As filed with the Securities and Exchange Commission on April 30, 1999
Registration No. 333-10015
File No. 811-07763
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
POST-EFFECTIVE AMENDMENT NO. 6 [X]
and
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
AMENDMENT NO. 8 [X]
MASTERS' SELECT FUNDS TRUST
(Exact Name of Registrant as Specified in Charter)
4 ORINDA WAY, SUITE 230-D
ORINDA, CA 94563
(Address of Principal Executive Offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (925) 254-8999
KENNETH E. GREGORY
4 Orinda Way, Suite 230-D
Orinda, CA 94563
(Name and Address of Agent for Service)
Copy to:
Julie Allecta, Esq.
Paul, Hastings, Janofsky & Walker LLP
345 California Street, 29th Floor
San Francisco, CA 94104
It is proposed that this filing will become effective (check appropriate box):
[X] Immediately upon filing pursuant to paragraph (b)
[ ] On April 30,1999, pursuant to paragraph (b) of Rule 485
[ ] 60 days after filing pursuant to paragraph (a)(1)
[ ] On _____________, pursuant to paragraph (a)(1)
[ ] 75 days after filing pursuant to paragraph (a)(2)
[ ] On _____________, pursuant to paragraph (a)(2) of Rule 485
================================================================================
<PAGE>
CROSS REFERENCE SHEET
(Pursuant to Rule 495 showing the location in the Prospectus and the
Statement of Additional Information of the responses to the Items of Parts A and
B of Form N-1A).
<TABLE>
<CAPTION>
Caption or Subheading in Prospectus or
Item No. on Form N-1A Statement of Additional Information
--------------------- --------------------------------------
<S> <C>
1. Front and Back Cover Pages Front and Back Cover Pages
2. Risk/Return Summary: Masters' Select Equity Fund - Objective, Strategy,
Investments, Risks, and Performance Risks, Past Performance; Masters' Select International
Fund - Objective, Strategy, Risks, Past Performance
3. Risk/return Summary: Fee Table Fees and Expenses
4. Investment Objectives, Principal Masters' Select Equity Fund; Masters' Select
Strategies, and Related Risks International Fund
5. Management's Discussion of Fund Not Applicable
Performance
Masters' Select Equity Fund in Detail; Masters' Select
6. Management, Organization, and Capital International Fund in Detail
Structure
7. Shareholder Information Shareholder Services
8. Distribution Arrangements Not Applicable
9. Financial Highlight Information Financial Highlights
</TABLE>
<PAGE>
PART B-INFORMATION REQUIRED IN STATEMENT OF ADDITIONAL INFORMATION
<TABLE>
<CAPTION>
Caption or Subheading in Prospectus or
Item No. on Form N-1A Statement of Additional Information
--------------------- --------------------------------------
<S> <C>
10. Cover Page and Table of Contents Cover Page and Table of Contents
11. Fund History General Information
12. Description of the Fund and Its
Investments and Risks Investment Objectives and Policies
13. Management of the Fund Management
Control Persons and Principal Holders of
14. Securities General Information
15. Investment Advisory and Other Services Management; General Information
16. Brokerage Allocation and Other Practices Portfolio Transactions and Brokerage
17. Capital Stock and Other Securities General Information
18. Purchase, Redemption and Pricing of Shares Net Asset Value
19. Taxation of the Fund Taxation
20. Underwriters Not applicable
21. Calculation of Performance Data Performance
22. Financial Statements Financial Statements
</TABLE>
<PAGE>
As filed with the Securities and Exchange Commission on April 30, 1999
Registration No. 333-10015
File No. 811-07763
================================================================================
Part A
of
Form N-1A
COMBINED REGISTRATION STATEMENT
MASTERS' SELECT FUNDS TRUST
Masters' Select Equity Fund
Masters' Select International Fund
================================================================================
<PAGE>
The Masters' Select Funds
Prospectus
The Masters' Select Equity Fund
The Masters' Select International Fund
April 30, 1999
These securities have not been approved or disapproved by the Securities and
Exchange Commission, nor has the Commission passed upon the accuracy or adequacy
of this prospectus. Any representation to the contrary is a criminal offense.
LITMAN/GREGORY FUND ADVISORS, LLC
<PAGE>
Contents
The Masters' Select Equity Fund - Fund Summary 2
The Masters' Select International Fund - Fund Summary 6
The Funds in Detail - Elements Common to Both Funds 10
The Masters' Select Equity Fund in Detail 14
The Masters' Select International Fund in Detail 20
Shareholder Services 27
Financial Highlights 36
For More Information 37
<PAGE>
THE MASTERS' SELECT EQUITY FUND
OBJECTIVE
The objective of the Fund is long-term growth of capital; that is, the increase
in the value of your investment over the long term.
PRINCIPAL STRATEGIES
The Advisor believes that it is possible to identify investment managers who
will deliver superior returns relative to their peer groups, over a market
cycle. The Advisor also believes that most stock pickers have a few select
stocks in which they have a high degree of confidence. In the case of certain
skilled stock pickers, the Advisor believes a portfolio of their "highest
confidence" stocks will outperform their more diversified portfolios over a
market cycle. Based on these beliefs, the Fund's strategy is to engage six
proven investment managers as sub-advisors, each to invest in the securities of
companies that they believe have strong appreciation potential. Each manager
runs a portion of the overall fund portfolio by independently managing a
portfolio composed of between 5 and 15 stocks. The Fund will primarily invest in
the securities of large and small sized U.S. companies, although the managers
will have limited flexibility to invest in the securities of foreign companies.
By executing this strategy the Fund seeks to:
* combine the efforts of several experienced, world class managers, all
with superior track records,
* access the favorite stock-picking ideas of each manager at any point
in time,
* deliver a portfolio that is prudently diversified in terms of stocks
(typically 65 to 90) and industries while still allowing each manager
to run portfolio segments focused on only his or her favorite stocks,
and
* further diversify across different-sized companies and stock-picking
styles by including managers with a variety of stock-picking
disciplines.
PRINCIPAL RISKS
Investment in stocks exposes shareholders of the Fund to the risk of losing
money if the value of the stocks held by the Fund declines during the period an
investor owns shares in the Fund. As with all mutual funds that invest in common
stocks, the value of an individual's investment will fluctuate daily in response
to the performance of the individual stocks held in the Fund.
2
<PAGE>
Though not a small-cap fund the Fund will invest a portion of its assets in the
securities of small companies. The prices of small companies' stocks are
generally more volatile than the prices of large companies' stocks. This is
because small companies may be more reliant on a few products, services or key
personnel, which can be riskier than owning larger companies with more diverse
product lines and structured management. In addition, because small companies
have fewer shares of stock outstanding, the ability to trade their securities
quickly may be affected by a lack of buyers and sellers in these stocks. This
lack of liquidity increases the Fund's risk to adverse market movements in the
prices of these stocks.
Though primarily a U.S. equity fund, the Fund may invest a portion of its assets
in foreign securities, the stocks and bonds of companies based outside of the
United States. The Fund is exposed to higher risk in owning these securities
because each country has its own rules regarding accounting practices,
government regulation, and government economic policies, which may differ from
the rules and policies that U.S. companies are subject to. In addition, the Fund
will, at times, be exposed to foreign currency fluctuations as the result of its
foreign holdings.
PAST PERFORMANCE
The following chart depicts the performance for the life of the Fund. The chart
illustrates the risk of investing in the Fund by showing the fluctuations in its
annual returns. Please keep in mind that past performance cannot guarantee
future returns.
1997 1998 During the periods shown to the left, the highest and
- ---- ---- lowest quarterly returns earned by the Fund were:
29.11% 14.90%
Highest: 21.49% Qtr. ended 12/31/98
Lowest: -17.11% Qtr. ended 9/30/98
The following table compares the Fund's performance over time with the Wilshire
5000, an unmanaged broad market index of stock performance.
Average Annual Return
One Year Ended Since Inception
12/31/98 (12/31/96)
-------- ----------
Masters' Select Equity Fund 14.90% 21.79%
Wilshire 5000 Index 23.45% 27.31%
3
<PAGE>
FEES AND 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 transaction fees, and annual operating
expenses, such as advisory fees. The Fund has no front-end or deferred sales
loads, and imposes no shareholder transaction fees. The following table
illustrates the fees and expenses you might pay over time as an investor in the
Fund.
SHAREHOLDER FEES (PAID DIRECTLY FROM YOUR INVESTMENT)
Sales Loads None
Redemption Fees None
Transfer Fees None
ANNUAL OPERATING EXPENSES (DEDUCTED FROM FUND ASSETS)
Management Fee 1.10%
Distribution (12b-1) Fee None
Other Operating Expenses(1) 0.28%
Total Annual Fund Operating Expenses 1.38%
Less: Fees waived 0.02%
----
Net Operating Expenses(2) 1.36%
1 Significant other expenses include custody, fund accounting, transfer
agency, legal, audit, administration.
2 The Advisor has contractually agreed to waive .02% of the Management Fee
through December 31, 1999.
EXAMPLE
This Example is intended to help you compare the cost of investing in the Fund
with the cost of investing in other mutual funds. It assumes that you invest
$10,000 in the Fund for the time periods indicated and then redeem all of your
shares at the end of those periods. The Example also assumes that your
investment has a 5% return each year and that the Fund's operating expenses
remain the same. Although your actual costs may be higher or lower, based on
these assumptions your costs would be:
ONE YEAR THREE YEARS FIVE YEARS TEN YEARS
-------- ----------- ---------- ---------
$138 $437 $758 $1,657
4
<PAGE>
MANAGEMENT
The Advisor to the Fund is Litman/Gregory Fund Advisors, LLC. The Advisor has
ultimate responsibility for the investment performance of the Fund due to its
responsibility to oversee the investment managers and recommend their hiring,
termination and replacement. The following table provides a description of the
six investment managers. A detailed discussion of the management structure of
the Fund begins on Page 14.
<TABLE>
<CAPTION>
INVESTMENT
INITIAL EXPERIENCE/
INVESTMENT ALLOCATION OF RELEVANT FUND SIZE OF STOCK-PICKING
MANAGER FUND ASSETS EXPERIENCE COMPANIES STYLE
- ---------- ------------- ------------- --------- -------------
<S> <C> <C> <C> <C>
Shelby Davis 20% Over 30 years/ Mostly large Growth at a
and New York companies reasonable price
Christopher Davis Venture Fund
since 1969
Foster Friess 10% Over 25 years/ Small and High earnings
and team Brandywine mid-sized growth
Fund since 1986 companies
Mason Hawkins 20% Over 20 years/ All sizes, but Value and global,
Longleaf mostly large may invest up to
Partners Fund and mid-sized 50% in foreign
since 1987 securities
Robert Sanborn 20% Over 15 years/ All sizes, but Value
Oakmark Fund mostly large
since 1991 and mid-sized
Spiros "Sig" 20% Over 30 years/ Mostly large High earnings
Segalas Harbor Capital companies growth
Appreciation
Fund since 1990
Dick Weiss 10% Over 20 years/ Small and mid- Growth at a
Strong Common sized companies reasonable price
Stock Fund
since 1991
</TABLE>
5
<PAGE>
THE MASTERS' SELECT INTERNATIONAL FUND
OBJECTIVE
The objective of the Fund is long-term growth of capital; that is, the increase
in the value of your investment over the long term.
PRINCIPAL STRATEGIES
The Advisor believes that it is possible to identify international investment
managers who, over a market cycle, will deliver superior returns relative to
their peers. The Advisor also believes that most stock pickers have a few select
stocks in which they have a high degree of confidence. In the case of certain
skilled stock pickers, the Advisor believes that a portfolio of their "highest
confidence" stocks will outperform their more diversified portfolios over a
market cycle.
Based on these beliefs, the Fund's strategy is to engage five proven investment
managers as sub-advisors, each to invest in the securities of companies that
they believe have strong appreciation potential. Each manages a portion of the
Fund's portfolio by independently managing a portfolio composed of between 8 and
15 stocks. The Fund will invest in the securities of foreign companies,
including large and small companies and companies located in emerging markets.
The managers will have limited flexibility to invest in the securities of U.S.
companies. By executing this strategy the Fund seeks to:
* combine the efforts of several experienced, world class international
stock pickers, all with superior track records,
* access the favorite stock-picking ideas of each manager at any point
in time,
* deliver a portfolio that is prudently diversified in terms of stocks
(typically 50 to 75) and industries while still allowing each manager
to run portfolio segments focused on only his or her favorite stocks,
and
* further diversify across different sized companies, countries, and
stock-picking styles by including managers with a variety of
stock-picking disciplines.
PRINCIPAL RISKS
Investment in stocks exposes shareholders of the Fund to the risk of losing
money if the value of the stocks held by the Fund declines during the period an
investor owns shares in the Fund. As with all mutual funds that invest in common
stocks, the value of an individual's investment will fluctuate daily in response
to the performance of the individual stocks held in the Fund.
6
<PAGE>
The Fund will normally be invested in foreign securities, the stocks and bonds
of companies based outside of the United States. The Fund is exposed to higher
risk in owning these securities because foreign countries have their own rules
regarding accounting practices, government regulation, and government economic
policies, which differ from the rules and policies that U.S. companies are
subject to. Owning foreign securities also exposes shareholders to the political
risks of other countries and the risk of fluctuations of the exchange rate of
the local currency relative to the U.S. dollar.
The Fund may invest a portion of its assets in emerging market countries.
Emerging market countries are those with immature economic and political
structures, and entail greater investment risk than in developed markets. Such
risks include government dependence on a few industries or resources, government
imposed taxes on foreign investment or limits on the removal of capital from a
country, unstable government, and volatile markets.
Though not a small-cap fund, the Fund will invest a portion of its assets in the
securities of small companies. The prices of small companies' stocks are
generally more volatile than the prices of large companies' stocks. This is
because small companies may be more reliant on a few products, services or key
personnel, which can be riskier than owning larger, more diversified companies
with more structured management. In addition, because small companies have fewer
shares of stock outstanding, the ability to trade their securities quickly may
be affected by a lack of buyers and sellers in these stocks. This lack of
liquidity increases the Fund's risk to adverse market movements in the prices of
these stocks.
PAST PERFORMANCE
The following chart depicts the performance for the life of the Fund. Please
keep in mind that past performance cannot guarantee future returns.
1998 During the period shown to the left, the highest and lowest
------ quarterly returns earned by the Fund were:
11.74%
Highest: 20.77% Qtr. ended 12/31/98
Lowest: -19.54% Qtr. ended 9/30/98
The following table compares the Funds' performance over time with the Morgan
Stanley Capital International Europe, Australasia, and Far East Index ("MSCI
EAFE Index"), an unmanaged broad market index of stock performance of selected
companies in 21 developed countries.
Average Annual Return
One Year Ended Since Inception
12/31/98 (12/1/97)
-------- ---------
Masters' Select International Fund 11.74 9.58
MSCI EAFE Index 19.97 19.25
7
<PAGE>
FEES AND 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 transaction fees, and annual operating
expenses, such as advisory fees. The Fund has no front-end or deferred sales
loads, and imposes no shareholder transaction fees. The following table
illustrates the fees and expenses you might pay over time as an investor in the
Fund.
SHAREHOLDER FEES (PAID DIRECTLY FROM YOUR INVESTMENT)
Sales Loads None
Redemption Fees None
Transfer Fees None
ANNUAL OPERATING EXPENSES (DEDUCTED FROM FUND ASSETS)
Management Fee 1.10%
Distribution (12b-1) Fees None
Other Operating Expenses(1) 0.54%
Total Annual Fund Operating Expenses 1.64%
Less: Fees waived 0.10%
----
Net Operating Expenses(2) 1.54%
1 Significant other expenses include custody, fund accounting, transfer
agency, legal, audit, and administration.
2 The Advisor has contractually agreed to waive 0.10% of the Management Fee
through December 31, 1999.
EXAMPLE
This example is intended to help you compare the cost of investing in the Fund
with the cost of investing in other mutual funds. It assumes that you invest
$10,000 in the Fund for the time periods indicated and then redeem all of your
shares at the end of those periods. The example also assumes that your
investment has a 5% return each year and that the Fund's operating expenses
remain the same. Although your actual costs may be higher or lower, based on
these assumptions your costs would be:
One Year Three Years Five Years Ten Years
-------- ----------- ---------- ---------
$157 $517 $892 $1,944
8
<PAGE>
MANAGEMENT
The Advisor to the Fund is Litman/Gregory Fund Advisors, LLC. The Advisor has
ultimate responsibility for the investment performance of the Fund due to its
responsibility to oversee the investment managers and to recommend their hiring,
termination and replacement. The following table provides a description of the
five investment managers. A detailed discussion of the management structure of
the Fund begins on Page 20.
<TABLE>
<CAPTION>
INVESTMENT
INITIAL EXPERIENCE/
INVESTMENT ALLOCATION OF RELEVANT FUND SIZE OF STOCK-PICKING
MANAGER FUND ASSETS EXPERIENCE COMPANIES STYLE
- ---------- ------------- ------------- --------- -------------
<S> <C> <C> <C> <C>
Bruce Bee 10% Over 25 years Mostly small Growth at a
companies reasonable price
Helen Young Hayes 22.5% Since 1984/ All sizes, but Growth at a
Janus Overseas mostly large reasonable price
Fund and Janus companies
Worldwide Fund
David Herro 22.5% Since 1986/ All sizes, but Value
Oakmark mostly large
International and mid-sized
Fund and Oakmark companies
International
Small Cap Fund
Dan Jaworski 22.5% Since 1988/ Mostly large Value
STI Classic companies
International
Equity Fund
(2/95-4/97)
and Princor
World Fund
(12/88-4/93)
Mark Yockey 22.5% Since 1981/ All sizes but Growth at a
Artisan Inter- mostly large reasonable price
national Fund companies
and United
International
Growth Fund
(1990-11/96)
</TABLE>
9
<PAGE>
THE FUNDS IN DETAIL--
ELEMENTS COMMON TO BOTH FUNDS
THE MASTERS' SELECT INVESTMENT PHILOSOPHY
Both Funds' strategies are based on several fundamental beliefs:
FIRST, the Advisor believes that it is possible to identify investment managers
who will deliver superior performance relative to their peer groups. This belief
is based on the Advisor's extensive experience evaluating and picking stock
mutual funds.
SECOND, the Advisor believes that at any point in time most investment managers
own a small number of stocks in which they are highly confident. But because
holding only 10 or 15 stocks is not considered prudent from a diversification
standpoint or practical given the large dollar amounts managed by most
successful managers, most stock mutual funds hold more than 50 stocks. The
Advisor believes that, over a market cycle, the performance of most skilled
investment managers' "highest confidence" stocks exceeds that of their more
diversified portfolios.
THIRD, the Advisor believes that during any given year certain stock-picking
styles will generate higher returns than comparable market indexes, while others
will lag. By including a variety of stock-picking styles in a single mutual
fund, the Advisor believes that the variability and volatility of returns can be
lessened.
THE ADVISOR
The Funds are managed by Litman/Gregory Fund Advisors, LLC, 4 Orinda Way, Orinda
CA 94563. The Advisor has overall responsibility for assets under management,
recommends selection of investment managers to the Board of Trustees of Masters'
Select Funds Trust, evaluates performance of the investment managers, monitors
changes at the investment managers' organizations that may impact their
abilities to deliver superior future performance, determines when to rebalance
the investment managers' assets, determines the amount of cash equivalents (if
any) that may be held in addition to cash in each of the investment managers'
sub-portfolios and coordinates with the managers with respect to diversification
and tax issues.
10
<PAGE>
Kenneth E. Gregory is a Trustee of the Trust and is responsible for monitoring
the day-to-day activities of the investment managers. Gregory is also President
of L/G Research, an affiliated firm that publishes the NO-LOAD FUND ANALYST
newsletter and conducts research on financial markets and mutual funds. Gregory
is also President and Chief Investment Officer of Litman/Gregory & Company, LLC,
a money management firm. He has held this position since the founding of
Litman/Gregory & Company, a predecessor firm, in 1987. He has been in the
investment business since 1979.
INVESTMENT MANAGER SELECTION CRITERIA
The Advisor believes that superior investment managers exhibit:
* Consistently above-average intermediate and long-term 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 Index (U.S. equity managers) or
the MSCI EAFE Index (foreign equity managers) over most periods of
five years or longer.
* The confidence and ability to think and act independently of the "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 that each of the investment managers selected
to participate in the Funds exhibits the qualities mentioned above.
11
<PAGE>
MULTI-MANAGER ISSUES
The investment methods used by these managers in selecting securities for the
Funds vary. The segment of each Fund portfolio managed by an investment manager
will, under normal circumstances, differ from the segments managed by the other
investment managers with respect to portfolio composition, turnover, issuer
capitalization and issuer financial condition. Because selections are made
independently by each investment manager, it is possible that a security held by
one portfolio segment may also be held by other portfolio segments of the Funds
or that several managers may simultaneously favor the same industry segment. The
Advisor monitors the overall portfolio on an ongoing 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. Each investment manager selects the brokers and
dealers to execute transactions for the segment of the Fund being managed by
that manager.
The Advisor has obtained an exemptive order from the Securities and Exchange
Commission which permits it, subject to certain conditions, to select new
investment managers with the approval of the Board of Trustees but without
obtaining shareholder approval. The order also permits the Advisor to change the
terms of agreements with the managers or to continue the employment of a manager
after an event that would otherwise cause the automatic termination of services.
Shareholders must be notified of any manager changes. Shareholders have the
right to terminate arrangements with a manager by vote of a majority of the
outstanding shares of a Fund. The order also permits a Fund to disclose
managers' fees only in the aggregate in its registration statement.
Each 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. The Advisor (not
the Funds) is responsible for payment of advisory fees to the investment
managers, each of whom is compensated monthly on the basis of the assets
committed to his or her individual discretion. The Advisor pays fees to the
investment managers of the Equity Fund at the aggregate annual rate of 0.68%.
The Advisor pays fees to the investment managers of the International Fund at
the aggregate annual rate of 0.6175%. The Advisor is waiving a portion of the
management fees equal to 0.02% of the total net assets of the Equity Fund and
0.10% of the total net assets of the International Fund through December 31,
1999.
12
<PAGE>
In the event an investment manager ceases to manage a segment of a Fund's
portfolio, the Advisor will select a replacement investment manager with an
investment style comparable to that of the investment manager being replaced.
