There are three key categories of risks:
risks that arise due to indirectly investing in the Underlying Funds through the Smartshares Funds (structural risks); and
risks that arise due to investing in the Underlying Funds generally; and risks that arise due to the operation of the Smartshares Funds generally. In summary, some of the principal risks are:
Structural Risks
• Foreign currency risk – The Smartshares Funds acquire investments and receive Returns in US dollars. Fluctuations in the value of the New Zealand dollar versus the US dollar may affect the Returns received by the Smartshares Funds because the value of the Underlying Shares and any distributions in respect of the Underlying Shares must be converted back into New Zealand
11 dollars by the Smartshares Funds. The Smartshares Funds do not hedge any of their exposure to the US dollar.
• Difference between market price and net asset value – The Underlying Shares are purchased by the Smartshares Funds at market prices. Although it is expected that the market price of an Underlying Share typically will approximate its net asset value, there may be times when the Smartshares Funds may pay more or less than the net asset value when buying Underlying Shares and may receive more or less than the net asset value when selling Underlying Shares. • US Legal Risk – The Underlying Funds are based in the United States and so there is a risk that
US tax and other laws will apply to the Smartshares Funds and/or investors in a way that the Manager did not anticipate or that such laws change in a way that adversely affects the Underlying Funds, the Smartshares Funds and/or investors.
• Passive investment risk – The Smartshares Funds are passive investments and so the Manager will not react to events that affect the value of its investments in the Underlying Funds (such as poor performance of Index Issuers in the Underlying Indices that the Underlying Funds track) and will continue to hold and purchase the relevant Underlying Shares in order to track the relevant Index.
Underlying Fund Risks
• Passive management risk – The Underlying Funds are passive investments, meaning that the Underlying Fund Manager does not make active investment decisions in relation to the Index Issuers that it invests in. The prospectus of the each Underlying Fund states that the Underlying Fund Manager aims to buy and sell Index Securities with the intention of tracking the relevant Underlying Index. If an Index Issuer were to perform poorly, the Underlying Fund Manager would not take any action, unless and until action would be required to ensure that the Underlying Fund continues to track the relevant Underlying Index.
• Tracking risk – For a variety of reasons the Underlying Fund Manager may not always track the relevant Underlying Index for each Underlying Fund exactly. As a result of this, the investment performance of the Index Securities held by each Underlying Fund may not, over time, match the investment performance of the relevant Underlying Index exactly. Of course, investors investing directly in order to track an Underlying Index are likely to face the same issues as the Underlying Fund Manager in trying to track the relevant Underlying Index.
• Distributions Risk – The level of distributions that the Smartshares Funds receive from the Underlying Funds is dependent on the level of distributions paid by Index Issuers on the Index Securities. The Manager has no influence over the dividend policies of Index Issuers or the Underlying Funds or over anything else that may affect the level of distributions paid by them. Accordingly, there is no guarantee of any particular level of distributions.
• Regulatory and Tax risk – The Underlying Funds may be adversely affected by future changes in applicable laws, including tax laws, or by decisions taken by regulatory agencies enforcing those laws, which may affect the value of Underlying Shares or distributions made to holders of Underlying Shares (including the relevant Underlying Fund).
• Index Securities risk – The Underlying Funds invest in broadly based portfolios of securities and there is a risk that the securities’ prices and distributions may decline, thereby adversely affecting the Return on such investment. Returns on Index Securities may be affected by the circumstances of individual Index Issuers (Index Issuer risk) or the circumstances of Index Issuers within a particular industry (sector risk) or geographic area (country-regional risk) or by general sharemarket fluctuations or volatile increases and decreases in the price of securities generally (market risk).
• Halt, Suspension or Delisting Risk – The Underlying Shares are listed for trading on NYSE Arca (an exchange). Trading in the Underlying Shares may be halted or suspended or the Underlying Shares may be delisted which may mean the Manager is unable to trade Underlying Shares either temporarily or permanently.
• Currency risk – The Underlying Funds pay distributions in US Dollars and the Underlying Shares are denominated in US Dollars. However, several of the Underlying Funds invest in foreign entities.
12 These funds may be exposed to a currency risk based on the exchange rate between the currency the Returns are received in and the US dollar.
General Risks
• Operational risk – There is a risk that errors, fraud or misconduct may cause a loss to a Smartshares Fund or otherwise affect Unitholders' Returns. Policies and procedures have been adopted by the Manager to mitigate this risk, and the Manager has also insured, subject to normal commercial excesses, against losses arising from fraud and misconduct.
• Underlying Fund Operational Risk – The Smartshares Funds rely on the Underlying Fund Manager to properly manage the Underlying Funds. The Manager does not have control over the Underlying Fund Manager and so there is a risk that the Underlying Fund Manager will not perform its functions properly (which the Manager may not immediately become aware of). Such performance failures could have a material adverse effect on the value of a Smartshares Fund's investment in an Underlying Fund, and thus on Unitholders. The Underlying Fund Manager does not owe any obligations to Unitholders and only owes obligations to each Smartshares Fund as a shareholder in the relevant Underlying Fund.
• Liquidity risk – Except in limited circumstances, Unitholders are only able to cash in their investment by selling their Units on market. The market price per Unit may vary from the Current Unit Value due to supply and demand factors. Once the Manager's application to quote Units on the NZX Main Board has been accepted, Units will be quoted on the NZX Main Board and, in the opinion of the Manager, a market for sales of Units will develop. However, although the Units are expected to be quoted on the NZX Main Board, the fact that investors can apply to purchase Units directly from the Manager may mean there are fewer buyers of Units on the NZX Main Board. • Regulatory and tax risk – The Smartshares Funds are subject to an ongoing risk that regulatory
or tax law requirements may change, and that this may have an adverse effect on Unitholders' Returns. Also, each Smartshares Fund will be a Portfolio Investment Entity (PIE), with benefits for Unitholders, and there is a risk that this status may be lost, as discussed on page 30 below. There is further information about risks on pages 32 to 36.