<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 SEVEN PORTFOLIOS MANAGED BY EITHER MORGAN STANLEY ASSET MANAGEMENT
INC. ("MSAM") OR MILLER ANDERSON & SHERRERD, LLP ("MAS"). THE FUND MAKES
AVAILABLE IN A SINGLE PRODUCT THE COMBINED STRENGTH OF THESE LEADING INVESTMENT
MANAGEMENT FIRMS. THE FUND ALSO OFFERS ELEVEN OTHER PORTFOLIOS MANAGED BY MSAM
OR MAS.
THIS PROSPECTUS CONTAINS IMPORTANT INFORMATION ABOUT THE FUND'S INVESTMENTS AND
SERVICES. YOU SHOULD READ IT BEFORE INVESTING, AND KEEP IT ON FILE FOR FUTURE
REFERENCE ALONG WITH THE PROSPECTUS FOR THE INSURANCE PRODUCT WHICH ACCOMPANIES
THIS PROSPECTUS.
A STATEMENT OF ADDITIONAL INFORMATION ("SAI") DATED MAY 1, 1998, AS
SUPPLEMENTED THROUGH NOVEMBER 3, 1998, HAS BEEN FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION AND IS AVAILABLE, ALONG WITH MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION REGARDING THE PORTFOLIOS, ON THE SECURITIES AND
EXCHANGE COMMISSION'S INTERNET WEB SITE (HTTP://WWW.SEC.GOV). THE SAI 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-
800-281-2715, 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:
Fixed Income U.S. Real Estate
Equity Growth Global Equity
Value International Magnum
Mid Cap Value
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.
Prospectus dated November 3, 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 seven 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
following Portfolios:
Equity Growth Global Equity
U.S. Real Estate International Magnum
MSAM conducts a worldwide investment advisory business. As of September 30,
1998, MSAM and its affiliated institutional asset management companies
(exclusive of MAS) had approximately $85.9 billion in assets under management
or fiduciary advice.
Miller Anderson & Sherrerd, LLP ("MAS" or the "Adviser") advises the following
Portfolios:
Fixed Income Mid Cap Value
Value
MAS's institutional investment advisory business was established in 1969. As of
September 30, 1998, MAS managed assets of approximately $70.4 billion.
OFFERING OF SHARES
The Fund is intended to be a funding vehicle for all types of variable annuity
contracts and variable life insurance policies offered by various insurance
companies. Shares of the Fund may also be offered to certain tax-qualified
investors, including qualified pension and retirement plans. It is possible
that material conflicts among the various insurance companies and other
investors in the Fund may arise. The Fund's Board of Directors will monitor
events in order to identify the existence of any material conflicts and to
determine what action, if any, should be taken in response to any such
conflicts.
PROSPECTUS OUTLINE
PAGE
FINANCIAL HIGHLIGHTS 3
- --------------------
Financial highlights tables as of December 31, 1997.
PORTFOLIO SUMMARIES 5
- -------------------
For each Portfolio, the investment objective and a summary of strategy,
potential investors, and investment characteristics and risks.
THE PORTFOLIOS' INVESTMENTS 6
- ---------------------------
A more detailed review of how each Portfolio invests and investment
characteristics and risks.
SECURITIES AND INVESTMENT TECHNIQUES 10
- ------------------------------------
More information about the types of investment strategies that may be used
by some or all of the Portfolios and information about investment risks and
limitations.
FUNDAMENTAL INVESTMENT LIMITS 24
- -----------------------------
Certain policies that may be changed only by shareholders.
MANAGEMENT OF THE FUND 25
- ----------------------
General information about the organization and operations of the Fund,
including details about MSAM, MAS and the individual portfolio managers, as
well as fees, expenses and performance calculations.
ACCOUNT POLICIES 32
- ----------------
Information on net asset value calculation, income and gain distributions,
taxes and share purchases and redemptions.
2
<PAGE>
FINANCIAL HIGHLIGHTS
The following tables provide audited financial highlights for the Portfolios
for the periods presented. The audited financial highlights for the periods
presented have been audited by Price Waterhouse LLP (now PricewaterhouseCoopers
LLP), whose unqualified report thereon appears in the Fund's Annual Report to
Shareholders and is incorporated by reference in the Statement of Additional
Information. The Annual Report and the financial statements therein, as well as
the Statement of Additional Information, are available at no cost from the Fund
at the toll free number noted on the cover page to this Prospectus or from your
insurance company.
<TABLE>
<CAPTION>
FIXED INCOME EQUITY GROWTH VALUE MID CAP VALUE
PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO
------------------- ------------------- ------------------- -------------------
PERIOD FROM PERIOD FROM PERIOD FROM PERIOD FROM
SELECTED PER SHARE DATA JANUARY 2, 1997* TO JANUARY 2, 1997* TO JANUARY 2, 1997* TO JANUARY 2, 1997* TO
AND RATIOS DECEMBER 31, 1997 DECEMBER 31, 1997 DECEMBER 31, 1997 DECEMBER 31, 1997
- ----------------------- ------------------- ------------------- ------------------- -------------------
<S> <C> <C> <C> <C>
NET ASSET VALUE, BEGIN-
NING OF PERIOD......... $ 10.00 $ 10.00 $ 10.00 $ 10.00
------- ------- ------- -------
INCOME FROM INVESTMENT
OPERATIONS
Net Investment Income.. 0.46 0.02 0.10 0.02
Net Realized and
Unrealized Gain....... 0.53 3.27 1.99 4.05
------- ------- ------- -------
Total From Investment
Operations............ 0.99 3.29 2.09 4.07
------- ------- ------- -------
DISTRIBUTIONS
Net Investment Income.. (0.45) (0.02) (0.10) (0.02)
In Excess of Net In-
vestment Income....... -- -- 0.00 + --
Net Realized Gain...... (0.13) (0.53) (0.21) (0.73)
In Excess of Net Real-
ized Gain............. -- -- 0.00 + --
------- ------- ------- -------
Total Distributions.... (0.58) (0.55) (0.31) (0.75)
------- ------- ------- -------
NET ASSET VALUE, END OF
PERIOD................. $ 10.41 $ 12.74 $ 11.78 $ 13.32
======= ======= ======= =======
TOTAL RETURN............ 9.93% 33.05% 20.98% 40.93%
======= ======= ======= =======
RATIOS AND SUPPLEMENTAL
DATA:
Net Assets, End of
Period (000's)......... $12,760 $12,419 $14,664 $11,461
Ratio of Expenses to
Average Net Assets..... 0.70%** 0.85%** 0.85%** 1.05%**
Ratio of Net Investment
Income to Average Net
Assets................. 5.66%** 0.41%** 1.70%** 0.19%**
Portfolio Turnover
Rate................... 185% 172% 34% 141%
Average Commission Rate
Per Share.............. -- $0.0542 $0.0585 $0.0490
- ---------------------------------------------------------------------------------------------------------
Effect of Voluntary
Expense Limitation
During the Period:
Per Share Benefit to
Net Investment
Income................ $ 0.08 $ 0.07 $ 0.06 $ 0.08
Ratios Before Expense
Limitation:
Expenses to Average Net
Assets................ 1.71%** 2.05%** 1.87%** 2.13%**
Net Investment Income
(Loss) to Average Net
Assets................ 4.65%** (0.80)%** 0.68%** (0.89)%**
</TABLE>
- --------------------------------------------------------------------------------
*Commencement of operations
**Annualized
+Amount is less than $0.01 per share.
3
<PAGE>
FINANCIAL HIGHLIGHTS (CONCLUDED)
<TABLE>
<CAPTION>
U.S. REAL ESTATE GLOBAL EQUITY INTERNATIONAL
PORTFOLIO PORTFOLIO MAGNUM PORTFOLIO
----------------- ------------------- -------------------
PERIOD FROM PERIOD FROM PERIOD FROM
SELECTED PER SHARE DATA AND MARCH 3, 1997 *TO JANUARY 2, 1997* TO JANUARY 2, 1997* TO
RATIOS DECEMBER 31, 1997 DECEMBER 31, 1997 DECEMBER 31, 1997
- --------------------------- ----------------- ------------------- -------------------
<S> <C> <C> <C>
NET ASSET VALUE, BEGINNING
OF PERIOD................. $ 10.00 $ 10.00 $ 10.00
------- ------- -------
INCOME FROM INVESTMENT
OPERATIONS
Net Investment Income.... 0.17 0.08 0.13
Net Realized and
Unrealized Gain ........ 1.61 1.92 0.59
------- ------- -------
Total From Investment
Operations............ 1.78 2.00 0.72
------- ------- -------
DISTRIBUTIONS
Net Investment Income.... (0.17) (0.08) (0.32)
Net Realized Gain........ (0.20) (0.18) (0.02)
In Excess of Net Realized
Gain.................... -- -- --
------- ------- -------
Total Distributions.... (0.37) (0.26) (0.34)
------- ------- -------
NET ASSET VALUE, END OF
PERIOD.................... $ 11.41 $ 11.74 $ 10.38
======= ======= =======
TOTAL RETURN............... 17.99% 20.04% 7.31%
======= ======= =======
RATIOS AND SUPPLEMENTAL
DATA:
Net Assets, End of Period
(000's)................... $13,055 $14,707 $18,855
Ratio of Expenses to
Average Net Assets........ 1.10%** 1.15%** 1.16%**
Ratio of Expenses to
Average Net Assets
Excluding Interest
Expense................... -- -- 1.15%**
Ratio of Net Investment
Income to Average Net
Assets.................... 3.14%** 1.24%** 1.43%**
Portfolio Turnover Rate.... 114% 20% 41%
Average Commission Rate
Per Share................ $0.0542 $0.0350 $0.0181
As a Percentage of Trade
Amount.................. -- 0.25% 0.20%
- --------------------------------------------------------------------------------------
Effect of Voluntary Expense
Limitation During the
Period:
Per Share Benefit to Net
Investment Income....... $ 0.07 $ 0.09 $ 0.15
Ratios Before Expense
Limitation:
Expenses to Average Net
Assets.................. 2.32%** 2.43%** 2.78%**
Net Investment Income
(Loss) to Average Net
Assets.................. 1.92%** (0.04)%** (0.19)%**
</TABLE>
- --------------------------------------------------------------------------------
*Commencement of operations
**Annualized
4
<PAGE>
PORTFOLIO SUMMARIES
Certain investment terms used below have initial capital letters ("Money Market
Instruments," for example). These terms are further described under "Securities
and Investment Techniques" below.
