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File No. 333-19181
Rule 497(e)
STEIN ROE
INSTITUTIONAL CLIENT FUNDS
Prospectus
Nov. 1, 1999
Stein Roe Institutional Client High Yield Fund
The Securities and Exchange Commission has not approved or
disapproved these securities or determined whether this prospectus
is truthful or complete. Anyone who tells you otherwise is
committing a crime.
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3 The Fund
Investment Goal
Principal Investment Strategy
Principal Investment Risks
Fund Performance
Your Expenses
7 Financial Highlights
8 Your Account
Purchasing Shares
Determining Share Price (NAV)
Selling Shares
Dividends and Distributions
11 Other Investments and Risks
Mortgage-Backed Securities and Asset-Backed Securities
When-Issued Securities and Forward Commitments
Zero Coupon Securities
PIK Bonds
Illiquid Investments
Portfolio Turnover
Temporary Defensive Positions
Interfund Lending Program
13 The Fund's Management
Investment Adviser
Portfolio Manager
Master/Feeder Fund Structure
Year 2000 Readiness
Please keep this prospectus as your reference manual.
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THE FUND
INVESTMENT GOAL Stein Roe Institutional Client High Yield Fund
seeks its total return by investing for a high level of current
income and capital growth.
PRINCIPAL INVESTMENT STRATEGY Institutional Client High Yield
Fund invests all of its assets in SR&F High Yield Portfolio as
part of a master fund/feeder fund structure. The Portfolio
invests at least 65% of total assets in high-yield, high-risk debt
securities. These securities are rated at the time of purchase:
* below BBB by Standard & Poor's,
* below Baa by Moody's Investors Service, Inc.,
* a comparable rating by another nationally recognized rating
agency, or
* unrated securities that Stein Roe believes to be of comparable
quality.
The Portfolio may invest in any type of debt securities, including
corporate bonds and mortgage-backed and asset-backed securities.
The Portfolio seeks to achieve capital appreciation through
purchasing bonds that increase in market value. In addition, to a
limited extent, the Portfolio may seek capital appreciation by
using hedging techniques such as futures and options.
In determining whether to buy or sell securities, the portfolio
manager evaluates relative values of the various types of
securities in which the Fund can invest (e.g., the relative value
of corporate debt securities versus mortgage-backed securities
under prevailing market conditions), relative values of various
rating categories (e.g., relative values of higher-rated
securities versus lower-rated securities under prevailing market
conditions), and individual issuer characteristics. The portfolio
manager may be required to sell portfolio investments to fund
redemptions. The Portfolio may invest in securities of any
maturity.
PRINCIPAL INVESTMENT RISKS The primary risks of investing in the
Fund are described below. These risks could cause you to lose
money by investing in the Fund.
The price of the Fund's shares-its net asset value per share
(NAV)-will fluctuate daily in response to changes in the market
value of the bonds it owns.
Market risk is the risk that the price of a security held by the
Portfolio will fall due to changing market, economic, or political
conditions, or due to the financial condition of the issuer of the
security. Market risk includes interest rate risk. Interest rate
risk is the risk of change in the price of a bond when interest
rates change. In general, if interest rates rise, bond prices
fall; and if interest rates fall, bond prices rise. Changes in
the values of bonds usually will not affect the amount of income
the Fund receives from them but will affect the value of the
Fund's shares. Interest rate risk is generally greater for bonds
having longer maturities.
Because the Portfolio may invest in debt securities issued by
private entities, including corporate bonds and privately issued
mortgage-backed and asset-backed securities, the Fund is subject
to issuer risk. Issuer risk is the possibility that changes in
the financial condition of the issuer of a security, changes in
general economic conditions, or changes in economic conditions
that affect the issuer may impact the issuer's ability to make
timely payments of interest or principal. This could result in
decreases in the price of the security.
High-yield, high-risk debt securities are sometimes referred to as
"junk bonds." High-yield, high-risk debt securities involve
greater risk of loss due to issuer risk and are less liquid,
especially during periods of economic uncertainty or change, than
higher-quality debt securities.
An economic downturn could severely disrupt the high-yield market
and adversely affect the value of outstanding bonds and the
ability of the issuers to repay principal and interest. In
addition, lower-quality bonds are less sensitive to interest rate
changes than higher-quality instruments and generally are more
sensitive to adverse economic changes or individual corporate
developments. During a period of adverse economic changes,
including a period of rising interest rates, issuers of such bonds
may experience difficulty in servicing their principal and
interest payment obligations.
Because the Fund seeks to achieve capital appreciation, you could
receive capital gains distributions. (See "Tax Consequences.")
An investment in the Fund is not a bank deposit and is not insured
or guaranteed by the Federal Deposit Insurance Corporation or any
other government agency.
For more information on the Portfolio's investment techniques,
please refer to "Other Investments and Risks."
Who Should Invest in the Fund?
You may want to invest in Institutional Client High Yield Fund if
you:
* want the high return potential associated with investing in
lower-rated bonds and can tolerate the high level of risk
associated with such securities
* are a long-term investor looking to diversify your investment
portfolio with high-yield, high-risk fixed-income securities
Institutional Client High Yield Fund is not appropriate for
investors who:
* are saving for a short-term investment
* want a relatively low-risk fixed-income investment
* want to avoid volatility or possible losses
* are not interested in generating taxable current income
FUND PERFORMANCE The following charts show the Fund's
performance through Dec. 31, 1998. The returns include the
reinvestment of dividends and distributions. As with all mutual
funds, past performance is no guarantee of future results.
Year-by-Year Total Returns
Year-by-year calendar total returns show the Fund's volatility
over a period of time. This chart illustrates performance
differences for the calendar year ended Dec. 31, 1998, and
provides an indication of the risks of investing in the Fund.
[bar chart]
YEAR-BY-YEAR TOTAL RETURNS
10%
5%
0% 4.92%
- -5%
1998
[/bar chart]
[ ] Institutional Client High Yield Fund
The Fund's year-to-date total return through Sept. 30, 1999, was
4.32%.
For period shown on the chart above:
Best quarter: 2nd quarter 1997, +6.55%
Worst quarter: 3rd quarter 1998, -6.07%
Average Annual Total Returns
Average annual total returns measure the Fund's performance over
time. We compare the Fund's returns with returns for the Merrill
Lynch High Yield Master II Index. We show returns for calendar
years to be consistent with the way other mutual funds report
performance in their prospectuses. This provides an indication of
the risks of investing in the Fund.
AVERAGE ANNUAL TOTAL RETURNS
Periods ending Dec. 31, 1998
1 yr Since Inception
(Feb. 14, 1997)
----------------------------
Institutional Client High Yield Fund 4.92% 9.77%
Merrill Lynch High Yield Master II
Index* 3.66% 7.62%
*The Merrill Lynch High Yield Master II Index is an unmanaged
group of securities that differs from the Fund's composition; it
is not available for direct investment.
YOUR EXPENSES This table shows fees and expenses you may pay if
you buy and hold shares of the Fund. You do not pay any sales
charge when you purchase or sell your shares. However, you pay
various other indirect expenses because the Fund or the Portfolio
pays fees and other expenses that reduce your investment return.
ANNUAL FUND OPERATING EXPENSES (a)
(expenses that are deducted from Fund assets)
Management fees(b) 0.65%
Distribution (12b-1) fees None
Other expenses 0.32%
Total annual fund operating expenses (c) 0.97%
Expense reimbursement 0.47%
Net expenses 0.50%
(a) Annual fund operating expenses consist of Fund expenses plus
the Fund's share of the expenses of the Portfolio. Fund expenses
include management fees and administrative costs such as
furnishing the Fund with offices and providing tax and compliance
services.
(b) Management fees include both the management fee and the
administrative fee charged to the Fund.
(c) Stein Roe will reimburse the Fund if its annual ordinary
operating expenses exceed 0.50% of average daily net assets. This
commitment expires on Oct. 31, 2000. After reimbursement,
management fees will be 0.18%. A reimbursement lowers the expense
ratio and increases overall return to investors.
Expense Example
This example compares the cost of investing in the Fund to the
cost of investing in other mutual funds. It uses the same
hypothetical assumptions that other funds use in their
prospectuses:
* $10,000 initial investment
* 5% total return each year
* the Fund's operating expenses remain constant as a percent of
net assets
* redemption at the end of each time period
Your actual costs may be higher or lower because in reality fund
returns and other expenses change. This example reflects expenses
of both the Fund and the Portfolio. Expense reimbursements are in
effect for the first year in the periods below. Expenses based on
these assumptions are:
EXPENSE EXAMPLE
1 yr 3 yrs 5 yrs 10 yrs
Institutional Client
High Yield Fund $51 $262 $490 $1,147
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FINANCIAL HIGHLIGHTS
The financial highlights table explains the Fund's financial
performance. We show information for the period of the Fund's
operations. The Fund's fiscal year runs from July 1 to June 30.
The total returns in the table represent the return that investors
earned assuming that they reinvested all dividends and
distributions. Certain information in the table reflects the
financial results for a single Fund share. Ernst & Young LLP,
independent auditors, audits this information and issues a report
that appears in the Fund's annual report along with the financial
statements. To request the annual report, please call 800-338-
2550.
Institutional Client High Yield Fund
PER SHARE DATA
For Period Ending
Years ending June 30,
1999 1998 1997(d)
-----------------------------
Net asset value, beginning of period $ 10.65 $ 10.21 $ 10.00
Income from investment operations
Net investment income 0.87 0.88 0.33
Net gains on securities (both
realized and unrealized) (0.49) 0.58 0.21
Total income from investment
operations 0.38 1.46 0.54
Less distributions
Dividends (from net investment
income) (0.87) (0.88) (0.33)
Distributions (from capital gains) (0.31) (0.14) -
Total distributions (1.18) (1.02) (0.33)
Net asset value, end of period $ 9.85 $ 10.65 $ 10.21
Total return (a) 4.20% 14.88% 5.48%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period (000
omitted) $55,395 $35,157 $24,674
Ratio of net expenses to average
net assets (b) 0.50% 0.50% 0.50%(c)
Ratio of net investment income to
average net assets (a) 8.72% 8.31% 8.76%(c)
Portfolio turnover rate (e) 296% 426% 168%
(a) Computed with the effect of Stein Roe's expense reimbursement.
