Please read this prospectus before investing, and keep it on file for future
reference. It contains important information, including how the Fund invests and
the services available to shareholders.
A Statement of Additional Information (SAI) dated December 31, 1996 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 OR ANY STATE SECURITIES COMMISSION NOR
HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
THE MASTERS'
SELECT EQUITY
FUND
A No-load Mutual Fund
The Masters' Select Equity Fund is a growth fund that 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.
Prospectus
December 31, 1996
Litman/Gregory Fund
Advisors, LLC
4 Orinda Way
Orinda, CA 94563
<PAGE>
Contents
The Fund at a Glance 3 Goal, Strategy and Management
Who May Want to Invest 4
Expenses 4
The Fund in Detail 5 Investment Philosophy; Management; Investment
Managers; Securities, Investment Practices and
Risks; Fundamental Policies and Investment
Restrictions; Breakdown of Expenses, Organization
Your Account 17 Ways to Set Up Your Account
18 How to Buy Shares
20 How to Sell Shares
Shareholder and Account 22 Statements and Reports, Investor Services, Share
Policies Price, Purchases, Redemptions
Dividends, Capital Gains 23 Distribution Options, Taxes
and Taxes
Performance 24
General Information 25
Prospectus 2
<PAGE>
The Fund at a Glance
Goal: The Masters' Select Equity Fund (the "Fund") seeks long term growth of
capital primarily from investment in U.S. equity securities. As with any mutual
fund, there is no assurance that the Fund will achieve this goal. Strategy: The
Fund is sub-advised by six highly regarded 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 six experienced, world class managers, all with
superior long term public track records at other mutual funds.
- - 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 Fund portfolio that is prudently diversified in terms of stocks
(typically 75 to 90) and industries while still allowing the managers to
run portfolio segments focused on only their favorite stocks.
- - Further diversify across different size companies and stock picking styles
by using six portfolio managers, each with a different stock picking
discipline.
The Fund's Advisor has extensive experience evaluating investment managers and
mutual funds. The Advisor has selected investment managers for the Fund that it
believes are superior, based on their track record as well as the Advisor's
subjective assessment of their investment philosophy, analytical support and
other characteristics that it believes are found in superior investment
managers.
Management: Litman/Gregory Fund Advisors, LLC is the Fund's 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.
The Advisor has contracted with investment managers to manage the day-to-day
stock picking. The individual portfolio managers are as follows:
Shelby Davis: CEO and Chief Investment Officer of Davis Selected Advisers, LP,
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 Friess Associates and also lead portfolio
manager of the Brandywine Fund.
Mason Hawkins: Chief Executive Officer of Southeastern Asset Management and
co-manager of Longleaf Partners Fund.
Spiros "Sig" Segalas: President and Chief Investment Officer of Jennison
Associates Capital Corp. and portfolio manager of Harbor Capital Appreciation
Fund.
Dick Weiss: Member of the Executive Committee at Strong Capital Management, Inc.
and co-manager of
3 Prospectus
<PAGE>
Strong Common Stock Fund.
Fund Closing: In order to ensure the integrity of the Fund's focused approach,
it is expected that the Fund may close to new investors periodically at certain
asset levels. Limiting the Fund's size will allow the investment managers to
maintain their focus on selected securities.
Who May Want to Invest
The 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 Fund's investments will vary from day to day, and generally
reflects 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 itself, the Fund does 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 Fund has no shareholder transaction expenses.
================================================================================
Annual Operating Expenses
================================================================================
Investment advisory fee 1.10%
12b-1 fee None
Other expenses of the Fund .65%
----
Total Fund operating expenses 1.75%
Example: Let's say, hypothetically, that the 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 close your
account after the number of years indicated:
After 1 year $ 18
After 3 years $ 55
The purpose of the above table is to provide an understanding of the various
annual operating expenses which may be borne directly or indirectly by an
investment in the 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 the Fund's assets. The Fund pays an
investment advisory fee to the Advisor equal to 1.10% of the Fund's average net
assets. Each of the investment managers receives a fee for its services from the
Advisor, not from the Fund. The Fund also incurs other expenses for services
such as administrative services, maintaining shareholder records and furnishing
shareholder statements and financial reports. "Other Expenses" in the table have
been estimated. (Total Fund operating expenses are not expected to exceed
1.75%.) The 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."
Prospectus 4
<PAGE>
The Fund in Detail
Investment Philosophy
The investment objective of the Fund 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 which they believe have strong
appreciation potential. Under normal circumstances, the Fund intends to be
substantially or fully invested in equity securities, including common stocks
and other securities with the characteristics of common stocks.
The Fund's strategy is 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. However,
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 the Standard & Poor's 500 Stock Index
("S&P 500"), while others will lag. By including a variety of stock picking
styles in a single mutual fund the Advisor believes the variability of returns
between stock picking styles can be lessened.
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 large company stocks at 50% to 75% of the
Fund's total assets, in normal market conditions. These fixed allocations will
be allowed to drift slightly. The Advisor is responsible for re-balancing 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 securities and a maximum of
15 securities. Though the overall Fund may hold more or less securities at any
point in time, it is generally expected that the Fund will hold between 75 and
90 securities.
Under unusual market conditions, for temporary defensive purposes, up to 35% of
the Fund's total assets may be
5 Prospectus
<PAGE>
invested in short term, high quality debt securities. Defensive positions may be
initiated by the individual portfolio managers or by the Advisor.
Management
The Fund is 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 which may impact their ability to deliver superior
future performance, determines when to re-balance the investment managers'
assets, and determines the amount of cash equivalents (if any) that may be held
in addition to cash held in each of the investment managers' sub-portfolios. The
Trustees will review the level and appropriateness of the various manager fee
schedules.
Kenneth E. Gregory is a Trustee of the Trust and will be responsible for
monitoring the day-to-day activity of the investment managers. Gregory is also
President of L/G Research, an affiliated firm which publishes the No-Load Fund
Analyst newsletter and conducts research on financial markets and mutual funds.
He has been co-editor of the newsletter since its beginning in 1989. 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.
Investment Managers
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 over most periods of five years or
longer (U.S. equity managers).
- - 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
non-investment distractions by delegating most business management and
marketing duties.
The Advisor has extensive experience evaluating investment advisory firms using
the above criteria and believes each of the investment managers selected to
participate in the Fund exhibit the qualities mentioned above.
Information on the investment managers is summarized in the grid below and
detailed in the paragraphs that follow.
Prospectus 6
<PAGE>
INVESTMENT MANAGER SUMMARY
<TABLE>
<CAPTION>
Investment
Initial Experience/
Portfolio Allocation of Relevant Fund Size of Stock Picking
Manager Fund Portfolio Experience Companies Style
<S> <C> <C> <C> <C>
Shelby Davis 20% Over 30 years/ Mostly large cap Growth at a
Davis New York 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 and 10% Over 25 years/ Small and mid High earnings
team Brandywine Fund cap growth
since 1986
Mason Hawkins 20% Over 25 years/ All sizes but Value
Longleaf Partners mostly mid and
Fund since 1987. large cap
Sprios "Sig" 20% Over 30 years/ Mostly large cap High earnings
Segalas Harbor Capital growth
Appreciation Fund
since 1990.
