer market. Purchases and sales of ETF Shares in the secondary market will be subject to customary brokerage commissions and charges.
  • the Applicant Fund declares and distributes dividends on a quarterly basis (March, June, September and December) for each of the Conventional Share classes, and the Fund intends to maintain the same policy for the proposed ETF Shares.
  • This policy is identical to the dividend declaration and distribution policies that apply to the Conventional and ETF Shares issued by several existing Vanguard ETFs, including, for example, Vanguard Dividend Appreciation ETF, Vanguard Financials ETF, Vanguard Growth ETFs, Vanguard Large-Cap ETFs, Vanguard REIT ETFs, Vanguard Total Stock Market ETFs, Vanguard Utilities ETFs and Vanguard Value ETFs.
  • Section 6(c) of the Act provides that the Commission may exempt any person, security, or transaction, or any class of persons, securities, or transactions, if and to the extent that such exemption is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Act.
  • Section 2(a)(32) of the Act in relevant part, defines a "redeemable security” as any security, other than short-term paper, under the terms of which the holder, upon its presentation to the issuer, is entitled to receive approximately his proportionate share of the issuer's current net assets, or the cash equivalent. Because ETF Shares will not be individually redeemable, applicants state that ETF Shares may not satisfy this definition. The Applicants request an order under section 6(c) of the Act to permit ETF Shares to be redeemed in Creation Units only. The Applicants note that because the market price of ETF Shares will be disciplined by arbitrage opportunities, investors generally should be able to sell ETF Shares in the secondary market at approximately their NAV.
  • Section 18(f)(l) of the Act prohibits a registered open-end company from issuing any class of "senior security," which is defined in section 18(g) of the Act to include any stock of a class having a priority over any other class as to the distribution of assets or payment of dividends.
  • Section 18(i) requires that every share of stock issued by a registered management company be voting stock, with the same voting rights as every other outstanding voting stock.
  • Rule 18f-3 under the Act permits an open-end fund to issue multiple classes of shares representing interests in the same portfolio without seeking exemptive relief from sections 18(f)(l) and 18(i), provided that the fund complies with certain requirements.
  • ETF Shares will not be marketed as a mutual fund investment. Marketing materials may refer to ETF Shares as an interest in an investment company or fund, but will not make reference to an "open-end fund” or “mutual fund,” except to compare or contrast the ETF Shares with the shares of a conventional open-end management investment company.
  • ETF Shares are not redeemable with the Fund other than in Creation Unit-size aggregations;
  • ETF Shares, other than in Creation Unit-size aggregations may be sold only through a broker, and a shareholder may have to pay brokerage commissions in connection with the sale; and
  • the selling shareholder may receive less than NAV in connection with the sale of ETF Shares.
  • Conventional Shares prospectus the ETF Shares prospectus, the Product Description, SAI, marketing or advertising materials, and reports to shareholders.
  • Section 22(d) of the Act prohibits a dealer from selling a redeemable security that is currently being offered to the public by or through an underwriter, except at a current public offering price described in the prospectus.
  • Rule 22c- 1 under the Act generally requires that a dealer selling, redeeming, or repurchasing a redeemable security do so only at a price based on its NAV.
  • the Applicants state that secondary market trading in ETF Shares will take place at negotiated prices, not at a current offering price described in the ETF Shares Prospectus, and not at a price based on NAV. Thus, purchases and sales of ETF Shares in the secondary market will not comply with section 22(d) and rule 22c- 1. The Applicants accordingly request an exemption under section 6(c) of the Act from these provisions.
  • Section 24(d) of the Act provides, in relevant part, that the prospectus delivery exemption provided to dealer transactions by section 4(3) of the Securities Act does not apply to any transaction in a redeemable security issued by an open-end investment company.
  • the Applicants request an exemption under section 6(c) of the Act from section 24(d) to permit dealers selling ETF Shares to rely on the prospectus delivery exemption provided by section 4(3) of the Securities Act.
  • ETF Shares as a listed security, merit a reduction in the compliance costs and regulatory burdens resulting from the imposition of prospectus delivery obligations in the secondary market.
  • the Applicants state that because ETF Shares will be exchange-listed, prospective investors will have access to several types of market information about the ETF Shares.
  • the Applicants state that information regarding market price and volume will be continually available on a real-time basis throughout the day on brokers' computer screens and other electronic services and on a 20-minute delayed basis free on numerous internet websites. The previous day's price and volume information also will be published on numerous websites and daily in the financial section of many newspapers.
  • Sections 17(a)(l) and (a)(2) of the Act generally prohibit an affiliated person of a registered investment company, or an affiliated person of such person, acting as principal, from selling any security to or purchasing any security from the company.
  • Section 2(a)(3)(A) and (C) of the Act define "affiliated person," respectively, as any person who owns 5% or more of an issuer's outstanding voting securities and any person who controls the fund.
  • Section 2(a)(9) of the Act provides that a control relationship will be presumed where one person owns 25% or more of another person's voting securities.
  • the Applicants state that a large institutional investor or the Exchange Specialist could own 5% or more, or more than 25%, of the Fund's outstanding voting securities and, as a result, be deemed an affiliated person of the Fund under section 2(a)(3)(A) or (C).
  • the Applicants further state that, because purchases and redemptions of Creation Units would be "in-kind" transactions, those investors would be precluded by sections 17(a)(l) and (a)(2) from purchasing or redeeming Creation Units from the Fund. Accordingly, Applicants request an exemption under sections 6(c) and 17(b) to permit these affiliated persons, and affiliated persons of such affiliated persons who are not otherwise affiliated with the Fund, to purchase and redeem Creation Units from the Fund in kind.