(b) If the Fund had paid all of its expenses and there had been no
reimbursement of expenses by Stein Roe, this ratio would have
been 0.97% for the year ended June 30, 1999, 1.28% for the
year ended June 30, 1998, and 2.59% for the period ended June
30, 1997.
(c) From commencement of operations on February 14, 1997.
(d) These percentages are for periods of less than one year. They
have been converted to an annual basis making it easier to
compare to complete years.
(e) Reflects the portfolio turnover rate of the Portfolio.
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YOUR ACCOUNT
PURCHASING SHARES You will not pay a sales charge when you
purchase Fund shares. Your purchases are made at the NAV next
determined after the Fund receives your check, wire transfer or
electronic transfer. The initial purchase minimum is $250,000 and
the minimum subsequent investment is $10,000. Third-party checks
will not be accepted. All checks must be made payable in U.S.
dollars and drawn on U.S. banks. For more information on how to
purchase Fund shares, please call Stein Roe Retirement Services at
800-322-1130.
An order to purchase Fund shares is not binding unless and until
an authorized officer, agent or designee of the Fund accepts it.
Once we accept your purchase order, you may not cancel or revoke
it; however, you may redeem your shares. The Fund may reject any
purchase order if it determines that the order is not in the best
interests of the Fund and its investors. The Fund may waive or
lower its investment minimums for any reason.
Transactions through Third Parties
If you purchase or sell Fund shares through certain broker-
dealers, banks or other intermediaries, they may charge a fee for
their services. They may also place limits on your ability to use
services the Fund offers. There are no charges or limitations if
you purchase or sell shares directly from the Fund, except those
fees described in this prospectus.
If an intermediary is an agent or designee of the Fund, orders are
processed at the net asset value next calculated after the
intermediary receives the order. The intermediary must segregate
any orders it receives after the close of regular trading on the
NYSE and transmit those orders separately for execution at the net
asset value next determined.
DETERMINING SHARE PRICE (NAV) The Fund's share price is its NAV
next determined. NAV is the difference between the values of the
Fund's assets and liabilities divided by the number of shares
outstanding. We determine NAV at the close of regular trading on
the New York Stock Exchange (NYSE)-normally 3 p.m. Central time.
If you place an order after that time, you receive the share price
determined on the next business day.
Securities for which market quotations are readily available at
the time of valuation are valued on that basis. We value long-
term straight-debt securities for which market quotations are not
readily available at fair value. Pricing services provide the
Fund with the value of the securities. Short-term debt securities
with remaining maturities of 60 days or less are valued at their
amortized cost, which does not take into account unrealized gains
or losses. The Board believes that the amortized cost represents
a fair value for such securities. Short-term debt securities with
remaining maturities of more than 60 days for which market
quotations are not readily available are valued by use of a matrix
prepared by Stein Roe based on quotations for comparable
securities. When the price of a security is not available,
including days when we determine that the sale or bid price of the
security does not reflect that security's market value, we value
the security at a fair value determined in good faith under
procedures established by the Board of Trustees.
We value a security at fair value when events have occurred after
the last available market price and before the close of the NYSE
that materially affect the security's price. In the case of
foreign securities, this could include events occurring after the
close of the foreign market and before the close of the NYSE. The
Portfolio's foreign securities may trade on days when the NYSE is
closed. We will not price shares on days that the NYSE is closed
for trading. You will not be able to purchase or redeem shares
until the next NYSE-trading day.
SELLING SHARES You may sell your shares any day the Fund is open
for business.
Once we receive and accept your order to sell shares, you may not
cancel or revoke it. We cannot accept an order to sell that
specifies a particular date or price or any other special
conditions.
The Fund redeems shares at the NAV next determined after an order
has been accepted. We mail proceeds within seven days after the
sale.
If the amount you redeem is in excess of the lesser of (1)
$250,000 or (2) 1% of the Fund's assets, the Fund may pay the
redemption "in kind." This is payment in portfolio securities
rather than cash. If this occurs, you may incur transaction costs
when you sell the securities.
If your account value falls below $250,000, the Fund may redeem
your shares and send the proceeds to the registered address. You
will receive notice 30 days before this happens.
DIVIDENDS AND DISTRIBUTIONS Income dividends are declared each
business day, paid monthly, and confirmed at least quarterly. The
Fund distributes, at least once a year, virtually all of its net
realized capital gains.
A dividend from net investment income represents the income the
Fund earns from dividends and interest paid on its investments,
after payment of the Fund's expenses.
A capital gain is the increase in value of a security that the
Portfolio holds. The gain is "unrealized" until the security is
sold. Each realized capital gain is either short term or long
term depending on whether the Portfolio held the security for one
year or less or more than one year, regardless of how long you
have held your Fund shares.
When the Fund makes a distribution of income or capital gains, the
distribution is automatically invested in additional shares of the
Fund unless you elect to have distributions paid by check.
If you elect to receive distributions by check and a distribution
check is returned to the Fund as undeliverable, or if you do not
present a distribution check for payment within six months, we
will change the distribution option on your account and reinvest
the proceeds of the check in additional shares of the Fund. You
will not receive any interest on amounts represented by uncashed
distribution or redemption checks.
Tax Consequences
You are subject to federal income tax on both dividends and
capital gains distributions whether you elect to receive them in
cash or reinvest them in additional Fund shares. If the Fund
declares a distribution in December, but does not pay it until
after December 31, you will be taxed as if the distribution were
paid in December. Stein Roe will process your distributions and
send you a statement for tax purposes each year showing the source
of distributions for the preceding year.
TRANSACTION TAX STATUS
- ----------------------------------------------------------------
Income dividend Ordinary income
Short-term capital gain distribution Ordinary income
Long-term capital gain distribution Capital gain
Sale of shares owned one year or less Gain is ordinary income;
loss is subject to special
rules
Sale of shares owned more than one year Capital gain or loss
In addition to the dividends and capital gains distributions made
by the Fund, you may realize a capital gain or loss when selling
and exchanging Fund shares. Such transactions may be subject to
federal income tax.
This tax information provides only a general overview. It does
not apply if you invest in a tax-deferred retirement account such
as an IRA. Please consult your own tax advisor about the tax
consequences of an investment in the Fund.
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OTHER INVESTMENTS AND RISKS
The first portion of this prospectus describes the Fund's
principal investment strategy and principal investment risks. In
seeking to meet its investment goals, the Fund also may invest in
other securities and use other investment techniques. The Fund
may elect not to buy any of these other securities or use any of
these other investment techniques. The Fund may not always
achieve its investment goal.
This section describes other securities and techniques, and risks
associated with them. The Statement of Additional Information
(SAI) contains additional information about the Fund's securities
and investment techniques (including other securities and
techniques) and the risks associated with them. Such risks could
cause you to lose money by investing in the Fund or could cause
the Fund's total return or yield to decrease. The SAI also
contains the Fund's fundamental and non-fundamental investment
policies.
The Board of Trustees can change the Fund's investment objective
without shareholder approval.
MORTGAGE-BACKED SECURITIES AND ASSET-BACKED SECURITIES The
Portfolio may invest in mortgage-backed securities which are
securities that represent ownership interests in large,
diversified pools of mortgage loans. Sponsors pool together
mortgages of similar rates and terms and offer them as a security
to investors.
Most mortgage securities are pooled together and structured as
pass-throughs. Monthly payments of principal and interest from
the underlying mortgage loans backing the pool are collected by a
service and "passed through" regularly to the investor. Pass-
throughs can have a fixed or an adjustable rate. The majority of
pass-through securities are issued by three agencies: Ginnie Mae,
Fannie Mae, and Freddie Mac.
Commercial mortgage-backed securities are secured by loans to
commercial properties such as office buildings, multi-family
apartment buildings and shopping centers. These loans usually
contain prepayment penalties that provide protection from
refinancing in a declining interest rate environment.
Real estate mortgage investment conduits (REMICs) are multiclass
securities that qualify for special tax treatment under the
Internal Revenue Code. REMICs invest in certain mortgages that
are secured principally by interests in real property such as
single family homes.
Asset-backed securities are securities backed by various types of
loans such as credit card, auto and home-equity loans. The
Portfolio generally invests in "mortgage-related" asset-backed
securities, which are backed by residential first and second lien
home equity, home improvement and manufactured housing loans.
WHEN-ISSUED SECURITIES AND FORWARD COMMITMENTS When-issued
securities and forward commitments are securities that are
purchased prior to the date they are actually issued or delivered.
These securities involve the risk that they may fall in value by
the time they are actually issued or that the other party may fail
to honor the contract terms.
ZERO COUPON SECURITIES The Portfolio may invest in zero coupon
securities. These securities do not pay interest in cash on a
current basis, but instead accrue over the life of the bond. As a
result, these securities are issued at a deep discount. The value
of these securities may fluctuate more than similar securities
that pay interest periodically. Although these securities pay no
interest to holders prior to maturity, interest on these
securities is reported as income to the Fund and distributed to
its shareholders.
PIK BONDS The Portfolio may invest in payable-in-kind bonds (PIK
bonds) which are bonds that pay interest in the form of additional
securities. These bonds are subject to greater price volatility
than bonds that pay cash interest on a current basis.
ILLIQUID INVESTMENTS The Portfolio may invest up to 15% of its
net assets in illiquid investments. An illiquid investment is a
security or other position that cannot be disposed of quickly in
the normal course of business. For example, some securities are
not registered under U.S. securities laws and cannot be sold to
the U.S. public because of SEC regulations (these are known as
"restricted securities"). Under procedures adopted by the Fund's
Trustees, certain restricted securities may be deemed liquid and
will not be counted toward this 15% limit.
PORTFOLIO TURNOVER There are no limits on turnover. Turnover
may vary significantly from year to year. Stein Roe does not
expect it to exceed 100% under normal conditions. Portfolio
turnover typically produces capital gains or losses resulting in
tax consequences for Fund investors. It also increases
transaction expenses, which reduce the Fund's return.
TEMPORARY DEFENSIVE POSITIONS When Stein Roe believes that a
temporary defensive position is necessary, the Portfolio may
invest, without limit, in high-quality debt securities or hold
assets in cash and cash equivalents. Stein Roe is not required to
take a temporary defensive position, and market conditions may
prevent such an action. The Fund may not achieve its investment
objective if its Portfolio takes a temporary defensive position.
