<PAGE>
SUPPLEMENT DATED MARCH 4, 1998
TO
STATEMENT OF ADDITIONAL INFORMATION DATED MAY 1, 1997
Previously Supplemented Through February 13, 1998
MORGAN STANLEY UNIVERSAL FUNDS, INC. (the "Fund")
P.O. BOX 2798
BOSTON, MA 02208-2798
-------------------
The Statement of Additional Information ("SAI") is being supplemented to
reflect the creation of an additional prospectus of the Fund. The following
sentence is added at the end of the second column on the first page of the SAI:
Prospectus dated March 4, 1998 for the Equity Growth, International Magnum
and Emerging Markets Equity Portfolios.
-------------------
PLEASE RETAIN THIS SUPPLEMENT FOR FUTURE REFERENCE
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
MORGAN STANLEY ASSET MANAGEMENT INC. MILLER 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 THREE PORTFOLIOS MANAGED BY MORGAN STANLEY ASSET MANAGEMENT INC.
("MSAM"). THE FUND ALSO OFFERS FOURTEEN OTHER PORTFOLIOS MANAGED BY MSAM OR
MILLER ANDERSON & SHERRERD, LLP ("MAS"), AN AFFILIATE OF MSAM.
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 FOR THE INSURANCE PRODUCT WHICH ACCOMPANIES
THIS PROSPECTUS.
A STATEMENT OF ADDITIONAL INFORMATION ("SAI") DATED MAY 1, 1997 AND
SUPPLEMENTED THROUGH MARCH 4, 1998, 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 COPY OF THE SAI AT NO CHARGE,
CONTACT THE FUND BY CALLING 1-800-422-6464 EXT. 7182 OR CONTACT 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, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
THE PORTFOLIOS:
Equity Growth 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 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 March 4, 1998
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 three 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
in seeking to achieve 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
Portfolios. MSAM conducts a worldwide investment advisory business. As of
January 31, 1998, MSAM and its affiliated institutional asset management
companies (exclusive of MAS) had approximately $87.4 billion in assets under
management or fiduciary advice.
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
FINANCIAL HIGHLIGHTS 3
Financial highlights tables as of June 30, 1997.
PORTFOLIO SUMMARIES 4
For each Portfolio, the investment objective and a summary
of strategy, potential investors, and investment characteristics
and risks.
THE PORTFOLIOS' INVESTMENTS 4
A more detailed review of how each Portfolio invests and
investment characteristics and risks.
SECURITIES AND INVESTMENT TECHNIQUES 7
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 21
Certain policies that may be changed only by shareholders.
MANAGEMENT OF THE FUND 21
General information on organization and operations of the
Fund, including details about MSAM and the individual portfolio
managers, as well as fees, expenses and performance calculations.
ACCOUNT POLICIES 27
Information on net asset value calculation, income and gain
distributions, taxes and share purchases and redemptions.
2
<PAGE>
FINANCIAL HIGHLIGHTS
The following tables provide financial highlights for the Equity Growth,
International Magnum and Emerging Markets Equity Portfolios for the period from
January 2, 1997 to June 30, 1997. The Emerging Markets Equity Portfolio was the
only Portfolio of the Fund operational in the fiscal year ended December 31,
1996 and, therefore, is the only Portfolio with audited financial highlights
for the period ended December 31, 1996. The Emerging Markets Equity Portfolio's
audited financial highlights for the period ended December 31, 1996 have been
audited by Price Waterhouse LLP, whose unqualified report thereon is included
in the Statement of Additional Information. The unaudited financial highlights
presented below for the six months ended June 30, 1997 are part of the Fund's
unaudited financial statements which are included in the Fund's current
Statement of Additional Information and in the Fund's most recent Semi-Annual
Report to Shareholders. The Semi-Annual Report and the financial statements
therein, along with the Statement of Additional Information, are available at
no cost from the Fund at the address and toll free number noted on the cover
page to this Prospectus or from your insurance company.