  • Section 17(b) of the Act authorizes the Commission to exempt a proposed transaction from section 17(a) if evidence establishes that the terms of the transaction, including the consideration to be paid or received, are reasonable and fair and do not involve overreaching, and the proposed transaction is consistent with the policies of the registered investment company and the general purposes of the Act.
  • the Applicants contend that no useful purpose would be served by prohibiting persons affiliated with the Fund as described above from purchasing or redeeming Creation Units from the Fund.
  • the Applicants represent that fund affiliates making in-kind purchases and redemptions would be treated no differently from non-affiliates making the same types of transactions.
  • the Applicants state that all investors who purchase or redeem Creation Units would receive the Fund's next calculated NAV.
  • the Applicants also referenced the Commission's concern whether the operation of an actively managed ETF would place investors who have the financial resources to purchase or redeem a Creation Unit at NAV in a different position than most retail investors who may buy and sell ETF shares only at market price.
  • the Applicants state that they do not believe that the issuance of ETF Shares by the Applicant Fund will give rise to any discriminatory treatment of shareholders, or create any imbalance of equities, of the type that Section l(b)(3) of the Act was designed to prevent.
  • the Applicants believe that the issuance of ETF Shares by the Fund would present no greater risk of discriminatory or inequitable treatment of shareholders than may be presented by existing index-based ETFs.
  • the Applicants state that all qualifying investors have the same opportunity to buy and sell Creation Units, although they may not have financial resources to do so.
  • the Applicants state that the Fund stands ready to sell and redeem Creation Units from any Authorized Participant under the terms and conditions described in this Application, which are substantially identical to the terms and conditions under which Creation Units of index-based ETFs are bought and sold every day under existing Commission exemptive orders.
  • the second potential new regulatory concern the Commission raised in the Concept Release relates to Section l(b)(2) of the Act, which states that the public interest and the interest of investors are adversely affected when investment companies are organized, operated, managed, or their portfolio securities are selected, in the interest of persons other than shareholders, including directors, officers, investment advisers, or other affiliated persons, and underwriters, brokers, or dealers.
  • the Applicants reference the Commission's observation that the operation of an ETF - specifically, the process in which a Creation Unit is purchased by delivering a Basket of securities to the ETF, and redeemed in exchange for a Basket of securities - may lend itself to certain conflicts for the ETF's investment adviser, who has discretion to specify the securities included in the Baskets. Addressing these concerns, the Applicants state that the Adviser has no conflicts of interest or other issues arising under Section l(b)(2) in managing the Applicant Fund or in facilitating its issuance of ETF
  • VGI unique "mutual" ownership structure employed by VGI, VMC and the Vanguard Funds eliminates the basic conflicts of interest that permeate the public and private ownership arrangements employed by other mutual fund families.
  • the Applicants also assert that the operation of the Fund as an ETF would not change the current practical impossibility of VGI or its corporate affiliates using the Fund to manipulate the TIPS and nominal U.S. government and agency securities market.
  • the Applicants believe that the U.S. government and agency securities market, as well as the TIPS sector, is simply too liquid, deep and competitive for the Adviser (through its trading activities for the Fund) or any other Vanguard affiliate contemplated by Section l(b)(2) of the Act to take self-serving actions or other actions favoring the interests of persons other than shareholders of the Fund.
  • the Applicants also believe that the Adviser cannot manipulate the intra-day pricing of ETF Shares in the Fund, or Creation Unit transactions, by aggressively or selectively trading nominal Treasury and agency securities.
  • the Adviser's basket construction methodology was engineered to maximize tight tracking of ETF Share prices and daily NAV, and could not be simultaneously used to manipulate the prices of Deposit Securities.
  • the ETF Shares of the Applicant Fund will not be advertised or marketed as shares of an open-end investment company or mutual fund.
  • the ETF Shares Prospectus of the Applicant Fund will prominently disclose that (i) ETF Shares are not individually redeemable, (ii) holders of ETF Shares may acquire the shares from the Applicant Fund and tender the shares for redemption to the Applicant Fund in Creation Unit aggregations only and (iii) the Applicant Fund is actively managed.
  • Any advertising material that describes the purchase or sale of Creation Units or refers to redeemability will prominently disclose that (i) ETF Shares are not individually redeemable, (ii) holders of ETF Shares may acquire the shares from the Applicant Fund and tender the shares for redemption to the Applicant Fund in Creation Unit aggregations only and (iii) the Applicant Fund is actively managed.
  • the board of trustees of the Applicant Fund must determine, for the Applicant Fund, that the allocation of distribution expenses among the classes of Conventional Shares and ETF Shares in accordance with the Multi-Class Distribution Formula is in the best interests of each class and of the Applicant Fund as a whole.
  • the Applicant Fund will preserve for a period of not less than six years from the date of a board determination, the first two years in an easily accessible place, a record of the determination and the basis and information upon which the determination was made. This record will be subject to examination by the SEC and its staff.
  • the Applicants' website which is and will be publicly accessible at no charge, will contain the following information, on a per ETF Share basis, for the Applicant Fund: (a) the prior business day's closing NAV and the mid-point of the bid-ask spread at the time that the applicable fund's NAV is calculated ("Bid-Ask Price"), and a calculation of the premium or discount of the Bid-Ask Price in relation to the closing NAV; and (b) data for a period covering at least the four previous calendar quarters (or the life of the Fund, if shorter) indicating how frequently the Applicant Fund's ETF Shares traded at a premium or discount to NAV based on the Bid-Ask Price and closing NAV, and the magnitude of such premiums and discounts.
  • the Product Description for the Applicant Fund will state that Applicants' website has information about the premiums and discounts at which the Applicant Fund's ETF Shares have traded.
