January 1, 2013
Fund
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Ticker Symbol
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No Load Class
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Advisor Class A
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Advisor Class C
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Institutional Class
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The Alternative Income Fund (formerly the Water Infrastructure Fund)
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KWINX
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KWIAX
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KWICX
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KWIIX
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The Alternative Income Fund, (the “Fund”) of Kinetics Mutual Funds, Inc. (the “Company”) is in a master/feeder fund structure. The Fund is a feeder fund to a corresponding series (the “Portfolio”) of Kinetics Portfolios Trust (the “Trust”). Unlike many other investment companies that directly acquire and manage their own portfolios of securities, the Fund seeks its investment objectives by investing all of its investable assets in the Portfolio. The Portfolio is an open-end, non-diversified investment company with investment objectives, strategies and policies that are substantially identical to those of the Fund.
This Statement of Additional Information (“SAI”) provides general information about the Fund and the Portfolio. This SAI is not a Prospectus and should be read in conjunction with the Fund’s current No Load Class Prospectus, Institutional Class Prospectus, or Advisor Class A and Advisor Class C Prospectus, each dated January 1, 2013, as supplemented and amended from time to time, which are incorporated herein by reference. To obtain a copy of the Fund’s Prospectus, please write or call the Fund at the address or telephone number below. To obtain a copy of the Portfolio’s Prospectus and SAI dated January 1, 2013, that provide general information about the Portfolio and are incorporated herein by reference, please write or call the Portfolio at the address or telephone number shown below.
Kinetics Mutual Funds, Inc.
c/o U.S. Bancorp Fund Services, LLC
P.O. Box 701
Milwaukee, WI 53201-0701
Phone: 1-800-930-3828
The financial statements, accompanying notes and report of independent registered public accounting firm appearing in the Company’s most recent Annual Report to shareholders are incorporated by reference into this SAI. The Fund’s Annual Report may be obtained free of charge upon request by writing or calling the Fund at the address or telephone number shown above.
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26
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48
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The Company is a Maryland corporation, established on March 26, 1999. The Company is comprised of several series of mutual funds, all of which are open-end investment companies. This SAI pertains to the No Load, Institutional, Advisor Class A and Advisor Class C shares of The Alternative Income Fund, a series of the Company. The Trust is a Delaware statutory trust, established on March 14, 2000. The Trust is comprised of several series of mutual funds, all of which are open-end investment companies. The principal business office for the Company and the Trust is located at
555 Taxter Road, Suite 175, Elmsford
, New York
10523
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General Information about the Investment Adviser
Kinetics Asset Management LLC (formerly known and conducting business as Kinetics Asset Management, Inc.) (“Kinetics” or “Adviser” or “Investment Adviser”) is a Delaware limited liability corporation that serves as the investment adviser to the Portfolios. Founded in 1996, the Adviser provides investment advisory services to the Company and the Trust, a family of eight mutual funds, with discretionary management authority over approximately $
7.09
billion in assets at September 30, 2012.
The Investment Adviser is a wholly-owned subsidiary of Horizon Kinetics, LLC.
Capitalization
The authorized capitalization of the Company consists of 1 billion shares of common stock of $0.001 par value per share. Each share has equal dividend, distribution and liquidation rights. There are no conversion or preemptive rights applicable to any shares of the Fund. All shares issued are fully paid and non-assessable. Each holder of common stock has one vote for each share held. Voting rights are non-cumulative.
The authorized capitalization of the Trust consists of an unlimited number of shares of beneficial interest with no par value. Each share has equal dividend, distribution and liquidation rights. There are no conversion or preemptive rights applicable to any shares of the Portfolios. All shares issued are fully paid and non-assessable. Each holder of shares of beneficial interest has one vote for each share held. Voting rights are non-cumulative.
Title and Description of Share Classes
The Company and the Trust currently consist of eight series each, respectively. Under the Company’s Articles of Incorporation and a Multiple Class Plan adopted pursuant to Rule 18f-3 under the Investment Company Act of 1940, as amended (“1940 Act”), the Fund is permitted to offer several classes of shares as follows: No Load Class, Institutional Class, Advisor Class A and Advisor Class C. Advisor Class A shares are subject to a front-end sales load and a Rule 12b-1 fee as described in the applicable Prospectus. Advisor Class C shares are subject to a Rule 12b-1 fee as described in the applicable Prospectus.
All Classes are sold primarily to individuals who purchase shares through Kinetics Funds Distributor, LLC (“KFD” or the “Distributor”), the Company’s distributor. The expenses incurred pursuant to the Rule 12b-1 Plans will be borne solely by Advisor Class A and Advisor Class C shares of the Fund and constitute the only expenses allocated on a Class by Class basis.
Rights of Each Share Class
Each share of common stock of the Fund is entitled to one vote in electing Directors and other matters that may be submitted to shareholders for a vote. All shares of all Classes of the Fund generally have equal voting rights. However, matters affecting only one particular Fund or Class of shares can be voted on only by shareholders in that Fund or Class. Only shareholders of Advisor Class A or Advisor Class C shares will be entitled to vote on matters submitted to a shareholder vote with respect to the Rule 12b-1 Plan applicable to such Class. All shareholders are entitled to receive dividends when and as declared by the Board of Directors from time to time and as further discussed in the Prospectuses.
Fund Structure
Unlike other mutual funds that directly acquire and manage their own portfolio securities, the Fund invests all of its investable assets in the Portfolio, which is a separately registered investment company. The Portfolio, in turn, invests in securities using the strategies described in the Prospectus. Accordingly, a shareholder’s interest in the Portfolio’s underlying investment securities is indirect. In addition to selling a beneficial interest to the Fund, the Portfolio could also sell beneficial interests to other mutual funds or institutional investors. Such investors would invest in the Portfolio on the same terms and conditions and would pay a proportionate share of the Portfolio’s expenses. However, other mutual fund or institutional investors in the Portfolio are not required to sell their shares at the same public offering price as the Fund, and might bear different levels of ongoing expenses than the Fund. Shareholders of the Fund should be aware that these differences would result in differences in returns experienced by the different mutual funds or institutional investors of the Portfolio. Such differences in return are also present in other mutual fund structures. In addition, a Master/Feeder Fund structure such as the structure used by the Fund, may serve as an alternative for large, institutional investors in the Fund who may prefer to offer separate, proprietary investment vehicles and who otherwise might establish such vehicles outside of the Fund’s current operational structure. The Fund structure may also allow the Fund to stabilize its expenses and achieve certain operational efficiencies. No assurance can be given, however, that the Fund structure will result in the Fund stabilizing its expenses or achieving greater operational efficiencies.
The Fund’s methods of operation and shareholder services are not materially affected by its investment in the Portfolio, except that the assets of the Fund may be managed as part of a larger pool of assets. Since the Fund invests all of its assets in the Portfolio, it holds only beneficial interests in the Portfolio; the Portfolio invests directly in individual securities of other issuers.
Certain changes in the Portfolio’s objective, policies and/or restrictions may require the Company to withdraw the Fund’s interest in the Portfolio. Any withdrawal could result in a distribution in kind of portfolio securities (as opposed to a cash distribution) from the Portfolio. The Fund could incur brokerage fees or other transaction costs in converting such securities to cash. In addition, a distribution in kind may result in a less diversified portfolio of investments or adversely affect the liquidity of the Fund. The Company’s Board of Directors retains the right to withdraw the investments of the Fund from the Portfolio at any time if it determines that such withdrawal would be in the best interest of the Fund’s shareholders. The Fund would then invest all of its assets directly in individual securities of other issuers or invest in another Portfolio of the Trust.
Smaller funds investing in the Portfolio may be materially affected by the actions of larger funds investing in the Portfolios. For example, if a large fund withdraws from the Portfolio, the remaining funds may experience higher pro rata operating expenses, thereby producing lower returns. Additionally, the Portfolio may become less diverse, resulting in increased portfolio risk. However, this possibility also exists for traditionally structured funds that have large or institutional investors.
Funds with a greater pro rata ownership in the Portfolio could have effective voting control of the operations of the Portfolio. Whenever the Company is requested to vote on matters pertaining to the Portfolio, the Company will hold a meeting of shareholders of the Fund and will cast all of its votes in the Portfolio in the same proportion as the Fund’s shareholders. Shares of the Fund for which no voting instructions have been received will be voted in the same proportion as those shares for which instructions are received.
The investment objectives listed below are fundamental objectives and therefore cannot be changed without the approval of shareholders.
The Alternative Income Fund
The
Alternative Income Fund
is a non-diversified fund with a primary investment objective of providing current income and gains and a secondary investment objective of obtaining long-term growth of capital. The Fund seeks to achieve its objectives by investing all of its investable assets in the Portfolio. Under normal circumstances, the Alternative Income Portfolio will hold a diversified portfolio of fixed income and equity securities and implement equity option strategies intended to generate returns from the collection of option premiums. The Alternative Income Portfolio may invest up to 100% of its net assets in fixed income securities, derivatives, stocks and cash or cash equivalents that may be committed as collateral for option strategies.
The investment restrictions of the Fund may be changed only with the approval of the holders of a majority of the Fund’s outstanding voting securities. The investment restrictions of the Portfolio may be changed only with the approval of the holders of a majority of the Portfolio’s outstanding voting securities. As used in this SAI, “a majority of the Fund’s (or Portfolio’s) outstanding voting securities” means the lesser of (1) 67% of the shares of common stock/beneficial interest of the Fund/Portfolio represented at a meeting at which more than 50% of the outstanding shares are present in person or by proxy, or (2) more than 50% of the outstanding shares of common stock/beneficial interest of the Fund/Portfolio. Unless otherwise noted, the Fund and the Portfolio have adopted and are subject to substantially identical fundamental investment restrictions.
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The Fund/Portfolio will not act as underwriter for securities of other issuers.
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The Fund/Portfolio will not make loans amounting to more than 33 1/3% of its total assets (including any collateral posted) or 50% of its total assets (excluding any collateral posted).
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With respect to 50% of its total assets, the Fund/Portfolio will not invest in the securities of any issuer if as a result the Fund/Portfolio holds more than 10% of the outstanding securities or more than 10% of the outstanding voting securities of such issuer. This policy shall not be deemed violated to the extent that the Fund invests all of its investable assets in its respective Portfolio.
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The Fund/Portfolio will not borrow money or pledge, mortgage, or hypothecate its assets except to facilitate redemption requests that might otherwise require the untimely disposition of portfolio securities and then only from banks and in amounts not exceeding the lesser of 10% of its total assets valued at cost or 5% of its total assets valued at market at the time of such borrowing, pledge, mortgage, or hypothecation and except that, with respect to the Fund/Portfolio, the Fund/Portfolio may enter into futures contracts and related options.
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The
Alternative Income Fund/Portfolio
will not invest more than 15% of the value of its net assets in illiquid securities, restricted securities, and other securities for which market quotations are not readily available. This policy shall not be deemed violated to the extent that the Fund invests all of its investable assets in the respective Portfolio.
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The
Alternative Income Fund/Portfolio
will not invest in the securities of any one industry with the exception of securities issued or guaranteed by the U.S. Government, its agencies and instrumentalities, if, as a result, more than 25% of the Fund’s/Portfolio’s total net assets would be invested in the securities of such industries. This policy shall not be deemed violated to the extent that the Fund invests all its investable assets in the Portfolio.
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The Fund/Portfolio will not purchase or sell commodities or commodity contracts, or invest in oil, gas or mineral exploration or development programs or real estate except that the Fund/Portfolio may purchase and sell securities of companies that deal in oil, gas, or mineral exploration or development programs or interests therein.
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The Fund/Portfolio will not issue senior securities.
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The following paragraphs provide a more detailed description of the Fund’s and Portfolio’s investment policies and risks identified in the Prospectus. Unless otherwise noted, the policies described in this SAI pertain to the Fund and the Portfolio. Furthermore, unless otherwise noted, the policies described in this SAI are not fundamental and may be changed by the Board of Directors of the Company and the Board of Trustees of the Trust, respectively, without shareholder approval.
Common and Preferred Stock; Convertible Securities
Common stocks are units of ownership of a corporation. Preferred stocks are stocks that often pay dividends at a specific rate and have a preference over common stocks in dividend payments and liquidation of assets. Some preferred stocks may be convertible into common stock. Convertible securities are securities that may be converted into or exchanged for a specified amount of common stock of the same or different issuer within a particular period of time at a specified price or formula.
Debt Securities
The Portfolio may invest in convertible and non-convertible debt obligations without regard to rating, and as a result, the Portfolio may purchase or hold securities in the lowest rating categories. Debt securities in these lowest investment grade categories are considered to be below investment grade securities that may not have adequate capacity to pay principal or that otherwise generally lack the characteristics of desirable investments. As compared to debt securities with higher ratings, these “high risk” securities are vulnerable to nonpayment and depend to a larger degree upon favorable business, financial and economic conditions for the obligor to meet its financial commitment on the obligation. At no time will the Portfolio have more than 50% of its total assets invested in any debt securities that are rated below investment grade or if the security is unrated, of comparable quality as determined by the Adviser, either at the time of purchase or as a result of a reduction in rating after purchase. Please see “Appendix A” to this SAI for a description of debt security ratings.
The fixed-income securities in which the Portfolio may invest are generally subject to interest rate risk, credit risk, market risk and call risk.
Interest Rate Risk.
The risk that when interest rates increase, fixed-income securities held by the Portfolio will decline in value. Long-term fixed-income securities will normally have more price volatility because of this risk than short-term fixed-income securities.
Credit Risk.
This risk relates to the ability of the issuer to meet interest and principal payments, as they become due. The ratings given a security by rating services such as Moody’s Investors Service, Inc. (“Moody’s”) and Standard & Poor’s Rating Service (“S&P”) provide a generally useful guide as to such credit risk. The lower the rating given a security by such rating service, the greater the credit risk such rating service perceives to exist with respect to such security. Increasing the amount of Portfolio assets invested in unrated or lower-grade securities, while intended to increase the yield produced by those assets, will also increase the credit risk to which those assets are subject.
Market Risk.
All mutual funds are affected by changes in the economy and swings in investment markets. These can occur within or outside the U.S. or worldwide, and may affect only particular companies or industries.