FIXED INCOME PORTFOLIO
OBJECTIVE AND STRATEGY: Above-average total return over a market cycle of three
to five years by investing primarily in a diversified portfolio of U.S.
Governments and Agencies, Corporate Bonds, MBSs, Foreign Bonds and other Fixed
Income Securities and Derivatives. The Portfolio's average weighted maturity
will ordinarily exceed five years and will usually be between five and fifteen
years.
INVESTOR PROFILE: The Portfolio may be appropriate for investors seeking an
above-average return from a diversified portfolio of Fixed Income Securities.
RISK PROFILE: Moderate potential risk and reward. The Portfolio will focus on
medium- to high-quality investments of intermediate maturity. The level of
risk, and potential reward, depends on the quality and maturity of the
investments. The Portfolio's share price can normally be expected to vary
inversely to changes in prevailing interest rates. While securities with longer
maturities tend to produce higher yields, the prices of longer maturity
securities are also subject to greater market fluctuations as a result of
changes in interest rates.
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.
VALUE PORTFOLIO
OBJECTIVE AND STRATEGY: Above-average total return over a market cycle of three
to five years by investing primarily in a diversified portfolio of Common
Stocks and other Equity Securities that are deemed by MAS to be relatively
undervalued based on various measures such as price/earnings ratios and
price/book ratios.
INVESTOR PROFILE: The Portfolio may be appropriate for investors seeking an
above-average return from Common Stocks of issuers with equity capitalizations
usually greater than $300 million that are deemed to be undervalued in the
marketplace.
RISK PROFILE: Moderate to high potential risk and reward. The Portfolio's share
price will fluctuate with changes in market, economic and foreign currency
exchange conditions.
MID CAP VALUE PORTFOLIO
OBJECTIVE AND STRATEGY: Above-average total return over a market cycle of three
to five years by investing in Common Stocks and other Equity Securities of
issuers with equity capitalizations in the range of the companies represented
in the S&P MidCap 400 Index. Such range is generally $500 million to $6 billion
but the range fluctuates over time with changes in the equity market.
INVESTOR PROFILE: The Portfolio may be appropriate for investors seeking an
above-average total return from Common Stocks of medium-size companies that are
deemed to be undervalued in the marketplace.
RISK PROFILE: High potential risk and reward. The Portfolio's share price will
fluctuate with changes in market and economic conditions.
U.S. REAL ESTATE PORTFOLIO
OBJECTIVE AND STRATEGY: Above-average current income and long-term capital
appreciation by investing primarily in Equity Securities of U.S. and non-U.S.
companies principally engaged in the U.S. real estate industry, including real
estate investment trusts ("REITs").
INVESTOR PROFILE: The Portfolio may be appropriate for investors who seek
above-average current income and long-term capital appreciation by investing in
Equity Securities of U.S. and non-U.S. companies principally engaged in the
U.S. real estate industry, including REITs.
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, the Portfolio's investments may be subject to the risks
associated with the direct ownership of real estate and direct investments of
REITs.
GLOBAL EQUITY PORTFOLIO
OBJECTIVE AND STRATEGY: Long-term capital appreciation by investing primarily
in Equity Securities of issuers throughout the world, including U.S. issuers,
using an approach that is oriented to the selection of individual stocks that
MSAM believes are undervalued.
5
<PAGE>
INVESTOR PROFILE: The Portfolio may be appropriate for investors who seek to
pursue their investment goals in markets throughout the world, including the
United States. By including 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.
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 (defined
herein).
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.
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, its
holdings in any one company or industry. Nevertheless, each Portfolio will
experience price volatility the extent of which will be affected by the types
of securities and techniques the particular Portfolio uses. In the short term,
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 U.S. Real Estate Portfolios are non-
diversified portfolios and are permitted greater flexibility to invest their
assets in the obligations of a single issuer, they are exposed to increased
risk of loss if such an investment underperforms expectations. See "Non-
Diversified Status" in this Prospectus and "Investment Limitations" in the SAI.
Investments in securities rated below investment grade, sometimes called high
risk or High Yield Securities or junk bonds, carry a high degree of risk and
are considered speculative. MSAM and MAS may use various investment techniques
to hedge risks, including 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.
FIXED INCOME PORTFOLIO
The Portfolio seeks to achieve above-average total return over a market cycle
of three to five years by investing in a diversified portfolio of U.S.
Governments and Agencies, Corporate Bonds, Foreign Bonds, MBSs of domestic
issuers, and other Fixed Income Securities and Derivatives. The Portfolio's
average weighted maturity will ordinarily exceed five years and will usually be
between five and fifteen years.
Under normal circumstances, the Portfolio will invest at least 65% of its total
assets in Fixed Income Securities, not more than 20% of which will be below
investment grade (commonly referred to as High Yield Securities or junk bonds).
The Portfolio may invest up to 50% of its assets in MBSs. The Portfolio may
also invest in Municipals, Loan Participations and Assignments, Investment
Company Securities, When-Issued and Delayed Delivery Securities, CMOs,
Derivatives, Foreign Currency Transactions, and may engage in Loans of
Portfolio Securities. For additional investment information, see "Securities
and Investment Techniques" below.
6
<PAGE>
The Adviser's approach is to actively manage the maturity and duration
structure of the Portfolio in anticipation of long-term trends in interest
rates and inflation. Investments are diversified among a wide variety of Fixed
Income Securities in all market sectors. For additional information about
strategies employed in managing the Portfolio, see "Maturity and Duration
Management," "Value Investing," "Mortgage Investing," "High Yield Investing,"
"Foreign Fixed Income Investing" and "Foreign Investing" in "Securities and
Investment Techniques" below.
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 Portfolio is not restricted
to investments in specific market sectors. 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
in relation to consensus expectations. The Portfolio may invest in any Equity
Security that, in the Adviser's judgment, provides above-average potential for
capital appreciation.
In selecting investments for the Portfolio, the Adviser emphasizes individual
security selection. The Portfolio's investments will generally be diversified
by number of issues but concentrated sector positions may result from the
investment process. The Portfolio has a long-term investment perspective;
however, the Adviser may take advantage of short-term opportunities that are
consistent with the Portfolio's objective by selling recently purchased
securities which have increased in value.
VALUE PORTFOLIO
The Portfolio seeks above-average total return over a market cycle of three to
five years by investing primarily in Common and Preferred Stocks, Convertible
Securities, Rights and Warrants to purchase Common Stocks, ADRs and other
Equity Securities of companies with equity capitalizations usually greater than
$300 million.
Under normal circumstances, the Portfolio will invest at least 65% of its total
assets in Equity Securities. The Portfolio may invest up to 5% of its total
assets in Foreign Equities (other than ADRs). The Portfolio may also invest in
U.S. Governments and Agencies, Corporate Bonds, Foreign Bonds, Zero Coupons,
Repurchase Agreements, Cash Equivalents, Foreign Currency Transactions,
Investment Company Securities, When-Issued or Delayed Delivery Securities and
Derivatives, and may engage in Loans of Portfolio Securities. For additional
information about investments, see "Securities and Investment Techniques"
below.
The Adviser's approach is to select Equity Securities that it deems to be
undervalued relative to the stock market in general as measured by the Standard
& Poor's Ratings Group ("S&P") 500 Stock Index ("S&P 500"), based on value
measures such as price/earnings ratios and price/book ratios, as well as
fundamental research. While capital return will be emphasized somewhat more
than income return, the Portfolio's total return will consist of both capital
and income returns. Stocks that are deemed to be under-valued in the
marketplace have, under most market conditions, provided higher dividend income
returns than stocks that are deemed to have long-term earnings growth potential
which normally sell at higher price/earnings ratios. For additional information
about strategies employed in managing the Portfolio, see "Value Stock
Investing" in "Securities and Investment Techniques."
MID CAP VALUE PORTFOLIO
The Portfolio seeks above-average total return over a market cycle of three to
five years by investing primarily in Common and Preferred Stocks, Convertible
Securities, Rights and Warrants to purchase Common Stocks, ADRs and other
Equity Securities of issuers with equity capitalizations in the
7
<PAGE>
range of the companies represented in the S&P MidCap 400 Index. Such range is
generally $500 million to $6 billion but the range fluctuates over time with
changes in the equity market.
Under normal circumstances, at least 65% of the Portfolio's total assets will
be invested in Equity Securities of mid-cap companies deemed to be under-
valued. The Portfolio may invest up to 5% of its total assets in Foreign
Equities (other than ADRs). The Portfolio may also invest in U.S. Governments
and Agencies, Corporate Bonds, Foreign Bonds, Zero Coupons, Repurchase
Agreements, Cash Equivalents, Foreign Currency Transactions, Investment Company
Securities, When-Issued and Delayed Delivery Securities and Derivatives, and
may engage in Loans of Portfolio Securities. For additional information about
investments, see "Securities and Investment Techniques" below.
The Adviser's approach is to select Common Stocks that are deemed to be
relatively under-valued at the time of purchase based on certain proprietary
measures of value. The Portfolio will typically exhibit a lower price/earnings
value ratio than the S&P MidCap 400 Index. The Portfolio will be structured
taking into account the economic sector weights of the S&P MidCap 400 Index,
with sector weights normally being within 5% of the sector weights of the
Index. For additional information about strategies employed in managing the
Portfolio, see "Value Stock Investing" in "Securities and Investment
Techniques."
