SPARROW GROWTH FUND
NOTES TO FINANCIAL STATEMENTS
FEBRUARY 28, 2013 (UNAUDITED)
NOTE 1. ORGANIZATION
The Sparrow Growth Fund (the “Fund”) was organized as a series of the Sparrow Funds (the “Trust”) on July 14, 1998 and commenced operations on October 4, 1998. The Trust is an open-end diversified investment company established under the laws of Ohio by an Agreement and Declaration of Trust dated July 14, 1998 (the “Trust Agreement”). The Fund’s investment objective is to provide long-term capital appreciation. The Trust Agreement permits the Board of Trustees (the “Board”) to issue an unlimited number of shares of beneficial interest of separate series. The Board has authorized three classes of shares: Class A shares, Class C shares, and No Load Class shares. Each class is subject to different expenses and a different sales charge structure. The investment advisor to the Fund is Sparrow Capital Management, Inc. (the “Advisor”).
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies followed by the Fund in the preparation of its financial statements. These policies are in conformity with accounting principles generally accepted in the U.S. (“GAAP”).
Security Valuations - All investments in securities are recorded at their estimated fair value, as described in Note 3.
Federal Income Taxes - The Fund’s policy is to continue to comply with requirements of Subchapter M of the Internal Revenue Code that are applicable to regulated investment companies and to distribute substantially all of its net investment income as dividends to its shareholders. Therefore, no federal income tax provision is required. It is the Fund’s policy to distribute annually, prior to the end of the calendar year, dividends sufficient to satisfy excise tax requirements of the Internal Revenue Code. This Internal Revenue Code requirement may cause an excess of distributions over the book year-end accumulated income. In addition, it is the Fund’s policy to distribute annually, after the end of the fiscal year, any remaining net investment income and net realized capital gains. Federal income tax capital loss carryforwards generated in prior years will be used to offset a portion of current year’s realized gains.
The Fund recognizes the tax benefits of certain tax positions only where the position is “more likely than not” to be sustained assuming examination by tax authorities. As of and during the six months ended February 28, 2013, management has analyzed the Fund’s tax positions, and has concluded that no liability for unrecognized tax benefits should be recorded related to uncertain tax positions taken on returns filed for open tax years (2009-2011), or expected to be taken in the Fund’s 2012 tax returns. The Fund identifies its major tax jurisdictions as U.S. Federal and certain State tax authorities. The Fund is not aware of any tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will change materially in the next twelve months. The Fund recognizes interest and penalties, if any, related to unrecognized tax benefits as income tax expense in the statement of operations. As of and during the six months ended February 28, 2013, the Fund did not incur any interest or penalties.
Security Transactions and Related Income - The Fund follows industry practice and records security transactions on the trade date. The first-in first-out (FIFO) method is used for determining gains or losses for financial statement and income tax purposes. Dividend income is recognized on the ex-dividend date and interest income is recognized on an accrual basis. Withholding taxes on foreign dividends have been provided for in accordance with the Fund’s understanding of the applicable country’s tax rules and rates.
Dividends and Distributions - The Fund typically distributes to its shareholders as dividends substantially all of its net investment income and taxable capital gains at least annually. These distributions, which are recorded on the ex-dividend date, are automatically reinvested in the Fund unless a shareholder requests cash distributions on the shareholder’s application or through a written request. The treatment for financial reporting purposes of distributions made to shareholders during the year from net investment income or net realized capital gains may differ from their ultimate treatment for federal income tax purposes. These differences are caused primarily by differences in the timing of the recognition of certain components of income, expense, or realized capital gain for federal income tax purposes. Where such differences are permanent in nature, they are reclassified in the components of the net assets based on their ultimate characterization for federal income tax purposes.
Estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of increases and decreases in net assets from operations during the reporting period. Actual results could differ from those estimates.