INTERFUND LENDING PROGRAM The Fund and Portfolio may lend money
to and borrow money from other funds advised by Stein Roe. They
will do so when Stein Roe believes such lending or borrowing is
necessary and appropriate. Borrowing costs will be the same as or
lower than the costs of a bank loan.
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THE FUND'S MANAGEMENT
INVESTMENT ADVISER Stein Roe & Farnham Incorporated (Stein Roe),
One South Wacker Drive, Chicago, IL 60606, manages the day-to-day
operations of the Fund and Portfolio. Stein Roe (and its
predecessor) has advised and managed mutual funds since 1949. For
the fiscal year ended June 30, 1999, the Fund paid to Stein Roe
aggregate fees of 0.65% of average net assets.
Stein Roe's mutual funds and institutional investment advisory
businesses are part of a larger business unit known as Liberty
Funds Group (LFG) that includes several separate legal entities.
LFG includes certain affiliates of Stein Roe, including Colonial
Management Associates, Inc. (Colonial). The LFG business unit is
managed by a single management team. Colonial and other LFG
entities also share personnel, facilities, and systems with Stein
Roe that may be used in providing administrative or operational
services to the Funds. Colonial is a registered investment
adviser. Stein Roe also has a wealth management business that is
not part of LFG and is managed by a different team. Stein Roe
and the other entities that make up LFG are subsidiaries of
Liberty Financial Companies, Inc.
PORTFOLIO MANAGER Stephen F. Lockman has been manager of High
Yield Portfolio since 1997 and of SR&F Income Portfolio since its
inception in 1998. He was portfolio manager of Income Fund from
1997, associate manager of Income Fund from 1995 to 1997, and
associate manager of High Yield Portfolio from 1996 to 1997. Mr.
Lockman was a senior research analyst for Stein Roe's fixed income
department from 1994, when he joined Stein Roe, to 1997. He
served as portfolio manager for the Illinois State Board of
Investment from 1987 to 1994. A chartered financial analyst, Mr.
Lockman earned a bachelor's degree from the University of Illinois
and a master's degree from DePaul University. As of June 30,
1999, Mr. Lockman managed $88 million in mutual fund net assets.
MASTER/FEEDER FUND STRUCTURE Unlike mutual funds that directly
acquire and manage their own portfolios of securities, the Fund is
a "feeder" fund in a "master/feeder" structure. This means that
the Fund invests its assets in a larger "master" portfolio of
securities (the Portfolio) that has an investment objective and
policies substantially identical to those of the Fund. The
investment performance of the Fund depends upon the investment
performance of the Portfolio. If the investment policies of the
Fund and the Portfolio became inconsistent, the Board of Trustees
of the Fund can decide what actions to take. Actions the Board of
Trustees may recommend include withdrawal of the Fund's assets
from the Portfolio. For more information on the master/feeder
fund structure, see the SAI.
YEAR 2000 READINESS Like other investment companies, financial
and business organizations and individuals around the world, the
Fund could be adversely affected if the computer systems used by
Stein Roe, other service providers and the issuers in which the
Fund invests do not properly process and calculate date-related
information and data from and after Jan. 1, 2000. This is
commonly known as the "Year 2000 problem." The Fund's service
providers are taking steps that they believe are reasonably
designed to address the Year 2000 problem, including communicating
with vendors who furnish services, software and systems to the
Fund to provide that date-related information and data can be
properly processed after Jan. 1, 2000. Many Fund service
providers and vendors, including the Fund's service providers, are
in the process of making Year 2000 modifications to their software
and systems and believe that such modifications will be completed
on a timely basis prior to Jan. 1, 2000. In addition, Year 2000
readiness is one of the factors considered by Stein Roe in its
ongoing assessment of issuers in which the Fund invests, to the
extent that information is readily available. However, no
assurances can be given that the Fund will not be adversely
affected by these matters.
<PAGE>
FOR MORE INFORMATION
You can obtain more information about the Fund's investments in
its semiannual and annual reports to investors. These reports
discuss the market conditions and investment strategies that
affected the Fund's performance over the past six months and year.
You may wish to read the Fund's SAI for more information. The SAI
is incorporated into this prospectus by reference, which means
that it is considered to be part of this prospectus and you are
deemed to have been told of its contents.
To obtain free copies of the Fund's semiannual and annual reports
or the SAI or to request other information about the Fund, write
or call:
Stein Roe Mutual Funds
One South Wacker Drive
Suite 3200
Chicago, IL 60606
800-338-2550
www.steinroe.com
Text-only versions of all Fund documents can be viewed online or
downloaded from the SEC at www.sec.gov. You can also obtain
copies by visiting the SEC's Public Reference Room in Washington,
DC, by calling 800-SEC-0330, or by sending your request and the
appropriate fee to the SEC's public reference section, Washington,
DC 20549-6009.
Investment Company Act file number of Liberty-Stein Roe Funds
Trust: 811-07997
LIBERTY FUNDS DISTRIBUTOR, INC.
<PAGE>
Statement of Additional Information Dated Nov. 1, 1999
LIBERTY-STEIN ROE FUNDS TRUST
Stein Roe Institutional Client High Yield Fund
Suite 3300, One South Wacker Drive, Chicago, IL 60606
This Statement of Additional Information (SAI) is not a
prospectus but provides additional information that should be read
in conjunction with the Fund's Prospectus dated Nov. 1, 1999 and
any supplements thereto. Financial statements, which are
contained in the Fund's June 30, 1999 Annual Report, are
incorporated by reference into this SAI. The Prospectus and
Annual Report may be obtained at no charge by telephoning Stein
Roe Retirement Services at 800-322-1130.
TABLE OF CONTENTS
Page
General Information and History............................2
Investment Policies........................................3
Portfolio Investments and Strategies.......................3
Investment Restrictions...................................19
Additional Investment Considerations......................22
Purchases and Redemptions.................................22
Management................................................25
Financial Statements......................................28
Principal Shareholders....................................28
Investment Advisory and Other Services....................29
Distributor...............................................31
Transfer Agent............................................31
Custodian.................................................31
Independent Auditors......................................32
Portfolio Transactions....................................32
Additional Income Tax Considerations......................37
Investment Performance....................................38
Master Fund/Feeder Fund: Structure and Risk Factors.......42
Appendix-Ratings..........................................44
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GENERAL INFORMATION AND HISTORY
Stein Roe Institutional Client High Yield Fund (the "Fund")
is a series of Liberty-Stein Roe Funds Trust (the "Trust"). Prior
to Oct. 18, 1999, the name of the Trust was Stein Roe Trust.
</sR>
The Trust is a Massachusetts business trust organized under
an Agreement and Declaration of Trust ("Declaration of Trust")
dated July 31, 1996, which provides that each shareholder shall be
deemed to have agreed to be bound by the terms thereof. The
Declaration of Trust may be amended by a vote of either the
Trust's shareholders or its trustees. The Trust may issue an
unlimited number of shares, in one or more series as the Board may
authorize. The Fund is the only series of the Trust authorized
and outstanding.
Under Massachusetts law, shareholders of a Massachusetts
business trust such as the Trust could, in some circumstances, be
held personally liable for unsatisfied obligations of the trust.
The Declaration of Trust provides that persons extending credit
to, contracting with, or having any claim against the Trust or any
particular series shall look only to the assets of the Trust or of
the respective series for payment under such credit, contract or
claim, and that the shareholders, trustees and officers shall have
no personal liability therefor. The Declaration of Trust requires
that notice of such disclaimer of liability be given in each
contract, instrument or undertaking executed or made on behalf of
the Trust. The Declaration of Trust provides for indemnification
of any shareholder against any loss and expense arising from
personal liability solely by reason of being or having been a
shareholder. Thus, the risk of a shareholder incurring financial
loss on account of shareholder liability is believed to be remote,
because it would be limited to circumstances in which the
disclaimer was inoperative and the Trust was unable to meet its
obligations. The risk of a particular series incurring financial
loss on account of unsatisfied liability of another series of the
Trust also is believed to be remote, because it would be limited
to claims to which the disclaimer did not apply and to
circumstances in which the other series was unable to meet its
obligations.
Each share of a series, without par value, is entitled to
participate pro rata in any dividends and other distributions
declared by the Board on shares of that series, and all shares of
a series have equal rights in the event of liquidation of that
series. Each whole share (or fractional share) outstanding on the
record date established in accordance with the By-Laws shall be
entitled to a number of votes on any matter on which it is
entitled to vote equal to the net asset value of the share (or
fractional share) in United States dollars determined at the close
of business on the record date (for example, a share having a net
asset value of $10.50 would be entitled to 10.5 votes). As a
business trust, the Trust is not required to hold annual
shareholder meetings. However, special meetings may be called for
purposes such as electing or removing trustees, changing
fundamental policies, or approving an investment advisory
contract. If requested to do so by the holders of at least 10% of
its outstanding shares, the Trust will call a special meeting for
the purpose of voting upon the question of removal of a trustee or
trustees and will assist in the communications with other
shareholders as if the Trust were subject to Section 16(c) of the
Investment Company Act of 1940. All shares of all series of the
Trust are voted together in the election of trustees. On any
other matter submitted to a vote of shareholders, shares are voted
in the aggregate and not by individual series, except that shares
are voted by individual series when required by the Investment
Company Act of 1940 or other applicable law, or when the Board of
Trustees determines that the matter affects only the interests of
one or more series, in which case shareholders of the unaffected
series are not entitled to vote on such matters.
Special Considerations Regarding Master Fund/Feeder Fund Structure
Rather than invest in securities directly, the Fund seeks to
achieve its objective by pooling its assets with those of other
investment companies for investment in another mutual fund having
the same investment objective and substantially the same
investment policies. The purpose of such an arrangement is to
achieve greater operational efficiencies and reduce costs. The
Fund invests all of its assets in SR&F High Yield Portfolio (the
"Portfolio"), which is a series of SR&F Base Trust. For more
information, please refer to Master Fund/Feeder Fund: Structure
and Risk Factors.
Stein Roe & Farnham Incorporated ("Stein Roe") provides
administrative and accounting and recordkeeping services to the
Fund and the Portfolio and provides investment advisory services
to the Portfolio.