U.S. REAL ESTATE PORTFOLIO
The Portfolio seeks above-average current income and long-term capital
appreciation by investing primarily in Equity Securities of companies in the
U.S. real estate industry. Such Equity Securities include Common Stocks, shares
or units of beneficial interest of REITs, limited partnership interests in
master limited partnerships, Rights or Warrants to purchase Common Stocks,
Convertible Securities, and Preferred Stock.
Under normal circumstances, at least 65% of the Portfolio's total assets will
be invested in income producing Equity Securities of U.S. and non-U.S.
companies principally engaged in the U.S. real estate industry. For purposes of
the Portfolio's investment policies, a company is "principally engaged" in the
real estate industry if (i) it derives at least 50% of its revenues or profits
from the ownership, construction, management, financing or sale of residential,
commercial or industrial real estate or (ii) it has at least 50% of the fair
market value of its assets invested in residential, commercial or industrial
real estate. Companies in the real estate industry may include among others:
REITs, master limited partnerships that invest in interests in real estate,
real estate operating companies, and companies with substantial real estate
holdings, such as hotel companies, residential builders and land-rich
companies. Risks relating to investments in securities of issuers primarily
engaged in the real estate industry are similar to those of direct investments
in real estate and include fluctuations in real estate values, changes in
zoning laws, increases in property taxes, environmental risks, and increases in
interest rates. Generally, increases in interest rates will increase the costs
of obtaining financing, which could directly and indirectly decrease the value
of the Portfolio's investments.
The Adviser's approach is to invest in Equity Securities of companies that it
believes will provide a dividend yield that exceeds the composite dividend
yield of securities comprising the S&P 500. A substantial portion of the
Portfolio's total assets will be invested in Equity Securities of REITs. REITs
pool investors funds for investment primarily in income producing real estate
or real estate related loans or interests, with certain tax advantages if
regulatory requirements are met. The Portfolio will invest primarily in Equity
REITs which invest the majority of their assets directly in real property and
derive their income primarily from rents and capital gains from appreciation
realized through property sales. The Portfolio may also invest in Mortgage
REITs and Hybrid REITs. Mortgage REITs invest the majority of their assets in
real estate mortgages and derive their income primarily from interest payments.
Hybrid REITs combine the characteristics of both Equity and Mortgage REITs.
Risks associated with investments in REITs include changes in the values of
their underlying properties and defaults by borrowers or tenants. In addition,
some REITs are not diversified and their value may be affected by events
related to a small number of properties.
The Portfolio may also invest in Fixed Income Securities issued or guaranteed
by real estate companies or secured by real estate assets that are Investment
Grade Securities, high-quality Money Market Instruments such as notes,
certificates of deposit or bankers' acceptances issued by domestic or foreign
issuers, or high-grade debt securities, consisting of corporate debt securities
and U.S. Governments and Agencies. The Portfolio may also invest in certain
securities or obligations, including Non-Publicly Traded Securities, Private
Placements, Restricted Securities, Repurchase Agreements, When-Issued and
Delayed Delivery Securities, Temporary Investments and Derivatives, and may
engage in Loans of Portfolio Securities. For additional information about the
Portfolio's investments, see "Securities and Investment Techniques" and "Non-
Diversified Status" below.
GLOBAL EQUITY PORTFOLIO
The Global Equity Portfolio seeks long-term capital appreciation by investing
primarily in Common and Preferred Stocks, Convertible Securities, and Rights
and Warrants to purchase Common Stocks, Depositary Receipts and other Equity
Securities of issuers throughout the world, including issuers in the United
States and emerging market countries. Under normal circumstances, at least 65%
of the total assets of the Portfolio will be invested in Equity Securities. In
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addition, under normal circumstances, at least 20% of the Portfolio's total
assets will be invested in the Common Stocks of U.S. issuers and the remaining
equity position will be invested in at least three countries other than the
United States. Although the Portfolio intends to invest primarily in securities
listed on stock exchanges, it will also invest in Equity Securities that are
traded over the counter or that are not admitted to listing on a stock exchange
or dealt in on a regulated market. As a result of the absence of a public
trading market, such securities may pose liquidity risks.
The Portfolio may also invest in Foreign Currency Transactions, Money Market
Instruments, Non-Publicly Traded Securities, Restricted Securities and Private
Placements, Repurchase Agreements and When-Issued or Delayed Delivery
Securities, and may engage in Loans of Portfolio Securities. For additional
information about investments, see "Securities and Investment Techniques"
below.
The Adviser's approach is oriented to individual stock selection and is value
driven. In selecting stocks for the Portfolio, the Adviser initially identifies
those stocks that it believes to be undervalued in relation to the issuer's
assets, cash flow, earnings and revenues, and then evaluates the future value
of such stocks by running the results of an in-depth study of the issuer
through a dividend discount model. In selecting investments, the Adviser
utilizes the research of a number of sources, including Morgan Stanley Capital
International, an affiliate of the Adviser located in Geneva, Switzerland.
Portfolio holdings are regularly reviewed and subjected to fundamental analysis
to determine whether they continue to conform to the Adviser's value criteria.
Equity Securities that no longer conform to such investment criteria will be
sold.
Although the Portfolio will not invest for short-term trading purposes,
investment securities may be sold from time to time without regard to the
length of time they have been held. Investing in foreign countries and emerging
market countries subjects the Portfolio to additional risk, see "Securities and
Investment Techniques" below.
INTERNATIONAL MAGNUM PORTFOLIO
The Portfolio seeks long-term capital appreciation by investing primarily in
Common and Preferred Stocks, Convertible Securities, Rights or Warrants to
purchase Common Stocks and other Equity Securities of non-U.S. issuers
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.
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 listed 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
funds and pooled investment vehicles. In addition, for temporary defensive
purposes during periods in which the Adviser believes changes in economic,
financial or political conditions make it advisable, the Portfolio may invest
up to 100% of its total assets in 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
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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.
SECURITIES AND INVESTMENT TECHNIQUES
- ------------------------------------
The following pages contain more detailed information about types of
instruments in which a Portfolio may invest and strategies each Adviser may
employ in pursuit of a Portfolio's investment objective. A summary of risks and
restrictions associated with these instruments and investment practices is
included as well. A complete listing of each Portfolio's policies and
limitations and more detailed information about each Portfolio's investments is
contained in the SAI. Policies and limitations are considered at the time such
investments are purchased; the sale of instruments is not required in the event
of a subsequent change in circumstances, for example, a rating's downgrade.
The investments of life insurance company separate accounts made under variable
annuity contracts and variable life insurance policies are subject to state
insurance laws and regulations. The Fund and its Portfolios will, when
required, comply with investment restrictions imposed under such laws and
regulations on life insurance company separate accounts investing in the
Portfolios.
The Advisers may not buy all of these instruments or use all of these
techniques to the full extent permitted unless they believe that doing so will
help a Portfolio achieve its investment objective. Current holdings and recent
investment strategies are described in the 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.
STRATEGIES
FOREIGN FIXED INCOME INVESTING: The Adviser seeks to invest in Foreign Bonds
and other Fixed Income Securities denominated in foreign currencies, where, in
the opinion of the Adviser, the combination of current yield and currency value
offer attractive expected returns. When the total return opportunities in a
foreign bond market appear attractive in local currency terms, but where in the
Adviser's judgment unacceptable currency risk exists, Foreign Currency
Transactions and Swaps may be used to hedge the currency risk.
FOREIGN INVESTING: Investing in securities issued by foreign companies or
governments involves certain special considerations which are not typically
associated with investing in U.S. issuers. Since the securities of foreign
issuers may be denominated in foreign currencies, and since a Portfolio may
temporarily hold uninvested reserves in bank deposits of foreign currencies
prior to reinvestment or conversion to U.S. dollars, a Portfolio may be
affected favorably or unfavorably by changes in currency exchange rates and in
exchange control regulations, and may incur costs in connection with
conversions between various currencies.
Because non-U.S. companies are not generally subject to uniform accounting,
auditing and financial reporting standards and practices comparable to those
applicable to U.S. companies, there may be less publicly available information
about certain foreign companies than about U.S. companies. Securities of some
non-U.S. companies may be less liquid and more volatile than securities of
comparable U.S. companies. There is generally less government supervision and
regulation of stock exchanges, brokers and listed companies than in the United
States. With respect to certain foreign countries, there is the possibility of
expropriation or confiscatory taxation, political or social instability, or
diplomatic developments which could affect U.S. investments in those countries.
Additionally, there may be difficulty in obtaining and enforcing judgments
against foreign issuers.
HIGH YIELD INVESTING: The Adviser seeks to invest in High Yield Securities
based on the Adviser's analysis of economic and industry trends and individual
security characteristics. The Adviser conducts a credit analysis for each
security considered for investment to evaluate its attractiveness relative to
its risk. A high level of diversification is also maintained to limit credit
exposure to individual issuers.
To the extent a Portfolio invests in High Yield Securities it will be exposed
to a substantial degree of credit risk. Lower-rated bonds are considered
speculative by traditional investment standards. High Yield Securities may be
issued as a consequence of corporate restructuring or similar events. Also,
High Yield Securities are often issued by smaller, less creditworthy companies,
or by highly leveraged (indebted) companies, which are generally less able than
more established or less leveraged companies to make scheduled payments of
interest and principal. The risks posed by securities issued under such
circumstances are substantial.
The market for High Yield Securities is still relatively new. Because of this,
a long-term track record for bond default rates does not exist. In addition,
the secondary market for High Yield Securities is generally less liquid than
that for investment grade corporate securities. In periods of reduced market
liquidity, High Yield Security prices may become more volatile, and both the
high yield market and a Portfolio
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may experience sudden and substantial price declines. This lower liquidity
might have an effect on a Portfolio's ability to value or dispose of such
securities. Also, there may be significant disparities in the prices quoted for
High Yield Securities by various dealers. Under such conditions, a Portfolio
may find it difficult to value its securities accurately. A Portfolio may also
be forced to sell securities at a significant loss in order to meet shareholder
redemptions. These factors add to the risks associated with investing in High
Yield Securities.