<TABLE>
<CAPTION>
INTERNATIONAL
EQUITY GROWTH MAGNUM EMERGING MARKETS
PORTFOLIO PORTFOLIO EQUITY PORTFOLIO
------------------- ------------------- ------------------------------------
PERIOD FROM PERIOD FROM
JANUARY 2, 1997* TO JANUARY 2, 1997* TO SIX MONTHS ENDED PERIOD FROM
SELECTED PER SHARE DATA JUNE 30, 1997 JUNE 30, 1997 JUNE 30, 1997 OCTOBER 1, 1996* TO
AND RATIOS (UNAUDITED) (UNAUDITED) (UNAUDITED) DECEMBER 31, 1996
- ----------------------- ------------------- ------------------- ---------------- -------------------
<S> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF PERIOD.... $ 10.00 $ 10.00 $ 9.78 $ 10.00
------- ------- ------- -------
INCOME FROM INVESTMENT
OPERATIONS
Net Investment
Income............... 0.03 0.09 0.05 0.01
Net Realized and
Unrealized Gain...... 1.50 1.58 2.20 (0.21)
------- ------- ------- -------
Total From Investment
Operations........... 1.53 1.67 2.25 (0.20)
------- ------- ------- -------
DISTRIBUTIONS
Net Investment
Income............... -- -- -- (0.02)
------- ------- ------- -------
Total Distributions... -- -- -- (0.02)
------- ------- ------- -------
NET ASSET VALUE, END OF
PERIOD................. $ 11.53 $ 11.67 $ 12.03 $ 9.78
======= ======= ======= =======
TOTAL RETURN............ 15.30% 16.70% 23.01% (2.03)%
======= ======= ======= =======
RATIOS AND SUPPLEMENTAL
DATA:
Net Assets, End of
Period (000's)......... $ 3,959 $14,643 $20,308 $11,789
Ratio of Expenses to
Average Net Assets..... 0.85%** 1.15%** 1.75%** 1.75%**
Ratio of Net Investment
Income to Average Net
Assets................. 0.60%** 1.96%** 1.03%** 0.32%**
Portfolio Turnover
Rate................... 95% 19% 38% 9%
Average Commission Rate:
Per Share............. $0.0510 $0.0170 $0.0012 $0.0013
As a Percentage of
Trade Amount......... NA 0.17% 0.40% 0.45%
Effect of Voluntary
Expense Limitation
During the Period:
Per Share Benefit to
Net Investment Income
(Loss)............... $ 0.85 $ 0.05 $ 0.12 $ 0.08
Ratios Before Expense
Limitation:
Expenses to Average
Net Assets........... 5.55%** 2.38%** 4.49%** 6.17%**
Net Investment Income
(Loss) to Average Net
Assets............... (4.11)%** 0.73%** (1.67)%** (4.06)%**
</TABLE>
- --------
*Commencement of operations
**Annualized
3
<PAGE>
PORTFOLIO SUMMARIES
Certain investment terms used below have initial capital letters ("Common
Stocks" or "MBSs," for example). These terms are further described under
"Securities and Investment Techniques" below.
EQUITY 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 be able to ride out market fluctuations in anticipation of greater long-
term growth.
INTERNATIONAL MAGNUM PORTFOLIO
OBJECTIVE AND STRATEGY: Long-term capital appreciation by investing primarily
in Equity Securities of non-U.S. issuers domiciled in EAFE countries.
INVESTOR PROFILE: The Portfolio may be appropriate for investors who seek to
pursue their investment goals in markets outside the United States. By
including Foreign 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, Foreign Investment involves different or increased
risks. The performance of the Portfolio will be affected by foreign currency
values, the greater volatility of foreign securities exchanges and the overall
political, economic and regulatory environment 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, Foreign Investment involves different or increased
risks. The performance of the Portfolio will be affected by foreign currency
values, the greater volatility of foreign securities exchanges, and the overall
political, economic and regulatory environment in the countries in which the
Portfolio invests. The risks of Foreign Investment are exacerbated in the case
of Emerging Market Country Securities.
THE PORTFOLIOS' INVESTMENTS
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.
The Portfolios spread investment risk by limiting, to varying degrees, 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,
Common Stock prices can fluctuate dramatically in response to these factors.
Over time, however, Common Stocks have shown greater growth potential than
other types of securities. The prices of Fixed Income Securities also fluctuate
and generally move in the opposite direction from interest rates.
Foreign Investment 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 greater volatility of foreign
securities exchanges, and the overall political, economic and regulatory
environment 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
4
<PAGE>
Status" in this Prospectus and "Investment Limitations" in the 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 may use various investment techniques to hedge
risks, including investment in Derivatives, but there is no guarantee that
these strategies will work as intended.