The Advisor will use the same criteria as those used in the original selection
of investment managers.
YEAR 2000 RISK
The operation of the Funds' service providers could be disrupted due to computer
problems related to the Year 2000. This situation exists across all industries
and may negatively impact the companies in which the Funds invest and, by
extension, the value of the Funds' shares. The Advisor is actively monitoring
its service providers and is developing a contingency plan in the event that
such service providers fail to adequately adapt their systems in time. However,
these actions may not prevent an adverse impact on the Funds. The Advisor does
not expect the costs related to the Year 2000 problem to be substantial to the
Funds because those costs are borne by the service providers and not directly by
the Funds.
13
<PAGE>
THE MASTERS' SELECT EQUITY FUND IN DETAIL
The Fund's six investment managers emphasize different stock-picking styles and
invest in stocks with a range of market capitalization. The portion of the Fund
assigned to each manager is fixed and has been determined with the specific
objective of maintaining exposure to stocks of large and mid-sized companies at
50% to 85% of the Fund's total assets in normal market conditions. These fixed
allocations are allowed to drift slightly. The Advisor is responsible for
rebalancing the allocations as total assets in the Fund fluctuate. The Advisor's
strategy is to allocate the portfolio's assets among investment managers who,
based on the Advisor's research, are judged to be among the best in their
respective style groups. The investment managers manage their individual
portfolio segments by building a focused portfolio representing their
highest-confidence stocks. Each investment manager's portfolio segment includes
a minimum of 5 and a maximum of 15 securities. Though the overall Fund may hold
more or fewer securities at any point in time, it is generally expected that the
Fund will hold between 65 and 90 securities. Under unusual market conditions or
for temporary defensive purposes, up to 35% of the Fund's total assets may be
invested in short-term, high-quality debt securities. Defensive positions may be
initiated by the individual portfolio managers or by the Advisor.
MASTERS' SELECT EQUITY FUND PORTFOLIO MANAGERS
SHELBY M. C. DAVIS
CHRISTOPHER DAVIS
Davis Selected Advisers, L.P.
124 E. Marcy Street
Santa Fe, NM 87501
Shelby Davis is the lead portfolio manager for the segment of the Fund's assets
managed by Davis Selected Advisers, L.P. ("Davis Advisers"), 124 E. Marcy
Street, Santa Fe, NM 87501. Davis has been in the investment business for more
than 30 years. He was a portfolio manager for Davis New York Venture Fund from
1969 through 1996 and is still actively involved in the stock selection process;
his son, Christopher C. Davis, joined Davis Selected Advisors in 1991 and was
named co-portfolio manager of the New York Venture Fund in 1995 and sole manager
in 1996. Before joining Davis Selected Advisers, Chris Davis was an associate at
Tanaka Capital Management. Shelby Davis retains ultimate responsibility for
researching and selecting each company included in their portion of the Masters'
portfolio, while
14
<PAGE>
Chris handles the daily portfolio management duties. In total, as of December
31, 1998, Davis Advisers managed more than $20 billion of mutual fund and ERISA
portfolios including Davis New York Venture Fund. In performing its investment
advisory services, Davis Advisers, while remaining ultimately responsible for
its segment of the Fund's assets, is able to draw on the portfolio management,
research and market expertise of its affiliates (including Davis Selected
Advisers-NY, Inc.). Approximately 20% of the Fund's assets are managed by the
Davises. They invest 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." The Davises prefer 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
The Davises often seek 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, they believe that there is often a catalyst
that will eventually push the stock price higher.
FOSTER FRIESS AND TEAM
Friess Associates, Inc.
350 Broadway
Jackson, WY 83001
Foster Friess is the lead portfolio manager for the segment of the Fund's assets
managed by Friess Associates, Inc. Friess has been in the investment business
for more than 25 years and has been lead manager of the Brandywine Fund since
1986. He is also President and, with his wife, Lynette Friess, sole owner of
Friess Associates. In total, as of December 31, 1998, Friess managed more than
$7 billion.
Approximately 10% of the Fund's assets are managed by Freiss and his team.
Friess invests in stocks of well-financed issuers that have proven records of
profitability and strong earnings momentum. Emphasis is placed on companies with
market capitalization of less than $5 billion. These companies are likely to be
lesser-known companies moving from a lower to higher market share position
within their industry groups, rather than the largest and best-known companies
in these groups.
15
<PAGE>
Friess may, however, purchase common stocks of well-known, highly researched
mid-sized companies if the team believes that those common stocks offer
particular opportunity for long-term capital growth. In selecting investments,
Friess considers financial characteristics of the issuer, including historical
sales and net income, debt/equity and price/earnings ratios, and book value.
Friess may also review research reports of broker-dealers and trade publications
and, in appropriate situations, meet with management. Greater weight is given to
internal factors, such as product or service development, than to external
factors, such as interest rate changes, commodity price fluctuations, general
stock market trends and foreign-currency exchange values. A particular issuer's
dividend history is not considered important.
MASON HAWKINS
Southeastern Asset Management, Inc.
6410 Poplar Avenue
Memphis, TN 38119
Mason Hawkins is the lead portfolio manager for the portion of the Fund's assets
run by Southeastern Asset Management, Inc. (Southeastern). Hawkins has been in
the investment business for more than 20 years and founded Southeastern, which
he controls, in 1975. He has managed the Longleaf Partners Fund since its
inception in 1987. In total, as of December 31, 1998, Southeastern managed more
than $13 billion.
Approximately 20% of the Fund's assets are managed by Southeastern, which uses a
value-oriented approach to picking stocks. The firm considers companies of all
sizes, although most of its portion of the Fund's assets are expected to be
invested in mid-sized and larger companies. Southeastern has the flexibility,
but not the requirement, to invest up to 50% of its portfolio segment in the
securities of foreign companies. Southeastern focuses on securities of companies
believed to have unrecognized intrinsic value and the potential to grow their
economic worth. Southeastern believes that superior long-term performance can be
achieved when positions in financially strong, well-managed companies are
acquired at prices significantly below their business value and are sold when
they approach their corporate worth. Corporate intrinsic value is determined
through careful securities analysis and the use of established disciplines
consistently applied over long periods of time. Securities that can be
identified and purchased at a price significantly discounted from their
intrinsic worth not only protect investment capital from significant loss but
also facilitate major rewards when the true business value is ultimately
recognized. Seeking the largest margin of safety possible,
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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 Hawkins believes to be the real economic value of the issuer's net
assets; the second examines the issuer's ability to generate free cash flow
after required or maintenance capital expenditures. After free cash flow is
determined, conservative projections about its rate of future growth are made.
The present value of that stream of cash flow plus its terminal value is then
calculated using a discount rate based on expected interest rates. If the
calculations are accurate, the present value would be the price at which buyers
and sellers negotiating at arm's length would accept for the whole company. In a
concluding analysis, the asset value determination and/or the discounted free
cash flow value are compared with 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
ROBERT SANBORN
Harris Associates, L.P.
2 North LaSalle Street
Chicago, IL 60602
Robert Sanborn is the portfolio manager for the segment of the Fund's assets
managed by Harris Associates, L.P. (Harris Associates). Sanborn has been in the
investment business since 1983 and has been employed by Harris Associates since
1988, where he is an Executive Vice President and Portfolio Manager. Sanborn has
been the portfolio manager of the Oakmark Fund since its inception in 1991.
Overall, Sanborn is responsible for management of more than $7 billion at Harris
Associates, which managed approximately $17 billion as a firm as of December 31,
1998.
Approximately 20% of the Fund's assets are managed by Robert Sanborn. He employs
a disciplined, value-oriented approach to investing that he combines with a
long-term outlook and a bias for concentration in his portfolios. Sanborn seeks
to identify and buy the stocks of companies that are out of favor or have been
overlooked by the marketplace, generally seeking a price that is 60% or less of
his estimate of private market value of the company. Under normal
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<PAGE>
circumstances, he holds those stocks until the stock price converges with at
least 90% of his estimate of the private market value of the company. To
determine private market value, Sanborn and the Harris team of analysts study a
company's ability to generate free cash flow. Sanborn ignores short-term market
movements, and employs a three to five-year time horizon when evaluating the
prospects of a business. He believes it is critical to own companies in which
the interests of management are aligned with those of the shareholders, and also
considers franchise value and barriers to market entry when evaluating the
long-term outlook of a company. The majority of the companies Sanborn will hold
in the Fund are large and mid-sized, although he will have the flexibility to
hold smaller companies and foreign securities if he finds them to be of
compelling value.
SPIROS SEGALAS
Jennison Associates Capital Corporation
466 Lexington Avenue
New York, NY 10017
Spiros "Sig" Segalas is the portfolio manager for the segment of the Fund's
assets managed by Jennison Associates Capital Corp. Segalas has been in the
investment business for more than 30 years and has been the portfolio manager
for the Harbor Capital Appreciation Fund since May 1990. He is a founding member
and President and Chief Investment Officer of Jennison Associates Capital Corp.,
a wholly-owned subsidiary of the Prudential Insurance Company of America. As of
December 31, 1998, Jennison Associates managed more than $48 billion in U.S.
equity securities.
Approximately 20% of the Fund's assets are managed by Segalas. He seeks to
invest in large and mid-sized companies experiencing superior absolute and
relative earnings growth. Earnings predictability and confidence in earnings
forecasts are an important part of the selection process. In considering a stock
for ownership, Segalas considers price/earnings ratios relative to the market as
well as the companies' histories. In addition, he seeks out companies
experiencing some or all of the following:
* High sales growth
* High unit growth
* High or improving returns on assets and equity
* Strong balance sheet
Segalas also prefers companies with a competitive advantage, such as unique
management, marketing, or research and development.
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RICHARD T. WEISS
Strong Capital Management, Inc.
100 Heritage Reserve
Menomonee Falls, WI 53051
Dick Weiss is the portfolio manager for the segment of the Fund's assets managed
by Strong Capital Management, Inc. Weiss has been in the investment business for
more than 20 years and has been the manager or 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, as of December 31, 1998,
Weiss co-managed approximately $6 billion. Strong Capital Management was founded
in 1974 and is controlled by Richard Strong.
Approximately 10% of the Fund's assets are run by Weiss. He invests in stocks of
small and mid-sized companies that are undervalued either because they are not
broadly recognized, are in transition, or are out of favor based on short-term
factors. In seeking attractively valued companies, Weiss focuses on companies
with above-average growth potential that also exhibit some or all of the
following:
* Low institutional ownership and low analyst coverage
* High-quality management
* Sustainable competitive advantage
Weiss evaluates the degree of under-valuation relative to his estimate of each
company's private market value. This private market value approach is based on
an assessment of what a private buyer would be willing to pay for the future
cash flow stream of the target company. Based on his experience, Weiss believes
that, except for technology and other high-growth stocks, most stocks trade at
between 50% and 80% of private market value. When trading at the low end of this
range, companies take steps to prevent takeover, or they are taken over. The
private market value estimate is applied flexibly, based on the outlook for the
industry and the company fundamentals.
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THE MASTERS' SELECT INTERNATIONAL FUND IN DETAIL
The Fund's five investment managers pursue the Fund's objective primarily
through investments in common stocks of issuers located outside of the United
States.
Each manager may invest in securities traded in both developed and emerging
markets. Though there is no limit on emerging market exposure, it is not
expected to be a primary focus, and the majority of the Fund's assets are
expected to be invested in stocks of companies listed and domiciled in developed
countries. There are no limits on the Fund's geographic asset distribution, but,
to provide adequate diversification, the Fund ordinarily invests in the
securities markets of at least five countries outside of the United States. In
most periods it is expected that the Fund will hold securities in more than five
countries. Although the Fund intends to invest substantially all of its assets
in issuers located outside of the United States, it may at times of abnormal
market conditions invest in U.S. issuers and it may at times invest all of its
assets in fewer than five countries.
Each manager has a distinct stock-picking approach. As a group, the managers
invest in stocks with a range of market capitalization. Although each manager
has the flexibility to invest on a worldwide basis (excluding the U.S.) in
companies with market capitalization of any size, it is expected that the Fund's
exposure to large and mid-sized foreign companies will range from 60% to 90% of
the Fund's total assets under normal market conditions. The Advisor's strategy
is to allocate the portfolio's assets among investment managers who, based on
the Advisor's research, are judged to be among the best relative to their
respective peer groups. The Advisor has focused exclusively on stock pickers who
emphasize bottom-up stock picking rather than macro-driven, top-down country
picking.
The Advisor believes that bottom-up stock pickers have an advantage in foreign
markets because:
* It is the Advisor's opinion that the dynamics that influence
individual countries' markets, including currencies, inflation,
economic growth, political factors, regulation and the like, are much
more difficult to assess than the prospects and valuation
characteristics of individual companies.
* The Advisor believes that many individual stocks in foreign markets
are less closely analyzed (the markets are less "efficient") than in
the United States. If true, the Advisor believes that this will result
in greater opportunities for skilled stock pickers to add value
through pure stock selection.
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* Based on the Advisor's observations, bottom-up stock pickers in
foreign markets, on average, seem to perform better than
top-down-oriented managers.
Though bottom-up stock picking is emphasized, each manager also monitors
specific macro-factors that he or she believes are relevant in specific
countries.
The portion of the Fund assigned to each manager is fixed. These fixed
allocations are allowed to drift slightly. The Advisor is responsible for
periodically rebalancing the allocations as total assets in the Fund fluctuate.
The investment managers manage their individual portfolio segments by building a
focused portfolio representing their highest-confidence stocks. Each investment
manager's portfolio segment includes a minimum of 8 and a maximum of 15
securities. Though the overall Fund may hold more or fewer securities at any
point in time, it is generally expected that the Fund will hold between 50 and
75 securities.
Under unusual market conditions or for temporary defensive purposes, up to 35%
of the Fund's total assets may be invested in short-term, high-quality debt
securities. Defensive positions may be initiated by the individual portfolio
managers or by the Advisor.
MASTERS' SELECT INTERNATIONAL FUND PORTFOLIO MANAGERS
BRUCE BEE
Bee & Associates, Inc.
370 Seventeenth Street, Suite 3560
Denver, CO 80202
Bruce Bee is the portfolio manager for the portion of the assets managed by Bee
& Associates, Inc. (Bee). Bee has been in the investment business for more than
25 years and founded Bee & Associates, which he controls, in 1989. In total, as
of December 31, 1998, Bee managed approximately $500 million. Bee has managed
global small-cap portfolios since 1989 and international small-cap portfolios
since January 1995.
Approximately 10% of the Fund is managed by Bee. Bee focuses exclusively on
small companies primarily in developed markets, though he may also invest in
emerging markets. He believes that these companies generally are
under-researched and often inefficiently priced. Within this sector, Bee seeks
to purchase companies with above-average growth prospects at a significant
discount to his assessment of their value. Portfolio construction is completely
bottom-up oriented (no top-down country selection). In researching candidates
for
21
<PAGE>
purchase, Bee typically reviews company financial reports, reconciling
company accounting to U.S. standards; he seeks information from a variety of
sources which may include international brokers, accounting firms, banks, and
other investors, and visits to the company. The ideal portfolio candidate has a
proprietary product or service and is generally involved in international trade;
has management depth and a coherent business strategy; and has a history of
growth in revenues, earnings, cash flow and return on shareholders' equity
which, in the manager's opinion, is sustainable and is available at a
significant discount to what another company might pay for it. Bee does not
expect to hedge against exchange rate risk.
HELEN YOUNG HAYES
Janus Capital Corporation
100 Filmore Street
Denver, CO 80206
Helen Young Hayes is the portfolio manager for the segment of the Fund's assets
managed by Janus Capital Corporation (Janus). Hayes has been in the investment
business since 1984 and has been with Janus since 1987. Hayes is the Vice
President of Janus Capital Corporation and the portfolio manager of the Janus
Worldwide Fund (a global fund) and co-portfolio manager of the Janus Overseas
Fund (an international fund). Janus also subadvises several other international
and global funds of which Hayes is the portfolio manager. She has managed or
co-managed both funds since their inceptions in May 1991 and May 1994,
respectively. In total, as of December 31, 1998, Janus managed more than $108
billion, of which $24 billion is managed by Hayes.
Approximately 22.5% of the Fund is managed by Hayes, who uses a bottom-up
approach to stock selection. Hayes may invest in companies of all sizes, though
she tends to focus mostly on large and mid-sized companies. She invests in
developed markets, and, to a lesser extent, emerging markets. Hayes seeks to
identify individual companies with earnings growth potential that may not be
recognized by the market at large. Intensive research focuses on the fundamental
factors affecting the business prospects of companies and may include review of
earnings reports, corporate and industry developments, trading activity,
research reports and other data. In addition, for a smaller number of companies,
additional scrutiny may include, but is not limited to: direct contacts with
corporate management; analysis of and contact with competitors, customers and
suppliers; and frequent on-site visits to facilities. The focus of the
analytical work is to identify companies with:
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* Rapid sales and earnings growth
* Strong cash flow generation and wise deployment of capital
* Efficient operations and high productivity
* Good management with the proper incentives
Hayes seeks companies that meet her selection criteria, regardless of country of
organization or place of principal business activity. Securities are generally
selected on a stock-by-stock basis without regard to any defined allocation
among countries or geographic regions. Certain factors, however, such as
expected levels of inflation, government policies influencing business
conditions, the outlook for currency relationships, and prospects for economic
growth among countries, regions or geographic areas, may influence security
selection. Hayes may use a variety of currency hedging techniques, including
forward currency contracts, to manage exchange rate risk.
DAVID HERRO
Harris Associates L.P.
2 North LaSalle Street
Chicago, IL 60602
David Herro is the portfolio manager for the portion of the Fund's assets
managed by Harris Associates L.P. (Harris Associates). Herro has been in the
investment business since 1986 and is a partner, portfolio manager and Director
of International Equities at Harris Associates. He has managed the Oakmark
International Fund and the Oakmark International Small Cap Fund since their
inceptions in 1992 and 1995, respectively. Overall, Herro is responsible for
$864 million in international equity assets. As a firm, Harris Associates
managed approximately $17 billion in equity and fixed-income assets as of
December 31, 1998.
Approximately 22.5% of the Fund's assets are managed by David Herro. Herro
believes that long-term results are achieved by investing as owners in
successful companies that may be purchased at a significant discount to their
true economic value. He selects stocks using a disciplined value investment
approach that emphasizes a bottom-up stock selection process. Herro searches for
international stocks in both established and emerging markets.
When looking for new investment ideas, Herro attempts to do two things:
* Seek out companies that are selling at a substantial discount to their
true value
* Determine the management's capability of enhancing the value of the
company
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<PAGE>
His focus is to buy securities at large discounts to their underlying value
(usually based on their current and potential cash generation). He also looks
for bargains based on companies' normalized earnings (the level of earnings
after backing out cyclical influences) and asset values. A company must be
selling at a 30% or greater discount to his estimate of its value to be a
candidate for purchase. Stocks are also analyzed in terms of financial strength,
the position of the company in its industry and the attractiveness of the
industry. Another key feature of Herro's investment approach is the thorough
assessment of a company's management team. Herro believes that investing in
companies with proven, capable managers enhances the likelihood of positive
returns. When interviewing management, Herro looks for two specific qualities in
a management team:
* Management's ability to generate cash from the company's asset base
* Management's ability to efficiently allocate capital
Because of his bottom-up approach, Herro focuses on stock selection rather than
industry or country selection. Currency hedging is done defensively and only if
the dollar appears excessively undervalued. Hedging is based on real interest
rate spreads, purchasing power parity differentials and differences in growth
and productivity.
DANIEL R. JAWORSKI
BPI Global Asset Management, LLP
1900 Summit Tower Boulevard
Orlando, FL 32810
Dan Jaworski is the portfolio manager for the segment of the Fund's assets
managed by BPI Global Asset Management, LLP. Jaworski has been in the investment
management business since 1988 and in 1997 founded and became Chief Investment
Officer of BPI Global Asset Management. As of December 31, 1998, BPI managed
approximately $1.2 billion in assets. Prior to founding BPI, Jaworski was the
portfolio manager of the STI Classic International Equity Fund and its
predecessor commingled fund from February 1, 1995, to April 30, 1997. Prior to
joining STI, Jaworski was an international portfolio manager with Lazard Freres
Asset Management. Jaworski began his portfolio management career as the manager
of the Princor World Fund (an international fund) for The Principle Financial
Group in December 1988.
Approximately 22.5% of the Fund's assets are run by Jaworski. He seeks to invest
in high-quality, low-leveraged companies with sustainable, globally competitive
products or services. Jaworski purchases these companies when they are selling
at a discount to their
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<PAGE>
global industrial peer group. Valuation criteria used are specific to the
industry, but typical factors include:
* Price to free cash flow
* Price to earnings
* Price to book
* Yield
Appreciation potential is determined assuming the security sells at the mean of
the industrial peer group. Potential returns are then adjusted to reflect the
estimated impact of the local market, the local currency or the general risk
profile of the security.
Securities ultimately selected by Jaworski are primarily large, well-established
companies that have, historically, generated higher returns and better profit
margins than their industry peers. Jaworski invests in developed and emerging
markets, and may use various hedging techniques to reduce exchange rate risk.
MARK YOCKEY
Artisan Partners LP
1000 North Water Street, Suite 1770
Milwaukee, WI 53202
Mark Yockey is the portfolio manager for the segment of the Fund's assets
managed by Artisan Partners LP. Artisan Partners was founded by Carlene Murphy
Ziegler and Andrew Ziegler in 1995 and is controlled by them. Yockey has been in
the investment management business for more than 15 years and has been the
portfolio manager of the Artisan International Fund since its inception in
January 1996. He is a partner in Artisan Partners and is the senior member of
the firm's international investment management group. Prior to joining Artisan
Partners, he was the portfolio manager of the United International Growth Fund
commencing in 1990. In total, as of December 31, 1998, Yockey managed
approximately $741 million.
Approximately 22.5% of the Fund's assets are run by Yockey. He invests primarily
in international growth stocks, concentrating on companies located in countries
that have accelerating growth prospects. He also invests in companies located in
emerging markets.