Call Risk.
The risk that an issuer will exercise its right to pay principal on an obligation held by the Portfolio (such as an asset-backed security) earlier than expected. This may happen when there is a decline in interest rates. Under these circumstances, the Portfolio may be unable to recoup all of its initial investment and will also suffer from having to reinvest in lower yielding securities.
When-Issued and Delayed Delivery Transactions
The Portfolio may purchase short-term obligations on a when-issued or delayed delivery basis. These transactions are arrangements in which the Portfolio purchases securities with payment and delivery scheduled for a future time. The seller’s failure to complete these transactions may cause the Portfolio to miss a price or yield considered advantageous. Settlement dates may be a month or more after entering into these transactions and the market values of the securities purchased may vary from the purchase prices.
The Portfolio may dispose of a commitment prior to settlement if the Adviser deems it appropriate to do so. In addition, the Portfolio may enter into transactions to sell its purchase commitments to third parties at current market values and simultaneously acquire other commitments to purchase similar securities at later dates. The Portfolio may realize short-term profits or losses upon the sale of such commitments.
These transactions are made to secure what is considered to be an advantageous price or yield for the Portfolio. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Portfolio sufficient to make payment for the securities to be purchased are segregated on the Portfolio’s records at the trade date. These assets are marked to market daily and are maintained until the transaction is settled. The Portfolio does not intend to engage in when-issued and delayed delivery transactions to an extent that would cause the segregation of more than 20% of the total value of its assets.
Exchange-Traded Funds (ETFs)
The Portfolio may invest in open-end investment companies whose shares are listed for trading on a national securities exchange or the Nasdaq Market System. ETF shares typically trade like shares of common stock and provide investment results that generally correspond to the price and yield performance of the component stocks of a widely recognized index such as the S&P 500
®
Index. There can be no assurance, however, that this can be accomplished as it may not be possible for an ETF to replicate the composition and relative weightings of the securities of its corresponding index. ETFs are subject to risks of an investment in a broadly based portfolio of common stocks, including the risk that the general level of stock prices may decline, thereby adversely affecting the value of such investment. Individual shares of an ETF are generally not redeemable at their net asset value, but trade on an exchange during the day at prices that are normally close to, but not the same as, their net asset value. There is no assurance that an active trading market will be maintained for the shares of an ETF or that market prices of the shares of an ETF will be close to their net asset values.
Investments in securities of ETFs beyond the limitations set forth in Section 12(d)(1)(A) of the 1940 Act are subject to certain terms and conditions set forth in an exemptive order issued by the SEC to the ETF. Section 12(d)(1)(A) states that a mutual fund may not acquire shares of other investment companies, such as ETFs, in excess of: 3% of the total outstanding voting stock of the investment company; 5% of its total assets invested in the investment company; or more than 10% of the fund’s total assets were to be invested in the aggregate in all investment companies. The purchase of shares of ETFs may result in duplication of expenses, including advisory fees, in addition to a mutual fund’s own expenses.
The Portfolio may also acquire investment company shares received or acquired as dividends, through offers of exchange or as a result of reorganization, consolidation or merger. The purchase of shares of other investment companies may result in duplication of expenses such that investors indirectly bear a proportionate share of the expenses of such mutual funds including operating costs and investment advisory and administrative fees.
Investment Company Securities
The Portfolio may invest in securities issued by other investment companies to the extent permitted by the 1940 Act. Under the 1940 Act, the Portfolio’s investments in such securities currently are limited to, subject to certain exceptions, (i) 3% of the total voting stock of any one investment company, (ii) 5% of the Portfolio’s total assets with respect to any one investment company and (iii) 10% of the Portfolio’s total assets with respect to investment companies in the aggregate. Investments in the securities of other investment companies will involve duplication of advisory fees and certain other expenses. In addition, Rule 12d1-1 under the 1940 Act permits the Portfolio to invest an unlimited amount of its uninvested cash in a money market fund so long as, among other things, said investment is consistent with the Portfolio’s investment objectives and policies, as applicable. As a shareholder in an investment company, the Portfolio would bear its pro rata portion of the investment company’s expenses, including advisory fees, in addition to its own expenses.
Restricted and Illiquid Securities
An illiquid asset is any asset which may not be sold or disposed of in the ordinary course of business within seven days at approximately the value at which the Portfolio has valued the investment. The Portfolio may invest in a limited amount of securities that are illiquid at the time of purchase, including restricted securities and other securities for which market quotations are not readily available. Restricted securities are any securities that are not registered under the Securities Act of 1933, as amended (“1933 Act”) and are illiquid. For purposes of the Fund’s/ Portfolio’s limitation on purchases of illiquid securities described in “Investment Restrictions” above, securities that are not registered under the 1933 Act and are determined to be liquid based upon a review of the trading markets for the specific restricted security will not be included. This practice could increase the level of illiquidity during any period that qualified institutional buyers become uninterested in purchasing these securities.
Depositary Receipts
The Portfolio may invest in ADRs and in other forms of depositary receipts, such as IDRs and GDRs. Depositary receipts are typically issued in connection with a U.S. or foreign bank or trust company and evidence ownership of underlying securities issued by a foreign corporation. In particular, ADRs represent the right to receive securities of foreign issuers deposited in a bank or other depositary. ADRs are traded in the United States and the prices of ADRs are quoted in U.S. dollars. Investments in depositary receipts involve certain inherent risks generally associated with investments in foreign securities, including the following:
Political and Economic Factors
. Individual foreign economies of certain countries may differ favorably or unfavorably from the United States economy in such respects as growth of gross national product, rate of inflation, capital reinvestment, resource self-sufficiency, diversification and balance of payments position. The internal politics of certain foreign countries may not be as stable as those of the United States. Governments in certain foreign countries also continue to participate to a significant degree, through ownership interest or regulation, in their respective economies. Action by these governments could include restrictions on foreign investment, nationalization, expropriation of goods or imposition of taxes, and could have a significant effect on market prices of securities and payment of interest. The economies of many foreign countries are heavily dependent upon international trade and are accordingly affected by the trade policies and economic conditions of their trading partners. Enactment by these trading partners of protectionist trade legislation could have a significant adverse effect upon the securities markets of such countries.
Currency Fluctuations.
A change in the value of any foreign currency against the U.S. dollar will result in a corresponding change in the U.S. dollar value of an ADR’s underlying portfolio securities denominated in that currency. Such changes will affect the Portfolio to the extent that the Portfolio is invested in ADRs comprised of foreign securities.
Taxes
. The interest and dividends payable on certain foreign securities comprising an ADR may be subject to foreign withholding taxes, thus reducing the net amount of income to be paid to the Portfolio and that may ultimately be available for distribution to the Portfolio’s and Fund’s shareholders.
Derivatives
Buying Call and Put Options
. The Portfolio may purchase call options. Such transactions may be entered into in order to limit the risk of a substantial increase in the market price of the security that the Portfolio intends to purchase. Prior to its expiration, a call option may be sold in a closing sale transaction. Any profit or loss from the sale will depend on whether the amount received is more or less than the premium paid for the call option plus the related transaction cost.
The Portfolio may purchase put options. By buying a put, the Portfolio has the right to sell a security at the exercise price, thus limiting its risk of loss through a decline in the market value of the security until the put expires. The amount of any appreciation in the value of the underlying security will be partially offset by the amount of the premium paid for the put option and any related transaction cost. Prior to its expiration, a put option may be sold in a closing sale transaction and any profit or loss from the sale will depend on whether the amount received is more or less than the premium paid for the put option plus the related transaction costs.
Writing (Selling) Call and Put Options
. The Portfolio may write covered options on equity and debt securities and indices. In the case of call options, so long as the Portfolio is obligated as the writer of a call option, it will own the underlying security subject to the option, however, index options and sector/industry based ETF options will be considered covered if the Portfolio holds a portfolio of securities substantially correlated with the movement of the index (or, to the extent it does not hold such a portfolio, segregates liquid assets in an amount equal to the value of the option on a daily, marked-to-market basis). In the case of put options, it will, through its custodian, deposit and maintain either cash or securities with a market value equal to or greater than the exercise price of the option.
Covered call options written by the Portfolio give the holder the right to buy the underlying securities from the Portfolio at a stated exercise price. A call option written by the Portfolio is “covered” if the Portfolio owns the underlying security that is subject to the call or has an absolute and immediate right to acquire that security without additional cash consideration (or for additional cash consideration held in a segregated account by its custodian bank) upon conversion or exchange of other securities held in its portfolio or, in the case of index options and sector/industry based ETF options, will be considered covered if the Portfolio holds a portfolio of securities substantially correlated with the movement of the index. A call option is also covered if the Portfolio holds a call on the same security and in the same principal amount as the call written where the exercise price of the call held (a) is equal to or less than the exercise price of the call written or (b) is greater than the exercise price of the call written if the difference is maintained by the Portfolio in cash and high grade debt securities in a segregated account with its custodian bank. The Portfolio may purchase securities, which may be covered with call options solely on the basis of considerations consistent with the investment objectives and policies of the Portfolio. The Portfolio’s turnover may increase through the exercise of a call option; this will generally occur if the market value of a “covered” security increases and the Portfolio has not entered into a closing purchase transaction.
As a writer of an option, the Portfolio receives a premium less a commission, and in exchange foregoes the opportunity to profit from any increase in the market value of the security exceeding the call option price. The premium serves to mitigate the effect of any depreciation in the market value of the security. The premium paid by the buyer of an option will reflect, among other things, the relationship of the exercise price to the market price, the volatility of the underlying security, the remaining term of the option, the existing supply and demand, and the interest rates.
The writer of a call option may have no control over when the underlying securities must be sold because the writer may be assigned an exercise notice at any time prior to the termination of the obligation. Exercise of a call option by the purchaser will cause the Portfolio, as applicable, to forego future appreciation of the securities covered by the option. Whether or not an option expires unexercised, the writer retains the amount of the premium. This amount may, in the case of a covered call option, be offset by a decline in the market value of the underlying security during the option period. If a call option is exercised, the writer experiences a profit or loss from the sale of the underlying security. Thus during the option period, the writer of a call option gives up the opportunity for appreciation in the market value of the underlying security or currency above the exercise price. It retains the risk of the loss should the price of the underlying security or foreign currency decline. Writing call options also involves risks relating to the Portfolio’s ability to close out the option it has written.
The Portfolio may write exchange-traded call options on its securities. Call options may be written on portfolio securities indices, or foreign currencies. With respect to securities and foreign currencies, the Portfolio may write call and put options on an exchange or over-the-counter. Call options on portfolio securities will be covered since the Portfolio, as applicable, will own the underlying securities. Call options on securities indices will be written only to hedge in an economically appropriate way portfolio securities that are not otherwise hedged with options or financial futures contracts and will be “covered” by identifying the specific portfolio securities being hedged. Options on foreign currencies will be covered by securities denominated in that currency. Options on securities indices will be covered by securities that substantially replicate the movement of the index.
A put option on a security, security index, or foreign currency gives the purchaser of the option, in return for the premium paid to the writer (seller), the right to sell the underlying security, index, or foreign currency at the exercise price at any time during the option period. When the Portfolio writes a secured put option, it will gain a profit in the amount of the premium, less a commission, so long as the price of the underlying security remains above the exercise price. However, the Portfolio remains obligated to purchase the underlying security from the buyer of the put option (usually in the event the price of the security falls below the exercise price) at any time during the option period. If the price of the underlying security falls below the exercise price, the Portfolio may realize a loss in the amount of the difference between the exercise price and the sale price of the security, less the premium received. Upon exercise by the purchaser, the writer of a put option has the obligation to purchase the underlying security or foreign currency at the exercise price. A put option on a securities index is similar to a put option on an individual security, except that the value of the option depends on the weighted value of the group of securities comprising the index and all settlements are made in cash.
During the option period, the writer of a put option has assumed the risk that the price of the underlying security or foreign currency will decline below the exercise price. However, the writer of the put option has retained the opportunity for appreciation above the exercise price should the market price of the underlying security or foreign currency increase. Writing put options also involves risks relating to the Portfolio’s ability to close out the option that it has written.
The writer of an option who wishes to terminate its obligation may effect a “closing purchase transaction” by buying an option of the same series as the option previously written. The effect of the purchase is that the clearing corporation will cancel the writer’s position. However, a writer may not effect a closing purchase transaction after being notified of the exercise of an option. There is also no guarantee that the Portfolio will be able to effect a closing purchase transaction for the options it has written.
Effecting a closing purchase transaction in the case of a written call option will permit the Portfolio to write another call option on the underlying security with a different exercise price, expiration date, or both. Effecting a closing purchase transaction will also permit the Portfolio to use cash or proceeds from the investments. If the Portfolio desires to sell a particular security from its portfolio on which it has written a call option, it will effect a closing purchase transaction before or at the same time as the sale of the security.
The Portfolio will realize a profit from a closing purchase transaction if the price of the transaction is less than the premium received from writing the option. Likewise, the Portfolio will realize a loss from a closing purchase transaction if the price of the transaction is more than the premium received from writing the option. Because increases in the market price of a call option will generally reflect increases in the market price of the underlying security, any loss resulting from the repurchase of a call option is likely to be offset in whole or in part by appreciation of the underlying security owned by the Portfolio.
Writing Over-The-Counter (“OTC”) Options
. The Portfolio may engage in options transactions that trade on the OTC market to the same extent that it intends to engage in exchange-traded options. The Portfolio may invest to a limited extent in OTC options. Just as with exchange-traded options, OTC options give the holder the right to buy an underlying security from, or sell an underlying security to, an option writer at a stated exercise price. However, OTC options differ from exchange-traded options in certain material respects.
OTC options are arranged directly with dealers and not, as is the case with exchange-traded options, through a clearing corporation. Thus, there is a risk of non-performance by the dealer. Because there is no exchange, pricing is typically done by reference to information obtained from market makers. Since OTC options are available for a greater variety of securities and in a wider range of expiration dates and exercise prices, the writer of an OTC option is paid the premium in advance by the dealer.