  • the ETF Shares Prospectus and annual report will include, for the Applicant Fund: (a) the information listed in condition 8(b), (i) in the case of the ETF Shares Prospectus, for the most recently completed calendar year (and the most recently completed quarter or quarters, as applicable), and (ii) in the case of the annual report, for no less than the immediately preceding five fiscal years (or the life of the Applicant Fund, if shorter); and (b) the cumulative total return
  • Vanguard Bond Index ETF Order a class of exchange-traded shares, known as "ETF Shares,” that trade on a national securities exchange
  • Vanguard Bond Index ETF Application 5 Vanguard Bond Index Funds, et al . File No. 812-13336, Investment Company Act Release Nos. 27750 (Mar. 9, 2007) (notice) and 27773 (April 2, 2007) (order).
  • the application for the Vanguard Bond Index ETF Order shall be referred to herein as the "Vanguard Bond Index ETF Application.”
  • Vanguard Bond Index ETF Application Collectively, the Prior Vanguard Stock Index ETF Applications and the Vanguard Bond Index ETF Application shall be referred to herein as the "Prior Vanguard Index ETF Applications.”
  • ETF Shareholders 6 Holders of ETF Shares hereafter are referred to as "ETF Shareholders.”
  • the Prior Vanguard Stock Index ETF Orders relate only to Vanguard stock index funds and the Vanguard Bond Index ETF Order relates only to bond index funds.
  • This Application differs from the Prior Vanguard Index ETF Applications in that it seeks relief to permit an actively managed fund to issue a class of exchange-traded shares.
  • the Commission previously has sought public comment on issues relating to the concept of an actively managed exchange-traded fund (“ETF") - that is, an ETF with an actively managed portfolio that does not seek to replicate the performance of any particular market index - to help inform the Commission's consideration of any proposals for actively managed ETFs.
  • ETF actively managed exchange-traded fund
  • ETF Shares interchangeably to refer to the class of exchange- traded shares issued by certain Vanguard funds as well as the exchange-traded shares issued by third-party, stand-alone ETFs.
  • Vanguard Fixed Income Securities Funds (“Fixed Income Securities Trust” or “Trust”) was originally organized in 1972 as a Maryland corporation and was reorganized as a Delaware statutory trust in 1998.
  • the Trust is registered with the Commission as an open-end management investment company. It currently consists often separate investment portfolios, including, among others, the following four actively managed bond funds (each, an "Applicant Fund” or “Fund”):
  • This Fund seeks to provide current income while maintaining limited price volatility.
  • the Fund invests at least 80% of its assets in U.S. Treasury securities, which include bills, bonds, and notes issued by the U.S. Treasury.
  • the Fund is expected to maintain a dollar- weighted average maturity of 1 to 3 years.
  • This Fund seeks to provide a moderate and sustainable level of current income.
  • the Fund invests at least 80% of its assets in U.S. Treasury securities, which include bills, bonds, and notes issued by the U.S. Treasury.
  • the Fund is expected to maintain a dollar-weighted average maturity of 5 to 10 years.
  • Vanguard Long-Term Treasury Fund This Fund seeks to provide a high and sustainable level of current income.
  • the Fund invests at least 80% of its assets in U.S. Treasury securities, which include bills, bonds, and notes issued by the U.S. Treasury.
  • the Fund is expected to maintain a dollar-weighted average maturity of 15 to 30 years.
  • Each Applicant Fund invests at least 80% of its assets in U.S. Treasury securities, which include bills, bonds, and notes issued by the U.S. Treasury.
  • Each Fund may invest up to 20% of its assets in investments issued or backed by the U.S. government, its agencies and its instrumentalities, including the following:
  • the Funds' credit quality policies which apply at the time of investment, require that 100% of Fund assets be held in investments issued or backed by the U.S. government, its agencies and its instrumentalities.
  • the Funds may hold on to bonds that are downgraded after purchase, even if they would no longer be eligible as new investments for a Fund.
  • a "TBA transaction” essentially is a purchase or sale of a pass-through security for future settlement at an agreed-upon date.
  • each Applicant Fund invest principally in bonds and other fixed income obligations, each may invest in other types of instruments. For example, each Applicant Fund may invest up to 15% of its net assets in illiquid securities. In addition, each Fund may invest in
  • MBS refers to a category of pass-through securities backed by pools of mortgages and issued by one of several U.S. government-sponsored enterprises: the Government National Mortgage Association, known as Ginnie Mae; the Federal National Mortgage Association, known as Fannie Mae; or the Federal Home Loan Mortgage Corporation, known as Freddie Mac.
  • Ginnie Mae the Government National Mortgage Association
  • Fannie Mae the Federal National Mortgage Association
  • Freddie Mac the Federal Home Loan Mortgage Corporation
  • mortgages with similar issuer, term, and coupon characteristics are collected and aggregated into a pool.
  • the pool is assigned a CUSIP number and undivided interests in the pool are traded and sold as MBS.
  • the holder of an MBS is entitled to a pro rata share of principal and interest payments (including unscheduled prepayments) from the pool of mortgage loans.
  • TBA transactions Most mortgage pass- through securities trades are executed as TBA transactions.
  • TBA transactions increase the liquidity and pricing efficiency of transactions in mortgage pass-through securities because they permit similar mortgage pass-through securities to be traded interchangeably pursuant to commonly observed settlement and delivery requirements. If a Fund purchases new MBS securities on a TBA basis, in most cases the Fund would accept delivery of specific MBS pools to settle the TBA trades in the month following the TBA purchase. When opportunities present themselves, a Fund may "roll" the TBAs to the next month to take advantage of favorable funding levels in the mortgage market.
  • the Funds' de ⁇ vative investments may include fixed income futures contracts, fixed income options, interest rate swaps, total return swaps, credit default swaps, or other derivatives.