Though not a country picker, Yockey prefers to invest in regions and countries
that are enjoying improving or rapid economic growth. This investment universe
includes developed and emerging markets. Yockey is less likely to invest in
countries that, while showing favorable economic growth, appear to have
overvalued markets. Economic
25
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growth is determined principally from the standpoint of gross domestic product
growth, corporate profitability, current account and currency issues, interest
rates and social changes. Having identified favorable areas of the world for
growth, Yockey seeks stocks of companies best positioned to capitalize on that
growth. In this process he emphasizes well-managed companies with dominant or
increasing market share in strong industries. He typically focuses on companies
with above-average financial fundamentals and accelerating earnings per share.
Yockey also analyzes relative valuations using a variety of criteria, such as
price-to-earnings ratios, and avoids stocks that are trading at unsustainable or
unusually high valuations. His research process is flexible and varies depending
on the country and company, with an emphasis on determining whether the company
has a sound business plan and is able to execute it.
In making this assessment, Yockey will typically rely on analysis of company
reports, analyst reports, visits to the company and other contact with senior
management and competitors. Yockey may engage in hedging activities to reduce
exchange rate risk.
26
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SHAREHOLDER SERVICES
Each Fund is a no-load fund, which means you pay no sales commissions of any
kind. Once each business day that the New York Stock Exchange (NYSE) is open,
each Fund calculates its share price, which is also called 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 calculated as of the close
of the NYSE, normally 4:00 p.m. Eastern Time.
HOW TO BUY SHARES
STEP 1
The first step is to determine the type of account you wish to open. The
following types of accounts are available to investors:
Individual or Joint Accounts For your general investment needs:
Individual accounts are owned by one person. Joint accounts can have two or
more owners (tenants).
Retirement Accounts Retirement plans allow individuals to shelter investment
income and capital gains from current taxes. In addition, contributions to these
accounts may be tax deductible. Retirement accounts require specific
applications and typically have lower minimums.
Individual Retirement Accounts (IRAs) allow anyone of legal age and under
701 1/42 with earned income to invest up to $2,000 per year. Individuals
can also invest in a spouse's IRA if the spouse has earned income of less
than $250 and the combined contributions do not exceed $2,250.
Rollover IRAs retain tax advantages for certain distributions from
employer-sponsored retirement plans.
Simplified Employee Pension Plans (SEP-IRAs) provide small business owners
or those with self-employed income (and their eligible employees) with many
of the same advantages as a Keogh retirement plan, but with fewer
administrative requirements.
Roth IRAs allow anyone of legal age who meets certain income limits to
invest up to $2,000 per year.
Other retirement plans, such as Keogh or corporate profit-sharing plans, 403(b)
plans and 401(k) plans, may invest in the Funds. All of these accounts need to
be established by the plan's trustee. The Funds do not offer versions of these
plans.
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If you are investing through a tax-sheltered retirement plan, such as an IRA,
for the first time, you will need an IRA Application and Adoption Agreement.
Retirement investing also involves its own investment procedures.
Gifts or Transfers to Minors (UGMA, UTMA) To invest for a child's education or
other future needs:
These custodial accounts provide a way to give money to a child and obtain
tax benefits. An individual can give up to $10,000 per year per child
without paying a federal gift tax. Depending on state laws, you can set up
a custodial account under the Uniform Gifts to Minors Act (UGMA) or the
Uniform Transfers to Minors Act (UTMA).
Trust For money being invested by a trust:
The trust must be established before an account can be opened. The Fund may
require additional documentation regarding the formation of the trust prior
to establishing an account.
Business or Organization For investment needs of corporations, associations,
partnerships or other groups:
The Fund does not require a special application, however the Fund may
require additional information prior to establishing an account.
STEP 2
The second step involves determining the amount of your investment. The Masters'
Select Funds have established the following minimum investment levels for your
initial investment, additional investments and ongoing account balances:
- --------------------------------------------------------------------------------
Minimum Initial Minimum Additional Minimum Account
Type of Account Investment Investment Balance
- --------------------------------------------------------------------------------
Regular
Account $5,000 $250 $2,500
- --------------------------------------------------------------------------------
Retirement
Account $1,000 $250 $250
- --------------------------------------------------------------------------------
Automatic
Investment
Account $2,500 $100 $2,500
- --------------------------------------------------------------------------------
The Distributor may waive the minimum investment from time to time.
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STEP 3
The third step involves completing your application to open your account. All
shareholders must complete and sign an application in order to establish their
account. The type of application depends on the type of account you chose to
open. Regular investment accounts, including individual, joint tenant, UGMA,
UTMA, business, or trust accounts must complete the Fund's standard New Account
Application. Shareholders who wish to establish retirement accounts must
complete the IRA Application and Adoption Agreement. Shareholders who wish to
transfer retirement holdings from another custodian must also complete the IRA
Transfer of Assets Form.
STEP 4
The final step in opening your account is to mail the completed application,
along with your check or money order payable to the Masters' Select Equity Fund
or the Masters' Select International Fund. THE FUNDS DO NOT ACCEPT THIRD-PARTY
CHECKS.
The mailing addresses for the Funds are:
FOR REGULAR DELIVERY: FOR OVERNIGHT DELIVERY:
Masters' Select Funds Masters' Select Funds
c/o National Financial Data Services c/o National Financial Data Services
P.O. Box 419922 330 W. Ninth Street
Kansas City, MO 64141-6922 Kansas City, MO 64105
If you wish to open or add to your account by wire, please call 1-800-960-0188
for instructions.
After your account is open, you may add to it by:
* Mailing a check or money order to the above addresses along with a
letter or the form at the bottom of your account statement. Be sure to
put your account number on your check and in your letter.
* Wiring money from your bank. Call 1-800-960-0188 for instructions
* Making automatic investments if you signed up for the Automatic
Investment Plan when you opened your account.
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.
To sell shares in a non-retirement account, you may use any of the methods
described in this section. To sell shares in a retirement account, your request
must be made in writing.
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Certain requests must include a signature guarantee. It is designed to protect
you and each Fund from fraud. Your request must be made in writing and include a
signature guarantee if any of the following situations apply:
* You wish to redeem more than $25,000 worth of shares.
* Your account registration information has changed within the past 30
days.
* The redemption check is being mailed to a different address from the
one on your account (address of record).
* The check is being made payable to someone other than the account
owner.
You should be able to obtain a signature guarantee from a bank, broker-dealer,
credit union (if authorized under state law), securities exchange or
association, clearing agency or savings association. A notary public cannot
provide a signature guarantee.
SELLING SHARES BY LETTER
Write and sign a "letter of instruction" with:
YOUR NAME
YOUR FUND'S ACCOUNT NUMBER
THE DOLLAR AMOUNT OR NUMBER OF SHARES TO BE REDEEMED
Please note the following special requirements for redeeming shares for
different types of accounts;
* Individual, Joint Tenant, Sole Proprietorship, UGMA or UTMA Accounts:
The letter of instruction must be signed by all persons required to
sign 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 Account: The trustee must sign the letter indicating capacity as
trustee. If a trustee's name is not in the account registration,
provide a copy of the trust document certified within the past 60
days.
* Business or Organization: At least one person authorized by corporate
resolutions to act on the account must sign the letter. Include a
corporate resolution with corporate seal or signature guarantee.
* Executor, Administrator, Conservator or Guardian: Call 1-800-960-0188
for instructions.
Unless otherwise instructed, the Fund will send a check to the address of
record.
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Mail your letter to:
REGULAR DELIVERY: OVERNIGHT DELIVERY:
Masters' Select Funds Masters' Select Funds
c/o National Financial Data Services c/o National Financial Data Services
P.O. Box 419922 330 W. Ninth Street
Kansas City, MO 64141-6922 Kansas City, MO 64105
SELLING SHARES BY TELEPHONE
You must select this option on your New Account Application if you wish to use
telephone redemption; it is not automatically available. If you selected the
telephone redemption option on your New Account Application, you can sell shares
simply by calling 1-800-960-0188. The amount you wish to redeem (up to $25,000)
will be wired to your bank account. This option is not available for retirement
accounts.
SELLING SHARES BY WIRE:
You must sign up for the wire feature before using it. To verify that it is in
place, please call 1-800-960-0188. The minimum wire amount is $5,000. Your wire
redemption request must be received by the Funds before 4:00 p.m. Eastern time
for money to be wired the next business day. This option is not available for
retirement accounts.
SHAREHOLDER AND ACCOUNT POLICIES
STATEMENTS, REPORTS AND INQUIRIES
Statements and reports that each Fund sends you include the following:
* Confirmation statements (after every transaction that affects your
account balance or your account registration)
* Financial reports (every six months)
The Transfer Agent for the Funds is National Financial Data Services. Its
address is 330 W. Ninth Street, Kansas City, MO 64105. You may call the Transfer
Agent at 1-800-960-0188 if you have questions about your account.
First Fund Distributors, Inc., an affiliate of the Administrator, is the
principal underwriter of the Funds. Its address is 4455 E. Camelback Road,
Phoenix, AZ 85018.
31
<PAGE>
EXCHANGE PRIVILEGE
Shareholders may exchange shares between the Masters' Select Equity Fund and the
Masters' Select International Fund by mailing or delivering written instructions
to the Transfer Agent. Please specify the name of the applicable Fund, the
number of shares or dollar amount to be exchanged, and your name and account
number.
You may also exchange shares by calling the Transfer Agent at 1-800-960-0188
between 9:00 a.m. and 4:00 p.m. Eastern time on a day that the New York Stock
Exchange (NYSE) is open for normal trading. Telephone exchanges are subject to
the identification procedures noted with respect to telephone redemptions above.
AUTOMATIC INVESTMENT/WITHDRAWAL PLANS
One easy way to pursue your financial goals is to invest money regularly. The
Funds offer a convenient service that lets you transfer money into your Fund
account automatically. Although Automatic Investment Plans do not guarantee a
profit and will not protect you against loss in a declining market, they can be
an excellent way to invest for retirement, a home, educational expenses and
other long-term financial goals.
A systematic withdrawal plan lets you set up periodic redemptions from your
account. Certain restrictions apply for retirement accounts. Call 1-800-960-0188
for more information.
SHARE PRICE
Each Fund is open for business each day the New York Stock Exchange is open.
Each Fund calculates its net asset value (NAV) as of the close of business of
the NYSE, normally 4 p.m. Eastern time.
Each Fund's NAV is the value of a single share. The NAV is computed by adding
the value of each Fund's investments, cash and other assets, subtracting its
liabilities and then dividing the result by the number of shares outstanding.
The NAV is also the redemption price (price to sell one share).
Each Fund's assets are valued primarily on the basis of market quotations. If
quotations are not readily available, assets are valued by a method that the
Board of Trustees believes accurately reflects fair value.
32
<PAGE>
PURCHASES
* All of your purchases must be made in U.S. dollars, and checks must be
drawn on U.S. banks.
* The Funds do not accept cash, credit cards or third-party checks.
* If your check does not clear, your purchase will be canceled and you
will be liable for any losses or fees the Funds or the Transfer Agent
incurs.
* Your ability to make automatic investments may be immediately
terminated if any item is unpaid by your financial institution.
* Each Fund reserves the right to reject any purchase order.
For example, a purchase order may be refused if, in the Advisor's opinion, it is
so large that it would disrupt management of the Funds. Orders may also be
rejected from persons believed by the Advisor to be "market timers."
Certain financial institutions that have entered into sales agreements with the
Funds may enter confirmed purchase orders on behalf of customers by phone, with
payment to follow no later than the time when the Fund is priced on the
following business day. If payment is not received by that time, the financial
institution could be held liable for resulting fees or losses. These
institutions may charge you a fee if you buy or sell shares through them.
REDEMPTIONS
* Normally, redemption proceeds will be mailed to you on the next
business day, but if making immediate payment could adversely affect
the Funds, it may take up to seven days to pay you.
* Redemptions may be suspended or payment dates postponed when the New
York Stock Exchange is closed (other than weekends or holidays), when
trading on the NYSE is restricted or as permitted by the SEC.
Each Fund may close small accounts. Due to the relatively high cost of
maintaining smaller accounts, the shares in your account (unless it is a
retirement plan or custodial account) may be redeemed by each Fund if, due to
redemptions you have made, the total value of your account is reduced to less
than $2,500. If a Fund decides to make such an involuntary redemption, you will
first be notified that the value of your account is less than $2,500, and you
will be allowed 30 days to make an additional investment to bring the value of
your account to at least $2,500 before a Fund takes any action.
33
<PAGE>
DIVIDENDS, CAPITAL GAINS AND TAXES
The Funds distribute substantially all of their net income and capital gains, if
any, to shareholders each year. Normally, dividends and capital gains are
distributed in December.
DISTRIBUTION OPTIONS
When you open an account, specify on your application how you want to receive
your distributions. If the option you prefer is not listed on the application,
call 1-800-960-0188 for instructions. The Funds offer three options:
* Reinvestment Option. Your dividend and capital gains distributions
will be automatically reinvested in additional shares of the Funds. If
you do not indicate a choice on your application, you will be assigned
this option.
* Income-Earned Option. Your capital gains distributions will be
automatically reinvested, but you will be sent a check for each
dividend distribution.
* Cash Option. You will be sent a check for your dividend and capital
gains distributions.
For retirement accounts all distributions are automatically reinvested. When you
are over 591 1/42 years old, you can receive distributions in cash.
When a Fund deducts a distribution from its NAV, the reinvestment price is the
Fund's NAV at the close of business that day. Cash distribution checks will be
mailed within seven days.
UNDERSTANDING DISTRIBUTIONS
As a Fund shareholder, you are entitled to your share of the Fund's net income
and gains on its investments. The Funds pass their earnings along to investors
as distributions. Each Fund earns dividends from stocks and interest from
short-term investments. These are passed along as dividend distributions. Each
Fund realizes capital gains whenever it sells securities for a higher price than
it paid for them. These are passed along as capital gains distributions.
34
<PAGE>
TAXES
As with any investment, you should consider how your investment in each Fund
will be taxed. If your account is not a tax-deferred retirement account, you
should be aware of these tax implications.
Taxes on Distributions. Distributions are subject to federal income tax and may
also be subject to state and local taxes. If you live outside of the United
States, your distributions could also be taxed by the country in which you
reside. Your distributions are taxable when they are paid, whether you take them
in cash or reinvest them. Distributions declared in December and paid in
January, however, are taxable as if they were paid on December 31.
For federal tax purposes, each Fund's income and short-term capital gains
distributions are taxed as dividends; long-term capital gains distributions are
taxed as long-term capital gains. Every January, each Fund will send you and the
Internal Revenue Service (IRS) a statement showing the taxable distributions.
Taxes on Transactions. Your redemptions, including transfers between Funds, are
subject to capital gains tax. A capital gain or loss is the difference between
the cost of your shares and the price you receive when you sell them. Whenever
you sell shares of a Fund, the Fund will send you a confirmation statement
showing how many shares you sold and at what price. You will also receive a
consolidated transaction statement every January. It is up to you or your tax
preparer, however, to determine whether the sales resulted in a capital gain
and, if so, the amount of the tax to be paid. Be sure to keep your regular
account statements; the information they contain will be essential in
calculating the amount of your capital gains.
"Buying a Dividend." If you buy shares just before a Fund deducts a distribution
from its NAV, you will pay the full price for the shares and then receive a
portion of the price back in the form of a taxable distribution.
There are tax requirements that all funds must follow in order to avoid federal
taxation. In their efforts to adhere to these requirements, the Funds may have
to limit their investment activity in some types of instruments.
When you sign your New Account Application, you will be asked to certify that
your Social Security or Taxpayer Identification number is correct and that you
are not subject to 31% withholding for failing to report income to the IRS. If
you violate IRS regulations, the IRS can require a fund to withhold 31% of your
taxable distributions and redemptions.
35
<PAGE>
FINANCIAL HIGHLIGHTS
The financial highlights table is intended to help you understand the
Funds' financial performance since their inception. Certain information
reflects financial results for a single Fund share. The total returns in
the table represent the rate that an investor would have earned or lost on
an investment in the Fund (assuming reinvestment of all dividends and
distributions). This information has been audited by McGladrey & Pullen
LLP, whose report, along with the Funds' financial statements, are included
in the annual report, which is available upon request.
<TABLE>
<CAPTION>
EQUITY FUND INTERNATIONAL FUND
For the period from For the period from
January 1, 1998 to January 1, 1997 to January 1, 1998 to December 1, 1997** to
December 31, 1998 December 31, 1997 December 31, 1998 December 31, 1997
<S> <C> <C> <C> <C>
Net asset value,
beginning of period $11.84 $10.00 $9.88 $10.00
-------------------------------------------------------------------------------------
Income from investment operations
Net investment income 0.03 0.03 0.08 --
Net realized and unrealized gain 1.73 2.90 1.08 (0.12)
-------------------------------------------------------------------------------------
Total from investment operations 1.76 2.93 1.16 (0.12)
-------------------------------------------------------------------------------------
Less distributions
From net investment income (0.02) (0.03) (0.09) --
From capital gains (0.01) (1.06) -- --
-------------------------------------------------------------------------------------
Total distributions (0.03) (1.09) (0.09) --
=====================================================================================
NET ASSET VALUE, END OF PERIOD $13.57 $11.84 $10.95 $9.88
-------------------------------------------------------------------------------------
Total return 14.90% 29.11% 11.74% (1.20%)
-------------------------------------------------------------------------------------
Net assets at end of period (in 000's) $405,458 $296,876 $95,222 %45,934
-------------------------------------------------------------------------------------
Ratio of expenses to average net assets 1.38%+ 1.47%+ 1.55%++ 1.77%*++
-------------------------------------------------------------------------------------
Ratio of net investment income to
average net assets 0.30% 0.12% 0.87% 0.42%*
-------------------------------------------------------------------------------------
Portfolio turnover rate 135.41% 145.11% 73.59% 0.00%
-------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** The Masters' Select International Fund commenced operations on December 1,
1997
+ Includes custody fees paid indirectly which amount to 0.00% and 0.03%,
respectively, of average net assets for the fiscal years ended December 31,
1998 and 1997, respectively.
++ Includes custody fees paid indirectly which amount to 0.01% and 0.06%,
respectively, of average net assets for the fiscal years ended December 31,
1998 and 1997, respectively.
36
<PAGE>
FOR MORE INFORMATION
STATEMENT OF ADDITIONAL INFORMATION:
The Statement of Additional Information (SAI) contains additional
information about the Funds. Further additional information about the
Funds' investments is available in the Funds' Annual and Semi-Annual
Reports to Shareholders.
ANNUAL AND SEMI-ANNUAL REPORTS:
In the Funds' annual report, you will find a discussion of the market
conditions and investment strategies that significantly affected the Funds'
performance during its last fiscal year.
The SAI, Annual Report to Shareholders and Semi-Annual Report to
Shareholders are available, without charge, upon request. To request a SAI,
Annual Report to Shareholders or Semi-Annual Report to Shareholders, or to
ask questions about your account or obtain other information about the
Funds, please call 1-800-960-0188.
SEC CONTACT INFORMATION:
If you have access to the Internet, you can view the SAI at the Securities
and Exchange Commission (SEC) Web site at www.sec.gov. You may also visit
the SEC public reference room by calling 1-800-SEC-0330 or request a copy
by writing to the Public Reference Section of the SEC, Washington, D.C.
20549-6009. The SEC charges a duplicating fee for this service. SEC File
No: 333-10015.
The Masters' Select Funds
P.O. Box 419922
Kansas City, MO 64141-6922
1-800-960-0188
First Fund Distributors, Inc., Phoenix, AZ 85018
(C) 1999 Litman/Gregory Fund Advisors, LLC. All rights reserved.
<PAGE>
As filed with the Securities and Exchange Commission on April 30, 1999
Registration No. 333-10015
File No. 811-07763
================================================================================
Part B
of
Form N-1A
COMBINED REGISTRATION STATEMENT
MASTERS' SELECT FUNDS TRUST
Masters' Select Equity Fund
Masters' Select International Fund
================================================================================
<PAGE>
MASTERS' SELECT FUNDS TRUST
Statement of Additional Information
Dated April 30, 1999
This Statement of Additional Information is not a prospectus, and it should be
read in conjunction with the prospectus dated April 30, 1999, as it may be
amended from time to time, of The Masters' Select Equity Fund (the "Masters'
Select Equity" or "Equity Fund") and The Masters' Select International Fund (the
"Masters' Select International" or "International Fund"), a series of Masters'
Select Funds Trust (the "Trust"), formerly known as the Masters' Select
Investment Trust until December 1997. The Trust, a diversified open-end
management investment company, is a Delaware business trust formed on August 1,
1996. Litman/Gregory Fund Advisors, LLC (the "Advisor") is the Advisor of the
Funds. The Advisor has retained investment managers as sub-advisers
("Managers"), each responsible for portfolio management of a segment of each
Fund's total assets. A copy of the combined prospectus may be obtained from the
Trust at 4 Orinda Way, Suite 230-D, Orinda, California 94563, telephone (800)
960-0188.
TABLE OF CONTENTS
Cross-reference to sections
Page in the prospectus
---- -----------------
Investment Objective
and Policies.................... B-2 The Masters' Select Equity Fund
- Fund Summary; The Masters' Select
International Fund - Fund Summary
Management...................... B-18 The Funds in Detail - Elements Common
To Both Funds; The Masters' Select
Equity Fund in Detail; The Masters'
Select International Fund in Detail
Portfolio Transactions and
Brokerage....................... B-22 The Funds in Detail: Investment
Managers
Net Asset Value................. B-23 Shareholder Services: How to Buy Shares
Taxation ...................... B-24 Dividends, Capital Gains, and Taxes
Dividends and Distributions..... B-26 Dividends, Capital Gains, and Taxes
Performance Information......... B-26 Past Performance
General Information............. B-27 Not applicable
Financial Statements............ B-29 Not applicable
Appendix ...................... B-30 Not applicable
B-1
<PAGE>
INVESTMENT OBJECTIVES AND POLICIES
The investment objective of each Fund is to provide long-term growth of
capital. There is no assurance that each Fund will achieve its objective. The
discussion below supplements information contained in the prospectus as to
investment policies of each Fund.
Under certain conditions, including unusual market conditions and for
temporary defensive purposes, up to 35% of each Fund's total assets may be
invested in short-term, high-quality debt securities. Defensive positions may be
initiated by the individual portfolio managers or by the Advisor.
