<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
MORGAN STANLEY MILLER
ASSET MANAGEMENT INC. ANDERSON &
SHERRERD, LLP
MORGAN STANLEY UNIVERSAL FUNDS, INC. (THE "FUND") IS A MUTUAL FUND DESIGNED TO
PROVIDE INVESTMENT VEHICLES FOR VARIABLE ANNUITY CONTRACTS AND VARIABLE LIFE
INSURANCE POLICIES AND FOR CERTAIN TAX-QUALIFIED INVESTORS. THIS PROSPECTUS
DESCRIBES EIGHT PORTFOLIOS MANAGED BY EITHER MORGAN STANLEY ASSET MANAGEMENT
INC. ("MSAM") OR MILLER ANDERSON & SHERRERD, LLP ("MAS"). THE FUND MAKES
AVAILABLE IN A SINGLE PRODUCT THE COMBINED STRENGTH OF THESE LEADING INVESTMENT
MANAGEMENT FIRMS. THE FUND ALSO OFFERS NINE OTHER PORTFOLIOS MANAGED BY MSAM OR
MAS.
THIS PROSPECTUS CONTAINS IMPORTANT INFORMATION ABOUT THE FUND'S INVESTMENTS AND
SERVICES. YOU SHOULD READ IT BEFORE INVESTING, AND KEEP IT ON FILE FOR FUTURE
REFERENCE ALONG WITH THE PROSPECTUS OF THE SEPARATE ACCOUNT OF THE SPECIFIC
INSURANCE PRODUCT WHICH ACCOMPANIES THIS PROSPECTUS.
A STATEMENT OF ADDITIONAL INFORMATION DATED OCTOBER 1, 1996, HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION AND IS INCORPORATED HEREIN BY
REFERENCE, AND, THEREFORE, LEGALLY FORMS A PART OF THE PROSPECTUS. FOR A FREE
COPY, CONTACT THE FUND OR YOUR INSURANCE COMPANY.
SHARES OF EACH PORTFOLIO MAY BE PURCHASED ONLY BY INSURANCE COMPANIES FOR THEIR
SEPARATE ACCOUNTS FOR THE PURPOSE OF FUNDING VARIABLE ANNUITY CONTRACTS AND
VARIABLE LIFE INSURANCE POLICIES AND BY CERTAIN TAX-QUALIFIED INVESTORS.
PARTICULAR PORTFOLIOS MAY NOT BE AVAILABLE IN YOUR STATE DUE TO VARIOUS
INSURANCE REGULATIONS. PLEASE CHECK WITH YOUR INSURANCE COMPANY FOR AVAILABLE
PORTFOLIOS. INCLUSION OF A PORTFOLIO IN THIS PROSPECTUS WHICH IS NOT AVAILABLE
IN YOUR STATE IS NOT TO BE CONSIDERED A SOLICITATION.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
THE PORTFOLIOS:
U.S. FIXED INCOME PORTFOLIOS
Fixed Income High Yield
U.S. EQUITY PORTFOLIOS
Growth Mid Cap Value
Value
GLOBAL PORTFOLIOS
Global Equity Emerging Markets Equity
International Magnum
AN INVESTMENT IN ANY PORTFOLIO IS NEITHER INSURED NOR GUARANTEED BY THE U.S.
GOVERNMENT. YOU MAY RECEIVE MORE OR LESS THAN YOU INVESTED WHEN YOU REDEEM YOUR
SHARES.
THE HIGH YIELD PORTFOLIO MAY INVEST WITHOUT LIMITATION IN LOWER-QUALITY DEBT
SECURITIES, SOMETIMES CALLED "JUNK BONDS." YOU SHOULD CONSIDER THAT THESE
SECURITIES CARRY GREATER RISKS, SUCH AS THE RISK OF DEFAULT, THAN OTHER DEBT
SECURITIES. REFER TO "SECURITIES AND INVESTMENT TECHNIQUES--HIGH YIELD
SECURITIES" FOR FURTHER INFORMATION.
THE EMERGING MARKETS EQUITY PORTFOLIO MAY INVEST IN EQUITY SECURITIES OF
RUSSIAN COMPANIES. RUSSIA'S SYSTEM OF SHARE REGISTRATION AND CUSTODY INVOLVES
CERTAIN RISKS OF LOSS THAT ARE NOT NORMALLY ASSOCIATED WITH INVESTMENTS IN
OTHER SECURITIES MARKETS. SEE "SECURITIES AND INVESTMENT TECHNIQUES--RUSSIAN
SECURITIES."
Prospectus dated January 13, 1997
MORGAN STANLEY UNIVERSAL FUNDS, INC.
P.O. Box 2798, Boston, MA 02208-2798
<PAGE>
THE FUND
The Fund is an open-end management investment company, or mutual fund. Each of
the eight separate investment portfolios (each, a "Portfolio") described in
this Prospectus has a distinct investment objective. The following pages
describe the types of securities and investment techniques each Portfolio uses
to seek its objective, as well as the risks inherent in those types of
securities and investment techniques.
MANAGEMENT
Morgan Stanley Asset Management Inc. ("MSAM" or the "Adviser") advises the
following Portfolios:
Global Equity Growth
International Magnum
Emerging Markets
Equity
MSAM conducts a worldwide investment advisory business and currently (with its
affiliates other than MAS) manages assets of approximately $66 billion.
Miller Anderson & Sherrerd, LLP ("MAS" or the "Adviser") advises the following
Portfolios:
Fixed Income Mid Cap Value
High Yield Value
MAS's institutional investment advisory business was established in 1969 and
MAS recently became an affiliate of MSAM. MAS currently manages assets of
approximately $37.5 billion.
OFFERING OF SHARES
The Fund is intended to be a funding vehicle for all types of variable annuity
contracts and variable life insurance policies offered by various insurance
companies. Shares of the Fund may also be offered to certain tax-qualified
investors, including qualified pension and retirement plans. It is possible
that material conflicts among the various insurance companies and other
investors in the Fund may arise. The Fund's Board of Directors will monitor
events in order to identify the existence of any material conflicts and to
determine what action, if any, should be taken in response to any such
conflicts.
PROSPECTUS OUTLINE PAGE
----
PORTFOLIO SUMMARIES 3
- -------------------
For each Portfolio, the investment objective and a summary of strategy,
potential investors, and investment characteristics and risks.
THE PORTFOLIOS' INVESTMENTS 5
- ---------------------------
A more detailed review of how each Portfolio invests and investment
characteristics and risks.
SECURITIES AND INVESTMENT TECHNIQUES 9
- ------------------------------------
More information about the types of investment strategies that may be used
by some or all of the Portfolios and information about investment risks and
limitations.
FUNDAMENTAL INVESTMENT LIMITS 24
- -----------------------------
Certain policies that may be changed only by shareholders.
MANAGEMENT OF THE FUND 24
- ----------------------
General information on organization and operations of the Fund, including
details about MSAM, MAS and the individual portfolio managers, as well as fees,
expenses and performance calculations.
ACCOUNT POLICIES 31
- ----------------
Information on net asset value calculation, income and gain distributions,
taxes and share purchases and redemptions.
2
<PAGE>
PORTFOLIO SUMMARIES
Certain investment terms used below have initial capital letters ("Common
Stocks," for example). These terms are further described under "Securities and
Investment Techniques" below.
U.S. FIXED INCOME PORTFOLIOS
FIXED INCOME PORTFOLIO
OBJECTIVE AND STRATEGY: Above-average total return over a market cycle of three
to five years by investing primarily in a diversified portfolio of U.S.
Governments and Agencies, Corporate Bonds, Mortgage-Backed Securities ("MBSs"),
Foreign Bonds and other Fixed Income Securities and Derivatives. The
Portfolio's average weighted maturity will ordinarily exceed five years and
will usually be between five and fifteen years.
INVESTOR PROFILE: The Portfolio may be appropriate for investors seeking an
above-average return from a diversified portfolio of Fixed Income Securities.
RISK PROFILE: Moderate potential risk and reward. The Portfolio will focus on
medium- to high-quality investments and intermediate maturity. The level of
risk, and potential reward, depends on the quality and maturity of the
investments. The Portfolio's share price can be expected to vary inversely to
changes in prevailing interest rates. While securities with longer maturities
tend to produce higher yields, the prices of longer maturity securities are
also subject to greater market fluctuations as a result of changes in interest
rates.
HIGH YIELD PORTFOLIO
OBJECTIVE AND STRATEGY: Above-average total return over a market cycle of three
to five years by investing primarily in a diversified portfolio of High Yield
Securities, including Corporate Bonds and other Fixed Income Securities and
Derivatives. High Yield Securities are rated below investment grade and are
commonly referred to as "junk bonds." The Portfolio's average weighted maturity
will ordinarily exceed five years and will usually be between five and fifteen
years.
INVESTOR PROFILE: The Portfolio may be appropriate for long-term, aggressive
investors who understand the potential risks and rewards of investing in lower-
quality securities, including defaulted securities, and are willing to accept
their greater price movements and credit risks.
RISK PROFILE: High potential risk and reward. Securities rated below investment
grade, as well as unrated securities of lower quality, usually entail greater
risk (including the possibility of default or bankruptcy of the issuers), and
generally involve greater price volatility and risk of principal and income,
and may be less liquid than securities in higher rated categories.
U.S. EQUITY PORTFOLIOS
GROWTH PORTFOLIO
OBJECTIVE AND STRATEGY: Long-term capital appreciation by investing primarily
in Equity Securities of medium and large capitalization companies that, in
MSAM's judgment, provide above-average potential for capital growth.
INVESTOR PROFILE: The Portfolio is designed for those who want to be invested
in the stock market for its long-term growth potential and who want to
diversify over a large number of individual stocks.
RISK PROFILE: Moderate to high potential risk and reward. An investor in the
Portfolio should be comfortable with the volatility of the U.S. stock market
and able to ride out market fluctuations in anticipation of greater long-term
growth.
VALUE PORTFOLIO
OBJECTIVE AND STRATEGY: Above-average total return over a market cycle of three
to five years by investing primarily in a diversified portfolio of Common
Stocks and other Equity Securities that are deemed by MAS to be relatively
undervalued based on various measures such as price/earnings ratios and
price/book ratios.
INVESTOR PROFILE: The Portfolio may be appropriate for investors seeking an
above-average return from Common Stocks of issuers with equity capitalizations
usually greater than $300 million that are deemed to be undervalued in the
marketplace.
RISK PROFILE: Moderate to high potential risk and reward. The Portfolio's share
price will fluctuate with changes in market, economic and Foreign Currency
exchange conditions.
MID CAP VALUE PORTFOLIO
OBJECTIVE AND STRATEGY: Above-average total return over a market cycle of three
to five years by investing in Common Stocks and other Equity Securities of
issuers with equity capitalizations in the range of the companies represented
in the Standard & Poor's Ratings Group ("S&P") MidCap 400 Index. Such range is
currently $100 million to $8 billion but the range fluctuates over time with
changes in the equity market.
INVESTOR PROFILE: The Portfolio may be appropriate for investors seeking an
above-average total return from Common Stocks of medium-size companies that are
deemed to be undervalued in the marketplace.
RISK PROFILE: High potential risk and reward. The Portfolio's share price will
fluctuate with changes in market and economic conditions.
3
<PAGE>
GLOBAL PORTFOLIOS
GLOBAL EQUITY PORTFOLIO
OBJECTIVE AND STRATEGY: Long-term capital appreciation by investing primarily
in Equity Securities of issuers throughout the world, including U.S. issuers,
using an approach that is oriented to the selection of individual stocks that
MSAM believes are undervalued.
INVESTOR PROFILE: The Portfolio may be appropriate for investors who seek to
pursue their investment goals in markets throughout the world, including the
United States. By including international investments in their portfolio,
investors can achieve additional diversification and participate in growth
opportunities around the world.
RISK PROFILE: High potential risk and reward. In addition to general risks
involved in equity investments, including fluctuations in the stock market and
changes in the economy, international investing involves different or increased
risks. The performance of the Portfolio will be affected by Foreign Currency
values, the political and regulatory environment, greater volatility of
securities exchanges and overall political and economic factors in the
countries in which the Portfolio invests.
INTERNATIONAL MAGNUM PORTFOLIO
OBJECTIVE AND STRATEGY: Long-term capital appreciation by investing primarily
in Equity Securities of non-U.S. issuers in accordance with the EAFE country
(defined herein) weightings determined by MSAM.
INVESTOR PROFILE: The Portfolio may be appropriate for investors who seek to
pursue their investment goals in markets outside the United States. By
including international investments in their portfolio, investors can achieve
additional diversification and participate in growth opportunities around the
world.
RISK PROFILE: High potential risk and reward. In addition to general risks
involved in equity investments, including fluctuations in the stock market and
changes in the economy, international investing involves different or increased
risks. The performance of the Portfolio will be affected by Foreign Currency
values, the political and regulatory environment, greater volatility of
securities exchanges and overall political and economic factors in the
countries in which the Portfolio invests.
EMERGING MARKETS EQUITY PORTFOLIO
OBJECTIVE AND STRATEGY: Long-term capital appreciation by investing primarily
in Equity Securities of emerging market country issuers with a focus on those
in which MSAM believes the economies are developing strongly and in which the
markets are becoming more sophisticated.
INVESTOR PROFILE: The Portfolio may be appropriate for investors who seek to
achieve long-term capital appreciation by investing in Emerging Market Country
Securities. By including emerging market country investments in their
portfolio, investors can achieve additional diversification and participate in
growth opportunities in emerging market countries.
RISK PROFILE: Very high potential risk and reward. In addition to the general
risks involved in Equity Securities, including fluctuations in the stock market
and changes in the economy, international investing involves different or
increased risks. The performance of the Portfolio will be affected by Foreign
Currency values, the political and regulatory environment, the greater
volatility of securities exchanges and overall political and economic factors
in the countries in which the Portfolio invests.
INVESTMENT CHARACTERISTICS AND RISKS
The value of each Portfolio's investments and the income they generate will
vary from day-to-day and generally reflect market conditions, interest rates,
and other company, political, or economic news both in the United States and
abroad.
Each Portfolio spreads investment risk by limiting its holdings in any one
company or industry. Nevertheless, each Portfolio will experience price
volatility the extent of which will be affected by the types of securities and
techniques the particular Portfolio uses. In the short term, stock prices can
fluctuate dramatically in response to these factors. Over time, however, stocks
have shown greater growth potential than other types of securities. The prices
of bonds also fluctuate and generally move in the opposite direction from
interest rates.
Investments in foreign securities may involve risks in addition to those of
U.S. investments. The performance of the Portfolios investing in foreign
securities will be affected by Foreign Currency values, the political and
regulatory environment, and overall economic factors in the countries in which
investments are made.
Because the International Magnum and Emerging Markets Equity Portfolios are
non-diversified portfolios and are permitted greater flexibility to invest
their assets in the obligations of a single issuer, they are exposed to
increased risk of loss if such an investment underperforms expectations. See
"Non-Diversified Status" in this Prospectus and "Investment Limitations" in the
Statement of Additional Information ("SAI").
Investments in securities rated below investment grade, sometimes called high
risk or High Yield Securities or junk bonds, carry a high degree of risk and
are considered speculative. MSAM and MAS may use various investment techniques
to hedge risks, including the use of Derivatives, but there is no guarantee
that these strategies will work as
4
<PAGE>
intended. When Portfolio shares are redeemed, they may be worth more or less
than their original cost. An investment in any one Portfolio is not in itself a
balanced investment plan. As with any mutual fund, there is no assurance that a
Portfolio will achieve its goal.
Each Portfolio will be invested according to its investment strategy. However,
the Portfolios also have the ability to invest without limitation in high
quality Money Market Instruments or Temporary Investments for temporary,
defensive purposes. See "Securities and Investment Techniques" below.
THE PORTFOLIOS' INVESTMENTS
U.S. FIXED INCOME PORTFOLIOS
FIXED INCOME PORTFOLIO
The Portfolio seeks to achieve above-average total return over a market cycle
of three to five years by investing in a diversified portfolio of U.S.
Governments and Agencies, Corporate Bonds, Foreign Bonds, MBSs of domestic
issuers, and other Fixed Income Securities and Derivatives. The Portfolio's
average weighted maturity will ordinarily exceed five years and will usually be
between five and fifteen years.
Under normal circumstances, the Portfolio will invest at least 65% of its total
assets in Fixed Income Securities, not more than 20% of which will be below
investment grade (commonly referred to as High Yield Securities or junk bonds).
Permissible investments include Municipals, Loan Participations and
Assignments, Investment Company Securities, When-Issued and Delayed Delivery
Securities and Derivatives, including but not limited to CMOs, Structured
Notes, Foreign Currency, Forward Foreign Currency Exchange Contracts, Futures,
Options and Swaps. For additional investment information, see "Securities and
Investment Techniques" below.
The Adviser's approach is to actively manage the maturity and duration
structure of the Portfolio in anticipation of long-term trends in interest
rates and inflation. Investments are diversified among a wide variety of Fixed
Income Securities in all market sectors. For additional information about
strategies employed in managing the Portfolio, see "Maturity and Duration
Management," "Value Investing," "Mortgage Investing," "High Yield Investing,"
"Foreign Fixed Income Investing" and "Foreign Investing" in "Securities and
Investment Techniques" below.