A writer or purchaser of a put or call option can terminate it voluntarily only by entering into a closing transaction. There can be no assurance that a continuously liquid secondary market will exist for any particular option at any specific time. Consequently, the Portfolio may be able to realize the value of an OTC option it has purchased only by exercising it or entering into a closing sale transaction with the dealer that issued it. Similarly, when the Portfolio writes an OTC option, it generally can close out that option prior to its expiration only by entering into a closing purchase transaction with the dealer to which it originally wrote the option. If a covered call option writer cannot effect a closing transaction, it cannot sell the underlying security or foreign currency until the option expires or the option is exercised. Therefore, the writer of a covered OTC call option may not be able to sell an underlying security even though it might otherwise be advantageous to do so. Likewise, the writer of a secured OTC put option may be unable to sell the securities pledged to secure the put for other investment purposes while it is obligated as a put writer. Similarly, a purchaser of an OTC put or call option might also find it difficult to terminate its position on a timely basis in the absence of a secondary market.
The staff of the Securities and Exchange Commission (“SEC”) has often taken the position that purchased OTC options and the assets used to “cover” written OTC options are illiquid securities.
The Portfolio will adopt procedures for engaging in OTC options transactions for the purpose of reducing any potential adverse effect of such transactions on the liquidity of the Portfolio.
Futures Contracts
. The Portfolio may buy and sell stock index futures contracts traded on domestic stock exchanges to hedge the value of its portfolio against changes in market conditions. A stock index futures contract is an agreement between two parties to take or make delivery of an amount of cash equal to a specified dollar amount, times the difference between the stock index value at the close of the last trading day of the contract and the price at which the futures contract is originally struck. A stock index futures contract does not involve the physical delivery of the underlying stocks in the index. Although stock index futures contracts call for the actual taking or delivery of cash, in most cases the Portfolio expects to liquidate its stock index futures positions through offsetting transactions, which may result in a gain or a loss, before cash settlement is required.
The Portfolio will incur brokerage fees when it purchases and sells stock index futures contracts, and at the time the Portfolio purchases or sells a stock index futures contract, it must make a good faith deposit known as the “initial margin”. Thereafter, the Portfolio may need to make subsequent deposits, known as “variation margin”, to reflect changes in the level of the stock index. The Portfolio may buy or sell a stock index futures contract so long as the sum of the amount of margin deposits on open positions with respect to all stock index futures contracts does not exceed 10% of the Portfolio’s total assets.
To the extent the Portfolio enters into a stock index futures contract, it will maintain with its custodian bank (to the extent required by the rules of the SEC) assets in a segregated account to cover its obligations or in futures or options accounts with custodial brokers. Such assets may consist of cash, cash equivalents, or high quality debt securities from its portfolio in an amount equal to the difference between the fluctuating market value of such futures contract and the aggregate value of the initial and variation margin payments.
Risks Associated With Options and Futures
. Although the Portfolio may write covered call options and purchase and sell stock index futures contracts to hedge against declines in market value of its portfolio securities, the use of these instruments involves certain risks. As the writer of covered call options, the Portfolio receives a premium but loses any opportunity to profit from an increase in the market price of the underlying securities, though the premium received may partially offset such loss.
Although stock index futures contracts may be useful in hedging against adverse changes in the value of investment securities, they are derivative instruments that are subject to a number of risks. During certain market conditions, purchases and sales of stock index futures contracts may not completely offset a decline or rise in the value of the Portfolio’s investments. In the futures markets, it may not always be possible to execute a buy or sell order at the desired price, or to close out an open position due to market conditions, limits on open positions and/or daily price fluctuations. Changes in the market value of the Portfolio’s investment securities may differ substantially from the changes anticipated by the Portfolio when it established its hedged positions, and unanticipated price movements in a futures contract may result in a loss substantially greater than the initial investment in such a contract.
Successful use of futures contracts depends upon the Adviser’s ability to correctly predict movements in the securities markets generally or of a particular segment of a securities market. No assurance can be given that the Adviser’s judgment in this respect will be correct.
The Commodity Futures Trading Commission (“CFTC”) and the various exchanges have established limits referred to as “speculative position limits” on the maximum net long or net short position that any person may hold or control in a particular futures contract. Trading limits are imposed on the number of contracts that any person may trade on a particular trading day. An exchange may order the liquidation of positions found to be in violation of these limits and it may impose sanctions or restrictions. These trading and positions limits will not have an adverse impact on the Portfolio’s strategies for hedging its securities.
Interest Rate Swaps, Total Rate of Return Swaps, Credit Swaps, Interest Rate Floors, Caps and Collars and Currency Swaps
The Portfolio may enter into swap transactions and transactions involving interest rate floors, caps and collars for hedging purposes or to seek to increase total return. These instruments are privately negotiated over-the-counter derivative products. A great deal of flexibility is possible in the way these instruments are structured. Interest rate swaps involve the exchange by the Portfolio with another party of their respective commitments to pay or receive interest, such as an exchange of fixed rate payments for floating rate payments. The purchase of an interest rate floor or cap entitles the purchaser to receive payments of interest on a notional principal amount from the seller, to the extent the specified index falls below (floor) or exceeds (cap) a predetermined interest rate. An interest rate collar is a combination of a cap and a floor that preserves a certain return within a predetermined range of interest rates. Total rate of return swaps are contracts that obligate a party to pay or receive interest in exchange for the payment by the other party of the total return generated by a security, a basket of securities, an index or an index component. Credit swaps are contracts involving the receipt of floating or fixed rate payments in exchange for assuming potential credit losses of an underlying security. Credit swaps give one party to a transaction the right to dispose of or acquire an asset (or group of assets), or, in the case of credit default swaps, the right to receive or make a payment from the other party, upon the occurrence of specific credit events. The Portfolio also may enter into currency swaps, which involve the exchange of the rights of the Portfolio and another party to make or receive payments in specific currencies.
Some transactions, such as interest rate swaps and total rate of return swaps are entered into on a net basis,
i.e.,
the two payment streams are netted out, with the Portfolio receiving or paying, as the case may be, only the net amount of the two payments. If the other party to such a transaction defaults, the Portfolio’s risk of loss consists of the net amount of payments that the Portfolio is contractually entitled to receive, if any. In contrast, other transactions involve the payment of the gross amount owed. For example, currency swaps usually involve the delivery of the entire principal amount of one designated currency in exchange for the other designated currency. Therefore, the entire principal value of a currency swap is subject to the risk that the other party to the swap will default on its contractual delivery obligations. To the extent that the amount payable by the Portfolio under a swap or an interest rate floor, cap or collar is covered by segregated cash or liquid assets, the Portfolio and the Adviser believe that transactions do not constitute senior securities under the 1940 Act and, accordingly, will not treat them as being subject to the Portfolio’s borrowing restrictions.
Credit default swaps are contracts whereby one party makes periodic payments to a counterparty in exchange for the right to receive from the counterparty a payment equal to the par (or other agreed-upon) value of a referenced debt obligation in the event of a default by the issuer of the debt obligation. The use of credit default swaps may be limited by the Portfolio’s limitation on illiquid investments.
When used for hedging purposes, the Portfolio would be the buyer of a credit default swap contract. In that case, the Portfolio would be entitled to receive the par (or other agreed-upon) value of a referenced debt obligation from the counterparty to the contract in the event of a default by a third party, such as a U.S. or non-U.S. issuer, on the debt obligation. In return, the Portfolio would pay to the counterparty a periodic stream of payments over the term of the contract provided that no event of default has occurred. If no default occurs, the Portfolio would have spent the stream of payments and received no benefit from the contract. Credit default swaps involve the risk that the investment may expire worthless and would generate income only in the event of an actual default by the issuer of the underlying obligation (as opposed to a credit downgrade or other indication of financial instability). It would also involve credit risk − that the seller may fail to satisfy its payment obligations to the Portfolio in the event of a default.
When the Portfolio is the seller of a credit default swap contract, it receives the stream of payments but is obligated to pay upon default of the referenced debt obligation. As the seller, the Portfolio would effectively add leverage to its portfolio because, in addition to its total assets, the Portfolio would be subject to investment exposure on the notional amount of the swap.
In addition to the risks applicable to derivatives generally, credit default swaps involve special risks because they are difficult to value, are highly susceptible to liquidity and credit risk, and generally pay a return to the party that has paid the premium only in the event of an actual default by the issuer of the underlying obligation (as opposed to a credit downgrade or other indication of financial difficulty).
The Portfolio will not enter into a total rate of return, credit, currency or interest rate swap or interest rate floor, cap or collar transaction unless the unsecured commercial paper, senior debt or the claims-paying ability of the other party thereto is rated either A or A-1 or better by S&P or Fitch, or A or Prime-1 or better by Moody’s or a comparable rating from another organization that is recognized as a nationally recognized statistical rating organization (“NSRO”) or, if unrated by such rating organization, is determined to be of comparable quality by the Adviser. If there is a default by the other party to such transaction, the Portfolio will have contractual remedies pursuant to the agreements related to the transaction. The use of interest rate, total rate of return, credit and currency swaps, as well as interest rate caps, floors and collars, is a highly specialized activity that involves investment techniques and risks different from those associated with ordinary portfolio securities transactions. If the Adviser is incorrect in its forecast of market values, interest rates and currency exchange rates, the investment performance of the Portfolio would be less favorable than it would have been if this investment technique were not used.
Real Estate Investment Trusts (“REITs”).
A REIT is a corporation or trust that pools the capital of many investors to purchase income property and/or mortgage loans.
A REIT is not taxed on income distributed to its shareholders or unitholders if it complies with regulatory requirements relating to its organization, ownership, assets and income, and with a regulatory requirement that it distribute to its shareholders or unitholders at least 95% of its taxable income for each taxable year. Generally, REITs can be classified as Equity REITs, Mortgage REITs and Hybrid REITs. Equity REITs invest the majority of their assets directly in real property and derive their income primarily from rents and capital gains from appreciation realized through property sales. Mortgage REITs invest the majority of their assets in real estate mortgages and derive their income primarily from interest payments. Hybrid REITs combine the characteristics of both Equity and Mortgage REITs. By investing in REITs indirectly through the Portfolio, shareholders of the Fund will bear not only their proportionate share of the expenses of the Portfolio, but also indirectly, similar expenses of underlying REITs.
REITs may be affected by changes in their underlying properties and by defaults by borrowers or tenants. Mortgage REITs may be affected by the quality of the credit extended. Furthermore, REITs are dependent on specialized management skills. Some REITs may have limited diversification and may be subject to risks inherent in financing a limited number of properties. REITs depend generally on their ability to generate cash flow to make distributions to shareholders or unitholders, and may be subject to defaults by borrowers and to self-liquidations.
In addition, the performance of a REIT may be affected by its failure to qualify for tax-free pass-through of income under the Internal Revenue Code or its failure to maintain exemption from registration under the 1940 Act.
To respond to adverse market, economic, political or other conditions, the
Portfolio
may invest up to 100% of its assets in high quality, U.S. short-term debt securities and money market instruments. The
Portfolio
may invest up to 35% of its assets at the time of purchase in these securities to maintain liquidity.
In order to have funds available for redemption and investment opportunities, the Portfolio may also hold a portion of its assets in cash or U.S. short-term money market instruments. Certificates of deposit purchased by the Portfolio will be those of U.S. banks having total assets at the time of purchase in excess of $1 billion, and bankers’ acceptances purchased by the Portfolio will be guaranteed by U.S. or foreign banks having total assets at the time of purchase in excess of $1 billion. The Portfolio anticipates that not more than 10% of its total assets will be so invested or held in cash at any given time, except when the Portfolio is in a temporary defensive posture.
The Fund has elected to be treated as a regulated investment company (“RIC”) for federal tax purposes. In order to qualify for the beneficial tax treatment afforded RICs, and to be relieved of Federal tax liabilities, RICs must distribute substantially all of their net income to shareholders generally on an annual basis. Thus, the Portfolio may have to dispose of portfolio securities under disadvantageous circumstances to generate cash or borrow cash in order to satisfy the distribution requirement. The Portfolio does not trade in securities for short-term profits but, when circumstances warrant, securities may be sold without regard to the length of time they have been held. Portfolio turnover rates may vary depending on the volume of buying and selling activities. Rates over 100% annually are considered high. The table below shows the portfolio turnover rates for the past two fiscal years. Portfolio turnover is reported at the Portfolio level.
Portfolio turnover rate for:
|
Fiscal Year Ended December 31, 2011
|
Fiscal Year Ended December 31, 2010
|
The Alternative Income Portfolio
|
69%
|
111%
|
Board of Directors/Board of Trustees
The management and affairs of the Fund and the Portfolio are supervised by the Board of Directors of the Company and the Board of Trustees of the Trust, respectively. Each Board consists of the same eight individuals, five of whom are not “interested persons” of the Company or the Trust as that term is defined in the 1940 Act (“Independent Directors/Trustees”). Each Board establishes policies for the operation of the Fund and the Portfolio and appoints the officers who conduct the daily business of the Fund and the Portfolio. The Boards have appointed Mr. Jay Kesslen, of the Adviser, as their Anti-Money Laundering Officer.
Each Board believes that each of the Director’s/Trustee’s experience, qualifications, attributes and skills on an individual basis and in combination with those of the other Directors/Trustees lead to the conclusion that each Director/Trustee should serve in such capacity. Among the attributes common to all Directors/Trustees is the ability to review critically, evaluate, question and discuss information provided to them, to interact effectively with the other Directors/Trustees, the Adviser, other service providers, counsel and the independent registered public accounting firm, and to exercise effective business judgment in the performance of their duties as Directors/Trustees. A Director’s/Trustee’s ability to perform his duties effectively may have been attained through the Director’s/Trustee’s business, consulting, public service and/or academic positions; experience as a board member of the Company and Trust, other investment funds, or non-profit entities or other organizations; education or professional training; and/or other life experiences. In addition to these shared characteristics, specific details regarding each Director’s/Trustee’s principal occupations during the past five years are included in the table below.
Officers and Directors/Trustees of the Company and the Trust are listed below with their ages, addresses, present positions with the Company and Trust and principal occupations over at least the last five years. Each Director/Trustee may be contacted by writing to the Director/Trustee c/o Kinetics Mutual Funds, Inc.,
555 Taxter Road, Suite 175, Elmsford
, New York,
10523
.