Sales Charges - With respect to Class A shares, there is a 5.75% maximum initial sales charge, except on purchases of $1 million or more or purchases by qualified retirement plans with at least 200 eligible employees. However, shares that are exempt from the initial sales charge will be subject to a contingent deferred sales charge (“CDSC”) of 1%, based on the lower of the shares’ cost or current net asset value (“NAV”), if the shares are redeemed within eighteen months of purchase. Effective October 1, 2008, the Fund’s Class C shares were reclassified as No Load Class shares and the fee structure was changed. With respect to No Load Class shares, there is no initial sales charge or CDSC. Prior to October 1, 2008, Class C shares were subject to a CDSC of 2.00% based on the lower of the shares’ cost or current NAV, if the shares were redeemed within two years of purchase. Effective January 5, 2012, the Fund opened up a new Class C of shares. There are no CDSC and redemption fees associated with this class of shares.
Allocation of Income and Expenses, Realized and Unrealized Gains and Losses – Income, realized gains and losses, unrealized appreciation and depreciation, and Fund-wide expenses are allocated on a daily basis to each class of shares based upon their relative net assets. Class-specific expenses are charged directly to the respective share class.
NOTE 3. SECURITIES VALUATIONS
As described in Note 2, all investments in securities are recorded at their estimated fair value. The Fund utilizes various methods to measure the fair value of most of its investments on a recurring basis. GAAP establishes a hierarchy that prioritizes inputs to valuation methods. The three levels of inputs are:
Level 1 - Unadjusted quoted prices in active markets for identical assets or liabilities that the Fund has the ability to access.
Level 2 - Observable inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These inputs may include quoted prices for the identical instrument on an inactive market, prices for similar instruments, interest rates, prepayment speeds, credit risk, yield curves, default rates and similar data.
Level 3 - Unobservable inputs for the asset or liability, to the extent relevant observable inputs are not available, representing the Fund’s own assumptions about the assumptions a market participant would use in valuating the asset or liability, and would be based on the best information available.
The availability of observable inputs can vary from security to security and is affected by a wide variety of factors, including, for example, the type of security, whether the security is new and not yet established in the marketplace, the liquidity of markets, and other characteristics particular to the security. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised in determining fair value is greatest for instruments categorized in Level 3.
The inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement falls in its entirety, is determined based on the lowest level input that is significant to the fair value measurement in its entirety.
Fair Value Measurements - A description of the valuation techniques applied to the Fund’s major categories of assets and liabilities measured at fair value on a recurring basis follows.
Equity securities (common stocks, including ADRs) - Equity securities are generally valued by using market quotations furnished by a pricing service when the Advisor believes such prices accurately reflect the fair market value of such securities. Securities that are traded on any stock exchange are valued by the pricing service at the last quoted sale price. Lacking a last sale price, an exchange traded security is valued by the pricing service at its last bid price. Securities traded in the NASDAQ over-the-counter market are valued by the pricing service at the NASDAQ Official Closing Price. Generally, if the security is traded in an active market and is valued at the last sale price in an active market, the security is categorized as Level 1 within the fair value hierarchy. When the security position is not considered to be part of an active market, or when the security is valued at the bid price, the position is generally categorized as Level 2 in the fair value hierarchy. When market quotations are not readily available, when the Advisor determines that the market quotation or the price provided by the pricing service does not accurately reflect the current market value or when restricted or illiquid securities are being valued, such securities are valued at fair value as determined by the Advisor in good faith, in accordance with guidelines adopted by and subject to review of the Board of Trustees and are categorized as Level 3 within the fair value hierarchy. Manually priced securities held by the Fund (if any) are reviewed by the Board of Trustees on a quarterly basis. To the extent these securities are actively traded and valuation adjustments are not applied, they are categorized as Level 1 within the fair value hierarchy.
Money market mutual funds are generally priced at the ending NAV provided by the service agent of the Fund. These securities will be categorized as Level 1 within the fair value hierarchy.