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.
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.
EQUITY 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
Transactions, Non-Publicly Traded Securities, Private Placements, Restricted
Securities, Money Market Instruments, Investment Company Securities, Repurchase
Agreements, When-Issued and Delayed Delivery Securities, Fixed Income
Securities and Derivatives, and may engage in Loans of 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, 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 Stocks.
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.
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
domiciled in EAFE countries (defined below). 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 primarily are those comprising
the Morgan Stanley Capital International EAFE Index (the "EAFE 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"). The Portfolio may
invest up to 5% of its total assets in the securities of issuers domiciled in
non-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.
5
<PAGE>
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) Fixed
Income Securities, Foreign Currency Transactions, Investment Company
Securities, Temporary Investments, Money Market Instruments, Non-Publicly
Traded Securities, Restricted Securities, Repurchase Agreements, Cash or Cash
Equivalents, When-Issued or Delayed Delivery Securities and Derivatives, and
may engage in Loans of Portfolio Securities. The Portfolio may also invest up
to 10% of its total assets in (i) Investment Funds with investment objectives
similar to that of the Portfolio and (ii) for temporary purposes, Money Market
Instruments 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 Investment Grade Securities. 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,
corporate profits and economic growth among the various regions represented in
the EAFE 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 Transactions, 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, 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 20%
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.
6
<PAGE>
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
Bulgaria Chile China (mainland
Colombia Egypt and Hong Kong)
Ghana Greece Hungary
India Indonesia Israel
Jamaica Jordan Kenya
Malaysia Mexico Morocco
Nigeria Pakistan Peru
Philippines Poland Russia
Singapore 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.
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 and certain risks
associated with investment in foreign issuers, see "Foreign Investment" below.
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."
SECURITIES AND INVESTMENT TECHNIQUES
The following pages contain more detailed information about types of
instruments in which a Portfolio may invest and strategies the 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 Adviser may not buy all of these instruments or use all of these techniques
to the full extent permitted unless it believes that doing so will help a
Portfolio achieve its investment objective. Current holdings and recent
investment strategies are described in the Portfolios' financial reports, which
will be sent to the Portfolios' shareholders twice a year. For a copy of an SAI
or financial report, at no charge, contact the Fund or your insurance company.
INSTRUMENTS AND INVESTMENTS
ABSS. Asset-backed securities ("ABSs") 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 ABSs 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 ABSs 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 ABSs, 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
7
<PAGE>
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.
ADRS. For information concerning ADRs, see "Depositary Receipts" below.
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.
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 U.S.
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 nationally
recognized statistical rating organizations (each, an "NRSRO") in one of their
two highest categories, (e.g., A-1 or A-1+ by Standard & Poor's Ratings Group
(" S&P") or Prime 1 by Moody's Investors Service, Inc. ("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
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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, MBSs
(as defined below) will generally decline in price when interest rates rise.
However, when interest rates fall, MBSs 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, MBSs 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.
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. The Portfolios are permitted to invest in various Derivatives for
both hedging and non-hedging purposes. Derivatives include Options, Futures,
Structured Notes, Caps, Floors, Collars and Swaps. Additionally, the Portfolios
may invest in other Derivatives that are developed over time if their use would
be consistent with the objectives of the Portfolios. Each of the Portfolios
will limit its use of Derivatives to 33 1/3% of its total assets measured by
the aggregate notional amount of outstanding Derivatives. The Portfolios'
investments in forward foreign currency contracts and Derivatives used for
hedging purposes are not subject to the foregoing limits.
The Portfolios may use Derivatives under a number of different circumstances to
further their investment objectives. The Portfolios may use Derivatives when
doing so provides more liquidity than the direct purchase of the securities
underlying such Derivatives. For example, a Portfolio may purchase Derivatives
to quickly gain exposure to a market in response to changes in the Portfolio's
asset allocation policy or upon the inflow of investable cash and at that time
the Derivative provides greater liquidity than the underlying securities
market. A Portfolio may also use Derivatives when it is restricted from
directly owning the underlying securities due to foreign investment
restrictions or other reasons or when doing so provides a price advantage over
purchasing the underlying securities directly, either because of a pricing
differential between the Derivatives and securities
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markets or because of lower transaction costs associated with the Derivatives
transaction. Derivatives may also be used by a Portfolio for hedging purposes
and under other circumstances in which a Portfolio's portfolio managers believe
it advantageous to do so consistent with the Portfolio's investment objective.