INVESTMENT POLICIES
The Trust and SR&F Base Trust are open-end management
investment companies. The Fund and the Portfolio are diversified,
as that term is defined in the Investment Company Act of 1940.
The investment objective and policies are described in the
Prospectus under The Fund. In pursuing its objective, the
Portfolio may also employ the investment techniques described
under Portfolio Investments and Strategies in this SAI. The
investment objective is a nonfundamental policy and may be changed
by the Board of Trustees without the approval of a "majority of
the outstanding voting securities."/1/
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/1/ A "majority of the outstanding voting securities" means the
approval of the lesser of (i) 67% or more of the shares at a
meeting if the holders of more than 50% of the outstanding shares
are present or represented by proxy or (ii) more than 50% of the
outstanding shares.
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PORTFOLIO INVESTMENTS AND STRATEGIES
Derivatives
Consistent with its objective, the Portfolio may invest in a
broad array of financial instruments and securities, including
conventional exchange-traded and non-exchange traded options,
futures contracts, futures options, securities collateralized by
underlying pools of mortgages or other receivables, and other
instruments the value of which is "derived" from the performance
of an underlying asset or a "benchmark" such as a security index,
an interest rate, or a currency ("Derivatives").
Derivatives are most often used to manage investment risk or
to create an investment position indirectly because using them is
more efficient or less costly than direct investment that cannot
be readily established directly due to portfolio size, cash
availability, or other factors. They also may be used in an
effort to enhance portfolio returns.
The successful use of Derivatives depends on Stein Roe's
ability to correctly predict changes in the levels and directions
of movements in security prices, interest rates and other market
factors affecting the Derivative itself or the value of the
underlying asset or benchmark. In addition, correlations in the
performance of an underlying asset to a Derivative may not be well
established. Finally, privately negotiated and over-the-counter
Derivatives may not be as well regulated and may be less
marketable than exchange-traded Derivatives.
The Portfolio does not intend to invest more than 5% of its
assets in any type of Derivative except for options, futures
contracts, and futures options.
Mortgage and Other Asset-Backed Securities
The Portfolio may invest in securities secured by mortgages
or other assets such as automobile or home improvement loans and
credit card receivables. These instruments may be issued or
guaranteed by the U.S. Government or by its agencies or
instrumentalities or by private entities such as commercial,
mortgage and investment banks and financial companies or financial
subsidiaries of industrial companies.
Mortgage-backed securities provide either a pro rata interest
in underlying mortgages or an interest in collateralized mortgage
obligations ("CMOs") which represent a right to interest and/or
principal payments from an underlying mortgage pool. CMOs are not
guaranteed by either the U.S. Government or by its agencies or
instrumentalities, and are usually issued in multiple classes each
of which has different payment rights, prepayment risks and yield
characteristics. Mortgage-backed securities involve the risk of
prepayment on the underlying mortgages at a faster or slower rate
than the established schedule. Prepayments generally increase
with falling interest rates and decrease with rising rates but
they also are influenced by economic, social and market factors.
If mortgages are prepaid during periods of declining interest
rates, there would be a resulting loss of the full-term benefit of
any premium paid by the Portfolio on purchase of the CMO, and the
proceeds of prepayment would likely be invested at lower interest
rates. The Portfolio intends to invest in CMOs of classes known
as planned amortization classes ("PACs") which have prepayment
protection features tending to make them less susceptible to price
volatility.
Non-mortgage asset-backed securities usually have less
prepayment risk than mortgage-backed securities, but have the risk
that the collateral will not be available to support payments on
the underlying loans which finance payments on the securities
themselves. Therefore, greater emphasis is placed on the credit
quality of the security issuer and the guarantor, if any.
REMICs
The Portfolio may invest in real estate mortgage investment
conduits ("REMICs"). REMICs, which were authorized under the Tax
Reform Act of 1986, are private entities formed for the purpose of
holding a fixed pool of mortgages secured by an interest in real
property. REMICs are similar to CMOs in that they issue multiple
classes of securities. A REMIC is a CMO that qualifies for
special tax treatment under the Internal Revenue Code and invests
in certain mortgages principally secured by interests in real
property. Investors may purchase beneficial interests in REMICs,
which are known as "regular" interests, or "residual" interests.
Guaranteed REMIC pass-through certificates ("REMIC Certificates")
issued by FNMA or FHLMC represent beneficial ownership interests
in a REMIC trust consisting principally of mortgage loans or FNMA-
, FHLMC- or GNMA-guaranteed mortgage pass-through certificates.
For FHLMC REMIC Certificates, FHLMC guarantees the timely payment
of interest and also guarantees the payment of principal as
payments are required to be made on the underlying mortgage
participation certificates. FNMA REMIC Certificates are issued
and guaranteed as to timely distribution and principal and
interest by FNMA.
Floating Rate Instruments
The Portfolio may also invest in floating rate instruments
which provide for periodic adjustments in coupon interest rates
that are automatically reset based on changes in amount and
direction of specified market interest rates. In addition, the
adjusted duration of some of these instruments may be materially
shorter than their stated maturities. To the extent such
instruments are subject to lifetime or periodic interest rate caps
or floors, such instruments may experience greater price
volatility than debt instruments without such features. Adjusted
duration is an inverse relationship between market price and
interest rates and refers to the approximate percentage change in
price for a 100 basis point change in yield. For example, if
interest rates decrease by 100 basis points, a market price of a
security with an adjusted duration of 2 would increase by
approximately 2%. The Portfolio does not intend to invest more
than 5% of its net assets in floating rate instruments.
Lending of Portfolio Securities
Subject to restriction (7) under Investment Restrictions, the
Portfolio may lend its portfolio securities to broker-dealers and
banks. Any such loan must be continuously secured by collateral
in cash or cash equivalents maintained on a current basis in an
amount at least equal to the market value of the securities loaned
by the Portfolio. The Portfolio would continue to receive the
equivalent of the interest or dividends paid by the issuer on the
securities loaned, and would also receive an additional return
that may be in the form of a fixed fee or a percentage of the
collateral. the Portfolio would have the right to call the loan
and obtain the securities loaned at any time on notice of not more
than five business days. In the event of bankruptcy or other
default of the borrower, the Portfolio could experience both
delays in liquidating the loan collateral or recovering the loaned
securities and losses including (a) possible decline in the value
of the collateral or in the value of the securities loaned during
the period while it seeks to enforce its rights thereto, (b)
possible subnormal levels of income and lack of access to income
during this period, and (c) expenses of enforcing its rights.
Repurchase Agreements
The Portfolio may invest in repurchase agreements, provided
that it will not invest more than 15% of net assets in repurchase
agreements maturing in more than seven days and any other illiquid
securities. A repurchase agreement is a sale of securities to the
Portfolio in which the seller agrees to repurchase the securities
at a higher price, which includes an amount representing interest
on the purchase price, within a specified time. In the event of
bankruptcy of the seller, the Portfolio could experience both
losses and delays in liquidating its collateral.
When-Issued and Delayed-Delivery Securities; Reverse Repurchase
Agreements; Standby Commitments
The Portfolio may purchase instruments on a when-issued or
delayed-delivery basis. Although payment terms are established at
the time the Portfolio enters into the commitment, the instruments
may be delivered and paid for some time after the date of
purchase, when their value may have changed and the yields
available in the market may be greater. The Portfolio will make
such commitments only with the intention of actually acquiring the
instruments, but may sell them before settlement date if it is
deemed advisable for investment reasons. Securities purchased in
this manner involve risk of loss if the value of the security
purchased declines before settlement date.
Securities purchased on a when-issued or delayed-delivery
basis are sometimes done on a "dollar roll" basis. Dollar roll
transactions consist of the sale by the Portfolio of securities
with a commitment to purchase similar but not identical
securities, generally at a lower price at a future date. A dollar
roll may be renewed after cash settlement and initially may
involve only a firm commitment agreement by the Portfolio to buy a
security. A dollar roll transaction involves the following risks:
if the broker-dealer to whom the Portfolio sells the security
becomes insolvent, the Portfolio's right to purchase or repurchase
the security may be restricted; the value of the security may
change adversely over the term of the dollar roll; the security
which the Portfolio is required to repurchase may be worth less
than a security which it originally held; and the return earned by
the Portfolio with the proceeds of a dollar roll may not exceed
transaction costs.
The Portfolio may enter into reverse repurchase agreements
with banks and securities dealers. A reverse repurchase agreement
is a repurchase agreement in which the Portfolio is the seller of,
rather than the investor in, securities and agrees to repurchase
them at an agreed-upon time and price. Use of a reverse
repurchase agreement may be preferable to a regular sale and later
repurchase of securities because it avoids certain market risks
and transaction costs.
At the time the Portfolio enters into a binding obligation to
purchase securities on a when-issued basis or enters into a
reverse repurchase agreement, liquid assets (cash, U.S. Government
or other "high grade" debt obligations) of the Portfolio having a
value at least as great as the purchase price of the securities to
be purchased will be segregated on the books of the Portfolio and
held by the custodian throughout the period of the obligation.
The use of these investment strategies, as well as borrowing under
a line of credit as described below, may increase net asset value
fluctuation.
Standby commitment agreements create an additional risk for
the Portfolio because the other party to the standby agreement
generally will not be obligated to deliver the security, but the
Portfolio will be obligated to accept it if delivered. Depending
on market conditions, the Portfolio may receive a commitment fee
for assuming this obligation. If prevailing market interest rates
increase during the period between the date of the agreement and
the settlement date, the other party can be expected to deliver
the security and, in effect, pass any decline in value to the
Portfolio. If the value of the security increases after the
agreement is made, however, the other party is unlikely to deliver
the security. In other words, a decrease in the value of the
securities to be purchased under the terms of a standby commitment
agreement will likely result in the delivery of the security, and,
therefore, such decrease will be reflected in the Portfolio's net
asset value. However, any increase in the value of the securities
to be purchased will likely result in the non-delivery of the
security and, therefore, such increase will not affect the net
asset value unless and until the Portfolio actually obtains the
security.
Short Sales Against the Box
The Portfolio may sell securities short against the box; that
is, enter into short sales of securities that it currently owns or
has the right to acquire through the conversion or exchange of
other securities that it owns at no additional cost. The
Portfolio may make short sales of securities only if at all times
when a short position is open it owns at least an equal amount of
such securities or securities convertible into or exchangeable for
securities of the same issue as, and equal in amount to, the
securities sold short, at no additional cost.
