Front Cover:
The Masters' Select Funds
Combined Prospectus
The Masters' Select Equity Fund
The Masters' Select International Fund
November 15, 1997
Litman/Gregory Fund Advisors, LLC
<PAGE>
Body:
The Masters' Select Funds
The Masters' Select Equity Fund
The Masters' Select International Fund Combined Prospectus
November 15, 1997
Litman/Gregory Fund Advisors, LLC
4 Orinda Way
Orinda, CA 94563
The Masters' Select Funds is a no-load mutual fund group consisting of two
mutual funds. The Masters' Select Equity Fund is a growth fund which primarily
invests in U.S. companies. It seeks to increase the value of your investment
over the long term by using the combined talents and favorite stock-picking
ideas of six highly regarded portfolio managers. The Masters' Select
International Fund invests primarily in foreign companies. It seeks to increase
the value of your investment over the long term by using the combined talents
and favorite stock-picking ideas of five highly regarded international stock
pickers.
Please read this prospectus before investing, and keep it on file for future
reference. It contains important information, including how the Funds invest and
the services available to shareholders.
A Statement of Additional Information (SAI) dated November 15, 1997, has been
filed with the Securities and Exchange Commission (SEC) and is incorporated
herein by reference (legally forms a part of this prospectus). For a free copy
of the SAI, call 1-800-656-8864. Mutual fund shares are not deposits or
obligations of, or guaranteed by, any depository institution. Shares are not
insured by the U.S. government, the FDIC, the Federal Reserve Board, or any
other U.S. government agency, and are subject to investment risk, including the
possible loss of principal.
LIKE ALL MUTUAL FUNDS, THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY
THE SECURITIES AND EXCHANGE COMMISSION, NOR HAS THE COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<PAGE>
Contents
The Funds at a Glance 3
Who May Want to Invest 4
Expenses 4
Financial Highlights 5
The Funds in Detail Elements Common to Both Funds 5
The Masters' Select Equity Fund in Detail 7
The Masters' Select International Fund in Detail 11
Multi-Manager Issues 16
Your Account 21
Shareholder and Account Policies 25
Dividends, Capital Gains and Taxes 26
Performance 28
General Information 28
Goal; Strategy; Management
The Masters' Select Investment Philosophy;
Investment Manager Selection Criteria;
The Advisor
Masters' Select Equity Fund
Portfolio Managers
Master's Select International Fund
Portfolio Managers
Foreign Investment Considerations;
Other Securities and Strategies;
Fundamental Policies and Investment Restrictions;
Breakdown of Expenses;
Organization
Ways to Set Up Your Account;
How to Buy Shares;
How to Sell Shares
Statements,
Reports and Inquiries;
Exchange Privilege;
Investor Services;
Share Price;
Purchases;
Redemptions
Distribution Options;
Understanding Distributions;
Taxes
<PAGE>
The Funds at a Glance Goal
The Masters' Select Equity Fund ("Masters' Select Equity" or the "Equity Fund")
seeks long-term growth of capital primarily from investment in U.S. equity
securities.
The Masters' Select International Fund ("Masters' Select International" or the
"International Fund") seeks long-term growth of capital primarily from
investment in foreign stocks.
As with any mutual fund, there is no assurance that the Funds will achieve their
goals.
Strategy
Both the Equity Fund and the International Fund (collectively, the "Funds") have
contracted with multiple subadvisors. The Equity Fund is subadvised by six
highly regarded investment managers. The International Fund is subadvised by
five highly regarded international investment managers. Each manager will run a
fixed percentage of the Fund's portfolio and invest in a maximum of 15 stocks.
This approach is designed to:
* Combine the efforts of several experienced, world-class managers, all with
superior track records.
* Access only the favorite stock-picking ideas of each manager at any point
in time. This will be achieved by limiting each manager to a maximum of 15
stocks within that manager's segment of the Fund.
* Deliver a portfolio that is prudently diversified in terms of stocks
(typically 70 to 90 for Masters' Select Equity, and 50 to 75 for Masters'
Select International) and industries while still allowing each manager to
run portfolio segments focused on only his or her favorite stocks.
* Further diversify across different-sized companies and stock-picking styles
by including managers with a variety of stock-picking disciplines.
The Funds' Advisor has extensive experience evaluating investment managers and
mutual funds. The Advisor has selected investment managers for the Funds that it
believes are superior, based on their track records as well as the Advisor's
subjective assessment of their investment philosophies, analytical support and
other characteristics that it believes are found in superior investment
managers.
Management
Litman/Gregory Fund Advisors, LLC, is the Funds' Advisor. The Advisor is an
affiliate of L/G Research, which publishes the No-Load Fund Analyst and conducts
in-depth research on mutual funds and investment management firms. The Advisor
is also affiliated with Litman/Gregory & Company, LLC, an investment management
firm.
Fund Closings. Limiting each Fund's size will allow the investment managers to
maintain their focus on a small number of favorite securities. We expect to
close Masters' Select Equity to new investors at some point when Fund assets are
between $500 million and $750 million. Masters' Select International is likely
to be closed when assets are between $600 million and $1 billion.
Who May Want to Invest
Each Fund is intended for investors who are willing to ride out short-term stock
market fluctuations in pursuit of potentially above-average long-term returns.
The value of the Funds' investments will vary from day to day, and generally
reflect market conditions, interest rates and other company, political or
economic events. In the short term, stock prices can fluctuate dramatically in
response to these factors. When you sell your shares, they may be worth more or
less than what you paid for them.
By themselves, the Funds do not constitute a balanced investment plan.
Expenses
Expenses are one of several factors to consider when investing in a mutual fund.
There are usually two types of expenses involved: shareholder transaction
expenses, such as sales loads, and annual operating expenses, such as investment
advisory fees. The Funds have no shareholder transaction expenses.
Annual Operating Expenses
Equity Fund Int'l Fund
----------- ----------
Investment advisory fee 1.10% 1.10%
12b-1 fee None None
Other expenses of the Fund 0.33% 0.85%
Total Fund
operating expenses 1.43% 1.95%
Example: Let's say, hypothetically, that a Fund's annual return is 5% and that
its operating expenses are exactly as just described. For every $1,000 you
invest, here's how much you would pay in total expenses if you closed your
account after the number of years indicated:
Equity Fund Int'l Fund
----------- ----------
After one year $15 $20
After three years $45 $61
The purpose of the above table is to provide an understanding of the various
annual operating expenses that may be borne directly or indirectly by an
investment in a Fund. This example illustrates the effect of expenses, but it is
not meant to suggest actual or expected costs or returns, all of which may vary.
Annual operating expenses are paid out of each Fund's assets. Each Fund pays an
investment advisory fee to the Advisor. Each of the investment managers receives
a fee for his or her services from the Advisor, not from the Fund. Each Fund
also incurs other expenses for such services as administrative services,
maintaining shareholder records and furnishing shareholder statements and
financial reports. "Other Expenses" in the table have been estimated. Each
Fund's expenses are factored into its share price and are not charged directly
to shareholder accounts.
For a more complete description of the various costs and expenses, see
"Breakdown of Expenses."
The Advisor has contracted with investment managers to manage the day-to-day
stock picking for both Funds. The individual portfolio managers are as follows:
Masters' Select Equity
Shelby Davis: CEO and Chief Investment Officer of Davis Selected
Advisers, L.P., the advisor to Davis New York
Venture Fund.
Jean-Marie Eveillard: President of Societe Generale Asset Management
Corporation and lead manager of SoGen
International and SoGen Overseas Funds.
Foster Friess (and team): President of Freiss Associates and also lead
portfolio manager of the Brandywine Fund.
Mason Hawkins: Chief Executive Officer of Southeastern Asset
Management, Inc., and co-manager of Longleaf
Partners Fund.
Spiros "Sig" Segalas: President and Chief Investment Officer of Jennison
Associates Capital Corporation and portfolio
manager of Harbor Capital Appreciation Fund.
Dick Weiss: Member of the Executive Committee at Strong
Capital Management, Inc., and co-manager of Strong
Common Stock Fund.
Masters' Select International
Bruce Bee: President and Chief Investment Officer of Bee &
Associates, Inc.
Helen Young Hayes: Vice President of Janus Capital Corporation and
portfolio manager of the Janus Overseas and Janus
Worldwide Funds.
David Herro: Director of International Equities and a partner
at Harris Associates L.P. and also lead porfolio
manager for Oakmark International and Oakmark
International Small Cap Funds.
Dan Jaworski: Founder and Chief Investment Officer of BPI Global
Asset Management, LLP. Formerly the portfolio
manager for the STI
Classic International Equity Fund.
Mark Yockey: Partner at Artisan Partners LP and the portfolio
manager of the Artisan International Fund.
<PAGE>
Financial Highlights
For a share outstanding throughout the period
Masters Select equity
For the period from
12/31/96 to 6/30/97(1)
Net asset value, beginning of period $ 10.00
Income from investment operations
Net investment income 0.03
Net realized and unrealized gain on investments 1.50
Total from investment operations 1.53
Less distributions
From net investment income -
From net realized gains -
Net asset value, end of period $ 11.53
Total return(2) 15.30%
Net assets at end of
period (in 000's) $ 204,677
Ratio of expenses to average net assets (net of expense
reimbursements) 1.47%*
Ratio of net investment income to average net assets 0.73%*
Portfolio turnover rate 62.73%*
*Annualized
1. The Masters' Select Equity Fund commenced operations on December 31, 1996.
2. Not annualized for periods of less than one year.
<PAGE>
The Funds in Detail-Elements Common to Both Funds
The Masters' Select
Investment Philosophy
The investment objective of the Funds is growth; that is, the increase in the
value of your investment over the long term. The investment managers selected by
the Advisor invest in securities of companies that they believe have strong
appreciation potential. Under normal circumstances, the Funds intend to be
substantially or fully invested in equity securities, including common stocks
and other securities with the characteristics of common stocks.
Both Funds' strategies are based on several fundamental beliefs:
First, the Advisor believes that it is possible to identify investment managers
who will deliver superior performance relative to their peer groups. This belief
is based on the Advisor's extensive experience evaluating and picking stock
mutual funds.
Second, the Advisor believes that at any point in time most investment managers
own a small number of stocks in which they are highly confident. But because
holding only 10 or 15 stocks is not considered prudent from a diversification
standpoint or practical given the large dollar amounts managed by most
successful managers, most stock mutual funds hold more than 50 stocks. The
Advisor believes that, over time, the performance of most investment managers'
"highest confidence" stocks exceeds that of their more diversified portfolios.
Third, the Advisor believes that during any given year certain stock-picking
styles will generate higher returns than comparable market indexes, while others
will lag. By including a variety of stock-picking styles in a single mutual
fund, the Advisor believes that the variability of returns among stock-picking
styles can be lessened.
Please see the sections titled "The Masters' Select Equity Fund in Detail" and
"The Masters' Select International Fund in Detail" for background specific to
each Fund.
Investment Manager
Selection Criteria
The Advisor believes that superior investment managers exhibit:
* Consistently above-average performance relative to an appropriate peer
group. The Advisor measures investment manager performance against
performance composites made up of other advisory firms using a similar
stock-picking style and market capitalization. The Advisor maintains its
own database and has developed proprietary software to measure performance
over various time periods.
* A record of outperforming the S&P 500 (U.S. equity managers) or the Morgan
Stanley Europe, Australasia, Far East Index ("EAFE Index") (foreign equity
managers) over most periods of five years or longer.
* The confidence and ability to think and act independently of "Wall Street
herd mentality."
* The passion for and obsession with stock picking that can result in working
harder and more creatively to get an edge.
* A focus on the job of stock picking and portfolio management. Thus the
Advisor seeks investment managers who have attempted to mitigate
noninvestment distractions by delegating most business management and
marketing duties. The Advisor has extensive experience evaluating
investment advisory firms, using the above criteria, and believes that each
of the investment managers selected to participate in the Funds exhibits
the qualities mentioned above.
Detailed information on the investment managers begins on page 7 for the
Masters' Select Equity Fund and page 11 for the Masters' Select International
Fund. There are also summary tables on pages 10 and 14.
The Advisor
The Funds are managed by Litman/Gregory Fund Advisors, LLC, 4 Orinda Way, Orinda
CA 94563. The Advisor has overall responsibility for assets under management,
recommends selection of investment managers to the Board of Trustees, evaluates
performance of the investment managers, monitors changes at the investment
managers' organizations that may impact their ability to deliver superior future
performance, determines when to rebalance the investment managers' assets,
determines the amount of cash equivalents (if any) that may be held in addition
to cash in each of the investment managers' sub-portfolios and coordinates with
the managers with respect to diversification and tax issues. The Trustees review
the level and appropriateness of the various manager fee schedules.
Kenneth E. Gregory is a Trustee of the Trust and is responsible for monitoring
the day-to-day activities of the investment managers. Gregory is also President
of L/G Research, an affiliated firm that publishes the No-Load Fund Analyst
newsletter and conducts research on financial markets and mutual funds. Gregory
is also President and Chief Investment Officer of Litman/Gregory & Company, LLC,
a money management firm. He has held this position since the founding of
Litman/Gregory & Company, a predecessor firm, in 1987. He has been in the
investment business since 1979.
The Masters' Select Equity Fund in Detail
The Fund's six investment managers emphasize different stock-picking styles and
invest in stocks with a range of market capitalizations. The portion of the Fund
assigned to each manager is fixed and has been determined with the specific
objective of maintaining exposure to stocks of large and mid-sized companies at
50% to 75% of the Fund's total assets in normal market conditions. These fixed
allocations are allowed to drift slightly. The Advisor is responsible for
rebalancing the allocations as total assets in the Fund fluctuate. The Advisor's
strategy is to allocate the portfolio's assets among investment managers who,
based on the Advisor's research, are judged to be among the best in their
respective style groups. The investment managers manage their individual
portfolio segments by building a focused portfolio representing their
highest-confidence stocks. Each investment manager's portfolio segment includes
a minimum of 5 and a maximum of 15 securities. Though the overall Fund may hold
more or fewer securities at any point in time, it is generally expected that the
Fund will hold between 70 and 90 securities. Under unusual market conditions,
for temporary defensive purposes, up to 35% of the Fund's total assets may be
invested in short-term, high-quality debt securities. Defensive positions may be
initiated by the individual portfolio managers or by the Advisor.
Masters' Select Equity Fund Portfolio Managers
Shelby M. C. Davis
Davis Selected Advisers, L.P.
Shelby Davis is the lead portfolio manager for the segment of the Fund's assets
managed by Davis Selected Advisers, L.P. ("Davis Advisers"), 124 E. Marcy
Street, Santa Fe, NM 87501. Davis has been in the investment business for more
than 30 years. He was a portfolio manager for Davis New York Venture Fund from
1969 through 1996 and is still actively involved in the stock selection process;
his son, Christopher C. Davis, was named co-portfolio manager in 1995 and sole
manager in 1996. In total, Davis Advisers manages more than $13.5 billion of
mutual fund and ERISA portfolios including Davis New York Venture Fund. In
performing its investment advisory services, Davis Advisers, while remaining
ultimately responsible for its segment of the Fund's assets, is able to draw on
the portfolio management, research and market expertise of its affiliates
(including Davis Selected Advisers-NY, Inc.). Approximately 20% of the Fund's
assets are managed by Davis. He invests primarily in large companies, using a
strategy that takes into account both growth and value. This approach is often
referred to as "growth at a reasonable price." Davis prefers high-quality
companies as evidenced by some or all of the following:
* Solid top-line (revenue) and unit growth
* Management with a stake in the business
* A business plan for the next three to five years
* Participation in an industry that is capable of earning a good return on
capital
* Respected by competitors
* Low-cost operations
Davis often seeks to buy companies exhibiting some or all of these
characteristics at depressed prices because they are temporarily out of favor.
When buying out-of-favor stocks, he believes that there is often a catalyst that
will eventually push the stock price higher.
Jean-Marie Eveillard
Societe Generale Asset
Management Corporation
Jean-Marie Eveillard is the portfolio manager for the segment of the Fund's
assets run by Societe Generale Asset Management (SGAM), 1221 Avenue of the
Americas, New York, NY 10020. Eveillard has been in the investment business for
more than 30 years and has been the portfolio manager for SoGen International
Fund, a multi-asset global fund, since 1979. Eveillard is also President of
SGAM, an indirect subsidiary of Societe Generale, one of France's largest banks.
SGAM currently manages nearly $5.6 billion. Approximately 20% of the Fund's
assets are run by Eveillard, who invests in securities all over the world. At
least 50% of his segment must be invested in U.S. securities. Eveillard is a
value investor who uses a bottom-up orientation that focuses on the fundamentals
of a specific security rather than its immediate environment. In searching for
obscure or depressed securities, his approach is flexible so that despite an
equity focus, he will sometimes own fixed-income securities that he believes can
deliver equity-type returns. Eveillard is also flexible in the size of companies
he looks at (very small to very large) as well as their geographic location
(developed or emerging markets). Eveillard's time horizon is three to five
years, and his indifference to short-term issues allows him to consider
companies that have become bargains offering long-term value due to temporary
problems. Eveillard avoids a "black box" approach to assessing value. In
particular, whenever possible, he looks for an imbalance between his estimate of
what a reasonable buyer would pay for the entire company, and the price for the
security in the public market.
Foster Friess and Team
Friess Associates
Foster Friess is the lead portfolio manager for the segment of the Fund's assets
run by Friess Associates, Inc., 350 Broadway, Jackson, WY 83001. Friess has been
in the investment business for more than 25 years and has been lead manager of
the Brandywine Fund since 1986. He is also President and, with his wife, Lynette
Friess, sole owner of Friess Associates. In total, Friess manages more than $15
billion.
Approximately 10% of the Fund's assets are managed by Freiss and his team.
Friess invests in stocks of well-financed issuers that have proven records of
profitability and strong earnings momentum. Emphasis is placed on companies with
market capitalizations of less than $5 billion. These companies are likely to be
lesser-known companies moving from a lower to higher market share position
within their industry groups, rather than the largest and best-known companies
in these groups. Friess may, however, purchase common stocks of well-known,
highly researched mid-sized companies if the team believes that those common
stocks offer particular opportunity for long-term capital growth. In selecting
investments, Friess considers financial characteristics of the issuer, including
historical sales and net income, debt/equity and price/earnings ratios, and book
value. Friess may also review research reports of broker-dealers and trade
publications and, in appropriate situations, meet with management. Greater
weight is given to internal factors, such as product or service development,
than to external factors, such as interest rate changes, commodity price
fluctuations, general stock market trends and foreign-currency exchange values.
A particular issuer's dividend history is not considered important.
Mason Hawkins
Southeastern Asset Management
Mason Hawkins is the lead portfolio manager for the portion of the Fund's assets
run by Southeastern Asset Management, Inc. (Southeastern), 6075 Poplar Avenue,
Memphis, TN 38119. Hawkins has been in the investment business for more than 20
years and founded Southeastern, which he controls, in 1975. He has managed the
Longleaf Partners Fund since its inception in 1987. In total, Southeastern
manages more than $11 billion.
Approximately 20% of the Fund's assets are managed by Southeastern using a
value-oriented approach to picking stocks. The Firm considers companies of all
sizes, although most of its portion of the Fund's assets are expected to be
invested in mid-sized and larger companies. Southeastern focuses on securities
of companies believed to have unrecognized intrinsic value and the potential to
grow their economic worth. Southeastern believes that superior long-term
performance can be achieved when positions in financially strong, well-managed
companies are acquired at prices significantly below their business value and
are sold when they approach their corporate worth. Corporate intrinsic value is
determined through careful securities analysis and the use of established
disciplines consistently applied over long periods of time. Securities that can
be identified and purchased at a price significantly discounted from their
intrinsic worth not only protect investment capital from significant loss but
also facilitate major rewards when the true business value is ultimately
recognized. Seeking the largest margin of safety possible, Southeastern requires
at least a 40% market value discount from its appraisal of an issuer's intrinsic
value before purchasing the security. To determine intrinsic value, current
publicly available financial statements are carefully scrutinized, and two
primary methods of appraisal are applied. The first assesses what is believed to
be the real economic value of the issuer's net assets; the second examines the
issuer's ability to generate free cash flow after required or maintenance
capital expenditures. After free cash flow is determined, conservative
projections about its rate of future growth are made. The present value of that
stream of cash flow plus its terminal value is then calculated using a discount
rate based on expected interest rates. If the calculations are accurate, the
present value would be the price at which buyers and sellers negotiating at
arm's length would accept for the whole company. In a concluding analysis, the
asset value determination and/or the discounted free cash flow value are
compared to business transactions of comparable corporations. Other
considerations used in selecting potential investments include the following:
* Indications of shareholder-oriented management
* Evidence of financial strength
* Potential earnings improvement
Spiros Segalas
Jennison Associates Capital Corporation
Spiros "Sig" Segalas is the portfolio manager for the segment of the Fund's
assets run by Jennison Associates Capital Corp., 466 Lexington Avenue, New York,
NY 10017. Segalas has been in the investment business for more than 30 years and
has been the portfolio manager for the Harbor Capital Appreciation Fund since
May 1990. He is a founding member and President and Chief Investment Officer of
Jennison Associates Capital Corp., a wholly-owned subsidiary of the Prudential
Insurance Company of America. As of September 30, 1997, Jennison Associates
managed more than $38 billion in U.S. equity securities.