The Portfolios will not, however, use Derivatives in a manner that creates
leverage, except to the extent that the use of leverage is expressly permitted
by a particular Portfolio's investment policies, and then only in a manner
consistent with such policies.
Some of the derivative instruments in which the Portfolios may invest and the
risks related thereto are described in more detail below.
Caps, Floors and Collars. The Portfolios may invest in Caps, Floors and
Collars, which are instruments analogous to Options. A Cap is the right to
receive the excess of a reference rate over a given rate and is analogous to a
put Option. A Floor is the right to receive the excess of a given rate over a
reference rate and is analogous to a call Option. A Collar is an instrument
that combines a Cap and a Floor. The buyer of a Collar buys a Cap and writes a
Floor, and the writer of a Collar writes a Cap and buys a Floor. The risks
associated with Caps, Floors and Collars are similar to those associated with
Options. In addition, Caps, Floors and Collars are subject to risk of default
by the counterparty because they are privately negotiated instruments.
Futures. The Portfolios may purchase and sell futures contracts and options on
futures contracts, including but not limited to securities index futures,
foreign currency exchange futures, interest rate futures contracts and other
financial futures (collectively, "Futures"). Futures contracts provide for the
sale by one party and purchase by another party of a specified amount of a
specific security, instrument or basket thereof, at a specific future date and
at a specified price. An option on a futures contract is a legal contract that
gives the holder the right to buy or sell a specified amount of futures
contracts at a fixed or determinable price upon the exercise of the option.
The Portfolios may sell securities index futures contracts and/or options
thereon in anticipation of or during a market decline to attempt to offset the
decrease in market value of investments in its portfolio, or purchase
securities index futures in order to gain market exposure. Subject to
applicable laws, the Portfolios may engage in transactions in securities index
futures contracts (and options thereon) which are traded on a recognized
securities or futures exchange, or may purchase or sell such instruments in the
over-the-counter market. There currently are limited securities index futures
and options on such futures in many countries, particularly emerging countries.
The nature of the strategies adopted by the Adviser, and the extent to which
those strategies are used, may depend on the development of such markets.
The Portfolios may engage in transactions involving foreign currency exchange
futures contracts. Such contracts involve an obligation to purchase or sell a
specific currency at a specified future date and at a specified price. The
Portfolios may engage in such transactions to hedge their respective holdings
and commitments against changes in the level of future currency rates or to
adjust their exposure to a particular currency. For more information, see
"Foreign Currency Transactions" above.
The Portfolios may engage in transactions in interest rate futures
transactions. Interest rate futures contracts involve an obligation to purchase
or sell a specific debt security, instrument or basket thereof at a specified
future date at a specified price. The value of the contract rises and falls
inversely with changes in interest rates. The Portfolios may engage in such
transactions to hedge their holdings of debt instruments against future changes
in interest rates.
Financial futures are futures contracts relating to financial instruments, such
as U.S. Government securities, foreign currencies, and certificates of deposit.
Such contracts involve an obligation to purchase or sell a specific security,
instrument or basket thereof at a specified future date at a specified price.
Like interest rate futures contracts, the value of financial futures contracts
rises and falls inversely with changes in interest rates. The Portfolios may
engage in financial futures contracts for hedging and non-hedging purposes.
Under rules adopted by the Commodity Futures Trading Commission, each Portfolio
may enter into futures contracts and options thereon for both hedging and non-
hedging purposes, provided that not more than 5% of such Portfolio's total
assets at the time of entering the transaction are required as margin and
option premiums to secure obligations under such contracts relating to non-
hedging activities.
Gains and losses on futures contracts and options thereon depend on the
Adviser's ability to predict correctly the direction of securities prices,
interest rates and other economic factors. Other risks associated with the use
of futures and options are (i) imperfect correlation between the change in
market value of investments held by a Portfolio and the prices of futures and
options relating to investments purchased or sold by the Portfolio, and (ii)
possible lack of a liquid secondary market for a futures contract and the
resulting inability to close a futures position. The risk
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that a Portfolio will be unable to close out a futures position or options
contract will be minimized by only entering into futures contracts or options
transactions for which there appears to be a liquid exchange or secondary
market. The risk of loss in trading on futures contracts in some strategies can
be substantial, due both to the low margin deposits required and the extremely
high degree of leverage involved in futures pricing.