Independent Directors/Trustees
Name, Address and Age
|
Position(s) Held with
Company/ Trust
|
Term of Office and
Length of Time Served
|
Principal Occupation(s)
During Past Five Years
|
# of Portfolios in Fund Complex** Overseen by Director/ Trustee
|
Other Directorships
Held by Director/ Trustee
|
Steven T. Russell (48)
c/o Kinetics Asset Management LLC
555 Taxter Road, Suite 175
Elmsford, New York 10523
|
Independent Director/ Independent Trustee
|
Indefinite/
12 years
|
Attorney and Counselor at Law, Partner, Law firm of Russell and Fig (September 2002 to April 2010); Steven Russell Law Firm (April 2010 to present); Professor of Business Law and Finance, Suffolk County Community College (1997 to Present).
|
16
|
Director, The Magnetic Fund of Long Island, LP (a private investment company).
|
|
|
|
|
|
|
Douglas Cohen CPA (50)
c/o Kinetics Asset Management LLC
555 Taxter Road, Suite 175
Elmsford, New York 10523
|
Independent Director/ Independent Trustee
|
Indefinite/
12 years
|
Chief Financial Officer, Sunrise Credit Services, Inc. (2005 to Present); Wagner & Zwerman, LLP Certified Public Accountant (1997 to 2005).
|
16
|
Director,
The Kinetics Fund, Inc. (a private investment company).
|
|
|
|
|
|
|
William J. Graham (50)
c/o Kinetics Asset Management LLC
555 Taxter Road, Suite 175
Elmsford, New York 10523
|
Independent Director/ Independent Trustee
|
Indefinite/
12 years
|
Attorney, William J. Graham, PC (2001 to Present); Bracken & Margolin, LLP (1997 to 2001)
|
16
|
N/A
|
Independent Directors/Trustees
Name, Address and Age
|
Position(s) Held with
Company/ Trust
|
Term of Office and
Length of Time Served
|
Principal Occupation(s)
During Past Five Years
|
# of Portfolios in Fund Complex** Overseen by Director/ Trustee
|
Other Directorships
Held by Director/ Trustee
|
Joseph E. Breslin (59)
c/o Kinetics Asset Management LLC
555 Taxter Road, Suite 175
Elmsford, New York 10523
|
Independent Director/ Independent Trustee
|
Indefinite/
12 years
|
Private Investor, 2009 –Present; Chief Operating Officer, Central Park Credit Holdings, (2007 – 2009); Chief Operating Officer, Aladdin Capital Management, LLC (2005 - 2007).
|
16
|
Trustee, Hatteras Alternative Mutual Funds Trust (4 portfolios); Trustee, Underlying Funds Trust (6 portfolios).
|
|
|
|
|
|
|
James M. Breen (53)
c/o Kinetics Asset Management LLC
555 Taxter Road, Suite 175
Elmsford, New York 10523
|
Independent Director/ Independent Trustee
|
Indefinite/ Appointed
December 2008
|
Senior Special Agent, Homeland Investigations, Miami, FL (2011 to present); Assistant Attaché Immigration & Customs Enforcement, Pretoria, South Africa (2008 to 2011); Immigration & Customs Enforcement Representative, Athens, Greece (2006 to 2008); Immigration & Customs Enforcement, Senior Special Agent, Miami, FL (2000 to 2008).
|
16
|
N/A
|
Interested Directors/Trustees & Officers
Name, Address and Age
|
Position(s) Held
with the
Company/
Trust
|
Term of Office and
Length of Time Served
|
Principal Occupation(s)
During Past Five Years
|
# of Portfolios in Fund
Complex** Overseen by Director/
Trustee
|
Other Directorships
Held by Director/Trustee
|
Murray Stahl* (59)
c/o Kinetics Asset Management LLC
555 Taxter Road, Suite 175
Elmsford, New York 10523
|
Director/Trustee & Secretary
|
Indefinite/
12 years
|
Chairman,
The FRMO Corp. (2001 to Present) (provides consulting services to private investment funds and research services with respect to marketable securities); Chairman and Chief Investment Officer Horizon Kinetics, LLC, (formerly, Horizon Asset Management, LLC (an investment adviser) (1994 to Present); Kinetics Asset Management LLC and Kinetics Mutual Funds, Inc. (2002 to Present).
|
16
|
Chairman of Horizon Kinetics, LLC; Chairman of FRMO Corporation.
|
|
|
|
|
|
|
Peter B. Doyle* (50)
c/o Kinetics Asset Management LLC
555 Taxter Road, Suite 175
Elmsford, New York 10523
|
Director/Trustee, President & Chairman of the Board
|
Indefinite/
10 years
|
President, Kinetics Asset Management LLC (2002 to Present); Director, Kinetics Advisers, LLC (2000 to Present); Director and Officer, Horizon Asset Management, LLC (1994 to Present); Chief Investment Strategist, Kinetics Asset Management LLC and Kinetics Mutual Funds, Inc. (1998 to Present).
|
16
|
Director,
The Kinetics Fund, Inc. (a private investment company); Director and Officer of FRMO Corporation.
|
|
|
|
|
|
|
Leonid Polyakov* (53)
c/o Kinetics Asset Management LLC
555 Taxter Road, Suite 175
Elmsford, New York 10523
|
Director/Trustee & Treasurer
|
Indefinite/
8 years
|
CFO, Kinetics Asset Management LLC (2000 to Present); President, Kinetics Funds Distributor, LLC (2002 to Present); Director, Kinetics Advisers, LLC (2000 to Present); formerly, CFO, KBD Securities, LLC (2000 to Present).
|
16
|
Director,
The Kinetics Fund, Inc. (a private investment company).
|
*
|
Directors/Trustees who are considered "interested persons" as defined in Section 2(a)(19) of the 1940 Act because of their association with the Adviser and its affiliates.
|
**
|
The term “fund complex” refers to the Company and the Trust, which hold themselves out as related for investment purposes.
|
Leadership Structure and Oversight Responsibilities
Overall responsibility for oversight of the Fund and Portfolio rests with the Board of Directors of the Company and Board of Trustees of the Trust, respectively. The Trust, on behalf of the Portfolio, has engaged the Adviser to manage the Portfolio on a day-to-day basis. The Board is responsible for overseeing the Adviser and other service providers in the operations of the Portfolio in accordance with the provisions of the 1940 Act, applicable provisions of state and other laws and the Company’s Articles of Incorporation and By-laws and the Trust’s Declaration of Trust and By-laws. The Boards meet concurrently in-person at regularly scheduled meetings four times each year. In addition, the Boards may hold special in-person or telephonic meetings or informal conference calls to discuss specific matters that may arise or require action between regular meetings. The Independent Directors/Trustees have also engaged independent legal counsel to assist them in performing their oversight responsibility. The Independent Directors/Trustees meet with their independent legal counsel in-person during each quarterly in-person board meeting. As described below, the Boards have established an Audit Committee and a Pricing Committee, and may establish ad hoc committees or working groups from time to time to assist them in fulfilling their oversight responsibilities.
The Boards have appointed Peter B. Doyle, an interested Director/Trustee, to serve in the role of Chairman. The Chairman’s role is to preside at all meetings of the Boards and to act as liaison with the Trust’s and Company’s service providers, counsel and other Directors/Trustees generally between meetings. The Chairman may also perform such other functions as may be delegated by each Board from time to time. The Boards do not have a lead independent Director/Trustee. Each Board has determined that the Board’s leadership structure is appropriate because it allows the Board to exercise informed and independent judgment over matters under its purview and it allocates areas of responsibility among committees of Directors/Trustees and the full Board in a manner that enhances effective oversight.
The Portfolio, and also the Fund, are subject to a number of risks, including investment, compliance, operational and valuation risks, among others. Risk oversight forms part of each Board’s general oversight of the Portfolio and Fund and is addressed as part of various Board and committee activities. Day-to-day risk management functions are subsumed within the responsibilities of the Adviser and other service providers (depending on the nature of the risk), which carry out the Portfolio’s and Fund’s investment management and business affairs. The Adviser and other service providers employ a variety of processes, procedures and controls to identify various events or circumstances that give rise to risks, to lessen the probability of their occurrence and/or to mitigate the effects of such events or circumstances if they do occur. The Adviser and other service providers have their own independent interests in risk management, and their policies and methods of risk management will depend on their functions and business models. Each Board recognizes that it is not possible to identify all of the risks that may affect the Portfolio and Fund or to develop processes and controls to eliminate or mitigate their occurrence or effects. The Boards require senior officers of the Company and Trust, including the President, Treasurer and Chief Compliance Officer, and the Adviser, to report to the full Boards on a variety of matters at regular and special meetings of the Boards, including matters relating to risk management. The Boards and the Audit Committee also receive regular reports from the Company’s/Trust’s independent registered public accounting firm on internal control and financial reporting matters. The Boards also receive reports from certain of the Company’s/Trust’s other primary service providers on a periodic or regular basis, including the Company’s/Trust’s custodian, distributor and administrator. The Boards may, at any time and in their discretion, change the manner in which they conduct risk oversight.
Board Committees
The Boards have two standing committees as described below:
Audit Committee
|
Members
|
Description
|
# of Meetings during Past
Fiscal Year
|
James M. Breen
Joseph E. Breslin
Douglas Cohen, CPA*
William J. Graham
Steven T. Russell
|
Responsible for advising the full Board with respect to accounting, auditing and financial matters affecting the Fund/Portfolio.
|
The Committee met two times during the year ended December 31, 2011.
|
Pricing Committee
|
Members
|
Description
|
# of Meetings during Past Fiscal Year
|
James M. Breen
Joseph E. Breslin*
Douglas Cohen
William J. Graham
Steven T. Russell
|
Responsible for (1) monitoring the valuation of the Portfolio’s securities and other investments; and (2) as required by the Portfolio’s valuation policies, when the full Board is not in session, determining the fair value of illiquid and other holdings after consideration of all relevant factors, which determinations shall be reported to the full Board.
|
The Committee met two times during the year ended December 31, 2011.
|
* Designates the Chairperson of the respective Committee.
Board Interest in the Funds
As of December 31, 2011, the Directors/Trustees owned the following amounts in the Fund and in all of the Funds/Portfolios overseen by the Directors/Trustees:
Name of Director/Trustee
|
Dollar Range of
Equity Securities in the Fund
|
Aggregate Dollar Range of
Equity Securities in
All Funds/Portfolios
Overseen by Director/Trustee
|
INDEPENDENT DIRECTORS/TRUSTEES
|
|
Steven T. Russell
|
None
|
None
|
Douglas Cohen
|
None
|
$50,001-$100,000
|
William J. Graham
|
None
|
$10,001-$50,000
|
Joseph E. Breslin
|
None
|
$50,001-$100,000
|
James M. Breen
|
None
|
None
|
INTERESTED DIRECTORS/TRUSTEES
|
|
Murray Stahl
|
None
|
Over $100,000
|
Leonid Polyakov
|
$10,001-$50,000
|
Over $100,000
|
Peter B. Doyle
|
$10,001-$50,000
|
Over $100,000
|
Compensation
For their service as Directors of the Company and Trustees of the Trust, the Independent Directors/Independent Trustees receive an aggregate fee of $19,000 per year and $2,500 per Board meeting attended, with an additional $1,500 for each Pricing and/or Audit Committee meeting attended, as well as reimbursement for expenses incurred in connection with attendance at such meetings. In addition, each Committee Chairman of the Company and the Trust (such as the Audit Committee or Pricing Committee) receives an additional fee of $5,000 per year for his service as chairman. The “interested persons” who serve as Directors of the Company or Trustees of the Trust receive no compensation for their service as Directors or Trustees. None of the executive officers receive compensation from the Fund or the Portfolio except the Company’s/Trust’s Chief Compliance Officer. The following table provides compensation information for the Directors/Trustees for the year-ended December 31, 2011.
Compensation Table
Name and Position
|
Aggregate Compensation From Fund
|
Pension or Retirement Benefits
Accrued as Part of
Fund/Portfolio Expenses
|
Estimated
Annual Benefits Upon Retirement
|
Total Compensation from Funds and
Fund Complex Paid to
Directors/Trustees
(2)
|
Interested Directors/Trustees
|
|
|
Murray Stahl
(1)
|
None
|
None
|
None
|
None
|
Peter B. Doyle
(1)
|
None
|
None
|
None
|
None
|
Leonid Polyakov
(1)
|
None
|
None
|
None
|
None
|
Independent Directors/Trustees
|
|
|
Steven T. Russell
|
$16,000
|
None
|
None
|
$35,000
|
Douglas Cohen
|
$18,500
|
None
|
None
|
$40,000
|
William J. Graham
|
$16,000
|
None
|
None
|
$35,000
|
Joseph E. Breslin
|
$16,000
|
None
|
None
|
$40,000
|
James M. Breen
|
$16,000
|
None
|
None
|
$35,000
|
(1)
|
“Interested person” as defined under the 1940 Act.
|
(2)
|
Includes compensation paid by Kinetics Portfolios Trust.
|
The following table provides the name and address of any person who owned of record or beneficially 5% or more of the outstanding shares of the Fund as of November 30, 2012 (a “principal shareholder”). A control person is one who owns beneficially either directly or through controlled companies more than 25% of the voting securities of a company or who acknowledges or asserts the existence of control. For all control persons that are companies, the parent company and jurisdiction under which the control person is organized is also provided.
The Alternative Income Fund
(No Load Shares)
Name and Address
|
Parent
Company
|
Jurisdiction
|
%
Ownership
|
Type of
Ownership
|
Charles Schwab & Co., Inc.