In a short sale against the box, the Portfolio does not
deliver from its portfolio the securities sold. Instead, the
Portfolio borrows the securities sold short from a broker-dealer
through which the short sale is executed, and the broker-dealer
delivers such securities, on behalf of the Portfolio, to the
purchaser of such securities. The Portfolio is required to pay to
the broker-dealer the amount of any dividends paid on shares sold
short. Finally, to secure its obligation to deliver to such
broker-dealer the securities sold short, the Portfolio must
deposit and continuously maintain in a separate account with its
custodian an equivalent amount of the securities sold short or
securities convertible into or exchangeable for such securities at
no additional cost. The Portfolio is said to have a short
position in the securities sold until it delivers to the broker-
dealer the securities sold. The Portfolio may close out a short
position by purchasing on the open market and delivering to the
broker-dealer an equal amount of the securities sold short, rather
than by delivering portfolio securities.
Short sales may protect the Portfolio against the risk of
losses in the value of its portfolio securities because any
unrealized losses with respect to such portfolio securities should
be wholly or partially offset by a corresponding gain in the short
position. However, any potential gains in such portfolio
securities should be wholly or partially offset by a corresponding
loss in the short position. The extent to which such gains or
losses are offset will depend upon the amount of securities sold
short relative to the amount the Portfolio owns, either directly
or indirectly, and, in the case where the Portfolio owns
convertible securities, changes in the conversion premium.
Short sale transactions involve certain risks. If the price
of the security sold short increases between the time of the short
sale and the time the Portfolio replaces the borrowed security,
the Portfolio will incur a loss and if the price declines during
this period, the Portfolio will realize a short-term capital gain.
Any realized short-term capital gain will be decreased, and any
incurred loss increased, by the amount of transaction costs and
any premium, dividend or interest which the Portfolio may have to
pay in connection with such short sale. Certain provisions of the
Internal Revenue Code may limit the degree to which the Portfolio
is able to enter into short sales. There is no limitation on the
amount of the Portfolio's assets that, in the aggregate, may be
deposited as collateral for the obligation to replace securities
borrowed to effect short sales and allocated to segregated
accounts in connection with short sales. The Portfolio currently
expects that no more than 5% of its total assets would be involved
in short sales against the box.
Line of Credit
Subject to restriction (8) under Investment Restrictions, the
Fund and the Portfolio may establish and maintain a line of credit
with a major bank in order to permit borrowing on a temporary
basis to meet share redemption requests in circumstances in which
temporary borrowing may be preferable to liquidation of portfolio
securities.
Interfund Borrowing and Lending Program
Pursuant to an exemptive order issued by the Securities and
Exchange Commission, the Fund and the Portfolio may lend money to
and borrow money from other mutual funds advised by Stein Roe.
They will borrow through the program when borrowing is necessary
and appropriate and the costs are equal to or lower than the costs
of bank loans.
PIK and Zero Coupon Bonds
The Portfolio may invest up to 20% of its assets in zero
coupon bonds and bonds the interest on which is payable in kind
("PIK bonds"). A zero coupon bond is a bond that does not pay
interest for its entire life. A PIK bond pays interest in the
form of additional securities. The market prices of both zero
coupon and PIK bonds are affected to a greater extent by changes
in prevailing levels of interest rates and thereby tend to be more
volatile in price than securities that pay interest periodically
and in cash. In addition, because the Portfolio accrues income
with respect to these securities prior to the receipt of such
interest in cash, it may have to dispose of portfolio securities
under disadvantageous circumstances in order to obtain cash needed
to pay income dividends in amounts necessary to avoid unfavorable
tax consequences.
Rated Securities
For a description of the ratings applied by rating services
to debt securities, please refer to the Appendix to the
Prospectus. The rated debt securities described under Investment
Policies include securities given a rating conditionally by
Moody's or provisionally by S&P. If the rating of a security is
withdrawn or reduced, the Portfolio is not required to sell the
security, but Stein Roe will consider such fact in determining
whether to continue to hold the security. To the extent that the
ratings accorded by Moody's or S&P for debt securities may change
as a result of changes in such organizations, or changes in their
rating systems, the Portfolio will attempt to use comparable
ratings as standards for its investments in debt securities in
accordance with its investment policies.
Foreign Securities
The Portfolio may invest up to 25% of total assets (taken at
market value at the time of investment) in securities of foreign
issuers that are not publicly traded in the United States
("foreign securities"). For purposes of these limits, foreign
securities do not include securities represented by American
Depositary Receipts ("ADRs"), securities denominated in U.S.
dollars, or securities guaranteed by U.S. persons. Investment in
foreign securities may involve a greater degree of risk (including
risks relating to exchange fluctuations, tax provisions, or
expropriation of assets) than does investment in securities of
domestic issuers.
The Portfolio may invest in both "sponsored" and
"unsponsored" ADRs. In a sponsored ADR, the issuer typically pays
some or all of the expenses of the depositary and agrees to
provide its regular shareholder communications to ADR holders. An
unsponsored ADR is created independently of the issuer of the
underlying security. The ADR holders generally pay the expenses
of the depositary and do not have an undertaking from the issuer
of the underlying security to furnish shareholder communications.
The Portfolio does not expects to invest as much as 5% of its
total assets in unsponsored ADRs.
With respect to portfolio securities that are issued by
foreign issuers or denominated in foreign currencies, investment
performance is affected by the strength or weakness of the U.S.
dollar against these currencies. For example, if the dollar falls
in value relative to the Japanese yen, the dollar value of a yen-
denominated stock held in the investment portfolio will rise even
though the price of the stock remains unchanged. Conversely, if
the dollar rises in value relative to the yen, the dollar value of
the yen-denominated stock will fall. (See discussion of
transaction hedging and portfolio hedging under Currency Exchange
Transactions.)
Investors should understand and consider carefully the risks
involved in foreign investing. Investing in foreign securities,
positions which are generally denominated in foreign currencies,
and utilization of forward foreign currency exchange contracts
involve certain considerations comprising both risks and
opportunities not typically associated with investing in U.S.
securities. These considerations include: fluctuations in
exchange rates of foreign currencies; possible imposition of
exchange control regulation or currency restrictions that would
prevent cash from being brought back to the United States; less
public information with respect to issuers of securities; less
governmental supervision of stock exchanges, securities brokers,
and issuers of securities; lack of uniform accounting, auditing,
and financial reporting standards; lack of uniform settlement
periods and trading practices; less liquidity and frequently
greater price volatility in foreign markets than in the United
States; possible imposition of foreign taxes; possible investment
in securities of companies in developing as well as developed
countries; and sometimes less advantageous legal, operational, and
financial protections applicable to foreign sub-custodial
arrangements.
Although the Portfolio will try to invest in companies and
governments of countries having stable political environments,
there is the possibility of expropriation or confiscatory
taxation, seizure or nationalization of foreign bank deposits or
other assets, establishment of exchange controls, the adoption of
foreign government restrictions, or other adverse political,
social or diplomatic developments that could affect investment in
these nations.
Currency Exchange Transactions. Currency exchange
transactions may be conducted either on a spot (i.e., cash) basis
at the spot rate for purchasing or selling currency prevailing in
the foreign exchange market or through forward currency exchange
contracts ("forward contracts"). Forward contracts are
contractual agreements to purchase or sell a specified currency at
a specified future date (or within a specified time period) and
price set at the time of the contract. Forward contracts are
usually entered into with banks and broker-dealers, are not
exchange traded, and are usually for less than one year, but may
be renewed.
The Portfolio's foreign currency exchange transactions are
limited to transaction and portfolio hedging involving either
specific transactions or portfolio positions, except to the extent
described below under Synthetic Foreign Positions. Transaction
hedging is the purchase or sale of forward contracts with respect
to specific receivables or payables of the Portfolio arising in
connection with the purchase and sale of its portfolio securities.
Portfolio hedging is the use of forward contracts with respect to
portfolio security positions denominated or quoted in a particular
foreign currency. Portfolio hedging allows the Portfolio to limit
or reduce its exposure in a foreign currency by entering into a
forward contract to sell such foreign currency (or another foreign
currency that acts as a proxy for that currency) at a future date
for a price payable in U.S. dollars so that the value of the
foreign-denominated portfolio securities can be approximately
matched by a foreign-denominated liability. The Portfolio may not
engage in portfolio hedging with respect to the currency of a
particular country to an extent greater than the aggregate market
value (at the time of making such sale) of the securities held in
its portfolio denominated or quoted in that particular currency,
except that the Portfolio may hedge all or part of its foreign
currency exposure through the use of a basket of currencies or a
proxy currency where such currencies or currency act as an
effective proxy for other currencies. In such a case, the
Portfolio may enter into a forward contract where the amount of
the foreign currency to be sold exceeds the value of the
securities denominated in such currency. The use of this basket
hedging technique may be more efficient and economical than
entering into separate forward contracts for each currency held in
the Portfolio. The Portfolio may not engage in "speculative"
currency exchange transactions.
At the maturity of a forward contract to deliver a particular
currency, the Portfolio may either sell the portfolio security
related to such contract and make delivery of the currency, or it
may retain the security and either acquire the currency on the
spot market or terminate its contractual obligation to deliver the
currency by purchasing an offsetting contract with the same
currency trader obligating it to purchase on the same maturity
date the same amount of the currency.
It is impossible to forecast with absolute precision the
market value of portfolio securities at the expiration of a
forward contract. Accordingly, it may be necessary for the
Portfolio to purchase additional currency on the spot market (and
bear the expense of such purchase) if the market value of the
security is less than the amount of currency it is obligated to
deliver and if a decision is made to sell the security and make
delivery of the currency. Conversely, it may be necessary to sell
on the spot market some of the currency received upon the sale of
the portfolio security if its market value exceeds the amount of
currency the Portfolio is obligated to deliver.