Options. The Portfolios may seek to increase their returns or may hedge their
portfolio investments through Options transactions with respect to securities,
instruments, indices or baskets thereof in which such Portfolios may invest, as
well as with respect to foreign currency. Purchasing a put Option gives a
Portfolio the right to sell a specified security, currency or basket of
securities or currencies at the exercise price until the expiration of the
Option. Purchasing a call Option gives a Portfolio the right to purchase a
specified security, currency or basket of securities or currencies at the
exercise price until the expiration of the Option.
Each Portfolio also may write (i.e., sell) put and call Options on investments
held in its portfolio, as well as with respect to foreign currency. A Portfolio
that has written an Option receives a premium, which increases the Portfolio's
return on the underlying security or instrument in the event the Option expires
unexercised or is closed out at a profit. However, by writing a call Option, a
Portfolio will limit its opportunity to profit from an increase in the market
value of the underlying security or instrument above the exercise price of the
Option for as long as the Portfolio's obligation as writer of the Option
continues. The Portfolios may only write Options that are "covered". A covered
call Option means that so long as the Portfolio is obligated as the writer of
the Option, it will earmark or segregate sufficient liquid assets to cover its
obligations under the Option or own (i) the underlying security or instrument
subject to the Option, (ii) securities or instruments convertible or
exchangeable without the payment of any consideration into the security or
instrument subject to the Option, or (iii) a call Option on the same underlying
security with a strike price no higher than the price at which the underlying
instrument was sold pursuant to a short Option position.
By writing (or selling) a put Option, a Portfolio incurs an obligation to buy
the security or instrument underlying the Option from the purchaser of the put
at the Option's exercise price at any time during the Option period, at the
purchaser's election. The Portfolios may also write Options that may be
exercisable by the purchaser only on a specific date. A Portfolio that has
written a put Option will earmark or segregate sufficient liquid assets to
cover its obligations under the Option or will own a put Option on the same
underlying security with an equal or higher strike price.
The Portfolios may engage in transactions in Options which are traded on
recognized exchanges or over-the-counter. There currently are limited Options
markets in many countries, particularly emerging countries such as Latin
American countries, and the nature of the strategies adopted by the Adviser and
the extent to which those strategies are used will depend on the development of
such Options markets. The primary risks associated with the use of Options are
(i) imperfect correlation between the change in market value of investments
held, purchased or sold by a Portfolio and the prices of Options relating to
such investments, and (ii) possible lack of a liquid secondary market for an
Option.
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 Index. In some cases, the impact of the
movements of these factors may increase or decrease through the use of
multipliers or deflators. The Portfolios may use Structured Notes to tailor
their 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 in which two parties agree to exchange the returns
generated by a security, instrument, basket thereof or index for the returns
generated by another security, instrument, basket thereof or index. The payment
streams are calculated by reference to a specific security, index or instrument
and an agreed upon notional amount. The relevant indices include but are 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 the Portfolios 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
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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 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 payments that a
Portfolio is contractually entitled to receive. In contrast, currency Swaps may
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 may be 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 Swaps 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 Swaps 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 the Portfolios would be less favorable than it would have been if this
investment technique were not used.
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.
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,
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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, ABSs, 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 Union, the Asian Development Bank and others; (3) non-
government foreign corporate debt securities; (4) foreign MBSs and various
other MBSs and ABSs 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 TRANSACTIONS. Portfolios investing in foreign securities will
regularly transact security purchases and sales in foreign currencies. The
Portfolios may hold foreign currency or engage in the Foreign Currency
Transactions discussed below.
As a means of reducing the risks associated with investing in securities
denominated in foreign currencies, a Portfolio may purchase or sell foreign
currency on a forward basis ("Forwards" or "forward contracts"), enter into
foreign currency futures and options on futures contracts ("Forex Futures") and
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.
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 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.
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
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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.
Forwards 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 Forwards 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.
A Portfolio engaging in Forwards will comply with the segregation requirements
required by the Investment Company Act of 1940, as amended (the "1940 Act") and
the rules adopted thereunder. 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.
FOREIGN EQUITIES. Foreign Equity Securities ("Foreign Equities") include, but
are not limited to, Common Stocks, Preferred Stocks, 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
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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, 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.
