DARUMA MID-CAP VALUE FUND
60 East 42nd Street
Suite 1112
New York, NY 10165
(800) 435-5076
December 22, 1997
The Daruma Mid-Cap Value Fund (the "Fund") is a series of The Daruma
Funds, Inc. (the "Company"), a no-load diversified, open-end management
investment company incorporated in the State of Maryland. The Fund's
objective is to seek long-term capital appreciation by investing primarily
(at least 65% of its total assets) in the common stocks of medium
capitalization companies. Current income is incidental to the Fund's
investment objective. The Fund seeks to provide investors an
opportunity to participate in the long-term growth of the economy
through the investment returns offered by the common stocks of
companies which are undervalued and whose earnings growth prospects
are improving. The Fund is designed for long-term investors who can
accept stock market risk as well as the more volatile returns of mid-cap
stocks vs. "blue chip" stocks. There can be no assurance that the Fund's
investment objective will be met.
Investment Adviser - CastleRock Capital Management, Inc.
The Fund is offered on a no-load basis and there are no sales commissions,
exchange, redemption or 12b-1 fees. The Fund's minimum initial investment
is $1,000 and the minimum subsequent investment is $100. The minimum
initial purchase requirement for retirement and UGMA (Uniform Gifts to
Minors Act) accounts as well as accounts established with automatic
investment plans is $500.
This Prospectus concisely sets forth information about the Fund a prospective
investor should know before investing. It should be read and retained for
future reference. The Statement of Additional Information, dated December 12,
1997,
has been filed with the Securities and Exchange Commission and is incorporated
herein by reference. For a free copy of the Statement of Additional
Information,
write or call the Fund at the address or telephone number shown above.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED
BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE
SECURITIES COMMISSION, NOR HAS THE COMMISSION OR ANY
STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
FUND FACTS
Investment Objective
To provide long-term capital appreciation by investing, under
normal circumstances, at least 65% of its total assets in medium
capitalization (mid-cap) companies.
Investment Strategy
The Fund invests in undervalued mid-cap companies whose
anticipated earnings growth will accelerate. The Fund believes
that buying the common stock of companies that are cheap and
changing provides the best combination of risk and reward.
The Fund will invest in a portfolio normally composed of approximately
35 common stocks representing the CastleRock's best ideas, diversified
among a broad range of industries.
Why Focus on Mid-Cap Stocks?
The cumulative performance of mid-cap stocks since 1926 falls slightly
below that of small-cap stocks, but well ahead of large-cap stocks. At
the same time, mid-cap stocks are subject to less volatility than small-cap
stocks. By focusing on the mid-cap sector, the Fund hopes to capture
most of the long-term outperformance smaller companies generate
versus larger companies, while experiencing less volatility and risk.
Secondly, the mid-cap universe is not well followed on Wall Street,
allowing CastleRock's emphasis on primary research to add value.
Thirdly, medium-sized companies historically undergo evolutionary changes
in their businesses at a faster rate than large companies do, allowing for more
frequent investment opportunities.
Who Should Invest in the Fund?
Investors who have a long-term time horizon and are willing to take on the
additional risk of investing in mid-cap stocks. This is an appropriate
vehicle for individuals, educational funding accounts, trusts, foundations,
endowments, as well as IRAs and other tax-deferred accounts.
Fees & Sales Charges
The Daruma Mid-Cap Value Fund is 100% no-load. There are no sales
charges, no 12b-1 fees, no redemption fees and no fees associated with
the reinvestment of dividends.
Purchase and Redemptions of Fund Shares
A complete description regarding the alternatives available to shareholders
for the purchase and/or redemption of Fund shares is provided under
"Purchase of Shares" on page 8 and "Redemption of Shares" on page
10 of this Prospectus.
Minimum Investment
The Fund's minimum initial investment is $1,000 and subsequent
investments are $100. For retirement and UGMA (Uniform Gifts
to Minors Act) accounts and accounts established with automatic
investment plans, the minimum initial requirement is $500.
FUND TABLE OF CONTENTS
Page Page
Fund Expenses 3 SHAREHOLDER GUIDE
Financial Highlights 4
Investment Objective 4 Purchase of Shares 9
Investment Policies 5 Choosing a Distribution Option 13
Investment Risks 7 Redemption of Shares 11
Investment Restrictions 8
Management of the Fund 8
Dividends and Distributions 13
Taxes 13
Net Asset Value 14
FUND EXPENSES
The following table illustrates all expenses and fees that you would incur
as a shareholder of the Fund.
Shareholder Transaction Expenses:
Sales Load Imposed on Purchases None
Sales Load Imposed on Reinvested Dividends None
Deferred Sales Load None
12b-1 Fee None
Redemption Fee None
Annual Fund Operating Expenses (as a percentage of average net assets)
Management Fees (after waivers)*0.00%
Other Expenses (after expense reimbursements)**1.49%
Total Fund Operating Expenses (after fee waivers and
expense reimbursements)***1.49%
The above table is designed to assist you in understanding the various costs
and expenses that a shareholder would bear directly or indirectly as an investor
in this Fund. The management fee will decline as the Fund's assets increase.
See "Management of the Fund". The Fund's investment adviser, CastleRock
Capital Management, Inc. ('CastleRock"), is committed to keeping the total
expenses of the Fund at or below 1.50% and intends to waive all management
fees and assume other expenses, if necessary, to maintain that expense ratio.
*Management fees would have been 1.00% before taking into account fee waivers.
**Estimated other expenses would have been 4.10% before
reimbursement of expenses.
***Estimated total Fund Operating Expenses would have been
5.10% before waiver of fees and reimbursement of expenses by
the adviser.
The following example illustrates the expenses that you would incur on a
$1,000 investment over various periods, assuming a 5% annual rate of return,
and at a 1.50% expense ratio:
1 Year 3 Years
Daruma Mid-Cap Value Fund $16 $49
This example should not be considered a representation of past or future
expenses or performance. Actual expenses may be higher or lower than
those shown.
Financial Highlights
The following financial highlights are part of the Fund's financial statements
and have been audited by Ernst & Young LLP, Independent Auditors. The Fund's
financial statements and Ernst & Young LLP's report on them are included in
the Fund's Annual Report to Shareholders and are incorporated by reference
into the Statement of Additional Information and this Prospectus. Futher
information about the Fund's performance is contained elsewhere in this
Prospectus and in the Fund's Annual Report to Shareholders for the period
ended June 30, 1997.
For the period
8/16/96
through
6/30/97
Net Asset Value, Beginning of Period $10.00
Income from Investment Operations:
Net investment loss (0.07)
Net realized and unrealized gain on investments 2.98
Total from Investment Operations 2.91
Less Distributions:
Distributions from net realized gains (0.01)
Total Distributions (0.01)
Net Asset Value, End of Period $12.90
Total Investment Return 29% (c)
Ratios/Supplemental Data:
Net Assets, End of Period (a) $1,459,161
Ratio of Expenses to Average Net Assets(b) 1.49% (c)
Ratio of Net Investment Loss to Average Net Assets (b) (0.60%) (c)
Portfolio Turnover Rate 46%
Average Commission Rate (d) $0.04
(a) The ratio of expenses to average net assets before waiver of fees and
reimbursements of expenses by the investment adviser would have been
5.10% for the period ended June 30,1997.
(b) the ratio of net investment loss to average net assets before the waiver
of fees and reimbursements of expenses by the investment adviser would
have been (4.21%) for the period ended June 30, 1997.
(c) Not annualized.
(d) The Fund is required to disclose its average commission rate paid per share
for the purchases and sales of investment securities.
Investment Objective
The Fund's investment objective is to seek long-term capital appreciation by
investing, under normal circumstances, at least 65% of its total assets in
the common stocks of medium capitalization companies (companies
with market capitalization ranging from $500 million to $7 billion,
including common stocks of companies listed on the S&P MidCap
Index. Current income is incidental to the Fund's investment
objective. There can be no assurance that the Fund's investment
objective will be met. The Fund attempts to achieve its investment
objective by investing primarily in common stocks.
Investment Policies
CastleRock believes that original research drives performance. CastleRock,
on behalf of its clients, invests in companies that it believes are about to
undergo
significant positive changes in earnings growth, and whose valuations do not
yet
reflect such changes. CastleRock attempts to identify those mid-cap companies
who
meet these investment criteria by conducting its own thorough and original
research.
The Fund will normally consist of a portfolio of approximately 35 securities
considered
by CastleRock to be the companies with the most compelling risk/reward profiles.
CastleRock believes that by investing in a portfolio of approximately 35
companies,
the Fund will be able to diversify its holdings and avoid certain of the risks
associated with an investment in mid-cap companies. Although the Fund will
invest, under normal circumstances, at least 65% of its total assets in the
common
stocks of medium capitalization companies, it may also invest in other types of
securities such as nonconvertible and convertible preferred stocks, bonds and
warrants, foreign securities (ADRs), short-term fixed income securities, and
cash equivalents, when the investment in such securities is considered
consistent
with the Fund's investment objective by CastleRock. The Fund will only
invest in investment grade bonds and short-term fixed income securities
having an S&P rating of at least, or equivalent to, BBB (which rating may
have speculative characteristics) or, if unrated, determined by CastleRock
to be of comparable quality. Securities in the lowest investment grade
debt category generally have higher yields, may have speculative
characteristics
and, as a result, changes in economic conditions or other circumstances are
more likely to lead to a weakened capacity to make principal and interest
payments than is the case with higher investment grade securities. Although
the Fund currently does not do so, it may, from time to time, invest more
than 25% of the value of its total assets in the securities of other investment
companies (open or closed-end) and up to 5% of its total assets in the
securities
of any one other investment company. Shareholders should be aware that such
an investment would result in a layering of fees.
Additional Investment Policies
Borrowing
The Fund, may from time to time , borrow money from banks for
temporary, and/or extraordinary purposes. The Fund does not
intend to engage in reverse repurchase agreements. Such
borrowing will not exceed an amount equal to one-third of
the value of the Fund's total assets less its liabilities.
The Fund will not purchase additional securities when
borrowings exceed 5% of total assets.
Illiquid Securities
The Fund may invest up to 15% of its net assets in illiquid
securities, including restricted securities (i.e., securities
not readily marketable). Any illiquid securities purchased
by the Fund will have been registered under the Securities
Act of 1933. The Fund may purchase restricted securities
that may be offered and sold only to "qualified institutional
buyers" under Rule 144A of the Securities Act of 1933,
and the Fund's Board of Directors may determine, when
Appropriate, that specific Rule 144A securities are liquid
and not subject to the 15% limitation on illiquid securities.