High Yield Securities may also present risks based on payment expectations. For
example, High Yield Securities may contain redemption or call provisions. If an
issuer exercises these provisions in a declining interest rate market, a
Portfolio would have to replace the security with a lower yielding security,
resulting in a decreased return for investors. Conversely, a High Yield
Security's value will decrease in a rising interest rate market.
Certain types of High Yield Securities are non-income paying securities. For
example, Zero Coupons pay interest only at maturity and Pay-In-Kind Securities
pay interest in the form of additional securities. Payment in the form of
additional securities, or interest income recognized through discount
accretion, will, however, be treated as ordinary income which will be
distributed to shareholders even though the Portfolio does not receive periodic
cash flow from these investments.
MATURITY AND DURATION MANAGEMENT: One of two primary components of the
Adviser's fixed income investment strategy is Maturity and Duration Management.
The second primary component of fixed income strategy is Value Investing. See
"Value Investing" below.
The maturity and duration structure of a Portfolio investing in Fixed Income
Securities is actively managed in anticipation of cyclical interest rate
changes. Adjustments are not made in an effort to capture short-term, day-to-
day movements in the market, but instead are implemented in anticipation of
longer-term shifts in the levels of interest rates. Adjustments made to shorten
Portfolio maturity and duration are made to limit capital losses during periods
when interest rates are expected to rise. Conversely, adjustments made to
lengthen maturity are intended to produce capital appreciation in periods when
interest rates are expected to fall. The foundation for maturity and duration
strategy lies in analysis of the U.S. and global economies, focusing on levels
of real interest rates, monetary and fiscal policy actions, and cyclical
indicators.
Most Fixed Income Securities provide interest (coupon) payments in addition to
a final (par) payment at maturity. Some securities also have call provisions.
Depending on the relative magnitude of these payments and the nature of the
call provisions, the market values of Fixed Income Securities may respond
differently to changes in the level and structure of interest rates.
Traditionally, a Fixed Income Security's term-to-maturity has been used as a
proxy for the sensitivity of the security's price to changes in interest rates
(which is the interest rate risk or volatility of the security). However, term-
to-maturity measures only the time until a Fixed Income Security provides its
final payment, taking no account of the pattern of the security's payments
prior to maturity.
Duration is a measure of the expected life of a Fixed Income Security on a
present value basis that was developed as a more precise alternative to the
concept of term-to-maturity. Duration incorporates a Fixed Income Security's
yield, coupon interest payments, final maturity and call features into one
measure. Duration is one of the fundamental tools used by the Adviser in the
selection of Fixed Income Securities.
Duration takes the length of the time intervals between the present time and
the time that the interest and principal payments are scheduled or, in the case
of a callable bond, expected to be received, and weights them by the present
values of the cash to be received at each future point in time. For any Fixed
Income Security with interest payments occurring prior to the payment of
principal, duration is always less than maturity. In general, all other factors
being the same, the lower the stated or coupon rate of interest of a Fixed
Income Security, the longer the duration of the security; conversely, the
higher the stated or coupon rate of interest of a Fixed Income Security, the
shorter the duration of the security.
There are some situations where even the standard duration calculation does not
properly reflect the interest rate exposure of a security. For example,
Floaters often have final maturities of ten or more years; however, their
interest rate exposure corresponds to the frequency of the coupon reset.
Another example where the interest rate exposure is not properly captured by
duration is the case of mortgage pass-through securities. The stated final
maturity of such securities is generally 30 years, but current prepayment rates
are more critical in determining the securities' interest rate exposure. In
these and other similar situations, the Adviser's analysis of interest rate
exposure incorporates the economic life of a security.
MORTGAGE INVESTING: At times it is anticipated that greater than 50% of the
Fixed Income Portfolio's assets may be invested in MBSs. These include
securities which represent pools of mortgage loans made by lenders such as
commercial banks, savings and loan associations, mortgage bankers and others.
The pools are assembled by various Governmental, Government-related and private
organizations. The Portfolio will invest in securities issued by the Government
National Mortgage Association ("GNMA"), Federal Home Loan Mortgage Corporation
("FHLMC"), Fannie Mae, other Government agencies, and private issuers. It is
expected that the Portfolio's primary emphasis will be in MBSs issued by the
various Government-related organizations. However, the Portfolio may invest,
without
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limit, in MBSs issued by private issuers when the Adviser deems that the
quality of the investment, the quality of the issuer, and market conditions
warrant such investments. Securities issued by private issuers will be rated
investment grade by Moody's Investors Service, Inc. ("Moody's") or S&P or be
deemed by the Adviser to be of comparable investment quality.
VALUE INVESTING: One of two primary components of the Adviser's fixed income
strategy is Value Investing, whereby the Adviser seeks to identify undervalued
sectors and securities through analysis of credit quality, Option
characteristics and liquidity. Quantitative models are used in conjunction with
judgement and experience to evaluate and select securities with embedded put or
call Options which are attractive on a risk- and option-adjusted basis.
Successful Value Investing will permit a Portfolio to benefit from the price
appreciation of individual securities during periods when interest rates are
unchanged. See "Maturity and Duration Management" for a description of the
other key component of the Adviser's fixed income investment strategy.
VALUE STOCK INVESTING: Emphasizes Common Stocks that are deemed by the Adviser
to be undervalued relative to the stock market in general as measured by the
appropriate market index, based on value measures such as price/earnings ratios
and price/book ratios. Value stocks are generally dividend-paying Common
Stocks. However, non-dividend- paying stocks may also be selected for their
value characteristics.
INSTRUMENTS AND INVESTMENTS
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 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 American Depositary Receipts ("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. 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.
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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 ("NRSROs") in one of their two
highest categories, (e.g., A-1 or A-1+ by S&P or Prime 1 by Moody's, or, if not
rated, issued by a corporation having an outstanding unsecured debt issue rated
high-grade by an NRSRO (e.g., A or better by Moody's, S&P or Fitch Investors
Service, Inc. ("Fitch")).
(3)Short-term corporate obligations rated high-grade at the time of purchase by
an NRSRO (e.g., A or better by Moody's, S&P or Fitch).
(4)U.S. Governments and Agencies.
(5)Repurchase Agreements collateralized by securities listed above.
CMOS. Collateralized Mortgage Obligations ("CMOs") are Derivatives which are
collateralized by mortgage pass-through securities. Cash flows from the
mortgage pass-through securities are allocated to various tranches (a "tranche"
is essentially a separate security) in a predetermined, specified order. Each
tranche has a stated maturity--the latest date by which the tranche can be
completely repaid, assuming no prepayments--and has an average life--the
average of the time to receipt of a principal payment weighted by the size of
the principal payment. The average life is typically used as a proxy for
maturity because the debt is amortized (repaid a portion at a time), rather
than paid off entirely at maturity, as would be the case in a straight debt
instrument.
Due to the possibility that prepayments (on home mortgages and other
collateral) will alter the cash flow on CMOs, it is not possible to determine
in advance the actual final maturity date or average life. Faster prepayment
will shorten the average life and slower prepayment will lengthen it. However,
it is possible to determine what the range of that movement could be and to
calculate the effect that it will have on the price of the security. In
selecting these securities, the Adviser will look for those securities that
offer a higher yield to compensate for any variation in average maturity.
Prepayment risk has two important effects. First, like bonds in general, MBSs
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
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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 caps, floors and
collars, futures contracts and forward contracts, options, structured notes 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. These Derivatives may be based upon a wide variety of underlying
rates, indicies, instruments, securities and other products, such as interest
rates, foreign currencies, foreign and domestic fixed income and equity
securities, group or "baskets" of Securities and Securities indicies (for each
Derivative, the "underlying"). Each of the Equity Growth, U.S. Real Estate,
Global Equity and International Magnum 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 Fixed Income, Value and Mid Cap Value
Portfolios will not enter into futures to the extent that each Portfolio's
outstanding obligations to purchase securities under these contracts, in
combination with its outstanding obligations with respect to options, would
exceed 50% of its total assets. 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 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.
The use of Derivatives 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 forecasts of
market values, interest rates, and currency exchange rates, the investment
performance of the Portfolios will be less favorable than it would have been if
these investment techniques had not been used.
Some of the Derivatives in which the Portfolios may invest and the risks
related thereto are described in more detail below.
Futures Contracts (Futures) and Forward Contracts (Forwards). The Portfolios
may purchase and sell futures contracts, such as futures on securities indices,
baskets of securities, foreign currencies and interest rates of the type
generally known as financial futures. These are standardized contracts that are
bought and sold on organized exchanges. A futures contract obligates a party to
buy or sell a specific amount of the "underlying," such as for example, a
particular foreign currency, on a specified future date at a specified price or
to settle the value in cash.
The Portfolios may also purchase and sell forward contracts, such as forward
rate agreements and other financial forward contracts. The Portfolios may also
use foreign currency forward contracts which are separately discussed elsewhere
in this Prospectus. See "Foreign Currency Transactions " below. These forward
contracts are privately negotiated and are bought and sold in the over-the-
counter market. Like a future, a forward contract obligates a party to buy or
sell a specific amount of the underlying on a specified future date at a
specified price. The terms of the forward contract are customized. Forward
contracts, like other over-the-counter contracts that are negotiated directly
with an individual counterparty, subject the Portfolio to the risk of
counterparty default.
In some cases, the Portfolios may be able to use either futures contracts,
forward contracts or exchange-traded or over-the-counter options to accomplish
similar purposes. In all cases, the Portfolios will use these products only as
permitted by applicable laws and regulations. Some of the ways in which the
Portfolios may utilize futures contracts, forward contracts and related options
are described below.
The Portfolios may sell securities index futures contracts and/or index 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 may purchase
securities index futures or options in order to gain market exposure. 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 also purchase and
sell foreign currency futures 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.
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The Portfolios may engage in transactions in interest rate futures and related
products. The value of these contracts 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 or
for other purposes.