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 High Yield Securities 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,
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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 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 any security of a registered closed-end
investment company if the Portfolio and other investment companies with the
same adviser would own more than 10% of the outstanding voting shares of the
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 under the 1940 Act or 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 Portfolios 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
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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
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 Net Asset
Value ("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. Pursuant to an order
issued by the SEC, the Fund may lend portfolio securities to affiliated broker-
dealers. 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, Fannie Mae, private issuers and other
government agencies. There can be no
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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 Adviser 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.
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.
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 "Internal Revenue 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 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 in Rule 144A Securities that are deemed to be
liquid. The Equity
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Growth Portfolio may invest an unlimited amount 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.
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 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
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of share registration. Although Russian companies with more than 1,000
shareholders are required by law to employ an independent registrar, 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 may be deemed
illiquid and subject to a Portfolio's limitations on investment in illiquid
securities.
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 information on these securities, see
"Securities and Investment Techniques--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
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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 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 under "Portfolio
Summaries" above 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.
The Equity Growth Portfolio is a diversified investment company and is
therefore subject to the following fundamental limitations: as to 75% of its
total assets, the 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. For additional
information, see "Investment Limitations" in the SAI.
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 MSAM
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 a Portfolio will be required to report any potential or existing conflicts
to the Directors of the Fund, and if a 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, any of its
21
<PAGE>
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 ADVISER. MSAM serves as the adviser for the Portfolios. It 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 Portfolios' day-to-day investment decisions, arranges for
the execution of portfolio transactions and generally manages the Portfolios'
investments. 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,
Dean Witter, Discover & Co. ("MSDWD"), which is a preeminent global financial
services firm that maintains leading market positions in each of its three
primary businesses--securities, asset management and credit services. 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 as well as to employee benefit plans, endowment funds,
foundations and other institutional investors. As of January 31, 1998, MSAM,
together with its institutional investment advisory affiliates (exclusive of
MAS) had approximately $87.4 billion in assets under management or fiduciary
advice. See "Management of the Fund" in the SAI.
PORTFOLIO MANAGERS. The following individuals have primary responsibility for
the Portfolios as indicated below.
EQUITY GROWTH PORTFOLIO -- Kurt Feuerman and Margaret K. Johnson. 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 the Research
Department at Morgan Stanley & Co. Incorporated ("Morgan Stanley"), 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. Mr. Feuerman and Ms. Johnson have shared primary
responsibility for managing the Portfolio's assets since its inception.
INTERNATIONAL MAGNUM PORTFOLIO -- Francine J. Bovich. Francine Bovich, a
Managing Director of Morgan Stanley, joined MSAM 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 its inception.
EMERGING MARKETS EQUITY PORTFOLIO--Madhav Dhar and Robert L. Meyer. Madhav Dhar
joined the Adviser in 1984. He is a Managing Director of the Adviser and of
Morgan Stanley. He is a member of the Adviser's executive committee, head of
the Adviser's emerging markets group and chief investment officer of the
Adviser's global emerging market equity portfolios. He holds a B.S. (honors)
from St. Stephen's College, Delhi University India and an M.B.A. from Carnegie-
Mellon University. Mr. Dhar has been primarily responsible for managing the
Portfolio's assets since it commenced operations. Robert L. Meyer joined the
Adviser in 1989. He is a Managing Director of the Adviser and of Morgan Stanley
and co-manager of the Adviser's emerging markets group and head of the
Adviser's Latin American team. He was born in Argentina and graduated from Yale
University with a B.A. in Economics and Political Science. He received a J.D.
from Harvard Law School. In addition, he is also a Chartered Financial Analyst.
Mr. Meyer has worked with Mr. Dhar in managing the Portfolio's assets since it
commenced operations.
OTHER SERVICES
DISTRIBUTOR. Under its Distribution Agreement with the Fund, Morgan Stanley, a
subsidiary of MSDWD,
22
<PAGE>
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 semi-annual reports) used as sales materials.
ADMINISTRATOR. MSAM also provides the Portfolios with administrative services
pursuant to an Administration Agreement. The services provided under the
Administration Agreement 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 Agreement also
provides that MSAM through its agents will provide the Fund with dividend
disbursing and transfer agent services. For its services under the
Administration Agreement, the Fund pays MSAM a monthly fee which on an annual
basis equals 0.25% of the average daily net assets of each Portfolio.