HIGH YIELD PORTFOLIO
The Portfolio seeks above-average total return over a market cycle of three to
five years by investing at least 65% of its total assets in High Yield
Securities of U.S. and foreign issuers including Corporate Bonds and other
Fixed Income Securities. High Yield Securities are rated below investment grade
and are commonly referred to as high yield bonds or junk bonds. The Portfolio
expects to achieve its objective through maximizing current income, although
the Portfolio may seek capital growth opportunities when consistent with its
objective. The Portfolio's average weighted maturity ordinarily will exceed
five years and will usually be between five and fifteen years.
Under normal circumstances, the Portfolio will invest at least 65% of its total
assets in High Yield Securities. The Portfolio may also invest in investment
grade Fixed Income Securities of domestic and foreign issuers, including
Eastern European and Emerging Market Country Securities, and in Foreign
Currency, Investment Company Securities, Foreign Equities, Loan Participations
and Assignments, Municipals, Brady Bonds, Asset-Backeds, When-Issued or Delayed
Delivery Securities, and Derivatives, including but not limited to SMBSs, CMOs,
Structured Notes, Forwards, Futures, Options and Swaps. For risks associated
with High Yield Securities and additional information about investments, see
"Securities and Investment Techniques" below.
The Adviser's approach is to use equity and fixed income valuation techniques
and analyses of economic and industry trends to determine portfolio structure.
Individual securities are selected and monitored by fixed income portfolio
managers who specialize in credit analysis of Fixed Income Securities and use
in-depth financial analysis to uncover opportunities in undervalued issues. For
additional information about strategies employed in managing the Portfolio, see
"High Yield Investing," "Maturity and Duration Management," "Value Investing,"
"Mortgage Investing," "Foreign Fixed Income Investing," "Foreign Investing" and
"Emerging Markets Investing" in "Securities and Investment Techniques" below.
U.S. EQUITY PORTFOLIOS
GROWTH PORTFOLIO
The Portfolio seeks long-term capital appreciation by investing primarily in
growth-oriented Common and Preferred Stocks, Convertible Securities, Rights and
Warrants to purchase Common Stocks, Depositary Receipts and other Equity
Securities.
Under normal circumstances, the Portfolio will invest at least 65% of its total
assets in Equity Securities. The Portfolio may also invest in Foreign Currency,
Non-Publicly Traded Securities, Private Placements, Restricted Securities,
Money Market Instruments, Investment Company Securities, Repurchase Agreements,
When-Issued and Delayed Delivery Securities, other Fixed Income Securities and
Derivatives, including but not limited to Forwards, Futures, Options and Swaps,
and may lend its portfolio securities. For additional information about
investments, see "Securities and Investment Techniques" below.
The Portfolio will focus its investments on Equity Securities of medium and
large capitalization U.S. corporations and,
5
<PAGE>
subject to an overall 25% limit, Foreign Equities. The Portfolio may invest in
securities of foreign issuers directly or in the form of Depositary Receipts.
Since the Portfolio invests in both Common Stocks and Convertible Securities
(when due to market conditions, it is more advantageous to purchase Convertible
Securities), the risks of investing in the general equity markets may be
tempered to a degree by the Portfolio's investments in Convertible Securities
which are often not as volatile as Common Stock.
The Adviser employs a flexible and eclectic investment process in pursuit of
the Portfolio's investment objectives. In selecting stocks for the Portfolio,
the Adviser concentrates on a universe of rapidly growing, high-quality
companies and lower, but accelerating, earnings growth situations. The
Adviser's universe of potential investments generally comprises companies with
market capitalizations of $500 million or more. The Adviser concentrates on
companies with strong, communicative managements and clearly defined strategies
for growth. In addition, the Adviser rigorously assesses company developments,
including changes in strategic direction, management focus and current and
likely future earnings results. Valuation is important to the Adviser but is
viewed in the context of prospects for sustainable earnings growth and the
potential for positive earnings surprises vis-a-vis consensus expectations. The
Portfolio may invest in any Equity Security that, in the Adviser's judgment,
provides above-average potential for capital appreciation.
In selecting investments for the Portfolio, the Adviser emphasizes individual
security selection. The Portfolio's investments will generally be diversified
by number of issues but concentrated sector positions may result from the
investment process. The Portfolio has a long-term investment perspective;
however, the Adviser may take advantage of short-term opportunities that are
consistent with the Portfolio's objective by selling recently purchased
securities which have increased in value.
VALUE PORTFOLIO
The Portfolio seeks above-average total return over a market cycle of three to
five years by investing primarily in Common and Preferred Stocks, Convertible
Securities, Rights and Warrants to purchase Common Stocks, American Depositary
Receipts ("ADRs") and other Equity Securities of companies with equity
capitalizations usually greater than $300 million.
Under normal circumstances, the Portfolio will invest at least 65% of its total
assets in Equity Securities. The Portfolio may invest up to 5% of its total
assets in Foreign Equities (other than ADRs). The Portfolio may also invest in
U.S. Governments and Agencies, Corporate Bonds, Foreign Bonds, Zero Coupons,
Repurchase Agreements, Cash Equivalents, Foreign Currency, Investment Company
Securities, When-Issued or Delayed Delivery Securities and Derivatives,
including but not limited to Forwards, Futures, Options and Swaps. For
additional information about investments, see "Securities and Investment
Techniques" below.
The Adviser's approach is to select Equity Securities that are deemed to be
undervalued relative to the stock market in general as measured by the S&P 500
Index ("S&P 500"), based on value measures such as price/earnings ratios and
price/book ratios, as well as fundamental research. While capital return will
be emphasized somewhat more than income return, the Portfolio's total return
will consist of both capital and income returns. Stocks that are deemed to be
under-valued in the marketplace have, under most market conditions, provided
higher dividend income returns than stocks that are deemed to have long-term
earnings growth potential which normally sell at higher price/earnings ratios.
For additional information about strategies employed in managing the Portfolio,
see "Value Stock Investing" in "Securities and Investment Techniques."
MID CAP VALUE PORTFOLIO
The Portfolio seeks above-average total return over a market cycle of three to
five years by investing primarily in Common and Preferred Stocks, Convertible
Securities, Rights and Warrants to purchase Common Stocks, ADRs and other
Equity Securities of issuers with equity capitalizations in the range of the
companies represented in the S&P MidCap 400 Index. Such range is currently $100
million to $8 billion but the range fluctuates over time with changes in the
equity market.
Under normal circumstances, at least 65% of the Portfolio's total assets will
be invested in Equity Securities of mid-cap companies deemed to be undervalued.
The Portfolio may invest up to 5% of its total assets in Foreign Equities
(other than ADRs). The Portfolio may also invest in U.S. Governments and
Agencies, Corporate Bonds, Foreign Bonds, Zero Coupons, Repurchase Agreements,
Cash Equivalents, Foreign Currency, Investment Company Securities, When-Issued
and Delayed Delivery Securities and Derivatives, including but not limited to
Forwards, Futures, Options and Swaps. For additional information about
investments, see "Securities and Investment Techniques" below.
The Adviser's approach is to select Common Stocks that are deemed to be
relatively undervalued at the time of purchase based on certain proprietary
measures of value. The Portfolio will typically exhibit a lower price/earnings
value ratio than the S&P MidCap 400 Index. The Portfolio will be structured
taking into account the economic sector weights of the S&P MidCap 400 Index,
with sector weights normally being within 5% of the sector weights of the
Index. For additional information about strategies employed in managing the
Portfolio, see "Value Stock Investing" in "Securities and Investment
Techniques."
6
<PAGE>
GLOBAL PORTFOLIOS
GLOBAL EQUITY PORTFOLIO
The Global Equity Portfolio seeks long-term capital appreciation by investing
primarily in Common and Preferred Stocks, Convertible Securities, and Rights
and Warrants to purchase Common Stocks, Depositary Receipts and other Equity
Securities of issuers throughout the world, including issuers in the United
States and emerging market countries. Under normal circumstances, at least 65%
of the total assets of the Portfolio will be invested in Equity Securities. In
addition, under normal circumstances, at least 20% of the Portfolio's total
assets will be invested in the Common Stocks of U.S. issuers and the remaining
equity position will be invested in at least three countries other than the
United States. Although the Portfolio intends to invest primarily in securities
listed on stock exchanges, it will also invest in Equity Securities that are
traded over the counter or that are not admitted to listing on a stock exchange
or dealt in on a regulated market. As a result of the absence of a public
trading market, such securities may pose liquidity risks.
The Portfolio may also invest in Forwards, Money Market Instruments, Repurchase
Agreements and When-Issued or Delayed Delivery Securities, and may lend its
portfolio securities. For additional information about investments, see
"Securities and Investment Techniques" below.
The Adviser's approach is oriented to individual stock selection and is value
driven. In selecting stocks for the Portfolio, the Adviser initially identifies
those stocks that it believes to be undervalued in relation to the issuer's
assets, cash flow, earnings and revenues, and then evaluates the future value
of such stocks by running the results of an in-depth study of the issuer
through a dividend discount model. In selecting investments, the Adviser
utilizes the research of a number of sources, including Morgan Stanley Capital
International, an affiliate of the Adviser located in Geneva, Switzerland.
Portfolio holdings are regularly reviewed and subjected to fundamental analysis
to determine whether they continue to conform to the Adviser's value criteria.
Equity Securities that no longer conform to such investment criteria will be
sold.
Although the Portfolio will not invest for short-term trading purposes,
investment securities may be sold from time to time without regard to the
length of time they have been held. Investing in foreign countries and emerging
market countries is subject to additional risk, see "Securities and Investment
Techniques" below.
INTERNATIONAL MAGNUM PORTFOLIO
The Portfolio seeks long-term capital appreciation by investing primarily in
Common and Preferred Stocks, Convertible Securities, Rights or Warrants to
purchase Common Stocks and other Equity Securities of non-U.S. issuers in
accordance with the EAFE country (defined below) weightings determined by the
Adviser. The production of any current income is incidental to this objective.
The Equity Securities in which the Portfolio may invest may be denominated in
any currency.
The countries in which the Portfolio will invest are those comprising the
Morgan Stanley Capital International EAFE Index (the "Index"), which includes
Australia, Japan, New Zealand, most nations located in Western Europe and
certain developed countries in Asia, such as Hong Kong and Singapore (each an
"EAFE country," and collectively the "EAFE countries"). Under normal
circumstances, at least 65% of the total assets of the Portfolio will be
invested in Equity Securities of issuers in at least three different EAFE
countries.
Although the Portfolio intends to invest primarily in Equity Securities listed
on a stock exchange in an EAFE country, the Portfolio may invest without limit
in Equity Securities that are traded over the counter or that are not admitted
to listing on a stock exchange or dealt in on a regulated market. As a result
of the absence of a public trading market, such securities may pose liquidity
risks.
The Portfolio may also invest in Private Placements or initial public offerings
in the form of oversubscriptions, certain short-term (less than twelve months
to maturity) and medium-term (not greater than five years to maturity) debt
securities, Foreign Currency, Investment Company Securities, Temporary
Investments, Money Market Instruments, Non-Publicly Traded Securities, Private
Placements, Restricted Securities, Repurchase Agreements, Cash or Cash
Equivalents, When-Issued or Delayed Delivery Securities, and Derivatives,
including but not limited to Forwards, Futures (including stock index futures)
and Options, and may lend its Portfolio securities. The Portfolio may also
invest up to 10% of its total assets in (i) Investment Company Securities with
investment objectives similar to that of the Portfolio and (ii) for temporary
purposes, money market funds and pooled investment vehicles. In addition, for
temporary defensive purposes during periods in which the Adviser believes
changes in economic, financial or political conditions make it advisable, the
Portfolio may invest up to 100% of its total assets in such short-term and
medium-term Fixed Income Securities or hold cash. The Portfolio will not invest
in Fixed Income Securities that are not rated at least investment grade by
either Moody's Investors Service, Inc. ("Moody's") or S&P. Although the
Portfolio will not invest for short-term trading purposes, investment
securities may be sold from time to time without regard to the length of time
they have been held. For additional information about investments, see
"Securities and Investment Techniques" and "Non-Diversified Status" below.
The Adviser's approach is to establish regional allocation strategies. By
analyzing a variety of macroeconomic and political factors, the Adviser
develops fundamental projections on comparative interest rates, currencies,
7
<PAGE>
corporate profits and economic growth among the various regions represented in
the Index. These projections will be used to establish regional allocation
strategies. Within these regional allocations, the Adviser then selects Equity
Securities among issuers of a region.
The Adviser's approach in selecting among Equity Securities within a region
comprised of EAFE countries is oriented towards individual stock selection and
is value driven. The Adviser identifies those Equity Securities which it
believes to be undervalued in relation to the issuer's assets, cash flow,
earnings and revenues. In selecting investments, the Adviser utilizes the
research of a number of sources, including Morgan Stanley Capital
International, an affiliate of the Adviser located in Geneva, Switzerland.
Portfolio holdings are regularly reviewed and subjected to fundamental analysis
to determine whether they continue to conform to the Adviser's investment
criteria. Equity Securities which no longer conform to such investment criteria
will be sold.
EMERGING MARKETS EQUITY PORTFOLIO
The Portfolio seeks long-term capital appreciation by investing primarily in
Common and Preferred Stocks, Convertible Securities, Rights and Warrants to
purchase Common Stocks, sponsored or unsponsored ADRs and other Equity
Securities of emerging market country issuers. Under normal circumstances, at
least 65% of the Portfolio's total assets will be invested in Emerging Market
Country Equity Securities.
The Portfolio may also invest in Fixed Income Securities denominated in the
currency of an emerging market country or issued or guaranteed by an emerging
market country company or the government of an emerging market country, Equity
Securities or Fixed Income Securities of corporate or governmental issuers
located in industrialized countries, Foreign Currency, Investment Funds, Loan
Participations and Assignments, Money Market Instruments, Investment Company
Securities, Repurchase Agreements, Non-Publicly Traded Securities, Private
Placements, Restricted Securities, Temporary Investments, When-Issued and
Delayed Delivery Securities, and Derivatives, including but not limited to
Forwards, Futures and Options and may engage in Loans of Portfolio Securities.
It is likely that many of the Fixed Income Securities in which the Portfolio
will invest will be unrated, and whether or not rated, such securities may have
speculative characteristics.
When deemed appropriate by the Adviser, the Portfolio may also invest up to 10%
of its total assets (measured at the time of the investment) in Fixed Income
Securities that are not Investment Grade Securities (commonly referred to as
High Yield Securities or junk bonds). For temporary defensive purposes, the
Portfolio may invest less than 65% of its total assets in Emerging Market
Country Equity Securities, in which case the Portfolio may invest in other
Equity Securities or may invest in Fixed Income Securities as described in
"Securities and Investment Techniques--Temporary Investments" below. The
Portfolio also has the ability to invest without limitation in high quality
Money Market Instruments or Temporary Investments for temporary defensive
purposes. For additional information about investments, see "Securities and
Investment Techniques" and "Non-Diversified Status" below.
The Adviser's approach is to focus the Portfolio's investments on those
emerging market countries in which it believes the economies are developing
strongly and in which the markets are becoming more sophisticated. There are
currently over 130 countries which, in the opinion of the Adviser, are
generally considered to be emerging or developing countries by the
international financial community, approximately 40 of which currently have
stock markets. Currently, investing in many emerging market countries is not
feasible or may involve unacceptable political risks.
The Portfolio intends to invest primarily in some or all of the following
emerging market countries:
Argentina Botswana Brazil Chile
China Colombia Greece Hong Kong
Hungary India Indonesia Jamaica
Jordan Kenya Malaysia Mexico
Nigeria Pakistan Peru Philippines
Poland Portugal Russia South Africa
South Korea Sri Lanka Taiwan Thailand
Turkey Venezuela Zimbabwe
As markets in other countries develop, the Portfolio expects to expand and
further diversify the emerging market countries in which it invests. The
Portfolio does not intend to invest in any security in a country where the
currency is not freely convertible to U.S. dollars, unless the Portfolio has
obtained the necessary governmental licensing to convert such currency or other
appropriately licensed or sanctioned contractual guarantees to protect such
investment against loss of that currency's external value, or the Portfolio has
a reasonable expectation at the time the investment is made that such
governmental licensing or other appropriately licensed or sanctioned guarantees
would be obtained or that the currency in which the security is quoted would be
freely convertible at the time of any proposed sale of the security by the
Portfolio. The Adviser will analyze assets, revenues and earnings of an issuer.
In selecting industries and particular issuers, the Adviser will evaluate costs
of labor and raw materials, access to technology, export of products and
government regulation. Although the Portfolio seeks to invest in larger
companies, it may invest in small- and medium-size companies that, in the
Adviser's view, have potential for growth.
Emerging Market Country Securities pose greater liquidity risks and other risks
than securities of companies located in developed countries and traded in more
established markets. The Portfolio may not be able to hedge Foreign Currency
risk adequately. For a description of special considerations
8
<PAGE>
and certain risks associated with investment in foreign issuers, see
"Securities and Investment Techniques." Also, the registration, clearing and
settlement of securities transactions in Russia are subject to significant
risks not normally associated with securities transactions in the United States
and other more developed markets. See "Securities and Investment Techniques--
Russian Securities."
When Portfolio shares are redeemed, they may be worth more or less than their
original cost. An investment in the Portfolio is not in itself a balanced
investment plan. As with any mutual fund, there is no assurance that the
Portfolio will achieve its goal.