The Advisor does not expect each Fund's portfolio turnover rate to exceed
150% in most years.
CASH POSITION
When a Fund's Manager believes that market conditions are unfavorable for
profitable investing, or when he or she is otherwise unable to locate attractive
investment opportunities, the Funds' cash or similar investments may increase.
In other words, the Funds do not always stay fully invested in stocks and bonds.
Cash or similar investments generally are a residual - they represent the assets
that remain after a portfolio manager has committed available assets to
desirable investment opportunities. However, a portfolio manager may also
temporarily increase a Fund's cash position to protect its assets or maintain
liquidity. Partly because the portfolio managers act independently of each
other, the cash positions of the Funds may vary significantly.
When a Fund's investments in cash or similar investments increase, it may
not participate in market advances or declines to the same extent that it would
if the Fund remained more fully invested in stocks or bonds.
CONVERTIBLE SECURITIES AND WARRANTS
Each Fund may invest in convertible securities and warrants. A convertible
security is a fixed income security (a debt instrument or a preferred stock)
which may be converted at a stated price within a specified period of time into
a certain quantity of the common stock of the same or a different issuer.
Convertible securities are senior to common stocks in an issuer's capital
structure, but are usually subordinated to similar non-convertible securities.
While providing a fixed income stream (generally higher in yield than the income
derivable from common stock but lower than that afforded by a similar
nonconvertible security), a convertible security also affords an investor the
opportunity, through its conversion feature, to participate in the capital
appreciation attendant upon a market price advance in the convertible security's
underlying common stock.
A warrant gives the holder a right to purchase at any time during a
specified period a predetermined number of shares of common stock at a fixed
price. Unlike convertible debt securities or preferred stock, warrants do not
pay a fixed dividend. Investments in warrants involve certain risks, including
the possible lack of a liquid market for resale of the warrants, potential price
fluctuations as a result of speculation or other factors, and failure of the
price of the underlying security to reach or have reasonable prospects of
reaching a level at which the warrant can be prudently exercised (in which event
the warrant may expire without being exercised, resulting in a loss of a Fund's
entire investment therein).
OTHER CORPORATE DEBT SECURITIES
Each Fund may invest in non-convertible debt securities of foreign and
domestic companies over a cross-section of industries. The debt securities in
which each Fund may invest will be of varying maturities and may include
corporate bonds, debentures, notes and other similar corporate debt instruments.
The value of a longer-term debt security fluctuates more widely in response to
changes in interest rates than do shorter-term debt securities.
RISKS OF INVESTING IN DEBT SECURITIES
There are a number of risks generally associated with an investment in debt
securities (including convertible securities). Yields on short, intermediate,
and long-term securities depend on a variety of factors, including the general
condition of the money and bond markets, the size of a particular offering, the
maturity of the obligation, and the rating of the issue.
Debt securities with longer maturities tend to produce higher yields and
are generally subject to potentially greater capital appreciation and
depreciation than obligations with short maturities and lower yields. The market
prices of debt securities usually vary, depending upon available yields. An
increase in interest rates will generally reduce the value of such portfolio
B-2
<PAGE>
investments, and a decline in interest rates will generally increase the value
of such portfolio investments. The ability of each Fund to achieve its
investment objective also depends on the continuing ability of the issuers of
the debt securities in which each Fund invests to meet their obligations for the
payment of interest and principal when due.
RISKS OF INVESTING IN LOWER-RATED DEBT SECURITIES
Each Fund may invest a portion of its net assets in debt securities rated
below "Baa" by Moody's or "BBB" by S&P or below investment grade by other
recognized rating agencies, or in unrated securities of comparable quality under
certain circumstances. Securities with ratings below "Baa" and/or "BBB" are
commonly referred to as "junk bonds." Such bonds are subject to greater market
fluctuations and risk of loss of income and principal than higher rated bonds
for a variety of reasons, including the following:
SENSITIVITY TO INTEREST RATE AND ECONOMIC CHANGES. The economy and interest
rates affect high yield securities differently from other securities. For
example, the prices of high yield bonds have been found to be less sensitive to
interest rate changes than higher-rated investments, but more sensitive to
adverse economic changes or individual corporate developments. Also, during an
economic downturn or substantial period of rising interest rates, highly
leveraged issuers may experience financial stress which would adversely affect
their ability to service their principal and interest obligations, to meet
projected business goals, and to obtain additional financing. If the issuer of a
bond defaults, each Fund may incur additional expenses to seek recovery. In
addition, periods of economic uncertainty and changes can be expected to result
in increased volatility of market prices of high yield bonds and a Fund's asset
values.
PAYMENT EXPECTATIONS. High yield bonds present certain risks based on
payment expectations. For example, high yield bonds may contain redemption and
call provisions. If an issuer exercises these provisions in a declining interest
rate market, a Fund would have to replace the security with a lower yielding
security, resulting in a decreased return for investors. Conversely, a high
yield bond's value will decrease in a rising interest rate market, as will the
value of a Fund's assets. If a Fund experiences unexpected net redemptions, it
may be forced to sell its high yield bonds without regard to their investment
merits, thereby decreasing the asset base upon which a Fund's expenses can be
spread and possibly reducing a Fund's rate of return.
LIQUIDITY AND VALUATION. To the extent that there is no established retail
secondary market, there may be thin trading of high yield bonds, and this may
impact a Manager's ability to accurately value high yield bonds and a Fund's
assets and hinder a Fund's ability to dispose of the bonds. Adverse publicity
and investor perceptions, whether or not based on fundamental analysis, may
decrease the values and liquidity of high yield bonds, especially in a thinly
traded market.
CREDIT RATINGS. Credit ratings evaluate the safety of principal and
interest payments, not the market value risk of high yield bonds. Also, since
credit rating agencies may fail to timely change the credit ratings to reflect
subsequent events, a Manager must monitor the issuers of high yield bonds in a
Fund's portfolio to determine if the issuers will have sufficient cash flow and
profits to meet required principal and interest payments, and to assure the
bonds' liquidity so a Fund can meet redemption requests. A Fund will not
necessarily dispose of a portfolio security when its rating has been changed.
SHORT-TERM INVESTMENTS
Each Fund may invest in any of the following securities and instruments:
BANK CERTIFICATES OR DEPOSIT, BANKERS' ACCEPTANCES AND TIME DEPOSITS. Each
Fund may acquire certificates of deposit, bankers' acceptances and time
deposits. Certificates of deposit are negotiable certificates issued against
funds deposited in a commercial bank for a definite period of time and earning a
specified return. Bankers' acceptances are negotiable drafts or bills of
exchange, normally drawn by an importer or exporter to pay for specific
merchandise, which are "accepted" by a bank, meaning in effect that the bank
unconditionally agrees to pay the face value of the instrument on maturity.
Certificates of deposit and bankers' acceptances acquired by a Fund will be
dollar-denominated obligations of domestic or foreign banks or financial
institutions which at the time of purchase have capital, surplus and undivided
profits in excess of $100 million (including assets of both domestic and foreign
branches), based on latest published reports, or less than $100 million if the
principal amount of such bank obligations are fully insured by the U.S.
B-3
<PAGE>
Government. If a Fund holds instruments of foreign banks or financial
institutions, it may be subject to additional investment risks that are
different in some respects from those incurred by a fund which invests only in
debt obligations of U.S. domestic issuers. See "Foreign Investments" below. Such
risks include future political and economic developments, the possible
imposition of withholding taxes by the particular country in which the issuer is
located on interest income payable on the securities, the possible seizure or
nationalization of foreign deposits, the possible establishment of exchange
controls or the adoption of other foreign governmental restrictions which might
adversely affect the payment of principal and interest on these securities.
Domestic banks and foreign banks are subject to different governmental
regulations with respect to the amount and types of loans which may be made and
interest rates which may be charged. In addition, the profitability of the
banking industry depends largely upon the availability and cost of funds for the
purpose of financing lending operations under prevailing money market
conditions. General economic conditions as well as exposure to credit losses
arising from possible financial difficulties of borrowers play an important part
in the operations of the banking industry.
As a result of federal and state laws and regulations, domestic banks are,
among other things, required to maintain specified levels of reserves, limited
in the amount which they can loan to a single borrower, and subject to other
regulations designed to promote financial soundness. However, such laws and
regulations do not necessarily apply to foreign bank obligations that a Fund may
acquire.
In addition to purchasing certificates of deposit and bankers' acceptances,
to the extent permitted under its investment objectives and policies stated
above and in its prospectus, a Fund may make interest-bearing time or other
interest-bearing deposits in commercial or savings banks. Time deposits are
non-negotiable deposits maintained at a banking institution for a specified
period of time at a specified interest rate.
SAVINGS ASSOCIATION OBLIGATIONS. Each Fund may invest in certificates of
deposit (interest-bearing time deposits) issued by savings banks or savings and
loan associations that have capital, surplus and undivided profits in excess of
$100 million, based on latest published reports, or less than $100 million if
the principal amount of such obligations is fully insured by the U.S.
Government.
COMMERCIAL PAPER, SHORT-TERM NOTES AND OTHER CORPORATE OBLIGATIONS. Each
Fund may invest a portion of its assets in commercial paper and short-term
notes. Commercial paper consists of unsecured promissory notes issued by
corporations. Issues of commercial paper and short-term notes will normally have
maturities of less than nine months and fixed rates of return, although such
instruments may have maturities of up to one year.
Commercial paper and short-term notes will consist of issues rated at the
time of purchase "A-2" or higher by S&P, "Prime-1" or "Prime-2" by Moody's, or
similarly rated by another nationally recognized statistical rating organization
or, if unrated, will be determined by a Manager to be of comparable quality.
These rating symbols are described in Appendix A.
Corporate obligations include bonds and notes issued by corporations to
finance longer-term credit needs than supported by commercial paper. While such
obligations generally have maturities of ten years or more, a Fund may purchase
corporate obligations which have remaining maturities of one year or less from
the date of purchase and which are rated "AA" or higher by S&P or "Aa" or higher
by Moody's.
MONEY MARKET FUNDS
Each Fund may under certain circumstances invest a portion of its assets in
money market funds. The Investment Company Act of 1940 (the "1940 Act")
prohibits a Fund from investing more than 5% of the value of its total assets in
any one investment company. or more than 10% of the value of its total assets in
investment companies as a group, and also restricts its investment in any
investment company to 3% of the voting securities of such investment company.
The Advisor and the Managers will not impose advisory fees on assets of a Fund
invested in a money market mutual fund. However, an investment in a money market
mutual fund will involve payment by a Fund of its pro rata share of advisory and
administrative fees charged by such fund.
GOVERNMENT OBLIGATIONS
Each Fund may make short-term investments in U.S. Government obligations.
Such obligations include Treasury bills, certificates of indebtedness, notes and
bonds, and issues of such entities as the Government National Mortgage
B-4
<PAGE>
Association ("GNMA"), Export-Import Bank of the United States, Tennessee Valley
Authority, Resolution Funding Corporation, Farmers Home Administration, Federal
Home Loan Banks, Federal Intermediate Credit Banks, Federal Farm Credit Banks,
Federal Land Banks, Federal Housing Administration, Federal National Mortgage
Association ("FNMA"), Federal Home Loan Mortgage Corporation, and the Student
Loan Marketing Association.
Some of these obligations, such as those of the GNMA, are supported by the
full faith and credit of the U.S. Treasury; others, such as those of the
Export-Import Bank of United States, are supported by the right of the issuer to
borrow from the Treasury; others, such as those of the FNMA, are supported by
the discretionary authority of the U.S. Government to purchase the agency's
obligations; still others, such as those of the Student Loan Marketing
Association, are supported only by the credit of the instrumentality. No
assurance can be given that the U.S. Government would provide financial support
to U.S. Government-sponsored instrumentalities if it is not obligated to do so
by law.
Each Fund may invest in sovereign debt obligations of foreign countries. A
sovereign debtor's willingness or ability to repay principal and interest in a
timely manner may be affected by a number of factors, including its cash flow
situation, the extent of its foreign reserves, the availability of sufficient
foreign exchange on the date a payment is due, the relative size of the debt
service burden to the economy as a whole, the sovereign debtor's policy toward
principal international lenders and the political constraints to which it may be
subject. Emerging market governments could default on their sovereign debt. Such
sovereign debtors also may be dependent on expected disbursements from foreign
governments, multilateral agencies and other entities abroad to reduce principal
and interest arrearages on their debt. The commitments on the part of these
governments, agencies and others to make such disbursements may be conditioned
on a sovereign debtor's implementation of economic reforms and/or economic
performance and the timely service of such debtor's obligations. Failure to meet
such conditions could result in the cancellation of such third parties'
commitments to lend funds to the sovereign debtor, which may further impair such
debtor's ability or willingness to service its debt in a timely manner.
ZERO COUPON SECURITIES
Each Fund may invest up to 35% of its net assets in zero coupon securities
issued by the U.S. Treasury. Zero coupon Treasury securities are U.S. Treasury
notes and bonds which have been stripped of their unmatured interest coupons and
receipts, or certificates representing interests in such stripped debt
obligations or coupons. Because a zero coupon security pays no interest to its
holder during its life or for a substantial period of time, it usually trades at
a deep discount from its face or par value and will be subject to greater
fluctuations of market value in response to changing interest rates than debt
obligations of comparable maturities which make current distributions of
interest.
VARIABLE AND FLOATING RATE INSTRUMENTS
Each Fund may acquire variable and floating rate instruments. Such
instruments are frequently not rated by credit rating agencies; however, unrated
variable and floating rate instruments purchased by a Fund will be determined by
a Manager under guidelines established by the Trust's Board of Trustees to be of
comparable quality at the time of the purchase to rated instruments eligible for
purchase by a Fund. In making such determinations, a Manager will consider the
earning power, cash flow and other liquidity ratios of the issuers of such
instruments (such issuers include financial, merchandising, bank holding and
other companies) and will monitor their financial condition. An active secondary
market may not exist with respect to particular variable or floating rate
instruments purchased by a Fund. The absence of such an active secondary market
could make it difficult for a Fund to dispose of the variable or floating rate
instrument involved in the event of the issuer of the instrument defaulting on
its payment obligation or during periods in which a Fund is not entitled to
exercise its demand rights, and a Fund could, for these or other reasons, suffer
a loss to the extent of the default. Variable and floating rate instruments may
be secured by bank letters of credit.
MORTGAGE-RELATED SECURITIES
Each Fund may invest in mortgage-related securities. Mortgage-related
securities are derivative interests in pools of mortgage loans made to U.S.
residential home buyers, including mortgage loans made by savings and loan
institutions, mortgage bankers, commercial banks and others. Pools of mortgage
B-5
<PAGE>
loans are assembled as securities for sale to investors by various governmental,
government-related and private organizations. Each Fund may also invest in debt
securities which are secured with collateral consisting of U.S. mortgage-related
securities, and in other types of U.S. mortgage-related securities.
U.S. MORTGAGE PASS-THROUGH SECURITIES. Interests in pools of
mortgage-related securities differ from other forms of debt securities, which
normally provide for periodic payment of interest in fixed amounts with
principal payments at maturity or specified call dates. Instead, these
securities provide a monthly payment which consists of both interest and
principal payments. In effect, these payments are a "pass-through" of the
monthly payments made by the individual borrowers on their residential mortgage
loans, net of any fees paid to the issuer or guarantor of such securities.
Additional payments are caused by repayments of principal resulting from the
sale of the underlying residential property, refinancing or foreclosure, net of
fees or costs which may be incurred. Some mortgage-related securities (such as
securities issued by GNMA) are described as "modified pass-throughs." These
securities entitle the holder to receive all interest and principal payments
owed on the mortgage pool, net of certain fees, at the scheduled payment dates
regardless of whether or not the mortgagor actually makes the payment.
The principal governmental guarantor of U.S. mortgage-related securities is
GNMA, a wholly owned United States Government corporation within the Department
of Housing and Urban Development. GNMA is authorized to guarantee, with the full
faith and credit of the United States Government, the timely payment of
principal and interest on securities issued by institutions approved by GNMA
(such as savings and loan institutions, commercial banks and mortgage bankers)
and backed by pools of mortgages insured by the Federal Housing Agency or
guaranteed by the Veterans Administration.
Government-related guarantors include the Federal National Mortgage
Association ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC").
FNMA is a government-sponsored corporation owned entirely by private
stockholders and subject to general regulation by the Secretary of Housing and
Urban Development. FNMA purchases conventional residential mortgages not insured
or guaranteed by any government agency from a list of approved seller/services
which include state and federally chartered savings and loan associations,
mutual savings banks, commercial banks and credit unions and mortgage bankers.
FHLMC is a government-sponsored corporation created to increase availability of
mortgage credit for residential housing and owned entirely by private
stockholders. FHLMC issues participation certificates which represent interests
in conventional mortgages from FHLMC's national portfolio. Pass-through
securities issued by FNMA and participation certificates issued by FHLMC are
guaranteed as to timely payment of principal and interest by FNMA and FHLMC,
respectively, but are not backed by the full faith and credit of the United
States Government.
Although the underlying mortgage loans in a pool may have maturities of up
to 30 years, the actual average life of the pool certificates typically will be
substantially less because the mortgages will be subject to normal principal
amortization and may be prepaid prior to maturity. Prepayment rates vary widely
and may be affected by changes in market interest rates. In periods of falling
interest rates, the rate of prepayment tends to increase, thereby shortening the
actual average life of the pool certificates. Conversely, when interest rates
are rising, the rate of prepayments tends to decrease, thereby lengthening the
actual average life of the certificates. Accordingly, it is not possible to
predict accurately the average life of a particular pool.
COLLATERALIZED MORTGAGE OBLIGATIONS ("CMOS"). A domestic or foreign CMO in
which a Fund may invest is a hybrid between a mortgage-backed bond and a
mortgage pass-through security. Like a bond, interest is paid, in most cases,
semiannually. CMOs may be collateralized by whole mortgage loans, but are more
typically collateralized by portfolios of mortgage pass-through securities
guaranteed by GNMA, FHLMC, FNMA or equivalent foreign entities.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life depend upon the prepayment experience
of the collateral. CMOs provide for a modified form of call protection through a
de facto breakdown of the underlying pool of mortgages according to how quickly
the loans are repaid. Monthly payment of principal and interest received from
the pool of underlying mortgages, including prepayments, is first returned to
the class having the earliest maturity date or highest maturity. Classes that
have longer maturity dates and lower seniority will receive principal only after
the higher class has been retired.
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FOREIGN INVESTMENTS AND CURRENCIES
Each Fund may invest in securities of foreign issuers that are not publicly
traded in the United States (the International Fund will invest substantially
all of its assets in securities of foreign issuers). Each Fund may also invest
in depositary receipts and in foreign currency futures contracts and may
purchase and sell foreign currency on a spot basis.
DEPOSITARY RECEIPTS. Depositary Receipts ("DRs") include American
Depositary Receipts ("ADRs"), European Depositary Receipts ("EDRs"), Global
Depositary Receipts ("GDRs") or other forms of depositary receipts. DRs are
receipts typically issued in connection with a U.S. or foreign bank or trust
company which evidence ownership of underlying securities issued by a foreign
corporation.
RISKS OF INVESTING IN FOREIGN SECURITIES. Investments in foreign securities
involve certain inherent risks, including the following:
POLITICAL AND ECONOMIC FACTORS. Individual foreign economies of certain
countries may differ favorably or unfavorably from the United States' economy in
such respects as growth of gross national product, rate of inflation, capital
reinvestment, resource self-sufficiency, diversification and balance of payments
position. The internal politics of certain foreign countries may not be as
stable as those of the United States. Governments in certain foreign countries
also continue to participate to a significant degree, through ownership interest
or regulation, in their respective economies. Action by these governments could
include restrictions on foreign investment, nationalization, expropriation of
goods or imposition of taxes, and could have a significant effect on market
prices of securities and payment of interest. The economies of many foreign
countries are heavily dependent upon international trade and are accordingly
affected by the trade policies and economic conditions of their trading
partners. Enactment by these trading partners of protectionist trade legislation
could have a significant adverse effect upon the securities markets of such
countries.
CURRENCY FLUCTUATIONS. Each Fund may invest in securities denominated in
foreign currencies. Accordingly, a change in the value of any such currency
against the U.S. dollar will result in a corresponding change in the U.S. dollar
value of a Fund's assets denominated in that currency. Such changes will also
affect a Fund's income. The value of a Fund's assets may also be affected
significantly by currency restrictions and exchange control regulations enacted
from time to time.
MARKET CHARACTERISTICS. The Managers expect that many foreign securities in
which a Fund invests will be purchased in over-the-counter markets or on
exchanges located in the countries in which the principal offices of the issuers
of the various securities are located, if that is the best available market.
Foreign exchanges and markets may be more volatile than those in the United
States. While growing in volume, they usually have substantially less volume
than U.S. markets, and a Fund's portfolio securities may be less liquid and more
volatile than U.S. Government securities. Moreover, settlement practices for
transactions in foreign markets may differ from those in United States markets,
and may include delays beyond periods customary in the United States. Foreign
security trading practices, including those involving securities settlement
where Fund assets may be released prior to receipt of payment or securities, may
expose a Fund to increased risk in the event of a failed trade or the insolvency
of a foreign broker-dealer.
Transactions in options on securities, futures contracts, futures options
and currency contracts may not be regulated as effectively on foreign exchanges
as similar transactions in the United States, and may not involve clearing
mechanisms and related guarantees. The value of such positions also could be
adversely affected by the imposition of different exercise terms and procedures
and margin requirements than in the United States. The value of a Fund's
positions may also be adversely impacted by delays in its ability to act upon
economic events occurring in foreign markets during non-business hours in the
United States.
LEGAL AND REGULATORY MATTERS. Certain foreign countries may have less
supervision of securities markets, brokers and issuers of securities, and less
financial information available to issuers, than is available in the United
States.
TAXES. The interest payable on certain of a Fund's foreign portfolio
securities may be subject to foreign withholding taxes, thus reducing the net
amount of income available for distribution to a Fund's shareholders.
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COSTS. To the extent that each Fund invests in foreign securities, its
expense ratio is likely to be higher than those of investment companies
investing only in domestic securities, since the cost of maintaining the custody
of foreign securities is higher.