101 Montgomery Street
San Francisco, CA 94104-4151
|
The Charles Schwab Corporation
|
DE
|
24.70%
|
Record
|
First Clearing, LLC
Special Custody Account
FEBO Customer
2801 Market Street
St. Louis, MO 63103-2523
|
N/A
|
N/A
|
20.55%
|
Record
|
National Financial Services, LLC
FEBO
Peter Brendan Doyle
35 Greenacres Avenue
Scarsdale, NY 10583-1413
|
N/A
|
N/A
|
5.12%
|
Record
|
(Advisor Class A Shares)
Name and Address
|
Parent
Company
|
Jurisdiction
|
%
Ownership
|
Type of
Ownership
|
UBS Wealth Management, USA
Omni Account M/F
ATTN: Department Manager
1000 Harbor Boulevard,
5
th
Floor
Weehawken, NJ 07086-6761
|
UBS Americas Inc.
|
DE
|
31.31%
|
Record
|
First Clearing, LLC
Special Custody Account
FEBO Customer
2801 Market Street
St. Louis, MO 63103-2523
|
N/A
|
N/A
|
22.90%
|
Record
|
(Advisor Class C Shares)
Name and Address
|
Parent
Company
|
Jurisdiction
|
%
Ownership
|
Type of
Ownership
|
First Clearing, LLC
Special Custody Account
FEBO Customer
2801 Market Street
St. Louis, MO 63103-2523
|
N/A
|
N/A
|
21.16%
|
Record
|
Morgan Stanley & Co.
FBO Premier Management LTD
2230 S MacArthur Drive
Suite 9
Alexandria, LA 71301-3059
|
N/A
|
N/A
|
7.45%
|
Record
|
UBS Wealth Management, USA
Omni Account M/F
ATTN: Department Manager
1000 Harbor Boulevard,
5
th
Floor
Weehawken, NJ 07086-6761
|
N/A
|
N/A
|
6.78%
|
Record
|
(Institutional Shares)
Name and Address
|
Parent
Company
|
Jurisdiction
|
%
Ownership
|
Type of
Ownership
|
Horizon Kinetics LLC
ATTN Robin Shulman CCO
470 Park Avenue South,
4
th
Floor
New York, NY 10016-6819
|
Kinetics Asset Management LLC
|
NY
|
59.56%
|
Record
|
MSSB C/F
Concepcion Tan Yen
IRA Standard
1051 North 18
th
Street
Allentown, PA 18104-3133
|
N/A
|
N/A
|
6.03%
|
Record
|
Citigroup Global Markets, Inc.
333 West 34
th
Street
New York, NY 10001-2402
|
N/A
|
N/A
|
5.79%
|
Record
|
Kinetics Asset Management LLC
ATTN Leonid Polyakov
555 Taxter Road, Suite 175
Elmsford, NY 10523-2314
|
N/A
|
N/A
|
5.31%
|
Record
|
Management Ownership
As of November 30, 2012, the officers and/or Directors of the Fund as a group owned 3.14%, 4.22%, 64.86% and 8.99% of the outstanding shares of the Class A, Class C, Institutional Class and No Load Class shares of the Fund, respectively.
The Trust, on behalf of the Portfolio, has delegated the voting of portfolio securities to the Adviser. The Adviser has adopted policies and procedures for the voting of proxies on behalf of client accounts, including the Portfolio, for which the Adviser has voting discretion. Pursuant to these policies and procedures, the Adviser’s guiding principles in voting proxies is to ensure that the manner in which proxies are voted is in the best interest of its clients and the value of the investment. To this end, an independent third party proxy service, Institutional Shareholder Services Inc. (“ISS”), has been retained by the Adviser for their fundamental research on the proxy question and subsequent recommendations. Proxies are voted by ISS in accordance with their proxy voting guidelines with the intent of serving the best interests of the Adviser’s clients. The Adviser’s Proxy Voting Policies and Procedures and a summary of ISS’ guidelines are attached as Appendix B.
ISS will inform the Adviser’s proxy administrator of any proxies that do not fall within the adopted guidelines. The Adviser’s proxy administrator will send the proxies in question to the Portfolio’s portfolio manager for review, documentation of vote rationale, and signature. In the event the designated portfolio manager is unavailable, the proxy will be forwarded to the Chief Investment Strategist for execution.
ISS also updates and revises the Guidelines on a periodic basis, and the revisions are reviewed by the Adviser to determine whether they are consistent with the Adviser’s guiding principles. ISS also assists the Adviser in the proxy voting process by providing operational, recordkeeping and reporting services.
The Adviser is responsible for reviewing its relationship with ISS and for evaluating the quality and effectiveness of the various services provided by ISS. The Adviser may hire other service providers to replace or supplement ISS with respect to any of the services the Adviser currently receives from ISS.
The Adviser has implemented procedures that are intended to prevent conflicts of interest from influencing proxy voting decisions. These procedures include the Adviser’s use of ISS as an independent third party and a review and approval process for individual decisions that do not follow ISS recommendations.
More Information
The Portfolio’s actual voting records relating to portfolio securities during the most recent 12-month period ended June 30 is available without charge, upon request by calling toll-free at 1-800-930-3828 or by accessing the SEC’s website at www.sec.gov. In addition, a copy of the Adviser’s proxy voting policies and procedures are also available on the Funds’ website at
www.kineticsfunds.com
or by calling toll-free at 1-800-930-3828 and will be sent within three business days of receipt of a request.
The Board of the Trustees of the Trust, on behalf of the Portfolio, approved an advisory contract (the “Advisory Agreement”) with Kinetics. The Advisory Agreement continues on a year-to-year basis provided that specific approval is voted at least annually by the Board of Trustees of the Trust or by the vote of the holders of a majority of the outstanding voting securities of the Portfolio, as applicable. In either event, it must also be approved by a majority of the Trustees of the Portfolio who are neither parties to the Advisory Agreement nor “interested persons” of the Trust as defined in the 1940 Act at a meeting called for the purpose of voting on such approval. The Adviser’s investment decisions are made subject to the direction and supervision of the Board of Trustees. The Advisory Agreement may be terminated at any time, without the payment of any penalty, by the Board of Trustees or by vote of a majority of the outstanding voting securities of the Portfolio. Ultimate decisions as to the Portfolio’s investment policies are made by the Portfolio’s officers and the Trustees or Directors.
Under the Advisory Agreement, Kinetics furnishes investment advice to the Portfolio by continuously reviewing the securities portfolios and recommending to the Portfolio to what extent securities should be purchased or sold. Pursuant to the Advisory Agreement, the Adviser:
(1)
|
renders research, statistical and advisory services to the Portfolio;
|
(2)
|
makes specific recommendations based on the Portfolio’s investment requirements; and
|
(3)
|
pays the salaries of those of the Portfolio’s employees who may be officers or directors or employees of the Adviser.
|
A discussion regarding the basis for the Board of Trustees’ approval of the investment advisory agreement for the Portfolio is available in the Fund’s semi-annual report to shareholders for the period ended June 30, 2012.
Advisory Fees
The Investment Adviser conducts investment research and supervision for the Portfolio and is responsible for the purchase and sale of securities for the Portfolio.
For the above advisory services, the Portfolio has agreed to pay to Kinetics an annual fee of 0.90% of the Portfolio’s average daily net assets. All fees are computed on the average daily closing net asset value (“NAV”) of the Portfolio and are payable monthly. Advisory fees are subsequently allocated to the Fund based on the Fund’s respective interest in the Portfolio. Horizon provides certain research services to the Portfolio and does not receive a fee for such services.
During the fiscal years ended December 31, 2011, 2010 and 2009, the advisory fees payable to the Adviser that were allocated to the Fund were as follows:
Advisory Fees
(1)
|
2011
|
2010
|
2009
|
The Alternative Income Fund
|
$104,640
|
$187,048
|
$89,713
|
(1)
|
Fees reflect Portfolio level expenses allocated to the Fund. Prior to January 1, 2013, the Fund’s advisory fee was 1.25%.
|
The Adviser has voluntarily agreed to waive advisory fees allocated to the Fund and to reimburse Fund expenses in order to keep total annual Fund operating expenses at a certain percentage for the Fund, as described in the Prospectus. During the fiscal years ended December 31, 2011, 2010 and 2009 Kinetics waived advisory fees and reimbursed other Fund expenses in the following amounts:
|
2011
|
2010
|
2009
|
Waiver and Reimbursements
|
Advisory Fee Waiver
|
Expense Reimbursements
|
Advisory Fee Waiver
|
Expense Reimbursements
|
Advisory Fee Waiver
|
Expense Reimbursements
|
The Alternative Income Fund
|
$112,918
|
$0
|
$137,029
|
$0
|
$123,364
|
$0
|
Fees of the custodian, administrator, fund accountant and transfer agent are paid by the Fund or by the Portfolio or by the Fund and the Portfolio jointly, as more fully described below. The Fund and/or Portfolio pay all other expenses, including:
·
|
fees and expenses of directors not affiliated with the Adviser;
|
·
|
legal and accounting fees;
|
·
|
interest, taxes, and brokerage commissions; and
|
·
|
record keeping and the expense of operating its offices.
|
Portfolio Managers
Investment Professionals for the Adviser
Mr. Peter B. Doyle
Mr. Doyle serves as the Chief Investment Strategist for the Portfolios and is a member of the investment team for the Portfolio. The following provides information regarding other accounts managed by Mr. Doyle as of September 30, 2012:
Category of Account
|
Total Number of
Accounts Managed
|
Total Assets in
Accounts Managed
(in Millions)
|
Number of Accounts
for which Advisory Fee is
Based on Performance
|
Assets in Accounts
f
or which Advisory Fee is
Based on Performance
(in Millions)
|
Other Registered Investment Companies
|
8
|
$1,201.24
|
0
|
$0.00
|
Other Pooled Investment Vehicles
|
11
|
$747.95
|
8
|
$176.44
|
Other Accounts
|
555
|
$1,048.44
|
3
|
$215.33
|
Mr. Murray Stahl
Mr. Stahl serves as the Co-Portfolio Manager for the Portfolio. The following provides information regarding other accounts managed by Mr. Stahl as of September 30, 2012:
Category of Account
|
Total Number of
Accounts Managed
|
Total Assets in
Accounts Managed
(in Millions)
|
Number of Accounts
for which Advisory Fee is
Based on Performance
|
Assets in Accounts
for which Advisory Fee is
Based on Performance
(in Millions)
|
Other Registered Investment Companies
|
10
|
$1,781.00
|
0
|
$0.00
|
Other Pooled Investment Vehicles
|
22
|
$1,128.53
|
20
|
$929.04
|
Other Accounts
|
778
|
$1,399.81
|
7
|
$250.20
|
Mr. David Kingsley
Mr. Kingsley is a member of the investment team for the Portfolio. The following provides information regarding other accounts managed by Mr. Kingsley as of September 30, 2012:
Category of Account
|
Total Number of
Accounts Managed
|
Total Assets in
Accounts Managed
(in Millions)
|
Number of Accounts
for which Advisory Fee is
Based on Performance
|
Assets in Accounts
for which Advisory Fee is
Based on Performance
(in Millions)
|
Other Registered Investment Companies
|
2
|
$63.95
|
0
|
$0.00
|
Other Pooled Investment Vehicles
|
4
|
$99.39
|
4
|
$99.39
|
Other Accounts
|
0
|
$0.00
|
0
|
$0.00
|
Mr. Derek Devens
Mr. Devens serves as a Co-Portfolio Manager for the Alternative Income Portfolio. The following provides information regarding other accounts managed by Mr. Devens as of September 30, 2012:
Category of Account
|
Total Number of
Accounts Managed
|
Total Assets in
Accounts Managed
(in Millions)
|
Number of Accounts
for which Advisory Fee is
Based on Performance
|
Assets in Accounts
for which Advisory Fee is
Based on Performance
(in Millions)
|
Other Registered Investment Companies
|
2
|
$63.95
|
0
|
$0.00
|
Other Pooled Investment Vehicles
|
0
|
$0.00
|
0
|
$0.00
|
Other Accounts
|
0
|
$0.00
|
0
|
$0.00
|
Mr. James Davolos
Mr. Davolos is a member of the investment team for the Portfolio. The following provides information regarding other accounts managed by Mr. Davolos as of September 30, 2012:
Category of Account
|
Total Number of
Accounts Managed
|
Total Assets in
Accounts Managed
(in Millions)
|
Number of Accounts
for which Advisory Fee is
Based on Performance
|
Assets in Accounts
for which Advisory Fee is
Based on Performance
(in Millions)
|
Other Registered Investment Companies
|
4
|
$1,000.85
|
0
|
$0.00
|
Other Pooled Investment Vehicles
|
0
|
$0.00
|
0
|
$0.00
|
Other Accounts
|
0
|
$0.00
|
0
|
$0.00
|
As of September 30, 2012, the Portfolio Managers that are responsible for the day-to-day management of the Portfolio beneficially owned shares of the Fund as shown below.
Dollar Range of Equity Securities in the Fund Beneficially Owned
A.
None
B.
$1-$10,000
C.
$10,001-$50,000
D.
$50,001-$100,000
E.
$100,001-$500,000
F.
$500,001-$1,000,000
G.
Over $1,000,000
|
Name of Fund
|
|
|
|
|
|
|
Peter Doyle
|
Murray Stahl
|
James Davolos
|
David Kingsley
|
Derek Devens
|
The Alternative Income Fund
|
E
|
A
|
A
|
A
|
E
|
Compensation
Portfolio Managers are compensated with a base salary and bonus. The base salary is a fixed amount. Bonuses are subjective and are not tied to performance of the Fund, but instead are based on the overall contribution to the firm. The Portfolio Managers also have access to a 401(k) retirement plan (to which the Adviser may make pretax contributions). Additionally, certain Portfolio Managers are also equity owners of the Adviser.
Material Conflicts of Interest
The Adviser’s portfolio managers are responsible for managing one or more of the Portfolio, as well as other accounts. A portfolio manager may manage a separate account or other pooled investment vehicle that may have a materially higher or lower fee arrangement than the Portfolio or that may have a performance fee arrangement. The side-by-side management of these accounts may raise potential conflicts of interest relating to cross trading, the allocation of investment opportunities and the aggregation and allocation of trades. In addition, while portfolio managers generally only manage accounts with similar investment strategies, it is possible that due to varying investment restrictions among accounts and for other reasons that certain investments could be made for some accounts and not others or conflicting investment positions could be taken among accounts. The Adviser has a fiduciary responsibility to manage all client accounts in a fair and equitable manner. The Adviser seeks to provide best execution of all securities transactions and aggregates and then allocates securities to client accounts in a fair and timely manner. To this end, the Adviser has developed policies and procedures designed to mitigate and manage the potential conflicts of interest that may arise from side-by-side management.