Should the Board of Directors make this determination,
it will carefully monitor the security (focusing on such
factors, among others, as trading activity and availability
of information) to determine that the Rule 144A security
continues to be liquid. It is not possible to predict with
assurance exactly how the market for Rule 144A securities
will further evolve. This investment practice could have
the effect of increasing the level of illiquidity in the Fund
to the extent that qualified institutional buyers become for
a time uninterested in purchasing Rule 144A securities.
Temporary Investments
When CastleRock believes that market conditions warrant a temporary
defensive position, the Fund may invest up to 100% of its assets in short-
term instruments such as U.S. Treasury bills, high quality
commercial paper, bank certificates of deposit, bankers'
acceptances, or repurchase agreements collateralized by
U.S. Government securities.
Repurchase Agreements
The Fund may enter into repurchase agreements. In a repurchase
agreement agreement the Fund effectively makes a loan by
purchasing a U.S. Government security and simultaneously
committing to resell that security to the seller at an agreed
upon price on an agreed upon date (usually not more than
seven days) from the date of purchase. Repurchase agreements
may be entered into with a Federal Reserve System bank or
"primary dealers" in U.S. Government securities.
Foreign Securities
The Fund will not invest more than 15% of its total assets in
foreign debt and/or equity securities, or ADRs. Foreign
securities investments involve certain risks, such as political
or economic instability of the issuer or of the country of issue,
fluctuating exchange rates and the possibility of imposition of
exchange controls. These securities may also be subject to
greater fluctuations in price than the securities of U.S. corporations,
and there may be less publicly available information about their
operations. Foreign companies may not be subject to accounting
standards or governmental supervision comparable to U.S. companies,
and foreign markets may be less liquid or more volatile than U.S.
markets and may offer less protection to investors such as the Fund.
In addition, dividends and interest paid by foreign issuers may be subject
to withholding and other foreign taxes, and transaction costs such as
brokerage commissions are generally higher than in the United States.
Short Sales
The Fund will only make short sales (up to a maximum of 10%)
that are short sales of securities
"against the box". A short sale "against the box" is a sale of a
security that the Fund either owns an equal amount of or has the
immediate and unconditional right to acquire at no additional cost.
The Fund will make short sales "against the box" as a form of
hedging to offset potential declines in long positions in the same
or similar securities.
Portfolio Turnover
The Fund's portfolio turnover rate will be influenced by the
Fund's investment objectives, other investment policies, and
the need to meet redemptions. While the rate of portfolio
turnover will not be a limiting factor when CastleRock
deems changes appropriate, it is anticipated that
given the Fund's objective, its annual portfolio turnover
should not generally exceed 50%. (A portfolio turnover
rate of 50% would occur, for example, if half of the stocks
in the Fund were replaced over a period of one year.)
Except as noted elsewhere in this prospectus, the aforementioned
investment policies and practices are not fundamental and the Board
of Directors of the Fund may change such policies without the vote
of a majority of outstanding voting securities of the Fund as defined by
the Investment Company Act of 1940, as amended. A more detailed
description of the Fund's investment policies, including a list of those
restrictions on the Fund's investment activities which cannot be changed
without such a vote, appears in the Statement of Additional Information.
Investment Risks
The Fund is designed for long-term investors who are willing to accept the
risks associated with investing in a mutual fund seeking long-term capital
appreciation. Investors should consider their investment goals, their time
horizon for achieving them and their tolerance for risk before investing in
the Fund. The Fund which will be primarily invested in common stocks of
mid-cap companies is subject to different risk profiles. Market risk is
risk associated with price declines over short or extended periods of time.
As the U.S. economy has expanded, corporate profits have grown and share
prices have risen. Economic growth has been punctuated by periodic declines
where share prices of even the best managed and most profitable companies
decline. Stocks of mid-cap companies may not be well known to the public,
have lower trading volume and may be more volatile in price than larger
capitalized stocks included in the S&P 500 Stock Index. Thus, the Fund
should only be used as an investment vehicle for those with longer time
horizons, and should not be used to capture short-term swings in the market.
Although the Fund is diversified within the meaning of the Investment Company
Act of 1940, it will normally invest in a limited number (approximately 35)
of securities. Thus this Fund may contain more risk than other funds with a
similar objective invested in a broader range of securities. To the extent
that the Fund invests in a limited number of securities, it may be more
susceptible to any single, corporate, economic, political or regulatory
occurrence than a more widely diversified fund.
INVESTMENT RESTRICTIONS
As a diversified investment company the Fund has adopted certain fundamental
restrictions which may not be changed without the approval of a majority of
the outstanding voting shares, as that term is defined in the Investment
Company Act of 1940. These restrictions are provided in greater detail in
the Statement of Additional Information and provide, in part, that the Fund
will not:
(a)with respect to 75% of its total assets, invest more than 5% of its assets
in the securities of any one issuer, excluding obligations of the U.S.
Government;
(b)own more than 10% of the outstanding voting securities of any one issuer,;
(c)invest more than 25% of its total assets in any one industry except U.S.
Government obligations; or
(d)invest in companies for the purpose of exercising control of management.
In addition to the aforementioned investment restrictions, and in addition to
other restrictions listed in the Statement of Additional Information, the Fund
may not (except where specified):
(i) purchase securities on margin or borrow money, except from banks for
temporary and/or extraordinary purposes;
(ii) mortgage, pledge or hypothecate any assets except that the Fund may
pledge not more than one-third of its total assets to secure borrowings made
in accordance with paragraph (i) above. However, although not a fundamental
policy of the Fund, as a matter of operating policy in order to comply with
certain state statutes, the Fund will not pledge its assets in excess of an
amount equal to 15% of total assets;
(iii) lend portfolio securities of value exceeding in the aggregate one
third of the market value of the Fund's total assets less liabilities
other than obligations created by these transactions; or
(iv) make loans to others, except through the purchase of portfolio
investments, including repurchase agreements.
MANAGEMENT OF THE FUND
Adviser
CastleRock Capital Management, Inc., a registered investment adviser, is a New
York corporation with its principal office located at 60 East 42nd Street,
Suite 1112, New York, New York 10165. CastleRock has been retained by the
Board of Directors as the investment adviser for the Fund pursuant to an
Investment Advisory Agreement entered into with the Fund. Mariko O. Gordon,
President and Chief Investment Officer of CastleRock, is primarily
responsible for supervising the Fund's daily investment management
activities. CastleRock had assets under management of approximately
$54,000,000 at September 30, 1997.
CastleRock, however, has not managed the assets of a mutual fund prior to the
Fund. Ms. Gordon has over ten years experience in the investment management
business. Prior to founding CastleRock in 1995, Ms. Gordon was an equity
owner in and Director of Research at Valenzuela Capital Management, Inc.
("VCM") from 1990 to 1995, a firm specializing in small to mid-cap stocks
with over $1 billion under management. Ms. Gordon's sole responsibility at
VCM was portfolio management. Prior to joining VCM, from 1987 to 1990, she
was the Director of Systematic Research at Rocye & Associates, Inc., an
investment firm specializing in small-cap value stocks and adviser to
several mutual funds, including the Pennsylvania Mutual Fund.
Ms. Gordon started her investment career as a research analyst at Manning &
Napier Advisors, Inc., a firm managing $2 billion for ERISA and Taft-Hartley
clients. Ms. Gordon is a Chartered Financial Analyst and a graduate of
Princeton University.
The Fund's Annual Report to shareholders will contain information regarding
the Fund's performance and will be provided without charge, upon request.
Adviser's Fees
According to the terms of the Investment Advisory Agreement, the Fund will pay
a monthly advisory fee at an annual rate equal to 1% of the first $100 million
of the Fund's average daily net assets; 0.75% of the next $100 million of such
net assets; and 0.50% of the Fund's average daily net assets more than $200
million. Any portion of the advisory fee received by CastleRock may be used
by CastleRock to provide investor and administrative services and for
distribution of Fund shares. CastleRock may voluntarily waive a portion of
its fee or assume certain expenses of the Fund. This would have the effect
of lowering the overall expense ratio of the Fund and of increasing total
return to investors in the Fund. See "Expense Limitation" in the Statement
of Additional Information.
Other Expenses
In addition to CastleRock's management fee, the Fund bears the costs of the
following:
shareholder servicing expenses; custodial, transfer agent, accounting, legal
and audit fees; costs of preparing and printing prospectuses and reports sent
to shareholders; state and federal registration fees and expenses; proxy and
annual meeting expenses (if any); and director/trustee fees and expenses.
PURCHASE OF SHARES
Initial Investments by Mail
Subject to acceptance by the Fund, an account may be opened by completing and
signing an Account Application Form and mailing it to the Fund at the
address noted below, together with a check (subject to the Fund's minimum
investment) payable to:
U.S. Mail: Daruma Mid-Cap Value Fund
or c/o American Data Services, Inc.
Overnight 150 Motor Parkway, Ste. 109
Hauppague, NY 11788
The minimum initial investment in the Fund is $1,000. Retirement and UGMA
(Uniform Gifts to Minors Act) accounts, as well as accounts established with
automatic investment plans, however, may initially invest a minimum of $500.
Subject to acceptance by the Fund, payment for the purchase of shares received
by mail will be credited to a shareholder's account at the net asset value per
share of the Fund next determined after receipt. Your purchase of shares of
the Fund will be effected at the next share price calculated after receipt of
your investment.
Initial Investments by Wire
Subject to acceptance by the Fund, shares of the Fund may be purchased by
wiring immediately available federal funds (subject to the Fund's minimum
investment) to the Fund's custodian, Star Bank (the "Custodian")
(see instructions below). The minimum initial investment in the Fund
is $1,000. Retirement and UGMA Uniform Gifts to Minors Act) accounts,
as well as accounts established with automatic investment plans, however,
may initially invest a minimum of $500.
In order to wire funds, you must first call the Fund's transfer agent,
American Data Services, Inc. (the "Transfer Agent"), at 888-532-7862 to
set up your account and obtain an account number. You should be prepared to
provide the information on the application to the Transfer Agent. Then, you
should provide your bank with the following information for purposes of wiring
your investment:
Star Bank, N.A. Cinti/Trust
ABA #0420-0001-3
Ref: Daruma Mid-Cap Value Fund
DDA# 485776538
Shareholder Account Number:
Account Name:
You are required to mail a signed application to the American Data Services,
Inc.150 Motor Parkway, Ste. 109, Hauppage, NY 11788 in order to complete your
initial wire purchase. Wire orders will be accepted only on a day which the
Fund and the Custodian and Transfer Agent are open for business. A wire
purchase will not be considered made until the wired money is received and
the purchase is accepted by the Fund. Any delays which may occur in wiring
money, including delays which may occur in processing by the banks, are not
the responsibility of the Fund or the Transfer Agent. There is presently
no fee for the receipt of wired funds, but the right to charge shareholders
for this service is reserved by the Fund.