  • the Adviser uses the following benchmark indexes (each, a "benchmark index") as benchmarks for performance, the average maturity and mix of bonds of each Applicant Fund may differ from those of its benchmark index:
  • the Adviser identifies return enhancement opportunities based on its expectation of future interest rates.
  • the Adviser acts on these return enhancement opportunities by differentiating the
  • This benchmark index is composed of mvestment-grade fixed-rate public obligations of the U S Treasury with maturities between one and five years.
  • This benchmark index is composed of investment-grade fixed-rate public obligations of the U S Treasury with maturities between five and 10 years
  • This benchmark index is composed of investment-grade fixed-rate public obligations of the U S Treasury with maturities of ten years or more
  • the first way the Adviser identifies return enhancement opportunities for an Applicant Fund is by comparing its own prediction of future interest rates to the interest rate levels that are implied by (1) the securities that comprise the Fund's benchmark index and (2) the secu ⁇ ties that are eligible for investment by the Fund.
  • the Adviser implements its interest rate insights primarily by managing a Fund's duration and yield curve slope exposure consistent with the Adviser's prediction of future interest rates. Duration and yield curve slope exposure measure the principal market forces that drive the performance of a portfolio of U.S. government and agency securities. As explained further below, the Adviser's decision to differentiate a Fund from its benchmark index on the basis of these two measures will cause most of the performance variation between the Fund and its benchmark index
  • the measure known as "duration" represents a bond's (or a bond fund's) market-value sensitivity to changes in yields - real or nominal. 16 If the duration of an Applicant Fund differs from the duration of its benchmark index, changes in interest rates will have a greater or lesser impact on the performance of the Fund than on the performance of the benchmark index. The Adviser actively manages the duration of each Fund within one of three ranges (bullish, neutral or bearish, versus the benchmark index) that best reflects its expectations regarding future interest rates. 17 The Adviser's use of Treasury futures contracts to alter a Fund's duration 18
  • the real duration is the percentage change in its market value associated with a 1 % change in its real yield Id
  • Yield curve slope exposure describes the distribution of the portfolio holdings of an Applicant Fund along the yield curve. If a Fund has a different yield curve slope exposure than its benchmark index, non-parallel shifts in the yield curve will have a more or less favorable impact on the total return of the Fund than on the total return of the benchmark index.
  • the Adviser's investment decision-making process also incorporates a consideration of several minor factors that contribute to the performance of the Applicant Funds.
  • the Adviser may believe that securities issued by certain U.S. government agencies or instrumentalities are more attractive than the securities comprising a Fund's benchmark index, and on that basis would to some degree differentiate the Fund's portfolio holdings from the constituent holdings of the benchmark index.
  • the Adviser's security selection process also incorporates a consideration of call risk. As a result, some securities may be more or less attractive to the Adviser at a given point in time than others.
  • the Adviser's assessment of call risk may cause the Adviser to make purchase and sale decisions that further differentiate a Fund from its benchmark index.
  • Basis is the difference between the spot or cash price of a commodity and the price of the nearest futures contract for the same or a related commodity, while “basis risk” is the risk associated with an unexpected widening or narrowing of basis between the time a position is established and the time that it is lifted. See “The CFTC Glossary, A Guide to the Language of the Futures Industry", Office of External Affairs, Commodity Futures Trading Commission (Sept. 2005), reprinted at http://www.cftc.gov/files/opa/cftcglossary.pdf.
  • the Adviser's investment decision-making process further incorporates a consideration of expected inflation rates and the relative value of nominal securities 20 and inflation-indexed securities. 21 If the Adviser believes that nominal securities are overvalued versus inflation- indexed securities, the Adviser could seek to exploit this opportunity by increasing the duration contribution of inflation-indexed securities in one or more of the Applicant Funds. If the Adviser believes that inflation-indexed securities are overvalued as compared to nominal securities, the Adviser could seek to exploit this opportunity by reducing the duration contribution ⁇ i.e., the amount of the investment portfolio's duration that comes from that secunty or security type) of the inflation-indexed securities in a Fund 23 and increasing the duration contribution of the nominal securities in the Fund. 24
  • the Adviser also implements its judgments concerning fixed income securities through differentiated issue selection. "Issue selection” involves deciding, at each point along the yield curve, whether to purchase one issue of available securities instead of another based on the Adviser's perception of their relative value, taking into consideration auction supply and liquidity differentials, among other factors. Differences between the issue structure of the portfolio secu ⁇ ties of the Applicant Funds and the secu ⁇ ties that compose their respective
  • Inflation- indexed securities are designed to provide a "real rate of return" — a return after adjusting for the impact of inflation
  • an inflation- indexed security provides pnncipal and interest payments that are adjusted over time to reflect a ⁇ se (inflation) or a drop (deflation) in the general pnce level Treasury Inflation- Protected Securities (“TIPS”) are securities issued by the U S Treasury whose principal and interest is increased or decreased based on changes m the Consumer Price Index (“CPI”) TIPS differ from nominal Treasuries, which are not adjusted to reflect the effect of inflation on investors' purchasing power.
  • CPI Consumer Price Index
  • VGI The Vanguard Group, Inc. is a Pennsylvania corporation that is wholly and jointly owned by 35 registered investment companies 25 that offer, in the aggregate, more than 140 distinct investment portfolios (each, a "Vanguard Fund"). This "mutual" ownership structure is unique in the mutual fund industry.
  • VGI is a registered investment adviser under the Investment Advisers Act of 1940 and a registered transfer agent under the Securities Exchange Act of 1934 ("Exchange Act").