Richard Weiss 10% Over 20 years/ Small and Growth at a
Strong Common mid cap reasonable price
Stock Fund since
1991.
</TABLE>
7 Prospectus
<PAGE>
Shelby Davis/Davis Selected Advisers.
Shelby M. C. Davis is the lead portfolio manager for the segment of the Fund's
assets managed by Davis Selected Advisers LP ("Davis Advisers"), 124 E. Marcy
Street, Santa Fe, NM 87501. Davis has been in the investment business for over
30 years. He has been a portfolio manager for Davis New York Venture Fund since
1969; his son, Christopher C. Davis, was named co-portfolio manager in 1995. In
total, Davis Advisers manages over $6.4 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.). The average annual total return of Davis New York Venture
Fund and the Standard & Poor's 500 Stock Index, through September 30, 1996, is
as follows:
Period Fund S&P 500
One year 14.73% 20.33%
Five years 17.86% 15.23%
Ten years 16.91% 14.96%
(Note: Past performance is not necessarily indicative of future performance of
the Fund.)
Approximately 20% of the Fund's assets will be 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 there is often a catalyst which
will eventually push the stock price higher.
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, Tennessee 38119.
Hawkins has been in the investment business for over 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 over $6
billion. The average annual total return of Longleaf Partners Fund and the
Standard & Poor's 500 Stock Index, through September 30, 1996, is as follows:
Period Fund S&P 500
One year 14.89% 20.33%
Three years 18.86% 17.42%
Five years 19.81% 15.23%
(Note: Past performance is not necessarily indicative of future performance of
the Fund.)
Approximately 20% of the Fund's assets are managed by Southeastern using a value
oriented approach to picking stocks. The Firm considers
Prospectus 8
<PAGE>
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 which 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, and 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 arms 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.
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,
New York 10017. Segalas has been in the investment business for over 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, 1996, Jennison
Associates managed over $17 billion in U.S. equity securities. The average
annual total return of Harbor Capital Appreciation Fund and the Standard &
Poor's 500 Stock Index, since May, 1990, when Segalas became portfolio manager
through September 30, 1996, is as follows:
9 Prospectus
<PAGE>
Period Fund S&P 500
One year 12.10% 20.33%
Three years 19.01% 17.42%
Five years 18.61% 15.23%
(Note: Past performance is not necessarily indicative of future performance of
the Fund.)
Approximately 20% of the Fund's assets will be run by Segalas. He seeks to
invest in mid-sized and large 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.
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, Wyoming 83001. Friess has been in the investment business for
over 25 years and has been 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 over $9 billion. The average annual total return of
Brandywine Fund and the Standard & Poor's 500 Stock Index, through September 30,
1996, is as follows:
Period Fund S&P 500
One year 9.95% 20.33%
Five years 19.94% 15.23%
Ten years 19.08% 14.96%
(Note: Past performance is not necessarily indicative of future performance of
the Fund.)
Approximately 10% of the Fund's assets will be run by Friess and his team.
Friess invests in stocks of well-financed issuers which have proven records of
profitability and strong earnings momentum. Emphasis will be placed on companies
with market capitalizations under $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 those common stocks offer
particular opportunity for long term capital growth. In selecting investments,
Friess will consider 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 will be given to internal factors, such as product or service
development, than to external factors,
Prospectus 10
<PAGE>
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.
Richard T. Weiss/Strong Capital Management.
Richard Weiss is the co-manager for the segment of the Fund's assets run by
Strong Capital Management, Inc., 100 Heritage Reserve, Menomonee Falls,
Wisconsin 53051. Weiss has been in the investment business for over 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 over $3 billion. Strong Capital Management was
founded in 1974 and is controlled by Richard Strong. The average annual total
return of Strong Common Stock Fund and the Standard & Poor's 500 Stock Index,
through September 30, 1996, is as follows:
Period Fund S&P 500
One year 15.67% 20.33%
Three years 15.09% 17.42%
Five years 18.37% 15.23%
(Note: Past performance is not necessarily indicative of future performance of
the Fund.)
Approximately 10% of the Fund's assets will be run by Weiss. He will invest 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 undervaluation 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
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.
Jean-Marie Eveillard/Societe Generale Asset Management Corp. 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,
New York 10020. Eveillard has been in the investment business for over 30 years
and has been the portfolio manager for SoGen International Fund, a multi-asset
global fund, since 1979. Eveillard is also
11 Prospectus
<PAGE>
President of SGAM, an indirect subsidiary of Societe Generale, one of France's
largest banks. SGAM currently manages nearly $5 billion. The average annual
total return of SoGen International Fund, the Standard & Poor's 500 Stock Index
and the Morgan Stanley EAFE Index through September 30, 1996, are as follows:
Period Fund EAFE S&P 500
One year 12.06% 8.61% 20.33%
Five years 13.01% 8.17% 15.23%
Ten years 12.59% 8.67% 14.96%
(Note: Past performance is not necessarily indicative of future performance of
the Fund.)
Because SoGen International Fund invested in fixed income investments as well as
stocks, the above indexes are not ideal benchmarks.
Approximately 20% of the Fund's assets will be run by Eveillard, who will invest
in securities all over the world. At least 50% of his segment must be invested
in U.S. securities. Eveillard is a value investor and 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 looked at (very small to
very large) as well 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.
It is expected that Eveillard will limit his segment of the Fund's portfolio to
$150 million. When his allocation reaches this limit, it is likely that the Fund
will add an additional manager to manage new cash flows that would otherwise
have been allocated to Eveillard.
The investment methods used by these managers in selecting securities for the
Fund varies. The segment of the Fund's 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. Since 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 Fund
or that several managers may simultaneously favor the same industry segment. The
Advisor will monitor 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 were no longer able to continue to manage a
segment of the Fund's portfolio, the Advisor would select a replacement
investment manager with an investment style comparable to that
Prospectus 12
<PAGE>
of the investment manager being replaced. In addition, if an investment manager
is no longer able to manage all of the assets allocated to it, as a result of
the growth of the Fund, the Advisor would select an additional manager with a
comparable style. The Advisor would use the same criteria as those used in the
original selection of investment managers.
The Advisor has applied for an exemptive order from the Securities and Exchange
Commission which, if received, would permit the Advisor, subject to certain
conditions, to select new managers with the approval of the Board of Trustees,
but without obtaining shareholder approval. The order would also permit the
Advisor to change the terms of agreements with the managers or continue the
employment of a manager after an event which 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 the Fund. The order would also permit
the Fund to disclose manager's 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 Fund intends 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. The Fund will typically invest 20% to 30% of its assets in
small companies. While 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.