The Adviser has entered into shareholder servicing agreements with the Fund under which the Adviser may perform, or arrange for others to perform, certain shareholder servicing functions. The Adviser has entered into written agreements with shareholder servicing agents that perform shareholder services on behalf of their clients who own shares of the Fund. For these shareholder servicing functions, the Adviser and/or shareholder servicing agents are entitled to receive an annual shareholder servicing fee in the amount of 0.25% of the average daily net assets for each of the No-Load Class and Advisor Class of the Fund and 0.20% of the average daily net assets of the Institutional Class of the Fund. The Adviser has contractually agreed to waive and/or reimburse a portion of the shareholder servicing fee with respect to the Institutional Class in excess of 0.05% of the average daily net assets of the Institutional Class until at least January 1, 2014. The Adviser and/or its affiliates may pay additional compensation from time to time, out of their respective assets and not as an additional charge to the Fund, to selected shareholder servicing agents and other persons in connection with providing services to shareholders of the Fund. During the fiscal years ended December 31, 2011, 2010 and 2009, the Fund paid shareholder servicing fees as follows:
Shareholder Servicing Fees
|
2011
|
2010
|
2009
|
The Alternative Income Fund
(1)
|
$42,799
|
$62,825
|
$42,554
|
(1)
|
The Adviser waived shareholder servicing fees in the amount of $2,089, $6,482 and $1,091 for the Institutional Class of the Alternative Income Fund for the fiscal year ended December 31, 2011, 2010 and 2009, respectively.
|
U.S. Bancorp Fund Services, LLC (“U.S. Bancorp”), located at 615 East Michigan Street, Milwaukee, Wisconsin 53202, serves as Administrator of the Fund. The Administrator is entitled to receive annual fees of 0.04% based on the Fund’s first $1 billion in average net assets, 0.02% on the next $6 billion in average net assets, and 0.015% on the balance, plus out-of-pocket expenses, which are payable monthly. During the fiscal years ended December 31, 2011, 2010 and 2009, the aggregate amounts payable by the Fund to U.S. Bancorp (including amounts payable by the Portfolio and allocated to the Fund) for administrative services were as follows:
Administrative Services Fees
(1)
|
2011
|
2010
|
2009
|
The Alternative Income Fund
|
$14,421
|
$20,552
|
$12,994
|
(1)
|
Fees reflect Fund level expenses as well as Portfolio level expenses allocated to the Fund.
|
U.S. Bancorp also serves as the Fund’s accountant and transfer agent. As such, U.S. Bancorp provides certain shareholder services and record management services and acts as the Portfolio’s dividend disbursement agent.
Administrative services include, but are not limited to, providing office space, equipment, telephone facilities, various personnel, including clerical and supervisory, and computers, as is necessary or beneficial to:
·
|
establish and maintain shareholders’ accounts and records,
|
·
|
process purchase and redemption transactions,
|
·
|
process automatic investments of client account cash balances,
|
·
|
answer routine client inquiries regarding the Portfolio,
|
·
|
assist clients in changing dividend options,
|
·
|
account designations, and addresses, and
|
·
|
providing such other services as the Portfolio may reasonably request.
|
Kinetics Funds Distributor, LLC,
470 Park Avenue South, New York, New York 10016
is the distributor of the Fund’s shares. KFD is a registered broker-dealer and member of the Financial Industry Regulatory Authority, and an affiliate of the Adviser.
The Distributor was paid the following commissions on sales of Advisor Class A shares during the last three fiscal years.
Fund
|
2011
|
2010
|
2009
|
The Alternative Income Fund
|
$29,294
|
$118,102
|
$123,843
|
The Distributor retained approximately the following commissions on sales of Advisor Class A shares during the last three fiscal years:
Fund
|
2011
|
2010
|
2009
|
The Alternative Income Fund
|
$2,650
|
$12,605
|
$12,905
|
The following table shows all sales charges, commissions and other compensation received by KFDI directly or indirectly from the Fund during the fiscal year ended December 31, 2011.
Fund
|
Net Underwriting
Discounts and Commissions
(1)
|
Compensation on
Redemption and Repurchase
|
Brokerage Commissions
in Connection with
Fund Transactions
|
Other
Compensation
(2)
|
Alternative Income Fund
|
$2,650
|
0
|
0
|
0
|
(1)
|
Represents amounts received from front-end sales charges on Advisor Class A shares.
|
(2)
|
Represents payments made under Distribution Plans (see “Distribution Plans” below.)
|
The Company, on behalf of the Fund, has adopted separate Distribution Plans pursuant to Rule 12b-1 promulgated by the SEC pursuant to the 1940 Act (the “Plans”) for each of the Advisor Class A and Advisor Class C shares. Under the Advisor Class A Plan, Advisor Class A shares may pay up to an annual rate of 0.50% (currently limited to 0.25%) of the average daily NAV of such shares to the Distributor or other qualified recipient under the Plan. Under the Advisor Class C Plan, Advisor Class C shares may pay an annual rate of 0.75% of the average daily NAV of Advisor Class C shares to the Distributor. The Plans were adopted to facilitate the sale of a sufficient number of shares to allow the Fund to achieve economic viability.
The Plan for the Advisor Class A shares is a “reimbursement” Plan that provides the Company the ability to use assets of the Fund to reimburse KFDI and other qualified recipients (
e.g.,
securities dealers, financial institutions and other industry professionals) for any expenses incurred in connection with any activity that is principally intended to result in the sale of the Fund’s shares subject to the Plan up to 0.50% of average daily net assets. The Plan for Advisor Class C shares is a “compensation” type plan that provides the Company with the ability to use assets of the Fund to pay KFDI and other qualified recipients (
e.g.
, securities dealers, financial institutions and other industry professionals) fees in the amount of 0.75% of average daily net assets to finance any activity that is principally intended to result in the sale of the Fund’s shares subject to the Plan.
Activities covered by the Plans include:
·
|
the advertising and marketing of shares of the Fund covered by the Plans;
|
·
|
preparing, printing, and distributing Prospectuses and sales literature to prospective shareholders, brokers, or administrators; and
|
·
|
implementing and operating the Plans.
|
The Plans must be renewed annually by the Board of Directors, including a majority of the Directors who have no direct or indirect financial interest in the operation of the Plans (as used in this section, “Independent Directors”), cast in person at a meeting called for that purpose. As long as the Plans are in effect, the Independent Directors must select and nominate other Independent Directors.
The Plans and any related agreements may not be amended to materially increase the amounts to be spent for distribution expenses without approval by a majority of the Fund’s outstanding shares covered by the Plans. All material amendments to the Plans or any related agreements must be approved by a vote of the Independent Directors, cast in person at a meeting called for the purpose of voting on any such amendment.
KFDI is required to report in writing to the Board of Directors, at least quarterly, on the amounts and purpose of any payments made under the Plans. KFDI is also required to furnish the Board of Directors with such other information as may reasonably be requested in order to enable the Directors to make an informed determination of whether the Plans should be continued.
Pursuant to the Plans, during the fiscal year ending December 31, 2011, the Advisor Class A and Advisor Class C shares accrued the following fees:
Advisor Class A shares
12b-1 Fees
|
2011
|
Alternative Income Fund
|
$17,006
|
Advisor Class C shares
12b-1 Fees
|
2011
|
Alternative Income Fund
|
$20,016
|
These amounts were accrued and paid to broker-dealers as compensation for distribution services. No payments pursuant to the Plans were made by the Fund for advertising, printing or mailing Prospectuses, or interest or other carrying or finance charges.
U.S. Bank N.A. (“U.S. Bank”), with principal offices at 1555 N. River Center Drive, Suite 302, Milwaukee, WI 53212 is custodian for the securities and cash of the Portfolio. Under a Custody Agreement with the Portfolio, U.S. Bank holds the Portfolio’s assets in safekeeping and keeps all necessary records and documents relating to its duties. U.S. Bank receives an annual fee equal to 0.005% of the Portfolio’s market value with a minimum annual fee of $3,000.
U.S. Bank also serves as custodian of the securities and cash held by the Fund pursuant to a Custody Agreement under which U.S. Bank is responsible for the safekeeping and keeps all necessary records and documents relating to its duties.
The Company, Kinetics and KFD have each adopted Codes of Ethics pursuant to Rule 17j-1 under the 1940 Act that permits investment personnel subject to the particular Code of Ethics to invest in securities, including securities that may be purchased or held by the Portfolio, for their own accounts.
Shares of the Fund are sold on a continual basis at the NAV per share next computed, plus any applicable sales charge, following acceptance of an order by the Fund. The Fund’s NAV per share for the purpose of pricing purchase and redemption orders is determined at the close of normal trading (currently 4:00 p.m. Eastern Time) on each day the New York Stock Exchange (“NYSE”) is open for trading. The NYSE is closed on the following holidays: New Year’s Day, Martin Luther King, Jr.’s Day, Washington’s Birthday/President’s Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
Equity securities are valued each day at the last quoted sales price on the securities principal exchange. If there is no sales price, a security is valued at the last reported bid price. Securities that are listed on the Nasdaq Stock Market Inc. are valued using the NASDAQ Official Closing Price (“NOCP”) , and if no NOCP is available, then at the last reported bid price. In the event market quotations are not readily available or if events occur that may materially affect the value of a particular security between the time trading ends on a particular security and the close of regular trading on the NYSE, “fair value” will be determined in good faith in accordance with procedures approved by the Board of Trustees. The Portfolio may use independent pricing services to assist in calculating the NAV of the Portfolio’s shares.
Futures, options on futures and swap contracts that are listed or traded on a national securities exchange, commodities exchange, contract market or over-the-counter markets and that are freely transferable will be valued at the composite price, using the National Best Bid and Offer quotes (“NBBO”). NBBO consists of the highest bid price and lowest ask price across any of the exchanges on which an option is quoted thus providing a view across the entire U.S. options marketplace. Composite option pricing calculates the mean of the highest bid price and lowest ask price across the exchanges where the option is traded. If a composite price is not available, the mean of the highest bid price and lowest ask priced on the exchange where the option or future is traded will be used. If neither a composite price or a mean of the highest bid price and lowest ask price is available, the security will be valued at the last quoted sales price. Non-exchange traded options also will be valued at the mean between the last bid and asked quotations. Securities which have no public market and all other assets of the Portfolio are considered at such value as the Investment Adviser may determine in good faith, in accordance with the Portfolio’s valuation procedures as approved by the Trust’s Board of Trustees and the Company’s Board of Directors.
Debt obligations that are investment grade and that have 60 days or less remaining until maturity are valued at amortized cost. Any discount or premium is accreted or amortized on a straight-line basis until maturity. Debt obligations (including convertible debt securities) (a) that are not investment grade or (b) that are investment grade and have more than 60 days remaining until maturity at purchase, will be valued at evaluated mean by a third party pricing vendor which uses various valuation methodologies such as matrix pricing and other analytical pricing models as well as market transactions and dealer quotations. Debt securities and other securities which, in the judgment of the Investment Adviser, do not properly represent the value of a security will be valued at their fair market value as determined in good faith in accordance with procedures approved by the Trust’s Board of Trustees and the Company’s Board of Directors.
Trading in foreign securities may be completed at times when the NYSE is closed. In computing the NAV of the Fund and the Portfolio, the value of a foreign security is determined as of the close of trading on the foreign exchange on which it is principally traded or as of the scheduled close of trading on the NYSE, whichever is earlier, at the closing sales prices provided by approved pricing services or other alternate sources. In the absence of sales, the last available mean price between the closing bid and asked prices will be used. Securities and assets for which market quotations are not readily available are valued at fair value as determined in good faith by or under the direction of the Trust’s Board of Trustees
and the Company’s Board of Directors
. Values of foreign securities are translated from the local currency into U.S. dollars on the basis of the foreign currency exchange rates, as provided by an independent pricing service or reporting agency, generally prior to the close of the NYSE. Occasionally, events affecting the value of foreign securities and such exchange rates occur between the time at which they are determined and the close of the NYSE, which events would not be reflected in the computation of a Portfolio’s net asset value. If events materially affecting the value of such securities or currency exchange rates occur during such time period, the securities will be valued at their fair value as determined in good faith by or under the direction of the Trust’s Board of Trustees
and the Company’s Board of Directors
.
The NAV per share of each Class of shares of the Fund is computed by dividing the value of the securities held by the Fund plus any cash or other assets attributable to that Class (including interest and dividends accrued but not yet received) minus all liabilities (including accrued expenses attributable to that Class) by the total number of shares of that Class outstanding at such time, as shown below:
(Value of Assets of the Class) - (Liabilities of the Class)
|
=
|
NAV per share
|
Shares Outstanding of the Class
|
|
|
Fixed-income securities (other than obligations having a maturity of 60 days or less) are normally valued on the basis of quotes obtained from pricing services, which take into account appropriate factors such as institutional sized trading in similar groups of securities, yield, quality, coupon rate, maturity, type of issue, trading characteristics and other market data. Fixed-income securities purchased with remaining maturities of 60 days or less are valued at amortized cost if it reflects fair market value. In the event that amortized cost does not reflect market value, market prices as determined above will be used. Other assets and securities for which no quotations are readily available (including restricted securities) will be valued in good faith at fair value using methods determined by the Trust’s Board of Trustees.
The Company, on behalf of the Fund, and the Trust, on behalf of the Portfolio, maintains policies and procedures relating to selective disclosure of portfolio holdings (“Portfolio Holdings Policies”) that govern the timing and circumstances of disclosure to shareholders and third parties of information regarding the portfolio investments held by the Fund and the Portfolio. These Portfolio Holdings Policies have been approved by the Board of Directors of the Company on behalf of the Fund and the Board of Trustees of the Trust on behalf of the Portfolio. Disclosure of the Fund’s/Portfolio’s complete holdings is required to be made quarterly within 60 days of the end of each fiscal quarter in the Annual Report and Semi-Annual Report to Fund shareholders and in the quarterly holdings report on Form N-Q. These reports are available, free of charge, on the EDGAR database on the SEC’s website at www.sec.gov. Under the Portfolio Holdings Policies, neither the Company/Trust nor any representative of the Company/Trust may solicit or accept any compensation or other consideration in connection with Portfolio Holdings.