Additional Investments
Additional investments may be made at any time subject to the Fund's minimum
subsequent investment of $100, by mailing a check to the Fund at the address
noted under "Initial Investments by Mail" (payable to Daruma Mid-Cap Value
Fund) or by wiring monies to the Custodian using the instructions outlined
above (Initial Investments by Wire).
Additional investments may also be made by the Automatic Investment Plan which
allows you to make
regular, automatic transfers ($50 minimum) from your bank account to purchase
shares in your Daruma Fund account on the monthly or quarterly schedule you
select. For more information on the Automatic Investment Plan please call
the Fund at 800-435-5076.
The purchase price paid for shares of the Fund is the current public offering
price, that is, the next determined net asset value of the shares after the
order is placed. See "Net Asset Value" herein. The Fund reserves the right
to reject any subscription for shares.
The Fund must receive an order and payment by the close of business for the
purchase to be effective and dividends to be earned on the same day. If
funds are received after the close of business, the purchase will become
effective and dividends will be earned on the next business day. Purchases
made by check will be invested and begin earning income
on the next business day after the check is received.
The Fund will not cancel any trade (purchase or redemption) believed to be
authentic once the trade has been received. If your check or wire does not
clear your transaction will be canceled and you will be responsible for any
loss the Fund incurs. If you are already a shareholder, the Fund can redeem
shares from any identically registered account in the Fund as reimbursement
for any loss incurred.
Shares of the Fund may also be sold to corporations or other institutions
such as trusts, foundations or broker-dealers purchasing for the accounts
of others ("Shareholder Organizations"). Investors purchasing and redeeming
shares of the Fund through a Shareholder Organization may be charged a
transaction-based fee or other fee for the services of such organization.
Each Shareholder Organization is responsible for transmitting to its
customers a schedule of any such fees and information regarding any
additional or different conditions regarding purchases and redemptions.
Customers of Shareholder Organizations should read this Prospectus in light
of the terms governing accounts with their organization. The Fund does not
pay to or receive compensation from Shareholder Organizations for the sale
of the Fund's shares.
Retirement Plans
The Fund offers a wide range of plans for individuals and institutions,
including large and small businesses: IRAs, SEP-IRAs and Keoghs (profit
sharing, money purchase pension). For information on IRAs and all other
retirement plans, please call the Fund at (800) 435-5076.
REDEMPTION OF SHARES
The Fund allows you to redeem shares without redemption fees. You may redeem
any portion of your account at any time. Shares of the Fund may be redeemed
by mail, or, if authorized, by telephone. The value of shares redeemed may
be more or less than the purchase price, depending on the market value of the
investment securities held by the Fund.
By Mail. The Fund will redeem its shares at the net asset value next determined
after the request is received if all the required documentation is received in
"good order". The net asset value per share of the Fund is determined as of
4:15 p.m., New York time, on each day that the New York Stock Exchange (the
"NYSE") and the Fund are open for business. Requests should be addressed
to Daruma Mid-Cap Value Fund c/o American Data Services, 150 Motor Parkway,
Suite 109, Hauppauge, NY 11788.
Requests in "good order" must include the following information and
documentation:
(1) The account number and fund name;
(2) The amount of the transaction (specified in dollars or shares);
(3) Signatures of all owners EXACTLY as they are registered on the
account;
(4)Any certificates that you hold for the account; any required
signature guarantees (see "Signature Guarantees" below); and
(5)Other supporting legal documents, if required, in the case of estates,
trusts,guardianships, custodianships, corporations, pension and profit
sharing plans and other organizations.
If you are not certain of the requirements for a redemption, please call
Shareholder Services at (888) 532-7862. Redemptions specifying a certain date
or share price cannot be accepted and will be returned.
Signature Guarantees
To protect shareholder accounts, the Fund and its transfer agent from fraud,
signature guarantees are required to enable the Fund to verify the identity
of the person who has authorized a redemption from an account. Signature
guarantees are required for (1) redemptions where the proceeds are to be
sent to someone other than the registered shareholder(s) and the registered
address, and (2) share transfer requests. Signature guarantees may be
obtained from certain eligible financial institutions, including but not
limited to, the following: banks, trust companies, credit unions,
securities brokers and dealers, savings and loan associations and
participants in the Securities Transfer Association Medallion Program
("STAMP"), the Stock Exchange Medallion Program ("SEMP") or the New York
Stock Exchange Medallion Signature Program ("MSP"). Shareholders may
contact Shareholder Services at (888) 532-7862 for further details.
By Telephone
Shareholders, who have elected on their application form telephone redemption
privileges,may redeem by telephone provided the proceeds are mailed to their
address of record. To redeem shares by telephone, you or your preauthorized
representative may call shareholder services at (888) 532-7862. Redemption
requests received by telephone by 4:15 p.m. eastern time are processed on the
day of receipt; redemption requests received by telephone after 4:15 p.m.
eastern time are processed on the business day following receipt. TELEPHONE
REDEMPTIONS WILL NOT BE PERMITTED FOR A PERIOD OF SIXTY DAYS AFTER A CHANGE
IN THE ADDRESS OF RECORD. The Fund has authorized the Transfer Agent
to act on telephone instructions from any person representing himself or
herself to be a shareholder and reasonably believed by the Transfer Agent
to be genuine. The Fund and the Transfer Agent will employ reasonable
procedures to confirm that instructions communicated are genuine and, if
it does not, the Fund or the Transfer Agent may be liable for any losses
due to unauthorized or fraudulent instructions.
The procedures employed by the Fund in connection with transactions
initiated by telephone include tape recording of telephone instructions
and requiring some form of personal identification prior to acting upon
instructions received by telephone.
Neither the Fund nor the Transfer Agent will be liable for following
telephone instructions reasonably believed to be genuine. The Fund
reserves the right to revise or terminate the telephone redemption
privilege at any time. If you have trouble making a telephone
redemption during periods of drastic economic or market changes, your
redemption request may be made by regular or express mail. It will be
implemented at the net asset value next determined after your request has
been received by our transfer agent in Good Order.
Further Redemption Information
Redemption proceeds for shares of the Fund recently purchased by check may
not be distributed until payment for the purchase has been collected, which
may take up to fifteen business days from the purchase date. Shareholders
can avoid this delay by utilizing the wire purchase option.
Other than as described above, payment of the redemption proceeds will be made
within five days after receipt of an order for a redemption. The Fund may
suspend the right of redemption or postpone the date at times when the NYSE
or the bond market is closed or under any emergency circumstances as
determined by the United States Securities and Exchange Commission
(the "SEC").If the Board of Directors determines that it would be
detrimental to the best interests of the remaining shareholders of the Fund
to make a payment wholly or partly in cash, the Fund may pay the redemption
proceeds in whole or in part by a distribution in-kind of readily marketable
securities held by the Fund in lieu of cash in conformity with applicable
rules of the SEC. Investors generally will incur brokerage charges on the
sale of portfolio securities so received in payment of redemptions.
DIVIDENDS AND DISTRIBUTIONS
The Fund intends to pay dividends from net investment income annually in
December. The Fund also intends to distribute its net realized capital
gains, if any, in December. Dividends and distributions will be
automatically reinvested in additional shares of the Fund unless the
shareholder chooses otherwise. Dividends and distributions may be made
on a more frequent basis to comply with the distribution requirement
of the Internal Revenue Code.
Choosing A Distribution Option
Distribution of dividends from the Fund may be made in accordance with several
options. A shareholder may select one of two distribution options:
1. Automatic Reinvestment Option. Both dividends and capital gains
distributions will be automatically reinvested in additional shares
of the Fund unless the investor has elected the all cash option.
2. All Cash Option. Both dividend and capital gains distributions will be
paid in cash.
TAXES
The Fund intends to qualify under the Internal Revenue Code of 1986, as amended,
as a regulated investment company. As a regulated investment company, the Fund
will not be subject to federal income taxes on the investment company taxable
income and long-term capital gains that it distributes to its investors,
provided that at least 90% of its investment company taxable income for the
taxable year is distributed. Shareholders will receive information annually
as to the tax status of distributions made by the Fund for the calendar year.
Distributions are paid from a Fund's net investment income and short-term
capital gains are taxable to shareholders as ordinary income dividends.
A portion of the Fund's dividend may qualify for the corporate dividends-
received deduction, subject to certain limitations. The portion of a Fund's
dividends qualifying for such deduction is generally limited to the aggregate
taxable dividends received by the Fund from domestic corporations.
Distributions paid from long-term capital gains of a Fund are treated by a
shareholder for Federal income tax purposes as long-term capital gains,
regardless of how long a shareholder has held Fund shares. The Taxpayer
Relief Act of 1997 (the "Act"), enacted in August 1997, dramatically changes
the taxation of net capital gains by applying different rates thereto,
depending on the taxpayers holding period and marginal rate of
federal income tax. The Act, however, does not address the
application of these rules to distributions by regulated investment
companies and instead authorizes the issuance of regulations to do so.
Accordingly, shareholders should consult their tax advisers as to the
effect of the Act on distributions by the Fund to them of net capital gains.
The redemption of shares is a taxable event, and a shareholder may realize a
capital gain orcapital loss. The Fund will report to redeeming shareholders
the proceeds of the redemptions. However, because the tax consequences of a
redemption will also depend on the shareholder's basis in the redeemed
shares for tax purposes, shareholders should retain their account statements
for use in determining their tax liability on a redemption.
At the time of the shareholder's purchase, the Fund's net asset value may
reflect undistributed income or capital gains. A subsequent distribution of
these amounts by the Fund will be taxable to the shareholder even though
the distribution economically is a return of part of the shareholder's
investment.
Keep in mind that if you purchase shares in the Fund shortly before the record
date for a dividend or capital gains distribution, regardless of whether you are
investing your distributions or receiving them in cash, you will be assessed
taxes on the amount of the capital gain and/or dividend distribution later paid
even though you owned the Fund shares for just a short period of time. While
the total value of your investment will be the same after the distribution
- -- the amount of the distribution will offset the drop in the net asset value
of the shares -- you should be aware of the tax implications the timing of
your purchase may have. Prospective investors should, therefore, inquire
about potential distributions before investing.
The Fund is required to withhold 31% of taxable dividends, capital gain
distributions and redemptions that are paid to non-corporate shareholders
who have not complied with Internal Revenue Service taxpayer identification
regulations. Shareholders may avoid the withholding requirement by certifying
on the Account Application Form their proper Social Security or Taxpayer
Identification Number and certifying that they are not subject to backup
withholding.