Approximately 20% of the Fund's assets are run by Segalas. He seeks to invest in
large and mid-sized companies experiencing superior absolute and relative
earnings growth. Earnings predictability and confidence in earnings forecasts
are an important part of the selection process. In considering a stock for
ownership, Segalas considers price/earnings ratios relative to the market as
well as the companies' histories. In addition, he seeks out companies
experiencing some or all of the following:
* High sales growth
* High unit growth
* High or improving returns on assets and equity
* Strong balance sheet
Segalas also prefers companies with a competitive advantage, such as unique
management, marketing or research and development.
Richard T. Weiss
Strong Capital Management, Inc.
Dick Weiss is the portfolio manager for the segment of the Fund's assets run by
Strong Capital Management, Inc., 100 Heritage Reserve, Menomonee Falls, WI
53051. Weiss has been in the investment business for more than 20 years and has
been the co-manager of the Strong Common Stock Fund since joining Strong in
1991. Weiss is a member of the firm's Executive Committee. Prior to joining
Strong, he was the lead manager of the SteinRoe Special Fund commencing in 1981.
In total, Weiss co-manages more than $6 billion. Strong Capital Management was
founded in 1974 and is controlled by Richard Strong.
Approximately 10% of the Fund's assets are run by Weiss. He invests in stocks of
small and mid-sized companies that are undervalued either because they are not
broadly recognized, are in transition, or are out of favor based on short-term
factors. In seeking attractively valued companies, Weiss focuses on companies
with above-average growth potential that also exhibit some or all of the
following:
* Low institutional ownership and low analyst coverage
* High-quality management
* Sustainable competitive advantage
Weiss evaluates the degree of under-valuation relative to his estimate of each
company's private market value. This private market value approach is based on
an assessment of what a private buyer would be willing to pay for the future
cash flow stream of the target company. Based on his experience, Weiss believes
that, except for technology and other high-growth stocks, most stocks trade at
between 50% and 80% of private market value. When trading at the low end of this
range, companies take steps to prevent takeover, or they are taken over. The
private market value estimate is applied flexibly, based on the outlook for the
industry and the company fundamentals.
Masters' Select Equity Fund Investment Manager Summary
<TABLE>
<CAPTION>
Portfolio Initial Investment Size of Stock-Picking
Manager Allocation Experience/ Companies Style
of Fund Relevant Fund
Portfolio Experience
- ---------- ---------- ------------- --------- -------------
<S> <C> <C> <C> <C>
Shelby Davis 20% Over 30 years/ Mostly Growth at a
Davis New York large-cap reasonable price
Venture Fund
since 1969
Jean-Marie 20% Over 30 years/ No market-cap Value-oriented
Eveillard SoGen International restrictions and global. At
Fund since 1979 least 50% invested in the U.S.
Foster Friess 10% Over 25 years/ Small- and High earnings
and team Brandywine Fund mid-cap growth
since 1986
Mason Hawkins 20% Over 20 years/ All sizes but Value
Longleaf Partners mostly mid-
Fund since 1987 and large-cap
Spiros "Sig" 20% Over 30 years/ Mostly High earnings
Segalas Harbor Capital large-cap growth
Appreciation Fund
since 1990
Dick Weiss 10% Over 20 years/ Small- and Growth at a
Strong Common mid-cap reasonable price
Stock Fund
since 1991
</TABLE>
<PAGE>
The Masters' Select International Fund in Detail
The Fund's five investment managers pursue the Fund's objective primarily
through investments in common stocks of issuers located outside of the United
States.
Each manager may invest in securities traded in both developed and emerging
markets. Though there is no limit on emerging market exposure, it is not
expected to be a primary focus, and the majority of the Fund's assets are
expected to be invested in stocks of companies listed and domiciled in developed
countries. There are no limits on the Fund's geographic asset distribution, but,
to provide adequate diversification, the Fund ordinarily invests in the
securities markets of at least five countries outside of the United States. In
most periods it is expected that the Fund will hold securities in more than five
countries. Although the Fund intends to invest substantially all of its assets
in issuers located outside of the United States, it may at times of abnormal
market conditions invest in U.S. issuers and it may at times invest all of its
assets in fewer than five countries.
Each manager has a distinct stock-picking approach. As a group the managers
invest in stocks with a range of market capitalizations. Although each manager
has the flexibility to invest on a worldwide basis (excluding the U.S.) in
companies with market capitalizations of any size, it is expected that the
Fund's exposure to large and mid-sized foreign companies will range from 60% to
90% of the Fund's total assets under normal market conditions. The Advisor's
strategy is to allocate the portfolio's assets among investment managers who,
based on the Advisor's research, are judged to be among the best relative to
their respective peer groups. The Advisor has focused exclusively on stock
pickers who emphasize bottom-up stock picking rather than macro-driven, top-down
country picking.
The Advisor believes that bottom-up stock pickers have an advantage in foreign
markets because:
* It is the Advisor's opinion that the dynamics that influence individual
countries' markets, including currencies, inflation, economic growth,
political factors, regulation and the like, are much more difficult to
assess than the prospects and valuation characteristics of individual
companies.
* The Advisor believes that many individual stocks in foreign markets are
less closely analyzed (the markets are less "efficient") than in the United
States. If true, the Advisor believes that this will result in greater
opportunities for skilled stock pickers to add value through pure stock
selection.
* Based on the Advisor's observations, bottom-up stock pickers in foreign
markets, on average, seem to perform better than top-down-oriented
managers.
Though bottom-up stock picking is emphasized, each manager also monitors
specific macro-factors that he or she believes are relevant in specific
countries.
The portion of the Fund assigned to each manager is fixed. These fixed
allocations are allowed to drift slightly. The Advisor is responsible for
rebalancing the allocations as total assets in the Fund fluctuate.
The investment managers manage their individual portfolio segments by building a
focused portfolio representing their highest-confidence stocks. Each invest-ment
manager's portfolio segment includes a minimum of 8 and a maximum of 15
securities. Though the overall Fund may hold more or fewer securities at any
point in time, it is generally expected that the Fund will hold between 50 and
75 securities.
Under unusual market conditions, for
temporary defensive purposes, up to 35% of the Fund's total assets may be
invested in short-term, high-quality debt securities. Defensive positions may be
initiated by the individual portfolio managers or by the Advisor.
Masters' Select International
Fund Portfolio Managers
Bruce Bee
Bee & Associates, Inc.
Bruce Bee is the portfolio manager for the portion of the assets run by Bee &
Associates, Inc. (Bee), 370 Seventeenth Street, Suite 3560, Denver, CO 80202.
Bee has been in the investment business for more than 25 years and founded Bee &
Associates, which he controls, in 1989. In total, Bee manages more than $500
million. Bee has managed global small-cap portfolios since 1989 and
international small-cap portfolios since January 1995.
Approximately 10% of the Fund is managed by Bee. Bee focuses exclusively on
small companies primarily in developed markets, though he may also invest in
emerging markets. He believes that these companies generally are
under-researched and often inefficiently priced. Within this sector, Bee seeks
to purchase companies with above-average growth prospects at a significant
discount to his assessment of their value. Portfolio construction is completely
bottom-up oriented (no top-down country selection). In researching candidates
for purchase, Bee typically reviews company financial reports, reconciling
company accounting to U.S. standards; he seeks information from a variety of
sources which may include international brokers, accounting firms, banks, and
other investors, and visits the company. The ideal portfolio candidate has a
proprietary product or service and is generally involved in international trade;
has management depth and a coherent business strategy; and has a history of
growth in revenues, earnings, cash flow and return on shareholders' equity
which, in the manager's opinion, is sustainable and is available at a
significant discount to what another company might pay for it. Bee does not
expect to hedge against exchange rate risk.
Helen Young Hayes
Janus Capital Corporation
Helen Young Hayes is the portfolio man-ager for the segment of the Fund's assets
managed by Janus Capital Corporation (Janus), 100 Fillmore Street, Denver, CO
80206. Hayes has been in the investment business since 1984 and has been with
Janus since 1987. Hayes is the Vice President of Janus Capital Corporation and
the portfolio manager of the Janus Worldwide Fund (a global fund) and the Janus
Overseas Fund (an international fund). Janus also subadvises several other
international and global funds of which Hayes is the portfolio manager. She has
managed both funds since their inceptions in May 1991 and May 1994,
respectively. In total, as of September 30, 1997, Janus managed more than $67.6
billion, of which $17.3 billion is managed by Hayes.
Approximately 22.5% of the Fund is managed by Hayes, who uses a bottom-up
approach to stock selection. Hayes may invest in companies of all sizes, though
she tends to focus mostly on large and mid-sized companies. She invests
developed markets, and to a lesser extent emerging markets. Hayes seeks to
identify individual companies with earnings growth potential that may not be
recognized by the market at large. Intensive research focuses on the fundamental
factors affecting the business prospects of companies and may include review of
earnings reports, corporate and industry developments, trading activity,
research reports and other data. In addition, for a smaller number of companies,
additional scrutiny may include (but is not limited to) direct contacts with
corporate management; analysis of and contact with competitors, customers and
suppliers; and frequent on-site visitation of facilities. The focus of the
analytical work is to identify companies with:
* Rapid sales and earnings growth
* Strong cash flow generation and wise deployment of capital
* Efficient operations and high productivity
* Good management with the proper incentives
Hayes seeks companies that meet her selection criteria, regardless of country of
organization or place of principal business activity. Securities are generally
selected on a stock-by-stock basis without regard to any defined allocation
among countries or geographic regions. Certain factors, however, such as
expected levels of inflation, government policies influencing business
conditions, the outlook for currency relationships, and prospects for economic
growth among countries, regions or geographic areas, may influence security
selection. Hayes may use a variety of currency hedging techniques, including
forward currency contracts, to manage exchange rate risk.
David Herro
Harris Associates L.P.
David Herro is the portfolio manager for the portion of the Fund's assets run by
Harris Associates L.P. (Harris Associates), 2 North LaSalle Street, Chicago, IL
60602. Herro has been in the investment business since 1986 and is a partner,
portfolio manager and director of international equities at Harris Associates.
He has managed the Oakmark International Fund and the Oakmark International
Small Cap Fund since their inceptions in 1992 and 1995, respectively. Overall,
Herro is responsible for more than $1.9 billion in international equity assets.
As a firm, Harris Associates manages $16.7 billion in equity and fixed-income
assets.
Approximately 22.5% of the Fund's assets are managed by David Herro. Herro
believes that long-term results are achieved by investing as owners in
successful companies that may be purchased at a significant discount to their
true economic value. He selects stocks using a disciplined value investment
approach that emphasizes a bottom-up stock selection process. Herro searches for
international stocks in both established and emerging markets.
When looking for new investment ideas, Herro attempts to do two things:
* Seek out companies that are selling at a substantial discount to their true
value
* Determine the management's capability of enhancing the value of the company
His focus is to buy securities at large discounts to their underlying value
(usually based on its current and potential cash generation). He also looks for
bargains based on companies' normalized earnings (the level of earnings after
backing out cyclical influences) and asset values. A company must be selling at
a 30% or greater discount to its value to be a candidate for purchase. Stocks
are also analyzed in terms of financial strength, the position of the company in
its industry and the attractiveness of the industry. Another key feature of
Herro's investment approach is the thorough assessment of a company's management
team. Herro believes that investing in companies with proven, capable managers
enhances the likelihood of positive returns. When interviewing management, Herro
looks for two specific qualities in a management team:
* Management's ability to generate cash from the company's asset base
* Management's ability to efficiently allocate capital
Because of his bottom-up approach, Herro focuses on stock selection rather than
in-dustry or country selection. Currency hedging is done defensively and only if
the dollar appears excessively undervalued. Hedging is based on real interest
rate spreads, purchasing power parity differentials and differences in growth
and productivity.
Daniel R. Jaworski
BPI Global Asset Management, LLP
Dan Jaworski is the portfolio manager for the segment of the Fund's assets run
by BPI Global Asset Management, LLP, 1900 Summit Tower Boulevard, Orlando, FL
32810. Jaworski has been in the investment management business since 1988 and in
1997 founded and became Chief Investment Officer of BPI Global Asset Management.
BPI is currently managing more than $700 million in assets. Prior to founding
BPI, Jaworski was the portfolio manager of the STI Classic International Equity
Fund and its predecessor commingled fund from February 1, 1995, to April 30,
1997. Prior to joining STI, Jaworski was an international portfolio manager with
Lazard Freres Asset Management. Jaworski began his portfolio management career
as the manager of the Princor World Fund (an international fund) for The
Principle Financial Group in December 1988.
Approximately 22.5% of the Fund's assets are run by Jaworski. He seeks to invest
in high-quality, low-leveraged companies with sustainable, globally competitive
products or services. Jaworski purchases these companies when they are selling
at a discount to their global industrial peer group. Valuation criteria used are
specific to the industry, but typical factors include:
* Price to free cash flow
* Price to earnings
* Price to book
* Yield
Appreciation potential is determined assuming the security sells at the mean of
the industrial peer group. Potential returns are then adjusted to reflect the
estimated impact of the local market, the local currency or the general risk
profile of the security.
Securities ultimately selected by Jaworski are primarily large, well-established
companies that have, historically, generated higher returns and better profit
margins than their industry peers. Jaworski invests in developed and emerging
markets, and may use various hedging techniques to reduce exchange rate risk.
Mark Yockey
Artisan Partners LP
Mark Yockey is the portfolio manager for the segment of the Fund's assets run by
Artisan Partners LP, 1000 North Water Street, Suite 1770, Milwaukee, WI 53202.
Artisan Partners was founded by Carlene Murphy Ziegler and Andrew Ziegler in
1995 and is controlled by the Zieglers. Yockey has been in the investment
management business for more than 15 years and has been the portfolio manager of
the Artisan International Fund since its inception in January 1996. He is a
partner in Artisan Partners and is the senior member of the firm's international
investment management group. Prior to joining Artisan Partners, he was the
portfolio manager of the United International Growth Fund commencing in 1990. In
total, Yockey manages more than $350 million.
Approximately 22.5% of the Fund's assets are run by Yockey. He invests primarily
in international growth stocks, concentrating on companies located in countries
that have accelerating growth prospects. He also invests in companies located in
emerging markets.
Though not a country picker, Yockey prefers to invest in regions and countries
that are enjoying improving or rapid economic growth. This investment universe
includes developed and emerging markets. Yockey is less likely to invest in
countries that, while showing favorable economic growth, appear to have
overvalued markets. Economic growth is determined principally from the
standpoint of gross domestic product growth, corporate profitability, current
account and currency issues, interest rates and social changes. Having
identified favorable areas of the world for growth, Yockey seeks stocks of
companies best positioned to capitalize on that growth. In this process he
emphasizes well-managed companies with dominant or increasing market share in
strong industries. He typically focuses on companies with above-average
financial fundamentals and accelerating earnings per share. Yockey also analyzes
relative valuations using a variety of criteria, such as price-to-earnings
ratios, and avoids stocks that are trading at unsustainable or unusually high
valuations. His research process is flexible and varies depending on the country
and company, with an emphasis on determining whether the company has a sound
business plan and is able to execute it.
In making this assessment, Yockey will typically rely on analysis of company
reports, analyst reports, visits to the company and other contact with senior
management and competitors. Yockey may engage in hedging activities to reduce
exchange rate risk.
Masters' Select International Investment Manager Summary
<TABLE>
<CAPTION>
Portfolio Initial Investment Size of Stock-Picking
Manager Allocation Experience/ Companies Style
of Fund Relevant Fund
Portfolio Experience
<S> <C> <C> <C> <C>
Bruce Bee 10.0% Over 25 years Mostly small-cap Growth at a
reasonable price
Helen Young Hayes 22.5% Since 1984/Janus All sizes but Growth at a
Overseas Fund and mostly large-cap reasonable price Janus
Worldwide Fund
David Herro 22.5% Since 1986/Oakmark All sizes but Value
International Fund and mostly mid- and
Oakmark International large-cap
Small Cap Fund
Dan Jaworski 22.5% Since 1988/STI Classic Mostly large-cap Value
International Equity Fund
(2/95 through 4/97)
and the Princor World
Fund (12/88 through 4/93)
Mark Yockey 22.5% Since 1981/Artisan All sizes Growth at a
International Fund and reasonable price
United International
Growth Fund (1990
through November 1996)
</TABLE>
<PAGE>
Multi-Manager Issues
The investment methods used by these managers in selecting securities for the
Funds vary. The segment of each Fund portfolio managed by an investment manager
will, under normal circumstances, differ from the segments managed by the other
investment managers with respect to portfolio composition, turnover, issuer
capitalization and issuer financial condition. Because selections are made
independently by each investment manager, it is possible that a security held by
one portfolio segment may also be held by other portfolio segments of the Funds
or that several managers may simultaneously favor the same industry segment. The
Advisor monitors the overall portfolio on a daily basis to ensure that such
overlaps do not create an unintended industry concentration or lack of
diversification. The allocation of Fund assets to each investment manager is not
expected to change materially.
In the event an investment manager is no longer able to continue to manage a
segment of a Fund portfolio, the Advisor will select a replacement investment
manager with an investment style comparable to that of the investment manager
being replaced. The Advisor will use the same criteria as those used in the
original selection of investment managers.
The Advisor has obtained an exemptive order from the Securities and Exchange
Commission which permits it, subject to certain conditions, selection of new
investment managers with the approval of the Board of Trustees but without
obtaining shareholder approval. The order also permits the Advisor to change the
terms of agreements with the managers or to continue the employment of a manager
after an event that would otherwise cause the automatic termination of services.
Shareholders would be notified of any manager changes. Shareholders have the
right to terminate arrangements with a manager by vote of a majority of the
outstanding shares of a Fund. The order also permits a Fund to disclose
managers' fees only in the aggregate in its registration statement.
Each investment manager selects the brokers and dealers to execute transactions
for the segment of the Fund being managed by that manager.
Securities, Investment Practices and Risks. Under normal circumstances the Funds
intend to be substantially or fully invested in equity securities, including
common stocks and other securities with the characteristics of common stocks.
These securities include, but are not limited to, those issued by small
companies and foreign companies.
Small Companies. Although smaller companies generally have potential for rapid
growth, investments in smaller companies also often involve greater risks,
because they may lack the management experience, financial resources, product
diversification and competitive strengths of larger companies. In addition, in
many instances the securities of smaller companies may be less liquid than those
of larger companies. The Masters' Select Equity Fund typically invests 20% to
30% of its assets in small companies. The Masters' Select International Fund
typically invests 10% to 40% of its assets in small companies.
Convertible Securities. Each Fund may invest in convertible securities. A
convertible security is a fixed-income equity security that may be converted
into a prescribed amount of common stock at a specified formula. A convertible
security entitles the owner to receive interest until the security matures or is
converted. Convertibles have several unique investment characteristics such as:
(a) higher yields than common stocks but lower yields than straight debt
securities; (b) lesser degree of fluctuation in value than the underlying stock
because they have fixed-income characteristics; and (c) potential for capital
appreciation if the market price of the underlying security increases.
Foreign Investment Considerations
The Masters' Select Equity Fund may invest up to 25% of its total assets in
foreign securities, including depositary receipts. Under normal circumstances
the Advisor expects that the total invested in foreign securities by the
Masters' Select Equity Fund will be less than 15% of total assets.
The Masters' Select International Fund may invest up to 100% of its total assets
in foreign securities, including depositary receipts.
Securities of some foreign companies and governments may be traded in the United
States, but many foreign securities are traded primarily in foreign markets.
Risks and other aspects specific to foreign investing include:
* Currency Risk. A Fund may buy the local currency when it buys a
foreign-currency-denominated security and sell the local currency when it
sells the security. For as long as a Fund holds a foreign security, its
value will be affected by the value of the local currency relative to the
U.S. dollar. When a Fund sells a foreign-denominated security, its value
may be worth less in U.S. dollars even though the security increases in
value in its home country. U.S. dollar-denominated securities of foreign
issuers may also be affected by currency risk.
* Political and Economic Risk. Foreign investments may be subject to
heightened political and economic risks, particularly in underdeveloped or
developing countries, which may have relatively unstable governments and
economies based on only a few industries. In some countries there is the
risk that the government may take over the assets or operations of a
company or that the government may impose taxes or limits on the removal of
a Fund's assets from that country.
* The Funds may invest in emerging market countries. Emerging market
countries involve greater risks, such as immature economic structures,
national policies restricting investments by foreigners, and different
legal systems.
* Regulatory and Market Risk. The securities markets of certain foreign
countries, particularly those with emerging securities markets, are
substantially smaller, less developed, less liquid and more volatile than
the securities markets of the United States and other more developed
countries. Disclosure and regulatory standards in many respects are less
stringent than in the United States and other major markets. There also may
be a lower level of monitoring and regulation of emerging markets, and the
activities of investors in such markets and enforcement of existing
regulations have been extremely limited.
* Transaction Costs. Transaction costs of buying and selling foreign
securities, including brokerage, tax and custody costs, are generally
higher than those involved in domestic transactions.