Foreign Securities. The 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 will be less than
15% of total assets. 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. The 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.
There are special risks associated with investing in foreign securities,
including increased political and economic risk, as well as exposure to currency
fluctuations. The Fund may also invest in foreign securities of issuers in
emerging or developing countries, which involve greater risks than other foreign
investments. Emerging markets may be more volatile than both the U.S. and more
developed foreign markets, and there are other risks more fully described in the
SAI.
* * *
The following paragraphs describe briefly some of the other securities the Fund
may buy and some of the strategies that may be used by the
13 Prospectus
<PAGE>
Fund, as well as some of the risks associated with investing in the Fund. More
information on this subject is contained in the SAI.
Options on Securities and Securities Indices. The Fund may buy call options on
securities in order to fix the cost of a future purchase or to attempt to
enhance return. The Fund may buy put options on securities to hedge against a
decline in the value of securities it owns. The Fund may also write (sell) put
and covered call options on securities in which it is authorized to invest. The
Fund may also purchase and write options on U.S. securities indices. Options
transactions will be entered into for hedging purposes and not for speculation.
The Fund's ability to use these instruments successfully will depend on an
investment manager's ability to predict accurately movements in the prices of
securities, interest rates and the securities markets. There is no assurance
that liquid secondary markets for options will always exist, and the correlation
between hedging instruments and the securities or sectors being hedged may be
imperfect. The requirement to cover obligations may impede portfolio management
or the ability to meet redemption requests. It may also be necessary to defer
closing out options positions to avoid adverse tax consequences.
U.S. Government Securities. The Fund 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 Fund 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 Fund may also invest in
mortgage-backed securities.
Repurchase Agreements. The Fund may enter into repurchase agreements, in which
the Fund buys securities and the seller agrees to repurchase them from the Fund
at a mutually agree-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 Fund's rate of return. Each repurchase agreement is fully
collateralized, but if the seller defaults, the Fund may incur a loss. The Fund
only enters into repurchase agreements with institutions which meet certain
creditworthiness and other criteria.
Illiquid Securities. The Fund may invest up to 15% of its net assets in
securities that at the time of purchase have legal or contractual restrictions
on resale or are otherwise illiquid.
Securities Lending. The Fund may lend up to 10% of its portfolio securities to
financial institutions in order to increase the Fund's income.
Borrowing. The Fund may borrow from banks in an amount up to 20% of its
Prospectus 14
<PAGE>
total assets, but only for temporary, extraordinary or emergency purposes. The
Fund may also engage in reverse repurchase agreements.
Junk Bonds. The Fund may invest up to 10% of its 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 Fund may also engage in transactions in stock index
futures and may sell short "against the box," which is a way of locking in
unrealized gains; it does not currently intend to engage in any other short
sales. The Fund may invest up to 5% of its total assets in securities on a
when-issued or delayed-delivery basis.
The Advisor does not expect the Fund's portfolio turnover rate to exceed 100%.
Fundamental Policies and Investment Restrictions
A fundamental policy is one which cannot be changed without the vote of a
majority of the Fund's outstanding shares, as defined in the Investment Company
Act of 1940 (the "1940 Act"). The 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 the Fund's
fundamental policies and investment restrictions is contained in the SAI.
- --------------------------------------------------------------------------------
Breakdown of Expenses
Breakdown of Expenses
Like all mutual funds, the Fund pays expenses related to its daily operations.
Expenses paid out of the Fund's assets are reflected in its share price; they
are neither billed directly to shareholders nor deducted from shareholder
accounts.
The 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 Fund) pays the
investment managers, each of which is also compensated monthly on the basis of
the assets committed to their individual discretion.
While the investment advisory fee is a significant component of the Fund's
annual operating expenses, the Fund also pays other expenses. The Fund pays 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 Fund, at the annual rate of
0.10% on the first $200 million of its average net assets, subject to an annual
15 Prospectus
<PAGE>
minimum of $40,000. The Fund also pays 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.
Assuming the Fund has total assets of $75 million or less, the specific fees
that the Advisor is obligated to pay each Manager annually are as follows:
Southeastern Asset Management, 0.75% of its allocated portion; Davis Selected
Advisers, L.P., 0.60% of its allocated portion; Strong Capital Management, Inc.,
0.75% of its allocated portion; Jennison Associates Capital Corp., 0.75% of the
first $10,000,000 of its allocated portion, 0.50% of the next $30,000,000 of its
allocated portion, and 0.35% of the remainder of its allocated portion; Friess
Associates, 1.00% of its allocated portion; and Societe Generale Asset
Management, 0.75% of its allocated portion.
The Advisor has agreed to reimburse the Fund for any ordinary operating expenses
above 1.75% of the Fund's average net assets. The Advisor reserves the right to
be repaid by the Fund if expenses subsequently fall below the specified limit in
future years. But the Fund's operating expenses including any repayments will
never be allowed to exceed 1.75% of average annual net assets. This expense
limitation arrangement is guaranteed by the Advisor for at least the first year
of the Fund's operations. 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 is a series of Masters' Select Investment Trust
(the Trust), an open-end management investment 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 Fund, review the
compensation arrangements between the Advisor and the investment managers,
review contractual arrangements with companies that provide services to the Fund
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.
The 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. The Fund will mail proxy
materials in advance, including a voting card and information about the
proposals to be voted on. The number of votes you are entitled to is based on
the number of shares of the Fund you own.
Prospectus 16
<PAGE>
================================================================================
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 special 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 $2000 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 special 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 Fund. All of these
accounts need to be established by the plan's trustee. The Fund does not
offer prototypes of these plans.
- --------------------------------------------------------------------------------
Gifts or Transfers to Minor (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
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.
17 Prospectus
<PAGE>
Your Account
How to Buy Shares
You can open a new account by mailing in 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 the form at the bottom of your
account statement, or a letter;
- - wiring money from your bank; or
- - making automatic investments.
The Fund is a no-load fund, which means you pay no sales commissions of any
kind. Once each business day, the Fund calculates its share price: the share
price 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 a special application. Retirement investing
also involves its own investment procedures. Call 1-800-960-0188 for more
information and a retirement 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 is the Fund's Transfer and Dividend Paying
Agent; its address is 1004 Baltimore, 5th Floor; Kansas City, MO 64105, and its
mailing address is P.O. Box 419929, Kansas City, MO 64141-6929.
First Fund Distributors, Inc., 4455 E. Camelback Road, Suite 261E, Phoenix AZ
85018, an affiliate of the Administrator, is the Fund's 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.
For Information: 1-800-960-0188
To Invest
By Mail:
By Wire: Call:
1-800-960-0188 to set up an account and arrange a wire transfer
Prospectus 18
<PAGE>
================================================================================
How to Buy Shares
================================================================================
Mail [GRAPHIC]
- --------------------------------------------------------------------------------
To open an account:
- - Complete and sign the new account application. Make your check or money
order payable to "Masters' Select Equity 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
To add to an account:
- - Make your check or money order payable to "Masters' Select Equity Fund."