The Portfolios may also purchase or sell futures and forwards on other
financial instruments, such as U.S. Government securities and certificates of
deposit. The value of these contracts also rises and falls inversely with
changes in interest rates. The Portfolios may engage in financial futures and
forward contracts for both hedging and non-hedging purposes.
Gains and losses on futures contracts, forward contracts and related options
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 these instruments include (i) imperfect correlation
between the change in market value of investments held by a Portfolio and the
prices of derivative products relating to investments purchased or sold by the
Portfolio, and (ii) possible lack of a liquid secondary market for a derivative
product and the resulting inability to close out a position. The risk that a
Portfolio will be unable to close out a position will be minimized by only
entering into transactions for which there appears to be a liquid exchange or
secondary market. In some strategies, the risk of loss in trading on futures
and related transactions can be substantial, due both to the low margin
deposits required and the extremely high degree of leverage involved in
pricing.
Under rules adopted by the Commodity Futures Trading Commission (the "CFTC"),
each Portfolio may, without registering with the CFTC as a Commodity Pool
Operator, 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-bona
fide hedging activities.
Options Transactions (Options). The Portfolios may seek to increase their
returns or may hedge their portfolio investments through options transactions
with respect to individual securities, indices or baskets in which such
Portfolios may invest; other financial instruments; and foreign currency.
Various options may be purchased and sold on either the exchange-traded or
over-the-counter markets.
Each Portfolio may purchase put and call options. Purchasing a put option gives
a Portfolio the right, but not the obligation, to sell the underlying (such as
a securities index or a particular foreign currency) at the exercise price
either on a specific date or during a specified exercise period. Purchasing a
call option gives a Portfolio a similar right, but not the obligation, to
purchase the underlying. The purchaser pays a premium to the seller (also known
as the writer) of the option.
Each Portfolio also may write put and call options on investments held in its
portfolio, as well as foreign currency options. A Portfolio that has written an
option receives a premium that increases the Portfolio's return on the
underlying 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
above the exercise price of the option. By writing a put option, a Portfolio
will be exposed to the amount by which the price of the underlying is less than
the strike price.
By writing an option, a Portfolio incurs an obligation either to buy (in the
case of a put option) or sell (in the case of a call option) the underlying
from the purchaser of the option at the option's exercise price, upon exercise
by the purchaser. Pursuant to guidelines established by the Board of Directors,
the Portfolios may only write options that are "covered." A covered call option
means that until the expiration of the option, the Portfolio will either
earmark or segregate sufficient liquid assets to cover its obligations under
the option or will continue to own (i) the underlying; (ii) securities or
instruments convertible or exchangeable without the payment of any
consideration into the underlying; or (iii) a call option on the same
underlying with a strike price no higher than the price at which the underlying
was sold pursuant to a short option position. In the case of a put option, the
Portfolio will either earmark or segregate sufficient liquid assets to cover
its obligations under the option or will own another put option on the same
underlying with an equal or higher strike price.
There currently are limited options markets in many countries, particularly
emerging market 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 these options markets. The primary risks associated with the
Portfolios' use of options as described include (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.
Interest Rate, Currency, Commodity and Equity Swaps, Caps, Collars and
Floors. Swaps are privately negotiated over-the-counter derivative products in
which two parties agree to exchange payment streams calculated in relation to a
rate, index, instrument or certain securities and a particular "notional
amount." As with many of the other derivative products available to the
Portfolios, the underlying may include an interest rate (fixed or floating), a
currency exchange rate, a commodity price index, and a security, securities
index or a combination thereof. A great deal of flexibility is possible in the
way the products may be
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structured, with the effect being that the parties may have exchanged amounts
equal to the return on one rate, index or group of securities for another. For
example, in a simple fixed-to-floating interest rate swap, one party makes
payments equivalent to a fixed interest rate, and the other makes payments
equivalent to a specified interest rate index. A Portfolio may engage in simple
or more complex swap transactions involving a wide variety of underlyings. The
currency swaps that 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.
Caps, collars and floors are privately-negotiated option-based derivative
products. A Portfolio may use one or more of these products in addition to or
in lieu of a swap involving a similar rate or index. As in the case of a put or
call option, the buyer of a cap or floor pays a premium to the writer. In
exchange for that premium, the buyer receives the right to a payment equal to
the differential if the specified index or rate rises above (in the case of a
cap) or falls below (in the case of a floor) a pre-determined strike level. As
in the case of swaps, obligations under caps and floors are calculated based
upon an agreed notional amount, and like most swaps (other than foreign
currency swaps), the entire notional amount is not exchanged and thus is not at
risk. A collar is a combination product in which the same party, such as the
Portfolio, buys a cap from and sells a floor to the other party. As with put
and call options, the amount at risk is limited for the buyer, but, if the cap
or floor is not hedged or covered, may be unlimited for the seller. Under
current market practice, caps, collars and floors between the same two parties
are generally documented under the same "master agreement." In some cases,
options and forward agreements may also be governed by the same master
agreement. In the event of a default, amounts owed under all transactions
entered into under, or covered by, the same master agreement would be netted
and only a single payment would be made.
Swaps, caps, collars and floors are credit-intensive products. A Portfolio that
enters into a swap transaction bears the risk of default, i.e. nonpayment, by
the other party. The guidelines under which each Portfolio enters derivative
transactions, along with some features of the transactions themselves, are
intended to reduce these risks to the extent reasonably practicable, although
they cannot eliminate the risks entirely. Under guidelines established by the
Board of Directors, a Portfolio may enter into swaps only with parties that
meet certain credit rating guidelines. Consistent with current market
practices, a Portfolio will generally enter into swap transactions on a net
basis, and all swap transactions with the same party will be documented under a
single master agreement to provide for net payment upon default. In addition, a
Portfolio's obligations under an agreement will be accrued daily (offset
against any amounts owing to the Portfolio) and any accrued, but unpaid, net
amounts owed to the other party to a master agreement will be covered by the
maintenance of a segregated account consisting of cash or liquid securities.
Interest rate and total rate of return (fixed income or equity) swaps generally
do not involve the delivery of securities, other underlying assets, or
principal. In such case, if the other party to an interest rate or total rate
of return swap defaults, a Portfolio's risk of loss will consist of the
payments that a Portfolio is contractually entitled to receive from the other
party. This may not be true for currency swaps that require the delivery of the
entire notional amount of one designated currency in exchange for the other. If
there is a default by the other party, a Portfolio may have contractual
remedies pursuant to the agreements related to the transaction.
Structured Notes. Structured notes are Derivatives on which the amount of
principal repayment and/or interest payments is based upon the movement of one
or more factors. These factors include, but are not limited to, currency
exchange rates, interest rates (such as the prime lending rate and LIBOR) and
stock indices, such as the S&P 500. In some cases, the impact of the movements
of these factors may increase or decrease through the use of multipliers or
deflators. The 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.
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
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such respects as growth of gross domestic product, rate of inflation, currency
depreciation, capital reinvestment, resource self-sufficiency and balance of
payments position. Further, the economies of developing countries generally are
heavily dependent upon international trade and, accordingly, have been, and may
continue to be, adversely affected by trade barriers, exchange controls,
managed adjustments in relative currency values and other protectionist
measures imposed or negotiated by the countries with which they trade. These
economies also have been, and may continue to be, adversely affected by
economic conditions in the countries with which they trade.
Investing in emerging market countries may entail purchasing securities issued
by or on behalf of entities that are insolvent, bankrupt, in default or
otherwise engaged in an attempt to reorganize or reschedule their obligations,
and in entities that have little or no proven credit rating or credit history.
In any such case, the issuer's poor or deteriorating financial condition may
increase the likelihood that the investing Portfolio will experience losses or
diminution in available gains due to bankruptcy, insolvency or fraud.
With respect to any emerging market country, there is the possibility of
nationalization, expropriation or confiscatory taxation, political changes,
government regulation, social instability or diplomatic developments (including
war) that could affect adversely the economies of such countries or the value
of a Portfolio's investments in those countries. In addition, it may be
difficult to obtain and enforce a judgment in a court outside of the United
States.
EQUITY SECURITIES. Equity Securities commonly include, but are not limited to,
Common Stocks, Preferred Stocks, Depositary Receipts, Rights, Warrants, and
Foreign Equities. Preferred Stock is contained in both the definition of Equity
Securities and Fixed Income Securities because it exhibits characteristics
commonly associated with each type of security. See "The 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, Foreign Bonds and Yankee 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.
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 also purchase or sell
foreign currency on a forward basis ("Forwards" or "forward contracts"), enter
into foreign currency futures contracts and options on futures contracts
("Forex Futures") and foreign currency options ("Forex Options"). These
investment techniques are designed
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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 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
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domestic banks involves somewhat different investment risks than those
affecting obligations of U.S. issuers. There may be limited publicly available
information with respect to foreign issuers, and foreign issuers are not
generally subject to uniform accounting, auditing and financial standards and
requirements comparable to those applicable to U.S. companies. There may also
be less government supervision and regulation of foreign securities exchanges,
brokers and listed companies than in the United States. Many foreign securities
markets have substantially less volume than U.S. national securities exchanges,
and securities of some foreign issuers are less liquid and more volatile than
securities of comparable domestic issuers. Brokerage commissions and other
transaction costs on foreign securities exchanges are generally higher than in
the United States. Dividends and interest paid by foreign issuers may be
subject to withholding and other foreign taxes, which may decrease the net
return on Foreign Investments as compared to dividends and interest paid by
U.S. companies. Additional risks include future political and economic
developments, the possibility that a foreign jurisdiction will impose or change
withholding taxes on income payable with respect to foreign securities, and the
possible adoption of foreign governmental restrictions such as exchange
controls.
Prior governmental approval for Foreign Investments may be required under
certain circumstances in some emerging countries, and the extent of Foreign
Investment in certain Fixed Income Securities and domestic companies may be
subject to limitation in other emerging countries. Foreign ownership
limitations also may be imposed by the charters of individual companies in
emerging countries to prevent, 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) companies, which are
generally less able than more established or less leveraged companies 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.