NET ASSET VALUE
Purchases and redemptions are made at net asset value. The Transfer Agent
determines net asset value per share as of the close of regular trading on
the NYSE, on each day the NYSE is open for trading. Net asset value is
determined by dividing the total assets of the Fund, less all liabilities,
by the total number of shares outstanding.
Market values for securities listed on an exchange are based upon the latest
quoted sales prices as of 4:00 p.m. eastern time, on the valuation date.
Securities not traded on the valuation date are valued at the mean of the
latest quoted bid and asked prices. Securities not listed on an exchange
are valued at the latest quoted bid price. Temporary cash investments and
debt obligations with 60 days or less remaining to maturity are valued at
cost, unless the Board of Directors determines that this does not represent
fair value. All prices of listed securities are taken from the exchange
where the security is primarily traded. Securities may be valued on the
basis of prices provided by a pricing service when such prices are believed
to reflect the fair market value of such securities.
Securities for which market quotations are not readily available or which are
restricted as to sale, and other assets are valued by such methods the Board
of Director deems in good faith to reflect fair value.
The Transfer Agent computes the Fund's net asset value once daily on Monday
throughFriday, at 4:15 p.m. New York time, except on the holidays listed
under "Net Asset Value" in the Statement of Additional Information.
FUND PERFORMANCE
From time to time, the Fund may include in communications to current or
prospective shareholders figures reflecting total return over various time
periods. "Total return" is the rate of return on an amount invested in
a Fund from the beginning to the end of the stated period. "Average annual
total return" is the annual compounded percentage change in the value of an
amount invested in a Fund from the beginning until the end of the stated
period. Total returns are historical measures of past performance and are not
intended to indicate future performance. Total returns assume the reinvestment
of all dividends and capital gains distributions.
The Fund may compare its performance with performance rankings compiled by
independent organizations and publications that monitor the performance of
mutual funds (such as Lipper Analytical Services, Inc., Morningstar, Inc.,
or Barron's).
Performance information may be quoted numerically or may be presented in a
table, graph or other illustration. In addition, Fund performance may be
compared to well-known indices of market performance including the Standard
& Poor's ("S&P") 500 Index, S&P MidCap Index and the Russell 2000.
DESCRIPTION OF COMMON STOCK
The Fund was incorporated in the State of Maryland on May 13, 1996, and began
operationson August 16, 1996. The authorized capital stock of the Fund
consists of one billion sharesof stock having a par value of one-tenth of
one cent ($0.001) per share. The Company's Board of Directors is authorized
to divide the unissued shares into separate series of stock, each series
representing a separate, additional investment portfolio. The Board
currently has authorized the division of the unissued shares into one series.
Shares of any series or class will have identical voting rights, except
where, by law, certain issues must be approved by a majority of the shares
of the affected series or class. Each share of any series or class of
shares when issued will have equal dividend, distribution, liquidation and
voting rights for which it will be issued and each fractional share will
have those rights in proportion to the percentage that the fractional share
represents of a whole share. Shares will be voted in the aggregate. All
shares, when issued in accordance with the terms of the offering, will be
fully paid and non-assessable. Shares are redeemable at net asset value,
at the option of the investor. On July 24 , 1996, certain persons
purchased 10,189 shares of the Fund at an initial purchase price of
$10.00 per share.
The shares of the Fund have non-cumulative voting rights, which means that
the holders of more than 50% of the shares outstanding voting for the election
of directors can elect 100% of the directors if the holders choose to do so, and
, in that event, the holders of the remaining shares will not be able to elect
any person or persons to the Board of Directors. Unless specifically requested
by an investor who is an investor of record, the Fund does not issue
certificates evidencing Fund shares.
Annual meetings of shareholders will not be held except as required by the
Investment Company Act of 1940 and other applicable law . An annual
meeting will be held to vote on the removal of a Director or Directors
of the Company if requested in writing by the holders of shares entitled
to cast not less than 10% of all the votes entitled to be cast at such
meeting. Special meetings may be called for purposes such as electing
and removing Directors, changing fundamental investment policies or
approving an investment management contract. If a meeting is held and
you cannot attend, you can vote by proxy. Before the meeting, the Fund
will send you proxy materialsthat explain the issues to be decided and
include a voting card for you to mail back.
SHAREHOLDER INFORMATION
General information about the Fund may be requested in writing to the
shareholder servicing department of the Fund, 60 East 42nd Street, Ste. 1112,
New York, New York 10165 or by calling the Fund at (212) 687-1233
or (800) 435-5076.
CUSTODIAN, TRANSFER AND DIVIDEND AGENT
Star Bank, N.A. of Cincinnati, Ohio, serves as custodian for the Fund's cash
and securities. The Custodian does not assist in, and is not responsible
for, investment decisions involving assets of the Fund. American Data
Services, Inc., Hauppague, New York, is the Fund's transfer agent , and
dividend and disbursing agent.
COUNSEL AND INDEPENDENT AUDITORS
Legal matters in connection with the issuance of shares of common stock of the
Fund are passed upon by Battle Fowler LLP, 75 East 55th Street, New York, New
York 10022. Ernst & Young LLP, independent auditors, has been selected as
auditors for the Fund.
DARUMA MID-CAP VALUE FUND
Statement of Additional Information
This Statement of Additional Information sets forth information which may be
of interest to investors but which is not necessarily included in the Fund's
Prospectus, dated December 22, 1997 (the "Prospectus"). This Statement of
Additional Information is not a prospectus and should be read in conjunction
with the Prospectus, a copy of which may be obtained without charge by
writing to the Fund at 60 East 42nd Street, Suite 1112, New York, New York
10165, or by calling Shareholder Services at (800) 435-5076.
Investment Adviser
CastleRock Capital Management, Inc.
Custodian Transfer Agent
Star Bank, N.A. American Data Services, Inc.
December 22, 1997
TABLE OF CONTENTS
PAGE
THE FUND 2
INVESTMENT OBJECTIVE, POLICES AND RESTRICTIONS 2
RISK FACTORS AND SPECIAL CONSIDERATIONS 4
MANAGEMENT OF THE FUND 8
INVESTMENT ADVISOR 11
PORTFOLIO TRANSACTIONS 13
PRICING OF SHARES 13
REDEMPTIONS IN KIND 14
TAXATION 14
DESCRIPTION OF THE FUND 16
PERFORMANCE DATA 17
CUSTODIAN AND TRANSFER AND DIVIDEND AGENT 21
COUNSEL AND INDEPENDENT ACCOUNTANTS 21
THE FUND
Daruma Mid-Cap Value Fund (the "Fund"), is a no-load diversified, open-end,
investment company, and a series of The Daruma Funds, Inc. which was
incorporated under Maryland law on May 13, 1996. This Fund is designed
for long-term investors who understand and are willing to accept the risk
of loss involved in seeking long-term capital appreciation. The Fund
should not be used as a trading vehicle. CastleRock Capital Management Inc.
("CastleRock"), manages the investments of the Fund from day-to-day in
accordance with the Fund's investment objective and policies.
INVESTMENT OBJECTIVE, POLICIES AND RESTRICTIONS
A detailed description of the types and quality of the securities in which
the Fund may invest is given in the Prospectus and is incorporated herein by
reference. The investment objective is fundamental and may be changed only
with the approval of a "majority of the outstanding voting securities"
(as defined in the Investment Company Act of 1940) of the Fund. There can
be no assurance that the Fund's investment objective will be achieved.
The Fund's investment objective is to seek long-term capital appreciation by
investing primarily in the common stocks of medium capitalization U.S.
companies. Current income is incidental to the Fund's investment objective.
The Fund is designed for long-term investors who understand and are
willing to accept the risk of loss involved in investing in a mutual fund
seeking long-term capital appreciation. Investors should consider their
investment goals, their time horizon for achieving them, and their
tolerance for risks before investing in the Fund.
CastleRock believes that the Fund is suitable for investment only by persons
who can invest without concern for current income and who are in a financial
position to assume above-average investment risks in search for long-term
capital appreciation.
CastleRock believes that original research drives performance. CastleRock
invests for its clients in companies that are about to undergo significant
positive changes in earnings growth, and whose valuations do not yet reflect
those changes. CastleRock attempts to identify those mid-cap companies who
meet these investment criteria by conducting its own thorough and original
research.
The Fund will concentrate its portfolio in companies whose market cap ranges
from $750 million to $5 billion, across a wide array of industry sectors.
CastleRock's overall stock selection for the Fund is not based on the
capitalization or size of the company but rather on an assessment of the
company's fundamental prospects.
The Fund will normally consist of a portfolio normally made up of
approximately 35 securities representing CastleRock's best ideas,
diversified among a broad range of industries which are considered to be
companies with the most compelling risk/reward profiles. As such, the
Fund is not an appropriate investment for individuals who are not long-
term investors and who, as their primary objective, require safety of
principal or stable income from their investments.
The Fund may not, as a matter of fundamental policy:
(1)Issue any senior securities except insofar as the Fund may be deemed to
have issued a senior security in connection with any permitted borrowing.
(2)Purchase securities on margin or write call options on its portfolio
securities; or purchase securities while borrowings exceed 15% of its total
assets.
(3)Sell securities short except to sell securities "short against the box";
(4)Borrow money, except from banks for temporary and/or extraordinary
purposes in an amount not to exceed one-third of the value of the Fund's total
assets less its liabilities (total net assets).
(5)Underwrite the securities of other issuers, except insofar as the Fund may
be deemed an underwriter under the Securities Act of 1933 in disposing of a
portfolio security.
(6)Invest more than an aggregate of 15% of its total assets in repurchase
agreements maturing in more than seven days, variable rate demand
instruments exercisable in more than seven days or securities that are not
readily marketable.
(7)Purchase or sell real estate, real estate investment trust securities,
commodities or commodity contracts, or oil and gas interests, but this
shall not prevent the Fund from investing in Government obligations secured
by real estate or an interest in real estate.
(8)Make loans to others, except through the purchase of portfolio investments,
including repurchase agreements, as described under "Risk Factors and Special
Considerations".(9) Invest more than 25% of its assets in the securities of
"issuers" in any single industry and provided also that there shall be no
limitation on the Fund to purchase obligations issued or guaranteed by the
United States government, its agencies or instrumentalities.
When the assets and revenues of an agency, authority, instrumentality or
other political subdivision are separate from those of the government
creating the issuing entity and a security is backed only by the assets
and revenues of the entity, the entity would be deemed to be the sole
issuer of the security. Similarly, in the case of an industrial revenue
bond, if that bond is backed only by the assets and revenues of the non-
governmental issuer, then such non-governmental issuer would be deemed to be
the sole issuer. If, however, in either case, the creating government
guarantees a security, such a guarantee would be considered a separate
security and would be treated as an issue of such government.