The following table summarizes the inputs used to value the Fund’s assets measured at fair value as of February 28, 2013:
| | | | |
Valuation Inputs of Assets | Level 1 | Level 2 | Level 3 | Total |
Common Stock | $10,542,448 | $0 | $0 | $10,542,448 |
Short-Term Investments | 14,388 | 0 | 0 | 14,388 |
Total | $10,556,836 | $0 | $0 | $10,556,836 |
The Fund did not hold any Level 3 assets during the six months ended February 28, 2013. For more detail on the investments in common stocks please refer to the Schedule of Investments. The Fund did not hold any derivative instruments at any time during the six months ended February 28, 2013. There were no transfers into or out of Level 1 or Level 2 during the six months ended February 28, 2013. The Fund considers transfers into or out of Level 1 and Level 2 as of the end of the reporting period.
NOTE 4. AGREEMENTS AND OTHER TRANSACTIONS WITH AFFILIATES
The Fund retains the Advisor to manage the Fund’s investments. The President of the Advisor is also a Trustee of the Trust.
Under the terms of the management agreement between the Advisor and the Trust on behalf of the Fund (the “Agreement”), the Advisor manages the Fund’s investments. The Fund pays the Advisor a management fee at the annual rate of 1.00% of the Fund’s average daily net assets. The Fund pays all of its operating expenses. Effective October 1, 2008 the Advisor contractually agreed to waive its management fee and/or to reimburse certain operating expenses to the extent necessary to maintain the Fund’s total annual operating expenses, excluding interest, brokerage fees and commissions, taxes, 12b-1 fees, extraordinary litigation expenses, any indirect expenses (such as fees and expenses incurred by other investment companies in which the Fund may invest), and certain expenses incurred in connection with the closing of the Fund or the class at 1.25% of the average daily net assets for each class. The contractual agreement expired as of December 31, 2010, and the Advisor did not renew the contractual obligation to the Fund. Each fee waiver and expense reimbursement by the Advisor for the Fund is subject to repayment by the Fund within the three fiscal years following the fiscal year in which the expense was incurred, provided that the Fund is able to make the repayment without exceeding the 1.25% expense limitation. For the six months ended February 28, 2013, the Advisor earned fees of $57,093 from the Fund. As of February 28, 2013, the Fund owed $8,277 to the Advisor. At February 28, 2013, the amount subject to future recoupment is as follows:
| | |
Fiscal Year Ended | Recoverable Through | Amount |
August 31, 2010 | August 31, 2013 | $66,933 |
August 31, 2011 | August 31, 2014 | $27,562 |
| | $94,495 |
Rafferty Capital Markets, LLC (the “Distributor”) acts as the principal distributor of the Fund’s shares. The Fund has adopted Distribution Plans (the “Plans”) pursuant to Rule 12b-1 under the Investment Company Act of 1940, as amended.
Under the Plans, the Fund pays an annual fee of 0.50% of the average daily net assets of the Fund invested in Class A shares and 1.00% of the average daily net assets of the Fund invested in Class C shares to help defray the cost of distributing shares. The 12b-1 fees are used by the distributor to compensate qualifying financial institutions (such as banks, brokers-dealers and other industry professionals) who sell shares and provide distribution-related and other services to the Fund's shareholders to the extent these institutions are allowed to do so by applicable statutes, rules or regulations. The Fund may also pay no more than 0.25% of these amounts directly to the Fund’s adviser, to be used by the adviser to compensate any entity, including registered broker-dealers, custodians, investment advisers, financial planners, 401(k) administrators, etc, that perform certain administrative or other servicing functions for the Fund’s shareholders.
Under the No-Load Class Plan, the Fund pays the Advisor an annual fee of 0.25% of the average daily net assets of the Fund invested in No-Load Class shares to help defray the cost of servicing the No-Load Class shares. The Advisor will use these fees to compensate with a “service fee,” any entities that perform certain administrative or other servicing functions for the Fund’s No-Load Class shares, including registered broker-dealers, custodians, mutual fund platform sponsors, investment advisers, financial planners, 401(k) administrators, etc.
The Plans are compensation plans, which means that compensation is provided irrespective of actual 12b-1 fees incurred. For the six months ended February 28, 2013, Class A incurred 12b-1 expenses of $26,040, Class C incurred 12b-1 expenses of $1,084, and No Load Class incurred 12b-1 expenses of $982.