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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, 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 a Portfolio's
shareholders will bear not only their proportionate share of the expenses of
the Portfolio (including operating expenses and the fees of the Adviser), but
also will indirectly bear similar expenses of the underlying Investment Funds.
Certain Investment Funds are advised by an Adviser. The Portfolios may, to the
extent permitted under the 1940 Act and other applicable law, invest in these
Investment Funds. If a Portfolio does elect to make an investment in such an
Investment Fund, it will only purchase the securities of such Investment Fund
in the secondary market.
INVESTMENT GRADE SECURITIES. Investment Grade Securities are those rated by one
or more NRSROs in one of the four highest rating categories at the time of
purchase (e.g., AAA, AA, A or BBB by S&P or Fitch, or Aaa, Aa, A or Baa by
Moody's). Securities rated BBB or Baa represent the lowest of four levels of
Investment Grade Securities and are regarded as borderline between definitely
sound obligations and those in which the speculative element begins to
predominate. MBSs, including mortgage pass-throughs and CMOs, deemed investment
grade by the Adviser, will either carry a guarantee from an agency of the U.S.
Government or a private issuer of the timely payment of principal and interest
(such guarantees do not extend to the market value of such securities or the
net asset value per share of the Portfolio) or, in the case of unrated
securities, be sufficiently seasoned and considered by the Adviser to be of
comparable quality. The Adviser may retain a security if its rating falls below
investment grade if it deems retention of the security to be in the best
interests of the Portfolio. Any Portfolio permitted to hold Investment Grade
Securities may hold unrated securities if the Adviser considers the risks
involved in owning that security to be equivalent to the risks involved in
holding an Investment Grade Security.
LOAN PARTICIPATIONS AND ASSIGNMENTS. Loan Participations are loans or other
direct debt instruments which are interests in amounts owed by a corporate,
governmental or other borrower to another party. They may represent amounts
owed to lenders or lending syndicates, to suppliers of goods or services (trade
claims or other receivables), or to other parties. A Portfolio may invest in
fixed rate and floating rate loans ("Loans") arranged through private
negotiations between an issuer of sovereign debt obligations and one or more
financial institutions ("Lenders"). A Portfolio's investments in Loans are
expected in most instances to be in the form of participation in Loans
("Participations") and assignments of all or a portion of Loans ("Assignments")
from third parties. A Portfolio will have the right to receive payments of
principal, interest and any fees to which it is entitled only from the Lender
selling the Participation and only upon receipt by the Lender of the payments
from the borrower. In the event of the insolvency of the Lender selling a
Participation, a Portfolio may be treated as a general creditor of the Lender
and may not benefit from any set-off between the Lender and the borrower.
Certain Participations may be structured in a manner designed to avoid
purchasers of Participations being
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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 GNMA, FHLMC, Fannie Mae, private issuers and other government
agencies. There can be no assurance that the private insurers can meet their
obligations under the policies. MBSs issued by non-agency issuers, whether or
not such securities are subject to guarantees, may entail greater risk. If
there is no guarantee provided by the issuer, MBSs purchased by a Portfolio
will be those which at the time of purchase are rated investment grade by one
or more NRSRO, or, if unrated, are deemed by the 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
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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.
MUNICIPALS. Municipal securities ("Municipals") are debt obligations issued by
local, state and regional governments that provide interest income that is
exempt from federal income taxes. Municipals include both municipal bonds
(those securities with maturities of five years or more) and municipal notes
(those securities with maturities of less than five years). Municipal bonds are
issued for a wide variety of reasons: to construct public facilities, such as
airports, highways, bridges, schools, hospitals, mass transportation, streets,
water and sewer works; to obtain funds for operating expenses; to refund
outstanding municipal obligations; and to loan funds to various public
institutions and facilities. Certain industrial development bonds are also
considered municipal bonds if their interest is exempt from federal income
taxes. Industrial development bonds are issued by or on behalf of public
authorities to obtain funds for various privately-operated manufacturing
facilities, housing, sports arenas, convention centers, airports, mass
transportation systems and water, gas or sewer works. Industrial development
bonds are ordinarily dependent on the credit quality of a private user, not the
public issuer.
NON-DIVERSIFIED STATUS. The International Magnum and U.S. Real Estate
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 U.S. Real
Estate Portfolio may invest up to 15% of its total assets and the International
Magnum Portfolio may invest up to 25% of its total assets in Rule 144A
Securities that are deemed to be liquid. Other Portfolios may invest an
unlimited amount in Rule 144A Securities that are deemed to be liquid.
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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.
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 repayments
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
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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 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 Equity
Growth, U.S. Real Estate, Global Equity and International Magnum 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.
Each Portfolio (excluding the International Magnum and U.S. Real Estate
Portfolios) is a diversified investment company and is therefore subject to the
following fundamental limitations: as to 75% of its total assets, a Portfolio
may not (a) invest more than 5% of its total assets in the securities of any
one issuer, except obligations of the U.S. Government, its agencies and
instrumentalities, or (b) own more than 10% of the outstanding voting
securities of any one issuer.
INTERNAL REVENUE SERVICE ("IRS") LIMITATIONS. In addition to the above, each
Portfolio also follows certain
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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 the
Advisers, 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, MAS, any of their
affiliates, any of the other companies that provide services to the Fund or any
of their affiliates. The officers of the Fund conduct and supervise its daily
business operations.
THE FUND MAY HOLD SPECIAL MEETINGS. The Fund will not hold annual shareholder
meetings, but may call special meetings when required by law, when requested by
a sufficient number of shareholders or for other reasons. An insurance company
issuing a variable annuity contract or variable life insurance policy that
participates in the Portfolios will vote shares held in its separate account as
required by law and interpretations thereof, as may be amended or changed from
time to time. In accordance with current law and interpretations thereof, a
participating insurance company is required to request voting instructions from
contract or policy owners and must vote shares in the separate account in
proportion to the voting instructions received. For a further discussion,
please refer to your insurance company's separate account prospectus.
INVESTMENT MANAGEMENT
INVESTMENT ADVISERS. The Adviser assigned to a Portfolio provides investment
advice and portfolio management services, pursuant to an Investment Advisory
Agreement and, subject to the supervision of the Fund's Board of Directors,
makes the Portfolio's day-to-day investment decisions, arranges for the
execution of portfolio transactions and generally manages the Portfolio's
investments. MSAM serves as the Adviser for the Equity Growth, U.S. Real
Estate, Global Equity and International Magnum Portfolios. MAS serves as the
Adviser for the Fixed Income, Value and Mid Cap Value Portfolios. MSAM, with
principal offices at 1221 Avenue of the Americas, New York, New York 10020,
conducts a worldwide investment management business, providing a broad range of
portfolio management services to customers in the United States and abroad.
MSAM is a subsidiary of Morgan Stanley Dean Witter & Co. ("MSDW"), 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. MAS is a
Pennsylvania limited liability partnership founded in 1969 with principal
offices at One Tower Bridge, West Conshohocken, Pennsylvania 19428. MAS is also
a subsidiary of MSDW. MAS provides investment advisory services to employee
benefit plans, endowment funds, foundations and other institutional investors
and has served as investment adviser to several open-end investment companies
since 1984. As of September 30, 1998, MSAM and its institutional investment
advisory affiliates (exclusive of MAS) had approximately $85.9 billion in
assets under management or fiduciary advice and MAS managed assets of
approximately $70.4 billion. See "Management of the Fund" in the SAI.
YEAR 2000. The services provided to the Fund by the Advisers and Morgan Stanley
& Co. Incorporated ("Morgan Stanley") depend on the smooth functioning of their
computer systems. Many computer software systems in use today cannot recognize
the year 2000, but revert to 1900 or some other date, due to the manner in
which dates were encoded and calculated. That failure could have a negative
impact on the handling of securities trades, pricing and account services. The
Advisers and Morgan Stanley have been actively working on necessary changes to
their own computer systems to prepare for the year 2000 and expect that their
systems will be adapted before that date, but there can be no assurance that
they will be successful, or that interaction with other non-complying computer
systems will not impair their services at that time. The Advisers and Morgan
Stanley are contacting their vendors and service providers to obtain assurances
that such vendors and service
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providers have taken appropriate measures to address the "Year 2000" problem.
In addition, it is possible that the markets for securities in which the Fund
invests may be detrimentally affected by computer failures throughout the
financial services industry beginning January 1, 2000. Improperly functioning
trading systems may result in settlement problems and liquidity issues.
Furthermore, corporate and governmental data processing errors may result in
production problems for individual companies and overall economic
uncertainties. Earnings of individual issuers will be affected by remediation
costs, which may be substantial and may be reported inconsistently in U.S. and
foreign financial statements. Accordingly, the Fund's investments may be
adversely affected.
PORTFOLIO MANAGERS. The following individuals have primary responsibility for
the Portfolios as indicated below.
FIXED INCOME PORTFOLIO -- Thomas L. Bennett, Kenneth B. Dunn and Richard B.