(10)Invest more than 25% of the value of its total assets in the securities
of other investment companies (open or closed-end) and up to 5% of its total
assets in the securities of any one other investment company. All such
securities must be acquired by the Fund in the open market, in transactions
involving no commissions or discounts to a sponsor or dealer (other than
customary brokerage commissions). The issuers of such securities acquired
by the Fund are not required to redeem them in an amount exceeding 1% of
such issuers' total outstanding securities during any period of less than 30
days, and the Fund will vote all proxies with respect to such securities in
the same proportion as the vote of all other holders of such securities.
(11)Invest in companies for the purpose of exercising control of management.
(12)Own more than 10% of the outstanding voting securities of any one issuer;
(13) With respect to 75% of its assets, invest more than 5% of its assets in
the securities of any one issuer, excluding obligations of the U.S.
Government. (14)Mortgage, pledge or hypothecate any assets except that
the Fund may pledge not more than one-third of its total assets to secure
borrowings. However, although not a fundamental policy of the Fund, as a
matter of operating policy in order to comply with certain state statutes,
the Fund will not pledge its assets in excess of an amount equal to 15% of
total assets.
Percentage Restrictions
Any investment restrictions herein which involve a maximum percentage
of securities or assets shall not be considered to be violated unless an
excess over the percentage occurs immediately after, and is caused by, an
acquisition or disposition of securities or assets of, or borrowings by,
the Fund.
RISK FACTORS AND SPECIAL CONSIDERATIONS
Fund's Rights as Stockholder
As noted above, the Fund may not invest in a company for the purpose of
exercising control or management. However, the Fund may exercise its rights
as a stockholder and communicate its views on important matters of policy to a
company's management, the board of directors and/or stockholders if CastleRock
or the Board of Directors determine that such matters could have a significant
effect on the value of the Fund's investment in the company. The activities
that the Fund may engage in, either individually or in conjunction with others,
may include, among others, supporting or opposing proposed changes in a
company's corporate structure or business activities; seeking changes in a
company's board of directors or management; seeking changes in a company's
direction or policies; seeking the sale or reorganization of a company or a
portion of its assets; or supporting or opposing third party takeover attempts.
This area of corporate activity is increasingly prone to litigation, and
therefore it is possible but not likely that the Fund could be involved in
lawsuits related to such activities. CastleRock will monitor such
activities with a view to mitigating, to the extent possible, the risk of
litigation against the Fund and the risk of actual
liability if the Fund is involved in litigation. However, no guarantee
can be made that litigation against the Fund will not be undertaken or
liabilities incurred.
The Fund may, at its expense or in conjunction with others, pursue litigation
or otherwise exercise its rights as a security holder to seek to protect the
interests of security holders if CastleRock and the Fund's Board of Directors
determinethis to be in the best interest of the Fund's shareholders.
Foreign Securities
The Fund may invest up to 15% of its assets in certain foreign debt and equity
securities or ADRs. Investment in foreign equity securities, obligations of
foreign issuers and in direct obligations of foreign nations involves
somewhat different investment risks from those of United States domestic
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 domestic companies. There may also be less government
supervision and regulation of foreign securities exchanges, brokers
and listed companies than in the United States. Foreign securities markets
have substantially less volume than domestic securities exchanges and
securities of some foreign companies are less liquid and more volatile
than securities of comparable domestic companies. 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 to the Fund by domestic companies. Additional risks include
future political and economic developments, the possibility that a foreign
jurisdiction might impose or change withholding taxes on income payable with
respect to foreign securities, the possible seizure, nationalization or
expropriation of foreign issuer or foreign deposits and the possible
adoption of foreign governmental restrictions such as exchange controls.
American Depository Receipts (ADRs) are certificates held in trust by a bank
or similar financial institution evidencing ownership of shares of a foreign
- -based issuer. Designed for use in U.S. securities markets, ADRs are
alternatives to the purchase of the underlying foreign securities in their
national markets and currencies. ADR facilities may be established as either
unsponsored or sponsored. While ADRs issued under these two types of
facilities are in some respects similar, there are distinctions between
them relating to the rights and obligations of ADR holders and the
practices of market participants. A depository may establish an unsponsored
facility without participation by (or even necessarily the acquiescence of)
the issuer of the deposited securities, although typically the depository
requests a letter of non-objection from such issuer prior to the establishment
of the facility. Holders of unsponsored ADRs generally bear all the cost of
such facilities. The depository usually charges fees upon the deposit and
withdrawal of the deposited securities, the conversion of dividends
into U.S. dollars, the disposition of non-cash distributions and the
performance of other services. The depository of an unsponsored facility
frequently is under no obligation to distribute shareholder communications
received from the issuer of the deposited securities or to pass through
voting rights to ADR holders in respect of the deposited securities.
Sponsored ADR facilities are created in generally the same manner as
unsponsored facilities, except that the issuer of the deposited securities
enters into a deposit agreement with the depository. The deposit agreement
sets out the rights and responsibilities of the issuer, the depository
and the ADR holders. With sponsored facilities, the issuer of the deposited
securities generally will bear some of the costs relating to the facility
(such as deposit and withdrawal fees). Under the terms of most sponsored
arrangements, depositories agree to distribute notices of shareholder
meetings and voting instructions and to provide shareholder communications
and other information to the ADR holders at the request of the issuer of
the deposited securities.
U.S. Government Obligations
U.S. Government obligations are obligations which are backed by the full
faith and credit of the United States, by the credit of the issuing or
guaranteeing agency or by the agency's right to borrow from the U.S.
Treasury. They include(i) U.S. Treasury Obligations, which differ only in
their interest rates, maturitiesand times of issuance as follows: U.S.
Treasury bills (maturity of one year or less),U.S. Treasury notes (maturity
of one year or ten years), U.S. Treasury bonds (generally maturities of
more than ten years); and (ii) obligations issued or guaranteed by U.S.
Government agencies and instrumentalities that are supported by the full
faith and credit of the United States (such as securities issued by the
Government national Mortgage Association, the Federal Housing Administration,
the Department of Housing and Urban Development, the Export-Import
Bank, the General Services Administration and the Maritime Administration
and certain securities issued by the Farmers' Home Administration and the
Small Business Administration. The maturities of U.S. Government obligations
usually range from three months to thirty years.
Repurchase Agreements
When the Fund purchases securities, it may enter into a repurchase agreement
with the seller wherein the seller agrees, at the time of sale, to repurchase
the security at a mutually agreed upon time and price. The Fund may enter
into repurchase agreements with member banks of the Federal Reserve System
and with broker-dealers who are recognized as primary dealers in the United
States government securities by the Federal Reserve Bank of New York.
Although the securities subject to the repurchase agreement might bear
maturities exceeding one year, settlement for the repurchase would never
be more that 397 days after the Fund's acquisition of the securities and
normally would be within a shorter period of time. The resale price will
be in excess of the purchase price, reflecting an agreed upon market
rate effective for the period of time the Fund's money will be invested
in the security, and will not be related to the coupon rate of the
purchased security. At the time the Fund enters into a repurchase
agreement the value of the underlying security, including accrued interest,
will be equal to or exceed the value of the repurchase agreement and, in
the case of a repurchase agreement exceeding one day, the seller will agree
that the value of the underlying security, including accrued interest, will
at all times be equal to or exceed the value of the repurchase agreement.
The Fund may engage in a repurchase agreement with respect to any security
in which it is authorized to invest, even though the underlying security may
mature in more than one year. The collateral securing the seller's
obligation must be of a credit quality at least equal to the Fund's
investment criteria for securities in which it invests and will be
held by the Custodian or in the Federal Reserve Book Entry System.
For purposes of the Investment Company Act of 1940, a repurchase agreement
is deemed to be a loan from the Fund to the seller subject to the repurchase
agreement and is therefore subject to the Fund's investment restriction
applicable to loans. It is not clear whether a court would consider the
securities purchased by the Fund subject to a repurchase agreement as being
owned by the Fund or as being collateral for a loan by the Fund to the
seller. In the event of the commencement of bankruptcy or insolvency
proceedings with respect to the seller of the securities before repurchase
of the security under a repurchase agreement, the Fund may encounter delay
and incur costs before being able to sell the security. Delays may involve
loss of interest or decline in price of the security. If the court
characterized the transactions as a loan and the Fund has not perfected a
security interest in the security, the Fund may be required to return the
security to the seller's estate and be treated as unsecured creditor of
the seller. As an unsecured creditor, the Fund would be at the risk of
losing some or all of the principal income involved in the transaction.
As with any unsecured debt obligation purchased for the Fund, CastleRock
seeks to minimize the risk of loss thorough repurchase agreements by
analyzing the creditworthiness of the obligor, in this case the seller.
Apart from the risk of bankruptcy or insolvency proceedings, there is
also the risk that the seller may fail to repurchase the security, in
which case the Fund may incur a loss if the proceeds of the sale to a
third party are less than the repurchase price.
However, if the market value of the securities subject to the repurchase
agreement becomes less than the repurchase price (including interest), the
Fund involved will direct the seller of the security to deliver additional
securities so that the market value of all securities subject to the
repurchase agreement will equal or exceed the repurchase price. It is
possible that a Fund will be unsuccessful in seeking to impose on the
seller a contractual obligation to deliver additional securities.
Selling Short Against the Box
The Fund may make short sales of securities "against the box". A short sale
"against the box" is a sale of a security that the Fund either owns an equal
amount of or has the immediate and unconditional right to acquire at no
additional cost. The Fund will make short sales "against the box" as a
form of hedging to offset potential declines in long positions in the same
or similar securities.
MANAGEMENT OF THE FUND
The directors and officers of the Fund and their principal occupations during
the past five years are set forth below. Their titles may have varied during
this period. Unless otherwise indicated, the address of each director and
officer is 60 East 42nd Street Suite 1112, New York, NY 10165.
The following table sets forth certain information as to each
director and officer of the Fund:
Compensation Table
(Estimated for the fiscal year ended June 30, 1997)
Retirement Benefits
Name of Person Aggregate Compensation Accrued as Part of
Position From Fund Fund Expenses
Fred Ali -0- -0-
Director
25542 Novela Way
Valencia, CA 91355
Elizabeth A. Duffy -0- -0-
Director
230 W. 55th Street, #3D
New York, NY 10019
Brian J. Heidtke -0- -0-
Director
Colgate-Palmolive
300 Park Avenue
New York, NY 10022
Mariko Gordon* -0- -0-
President and Director
of the Fund; & President and CEO of
CastleRock
Noreen McKee* -0- -0-
Vice President, Treasurer
and Director of the Fund; &
Vice President & Treasurer
of CastleRock.