SECURITIES AND INVESTMENT TECHNIQUES
- ------------------------------------
The following pages contain more detailed information about types of
instruments in which a Portfolio may invest and strategies each Adviser may
employ in pursuit of a Portfolio's investment objective. A summary of risks and
restrictions associated with these instruments and investment practices is
included as well. A complete listing of each Portfolio's policies and
limitations and more detailed information about each Portfolio's investments is
contained in the SAI. Policies and limitations are considered at the time such
investments are purchased; the sale of instruments is not required in the event
of a subsequent change in circumstances, for example, a rating's downgrade.
The investments of life insurance company separate accounts made under variable
annuity contracts and variable life insurance policies are subject to state
insurance laws and regulations. The Fund and its Portfolios will, when
required, comply with investment restrictions imposed under such laws and
regulations on life insurance company separate accounts investing in the
Portfolios.
The Advisers may not buy all of these instruments or use all of these
techniques to the full extent permitted unless they believe that doing so will
help a Portfolio achieve its investment objective. Current holdings and recent
investment strategies are described in the Portfolio's financial reports, which
will be sent to the Portfolios' shareholders twice a year. For a free SAI or
financial report, contact the Fund or your insurance company.
STRATEGIES
EMERGING MARKETS INVESTING: The Adviser's approach to Emerging Markets
Investing is based on the Adviser's evaluation of both short-term and long-term
international economic trends and the relative attractiveness of emerging
markets and individual emerging market securities.
As used in this Prospectus, emerging markets describes any country which is
generally considered to be an emerging, or developing country by the
international financial community such as the International Bank for
Reconstruction and Development (more commonly known as the World Bank) and the
International Finance Corporation. There are currently over 130 countries which
are generally considered to be emerging or developing countries by the
international financial community, approximately 40 of which currently have
stock markets. Emerging markets can include every nation in the world except
the United States, Canada, Japan, Australia, New Zealand and most nations
located in Western Europe.
Currently, investing in many emerging market countries is either not feasible
or very costly, or may involve unacceptable political risks. Other special
risks include the possible increased likelihood of expropriation or the return
to power of a political regime which would institute policies to expropriate,
nationalize or otherwise confiscate investments. A Portfolio will focus its
investments on those emerging market countries in which the Adviser believes
the potential for market appreciation outweighs these risks and/or the cost of
investment. Investing in emerging markets also involves an extra degree of
custodial and/or market risk, especially where the securities purchased are not
traded on an official exchange or where ownership records regarding the
securities are maintained by an unregulated entity (or even the issuer itself).
FOREIGN FIXED INCOME INVESTING: The Adviser seeks to invest in Foreign Bonds
and other Fixed Income Securities denominated in Foreign Currencies, where, in
the opinion of the Adviser, the combination of current yield and currency value
offer attractive expected returns. When the total return opportunities in a
foreign bond market appear attractive in local currency terms, but where in the
Adviser's judgment unacceptable currency risk exists, Foreign Currency Futures
Contracts and Options, Forwards and Swaps may be used to hedge the currency
risk.
FOREIGN INVESTING: Investing in securities issued by foreign companies or
governments involves certain special considerations which are not typically
associated with investing in U.S. issuers. Since the securities of foreign
issuers may be denominated in Foreign Currencies, and since a Portfolio may
temporarily hold uninvested reserves in bank deposits of Foreign Currencies
prior to reinvestment or conversion to U.S. dollars, a Portfolio may be
affected favorably or unfavorably by changes in currency exchange rates and in
exchange control regulations, and may incur costs in connection with
conversions between various currencies.
Because non-U.S. companies are not generally subject to uniform accounting,
auditing and financial reporting standards and practices comparable to those
applicable to U.S. companies, there may be less publicly available information
about certain foreign companies than about U.S. companies. Securities of some
non-U.S. companies may be less liquid and more volatile than securities of
comparable U.S. companies. There is generally less government supervision and
regulation of stock exchanges, brokers and listed companies than in the United
States. With respect to certain foreign countries, there is the possibility of
9
<PAGE>
expropriation or confiscatory taxation, political or social instability, or
diplomatic developments which could affect U.S. investments in those countries.
Additionally, there may be difficulty in obtaining and enforcing judgments
against foreign issuers.
Although a Portfolio will endeavor to achieve the most favorable execution
costs in its portfolio transactions in foreign securities, fixed commissions on
many foreign stock exchanges are generally higher than negotiated commissions
on U.S. exchanges. In addition, it is expected that the expenses for custodial
arrangements of a Portfolio's foreign securities will be greater than the
expenses for the custodial arrangements for handling U.S. securities of equal
value. Certain foreign governments levy withholding taxes against dividend and
interest income. Although in some countries a portion of these taxes is
recoverable, the non-recovered portion of foreign withholding taxes will reduce
the income a Portfolio receives from the companies comprising the Portfolio's
investments.
GROWTH STOCK INVESTING: The Adviser seeks to invest in Equity Securities
generally characterized by higher growth rates of revenues and earnings. These
stocks tend to have higher price volatility, higher price/earnings ratios, and
lower yields than the stock market in general as measured by the S&P 500.
HIGH YIELD INVESTING: The Adviser seeks to invest in High Yield Securities
based on the Adviser's analysis of economic and industry trends and individual
security characteristics. The Adviser conducts credit analysis for each
security considered for investment to evaluate its attractiveness relative to
its risk. A high level of diversification is also maintained to limit credit
exposure to individual issuers.
To the extent a Portfolio invests in High Yield Securities it will be exposed
to a substantial degree of credit risk. Lower-rated bonds are considered
speculative by traditional investment standards. High Yield Securities may be
issued as a consequence of corporate restructuring or similar events. Also,
High Yield Securities are often issued by smaller, less credit worthy
companies, or by highly leveraged (indebted) companies, which are generally
less able than more established or less leveraged companies to make scheduled
payments of interest and principal. The risks posed by securities issued under
such circumstances are substantial.
The market for High Yield Securities is still relatively new. Because of this,
a long-term track record for bond default rates does not exist. In addition,
the secondary market for High Yield Securities is generally less liquid than
that for investment grade corporate securities. In periods of reduced market
liquidity, High Yield Security prices may become more volatile, and both the
high yield market and a Portfolio may experience sudden and substantial price
declines. This lower liquidity might have an effect on a Portfolio's ability to
value or dispose of such securities. Also, there may be significant disparities
in the prices quoted for High Yield Securities by various dealers. Under such
conditions, a Portfolio may find it difficult to value its securities
accurately. A Portfolio may also be forced to sell securities at a significant
loss in order to meet shareholder redemptions. These factors add to the risks
associated with investing in High Yield Securities.
High Yield Securities may also present risks based on payment expectations. For
example, High Yield Securities may contain redemption or call provisions. If an
issuer exercises these provisions in a declining interest rate market, a
Portfolio would have to replace the security with a lower yielding security,
resulting in a decreased return for investors. Conversely, a High Yield
Security's value will decrease in a rising interest rate market.
Certain types of High Yield Securities are non-income paying securities. For
example, Zero Coupons pay interest only at maturity and Pay-In-Kind Securities
pay interest in the form of additional securities. Payment in the form of
additional securities, or interest income recognized through discount
accretion, will, however, be treated as ordinary income which will be
distributed to shareholders even though the Portfolio does not receive periodic
cash flow from these investments.
MATURITY AND DURATION MANAGEMENT: One of two primary components of the
Adviser's fixed income investment strategy is Maturity and Duration Management.
The second primary component of fixed income strategy is Value Investing. See
"Value Investing" below.
The maturity and duration structure of a Portfolio investing in Fixed Income
Securities is actively managed in anticipation of cyclical interest rate
changes. Adjustments are not made in an effort to capture short-term, day-to-
day movements in the market, but instead are implemented in anticipation of
longer-term shifts in the levels of interest rates. Adjustments made to shorten
Portfolio maturity and duration are made to limit capital losses during periods
when interest rates are expected to rise. Conversely, adjustments made to
lengthen maturity are intended to produce capital appreciation in periods when
interest rates are expected to fall. The foundation for maturity and duration
strategy lies in analysis of the U.S. and global economies, focusing on levels
of real interest rates, monetary and fiscal policy actions, and cyclical
indicators.
Most Fixed Income Securities provide interest (coupon) payments in addition to
a final (par) payment at maturity. Some securities also have call provisions.
Depending on the relative magnitude of these payments and the nature of the
call provisions, the market values of Fixed Income Securities may respond
differently to changes in the level and structure of interest rates.
Traditionally, a Fixed Income Security's term-to-maturity has been used as a
proxy for the sensitivity of the security's price to changes in interest rates
(which is the interest rate risk or
10
<PAGE>
volatility of the security). However, term-to-maturity measures only the time
until a Fixed Income Security provides its final payment, taking no account of
the pattern of the security's payments prior to maturity.
Duration is a measure of the expected life of a Fixed Income Security on a
present value basis that was developed as a more precise alternative to the
concept of term-to-maturity. Duration incorporates a Fixed Income Security's
yield, coupon interest payments, final maturity and call features into one
measure. Duration is one of the fundamental tools used by the Adviser in the
selection of Fixed Income Securities.
Duration takes the length of the time intervals between the present time and
the time that the interest and principal payments are scheduled or, in the case
of a callable bond, expected to be received, and weights them by the present
values of the cash to be received at each future point in time. For any Fixed
Income Security with interest payments occurring prior to the payment of
principal, duration is always less than maturity. In general, all other factors
being the same, the lower the stated or coupon rate of interest of a Fixed
Income Security, the longer the duration of the security; conversely, the
higher the stated or coupon rate of interest of a Fixed Income Security, the
shorter the duration of the security.
There are some situations where even the standard duration calculation does not
properly reflect the interest rate exposure of a security. For example,
Floaters often have final maturities of ten or more years; however, their
interest rate exposure corresponds to the frequency of the coupon reset.
Another example where the interest rate exposure is not properly captured by
duration is the case of mortgage pass-through securities. The stated final
maturity of such securities is generally 30 years, but current prepayment rates
are more critical in determining the securities' interest rate exposure. In
these and other similar situations, the Adviser's analysis of interest rate
exposure incorporates the economic life of a security.
MORTGAGE INVESTING: At times it is anticipated that greater than 50% of a fixed
income Portfolio's assets may be invested in MBSs. These include securities
which represent pools of mortgage loans made by lenders such as commercial
banks, savings and loan associations, mortgage bankers and others. The pools
are assembled by various Governmental, Government-related and private
organizations. A Portfolio will invest in securities issued by the Government
National Mortgage Association ("GNMA"), Federal Home Loan Mortgage Corporation
("FHLMC"), Federal National Mortgage Association ("FNMA"), other Government
agencies, and private issuers. It is expected that the Portfolio's primary
emphasis will be in MBSs issued by the various Government-related
organizations. However, a Portfolio may invest, without limit, in MBSs issued
by private issuers when the Adviser deems that the quality of the investment,
the quality of the issuer, and market conditions warrant such investments.
Securities issued by private issuers will be rated investment grade by Moody's
or S&P or be deemed by the Adviser to be of comparable investment quality.
VALUE INVESTING: One of two primary components of the Adviser's fixed income
strategy is Value Investing, whereby the Adviser seeks to identify undervalued
sectors and securities through analysis of credit quality, Option
characteristics and liquidity. Quantitative models are used in conjunction with
judgement and experience to evaluate and select securities with embedded put or
call Options which are attractive on a risk- and option-adjusted basis.
Successful Value Investing will permit a Portfolio to benefit from the price
appreciation of individual securities during periods when interest rates are
unchanged. See "Maturity and Duration Management" for a description of the
other key component of the Adviser's fixed income investment strategy.
VALUE STOCK INVESTING: Emphasizes Common Stocks which are deemed by the Adviser
to be undervalued relative to the stock market in general as measured by the
appropriate market index, based on value measures such as price/earnings ratios
and price/book ratios. Value stocks are generally dividend paying Common
Stocks. However, non-dividend paying stocks may also be selected for their
value characteristics.
INSTRUMENTS AND INVESTMENTS
AGENCIES. Agencies are securities which are not guaranteed by, or backed by the
full faith and credit of, the U.S. Government, but which are issued, sponsored
or guaranteed by a federal agency or federally sponsored agency such as the
Student Loan Marketing Association, Resolution Funding Corporation, or any of
several other agencies. For further information on these securities, see
"Description of U.S. Government Securities" in the SAI.
ASSET-BACKEDS. Asset-backed securities ("Asset-Backeds") are securities
collateralized by shorter-term loans such as automobile loans, home equity
loans, computer leases or credit card receivables. The payments from the
collateral are passed through to the security holder. The collateral behind
Asset-Backeds tends to have prepayment rates that usually do not vary with
interest rates. In addition the short-term nature of the loans reduces the
impact of any change in prepayment level. Due to amortization, the average life
for Asset-Backeds is also the conventional proxy for maturity.
Due to the possibility that prepayments (on automobile loans and other
collateral) will alter the cash flow on Asset-Backeds, it is not possible to
determine in advance the actual final maturity date or average life. Faster
prepayment will shorten the average life and slower prepayment will lengthen
it. However, it is possible to determine what the range of that movement could
be and to calculate the effect that it will have on the price of the security.
In selecting these securities,
11
<PAGE>
the Adviser will look for those securities that offer a higher yield to
compensate for any variation in average maturity.
BRADY BONDS. Brady Bonds are Fixed Income Securities that are created through
the exchange of existing commercial bank loans to foreign entities for new
obligations in connection with debt restructuring under a plan introduced by
Nicholas F. Brady when he was the U.S. Secretary of the Treasury (the "Brady
Plan"). Brady Bonds have been issued only in relatively recent years, and,
accordingly, do not have a long payment history. They may be collateralized or
uncollateralized and issued in various currencies (although most are dollar-
denominated) and they are actively traded in the over-the-counter secondary
market. For further information on these securities, see the SAI. A Portfolio
will invest in Brady Bonds only if they are consistent with quality
specifications.
CASH EQUIVALENTS. Cash Equivalents are short-term Fixed Income Securities
comprising:
(1) Time deposits, certificates of deposit (including marketable variable rate
certificates of deposit) and bankers' acceptances issued by a commercial bank
or savings and loan association. Time deposits are non-negotiable deposits
maintained in a banking institution for a specified period of time at a stated
interest rate. Certificates of deposit are negotiable short-term obligations
issued by commercial banks or savings and loan associations against funds
deposited in the issuing institution. Variable rate certificates of deposit are
certificates of deposit on which the interest rate is periodically adjusted
prior to their stated maturity based upon a specified market rate. A bankers'
acceptance is a time draft drawn on a commercial bank by a borrower, usually in
connection with an international commercial transaction (to finance the import,
export, transfer or storage of goods).
A Portfolio may invest in obligations of U.S. banks, obligations of foreign
branches of U.S. banks ("Eurodollars") and obligations of U.S. branches of
foreign banks ("Yankee dollars"). Investments in Eurodollars and Yankee dollars
involve some of the same risks of investing in international securities that
are discussed in "Foreign Investment" below.
A Portfolio will not invest in any security issued by a commercial bank unless
(i) the bank has total assets of at least $1 billion, or the equivalent in
other currencies, or, in the case of domestic banks which do not have total
assets of at least $1 billion, the aggregate investment made in any one such
bank is limited to $100,000 and the principal amount of such investment is
insured in full by the Federal Deposit Insurance Corporation ("FDIC"), (ii) in
the case of a U.S. bank, it is a member of the FDIC, and (iii) in the case of a
foreign branch of a U.S. bank, the security is deemed by the Adviser to be of
an investment quality comparable with other Fixed Income Securities which may
be purchased by the Portfolio.
(2) Commercial paper rated at time of purchase by one or more NRSROs in one of
their two highest categories, (e.g., A-1 or A-1+ by S&P or Prime 1 by Moody's,
or, if not rated, issued by a corporation having an outstanding unsecured debt
issue rated high-grade by an NRSRO (e.g., A or better by Moody's, S&P or Fitch
Investors Service, Inc. ("Fitch")).
(3) Short-term corporate obligations rated high-grade at the time of purchase
by an NRSRO (e.g., A or better by Moody's, S&P or Fitch).
(4) U.S. Governments and Agencies.
(5) Repurchase Agreements collateralized by securities listed above.
CMOS. Collateralized Mortgage Obligations ( "CMOs") are Derivatives which are
collateralized by mortgage pass-through securities. Cash flows from the
mortgage pass-through securities are allocated to various tranches (a "tranche"
is essentially a separate security) in a predetermined, specified order. Each
tranche has a stated maturity--the latest date by which the tranche can be
completely repaid, assuming no prepayments--and has an average life--the
average of the time to receipt of a principal payment weighted by the size of
the principal payment. The average life is typically used as a proxy for
maturity because the debt is amortized (repaid a portion at a time), rather
than paid off entirely at maturity, as would be the case in a straight debt
instrument.
Due to the possibility that prepayments (on home mortgages and other
collateral) will alter the cash flow on CMOs, it is not possible to determine
in advance the actual final maturity date or average life. Faster prepayment
will shorten the average life and slower prepayment will lengthen it. However,
it is possible to determine what the range of that movement could be and to
calculate the effect that it will have on the price of the security. In
selecting these securities, the Adviser will look for those securities that
offer a higher yield to compensate for any variation in average maturity.
Prepayment risk has two important effects. First, like bonds in general,
mortgage-backed securities will generally decline in price when interest rates
rise. However, when interest rates fall, mortgage-backed securities may not
enjoy as large a gain in market value due to prepayment risk. Second, when
interest rates fall, additional mortgage prepayments must be reinvested at
lower interest rates. In part to compensate for these risks, mortgage-backed
securities will generally offer higher yields than comparable bonds. See "MBSs"
below.