Worley. Thomas L. Bennett, a Managing Director of Morgan Stanley, joined MAS in
1984. He assumed responsibility for the MAS Funds Fixed Income Portfolio in
1984, the MAS Funds Domestic Fixed Income Portfolio in 1987, the MAS Funds High
Yield Portfolio in 1985, the MAS Funds Fixed Income Portfolio II in 1990, the
MAS Funds Special Purpose Fixed Income and Balanced Portfolios in 1992 and the
MAS Funds Multi-Asset-Class Portfolio in 1994. Mr. Bennett is Chairman of the
Board of Trustees of MAS Funds, a member of the Executive Committee of MAS and
a Director of MAS Fund Distributors, Inc. Mr. Bennett holds a B.S. in Chemistry
and an M.B.A. from University of Cincinnati. Kenneth B. Dunn, a Managing
Director of Morgan Stanley, joined MAS in 1987. He assumed responsibility for
the MAS Funds Fixed Income and Domestic Fixed Income Portfolios in 1987, the
MAS Funds Fixed Income II Portfolio in 1990, the MAS Funds Mortgage-Backed
Securities and Special Purpose Fixed Income Portfolios in 1992, and the MAS
Funds Municipal and PA Municipal Portfolios in 1994. Mr. Dunn received a B.S.
and an M.B.A. from The Ohio State University and a Ph.D. from Purdue
University. Richard B. Worley, a Managing Director of Morgan Stanley, joined
MAS in 1978. He assumed responsibility for the MAS Funds Fixed Income Portfolio
in 1984, the MAS Funds Domestic Fixed Income Portfolio in 1987, the MAS Funds
Fixed Income Portfolio II in 1990, the MAS Funds Balanced and Special Purpose
Fixed Income Portfolios in 1992, the MAS Funds Global Fixed Income and
International Fixed Income Portfolios in 1993 and the MAS Funds Multi-Asset-
Class Portfolio in 1994. Mr. Worley received a B.A. in Economics from
University of Tennessee and attended the Graduate School of Economics at
University of Texas. Messrs. Bennett, Dunn, and Worley have shared primary
responsibility for managing the Portfolio's assets since its inception.
EQUITY GROWTH PORTFOLIO -- Philip W. Friedman, Margaret K. Johnson and William
S. Auslander. Philip W. Friedman is a Managing Director of Morgan Stanley and
MSAM and is a member of MSAM's investment management team. In addition to
portfolio management, his equity research responsibilities include business
equipment and services, capital goods, consumer durables, multi-industry and
transportation. Prior to joining MSAM in 1997, he was the North American
Director of Equity Research at Morgan Stanley. From 1990 to 1995, he was a
member of Morgan Stanley's Equity Research team. Mr. Friedman graduated from
Rutgers University with a B.A. (Phi Beta Kappa and Summa Cum Laude) in
Economics. He also holds an M.B.A. from the J. L. Kellogg School of Management
at Northwestern University. Margaret K. Johnson is a Principal of MSAM and
Morgan Stanley 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. William S. Auslander is a Vice President of MSAM
and Morgan Stanley. He joined MSAM in 1995 as an equity analyst in the
Institutional Equity Group. Prior to joining MSAM, he worked at Ichan & Co. for
nine years as an equity analyst. He graduated from the University of Wisconsin
at Madison with a B.A. in Economics and received an M.B.A. from Columbia
University. Ms. Johnson has shared primary responsibility for managing the
Portfolio's assets since its inception. Messrs. Friedman and Auslander have
shared primary responsibility for managing the Portfolio's assets since
September 1998.
VALUE PORTFOLIO -- Robert J. Marcin, Richard M. Behler and Nicholas J. Kovich.
Robert J. Marcin, a Managing Director of Morgan Stanley, joined MAS in 1988. He
assumed responsibility for the MAS Funds Value Portfolio in 1990 and the MAS
Funds Equity Portfolio in 1994. Mr. Marcin holds a B.A. (Cum Laude) from
Dartmouth College and is a Chartered Financial Analyst. Richard M. Behler, a
Principal of Morgan Stanley, joined MAS in 1995. He served as a Portfolio
Manager from 1992 through 1995 for Moore Capital Management and as Senior Vice
President for Merrill Lynch Economics from 1987 through 1992. He assumed
responsibility for the MAS Fund's Value Portfolio in 1996. Mr. Behler received
a B.A. (Cum Laude) in Economics from Villanova University and an M.A. and a
Ph.D. in Economics from the University of Notre Dame. Nicholas J. Kovich, a
Managing Director of Morgan Stanley, joined MAS in 1988. He assumed
responsibility for the MAS Funds Equity Portfolio in 1994. Mr. Kovich received
a B.S. in Chemical Engineering and an M.B.A. from University of Kansas. Mr.
Behler and Mr. Marcin have shared primary responsibility for managing the
Portfolio's assets since its inception. Mr. Kovich assumed responsibilities
with the Value Portfolio in 1997.
MID CAP VALUE PORTFOLIO -- William B. Gerlach, Gary G. Schlarbaum, Bradley S.
Daniels and Chris Leavy. William B. Gerlach, a Vice President of Morgan
Stanley, joined MAS in 1991. He served as a Programmer in Applications Software
26
<PAGE>
Development at Alphametrics Corporation from 1987 through 1991 and as a Data
Analyst and Inflation Economist at Wharton Econometric Forecasting Associates
from 1984 through 1987. He holds a B.A. in Economics from Haverford College.
Gary G. Schlarbaum, a Managing Director of Morgan Stanley, joined MAS in 1987.
He assumed responsibility for the MAS Funds Equity and Small Cap Value
Portfolios in 1987, the MAS Funds Balanced Portfolio in 1992 and the MAS Funds
Multi-Asset-Class and Mid Cap Value Portfolios in 1994. Mr. Schlarbaum holds a
B.A. from Coe College and a Ph.D. from University of Pennsylvania. Bradley S.
Daniels, a Vice President of Morgan Stanley, joined MAS in 1985. Chris Leavy
joined MAS in 1997. He served as a Portfolio Manager for Capitoline Investment
Services from 1995-1997; a Portfolio Manager for Premier Trust Company from
1994 to 1995; and as a Research Analyst for Leavy Investment Management from
1993-1994. Messrs. Gerlach, Schlarbaum, Daniels and Leavy have had primary
responsibility for managing the Portfolio's assets since its inception.
U.S. REAL ESTATE PORTFOLIO -- Theodore R. Bigman and Russell Platt. Mr. Bigman,
a Principal of Morgan Stanley and MSAM, joined MSAM in 1995. Together with
Russell Platt, he is responsible for MSAM's real estate securities research.
Prior to joining MSAM, he was a Director at CS First Boston, where he worked
for eight years in the Real Estate Group. Mr. Bigman graduated from Brandeis
University with a B.A. in Economics and received an M.B.A. from Harvard
University. Russell Platt joined MSAM in 1994. Mr. Platt, a Managing Director
of Morgan Stanley and MSAM, previously served as a Director of the General
Partner of The Morgan Stanley Real Estate Fund I, where he was involved in
capital raising, acquisitions, oversight of investments and investor relations.
From 1991 to 1993, Mr. Platt was head of Morgan Stanley Realty's Transaction
Development Group. As such, he was actively involved in Morgan Stanley's
worldwide real estate business. Mr. Platt graduated from Williams College with
a B.A. in Economics and received an M.B.A. from Harvard Business School. Mr.
Bigman and Mr. Platt have had primary responsibility for managing the
Portfolio's assets since its inception.
GLOBAL EQUITY PORTFOLIO -- Frances Campion. Frances Campion, a Managing
Director of Morgan Stanley and MSAM, joined MSAM in January 1990 as a Global
Equity Fund Manager. Her responsibilities include day-to-day management of the
Global Equity product. Prior to joining MSAM, Ms. Campion was a U.S. equity
analyst with Lombard Odier Limited where she had responsibility for the
management of global portfolios. She is a graduate of University of College,
Dublin. Ms. Campion has had 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 and MSAM, 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.
OTHER SERVICES
DISTRIBUTOR. Under its Distribution Agreement with the Fund, Morgan Stanley, a
subsidiary of MSDW, 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.
Morgan Stanley does not receive compensation for providing distribution
services.
ADMINISTRATOR. MSAM and MAS also provide the respective Portfolios of the Fund
which they manage with administrative services pursuant to Administration
Agreements. The services provided under the respective Administration
Agreements are subject to the supervision of the officers and the Board of
Directors of the Fund, and include day-to-day administration of matters related
to the corporate existence of the Fund, maintenance of its records, preparation
of reports, supervision of the Fund's arrangements with its Custodian, and
assistance in the preparation of the Fund's registration statements under
federal and state laws. The Administration Agreements also provide that the
Administrators through their agents will provide the Fund with dividend
disbursing and transfer agent services. For their services under the
Administration Agreements, the Fund pays MSAM and MAS a monthly fee which on an
annual basis equals 0.25% of the average daily net assets of each Portfolio
that they administer.
MSAM and MAS have each entered into a Sub-Administration Agreement with Chase
Global Funds Services Company ("Chase Global"), a corporate affiliate of The
Chase Manhattan Bank ("Chase"), pursuant to which Chase Global has agreed to
provide certain administrative services to the Fund. MSAM and MAS supervise and
monitor such administrative services provided by Chase Global. The services
provided under the Administration Agreements and the Sub-Administration
Agreements are also subject to the supervision of the Board of Directors of the
Fund. The Board of Directors of the Fund has approved the provision of services
described above pursuant to the Administration Agreements and the Sub-
Administration Agreements as being in the best interests of the Fund. As
compensation for its
27
<PAGE>
services, Chase is paid by MSAM and MAS out of their respective administration
fees. Chase Global's business address is 73 Tremont Street, Boston,
Massachusetts 02108-3913. For additional information regarding the
Administration Agreements or the Sub-Administration Agreements, see "Management
of the Fund" in the SAI.
Certain administrative and record-keeping services that would otherwise be
performed by the Advisers or their service providers may be performed by
insurance companies that purchase shares of the Portfolios. An Adviser may make
payments to these insurance companies to defray the costs of providing those
services.
Chase Global calculates the NAV and dividends and maintains the general
accounting records for each Portfolio.
CUSTODIANS. Chase serves as the Custodian of the assets of the Portfolios.
Chase is not an affiliate of either of the Advisers or the Distributor. In
maintaining custody of foreign assets held outside the United States, Chase
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.
DIVIDEND DISBURSING AND TRANSFER AGENT. Chase Global acts as dividend
disbursing and transfer agent for the Fund.
INDEPENDENT ACCOUNTANTS. PricewaterhouseCoopers LLP serves as independent
accountants for the Fund and will audit the annual financial statements of each
Portfolio.
LEGAL COUNSEL. Morgan, Lewis & Bockius LLP serves as legal counsel to the Fund.