*An interested person of the Fund and/or CastleRock within the
meaning of Section 2(a)(19) of the Investment Company Act of
1940 (the "1940 Act")
Fred Ali, 47, Director of the Fund. Executive director of Covenant House
California since February 1991.
Elizabeth A. Duffy, 31, Director of the Fund. Program & Reseach Associate
of The Andrew W. Mellon Foundation since June 1993. From September
1991 to June 1993 she attended and completed the MBA program at Stanford
University Graduate School of Business.
Brian J. Heidtke, 56, Director of the Fund. Vice President, Finance and
Treasurer of Colgate-Palmolive Company since June 1986.
Mariko O. Gordon, 36, President and Director of the Fund, and President and
Chief Investment Officer of CastleRock has over ten years experience in the
investment management business. Prior to co-founding CastleRock in 1995,
Ms. Gordon was an equity owner in and Director of Research at Valenzuela
Capital Management, Inc. ("VCM") a firm specializing in small to mid-cap
stocks with over $1 billion under management. Ms. Gordon's sole responsibility
at VCM was portfolio management. Prior to joining VCM, from 1987 to 1990 she
was the Director of Systematic Research at Royce & Associates, Inc., an
investment firm specializing in small-cap value stocks and adviser to several
mutual funds, including the Pennsylvania Mutual Fund. Ms. Gordon started her
investment career as a research analyst at Manning & Napier Advisors, Inc., a
firm managing $2 billion for ERISA and Taft-Hartley clients. Ms. Gordon is a
Chartered Financial Analyst and a graduate of Princeton University.
Noreen D. McKee, 47, Vice-President and Treasurer of the Fund and of
CastleRock is a certified public accountant and has over 10 years
experience in the investment management business. For one year prior to
joining CastleRock in 1995, she was the Chief Operating Officer at
Valenzuela Capital Management, Inc. At VCM she was responsible for the
financial, administrative and compliance functions of the firm. From 1985 to
1993, she worked as the Controller of Royce & Associates, Inc. ("Royce").
At Royce, her primary responsibilities included the accounting, tax and
managerial functions for six mutual funds and two limited partnerships in
compliance with the Investment Advisors Act and the Investment Company Act
of 1940. Ms. McKee has an M.S. in Accounting from Pace University and a
B.S. in Behavioral Science from York College of Pennsylvania.
Mary B. O'Byrne, 37, Secretary of the Fund and Director of Operations.
Prior to joining the Fund, from 1985 to 1996, Ms. O'Byrne worked at The
Royce Funds ("the funds"), a family of ten mutual funds with over $2 billion
in assets. She was primarily responsible for all Blue Sky registrations and
assisted with SEC filings. In addition, she handled the funds' day-to-day
financial management activities interfacing with the funds' custodian and
transfer agent.Ms. O'Byrne has extensive knowledge and experience in all
aspects of mutual fund administration. In 1980, she received a certificate
in business administration from the College of Further Studies, Cavan,
Ireland.
Each Director who is not an interested person of the Fund receives a base
annual fee of $0.
PRINCIPAL HOLDERS OF SHARES
As of July 24, 1997, the following persons were known to the Fund
to be the beneficial owners of 5% or more of the outstanding shares of
the Fund:
Number Percentage of
Name Shares Outstanding Shares
Wm. F. & Donald Gratz TTEE 23,455 20.25%
Treitel-Gratz Co. Inc. Pft. Sh. Tr.
U/A Dtd 1/1/83
13-01 Queens Plaza South
Long Island City, NY 11101
Anthony D'Ottavio 15,997 13.81%
47 East Maple St.
Dallastown, PA 17313
John W. Baackes 10,431 9.01%
Capital Area Community
Health Plan 403(B)
15 Pateman Circle
Menands, NY 12204
Alec J. Wilkinson TTEE 9,287 8.02%
A.J. Wilkinson Profit Sharing Plan
310 West End Avenue, #5A
New York, NY 10023
Mariko O. Gordon 6,990 6.04%
410 West End Avenue
Apt. 3E
New York, NY 10024
Janis Burenga IRA 5,800 5.01%
Star Bank NA Cust.
4 Sanford Rd.
Stockton, NJ 08559
As of July 24, 1997, all of the directors and officers of the Fund,
collectively, beneficially owned, directly or indirectly (including the power to
vote or to dispose of any shares), approximately 16.2% of the outstanding
shares.
INVESTMENT ADVISER
CastleRock Capital Management Inc., a registered investment adviser, is
a New York corporation, with its principal offices located at 60 East 42nd
Street, Suite 1112, New York, NY 10165. CastleRock has been employed by the
Board
Of Directors to serve as the investment adviser of the Fund pursuant to an
Investment
Advisory Agreement entered into by the Fund. Currently, CastleRock's only
investment
company client is the Fund. CastleRock supervises all aspects of the Fund's
operations
and provides investment advice and portfolio management services to the Fund.
Pursuant to the Advisory Agreement and subject to the supervision of the Fund's
Board
of Directors, CastleRock makes the Fund's day-to-day investment decisions,
arranges
for the execution of portfolio transactions and generally manages the Fund's
investments.
Mariko O. Gordon, President and Chief Investment Officer of CastleRock, is
responsible for supervising the Fund's investment management activities.
CastleRock had assets under management of approximately $54,000,000 at
September 30, 1997.
CastleRock provides persons satisfactory to the Board of Directors of the
Fund to serve as officers of the Fund. Such officers, as well as certain
other employees and directors of the Fund, may be directors, officers or
employees of CastleRock or it affiliates.
CastleRock also may provide the Fund with supervisory personnel who will be
responsible for supervising the performance of administrative services,
accounting and related services, net asset value calculation, reports to
and filings with regulatory authorities, and services relating to such
functions. The personnel rendering such supervisory services may be
employees of CastleRock, of its affiliates or of other organizations.
The Advisory Agreement was approved on July 19, 1996, by the Board of
Directors, including a majority of the directors who are not interested
persons (as defined in the Investment Company Act of 1940) of the Fund or
CastleRock.
The Advisory Agreement has a term which extends to July 31, 1999 and
may be continued thereafter for successive twelve-month periods beginning
each July 31, provided that such continuance is specifically approved
annually by a majority vote of the Fund's outstanding voting securities
or by the Board of Directors, and in either case by a majority of the
directors who are not parties to the Advisory Agreement or interested
persons of any such party, by votes cast in person at a meeting called
for the purpose of voting on such matter.
The Advisory Agreement is terminable without penalty by the Fund on sixty
days' written notice when authorized either by a majority vote of the
outstanding voting shares of the Fund or by a vote of a majority of the
Fund's Board of Directors, or by CastleRock on sixty days' written notice,
and will automatically terminate in the event of its assignment. The
Advisory Agreement provides that in the absence of willful misfeasance,
bad faith or gross negligence on the part of CastleRock, or of reckless
disregard of its obligations thereunder, CastleRock shall not be liable for
any action or failure to act in accordance with its duties thereunder.
Adviser's Fees
Pursuant to the terms of the Advisory Agreement, the Fund will pay a
monthly advisory fee equal to 1% of the first $100 million of the Fund's
average daily net assets; 0.75% of the next $100 million of such net assets;
and 0.50% of the Fund's average daily net assets over $200 million. Any
portion of the advisory fees received by CastleRock may be used by
CastleRock to provide investor and administrative services and for distribution
of Fund Shares. CastleRock may voluntarily waive a portion or all of its fee
or assume certain expenses of the Fund. This would have the effect of lowering
the overall expense ratio of the Fund and of increasing yield to investors.
See "Expense Limitations" below.
Expense Limitations
CastleRock has agreed to reimburse the Fund for its expenses (exclusive of
interest, taxes, brokerage, and extraordinary expenses) which in any year
exceed the limits on investment company expenses prescribed by any state in
which the Fund's shares are qualified for sale or 1.5%. For the purpose of
this obligation to reimburse expenses, the Fund's annual expenses are
estimated and accrued daily, and any appropriate estimated payments are
made to it on a monthly basis. From time to time, CastleRock may
voluntarily assume certain expenses of the Fund. This would have the
effect of lowering the overall expense ratio and of increasing yield to
investors. Subject to the obligations of CastleRock to reimburse the Fund
for its excess expenses as described above, the Fund has, under the Advisory
Agreement, confirmed its obligation for payment of all other expenses,
including without limitation: fees payable to CastleRock, Custodian and
Transfer and Dividend Agent; brokerage and commission expenses; federal,
state or local taxes, including issuance and transfer taxes incurred by or
levied on it; commitment fees, certain insurance premiums and
membership fees and dues in investment company organizations; interest charges
on borrowings; telecommunications expenses; recurring and non-recurring legal
and accounting expenses; costs of organization and maintaining the Fund's
existence as a corporation; compensation, including directors's fees, of any
directors, officers or employees who are not also officers of CastleRock
or its affiliates and costs of other personnel providing administrative and
clerical services; costs of stockholders' services and costs of stockholders
reports, proxy solicitations and corporate meetings, fees and expenses or
registering its shares under the appropriate Federal securities laws and
of qualifying its shares under applicable state securities laws, including
expenses attendant upon the initial registration and qualification of these
shares and attendant upon renewals of, or amendments to, those registrations
and qualifications; and expenses of preparing, printing and delivering
the Prospectus and financial statements to existing shareholders and
of printing shareholder application forms for shareholder accounts.
The Fund may from time-to-time hire its own employees
or contract to have management services performed by third parties,
and the management of the Fund intends to do so whenever it appears
advantageous to the Fund. The Fund's expenses for employees and for
such services are among the expenses subject to the expense limitation
described above.
PORTFOLIO TRANSACTIONS
CastleRock is responsible for selecting the brokers who effect the purchases
and sales of the Fund's portfolio securities. No broker is selected to effect
a securities transaction for the Fund unless such broker is believed by
CastleRock to be capable of obtaining the best price and execution for
the security involved in the transaction. In addition to considering a
broker's execution capability, CastleRock generally considers the brokerage
and research services which the broker has provided to it, including any
research relating to the security involved in the transaction and/or to other
securities. Such services may include general economic research, market
and statistical information, industry and technical research, strategy and
company research, and may be written or oral. CastleRock determines
the overall reasonableness of brokerage commissions paid, after considering
the amount another broker might have charged for effecting the transaction
and the value placed by CastleRock upon the brokerage and/or research
services provided by such broker, viewed in terms of either that particular
transaction or CastleRock's overall responsibilities with respect to its
accounts.