EMERGING MARKETS. Some of the securities in which each Fund may invest may
be located in developing or emerging markets, which entail additional risks,
including less social, political and economic stability; smaller securities
markets and lower trading volume, which may result in a less liquidity and
greater price volatility; national policies that may restrict a Fund's
investment opportunities, including restrictions on investment in issuers or
industries, or expropriation or confiscation of assets or property; and less
developed legal structures governing private or foreign investment.
In considering whether to invest in the securities of a foreign company, a
Manager considers such factors as the characteristics of the particular company,
differences between economic trends and the performance of securities markets
within the U.S. and those within other countries, and also factors relating to
the general economic, governmental and social conditions of the country or
countries where the company is located. The extent to which a Fund will be
invested in foreign companies and countries and depository receipts will
fluctuate from time to time within the limitations described in the prospectus,
depending on a Manager's assessment of prevailing market, economic and other
conditions.
OPTIONS ON SECURITIES AND SECURITIES INDICES
PURCHASING PUT AND CALL OPTIONS. Each Fund may purchase covered "put" and
"call" options with respect to securities which are otherwise eligible for
purchase by a Fund and with respect to various stock indices subject to certain
restrictions. Each Fund will engage in trading of such derivative securities
primarily for hedging purposes.
If a Fund purchases a put option, a Fund acquires the right to sell the
underlying security at a specified price at any time during the term of the
option (for "American-style" options) or on the option expiration date (for
"European-style" options). Purchasing put options may be used as a portfolio
investment strategy when a Manager perceives significant short-term risk but
substantial long-term appreciation for the underlying security. The put option
acts as an insurance policy, as it protects against significant downward price
movement while it allows full participation in any upward movement. If a Fund is
holding a stock which it feels has strong fundamentals, but for some reason may
be weak in the near term, a Fund may purchase a put option on such security,
thereby giving itself the right to sell such security at a certain strike price
throughout the term of the option. Consequently, a Fund will exercise the put
only if the price of such security falls below the strike price of the put. The
difference between the put's strike price and the market price of the underlying
security on the date a Fund exercises the put, less transaction costs, will be
the amount by which a Fund will be able to hedge against a decline in the
underlying security. If during the period of the option the market price for the
underlying security remains at or above the put's strike price, the put will
expire worthless, representing a loss of the price a Fund paid for the put, plus
transaction costs. If the price of the underlying security increases, the profit
a Fund realizes on the sale of the security will be reduced by the premium paid
for the put option less any amount for which the put may be sold.
If a Fund purchases a call option, it acquires the right to purchase the
underlying security at a specified price at any time during the term of the
option. The purchase of a call option is a type of insurance policy to hedge
against losses that could occur if a Fund has a short position in the underlying
security and the security thereafter increases in price. Each Fund will exercise
a call option only if the price of the underlying security is above the strike
price at the time of exercise. If during the option period the market price for
the underlying security remains at or below the strike price of the call option,
the option will expire worthless, representing a loss of the price paid for the
option, plus transaction costs. If the call option has been purchased to hedge a
short position of a Fund in the underlying security and the price of the
underlying security thereafter falls, the profit a Fund realizes on the cover of
the short position in the security will be reduced by the premium paid for the
call option less any amount for which such option may be sold.
Prior to exercise or expiration, an option may be sold when it has
remaining value by a purchaser through a "closing sale transaction," which is
accomplished by selling an option of the same series as the option previously
purchased. Each Fund generally will purchase only those options for which a
Manager believes there is an active secondary market to facilitate closing
transactions.
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WRITING CALL OPTIONS. Each Fund may write covered call options. A call
option is "covered" if a Fund owns the security underlying the call or has an
absolute right to acquire the security without additional cash consideration
(or, if additional cash consideration is required, cash or cash equivalents in
such amount as are held in a segregated account by the Custodian). The writer of
a call option receives a premium and gives the purchaser the right to buy the
security underlying the option at the exercise price. The writer has the
obligation upon exercise of the option to deliver the underlying security
against payment of the exercise price during the option period. If the writer of
an exchange-traded option wishes to terminate his obligation, he may effect a
"closing purchase transaction." This is accomplished by buying an option of the
same series as the option previously written. A writer may not effect a closing
purchase transaction after it has been notified of the exercise of an option.
Effecting a closing transaction in the case of a written call option will
permit a Fund to write another call option on the underlying security with
either a different exercise price, expiration date or both. Also, effecting a
closing transaction will permit the cash or proceeds from the concurrent sale of
any securities subject to the option to be used for other investments of a Fund.
If a Fund desires to sell a particular security from its portfolio on which it
has written a call option, it will effect a closing transaction prior to or
concurrent with the sale of the security.
Each Fund will realize a gain from a closing transaction if the cost of the
closing transaction is less than the premium received from writing the option or
if the proceeds from the closing transaction are more than the premium paid to
purchase the option. Each Fund will realize a loss from a closing transaction if
the cost of the closing transaction is more than the premium received from
writing the option or if the proceeds from the closing transaction are less than
the premium paid to purchase the option. However, because increases in the
market price of a call option will generally reflect increases in the market
price of the underlying security, any loss to a Fund resulting from the
repurchase of a call option is likely to be offset in whole or in part by
appreciation of the underlying security owned by a Fund.
STOCK INDEX OPTIONS. Each Fund may also purchase put and call options with
respect to the S&P 500 and other stock indices. Such options may be purchased as
a hedge against changes resulting from market conditions in the values of
securities which are held in a Fund's portfolio or which it intends to purchase
or sell, or when they are economically appropriate for the reduction of risks
inherent in the ongoing management of a Fund.
The distinctive characteristics of options on stock indices create certain
risks that are not present with stock options generally. Because the value of an
index option depends upon movements in the level of the index rather than the
price of a particular stock, whether a Fund will realize a gain or loss on the
purchase or sale of an option on an index depends upon movements in the level of
stock prices in the stock market generally rather than movements in the price of
a particular stock. Accordingly, successful use by a Fund of options on a stock
index would be subject to a Manager's ability to predict correctly movements in
the direction of the stock market generally. This requires different skills and
techniques than predicting changes in the price of individual stocks.
Index prices may be distorted if trading of certain stocks included in the
index is interrupted. Trading of index options also may be interrupted in
certain circumstances, such as if trading were halted in a substantial number of
stocks included in the index. If this were to occur, a Fund would not be able to
close out options which it had purchased, and if restrictions on exercise were
imposed, a Fund might be unable to exercise an option it holds, which could
result in substantial losses to a Fund. It is the policy of each Fund to
purchase put or call options only with respect to an index which a Manager
believes includes a sufficient number of stocks to minimize the likelihood of a
trading halt in the index.
RISKS OF INVESTING IN OPTIONS. There are several risks associated with
transactions in options on securities and indices. Options may be more volatile
than the underlying instruments and, therefore, on a percentage basis, an
investment in options may be subject to greater fluctuation than an investment
in the underlying instruments themselves. There are also significant differences
between the securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction not to achieve
its objective. In addition, a liquid secondary market for particular options may
be absent for reasons which include the following: there may be insufficient
trading interest in certain options; restrictions may be imposed by an exchange
on opening transactions or closing transactions or both; trading halts,
suspensions or other restrictions may be imposed with respect to particular
classes or series of option of underlying securities; unusual or unforeseen
circumstances may interrupt normal operations on an exchange; the facilities of
an exchange or clearing corporation may not at all times be adequate to handle
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current trading volume; or one or more exchanges could, for economic or other
reasons, decide or be compelled at some future date to discontinue the trading
of options (or a particular class or series of options), in which event the
secondary market on that exchange (or in that class or series of options) would
cease to exist, although outstanding options that had been issued by a clearing
corporation as a result of trades on that exchange would continue to be
exercisable in accordance with their terms.
A decision as to whether, when and how to use options involves the exercise
of skill and judgment, and even a well-conceived transaction may be unsuccessful
to some degree because of market behavior or unexpected events. The extent to
which a Fund may enter into options transactions may be limited by the Internal
Revenue Code (the "Code") requirements for qualification of a Fund as a
regulated investment company. See "Dividends and Distributions" and "Taxation."
In addition, when trading options on foreign exchanges, many of the
protections afforded to participants in United States option exchanges will not
be available. For example, there may be no daily price fluctuation limits in
such exchanges or markets, and adverse market movements could therefore continue
to an unlimited extent over a period of time. Although the purchaser of an
option cannot lose more than the amount of the premium plus related transaction
costs, this entire amount could be lost. Moreover, a Fund as an option writer
could lose amounts substantially in excess of its initial investment, due to the
margin and collateral requirements typically associated with such option
writing. See "Dealer Options" below.
DEALER OPTIONS. Each Fund will engage in transactions involving dealer
options as well as exchange-traded options. Certain risks are specific to dealer
options. While a Fund might look to a clearing corporation to exercise
exchange-traded options, if a Fund were to purchase a dealer option it would
need to rely on the dealer from which it purchased the option to perform if the
option were exercised. Failure by the dealer to do so would result in the loss
of the premium paid by a Fund as well as loss of the expected benefit of the
transaction.
Exchange-traded options generally have a continuous liquid market while
dealer options may not. Consequently, a Fund may generally be able to realize
the value of a dealer option it has purchased only by exercising or reselling
the option to the dealer who issued it. Similarly, when a Fund writes a dealer
option, a Fund may generally be able to close out the option prior to its
expiration only by entering into a closing purchase transaction with the dealer
to whom a Fund originally wrote the option. While a Fund will seek to enter into
dealer options only with dealers who will agree to and which are expected to be
capable of entering into closing transactions with a Fund, there can be no
assurance that a Fund will at any time be able to liquidate a dealer option at a
favorable price at any time prior to expiration. Unless a Fund, as a covered
dealer call option writer, is able to effect a closing purchase transaction, it
will not be able to liquidate securities (or other assets) used as cover until
the option expires or is exercised. In the event of insolvency of the other
party, a Fund may be unable to liquidate a dealer option. With respect to
options written by a Fund, the inability to enter into a closing transaction may
result in material losses to a Fund. For example, because a Fund must maintain a
secured position with respect to any call option on a security it writes, a Fund
may not sell the assets which it has segregated to secure the position while it
is obligated under the option. This requirement may impair a Fund's ability to
sell portfolio securities at a time when such sale might be advantageous.
The Staff of the Securities and Exchange Commission (the "Commission") has
taken the position that purchased dealer options are illiquid securities. A Fund
may treat the cover used for written dealer options as liquid if the dealer
agrees that a Fund may repurchase the dealer option it has written for a maximum
price to be calculated by a predetermined formula. In such cases, the dealer
option would be considered illiquid only to the extent the maximum purchase
price under the formula exceeds the intrinsic value of the option. Accordingly,
each Fund will treat dealer options as subject to a Fund's limitation on
illiquid securities. If the Commission changes its position on the liquidity of
dealer options, each Fund will change its treatment of such instruments
accordingly.
FOREIGN CURRENCY OPTIONS. Each Fund may buy or sell put and call options on
foreign currencies. A put or call option on a foreign currency gives the
purchaser of the option the right to sell or purchase a foreign currency at the
exercise price until the option expires. Each Fund will use foreign currency
options separately or in combination to control currency volatility. Among the
strategies employed to control currency volatility is an option collar. An
option collar involves the purchase of a put option and the simultaneous sale of
call option on the same currency with the same expiration date but with
different exercise (or "strike") prices. Generally, the put option will have an
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out-of-the-money strike price, while the call option will have either an
at-the-money strike price or an in-the-money strike price. Foreign currency
options are derivative securities. Currency options traded on U.S. or other
exchanges may be subject to position limits which may limit the ability of a
Fund to reduce foreign currency risk using such options.
As with other kinds of option transactions, the writing of an option on
foreign currency will constitute only a partial hedge, up to the amount of the
premium received. Each Fund could be required to purchase or sell foreign
currencies at disadvantageous exchange rates, thereby incurring losses. The
purchase of an option on foreign currency may constitute an effective hedge
against exchange rate fluctuations: however, in the event of exchange rate
movements adverse to a Fund's position, a Fund may forfeit the entire amount of
the premium plus related transaction costs.
SPREAD TRANSACTIONS. Each Fund may purchase covered spread options from
securities dealers. These covered spread options are not presently
exchange-listed or exchange-traded. The purchase of a spread option gives a Fund
the right to put a securities that it owns at a fixed dollar spread or fixed
yield spread in relationship to another security that a Fund does not own, but
which is used as a benchmark. The risk to a Fund, in addition to the risks of
dealer options described above, is the cost of the premium paid as well as any
transaction costs. The purchase of spread options will be used to protect a Fund
against adverse changes in prevailing credit quality spreads, I.E., the yield
spread between high quality and lower quality securities. This protection is
provided only during the life of the spread options.
FORWARD CURRENCY CONTRACTS
Each Fund may enter into forward currency contracts in anticipation of
changes in currency exchange rates. A forward currency contract is an obligation
to purchase or sell a specific currency at a future date, which may be any fixed
number of days from the date of the contract agreed upon by the parties, at a
price set at the time of the contract. For example, a Fund might purchase a
particular currency or enter into a forward currency contract to preserve the
U.S. dollar price of securities it intends to or has contracted to purchase.
Alternatively, it might sell a particular currency on either a spot or forward
basis to hedge against an anticipated decline in the dollar value of securities
it intends to or has contracted to sell. Although this strategy could minimize
the risk of loss due to a decline in the value of the hedged currency, it could
also limit any potential gain from an increase in the value of the currency.
FUTURES CONTRACTS AND RELATED OPTIONS
Each Fund may invest in futures contracts and options on futures contracts
as a hedge against changes in market conditions or interest rates. A Fund may
trade in such derivative securities for bona fide hedging purposes and otherwise
in accordance with the rules of the Commodity Futures Trading Commission
("CFTC"). A Fund will segregate liquid assets in a separate account with its
Custodian when required to do so by CFTC guidelines in order to cover its
obligation in connection with futures and options transactions.
No price is paid or received by a Fund upon the purchase or sale of a
futures contract. When it enters into a domestic futures contract, a Fund will
be required to deposit in a segregated account with its Custodian an amount of
cash or U.S. Treasury bills equal to approximately 5% of the contract amount.
This amount is known as initial margin. The margin requirements for foreign
futures contracts may be different.
The nature of initial margin in futures transactions is different from that
of margin in securities transactions. Futures contract margin does not involve
the borrowing of funds by the customer to finance the transactions. Rather, the
initial margin is in the nature of a performance bond or good faith deposit on
the contract which is returned to a Fund upon termination of the futures
contract, assuming all contractual obligations have been satisfied. Subsequent
payments (called variation margin) to and from the broker will be made on a
daily basis as the price of the underlying stock index fluctuates, to reflect
movements in the price of the contract making the long and short positions in
the futures contract more or less valuable. For example, when a Fund has
purchased a stock index futures contract and the price of the underlying stock
index has risen, that position will have increased in value and a Fund will
receive from the broker a variation margin payment equal to that increase in
value. Conversely, when a Fund has purchased a stock index futures contract and
the price of the underlying stock index has declined, the position will be less
valuable and a Fund will be required to make a variation margin payment to the
broker.
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At any time prior to expiration of a futures contract, a Fund may elect to
close the position by taking an opposite position, which will operate to
terminate a Fund's position in the futures contract A final determination of
variation margin is made on closing the position. Additional cash is paid by or
released to a Fund, which realizes a loss or a gain.
In addition to amounts segregated or paid as initial and variation margin,
a Fund must segregate liquid assets with its custodian equal to the market value
of the futures contracts, in order to comply with Commission requirements
intended to ensure that a Fund's use of futures is unleveraged. The requirements
for margin payments and segregated accounts apply to both domestic and foreign
futures contracts.
STOCK INDEX FUTURES CONTRACTS. Each Fund may invest in futures contracts on
stock indices. Currently, stock index futures contracts can be purchased or sold
with respect to the S&P 500 Stock Price Index on the Chicago Mercantile
Exchange, the Major Market Index on the Chicago Board of Trade, the New York
Stock Exchange Composite Index on the New York Futures Exchange and the Value
Line Stock Index on the Kansas City Board of Trade. Foreign financial and stock
index futures are traded on foreign exchanges including the London International
Financial Futures Exchange, the Singapore International Monetary Exchange, the
Sydney Futures Exchange Limited and the Tokyo Stock Exchange.
INTEREST RATE OR FINANCIAL FUTURES CONTRACTS. Each Fund may invest in
interest rate or financial futures contracts. Bond prices are established in
both the cash market and the futures market. In the cash market, bonds are
purchased and sold with payment for the full purchase price of the bond being
made in cash, generally within five business days after the trade. In the
futures market, a contract is made to purchase or sell a bond in the future for
a set price on a certain date. Historically, the prices for bonds established in
the futures markets have generally tended to move in the aggregate in concert
with cash market prices, and the prices have maintained fairly predictable
relationships.
The sale of an interest rate or financial futures contract by a Fund would
create an obligation by a Fund, as seller, to deliver the specific type of
financial instrument called for in the contract at a specific future time for a
specified price. A futures contract purchased by a Fund would create an
obligation by a Fund, as purchaser, to take delivery of the specific type of
financial instrument at a specific future time at a specific price. The specific
securities delivered or taken, respectively, at settlement date, would not be
determined until at or near that date. The determination would be in accordance
with the rules of the exchange on which the futures contract sale or purchase
was made.
Although interest rate or financial futures contracts by their terms call
for actual delivery or acceptance of securities, in most cases the contracts are
closed out before the settlement date without delivery of securities. Closing
out of a futures contract sale is effected by a Fund's entering into a futures
contract purchase for the same aggregate amount of the specific type of
financial instrument and the same delivery date. If the price in the sale
exceeds the price in the offsetting purchase, a Fund is paid the difference and
thus realizes a gain. If the offsetting purchase price exceeds the sale price, a
Fund pays the difference and realizes a loss. Similarly, the closing out of a
futures contract purchase is effected by a Fund's entering into a futures
contract sale. If the offsetting sale price exceeds the purchase price, a Fund
realizes a gain, and if the purchase price exceeds the offsetting sale price, a
Fund realizes a loss.
Each Fund will deal only in standardized contracts on recognized exchanges.
Each exchange guarantees performance under contract provisions through a
clearing corporation, a nonprofit organization managed by the exchange
membership. Domestic interest rate futures contracts are traded in an auction
environment on the floors of several exchanges - principally, the Chicago Board
of Trade and the Chicago Mercantile Exchange. A public market now exists in
domestic futures contracts covering various financial instruments including
long-term United States Treasury bonds and notes; GNMA modified pass-through
mortgage-backed securities; three-month United States Treasury bills; and 90-day
commercial paper. Each Fund may trade in any futures contract for which there
exists a public market, including, without limitation, the foregoing
instruments. International interest rate futures contracts are traded on the
London International Financial Futures Exchange, the Singapore International
Monetary Exchange, the Sydney Futures Exchange Limited and the Tokyo Stock
Exchange.
FOREIGN CURRENCY FUTURES CONTRACTS. Each Fund may use foreign currency
future contracts for hedging purposes. A foreign currency futures contract
provides for the future sale by one party and purchase by another party of a
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specified quantity of a foreign currency at a specified price and time. A public
market exists in futures contracts covering several foreign currencies,
including the Australian dollar, the Canadian dollar, the British pound, the
German mark, the Japanese yen, the Swiss franc, and certain multinational
currencies such as the European Currency Unit ("ECU"). Other foreign currency
futures contracts are likely to be developed and traded in the future. Each Fund
will only enter into futures contracts and futures options which are
standardized and traded on a U.S. or foreign exchange, board of trade, or
similar entity, or quoted on an automated quotation system.
RISKS OF TRANSACTIONS IN FUTURES CONTRACTS. There are several risks related
to the use of futures as a hedging device. One risk arises because of the
imperfect correlation between movements in the price of the futures contract and
movements in the price of the securities which are the subject of the hedge. The
price of the future may move more or less than the price of the securities being
hedged. If the price of the future moves less than the price of the securities
which are the subject of the hedge, the hedge will not be fully effective, but
if the price of the securities being hedged has moved in an unfavorable
direction, a Fund would be in a better position than if it had not hedged at
all. If the price of the securities being hedged has moved in a favorable
direction, this advantage will be partially offset by the loss on the future. If
the price of the future moves more than the price of the hedged securities, a
Fund will experience either a loss or a gain on the future which will not be
completely offset by movements in the price of the securities which are subject
to the hedge.
To compensate for the imperfect correlation of movements in the price of
securities being hedged and movements in the price of the futures contract, a
Fund may buy or sell futures contracts in a greater dollar amount than the
dollar amount of securities being hedged if the historical volatility of the
prices of such securities has been greater than the historical volatility over
such time period of the future. Conversely, a Fund may buy or sell fewer futures
contracts if the historical volatility of the price of the securities being
hedged is less than the historical volatility of the futures contract being
used. It is possible that, when a Fund has sold futures to hedge its portfolio
against a decline in the market, the market may advance while the value of
securities held in a Fund's portfolio may decline. If this occurs, a Fund will
lose money on the future and also experience a decline in value in its portfolio
securities. However, the Advisor believes that over time the value of a
diversified portfolio will tend to move in the same direction as the market
indices upon which the futures are based.
Where futures are purchased to hedge against a possible increase in the
price of securities before a Fund is able to invest its cash (or cash
equivalents) in securities (or options) in an orderly fashion, it is possible
that the market may decline instead. If a Fund then decides not to invest in
securities or options at that time because of concern as to possible further
market decline or for other reasons, it will realize a loss on the futures
contract that is not offset by a reduction in the price of securities purchased.
In addition to the possibility that there may be an imperfect correlation,
or no correlation at all, between movements in the futures and the securities
being hedged, the price of futures may not correlate perfectly with movement in
the stock index or cash market due to certain market distortions. All
participants in the futures market are subject to margin deposit and maintenance
requirements. Rather than meeting additional margin deposit requirements,
investors may close futures contracts through offsetting transactions, which
could distort the normal relationship between the index or cash market and
futures markets. In addition, the deposit requirements in the futures market are
less onerous than margin requirements in the securities market. Therefore,
increased participation by speculators in the futures market may also cause
temporary price distortions. As a result of price distortions in the futures
market and the imperfect correlation between movements in the cash market and
the price of securities and movements in the price of futures, a correct
forecast of general trends by a Manager may still not result in a successful
hedging transaction over a very short time frame.
