dissenting:
I respectfully dissent. This stock fraud claim alleges that the issuers of closed-end funds, formed to invest primarily in mortgage-backed securities, represented that the portfolios would be “balanced,” i.e., invested in debt instruments that respond in opposite directions to fluctuations in interest rates, and failed to disclose that the fund managers *10were in fact betting heavily on rising interest rates and invested disproportionately in instruments that would benefit from rising rates.1 During the class period, interest rates declined 1.3 percentage points, contrary to the managers’ expectation of a rise, and the three funds lost 8.5 percent, 10.5 percent, and nearly 25 percent, respectively, of their net asset values — an outcome that Barron’s described as “far and away the worst showing of any closed-end bond fund.” Complaint ¶ 16. It is undisputed that several months after the prospectuses were issued and the appellants’ investments were made, the chairman and chief executive officer of the issuer of the funds disclosed in a report to shareholders that the initial portfolio of one of the funds was designed “with a bias toward a rising interest rate environment.”
The Court affirms the dismissal of the complaint for failure to state a claim on the ground that the allegedly undisclosed bias in favor of rising interest rates was in fact disclosed. Though the Court acknowledges that “the prospectuses contain no specific statement that there was a bias in favor of rising interest rates,” 98 F.3d at 7, the Court nevertheless concludes that the prospectuses “implicitly and clearly communicated such a bias.” Id. As evidence, the Court points to a passage in the prospectuses that disclosed that the decrease in net income and dividends that could result from a significant decline in interest rates could be greater than the increase in net income and dividends that could result from a significant rise in interest rates.2
The disclosure of these unequal consequences, the majority states, revealed the fund managers’ bias toward rising interest rates because “[t]he only way reasonable investors would then invest in the Trusts would be if they believed that the probability of rates rising exceeded the probability of interest rates dropping.” Id. (emphasis in original). To reach this conclusion before any evidence has been presented is contrary to Rule 12(b)(6) standards, which, as the Court recognizes, prohibit dismissal of a complaint unless “it is clear that no relief could be granted under any set of facts that could be proved consistent with the allegations.” I. Meyer Pincus & Associates v. Oppenheimer & Co., 936 F.2d 759, 762 (2d Cir.1991).
Not only is the Court’s assumption about purchasers of fixed-income securities unsupported by any evidence, it is also highly likely to be incorrect. Many investors, alerted to the possibility that falling interest rates “could” decrease their return in a particular fixed-income fund to a greater extent than rising interest rates “could” raise their return, will nevertheless buy such a fund, if described as “balanced,” in the expectation that the fund managers will try to balance their portfolio without a pronounced bias in favor of interest rate movements in either direction. They buy for stable return, slight*11ly above government securities, and for preservation of capital.
To assert, especially in the absence of evidence, that the purchasers of the Hyperion funds bought in the expectation of rising rates is a proposition at least unsupported and in all likelihood unsupportable. It is possible that a few of the purchasers expected a slight increase in interest rates. Others who bought might have expected a slight decrease in interest rates. Regardless of their expectations as to rates, the repeated assurances that the funds would be “balanced” entitled all of them to believe that the funds would be so structured as to be relatively insulated from any significant rate movements.
The fixed-income securities market uses the term “convexity” to describe the degree to which the values of securities are subject to interest rate fluctuations. The term applies primarily to mortgage-backed securities with components of principal and interest. A security that decreases in value in a rising interest rate environment to a greater extent than it increases in value in a declining interest rate environment is said to have “negative convexity.” Conversely, a security that increases in value in a declining interest rate environment to a greater extent than it decreases in value in a rising interest rate environment is said to have “positive convexity.” A fund sold as “balanced” can reasonably be expected to try to select securities so that the fund’s net convexity approaches zero. If a fund elects not to aim for as much balance as it can achieve and instead bets on a pronounced change in interest rates, it can be so structured (using significant amounts of 10 strips) that its overall value will increase with a rise in interest rates or decrease with declining interest rates. That is what happened with the Hyperion funds. But a “balanced” fund, even one that acknowledges the possibility that significant rate decreases could harm more than significant rate increases could benefit, is still expected to structure the portfolio so that the net convexity is very slight. If the fund managers are secretly betting so heavily on rising interest rates by such a significant inclusion of leveraged 10 strips that an interest rate decline will cause substantial decreases, they must say so. Their acknowledgement of the possible differing consequences of significantly decreasing and increasing rates does not reveal that their investment strategy is contrary to what would reasonably be expected of a “balanced” fund.
Of course, the investors in such funds have no valid stock fraud claim if fund managers turn out to be less skillful at balancing their portfolios than the investors hoped; if that is all that the appellants in this case were claiming, their suit would be properly dismissed. But they are not alleging unsuccessful balancing. Their claim is that the fund managers misrepresented when they announced their intention to try to balance the funds to an extent that would insulate against significant rate fluctuations, yet planned, from the outset and thereafter, to structure the portfolios in a way that would yield benefits only if their undisclosed bet on rising interest rates was successful.
The Court asserts that the prospectuses warn investors of exactly the risk the plaintiffs claim was not disclosed. A reasonable investor could not have read the prospectuses without realizing that, despite the use of balancing in an attempt to minimize the impact of fluctuating interest rates, a significant downturn in interest rates could decrease the value of the Trusts and decrease earnings.