If the Portfolio retains the portfolio security and engages
in an offsetting transaction, it will incur a gain or a loss to
the extent that there has been movement in forward contract
prices. If the Portfolio engages in an offsetting transaction, it
may subsequently enter into a new forward contract to sell the
currency. Should forward prices decline during the period between
the Portfolio's entering into a forward contract for the sale of a
currency and the date it enters into an offsetting contract for
the purchase of the currency, the Portfolio will realize a gain to
the extent the price of the currency it has agreed to sell exceeds
the price of the currency it has agreed to purchase. Should
forward prices increase, the Portfolio will suffer a loss to the
extent the price of the currency it has agreed to purchase exceeds
the price of the currency it has agreed to sell. A default on the
contract would deprive the Portfolio of unrealized profits or
force the Portfolio to cover its commitments for purchase or sale
of currency, if any, at the current market price.
Hedging against a decline in the value of a currency does not
eliminate fluctuations in the prices of portfolio securities or
prevent losses if the prices of such securities decline. Such
transactions also preclude the opportunity for gain if the value
of the hedged currency should rise. Moreover, it may not be
possible for the Portfolio to hedge against a devaluation that is
so generally anticipated that the Portfolio is not able to
contract to sell the currency at a price above the devaluation
level it anticipates. The cost to the Portfolio of engaging in
currency exchange transactions varies with such factors as the
currency involved, the length of the contract period, and
prevailing market conditions. Since currency exchange
transactions are usually conducted on a principal basis, no fees
or commissions are involved.
Synthetic Foreign Positions. The Portfolio may invest in
debt instruments denominated in foreign currencies. In addition
to, or in lieu of, such direct investment, the Portfolio may
construct a synthetic foreign position by (a) purchasing a debt
instrument denominated in one currency, generally U.S. dollars,
and (b) concurrently entering into a forward contract to deliver a
corresponding amount of that currency in exchange for a different
currency on a future date and at a specified rate of exchange.
Because of the availability of a variety of highly liquid U.S.
dollar debt instruments, a synthetic foreign position utilizing
such U.S. dollar instruments may offer greater liquidity than
direct investment in foreign currency debt instruments. The
results of a direct investment in a foreign currency and a
concurrent construction of a synthetic position in such foreign
currency, in terms of both income yield and gain or loss from
changes in currency exchange rates, in general should be similar,
but would not be identical because the components of the
alternative investments would not be identical.
The Portfolio may also construct a synthetic foreign position
by entering into a swap arrangement. A swap is a contractual
agreement between two parties to exchange cash flows-at the time
of the swap agreement and again at maturity, and, with some swaps,
at various intervals through the period of the agreement. The use
of swaps to construct a synthetic foreign position would generally
entail the swap of interest rates and currencies. A currency swap
is a contractual arrangement between two parties to exchange
principal amounts in different currencies at a predetermined
foreign exchange rate. An interest rate swap is a contractual
agreement between two parties to exchange interest payments on
identical principal amounts. An interest rate swap may be between
a floating and a fixed rate instrument, a domestic and a foreign
instrument, or any other type of cash flow exchange. A currency
swap generally has the same risk characteristics as a forward
currency contract, and all types of swaps have counter-party risk.
Depending on the facts and circumstances, swaps may be considered
illiquid. Illiquid securities usually have greater investment
risk and are subject to greater price volatility. The net amount
of the excess, if any, of the Portfolio's obligations over which
it is entitled to receive with respect to an interest rate or
currency swap will be accrued daily and liquid assets (cash, U.S.
Government securities, or other "high grade" debt obligations) of
the Portfolio having a value at least equal to such accrued excess
will be segregated on the books of the Portfolio and held by the
custodian for the duration of the swap.
The Portfolio may also construct a synthetic foreign position
by purchasing an instrument whose return is tied to the return of
the desired foreign position. An investment in these "principal
exchange rate linked securities" (often called PERLS) can produce
a similar return to a direct investment in a foreign security.
Rule 144A Securities
The Portfolio may purchase securities that have been
privately placed but that are eligible for purchase and sale under
Rule 144A under the 1933 Act. That Rule permits certain qualified
institutional buyers, such as the Portfolio, to trade in privately
placed securities that have not been registered for sale under the
1933 Act. Stein Roe, under the supervision of the Board of
Trustees, will consider whether securities purchased under Rule
144A are illiquid and thus subject to the Portfolio's restriction
of investing no more than 15% of its net assets in illiquid
securities. A determination of whether a Rule 144A security is
liquid or not is a question of fact. In making this
determination, Stein Roe will consider the trading markets for the
specific security, taking into account the unregistered nature of
a Rule 144A security. In addition, Stein Roe could consider the
(1) frequency of trades and quotes, (2) number of dealers and
potential purchasers, (3) dealer undertakings to make a market,
and (4) nature of the security and of marketplace trades (e.g.,
the time needed to dispose of the security, the method of
soliciting offers, and the mechanics of transfer). The liquidity
of Rule 144A securities would be monitored and if, as a result of
changed conditions, it is determined that a Rule 144A security is
no longer liquid, the Portfolio's holdings of illiquid securities
would be reviewed to determine what, if any, steps are required to
assure that the Portfolio does not invest more than 15% of its
assets in illiquid securities. Investing in Rule 144A securities
could have the effect of increasing the amount of assets invested
in illiquid securities if qualified institutional buyers are
unwilling to purchase such securities. The Portfolio does not
expect to invest as much as 5% of its total assets in Rule 144A
securities that have not been deemed to be liquid by Stein Roe.
Portfolio Turnover
The turnover rate for the Portfolio in the future may vary
greatly from year to year, and when portfolio changes are deemed
appropriate due to market or other conditions, such turnover rate
may be greater than might otherwise be anticipated. A high rate
of portfolio turnover may result in increased transaction expenses
and the realization of capital gains or losses. Distributions of
any net realized gains are subject to federal income tax.
Options on Securities and Indexes
The Portfolio may purchase and may sell both put options and
call options on debt or other securities or indexes in
standardized contracts traded on national securities exchanges,
boards of trade, or similar entities, or quoted on Nasdaq, and
agreements, sometimes called cash puts, that may accompany the
purchase of a new issue of bonds from a dealer.
An option on a security (or index) is a contract that gives
the purchaser (holder) of the option, in return for a premium, the
right to buy from (call) or sell to (put) the seller (writer) of
the option the security underlying the option (or the cash value
of the index) at a specified exercise price at any time during the
term of the option. The writer of an option on an individual
security has the obligation upon exercise of the option to deliver
the underlying security upon payment of the exercise price or to
pay the exercise price upon delivery of the underlying security.
Upon exercise, the writer of an option on an index is obligated to
pay the difference between the cash value of the index and the
exercise price multiplied by the specified multiplier for the
index option. (An index is designed to reflect specified facets
of a particular financial or securities market, a specific group
of financial instruments or securities, or certain economic
indicators.)
The Portfolio will write call options and put options only if
they are "covered." In the case of a call option on a security,
the option is "covered" if the Portfolio owns the security
underlying the call or has an absolute and immediate right to
acquire that security without additional cash consideration (or,
if additional cash consideration is required, cash or cash
equivalents in such amount are held in a segregated account by its
custodian) upon conversion or exchange of other securities held in
its portfolio.
If an option written by the Portfolio expires, it realizes a
capital gain equal to the premium received at the time the option
was written. If an option purchased by the Portfolio expires, it
realizes a capital loss equal to the premium paid.
Prior to the earlier of exercise or expiration, an option may
be closed out by an offsetting purchase or sale of an option of
the same series (type, exchange, underlying security or index,
exercise price, and expiration). There can be no assurance,
however, that a closing purchase or sale transaction can be
effected when the Portfolio desires.
The Portfolio will realize a capital gain from a closing
purchase transaction if the cost of the closing option is less
than the premium received from writing the option, or, if it is
more, the Portfolio will realize a capital loss. If the premium
received from a closing sale transaction is more than the premium
paid to purchase the option, the Portfolio will realize a capital
gain or, if it is less, it will realize a capital loss. The
principal factors affecting the market value of a put or a call
option include supply and demand, interest rates, the current
market price of the underlying security or index in relation to
the exercise price of the option, the volatility of the underlying
security or index, and the time remaining until the expiration
date.
A put or call option purchased by the Portfolio is an asset
of the Portfolio, valued initially at the premium paid for the
option. The premium received for an option written by the
Portfolio is recorded as a deferred credit. The value of an
option purchased or written is marked-to-market daily and is
valued at the closing price on the exchange on which it is traded
or, if not traded on an exchange or no closing price is available,
at the mean between the last bid and asked prices.
Risks Associated with Options on Securities and Indexes.
There are several risks associated with transactions in options on
securities and on indexes. For example, there are significant
differences between the securities markets and options markets
that could result in an imperfect correlation between these
markets, causing a given transaction not to achieve its
objectives. 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.
There can be no assurance that a liquid market will exist
when the Portfolio seeks to close out an option position. If the
Portfolio were unable to close out an option that it had purchased
on a security, it would have to exercise the option in order to
realize any profit or the option would expire and become
worthless. If the Portfolio were unable to close out a covered
call option that it had written on a security, it would not be
able to sell the underlying security until the option expired. As
the writer of a covered call option, the Portfolio foregoes,
during the option's life, the opportunity to profit from increases
in the market value of the security covering the call option above
the sum of the premium and the exercise price of the call.
If trading were suspended in an option purchased by the
Portfolio, it would not be able to close out the option. If
restrictions on exercise were imposed, the Portfolio might be
unable to exercise an option it has purchased.
Futures Contracts and Options on Futures Contracts
The Portfolio may use interest rate futures contracts and
index futures contracts. An interest rate or index futures
contract provides for the future sale by one party and purchase by
another party of a specified quantity of a financial instrument or
the cash value of an index/2/ at a specified price and time. A
public market exists in futures contracts covering a number of
indexes as well as the following financial instruments: U.S.
Treasury bonds; U.S. Treasury notes; GNMA Certificates; three-
month U.S. Treasury bills; 90-day commercial paper; bank
certificates of deposit; Eurodollar certificates of deposit; and
foreign currencies. It is expected that other futures contracts
will be developed and traded.
- ------------
/2/ A futures contract on an index is an agreement pursuant to
which two parties agree to take or make delivery of an amount of
cash equal to the difference between the value of the index at the
close of the last trading day of the contract and the price at
which the index contract was originally written. Although the
value of a securities index is a function of the value of certain
specified securities, no physical delivery of those securities is
made.