* Depositary Receipts. American Depositary Receipts (ADRs) are receipts
issued by a U.S. bank or trust company evidencing ownership of underlying
securities issued by a foreign issuer. European and Global Depositary
Receipts (EDRs and GDRs) are bearer receipts designed for use in foreign
securities markets. Depositary receipts may be sponsored or unsponsored;
unsponsored depositary receipts are organized without the cooperation of
the foreign issuer of the underlying securities. As a result, information
about the issuer may not be as current or complete as for sponsored
receipts, and the prices of unsponsored receipts may be more volatile.
* Each Fund may also invest in foreign- exchange forward contracts or
currency futures or options on foreign currency in connection with its
investments in foreign securities.
* Privatizations. Some foreign governments have been engaged in programs of
selling part or all of their stakes in government-owned or -controlled
enterprises ("privatizations"). The Advisor believes that privatizations
may offer opportunities for significant capital appreciation, and the Funds
may invest assets in privatizations in appropriate circumstances. In
certain of those markets, the ability of foreign entities such as the Funds
to participate in privatizations may be limited by local law, and/or the
terms on which each Fund may be permitted to participate may be less
advantageous than those afforded local investors. There can be no assurance
that governments will continue to sell companies currently owned or
controlled by them or that privatization programs will be successful.
Other Securities and Strategies
The following paragraphs describe briefly some of the other securities a Fund
may buy and some of the strategies that may be used by a Fund, as well as some
of the risks associated with investing in a Fund. More information on this
subject is contained in the SAI.
Futures, Options and Other Derivative Instruments. Each Fund may enter into
futures contracts on securities, financial indexes and foreign currencies and
options on such contracts ("futures contracts") and may invest in options on
securities, financial indexes and foreign currencies ("options"), forward
contracts and interest rate swaps and swap-related products (collectively
"derivative instruments").
The Funds intend to use most derivative instruments primarily to hedge the value
of their portfolios against potential adverse movements in securities prices,
foreign-currency markets or interest rates. Options transactions will be entered
into for hedging purposes and not for speculation. The Funds' abilities to use
these instruments successfully will depend on an investment manager's ability to
accurately predict movements in the prices of securities, interest rates and
securities markets. The use of derivative instruments exposes the Funds to
additional investment risks and transaction costs. Risks inherent in the use of
derivative instruments include:
* The risk that interest rates, securities prices and currency markets will
not move in the direction that a portfolio manager anticipates
* Imperfect correlation between the price of derivative instruments and
movements in the prices of the securities, interest rates or currencies
being hedged
* Inability to close out certain hedged positions to avoid adverse tax
consequences
* The possible absence of a liquid secondary market for any particular
instrument and possible exchange-imposed price fluctuation limits, either
of which may make it difficult or impossible to close out a position when
desired
* Leverage risk, that is, the risk that adverse price movements in an
instrument can result in a loss substantially greater than a Fund's initial
investment in that instrument (in some cases, the potential loss is
unlimited)
* Particularly in the case of privately negotiated instruments, the risk that
the counterparty will fail to perform its obligations, which could leave a
Fund worse off than if it had not entered into the position
Although the Funds believe that the use of derivative instruments will benefit
the Funds, a Fund's performance could be worse than if the Fund had not used
such instruments if a portfolio manager's judgment proves incorrect. When a Fund
invests in a derivative instrument, it may be required to segregate liquid
assets with its custodian to "cover" the Fund's position. Assets segregated or
set aside generally may not be disposed of so long as the Fund maintains the
positions requiring segregation or cover. Segregating assets could diminish the
Fund's return due to the op-portunity losses of forgoing other potential
investments with the segregated assets. U.S. Government Securities. The Funds
may invest in direct obligations of the United States, such as Treasury bills,
notes and bonds, as well as obligations of U.S. agencies and instrumentalities.
Not all securities issued by agencies and instrumentalities of the U.S.
government are backed by the full faith and credit of the United States. Some,
such as securities issued by the
Federal National Mortgage
Association, are supported solely or primarily by the creditworthiness of the
issuer. If an obligation is not backed by the full faith and credit of the
United States, the Funds must look principally to the agency or instrumentality
issuing or guaranteeing the security for repayment and may not be able to assert
a claim against the U.S. government if the agency or instrumentality does not
meet its commitments. The Funds may also invest in mortgage-backed securities.
Repurchase Agreements. The Funds may enter into repurchase agreements, in which
the Funds buy securities and the seller agrees to repurchase them from the Funds
at a mutually agreed-upon time and price. The period of maturity is normally
overnight or a few days. The resale price is higher than the purchase price,
reflecting the Funds' rate of return. Each repurchase agreement is fully
collateralized, but if the seller defaults, the Funds may incur a loss. The
Funds enter into repurchase agreements only with institutions that meet certain
credit worthiness and other criteria.
Illiquid Securities. The Funds may invest up to 15% of their net assets in
illiquid securities, including restricted securities, that are not deemed to be
liquid by the subadvisor.
Securities Lending. The Funds may lend up to 10% of their portfolio securities
to financial institutions in order to increase the Funds' income.
Borrowing. The Funds may borrow from banks in an amount up to 20% of their total
assets, but only for temporary, extraordinary or emergency purposes.
The Funds may also engage in reverse repurchase agreements. Junk Bonds. The
Funds may invest up to 10% of their total assets in debt securities rated below
investment grade by a recognized rating agency or in unrated securities
determined by an investment manager to be of comparable quality. These
securities are subject to greater risk of loss of income and principal than
higher-rated bonds, as well as greater market risk and greater price volatility.
Other Information. The Funds may invest up to 5% of their total assets in
securities on a when-issued or delayed-delivery basis. The Advisor does not
expect each Fund's portfolio turnover rate to exceed 100% in most years.
Fundamental Policies and Investment Restrictions
A fundamental policy is one that cannot be changed without the vote of a
majority of each Fund's outstanding shares, as defined in the Investment Company
Act of 1940 (the "1940 Act"). Each Fund's investment objective is a fundamental
policy, as is its policy to be a diversified fund and not to concentrate in
securities of issuers in any one industry. Most of the limits and restrictions
set forth above are not fundamental policies and may be changed by the Board of
Trustees without shareholder approval. A complete description of each Fund's
fundamental policies and investment restrictions is contained in the SAI.
Breakdown of Expenses
Like all mutual funds, the Funds pay expenses related to their daily operations.
Expenses paid out of each Fund's assets are reflected in its share price; they
are neither billed directly to shareholders nor deducted from shareholder
accounts. Each Fund pays an investment advisory fee to the Advisor each month,
at the annual rate of 1.10% of the Fund's average daily net assets.
This fee is higher than that paid by most mutual funds. The Advisor (not the
Funds) pays the investment managers, each of whom is compensated monthly on the
basis of the assets committed to his or her individual discretion. The Advisor
pays fees to the investment managers of the Equity Fund at the aggregate annual
rate of 0.70%. The Advisor pays fees to the investment managers of the
International Fund at the aggregate annual rate of 0.6175%. Although the
investment advisory fee is a significant component of each Fund's annual
operating expenses, the Funds also pay other expenses. The Funds pay a monthly
administration fee to Investment Company Administration Corporation for such
services as preparing various reports and regulatory filings and monitoring the
activities of other service providers to the Funds, at the annual rate of 0.10%
on the first $100 million of its average net assets, 0.05% on the next $150
million of such net assets, 0.025% of the next $250 million of such net assets,
and 0.0125% of such net assets over $500 million subject to an annual minimum of
$40,000 per Fund. The Funds also pay other expenses, such as legal, audit,
custodian and transfer agency fees, as well as the compensation of Trustees who
are not affiliated with the Advisor or any of the investment managers.
The Advisor has agreed to reimburse the Masters' Select Equity Fund and Masters'
Select International Fund for any ordinary operating expenses above 1.75% and
1.95%, respectively, of each Funds' average net assets. The Advisor reserves the
right to be repaid by a Fund if expenses subsequently fall below the specified
limit in future years. But the Masters' Select Equity Fund's and Masters' Select
International Fund's operating expenses including any repayments will never be
allowed to exceed 1.75% and 1.95%, respectively, of average annual net assets.
This expense limitation arrangement is guaranteed by the Advisor for at least
the first year of a Fund's operation. After that it may be terminated at any
time, subject to approval by the Board of Trustees and prior notice to
shareholders. This expense limitation will decrease the Fund's expenses and
boost its performance.
Organization
The Masters' Select Equity Fund and the Masters' Select International Fund are
series of the Masters' Select Funds (the "Trust"), an open-end investment
management company, organized as a Delaware business trust on August 1, 1996.
The Trust is governed by a Board of Trustees, responsible for protecting the
interests of shareholders. The Trustees are experienced executives who meet
throughout the year to oversee the activities of the Funds, review the
compensation arrangements between the Advisor and the investment managers,
review contractual arrangements with companies that provide services to the
Funds and review performance. The majority of Trustees are not otherwise
affiliated with the Advisor or any of the investment managers. Information about
the Trustees and officers is contained in the SAI. Each Fund may hold special
meetings and mail proxy materials. These meetings may be called to elect or
remove Trustees, change fundamental policies, approve an investment advisory
contract or for other purposes. Shareholders not attending these meetings are
encouraged to vote by proxy. Each Fund will mail proxy materials in ad-vance,
including a voting card and information about the proposals to be voted on. The
number of votes each shareholder is entitled to is based on the number of shares
he or she owns.
Your Account
Ways to Set Up Your Account
Individual or Joint Account
For your general investment needs Individual accounts are owned by one person.
Joint accounts can have two or more owners (tenants).
Retirement
To shelter your retirement savings from taxes Retirement plans allow individuals
to shelter investment income and capital gains from current taxes. In addition,
contributions to these accounts may be tax deductible. Retirement accounts
require specific applications and typically have lower minimums.
Individual Retirement Accounts (IRAs) allow anyone of legal age and under 70 1/2
with earned income to invest up to $2,000 per tax year. Individuals can also
invest in a spouse's IRA if the spouse has earned income of less than $250 and
the combined contributions do not exceed $2,250.
* Rollover IRAs retain tax advantages for certain distributions from
employer-sponsored retirement plans.
* Simplified Employee Pension Plans (SEP-IRAs) provide small business owners
or those with self-employed income (and their eligible employees) with many
of the same advantages as a Keogh, but with fewer administrative
requirements.
* Other retirement plans, such as Keogh or corporate profit-sharing plans,
403(b) plans and 401(k) plans, may invest in the Funds.
All of these accounts need to be established by the plan's trustee. The Funds do
not offer versions of these plans.
Gifts or Transfers to Minors (UGMA, UTMA)
To invest for a child's education or other future needs
These custodial accounts provide a way to give money to a child and obtain tax
benefits. An individual can give up to $10,000 a year per child without paying a
federal gift tax. Depending on state laws, you can set up a custodial account
under the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors
Act (UTMA).
Trust
For money being invested by a trust
The trust must be established before an account can be opened.
Business or Organization
For investment needs of corporations, associations, partnerships or other groups
Does not require a special application.
How to Buy Shares
You can open a new account by mailing an application with a check for $5,000 or
more.
After your account is open, you may add to it by:
* Mailing a check or money order along with a letter or the form at the
bottom of your account statement
* Wiring money from your bank
* Making automatic investments
Each Fund is a no-load fund, which means you pay no sales commissions of any
kind. Once each business day, each Fund calculates its share price, which is the
Fund's net asset value (NAV). Shares are purchased at the next share price
calculated after your investment is received and accepted. Share price is
normally calculated at 4 p.m. eastern time.
If you are investing through a tax-sheltered retirement plan, such as an IRA,
for the first time, you will need an IRA Application and Adoption Agreement.
Retirement investing also involves its own investment procedures. Call
1-800-960-0188 for more information and an IRA application.
If you buy shares by check and then sell those shares within two weeks, the
payment may be delayed for up to seven business days to ensure that your
purchase check has cleared.
National Financial Data Services (NFDS) is the Funds' Transfer and Dividend
Paying Agent. Its address is
1004 Baltimore,
5th Floor,
Kansas City, MO 64105;
and its mailing address is
P.O. Box 419922,
Kansas City, MO 64141-6922.
First Fund Distributors, Inc.,
4455 E. Camelback Road,
Suite 261E,
Phoenix AZ 85018,
an affiliate of the Administrator, is the
Funds' principal underwriter.
Minimum Investments
To open an account* $5,000
For Automatic Investment Plans $2,500
For retirement accounts $1,000
To add to an account* $ 250
For retirement accounts $ 250
Through Automatic Investment Plans $ 100
Minimum balance $2,500
For retirement accounts $ 250
* The minimum investment requirements may be waived from time to time by the
Distributor.
How to Buy Shares For Information: 1-800-960-0188
By Mail
To open an account:
* Complete and sign the New Account Application. Make your check or money
order payable to "Masters' Select Equity Fund" or "Masters' Select
International Fund."
* Mail to the address on the New Account Application or, for overnight
delivery, send to:
National Financial Data Services
1004 Baltimore, 5th Floor
Kansas City, MO 64105
By Wire To open an account:
* Call 1-800-960-0188 for instructions on opening an account by wire.
Automatic Investment Plan
To open an account:
* If you sign up for the Automatic Investment Plan when you open your
account, the minimum initial investment is $2,500.
* Complete and sign the Automatic Investment Plan section of the New Account
Application. To add to an account:
* Make your check or money order payable to "Masters' Select Equity Fund" or
"Masters' Select International Fund." Put your account number on your
check.
* Mail your check and the form at the bottom of your account statement (or
enclose a note with your name, address and account number) to the address
on your account statement or, for overnight delivery, send to:
National Financial Data Services
1004 Baltimore, 5th Floor
Kansas City, MO 64105
To add to an account:
* Call 1-800-960-0188 for instructions on adding to an account by wire. To
add to an account:
* Sign up for the Automatic Investment Plan or call 1-800-960-0188 for
instructions on how to establish this service.
How to Sell Shares
By Phone
All account types 1-800-960-0188
except retirement Maximum check request: $25,000.
By Mail or In Person
Individual, Joint Tenant, The letter of instruction must be signed by
Sole Proprietorship, all persons required to sign for
UGMA, UTMA transactions, exactly as their names appear
Retirement on the account. Account The account owner
should complete an IRA Application and
Adoption Agreement.
Call 1-800-960-0188 to request one.
Trust The trustee must sign the letter indicating
capacity as trustee. If the trustee's name
is not in the account registration, provide
a copy of the trust document certified
within the past 60 days.
Business or Organization At least one person authorized by corporate
resolutions to act on the account must sign
the letter.
Include a corporate resolution with
corporate seal or a signature guarantee.
Executor, Administrator,
Call 1-800-960-0188 for instructions.
Conservator, Guardian By Wire All account types You must sign up
for the wire feature before except
retirement using it. To verify that it is in
place,
call 1-800-960-0188. Minimum wire amount:
$5,000.
Your wire redemption request must be
received by the Fund before 4 p.m. eastern
time for money to be wired the next business
day.
How to Sell Shares
You can arrange to take money out of your account at any time by selling
(redeeming) some or all of your shares. Your shares will be sold at the next net
asset value per share (share price) calculated after your order is received and
accepted. The share price is normally calculated at 4 p.m. eastern time.
To sell shares in a non-retirement account, you may use any of the methods
described on these two pages. To sell shares in a retirement account, your
request must be made in writing.
Certain requests must include a signature guarantee. It is designed to protect
you and each Fund from fraud. Your request must be made in writing and include a
signature guarantee if any of the following situations apply:
* You wish to redeem more than $25,000 worth of shares
* Your account registration has changed within the last 30 days
* The check is being mailed to a different address from the one on your
account (address of record)
* The check is being made payable to someone other than the account owner
You should be able to obtain a signature guarantee from a bank, broker-dealer,
credit union (if authorized under state law), securities exchange or
association, clearing agency or savings association.
A notary public cannot provide a signature guarantee.
Each Fund may close small accounts. Due to the relatively high cost of
maintaining smaller accounts, the shares in your account (unless it is a
retirement plan or custodial account) may be redeemed by each Fund if, due to
redemptions you have made, the total value of your account is reduced to less
than $2,500. If a Fund determines to make such an involuntary redemption, you
will first be notified that the value of your account is less than $2,500, and
you will be allowed 30 days to make an additional investment to bring the value
of your account to at least $2,500 before a Fund takes any action.
Selling Shares by Letter
Write a "letter of instruction" with:
* Your name
* Your Fund account number
* The dollar amount or number of shares to be redeemed
* Any other applicable requirements listed in the table on the previous page
Unless otherwise instructed, the Fund will send a check to the address of
record.
Mail your letter to:
National Financial Data Services
P.O. Box 419922
Kansas City, MO 64141-6922
Selling Shares by Telephone
If you accepted the telephone redemption option on your New Account Application,
you can sell shares simply by calling 1-800-960-0188. The amount you wish to
redeem (up to $25,000) will be wired to your bank account.
Shareholder and Account Policies
Statements, Reports and Inquiries
Statements and reports that each Fund sends you include the following:
* Confirmation statements (after every transaction that affects your account
balance or your account registration)
* Financial reports (every six months)
You may call the Transfer Agent at 1-800-960-0188 if you have questions about
your account.
Exchange Privilege
Shareholders may exchange shares between the Masters' Select Equity Fund and the
Masters' Select International Fund by mailing or delivering written instructions
to the Transfer Agent. Please specify the name of the applicable Fund, the
number of shares or dollar amount to be exchanged and your name and account
number.
You may also exchange shares by calling the Transfer Agent at 1-800-960-0188
between 9:00 a.m. and4:00 p.m. eastern time on a day when the New York Stock
Exchange (NYSE)is open for normal trading. Telephone exchanges are subject to
the identification procedures noted with respect to telephone redemptions above.
Investor Services
The Funds offers the following services to investors:
A systematic withdrawal plan lets you set up periodic redemptions from your
account.
One easy way to pursue your financial goals is to invest money regularly. The
Funds offer a convenient service that lets you transfer money into your Fund
account automatically. Although Automatic Investment Plans do not guarantee a
profit and will not protect you against loss in a declining market, they can be
an excellent way to invest for retirement, a home, educational expenses and
other long-term financial goals. Certain restrictions apply for retirement
accounts. Call 1-800-960-0188 for more information.
Share Price
Each Fund is open for business each day the New York Stock Exchange is open.
Each Fund calculates its net asset value (NAV) as of the close of business of
the NYSE, normally 4 p.m. eastern time.
Each Fund's NAV is the value of a single share. The NAV is computed by adding
the value of each Fund's investments, cash and other assets, subtracting its
liabilities and then dividing the result by the number of shares outstanding.
The NAV is also the redemption price (price to sell one share).
Each Fund's assets are valued primarily on the basis of market quotations. If
quotations are not readily available, assets are valued by a method that the
Board of Trustees believes accurately reflects fair value.
Purchases
* All of your purchases must be made in U.S. dollars, and checks must be
drawn on U.S. banks.
* The Funds do not accept cash, credit cards or third-party checks.
* If your check does not clear, your purchase will be canceled and you will
be liable for any losses or fees the Funds or the
Transfer Agent incurs.
* Your ability to make automatic investments may be immediately terminated if
any item is unpaid by your financial institution.
* Each Fund reserves the right to reject any purchase order.
For example, a purchase order may be refused if, in the Advisor's opinion, it is
so large that it would disrupt management of the Funds. Orders may also be
rejected from persons believed by the Advisor to be "market timers."
Certain financial institutions that have entered into sales agreements with the
Funds may enter confirmed purchase orders on behalf of customers by phone, with
payment to follow no later than the time when the Fund is priced on the
following business day.
If payment is not received by that time, the financial institution could be held
liable for resulting fees or losses.
These institutions may charge you a fee if you buy or sell shares through them.
Redemptions
* Normally, redemption proceeds will be mailed to you on the next business
day, but if making immediate payment could adversely affect the Funds, it
may take up to seven days to pay you.
* Redemptions may be suspended or payment dates postponed when the New York
Stock Exchange is closed (other than weekends or holidays), when trading on
the NYSE is restricted or as permitted by the SEC.
Dividends, Capital Gains and Taxes
The Funds distribute substantially all of their net income and capital gains, if
any, to shareholders each year. Normally, dividends and capital gains are
distributed in December.
Distribution Options
When you open an account, specify on your application how you want to receive
your distributions. If the option you prefer is not listed on the application,
call 1-800-960-0188 for instructions. The Funds offer three options:
1. Reinvestment Option. Your dividend and capital gains distributions will be
automatically reinvested in additional shares of the Funds. If you do not
indicate a choice on your application, you will be assigned this option.
2. Income-Earned Option. Your capital gains distributions will be automatically
reinvested, but you will be sent a check for each dividend distribution.
3. Cash Option. You will be sent a check for your dividend and capital gains
distributions.
For retirement accounts all distributions are automatically reinvested. When you
are over 59 1/2 years old, you can receive distributions in cash.
When a Fund deducts a distribution from its NAV, the reinvestment price is the
Fund's NAV at the close of business that day. Cash distribution checks will be
mailed within seven days.
Understanding Distributions
As a Fund shareholder, you are entitled to your share of the Fund's net income
and gains on its investments. The Funds pass their earnings along to investors
as distributions. Each Fund earns dividends from stocks and interest from
short-term investments. These are passed along as dividend distributions. Each
Fund realizes capital gains whenever it sells securities for a higher price than
it paid for them. These are passed along as capital gains distributions.