MSAM has entered into a Sub-Administration Agreement with Chase Global Funds
Services Company ("Chase Global"), a corporate affiliate of The Chase Manhattan
Bank ("Chase"), pursuant to which Chase Global has agreed to provide certain
administrative services to the Fund. MSAM supervises and monitors such
administrative services provided by Chase Global. The services provided under
the Administration Agreement and the Sub-Administration Agreement 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 Agreement and the Sub-Administration Agreement
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 Agreement or the Sub-Administration Agreement, see
"Management of the Fund" in the SAI.
Certain administrative and recordkeeping services that would otherwise be
performed by the Adviser or its service providers, may be performed by
insurance companies that purchase shares of the Portfolios. The Adviser may
make payments to these insurance companies to defray the cost of providing
those services.
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 the Adviser or the Distributor.
Morgan Stanley Trust Company, Brooklyn, New York ("MSTC"), an affiliate of MSAM
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 audits 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 pays fees to affiliates who provide
assistance with these services. Each Portfolio also pays other expenses, which
are explained below. The Adviser may, from time to time, reduce its 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.
23
<PAGE>
MANAGEMENT FEE
The Adviser is entitled to receive from each Portfolio a management fee,
payable quarterly, at an annual rate as a percentage of average daily net
assets as set forth in the table below.
<TABLE>
<CAPTION>
Emerging
Equity International Markets
Assets Growth Magnum Equity
- ------------------------------------------------
<S> <C> <C> <C>
First $500
million 0.55% 0.80% 1.25%
- ------------------------------------------------
From $500
million to
$1 billion 0.50% 0.75% 1.20%
- ------------------------------------------------
More than $1
billion 0.45% 0.70% 1.15%
</TABLE>
However, the Adviser, with respect to certain of the Portfolios, has
voluntarily waived receipt of its 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
Fee Waivers and
Portfolio Reimbursements
- --------- ------------------------
<S> <C>
Equity Growth.......................................... 0.85%
International Magnum................................... 1.15%
Emerging Markets Equity................................ 1.75%
</TABLE>
The fee waivers and reimbursements are voluntary and may be terminated by the
Adviser at any time.
OTHER EXPENSES
In addition to investment advisory and certain administrative expenses charged
by the administrators, each Portfolio pays all expenses not assumed by MSAM.
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;
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 TRANSACTIONS
The Investment Advisory Agreement authorizes the Adviser to select the brokers
or dealers that will execute the purchases and sales of investment securities
for the Portfolios and directs the Adviser to use its best efforts to obtain
the best available price and most favorable execution with respect to all
transactions for the Portfolios. The Fund has authorized the Adviser to pay
higher commissions in recognition of brokerage services which, in the opinion
of the Adviser, are necessary for the achievement of better execution, provided
the Adviser believes this to be in the best interest of the Fund.
Since shares of the Portfolios are not marketed through intermediary brokers or
dealers, it is not the Fund's practice to allocate brokerage or principal
business on the basis of sales of shares which may be made through such firms.
In purchasing and selling securities for the Portfolios, it is the Fund's
policy to seek to obtain quality execution at the most favorable prices through
responsible broker-dealers. In selecting broker-dealers to execute the
securities transactions for the Portfolios, consideration will be given to such
factors as the price of the security, the rate of the commission, the size and
difficulty of the order, the reliability, integrity, financial condition,
general execution and operational capabilities of competing broker-dealers, and
the brokerage and research services which they provide to the Fund. Some
securities considered for investment by the Portfolios may also be appropriate
for other clients served by the Adviser. If the purchase or sale of securities
consistent with the investment policies of the Portfolios and one or more of
these other clients serviced by the Adviser is considered at or about the same
time, transactions in such securities will be allocated among the Portfolios
and such other clients in a manner deemed fair and reasonable by the Adviser.
Although there is no specified formula for allocating such transactions, the
various allocation methods used by the Adviser, and the results of such
allocations, are subject to periodic review by the Fund's Board of Directors.