COMMON STOCKS. Common Stocks are Equity Securities which represent an ownership
interest in a corporation, entitling the shareholder to voting rights and
receipt of dividends paid based on proportionate ownership.
12
<PAGE>
CONVERTIBLE SECURITIES. Convertible Securities are securities, such as
convertible Corporate Bonds, convertible Preferred Stocks, Warrants or other
securities which may be exchanged under certain circumstances for a fixed
number of shares of Common Stock.
CORPORATE BONDS. Corporate Bonds are Fixed Income Securities issued by private
corporations. Bondholders, as creditors, have a prior legal claim over common
and preferred stockholders of the corporation as to both income and assets for
the principal and interest due to the bondholder. A Portfolio will buy
Corporate Bonds subject to any quality constraints. If a security held by a
Portfolio is down-graded, the Portfolio may retain the security.
DEPOSITARY RECEIPTS. Depositary Receipts are securities representing ownership
interests in securities of foreign companies (an "underlying issuer") and are
deposited with the depositary. Depositary Receipts are not necessarily
denominated in the same currency as the underlying securities. Depositary
Receipts include ADRs, Global Depositary Receipts ("GDRs") and other types of
Depositary Receipts (which, together with ADRs and GDRs, are hereinafter
collectively referred to as "Depositary Receipts"). ADRs are dollar-denominated
Depositary Receipts typically issued by a U.S. financial institution which
evidence ownership interests in a security or pool of securities issued by a
foreign issuer. ADRs are listed and traded in the United States. GDRs and other
types of Depositary Receipts are typically issued by foreign banks or trust
companies, although they also may be issued by U.S. financial institutions, and
evidence ownership interests in a security or pool of securities issued by
either a foreign or a U.S. corporation. Generally, Depositary Receipts in
registered form are designed for use in the U.S. securities market and
Depositary Receipts in bearer form are designed for use in securities markets
outside the United States.
Depositary Receipts may be "sponsored" or "unsponsored". Sponsored Depositary
Receipts are established jointly by a depositary and the underlying issuer,
whereas unsponsored Depositary Receipts may be established by a depositary
without participation by the underlying issuer. Holders of an unsponsored
Depositary Receipt generally bear all the costs associated with establishing
the unsponsored Depositary Receipt. In addition, the issuers of the securities
underlying unsponsored Depositary Receipts are not obligated to disclose
material information in the United States and, therefore, there may be less
information available regarding such issuers and there may not be a correlation
between such information and the market value of the Depositary Receipts. For
purposes of a Portfolio's investment policies, the Portfolio's investments in
Depositary Receipts will be deemed to be investments in the underlying
securities except as noted.
DERIVATIVES. Derivatives are financial products or instruments that derive
their value from the value of an
underlying asset, reference rate or index. Derivatives include, but are not
limited to, the following: CMOs, SMBSs (i.e., Stripped Mortgage-Backed
Securities), Convertible Securities, Warrants, Forwards, Futures, Options,
Structured Notes and Swaps.
The Adviser will use Derivatives only in circumstances where they offer the
most economic means of improving the risk/reward profile of a Portfolio. The
Adviser will not use Derivatives to increase Portfolio risk above the level
that could be achieved in the Portfolio using only traditional investment
securities. In addition, the Adviser will not use Derivatives to acquire
exposure to changes in the value of assets or indexes of assets that are not
allowable investments for the Portfolio. A Portfolio may enter into over-the-
counter derivative transactions (Swaps, Caps, Floors, etc., but excluding CMOs,
Forwards, Futures, Options, and SMBSs) with counterparties approved by the
Adviser in accordance with guidelines established by the Fund's Board of
Directors. These guidelines provide for a minimum credit rating for each
counterparty and various credit enhancement techniques (for example,
collateralization of amounts due from counterparties) to limit exposure to
counterparties with ratings below AA.
See elsewhere in this "Securities and Investment Techniques" section for
descriptions of these various Derivatives, and see the SAI for more information
regarding any investment policies or limitations applicable to their use.
EASTERN EUROPEAN SECURITIES. The economies of Eastern European countries are
currently suffering both from the stagnation resulting from centralized
economic planning and control and the higher prices and unemployment associated
with the transition to market economics. Unstable economic and political
conditions may adversely affect security values. Upon the accession to power of
Communist regimes approximately 40 years ago, the governments of a number of
Eastern European countries expropriated a large amount of property. The claims
of many property owners against those governments were never finally settled.
In the event of the return to power of the Communist Party, there can be no
assurance that a Portfolio's investments in Eastern Europe would not be
expropriated, nationalized or otherwise confiscated.
EMERGING MARKET COUNTRY SECURITIES. An Emerging Market Country Security is one
issued by a company that has one or more of the following characteristics: (i)
its principal securities trading market is in an emerging market, (ii) alone or
on a consolidated basis it derives 50% or more of its annual revenue from
either goods produced, sales made or services performed in emerging markets, or
(iii) it is organized under the laws of, and has a principal office in, an
emerging market country. The Adviser will base determinations as to eligibility
on publicly available information and inquiries made to the companies.
13
<PAGE>
The economies of individual emerging market countries may differ favorably or
unfavorably from the U.S. economy in such respects as growth of gross domestic
product, rate of inflation, currency depreciation, capital reinvestment,
resource self-sufficiency and balance of payments position. Further, the
economies of developing countries generally are heavily dependent upon
international trade and, accordingly, have been, and may continue to be,
adversely affected by trade barriers, exchange controls, managed adjustments in
relative currency values and other protectionist measures imposed or negotiated
by the countries with which they trade. These economies also have been, and may
continue to be, adversely affected by economic conditions in the countries with
which they trade.
Investing in emerging market countries may entail purchasing securities issued
by or on behalf of entities that are insolvent, bankrupt, in default or
otherwise engaged in an attempt to reorganize or reschedule their obligations,
and in entities that have little or no proven credit rating or credit history.
In any such case, the issuer's poor or deteriorating financial condition may
increase the likelihood that the investing Portfolio will experience losses or
diminution in available gains due to bankruptcy, insolvency or fraud.
With respect to any emerging market country, there is the possibility of
nationalization, expropriation or confiscatory taxation, political changes,
government regulation, social instability or diplomatic developments (including
war) that could affect adversely the economies of such countries or the value
of a Portfolio's investments in those countries. In addition, it may be
difficult to obtain and enforce a judgment in a court outside of the United
States.
EQUITY SECURITIES. Equity Securities commonly include, but are not limited to,
Common Stocks, Preferred Stocks, Depositary Receipts, Rights, Warrants, and
Foreign Equities. Preferred Stock is contained in both the definition of Equity
Securities and Fixed Income Securities because it exhibits characteristics
commonly associated with each type of security. See the "The Portfolios'
Investments" section applicable to a particular Portfolio to determine in which
of the above a Portfolio may invest.
FIXED INCOME SECURITIES. Fixed Income Securities commonly include, but are not
limited to, debentures, U.S. Governments, Zero Coupons, Agencies, Corporate
Bonds, High Yield Securities, MBSs, SMBSs, CMOs, Asset-Backeds, Convertible
Securities, Brady Bonds, Floaters, Inverse Floaters, Cash Equivalents,
Municipals, Repurchase Agreements, Preferred Stocks and Foreign Bonds.
Preferred Stock is contained in both the definition of Equity Securities and
Fixed Income Securities since it exhibits characteristics commonly associated
with each type of security. See the "The Portfolios' Investments" section
applicable to a particular Portfolio to determine in which of the above a
Portfolio may invest.
The short-term and medium-term Fixed Income Securities in which the
International Magnum Portfolio may invest consist of (a) obligations of
governments, agencies or instrumentalities of any member state of the
Organization for Economic Cooperation and Development ("OECD"), including the
United States; (b) bank deposits and bank obligations (including certificates
of deposit, time deposits and bankers' acceptances) of banks organized under
the laws of any member state of the OECD, including the United States,
denominated in any currency; and (c) finance company and corporate commercial
paper and other short-term corporate debt obligations of corporations organized
under the laws of any member state of the OECD, including the United States,
meeting the Portfolio's credit quality standards, provided that no more than
20% of the Portfolio's assets are invested in any one of such issuers. The
short-term and medium-term securities in which the Portfolio may invest will be
rated investment grade by an NRSRO (e.g., rated A or higher by Moody's or S&P),
or if unrated, will be determined to be of comparable quality by the Adviser.
FLOATERS. Floaters are Fixed Income Securities with a floating or variable rate
of interest, i.e. the rate of interest varies with changes in specified market
rates or indices, such as the prime rate, or at specified intervals. Certain
Floaters may carry a demand feature that permits the holder to tender them back
to the issuer of the underlying instrument, or to a third party, at par value
prior to maturity. When the demand feature of certain Floaters represents an
obligation of a foreign entity, the demand feature will be subject to certain
risks discussed under "Foreign Investment".
FOREIGN BONDS. Foreign Bonds are Fixed Income Securities denominated in Foreign
Currency and issued and traded primarily outside the United States, including:
(1) obligations issued or guaranteed by foreign national governments, their
agencies, instrumentalities, or political subdivisions; (2) Fixed Income
Securities issued, guaranteed or sponsored by supranational organizations
established or supported by several national governments, including the World
Bank, the European Community, the Asian Development Bank and others; (3) non-
government foreign corporate debt securities; (4) foreign MBSs and various
other MBSs and Asset-Backeds denominated in Foreign Currency; and (5) Brady
Bonds. Investing in foreign companies involves certain special considerations
that are not typically associated with investing in U.S. companies. See
"Foreign Investment" below.
FOREIGN CURRENCY. Portfolios investing in foreign securities will regularly
transact security purchases and sales in Foreign Currencies. These Portfolios
may hold Foreign Currency or purchase or sell Foreign Currency on a forward
basis (see "Forwards").
FOREIGN CURRENCY FUTURES CONTRACTS AND OPTIONS. As another means of reducing
the risks associated with investing in securities denominated in
14
<PAGE>
Foreign Currencies, a Portfolio may enter into contracts for the future
acquisition or delivery of Foreign Currencies and may purchase Foreign Currency
Options ("Forex Options"). These investment techniques are designed primarily
to hedge against anticipated future changes in currency prices that otherwise
might adversely affect the value of the Portfolio's investments.
Foreign Currency Futures Contracts ("Forex Futures") are standardized contracts
for the future delivery of a specified amount of a Foreign Currency at a future
date at a price set at the time of the contract. Forex Futures traded in the
United States are traded on regulated futures exchanges. A Portfolio will incur
brokerage fees when it purchases or sells Forex Futures or Forex Options, and
it will be required to maintain margin deposits. Parties to a Forex Future must
make initial margin deposits to secure performance of the contract, which
generally range from 2% to 5% of the contract price. There also are
requirements to make "variation" margin deposits as the value of the Futures
contract fluctuates. In addition, a Portfolio may enter into a Futures contract
only if immediately thereafter not more than 5% of its total assets are
required as deposits to secure obligations under such contracts. The Portfolio
also will be required to segregate assets to cover its Futures contracts
obligations.
At the maturity of a Forex Future, a Portfolio may either accept or make
delivery of the currency specified in the contract or, prior to maturity, enter
into a closing purchase transaction involving the purchase or sale of an
offsetting contract. Closing purchase transactions with respect to Forex
Futures are effected on a regulated futures exchange. A Portfolio will only
enter into such a Forex Future if it is expected that there will be a liquid
market in which to close out such contract. There can, however, be no assurance
that such a liquid market will exist in which to close a Forward or Futures
contract, in which case the Portfolio may suffer a loss.
A Portfolio may also purchase put or call Forex Options on exchanges. A put
Option gives the Portfolio the right to sell a currency at the exercise price
until the expiration of the Option. A call Option gives the Portfolio the right
to purchase a currency at the exercise price until the expiration of the
Option.
Purposes for which such Forex Futures and Forex Options may be used include
protecting against a decline in a Foreign Currency against the U.S. dollar
between the trade date and settlement date when the Portfolio purchases or
sells securities, locking in the U.S. dollar value of dividends declared on
securities held by the Portfolio and generally protecting the U.S. dollar value
of securities held by the Portfolio against exchange rate fluctuations. Such
contracts will be used only as a protective measure against the effects of
fluctuating rates of currency exchange and exchange control regulations. While
Forex Futures and Forex Options may limit losses to the Portfolio as a result
of exchange rate fluctuation, they will also limit any gains that may otherwise
have been realized.
The primary risks associated with the use of Forex Futures and Forex Options
are (i) failure to predict accurately the direction of currency movements and
(ii) market risks (e.g., lack of liquidity or lack of correlation between the
change in value of underlying currencies and the change in the value of the
Portfolio's Forex Futures or Forex Options contracts). The risk that a
Portfolio will be unable to close out a Forex Futures position or Forex Options
contract will be minimized by the Portfolio only entering into such
transactions when there appears to be a liquid secondary market. For more
detailed information about Futures transactions, see "Securities and Investment
Techniques" in the SAI.
FOREIGN EQUITIES. Foreign Equity Securities ("Foreign Equities") include, but
are not limited to, Common Stock, Preferred Stock, Depositary Receipts, Rights,
Warrants and Convertible Securities of foreign issuers. Investing in foreign
companies involves certain special considerations which are not typically
associated with investing in U.S. companies. See "Foreign Investment" below.
FOREIGN INVESTMENT. Investment in securities and obligations of foreign issuers
and in foreign branches of domestic banks involves somewhat different
investment risks than those affecting obligations of U.S. issuers. There may be
limited publicly available information with respect to foreign issuers, and
foreign issuers are not generally subject to uniform accounting, auditing and
financial standards and requirements comparable to those applicable to U.S.
companies. There may also be less government supervision and regulation of
foreign securities exchanges, brokers and listed companies than in the United
States. Many foreign securities markets have substantially less volume than
U.S. national securities exchanges, and securities of some foreign issuers are
less liquid and more volatile than securities of comparable domestic issuers.
Brokerage commissions and other transaction costs on foreign securities
exchanges are generally higher than in the United States. Dividends and
interest paid by foreign issuers may be subject to withholding and other
foreign taxes, which may decrease the net return on Foreign Investments as
compared to dividends and interest paid by U.S. companies. Additional risks
include future political and economic developments, the possibility that a
foreign jurisdiction will impose or change withholding taxes on income payable
with respect to foreign securities, and the possible adoption of foreign
governmental restrictions such as exchange controls.
Prior governmental approval for Foreign Investments may be required under
certain circumstances in some emerging countries, and the extent of Foreign
Investment in certain Fixed Income Securities and domestic companies may be
subject to limitation in other emerging countries. Foreign ownership
limitations also may be imposed by the charters of individual companies in
emerging countries to prevent,
15
<PAGE>
among other concerns, violation of Foreign Investment limitations.
Repatriation of investment income, capital and the proceeds of sales by foreign
investors may require governmental registration and/or approval in some
emerging countries. A Portfolio could be adversely affected by delays in, or a
refusal to grant, any required governmental registration or approval for such
repatriation. Any investment subject to such repatriation controls will be
considered illiquid if it appears reasonably likely that this process will take
more than seven days.
Investments in securities of foreign issuers are frequently denominated in
Foreign Currencies. Because a Portfolio may temporarily hold uninvested
reserves in bank deposits in Foreign Currencies, the value of the Portfolio's
assets, as measured in U.S. dollars, may be affected favorably or unfavorably
by changes in currency exchange rates and in exchange control regulations and a
Portfolio may incur costs in connection with conversions between various
currencies.
FORWARDS. Forward Foreign Currency exchange contracts ("Forwards" or "forward
contracts") are obligations to purchase or sell an amount of a specified
currency at a future date, which may be any fixed number of days from the date
of the contract agreed upon by the parties, at a price set at the time of the
contract. Forwards are traded in the interbank market conducted directly
between currency traders (usually large commercial banks).
A Portfolio may use currency exchange contracts in the normal course of
business to lock in an exchange rate in connection with purchases and sales of
securities (transaction hedge) or to lock in the dollar value of portfolio
positions (position hedge). In addition a Portfolio may cross-hedge currencies
by entering into a transaction to purchase or sell one or more currencies that
are expected to decline in value relative to other currencies to which a
Portfolio has or expects to have portfolio exposure. A Portfolio may also
engage in proxy hedging which is defined as entering into positions in one
currency to hedge investments denominated in another currency, where the two
currencies are economically linked. Forwards will be used only as a protective
measure against the effects of fluctuating rates of currency exchange and
exchange control regulations. While such contracts may limit losses to the
Portfolio as a result of exchange rate fluctuation, they will also limit any
gains that may otherwise have been realized.
A Portfolio may also combine forward contracts with investments in securities
denominated in other currencies in order to achieve desired credit and currency
exposures. Such combinations are generally referred to as synthetic securities.
For example, in lieu of purchasing a Foreign Bond, a Portfolio may purchase a
U.S. dollar-denominated security and at the same time enter into a forward
contract to exchange U.S. dollars for the contract's underlying currency at a
future date. By matching the amount of U.S. dollars to be exchanged with the
anticipated value of the U.S. dollar-denominated security, a Portfolio may be
able to lock in the Foreign Currency value of the security and adopt a
synthetic investment position reflecting the credit quality of the U.S. dollar-
denominated security.
There is a risk in adopting a synthetic investment position to the extent that
the value of a security denominated in U.S. dollars or other Foreign Currency
is not exactly matched with a Portfolio's obligation under the forward
contract. On the date of maturity, a Portfolio may be exposed to some risk of
loss from fluctuations in that currency. Although the Adviser will attempt to
hold such mismatching to a minimum, there can be no assurance that the Adviser
will be able to do so. When a Portfolio enters into a forward contract for
purposes of creating a synthetic security, it will generally be required to
hold liquid assets in a segregated account with a daily value at least equal to
its obligation under the forward contract.