- ------------
The Portfolio may purchase and write call and put futures
options. Futures options possess many of the same characteristics
as options on securities and indexes (discussed above). A futures
option gives the holder the right, in return for the premium paid,
to assume a long position (call) or short position (put) in a
futures contract at a specified exercise price at any time during
the period of the option. Upon exercise of a call option, the
holder acquires a long position in the futures contract and the
writer is assigned the opposite short position. In the case of a
put option, the opposite is true. The Portfolio might, for
example, use futures contracts to hedge against or gain exposure
to fluctuations in the general level of security prices,
anticipated changes in interest rates or currency fluctuations
that might adversely affect either the value of its securities or
the price of the securities that it intends to purchase. Although
other techniques could be used to reduce exposure to security
price, interest rate and currency fluctuations, the Portfolio may
be able to achieve its exposure more effectively and perhaps at a
lower cost by using futures contracts and futures options.
The Portfolio will only enter into futures contracts and
futures options that are standardized and traded on an exchange,
board of trade, or similar entity, or quoted on an automated
quotation system.
The success of any futures transaction depends on accurate
predictions of changes in the level and direction of security
prices, interest rates, currency exchange rates and other factors.
Should those predictions be incorrect, the return might have been
better had the transaction not been attempted; however, in the
absence of the ability to use futures contracts, Stein Roe might
have taken portfolio actions in anticipation of the same market
movements with similar investment results but, presumably, at
greater transaction costs.
When a purchase or sale of a futures contract is made, the
Portfolio is required to deposit with its custodian (or broker, if
legally permitted) a specified amount of cash or U.S. Government
securities or other securities acceptable to the broker ("initial
margin"). The margin required for a futures contract is set by
the exchange on which the contract is traded and may be modified
during the term of the contract. The initial margin is in the
nature of a performance bond or good faith deposit on the futures
contract that is returned to the Portfolio upon termination of the
contract, assuming all contractual obligations have been
satisfied. The Portfolio expects to earn interest income on its
initial margin deposits. A futures contract held by the Portfolio
is valued daily at the official settlement price of the exchange
on which it is traded. Each day the Portfolio pays or receives
cash, called "variation margin," equal to the daily change in
value of the futures contract. This process is known as "marking-
to-market." Variation margin paid or received by the Portfolio
does not represent a borrowing or loan by the Portfolio but is
instead settlement between the Portfolio and the broker of the
amount one would owe the other if the futures contract had expired
at the close of the previous trading day. In computing daily net
asset value, the Portfolio will mark-to-market its open futures
positions.
The Portfolio is also required to deposit and maintain margin
with respect to put and call options on futures contracts written
by it. Such margin deposits will vary depending on the nature of
the underlying futures contract (and the related initial margin
requirements), the current market value of the option, and other
futures positions held by the Portfolio.
Although some futures contracts call for making or taking
delivery of the underlying securities, usually these obligations
are closed out prior to delivery by offsetting purchases or sales
of matching futures contracts (same exchange, underlying security
or index, and delivery month). If an offsetting purchase price is
less than the original sale price, the Portfolio realizes a
capital gain, or if it is more, it realizes a capital loss.
Conversely, if an offsetting sale price is more than the original
purchase price, the Portfolio realizes a capital gain, or if it is
less, it realizes a capital loss. The transaction costs must also
be included in these calculations.
Risks Associated with Futures
There are several risks associated with the use of futures
contracts and futures options as hedging techniques. A purchase
or sale of a futures contract may result in losses in excess of
the amount invested in the futures contract. In trying to
increase or reduce market exposure, there can be no guarantee that
there will be a correlation between price movements in the futures
contract and in the portfolio exposure sought. In addition, there
are significant differences between the securities and futures
markets that could result in an imperfect correlation between the
markets, causing a given transaction not to achieve its
objectives. The degree of imperfection of correlation depends on
circumstances such as: variations in speculative market demand for
futures, futures options and debt securities, including technical
influences in futures trading and futures options and differences
between the financial instruments and the instruments underlying
the standard contracts available for trading in such respects as
interest rate levels, maturities, and creditworthiness of issuers.
A decision as to whether, when and how to hedge 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 interest rate trends.
Futures exchanges may limit the amount of fluctuation
permitted in certain 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 the current
trading session. Once the daily limit has been reached in a
futures contract subject to the limit, no more trades may be made
on that day at a price beyond that limit. The daily limit governs
only price movements during a particular trading day and therefore
does not limit potential losses because the limit may work to
prevent the liquidation of unfavorable positions. For example,
futures prices have occasionally moved to the daily limit for
several consecutive trading days with little or no trading,
thereby preventing prompt liquidation of positions and subjecting
some holders of futures contracts to substantial losses.
There can be no assurance that a liquid market will exist at
a time when the Portfolio seeks to close out a futures or a
futures option position. The Portfolio would be exposed to
possible loss on the position during the interval of inability to
close and would continue to be required to meet margin
requirements until the position is closed. In addition, many of
the contracts discussed above are relatively new instruments
without a significant trading history. As a result, there can be
no assurance that an active secondary market will develop or
continue to exist.
Limitations on Options and Futures
If other options, futures contracts, or futures options of
types other than those described herein are traded in the future,
the Portfolio may also use those investment vehicles, provided the
Board of Trustees determines that their use is consistent with the
investment objective.
The Portfolio will not enter into a futures contract or
purchase an option thereon if, immediately thereafter, the initial
margin deposits for futures contracts held plus premiums paid for
open futures option positions, less the amount by which any such
positions are "in-the-money,"/3/ would exceed 5% of its total
assets.
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/3/ A call option is "in-the-money" if the value of the futures
contract that is the subject of the option exceeds the exercise
price. A put option is "in-the-money" if the exercise price
exceeds the value of the futures contract that is the subject of
the option.
- ------------------
When purchasing a futures contract or writing a put on a
futures contract, the Portfolio must maintain with its custodian
(or broker, if legally permitted) cash or cash equivalents
(including any margin) equal to the market value of such contract.
When writing a call option on a futures contract, the Portfolio
similarly will maintain with its custodian cash or cash
equivalents (including any margin) equal to the amount by which
such option is in-the-money until the option expires or is closed
out by the Portfolio.
The Portfolio may not maintain open short positions in
futures contracts, call options written on futures contracts or
call options written on indexes if, in the aggregate, the market
value of all such open positions exceeds the current value of the
securities in its portfolio, plus or minus unrealized gains and
losses on the open positions, adjusted for the historical relative
volatility of the relationship between the portfolio and the
positions. For this purpose, to the extent the Portfolio has
written call options on specific securities in its portfolio, the
value of those securities will be deducted from the current market
value of the securities portfolio.
In order to comply with Commodity Futures Trading Commission
Regulation 4.5 and thereby avoid being deemed a "commodity pool
operator," the Portfolio will use commodity futures or commodity
options contracts solely for bona fide hedging purposes within the
meaning and intent of Regulation 1.3(z), or, with respect to
positions in commodity futures and commodity options contracts
that do not come within the meaning and intent of 1.3(z), the
aggregate initial margin and premiums required to establish such
positions will not exceed 5% of the fair market value of the
assets of the Portfolio, after taking into account unrealized
profits and unrealized losses on any such contracts it has entered
into [in the case of an option that is in-the-money at the time of
purchase, the in-the-money amount (as defined in Section 190.01(x)
of the Commission Regulations) may be excluded in computing such
5%].
Taxation of Options and Futures
If the Portfolio exercises a call or put option that it
holds, the premium paid for the option is added to the cost basis
of the security purchased (call) or deducted from the proceeds of
the security sold (put). For cash settlement options and futures
options exercised by the Portfolio, the difference between the
cash received at exercise and the premium paid is a capital gain
or loss.
If a call or put option written by the Portfolio is
exercised, the premium is included in the proceeds of the sale of
the underlying security (call) or reduces the cost basis of the
security purchased (put). For cash settlement options and futures
options written by the Portfolio, the difference between the cash
paid at exercise and the premium received is a capital gain or
loss.
Entry into a closing purchase transaction will result in
capital gain or loss. If an option written by the Portfolio was
in-the-money at the time it was written and the security covering
the option was held for more than the long-term holding period
prior to the writing of the option, any loss realized as a result
of a closing purchase transaction will be long-term. The holding
period of the securities covering an in-the-money option will not
include the period of time the option is outstanding.
A futures contract held until delivery results in capital
gain or loss equal to the difference between the price at which
the futures contract was entered into and the settlement price on
the earlier of delivery notice date or expiration date. If the
Portfolio delivers securities under a futures contract, it also
realizes a capital gain or loss on those securities.
For federal income tax purposes, the Portfolio generally is
required to recognize as income for each taxable year its net
unrealized gains and losses as of the end of the year on options,
futures and futures options positions ("year-end mark-to-market").
Generally, any gain or loss recognized with respect to such
positions (either by year-end mark-to-market or by actual closing
of the positions) is considered to be 60% long-term and 40% short-
term, without regard to the holding periods of the contracts.
However, in the case of positions classified as part of a "mixed
straddle," the recognition of losses on certain positions
(including options, futures and futures options positions, the
related securities and certain successor positions thereto) may be
deferred to a later taxable year. Sale of futures contracts or
writing of call options (or futures call options) or buying put
options (or futures put options) that are intended to hedge
against a change in the value of securities held by the Portfolio:
(1) will affect the holding period of the hedged securities; and
(2) may cause unrealized gain or loss on such securities to be
recognized upon entry into the hedge.
In order to continue to qualify for federal income tax
treatment as a regulated investment company, at least 90% of gross
income for a taxable year must be derived from qualifying income;
i.e., dividends, interest, income derived from loans of
securities, and gains from the sale of securities or foreign
currencies or other income (including but not limited to gains
from options, futures, and forward contracts). Any net gain
realized from futures (or futures options) contracts will be
considered gain from the sale of securities and therefore be
qualifying income for purposes of the 90% requirement.
The Fund distributes to shareholders annually any net capital
gains that have been recognized for federal income tax purposes
(including year-end mark-to-market gains) on options and futures
transactions. Such distributions are combined with distributions
of capital gains realized on the other investments and
shareholders are advised of the nature of the payments.
The Taxpayer Relief Act of 1997 (the "Act") imposed
constructive sale treatment for federal income tax purposes on
certain hedging strategies with respect to appreciated securities.