Taxes
As with any investment, you should consider how your investment in each Fund
will be taxed. If your account is not a tax-deferred retirement account, you
should be aware of these tax implications.
Taxes on Distributions. Distributions are subject to federal income tax and may
also be subject to state and local taxes. If you live outside of the United
States, your distributions could also be taxed by the country in which you
reside. Your distributions are taxable when they are paid, whether you take them
in cash or reinvest them. Distributions declared in December and paid in
January, however, are taxable as if they were paid on December 31.
For federal tax purposes, each Fund's income and short-term capital gains
distributions are taxed as dividends; long-term capital gains distributions are
taxed as long-term capital gains. Every January, each Fund will send you and the
IRS a statement showing the taxable distributions.
Taxes on Transactions. Your redemptions are subject to capital gains tax. A
capital gain or loss is the difference between the cost of your shares and the
price you receive when you sell them. Whenever you sell shares of a Fund, the
Fund will send you a confirmation statement showing how many shares you sold and
at what price. You will also receive a consolidated transaction statement every
January. It is up to you or your tax preparer, however, to determine whether the
sales resulted in a capital gain and, if so, the amount of the tax to be paid.
Be sure to keep your regular account statements; the information they contain
will be essential in calculating the amount of your capital gains.
"Buying a Dividend." If you buy shares just before a Fund deducts a distribution
from its NAV, you will pay the full price for the shares and then receive a
portion of the price back in the form of a taxable distribution.
There are tax requirements that all funds must follow in order to avoid federal
taxation. In their efforts to adhere to these requirements, the Funds may have
to limit their investment activity in some types of instruments.
When you sign your New Account Application, you will be asked to certify that
your Social Security or Taxpayer Identification number is correct and that you
are not subject to 31% withholding for failing to report income to the IRS. If
you violate IRS regulations, the IRS can require a fund to withhold 31% of your
taxable distributions and redemptions.
Performance
Mutual fund performance is commonly measured as total return. Total return is
the change in value of an investment over a given period, assuming reinvestment
of any dividends and capital gains. Total return reflects a Fund's performance
over a stated period of time. An average annual total return is a hypothetical
rate of return that, if achieved annually, would have produced the same total
return if performance had been constant over the entire period. Average annual
total return smooths out variations in performance; it is not the same as actual
year-by-year results.
Total return and average annual total return are based on past results and are
not a prediction of future performance. They do not include the effect of income
taxes paid by shareholders. The Funds may sometimes show their performance
compared with certain performance rankings, averages or stock indexes (described
more fully in the SAI).
General Information
The Masters' Select Equity Fund and the Masters' Select International Fund are
the only existing series of shares of Masters' Select Funds (the "Trust"). The
Board of Trustees may, at its own discretion, create additional series of
shares. The Declaration of Trust contains an express disclaimer of shareholder
liability for the Trust's acts or obligations and provides for indemnification
and reimbursement of expenses out of the Trust's property for any shareholder
held personally liable for its obligations.
Shareholders are entitled to one vote for each full share held (and fractional
votes for fractional shares) and may vote in the election of Trustees and on
other matters submitted to meetings of shareholders.
It is not contemplated that regular annual meetings of shareholders will be
held.
The Declaration of Trust provides that the shareholders have the right to remove
a Trustee. Upon the written request of the record holders of 10% of the Trust's
shares, the Trustees will call a meeting of shareholders to vote on the removal
of a Trustee. In addition, 10 shareholders holding the lesser of $25,000 worth
or 1% of the shares may communicate with other shareholders to request a meeting
to remove a Trustee. No amendment may be made to the Declaration of Trust that
would have a material adverse effect on shareholders without the approval of the
holders of more than 50% of the Trust's shares. Shareholders have no preemptive
or conversion rights. Shares when issued are fully paid and nonassessable,
except as set forth above.
The legality of share issuance is passed upon by Paul, Hastings, Janofsky &
Walker.
<PAGE>
Back Cover:
The Masters' Select Funds
P.O. Box 419922
Kansas City, MO 64141-6922
1-800-960-0188
First Fund Distributors, Inc.,
Phoenix, AZ 85018
(c) 1997 Litman/Gregory Fund Advisors, LLC.
All rights reserved.
<PAGE>
THE MASTERS' SELECT EQUITY FUND
Statement of Additional Information
Dated November 15, 1997
This Statement of Additional Information is not a prospectus, and it should be
read in conjunction with the prospectus dated November 15, 1997, as may be
amended from time to time, of The Masters' Select Equity Fund (the "Masters'
Select Equity" or "Equity Fund") and The Masters' Select International Fund (the
"Masters' Select International" or "International Fund"), a series of Masters'
Select Investment Trust (the "Trust"). Litman/Gregory Fund Advisors, LLC (the
"Advisor") is the Advisor of the Funds. The Advisor has retained investment
managers as sub-advisers ("Managers"), each responsible for portfolio management
of a segment of each Fund's total assets. A copy of the combined prospectus may
be obtained from the Trust at 4 Orinda Way, Suite 230-D, Orinda, California
94563, Telephone (510) 254-8999.
TABLE OF CONTENTS
Cross-reference to sections
Page in the prospectus
Investment Objective and Policies........... B-4 The Fund at a Glance; The
Fund in Detail
Management.................................. B-21 The Fund in Detail:
Management, Investment
Managers, Breakdown of
Expenses, Organization
Portfolio Transactions and Brokerage........ B-24 The Fund in Detail:
Investment Managers
Net Asset Value............................. B-25 Your Account: How to Buy
Shares
Taxation .................................. B-26 Taxes
Dividends and Distributions................. B-28 Dividends, Capital Gains,
and Taxes
Performance Information..................... B-29 Performance
General Information......................... B-30 General Information
Appendix.................................... B-30 Not applicable
Statement of Assets and Liabilities......... B-31 Not applicable
Notes to Statement of Assets and Liabilities B-31 Not applicable
B-1
<PAGE>
INVESTMENT OBJECTIVES AND POLICIES
The investment objective of each Fund is to provide long-term growth of
capital. There is no assurance that each Fund will achieve its objective. The
discussion below supplements information contained in the prospectus as to
investment policies of each Fund.
Convertible Securities and Warrants
Each Fund may invest in convertible securities and warrants. A
convertible security is a fixed income security (a debt instrument or a
preferred stock) which may be converted at a stated price within a specified
period of time into a certain quantity of the common stock of the same or a
different issuer. Convertible securities are senior to common stocks in an
issuer's capital structure, but are usually subordinated to similar
non-convertible securities. While providing a fixed income stream (generally
higher in yield than the income derivable from common stock but lower than that
afforded by a similar nonconvertible security), a convertible security also
affords an investor the opportunity, through its conversion feature, to
participate in the capital appreciation attendant upon a market price advance in
the convertible security's underlying common stock.
A warrant gives the holder a right to purchase at any time during a
specified period a predetermined number of shares of common stock at a fixed
price. Unlike convertible debt securities or preferred stock, warrants do not
pay a fixed dividend. Investments in warrants involve certain risks, including
the possible lack of a liquid market for resale of the warrants, potential price
fluctuations as a result of speculation or other factors, and failure of the
price of the underlying security to reach or have reasonable prospects of
reaching a level at which the warrant can be prudently exercised (in which event
the warrant may expire without being exercised, resulting in a loss of a Fund's
entire investment therein).
Other Corporate Debt Securities
Each Fund may invest in non-convertible debt securities of foreign and
domestic companies over a cross-section of industries. The debt securities in
which each Fund may invest will be of varying maturities and may include
corporate bonds, debentures, notes and other similar corporate debt instruments.
The value of a longer-term debt security fluctuates more widely in response to
changes in interest rates than do shorter-term debt securities.
Risks of Investing in Debt Securities
There are a number of risks generally associated with an investment in
debt securities (including convertible securities). Yields on short,
intermediate, and long-term securities depend on a variety of factors, including
the general condition of the money and bond markets, the size of a particular
offering, the maturity of the obligation, and the rating of the issue.
Debt securities with longer maturities tend to produce higher yields
and are generally subject to potentially greater capital appreciation and
depreciation than obligations with short maturities and lower yields. The market
prices of debt securities usually vary, depending upon available yields. An
increase in interest rates will generally reduce the value of such portfolio
investments, and a decline in interest rates will generally increase the value
of such portfolio investments. The ability of each Fund to achieve its
investment objective also depends on the continuing ability of the issuers of
the debt securities in which each Fund invests to meet their obligations for the
payment of interest and principal when due.
Risks of Investing in Lower-Rated Debt Securities
As set forth in the prospectus, each Fund may invest a portion of its
net assets in debt securities rated below "Baa" by Moody's or "BBB" by S&P or
below investment grade by other recognized rating agencies, or in unrated
securities of comparable quality under certain circumstances. Securities with
ratings below "Baa" and/or "BBB" are commonly referred to as "junk bonds." Such
bonds are subject to greater market fluctuations and risk of loss of income and
principal than higher rated bonds for a variety of reasons, including the
following:
Sensitivity to Interest Rate and Economic Changes. The economy and
interest rates affect high yield securities differently from other securities.
For example, the prices of high yield bonds have been found to be less sensitive
to interest rate changes than higher-rated investments, but more sensitive to
adverse economic changes or
B-2
<PAGE>
individual corporate developments. Also, during an economic downturn or
substantial period of rising interest rates, highly leveraged issuers may
experience financial stress which would adversely affect their ability to
service their principal and interest obligations, to meet projected business
goals, and to obtain additional financing. If the issuer of a bond defaults,
each Fund may incur additional expenses to seek recovery. In addition, periods
of economic uncertainty and changes can be expected to result in increased
volatility of market prices of high yield bonds and a Fund's asset values.
Payment Expectations. High yield bonds present certain risks based on
payment expectations. For example, high yield bonds may contain redemption and
call provisions. If an issuer exercises these provisions in a declining interest
rate market, a Fund would have to replace the security with a lower yielding
security, resulting in a decreased return for investors. Conversely, a high
yield bond's value will decrease in a rising interest rate market, as will the
value of a Fund's assets. If a Fund experiences unexpected net redemptions, it
may be forced to sell its high yield bonds without regard to their investment
merits, thereby decreasing the asset base upon which a Fund's expenses can be
spread and possibly reducing a Fund's rate of return.
Liquidity and Valuation. To the extent that there is no established
retail secondary market, there may be thin trading of high yield bonds, and this
may impact a Manager's ability to accurately value high yield bonds and a Fund's
assets and hinder a Fund's ability to dispose of the bonds. Adverse publicity
and investor perceptions, whether or not based on fundamental analysis, may
decrease the values and liquidity of high yield bonds, especially in a thinly
traded market.
Credit Ratings. Credit ratings evaluate the safety of principal and
interest payments, not the market value risk of high yield bonds. Also, since
credit rating agencies may fail to timely change the credit ratings to reflect
subsequent events, a Manager must monitor the issuers of high yield bonds in a
Fund's portfolio to determine if the issuers will have sufficient cash flow and
profits to meet required principal and interest payments, and to assure the
bonds' liquidity so a Fund can meet redemption requests. A Fund will not
necessarily dispose of a portfolio security when its rating has been changed.
Short-Term Investments
Each Fund may invest in any of the following securities and
instruments:
Bank Certificates or Deposit, Bankers' Acceptances and Time Deposits.
Each Fund may acquire certificates of deposit, bankers' acceptances and time
deposits. Certificates of deposit are negotiable certificates issued against
funds deposited in a commercial bank for a definite period of time and earning a
specified return. Bankers' acceptances are negotiable drafts or bills of
exchange, normally drawn by an importer or exporter to pay for specific
merchandise, which are "accepted" by a bank, meaning in effect that the bank
unconditionally agrees to pay the face value of the instrument on maturity.
Certificates of deposit and bankers' acceptances acquired by a Fund will be
dollar-denominated obligations of domestic or foreign banks or financial
institutions which at the time of purchase have capital, surplus and undivided
profits in excess of $100 million (including assets of both domestic and foreign
branches), based on latest published reports, or less than $100 million if the
principal amount of such bank obligations are fully insured by the U.S.
Government. If a Fund holds instruments of foreign banks or financial
institutions, it may be subject to additional investment risks that are
different in some respects from those incurred by a fund which invests only in
debt obligations of U.S. domestic issuers. See "Foreign Investments" below. Such
risks include future political and economic developments, the possible
imposition of withholding taxes by the particular country in which the issuer is
located on interest income payable on the securities, the possible seizure or
nationalization of foreign deposits, the possible establishment of exchange
controls or the adoption of other foreign governmental restrictions which might
adversely affect the payment of principal and interest on these securities.
Domestic banks and foreign banks are subject to different governmental
regulations with respect to the amount and types of loans which may be made and
interest rates which may be charged. In addition, the profitability of the
banking industry depends largely upon the availability and cost of funds for the
purpose of financing lending operations under prevailing money market
conditions. General economic conditions as well as exposure to credit losses
arising from possible financial difficulties of borrowers play an important part
in the operations of the banking industry.
As a result of federal and state laws and regulations, domestic banks
are, among other things, required to maintain specified levels of reserves,
limited in the amount which they can loan to a single borrower, and subject to
other regulations designed to promote financial soundness. However, such laws
and regulations do not necessarily apply to
B-3
<PAGE>
foreign bank obligations that a Fund may acquire.
In addition to purchasing certificates of deposit and bankers'
acceptances, to the extent permitted under its investment objectives and
policies stated above and in its prospectus, a Fund may make interest-bearing
time or other interest-bearing deposits in commercial or savings banks. Time
deposits are non-negotiable deposits maintained at a banking institution for a
specified period of time at a specified interest rate.
Savings Association Obligations. Each Fund may invest in certificates
of deposit (interest-bearing time deposits) issued by savings banks or savings
and loan associations that have capital, surplus and undivided profits in excess
of $100 million, based on latest published reports, or less than $100 million if
the principal amount of such obligations is fully insured by the U.S.
Government.
Commercial Paper, Short-Term Notes and Other Corporate Obligations.
Each Fund may invest a portion of its assets in commercial paper and short-term
notes. Commercial paper consists of unsecured promissory notes issued by
corporations. Issues of commercial paper and short-term notes will normally have
maturities of less than nine months and fixed rates of return, although such
instruments may have maturities of up to one year.
Commercial paper and short-term notes will consist of issues rated at
the time of purchase "A-2" or higher by S&P, "Prime-1" or "Prime-2" by Moody's,
or similarly rated by another nationally recognized statistical rating
organization or, if unrated, will be determined by a Manager to be of comparable
quality. These rating symbols are described in Appendix A.
Corporate obligations include bonds and notes issued by corporations to
finance longer-term credit needs than supported by commercial paper. While such
obligations generally have maturities of ten years or more, a Fund may purchase
corporate obligations which have remaining maturities of one year or less from
the date of purchase and which are rated "AA" or higher by S&P or "Aa" or higher
by Moody's.
Money Market Funds
Each Fund may under certain circumstances invest a portion of its
assets in money market funds. The Investment Company Act of 1940 (the "1940
Act") prohibits a Fund from investing more than 5% of the value of its total
assets in any one investment company. or more than 10% of the value of its total
assets in investment companies as a group, and also restricts its investment in
any investment company to 3% of the voting securities of such investment
company. The Advisor and the Managers will not impose advisory fees on assets of
a Fund invested in a money market mutual fund. However, an investment in a money
market mutual fund will involve payment by a Fund of its pro rata share of
advisory and administrative fees charged by such fund.
Government Obligations
Each Fund may make short-term investments in U.S. Government
obligations. Such obligations include Treasury bills, certificates of
indebtedness, notes and bonds, and issues of such entities as the Government
National Mortgage Association ("GNMA"), Export-Import Bank of the United States,
Tennessee Valley Authority, Resolution Funding Corporation, Farmers Home
Administration, Federal Home Loan Banks, Federal Intermediate Credit Banks,
Federal Farm Credit Banks, Federal Land Banks, Federal Housing Administration,
Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage
Corporation, and the Student Loan Marketing Association.
Some of these obligations, such as those of the GNMA, are supported by
the full faith and credit of the U.S. Treasury; others, such as those of the
Export-Import Bank of United States, are supported by the right of the issuer to
borrow from the Treasury; others, such as those of the FNMA, are supported by
the discretionary authority of the U.S. Government to purchase the agency's
obligations; still others, such as those of the Student Loan Marketing
Association, are supported only by the credit of the instrumentality. No
assurance can be given that the U.S. Government would provide financial support
to U.S. Government-sponsored instrumentalities if it is not obligated to do so
by law.
Each Fund may invest in sovereign debt obligations of foreign
countries. A sovereign debtor's willingness or ability to repay principal and
interest in a timely manner may be affected by a number of factors, including
its cash flow situation, the extent of its foreign reserves, the availability of
sufficient foreign exchange on the date a payment is due, the relative size of
the debt service burden to the economy as a whole, the sovereign debtor's policy
toward principal international lenders and the political constraints to which it
may be subject. Emerging market governments could default
B-4
<PAGE>
on their sovereign debt. Such sovereign debtors also may be dependent on
expected disbursements from foreign governments, multilateral agencies and other
entities abroad to reduce principal and interest arrearages on their debt. The
commitments on the part of these governments, agencies and others to make such
disbursements may be conditioned on a sovereign debtor's implementation of
economic reforms and/or economic performance and the timely service of such
debtor's obligations. Failure to meet such conditions could result in the
cancellation of such third parties' commitments to lend funds to the sovereign
debtor, which may further impair such debtor's ability or willingness to service
its debt in a timely manner.
Zero Coupon Securities
Each Fund may invest up to 35% of its net assets in zero coupon
securities issued by the U.S. Treasury. Zero coupon Treasury securities are U.S.
Treasury notes and bonds which have been stripped of their unmatured interest
coupons and receipts, or certificates representing interests in such stripped
debt obligations or coupons. Because a zero coupon security pays no interest to
its holder during its life or for a substantial period of time, it usually
trades at a deep discount from its face or par value and will be subject to
greater fluctuations of market value in response to changing interest rates than
debt obligations of comparable maturities which make current distributions of
interest.
Variable and Floating Rate Instruments
Each Fund may acquire variable and floating rate instruments. Such
instruments are frequently not rated by credit rating agencies; however, unrated
variable and floating rate instruments purchased by a Fund will be determined by
a Manager under guidelines established by the Trust's Board of Trustees to be of
comparable quality at the time of the purchase to rated instruments eligible for
purchase by a Fund. In making such determinations, a Manager will consider the
earning power, cash flow and other liquidity ratios of the issuers of such
instruments (such issuers include financial, merchandising, bank holding and
other companies) and will monitor their financial condition. An active secondary
market may not exist with respect to particular variable or floating rate
instruments purchased by a Fund. The absence of such an active secondary market
could make it difficult for a Fund to dispose of the variable or floating rate
instrument involved in the event of the issuer of the instrument defaulting on
its payment obligation or during periods in which a Fund is not entitled to
exercise its demand rights, and a Fund could, for these or other reasons, suffer
a loss to the extent of the default. Variable and floating rate instruments may
be secured by bank letters of credit.
Mortgage-Related Securities
Each Fund may invest in mortgage-related securities. Mortgage-related
securities are derivative interests in pools of mortgage loans made to U.S.
residential home buyers, including mortgage loans made by savings and loan
institutions, mortgage bankers, commercial banks and others. Pools of mortgage
loans are assembled as securities for sale to investors by various governmental,
government-related and private organizations. Each Fund may also invest in debt
securities which are secured with collateral consisting of U.S. mortgage-related
securities, and in other types of U.S. mortgage-related securities.
U.S. Mortgage Pass-Through Securities. Interests in pools of
mortgage-related securities differ from other forms of debt securities, which
normally provide for periodic payment of interest in fixed amounts with
principal payments at maturity or specified call dates. Instead, these
securities provide a monthly payment which consists of both interest and
principal payments. In effect, these payments are a "pass-through" of the
monthly payments made by the individual borrowers on their residential mortgage
loans, net of any fees paid to the issuer or guarantor of such securities.
Additional payments are caused by repayments of principal resulting from the
sale of the underlying residential property, refinancing or foreclosure, net of
fees or costs which may be incurred. Some mortgage-related securities (such as
securities issued by GNMA) are described as "modified pass-throughs." These
securities entitle the holder to receive all interest and principal payments
owed on the mortgage pool, net of certain fees, at the scheduled payment dates
regardless of whether or not the mortgagor actually makes the payment.
The principal governmental guarantor of U.S. mortgage-related
securities is GNMA, a wholly owned United States Government corporation within
the Department of Housing and Urban Development. GNMA is authorized to
guarantee, with the full faith and credit of the United States Government, the
timely payment of principal and interest on securities issued by institutions
approved by GNMA (such as savings and loan institutions, commercial banks and
mortgage bankers) and backed by pools of mortgages insured by the Federal
Housing Agency or guaranteed by the
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Veterans Administration.
Government-related guarantors include the Federal National Mortgage
Association ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC").