Except in circumstances where segregated accounts are not required by the 1940
Act and the rules adopted thereunder, a Portfolio's entry into Forwards, as
well as any use of cross or proxy hedging techniques, will generally require
the Portfolio's custodian to place liquid assets into a segregated account of
the Portfolio in an amount equal to the value of the Portfolio's total assets
committed to the consummation of forward contracts. If the value of the
securities placed in the segregated account declines, additional liquid assets
will be placed in the account on a daily basis so that the value of the account
will be at least equal to the amount of the Portfolio's commitments with
respect to such contracts. See "Investment Objectives and Policies-Forward
Foreign Currency Exchange Contracts" in the SAI.
At the maturity of a forward contract, a Portfolio may either accept or make
delivery of the currency specified in the contract or, prior to maturity, enter
into a closing purchase transaction involving the purchase or sale of an
offsetting contract. Closing purchase transactions with respect to Forwards are
usually effected with the currency trader who is a party to the original
forward contract. A Portfolio will only enter into such a forward contract if
it is expected that there will be a liquid market in which to close out such
contract. There can, however, be no assurance that such a liquid market will
exist in which to close a forward contract, in which case the Portfolio may
suffer a loss.
FUTURES. The term "Futures" includes futures contracts and Options on futures
contracts. Futures contracts provide for the sale by one party and purchase by
another party of a specified amount of a specific security, at a specified
future time and price. An Option on a futures contract gives the purchaser the
right (in return for the premium paid) to assume a position in a futures
contract at a specified exercise price at any time during the term of the
Option (a long position if the Option is a call
16
<PAGE>
and a short position if the Option is a put). Upon exercise of the Option, the
holder is entitled to delivery of the accumulated balance in the writer's
Futures margin account, which represents the amount by which the market price
of the futures contract at the time of exercise exceeds, in the case of a call,
or is less than, in the case of a put, the exercise price of the Option on the
futures contract.
The Emerging Markets Equity, Global Equity, Growth and International Magnum
Portfolios may enter into futures contracts to the extent that their
outstanding obligations under such contracts do not exceed 20% of their
respective total assets. The Fixed Income, High Yield, Mid Cap Value and Value
Portfolios may enter into futures contracts to the extent that their
outstanding obligations under futures contracts and option transactions do not
exceed 50% of their respective total assets. No Portfolio will enter into
futures contracts if immediately thereafter its initial margin deposits on open
contracts would exceed 5% of its total assets. The Portfolio also will be
required to segregate assets to cover its futures contract obligations.
Futures are derivative securities, in which a Portfolio may invest for hedging
purposes, as well as to remain fully invested and to reduce transaction costs.
Investing for the latter two purposes may be considered speculative. The
primary risks associated with the use of Futures are (i) imperfect correlation
between the change in market value of the stocks held by the Portfolio and the
prices of Futures and Options relating to the stocks purchased or sold by the
Portfolio and (ii) possible lack of a liquid secondary market for an Option or
a futures contract and the resulting inability to close a Futures position
which could have an adverse impact on the Portfolio's ability to hedge.
Additional risks associated with Options transactions are (i) the risk that an
Option will expire worthless; (ii) the risk that the issuer of an over-the-
counter Option will be unable to fulfill its obligation to the Portfolio due to
bankruptcy or related circumstances; (iii) the risk that Options may exhibit
greater short-term price volatility than the underlying security; and (iv) the
risk that a Portfolio may be forced to forego participation in the appreciation
of the value of underlying securities, futures contracts or currency due to the
writing of a call Option.
HIGH YIELD SECURITIES. High Yield Securities are generally considered to
include Corporate Bonds, Preferred Stocks and Convertible Securities rated Ba
through C by Moody's or BB through D by S&P, and unrated securities considered
to be of equivalent quality. Securities rated less than Baa by Moody's or BBB
by S&P are classified as non-Investment Grade Securities and are commonly
referred to as junk bonds or High Yield Securities. Such securities carry a
high degree of risk and are considered speculative by the major credit rating
agencies. The following are excerpts from the Moody's and S&P definitions for
speculative-grade debt obligations:
Moody's: Ba-rated bonds have "speculative elements" so their future
"cannot be considered assured," and protection of principal and interest
is "moderate" and "not well safeguarded during both good and bad times in
the future." B-rated bonds "lack characteristics of a desirable
investment" and the assurance of interest or principal payments "may be
small." Caa-rated bonds are "of poor standing," and "may be in default"
or may have "elements of danger with respect to principal or interest."
Ca-rated bonds represent obligations which are speculative in a high
degree. Such issues are often in default or have other marked
shortcomings. C-rated bonds are the "lowest rated" class of bonds, and
issues so rated can be regarded as having "extremely poor prospects" of
ever attaining any real investment standing.
S&P: BB-rated bonds have "less near-term vulnerability to default" than
B- or CCC-rated securities but face major ongoing uncertainties..... which
may lead to inadequate capacity to pay interest or principal. B-rated
bonds have a ""greater vulnerability to default than BB-rated bonds and
the ability to pay interest or principal will likely be impaired by
adverse business conditions.'' CCC-rated bonds have a currently
identifiable ""vulnerability to default'' and, without favorable business
conditions, will be ""unable to repay interest and principal.'' The
rating C is reserved for income bonds on which ""no interest is being
paid.'' Debt rated D is in default,'' and ""payment of interest and/or
repayment of principal is in arrears.''
While such securities offer high yields, they also normally carry with them a
greater degree of risk than securities with higher ratings. Lower-rated bonds
are considered speculative by traditional investment standards. High Yield
Securities may be issued as a consequence of corporate restructuring or similar
events. Also, High Yield Securities are often issued by smaller, less credit
worthy companies, or by highly leveraged (indebted) firms, which are generally
less able than more established or less leveraged firms to make scheduled
payments of interest and principal. The price movement of these securities is
influenced less by changes in interest rates and more by the financial and
business position of the issuing corporation when compared to Investment Grade
Securities.
The risks posed by securities issued under such circumstances are substantial.
If a security held by a Portfolio is down-graded, the Portfolio may retain the
security.
INVERSE FLOATERS. Inverse floating rate obligations ("Inverse Floaters") are
Fixed Income Securities, which have coupon rates that vary inversely at a
multiple of a designated floating rate, such as LIBOR (London Inter-Bank
Offered Rate). Any rise in the reference rate of an Inverse
17
<PAGE>
Floater (as a consequence of an increase in interest rates) causes a drop in
the coupon rate while any drop in the reference rate of an Inverse Floater
causes an increase in the coupon rate. Inverse Floaters may exhibit
substantially greater price volatility than fixed rate obligations having
similar credit quality, redemption provisions and maturity, and Inverse Floater
CMOs exhibit greater price volatility than the majority of mortgage pass-
through securities or CMOs. In addition, some Inverse Floater CMOs exhibit
extreme sensitivity to changes in prepayments. As a result, the yield to
maturity of an Inverse Floater CMO is sensitive not only to changes in interest
rates but also to changes in prepayment rates on the related underlying
mortgage assets.
INVESTMENT COMPANY SECURITIES. Investments in investment companies are
securities of other open-end or closed-end investment companies. The 1940 Act
generally prohibits a Portfolio from acquiring more than 3% of the outstanding
voting shares of an investment company and limits such investments to no more
than 5% of the Portfolio's total assets in any one investment company and no
more than 10% in any combination of investment companies. The 1940 Act also
prohibits a Portfolio from acquiring in the aggregate more than 10% of the
outstanding voting shares of any registered close-end investment company.
To the extent a Portfolio invests a portion of its assets in Investment Company
Securities, those assets will be subject to the expenses of the purchased
investment company as well as to the expenses of the Portfolio itself. A
Portfolio may not purchase shares of any affiliated investment company except
as permitted by a rule or order of the Securities and Exchange Commission
("SEC").
INVESTMENT FUNDS. Some emerging market countries have laws and regulations that
currently preclude direct investment in the securities of their companies.
However, indirect investment in the securities of companies listed and traded
on the stock exchanges in these countries is permitted by certain emerging
market countries through Investment Funds that have been specifically
authorized. A Portfolio may invest in these Investment Funds subject to the
provisions of the 1940 Act, as applicable, and other applicable laws as
discussed in "Investment Limitations" in the SAI. The Emerging Markets Equity
Portfolio will invest in such Investment Funds only where appropriate given
that the Portfolio's shareholders will bear not only their proportionate share
of the expenses of the Portfolio (including operating expenses and the fees of
the Adviser), but also will indirectly bear similar expenses of the underlying
Investment Funds.
Certain Investment Funds are advised by an Adviser. The Portfolios may, to the
extent permitted under the 1940 Act and other applicable law, invest in these
Investment Funds. If a Portfolio does elect to make an investment in such an
Investment Fund, it will only purchase the securities of such Investment Fund
in the secondary market.
INVESTMENT GRADE SECURITIES. Investment Grade Securities are those rated by one
or more NRSROs in one of the four highest rating categories at the time of
purchase (e.g., AAA, AA, A or BBB by S&P or Fitch, or Aaa, Aa, A or Baa by
Moody's). Securities rated BBB or Baa represent the lowest of four levels of
Investment Grade Securities and are regarded as borderline between definitely
sound obligations and those in which the speculative element begins to
predominate. MBSs, including mortgage pass-throughs and CMOs, deemed investment
grade by the Adviser, will either carry a guarantee from an agency of the U.S.
Government or a private issuer of the timely payment of principal and interest
(such guarantees do not extend to the market value of such securities or the
net asset value per share of the Portfolio) or, in the case of unrated
securities, be sufficiently seasoned and considered by the Adviser to be of
comparable quality. The Adviser may retain a security if its rating falls below
investment grade if it deems retention of the security to be in the best
interests of the Portfolio. Any Portfolio permitted to hold Investment Grade
Securities may hold unrated securities if the Adviser considers the risks
involved in owning that security to be equivalent to the risks involved in
holding an Investment Grade Security.
LOAN PARTICIPATIONS AND ASSIGNMENTS. Loan Participations are loans or other
direct debt instruments which are interests in amounts owed by a corporate,
governmental or other borrower to another party. They may represent amounts
owed to lenders or lending syndicates, to suppliers of goods or services (trade
claims or other receivables), or to other parties. A Portfolio may invest in
fixed rate and floating rate loans ("Loans") arranged through private
negotiations between an issuer of sovereign debt obligations and one or more
financial institutions ("Lenders"). A Portfolio's investments in Loans are
expected in most instances to be in the form of participation in Loans
("Participations") and assignments of all or a portion of Loans ("Assignments")
from third parties. A Portfolio will have the right to receive payments of
principal, interest and any fees to which it is entitled only from the Lender
selling the Participation and only upon receipt by the Lender of the payments
from the borrower. In the event of the insolvency of the Lender selling a
Participation, a Portfolio may be treated as a general creditor of the Lender
and may not benefit from any set-off between the Lender and the borrower.
Certain Participations may be structured in a manner designed to avoid
purchasers of Participations being subject to the credit risk of the Lender
with respect to the Participation. Even under such a structure, in the event of
the Lender's insolvency, the Lender's servicing of the Participation may be
delayed and the assignability of the Participation may be impaired. A Portfolio
will acquire Participations only if the Lender interpositioned between a
Portfolio and the borrower is determined by the Adviser to be creditworthy.
When a Portfolio purchases Assignments from Lenders it will acquire direct
rights against the borrower on the Loan. However, because Assignments are
arranged through private negotiations between potential assignees and potential
18
<PAGE>
assignors, the rights and obligations acquired by a Portfolio as the purchaser
of an Assignment may differ from, and be more limited than, those held by the
assigning Lender. Because there is no liquid market for such securities, a
Portfolio anticipates that such securities could be sold only to a limited
number of institutional investors. The lack of a liquid secondary market may
have an adverse impact on the value of such securities and a Portfolio's
ability to dispose of particular Assignments or Participations when necessary
to meet a Portfolio's liquidity needs or in response to a specific economic
event such as a deterioration in the creditworthiness of the borrower. The lack
of a liquid secondary market for Assignments and Participations also may make
it more difficult for a Portfolio to assign a value to these securities for
purposes of valuing a Portfolio's securities and calculating its NAV.
Direct debt instruments involve the risk of loss in case of default or
insolvency of the borrower. Direct debt instruments may offer less legal
protection to a Portfolio in the event of fraud or misrepresentation and may
involve a risk of insolvency of the lending bank or other financial
intermediary. Direct debt instruments may also include standby financing
commitments that obligate the investing Portfolio to supply additional cash to
the borrower on demand. Participations involving emerging market country
issuers may relate to Loans as to which there has been or currently exists an
event of default or other failure to make payment when due, and may represent
amounts owed to financial institutions that are themselves subject to political
and economic risks, including the risk of currency devaluation, expropriation,
or failure. Such Participations present additional risks of default or loss.
LOANS OF PORTFOLIO SECURITIES. Each Portfolio may lend its securities to
brokers, dealers, domestic and foreign banks or other financial institutions
for the purpose of increasing its net investment income. These loans must be
secured continuously by cash or equivalent collateral, or by a letter of credit
at least equal to the market value of the securities loaned plus accrued
interest or income. There may be a risk of delay in recovery of the securities
or even loss of rights in the collateral should the borrower of the securities
fail financially. A Portfolio will not enter into securities loan transactions
exceeding, in the aggregate, 33 1/3% of its total assets. For more detailed
information about securities lending, see "Securities and Investment
Techniques" in the SAI.
MONEY MARKET INSTRUMENTS. Each Portfolio may invest in Money Market
Instruments, although the Portfolios intend to stay invested in securities
satisfying their primary investment objective to the extent practical. Each
Portfolio may invest in Money Market Instruments pending other investment or
settlement for liquidity, or in adverse market conditions. The Money Market
Instruments permitted for the Portfolios include obligations of the U.S.
Government and its agencies and instrumentalities; obligations of foreign
sovereignties; obligations of the International Bank for Reconstruction and
Development; other debt securities; commercial paper, including bank
obligations; certificates of deposit, including Eurodollar certificates of
deposit; and Repurchase Agreements. For more detailed information about these
Money Market Instruments, see "Description of Certain Securities and Ratings"
in the SAI.
MBSs. Mortgage-Backed Securities ("MBSs") are instruments that entitle the
holder to a share of all interest and principal payments from pools of
residential and commercial mortgage loans underlying the instruments, and may
take the form of pass-through securities or CMOs (see "CMOs," above).
Generally, these securities are designed to provide monthly payments of
interest and principal to the investor.
Pass-Through Securities. The mortgagee's monthly payments to his or her lending
institution are passed through to investors such as the Portfolio. Most issuers
or poolers provide guarantees of payments, regardless of whether the mortgagor
actually makes the payment. The guarantees made by issuers or poolers are
supported by various forms of credit, collateral, guarantees or insurance,
including individual loan, title, pool and hazard insurance purchased by the
issuer or pooler. The pools are assembled by various governmental, Government-
related and private organizations. A Portfolio may invest in securities issued
or guaranteed by the GNMA, FHLMC, FNMA, private issuers and other government
agencies. There can be no assurance that the private insurers can meet their
obligations under the policies. MBSs issued by non-agency issuers, whether or
not such securities are subject to guarantees, may entail greater risk. If
there is no guarantee provided by the issuer, MBSs purchased by a Portfolio
will be those which at the time of purchase are rated investment grade by one
or more NRSRO, or, if unrated, are deemed by the Advisers to be of comparable
quality.
Due to the possibility that prepayments on home mortgages will alter cash flow
on MBSs, it is not possible to determine in advance the actual final maturity
date or average life. Like Fixed Income Securities in general, MBSs will
generally decline in price when interest rates rise. Due to prepayment risk,
rising interest rates also tend to discourage refinancings of home mortgages,
with the result that the average life of MBSs held by a Portfolio may be
lengthened. This extension of average life causes the market price of the MBSs
to decrease further than if their average lives were fixed. However, when
interest rates fall, mortgages may not enjoy as large a gain in market value
due to prepayment risk because additional mortgage prepayments must be
reinvested at lower interest rates. Faster prepayment will shorten the average
life and slower prepayments will lengthen it. However, it is possible to
determine what the range of that movement could be and to calculate the effect
that it will have on the price of the MBS. In selecting these MBSs, the Adviser
will look for those that offer a higher yield to compensate for any variation
in average maturity.
19
<PAGE>
There are two methods of trading MBSs. A specified pool transaction is a trade
in which the pool number of the security to be delivered on the settlement date
is known at the time the trade is made. This is in contrast with the typical
MBS transaction, called a TBA (to be announced) transaction, in which the type
of MBS to be delivered is specified at the time of trade but the actual pool
numbers of the securities that will be delivered are not known at the time of
the trade. The pool numbers of the pools to be delivered at settlement will be
announced shortly before settlement takes place. The terms of the TBA trade may
be made more specific if desired. Generally, agency pass-through MBSs are
traded on a TBA basis.
CMOs. CMOs are debt securities that are issued by a thrift or other financial
institution and are collateralized as follows. The bondholder has a first
priority perfected security interest in collateral, usually consisting of
agency mortgage pass-through securities, although other assets, including U.S.