  • VGI provides each of the Vanguard Funds, at cost, with corporate management, administrative, transfer agency, and (through Vanguard Marketing Corporation, a wholly-owned subsidiary) distribution services. It also provides advisory services, at cost, to certain of the Vanguard Funds, including each of the Applicant Funds. 26
  • VGI employs a supporting staff of management and administrative personnel needed to provide the requisite services, and also provides the Vanguard Funds with furnishings and equipment. Pursuant to exemptive orders issued by the Commission in 1975 and 1981 , each Vanguard Fund, including the Applicant Funds, pays its share of VGF s total expenses pursuant to allocations approved by the board of trustees of each Vanguard Fund. 27 In addition, each Vanguard Fund bears its own direct expenses such as legal, auditing, and custodian fees.
  • VMC Vanguard Marketing Corporation
  • the Trust's board of trustees may engage a party other than VGI to provide advisory services to the Applicant Funds. Any such advisers will be registered or exempt from registration under the Investment Advisers Act of 1940.
  • VMC operates a retail brokerage business.
  • the Applicants wish to make available, in response to market demand, three investment company securities, each of which provides intra-day liquidity and low-cost exposure to U.S. government and agency securities.
  • -B 17- fund would create additional overhead costs; a new class of shares can be created and offered with much less cost than creating and offering a new stand-alone fund.
  • assets invested in a Fund's non-ETF share classes should provide additional economies of scale and opportunities for greater diversification and above-market performance, which would not occur if ETF Shares were instead offered by a stand-alone fund.
  • a separate share class that attracts additional capital through in-kind contributions should also allow each Fund to better achieve its investment objective (due to lower investment costs) and may help a Fund outperform the benchmark index (for the same reasons).
  • redemptions from the ETF Share class will be fulfilled in kind by selecting the lowest cost lots of each security distributed.
  • the written plan required by paragraph (d) of the rule will be amended to provide that the Applicant Funds may issue ETF Shares before they actually issue such shares.
  • a Fund will not issue ETF Shares until it amends its multiclass plan under Rule 18f-3(a) to permit the issuance of such shares.
  • the board of trustees of each Fund including a majority of the trustees who are not interested persons, as defined in Section 2(a)(19) of the Act ("Disinterested Trustees"), will determine that the allocation of distribution expenses among the classes of Conventional Shares and ETF Shares in accordance with the Multi-Class Distribution Formula (described in Part VI. C.) is in the best interests of each share class and of the Fund as a whole.
  • a similar determination will be made by the board of any Vanguard Fund whose expense ratio may be affected by the allocation of distribution expenses to the ETF Share class in accordance with the Multi-Class Distribution Formula.
  • each Fund will issue and redeem ETF Shares only in aggregations of a specified number ("Creation Units"). Purchasers of Creation Units will be able to separate the Creation Units into individual ETF Shares.
  • the actual number of ETF Shares in a Creation Unit may differ from Fund to Fund based in part on the net asset value per share of the Fund and the dollar value initially established for the Fund's Creation Unit. It is expected that a Creation Unit will have an initial value of between $7.5 million and $15 million, and that the number of ETF Shares in a Creation Unit will be between 100,000 and 200,000 (although the numbers in each case could be
  • ETF Shares in a Creation Unit Once the number of ETF Shares in a Creation Unit is determined, it will not change thereafter (except in the event of a stock split or similar revaluation). The initial value of an ETF Share is expected to be between $50 and $100 per share, depending on the Fund.
  • the novelty of the Applicants' proposal is confined to the Applicant Funds' investment objectives and securities selection methodologies. Instead of seeking to replicate the performance of a particular market index (such as the U.S. government and agency securities sector of the fixed income securities market), the Funds seek current income from U.S. government and agency securities based on the Adviser's judgment about issuers, the prices of the securities, and other economic factors. While the Adviser uses the benchmark indexes as benchmarks for the Funds' performance, each Fund's average maturity and mix of bonds may differ from those of its respective benchmark index. This may occur, for example, when the
  • the Applicant Funds will list their ETF Shares on a domestic Exchange. 31 Each Fund will comply with all applicable rules of the Exchange on which its ETF Shares are listed. Neither the Funds' Distributor nor any other Vanguard entity will maintain a secondary market in individual ETF Shares.
  • the Exchange will designate one or more member firms to act as a specialist and maintain a market for the ETF Shares that trade on the Exchange (the "Exchange Specialist").
  • the Funds' ETF Shares will trade on the Exchange in a manner similar to the hundreds of other currently available ETF Shares.
  • ETF Shares offered by the Applicant Funds will be registered in book-entry form only; the Funds will not issue individual share certificates for ETF Shares.
  • the Depository Trust Company (“DTC") or its nominee will be the record or registered owner of all outstanding ETF Shares. Beneficial ownership of ETF Shares will be shown on the records of DTC or a broker-dealer that
  • -B21- is a participant in DTC (a "DTC Participant").
  • DTC Participant a participant in DTC
  • Any retail investor wishing to own ETF Shares must do so through an account maintained by a broker-dealer that (i) is a DTC Participant or (ii) has a relationship with another broker-dealer that is a DTC Participant.
  • ETF Shareholders will receive all of the statements, notices, and reports required under the Act and other applicable laws. They will receive, for example, annual and semi-annual fund reports, written statements accompanying dividend payments, proxy statements, annual notifications detailing the tax status of fund distributions, Form 1099-DIVs, etc. Some of these documents will be provided to ETF Shareholders by their brokers, while others will be provided by the Applicant Funds through the brokers. This arrangement is identical to that of hundreds of other exchange-traded funds and is similar to that used by funds whose shares are owned through mutual fund supermarket intermediaries.
  • the Applicant Funds will issue ETF Shares in Creation Unit-size aggregations to Authorized Participants 33 in exchange for an in-kind deposit of securities, together with a deposit of a specified cash payment described more fully in Part III.C. through E. below.