FNMA is a government-sponsored corporation owned entirely by private
stockholders and subject to general regulation by the Secretary of Housing and
Urban Development. FNMA purchases conventional residential mortgages not insured
or guaranteed by any government agency from a list of approved seller/services
which include state and federally chartered savings and loan associations,
mutual savings banks, commercial banks and credit unions and mortgage bankers.
FHLMC is a government-sponsored corporation created to increase availability of
mortgage credit for residential housing and owned entirely by private
stockholders. FHLMC issues participation certificates which represent interests
in conventional mortgages from FHLMC's national portfolio. Pass- through
securities issued by FNMA and participation certificates issued by FHLMC are
guaranteed as to timely payment of principal and interest by FNMA and FHLMC,
respectively, but are not backed by the full faith and credit of the United
States Government.
Although the underlying mortgage loans in a pool may have maturities of
up to 30 years, the actual average life of the pool certificates typically will
be substantially less because the mortgages will be subject to normal principal
amortization and may be prepaid prior to maturity. Prepayment rates vary widely
and may be affected by changes in market interest rates. In periods of falling
interest rates, the rate of prepayment tends to increase, thereby shortening the
actual average life of the pool certificates. Conversely, when interest rates
are rising, the rate of prepayments tends to decrease, thereby lengthening the
actual average life of the certificates. Accordingly, it is not possible to
predict accurately the average life of a particular pool.
Collateralized Mortgage Obligations ("CMOs"). A domestic or foreign CMO
in which a Fund may invest is a hybrid between a mortgage-backed bond and a
mortgage pass-through security. Like a bond, interest is paid, in most cases,
semiannually. CMOs may be collateralized by whole mortgage loans, but are more
typically collateralized by portfolios of mortgage pass-through securities
guaranteed by GNMA, FHLMC, FNMA or equivalent foreign entities.
CMOs are structured into multiple classes, each bearing a different
stated maturity. Actual maturity and average life depend upon the prepayment
experience of the collateral. CMOs provide for a modified form of call
protection through a de facto breakdown of the underlying pool of mortgages
according to how quickly the loans are repaid. Monthly payment of principal and
interest received from the pool of underlying mortgages, including prepayments,
is first returned to the class having the earliest maturity date or highest
maturity. Classes that have longer maturity dates and lower seniority will
receive principal only after the higher class has been retired.
Foreign Investments and Currencies
Each Fund may invest in securities of foreign issuers that are not
publicly traded in the United States (the International Fund will invest
substantially all of its assets in securities of foreign issuers). Each Fund may
also invest in depositary receipts and in foreign currency futures contracts and
may purchase and sell foreign currency on a spot basis.
Depositary Receipts. Depositary Receipts ("DRs") include American
Depositary Receipts ("ADRs"), European Depositary Receipts ("EDRs"), Global
Depositary Receipts ("GDRs") or other forms of depositary receipts. DRs are
receipts typically issued in connection with a U.S. or foreign bank or trust
company which evidence ownership of underlying securities issued by a foreign
corporation.
Risks of Investing in Foreign Securities. Investments in foreign
securities involve certain inherent risks, including the following:
Political and Economic Factors. Individual foreign economies of certain
countries may differ favorably or unfavorably from the United States' economy in
such respects as growth of gross national product, rate of inflation, capital
reinvestment, resource self-sufficiency, diversification and balance of payments
position. The internal politics of certain foreign countries may not be as
stable as those of the United States. Governments in certain foreign countries
also continue to participate to a significant degree, through ownership interest
or regulation, in their respective economies. Action by these governments could
include restrictions on foreign investment, nationalization, expropriation of
goods or imposition of taxes, and could have a significant effect on market
prices of securities and payment of interest. The economies of many foreign
countries are heavily dependent upon international trade and are accordingly
affected by the
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trade policies and economic conditions of their trading partners. Enactment by
these trading partners of protectionist trade legislation could have a
significant adverse effect upon the securities markets of such countries.
Currency Fluctuations. Each Fund may invest in securities denominated
in foreign currencies. Accordingly, a change in the value of any such currency
against the U.S. dollar will result in a corresponding change in the U.S. dollar
value of a Fund's assets denominated in that currency. Such changes will also
affect a Fund's income. The value of a Fund's assets may also be affected
significantly by currency restrictions and exchange control regulations enacted
from time to time.
Market Characteristics. The Managers expect that many foreign
securities in which a Fund invests will be purchased in over-the-counter markets
or on exchanges located in the countries in which the principal offices of the
issuers of the various securities are located, if that is the best available
market. Foreign exchanges and markets may be more volatile than those in the
United States. While growing in volume, they usually have substantially less
volume than U.S. markets, and a Fund's portfolio securities may be less liquid
and more volatile than U.S. Government securities. Moreover, settlement
practices for transactions in foreign markets may differ from those in United
States markets, and may include delays beyond periods customary in the United
States. Foreign security trading practices, including those involving securities
settlement where Fund assets may be released prior to receipt of payment or
securities, may expose a Fund to increased risk in the event of a failed trade
or the insolvency of a foreign broker-dealer.
Transactions in options on securities, futures contracts, futures
options and currency contracts may not be regulated as effectively on foreign
exchanges as similar transactions in the United States, and may not involve
clearing mechanisms and related guarantees. The value of such positions also
could be adversely affected by the imposition of different exercise terms and
procedures and margin requirements than in the United States. The value of a
Fund's positions may also be adversely impacted by delays in its ability to act
upon economic events occurring in foreign markets during non-business hours in
the United States.
Legal and Regulatory Matters. Certain foreign countries may have less
supervision of securities markets, brokers and issuers of securities, and less
financial information available to issuers, than is available in the United
States.
Taxes. The interest payable on certain of a Fund's foreign portfolio
securities may be subject to foreign withholding taxes, thus reducing the net
amount of income available for distribution to a Fund's shareholders.
Costs. To the extent that each Fund invests in foreign securities, its
expense ratio is likely to be higher than those of investment companies
investing only in domestic securities, since the cost of maintaining the custody
of foreign securities is higher.
Emerging markets. Some of the securities in which each Fund may invest
may be located in developing or emerging markets, which entail additional risks,
including less social, political and economic stability; smaller securities
markets and lower trading volume, which may result in a less liquidity and
greater price volatility; national policies that may restrict a Fund's
investment opportunities, including restrictions on investment in issuers or
industries, or expropriation or confiscation of assets or property; and less
developed legal structures governing private or foreign investment.
In considering whether to invest in the securities of a foreign
company, a Manager considers such factors as the characteristics of the
particular company, differences between economic trends and the performance of
securities markets within the U.S. and those within other countries, and also
factors relating to the general economic, governmental and social conditions of
the country or countries where the company is located. The extent to which a
Fund will be invested in foreign companies and countries and depository receipts
will fluctuate from time to time within the limitations described in the
prospectus, depending on a Manager's assessment of prevailing market, economic
and other conditions.
Options on Securities and Securities Indices
Purchasing Put and Call Options. Each Fund may purchase covered "put"
and "call" options with respect to securities which are otherwise eligible for
purchase by a Fund and with respect to various stock indices subject to certain
restrictions. Each Fund will engage in trading of such derivative securities
primarily for hedging purposes.
If a Fund purchases a put option, a Fund acquires the right to sell the
underlying security at a specified price at any time during the term of the
option (for "American-style" options) or on the option expiration date (for
"European- style" options). Purchasing put options may be used as a portfolio
investment strategy when a Manager perceives significant short-term risk but
substantial long-term appreciation for the underlying security. The put option
acts as an insurance policy, as it protects against significant downward price
movement while it allows full participation in any upward movement. If a Fund is
holding a stock which it feels has strong fundamentals, but for some reason may
be weak in the near term, a Fund may purchase a put option on such security,
thereby giving itself the right to sell such security at a certain strike price
throughout the term of the option. Consequently, a Fund will exercise the put
only if the price of such security falls below the strike price of the put. The
difference between the put's strike price and the market price of the underlying
security on the date a Fund exercises the put, less transaction costs, will be
the amount by which a Fund will be able to hedge against a decline in the
underlying security. If during the period of the option the market price for the
underlying security remains at or above the put's strike price, the put will
expire worthless, representing a loss of the price a Fund paid for the put, plus
transaction costs. If the price of the underlying security increases, the profit
a Fund realizes on the sale of the security will be reduced by the premium paid
for the put option less any amount for which the put may be sold.
If a Fund purchases a call option, it acquires the right to purchase
the underlying security at a specified price at any time during the term of the
option. The purchase of a call option is a type of insurance policy to hedge
against losses that could occur if a Fund has a short position in the underlying
security and the security thereafter increases in price. Each Fund will exercise
a call option only if the price of the underlying security is above the strike
price at the time of exercise. If during the option period the market price for
the underlying security remains at or below the strike price of the call option,
the option will expire worthless, representing a loss of the price paid for the
option, plus transaction costs. If the call option has been purchased to hedge a
short position of a Fund in the underlying security and the price of the
underlying security thereafter falls, the profit a Fund realizes on the cover of
the short position in the security will be reduced by the premium paid for the
call option less any amount for which such option may be sold.
Prior to exercise or expiration, an option may be sold when it has
remaining value by a purchaser through a "closing sale transaction," which is
accomplished by selling an option of the same series as the option previously
purchased. Each Fund generally will purchase only those options for which a
Manager believes there is an active secondary market to facilitate closing
transactions.
Writing Call Options. Each Fund may write covered call options. A call
option is "covered" if a Fund owns the security underlying the call or has an
absolute right to acquire the security without additional cash consideration
(or, if additional cash consideration is required, cash or cash equivalents in
such amount as are held in a segregated account by the Custodian). The writer of
a call option receives a premium and gives the purchaser the right to buy the
security underlying the option at the exercise price. The writer has the
obligation upon exercise of the option to deliver the underlying security
against payment of the exercise price during the option period. If the writer of
an exchange-traded option wishes to terminate his obligation, he may effect a
"closing purchase transaction." This is accomplished by buying an option of the
same series as the option previously written. A writer may not effect a closing
purchase transaction after it has been notified of the exercise of an option.
Effecting a closing transaction in the case of a written call option
will permit a Fund to write another call option on the underlying security with
either a different exercise price, expiration date or both. Also, effecting a
closing transaction will permit the cash or proceeds from the concurrent sale of
any securities subject to the option to be used for other investments of a Fund.
If a Fund desires to sell a particular security from its portfolio on which it
has written a call option, it will effect a closing transaction prior to or
concurrent with the sale of the security.
Each Fund will realize a gain from a closing transaction if the cost of
the closing transaction is less than the premium received from writing the
option or if the proceeds from the closing transaction are more than the premium
paid to purchase the option. Each Fund will realize a loss from a closing
transaction if the cost of the closing transaction is more than the premium
received from writing the option or if the proceeds from the closing transaction
are less than the premium paid to purchase the option. However, because
increases in the market price of a call option will generally reflect increases
in the market price of the underlying security, any loss to a Fund resulting
from the repurchase of a call option is likely to be offset in whole or in part
by appreciation of the underlying security owned by a Fund.
Stock Index Options. Each Fund may also purchase put and call options
with respect to the S&P 500 and other stock indices. Such options may be
purchased as a hedge against changes resulting from market conditions in the
values of securities which are held in a Fund's portfolio or which it intends to
purchase or sell, or when they are economically
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appropriate for the reduction of risks inherent in the ongoing management of a
Fund.
The distinctive characteristics of options on stock indices create
certain risks that are not present with stock options generally. Because the
value of an index option depends upon movements in the level of the index rather
than the price of a particular stock, whether a Fund will realize a gain or loss
on the purchase or sale of an option on an index depends upon movements in the
level of stock prices in the stock market generally rather than movements in the
price of a particular stock. Accordingly, successful use by a Fund of options on
a stock index would be subject to a Manager's ability to predict correctly
movements in the direction of the stock market generally. This requires
different skills and techniques than predicting changes in the price of
individual stocks.
Index prices may be distorted if trading of certain stocks included in
the index is interrupted. Trading of index options also may be interrupted in
certain circumstances, such as if trading were halted in a substantial number of
stocks included in the index. If this were to occur, a Fund would not be able to
close out options which it had purchased, and if restrictions on exercise were
imposed, a Fund might be unable to exercise an option it holds, which could
result in substantial losses to a Fund. It is the policy of each Fund to
purchase put or call options only with respect to an index which a Manager
believes includes a sufficient number of stocks to minimize the likelihood of a
trading halt in the index.
Risks Of Investing in Options. There are several risks associated with
transactions in options on securities and indices. Options may be more volatile
than the underlying instruments and, therefore, on a percentage basis, an
investment in options may be subject to greater fluctuation than an investment
in the underlying instruments themselves. There are also significant differences
between the securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction not to achieve
its objective. In addition, a liquid secondary market for particular options may
be absent for reasons which include the following: there may be insufficient
trading interest in certain options; restrictions may be imposed by an exchange
on opening transactions or closing transactions or both; trading halts,
suspensions or other restrictions may be imposed with respect to particular
classes or series of option of underlying securities; unusual or unforeseen
circumstances may interrupt normal operations on an exchange; the facilities of
an exchange or clearing corporation may not at all times be adequate to handle
current trading volume; or one or more exchanges could, for economic or other
reasons, decide or be compelled at some future date to discontinue the trading
of options (or a particular class or series of options), in which event the
secondary market on that exchange (or in that class or series of options) would
cease to exist, although outstanding options that had been issued by a clearing
corporation as a result of trades on that exchange would continue to be
exercisable in accordance with their terms.
A decision as to whether, when and how to use options involves the
exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events. The
extent to which a Fund may enter into options transactions may be limited by the
Internal Revenue Code (the "Code") requirements for qualification of a Fund as a
regulated investment company. See "Dividends and Distributions" and "Taxation."
In addition, when trading options on foreign exchanges, many of the
protections afforded to participants in United States option exchanges will not
be available. For example, there may be no daily price fluctuation limits in
such exchanges or markets, and adverse market movements could therefore continue
to an unlimited extent over a period of time. Although the purchaser of an
option cannot lose more than the amount of the premium plus related transaction
costs, this entire amount could be lost. Moreover, a Fund as an option writer
could lose amounts substantially in excess of its initial investment, due to the
margin and collateral requirements typically associated with such option
writing. See "Dealer Options" below.
Dealer Options. Each Fund will engage in transactions involving dealer
options as well as exchange-traded options. Certain risks are specific to dealer
options. While a Fund might look to a clearing corporation to exercise
exchange-traded options, if a Fund were to purchase a dealer option it would
need to rely on the dealer from which it purchased the option to perform if the
option were exercised. Failure by the dealer to do so would result in the loss
of the premium paid by a Fund as well as loss of the expected benefit of the
transaction.
Exchange-traded options generally have a continuous liquid market while
dealer options may not. Consequently, a Fund may generally be able to realize
the value of a dealer option it has purchased only by exercising or reselling
the option to the dealer who issued it. Similarly, when a Fund writes a dealer
option, a Fund may generally be able to close out the option prior to its
expiration only by entering into a closing purchase transaction with the dealer
to whom a Fund
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originally wrote the option. While a Fund will seek to enter into dealer options
only with dealers who will agree to and which are expected to be capable of
entering into closing transactions with a Fund, there can be no assurance that a
Fund will at any time be able to liquidate a dealer option at a favorable price
at any time prior to expiration. Unless a Fund, as a covered dealer call option
writer, is able to effect a closing purchase transaction, it will not be able to
liquidate securities (or other assets) used as cover until the option expires or
is exercised. In the event of insolvency of the other party, a Fund may be
unable to liquidate a dealer option. With respect to options written by a Fund,
the inability to enter into a closing transaction may result in material losses
to a Fund. For example, because a Fund must maintain a secured position with
respect to any call option on a security it writes, a Fund may not sell the
assets which it has segregated to secure the position while it is obligated
under the option. This requirement may impair a Fund's ability to sell portfolio
securities at a time when such sale might be advantageous.
The Staff of the Securities and Exchange Commission (the "Commission")
has taken the position that purchased dealer options are illiquid securities. A
Fund may treat the cover used for written dealer options as liquid if the dealer
agrees that a Fund may repurchase the dealer option it has written for a maximum
price to be calculated by a predetermined formula. In such cases, the dealer
option would be considered illiquid only to the extent the maximum purchase
price under the formula exceeds the intrinsic value of the option. Accordingly,
each Fund will treat dealer options as subject to a Fund's limitation on
illiquid securities. If the Commission changes its position on the liquidity of
dealer options, each Fund will change its treatment of such instruments
accordingly.
Foreign Currency Options. Each Fund may buy or sell put and call
options on foreign currencies. A put or call option on a foreign currency gives
the purchaser of the option the right to sell or purchase a foreign currency at
the exercise price until the option expires. Each Fund will use foreign currency
options separately or in combination to control currency volatility. Among the
strategies employed to control currency volatility is an option collar. An
option collar involves the purchase of a put option and the simultaneous sale of
call option on the same currency with the same expiration date but with
different exercise (or "strike") prices. Generally, the put option will have an
out-of-the-money strike price, while the call option will have either an
at-the-money strike price or an in-the-money strike price. Foreign currency
options are derivative securities. Currency options traded on U.S. or other
exchanges may be subject to position limits which may limit the ability of a
Fund to reduce foreign currency risk using such options.
As with other kinds of option transactions, the writing of an option on
foreign currency will constitute only a partial hedge, up to the amount of the
premium received. Each Fund could be required to purchase or sell foreign
currencies at disadvantageous exchange rates, thereby incurring losses. The
purchase of an option on foreign currency may constitute an effective hedge
against exchange rate fluctuations: however, in the event of exchange rate
movements adverse to a Fund's position, a Fund may forfeit the entire amount of
the premium plus related transaction costs.
Spread Transactions. Each Fund may purchase covered spread options from
securities dealers. These covered spread options are not presently
exchange-listed or exchange-traded. The purchase of a spread option gives a Fund
the right to put a securities that it owns at a fixed dollar spread or fixed
yield spread in relationship to another security that a Fund does not own, but
which is used as a benchmark. The risk to a Fund, in addition to the risks of
dealer options described above, is the cost of the premium paid as well as any
transaction costs. The purchase of spread options will be used to protect a Fund
against adverse changes in prevailing credit quality spreads, i.e., the yield
spread between high quality and lower quality securities. This protection is
provided only during the life of the spread options.
Forward Currency Contracts
Each Fund may enter into forward currency contracts in anticipation of
changes in currency exchange rates. A forward currency contract is an obligation
to purchase or sell a specific currency at a future date, which may be any fixed
number of days from the date of the contract agreed upon by the parties, at a
price set at the time of the contract. For example, a Fund might purchase a
particular currency or enter into a forward currency contract to preserve the
U.S. dollar price of securities it intends to or has contracted to purchase.
Alternatively, it might sell a particular currency on either a spot or forward
basis to hedge against an anticipated decline in the dollar value of securities
it intends to or has contracted to sell. Although this strategy could minimize
the risk of loss due to a decline in the value of the hedged currency, it could
also limit any potential gain from an increase in the value of the currency.
Futures Contracts and Related Options
Each Fund may invest in futures contracts and options on futures
contracts as a hedge against changes in market
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conditions or interest rates. A Fund will trade in such derivative securities
for bona fide hedging purposes and otherwise in accordance with the rules of the
Commodity Futures Trading Commission ("CFTC"). A Fund will segregate liquid
assets in a separate account with its Custodian when required to do so by CFTC
guidelines in order to cover its obligation in connection with futures and
options transactions.
No price is paid or received by a Fund upon the purchase or sale of a
futures contract. When it enters into a domestic futures contract, a Fund will
be required to deposit in a segregated account with its Custodian an amount of
cash or U.S. Treasury bills equal to approximately 5% of the contract amount.
This amount is known as initial margin. The margin requirements for foreign
futures contracts may be different.
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The nature of initial margin in futures transactions is different from
that of margin in securities transactions. Futures contract margin does not
involve the borrowing of funds by the customer to finance the transactions.
Rather, the initial margin is in the nature of a performance bond or good faith
deposit on the contract which is returned to a Fund upon termination of the
futures contract, assuming all contractual obligations have been satisfied.
Subsequent payments (called variation margin) to and from the broker will be
made on a daily basis as the price of the underlying stock index fluctuates, to
reflect movements in the price of the contract making the long and short
positions in the futures contract more or less valuable. For example, when a
Fund has purchased a stock index futures contract and the price of the
underlying stock index has risen, that position will have increased in value and
a Fund will receive from the broker a variation margin payment equal to that
increase in value. Conversely, when a Fund has purchased a stock index futures
contract and the price of the underlying stock index has declined, the position
will be less valuable and a Fund will be required to make a variation margin
payment to the broker.
At any time prior to expiration of a futures contract, a Fund may elect
to close the position by taking an opposite position, which will operate to
terminate a Fund's position in the futures contract A final determination of
variation margin is made on closing the position. Additional cash is paid by or
released to a Fund, which realizes a loss or a gain.
In addition to amounts segregated or paid as initial and variation
margin, a Fund must segregate liquid assets with its custodian equal to the
market value of the futures contracts, in order to comply with Commission
requirements intended to ensure that a Fund's use of futures is unleveraged. The
requirements for margin payments and segregated accounts apply to both domestic
and foreign futures contracts.