BREAKDOWN OF EXPENSES
The Portfolios pay fees and other costs related to their daily operations.
Expenses paid out of a Portfolio's assets are reflected in its share price.
Each Portfolio pays a management fee to its Adviser for managing its
investments and business affairs. MSAM and MAS pay fees to affiliates who
provide assistance with these services. Each Portfolio also pays other
expenses, which are explained below. The Advisers may, from time to time,
reduce their fees or reimburse the Portfolios for expenses above a specified
limit. These fee reductions or expense reimbursements, which may be terminated
at any time without notice, can decrease a Portfolio's expenses and boost its
performance.
MANAGEMENT FEE
The Adviser assigned to a Portfolio is entitled to receive from such Portfolio
a management fee, payable quarterly, at an annual rate as a percentage of
average daily net assets as set forth in the table below.
<TABLE>
<CAPTION>
Mid U.S.-
Fixed Equity Cap Real Global International
Assets Income Growth Value Value Estate Equity Magnum
- -----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
First $500 mil-
lion 0.40% 0.55% 0.55% 0.75% 0.80% 0.80% 0.80%
- -----------------------------------------------------------------------
From $500 mil-
lion to $1 bil-
lion 0.35% 0.50% 0.50% 0.70% 0.75% 0.75% 0.75%
- -----------------------------------------------------------------------
More than $1
billion 0.30% 0.45% 0.45% 0.65% 0.70% 0.70% 0.70%
</TABLE>
However, the Advisers, with respect to certain of the Portfolios, have
voluntarily waived receipt of their management fees and agreed to reimburse the
Portfolio, if necessary, if such fees would cause the total annual operating
expenses of the Portfolio to exceed the respective percentage of average daily
net assets set forth in the table below.
<TABLE>
<CAPTION>
Maximum Total Annual
Operating Expenses After
Fee Waivers and
Portfolio Reimbursements
- --------- ------------------------
<S> <C>
Fixed Income........................................... 0.70%
Equity Growth.......................................... 0.85%
Value.................................................. 0.85%
Mid Cap Value.......................................... 1.05%
U.S. Real Estate....................................... 1.10%
Global Equity.......................................... 1.15%
International Magnum................................... 1.15%
</TABLE>
These fee waivers and reimbursements are voluntary and may be terminated by
MSAM or MAS at any time without notice.
OTHER EXPENSES
In addition to investment advisory and certain administrative expenses charged
by the administrators, each Portfolio pays all expenses not assumed by MSAM or
MAS. Such expenses include or could include investment-related expenses, such
as brokers' commissions, transfer taxes and fees related to the purchase, sale,
or loan of securities; fees and expenses for Directors not affiliated with MSAM
or MAS; fees and expenses of its independent accountants and legal counsel;
costs of Directors and shareholder meetings; SEC fees; expenses of preparing
and filing registration statements; the cost of providing proxy statements,
prospectuses and statements of additional information to existing variable
annuity contract and variable life insurance policy owners; expenses of
preparing and printing the annual and semi-annual shareholder reports to
variable annuity contract and variable life insurance policy owners; bank
transaction charges and certain custodians' fees and expenses; federal,
28
<PAGE>
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 Agreements authorize the Advisers to select the brokers
or dealers that will execute the purchases and sales of investment securities
for the Portfolios and direct the Advisers 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 Advisers to pay
higher commissions in recognition of brokerage services which, in the opinion
of the Advisers, are necessary for the achievement of better execution,
provided the Advisers believe 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 Advisers. 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 Advisers 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 Advisers.
Although there is no specified formula for allocating such transactions, the
various allocation methods used by the Advisers, 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 Advisers may allocate 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 Advisers 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. For the
periods ended December 31, 1997, the Portfolio turnover rates for the Fixed
Income, Equity Growth, Mid Cap Value and U.S. Real Estate Portfolios were 185%,
172%, 141% and 114%, respectively. 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.
29
<PAGE>
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.
PERFORMANCE OF INVESTMENT ADVISERS
The Advisers manage portfolios of Morgan Stanley Institutional Fund, Inc.
("MSIF") and MAS Funds, which served as the models for the Portfolios of the
Fund. The portfolios of MSIF and MAS Funds have substantially the same
investment objectives, policies and strategies as the Portfolios of the Fund.
In addition, the Advisers intend the Portfolios of the Fund and the
corresponding portfolios of MSIF and MAS Funds to be managed by the same
personnel and to continue to have substantially similar investment strategies,
techniques and characteristics. The following table sets forth the name of each
Portfolio of the Fund and the name of the corresponding portfolio of MSIF or
MAS Funds from which the Portfolio is cloned.
<TABLE>
<CAPTION>
Corresponding MSIF Correspondng MAS
Fund Portfolio portfolio Funds portfolio
-------------- -------------------- ----------------
<S> <C> <C>
Fixed Income Fixed Income
Equity Growth Equity Growth
Value Value
Mid Cap Value Mid Cap Value
U.S. Real Estate U.S. Real Estate
Global Equity Global Equity
International Magnum International Magnum
</TABLE>
Past investment performance of the Class A Shares of the MSIF portfolios and
the Institutional Class Shares of the MAS Funds, as shown in the table below,
may be relevant to your consideration of the Portfolios. The investment
performance of the portfolios of MSIF and MAS Funds is not necessarily
indicative of future performance of the Portfolios of the Fund. Also, the
operating expenses of each of the Portfolios of the Fund will be different
from, and may be higher than, the operating expenses of the corresponding
portfolio of MSIF or MAS Funds. The investment performance of the Class A
Shares of the MSIF portfolios and the Institutional Class Shares of the MAS
Funds is provided merely to indicate the experience of the Advisers in managing
similar portfolios.
<TABLE>
<CAPTION>
Average Average Average
Annual Annual Annual Average
Total Return Total Return Total Return Total Return Total Return Total Return Annual
One Year Three Years Five Years Three Years Five Years Ten Years Total Return
Inception Ended Ended Ended Ended Ended Ended Since
Fund Name Date 9/30/98 9/30/98 9/30/98 9/30/98 9/30/98 9/30/98 Inception
- --------- --------- ------------ ------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
MSIF:
Equity Growth....... 4/2/91 0.76% 76.16% 156.27% 20.77% 20.71% N/A 16.55%
U.S. Real Estate.... 2/24/95 (12.32)% 60.75% N/A 17.14% N/A N/A 18.64%
Global Equity....... 7/15/92 0.08% 53.00% 110.22% 15.23% 16.02% N/A 17.33%
International
Magnum............. 3/15/96 (10.05)% N/A N/A N/A N/A N/A 4.65%
MAS FUNDS:
Fixed Income........ 11/14/84 7.90% 29.44% 41.27% 8.98% 7.15% 9.75% 10.74%
Value............... 11/5/84 (16.41)% 39.81% 99.17% 11.82% 14.77% 14.95% 15.64%
Mid Cap Value....... 12/30/94 (6.92)% 83.74% N/A 22.48% N/A N/A 27.28%
</TABLE>
30
<PAGE>
PRINCIPAL HOLDERS OF SECURITIES
As of March 16, 1998, MSDW owned more than 25% of the outstanding voting
securities of the U.S. Real Estate, Mid Cap Value and Global Equity Portfolios.
Also, as of that date, General American Life Insurance owned more than 25% of
the International Magnum, Equity Growth and Fixed Income Portfolios, American
General Life Insurance Company owned more than 25% of the International Magnum,
Mid Cap Value, Value and Equity Growth Portfolios, Fidelity Investments Life
Insurance Company owned more than 25% of the Global Equity Portfolio and
Allmerica Financial Life Insurance & Annuity Company owned more than 25% of the
Fixed Income Portfolio pursuant to variable annuity contracts and variable life
insurance policies they have 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. MSDW 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 MSDW nor
the insurance companies are deemed to be in control of the Portfolios.
For more information, see "Principal Holders of Securities" in the SAI.
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 Equity Growth, Value, Mid Cap Value, U.S. Real
Estate, Global Equity and International Magnum 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.
The Fixed Income Portfolio's NAV is determined as of one hour after the close
of the bond markets (normally 4:00 p.m. Eastern time) on each day that the
Portfolio is open for business.
Each Portfolio's NAV is the value of a single share. The NAV is computed by
adding the value of the Portfolio's investments, cash and other assets,
subtracting its liabilities, and then dividing the result by the number of
shares outstanding.
Each Portfolio's investments 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.
For Portfolios that engage in Foreign Investment, certain securities from time
to time may be listed primarily on foreign exchanges that trade on days when
the NYSE is closed (such as Saturday). As a result, the NAV of these Portfolios
may be affected significantly by such trading on days when shareholders can not
purchase or redeem shares of the Portfolio.
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.
31
<PAGE>
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.
32
<PAGE>
SUPPLEMENT DATED NOVEMBER 3, 1998
TO
STATEMENT OF ADDITIONAL INFORMATION DATED MAY 1, 1998
AS PREVIOUSLY SUPPLEMENTED THROUGH SEPTEMBER 10, 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 additional prospectuses of the Fund. The following is
added at the end of the second column on the first page of the SAI:
Prospectus dated May 12, 1998 for the Value, U.S. Real Estate,
International Magnum and Emerging Markets Equity Portfolios.
Prospectus dated May 19, 1998 for the Fixed Income, High Yield, U.S. Real
Estate and Global Equity Portfolios.
Prospectus dated June 5, 1998 for the Value, Mid Cap Value and Global
Equity Portfolios.
Prospectus dated August 28, 1998 for the Equity Growth Portfolio.
Prospectus dated September 10, 1998 for the High Yield and U.S. Real Estate
Portfolios.
Prospectus dated November 3, 1998 for the Fixed Income, Equity Growth,
Value, Mid Cap Value, U.S. Real Estate, Global Equity and International Magnum
Portfolios.
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PLEASE RETAIN THIS SUPPLEMENT FOR FUTURE REFERENCE