Put your account number on your check.
Mail your check and the stub from 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
- --------------------------------------------------------------------------------
Wire [GRAPHIC]
- --------------------------------------------------------------------------------
To open an account:
- - Call 1-800-960-0188 for instructions on opening an account by wire.
To add to an account:
- - Call 1-800-960-0188 for instructions on adding to an account by wire.
- --------------------------------------------------------------------------------
Automatic Investment Plan [GRAPHIC]
- --------------------------------------------------------------------------------
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:
- - Sign up for the Automatic Investment Plan or call 1-800-960-0188 for
instructions on how to establish this Plan.
19 Prospectus
<PAGE>
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 the 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 (record address), or
- - 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.
The 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 Uniform Gifts or Transfers to Minors Act accounts) may be
redeemed by the Fund if, due to redemptions you have made, the total value of
your account is reduced to less than $2,500. If the 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 the 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, and
- - Any other applicable requirements listed in the table on page 17.
- - Unless otherwise instructed, the Fund will send a check to the record
address. Mail your letter to:
National Financial Data Services
1004 Baltimore, 5th Floor
Kansas City, MO 64105
Selling Shares by Telephone
If you accepted the telephone redemption option when you filled out your new
account application, you can sell shares simply by calling 1-800-960-0188. The
amount you wish redeemed (up to $25,000) will be wired to your bank account.
Prospectus 20
<PAGE>
================================================================================
How to Sell Shares
================================================================================
<TABLE>
<CAPTION>
By Phone All account types - Maximum check request: $25,000
1-800-960-0188 except retirement
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
Mail or in Person Individual, Joint Tenant, - The letter of instructions must be
Sole Proprietorship, signed by all persons required to sign
UGMA, UTMA for transactions, exactly as their
names appear on the account.
Retirement Account - The account owner should complete a
retirement distribution form.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 last 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
- ---------------------------------------------------------------------------------------------
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: $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.
</TABLE>
21 Prospectus
<PAGE>
Shareholder and Account Policies
Statements, Reports and Inquiries
Statements and reports that the 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)
If you have questions about your account, you may call the Transfer Agent at
1-800-960-0188.
Investor Services
The Fund offers the following services to investors:
A systematic withdrawal plan lets you set up periodic redemptions from your
account.
Regular Investment Plan: One easy way to pursue your financial goals is to
invest money regularly. The Fund offers a convenient service that lets you
transfer money into your Fund account automatically. While regular 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
The Fund is open for business each day the New York Stock Exchange (NYSE) is
open. The Fund calculates its NAV as of the close of business of the NYSE,
normally 4 p.m. Eastern time.
The Fund's NAV is the value of a single share. The NAV is computed by adding the
value of the 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).
The 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 Fund does not accept cash, credit cards or third-party checks.
- - If your check does not clear, your purchase will be cancelled and you will
be liable for any losses or fees the Fund or its transfer agent incurs.
- - Your ability to make automatic investments may be immediately terminated if
any item is unpaid by your financial institution.
- - The 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 Fund. Order may also be rejected
from persons believed by the Advisor to be "market timers."
Prospectus 22
<PAGE>
Certain financial institutions that have entered into sales agreements with the
Fund 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 Fund, it
may take up to seven days to pay you.
- - Redemptions may be suspended or payment dates postponed when the New York
Stock Exchange (NYSE) 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 Fund distributes substantially all of its 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 Fund offers three options:
1. Reinvestment Option. Your dividend and capital gain distributions will be
automatically reinvested in additional shares of the Fund. If you do not
indicate a choice on your application, you will be assigned this option.
2. Income-Earned Option. Your capital gain 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 gain
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 the 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 Fund passes its earnings along to its
investors as distributions.
The Fund earns dividends from stocks and interest from short term investments.
These are passed along as dividend distributions. The Fund realizes capital
gains whenever it sells securities for a higher price than it paid for them.
These are passed along as capital gain distributions.
23 Prospectus
<PAGE>
Taxes
As with any investment, you should consider how your investment in the 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 or local taxes. If you live outside 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. However, distributions declared in December and paid in January
are taxable as if they were paid on December 31.
For federal tax purposes, the Fund's income and short term capital gain
distributions are taxed as dividends; long term capital gain distributions are
taxed as long term capital gains. Every January, the 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 the 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. However, it is up to
you or your tax preparer 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 the 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 its effort to adhere to these requirements, the Fund may have to
limit its investment activity in some types of instruments.
When you sign your 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 the 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
Prospectus 24
<PAGE>
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 Fund
may sometimes show its performance compared to certain performance rankings,
averages or stock indices (described more fully in the SAI).
General Information
The Fund is the only existing series of shares of Masters' Select Investment
Trust (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 ten percent of the
Trust's shares, the Trustees will call a meeting of shareholders to vote on the
removal of a Trustee. In addition, ten shareholders holding the lesser of
$25,000 worth or one per cent 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 pre-emptive or conversion rights. Shares when
issued are fully paid and non-assessable, except as set forth above.
The legality of share issuance is passed upon by Heller, Ehrman, White &
McAuliffe, San Francisco, California.
25 Prospectus
<PAGE>
THE MASTERS' SELECT EQUITY FUND
Statement of Additional Information
Dated December 31, 1996
This Statement of Additional Information is not a prospectus, and it should be
read in conjunction with the prospectus dated December 31, 1996, as may be
amended from time to time, of The Masters' Select Equity Fund (the "Fund"), a
series of Masters' Select Investment Trust (the "Trust"). Litman/Gregory Fund
Advisors, LLC (the "Advisor") is the Advisor of the Fund. The Advisor has
retained six investment managers as sub-advisers ("Managers"), each responsible
for portfolio management of a segment of the Fund's total assets. A copy of the
prospectus may be obtained from the Fund at 4 Orinda Way, Suite 230D, Orinda,
California 94563, telephone (510) 254-8999.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Cross-reference to sections
Page in the prospectus
---- ---------------------------
<S> <C> <C>
Introduction to the Masters' Select Equity Fund...... B-2 The Fund at a Glance
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-28 Performance
General Information.................................. B-29 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
</TABLE>
B-1
<PAGE>
INTRODUCTION TO THE MASTERS' SELECT EQUITY FUND
The Masters' Select Equity Fund is a new Fund designed to access the
favorite stock picking ideas of six of the mutual fund industry's most
successful portfolio managers. Today there are hundreds of equity mutual funds
available to investors. Typically, these funds invest in a well diversified
portfolio of 50 to 200 stocks by focusing on a particular stock picking
approach. Without a doubt there are many good funds to choose from. However, we
think there is a better way.