Positions in futures may be closed out only on an exchange or board of
trade which provides a secondary market for such futures. Although a Fund may
intend to purchase or sell futures only on exchanges or boards of trade where
there appears to be an active secondary market, there is no assurance that a
liquid secondary market on an exchange or board of trade will exist for any
particular contract or at any particular time. In such event, it may not be
possible to close a futures position, and in the event of adverse price
movements, a Fund would continue to be required to make daily cash payments of
variation margin. When futures contracts have been used to hedge portfolio
securities, such securities will not be sold until the futures contract can be
terminated. In such circumstances, an increase in the price of the securities,
if any, may partially or completely offset losses on the futures contract.
However, as described above, there is no guarantee that the price of the
securities will in fact correlate with the price movements in the futures
contract and thus provide an offset to losses on a futures contract.
B-13
<PAGE>
Most United States futures exchanges limit the amount of fluctuation
permitted in futures contract prices during a single trading day. The daily
limit establishes the maximum amount that the price of a futures contract may
vary either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
futures contract, no trades may be made on that day at a price beyond that
limit. The daily limit governs only price movement during a particular trading
day and therefore does not limit potential losses, because the limit may prevent
the liquidation of unfavorable positions. Futures contract prices have
occasionally moved to the daily limit for several consecutive trading days with
little or no trading, thereby preventing prompt liquidation of futures positions
and subjecting some futures traders to substantial losses.
Successful use of futures by a Fund is also subject to a Manager's ability
to predict correctly movements in the direction of the market. For example, if a
Fund has hedged against the possibility of a decline in the market adversely
affecting stocks held in its portfolio and stock prices increase instead, a Fund
will lose part or all of the benefit of the increased value of the stocks which
it has hedged because it will have offsetting losses in its futures positions.
In addition, in such situations, if a Fund has insufficient cash, it may have to
sell securities to meet daily variation margin requirements. Such sales of
securities may be, but will not necessarily be, at increased prices which
reflect the rising market. Each Fund may have to sell securities at a time when
it may be disadvantageous to do so.
In the event of the bankruptcy of a broker through which a Fund engages in
transactions in futures contracts or options, a Fund could experience delays and
losses in liquidating open positions purchased or sold through the broker, and
incur a loss of all or part of its margin deposits with the broker.
OPTIONS ON FUTURES CONTRACTS. As described above, each Fund may purchase
options on the futures contracts they can purchase or sell. A futures option
gives the holder, in return for the premium paid, the right to buy (call) from
or sell (put) to the writer of the option a futures contract at a specified
price at any time during the period of the option. Upon exercise, the writer of
the option is obligated to pay the difference between the cash value of the
futures contract and the exercise price. Like the buyer or seller of a futures
contract, the holder or writer of an option has the right to terminate its
position prior to the scheduled expiration of the option by selling, or
purchasing an option of the same series, at which time the person entering into
the closing transaction will realize a gain or loss. There is no guarantee that
such closing transactions can be effected.
Investments in futures options involve some of the same considerations as
investments in futures contracts (for example, the existence of a liquid
secondary market). In addition, the purchase of an option also entails the risk
that changes in the value of the underlying futures contract will not be fully
reflected in the value of the option. Depending on the pricing of the option
compared to either the futures contract upon which it is based, or upon the
price of the securities being hedged, an option may or may not be less risky
than ownership of the futures contract or such securities. In general, the
market prices of options can be expected to be more volatile than the market
prices on the underlying futures contracts. Compared to the purchase or sale of
futures contracts, however, the purchase of call or put options on futures
contracts may frequently involve less potential risk to a Fund because the
maximum amount at risk is limited to the premium paid for the options (plus
transaction costs).
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS AND RELATED OPTIONS. Each
Fund will engage in transactions in futures contracts or related options
primarily as a hedge against changes resulting from market conditions in the
values of securities held in a Fund's portfolio or which it intends to purchase
and where the transactions are economically appropriate to the reduction of
risks inherent in the ongoing management of each Fund. A Fund may not purchase
or sell futures or purchase related options for purposes other than bona fide
hedging if, immediately thereafter, more than 25% of its net assets would be
hedged. A Fund also may not purchase or sell futures or purchase related options
if, immediately thereafter, the sum of the amount of margin deposits on a Fund's
existing futures positions and premiums paid for such options would exceed 5% of
the market value of a Fund's net assets.
These restrictions, which are derived from current federal regulations
regarding the use of options and futures by mutual funds, are not "fundamental
restrictions" and may be changed by the Trustees of the Trust if applicable law
permits such a change and the change is consistent with the overall investment
objective and policies of each Fund.
The extent to which a Fund may enter into futures and options transactions
may be limited by the Code requirements for qualification of a Fund as a
regulated investment company. See "Taxation."
B-14
<PAGE>
REPURCHASE AGREEMENTS
Each Fund may enter into repurchase agreements with respect to its
portfolio securities. Pursuant to such agreements, a Fund acquires securities
from financial institutions such as banks and broker-dealers as are deemed to be
creditworthy by the Advisor or a Manager, subject to the seller's agreement to
repurchase and a Fund's agreement to resell such securities at a mutually agreed
upon date and price. The repurchase price generally equals the price paid by a
Fund plus interest negotiated on the basis of current short-term rates (which
may be more or less than the rate on the underlying portfolio security).
Securities subject to repurchase agreements will be held by the Custodian or in
the Federal Reserve/Treasury Book-Entry System or an equivalent foreign system.
The seller under a repurchase agreement will be required to maintain the value
of the underlying securities at not less than 102% of the repurchase price under
the agreement. If the seller defaults on its repurchase obligation, a Fund
holding the repurchase agreement will suffer a loss to the extent that the
proceeds from a sale of the underlying securities are less than the repurchase
price under the agreement. Bankruptcy or insolvency of such a defaulting seller
may cause a Fund's rights with respect to such securities to be delayed or
limited. Repurchase agreements are considered to be loans under the 1940 Act.
REVERSE REPURCHASE AGREEMENTS.
Each Fund may enter into reverse repurchase agreements. A Fund typically
will invest the proceeds of a reverse repurchase agreement in money market
instruments or repurchase agreements maturing not later than the expiration of
the reverse repurchase agreement. A Fund may use the proceeds of reverse
repurchase agreements to provide liquidity to meet redemption requests when sale
of a Fund's securities is disadvantageous.
Each Fund causes the custodian to segregate liquid assets, such as cash,
U.S. Government securities or other high grade liquid debt securities equal in
value to its obligations (including accrued interest) with respect to reverse
repurchase agreements. In segregating such assets, the custodian either places
such securities in a segregated account or separately identifies such assets and
renders them unavailable for investment. Such assets are marked to market daily
to ensure full collateralization is maintained.
DOLLAR ROLL TRANSACTIONS
Each Fund may enter into dollar roll transactions. A dollar roll
transaction involves a sale by a Fund of a security to a financial institution
concurrently with an agreement by a Fund to purchase a similar security from the
institution at a later date at an agreed-upon price. The securities that are
repurchased will bear the same interest rate as those sold, but generally will
be collateralized by different pools of mortgages with different prepayment
histories than those sold. During the period between the sale and repurchase, a
Fund will not be entitled to receive interest and principal payments on the
securities sold. Proceeds of the sale will be invested in additional portfolio
securities of a Fund, and the income from these investments, together with any
additional fee income received on the sale, may or may not generate income for a
Fund exceeding the yield on the securities sold.
At the time a Fund enters into a dollar roll transaction, it causes its
custodian to segregate liquid assets such as cash, U.S. Government securities or
other high-grade liquid debt securities having a value equal to the purchase
price for the similar security (including accrued interest) and subsequently
marks the assets to market daily to ensure that full collateralization is
maintained.
WHEN-ISSUED SECURITIES, FORWARD COMMITMENTS AND DELAYED SETTLEMENTS
Each Fund may purchase securities on a "when-issued," forward commitment or
delayed settlement basis. In this event, the Custodian will set aside cash or
liquid portfolio securities equal to the amount of the commitment in a separate
account. Normally, the Custodian will set aside portfolio securities to satisfy
a purchase commitment. In such a case, a Fund may be required subsequently to
place additional assets in the separate account in order to assure that the
value of the account remains equal to the amount of a Fund's commitment. It may
be expected that a Fund's net assets will fluctuate to a greater degree when it
sets aside portfolio securities to cover such purchase commitments than when it
sets aside cash.
Each Fund does not intend to engage in these transactions for speculative
purposes but only in furtherance of its investment objectives. Because a Fund
will set aside cash or liquid portfolio securities to satisfy its purchase
commitments in the manner described, a Fund's liquidity and the ability of a
Manager to manage it may be affected in the event a Fund's forward commitments,
commitments to purchase when-issued securities and delayed settlements ever
exceeded 15% of the value of its net assets.
B-15
<PAGE>
Each Fund will purchase securities on a when-issued, forward commitment or
delayed settlement basis only with the intention of completing the transaction.
If deemed advisable as a matter of investment strategy, however, a Fund may
dispose of or renegotiate a commitment after it is entered into, and may sell
securities it has committed to purchase before those securities are delivered to
a Fund on the settlement date. In these cases a Fund may realize a taxable
capital gain or loss. When a Fund engages in when-issued, forward commitment and
delayed settlement transactions, it relies on the other party to consummate the
trade. Failure of such party to do so may result in a Fund's incurring a loss or
missing an opportunity to obtain a price credited to be advantageous.
The market value of the securities underlying a when-issued purchase,
forward commitment to purchase securities, or a delayed settlement and any
subsequent fluctuations in their market value is taken into account when
determining the market value of a Fund starting on the day a Fund agrees to
purchase the securities. A Fund does not earn interest on the securities it has
committed to purchase until they are paid for and delivered on the settlement
date.
ZERO-COUPON, STEP-COUPON AND PAY-IN-KIND SECURITIES
Each Fund may invest in zero-coupon, step-coupon and pay-in-kind
securities. These securities are debt securities that do not make regular cash
interest payments. Zero-coupon and step-coupon securities are sold at a deep
discount to their face value. Pay-in-kind securities pay interest through the
issuance of additional securities. Because these securities do not pay current
cash income, the price of these securities can be volatile when interest rates
fluctuate. While these securities do not pay current cash income, the Code
requires the holders of these securities to include in income each year the
portion of the original issue discount (or deemed discount) and other non-cash
income on the securities accruing that year. A Fund may be required to
distribute a portion of that discount and income and may be required to dispose
of other portfolio securities, which may occur in periods of adverse market
prices, in order to generate cash to meet these distribution requirements.
BORROWING
Each Fund is authorized to borrow money from time to time for temporary,
extraordinary or emergency purposes or for clearance of transactions in amounts
up to 20% of the value of its total assets at the time of such borrowings. The
use of borrowing by the Fund involves special risk considerations that may not
be associated with other funds having similar objectives and policies. Since
substantially all of the Fund's assets fluctuate in value, whereas the interest
obligation resulting from a borrowing will be fixed by the terms of the Fund's
agreement with its lender, the asset value per share of the Fund will tend to
increase more when its portfolio securities increase in value and to decrease
more when its portfolio assets decrease in value than would otherwise be the
case if the Fund did not borrow funds. In addition, interest costs on borrowings
may fluctuate with changing market rates of interest and may partially offset or
exceed the return earned on borrowed funds. Under adverse market conditions, the
Fund might have to sell portfolio securities to meet interest or principal
payments at a time when fundamental investment considerations would not favor
such sales.
LENDING PORTFOLIO SECURITIES
Each Fund may lend its portfolio securities in an amount not exceeding 10%
of its total assets to financial institutions such as banks and brokers if the
loan is collateralized in accordance with applicable regulations. Under the
present regulatory requirements which govern loans of portfolio securities, the
loan collateral must, on each business day, at least equal the value of the
loaned securities and must consist of cash, letters of credit of domestic banks
or domestic branches of foreign banks, or securities of the U.S. Government or
its agencies. To be acceptable as collateral, letters of credit must obligate a
bank to pay amounts demanded by a Fund if the demand meets the terms of the
letter. Such terms and the issuing bank would have to be satisfactory to a Fund.
Any loan might be secured by any one or more of the three types of collateral.
The terms of a Fund's loans must permit a Fund to reacquire loaned securities on
five days' notice or in time to vote on any serious matter and must meet certain
tests under the Code.
SHORT SALES
Each Fund is authorized to make short sales of securities which it does not
own or have the right to acquire. In a short sale, a Fund sells a security which
it does not own, in anticipation of a decline in the market value of the
security. To complete the sale, a Fund must borrow the security (generally from
the broker through which the short sale is made) in order to make delivery to
the buyer. Each Fund is then obligated to replace the security borrowed by
B-16
<PAGE>
purchasing it at the market price at the time of replacement. Each Fund is said
to have a "short position" in the securities sold until it delivers them to the
broker. The period during which a Fund has a short position can range from one
day to more than a year. Until the security is replaced, the proceeds of the
short sale are retained by the broker, and a Fund is required to pay to the
broker a negotiated portion of any dividends or interest which accrue during the
period of the loan. To meet current margin requirements, a Fund is also required
to deposit with the broker additional cash or securities so that the total
deposit with the broker is maintained daily at 150% of the current market value
of the securities sold short (100% of the current market value if a security is
held in the account that is convertible or exchangeable into the security sold
short within 90 days without restriction other than the payment of money).
Short sales by a Fund create opportunities to increase a Fund's return but,
at the same time, involve specific risk considerations and may be considered a
speculative technique. Since each Fund in effect profits from a decline in the
price of the securities sold short without the need to invest the full purchase
price of the securities on the date of the short sale, a Fund's net asset value
per share will tend to increase more when the securities it has sold short
decrease in value, and to decrease more when the securities it has sold short
increase in value, than would otherwise be the case if it had not engaged in
such short sales. The amount of any gain will be decreased, and the amount of
any loss increased, by the amount of any premium, dividends or interest a Fund
may be required to pay in connection with the short sale. Furthermore, under
adverse market conditions a Fund might have difficulty purchasing securities to
meet its short sale delivery obligations, and might have to sell portfolio
securities to raise the capital necessary to meet its short sale obligations at
a time when fundamental investment considerations would not favor such sales.
ILLIQUID SECURITIES
Each Fund may not invest more than 15% of the value of its net assets in
illiquid securities, including restricted securities, that are not deemed to
liquid by the sub-advisor. The Advisor and the Managers will monitor the amount
of illiquid securities in a Fund's portfolio, under the supervision of the
Trust's Board of Trustees, to ensure compliance with a Fund's investment
restrictions.
Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act of 1933 (the "Securities Act"), securities
which are otherwise not readily marketable and repurchase agreements having a
maturity of longer than seven days. Securities which have not been registered
under the Securities Act are referred to as private placement or restricted
securities and are purchased directly from the issuer or in the secondary
market. Mutual funds do not typically hold a significant amount of these
restricted or other illiquid securities because of the potential for delays on
resale and uncertainty in valuation. Limitations on resale may have an adverse
effect on the marketability of portfolio securities and a Fund might be unable
to dispose of restricted or other illiquid securities promptly or at reasonable
prices and might thereby experience difficulty satisfying redemption within
seven days. A Fund might also have to register such restricted securities in
order to dispose of them, resulting in additional expense and delay. Adverse
market conditions could impede such a public offering of securities.
In recent years, however, a large institutional market has developed for
certain securities that are not registered under the Securities Act, including
repurchase agreements, commercial paper, foreign securities, municipal
securities and corporate bonds and notes. Institutional investors depend on an
efficient institutional market in which the unregistered security can be readily
resold or on an issuer's ability to honor a demand for repayment. The fact that
there are contractual or legal restrictions on resale to the general public or
to certain institutions may not be indicative of the liquidity of such
investments. If such securities are subject to purchase by institutional buyers
in accordance with Rule 144A promulgated by the Commission under the Securities
Act, the sub-advisor, pursuant to procedures adopted by the Trust's Board of
Trustees, may determine that such securities are not illiquid securities
notwithstanding their legal or contractual 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, each 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
B-17
<PAGE>
than is typical of larger companies. Therefore, the securities of smaller
companies may be subject to greater and more abrupt price fluctuations. When
making large sales, a Fund may have to sell portfolio holdings at discounts from
quoted prices or may have to make a series of small sales over an extended
period of time due to the trading volume of smaller company securities.
Investors should be aware that, based on the foregoing factors, an investment in
the Funds may be subject to greater price fluctuations than an investment in a
fund that invests exclusively in larger, more established companies. A Manager's
research efforts may also play a greater role in selecting securities for a Fund
than in a fund that invests in larger, more established companies.
INVESTMENT RESTRICTIONS
The Trust (on behalf of a Fund) has adopted the following restrictions as
fundamental policies, which may not be changed without the favorable vote of the
holders of a "majority," as defined in the 1940 Act, of the outstanding voting
securities of a Fund. Under the 1940 Act, the "vote of the holders of a majority
of the outstanding voting securities" means the vote of the holders of the
lesser of (i) 67% of the shares of a Fund represented at a meeting at which the
holders of more than 50% of its outstanding shares are represented or (ii) more
than 50% of the outstanding shares of a Fund.
As a matter of fundamental policy, a Fund is diversified; I.E., as to 75%
of the value of a its total assets: (i) no more than 5% of the value of its
total assets may be invested in the securities of any one issuer (other than
U.S. Government securities); and (ii) a Fund may not purchase more than 10% of
the outstanding voting securities of an issuer. Each Fund's investment objective
is also fundamental.
In addition, a Fund may not:
1. Issue senior securities, borrow money or pledge its assets, except that
(i) a Fund may borrow on an unsecured basis from banks for temporary or
emergency purposes or for the clearance of transactions in amounts not exceeding
20% of its total assets (not including the amount borrowed), provided that it
will not make investments while borrowings in excess of 5% of the value of its
total assets are outstanding; and (ii) this restriction shall not prohibit a
Fund from engaging in options, futures and foreign currency transactions or
short sales;
2. Purchase securities on margin, except such short-term credits as may be
necessary for the clearance of transactions;
3. Act as underwriter (except to the extent a Fund may be deemed to be an
underwriter in connection with the sale of securities in its investment
portfolio);
4. Invest 25% or more of its total assets, calculated at the time of
purchase and taken at market value, in any one industry (other than U.S.
Government securities);
5. Purchase or sell real estate or interests in real estate or real estate
limited partnerships (although a Fund may purchase and sell securities which are
secured by real estate and securities of companies which invest or deal in real
estate);
6. Purchase or sell commodities or commodity futures contracts, except that
a Fund may purchase and sell stock index futures contracts and currency and
financial futures contracts and related options in accordance with any rules of
the Commodity Futures Trading Commission;
7. Invest in oil and gas limited partnerships or oil, gas or mineral
leases;
8. Make loans of money (except for purchases of debt securities consistent
with the investment policies of a Fund and except for repurchase agreements); or
9. Make investments for the purpose of exercising control or management.
Each Fund observes the following restrictions as a matter of operating but
not fundamental policy, pursuant to positions taken by federal regulatory
authorities:
Each Fund may not:
B-18
<PAGE>
1. Invest in the securities of other investment companies or purchase any
other investment company's voting securities or make any other investment in
other investment companies except to the extent permitted by federal law.
2. Invest more than 15% of its assets in securities which are restricted as
to disposition or otherwise are illiquid or have no readily available market
(except for securities which are determined by the sub-advisor, pursuant to
procedures adopted by the Board of Trustees, to be liquid).
MANAGEMENT
The overall management of the business and affairs of the Trust is vested
with its Board of Trustees, who are responsible for protecting the interests of
shareholders. The Trustees are experienced executives who meet throughout the
year to oversee the activities of the Funds, review the compensation
arrangements between the Advisor and the investment managers, review contractual
arrangements with companies that provide services to the Funds, including the
Advisor, Managers, Administrator, Custodian and Transfer Agent, and review
performance. The day to day operations of the Trust are delegated to its
officers, subject to a Fund's investment objectives and policies and to general
supervision by the Board of Trustees. The majority of Trustees are not otherwise
affiliated with the Advisor or any of the investment managers.
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 (55) Trustee Senior Fellow, The Aspen Institute since June, 1995. Director of
1065 Sterling Avenue Peoplesoft, Inc.; Barra, Inc.; and Fair, Isaac. Formerly (until 1995)
Berkeley, CA 94708 Managing Partner, Market Development of Andersen Consulting.
Frederick August Trustee Senior Vice President, Right Associates (industrial psychologists)
Eigenbrod, Jr. PhD (58)
19925 Stevens Creek Blvd.
Cupertino, CA 95014
Kenneth E. Gregory* (41) 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* (52) 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 (39) Trustee Partner, Bowman & Company, LLP (certified public accountants)
2431 W. March Lane
Suite 100
Stockton, CA 95207
John Coughlan (42) Treasurer Chief Operating Officer, Litman/Gregory & Co., LLC
4 Orinda Way since 1996; 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.
B-19
<PAGE>
The table below illustrates the annual compensation paid to each Trustee of the
Masters' Select Funds Trust:
<TABLE>
<CAPTION>
Aggregate Total
Compensation Pension or Compensation
from Masters' Retirement Benefits Estimated Annual from Masters'
Select Funds Accrued as Part of Benefits Upon Select Funds
Name of Trustee Trust Fund Expenses Retirement Trust
- --------------- ----- ------------- ---------- -----
<S> <C> <C> <C> <C>
A. George Battle $10,000 $0 $0 $10,000
Frederick A. Eigenbrod, Jr. $10,000 $0 $0 $10,000
Taylor M. Welz $10,000 $0 $0 $10,000
Kenneth E. Gregory $0 $0 $0 $0
Craig A. Litman $0 $0 $0 $0
</TABLE>
Each Trustee who is not an "interested person" of the Funds receives an
annual fee of $10,000 allocated equally between the Funds, plus expenses
incurred by the Trustees in connection with attendance at meetings of the Board
of Trustees and their Committees. As of December 31, 1998, to the best of the
knowledge of the Masters' Select Funds Trust, the Board of Trustees and officers
of the Funds, as a group, owned of record less than 1% of each Fund's
outstanding shares.