  • Each in-kind deposit will consist of a basket ("Basket") of securities ("Deposit Securities”) determined by the Adviser to closely resemble - but not replicate - the composition and characteristics, and closely track the expected performance, of the investment portfolio of the corresponding Fund.
  • DTC Participants include banks, trust companies, clearing companies, and other organizations.
  • An "Authorized Participant” is a broker-dealer that is a DTC Participant that has executed a "Participant Agreement" with the Distributor.
  • the Adviser will use a sophisticated computer program to sample the investment portfolio of an Applicant Fund and, based on that sample, structure a Basket that satisfies each of the following requirements (the "Minimum Basket Requirements").
  • the Basket will contain a representative sample of the U.S. government and agency securities comprising the investment portfolio of the Fund.
  • an expected daily tracking error (“Expected Daily Tracking Error") between the daily total return of the Basket (as measured by its market value or "MV”) and the daily total return of the Fund's ETF Shares (as measured by their net asset value per share or "NAV”) that is no greater than ⁇ 3 basis points ("bps").
  • MV daily total return of the Basket
  • NAV net asset value per share
  • Standard deviation is a statistical measure of the degree to which an individual value in a collection of values tends to vary from the mean of all values. Statistically, 2/3 of observations should fall within +/- one standard deviation of the mean.
  • each Basket will closely resemble the composition and characteristics of the investment portfolio of the related Applicant Fund, the Applicants believe that (i) the daily total return of each Basket will closely track the daily total return of the corresponding ETF Shares and (ii) Exchange Specialists and market makers will have sufficient information about each Fund to maintain reasonable spreads between the bid and offer prices of its ETF Shares. Furthermore, because the Adviser will ensure that the composition and characteristics of each Basket have a high statistical probability of causing the Expected Daily Tracking Error to be less than or equal to ⁇ 3 bps, Exchange Specialists and market makers will have added assurance that their arbitrage activities will be successful without having to widen spreads as protection from uncertainty.
  • the Adviser has back-tested its basket design methodology for the Applicant Funds over an eight year period (incorporating real-world interest rates and other bond market conditions) and determined that, at a one standard deviation level of confidence, the historic daily tracking error between the daily total return of a Basket and the daily total return of the ETF Shares of each Fund ranges from 0.7 bps to 1.4 bps.
  • the Adviser also applied its methodology for the Funds on a forward-looking basis (with good faith assumptions about interest rates and other bond market conditions) and determined that, at a one standard deviation level of confidence, the predicted daily tracking error between the daily total return of a Basket and the daily total return of the ETF Shares of each Fund ranges from 1.6 bps to 2.1 bps.
  • the Adviser developed its basket design methodology in light of the concerns the Commission expressed in the Concept Release over two factors that may contribute significantly to the effectiveness of arbitrage in the ETF structure: the transparency of an ETF's portfolio and the liquidity of the securities in the ETF's portfolio. These concerns are addressed below.
  • the Adviser and the Vanguard Funds maintain written policies and procedures that govern the disclosure of the portfolio holdings of a Vanguard Fund to any person, including any ongoing arrangement to disclose portfolio holdings to any person.
  • Those policies and procedures are designed to prevent the misuse of matenal nonpublic information concerning the portfolio holdings of the funds, and generally prohibit the portfolio holdings of the funds from being disclosed to any person other than specified affiliates or service providers, and then only for legitimate business purposes within the scope of such persons' official duties and responsibilities, and subject to such persons' continuing legal duty of confidentiality and legal duty not to trade on the basis of any material nonpublic information.
  • the Applicants propose to use a modified version of the same sophisticated computer program the Adviser has used to sample the target indexes tracked by the Vanguard Bond Index Funds since December 11, 1986.
  • the investment process the Adviser uses for these funds enables them to invest in a representative sample of bonds from their respective target indexes. That sample resembles the full target indexes in terms of characteristics such as maturity, credit quality, issuer type, and yield.
  • This approach has been highly successful, as demonstrated by the Vanguard Bond Index Funds' history of tracking tightly to their target indexes.
  • an investment adviser can construct a portfolio that is a subset of the component securities in the corresponding index, rather than a replication of the index.
  • the investment adviser also may acquire securities for the ETF portfolio that are not included in the corresponding index. While these ETFs still seek to track the performance of their respective indices, they have greater flexibility in accomplishing that goal.”); see also Original Vanguard ETF Order (permitting Total Stock Market ETF Shares and Extended Market ETF Shares to publish baskets that sample rather than replicate a target index).
  • the Adviser proposes to sample the investment portfolio of each Applicant Fund to generate a Basket of Deposit Securities which duplicate approximately 40% to 50% of the securities held in the investment portfolio.
  • the sampling techniques used to determine the Basket should not harm tracking.
  • Vanguard Total Stock Market ETFs and Vanguard Extended Market ETFs are the only two domestic Vanguard stock index ETFs whose baskets sample rather than replicate a target index. Based on data for the six month period ending December 31 , 2006, the monthly tracking error figures for the two funds were +0.7 bps for Total Stock Market ETFs and +1.28 bps for Extended Market ETFs.
  • Vanguard Short-Term Treasury Fund (from 17 to 21); Vanguard Intermediate-Term Treasury Fund (21 to 26); and Vanguard Long-Term Treasury Fund (from 10 to 13).
  • These Basket sizes are similar to the size of the Baskets of Deposit Securities for similar index-based ETFs, such as the following (typical number of Deposit Securities in parentheses): iShares Lehman TIPS Bond Fund (17); iShares Lehman 1-3 Year Treasury Bond Fund (21); iShares Lehman 7-10 Year Treasury Bond Fund (10); and iShares Lehman 20+ Year Treasury Bond Fund (12).