The Masters' Select Equity Fund takes a different approach. We marshal
the efforts of six world class investment managers, with each focusing on their
specialty and, within that specialty, concentrating on only their most
compelling investment ideas. Working independently, and representing a variety
of stock picking styles, each manager contributes a minimum of 5 and a maximum
of 15 stocks to the Fund's portfolio. By limiting each manager's holdings to
only their most compelling ideas, the Fund seeks to isolate the stock picker's
skill in a way traditional funds cannot. And, while benefiting from each
manager's very focused portfolio, the overall Fund is well-diversified with the
six managers directing a total Fund portfolio of up to 90 stocks in a variety of
industries. The Fund will be closed at a level that will protect the integrity
of the concept.
The following provides more detailed answers to commonly asked
questions about the Masters' Select Equity Fund.
Q: How is the Fund structured?
A: The Fund's portfolio is divided up into six parts, each being managed by a
different sub-advisor/stock picker. Each stock picker works independently
investing their portion of the Fund's portfolio in not more than 15 securities
(typically stocks). Each of the sub-advisors are well known, highly respected
stock fund managers, possessing what we believe are exceptional track records.
Q: Why is each manager limited to 15 holdings?
A: We have studied, interviewed and analyzed mutual funds and their stock
pickers for years and have come to believe that most stock pickers/fund managers
own a handful of stocks at any point in time in which they have a higher degree
of confidence than the other stocks that round out their portfolios. We believe
these "high confidence" stocks, on average, over a market cycle, have the
potential to out-perform the manager's total portfolio.
Q: What support is there for this highly focused approach to investing?
A: There are a number of arguments in favor of a highly focused approach to
investing. First, is basic common sense. We believe it is unlikely that a stock
picker will do as well with his/her 30th, 50th or 100th pick as with his or her
favorite 10 or 15. Secondly, in talking to managers over the years we've learned
that many invest their own portfolios in fewer stocks than they use for their
own funds. Third, if we look at the few funds that are more focused, we find
some of the best performers in the industry (Longleaf Partners, Sequoia Fund,
CGM Capital Development, Baron Asset, Clipper, Oakmark, FPA Capital). And of
course there is Warren Buffett, arguably the greatest investor alive, who is
famous for investing in a small handful of good businesses. Finally, we are
familiar with a number of fund managers who have told us about (or showed us)
their superior performance on separate accounts or private funds they run in a
less diversified fashion. Focused investing isn't necessary to be a successful
investor. But, in the hands of superior investors, we believe it significantly
raises the odds of superior performance.
Q: If this approach of focusing on a small group of compelling investment ideas
is so good, why haven't many similar funds been formed already?
A: There are two reasons why focused or minimally diversified funds are not
common. First, a portfolio of only 15 stocks is potentially risky precisely
because of the limited diversification. Second, most good stock funds attract
billions of dollars. With a portfolio in the billions, the fund's manager loses
flexibility to invest in only a few stocks. So, in order to invest the sizable
asset base, funds often expand the number of stocks in their portfolios as they
grow.
Q: How does the Masters' Select Equity Fund solve these problems? A: The
multi-manager approach solves the diversification problem. By including six
managers, each with a portfolio
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of not more than 15 stocks, we can "capture" each manager's most compelling
ideas, while at the same time provide investors with a very diversified
portfolio. Typically, we expect the Fund to hold 75 to 90 stocks. We will avoid
the asset growth problem by closing the Fund at a level that will not allow the
managers to stray from the Fund's strategy.
Q: What are the stock picking styles represented in the Fund?
A: There are a mix of styles represented. They include: mid/large cap value,
mid/large cap growth-at-a-reasonable price, mid/large cap earnings momentum,
small cap earnings momentum, small-cap growth-at-a-reasonable price, and global
value.
Q: Why is there such a mix of styles?
A: In designing the Fund, one of our objectives was to structure the portfolio
so that it would make sense as a core equity fund holding for most investors. We
believe a mix of stock picking styles will help to smooth out the performance
over time. For example, whether a particular market environment favors value
stocks over growth, big cap over small, this Fund should always have a portion
of its portfolio participating in the strong segment. It will never be totally
invested in an out-of-favor segment (for example, a big cap value fund in a big
cap growth market).
Q: How did we decide on the allocations to styles and managers, and will these
change?
A: Because we wanted the Fund to make sense as a core holding, appealing to a
broad group of investors, we chose to overweight U.S. big cap stocks. Each big
cap manager will be allocated 20% of the portfolio (for a total of 60%). The
global value manager will also receive a 20% weighting. The two small cap
managers will each run 10%. These initial allocations may drift slightly over
time. As the Fund's advisor, we will determine when to re-balance back to the
original allocations. The overall effect is to create a very diversified Fund
with enough small cap exposure (20% to 25% at any point in time) and aggressive
growth exposure (30% -- this includes 10% of the small cap exposure) to give the
Fund some drive in a bull market. At the same time, we believe there is enough
out-of-sync international exposure (10% to 15% in normal circumstances) and more
conservative big cap exposure to keep the Fund's risk profile in line with the
overall stock market.
Q: Who are the sub-advisors?
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
SUB-ADVISOR INITIAL RELEVANT STYLE IN MASTERS'
ALLOCATION FUND EXPERIENCE FUND
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Shelby Davis 20% New York Venture Fund Large/mid-cap growth-at-a-
reasonable price
- -------------------------------------------------------------------------------------------------------------------
Jean-Marie Eveillard 20% Sogen Overseas Global value
Sogen International
- -------------------------------------------------------------------------------------------------------------------
Mason Hawkins 20% Longleaf Partners Large/mid-cap value
- -------------------------------------------------------------------------------------------------------------------
Spiros "Sig" Segalas 20% Harbor Capital Appreciation Large cap earnings
momentum
- -------------------------------------------------------------------------------------------------------------------
Foster Friess/team 10% Brandywine Fund Small/mid cap earnings
momentum
- -------------------------------------------------------------------------------------------------------------------
Dick Weiss 10% Strong Common Stock Small cap growth-at-a-
reasonable price
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
Q: How were the sub-advisors selected?
A: We sought our favorite managers in each style category. Our evaluation
process is both quantitative and qualitative. On the quantitative side we study
the records of stock pickers with an eye to consistency of performance and
superior performance over a market cycle, relative to the appropriate peer
group. On the qualitative side we look for traits we have come to believe are
common in great stock pickers. These include a passion for their job that often
borders on obsession; the ability to think independently with the conviction
level to act on those thoughts; and a focus on the job of stock picking (limited
business related or marketing distractions). In addition, all the managers are
very experienced
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and have a long-term focus. We believe this group of managers brings together in
a single Fund an unprecedented level of talent and experience.
Q: How will the managers work together? Is there potential for egos to get in
the way?
A: This will not be a Fund run by committee. Each sub-advisor will work
independently of the others and for this reason we don't envision any conflicts.
We also don't expect to have overlapping portfolios because of the differing
market caps and investment styles the managers employ. However, as the Fund's
overall advisor, part of Litman/Gregory's role will be to watch for excessive
overlap or industry concentration.