NOTE 5. INVESTMENT TRANSACTIONS
For the six months ended February 28, 2013, purchases and sales of investment securities, other than short-term investments, were as follows:
Purchases
Investment Securities $ 13,679,900
Sales
Investment Securities $ 16,709,082
NOTE 6. TAX MATTERS
At February 28, 2013, the aggregate cost of securities for federal income tax purposes was $9,265,777.
As of February 28, 2013, the net unrealized appreciation of investments for tax purposes was as follows:
Gross Appreciation $ 1,346,844
Gross (Depreciation) (55,785)
Net Appreciation on Investments * $ 1,291,059
The tax character of distributions paid during the six months ended February 28, 2013, and the fiscal year ended August 31, 2012, were as follows:
| | |
| February 28, 2013 | August 31, 2012 |
Distributions paid from: | | |
Ordinary Income | $ - | $ - |
Return of Capital | - | - |
Total | $ - | $ - |
As of February 28, 2013, the components of distributable earnings (accumulated losses) on a tax basis were as follows:
Capital Loss Carryforward $ (1,497,312)
Accumulated Net Investment Loss (120,939)
Net Unrealized Appreciation * 1,291,059
$ (327,192)
* Differences between financial reporting basis and tax-basis are primarily attributable to post-October losses which amounted to $147,976.
NOTE 7. CAPITAL LOSS CARRYFORWARD
Under the recently enacted Regulated Investment Company Act of 2010 (the “Act”), funds are permitted to carryforward capital losses incurred in taxable years beginning after December 22, 2010 for an unlimited period of time. The short-term and long-term characters of such losses are retained rather than being treated as short-term as under previous law. Pre-enactment losses are eligible to be carried forward for a maximum period of eight years. Pursuant to the Act, post-enactment capital loss carryforwards must be utilized before pre-enactment losses and therefore pre-enactment losses may be more likely to expire unused. The Fund’s capital loss carryforward amounts as of February 28, 2013, are as follows:
| |
Capital Loss Carryforward | Amount |
Expiring August 31, 2018 | $ 1,497,312 |
Total | $ 1,497,312 |
To the extent that the capital loss carryforwards are used to offset future realized capital gains, it is probable that the amount, which is offset, will not be distributed.
NOTE 8. BENEFICIAL OWNERSHIP
The beneficial ownership, either directly or indirectly, of more than 25% of the voting securities of a fund creates a presumption of control of the fund, under Section 2(a)(9) of the Investment Company Act of 1940. As of February 28, 2013, TD Ameritrade, Inc. owned, for the benefit of its customers, 38.96% of the outstanding shares of Class A. As of February 28, 2013, First Clearing, LLC owned, for the benefit of its customers, 84.46% of the outstanding shares of Class C. As of February 28, 2013, Samantha B. Rhodes Revocable Living Trust 10/24/07, owned 32.12% of the outstanding shares of the No-Load Class.
NOTE 9. NEW ACCOUNTING PRONOUNCEMENT
In December 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (“ASU”) No. 2011-11 related to disclosures about offsetting assets and liabilities. The amendments in this ASU require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The ASU is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. The guidance requires retrospective application for all comparative periods presented. Management is currently evaluating the impact of this amendment may have on the Fund’s financial statements.
SPARROW GROWTH FUND
EXPENSE ILLUSTRATION
FEBRUARY 28, 2013 (UNAUDITED)
Expense Example
As a shareholder of the Fund, you incur two types of costs: (1) transaction costs, including sales charges (loads) on purchase payments, reinvested dividends, or other distributions; and (2) ongoing costs, including management fees; distribution and/or service (12b-1) fees; and other Fund expenses. This Example is intended to help you understand your ongoing costs (in dollars) of investing in the Fund and to compare these costs with the ongoing costs of investing in other mutual funds.
The Example is based on an investment of $1,000 invested at the beginning of the period and held for the entire period, September 1, 2012 through February 28, 2013.