  • the first Minimum Basket Requirement specifies that each Basket must contain a representative sample of the U.S. government and agency securities comprising the investment portfolio of the corresponding Fund. This requirement ensures a significant overlap between the Deposit Securities and the securities comprising the investment portfolio of a Fund, which will increase the degree of positive correlation of price movements between the Basket and the
  • the second Minimum Basket Requirement specifies that the duration and yield curve slope exposure of each Basket must closely approximate the duration and yield curve slope exposure of the investment portfolio of the corresponding Fund. This ensures that the Basket and the investment portfolio of the Fund will have closely matched exposures to the principal market forces that drive the performance of a portfolio of U.S. government and agency securities, which will further increase the degree of positive correlation of price movements between each Basket and its ETF Shares. Minimal Tracking Error.
  • the third Minimum Basket Requirement specifies that each Basket must be expected to produce, at a one standard deviation level of confidence, an Expected Daily Tracking Error between the daily total return of the Basket and the daily total return of the applicable ETF Shares that is no greater than ⁇ 3 bps. This measure is the "gold standard" for determining the reliability of the Basket as a proxy for a Fund's investment portfolio prior to actual trading.
  • the Applicants have taken several steps to eliminate the possibility of predatory trading practices and avoid conflicts of interest involving the Adviser.
  • the Adviser's proprietary basket design methodology deliberately restricts the amount of information market participants receive about the composition and characteristics of the investment portfolio of an Applicant Fund.
  • a Basket will only duplicate approximately 40% to 50% of the securities held by the corresponding Fund, and will not include any of the futures contracts or other derivatives comprising the investment portfolio.
  • Second, the duration of the Basket will only closely approximate, and will rarely (and only by chance) exactly equal, the duration of the investment portfolio.
  • the Adviser developed its basket design methodology in light of the concerns the Commission expressed in the Concept Release over the liquidity of the securities in the investment portfolio of an actively managed ETF.
  • the Adviser considered the fact that each Applicant Fund invests at least 80% of its assets in U.S. Treasury securities (including bills, bonds, and notes issued by the U.S. Treasury), and invest up to 20% of their assets in investments issued or backed by the U.S. government, its agencies and its instrumentalities.
  • each Fund's portfolio holdings are extremely liquid.
  • the prospectus permits each Fund, as a secondary investment strategy, to invest up to 15% of its net assets in illiquid securities.
  • each Fund will impose a Transaction Fee on Authorized Participants who deposit cash in lieu of illiquid, unregistered or unsold allotment secu ⁇ ties in order to offset the transaction costs to the Fund of buying those particular Deposit Securities, as well as to protect the existing shareholders of the Fund from the dilutive effect of the transaction costs (primarily custodial costs) that the Fund incurs when Authorized
  • Each Applicant Fund will issue ETF Shares only in Creation Unit-size aggregations to Authorized Participants, and only in exchange for an in-kind deposit of securities, together with a deposit of a specified cash payment described more fully below.
  • the in-kind deposit will consist of a Basket of Deposit Securities (duplicating approximately 40% to 50% of the securities held in the Fund's investment portfolio) determined by the Adviser to closely resemble the composition and characteristics, and closely track the expected performance, of the investment portfolio of the applicable Fund.
  • the identities and amounts of the Deposit Securities will be determined by the Adviser and made available to Authorized Participants.
  • the Funds can minimize brokerage expenses and other transaction costs.
  • the Applicant Funds reserve the right, in their sole discretion, to allow a purchaser to substitute cash for some or all of the Deposit Securities. See i «/r ⁇ Part III.C.3.
  • the NAV of ETF Shares will be determined as of the close of regular trading on the New York Stock Exchange ("NYSE") on each day that the NYSE is open.
  • ETF Shares will be listed on an Exchange and traded in the secondary market in the same manner as other equity securities.
  • the price of ETF Shares trading on the secondary market will be based on a current bid/offer market. No secondary sales will be made to brokers or dealers at a concession by the Distributor or by an Applicant Fund. Purchases and sales of ETF Shares in the secondary market - which will not involve a Fund - will be subject to customary brokerage commissions and charges.
  • ETF Shares by means of bids and offers on an Exchange in the secondary market is not novel.
  • the ETF Shares currently offered by Vanguard's stock and bond index funds trade using this method, as do the shares offered by non-Vanguard ETFs.
  • the price at which ETF Shares of the Applicant Fund trade will be disciplined by arbitrage opportunities created by the ability to purchase or redeem Creation Units at NAV, which should ensure that ETF Shares similarly do not trade at a material premium or discount in relation to NAV.
  • ETF Shares in Creation Unit-size aggregations
  • the Applicant Funds will accept purchase orders only on days that the NYSE is open.
  • NAV is calculated each business day as of the close of regular trading on the New York Stock Exchange, generally 4 p.m., Eastern time.
  • the Distributor will inform the Adviser and the custodian ("Custodian") of the corresponding Applicant Fund.
  • the Authorized Participant will deliver to the Custodian, on behalf of itself or the ETF Shareholder, the relevant Deposit Securities and any required cash, with appropriate adjustments as determined by each Fund.
  • Purchase orders for an Applicant Fund's ETF Shares must be received by the Distributor prior to the closing time of the regular trading session of the NYSE (ordinarily 4 p.m., Eastern time) in order to receive that day's NAV.
  • the Distributor will maintain a record of Creation Unit purchases.
  • the Distributor will transmit all purchase orders to the relevant Applicant Fund.
  • a Fund may reject any order that is not in proper form.
  • DTC will instruct the Fund to initiate "delivery" of the appropriate number of ETF Shares to the book entry account specified by the purchaser.
  • the Custodian will then notify the Adviser and the Distributor.