Q: How will we evaluate the managers?
A: In terms of performance, evaluation will be relative to an appropriate peer
group. We will measure performance against style benchmarks we have created and
against the better managers in a particular style group. Our evaluation horizon
will be long-term. We will not focus on performance of one year or less. In
general, we do not believe short-term performance evaluation adds value and it
can put undue pressure on a manager. Moreover, the 15-stock portfolios each
manager will run make a short-term evaluation horizon even less appropriate. Our
expectation is to focus more heavily on performance over two to three years.
From a qualitative standpoint we will monitor the sub-advisors' focus, staff
continuity, and other factors which will impact our confidence in each manager's
ability to perform well in the future.
Q: What will the Fund's risk level be?
A: This is an equity fund so it will exhibit equity market risk. When the
overall stock market is declining, it is likely that this Fund will decline as
well. At times declines will be severe. Though we can't say for sure, based on
our many years of experience constructing portfolios of mutual funds, we believe
the Fund's broad diversification will result in risk over a market cycle that is
similar to that of the S&P 500 (the overall U.S. stock market).
Q: Who is this Fund for?
A: We believe the Masters' Select Equity Fund is appropriate for most investors
looking for long-term stock market exposure. We believe the combination of style
diversification, some (limited) foreign exposure, and proven managers with
superior track records make the Fund appropriate as a core holding for the
equity portion of most investor's portfolios. For less active investors this
Fund may make sense for the entire equity portion of the portfolio. For active
investors, the Fund may be a core position that is supplemented by various types
of equity funds depending on the objectives of the investor. For investors who
believe in a combination of indexing and active management, the potential for
higher market cycle performance from this Fund may make it an appropriate
complement to an indexed portfolio.
Q: What are reasonable performance expectations for the Masters' Select Equity
Fund?
A: Though there can be no guarantees, we believe this Fund, built on the concept
of isolating the most compelling stock picks of a gifted group of stock pickers,
is likely to deliver superior performance over a market cycle. However, we
believe it is important to point out that we don't believe this Fund will be a
chart topping fund year-in and year-out. The diversification that we believe
will smooth out the performance over time is also likely to keep this Fund off
the top of the charts over short time periods.
Q: What will the expense level be?
A: Expenses will begin at 1.75%. These will decline as the Fund's assets grow.
If we achieve the asset growth we expect, we believe the expenses will decline
to levels lower than that of the average equity fund. The Fund is a no-load, no
12b-1 fund.
INVESTMENT OBJECTIVES AND POLICIES
The investment objective of the Fund is to provide long-term growth of
capital. There is no assurance that the Fund will achieve its objective. The
discussion below supplements information contained in the prospectus as to
investment policies of the Fund. Convertible Securities and Warrants
The Fund may invest in convertible securities and warrants. A
convertible security is a fixed income security
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<PAGE>
(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 the
Fund's entire investment therein).
Other Corporate Debt Securities
The Fund may invest in non-convertible debt securities of foreign and
domestic companies over a cross-section of industries. The debt securities in
which the 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 the Fund to achieve its investment
objective also depends on the continuing ability of the issuers of the debt
securities in which the 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, the 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 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, the 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 the 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, the Fund would have to replace the security with a lower yielding
security, resulting in a decreased return
B-5
<PAGE>
for investors. Conversely, a high yield bond's value will decrease in a rising
interest rate market, as will the value of the Fund's assets. If the 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 the Fund's expenses can be spread and possibly reducing the
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 the
Fund's assets and hinder the 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 the
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 the Fund can meet redemption requests. The Fund will not
necessarily dispose of a portfolio security when its rating has been changed.
Short-Term Investments
The Fund may invest in any of the following securities and instruments:
Bank Certificates or Deposit, Bankers' Acceptances and Time Deposits.
The 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 the 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 the 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 foreign bank obligations that the
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, the 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. The 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
B-6
<PAGE>
$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. The
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, the 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
The 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 the 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 the Fund
invested in a money market mutual fund. However, an investment in a money market
mutual fund will involve payment by the Fund of its pro rata share of advisory
and administrative fees charged by such fund.
Government Obligations
The 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.
The 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 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.
B-7
<PAGE>
Zero Coupon Securities
The 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
The 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 the 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 the 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 the Fund. The absence of such an active secondary
market could make it difficult for the 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 the Fund is not
entitled to exercise its demand rights, and the 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
The 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. The 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 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
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<PAGE>
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 the 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
The Fund may invest in securities of foreign issuers that are not
publicly traded in the United States. The 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 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. The 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 the Fund's assets denominated in that currency. Such changes will also
affect the Fund's income. The value of the Fund's assets may also be affected
significantly by currency restrictions and exchange control regulations enacted
from time to time.
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Market Characteristics. The Managers expect that many foreign
securities in which the Fund invest 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 the 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 the 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 the
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 the Fund's foreign portfolio
securities may be subject to foreign withholding taxes, thus reducing the net
amount of income available for distribution to the Fund's shareholders.
Costs. To the extent that the 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 the 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 the 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 the
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. The Fund may purchase covered "put"
and "call" options with respect to securities which are otherwise eligible for
purchase by the Fund and with respect to various stock indices subject to
certain restrictions. The Fund will engage in trading of such derivative
securities exclusively for hedging purposes.
If the Fund purchases a put option, the 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 the Fund
is holding a stock which it feels has strong fundamentals, but for some reason
may be weak in the near term, the 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, the 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 the Fund exercises the put, less
transaction costs, will be the amount
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by which the 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 the Fund paid for the put, plus
transaction costs. If the price of the underlying security increases, the profit
the 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 the 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 the Fund has a short position in the
underlying security and the security thereafter increases in price. The 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 the Fund in the underlying security and
the price of the underlying security thereafter falls, the profit the 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. The 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. The Fund may write covered call options. A call
option is "covered" if the 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 the 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 the
Fund. If the 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.
The 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. The 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 the 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 the Fund.
Stock Index Options. The 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 the Fund's portfolio or which it intends
to purchase or sell, or when they are economically appropriate for the reduction
of risks inherent in the ongoing management of the 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 the 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 the 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
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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, the Fund would not be able
to close out options which it had purchased, and if restrictions on exercise
were imposed, the Fund might be unable to exercise an option it holds, which
could result in substantial losses to the Fund. It is the policy of the 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 the Fund may enter into options transactions may be limited by
the Internal Revenue Code (the "Code") requirements for qualification of the
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, the 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. The Fund will engage in transactions involving dealer
options as well as exchange-traded options. Certain risks are specific to dealer
options. While the Fund might look to a clearing corporation to exercise
exchange-traded options, if the 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 the 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, the 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 the Fund writes a dealer
option, the 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 the Fund originally wrote the option. While the 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 the Fund, there can be
no assurance that the Fund will at any time be able to liquidate a dealer option
at a favorable price at any time prior to expiration. Unless the 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, the Fund may be unable to liquidate a dealer option. With
respect to options written by the Fund, the inability to enter into a closing
transaction may result in material losses to the Fund. For example, because the
Fund must maintain a secured position with respect to any call option on a
security it writes, the Fund may not sell the
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assets which it has segregated to secure the position while it is obligated
under the option. This requirement may impair the 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.