Stock Index Futures Contracts. Each Fund may invest in futures
contracts on stock indices. Currently, stock index futures contracts can be
purchased or sold with respect to the S&P 500 Stock Price Index on the Chicago
Mercantile Exchange, the Major Market Index on the Chicago Board of Trade, the
New York Stock Exchange Composite Index on the New York Futures Exchange and the
Value Line Stock Index on the Kansas City Board of Trade. Foreign financial and
stock index futures are traded on foreign exchanges including the London
International Financial Futures Exchange, the Singapore International Monetary
Exchange, the Sydney Futures Exchange Limited and the Tokyo Stock Exchange.
Interest Rate or Financial Futures Contracts. Each Fund may invest in
interest rate or financial futures contracts. Bond prices are established in
both the cash market and the futures market. In the cash market, bonds are
purchased and sold with payment for the full purchase price of the bond being
made in cash, generally within five business days after the trade. In the
futures market, a contract is made to purchase or sell a bond in the future for
a set price on a certain date. Historically, the prices for bonds established in
the futures markets have generally tended to move in the aggregate in concert
with cash market prices, and the prices have maintained fairly predictable
relationships.
The sale of an interest rate or financial futures contract by a Fund
would create an obligation by a Fund, as seller, to deliver the specific type of
financial instrument called for in the contract at a specific future time for a
specified price. A futures contract purchased by a Fund would create an
obligation by a Fund, as purchaser, to take delivery of the specific type of
financial instrument at a specific future time at a specific price. The specific
securities delivered or taken, respectively, at settlement date, would not be
determined until at or near that date. The determination would be in accordance
with the rules of the exchange on which the futures contract sale or purchase
was made.
Although interest rate or financial futures contracts by their terms
call for actual delivery or acceptance of securities, in most cases the
contracts are closed out before the settlement date without delivery of
securities. Closing out of a futures contract sale is effected by a Fund's
entering into a futures contract purchase for the same aggregate amount of the
specific type of financial instrument and the same delivery date. If the price
in the sale exceeds the price in the offsetting purchase, a Fund is paid the
difference and thus realizes a gain. If the offsetting purchase price exceeds
the sale price, a Fund pays the difference and realizes a loss. Similarly, the
closing out of a futures contract purchase is effected by a Fund's entering into
a futures contract sale. If the offsetting sale price exceeds the purchase
price, a Fund realizes a gain, and if the purchase price exceeds the offsetting
sale price, a Fund realizes a loss.
Each Fund will deal only in standardized contracts on recognized
exchanges. Each exchange guarantees performance under contract provisions
through a clearing corporation, a nonprofit organization managed by the exchange
membership. Domestic interest rate futures contracts are traded in an auction
environment on the floors of several exchanges - principally, the Chicago Board
of Trade and the Chicago Mercantile Exchange. A public market now exists
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in domestic futures contracts covering various financial instruments including
long-term United States Treasury bonds and notes; GNMA modified pass-through
mortgage-backed securities; three-month United States Treasury bills; and 90-
day commercial paper. Each Fund may trade in any futures contract for which
there exists a public market, including, without limitation, the foregoing
instruments. International interest rate futures contracts are traded on the
London International Financial Futures Exchange, the Singapore International
Monetary Exchange, the Sydney Futures Exchange Limited and the Tokyo Stock
Exchange.
Foreign Currency Futures Contracts. Each Fund may use foreign currency
future contracts for hedging purposes. A foreign currency futures contract
provides for the future sale by one party and purchase by another party of a
specified quantity of a foreign currency at a specified price and time. A public
market exists in futures contracts covering several foreign currencies,
including the Australian dollar, the Canadian dollar, the British pound, the
German mark, the Japanese yen, the Swiss franc, and certain multinational
currencies such as the European Currency Unit ("ECU"). Other foreign currency
futures contracts are likely to be developed and traded in the future. Each Fund
will only enter into futures contracts and futures options which are
standardized and traded on a U.S. or foreign exchange, board of trade, or
similar entity, or quoted on an automated quotation system.
Risks of Transactions in Futures Contracts. There are several risks
related to the use of futures as a hedging device. One risk arises because of
the imperfect correlation between movements in the price of the futures contract
and movements in the price of the securities which are the subject of the hedge.
The price of the future may move more or less than the price of the securities
being hedged. If the price of the future moves less than the price of the
securities which are the subject of the hedge, the hedge will not be fully
effective, but if the price of the securities being hedged has moved in an
unfavorable direction, a Fund would be in a better position than if it had not
hedged at all. If the price of the securities being hedged has moved in a
favorable direction, this advantage will be partially offset by the loss on the
future. If the price of the future moves more than the price of the hedged
securities, a Fund will experience either a loss or a gain on the future which
will not be completely offset by movements in the price of the securities which
are subject to the hedge.
To compensate for the imperfect correlation of movements in the price
of securities being hedged and movements in the price of the futures contract, a
Fund may buy or sell futures contracts in a greater dollar amount than the
dollar amount of securities being hedged if the historical volatility of the
prices of such securities has been greater than the historical volatility over
such time period of the future. Conversely, a Fund may buy or sell fewer futures
contracts if the historical volatility of the price of the securities being
hedged is less than the historical volatility of the futures contract being
used. It is possible that, when a Fund has sold futures to hedge its portfolio
against a decline in the market, the market may advance while the value of
securities held in a Fund's portfolio may decline. If this occurs, a Fund will
lose money on the future and also experience a decline in value in its portfolio
securities. However, the Advisor believes that over time the value of a
diversified portfolio will tend to move in the same direction as the market
indices upon which the futures are based.
Where futures are purchased to hedge against a possible increase in the
price of securities before a Fund is able to invest its cash (or cash
equivalents) in securities (or options) in an orderly fashion, it is possible
that the market may decline instead. If a Fund then decides not to invest in
securities or options at that time because of concern as to possible further
market decline or for other reasons, it will realize a loss on the futures
contract that is not offset by a reduction in the price of securities purchased.
In addition to the possibility that there may be an imperfect
correlation, or no correlation at all, between movements in the futures and the
securities being hedged, the price of futures may not correlate perfectly with
movement in the stock index or cash market due to certain market distortions.
All participants in the futures market are subject to margin deposit and
maintenance requirements. Rather than meeting additional margin deposit
requirements, investors may close futures contracts through offsetting
transactions, which could distort the normal relationship between the index or
cash market and futures markets. In addition, the deposit requirements in the
futures market are less onerous than margin requirements in the securities
market. Therefore, increased participation by speculators in the futures market
may also cause temporary price distortions. As a result of price distortions in
the futures market and the imperfect correlation between movements in the cash
market and the price of securities and movements in the price of futures, a
correct forecast of general trends by a Manager may still not result in a
successful hedging transaction over a very short time frame.
Positions in futures may be closed out only on an exchange or board of
trade which provides a secondary market
B-12
<PAGE>
for such futures. Although a Fund may intend to purchase or sell futures only on
exchanges or boards of trade where there appears to be an active secondary
market, there is no assurance that a liquid secondary market on an exchange or
board of trade will exist for any particular contract or at any particular time.
In such event, it may not be possible to close a futures position, and in the
event of adverse price movements, a Fund would continue to be required to make
daily cash payments of variation margin. When futures contracts have been used
to hedge portfolio securities, such securities will not be sold until the
futures contract can be terminated. In such circumstances, an increase in the
price of the securities, if any, may partially or completely offset losses on
the futures contract. However, as described above, there is no guarantee that
the price of the securities will in fact correlate with the price movements in
the futures contract and thus provide an offset to losses on a futures contract.
Most United States futures exchanges limit the amount of fluctuation
permitted in futures contract prices during a single trading day. The daily
limit establishes the maximum amount that the price of a futures contract may
vary either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
futures contract, no trades may be made on that day at a price beyond that
limit. The daily limit governs only price movement during a particular trading
day and therefore does not limit potential losses, because the limit may prevent
the liquidation of unfavorable positions. Futures contract prices have
occasionally moved to the daily limit for several consecutive trading days with
little or no trading, thereby preventing prompt liquidation of futures positions
and subjecting some futures traders to substantial losses.
Successful use of futures by a Fund is also subject to a Manager's
ability to predict correctly movements in the direction of the market. For
example, if a Fund has hedged against the possibility of a decline in the market
adversely affecting stocks held in its portfolio and stock prices increase
instead, a Fund will lose part or all of the benefit of the increased value of
the stocks which it has hedged because it will have offsetting losses in its
futures positions. In addition, in such situations, if a Fund has insufficient
cash, it may have to sell securities to meet daily variation margin
requirements. Such sales of securities may be, but will not necessarily be, at
increased prices which reflect the rising market. Each Fund may have to sell
securities at a time when it may be disadvantageous to do so.
In the event of the bankruptcy of a broker through which a Fund engages
in transactions in futures contracts or options, a Fund could experience delays
and losses in liquidating open positions purchased or sold through the broker,
and incur a loss of all or part of its margin deposits with the broker.
Options on Futures Contracts. As described above, each Fund may
purchase options on the futures contracts they can purchase or sell. A futures
option gives the holder, in return for the premium paid, the right to buy (call)
from or sell (put) to the writer of the option a futures contract at a specified
price at any time during the period of the option. Upon exercise, the writer of
the option is obligated to pay the difference between the cash value of the
futures contract and the exercise price. Like the buyer or seller of a futures
contract, the holder or writer of an option has the right to terminate its
position prior to the scheduled expiration of the option by selling, or
purchasing an option of the same series, at which time the person entering into
the closing transaction will realize a gain or loss. There is no guarantee that
such closing transactions can be effected.
Investments in futures options involve some of the same considerations
as investments in futures contracts (for example, the existence of a liquid
secondary market). In addition, the purchase of an option also entails the risk
that changes in the value of the underlying futures contract will not be fully
reflected in the value of the option. Depending on the pricing of the option
compared to either the futures contract upon which it is based, or upon the
price of the securities being hedged, an option may or may not be less risky
than ownership of the futures contract or such securities. In general, the
market prices of options can be expected to be more volatile than the market
prices on the underlying futures contracts. Compared to the purchase or sale of
futures contracts, however, the purchase of call or put options on futures
contracts may frequently involve less potential risk to a Fund because the
maximum amount at risk is limited to the premium paid for the options (plus
transaction costs).
Restrictions on the Use or Futures Contracts and Related Options. Each
Fund will engage in transactions in futures contracts or related options
primarily as a hedge against changes resulting from market conditions in the
values of securities held in a Fund's portfolio or which it intends to purchase
and where the transactions are economically appropriate to the reduction of
risks inherent in the ongoing management of each Fund. A Fund may not purchase
or sell futures or purchase related options if, immediately thereafter, more
than 25% of its net assets would be hedged. A Fund also may not purchase or sell
futures or purchase related options if, immediately thereafter, the sum of the
amount of margin deposits on a Fund's existing futures positions and premiums
paid for such options would exceed 5% of the
B-13
<PAGE>
market value of a Fund's net assets.
These restrictions, which are derived from current federal regulations
regarding the use of options and futures by mutual funds, are not "fundamental
restrictions" and may be changed by the Trustees of the Trust if applicable law
permits such a change and the change is consistent with the overall investment
objective and policies of each Fund.
The extent to which a Fund may enter into futures and options
transactions may be limited by the Code requirements for qualification of a Fund
as a regulated investment company. See "Taxation." Repurchase Agreements
Each Fund may enter into repurchase agreements with respect to its
portfolio securities. Pursuant to such agreements, a Fund acquires securities
from financial institutions such as banks and broker-dealers as are deemed to be
creditworthy by the Advisor or a Manager, subject to the seller's agreement to
repurchase and a Fund's agreement to resell such securities at a mutually agreed
upon date and price. The repurchase price generally equals the price paid by a
Fund plus interest negotiated on the basis of current short-term rates (which
may be more or less than the rate on the underlying portfolio security).
Securities subject to repurchase agreements will be held by the Custodian or in
the Federal Reserve/Treasury Book-Entry System or an equivalent foreign system.
The seller under a repurchase agreement will be required to maintain the value
of the underlying securities at not less than 102% of the repurchase price under
the agreement. If the seller defaults on its repurchase obligation, a Fund
holding the repurchase agreement will suffer a loss to the extent that the
proceeds from a sale of the underlying securities are less than the repurchase
price under the agreement. Bankruptcy or insolvency of such a defaulting seller
may cause a Fund's rights with respect to such securities to be delayed or
limited. Repurchase agreements are considered to be loans under the 1940 Act.
Reverse Repurchase Agreements.
Each Fund may enter into reverse repurchase agreements. A Fund
typically will invest the proceeds of a reverse repurchase agreement in money
market instruments or repurchase agreements maturing not later than the
expiration of the reverse repurchase agreement. A Fund may use the proceeds of
reverse repurchase agreements to provide liquidity to meet redemption requests
when sale of a Fund's securities is disadvantageous.
Each Fund causes the custodian to segregate liquid assets, such as
cash, U.S. Government securities or other high grade liquid debt securities
equal in value to its obligations (including accrued interest) with respect to
reverse repurchase agreements. In segregating such assets, the custodian either
places such securities in a segregated account or separately identifies such
assets and renders them unavailable for investment. Such assets are marked to
market daily to ensure full collateralization is maintained. Dollar Roll
Transactions
Each Fund may enter into dollar roll transactions. A dollar roll
transaction involves a sale by a Fund of a security to a financial institution
concurrently with an agreement by a Fund to purchase a similar security from the
institution at a later date at an agreed-upon price. The securities that are
repurchased will bear the same interest rate as those sold, but generally will
be collateralized by different pools of mortgages with different prepayment
histories than those sold. During the period between the sale and repurchase, a
Fund will not be entitled to receive interest and principal payments on the
securities sold. Proceeds of the sale will be invested in additional portfolio
securities of a Fund, and the income from these investments, together with any
additional fee income received on the sale, may or may not generate income for a
Fund exceeding the yield on the securities sold.
At the time a Fund enters into a dollar roll transaction, it causes its
custodian to segregate liquid assets such as cash, U.S. Government securities or
other high-grade liquid debt securities having a value equal to the purchase
price for the similar security (including accrued interest) and subsequently
marks the assets to market daily to ensure that full collateralization is
maintained. When-Issued Securities, Forward Commitments and Delayed Settlements
Each Fund may purchase securities on a "when-issued," forward
commitment or delayed settlement basis. In this event, the Custodian will set
aside cash or liquid portfolio securities equal to the amount of the commitment
in a separate account. Normally, the Custodian will set aside portfolio
securities to satisfy a purchase commitment. In such a case, a Fund may be
required subsequently to place additional assets in the separate account in
order to assure that the value of the account remains equal to the amount of a
Fund's commitment. It may be expected that a Fund's net assets
B-14
<PAGE>
will fluctuate to a greater degree when it sets aside portfolio securities to
cover such purchase commitments than when it sets aside cash.
Each Fund does not intend to engage in these transactions for
speculative purposes but only in furtherance of its investment objectives.
Because a Fund will set aside cash or liquid portfolio securities to satisfy its
purchase commitments in the manner described, a Fund's liquidity and the ability
of a Manager to manage it may be affected in the event a Fund's forward
commitments, commitments to purchase when-issued securities and delayed
settlements ever exceeded 15% of the value of its net assets.
Each Fund will purchase securities on a when-issued, forward commitment
or delayed settlement basis only with the intention of completing the
transaction. If deemed advisable as a matter of investment strategy, however, a
Fund may dispose of or renegotiate a commitment after it is entered into, and
may sell securities it has committed to purchase before those securities are
delivered to a Fund on the settlement date. In these cases a Fund may realize a
taxable capital gain or loss. When a Fund engages in when-issued, forward
commitment and delayed settlement transactions, it relies on the other party to
consummate the trade. Failure of such party to do so may result in a Fund's
incurring a loss or missing an opportunity to obtain a price credited to be
advantageous.
The market value of the securities underlying a when-issued purchase,
forward commitment to purchase securities, or a delayed settlement and any
subsequent fluctuations in their market value is taken into account when
determining the market value of a Fund starting on the day a Fund agrees to
purchase the securities. A Fund does not earn interest on the securities it has
committed to purchase until they are paid for and delivered on the settlement
date.
Zero-Coupon, Step-Coupon and Pay-in-Kind Securities
Each Fund may invest in zero-coupon, step-coupon and pay-in-kind
securities. These securities are debt securities that do not make regular cash
interest payments. Zero-coupon and step-coupon securities are sold at a deep
discount to their face value. Pay-in-kind securities pay interest through the
issuance of additional securities. Because these securities do not pay current
cash income, the price of these securities can be volatile when interest rates
fluctuate. While these securities do not pay current cash income, the Code
requires the holders of these securities to include in income each year the
portion of the original issue discount (or deemed discount) and other non-cash
income on the securities accruing that year. A Fund may be required to
distribute a portion of that discount and income and may be required to dispose
of other portfolio securities, which may occur in periods of adverse market
prices, in order to generate cash to meet these distribution requirements.
Borrowing
Each Fund is authorized to borrow money from time to time for
temporary, extraordinary or emergency purposes or for clearance of transactions
in amounts up to 20% of the value of its total assets at the time of such
borrowings. The use of borrowing by the Fund involves special risk
considerations that may not be associated with other funds having similar
objectives and policies. Since substantially all of the Fund's assets fluctuate
in value, whereas the interest obligation resulting from a borrowing will be
fixed by the terms of the Fund's agreement with its lender, the asset value per
share of the Fund will tend to increase more when its portfolio securities
increase in value and to decrease more when its portfolio assets decrease in
value than would otherwise be the case if the Fund did not borrow funds. In
addition, interest costs on borrowings may fluctuate with changing market rates
of interest and may partially offset or exceed the return earned on borrowed
funds. Under adverse market conditions, the Fund might have to sell portfolio
securities to meet interest or principal payments at a time when fundamental
investment considerations would not favor such sales. Lending Portfolio
Securities
B-15
<PAGE>
Each Fund may lend its portfolio securities in an amount not exceeding
30% of its total assets to financial institutions such as banks and brokers if
the loan is collateralized in accordance with applicable regulations. Under the
present regulatory requirements which govern loans of portfolio securities, the
loan collateral must, on each business day, at least equal the value of the
loaned securities and must consist of cash, letters of credit of domestic banks
or domestic branches of foreign banks, or securities of the U.S. Government or
its agencies. To be acceptable as collateral, letters of credit must obligate a
bank to pay amounts demanded by a Fund if the demand meets the terms of the
letter. Such terms and the issuing bank would have to be satisfactory to a Fund.
Any loan might be secured by any one or more
B-16
<PAGE>
of the three types of collateral. The terms of a Fund's loans must permit a Fund
to reacquire loaned securities on five days' notice or in time to vote on any
serious matter and must meet certain tests under the Code.
Short Sales
Each Fund is authorized to make short sales of securities which it does
not own or have the right to acquire. In a short sale, a Fund sells a security
which it does not own, in anticipation of a decline in the market value of the
security. To complete the sale, a Fund must borrow the security (generally from
the broker through which the short sale is made) in order to make delivery to
the buyer. Each Fund is then obligated to replace the security borrowed by
purchasing it at the market price at the time of replacement. Each Fund is said
to have a "short position" in the securities sold until it delivers them to the
broker. The period during which a Fund has a short position can range from one
day to more than a year. Until the security is replaced, the proceeds of the
short sale are retained by the broker, and a Fund is required to pay to the
broker a negotiated portion of any dividends or interest which accrue during the
period of the loan. To meet current margin requirements, a Fund is also required
to deposit with the broker additional cash or securities so that the total
deposit with the broker is maintained daily at 150% of the current market value
of the securities sold short (100% of the current market value if a security is
held in the account that is convertible or exchangeable into the security sold
short within 90 days without restriction other than the payment of money).
Short sales by a Fund create opportunities to increase a Fund's return
but, at the same time, involve specific risk considerations and may be
considered a speculative technique. Since each Fund in effect profits from a
decline in the price of the securities sold short without the need to invest the
full purchase price of the securities on the date of the short sale, a Fund's
net asset value per share will tend to increase more when the securities it has
sold short decrease in value, and to decrease more when the securities it has
sold short increase in value, than would otherwise be the case if it had not
engaged in such short sales. The amount of any gain will be decreased, and the
amount of any loss increased, by the amount of any premium, dividends or
interest a Fund may be required to pay in connection with the short sale.
Furthermore, under adverse market conditions a Fund might have difficulty
purchasing securities to meet its short sale delivery obligations, and might
have to sell portfolio securities to raise the capital necessary to meet its
short sale obligations at a time when fundamental investment considerations
would not favor such sales.
Illiquid Securities
Each Fund may not invest more than 15% of the value of its net assets
in illiquid securities, including restricted securities, that are not deemed to
liquid by the sub-advisor. The Advisor and the Managers will monitor the amount
of illiquid securities in a Fund's portfolio, under the supervision of the
Trust's Board of Trustees, to ensure compliance with a Fund's investment
restrictions.
Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act of 1933 (the "Securities Act"), securities
which are otherwise not readily marketable and repurchase agreements having a
maturity of longer than seven days. Securities which have not been registered
under the Securities Act are referred to as private placement or restricted
securities and are purchased directly from the issuer or in the secondary
market. Mutual funds do not typically hold a significant amount of these
restricted or other illiquid securities because of the potential for delays on
resale and uncertainty in valuation. Limitations on resale may have an adverse
effect on the marketability of portfolio securities and a Fund might be unable
to dispose of restricted or other illiquid securities promptly or at reasonable
prices and might thereby experience difficulty satisfying redemption within
seven days. A Fund might also have to register such restricted securities in
order to dispose of them, resulting in additional expense and delay. Adverse
market conditions could impede such a public offering of securities.
In recent years, however, a large institutional market has developed
for certain securities that are not registered under the Securities Act,
including repurchase agreements, commercial paper, foreign securities, municipal
securities and corporate bonds and notes. Institutional investors depend on an
efficient institutional market in which the unregistered security can be readily
resold or on an issuer's ability to honor a demand for repayment. The fact that
there are contractual or legal restrictions on resale to the general public or
to certain institutions may not be indicative of the liquidity of such
investments. If such securities are subject to purchase by institutional buyers
in accordance with Rule 144A promulgated by the Commission under the Securities
Act, the sub-advisor, pursuant to procedures adopted by the Trust's Board of
Trustees, may determine that such securities are not illiquid securities
notwithstanding their legal or contractual
B-17
<PAGE>
restrictions on resale. In all other cases, however, securities subject to
restrictions on resale will be deemed illiquid.
Risks of Investing in Small Companies
As stated in the prospectus, a Fund may invest in securities of small
companies. Additional risks of such investments include the markets on which
such securities are frequently traded. In many instances the securities of
smaller companies are traded only over-the-counter or on a regional securities
exchange, and the frequency and volume of their trading is substantially less
than is typical of larger companies. Therefore, the securities of smaller
companies may be subject to greater and more abrupt price fluctuations. When
making large sales, a Fund may have to sell portfolio holdings at discounts from
quoted prices or may have to make a series of small sales over an extended
period of time due to the trading volume of smaller company securities.
Investors should be aware that, based on the foregoing factors, an investment in
a Fund may be subject to greater price fluctuations than an investment in a fund
that invests exclusively in larger, more established companies. A Manager's
research efforts may also play a greater role in selecting securities for a Fund
than in a fund that invests in larger, more established companies.
Investment Restrictions
The Trust (on behalf of a Fund) has adopted the following restrictions
as fundamental policies, which may not be changed without the favorable vote of
the holders of a "majority," as defined in the 1940 Act, of the outstanding
voting securities of a Fund. Under the 1940 Act, the "vote of the holders of a
majority of the outstanding voting securities" means the vote of the holders of
the lesser of (I) 67% of the shares of a Fund represented at a meeting at which
the holders of more than 50% of its outstanding shares are represented or (ii)
more than 50% of the outstanding shares of a Fund.
As a matter of fundamental policy, a Fund is diversified; i.e., as to
75% of the value of a its total assets: (I) no more than 5% of the value of its
total assets may be invested in the securities of any one issuer (other than
U.S. Government securities); and (ii) a Fund may not purchase more than 10% of
the outstanding voting securities of an issuer.
Each Fund's investment objective is also fundamental. In addition, a
Fund may not:
1. Issue senior securities, borrow money or pledge its assets, except
that (I) a Fund may borrow on an unsecured basis from banks for temporary or
emergency purposes or for the clearance of transactions in amounts not exceeding
10% of its total assets (not including the amount borrowed), provided that it
will not make investments while borrowings in excess of 5% of the value of its
total assets are outstanding; and (ii) this restriction shall not prohibit a
Fund from engaging in options, futures and foreign currency transactions or
short sales;
2. Purchase securities on margin, except such short-term credits as may
be necessary for the clearance of transactions;
3. Act as underwriter (except to the extent a Fund may be deemed to be
an underwriter in connection with the sale of securities in its investment
portfolio);
4. Invest 25% or more of its total assets, calculated at the time of
purchase and taken at market value, in any one industry (other than U.S.
Government securities);
5. Purchase or sell real estate or interests in real estate or real
estate limited partnerships (although a Fund may purchase and sell securities
which are secured by real estate and securities of companies which invest or
deal in real estate);
6. Purchase or sell commodities or commodity futures contracts, except
that a Fund may purchase and sell stock index futures contracts and currency and
financial futures contracts and related options in accordance with any rules of
the Commodity Futures Trading Commission;
7. Invest in oil and gas limited partnerships or oil, gas or mineral
leases;
8. Make loans of money (except for purchases of debt securities
consistent with the investment policies of a Fund and except for repurchase
agreements); or
9. Make investments for the purpose of exercising control or
management.
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<PAGE>
Each Fund observes the following restrictions as a matter of operating
but not fundamental policy, pursuant to positions taken by federal regulatory
authorities:
Each Fund may not:
1. Invest in the securities of other investment companies or purchase
any other investment company's voting securities or make any other investment in
other investment companies except to the extent permitted by federal law.
2. Invest more than 15% of its assets in securities which are
restricted as to disposition or otherwise are illiquid or have no readily
available market (except for securities which are determined by the the
sub-advisor, pursuant to procedures adopted by the Board of Trustees, to be
liquid).
MANAGEMENT
The overall management of the business and affairs of the Trust is
vested with its Board of Trustees. The Board approves all significant agreements
between the Trust and persons or companies furnishing services to it, including
the agreements with the Advisor, Managers, Administrator, Custodian and Transfer
Agent. The day to day operations of the Trust are delegated to its officers,
subject to a Fund's investment objectives and policies and to general
supervision by the Board of Trustees.
The Trustees and officers of the Trust, their ages and positions with
the Trust, their business addresses and principal occupations during the past
five years are:
<TABLE>
<CAPTION>
Name, address and age Position Principal Occupation During Past Five Years
<S> <C> <C>
A. George Battle (52) Trustee Senior Fellow, The Aspen Institute since June, 1995. Director of
1065 Sterling Avenue Peoplesoft, Inc.; Barra, Inc.; and Fair, Isaac. Formerly (until 1995)
Berkeley, CA 94708 Managing Partner, Market Development of Andersen Consulting.
Frederick August Trustee Senior Vice President, Right Associates (industrial psychologists)
Eigenbrod, Jr. PhD (55)
19925 Stevens Creek Blvd.
Cupertino, CA 95014
Kenneth E. Gregory* (39) President and President of the Advisor; President of L/G Research Inc. (publishers)
4 Orinda Way Trustee and Litman/Gregory & Co., LLC (investment advisors)
Suite 230D
Orinda, CA 94556
Craig A. Litman* (49) Secretary and Treasurer and Secretary of the Advisor; Vice
Trustee President and Secretary of L/G Research Inc.; Chairman of Litman/Gregory & Co., LLC
100 Larkspur Landing Circle Suite 204 Larkspur, CA 94939
Taylor M. Welz (37) Trustee Partner, Bowman & Company, LLP (certified public accountants)
2431 W. March Lane
Suite 100
Stockton, CA 95207
John Coughlan (40) Treasurer Chief Operating Officer, Litman/Gregory & Co., LLC
since 1996; 4 Orinda Way Controller, Centex Homes of Northern CA, 1995 - 1996;
Suite 230D Senior Vice President, Countrywide Capital Markets, Inc., 1994;
Orinda, CA 94556, Executive Vice President, TMAC, 1992 - 1994 ; Vice President and
Treasurer, Barnett Range Corporation, prior to 1992
</TABLE>
* denotes Trustees who are "interested persons" of the Trust under the 1940
Act.
It is estimated that each Trustee who is not an interested person of
the Trust will receive a fee at the annual rate
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<PAGE>
of $5,000.
The Advisor and the Managers
Subject to the supervision of the Board of Trustees, investment
management and related services are provided by the Advisor, pursuant to an
Investment Advisory Agreement (the "Advisory Agreement"). In addition, the
assets of each Fund are divided into segments by the Advisor, and individual
selection of securities in each segment is provided by a Manager selected by the
Board of Trustees pursuant, in each case, to a form of sub-advisory agreement
("Management Agreement"). Under the Advisory Agreement, the Advisor has agreed
to (I) furnish each Fund with advice and recommendations with respect to the
selection and continued employment of Managers to manage the actual investment
of each Fund's assets; (ii) direct the allocation of each Fund's assets among
such Managers; (iii) oversee the investments made by such Managers on behalf of
each Fund, subject to the ultimate supervision and direction of the Trust's
Board of Trustees; (iv) oversee the actions of the Managers with respect to
voting proxies for each Fund, filing Section 13 ownership reports for each Fund,
and taking other actions on behalf of each Fund; (v) maintain the books and
records required to be maintained by each Fund except to the extent arrangements
have been made for such books and records to be maintained by the administrator,
another agent of each Fund or a Manager; (vi) furnish reports, statements and
other data on securities, economic conditions and other matters related to the
investment of each Fund's assets which each Fund's administrator or distributor
or the officers of the Trust may reasonably request; and (vii) render to the
Trust's Board of Trustees such periodic and special reports with respect to each
Fund's investment activities as the Board may reasonably request, including at
least one in-person appearance annually before the Board of Trustees. The
Advisor has agreed, at its own expense, to maintain such staff and employ or
retain such personnel and consult with such other persons as it shall from time
to time determine to be necessary to the performance of its obligations under
this Agreement. Personnel of the Advisor may serve as officers of the Trust
provided they do so without compensation from the Trust. Without limiting the
generality of the foregoing, the staff and personnel of the Advisor shall be
deemed to include persons employed or retained by the Advisor to furnish
statistical information, research, and other factual information, advice
regarding economic factors and trends, information with respect to technical and
scientific developments, and such other information, advice and assistance as
the Advisor or the Trust's Board of Trustees may desire and reasonably request.
With respect to the operation of each Fund, the Advisor has agreed to be
responsible for (I) providing the personnel, office space and equipment
reasonably necessary for the operation of the Trust and each Fund including the
provision of persons qualified to serve as officers of the Trust; (ii)
compensating the Managers selected to invest the assets of each Fund; (iii) the
expenses of printing and distributing extra copies of each Fund's prospectus,
statement of additional information, and sales and advertising materials (but
not the legal, auditing or accounting fees attendant thereto) to prospective
investors (but not to existing shareholders); and (iv) the costs of any special
Board of Trustees meetings or shareholder meetings convened for the primary
benefit of the Advisor or any Manager.
Under each Management Agreement, each Manager agrees to invest its
Allocated Portion of the assets of each Fund in accordance with the investment
objectives, policies and restrictions of each Fund as set forth in each Fund's
and Trust's governing documents, including, without limitation, the Trust's
Agreement and Declaration of Trust and By-Laws; each Fund's prospectus,
statement of additional information, and undertakings; and such other
limitations, policies and procedures as the Advisor or the Trustees of the Trust
may impose from time to time in writing to Manager. In providing such services,
Manager shall at all times adhere to the provisions and restrictions contained
in the federal securities laws, applicable state securities laws, the Internal
Revenue Code, and other applicable law.
Without limiting the generality of the foregoing, each Manager has
agreed to (I) furnish each Fund with advice and recommendations with respect to
the investment of the Manager's Allocated Portion of each Fund's assets, (ii)
effect the purchase and sale of portfolio securities for Manager's Allocated
Portion or determine that a portion of such Allocated Portion will remain
uninvested; (iii) manage and oversee the investments of the Manager's Allocated
Portion, subject to the ultimate supervision and direction of the Trust's Board
of Trustees; (iv) vote proxies and take other actions with respect to the
securities in Manager's Allocated Portion; (v) maintain the books and records
required to be maintained with respect to the securities in Manager's Allocated
Portion; (vi) furnish reports, statements and other data on securities, economic
conditions and other matters related to the investment of each Fund's assets
which the Advisor, Trustees or the officers of the Trust may reasonably request;
and (vii) render to the Trust's Board of Trustees such periodic and special
reports with respect to Manager's Allocated Portion as the Board may reasonably
request.
As compensation for the Advisor's services (including payment of the
Managers' fees), each Fund pays it an
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advisory fee at the rate specified in the prospectus. In addition to the fees
payable to the Advisor and the Administrator, the Trust is responsible for its
operating expenses, including: fees and expenses incurred in connection with the
issuance, registration and transfer of its shares; brokerage and commission
expenses; all expenses of transfer, receipt, safekeeping, servicing and
accounting for the cash, securities and other property of the Trust for the
benefit of each Fund including all fees and expenses of its custodian,
shareholder services agent and accounting services agent; interest charges on
any borrowings; costs and expenses of pricing and calculating its daily net
asset value and of maintaining its books of account required under the
Investment Company Act; taxes, if any; a pro rata portion of expenditures in
connection with meetings of each Fund's shareholders and the Trust's Board of
Trustees that are properly payable by each Fund; salaries and expenses of
officers and fees and expenses of members of the Trust's Board of Trustees or
members of any advisory board or committee who are not members of, affiliated
with or interested persons of the Advisor; insurance premiums on property or
personnel of each Fund which inure to its benefit, including liability and
fidelity bond insurance; the cost of preparing and printing reports, proxy
statements, prospectuses and statements of additional information of each Fund
or other communications for distribution to existing shareholders; legal,
auditing and accounting fees; trade association dues; fees and expenses
(including legal fees) of registering and maintaining registration of its shares
for sale under federal and applicable state and foreign securities laws; all
expenses of maintaining and servicing shareholder accounts, including all
charges for transfer, shareholder recordkeeping, dividend disbursing,
redemption, and other agents for the benefit of each Fund, if any; and all other
charges and costs of its operation plus any extraordinary and non-recurring
expenses, except as otherwise prescribed in the Advisory Agreement.
The Advisor may agree to waive certain of its fees or reimburse each
Fund for certain expenses, in order to limit the expense ratio of each Fund. In
that event, subject to approval by the Trust's Board of Trustees, each Fund may
reimburse the Advisor in subsequent years for fees waived and expenses
reimbursed, provided the expense ratio before reimbursement is less than the
expense limitation in effect at that time.
The Advisor is controlled by Craig A. Litman and Kenneth E. Gregory.
Under the Advisory Agreement and each Management Agreement, the Advisor
and the Managers will not be liable to the Trust for any error of judgment by
the Advisor or Managers or any loss sustained by the Trust except in the case of
a breach of fiduciary duty with respect to the receipt of compensation for
services (in which case any award of damages will be limited as provided in the
1940 Act) or of willful misfeasance, bad faith or gross negligence by reason of
reckless disregard of its obligations and duties under the applicable agreement.
The Advisory Agreement and the Management Agreements will remain in
effect for a period not to exceed two years. Thereafter, if not terminated, each
Advisory and Management Agreement will continue automatically for successive
annual periods, provided that such continuance is specifically approved at least
annually (I) by a majority vote of the
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<PAGE>
Independent Trustees cast in person at a meeting called for the purpose of
voting on such approval, and (ii) by the Board of Trustees or by vote of a
majority of the outstanding voting securities of the Portfolio.
The Advisory and Management Agreements are terminable by vote of the
Board of Trustees or by the holders of a majority of the outstanding voting
securities of the Trust at any time without penalty, on 60 days written notice
to the Advisor or a Manager. The Advisory and Management Agreements also may be
terminated by the Advisor or a Manager on 60 days written notice to the Trust.
The Advisory and Management Agreements terminate automatically upon their
assignment (as defined in the 1940 Act).
The Administrator. The Administrator has agreed to be responsible for
providing such services as the Trustees may reasonably request, including but
not limited to (I) maintaining the Trust's books and records (other than
financial or accounting books and records maintained by any custodian, transfer
agent or accounting services agent); (ii) overseeing the Trust's insurance
relationships; (iii) preparing for the Trust (or assisting counsel and/or
auditors in the preparation of) all required tax returns, proxy statements and
reports to the Trust's shareholders and Trustees and reports to and other
filings with the Securities and Exchange Commission and any other governmental
agency (the Trust agreeing to supply or cause to be supplied to the
Administrator all necessary financial and other information in connection with
the foregoing); (iv) preparing such applications and reports as may be necessary
to register or maintain the Trust's registration and/or the registration of the
shares of the Trust under the securities or "blue sky" laws of the various
states selected by the Trust (the Trust agreeing to pay all filing fees or other
similar fees in connection therewith); (v) responding to all inquiries or other
communications of shareholders, if any, which are directed to the Administrator,
or if any such inquiry or communication is more properly to be responded to by
the Trust's custodian, transfer agent or accounting services agent, overseeing
their response thereto; (vi) overseeing all relationships between the Trust and
any custodian(s), transfer agent(s) and accounting services agent(s), including
the negotiation of agreements and the supervision of the performance of such
agreements; (vii) together with the Advisor, monitoring compliance by the
Managers with tax, securities and other applicable requirements; and (viii)
authorizing and directing any of the Administrator's directors, officers and
employees who may be elected as Trustees or officers of the Trust to serve in
the capacities in which they are elected. All services to be furnished by the
Administrator under this Agreement may be furnished through the medium of any
such directors, officers or employees of the Administrator.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Each Management Agreement states that, with respect to the segment of
each Fund's portfolio allocated to the Manager, the Manager shall be responsible
for broker-dealer selection and for negotiation of brokerage commission rates,
provided that the Manager shall not direct orders to an affiliated person of the
Manager without general prior authorization to use such affiliated broker or
dealer by the Trust's Board of Trustees. In general, a Manager's primary
consideration in effecting a securities transaction will be execution at the
most favorable cost or proceeds under the circumstances. In selecting a
broker-dealer to execute each particular transaction, a Manager may take the
following into consideration: the best net price available; the reliability,
integrity and financial condition of the broker-dealer; the size of and
difficulty in executing the order; and the value of the expected contribution of
the broker-dealer to the investment performance of each Fund on a continuing
basis. The price to each Fund in any transaction may be less favorable than that
available from another broker-dealer if the difference is reasonably justified
by other aspects of the portfolio execution services offered.
Subject to such policies as the Advisor and the Board of Trustees of
the Trust may determine, a Manager shall not be deemed to have acted unlawfully
or to have breached any duty created by this Agreement or otherwise solely by
reason of its having caused each Fund to pay a broker or dealer that provides
(directly or indirectly) brokerage or research services to the Manager an amount
of commission for effecting a portfolio transaction in excess of the amount of
commission another broker or dealer would have charged for effecting that
transaction, if the Manager determines in good faith that such amount of
commission was reasonable in relation to the value of the brokerage and research
services provided by such broker or dealer, viewed in terms of either that
particular transaction or the Manager's or Advisor's overall responsibilities
with respect to each Fund or other advisory clients. Each Manager is further
authorized to allocate the orders placed by it on behalf of each Fund to such
brokers or dealers who also provide research or statistical material, or other
services, to the Trust, the Advisor, or any affiliate of either. Such allocation
shall be in such amounts and proportions as the Manager shall determine, and
each Manager shall report on such allocations regularly to the Advisor and the
Trust, indicating the broker-dealers to whom such allocations have been made and
the basis therefor. Each
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Manager is also authorized to consider sales of shares of each Fund as a factor
in the selection of brokers or dealers to execute portfolio transactions,
subject to the requirements of best execution.
On occasions when a Manager deems the purchase or sale of a security to
be in the best interest of each Fund as well as other clients of the Manager,
the Manager, to the extent permitted by applicable laws and regulations, may
aggregate the securities to be so purchased or sold in order to obtain the most
favorable price or lower brokerage commissions and the most efficient execution.
In such event, allocation of the securities so purchased or sold, as well as the
expenses incurred in the transaction, will be made by the Manager in the manner
it considers to be the most equitable and consistent with its fiduciary
obligations to each Fund and to such other clients.
NET ASSET VALUE
The net asset value of a Fund's shares will fluctuate and is determined
as of the close of trading on the New York Stock Exchange (currently 4:00 p.m.
Eastern time) each business day. The Exchange annually announces the days on
which it will not be open for trading. The most recent announcement indicates
that it will not be open on the following days: New Year's Day, Presidents' Day,
Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day. However, the Exchange may close on days not included in that
announcement.
The net asset value per share is computed by dividing the value of the
securities held by a Fund plus any cash or other assets (including interest and
dividends accrued but not yet received) minus all liabilities (including accrued
expenses) by the total number of shares in a Fund outstanding at such time.
Generally, trading in and valuation of foreign securities is
substantially completed each day at various times prior to the close of the
NYSE. In addition, trading in and valuation of foreign securities may not take
place on every day in which the NYSE is open for trading. In that case, the
price used to determine a Fund's net asset value on the last day on which such
exchange was open will be used, unless the Trust's Board of Trustees determines
that a different price should be used. Furthermore, trading takes place in
various foreign markets on days in which the NYSE is not open for trading and on
which a Fund's net asset value is not calculated. Occasionally, events affecting
the values of such securities in U.S. dollars on a day on which a Fund
calculates its net asset value may occur between the times when such securities
are valued and the close of the NYSE that will not be reflected in the
computation of a Fund's net asset value unless the Board or its delegates deem
that such events would materially affect the net asset value, in which case an
adjustment would be made.
Generally, a Fund's investments are valued at market value or, in the
absence of a market value, at fair value as determined in good faith by the
Managers and the Trust's Pricing Committee pursuant to procedures approved by or
under the direction of the Board.