Treasuries (including Zero Coupons), Agencies, Cash Equivalents, whole loans
and Corporate Bonds, may qualify. The amount of collateral must be continuously
maintained at levels from 115% to 150% of the principal amount of the bonds
issued, depending on the specific issue structure and collateral type. See
"CMOs" above.
MUNICIPALS. Municipal securities ("Municipals") are debt obligations issued by
local, state and regional governments that provide interest income that is
exempt from federal income taxes. Municipals include both municipal bonds
(those securities with maturities of five years or more) and municipal notes
(those securities with maturities of less than five years). Municipal bonds are
issued for a wide variety of reasons: to construct public facilities, such as
airports, highways, bridges, schools, hospitals, mass transportation, streets,
water and sewer works; to obtain funds for operating expenses; to refund
outstanding municipal obligations; and to loan funds to various public
institutions and facilities. Certain industrial development bonds are also
considered municipal bonds if their interest is exempt from federal income
taxes. Industrial development bonds are issued by or on behalf of public
authorities to obtain funds for various privately-operated manufacturing
facilities, housing, sports arenas, convention centers, airports, mass
transportation systems and water, gas or sewer works. Industrial development
bonds are ordinarily dependent on the credit quality of a private user, not the
public issuer.
NON-DIVERSIFIED STATUS. The International Magnum and Emerging Markets Equity
Portfolios are non-diversified portfolios under the 1940 Act, which means that
the Portfolios are not limited by the 1940 Act in the proportion of their
assets that may be invested in the obligations of a single issuer. Thus, the
Portfolios may invest a greater proportion of their assets in the securities of
a small number of issuers and, as a result, will be subject to greater risk
with respect to their portfolio securities. However, the Portfolios intend to
comply with diversification requirements imposed by the Internal Revenue Code
of 1986, as amended (the "Code"), for qualification as regulated investment
companies. See "Investment Limitations" and "Taxes" in the SAI.
NON-PUBLICLY TRADED SECURITIES, PRIVATE PLACEMENTS AND RESTRICTED
SECURITIES. The Growth, International Magnum, Emerging Markets Equity, Fixed
Income, High Yield, Value and Mid Cap Value Portfolios may invest in securities
that are neither listed on a stock exchange nor traded over-the-counter,
including privately placed securities. Such unlisted Equity Securities may
involve a higher degree of business and financial risk that can result in
substantial losses. As a result of the absence of a public trading market for
these securities, they may be less liquid than publicly traded securities.
Although these securities may be resold in privately negotiated transactions,
the prices realized from these sales could be less than those originally paid
by the Portfolio or less than what may be considered the fair value of such
securities. Furthermore, companies whose securities are not publicly traded may
not be subject to the disclosure and other investor protection requirements
which might be applicable if their securities were publicly traded. If such
securities are required to be registered under the securities laws of one or
more jurisdictions before being resold, the Portfolio may be required to bear
the expenses of registration.
As a general matter, a Portfolio may not invest more than 15% of its net assets
in illiquid securities, including securities for which there is no readily
available secondary market and securities that are restricted from sale to the
public without registration ("Restricted Securities") under the Securities Act
of 1933, as amended (the "1933 Act") and are deemed to be illiquid. Restricted
Securities that can be offered and sold to qualified institutional buyers under
Rule 144A under the 1933 Act ("Rule 144A Securities") may be deemed to be
liquid under guidelines adopted by the Fund's Board of Directors. The
International Magnum and Emerging Markets Equity Portfolios may each invest up
to 25% of their total assets, and the Growth Portfolio may invest up to 35% of
its total assets, in Rule 144A Securities that are deemed to be liquid.
The Fund's Board of Directors has adopted guidelines and delegated to each
Adviser, subject to the supervision of the Board of Directors, the daily
function of determining and monitoring the liquidity of Rule 144A Securities.
Rule 144A Securities may become illiquid if qualified institutional buyers are
not interested in acquiring the securities. Investors should note that
investment of 5% of a Portfolio's total assets in Restricted Securities may be
considered a speculative activity and may involve greater risk and expense to
that Portfolio.
OPTIONS. Options are legal contracts that give the holder the right to buy or
sell a specified amount of the underlying security or futures contract at a
fixed or determinable price
20
<PAGE>
upon the exercise of the Option. A call Option conveys the right to buy and a
put Option conveys the right to sell a specified quantity of the underlying
security.
A Portfolio may write (i.e., sell) covered call Options on portfolio securities
which give the purchaser the right to buy the underlying security covered by
the Option from the Portfolio at the stated exercise price. A "covered" call
Option means that so long as a Portfolio is obligated as the writer of the
Option, it will own (i) the underlying securities subject to the Option, or
(ii) securities convertible or exchangeable without the payment of any
consideration into the securities subject to the Option. By selling a covered
call Option, a Portfolio would become obligated during the term of the Option
to deliver the securities underlying the Option should the Option holder choose
to exercise the Option before the Option's termination date. In return for the
call Option it has written, a Portfolio will receive from the purchaser (or
Option holder) a premium which is the price of the Option, less a commission
charged by a broker. A Portfolio will keep the premium regardless of whether
the Option is exercised. When a Portfolio writes covered call Options, it
augments its income by the premiums received and is thereby hedged to the
extent of that amount against a decline in the price of the underlying
securities. The premiums received will offset a portion of the potential loss
incurred by a Portfolio if the securities underlying the Options are ultimately
sold by the Portfolio at a loss. However, during the Option period, a Portfolio
has, in return for the premium on the Option, given up the opportunity for
capital appreciation above the exercise price should the market price of the
underlying security increase, but has retained the risk of loss should the
price of the underlying security decline.
A Portfolio may also write (i.e., sell) covered put Options. Generally, a put
Option is "covered" if a Portfolio maintains cash, U.S. Governments or other
high grade debt obligations equal to the exercise price of the Option or if a
Portfolio holds a put Option on the same underlying security with the same or
higher exercise price.
By selling a covered put Option, a Portfolio incurs an obligation to buy the
security underlying the Option from the purchaser of the put Option at the
Option's exercise price at any time during the Option period, at the
purchaser's election (certain Options written by a Portfolio will be
exercisable by the purchaser only on a specific date). A Portfolio may sell put
Options to receive the premiums paid by purchasers and to close out a long put
Option position. In addition, when the Adviser wishes to purchase a security at
a price lower than its current market price, a Portfolio may write a covered
put Option at an exercise price reflecting the lower purchase price sought.
A Portfolio may purchase put or call Options on individual securities or
baskets of securities. When a Portfolio purchases a call Option it acquires the
right to buy a designated security at a designated price ("exercise price"),
and when a Portfolio purchases a put Option it acquires the right to sell a
designated security at the exercise price, in each case on or before a
specified date ("termination date"), usually not more than nine months from the
date the Option is issued. A Portfolio may purchase call Options to close out a
covered call Option position or to protect against an increase in the price of
a security it anticipates purchasing. A Portfolio may purchase put Options on
securities which it holds in its portfolio to protect itself against a decline
in the value of the security. If the value of the underlying security were to
fall below the exercise price of the put Option purchased in an amount greater
than the premium paid for the Option, a Portfolio would incur no additional
loss. A Portfolio may also purchase put Options to close out written put Option
positions in a manner similar to call Option closing purchase transactions.
PREFERRED STOCKS. Preferred Stocks are non-voting securities which evidence
ownership in a corporation and which pay a fixed or variable stream of
dividends.
REPURCHASE AGREEMENTS. Repurchase Agreements are transactions in which a
Portfolio purchases a security and simultaneously commits to resell that
security to the seller (a bank, broker or dealer) at a mutually agreed upon
date and price. The term of these agreements is usually from overnight to one
week, and never exceeds one year. Repurchase Agreements may be viewed as a
fully collateralized loan of money by the Portfolio to the seller. The resale
price reflects the purchase price plus an agreed upon market rate of interest
which is unrelated to the coupon rate or date of maturity of the purchased
security.
In these transactions, the securities received by a Portfolio have a market
value at least equal to the purchase price (including accrued interest) of the
Repurchase Agreement as collateral, and this value is maintained during the
term of the agreement. These securities are held by the Portfolio's Custodian
or an approved third party for the benefit of the Portfolio until repurchased.
Repurchase Agreements permit a Portfolio to keep all its assets invested while
retaining overnight flexibility in pursuit of investments of a longer- term
nature. If the seller defaults and the collateral value declines, the Portfolio
might incur a loss. If bankruptcy proceedings are commenced with respect to the
seller, the Portfolio's realization upon the collateral may be delayed or
limited.
Pursuant to an order expected to be issued by the SEC, the Portfolios may pool
their daily uninvested cash balances in order to invest in Repurchase
Agreements on a joint basis. By entering into Repurchase Agreements on a joint
basis, it is expected that the Portfolios will incur lower transaction costs
and potentially obtain higher rates of interest on such Repurchase Agreements.
Each Portfolio's participation in the income from jointly purchased Repurchase
Agreements will be based on that Portfolio's percentage share in the total
Repurchase Agreement. The Portfolios' ability to invest in
21
<PAGE>
Repurchase Agreements on a joint basis will be contingent upon issuance of the
order by the SEC described above.
REVERSE REPURCHASE AGREEMENTS. A Portfolio may enter into Reverse Repurchase
Agreements with brokers, dealers, domestic and foreign banks or other financial
institutions. In a Reverse Repurchase Agreement, the Portfolio sells a security
and agrees to repurchase it at a mutually agreed upon date and price,
reflecting the interest rate effective for the term of the agreement. It may
also be viewed as the borrowing of money by the Portfolio. The Portfolio's
investment of the proceeds of a Reverse Repurchase Agreement is the speculative
factor known as leverage. The Portfolio may enter into a Reverse Repurchase
Agreement only if the interest income from investment of the proceeds is
greater than the interest expense of the transaction and the proceeds are
invested for a period no longer than the term of the agreement. The Portfolio
will maintain with the Custodian a separate account with a segregated portfolio
of liquid assets in an amount at least equal to its purchase obligations under
these agreements. If interest rates rise during a Reverse Repurchase Agreement,
it may adversely affect the Portfolio's ability to maintain a stable NAV.
RIGHTS. Rights represent a preemptive right of stockholders to purchase
additional shares of a stock at the time of a new issuance, before the stock is
offered to the general public, allowing the stockholder to retain the same
ownership percentage after the new stock offering.
RUSSIAN SECURITIES. The registration, clearing and settlement of securities
transactions involving Russian issuers are subject to significant risks not
normally associated with securities transactions in the United States and other
more developed markets. Ownership of Equity Securities in Russian companies is
evidenced by entries in a company's share register (except where shares are
held through depositories that meet the requirements of the 1940 Act) and the
issuance of extracts from the register or, in certain limited cases, by formal
share certificates. However, Russian share registers are frequently unreliable
and a Portfolio could possibly lose its registration through oversight,
negligence or fraud. Moreover, Russia lacks a centralized registry to record
securities transactions and registrars located throughout Russia or the
companies themselves maintain share registers. Registrars are under no
obligation to provide extracts to potential purchasers in a timely manner or at
all and are not necessarily subject to effective state supervision. In
addition, while registrars are liable under law for losses resulting from their
errors, it may be difficult for a Portfolio to enforce any rights it may have
against the registrar or issuer of the securities in the event of loss of share
registration. Although Russian companies with more than 1,000 shareholders are
required by law to employ an independent company to maintain share registers,
in practice, such companies have not always followed this law. Because of this
lack of independence of registrars, management of a Russian company may be able
to exert considerable influence over who can purchase and sell the company's
shares by illegally instructing the registrar to refuse to record transactions
on the share register. Furthermore, these practices may prevent a Portfolio
from investing in the securities of certain Russian companies deemed suitable
by the Adviser and could cause a delay in the sale of Russian Securities by the
Portfolio if the company deems a purchaser unsuitable, which may expose the
Portfolio to potential loss on its investment.
In light of the risks described above, the Board of Directors of the Fund has
approved certain procedures concerning the Fund's investments in Russian
Securities. Among these procedures is a requirement that a Portfolio will not
invest in the securities of a Russian company unless that issuer's registrar
has entered into a contract with the Fund's sub-custodian containing certain
protective conditions, including, among other things, the sub-custodian's right
to conduct regular share confirmations on behalf of the Portfolio. This
requirement will likely have the effect of precluding investments in certain
Russian companies that a Portfolio would otherwise make.
SMBSS. Stripped Mortgage-Backed Securities ("SMBSs") are Derivatives in the
form of multi-class mortgage securities. SMBSs may be issued by agencies or
instrumentalities of the U.S. Government and private originators of, or
investors in, mortgage loans, including savings and loan associations, mortgage
banks, commercial banks, investment banks and special purpose entities of the
foregoing.
SMBSs are usually structured with two classes that receive different
proportions of the interest and principal distributions on a pool of mortgage
assets. One type of SMBS will have one class receiving some of the interest and
most of the principal from the mortgage assets, while the other class will
receive most of the interest and the remainder of the principal. In some cases,
one class will receive all of the interest ("interest-only" or "IO class"),
while the other class will receive all of the principal ("principal-only" or
"PO class"). The yield to maturity on IO classes and PO classes is extremely
sensitive to the rate of principal payments (including prepayments) on the
related underlying mortgage assets, and a rapid rate of principal payments may
have a material adverse effect on the portfolio yield to maturity. If the
underlying mortgage assets experience greater than anticipated prepayments of
principal, a Portfolio may fail to fully recoup its initial investment in these
securities, even if the security is in one of the highest rating categories.
Although SMBSs are purchased and sold by institutional investors through
several investment banking firms acting as brokers or dealers, these securities
were only recently developed. As a result, established trading markets have not
yet developed and, accordingly, certain of these securities
22
<PAGE>
may be deemed illiquid and subject to a Portfolio's limitations on investment
in illiquid securities.
STRUCTURED NOTES. Structured Notes are Derivatives on which the amount of
principal repayment and/or interest payments is based upon the movement of one
or more factors. These factors include, but are not limited to, currency
exchange rates, interest rates (such as the prime lending rate and LIBOR) and
stock indices such as the S&P 500. In some cases, the impact of the movements
of these factors may increase or decrease through the use of multipliers or
deflators. The use of Structured Notes allows a Portfolio to tailor its
investments to the specific risks and returns the Adviser wishes to accept
while avoiding or reducing certain other risks.
SWAPS. Swap contracts ("Swaps") are Derivatives in the form of a contract or
other similar instrument which is an agreement to exchange the return generated
by one instrument for the return generated by another instrument. The payment
streams are calculated by reference to a specified index and agreed upon
notional amount. The term "specified index" includes, but is not limited to,
currencies, fixed interest rates, prices and total return on interest rate
indices, fixed income indices, stock indices and commodity indices (as well as
amounts derived from arithmetic operations on these indices). For example, a
Portfolio may agree to swap the return generated by a fixed income index for
the return generated by a second fixed income index. The currency Swaps in
which a Portfolio may enter will generally involve an agreement to pay interest
streams in one currency based on a specified index in exchange for receiving
interest streams denominated in another currency. Such Swaps may involve
initial and final exchanges that correspond to the agreed upon notional amount.
A Portfolio will usually enter into Swaps on a net basis, i.e., the two return
streams are netted out in a cash settlement on the payment date or dates
specified in the instrument, with a Portfolio receiving or paying, as the case
may be, only the net amount of the two returns. A Portfolio's obligations under
a Swap agreement will be accrued daily (offset against any amounts owing to the
Portfolio) and any accrued but unpaid net amounts owed to a Swap counterparty
will be covered by the maintenance of a segregated account consisting of cash
or liquid securities. A Portfolio will not enter into any Swap agreement unless
the counterparty meets the rating requirements set forth in guidelines
established by the Fund's Board of Directors.
Interest rate and total rate of return Swaps do not involve the delivery of
securities, other underlying assets, or principal. Accordingly, the risk of
loss with respect to interest rate and total rate of return Swaps is limited to
the net amount of interest payments that a Portfolio is contractually obligated
to make. If the other party to an interest rate or total rate of return Swap
defaults, a Portfolio's risk of loss consists of the net amount of interest
payments that a Portfolio is contractually entitled to receive. In contrast,
currency Swaps usually involve the delivery of the entire principal value 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. If there is a default by the counterparty, a Portfolio may have
contractual remedies pursuant to the agreements related to the transaction. The
Swap market has grown substantially in recent years with a large number of
banks and investment banking firms acting both as principals and as agents
utilizing standardized Swap documentation. As a result, the Swap market has
become relatively liquid. Swaps that include caps, floors, and collars are more
recent innovations for which standardized documentation has not yet been fully
developed and, accordingly, they are less liquid than "traditional" Swaps.
The use of Swaps is a highly specialized activity which involves investment
techniques and risks different from those associated with ordinary portfolio
securities transactions. If the Adviser is incorrect in its forecasts of market
values, interest rates, and currency exchange rates, the investment performance
of a Portfolio would be less favorable than it would have been if this
investment technique was not used.
TEMPORARY INVESTMENTS. During periods in which the Adviser believes changes in
economic, financial or political conditions make it advisable, each Portfolio
may reduce its holdings for temporary defensive purposes and may invest in
certain short-term (less than twelve months to maturity) and medium-term (not
greater than five years to maturity) debt securities or may hold cash. The
short-term and medium-term debt obligations in which a Portfolio may invest
consist of (a) obligations of the U.S. or foreign governments, their respective
agencies or instrumentalities; (b) bank deposits and bank obligations
(including certificates of deposit, time deposits and bankers' acceptances) of
U.S. or foreign banks denominated in any currency; (c) Floaters and other
instruments denominated in any currency issued by international development
agencies; (d) finance company and corporate commercial paper and other short-
term corporate debt obligations of U.S. and foreign corporations meeting a
Portfolio's credit quality standards; and (e) Repurchase Agreements with banks
and broker-dealers with respect to such securities. For temporary defensive
purposes, the Portfolios intend to invest only in short-term and medium-term
debt obligations that the Adviser believes to be of high quality, i.e., subject
to relatively low risk of loss of interest or principal (there is currently no
rating system for foreign debt obligations).