Actual Expenses
The first line of the table below provides information about actual account values and actual expenses. You may use the information in this line, together with the amount you invested, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number in the first line under the heading entitled "Expenses Paid During Period" to estimate the expenses you paid on your account during this period.
Hypothetical Example for Comparison Purposes
The second line of the table below provides information about hypothetical account values and hypothetical expenses based on the Fund’s actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Fund’s actual return. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period. You may use this information to compare the ongoing costs of investing in this Fund and other funds. To do so, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder reports of the other funds.
Please note that the expenses shown in the table are meant to highlight your ongoing costs only and do not reflect any transactional costs, such as sales charges (loads). Therefore, the second line of the table is useful in comparing ongoing costs only, and will not help you determine the relative cost of owning different funds. In addition, if these transactional costs were included, your cost could have been higher.
* Address of each Trustee is 211 N. Broadway, Suite 2080, St. Louis, MO 63102.
TRUSTEES
Gerald R. Sparrow
Richard N. Priest
Donald D. Woodruff
OFFICERS
Gerald R. Sparrow, President, Chief Compliance Officer, Secretary and Treasurer
INVESTMENT ADVISOR
Sparrow Capital Management, Inc.
211 N. Broadway, Suite 2080
St. Louis, MO 63102
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Cohen Fund Audit Services, Ltd.
1350 Euclid Ave., Suite 800
Cleveland, OH 44115
LEGAL COUNSEL
Thompson Hine LLP
312 Walnut Street, 14th Floor
Cincinnati, OH 45202
CUSTODIAN
US Bank, N.A.
425 Walnut St.
Cincinnati, OH 45202
TRANSFER AGENT AND FUND ACCOUNTANT
Mutual Shareholder Services, LLC
8000 Town Centre Drive Suite 400
Broadview Heights, OH 44147
Additional information about the Trustees is available in the Fund's Statement of Additional Information which is available, without charge, upon request by calling (888) 727-3301.
This report is intended only for the information of shareholders or those who have received the Fund’s prospectus which contains information about the Fund’s management fee and expenses. Please read the prospectus carefully before investing.
Item 2. Code of Ethics. Not applicable.
Item 3. Audit Committee Financial Expert. Not applicable.
Item 4. Principal Accountant Fees and Services. Not applicable.
Item 4. Principal Accountant Fees and Services.
Item 5. Audit Committee of Listed Companies. Not applicable.
Item 6. Schedule of Investments. Not applicable – schedule filed with Item 1.
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End Funds. Not applicable – applies to closed-end funds only.
Item 8. Portfolio Managers of Closed-End Management Investment Companies. Not applicable – applies to closed-end funds only.
Item 9. Purchases of Equity Securities by Closed-End Management Investment Companies and Affliliated Purchasers. Not applicable – applies to closed-end funds only.
Item 10. Submission of Matters to a Vote of Security Holders. Not applicable – the registrant has not adopted procedures by which shareholders may recommend nominees to the registrant’s board of trustees.
Item 11. Controls and Procedures.
(a)
The Principal Executive and Financial Officers concluded that the Registrant's Disclosure Controls and Procedures are effective based on their evaluation of the Disclosure Controls and Procedures as of a date within 90 days of the filing of this report.
(b)
There were no significant changes in the registrant’s internal control over financial reporting that occurred during the registrant’s second fiscal half-year that have materially affected, or are reasonably likely to materially affect, the registrant’s internal control over financial reporting.
Item 11. Exhibits.
(a)(1)
EX-99.CODE ETH. Filed herewith.
(a)(2)
EX-99.CERT. Filed herewith.
(a)(3)
Any written solicitation to purchase securities under Rule 23c-1 under the Act (17 CFR 270.23c-1) sent or given during the period covered by the report by or on behalf of the registrant to 10 or more persons. Not applicable.
(b)
EX-99.906CERT. Filed herewith.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Sparrow Funds
By /s/ Gerald Sparrow
*Gerald Sparrow
President
Date May 1, 2013
Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
By /s/ Gerald Sparrow
*Gerald Sparrow
President and Treasurer
Date May 1, 2013
* Print the name and title of each signing officer under his or her signature.
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