98 F.3d at 5 (footnote omitted). This assertion misconceives the risk on which this suit is based. The appellants are not suing because of the disclosed risk that if interest rates declined, asset values would decline. They are suing because of the undisclosed risk that the fund managers would structure the initial portfolios and make investment decisions thereafter by selecting securities that would respond significantly to rate fluctuations that the managers believed, but did not disclose, would be rate rises. The investors accepted the risk that interest rates might decline and that imperfect balancing might cost them some money. They did not accept the risk that a fund, sold as being balanced in order to minimize the effects of interest rate fluctuations, would in fact be *12deliberately tilted so heavily in the expectation of rising interest rates that a decline in interest rates would incur devastating losses.
It is no answer to suggest that the funds were “balanced” in that they contained some securities whose values would move in opposite directions in response to interest rate fluctuations. Appellants do not claim that no balancing occurred; clearly, there was some diversification in the portfolios. The claim is that whatever balancing occurred was undertaken, initially and thereafter, on the undisclosed prediction by the fund managers that interest rates would rise. The fact that some mortgage-backed securities and some 10 strips were included in the portfolios indicates only that some diversification occurred. The significant losses occurred because of the undisclosed fact that the fund managers, betting heavily on rising interest rates, purchased on a highly leveraged basis a quantity of 10 strips of particular rates and maturities to such an extent that interest rate declines proved devastating.
It may well be, as the majority suggests, that portfolio managers of funds claimed to be balanced must inevitably make some predictions about future interest rates. Since it is unlikely that interest rates will remain completely static for any significant period of time, a manager of a balanced portfolio probably makes some prediction of the likely near-term direction of rates. But the whole point of balancing is to structure a portfolio so as to minimize the effects of any interest fluctuations, whether interest rate declines or rises are expected. Even a manager who believes that rates will rise will try to live up to the promise of a balanced fund by selecting a group of securities of low net convexity to guard against the risk of significant loss from rate fluctuations in either direction.
It cannot be maintained that what happened here is simply the inevitable inability of fund managers to balance as skillfully as might have been hoped. The other fixed-income funds that claimed to be balanced survived the modest interest decline that devastated the Hyperion funds. The Hyperion funds ended disastrously not because the managers lacked skill in balancing, but because they bet their investors’ money so heavily on rising rates. They were free to market a fund on that basis and invite investments from those who were also willing to bet heavily on rising interest rates. But they were not free to bet heavily on rising rates and conceal this critical fact from their investors.
In a further effort to bolster the argument that the bias toward rising interest rates was disclosed, the Court points out in a footnote that the prospectuses disclosed percentage breakdowns of the initial portfolio investments. Id. at 5 n. 1. The implied point is that these percentage breakdowns enabled investors to make their own determination of the degree to which the portfolio managers were balancing and thereby infer the bias toward rising interest rates inherent in then-selection of securities. The appellants respond that disclosure of only the percentages of the portfolio in various forms of securities (ie., mortgage-backed securities and 10 strips) cannot inform an investor of a bias toward rising interest rates in the absence of detail as to the precise nature of the various securities, their interest rates, and their maturities. The appellants are probably correct in their response, but, at a minimum, they are entitled to present evidence to support their basic contention that a reasonable investor, reading the prospectuses, would not have learned that the portfolios were initially invested with a heavy bet on rising interest rates. Even if such an understanding was available as to the initial investments, no reasonable investor could possibly learn that, contrary to the promises to try to balance the funds in the future in an effort to preserve capital and minimize the consequences of interest rate fluctuations, the portfolio managers always intended to reinvest with a distinct bias toward rising interest rates.
The Court also suggests that the undisclosed bias toward rising interest rates did not cause the appellants’ losses, which the Court attributes to declining interest rates. I agree that the appellants cannot claim as damages the entire decline in their investment, some part of which is attributable to falling interest rates, but they are entitled to recover the difference between (a) the modest decline that would have occurred if a *13good faith effort to balance the funds with portfolios of low net convexity had been attempted and (b) the precipitous decline that occurred in the absence of such attempted balancing.
Investors in fixed-income securities or funds of such securities seek rates of return above Treasury issues and accept the risk that unforeseen developments might cause their asset values to drop. But they are entitled to their day in court when they allege, in a detailed complaint, that issuers have promised an attempt to balance a fund to minimize the effects of interest rate fluctuations and have in fact bet heavily on rising interest rates and used the investors’ money to make that bet.
For these reasons, I respectfully dissent.
. Normally, the value of mortgage-backed securities decrease when interest rates increase, and rise when interest rates decline. These effects are enhanced by the change in the rate at which mortgagors elect to pay off their mortgages. When interest rates rise, the pay-off rate declines, and holders of mortgage-backed securities have, in effect, lengthened maturities on average and thereby reduced value. When interest rates decline, the mortgage pay-off rate rises, and holders of mortgage-backed securities have, in effect, shortened maturities on average, received back principal sooner than anticipated, and thereby enhanced value. One way of balancing a portfolio of mortgage-backed securities in order to lessen the effect of interest rate fluctuations is to purchase interest-only securities ("IO strips")— securities that entitle the holder to the interest payments of a mortgage, but no principal payments. IO strips respond to interest rate fluctuations in opposite directions from mortgage-backed securities (both those that entitle the holder to receive principal and interest and those that entitle the holder to receive only principal). Thus, the value of IO strips increases when interest rates rise and decreases when interest rates decline.
The funds in this case included significant amounts of IO strips in anticipation of rising interest rates. Some IO strips were purchased with borrowed funds, and this leveraging accentuated the adverse impact of the decline in interest rates that occurred.
. The key sentence states, “A significant decline in interest rates could lead to a significant decrease in the Trust's net income and dividends while a significant rise in interest rates could lead to only a moderate increase in the Trust’s net income and dividends.” Prospectus for Hyperion 1997 Term Trust, Inc. at 2. Identical statements were contained in the prospectuses for the 1999 and 2002 funds.