The Adviser only discloses information concerning securities held by the Fund and the Portfolio under the following circumstances:
·
|
twenty calendar days after the end of each calendar month, the Adviser may post (a) the top fifteen (15) securities held by the Fund/Portfolio and their respective percentage of the Portfolio on the Company’s website and (b) the top five (5) performing and the bottom five (5) performing securities held by each of the Trust’s portfolios; and
|
·
|
as required by the federal securities laws, the Fund/Portfolio will disclose portfolio holdings in their applicable regulatory filings, including shareholder reports, reports on Forms N-CSR and N-Q or such other filings, reports or disclosure documents as the applicable regulatory authorities may require.
|
Portfolio holdings information that is not filed with the SEC or posted on the Company’s website may be provided to third parties only if the third party recipients are required to keep all portfolio holdings information confidential and are prohibited from trading on the information they receive. Disclosure to such third parties must be approved in advance by the Company’s/Trust’s or Adviser’s President. The Administrator is responsible for portfolio holdings disclosure to third party service providers of auditing, custody, proxy voting and other similar services for the Fund/Portfolio, as well as rating and ranking organizations, which will generally be permitted; however, information may be disclosed to other third parties (including, without limitation, individuals, institutional investors, and intermediaries that sell shares of the Fund/Portfolio) only upon approval by the Company’s/Trust’s or Adviser’s President, who must first determine that the Fund/Portfolio has a legitimate business purpose for doing so. In general, each recipient of non-public portfolio holdings information must sign a confidentiality and non-trading agreement, although this requirement will not apply when the recipient is otherwise subject to a duty of confidentiality. In accordance with the policy, the identity of those recipients who receive non-public portfolio holdings information on an ongoing basis is as follows: the Trust’s Adviser, the Company’s/Trust’s transfer agent and Administrator – U.S. Bancorp Fund Services, LLC, the Company’s/Trust’s independent registered public accounting firm, the Company’s/Trust’s custodian, the Company’s/Trust’s legal counsel and the Company’s/Trust’s proxy voting service. Such holdings are released on conditions of confidentiality, which include appropriate trading prohibitions. “Conditions of confidentiality” include confidentiality terms included in written agreements, implied by the nature of the relationship (
e.g.
, attorney-client relationship), or required by fiduciary or regulatory principles (
e.g.
, custody services provided by financial institutions). Portfolio holdings may also be provided earlier to shareholders and their agents who receive redemptions in kind that reflect a pro rata allocation of all securities held in the portfolio. Third party providers of custodial or accounting services to the Fund may release non-public portfolio holdings information of a Fund/Portfolio only with the permission of the Administrator. From time to time portfolio holdings information may be provided to broker-dealers solely in connection with the Fund/Portfolio seeking portfolio securities trading suggestions. In providing this information reasonable precautions, including limitations on the scope of the portfolio holdings information disclosed, are taken to avoid any potential misuse of the disclosed information.
The Company’s/Trust’s Portfolio Holdings Policies set forth the third parties who receive portfolio holdings information pursuant to ongoing arrangements. Furthermore, the Portfolio Holdings Policies can only be revised by Board approval. The Board will be notified by the Adviser and the Administrator if disclosures are made concerning the Company’s/Trust’s portfolio holdings in contravention of the Company’s/Trust’s Portfolio Holdings Policies.
In determining the existence of a legitimate business purpose, and in order to ensure that the disclosure of the Company’s/Trust’s portfolio holdings is in the best interests of the Company’s/Trust’s shareholders, the following factors, and any additional relevant factors, shall be considered by the Company/Trust or its service providers when disclosing non-public portfolio holdings information to selected third parties: (1) whether the disclosure is consistent with the anti-fraud provisions of the federal securities laws; and (2) avoidance of any conflicts of interest between the interests of the Company’s/Trust’s shareholders and the service providers.
Shares of the Fund are sold in a continuous offering and may be purchased on any business day through authorized investment dealers or directly from the Fund. Shares of the Fund are sold at its NAV plus any applicable sales charge. Except for the Fund itself (through KFD), only investment dealers that have an effective selling agreement with the Fund are authorized to sell shares of the Fund.
Anti-Money Laundering Program
The Fund have established an Anti-Money Laundering Compliance Program (the “Program”) as required by the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA PATRIOT Act”). To ensure compliance with this law, the Program provides for the development of internal practices, procedures and controls, designation of anti-money laundering compliance officers, an ongoing training program and an independent audit function to determine the effectiveness of the Program.
Procedures to implement the Program include, but are not limited to, determining that the Fund’s Distributor and transfer agent have established proper anti-money laundering procedures, reporting suspicious and/or fraudulent activity and completing a thorough review of all New Account Application Forms. The Fund will not transact business with any person or entity whose identity cannot be adequately verified under the provisions of the USA PATRIOT Act.
Offering Price of Advisor Class A Shares
Advisor Class A Shares of the Fund are sold with a maximum front-end sales charge of 5.75%. Using the NAV per share as of September 30, 2012, the maximum offering price of the Fund’s Advisor Class A Shares would be as follows:
Fund
|
Net
Asset
Value
|
Maximum
Sales
Charge
|
Offering
Price to
Public
|
The Alternative Income Fund
|
$8.53
|
5.75%
|
$9.05
|
The actual sales charge that is paid by an investor on the purchase of Advisor Class A Shares may differ slightly from the sales charge listed above or in the applicable Prospectus due to rounding in the calculations. Contact your broker or dealer for further information.
Advisor Class A Shares – Sales Load Waivers
You will not have to pay a sales charge on purchases of Advisor Class A shares if:
·
|
You are an employee of a broker-dealer or agent that has a selling agreement with the Distributor;
|
·
|
You buy Advisor Class A shares under a wrap program or other all-inclusive program offered by your broker-dealer or agent; or
|
·
|
The sales charge is voluntarily waived under certain circumstances by your broker-dealer or agent at their discretion.
|
Please consult your broker-dealer or agent to determine whether you may be eligible for these waivers.
Employees, directors or trustees of the Adviser, KFDI, the Company, the Trust or any of their affiliates, and members of the families (including parents, grandparents, siblings, spouses, children, and in-laws) of such entities’ employees, directors or trustees will also not have to pay a sales charge on Advisor Class A shares.
Advisor Class A Shares – Reducing the Sales Charge
Advisor Class A shares of the Fund are sold at its NAV plus a sales charge as described in the Prospectus. Shareholders can reduce the sales charge on purchases of Advisor Class A shares by:
·
|
purchasing larger quantities of shares or putting a number of purchases together to obtain the discounts
|
·
|
signing a 13-month
letter of intent
|
·
|
using the reinvestment privilege
|
·
|
making concurrent purchases
|
Certain broker-dealers may reduce sales charges under certain circumstances. Consult your broker-dealer.
Large Purchases and Quantity Discounts
As indicated in the applicable Prospectus, the more Advisor Class A shares a shareholder purchases, the smaller the sales charge per share. If a shareholder purchases Advisor Class A shares on the same day as his or her spouse or children under 21, all such purchases will be combined in calculating the sales charges.
Also, if shareholders later purchase additional shares of the Fund, the purchases will be added together with the amount already invested in the Fund. For example, if a shareholder already owns shares of the Fund with a value at the current NAV of $40,000 and subsequently purchases $10,000 more of the Fund at the current NAV, the sales charge on the additional purchase would be 4.75%, not 5.75% as shown in the Prospectus. At the time of purchasing additional purchases, shareholders should inform the Fund
in writing
that they already own Advisor Class A shares of the Fund.
Signing a Letter of Intent
If investors intend to purchase at least $50,000 of Advisor Class A shares over the next 13 months, they should consider signing a
letter of intent (“LOI”)
to reduce the sales charge. A letter of intent includes a provision providing for the assessment of the sales charge for each purchase based on the amount you intend to purchase within the 13-month period. It also allows the custodian to hold the maximum sales charge (
i.e.
, 5.75%) in shares in escrow until the purchases are completed. The shares held in escrow in the investor’s account will be released when the 13-month period is over. If the investor does not purchase the amount stated in the letter of intent, the Fund will redeem the appropriate number of escrowed shares to cover the difference between the sales charge paid and the sales charge applicable to the individual purchases had the LOI not been in effect. Any remaining escrow shares will be released from escrow.
The letter of intent does not obligate the investor to purchase shares, but simply allows the investor to take advantage of the lower sales charge applicable to the total amount intended to be purchased. Any shares purchased within 90 days of the date you establish a letter of intent may be used as credit toward fulfillment of the letter of intent, but the reduced sales charge will only apply to new purchases made on or after that date. The investor’s prior trade prices will not be adjusted.
Reinvestment Privilege
If Advisor Class A shares of any of the Fund have been redeemed, the investor has a one-time right, within 60 days, to reinvest the redemption proceeds at the next-determined NAV without any sales charge. Shareholders should inform the Fund,
in writing
, that they are reinvesting so that they will not be overcharged.
Concurrent Purchases
Another way to reduce the sales charge is to combine purchases made at the same time in a Fund and one or more other Funds offered by the Company that apply sales charges. For example, if an investor invests $30,000 in Advisor Class A shares of the Fund, and $70,000 in Advisor Class A shares of another Fund offered by the Company, the sales charge would be lower. Investors should inform the Fund
in writing
about the concurrent purchases so that they will not be overcharged.
Broker-Dealer Purchases
Purchases of Advisor Class A shares may be made with no initial sales charge (i) by an investment adviser, broker or financial planner, provided arrangements are pre-approved and purchases are placed through an omnibus account with the Fund or (ii) by clients of such investment adviser or financial planner who place trades for their own accounts, if such accounts are linked to a master account of such investment adviser or financial planner on the books and records of the broker or agent. Such purchases may also be made for retirement and deferred compensation plans and trusts used to fund those plans.
Involuntary Redemptions
The Fund reserves the right to redeem shares of accounts where the account balance is less than $1,000 with respect to the No Load, Advisor Class A and Advisor Class C shares and less than $100,000 with respect to the Institutional Class. See the applicable Prospectus for more information on accounts with low balances.
Exchange Privilege
Shareholders may exchange shares of the Fund for shares of any other Fund offered by the Company. Exercising the exchange privilege is treated as a sale for federal income tax purposes and you may realize short or long-term capital gains or losses on the exchange. An exchange of Fund shares held for 30 days or less may be subject to a 2.00% redemption fee.
Shareholders may exchange shares by telephone or in writing as follows:
You may exchange shares by telephone only if the shareholders registered on your account are the same shareholders registered on the account into which you are exchanging. Exchange requests must be received before 4:00 p.m. Eastern time to be processed that day.
You may send your exchange request in writing. Please provide the Fund name and account number for each of the Funds involved in the exchange and make sure the letter of instruction is signed by all shareholders on the account.
Generally, you may only exchange No Load shares for No Load shares, Institutional Class shares for Institutional Class shares, Advisor Class A shares for Advisor Class A shares and Advisor Class C shares for Advisor Class C shares. In all cases involving Advisor Class A share exchanges, shareholders will be required to pay a sales charge only once, assuming they are not eligible for a sales charge waiver.
NOTE
:
The Fund may modify or terminate the exchange privilege at any time upon 60 days prior notice to shareholders. Investors may have difficulty making exchanges by telephone through brokers or banks during times of drastic market changes. If you cannot contact your broker or bank by telephone, you should send your request in writing via overnight mail.
Stock Certificates and Confirmations
The Fund does not intend to issue stock certificates representing shares purchased. Confirmations of the opening of an account and of all subsequent transactions in the account are forwarded by the Fund to the shareholder’s address of record.
Special Incentive Programs
At various times the Fund may implement programs under which a dealer’s sales force may be eligible to (a) win nominal awards for certain sales efforts or as part of recognition programs conforming to criteria established by the Fund, or (b) participate in sales programs sponsored by the Fund. In addition, the Adviser, in its discretion, may from time to time, pursuant to objective criteria established by the Adviser, sponsor programs designed to reward selected dealers for certain services or activities that are primarily intended to result in the sale of shares of the Fund. These programs will not change the price you pay for your shares or the amount that the Fund will receive from such sale.
Investing Through Authorized Brokers or Dealers
The Fund may authorize one or more brokers to accept purchase orders on a shareholder’s behalf. Brokers are authorized to designate intermediaries to accept orders on the Fund’s behalf. An order is deemed to be received when an authorized broker or agent accepts the order. Orders will be priced at the Fund’s NAV next computed after they are accepted by an authorized broker or agent.
For all classes other than the Institutional Class, if any authorized dealer receives an order of at least $1,000, the dealer may contact the Fund directly. Orders received by dealers by the close of trading on the NYSE on a business day that are transmitted to the Fund by 4:00 p.m. Eastern Time on that day will be effected at the NAV per share determined as of the close of trading on the NYSE on that day. Otherwise, the orders will be effected at the next determined NAV. It is the dealer’s responsibility to transmit orders so that they will be received by the Distributor before 4:00 p.m. Eastern Time.
To redeem shares, shareholders may send a written request in “good order” to:
Kinetics Mutual Funds, Inc.
c/o U.S. Bancorp Fund Services
P.O. Box 701
Milwaukee, WI 53201-0701
1-800-930-3828
A written request in “good order” to redeem shares must include:
·
|
the shareholder’s name,
|
·
|
the share or dollar amount to be redeemed; and
|
·
|
signatures by all shareholders on the account.
|
The proceeds will be wired to the bank account of record or sent to the address of record within seven days.
If shareholders request redemption proceeds be sent to an address other than that on record with the Fund or proceeds be made payable other than to the shareholder(s) of record, the written request must have signatures guaranteed by:
·
|
a trust company or commercial bank whose deposits are insured by the Bank Insurance Fund, which is administered by the Federal Deposit Insurance Corporation (“FDIC”);
|
·
|
a member of the New York, Boston, American, Midwest, or Pacific Stock Exchange;
|
·
|
a savings bank or savings association whose deposits are insured by the Savings Association Insurance Fund, which is administered by the FDIC; or
|
·
|
any other “eligible guarantor institution” as defined in the Securities Exchange Act of 1934.
|
The Fund does not accept signatures guaranteed by a notary public.