Subject to the overriding objective of obtaining the best possible execution of
orders, the Adviser may allocate
24
<PAGE>
a portion of the Portfolio's brokerage transactions to Morgan Stanley or broker
affiliates of Morgan Stanley. In order for Morgan Stanley or its affiliates to
effect any portfolio transactions for the Fund, the commissions, fees or other
remuneration received by Morgan Stanley or such affiliates must be reasonable
and fair compared to the commissions, fees or other remuneration paid to other
brokers in connection with comparable transactions involving similar securities
being purchased or sold on a securities exchange during a comparable period of
time. Furthermore, the Board of Directors of the Fund, including a majority of
those Directors who are not "interested persons," as defined in the 1940 Act,
have adopted procedures which are reasonably designed to provide that any
commissions, fees or other remuneration paid to Morgan Stanley or such
affiliates are consistent with the foregoing standard.
Portfolio securities will not be purchased from or through, or sold to or
through, the Adviser or Morgan Stanley or any "affiliated persons," as defined
in the 1940 Act of Morgan Stanley when such entities are acting as principals,
except to the extent permitted by law.
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. 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.
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. 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. 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.
25
<PAGE>
PERFORMANCE OF INVESTMENT ADVISER
The Adviser manages portfolios of Morgan Stanley Institutional Fund, Inc.
("MSIF"), which served as the models for the Portfolios of the Fund. The
portfolios of MSIF Funds have substantially the same investment objectives,
policies and strategies as the Portfolios of the Fund. In addition, the Adviser
intends the Portfolios of the Fund and the corresponding portfolios of MSIF 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 from which that Portfolio is cloned.
<TABLE>
<CAPTION>
Corresponding
MSIF
Fund Portfolio portfolio
-------------- -------------
<S> <C>
Equity Growth Equity Growth
International Magnum International Magnum
Emerging Markets Equity Emerging Markets
</TABLE>
Past investment performance of the Class A Shares of the MSIF portfolios, as
shown in the table below, may be relevant to your consideration of the
Portfolios. The investment performance of the portfolios of MSIF 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 MSIF. The investment performance of the Class A
Shares of the MSIF portfolios is provided merely to indicate the experience of
the Adviser in managing similar portfolios.
<TABLE>
<CAPTION>
Average Average
Total Return Annual Annual Average
Eleven Total Return Total Return Total Return Total Return Total Return Annual
Months One Year Five Years Ten Years Five Years Ten Years Total Return
Inception Ended Ended Ended Ended Ended Ended Since
Fund Name Date 11/30/97 11/30/97 11/30/97 11/30/97 11/30/97 11/30/97 Inception
- --------- --------- ------------ ------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
MSIF:
Equity Growth....... 4/2/91 25.28% 26.28% 156.90% NA 20.77% NA 18.52%
International
Magnum............. 3/15/96 7.46% 8.11% NA NA NA NA 9.24%
Emerging Markets.... 9/25/92 0.38% 1.03% 71.51% NA 11.39% NA 10.67%
</TABLE>
PRINCIPAL HOLDERS OF SECURITIES
As of August 8, 1997, MSDWD owned more than 25% of the outstanding voting
securities of the Equity Growth and International Magnum Portfolios. Also, as
of that date, the American General Life Insurance Company owned more than 25%
of the Equity Growth Portfolio and New York Life Insurance and Annuity
Corporation owned more than 25% of the Emerging Markets Equity Portfolio
pursuant to variable annuity contracts and variable life insurance policies it
has issued to the public.
As currently required under law, insurance companies vote their shares of the
Portfolios in accordance with instructions received from their variable annuity
contract and variable life insurance policy owners. MSDWD will vote the shares
of each Portfolio that it owns in the same proportions as shares of the
Portfolio are voted by the insurance companies. Accordingly, neither MSDWD nor
the insurance companies are deemed to be in control of the Portfolios.
For more information, see "Control Persons and Principal Holders of Securities"
in the SAI.
26
<PAGE>
ACCOUNT POLICIES
DISTRIBUTIONS AND TAXES
The Fund intends each of its Portfolios to qualify as a separate entity under
the Internal Revenue Code, and to qualify as a "regulated investment company"
under Subchapter M of the Internal Revenue Code. As a regulated investment
company under the Internal Revenue 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 Internal Revenue 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 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, Martin Luther King, Jr. Day, Presidents' Day, 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 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 are made by insurance
companies for their variable annuity contracts and variable life insurance
policies and by tax qualified investors, such as qualified pension and
retirement plans.
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.
27