  • the Distributor will furnish an ETF Shares Prospectus (as defined in Part III. J.) and a confirmation order to those placing purchase orders.
  • 58 Creation Units may be issued to an Authorized Participant notwithstanding the fact that the corresponding Deposit Securities have not been received in part or in whole, in reliance on the Authorized Participant's undertaking to deliver the missing Deposit Securities as soon as possible, which undertaking shall be secured by the Authorized Participant's delivery and maintenance of collateral.
  • the Authorized Participant Agreement will permit an Applicant Fund to buy the missing Deposit Securities at any time and will subject the Authorized Participant to liability for any shortfall between the cost to the Fund of purchasing the securities and the value of the collateral.
  • SAI Statement of Additional Information
  • the Deposit Securities, the Purchase Balancing Amount, and Transaction Fee collectively are referred to as the "Creation Deposit.”
  • the Purchase Balancing Amount is a cash payment designed to ensure that the NAV of a Creation Deposit is identical to the NAV of the Creation Unit it is used to purchase.
  • the Purchase Balancing Amount is equal to the difference between the NAV of a Creation Unit and the market value of the Deposit Securities. 59
  • the Applicant Funds reserve the right to permit or require an Authorized Purchaser to substitute an amount of cash (referred to as a "cash in lieu" amount) or a different security to replace any prescribed Deposit Security.
  • Substitution might be permitted or required, for example, because one or more Deposit Securities may be unavailable, may not be available in the quantity needed to make a Creation Deposit, or may not be eligible for trading by an Authorized Participant (or the investor on whose behalf the Authorized Participant is acting). 61
  • the Purchase Balancing Amount will be a negative number, in which case the Purchase Balancing Amount will be paid by the Applicant Funds to the purchaser, rather than vice-versa.

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Abstract

La présente invention concerne des procédés et un appareil pour administrer une société d'investissement gérée activement qui investit des actifs dans des valeurs à revenus fixes. La société d'investissement émet une ou plusieurs classes d'actions qui sont listées pour négociation sur un échange de titres et achetées et vendues dans un marché secondaire à des prix de marché négociés. La société d'investissement sélectionne et détient un portefeuille de valeurs à revenus fixes qui se rapporte à un indice repère. La sélection est effectuée de manière gérée activement de telle sorte que la plage de durée des détections de titres est soit plus longue, soit proche de ou plus courte que la durée de l'indice repère. La société d'investissement définit un panier d'unités de création qui a une durée égale à un point médian de la plage de durée de détention de titres de la société d'investissement. La société d'investissement publie périodiquement le panier d'unités de création pour faciliter la création et le rachat des actions négociables en bourse.
PCT/US2008/077052 2007-09-20 2008-09-19 Procédé de création de panier pour un fonds indiciel négociable en bourse (etf) géré activement qui ne révèle pas tous les titres de fonds sous-jacents et société d'investissement qui investit dans des valeurs à revenus fixes et a des classes de fonds classiques et indiciels négociables en bourse avec des fréquences de paiement de dividendes différentes WO2009039395A1 (fr)

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US97399107P 2007-09-20 2007-09-20
US60/973,991 2007-09-20
US11/858,668 US7792725B2 (en) 2007-09-20 2007-09-20 Investment company that invests in fixed income securities and has conventional and ETF share classes with different dividend payment frequencies
US11/858,668 2007-09-20
US11/955,854 2007-12-13
US11/955,854 US7461027B1 (en) 2007-09-20 2007-12-13 Basket creation process for actively managed ETF that does not reveal all of the underlying fund securities

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US10241665B2 (en) 2015-10-20 2019-03-26 True Wealth AG Controlling graphical elements of a display
US20210090169A1 (en) * 2019-09-23 2021-03-25 Invesco Holding Company (Us), Inc. Platform for active non-transparent exchange-traded funds

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US20020046154A1 (en) * 2000-08-25 2002-04-18 Pritchard Andrew H. Systems and methods for developing and administering investment trusts
US20040073506A1 (en) * 1994-04-06 2004-04-15 Tull Robert Stanley Data processing system and method for administering financial instruments
US20050192889A1 (en) * 2001-03-07 2005-09-01 The Vanguard Group, Inc. Investment company that issues a class of conventional shares and a class of exchange-traded shares in the same fund
US20060253360A1 (en) * 2005-04-22 2006-11-09 Lehman Brothers Inc. Methods and systems for replicating an index with liquid instruments
US20070112657A1 (en) * 2005-10-03 2007-05-17 Huber John M Exchange Traded Fund or the Like Related to Basket of Fixed Income Securities Having Similar Maturities

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US20040073506A1 (en) * 1994-04-06 2004-04-15 Tull Robert Stanley Data processing system and method for administering financial instruments
US20020046154A1 (en) * 2000-08-25 2002-04-18 Pritchard Andrew H. Systems and methods for developing and administering investment trusts
US20050192889A1 (en) * 2001-03-07 2005-09-01 The Vanguard Group, Inc. Investment company that issues a class of conventional shares and a class of exchange-traded shares in the same fund
US20060253360A1 (en) * 2005-04-22 2006-11-09 Lehman Brothers Inc. Methods and systems for replicating an index with liquid instruments
US20070112657A1 (en) * 2005-10-03 2007-05-17 Huber John M Exchange Traded Fund or the Like Related to Basket of Fixed Income Securities Having Similar Maturities

Cited By (2)

* Cited by examiner, † Cited by third party
Publication number Priority date Publication date Assignee Title
US10241665B2 (en) 2015-10-20 2019-03-26 True Wealth AG Controlling graphical elements of a display
US20210090169A1 (en) * 2019-09-23 2021-03-25 Invesco Holding Company (Us), Inc. Platform for active non-transparent exchange-traded funds

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