The Fund and its transfer agent have adopted standards for accepting signature guarantees from the above institutions. The Fund may elect in the future to limit eligible signature guarantors to institutions that are members of a signature guarantee program. The Fund and its transfer agent reserve the right to amend these standards at any time without notice.
Redemption Fees
The Fund is designed for long-term investors willing to accept the risks associated with a long-term investment. The Fund is not designed for short-term traders.
For these reasons, the Fund assesses a 2.00% fee on the redemption or exchange of Fund shares held for 30 days or less. These fees will be paid to the Fund to help offset transaction costs. The Fund reserves the right to waive the redemption fee, subject to its sole discretion in instances it deems not to be disadvantageous to the Fund.
The Fund will use the first-in, first-out (“FIFO”) method to determine the 30-day holding period. Under this method, the date of the redemption or exchange will be compared to the earliest purchase date of shares held in the account. If this holding period is 30 days or less, the redemption fee will be assessed using the current NAV of those shares. The redemption fee will be applied on redemptions and exchanges of each investment made by a shareholder that does not remain in the Fund for a 30-day period from the date of purchase.
The redemption fee will not apply to any shares purchased through reinvested distributions (dividends and capital gains), or to redemptions made under the Fund’s Systematic Withdrawal Plan, as these transactions are typically de minimis. This fee will also not be assessed to the participants in employer-sponsored retirement plans that are held at the Funds in an omnibus account (such as 401(k), 403(b), 457, Keogh, Profit Sharing Plans, and Money Purchase Pension Plans) or to accounts held under trust agreements at a trust institution held at the Funds in an omnibus account. The redemption fee will also not be assessed to accounts of the Adviser or its affiliates used to capitalize the Fund as such accounts will be used specifically to control the volatility of shareholder subscriptions and redemptions to avoid adverse effects to the Fund.
In addition, the Fund are authorized to waive redemption fees for redemptions to asset allocation programs, wrap fee programs and other investment programs offered by financial institutions. Although frequent purchases and redemptions of Fund shares are generally permitted, the Fund only intends to waive redemption fees for redemptions the Fund reasonably believes does not raise frequent trading or market timing concerns.
The Portfolio’s assets are invested by the Adviser in a manner consistent with the Portfolio’s investment objective, strategies, policies and restrictions and with any instructions the Board of Trustees may issue from time to time. Within this framework, the Adviser is responsible for making all determinations as to the purchase and sale of portfolio securities and for taking all steps necessary to implement securities transactions on behalf of the Portfolio.
Transactions on U.S. stock exchanges, commodities markets and futures markets and other agency transactions may involve the payment by the Adviser, on behalf of the Portfolio, of negotiated brokerage commissions. Such commissions vary among different brokers. A particular broker may charge different commissions according to such factors as the difficulty and size of the transaction. Transactions in foreign investments often involve the payment of fixed brokerage commissions, which may be higher than those in the United States. There is generally no stated commission in the case of securities traded in the over-the-counter markets, but the price paid by the Adviser usually includes an undisclosed dealer commission or mark-up. In underwritten offerings, the price paid by the Adviser on behalf of the Portfolio includes a disclosed, fixed commission or discount retained by the underwriter or dealer.
U.S. Government securities generally are traded in the over-the-counter market through broker-dealers. A broker-dealer is a securities firm or bank that makes a market for securities by offering to buy at one price and sell at a slightly higher price. The difference between the prices is known as a spread.
In placing orders for the purchase and sale of portfolio securities for the Portfolio, the Adviser seeks to obtain the best price and execution, taking into account such factors as price, size of order, difficulty and risk of execution and operational facilities of the firm involved. For securities traded in the over-the-counter markets, the Adviser deals directly with the dealers who make markets in these securities unless better prices and execution are available elsewhere. The Adviser negotiates commission rates with brokers based on the quality and quantity of services provided in light of generally prevailing rates, and while the Adviser generally seeks reasonably competitive commission rates, the Portfolio does not necessarily pay the lowest commissions available. The Trust’s Board of Trustees and the Company’s Board of Directors periodically review the commission rates and allocation of orders.
When consistent with the objectives of best price and execution, business may be placed with broker-dealers who furnish investment research or services to the Adviser. Such research or services include advice, both orally and in writing, as to the value of securities; the advisability of investing in, purchasing or selling securities; and the availability of securities, or purchasers or sellers of securities; as well as analyses and reports concerning issues, industries, securities, economic factors and trends, portfolio strategy and the performance of accounts. To the extent portfolio transactions are effected with broker-dealers who furnish research services to the Adviser, the Adviser receives a benefit, not capable of evaluation in dollar amounts, without providing any direct monetary benefit to the Portfolio from these transactions. The Adviser believes that most research services obtained by it generally benefit several or all of the investment companies and private accounts that they manage, as opposed to solely benefiting one specific managed fund or account.
The Trust, on behalf of the Portfolio, may also enter into arrangements, commonly referred to as “broker/service arrangements” with broker-dealers pursuant to which a broker-dealer agrees to pay the cost of certain products or services provided to the Portfolio in exchange for fund brokerage. Under a typical brokerage/service arrangement, a broker agrees to pay a portion of the Portfolio’s custodian, administrative or transfer agency fees, and, in exchange, the Portfolio agrees to direct a minimum amount of brokerage to the broker. The Adviser, on behalf of the Trust/Company, usually negotiates the terms of the contract with the service provider, which is paid directly by the broker.
The Portfolio may direct certain portfolio trades to unaffiliated brokers who pay a portion of the commissions for those trades in cash to the Portfolio that generated the commission.
From time-to-time, the Adviser may effect transactions in portfolio securities with executing brokers that may also promote or sell shares of the Fund/Portfolio (“selling brokers”) pursuant to policies adopted by the Company’s/Trust’s Board of Directors/Trustees. These policies provide that the Adviser shall not (i) take into consideration the promotion or sale of the Fund’s/Portfolio’s shares as a factor in selecting executing brokers for the Fund/Portfolio, (ii) enter into an arrangement or understanding (whether oral or written) pursuant to which the Adviser directs, or is expected to direct, portfolio securities transactions or any other remuneration (as described below) to any broker or dealer in consideration for the promotion or sale of the Fund/Portfolio, and (iii) enter into a “step out” or any other type of arrangement under which a portion of the Fund’s/Portfolio’s commission is directed to the selling brokers for the purpose of compensating such brokers for promoting or selling shares of the Fund/Portfolio. This prohibition applies to all transactions whether such transaction involves a commission, mark-up, mark down, other fee or portion of another fee paid or to be paid from a transaction effected through an executing broker.
The same security may be suitable for the Portfolio, another Portfolio of the Trust or other private accounts managed by the Adviser. If and when the Portfolio and two or more accounts simultaneously purchase or sell the same security, the transactions will be allocated as to price and amount in accordance with arrangements equitable to the Portfolio and the accounts. The simultaneous purchase or sale of the same securities by the Portfolio and other accounts may have a detrimental effect on the Portfolio, as this may affect the price paid or received by the Portfolio or the size of the position obtainable or able to be sold by the Portfolio.
All brokerage commissions are reflected at the Portfolio level. The following table represents the total brokerage commissions paid by the Portfolio for the years ended December 31, 2011, 2010 and 2009, respectively:
Total Brokerage Commissions Paid
|
2011
|
2010
|
2009
|
The Alternative Income Portfolio
|
$17,044
|
$50,757
|
$24,375
|
The value of the Fund’s aggregate holdings of the securities of their regular broker or dealer as of December 31, 2011, was as follows:
Fund
|
Regular Broker-Dealer
|
Value
|
The Alternative Income Portfolio
|
U.S. Bank, N.A.
|
$239,000
|
The following summarizes certain additional tax considerations generally affecting the Fund and its shareholders that are not described in the Prospectus. No attempt is made to present a detailed explanation of the tax treatment of the Fund or its shareholders, and the discussions here and in the Prospectuses are not intended as a substitute for careful tax planning. Potential investors should consult their tax advisor with specific reference to their own tax situations.
The discussions of the federal tax consequences in the Prospectuses and this SAI are based on the Internal Revenue Code (the “Code”) and the regulations issued under it, and court decisions and administrative interpretations as in effect on the date of this SAI. Future legislative or administrative changes or court decisions may significantly alter the statements included herein, and any such changes or decisions may be retroactive.
Federal – General Information
The Fund has elected to be treated and intends to qualify for each taxable year as a regulated investment company under Subchapter M of Subtitle A, Chapter 1, of the Code. As a regulated investment company, the Fund generally is exempt from federal income tax on its net investment income and realized capital gains that it distributes to shareholders. To qualify for treatment as a regulated investment company, the Fund must meet three important tests each year.
First, the Fund must derive with respect to each taxable year at least 90% of its gross income from dividends, interest, certain payments with respect to securities loans, gains from the sale or other disposition of stock or securities or foreign currencies, other income derived with respect to its business of investing in stock, securities, or currencies or net income derived from interests in qualified publicly traded partnerships.
Second, generally, at the close of each quarter of its taxable year, at least 50% of the value of the Fund’s assets must consist of cash and cash items, U.S. government securities, securities of other regulated investment companies and securities of other issuers as to which the Fund has not invested more than 5% of the value of its total assets in securities of the issuer and as to which the Fund does not hold more than 10% of the outstanding voting securities of the issuer, and no more than 25% of the value of the Fund’s total assets may be invested in the securities of (1) any one issuer (other than U.S. government securities and securities of other regulated investment companies), (2) two or more issuers that the Fund controls and which are engaged in the same or similar trades or businesses, or (3) one or more qualified publicly traded partnerships.
Third, the Fund must distribute an amount equal to at least the sum of 90% of its investment company taxable income (net investment income and the excess of net short-term capital gain over net long-term capital loss) and 90% of its tax-exempt income, if any, for the year.
The Fund
intends to comply with this distribution requirement. If
the Fund
were to fail to make sufficient distributions, it could be liable for corporate income tax and for excise tax in respect of the shortfall or, if the shortfall is
large
enough, the Fund could be disqualified as a regulated investment company.
The Fund invests all of its assets in and derives all of its income from its corresponding master portfolio. The master portfolio is treated as a partnership for federal tax purposes, and the Fund will be treated as recognizing an allocable share of the income, gain, loss, deduction and credit of the master portfolio in which it invests. For purposes of the income and diversification requirements, the Fund will be treated as receiving its allocable share of items of income and gain of the master portfolio and as owning its allocable share of a master portfolio’s assets. Thus, the Fund’s ability to satisfy the income and diversification requirements depends upon the character of a master portfolio’s income and assets. The master portfolio intends to invest its assets so that its Fund investors will satisfy the income and diversification requirements.
If for any taxable year the Fund were not to qualify as a regulated investment company, all its taxable income would be subject to tax at regular corporate rates without any deduction for distributions to shareholders. In that event, taxable shareholders would recognize dividend income on distributions to the extent of the Fund’s current and accumulated earnings and profits, and corporate shareholders could be eligible for the dividends-received deduction.
The Code imposes a nondeductible 4% excise tax on regulated investment companies that fail to distribute each year an amount equal to specified percentages of their ordinary taxable income and capital gain net income (excess of capital gains over capital losses). The Fund intends to make sufficient distributions or deemed distributions each year to avoid liability for this excise tax.
Taxation of Certain Financial Instruments
The tax principles applicable to transactions in financial instruments, such as futures contracts and options, that may be engaged in by a master portfolio, and investments in passive foreign investment companies (“PFICs”), are complex and, in some cases, uncertain. The tax consequences of such transactions and investments will pass through to the Fund and may cause the Fund to recognize taxable income prior to the receipt of cash, thereby requiring the Fund to liquidate other positions, or to borrow money, so as to make sufficient distributions to shareholders to avoid corporate-level tax. Moreover, some or all of the taxable income recognized may be ordinary income or short-term capital gain, so that the distributions may be taxable to shareholders as ordinary income.
In addition, in the case of any shares of a PFIC in which any master portfolio invests, the Fund may be liable for corporate-level tax on any ultimate gain or distributions on the shares if a master portfolio fails to make an election to recognize income annually during the period of its ownership of the shares of the PFIC.
Capital Loss Carryforwards
For federal income tax purposes, the Fund is generally permitted to carry forward a net capital loss in any year beginning on or before December 22, 2010 to offset its own capital gains, if any, during the eight years following the year of loss. As of December 31, 2011, the Fund had net capital loss carryforwards available to reduce future capital gains in the amounts subject to the expiration dates set forth in the following table:
Fund
|
2018
|
2017
|
2016
|
2015
|
2014
|
2013
|
The Alternative Income Fund
|
$2,203,647
|
$4,868,599
|
$1,430,796
|
-
|
-
|
-
|
As a result of the Regulated Investment Company Modernization Act of 2010 (“the Modernization Act”), losses incurred in 2011 and subsequent years retain their character, short-term or long-term, may be carried forward indefinitely and are utilized prior to capital loss carryforwards accumulated before the enactment of the Modernization Act.
As of December 31, 2011, the Fund did not accumulate net capital loss carryforwards.
State and Local Taxes
Although the Fund expects to qualify as a “regulated investment company” and to be relieved of all or substantially all federal income taxes, depending upon the extent of its activities in states and localities in which its offices are maintained, in which its agents or independent contractors are located or in which it is otherwise deemed to be conducting business, the Fund could be subject to the tax laws of such states or localities.
Tait, Weller & Baker LLP, 1818 Market Street, Suite 2400, Philadelphia, Pennsylvania 19103, serves as the Fund’s independent registered public accounting firm. Its services include an audit of the Fund’s financial statements and the performance of other related audit and tax services.
The Fund’s Annual Report to Shareholders for the fiscal year ended December 31, 2011 and Semi-Annual Report for the period ended June 30, 2012, have been filed with the SEC. The financial statements, notes thereto and Report of Independent Registered Public Accounting Firm included in the Annual Report, and the financial statements and notes thereto included in the Semi-Annual Report, are incorporated by reference into this SAI.
Financial statements certified by the Fund’s independent registered public accounting firm will be submitted to shareholders at least annually.