Each Fund's securities, including ADRs, EDRs and GDRs, which are traded
on securities exchanges are valued at the last sale price on the exchange on
which such securities are traded, as of the close of business on the day the
securities are being valued or, lacking any reported sales, at the mean between
the last available bid and asked price. Securities that are traded on more than
one exchange are valued on the exchange determined by the Managers to be the
primary market. Securities traded in the over-the-counter market are valued at
the mean between the last available bid and asked price prior to the time of
valuation. Securities and assets for which market quotations are not readily
available (including restricted securities which are subject to limitations as
to their sale) are valued at fair value as determined in good faith by or under
the direction of the Board.
Short-term debt obligations with remaining maturities in excess of 60
days are valued at current market prices, as discussed above. Short-term
securities with 60 days or less remaining to maturity are, unless conditions
indicate otherwise, amortized to maturity based on their cost to a Fund if
acquired within 60 days of maturity or, if already held by a Fund on the 60th
day, based on the value determined on the 61st day.
Corporate debt securities, mortgage-related securities and asset-backed
securities held by a Fund are valued on the basis of valuations provided by
dealers in those instruments, by an independent pricing service, approved by the
Board, or at fair value as determined in good faith by procedures approved by
the Board. Any such pricing service, in determining value, will use information
with respect to transactions in the securities being valued, quotations from
dealers, market transactions in comparable securities, analyses and evaluations
of various relationships between securities and yield to maturity information.
B-23
<PAGE>
An option that is written by a Fund is generally valued at the last
sale price or, in the absence of the last sale price, the last offer price. An
option that is purchased by a Fund is generally valued at the last sale price
or, in the absence of the last sale price, the last bid price. The value of a
futures contract is the last sale or settlement price on the exchange or board
of trade on which the future is traded or, if no sales are reported, at the mean
between the last bid and asked price. When a settlement price cannot be used,
futures contracts will be valued at their fair market value as determined by or
under the direction of the Board. If an options or futures exchange closes after
the time at which a Fund's net asset value is calculated, the last sale or last
bid and asked prices as of that time will be used to calculate the net asset
value.
Any assets or liabilities initially expressed in terms of foreign
currencies are translated into U.S. dollars at the official exchange rate or,
alternatively, at the mean of the current bid and asked prices of such
currencies against the U.S. dollar last quoted by a major bank that is a regular
participant in the foreign exchange market or on the basis of a pricing service
that takes into account the quotes provided by a number of such major banks. If
neither of these alternatives is available or both are deemed not to provide a
suitable methodology for converting a foreign currency into U.S. dollars, the
Board in good faith will establish a conversion rate for such currency.
All other assets of a Fund are valued in such manner as the Board in
good faith deems appropriate to reflect their fair value.
TAXATION
Each Fund will be taxed, under the Internal Revenue Code (the "Code"),
as a separate entity from any other series of the Trust, and it intends to elect
to qualify for treatment as a regulated investment company ("RIC") under
Subchapter M of the Code. In each taxable year that a Fund qualifies, a Fund
(but not its shareholders) will be relieved of federal income tax on that part
of its investment company taxable income (consisting generally of interest and
dividend income, net short term capital gain and net realized gains from
currency transactions) and net capital gain that is distributed to shareholders.
In order to qualify for treatment as a RIC, a Fund must distribute
annually to shareholders at least 90% of its investment company taxable income
and must meet several additional requirements. Among these requirements are the
following: (1) at least 90% of a Fund's gross income each taxable year must be
derived from dividends, interest, payments with respect to securities loans and
gains from the sale or other disposition of securities or foreign currencies, or
other income derived with respect to its business of investing in securities or
currencies; (2) at the close of each quarter of a Fund's taxable year, at least
50% of the value of its total assets must be represented by cash and cash items,
U.S. Government securities, securities of other RICs and other securities,
limited in respect of any one issuer, to an amount that does not exceed 5% of
the value of a Fund and that does not represent more than 10% of the outstanding
voting securities of such issuer; and (3) at the close of each quarter of a
Fund's taxable year, not more than 25% of the value of its assets may be
invested in securities (other than U.S. Government securities or the securities
of other RICs) of any one issuer.
Distributions of net investment income and net realized capital gains
by a Fund will be taxable to shareholders whether made in cash or reinvested in
shares. In determining amounts of net realized capital gains to be distributed,
any capital loss carryovers from prior years will be applied against capital
gains. Shareholders receiving distributions in the form of additional shares
will have a cost basis for federal income tax purposes in each share so received
equal to the net asset value of a share of a Fund on the reinvestment date. Fund
distributions also will be included in individual and corporate shareholders'
income on which the alternative minimum tax may be imposed.
Each Fund or any securities dealer effecting a redemption of a Fund's
shares by a shareholder will be required to file information reports with the
IRS with respect to distributions and payments made to the shareholder. In
addition, a Fund will be required to withhold federal income tax at the rate of
31% on taxable dividends, redemptions and other payments made to accounts of
individual or other non-exempt shareholders who have not furnished their correct
taxpayer identification numbers and made certain required certifications on the
Account Application Form or with respect to which a Fund or the securities
dealer has been notified by the IRS that the number furnished is incorrect or
that the account is otherwise subject to withholding.
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<PAGE>
Each Fund intends to declare and pay dividends and other distributions,
as stated in the Prospectus. In order to avoid the payment of any federal excise
tax based on net income, a Fund must declare on or before December 31 of each
year, and pay on or before January 31 of the following year, distributions at
least equal to 98% of its ordinary income for that calendar year and at least
98% of the excess of any capital gains over any capital losses realized in the
one-year period ending October 31 of that year, together with any undistributed
amounts of ordinary income and capital gains (in excess of capital losses) from
the previous calendar year.
Each Fund may receive dividend distributions from U.S. corporations. To
the extent that a Fund receives such dividends and distributes them to its
shareholders, and meets certain other requirements of the Code, corporate
shareholders of a Fund may be entitled to the "dividends received" deduction.
Availability of the deduction is subject to certain holding period and
debt-financing limitations.
The use of hedging strategies, such as entering into futures contracts
and forward contracts and purchasing options, involves complex rules that will
determine the character and timing of recognition of the income received in
connection therewith by a Fund. Income from foreign currencies (except certain
gains therefrom that may be excluded by future regulations) and income from
transactions in options, futures contracts and forward contracts derived by a
Fund with respect to its business of investing in securities or foreign
currencies will qualify as permissible income under Subchapter M of the Code.
For accounting purposes, when the paid by the Fund is recorded as an
asset and is subsequently adjusted to the current market value of the option.
Any gain or loss realized by the Fund upon the expiration or sale of such
options held by the Fund generally will be capital gain or loss.
Any security, option, or other position entered into or held by the
Fund that substantially diminishes the Fund's risk of loss from any other
position held by that Fund may constitute a "straddle" for federal income tax
purposes. In general, straddles are subject to certain rules that may affect the
amount, character and timing of the Fund's gains and losses with respect to
straddle positions by requiring, among other things, that the loss realized on
disposition of one position of a straddle be deferred until gain is realized on
disposition of the offsetting position; that the Fund's holding period in
certain straddle positions not begin until the straddle is terminated (possibly
resulting in the gain being treated as short-term capital gain rather than
long-term capital gain); and that losses recognized with respect to certain
straddle positions, which would otherwise constitute short-term capital losses,
be treated as long-term capital losses. Different elections are available to the
Fund that may mitigate the effects of the straddle rules.
Certain options, futures contracts and forward contracts that are
subject to Section 1256 of the Code ("Section 1256 Contracts") and that are held
by the Fund at the end of its taxable year generally will be required to be
"marked to market" for federal income tax purposes, that is, deemed to have been
sold at market value. Sixty percent of any net gain or loss recognized on these
deemed sales and 60% of any net gain or loss realized from any actual sales of
Section 1256 Contracts will be treated as long-term capital gain or loss, and
the balance will be treated as short-term capital gain or loss.
Section 988 of the Code contains special tax rules applicable to
certain foreign currency transactions that may affect the amount, timing and
character of income, gain or loss recognized by the Fund. Under these rules,
foreign exchange gain or loss realized with respect to foreign
currency-denominated debt instruments, foreign currency forward contracts,
foreign currency-denominated payables and receivables and foreign currency
options and futures contracts (other than options and futures contracts that are
governed by the mark-to-market and 60/40 rules of Section 1256 of the Code and
for which no election is made) is treated as ordinary income or loss. Some part
of the Fund's gain or loss on the sale or other disposition of shares of a
foreign corporation may, because of changes in foreign currency exchange rates,
be treated as ordinary income or loss under Section 988 of the Code, rather than
as capital gain or loss.
Redemptions and exchanges of shares of the Fund will result in gains or
losses for tax purposes to the extent of the difference between the proceeds and
the shareholder's adjusted tax basis for the shares. Any loss realized upon the
redemption or exchange of shares within six months from their date of purchase
will be treated as a long-term capital loss to the extent of distributions of
long-term capital gain dividends with respect to such shares during such
six-month period. All or a portion of a loss realized upon the redemption of
shares of the Fund may be disallowed to the extent shares of the same Fund are
purchased (including shares acquired by means of reinvested dividends) within 30
days before or after such redemption.
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<PAGE>
Distributions and redemptions may be subject to state and local income
taxes, and the treatment thereof may differ from the federal income tax
treatment. Foreign taxes may apply to non-U.S. investors.
The above discussion and the related discussion in the Prospectus are
not intended to be complete discussions of all Paul Hastings Janofsky & Walker
has expressed no opinion in respect thereof. Nonresident aliens and foreign
persons are subject to different tax rules, and may be subject to withholding of
up to 30% on certain payments received from the Fund. Shareholders are advised
to consult with their own tax advisers concerning the application of foreign,
federal, state and local taxes to an investment in the Fund.
DIVIDENDS AND DISTRIBUTIONS
Dividends from the Fund's investment company taxable income (whether
paid in cash or invested in additional shares) will be taxable to shareholders
as ordinary income to the extent of the Fund's earnings and profits.
Distributions of the Fund's net capital gain (whether paid in cash or invested
in additional shares) will be taxable to shareholders as long-term capital gain,
regardless of how long they have held their Fund shares.
Dividends declared by the Fund in October, November or December of any
year and payable to shareholders of record on a date in one of such months will
be deemed to have been paid by the Fund and received by the shareholders on the
record date if the dividends are paid by the Fund during the following January.
Accordingly, such dividends will be taxed to shareholders for the year in which
the record date falls.
The Fund is required to withhold 31% of all dividends, capital gain
distributions and redemption proceeds payable to any individuals and certain
other noncorporate shareholders who do not provide the Fund with a correct
taxpayer identification number. The Fund also is required to withhold 31% of all
dividends and capital gain distributions paid to such shareholders who otherwise
are subject to backup withholding.
PERFORMANCE INFORMATION
Total Return
Average annual total return quotations used in the Fund's advertising
and promotional materials are calculated according to the following formula:
P(1 + T)n = ERV
where "P" equals a hypothetical initial payment of $1000; "T" equals average
annual total return; "n" equals the number of years; and "ERV" equals the ending
redeemable value at the end of the period of a hypothetical $1000 payment made
at the beginning of the period.
Under the foregoing formula, the time periods used in advertising will
be based on rolling calendar quarters, updated to the last day of the most
recent quarter prior to submission of the advertising for publication. Average
annual total return, or "T" in the above formula, is computed by finding the
average annual compounded rates of return over the period that would equate the
initial amount invested to the ending redeemable value. Average annual total
return assumes the reinvestment of all dividends and distributions.
Yield
Annualized yield quotations used in the Fund's advertising and
promotional materials are calculated by dividing the Fund's investment income
for a specified thirty-day period, net of expenses, by the average number of
shares outstanding during the period, and expressing the result as an annualized
percentage (assuming semi-annual compounding) of the net asset value per share
at the end of the period. Yield quotations are calculated according to the
following formula:
YIELD = 2 [(a-b + 1)6 - 1]
--
cd
where "a" equals dividends and interest earned during the period; "b" equals
expenses accrued for the period, net of reimbursements; "c" equals the average
daily number of shares outstanding during the period that are entitled to
receive dividends and "d" equals the maximum offering price per share on the
last day of the period. Except as noted below,
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in determining net investment income earned during the period ("a" in the above
formula), the Fund calculates interest earned on each debt obligation held by it
during the period by (1) computing the obligation's yield to maturity, based on
the market value of the obligation (including actual accrued interest) on the
last business day of the period or, if the obligation was purchased during the
period, the purchase price plus accrued interest; (2) dividing the yield to
maturity by 360 and multiplying the resulting quotient by the market value of
the obligation (including actual accrued interest). Once interest earned is
calculated in this fashion for each debt obligation held by the Fund, net
investment income is then determined by totaling all such interest earned.
For purposes of these calculations, the maturity of an obligation with
one or more call provisions is assumed to be the next date on which the
obligation reasonably can be expected to be called or, if none, the maturity
date.
Other information
Performance data of the Fund quoted in advertising and other
promotional materials represents past performance and is not intended to predict
or indicate future results. The return and principal value of an investment in
the Fund will fluctuate, and an investor's redemption proceeds may be more or
less than the original investment amount. In advertising and promotional
materials the Fund may compare its performance with data published by Lipper
Analytical Services, Inc. ("Lipper") or CDA Investment Technologies, Inc.
("CDA"). The Fund also may refer in such materials to mutual fund performance
rankings and other data, such as comparative asset, expense and fee levels,
published by Lipper or CDA. Advertising and promotional materials also may refer
to discussions of a Fund and comparative mutual fund data and ratings reported
in independent periodicals including, but not limited to, The Wall Street
Journal, Money Magazine, Forbes, Business Week, Financial World and Barron's.
GENERAL INFORMATION
The Trust is a Delaware Business Trust organized on August 1, 1996. The
Masters' Select Equity Fund series of shares commenced operations on January 2,
1997. The Masters' Select International Fund has not commenced operations as of
the date of this Statement of Additional Information. The Declaration of Trust
permits the Trustees to issue an unlimited number of full and fractional shares
of beneficial interest and to divide or combine the shares into a greater or
lesser number of shares without thereby changing the proportionate beneficial
interest in the Fund. Each share represents an interest in the Fund
proportionately equal to the interest of each other share. Upon the Trust's
liquidation, all shareholders would share pro rata in the net assets of the Fund
available for distribution to shareholders. If they deem it advisable and in the
best interest of shareholders, the Board of Trustees may create additional
series of shares which differ from each other only as to dividends. The Board of
Trustees has created two series of shares, and may create additional series in
the future, which have separate assets and liabilities. Income and operating
expenses not specifically attributable to a particular Fund will be allocated
fairly among the Funds by the Trustees, generally on the basis of the relative
net assets of each Fund.
Rule 18f-2 under the 1940 Act provides that as to any investment
company which has two or more series outstanding and as to any matter required
to be submitted to shareholder vote, such matter is not deemed to have been
effectively acted upon unless approved by the holders of a "majority" (as
defined in the Rule) of the voting securities of each series affected by the
matter. Such separate voting requirements do not apply to the election of
Trustees or the ratification of the selection of accountants. The Rule contains
special provisions for cases in which an advisory contract is approved by one or
more, but not all, series. A change in investment policy may go into effect as
to one or more series whose holders so approve the change even though the
required vote is not obtained as to the holders of other affected series.
The Trust's custodian, State Street Bank and Trust Company, 225
Franklin Street, Boston, MA 02110 is responsible for holding the Funds' assets
and acts as the Trust's accounting services agent. The Trust's independent
accountants, McGladrey & Pullen, LLP, 555 Fifth Avenue, New York, NY 10017,
assist in the preparation of certain reports to the Securities and Exchange
Commission and the Fund's tax returns.
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APPENDIX
Description of Ratings
Moody's Investors Service, Inc.: Corporate Bond Ratings
Aaa--Bonds which are rated Aaa are judged to be of the best quality and
carry the smallest degree of investment risk. Interest payments are protected by
a large or by an exceptionally stable margin, and principal is secure. While the
various protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position of such
issues.
Aa---Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long term risks appear somewhat larger than in Aaa securities.
Moody's applies numerical modifiers "1", "2" and "3" to both the Aaa
and Aa rating classifications. The modifier "1" indicates that the security
ranks in the higher end of its generic rating category; the modifier "2"
indicates a mid-range ranking; and the modifier "3" indicates that the issue
ranks in the lower end of its generic rating category.
A--Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate but elements may be
present which suggest a susceptibility to impairment sometime in the future.
Baa--Bonds which are rated Baa are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great period of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Standard & Poor's Corporation: Corporate Bond Ratings
AAA--This is the highest rating assigned by Standard & Poor's to a debt
obligation and indicates an extremely strong capacity to pay principal and
interest.
AA--Bonds rated AA also qualify as high-quality debt obligations.
Capacity to pay principal and interest is very strong, and in the majority of
instances they differ from AAA issues only in small degree.
A--Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions.
BBB--Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal and interest for bonds in
this category than for bonds in the A category.
Commercial Paper Ratings
Moody's commercial paper ratings are assessments of the issuer's
ability to repay punctually promissory obligations. Moody's employs the
following three designations, all judged to be investment grade, to indicate the
relative repayment capacity of rated issuers: Prime 1--highest quality; Prime
2--higher quality; Prime 3--high quality.
A Standard & Poor's commercial paper rating is a current assessment of
the likelihood of timely payment. Ratings are graded into four categories,
ranging from "A" for the highest quality obligations to "D" for the lowest.
Issues assigned the highest rating, A, are regarded as having the
greatest capacity for timely payment. Issues in this category are delineated
with the numbers "1", "2" and "3" to indicate the relative degree of safety. The
designation A-1 indicates that the degree of safety regarding timely payment is
either overwhelming or very strong. A "+" designation is applied to those issues
rated "A-1" which possess extremely strong safety characteristics. Capacity for
timely payment on issues with the designation "A-2" is strong. However, the
relative degree of safety is not as high as for issues designated A-1. Issues
carrying the designation "A-3" have a satisfactory capacity for timely payment.
They are, however, somewhat more vulnerable to the adverse effect of changes in
circumstances than obligations carrying the higher designations.
B-28
<PAGE>
MASTERS' SELECT EQUITY FUND
STATEMENT OF ASSETS AND LIABILITIES
DECEMBER 12, 1996
<TABLE>
<S> <C>
Assets
Cash in bank $100,000
Prepaid registration fees (Note 3) 21,091
Deferred organization costs (Note 4) 94,491
--------
Total assets $215,582
Liabilities
Payable for registration expenses and organization costs 115,582
--------
Net Assets
Applicable to 10,000 shares of beneficial interest issued and outstanding; an unlimited
number of shares (par value $.01 authorized) $100,000
========
Net Asset Value (Offering and Redemption Price) per share $ 10.00
========
</TABLE>
NOTES TO STATEMENT OF ASSETS AND LIABILITIES
1. Masters' Select Equity Fund (the "Fund") is a diversified series of
Masters' Select Investment Trust (the "Trust"), a Delaware business trust
organized on August 1, 1996 and registered under the Investment Company Act
of 1940 as an open-end management investment company.
2. The Trust, on behalf of the Fund, has entered into an Investment Advisory
Agreement with Litman/Gregory Fund Advisors LLC (the "Advisor"), a
Distribution Agreement with First Fund Distributors, Inc. (the
"Distributor") and an Administration Agreement with Investment Company
Administration Corporation (the "Administrator"). The Trust, on behalf of
the Fund, has also entered into sub-advisory agreements with six investment
managers pursuant to which each investment manager provides portfolio
management and related services with respect to a segment of the Fund's
portfolio. (See "Management" in the Statement of Additional Information.)
Certain officers and Trustees of the Trust are officers and/or directors of
the Advisor, the Distributor and the Administrator.
The Advisor has agreed to waive its fees, and/or reimburse the Fund for
other operating expenses, to the extent necessary to limit the Fund's total
annual operating expenses to 1.75% of the Fund's average net assets. Any
such waivers or reimbursements are subject to repayment by the Fund in
subsequent years to the extent that the Fund's operating expenses are then
less than that 1.75% limit.
3. Prepaid registration fees are charged to income as the related shares are
issued.
4. Deferred organization costs will be amortized over a period of sixty months
from the date on which the Fund commences operations. In the event that the
original shares invested in the Fund are redeemed prior to the end of the
amortization period, the proceeds of the redemption payable in respect of
those shares will be reduced by the pro rata share (based on the
proportionate share of the original shares redeemed to the total number of
original shares outstanding at the time of redemption) of the unamortized
deferred organization costs as of the date of that redemption. In the event
the Fund is liquidated prior to the end of the amortization period the
holders of the original shares will bear the unamortized deferred
organization costs.
B-29
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Trustees and Shareholders
Masters' Select Investment Trust
We have audited the accompanying statement of assets and liabilities of the
Masters' Select Equity Fund, a series of Masters' Select Investment Trust, as of
December 12, 1996. This financial statement is the responsibility of the Fund's
management. Our responsibility is to express an opinion on this financial
statement based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatements. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures related to the schedule. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statement referred to above presents fairly,
in all material respects, the financial position of Masters' Select Equity Fund
series of Masters' Select Investment Trust as of December 12, 1996, in
conformity with generally accepted accounting principles.
McGladrey & Pullen, LLP
New York, New York
December 13, 1996
B-30