U.S. GOVERNMENTS. U.S. Governments are Fixed Income Securities that are backed
by the full faith and credit of the U.S. Government as to the payment of both
principal and interest. U.S. Governments may include securities issued by the
U.S. Treasury and securities issued by federal agencies and U.S. Government
sponsored instrumentalities. For further
23
<PAGE>
information on these securities, see "Description of U.S. Government
Securities" in the SAI.
WARRANTS. Warrants are instruments giving holders the right, but not the
obligation, to buy shares of a company at a given price during a specified
period.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. When-Issued and Delayed Delivery
Securities are securities purchased with payment and delivery taking place in
the future in order to secure what is considered to be an advantageous yield or
price at the time of the transaction. Delivery of and payment for these
securities may take as long as a month or more after the date of the purchase
commitment, but will take place no more than 120 days after the trade date. The
payment obligation and the interest rates that will be received are each fixed
at the time a Portfolio enters into the commitment and no interest accrues to
the Portfolio until settlement. Thus, it is possible that the market value at
the time of settlement could be higher or lower than the purchase price if the
general level of interest rates has changed. The Portfolio will maintain with
the Custodian a separate account with a segregated portfolio of liquid
securities or cash in an amount at least equal to these commitments. The
Growth, Global Equity, International Magnum and Emerging Markets Equity
Portfolios will not enter into When-Issued or Delayed Delivery Securities
commitments exceeding, in the aggregate, 15% of the Portfolio's total assets
other than the obligations created by these commitments.
ZERO COUPONS, PAY-IN-KIND SECURITIES OR DEFERRED PAYMENT SECURITIES. Zero
Coupons are Fixed Income Securities that do not make regular interest payments.
Instead, Zero Coupons are sold at substantial discounts from their face value.
The difference between a Zero Coupon's issue or purchase price and its face
value represents the imputed interest an investor will earn if the obligation
is held until maturity. Zero Coupons may offer investors the opportunity to
earn higher yields than those available on ordinary interest-paying obligations
of similar credit quality and maturity. However, Zero Coupon prices may also
exhibit greater price volatility than ordinary Fixed Income Securities because
of the manner in which their principal and interest are returned to the
investor. Pay-In-Kind Securities are securities that have interest payable by
delivery of additional securities. Upon maturity, the holder is entitled to
receive the aggregate par value of the securities. Deferred Payment Securities
are securities that remain Zero Coupons until a predetermined date, at which
time the stated coupon rate becomes effective and interest becomes payable at
regular intervals. Zero Coupon, Pay-In-Kind and Deferred Payment Securities may
be subject to greater fluctuation in value and lesser liquidity in the event of
adverse market conditions than comparably rated securities paying cash interest
at regular interest payment periods.
FUNDAMENTAL INVESTMENT LIMITS
- -----------------------------
The investment objective of each Portfolio discussed on the preceding pages is
a fundamental policy, that is, a policy subject to change only by shareholder
approval. The policy for each Portfolio in the following paragraph is also
fundamental. All policies stated throughout this Prospectus, other than those
identified as fundamental, can be changed without shareholder approval. For
additional fundamental and non-fundamental investment limits, see "Investment
Limitations" in the SAI.
EACH PORTFOLIO (excluding the International Magnum and Emerging Markets Equity
Portfolios) is a diversified investment company and is therefore subject to the
following fundamental limitations: as to 75% of its total assets, a Portfolio
may not (a) invest more than 5% of its total assets in the securities of any
one issuer, except obligations of the U.S. Government, its agencies and
instrumentalities, or (b) own more than 10% of the outstanding voting
securities of any one issuer.
INTERNAL REVENUE SERVICE ("IRS") LIMITATIONS. In addition to the above, each
Portfolio also follows certain limitations imposed by the IRS on separate
accounts of insurance companies relating to the tax-deferred status of variable
annuity contracts and variable life insurance policies. More specific
information may be contained in the insurance company's separate account
prospectus.
MANAGEMENT OF THE FUND
- ----------------------
The Fund is governed by a Board of Directors which is responsible for the
management of the business and affairs of the Fund as provided in the laws of
the State of Maryland and the Fund's Articles of Incorporation and By-Laws. The
Board of Directors of the Fund has undertaken to monitor the Fund for the
existence of any material irreconcilable conflict among the interests of
variable annuity contract owners, variable life insurance policy owners and
qualified plans that invest in the Fund due to differences in tax treatment and
other considerations, and shall report any such conflict to the boards of the
respective life insurance companies that use the Fund as an investment vehicle
for their respective variable annuity contracts and variable life insurance
policies and to qualified plans. The Boards of Directors of those life
insurance companies and the fiduciaries of certain qualified plans and the
Adviser, have agreed or will agree to be responsible for reporting any
potential or existing conflicts to the Directors of the Fund. If a material
irreconcilable conflict exists that affects those life insurance companies,
they will be required, at their own cost, to remedy such conflict up to and
including establishing a new registered management investment company and
segregating the assets underlying the variable annuity contracts and the
variable life insurance policies. Qualified plans which acquire more than 10%
of the assets of the Fund will be required to report any potential or existing
conflicts to the Directors of the Fund, and if a
24
<PAGE>
material irreconcilable conflict exists, to remedy such conflict, up to and
including redeeming shares of the Portfolios held by the qualified plans. The
majority of the Fund's Directors are not affiliated with MSAM, MAS, any of
their affiliates, any of the other companies that provide services to the Fund
or any of their affiliates. The officers of the Fund conduct and supervise its
daily business operations.
THE FUND MAY HOLD SPECIAL MEETINGS. The Fund will not hold annual shareholder
meetings, but may call special meetings when required by law, when requested by
a sufficient number of shareholders or for other reasons. An insurance company
issuing a variable annuity contract or variable life insurance policy that
participates in the Portfolios will vote shares held in its separate account as
required by law and interpretations thereof, as may be amended or changed from
time to time. In accordance with current law and interpretations thereof, a
participating insurance company is required to request voting instructions from
contract or policy owners and must vote shares in the separate account in
proportion to the voting instructions received. For a further discussion,
please refer to your insurance company's separate account prospectus.
INVESTMENT MANAGEMENT
INVESTMENT ADVISERS. The Adviser assigned to a Portfolio provides investment
advice and portfolio management services, pursuant to an Investment Advisory
Agreement and, subject to the supervision of the Fund's Board of Directors,
makes the Portfolio's day-to-day investment decisions, arranges for the
execution of portfolio transactions and generally manages the Portfolio's
investments. MSAM serves as the Adviser for the Growth, Global Equity,
International Magnum and Emerging Markets Equity Portfolios. MAS serves as the
adviser for the Fixed Income, High Yield, Value, and Mid Cap Value Portfolios.
MSAM, with principal offices at 1221 Avenue of the Americas, New York, New York
10020, conducts a worldwide investment management business, providing a broad
range of portfolio management services to customers in the United States and
abroad. MSAM is a wholly-owned subsidiary of Morgan Stanley Group Inc.
("MSGI"), which is a publicly owned financial services corporation listed on
the New York, London and Pacific stock exchanges. MSAM, a registered Investment
Adviser under the Investment Advisers Act of 1940, as amended, serves as
investment adviser to numerous open-end and closed-end investment companies.
MAS is a Pennsylvania limited liability partnership founded in 1969 with
principal offices at One Tower Bridge, West Conshohocken, Pennsylvania 19428.
As of January 1996, MAS is also indirectly wholly-owned by MSGI. MAS provides
investment services to employee benefit plans, endowment funds, foundations and
other institutional investors and has served as investment adviser to several
open-end investment companies since 1984. As of September 30, 1996, MSAM,
together with its affiliated asset management companies (other than MAS),
managed investments totaling approximately $66 billion, including approximately
$49.4 billion under active management and $16.6 billion as Named Fiduciary or
Fiduciary Advisers. At September 30, 1996, MAS managed investments totaling
approximately $37.5 billion. See "Management of the Fund" in the SAI.
PORTFOLIO MANAGERS. The following individuals have primary responsibility for
the Portfolios as indicated below.
FIXED INCOME PORTFOLIO -- Thomas L. Bennett, Kenneth B. Dunn and Richard B.
Worley. Thomas L. Bennett, a Managing Director of Morgan Stanley & Co. Inc.
("Morgan Stanley"), joined MAS in 1984. He assumed responsibility for the MAS
Funds Fixed Income Portfolio in 1984, the MAS Funds Domestic Fixed Income
Portfolio 1987, the MAS Funds High Yield Portfolio in 1985, the MAS Funds Fixed
Income Portfolio II in 1990, the MAS Funds Special Purpose Fixed Income and
Balanced Portfolios in 1992 and the MAS Funds Multi-Asset-Class Portfolio in
1994. Mr. Bennett is Chairman of the Board of Trustees of MAS Funds, a member
of the Executive Committee of MAS and a Director of MAS Fund Distributors, Inc.
Mr. Bennett holds a B.S. in Chemistry and an M.B.A. from University of
Cincinnati. Kenneth B. Dunn, a Managing Director of Morgan Stanley, joined MAS
in 1987. He assumed responsibility for the MAS Funds Fixed Income and Domestic
Fixed Income Portfolios in 1987, the MAS Funds Fixed Income II Portfolio in
1990, the MAS Funds Mortgage-Backed Securities and Special Purpose Fixed Income
Portfolios in 1992, and the MAS Funds Municipal and PA Municipal Portfolios in
1994. Mr. Dunn received a B.S. and an M.B.A. from The Ohio State University and
a Ph.D. from Purdue University. Richard B. Worley, a Managing Director of
Morgan Stanley, joined MAS in 1978. He assumed responsibility for the MAS Funds
Fixed Income Portfolio in 1984, the MAS Funds Domestic Fixed Income Portfolio
in 1987, the MAS Funds Fixed Income Portfolio II in 1990, the MAS Funds
Balanced and Special Purpose Fixed Income Portfolios in 1992, the MAS Funds
Global Fixed Income and International Fixed Income Portfolios in 1993 and the
MAS Funds Multi-Asset-Class Portfolio in 1994. Mr. Worley received a B.A. in
Economics from University of Tennessee and attended the Graduate School of
Economics at University of Texas. Messrs. Bennett, Dunn, and Worley have shared
primary responsibility for managing the Portfolio's assets since inception.
HIGH YIELD PORTFOLIO -- Robert E. Angevine, Thomas L. Bennett, and Stephen F.
Esser. Robert Angevine is a Principal of Morgan Stanley and the Portfolio
Manager for high yield investments. Mr. Angevine received an M.B.A. from
Fairleigh Dickinson University and a B.A. in Economics from Lafayette College.
Information about Thomas L. Bennett is included under Fixed Income Portfolio
above. Stephen F. Esser, a Managing Director of Morgan Stanley, joined MAS in
1988. He assumed responsibility for the MAS Funds High Yield Portfolio in 1989.
Mr. Esser
25
<PAGE>
holds a B.S. from University of Delaware. Messrs. Bennett, Angevine and Esser
have shared primary responsibility for managing the Portfolio's assets since
inception.
GROWTH PORTFOLIO -- Kurt Feuerman, Margaret K. Johnson, and Daniel Lascano.
Kurt Feuerman is a Managing Director of MSAM and heads MSAM's Equity Group. He
joined MSAM in July 1993 after spending three years as a Managing Director of
Morgan Stanley's Research Department, where he was responsible for emerging
growth stocks, gaming and restaurants. Mr. Feuerman earned an M.B.A. from
Columbia University, an M.A. from Syracuse University and a B.A. from McGill
University. Margaret Johnson is a Principal of MSAM and a Portfolio Manager in
the Institutional Equity Group. She joined MSAM in 1984. She holds a B.A.
degree from Yale College and is a Chartered Financial Analyst. Daniel Lascano
is a Vice President of MSAM. He joined MSAM in 1993. Mr. Lascano graduated from
the University of California at Berkeley, with a B.A. in Economics and
Statistics. Mr. Feuerman, Ms. Johnson and Mr. Lascano have shared primary
responsibility for managing the Portfolio's assets since inception.
VALUE PORTFOLIO -- Richard M. Behler and Robert J. Marcin. Richard M. Behler, a
Principal of Morgan Stanley, joined MAS in 1995. He served as a Portfolio
Manager from 1992 through 1995 for Moore Capital Management and as Senior Vice
President for Merrill Lynch Economics from 1987 through 1992. He assumed
responsibility for the MAS Fund's Value Portfolio in 1996. Mr. Behler received
a B.A. (Cum Laude) in Economics from Villanova University and an M.A. and a
Ph.D. in Economics from University of Notre Dame. Robert J. Marcin, a Managing
Director of Morgan Stanley, joined MAS in 1988. He assumed responsibility for
the MAS Funds Value Portfolio in 1990 and the MAS Funds Equity Portfolio in
1994. Mr. Marcin holds a B.A. from Darmouth College. Mr. Behler and Mr. Marcin
have shared primary responsibility for managing the Portfolio's assets since
inception.
MID CAP VALUE PORTFOLIO -- William B. Gerlach and Gary G. Schlarbaum. William
B. Gerlach, a Vice President of Morgan Stanley, joined MAS in 1991. He holds a
B.A. in Economics from Haverford College. Gary G. Schlarbaum, a Managing
Director of Morgan Stanley, joined MAS in 1987. He assumed responsibility for
the MAS Funds Equity and Small Cap Value Portfolios in 1987, the MAS Funds
Balanced Portfolio in 1992 and the MAS Funds Multi-Asset-Class and Mid Cap
Value Portfolios in 1994. Mr. Schlarbaum holds a B.A. from Coe College and a
Ph.D. from University of Pennsylvania. Mr. Gerlach and Mr. Schlarbaum have had
primary responsibility for managing the Portfolio's assets since inception.
GLOBAL EQUITY PORTFOLIO -- Frances Campion. Frances Campion, a Principal of
Morgan Stanley, joined MSAM in January 1990 as a Global Equity Fund Manager.
Her responsibilities include day-to-day management of the Global Equity
product. She is a graduate of University of College, Dublin. Ms. Campion has
had primary responsibility for managing the Portfolio's assets since inception.
INTERNATIONAL MAGNUM PORTFOLIO -- Francine J. Bovich. Francine Bovich joined
Morgan Stanley as a Principal in 1993. She is responsible for product
development, portfolio management and communication of MSAM's asset allocation
strategy to institutional investor clients. Previously, Ms. Bovich was a
Principal and Executive Vice President of Westwood Management Corp. She holds a
B.A. in Economics from Connecticut College and an M.B.A. in Finance from New
York University. Ms. Bovich has had primary responsibility for managing the
Portfolio's assets since inception.
EMERGING MARKETS EQUITY PORTFOLIO -- Madhav Dhar and Marianne L. Hay. Madhav
Dhar is a Managing Director of MSAM and Morgan Stanley. He joined MSAM in 1984
to focus on global asset allocation and investment strategy and now heads
MSAM's emerging markets group and serves as the group's principal Portfolio
Manager. Mr. Dhar also coordinates MSAM's developing country funds effort and
has been involved in the launching of MSAM's country funds. He is a Director of
the Morgan Stanley Emerging Markets Fund, Inc. (a closed-end investment
company). He holds a B.S. (honors) from St. Stephens College, Delhi University
(India), and an M.B.A. from Carnegie-Mellon University. Marianne L. Hay, a
Managing Director of Morgan Stanley, joined the Adviser in June 1993 to work
with the Adviser's senior management covering all emerging markets assets
allocation, product development and client services. Ms. Hay has 17 years of
investment experience. Prior to joining the Adviser, she was a director of
Martin Currie Investment Management, Ltd. ("Martin Currie") where her
responsibilities included geographic asset allocation and portfolio management
for global and emerging markets funds, as well as being director in charge of
the company's North American clients. She graduated with an honors degree in
genetics from Edinburgh University and holds a Diploma in Education and the
qualification of the Association of the Institute of Bankers in Scotland. Mr.
Dhar and Ms. Hay have shared primary responsibility for managing the
Portfolio's assets since its inception.
26
<PAGE>
OTHER SERVICES
DISTRIBUTOR. Under its Distribution Agreement with the Fund, Morgan Stanley
serves as the exclusive Distributor of the Fund and sells shares of each
Portfolio upon the terms and at the current offering price described in this
Prospectus. Morgan Stanley is not obligated to sell any certain number of
shares of any Portfolio. Morgan Stanley, as principal underwriter, or the
insurance companies whose variable products are funded by the Fund, will bear
all of the Fund's marketing expenses. This includes the cost of reproducing
prospectuses, statements of additional information or any other Fund documents
(such as semiannual reports) used as sales materials.
ADMINISTRATION. MSAM and MAS also provide the respective Portfolios of the Fund
which they manage with administrative services pursuant to Administration
Agreements. The services provided under the respective Administration
Agreements are subject to the supervision of the officers and the Board of
Directors of the Fund, and include day-to-day administration of matters related
to the corporate existence of the Fund, maintenance of its records, preparation
of reports, supervision of the Fund's arrangements with its Custodian, and
assistance in the preparation of the Fund's registration statements under
federal and state laws. The Administration Agreements also provide that the
Administrators through their agents will provide the Fund with dividend
disbursing and transfer agent services. For their services under the
Administration Agreements, the Fund pays MSAM and MAS a monthly fee which on an
annual basis equals 0.25% of the average daily net assets of each Portfolio
that they administer.