The Fund may treat the cover used for written dealer options as liquid if the
dealer agrees that the 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, the Fund will treat dealer options as subject to the Fund's
limitation on illiquid securities. If the Commission changes its position on the
liquidity of dealer options, the Fund will change its treatment of such
instruments accordingly.
Foreign Currency Options. The 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. The 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 the
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. The 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 the Fund's position, the Fund may forfeit the entire amount
of the premium plus related transaction costs.
Spread Transactions. The 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 the
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 the Fund does not
own, but which is used as a benchmark. The risk to the 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
the 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
The 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, the 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
The Fund may invest in futures contracts and options on futures
contracts as a hedge against changes in market conditions or interest rates. The
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"). The 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 the Fund upon the purchase or sale of a
futures contract. When it enters into a domestic futures contract, the 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.
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The margin requirements for foreign futures contracts may be different.
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 the 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 the
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
the Fund will receive from the broker a variation margin payment equal to that
increase in value. Conversely, when the 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 the Fund will be required to make a variation margin
payment to the broker.
At any time prior to expiration of a futures contract, the Fund may
elect to close the position by taking an opposite position, which will operate
to terminate the 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 the Fund, which realizes a loss or a gain.
In addition to amounts segregated or paid as initial and variation
margin, the 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 the 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. The 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. The 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 the Fund
would create an obligation by the 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 the Fund would create an
obligation by the 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 the 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, the Fund is paid the
difference and thus realizes a gain. If the offsetting purchase price exceeds
the sale price, the Fund pays the difference and realizes a loss. Similarly, the
closing out of a futures contract purchase is effected by the Fund's entering
into a futures contract sale. If the offsetting sale price exceeds the purchase
price, the Fund realizes a gain, and if the purchase price exceeds the
offsetting sale price, the Fund realizes a loss.
The 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
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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 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. The 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. The 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. The 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, the 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, the 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,
the 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, the 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 the 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 the Fund's portfolio may decline. If this occurs,
the 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 the 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 the 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
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frame.
Positions in futures may be closed out only on an exchange or board of
trade which provides a secondary market for such futures. Although the 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, the 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 the Fund is also subject to a Manager's
ability to predict correctly movements in the direction of the market. For
example, if the Fund has hedged against the possibility of a decline in the
market adversely affecting stocks held in its portfolio and stock prices
increase instead, the 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 the 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. The 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 the Fund
engages in transactions in futures contracts or options, the 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, the 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 the 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. The
Fund will not engage in transactions in futures contracts or related options for
speculation, but only as a hedge against changes resulting from market
conditions in the values of securities held in the 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 the Fund. The
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Fund may not purchase or sell futures or purchase related options if,
immediately thereafter, more than 25% of its net assets would be hedged. The
Fund also may not purchase or sell futures or purchase related options if,
immediately thereafter, the sum of the amount of margin deposits on the Fund's
existing futures positions and premiums paid for such options would exceed 5% of
the market value of the 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 the Fund.
The extent to which the Fund may enter into futures and options
transactions may be limited by the Code requirements for qualification of the
Fund as a regulated investment company. See "Taxation."
Repurchase Agreements
The Fund may enter into repurchase agreements with respect to its
portfolio securities. Pursuant to such agreements, the 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 the Fund's agreement to resell such securities at a mutually
agreed upon date and price. The repurchase price generally equals the price paid
by the 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, the 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 the 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.
The Fund may enter into reverse repurchase agreements. The 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. The Fund may use the proceeds of
reverse repurchase agreements to provide liquidity to meet redemption requests
when sale of the Fund's securities is disadvantageous.
The 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
The Fund may enter into dollar roll transactions. A dollar roll
transaction involves a sale by the Fund of a security to a financial institution
concurrently with an agreement by the 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,
the 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 the Fund, and the income from these investments, together with any
additional fee income received on the sale, may or may not generate income for
the Fund exceeding the yield on the securities sold.
At the time the 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
The 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
B-17
<PAGE>
account. Normally, the Custodian will set aside portfolio securities to satisfy
a purchase commitment. In such a case, the 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 the Fund's commitment. It
may be expected that the Fund's net assets will fluctuate to a greater degree
when it sets aside portfolio securities to cover such purchase commitments than
when it sets aside cash.
The Fund does not intend to engage in these transactions for
speculative purposes but only in furtherance of its investment objectives.
Because the Fund will set aside cash or liquid portfolio securities to satisfy
its purchase commitments in the manner described, the Fund's liquidity and the
ability of a Manager to manage it may be affected in the event the Fund's
forward commitments, commitments to purchase when-issued securities and delayed
settlements ever exceeded 15% of the value of its net assets.
The 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,
the 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 the Fund on the settlement date. In these cases the Fund may
realize a taxable capital gain or loss. When the 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 the
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 the Fund starting on the day the Fund agrees to
purchase the securities. The 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
The 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. The 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
The 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
The 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 the Fund if the demand meets the terms of the
letter. Such
B-18
<PAGE>
terms and the issuing bank would have to be satisfactory to the Fund. Any loan
might be secured by any one or more of the three types of collateral. The terms
of the Fund's loans must permit the 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
The Fund is authorized to make short sales of securities it owns or has
the right to acquire at no added cost through conversion or exchange of other
securities it owns (referred to as short sales "against the box") and to make
short sales of securities which it does not own or have the right to acquire.
In a short sale that is not "against the box," the 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, the Fund must borrow the security
(generally from the broker through which the short sale is made) in order to
make delivery to the buyer. The Fund is then obligated to replace the security
borrowed by purchasing it at the market price at the time of replacement. The
Fund is said to have a "short position" in the securities sold until it delivers
them to the broker. The period during which the 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 the 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, the
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 the Fund that are not made "against the box" create
opportunities to increase the Fund's return but, at the same time, involve
specific risk considerations and may be considered a speculative technique.
Since the 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, the 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 the Fund may be required to pay
in connection with the short sale. Furthermore, under adverse market conditions
the 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.
If the Fund makes a short sale "against the box," the Fund would not
immediately deliver the securities sold and would not receive the proceeds from
the sale. The seller is said to have a short position in the securities sold
until it delivers the securities sold, at which time it receives the proceeds of
the sale. To secure its obligation to deliver securities sold short, the Fund
will deposit in escrow in a separate account with the Custodian an equal amount
of the securities sold short or securities convertible into or exchangeable for
such securities. The Fund can close out its short position by purchasing and
delivering an equal amount of the securities sold short, rather than by
delivering securities already held by the Fund, because the Fund might want to
continue to receive interest and dividend payments on securities in its
portfolio that are convertible into the securities sold short.