CastleRock is authorized, under Section 28(e) of the Securities
Exchange Act of 1934 and under its Investment Advisory Agreement with
the Fund, to pay a brokerage commission in excess of that which another
broker might have charged for effecting the same transaction, in recognition
of the value of brokerage and research services provided by the broker.
Brokerage and research services furnished by brokers through whom
the Fund effects securities transactions may be used by CastleRock in
servicing all of its accounts and not all of such services may be used
by CastleRock in connection with the Fund.
Even though investment decisions for the Fund are made
independently from those for other accounts managed by CastleRock, the
same security is frequently purchased, held or sold by the Fund and the other
accounts because such security may be suitable for all of them. When the Fund
and such other accounts are simultaneously engaged in the purchase or sale of
the same security, CastleRock seeks to average the transactions as to price and
allocate them as to amount in a manner believed to be equitable to each. In
some cases, this procedure may adversely affect the price paid or received by
the Fund or the size of the position obtainable for the Fund.
PRICING OF SHARES
The purchase and redemption price of the Fund's shares is based on its
current net asset value per share. See "Net Asset Value Per Share" in the
Fund's prospectus.
As set forth under "Net Asset Value Per Share", the Fund's custodian
determines the net asset value per share of the Fund at the close of regular
trading on the New York Stock Exchange (the "Exchange") on each day that the
Exchange is open. The Exchange is open on all weekdays which are not holidays
. Thus, it is closed on Saturdays and Sundays and on New Year's Day,
Washington's Birthday, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving and Christmas.
REDEMPTIONS IN KIND
It is possible that conditions may arise in the future which would, in the
judgement of the Fund's Board of Directors or management, make it undesirable
for the Fund to pay for all redemptions in cash. In such cases, payment may
be made in portfolio securities or other property of the Fund. However, the
Fund has obligated itself under the Investment Company Act of 1940 to redeem
for cash all shares presented for redemption by any one shareholder up to
$250,000 (or 1% of the Fund's net assets if that is less) in any 90-day
period. Securities delivered in payment of redemptions would be valued at
the same value assigned to them in computing the net asset value per share
for purposes of such redemption. Shareholders receiving such securities
would incur brokerage costs when securities are sold.
TAXATION
The Fund will elect to qualify under the Internal Revenue Code of 1986,
as amended ("the Code"), as a regulated investment company. As a regulated
investment company, the Fund will not be subject to federal income taxes
on its investment company taxable income and the long-term capital gains
that it distributes to its shareholders, provided that at least 90% of its
investmentcompany taxable income for the taxable year is distributed, and
numerous other requirements concerning regulated investment companies are
satisfied. The Fund's policy is to distribute as dividends each year 100%
(and in no event less than 90%) of its investment company taxable income.
The Fund will be treated as a separate corporation and generally will have
to comply with the qualifications and other requirements applicable to
regulated investment companies. If for any taxable year the Fund does not
qualify as a regulated investment company, all of its taxable income would
be taxable at corporate rates and no distributions would qualify as tax
exempt.
The Fund has adopted a policy of declaring dividends annually
in an amount based on its net investment income. The amount of each
dividend may differ from actual net investment income calculated in
accordance with federal income tax purposes. Dividends paid from
taxable income, if any, and distributions of any realized short-term
capital gains are taxable to shareholders as ordinary income, whether
received in cash or reinvested in additional shares of the Fund.
Distributions of new realized capital gains after utilization of capital
loss carryforwards, if any, are made annually to meet applicable
distribution and excise tax requirements.
The Fund may be subject to state or local tax in jurisdictions in which the
Fund is organized or may be deemed to be doing business. However, Maryland
taxes regulated investment companies in a manner that is generally similar
to the federal income tax rules described herein.
Distributions may be subject to state and local income taxes. In addition,
he treatment of the Fund and its shareholders in those states that have
income tax laws might differ from their treatments under the federal income
tax laws.
The Code imposes a nondeductible 4% excise tax on the Fund
unless it meets certain requirements with respect to distributions of ordinary
income and capital gain net income. The formula requires payment to
shareholders during a calendar year of distributions representing at least
98% of the Fund's ordinary income for the calendar year, plus at least 98%
of the excess of its capital gains over its capital losses realized during
the one-year period ending October 31 during such year, which shall be
reduced but not below net capital gain) by the amount of the Fund's net
ordinary loss for the year. It is anticipated that this provision will
not have any material impact on the Fund.
Dividends and interest paid by foreign issuers may be subject to withholding
and other foreign taxes, which may decrease the net return on foreign
investmentsas compared to dividends and interest paid by domestic issuers.
The Fund does not expect that it will qualify to elect to pass through to
its shareholders the rights to take a foreign tax credit for foreign taxes
withheld from dividends and interest payments.
For federal income tax purposes, distributions of net capital gains
(the excess of net long-term capital gains over net short-term capital loss),
if any, are taxable as long-term capital gains regardless of the length of time
shareholders have owned their shares. The Taxpayer Relief Act of 1997
(the "Act"), enacted in August 1997, dramatically changes the taxation
of new capital gains by applying different rates thereto depending on
the taxpayer's holding period and marginal rate of federal income tax.
The Act, however, does not address the application of these rules to
distributions by regulated investment companies and instead authorizes
the issuance of regulations to do so. Accordingly, shareholders
should consult their tax advisers as to the effect of the Act on distributions
by the Fund to them of net capital gains.
Back-up Withholding/Withholding Tax
Under the Code, certain non-corporate shareholders may be
subject to 31% withholding on reportable dividends, capital gains distributions
and redemption payments ("back-up withholding"). Generally, shareholders
subject to back-up withholding will be those for whom a taxpayer identification
number and certain required certifications are not on file with the Fund or who,
to the Fund's knowledge, have furnished an incorrect number. In addition, the
Fund is required to withhold from distributions to any shareholder who does
not certify to the Fund that such shareholder is not subject to back-up
withholding due to notification by the Internal Revenue Service that such
shareholder has under-reported interest or dividend income. When
establishing any account, an investor must certify under penalties of
perjury that such investor's taxpayer identification number is correct
and that such investor is not subject to or is exempt from back-up
withholding.
Ordinary income distributions paid to shareholders who are non-resident
aliens or which are foreign entities will be subject to 30% United States
withholding tax unless a reduced rate of withholding or a withholding
exemption is provided under an applicable treaty. Non-U.S. shareholders
are urged to consult their own tax advisers concerning the United States
tax consequences to them of investing in the Fund.
Timing of Purchases and Distributions
At the time of an investor's purchase, the Fund's net asset value may
reflect undistributed income or capital gains or net unrealized appreciation of
securities held by the Fund. A subsequent distribution to the investor of such
amounts, although it may in effect constitute a return of her or its investment
in an economic sense, would be taxable to the shareholder as ordinary income
or capital gain as described above. Investors should carefully consider the
tax consequences of purchasing Fund shares just prior to a distribution, as
they will receive a distribution that is taxable to them.
Sale or Redemptions of Shares
Gain or loss recognized by a shareholder upon the sale, redemption
or other taxable disposition of shares in the Fund (provided that such shares
are held by the shareholder as a capital asset) will be treated as capital
gain orloss, measured by the difference between the adjusted basis of the
shares and the amount realized on the sale, redemption or other taxable
disposition. Such gain or loss will be long-term capital gain or loss if
the shares disposed of were held for more than one year. Wash sale losses
will be disallowed. A wash sale loss occurs when the shares disposed of
are replaced (including by receiving shares upon the reinvestment of
distributions) within a period of 61 days, beginning 30 days before
and ending 30 days after the sale of the shares. In such a case, the
basis of the shares acquired will be increased to reflect the disallowed
loss. A loss recognized upon the sale, redemption or other taxable
disposition of shares held for 6 months or less will be treated as a
long-term capital loss to the extent of any long-term capital gain
distributions received with respect to such shares.
The foregoing relates to Federal income taxation. Distributions, as well
as any gains from a sale, redemption or other taxable disposition of Fund
shares, also may be subject to state and local taxes. Under current law,
so long as the Fund qualifies for Federal income tax treatment described
above, it is believed that the Fund will not be liable for any income or
franchise tax imposed by Maryland.
Investors are urged to consult their own tax advisers regarding
the application to them of Federal, state and local tax laws.
DESCRIPTION OF THE FUND
The Fund was incorporated in the State of Maryland on May 13,
1996. The authorized capital stock of the Fund consists of one billion shares
of stock having a par value of $.001 per share. The Fund's Board of Directors
is authorized to divide the unissued shares into separate classes and series
of stock, each series representing a separate, additional investment
portfolio. The Board currently has authorized the division of the unissued
shares into one series. Shares of any class or series will have identical
voting rights, except where, by law, certain matters must be approved by a
majority of the shares of the affected class or series. Each share of any
class or series of shares when issued has equal dividend, distribution,
liquidation and voting rights within the class or series for which it was
issued, and each fractional share has those rights in proportion to the
percentage that the fractional share represents a whole share.
Shares will be voted in the aggregate. There are no conversion or preemptive
rights in connection with any shares of the Fund. All shares, when issued in
accordance with the terms of the offering, will be fully paid and non-assessable
. Shares are redeemable at net asset value, at the option of the investor.
The shares of the Fund have non-cumulative voting rights, which means
that the holders of more than 50% of the shares outstanding voting for the
election of directors can elect 100% of the directors if the holders choose
to do so, and, in that event, the holders of the remaining shares will not
be able to elect any person or persons to the Board of Directors. Unless
specifically requested by an investor who is an investor of record, the Fund
does not issue certificates evidencing Fund shares.
As a general matter, the Fund will not hold annual or other meetings of the
Fund's shareholders. This is because the By-laws of the Fund provide for
annual meetings only (a) for the election of directors, (b) for approval of
revisions to the Fund's investment advisory agreement, and (c) upon the
written request of holders of shares entitled to cast not less than twenty-
five percent of all the votes entitled to be cast at such meeting. Annual
and other meetings may be required with respect to such additional matters
relating to the Fund as may be required by the Investment Company Act of
1940 (the "Act") including the removal of Fund directors and communication
among shareholders, any registration of the Fund with the Securities and
Exchange Commission or any state, or as the Directors may consider necessary
or desirable. Each Director serves until the next meeting of shareholders
called for the purpose of considering the election or reelection of such
Director or of a successor to such Director, and until the election and
qualification of his or her successor, elected at such meeting, or until
such Director sooner dies, resigns, retires or is removed by the vote of
the shareholders.