MSAM and MAS have each entered into a Sub-Administration Agreement with Chase
Global Funds Services Company ("Chase Global"), a subsidiary of The Chase
Manhattan Bank ("Chase"), pursuant to which Chase Global has agreed to provide
certain administrative services to the Fund. MSAM and MAS supervise and monitor
such administrative services provided by Chase Global. The services provided
under the Administration Agreements and the Sub-Administration Agreements are
also subject to the supervision of the Board of Directors of the Fund. The
Board of Directors of the Fund has approved the provision of services described
above pursuant to the Administration Agreements and the Sub-Administration
Agreements as being in the best interests of the Fund. Chase Global's business
address is 73 Tremont Street, Boston, Massachusetts 02108-3913. For additional
information regarding the Administration Agreements or the Sub-Administration
Agreements, see "Management of the Fund" in the SAI.
Chase Global calculates the NAV and dividends, maintains the general accounting
records and administers the securities lending program for each Portfolio.
CUSTODIANS. Chase serves as the Custodian of domestic securities and cash of
the Portfolios. Chase is not an affiliate of either of the Advisers or the
Distributor. Morgan Stanley Trust Company, Brooklyn, New York ("MSTC"), an
affiliate of MSAM, MAS and the Distributor, acts as the Fund's Custodian for
foreign assets held outside the United States (including, through sub-
custodians, securities held in Russia) and employs sub-custodians approved by
the Board of Directors of the Fund in accordance with regulations of the SEC
for the purpose of providing custodial services for such assets. MSTC may also
hold certain domestic assets for the Fund. For more information on the
Custodians, see "General Information--Custody Arrangements" in the SAI.
DIVIDEND DISBURSING AND TRANSFER AGENT. Chase Global acts as dividend
disbursing and transfer agent for the Fund.
INDEPENDENT ACCOUNTANTS. Price Waterhouse LLP serves as independent accountants
for the Fund and will audit the annual financial statements of each Portfolio.
LEGAL COUNSEL. Morgan, Lewis & Bockius LLP serves as legal counsel to the Fund.
BREAKDOWN OF EXPENSES
The Portfolios pay fees and other costs related to their daily operations.
Expenses paid out of a Portfolio's assets are reflected in its share price.
Each Portfolio pays a management fee to its Adviser for managing its
investments and business affairs. MSAM and MAS pay fees to affiliates who
provide assistance with these services. Each Portfolio also pays other
expenses, which are explained below. The Advisers may, from time to time,
reduce their fees or reimburse the Portfolios for expenses above a specified
limit. These fee reductions or expense reimbursements, which may be terminated
at any time without notice, can decrease a Portfolio's expenses and boost its
performance.
MANAGEMENT FEE
The Adviser assigned to a Portfolio is entitled to receive from such Portfolio
a management fee, payable quarterly, at an annual rate as a percentage of
average daily net assets as set forth in the tables below.
27
<PAGE>
U.S. FIXED INCOME PORTFOLIO ADVISORY FEES
<TABLE>
<CAPTION>
===========================================================================
Assets Fixed Income High Yield
- ---------------------------------------------------------------------------
<S> <C> <C>
First $500 million 0.40% 0.50%
- ---------------------------------------------------------------------------
From $500 million to $1 billion 0.35% 0.45%
- ---------------------------------------------------------------------------
More than $1 billion 0.30% 0.40%
===========================================================================
</TABLE>
U.S. EQUITY PORTFOLIO ADVISORY FEES
<TABLE>
<CAPTION>
=======================================================================================
Mid Cap
Assets Growth Value Value
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
First $500 million 0.55% 0.55% 0.75%
- ---------------------------------------------------------------------------------------
From $500 million to $1
billion 0.50% 0.50% 0.70%
- ---------------------------------------------------------------------------------------
More than $1 billion 0.45% 0.45% 0.65%
=======================================================================================
</TABLE>
GLOBAL PORTFOLIO ADVISORY FEES
<TABLE>
<CAPTION>
========================================================================================
Emerging
Global International Markets
Assets Equity Magnum Equity
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
First $500 million 0.80% 0.80% 1.25%
- ----------------------------------------------------------------------------------------
From $500 million to $1
billion 0.75% 0.75% 1.20%
- ----------------------------------------------------------------------------------------
More than $1 billion 0.70% 0.70% 1.15%
========================================================================================
</TABLE>
28
<PAGE>
However, the Advisers, with respect to certain of the Portfolios, have
voluntarily waived receipt of their management fees and agreed to reimburse the
Portfolio, if necessary, if such fees would cause the total annual operating
expenses of the Portfolio to exceed the respective percentage of average daily
net assets set forth in the table below.
<TABLE>
<CAPTION>
Maximum Total Annual
Operating Expenses After
Portfolio Fee Waivers
- --------- ------------------------
<S> <C>
Fixed Income........................................... 0.70%
High Yield............................................. 0.80%
Growth................................................. 0.85%
Value.................................................. 0.85%
Mid Cap Value.......................................... 1.05%
Global Equity.......................................... 1.15%
International Magnum................................... 1.15%
Emerging Markets Equity................................ 1.75%
</TABLE>
OTHER EXPENSES
In addition to investment advisory and certain administrative expenses charged
by the administrators, each Portfolio pays all expenses not assumed by MSAM or
MAS. Such expenses include or could include investment-related expenses, such
as brokers' commissions, transfer taxes and fees related to the purchase, sale,
or loan of securities; fees and expenses for Directors not affiliated with MSAM
or MAS; fees and expenses of its independent accountants and legal counsel;
costs of Directors and shareholder meetings; SEC fees; expenses of preparing
and filing registration statements; the cost of providing proxy statements,
prospectuses and statements of additional information to existing variable
annuity contract and variable life insurance policy owners; expenses of
preparing and printing the annual and semiannual shareholder reports to
variable annuity contract and variable life insurance policy owners; bank
transaction charges and certain custodians' fees and expenses; federal, state
or local income or other taxes; costs of maintaining the Portfolio's corporate
existence; membership fees for the Investment Company Institute and similar
organizations; fidelity bond and Directors' liability insurance premiums; and
any extraordinary expenses such as indemnification payments or damages awarded
in litigation or settlements made. All these expenses that are incurred by the
Portfolio will be passed on to the shareholders through a daily charge made to
the assets held in the Portfolios, which will be reflected in share prices.
PORTFOLIO TURNOVER
Under certain market conditions, a Portfolio may experience high portfolio
turnover as a result of its investment strategies. For example, the purchase or
sale of securities by a Portfolio in anticipation of a rise or decline in
interest rates or to take advantage of yield disparities among different issues
of Fixed Income Securities could result in high portfolio turnover. As a result
of their investment strategies, the Fixed Income and Mid Cap Value Portfolios'
annual portfolio turnover rates are expected to be as high as 200%. The High
Yield Portfolio's rate is expected to be as high as 150%. Higher portfolio
turnover rates for the Portfolios can result in corresponding increases in
expenses such as brokerage commissions and transaction costs. Although none of
the Portfolios will invest for short-term trading purposes, investment
securities may be sold from time to time without regard to the length of time
they have been held and the Portfolios will not consider portfolio turnover
rate a limiting factor in making investment decisions consistent with their
respective objectives and policies. The tables that will be set forth in
"Financial Highlights" will present the Portfolios' historical turnover rates.
PERFORMANCE OF PORTFOLIOS
Each Portfolio's total return and yield may be quoted in advertising if
accompanied by performance of your insurance company's separate account.
Performance is based on historical results and is not intended to indicate
future performance. For additional performance information, contact your
insurance company for a free annual report.
TOTAL RETURN is the change in value of an investment in a Portfolio over a
given period, assuming reinvestment of any dividends and capital gains. A
cumulative total return reflects actual performance over a stated period of
time. An average annual total return is a hypothetical rate of return that, if
achieved annually, would have produced the same cumulative total return if
performance had been constant over the entire period. Average annual total
returns smooth out variations in performance; they are not the same as actual
year-by-year results.
Average annual total returns covering periods of less than one year assume that
performance will remain constant for the rest of the year.
Yield refers to the income generated by an investment in a Portfolio over a
given period of time, expressed as an annual percentage rate. When a yield
assumes that income is reinvested, it is called an effective yield.
Total returns and yields quoted for the Portfolios include each Portfolio's
expenses, but may not include charges and expenses attributable to any
particular insurance product. Since shares of the Portfolios may be purchased
only through variable annuity contracts and variable life insurance policies
and by tax qualified investors, such as qualified pension and retirement plans,
you should carefully review the prospectus of the insurance product you have
chosen for information on relevant charges and expenses. Excluding these
charges from quotations of each Portfolio's performance has the effect of
increasing the performance quoted. You should bear in mind the effect of these
charges when comparing a Portfolio's performance to that of other mutual funds.
29
<PAGE>
PERFORMANCE OF INVESTMENT ADVISERS
The Advisers manage portfolios of Morgan Stanley Institutional Fund, Inc.
("MSIF") and MAS Funds, which served as the models for the Portfolios of the
Fund. The portfolios of MSIF and MAS Funds have substantially the same
investment objectives, policies and strategies as the Portfolios of the Fund.
In addition, the Advisers intend the Portfolios of the Fund and the
corresponding portfolios of MSIF and MAS Funds to be managed by the same
personnel and to continue to have closely similar investment strategies,
techniques and characteristics. The following table sets forth the name of each
Portfolio of the Fund and the name of the corresponding portfolio of MSIF or
MAS Funds from which the Portfolio is cloned.
<TABLE>
<CAPTION>
Corresponding Corresponding
MSIF MAS Funds
Fund Portfolio portfolio portfolio
-------------- ------------- -------------
<S> <C> <C>
Fixed Income Fixed Income
High Yield High Yield
Growth Equity Growth
Value Value
Mid Cap Value Mid Cap Value
Global Equity Global Equity
International Magnum International Magnum
Emerging Markets Equity Emerging Markets
</TABLE>
Past investment performance of the portfolios of MSIF and MAS Funds, as shown
in the table below, may be relevant to your consideration of the Portfolios.
The investment performance of the portfolios of MSIF and MAS Funds is not
necessarily indicative of future performance of the Portfolios of the Fund.
Also, the operating expenses of each of the Portfolios of the Fund will be
different from, and may be higher than, the operating expenses of the
corresponding portfolio of the MSIF or MAS Funds. The investment performance of
the portfolios of MSIF and MAS Funds is provided merely to indicate the
experience of the Advisers in managing similar portfolios.
<TABLE>
<CAPTION>
Average Average
Nine Months One Year Five Years Ten Years Annual Annual Average
Cumulative Cumulative Cumulative Cumulative Total Return Total Return Annual
Total Return Total Return Total Return Total Return Five Years Ten Years Total Return
Inception Ended Ended Ended Ended Ended Ended Since
Fund Name Date 9/30/96 9/30/96 9/30/96 9/30/96 9/30/96 9/30/96 Inception
- --------- --------- ------------ ------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
MSIF:
Equity Growth....... 11/1/89 21.14% 27.85% 119.88% NA 17.07% NA 16.25%
Global Equity....... 7/15/92 12.90% 14.19% NA NA NA NA 18.09%
International
Magnum............. 3/15/96 3.90%* NA NA NA NA NA NA
Emerging Markets
Equity............. 9/25/92 14.58% 6.59% NA NA NA NA 14.39%
MAS Funds:
Fixed Income........ 11/14/84 3.34% 7.63% 63.46% 145.13% 8.94% 9.38% 10.92%
High Yield.......... 2/28/89 10.53% 13.83% 97.01% NA 14.52% NA 11.45%
Value............... 11/5/84 13.95% 18.41% 127.75% 297.08% 17.89% 14.79% 16.86%
Mid Cap Value....... 12/30/94 22.95% 22.30% NA NA NA NA 32.88%
</TABLE>
- -------
* Cumulative (unannualized) total return since inception.
30
<PAGE>
ACCOUNT POLICIES
DISTRIBUTIONS AND TAXES
The Fund intends each of its Portfolios to qualify as a separate entity under
the Internal Revenue Code of 1986, as amended (the "Code"), and to qualify as a
"regulated investment company" under Subchapter M of the Code. As a regulated
investment company under the Code, net income and net realized gains of each
Portfolio will be distributed to shareholders at least once a year.
As stated on the cover of this prospectus, shares of the Portfolios will be
purchased by life insurance companies for their separate accounts under
variable annuity contracts and variable life insurance policies and by other
entities under qualified pension and retirement plans. Under the provisions of
the Code currently in effect, net income and realized capital gains are not
currently taxable when left to accumulate within a variable annuity contract or
variable life insurance policy or under a qualified pension or retirement plan.
For information on federal income taxation of a life insurance company with
respect to its receipt of distributions from the Fund and federal income
taxation of owners of variable annuity contracts or variable life insurance
policies, refer to the life insurance company's variable annuity contract or
variable life insurance policy prospectus.
TRANSACTION DETAILS
THE PORTFOLIOS ARE OPEN FOR BUSINESS each day the New York Stock Exchange
("NYSE") is open. Each of the Growth, Value, Mid Cap Value, Global Equity,
International Magnum and Emerging Markets Equity Portfolio's NAV is determined
as of the close of business of the NYSE (normally 4:00 p.m. Eastern time) on
each day that the NYSE is open for business. The NYSE is currently scheduled to
be closed on New Year's Day, Washington's Birthday, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day, and on the
preceding Friday or subsequent Monday when any of these holidays falls on a
Saturday or Sunday, respectively.
Each of the Fixed Income and High Yield Portfolio's NAV is determined as of one
hour after the close of the bond markets (normally 4:00 p.m. Eastern time) on
each day that the Portfolios are open for business.
EACH PORTFOLIO'S NAV is the value of a single share. The NAV is computed by
adding the value of the Portfolio's investments, cash and other assets,
subtracting its liabilities, and then dividing the result by the number of
shares outstanding.
Each Portfolio's assets are valued primarily on the basis of market quotations.
Foreign securities are valued on the basis of quotations from the primary
market in which they are traded, and are translated from the local currency
into U.S. dollars using current exchange rates. If quotations are not readily
available or if the values have been materially affected by events occurring
after the closing of a foreign market, assets are valued by a method that the
Fund's Board of Directors believes accurately reflects fair value.
EACH PORTFOLIO'S OFFERING PRICE (price to buy one share) and REDEMPTION PRICE
(price to sell one share) are its NAV.
EACH PORTFOLIO RESERVES THE RIGHT TO SUSPEND THE OFFERING OF SHARES for a
period of time. Each Portfolio also reserves the right to reject any specific
order. Purchase orders may be refused if, in the Adviser's opinion, they would
disrupt management of a Portfolio.
INVESTMENTS AND REDEMPTIONS. Investments and redemptions may be made only by
separate accounts established and maintained by insurance companies for the
purpose of funding variable annuity contracts and variable life insurance
policies and by tax qualified investors, such as qualified pension and
retirement plans. Please refer to the prospectus of your insurance company's
separate account or the qualified plan documents for information on how to
invest in and redeem shares of each Portfolio.
Each participating insurance company receives orders from its variable annuity
contract and variable life insurance policy owners to purchase or redeem shares
of the Portfolios each business day. That night, all orders received by that
insurance company on that business day are aggregated, and the insurance
company places a net purchase or redemption order for shares of one or more
Portfolios the morning of the next business day. These orders are normally
executed at the NAV that was computed at the close of the previous business day
in order to provide a match between the variable contract and policy owners'
orders to the insurance companies and the insurance companies' orders to a
Portfolio. In some cases, an insurance company's orders for Portfolio shares
may be executed at the NAV next computed after the order is actually
transmitted to a Portfolio.
Redemption proceeds will normally be wired to the insurance company on the next
business day after receipt of the redemption instructions by a Portfolio but in
no event later than seven days following receipt of instructions. Each
Portfolio may suspend redemptions or postpone payment dates on days when the
NYSE is closed (other than weekends or holidays), when trading on the NYSE is
restricted, or as permitted by the SEC.
31
<PAGE>
SUPPLEMENT DATED JANUARY 13,1997
TO
STATEMENT OF ADDITIONAL INFORMATION DATED OCTOBER 1, 1996
MORGAN STANLEY UNIVERSAL FUNDS, INC.
P.O. BOX 2798
BOSTON, MA 02208-2798
-----------------
The following paragraphs replace the last three paragraphs of the second column
of Page 1 of the Statement of Additional Information:
Statement of Additional Information dated October 1, 1996, relating to:
Prospectus dated January 13, 1997 for the Money Market, Fixed Income, High
Yield, Core Equity, Growth, Value, Mid Cap Growth, Mid Cap Value, U.S. Real
Estate, International Fixed Income, Emerging Markets Debt, Global Equity,
International Magnum, Emerging Markets Equity, Asian Equity, Balanced and
Multi-Asset-Class Portfolios.
Prospectus dated October 1, 1996, for the Emerging Markets Equity
Portfolio.
Prospectus dated January 13, 1997 for the Fixed Income, High Yield, Growth,
Value, Mid Cap Value, Global Equity, International Magnum and Emerging
Markets Equity Portfolios.
PLEASE RETAIN THIS SUPPLEMENT FOR FUTURE REFERENCE