The Fund's decision to make a short sale "against the box" may be a
technique to hedge against market risks when a Manager believes that the price
of a security may decline, causing a decline in the value of a security owned by
the Fund or a security convertible into or exchangeable for such security. In
such case, any future losses in the Fund's long position would be reduced by a
gain in the short position. The extent to which such gains or losses in the long
position are reduced will depend upon the amount of securities sold short
relative to the amount of the securities the Fund owns, either directly or
indirectly, and, in the case where the Fund owns convertible securities, changes
in the investment values or conversion premiums of such securities.
The extent to which the Fund may enter into short sales transactions
may be limited by the Code requirements for qualification of the Fund as a
regulated investment company. See "Taxation."
B-19
<PAGE>
Illiquid Securities
The Fund may not invest more than 15% of the value of its net assets in
securities that at the time of purchase have legal or contractual restrictions
on resale or are otherwise illiquid. The Advisor and the Managers will monitor
the amount of illiquid securities in the Fund's portfolio, under the supervision
of the Trust's Board of Trustees, to ensure compliance with the 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 the 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. The 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 Trust's Board of Trustees may determine that such securities are not
illiquid securities notwithstanding their legal or contractual 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, the 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, the 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
the 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 the
Fund than in a fund that invests in larger, more established companies.
Investment Restrictions
The Trust (on behalf of the 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 the 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 the 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 the Fund.
As a matter of fundamental policy, the 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) the Fund may not purchase more than 10% of
the outstanding voting securities of an issuer. The Fund's investment objective
is also fundamental.
B-20
<PAGE>
In addition, the Fund may not:
1. Issue senior securities, borrow money or pledge its assets, except
that (i) the 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 the
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 the 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 the 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 the 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 the Fund and except for repurchase
agreements); or
9. Make investments for the purpose of exercising control or
management.
The Fund observes the following restrictions as a matter of operating
but not fundamental policy, pursuant to positions taken by federal regulatory
authorities:
The 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 and state
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 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 the 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.
1065 Sterling Avenue Director of Peoplesoft, Inc.; Barra, Inc:, and Fair, Isaac.
Berkeley, CA 94708 Formerly (until 1995) Managing Partner, Market Development of
Andersen Consulting.
</TABLE>
B-21
<PAGE>
<TABLE>
<S> <C> <C>
Frederick August
Eigenbrod, Jr. PhD (55) Trustee Senior Vice President, Right Associates (industrial psychologists)
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 President and Secretary
100 Larkspur Landing Circle Trustee of L/G Research Inc.; Chairman of Litman/Gregory & Co., LLC
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 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 the 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 the Fund with advice and recommendations with respect to the
selection and continued employment of Managers to manage the actual investment
of the Fund's assets; (ii) direct the allocation of the Fund's assets among such
Managers; (iii) oversee the investments made by such Managers on behalf of the
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 the Fund, filing Section 13 ownership reports for the Fund, and
taking other actions on behalf of the Fund; (v) maintain the books and records
required to be maintained by the Fund except to the extent arrangements have
been made for such books and records to be maintained by the administrator,
another agent of the Fund or an Manager; (vi) furnish reports, statements and
other data on securities, economic conditions and other matters related to the
investment of the Fund's assets which the 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 the 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 the Fund including the
provision of persons
B-22
<PAGE>
qualified to serve as officers of the Trust; (ii) compensating the Managers
selected to invest the assets of the Funds; (iii) the expenses of printing and
distributing extra copies of the 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 the Fund in accordance with the investment
objectives, policies and restrictions of the Fund as set forth in the Fund's and
Trust's governing documents, including, without limitation, the Trust's
Agreement and Declaration of Trust and By-Laws; the 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 the Fund with advice and recommendations with respect to
the investment of the Manager's Allocated Portion of the 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 the 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
Manager's fees), the Fund pays it an 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 the 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 the Fund's
shareholders and the Trust's Board of Trustees that are properly payable by the
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 the 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 the 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 the
Fund for certain expenses, in order to limit the expense ratio of the Fund. In
that event, subject to approval by the Trust's Board of Trustees, the 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
B-23
<PAGE>
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 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
the 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 the Fund on a continuing
basis. The price to the 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 the Fund to pay a broker or dealer that
provides (directly or indirectly) brokerage or research services to the Advisor
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 the Fund. Each Manager is further authorized to allocate the
orders placed by it on behalf of the 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
B-24
<PAGE>
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 Manager is also authorized to consider sales of shares of the Fund as a
factor in the selection of brokers or dealers to execute portfolio transactions,
subject to the requirements of best execution price.
On occasions when a Manager deems the purchase or sale of a security to
be in the best interest of the 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 the Fund and to such other clients.
NET ASSET VALUE
The net asset value of the 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 the 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 the 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 the 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 the 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 the
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 the 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, the 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.
The 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 the Fund if
acquired within 60 days of maturity or, if already held by the 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 the 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
B-25
<PAGE>
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.
An option that is written by the 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 the 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 the 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 the Fund are valued in such manner as the Board in
good faith deems appropriate to reflect their fair value.
TAXATION
The 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 the Fund qualifies, the 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, the 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 the 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) less than 30% of the Fund's gross income each taxable year may
be derived from the sale or other disposition of securities held for less than
three months; (3) at the close of each quarter of the 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 the Fund and that does not represent more than 10% of
the outstanding voting securities of such issuer; and (4) at the close of each
quarter of the 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 the 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 the 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.
The Fund or any securities dealer effecting a redemption of the 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, the 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
B-26
<PAGE>
the 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.
The 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, the 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.
The Fund may receive dividend distributions from U.S. corporations. To
the extent that the Fund receives such dividends and distributes them to its
shareholders, and meets certain other requirements of the Code, corporate
shareholders of the 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 the 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 the
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 Fund purchases an option, the premium
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
B-27
<PAGE>
shares of the same Fund are purchased (including shares acquired by means of
reinvested dividends) within 30 days before or after such redemption.
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 applicable federal tax
consequences of an investment in the Fund. The law firm of Heller, Ehrman, White
& McAuliffe 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:
n
P(1 + T) = 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:
6
YIELD = 2 [(a-b + 1) - 1]
----
cd
B-28
<PAGE>
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, 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 newly organized entity and has no prior business
history. 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 one series of shares,
and may create additional series in the future, which have separate assets and
liabilities. In the event more than one series were created, income and
operating expenses not specifically attributable to a particular Fund would 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.
At December 12, 1996, all of the Fund's outstanding shares were owned
by Messrs. Litman and Gregory.
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<PAGE>
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.
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<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-31
<PAGE>
[McGLADREY & PULLEN LOGO]
McGLADREY & PULLEN, LLP
--------------------------------------------
Certified Public Accountants and Consultants
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 expres 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.
/s/ McGladrey & Pullen, LLP
New York, New York
December 13, 1996