PERFORMANCE DATA
The Fund's performance may be compared in advertisements to the performance
of other mutual funds in general or to the performance of particular types of
mutual funds, especially those with similar investment objectives. Such
comparisons may be expressed as mutual fund rankings prepared by Lipper
Analytical Services, Inc. ("Lipper"), an independent service that monitors
the performance of registered investment companies. Money market funds and
municipal funds are not included in the Lipper survey. The Lipper
performance analysis ranks funds on the basis of total return, assuming
reinvestment of distributions, but does not take sales charges or
redemption fees payable by shareholders into consideration and is
prepared without regard to tax consequences. The Lipper General Equity
Funds Average can be used to show how the Fund's performance compares
to a broad-based set of equity funds. The Lipper General Equity
Funds Average is an average of the total returns of all equity funds
(excluding international funds and funds that specialize in particular
industries or types of investments) tracked by Lipper.
Ibbotson Associates (Ibbotson) provides historical returns of the capital
markets in the United States. The Fund's performance may be compared to
the long-term performance of the U.S. capital markets in order to demonstrate
general long-term risk versus reward investment scenarios. Performance
comparisons could also include the value of a hypothetical investment in
common stocks, long-term bonds or U.S. Treasury securities. Ibbotson
calculates total returns in the same manner as the Fund.
The capital markets tracked by Ibbotson are common stocks, small
capitalization stocks, long-term corporate bonds, intermediate-term
government bonds, long-term government bonds, U.S. Treasury bills and
the U.S. rate of inflation. These capital markets are based on the returns
of several different indices. For common stocks, the S&P 500 is used.
For small capitalization stocks, return is based on the return achieved by
Dimensional Fund Advisors (DFA) Small Company Fund. This fund
is a market-value-weighted index of the ninth and tenth deciles of the New
York Stock Exchange (NYSE), plus stocks listed on the American Stock Exchange
(AMEX) and over-the-counter (OTC) with the same or less capitalization as
the upper bound of the NYSE ninth decile.
The S&P 500 Composite Stock Price Index is an unmanaged index
of common stocks frequently used as a general measure of stock market
performance. The Index's performance figures reflect changes of market
prices and quarterly reinvestment of all distributions.
The S&P Mid-Cap Index is an unmanaged index of 400 domestic
companies frequently used as a general measure of stock market performance.
The Index's performance figures reflect changes of market prices and quarterly
reinvestment of all distributions.
The Russell 2000, prepared by the Frank Russell Company,
tracks the return of the common stock of the 2,000 smallest out of the
3,000 largest publicly traded U.S.-domiciled companies by market
capitalization. The Russell 2000 tracks the return on these stocks
based on price appreciation or depreciation and includes dividends.
U.S. Treasury bonds are securities backed by the credit
and taxing power of the U.S. government, and, therefore, present
virtually no risk of default. Although such government securities
fluctuate in price, they are highly liquid and may be purchased and
sold with relatively small transaction costs (direct purchase of U.S.
Treasury securities can be made with no transaction costs). Returns
on intermediate-term government bonds are based on a one-bond
portfolio constructed each year, containing a bond that is the shortest
non-callable bond available with a maturity of not less than five years.
This bond is held for the calendar year and returns are recorded.
Returns on long-term government bonds are based on a one-bond
portfolio constructed each year, containing a bond that meets several
criteria, including having a term of approximately 20 years. The
bond is held for the calendar year and returns are recorded. Returns
on U.S. Treasury bills are based on a one-bill portfolio constructed
each month, containing the shortest term bill having not less than
one month to maturity. The total return on the bill is the month-end
price divided by the previous month-end price, minus one. Data up
to 1976 is from the U.S. Government Bond file at the University of
Chicago's Center for Research in Security Prices; the Wall Street
Journal is the source thereafter. Inflation rates are based on the
Consumer Price Index.
From time to time, in reports and promotional literature,
the Fund's performance also may be compared to other mutual
Funds tracked by financial or business publications and periodicals,
such as Kiplinger's, Individual Investor, Money, Forbes, Business
Week, Barron's, The Financial Times, Fortune, Mutual Fund Magazine
and The Wall Street Journal. In addition, financial or business publications
and periodicals as they relate to fund management, investment philosophy
and investment techniques may be quoted.
The Fund's performance may also be compared to those of other
compilations or indices.
Advertising for the Fund may contain examples of the effects of
periodic investment plans, including the principle of dollar cost averaging.
In such a program, an investor invests a fixed dollar amount in a fund at
periodic intervals, thereby purchasing fewer shares when prices are high
and more shares when prices are low. While such a strategy does not
assure a profit or guard against loss in a declining market, the investor's
average cost per share can be lower than if fixed numbers of shares are
purchased at the same intervals. In evaluating such a plan, investors
should consider their ability to continue purchasing shares during
periods of low price levels.
The Fund may be available for purchase through retirement
plans or other programs offering deferral of or exemption from income
axes, which may produce superior after-tax returns over time. For example,
a $1,000 investment earning a taxable return of 10% annually would have
an after-tax value of $2,004 after ten years, assuming tax was deducted from
the return each year at a 28% rate. An equivalent tax-deferred investment
would have an after-tax value of $2,147 after ten years, assuming tax was
deducted at a 28% rate from the tax-deferred earnings at the end of the
ten-year period.
Total Return Calculations
Total return quotes reflect all aspects of the Fund's return,
including the effect of reinvesting dividends and capital gains distributions,
and any change in the Fund's net asset value per share (NAV) over the period.
Average annual total returns are calculated by determining the growth or
decline in value of a hypothetical historical investment in the Fund over a
stated period, and then calculating the annually compounded percentage
rate that would have produced the same result if the rate of growth or
decline in value had been constant over the period. For example, a
cumulative return of 100% over ten years would produce an average
annual total return of 7.18%, which is the steady annual rate of return
that would equal 100% growth on a compounded basis in ten years.
While average annual total returns are a convenient means of comparing
investment alternatives, investors should realize that the Fund's performance
is not constant over time, but changes from year to year, and that average
annual total returns represent averaged figures as opposed to the actual
year-to-year performance of the Fund.
In addition to average annual total returns, the Fund's unaveraged
or cumulative or total returns, reflecting the simple change in value of an
investment over a stated period, may be quoted. Average annual and
cumulated total returns may be quoted as a percentage or as a dollar
amount, and may be calculated for a single investment, a series of
investments, or a series of redemptions, over any time period. Total
returns may be broken down into their components of income and capital
(including capital gains and changes in share prices) in order to illustrate
the relationship of these factors and their contributions to total return.
Total returns and other performance information may be quoted numerically
or in a table, graph or similar illustration.
Risk Measurements
Quantitative measures of "total risk", which quantify the total
variability of a portfolio's returns around, or below, its average return,
may be used in advertisements and in communications with current and
prospective shareholders. These measures include standard deviation of
total return and the Morningstar risk statistic. Such communications may
also include market risk measures, such as beta , and risk-adjusted measures
of performance such as the Sharpe Ratio and Morningstar's star rating system.
Standard Deviation. The risk associated with a fund or portfolio
can be viewed as the volatility of its returns, measured by the standard
deviation of those returns. For example, a fund's historical risk could
be measured by computing the standard deviation of its monthly total returns
over some prior period, such as three years. The larger the standard
deviation of monthly returns, the more volatile, i.e., spread out around
the fund's average monthly total return, the fund's monthly total returns
have been over the prior period. Standard deviation of total return can be
calculated for funds of different objectives, ranging from equity funds to
fixed income funds, and can be measured over different time frames.
The standard deviation figures presented are annualized statistics
based on the trailing 36 monthly returns. Approximately 68% of the
time, the annual total return of a fund will differ from its mean annual
total return by no more than plus or minus the standard deviation figure.
95% of the time, a fund's annual total return will be within a range of
plus or minus 2x the standard deviation from its mean annual total return.
Beta. Beta measures the sensitivity of a security's, or a portfolio's,
return to the market's returns. It measures the relationship between a fund's
Excess return (over 3-month T-bills) and the excess return of the benchmark
index (S&P500 for domestic equity funds). The market's beta is by definition
equal to 1. Portfolios with betas greater than 1 are more volatile than the
market, and portfolios with betas less than 1 are less volatile than the
market. For example, if a portfolio had a beta of 2, a 10% market excess
return would be expected to result in a 20% portfolio excess return, and a
10% market loss would be expected to result in a 20% portfolio loss
(excluding the effects of any firm-specific risk that has not been
eliminated through diversification).
Morningstar Risk. The Morningstar proprietary risk statistic
evaluates a fund's downside volatility relative to that of other funds in its
class based on the underperformance of the fund relative to the riskless
T-bill return. It then compares this statistic to those of other funds in
the same broad investment class.
Sharpe Ratio. Also known as the Reward-to-Variability Ratio, this
is the ratio of a fund's average return in excess of the risk-free rate of
return ("average excess return") to the standard deviation of the fund's
excess returns. It measures the returns earned in excess of those that
could have been earned on a riskless investment per unit of total risk
assumed.
Morningstar Star Ratings. Morningstar, Inc. is a mutual fund rating
service that rates mutual funds on the basis of risk-adjusted performance.
Ratings may change monthly. Funds with at least three years of performance
history are assigned ratings from one star (lowest) to five stars (highest).
Morningstar ratings are calculated from the funds' three-, five- and ten-year
average annual returns (when available). Funds' returns are adjusted for fees
and sales loads. Ten percent of the funds in an investment category receive
five stars, 22.5% receive four stars, 35% receive three stars, 22.5% receive
two stars, and the bottom 10% receive one star.
None of the quantitative risk measures taken alone can be used for
a complete analysis and, when taken individually, can be misleading at times.
However, when considered in some combination and with the total returns of
a fund, they can provide the investor with additional information regarding the
volatility of a fund's performance. Such risk measures will change over time
and are not necessarily predictive of future performance or risk.
CUSTODIAN AND TRANSFER AND DIVIDEND DISBURSING AGENT
Star Bank, N.A. (the "Custodian"), serves as custodian for the Fund's
cash and securities. Pursuant to a Custodian Agreement with the Fund, it is
responsible for maintaining the books and records of the Fund's portfolio
securities and cash. The Custodian does not assist in, and is not responsible
for, investment decisions involving assets of the Fund. American Data
Services , Inc. (the "Transfer Agent") acts as the Fund's transfer and
dividend disbursing agent.
COUNSEL AND INDEPENDENT AUDITORS
Legal matters in connection with the issuance of shares of
common stock of the Fund are passed upon by Battle Fowler LLP.
Ernst & Young LLP, independent auditors, has been selected as
auditors of the Fund.