The following persons, to the best knowledge of the Trust, owned of record
more than 5% of the outstanding shares of the Masters' Select Equity Fund as of
March 31, 1999:
CHARLES SCHWAB & CO INC
SPL CSTDY A/C FOR EXCL BNFT CUST
MUTUAL FUND DEPT - REINVEST A/C
101 MONTGOMERY ST
SAN FRANCISCO CA 94104-4122 - 51%
B-20
<PAGE>
NATIONAL FINANCIAL SERVICES CORP
FOR THE EXCLUSIVE BENEFIT OF
OUR CUSTOMERS
ATTN TERRI LOUIE
200 LIBERTY ST FL 5
NEW YORK NY 10281-5500 - 6%
The following persons, to the best knowledge of the Trust, owned of record
more than 5% of the outstanding shares of the Masters' Select International Fund
as of March 31, 1999:
CHARLES SCHWAB & CO INC
SPL CSTDY A/C FOR EXCL BNFT CUST
MUTUAL FUND DEPT - REINVEST A/C
101 MONTGOMERY ST
SAN FRANCISCO CA 94104-4122 - 65%
THE ADVISOR AND THE MANAGERS
Subject to the supervision of the Board of Trustees, investment management
and related services are provided by the Advisor, pursuant to an Investment
Advisory Agreement (the "Advisory Agreement"). In addition, the assets of each
Fund are divided into segments by the Advisor, and individual selection of
securities in each segment is provided by a Manager selected by the Board of
Trustees pursuant, in each case, to a form of sub-advisory agreement
("Management Agreement"). Under the Advisory Agreement, the Advisor has agreed
to (i) furnish each Fund with advice and recommendations with respect to the
selection and continued employment of Managers to manage the actual investment
of each Fund's assets; (ii) direct the allocation of each Fund's assets among
such Managers; (iii) oversee the investments made by such Managers on behalf of
each Fund, subject to the ultimate supervision and direction of the Trust's
Board of Trustees; (iv) oversee the actions of the Managers with respect to
voting proxies for each Fund, filing Section 13 ownership reports for each Fund,
and taking other actions on behalf of each Fund; (v) maintain the books and
records required to be maintained by each Fund except to the extent arrangements
have been made for such books and records to be maintained by the administrator,
another agent of each Fund or a Manager; (vi) furnish reports, statements and
other data on securities, economic conditions and other matters related to the
investment of each Fund's assets which each Fund's administrator or distributor
or the officers of the Trust may reasonably request; and (vii) render to the
Trust's Board of Trustees such periodic and special reports with respect to each
Fund's investment activities as the Board may reasonably request, including at
least one in-person appearance annually before the Board of Trustees. The
Advisor has agreed, at its own expense, to maintain such staff and employ or
retain such personnel and consult with such other persons as it shall from time
to time determine to be necessary to the performance of its obligations under
this Agreement. Personnel of the Advisor may serve as officers of the Trust
provided they do so without compensation from the Trust. Without limiting the
generality of the foregoing, the staff and personnel of the Advisor shall be
deemed to include persons employed or retained by the Advisor to furnish
statistical information, research, and other factual information, advice
regarding economic factors and trends, information with respect to technical and
scientific developments, and such other information, advice and assistance as
the Advisor or the Trust's Board of Trustees may desire and reasonably request.
With respect to the operation of each Fund, the Advisor has agreed to be
responsible for (i) providing the personnel, office space and equipment
reasonably necessary for the operation of the Trust and each Fund including the
provision of persons qualified to serve as officers of the Trust; (ii)
compensating the Managers selected to invest the assets of each Fund; (iii) the
expenses of printing and distributing extra copies of each Fund's prospectus,
statement of additional information, and sales and advertising materials (but
not the legal, auditing or accounting fees attendant thereto) to prospective
investors (but not to existing shareholders); and (iv) the costs of any special
Board of Trustees meetings or shareholder meetings convened for the primary
benefit of the Advisor or any Manager.
Under each Management Agreement, each Manager agrees to invest its
Allocated Portion of the assets of each Fund in accordance with the investment
objectives, policies and restrictions of each Fund as set forth in each Fund's
and Trust's governing documents, including, without limitation, the Trust's
Agreement and Declaration of Trust and By-Laws; each Fund's prospectus,
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statement of additional information, and undertakings; and such other
limitations, policies and procedures as the Advisor or the Trustees of the Trust
may impose from time to time in writing to Manager. In providing such services,
Manager shall at all times adhere to the provisions and restrictions contained
in the federal securities laws, applicable state securities laws, the Internal
Revenue Code, and other applicable law.
Without limiting the generality of the foregoing, each Manager has agreed
to (i) furnish each Fund with advice and recommendations with respect to the
investment of the Manager's Allocated Portion of each Fund's assets, (ii) effect
the purchase and sale of portfolio securities for Manager's Allocated Portion or
determine that a portion of such Allocated Portion will remain uninvested; (iii)
manage and oversee the investments of the Manager's Allocated Portion, subject
to the ultimate supervision and direction of the Trust's Board of Trustees; (iv)
vote proxies and take other actions with respect to the securities in Manager's
Allocated Portion; (v) maintain the books and records required to be maintained
with respect to the securities in Manager's Allocated Portion; (vi) furnish
reports, statements and other data on securities, economic conditions and other
matters related to the investment of each Fund's assets which the Advisor,
Trustees or the officers of the Trust may reasonably request; and (vii) render
to the Trust's Board of Trustees such periodic and special reports with respect
to Manager's Allocated Portion as the Board may reasonably request.
As compensation for the Advisor's services (including payment of the
Managers' fees), each Fund pays it an advisory fee at the rate specified in the
prospectus. In addition to the fees payable to the Advisor and the
Administrator, the Trust is responsible for its operating expenses, including:
fees and expenses incurred in connection with the issuance, registration and
transfer of its shares; brokerage and commission expenses; all expenses of
transfer, receipt, safekeeping, servicing and accounting for the cash,
securities and other property of the Trust for the benefit of each Fund
including all fees and expenses of its custodian, shareholder services agent and
accounting services agent; interest charges on any borrowings; costs and
expenses of pricing and calculating its daily net asset value and of maintaining
its books of account required under the Investment Company Act; taxes, if any; a
pro rata portion of expenditures in connection with meetings of each Fund's
shareholders and the Trust's Board of Trustees that are properly payable by each
Fund; salaries and expenses of officers and fees and expenses of members of the
Trust's Board of Trustees or members of any advisory board or committee who are
not members of, affiliated with or interested persons of the Advisor; insurance
premiums on property or personnel of each Fund which inure to its benefit,
including liability and fidelity bond insurance; the cost of preparing and
printing reports, proxy statements, prospectuses and statements of additional
information of each Fund or other communications for distribution to existing
shareholders; legal, auditing and accounting fees; trade association dues; fees
and expenses (including legal fees) of registering and maintaining registration
of its shares for sale under federal and applicable state and foreign securities
laws; all expenses of maintaining and servicing shareholder accounts, including
all charges for transfer, shareholder recordkeeping, dividend disbursing,
redemption, and other agents for the benefit of each Fund, if any; and all other
charges and costs of its operation plus any extraordinary and non-recurring
expenses, except as otherwise prescribed in the Advisory Agreement.
The Advisor may agree to waive certain of its fees or reimburse each Fund
for certain expenses, in order to limit the expense ratio of each Fund. In that
event, subject to approval by the Trust's Board of Trustees, each Fund may
reimburse the Advisor in subsequent years for fees waived and expenses
reimbursed, provided the expense ratio before reimbursement is less than the
expense limitation in effect at that time.
The Advisor is controlled by Craig A. Litman and Kenneth E. Gregory.
Under the Advisory Agreement and each Management Agreement, the Advisor and
the Managers will not be liable to the Trust for any error of judgment by the
Advisor or Managers or any loss sustained by the Trust except in the case of a
breach of fiduciary duty with respect to the receipt of compensation for
services (in which case any award of damages will be limited as provided in the
1940 Act) or of willful misfeasance, bad faith or gross negligence by reason of
reckless disregard of its obligations and duties under the applicable agreement.
The Advisory Agreement and the Management Agreements will remain in effect
for a period not to exceed two years. Thereafter, if not terminated, each
Advisory and Management Agreement will continue automatically for successive
annual periods, provided that such continuance is specifically approved at least
annually (i) by a majority vote of the 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.
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<PAGE>
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).
As compensation for its investment management services, each of the Funds
paid the Advisor investment advisory fees in the amount specified below.
Additional investment advisory fees payable under the investment advisory
agreement may have, instead, been waived by the Advisor, but may be subject to
reimbursement by the respective Fund, as discussed previously.
Advisory Fees Paid to Advisor
Year Equity Fund International Fund
---- ----------- ------------------
1997 $2,247,185 $ 35,638
1998 $4,056,899 $891,022
THE ADMINISTRATOR. The Administrator, Investment Company Administration,
L.L.C., 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.
Administration Fees Paid to Administrator
Year Equity Fund International Fund
---- ----------- ------------------
1997 $149,572 $ 1,644
1998 $184,423 $43,313
PORTFOLIO TRANSACTIONS AND BROKERAGE
Each Management Agreement states that, with respect to the segment of each
Fund's portfolio allocated to the Manager, the Manager shall be responsible for
broker-dealer selection and for negotiation of brokerage commission rates,
provided that the Manager shall not direct orders to an affiliated person of the
Manager without general prior authorization to use such affiliated broker or
dealer by the Trust's Board of Trustees. In general, a Manager's primary
consideration in effecting a securities transaction will be execution at the
most favorable cost or proceeds under the circumstances. In selecting a
broker-dealer to execute each particular transaction, a Manager may take the
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<PAGE>
following into consideration: the best net price available; the reliability,
integrity and financial condition of the broker-dealer; the size of and
difficulty in executing the order; and the value of the expected contribution of
the broker-dealer to the investment performance of each Fund on a continuing
basis. The price to each Fund in any transaction may be less favorable than that
available from another broker-dealer if the difference is reasonably justified
by other aspects of the portfolio execution services offered.
Brokerage commissions paid for the year ended December 31, 1998, by the
Masters' Select Equity Fund and the Masters' Select International Fund,
respectively, were $1,438,016 and $432,232. Of these amounts, the percentages
attributable to affiliated broker transactions were 1% and 0%, respectively.
Brokerage commissions paid for the year ended December 31, 1997 were
$1,537,490(1) and $117,416(2), respectively. Of these amounts, the percentages
attributable to affiliated broker transactions were 3% and 0%, respectively.
Subject to such policies as the Advisor and the Board of Trustees of the
Trust may determine, a Manager shall not be deemed to have acted unlawfully or
to have breached any duty created by this Agreement or otherwise solely by
reason of its having caused each Fund to pay a broker or dealer that provides
(directly or indirectly) brokerage or research services to the Manager an amount
of commission for effecting a portfolio transaction in excess of the amount of
commission another broker or dealer would have charged for effecting that
transaction, if the Manager determines in good faith that such amount of
commission was reasonable in relation to the value of the brokerage and research
services provided by such broker or dealer, viewed in terms of either that
particular transaction or the Manager's or Advisor's overall responsibilities
with respect to each Fund or other advisory clients. Each Manager is further
authorized to allocate the orders placed by it on behalf of each Fund to such
brokers or dealers who also provide research or statistical material, or other
services, to the Trust, the Advisor, or any affiliate of either. Such allocation
shall be in such amounts and proportions as the Manager shall determine, and
each Manager shall report on such allocations regularly to the Advisor and the
Trust, indicating the broker-dealers to whom such allocations have been made and
the basis therefor. Each Manager is also authorized to consider sales of shares
of each Fund as a factor in the selection of brokers or dealers to execute
portfolio transactions, subject to the requirements of best execution.
On occasions when a Manager deems the purchase or sale of a security to be
in the best interest of each Fund as well as other clients of the Manager, the
Manager, to the extent permitted by applicable laws and regulations, may
aggregate the securities to be so purchased or sold in order to obtain the most
favorable price or lower brokerage commissions and the most efficient execution.
In such event, allocation of the securities so purchased or sold, as well as the
expenses incurred in the transaction, will be made by the Manager in the manner
it considers to be the most equitable and consistent with its fiduciary
obligations to each Fund and to such other clients.
NET ASSET VALUE
The net asset value of a Fund's shares will fluctuate and is determined as
of the close of trading on the New York Stock Exchange (currently 4:00 p.m.
Eastern time) each business day. The Exchange annually announces the days on
which it will not be open for trading. The most recent announcement indicates
that it will not be open on the following days: New Year's Day, Martin Luther
King's Birthday, Presidents' Day, Good Friday, Memorial Day, Independence Day,
Labor Day, Thanksgiving Day and Christmas Day. However, the Exchange may close
on days not included in that announcement.
The net asset value per share is computed by dividing the value of the
securities held by a Fund plus any cash or other assets (including interest and
dividends accrued but not yet received) minus all liabilities (including accrued
expenses) by the total number of shares in a Fund outstanding at such time.
Generally, trading in and valuation of foreign securities is substantially
completed each day at various times prior to the close of the NYSE. In addition,
trading in and valuation of foreign securities may not take place on every day
in which the NYSE is open for trading. In that case, the price used to determine
a Fund's net asset value on the last day on which such exchange was open will be
used, unless the Trust's Board of Trustees determines that a different price
- --------
1 For the period 12/31/96 (commencement of operations) to 12/31/97.
2 For the period 12/1/97 (commencement of operations) to 12/31/97.
B-24
<PAGE>
should be used. Furthermore, trading takes place in various foreign markets on
days in which the NYSE is not open for trading and on which a Fund's net asset
value is not calculated. Occasionally, events affecting the values of such
securities in U.S. dollars on a day on which a Fund calculates its net asset
value may occur between the times when such securities are valued and the close
of the NYSE that will not be reflected in the computation of a Fund's net asset
value unless the Board or its delegates deem that such events would materially
affect the net asset value, in which case an adjustment would be made.
Generally, a Fund's investments are valued at market value or, in the
absence of a market value, at fair value as determined in good faith by the
Managers and the Trust's Pricing Committee pursuant to procedures approved by or
under the direction of the Board.
Each Fund's securities, including ADRs, EDRs and GDRs, which are traded on
securities exchanges are valued at the last sale price on the exchange on which
such securities are traded, as of the close of business on the day the
securities are being valued or, lacking any reported sales, at the mean between
the last available bid and asked price. Securities that are traded on more than
one exchange are valued on the exchange determined by the Managers to be the
primary market. Securities traded in the over-the-counter market are valued at
the mean between the last available bid and asked price prior to the time of
valuation. Securities and assets for which market quotations are not readily
available (including restricted securities which are subject to limitations as
to their sale) are valued at fair value as determined in good faith by or under
the direction of the Board.
Short-term debt obligations with remaining maturities in excess of 60 days
are valued at current market prices, as discussed above. Short-term securities
with 60 days or less remaining to maturity are, unless conditions indicate
otherwise, amortized to maturity based on their cost to a Fund if acquired
within 60 days of maturity or, if already held by a Fund on the 60th day, based
on the value determined on the 61st day.
Corporate debt securities, mortgage-related securities and asset-backed
securities held by a Fund are valued on the basis of valuations provided by
dealers in those instruments, by an independent pricing service, approved by the
Board, or at fair value as determined in good faith by procedures approved by
the Board. Any such pricing service, in determining value, will use information
with respect to transactions in the securities being valued, quotations from
dealers, market transactions in comparable securities, analyses and evaluations
of various relationships between securities and yield to maturity information.
An option that is written by a Fund is generally valued at the last sale
price or, in the absence of the last sale price, the last offer price. An option
that is purchased by a Fund is generally valued at the last sale price or, in
the absence of the last sale price, the last bid price. The value of a futures
contract is the last sale or settlement price on the exchange or board of trade
on which the future is traded or, if no sales are reported, at the mean between
the last bid and asked price. When a settlement price cannot be used, futures
contracts will be valued at their fair market value as determined by or under
the direction of the Board. If an options or futures exchange closes after the
time at which a Fund's net asset value is calculated, the last sale or last bid
and asked prices as of that time will be used to calculate the net asset value.
Any assets or liabilities initially expressed in terms of foreign
currencies are translated into U.S. dollars at the official exchange rate or,
alternatively, at the mean of the current bid and asked prices of such
currencies against the U.S. dollar last quoted by a major bank that is a regular
participant in the foreign exchange market or on the basis of a pricing service
that takes into account the quotes provided by a number of such major banks. If
neither of these alternatives is available or both are deemed not to provide a
suitable methodology for converting a foreign currency into U.S. dollars, the
Board in good faith will establish a conversion rate for such currency.
All other assets of a Fund are valued in such manner as the Board in good
faith deems appropriate to reflect their fair value.
TAXATION
Each Fund will be taxed, under the Internal Revenue Code (the "Code"), as a
separate entity from any other series of the Trust, and it intends to elect to
qualify for treatment as a regulated investment company ("RIC") under Subchapter
M of the Code. In each taxable year that a Fund qualifies, a Fund (but not its
shareholders) will be relieved of federal income tax on that part of its
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<PAGE>
investment company taxable income (consisting generally of interest and dividend
income, net short term capital gain and net realized gains from currency
transactions) and net capital gain that is distributed to shareholders.
In order to qualify for treatment as a RIC, a Fund must distribute annually
to shareholders at least 90% of its investment company taxable income and must
meet several additional requirements. Among these requirements are the
following: (1) at least 90% of a Fund's gross income each taxable year must be
derived from dividends, interest, payments with respect to securities loans and
gains from the sale or other disposition of securities or foreign currencies, or
other income derived with respect to its business of investing in securities or
currencies; (2) at the close of each quarter of a Fund's taxable year, at least
50% of the value of its total assets must be represented by cash and cash items,
U.S. Government securities, securities of other RICs and other securities,
limited in respect of any one issuer, to an amount that does not exceed 5% of
the value of a Fund and that does not represent more than 10% of the outstanding
voting securities of such issuer; and (3) at the close of each quarter of a
Fund's taxable year, not more than 25% of the value of its assets may be
invested in securities (other than U.S. Government securities or the securities
of other RICs) of any one issuer.
Distributions of net investment income and net realized capital gains by a
Fund will be taxable to shareholders whether made in cash or reinvested in
shares. In determining amounts of net realized capital gains to be distributed,
any capital loss carryovers from prior years will be applied against capital
gains. Shareholders receiving distributions in the form of additional shares
will have a cost basis for federal income tax purposes in each share so received
equal to the net asset value of a share of a Fund on the reinvestment date. Fund
distributions also will be included in individual and corporate shareholders'
income on which the alternative minimum tax may be imposed.
Each Fund or any securities dealer effecting a redemption of a Fund's
shares by a shareholder will be required to file information reports with the
IRS with respect to distributions and payments made to the shareholder. In
addition, a Fund will be required to withhold federal income tax at the rate of
31% on taxable dividends, redemptions and other payments made to accounts of
individual or other non-exempt shareholders who have not furnished their correct
taxpayer identification numbers and made certain required certifications on the
Account Application Form or with respect to which a Fund or the securities
dealer has been notified by the IRS that the number furnished is incorrect or
that the account is otherwise subject to withholding.
Each Fund intends to declare and pay dividends and other distributions, as
stated in the Prospectus. In order to avoid the payment of any federal excise
tax based on net income, a Fund must declare on or before December 31 of each
year, and pay on or before January 31 of the following year, distributions at
least equal to 98% of its ordinary income for that calendar year and at least
98% of the excess of any capital gains over any capital losses realized in the
one-year period ending October 31 of that year, together with any undistributed
amounts of ordinary income and capital gains (in excess of capital losses) from
the previous calendar year.
Each Fund may receive dividend distributions from U.S. corporations. To the
extent that a Fund receives such dividends and distributes them to its
shareholders, and meets certain other requirements of the Code, corporate
shareholders of a Fund may be entitled to the "dividends received" deduction.
Availability of the deduction is subject to certain holding period and
debt-financing limitations.
The use of hedging strategies, such as entering into futures contracts and
forward contracts and purchasing options, involves complex rules that will
determine the character and timing of recognition of the income received in
connection therewith by a Fund. Income from foreign currencies (except certain
gains therefrom that may be excluded by future regulations) and income from
transactions in options, futures contracts and forward contracts derived by a
Fund with respect to its business of investing in securities or foreign
currencies will qualify as permissible income under Subchapter M of the Code.
For accounting purposes, when the paid by the Fund is recorded as an asset
and is subsequently adjusted to the current market value of the option. Any gain
or loss realized by the Fund upon the expiration or sale of such options held by
the Fund generally will be capital gain or loss.
Any security, option, or other position entered into or held by the Fund
that substantially diminishes the Fund's risk of loss from any other position
held by that Fund may constitute a "straddle" for federal income tax purposes.
In general, straddles are subject to certain rules that may affect the amount,
character and timing of the Fund's gains and losses with respect to straddle
positions by requiring, among other things, that the loss realized on
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<PAGE>
disposition of one position of a straddle be deferred until gain is realized on
disposition of the offsetting position; that the Fund's holding period in
certain straddle positions not begin until the straddle is terminated (possibly
resulting in the gain being treated as short-term capital gain rather than
long-term capital gain); and that losses recognized with respect to certain
straddle positions, which would otherwise constitute short-term capital losses,
be treated as long-term capital losses. Different elections are available to the
Fund that may mitigate the effects of the straddle rules.
Certain options, futures contracts and forward contracts that are subject
to Section 1256 of the Code ("Section 1256 Contracts") and that are held by the
Fund at the end of its taxable year generally will be required to be "marked to
market" for federal income tax purposes, that is, deemed to have been sold at
market value. Sixty percent of any net gain or loss recognized on these deemed
sales and 60% of any net gain or loss realized from any actual sales of Section
1256 Contracts will be treated as long-term capital gain or loss, and the
balance will be treated as short-term capital gain or loss.
Section 988 of the Code contains special tax rules applicable to certain
foreign currency transactions that may affect the amount, timing and character
of income, gain or loss recognized by the Fund. Under these rules, foreign
exchange gain or loss realized with respect to foreign currency-denominated debt
instruments, foreign currency forward contracts, foreign currency-denominated
payables and receivables and foreign currency options and futures contracts
(other than options and futures contracts that are governed by the
mark-to-market and 60/40 rules of Section 1256 of the Code and for which no
election is made) is treated as ordinary income or loss. Some part of the Fund's
gain or loss on the sale or other disposition of shares of a foreign corporation
may, because of changes in foreign currency exchange rates, be treated as
ordinary income or loss under Section 988 of the Code, rather than as capital
gain or loss.
Redemptions and exchanges of shares of the Fund will result in gains or
losses for tax purposes to the extent of the difference between the proceeds and
the shareholder's adjusted tax basis for the shares. Any loss realized upon the
redemption or exchange of shares within six months from their date of purchase
will be treated as a long-term capital loss to the extent of distributions of
long-term capital gain dividends with respect to such shares during such
six-month period. All or a portion of a loss realized upon the redemption of
shares of the Fund may be disallowed to the extent shares of the same Fund are
purchased (including shares acquired by means of reinvested dividends) within 30
days before or after such redemption.
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 Funds. Paul, Hastings, Janofsky & Walker L.L.P. 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.
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<PAGE>
PERFORMANCE INFORMATION
TOTAL RETURN
Average annual total return quotations used in the Fund's advertising and
promotional materials are calculated according to the following formula:
P(1 + T)n = ERV
where "P" equals a hypothetical initial payment of $1000; "T" equals average
annual total return; "n" equals the number of years; and "ERV" equals the ending
redeemable value at the end of the period of a hypothetical $1000 payment made
at the beginning of the period.
Under the foregoing formula, the time periods used in advertising will be
based on rolling calendar quarters, updated to the last day of the most recent
quarter prior to submission of the advertising for publication. Average annual
total return, or "T" in the above formula, is computed by finding the average
annual compounded rates of return over the period that would equate the initial
amount invested to the ending redeemable value. Average annual total return
assumes the reinvestment of all dividends and distributions.
YIELD
Annualized yield quotations used in the Fund's advertising and promotional
materials are calculated by dividing the Fund's investment income for a
specified thirty-day period, net of expenses, by the average number of shares
outstanding during the period, and expressing the result as an annualized
percentage (assuming semi-annual compounding) of the net asset value per share
at the end of the period. Yield quotations are calculated according to the
following formula:
YIELD = 2 [(a-b + 1)6 - 1]
---
cd
where "a" equals dividends and interest earned during the period; "b" equals
expenses accrued for the period, net of reimbursements; "c" equals the average
daily number of shares outstanding during the period that are entitled to
receive dividends and "d" equals the maximum offering price per share on the
last day of the period. Except as noted below, 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.
B-28
<PAGE>
GENERAL INFORMATION
The Trust is a Delaware Business Trust organized on August 1, 1996. The
Masters' Select Equity Fund series of shares commenced operations on December
31, 1996. The Masters' Select International Fund commenced operations on
December 1, 1997. The Declaration of Trust permits the Trustees to issue an
unlimited number of full and fractional shares of beneficial interest and to
divide or combine the shares into a greater or lesser number of shares without
thereby changing the proportionate beneficial interest in the Fund. Each share
represents an interest in the Fund proportionately equal to the interest of each
other share. Upon the Trust's liquidation, all shareholders would share pro rata
in the net assets of the Fund available for distribution to shareholders. If
they deem it advisable and in the best interest of shareholders, the Board of
Trustees may create additional series of shares which differ from each other
only as to dividends. The Board of Trustees has created two series of shares,
and may create additional series in the future, which have separate assets and
liabilities. Income and operating expenses not specifically attributable to a
particular Fund will be allocated fairly among the Funds by the Trustees,
generally on the basis of the relative net assets of each Fund.
Rule 18f-2 under the 1940 Act provides that as to any investment company
which has two or more series outstanding and as to any matter required to be
submitted to shareholder vote, such matter is not deemed to have been
effectively acted upon unless approved by the holders of a "majority" (as
defined in the Rule) of the voting securities of each series affected by the
matter. Such separate voting requirements do not apply to the election of
Trustees or the ratification of the selection of accountants. The Rule contains
special provisions for cases in which an advisory contract is approved by one or
more, but not all, series. A change in investment policy may go into effect as
to one or more series whose holders so approve the change even though the
required vote is not obtained as to the holders of other affected series.
Each Fund may hold special meetings and mail proxy materials. These
meetings may be called to elect or remove Trustees, change fundamental policies,
approve an investment advisory contract or for other purposes. Shareholders not
attending these meetings are encouraged to vote by proxy. Each Fund will mail
proxy materials in advance, including a voting card and information about the
proposals to be voted on. The number of votes each shareholder is entitled to is
based on the number of shares he or she owns. 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 Masters' Select Equity Fund and the Masters' Select International Fund
are the only existing series of shares of 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.
The Declaration of Trust provides that the shareholders have the right to
remove a Trustee. Upon the written request of the record holders of 10% of the
Trust's shares, the Trustees will call a meeting of shareholders to vote on the
removal of a Trustee. In addition, 10 shareholders holding the lesser of $25,000
worth or 1% of the shares may communicate with other shareholders to request a
meeting to remove a Trustee. No amendment may be made to the Declaration of
Trust that would have a material adverse effect on shareholders without the
approval of the holders of more than 50% of the Trust's shares. Shareholders
have no preemptive or conversion rights. Shares when issued are fully paid and
non-assessable, except as set forth above.
The Advisor has obtained an exemptive order from the Securities and
Exchange Commission which permits it, subject to certain conditions, selection
of new investment managers with the approval of the Board of Trustees but
without obtaining shareholder approval. The order also permits the Advisor to
change the terms of agreements with the managers or to continue the employment
of a manager after an event that would otherwise cause the automatic termination
of services. Shareholders must be notified of any manager changes. Shareholders
have the right to terminate arrangements with a manager by vote of a majority of
the outstanding shares of a Fund. The order also permits a Fund to disclose
managers' fees only in the aggregate in its registration statement.
B-29
<PAGE>
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.
The Masters' Select Funds reserve the right, if conditions exist which make
cash payments undesirable, to honor any request for redemption or repurchase
order by making payment in whole or in part in readily marketable securities
chosen by the Fund and valued as they are for purposes of computing the Fund's
net asset value (a redemption in kind). If payment is made in securities, a
shareholder may incur transaction expenses in converting these securities into
cash.
FINANCIAL STATEMENTS
The audited statement of assets and liabilities and report thereon for the
Funds for the year ended December 31, 1998 are incorporated by reference. The
opinion of McGladrey & Pullen, LLP, independent accountants, with respect to the
audited financial statements, is incorporated herein in its entirety in reliance
upon such report of McGladrey & Pullen, LLP and on the authority of such firm as
experts in auditing and accounting. Shareholders will receive a copy of the
audited and unaudited financial statements at no additional charge when
requesting a copy of the Statement of Additional Information.
B-30
<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.
B-31
<PAGE>
As filed with the Securities and Exchange Commission on April 30, 1999
Registration No. 333-10015
File No. 811-07763
================================================================================
Part C
of
Form N-1A
COMBINED REGISTRATION STATEMENT
MASTERS' SELECT FUNDS TRUST
Masters' Select Equity Fund
Masters' Select International Fund
================================================================================
<PAGE>
PART C
OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS.
(1) Financial Statements:
The following financial statements are included in Part B of the
Registration Statement:
Statement of Assets and Liabilities as of December 31, 1998
Notes to Statement of Assets and Liabilities
(2) Exhibits:
(1) (a) Agreement and Declaration of Trust(1)
(b) Amendment to Agreement and Declaration of Trust(2)
(2) By-Laws(1)
(3) Not applicable
(4) Specimen stock certificate
(5) (a) Form of Investment Advisory Agreement(2)
(b) (i) Investment Management Agreement with Davis Selected
Advisers LP (3)
(ii) Investment Management Agreement with Friess Associates,
Inc.(3)
(iii) Investment Management Agreement with Jennison
Associates(3)
(iv) Investment Management Agreement with Southeastern Asset
Management, Inc.(3)
(v) Investment Management Agreement with Strong Capital
Management, Inc.(3)
(vi) Form of Investment Management Agreement with Masters'
Select International Sub-Advisors(4)
(vii) Form of Investment Management Agreement with Janus
Capital Corp.(4)
(viii) Form of Investment Management Agreement with Harris
Associates
(6) Distribution Agreement(3)
(7) Not applicable
(8) Custodian Agreement(3)
(9) Administration Agreement with Investment Company Administration
Corporation(2)
(10) Opinion and consent of counsel(5)
(11) Consent of Independent Auditors
(12) Not applicable
(13) Investment letter(3)
(14) Individual Retirement Account forms(6)
(15) Not applicable
(16) Not applicable
(17) Financial Data Schedule
- ----------
1 Previously filed as an exhibit to the Registration Statement on Form N-1A
of the Registration (File No. 333-10015) on August 12, 1996, and
incorporated herein by reference.
2 Previously filed as an exhibit to Pre-Effective Amendment No. 1 to the
Registration Statement on Form N-1A of the Registrant (File No. 333-10015)
on November 15, 1996, and incorporated herein by reference.
3 Previously filed as an exhibit to Pre-Effective Amendment No. 2 to the
Registration Statement on Form N-1A of the Registrant (File No. 333-10015)
on December 16, 1996, and incorporated herein by reference.
4 Previously filed as an exhibit to Post-Effective Amendment No. 3 to the
Registration Statement on Form N-1A of the Registrant (File No. 333-10015)
on August 29, 1997, and incorporated herein by reference.
5 Previously filed.
6 To be filed by amendment.
<PAGE>
ITEM 25. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT.
None.
ITEM 26. NUMBER OF HOLDERS OF SECURITIES.
The number of record holders for each fund as of March 31, 1999:
Name of Fund Number of Record Holders
------------ ------------------------
Masters' Select Equity Fund 7599
Masters' Select International Fund 1417
ITEM 27. INDEMNIFICATION:
Article VI of Registrant's By-Laws states as follows:
Section 1. AGENTS, PROCEEDINGS AND EXPENSES. For the purpose of this
Article, "agent" means any person who is or was a Trustee, officer, employee or
other agent of this Trust or is or was serving at the request of this Trust as a
Trustee, director, officer, employee or agent of another foreign or domestic
corporation, partnership, joint venture, trust or other enterprise or was a
Trustee, director, officer, employee or agent of a foreign or domestic
corporation which was a predecessor of another enterprise at the request of such
predecessor entity; "proceeding" means any threatened, pending or completed
action or proceeding, whether civil, criminal, administrative or investigative;
and "expenses" includes without limitation attorney's fees and any expenses of
establishing a right to indemnification under this Article.
Section 2. ACTIONS OTHER THAN BY TRUST. This Trust shall indemnify any
person who was or is a party or is threatened to be made a party to any
proceeding (other than an action by or in the right of this Trust) by reason of
the fact that such person is or was an agent of this Trust, against expenses,
judgments, fines, settlements and other amounts actually and reasonably incurred
in connection with such proceedings, if it is determined that persons acted in
good faith and reasonably believed:
(1) in the case of conduct in his official capacity as a Trustee of the
Trust, that his conduct was in the Trust's best interests, and
(2) in all other cases, that his conduct was at least not opposed to the
Trust's best interests, and
(3) in the case of a criminal proceeding, that he had no reasonable cause
to believe the conduct of that person was unlawful.
The termination of any proceeding by judgment, order, settlement,
conviction or upon a plea of nolo contendere or its equivalent shall not of
itself create a presumption that the person did not act in good faith and in a
manner which the person reasonably believed to be in the best interests of this
Trust or that the person had reasonable cause to believe that the person's
conduct was unlawful.
<PAGE>
Section 3. ACTIONS BY THE TRUST. This Trust shall indemnify any person who
was or is a party or is threatened to be made a party to any threatened, pending
or completed action by or in the right of this Trust to procure a judgment in
its favor by reason of the fact that that person is or was an agent of this
Trust, against expenses actually and reasonably incurred by that person in
connection with the defense or settlement of that action if that person acted in
good faith, in a manner that person believed to be in the best interests of this
Trust and with such care, including reasonable inquiry, as an ordinarily prudent
person in a like position would use under similar circumstances.
Section 4. EXCLUSION OF INDEMNIFICATION. Notwithstanding any provision to
the contrary contained herein, there shall be no right to indemnification for
any liability arising by reason of willful misfeasance, bad faith, gross
negligence, or the reckless disregard of the duties involved in the conduct of
the agent's office with this Trust.
No indemnification shall be made under Sections 2 or 3 of this Article:
(1) In respect of any claim, issue, or matter as to which that person
shall have been adjudged to be liable on the basis that personal
benefit was improperly received by him, whether or not the benefit
resulted from an action taken in the person's official capacity; or
(2) In respect of any claim, issue or matter as to which that person shall
have been adjudged to be liable in the performance of that person's
duty to this Trust, unless and only to the extent that the court in
which that action was brought shall determine upon application that in
view of all the circumstances of the case, that person was not liable
by reason of the disabling conduct set forth in the preceding
paragraph and is fairly and reasonably entitled to indemnity for the
expenses which the court shall determine; or
(3) Of amounts paid in settling or otherwise disposing of a threatened or
pending action, with or without court approval, or of expenses
incurred in defending a threatened or pending action which is settled
or otherwise disposed of without court approval, unless the required
approval set forth in Section 6 of this Article is obtained.
Section 5. SUCCESSFUL DEFENSE BY AGENT. To the extent that an agent of this
Trust has been successful on the merits in defense of any proceeding referred to
in Sections 2 or 3 of this Article or in defense of nay claim, issue or matter
therein, before the court or other body before whom the proceeding was brought,
the agent shall be indemnified against expenses actually and reasonably incurred
by the agent in connection therewith, provided that the Board of Trustees,
including a majority who are disinterested, non-party Trustees, also determines
that based upon a review of the facts, the agent was not liable by reason of the
disabling conduct referred to in Section 4 of this Article.
Section 6. REQUIRED APPROVAL. Except as provided in Section 5 of this
Article, any indemnification under this Article shall be made by this Trust only
if authorized in the specific case on a determination that indemnification of
the agent is proper in the circumstances because the agent has met the
applicable standard of conduct set forth in Sections 2 or 3 of this Article and
is not prohibited from indemnification because of the disabling conduct set
forth in Section 4 of this Article, by:
(1) A majority vote of a quorum consisting of Trustees who are not parties
to the proceeding and are not interested persons of the Trust (as
defined in the Investment Company Act of 1940); or
(2) A written opinion by an independent legal counsel.
<PAGE>
Section 7. ADVANCE OF EXPENSES. Expenses incurred in defending any
proceeding may be advanced by this Trust before the final disposition of the
proceeding upon a written undertaking by or on behalf of the agent, to repay the
amount of the advance if it is ultimately determined that he or she is not
entitled to indemnification, together with at least one of the following as a
condition to the advance: (i) security for the undertaking; or (ii) the
existence of insurance protecting the Trust against losses arising by reason of
any lawful advances; or (iii) a determination by a majority of a quorum of
Trustees who are not parties to the proceeding and are not interested persons of
the Trust, or by an independent legal counsel in a written opinion, based on a
review of readily available facts that there is reason to believe that the agent
ultimately will be found entitled to indemnification. Determinations and
authorizations of payments under this Section must be made in the manner
specified in Section 6 of this Article for determining that the indemnification
is permissible.
Section 8. OTHER CONTRACTUAL RIGHTS. Nothing contained in this Article
shall affect any right to indemnification to which persons other than Trustees
and officers of this Trust or any subsidiary hereof may be entitled by contract
or otherwise.
Section 9. LIMITATIONS. No indemnification or advance shall be made under
this Article, except as provided in Sections 5 or 6 in any circumstances where
it appears:
(1) that it would be inconsistent with a provision of the Agreement and
Declaration of Trust of the Trust, a resolution of the shareholders,
or an agreement in effect at the time of accrual of the alleged cause
of action asserted in the proceeding in which the expenses were
incurred or other amounts were paid which prohibits or otherwise
limits indemnification; or
(2) that it would be inconsistent with any condition expressly imposed by
a court in approving a settlement.
Section 10. INSURANCE. Upon and in the event of a determination by the
Board of Trustees of this Trust to purchase such insurance, this Trust shall
purchase and maintain insurance on behalf of any agent of this Trust against any
liability asserted against or incurred by the agent in such capacity or arising
out of the agent's status as such, but only to the extent that this Trust would
have the power to indemnify the agent against that liability under the
provisions of this Article and the Agreement and Declaration of Trust of the
Trust.
Section 11. FIDUCIARIES OF EMPLOYEE BENEFIT PLAN. This Article does not
apply to nay proceeding against any Trustee, investment manager or other
fiduciary of an employee benefit plan in that person's capacity as such, even
though that person may also be an agent of this Trust as defined in Section 1 of
this Article. Nothing contained in this Article shall imit any right to
indemnification to which such a Trustee, investment manager, or other fiduciary
may be entitled by contract or otherwise which shall be enforceable to the
extent permitted by applicable law other than this Article.
ITEM 28. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER.
The information required by this item is contained in the Form ADV of the
following entities and is incorporated herein by reference:
Name of investment adviser File No.
-------------------------- --------
Litman/Gregory Fund Advisors, LLC 801-52710
Davis Selected Advisers, L.P. 801-31648
Southeastern Asset Management, Inc. 801-11123
Jennison Associates Capital Corp. 801-5608
Freiss and Associates 801-16178
Strong Capital Management, Inc. 801-10724
Janus Capital Corp. 801-13991
Bee & Associates 801-34538
Harris Associates 801-50333
Artisan Partners 801-48435
BPI Global Asset Management 801-53972
<PAGE>
ITEM 29. PRINCIPAL UNDERWRITERS.
(a) First Fund Distributors, Inc. currently serves as distributor of the
shares of:
Advisors Series Trust
Brandes Investment Funds
Guinness Flight Investment Funds, Inc.
Fleming Capital Mutual Fund Group
Fremont Mutual Funds
Jurika & Voyles Mutual Funds
Kayne Anderson Mutual Funds
Masters' Select Funds Trust
O'Shaughnessy Funds, Inc.
RNC Mutual Fund Group, Inc.
PIC Investment Trust
Professionally Managed Portfolios
Purisima Total Return Fund
Rainier Investment Management Mutual Funds
Trent Equity Fund
(b) The officers of First Fund Distributors, Inc. are:
Robert H. Wadsworth President and Treasurer
Eric Banhazl Vice President
Steven J. Paggioli Vice President and Secretary
Each officer's business address with the Distributor is 4455 E. Camelback
Rd., Ste. 261-E, Phoenix, AZ 85018.
(c) Not applicable.
ITEMS 30. LOCATION OF ACCOUNTS AND RECORDS.
The accounts, books and other documents required to be maintained by
Registrant pursuant to Section 31(a) of the Investment Company Act of 1940 and
the rules promulgated thereunder are in the possession of the following persons:
(a) the documents required to be maintained by paragraph (4) of Rule
31a-1(b) will be maintained by the Registrant;
(b) the documents required to be maintained by paragraphs (5), (6), (10)
and (11) of Rule 31a-1(b) will be maintained by the respective investment
managers:
Davis Selected Advisers, L.P., 124 East Marcy Street, Santa Fe, NM 87501
Southeastern Asset Management, Inc., 6075 Poplar Avenue, Memphis, TN 38119
Jennison Associates Capital Corp., 466 Lexington Avenue, New York, NY 10017
Friess and Associates, 3711 Kenett Pike, Greenville, DE 19807
Strong Capital Management, Inc., 100 Heritage Reserve, Menomonee Falls, WI
53201
Janus Capital Corp., 100 Fillmore St., Denver, Colorado 80206-4928
Bee & Associates, 370 Seventeenth Street, Suite 3560, Denver, Colorado
80202
Harris Associates, Two North LaSalle, Suite 500, Chicago, Illinois
60602-3790
Artisan Partners, 1000 North Water Street, Suite 1770, Milwaukee, Wisconsin
53202
BPI Global Asset Management, Tower Place at the Summit, 1900 Summit Tower
Blvd., Ste. 450, Orlando, FL 32810
(c) all other documents will be maintained by Registrant's custodian, State
Street Bank and Trust Company, 225 Franklin Street, Boston, MA 02110.
<PAGE>
ITEM 31. MANAGEMENT SERVICES.
Not applicable.
ITEM 32. UNDERTAKINGS.
Registrant hereby undertakes to:
(1) Furnish each person to whom a Prospectus is delivered a copy of
Registrant's latest annual report to shareholders, upon request and
without charge.
(2) If requested to do so by the holders of at least 10% of the Trust's
outstanding shares, call a meeting of shareholders for the purposes of
voting upon the question of removal of a trustee and assist in
communications with other shareholders.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant certifies that it meets all of
the requirements for effectiveness of this Registration Statement pursuant to
Rule 485(b) under the Securities Act of 1933 and has duly caused this
Registration Statement (File No. 333-10015) to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Orinda, State of
California on the 30th day of April, 1999.
MASTERS' SELECT FUNDS TRUST
By: /s/ Kenneth E. Gregory
-----------------------------
Kenneth E. Gregory
President
Pursuant to the requirements of the Securities Act of 1933, this Post-Effective
Amendment to the Registration Statement has been signed below by the following
persons in the capacities and on the dates indicated.
/s/ Kenneth E. Gregory President and April 30, 1999
- ---------------------------------- Trustee
Kenneth E. Gregory
/s/ Craig A. Litman Trustee April 30, 1999
- ----------------------------------
Craig A. Litman
/s/ A. George Battle Trustee April 30, 1999
- ----------------------------------
A. George Battle
/s/ Frederick A. Eigenbrod, Jr. Trustee April 30, 1999
- ----------------------------------
Frederick A. Eigenbrod, Jr.
/s/ Taylor M. Welz Trustee April 30, 1999
- ----------------------------------
Taylor M. Welz
/s/ John Coughlan Chief Financial April 30, 1999
- ---------------------------------- and Accounting Officer
John Coughlan
CONSENT OF INDEPENDENT AUDITORS
We hereby consent to the use of our report dated February 12, 1999 on the
financial statements of The Masters' Select Equity Fund and The Masters' Select
International Fund, separate series of Masters' Select Funds Trust, incorporated
by reference therein in Post-Effective Amendment No. 6 to the Registration
Statement on Form N-1A, File No. 333-10015, as filed with the Securities and
Exchange Commission.
We also consent to the reference to our firm in the Prospectus under the
caption "Financial Highlights" and in the Statement of Additional Information
under the captions "General Information" and "Financial Statements."
McGladrey & Pullen, LLP
New York, New York
April 25, 1999