Under these rules, taxpayers will recognize gain, but not loss,
with respect to securities if they enter into short sales of
"offsetting notional principal contracts" (as defined by the Act)
or futures or "forward contracts" (as defined by the Act) with
respect to the same or substantially identical property, or if
they enter into such transactions and then acquire the same or
substantially identical property. These changes generally apply
to constructive sales after June 8, 1997. Furthermore, the
Secretary of the Treasury is authorized to promulgate regulations
that will treat as constructive sales certain transactions that
have substantially the same effect as short sales, offsetting
notional principal contracts, and futures or forward contracts to
deliver the same or substantially similar property.
INVESTMENT RESTRICTIONS
The Fund and the Portfolio operate under the following
investment restrictions. The Fund and the Portfolio may not:
(1) invest in a security if, as a result of such investment,
more than 25% of its total assets (taken at market value at the
time of such investment) would be invested in the securities of
issuers in any particular industry, except that this restriction
does not apply to U.S. Government Securities, and [Fund only]
except that all or substantially all of the assets of the Fund may
be invested in another registered investment company having the
same investment objective and substantially similar investment
policies as the Fund;
(2) invest in a security if, with respect to 75% of its
assets, as a result of such investment, more than 5% of its total
assets (taken at market value at the time of such investment)
would be invested in the securities of any one issuer, except that
this restriction does not apply to U.S. Government Securities or
repurchase agreements for such securities and [Fund only] except
that all or substantially all of the assets of the Fund may be
invested in another registered investment company having the same
investment objective and substantially similar investment policies
as the Fund;
(3) invest in a security if, as a result of such investment,
it would hold more than 10% (taken at the time of such investment)
of the outstanding voting securities of any one issuer, [Fund
only] except that all or substantially all of the assets of the
Fund may be invested in another registered investment company
having the same investment objective and substantially similar
investment policies as the Fund;
(4) purchase or sell real estate (although it may purchase
securities secured by real estate or interests therein, or
securities issued by companies which invest in real estate, or
interests therein);
(5) purchase or sell commodities or commodities contracts or
oil, gas or mineral programs, except that it may enter into (i)
futures and options on futures and (ii) forward contracts;
(6) purchase securities on margin, except for use of short-
term credit necessary for clearance of purchases and sales of
portfolio securities, but it may make margin deposits in
connection with transactions in options, futures, and options on
futures;
(7) make loans, although it may (a) lend portfolio securities
and participate in an interfund lending program with other Stein
Roe Funds and Portfolios provided that no such loan may be made
if, as a result, the aggregate of such loans would exceed 33 1/3%
of the value of its total assets (taken at market value at the
time of such loans); (b) purchase money market instruments and
enter into repurchase agreements; and (c) acquire publicly
distributed or privately placed debt securities;
(8) borrow except that it may (a) borrow for nonleveraging,
temporary or emergency purposes, (b) engage in reverse repurchase
agreements and make other borrowings, provided that the
combination of (a) and (b) shall not exceed 33 1/3% of the value
of its total assets (including the amount borrowed) less
liabilities (other than borrowings) or such other percentage
permitted by law, and (c) enter into futures and options
transactions; it may borrow from banks, other Stein Roe Funds and
Portfolios, and other persons to the extent permitted by
applicable law;
(9) act as an underwriter of securities, except insofar as it
may be deemed to be an "underwriter" for purposes of the
Securities Act of 1933 on disposition of securities acquired
subject to legal or contractual restrictions on resale, [Fund
only] except that all or substantially all of the assets of the
Fund may be invested in another registered investment company
having the same investment objective and substantially similar
investment policies as the Fund; or
(10) issue any senior security except to the extent permitted
under the Investment Company Act of 1940.
The above restrictions are fundamental policies and may not
be changed without the approval of a "majority of the outstanding
voting securities," as previously defined herein. The policy on
the scope of transactions involving lending of portfolio
securities to broker-dealers and banks (as set forth herein under
Portfolio Investments and Strategies) is also a fundamental
policy.
The Fund and the Portfolio are also subject to the following
restrictions and policies that may be changed by the Board of
Trustees. None of the following restrictions shall prevent the
Fund from investing all or substantially all of its assets in
another investment company having the same investment objective
and substantially similar investment policies as the Fund. Unless
otherwise indicated, the Fund and the Portfolio may not:
(A) invest for the purpose of exercising control or
management;
(B) purchase more than 3% of the stock of another investment
company or purchase stock of other investment companies equal to
more than 5% of its total assets (valued at time of purchase) in
the case of any one other investment company and 10% of such
assets (valued at time of purchase) in the case of all other
investment companies in the aggregate; any such purchases are to
be made in the open market where no profit to a sponsor or dealer
results from the purchase, other than the customary broker's
commission, except for securities acquired as part of a merger,
consolidation or acquisition of assets;/4/
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/4/ Stein Roe Funds have been informed that the staff of the
Securities and Exchange Commission takes the position that the
issuers of certain CMOs and certain other collateralized assets
are investment companies and that subsidiaries of foreign banks
may be investment companies for purposes of Section 12(d)(1) of
the Investment Company Act of 1940, which limits the ability of
one investment company to invest in another investment company.
Accordingly, the Portfolio intends to operate within the
applicable limitations under Section 12(d)(1)(A) of that Act.
- ----------------
(C) purchase portfolio securities from, or sell portfolio
securities to, any of the officers and directors or trustees of
the Trust or of its investment adviser;
(D) purchase shares of other open-end investment companies,
except in connection with a merger, consolidation, acquisition, or
reorganization;
(E) invest more than 5% of its net assets (valued at time of
investment) in warrants, nor more than 2% of its net assets in
warrants which are not listed on the New York or American Stock
Exchange;
(F) purchase a put or call option if the aggregate premiums
paid for all put and call options exceed 20% of its net assets
(less the amount by which any such positions are in-the-money),
excluding put and call options purchased as closing transactions;
(G) write an option on a security unless the option is issued
by the Options Clearing Corporation, an exchange, or similar
entity;
(H) invest in limited partnerships in real estate unless they
are readily marketable;
(I) sell securities short unless (i) it owns or has the right
to obtain securities equivalent in kind and amount to those sold
short at no added cost or (ii) the securities sold are "when
issued" or "when distributed" securities which it expects to
receive in a recapitalization, reorganization, or other exchange
for securities it contemporaneously owns or has the right to
obtain and provided that transactions in options, futures, and
options on futures are not treated as short sales;
(J) invest more than 15% of its total assets (taken at market
value at the time of a particular investment) in restricted
securities, other than securities eligible for resale pursuant to
Rule 144A under the Securities Act of 1933;
(K) invest more than 15% of its net assets (taken at market
value at the time of a particular investment) in illiquid
securities/5/, including repurchase agreements maturing in more
than seven days.
- --------------------
/5/ In the judgment of Stein Roe, Private Placement Notes, which
are issued pursuant to Section 4(2) of the Securities Act of 1933,
generally are readily marketable even though they are subject to
certain legal restrictions on resale. As such, they are not
treated as being subject to the limitation on illiquid securities.
- --------------------
ADDITIONAL INVESTMENT CONSIDERATIONS
Stein Roe seeks to provide superior long-term investment
results through a disciplined, research-intensive approach to
investment selection and prudent risk management. In working to
take sensible risks and make intelligent investments, it has been
guided by three primary objectives which it believes are the
foundation of a successful investment program. These objectives
are preservation of capital, limited volatility through managed
risk, and consistent above-average returns, as appropriate for the
particular client or managed account.
Because every investor's needs are different, Stein Roe
mutual funds are designed to accommodate different investment
objectives, risk tolerance levels, and time horizons. In
selecting a mutual fund, investors should ask the following
questions:
What are my investment goals?
It is important to a choose a fund that has investment objectives
compatible with your investment goals.
What is my investment time frame?
If you have a short investment time frame (e.g., less than three
years), a mutual fund that seeks to provide a stable share price,
such as a money market fund, or one that seeks capital
preservation as one of its objectives may be appropriate. If you
have a longer investment time frame, you may seek to maximize your
investment returns by investing in a mutual fund that offers
greater yield or appreciation potential in exchange for greater
investment risk.
What is my tolerance for risk?
All investments, including those in mutual funds, have risks which
will vary depending on investment objective and security type.
However, mutual funds seek to reduce risk through professional
investment management and portfolio diversification.
In general, equity mutual funds emphasize long-term capital
appreciation and tend to have more volatile net asset values than
bond or money market mutual funds. Although there is no guarantee
that they will be able to maintain a stable net asset value of
$1.00 per share, money market funds emphasize safety of principal
and liquidity, but tend to offer lower income potential than bond
funds. Bond funds tend to offer higher income potential than
money market funds but tend to have greater risk of principal and
yield volatility.
In addition, Stein Roe believes that investment in a high
yield fund provides an opportunity to diversify an investment
portfolio because the economic factors that affect the performance
of high-yield, high-risk debt securities differ from those that
affect the performance of high-quality debt securities or equity
securities.
PURCHASES AND REDEMPTIONS
The initial purchase minimum is $250,000 and the minimum
subsequent investment is $10,000. For more information on how to
purchase Fund shares, please call Stein Roe Retirement Services at
800-322-1130. The Trust reserves the right to waive or lower its
investment minimums for any reason.
You may purchase (or redeem) shares through certain broker-
dealers, banks, or other intermediaries ("Intermediaries").
Intermediaries may charge for their services or place limitations
on the extent to which you may use the services offered by the
Trust. It is the responsibility of any such Intermediary to
establish procedures insuring the prompt transmission to the Trust
of any such purchase order. An Intermediary, who accepts orders
that are processed at the net asset value next determined after
receipt of the order by the Intermediary, accepts such orders as
authorized agent or designee of the Fund. The Intermediary is
required to segregate any orders received on a business day after
the close of regular session trading on the New York Stock
Exchange and transmit those orders separately for execution at the
net asset value next determined after that business day.
Some Intermediaries that maintain nominee accounts with the
Fund for their clients for whom they hold Fund shares charge an
annual fee of up to 0.35% of the average net assets held in such
accounts for accounting, servicing, and distribution services they
provide with respect to the underlying Fund shares. Stein Roe and
the Fund's transfer agent share in the expense of these fees, and
Stein Roe pays all sales and promotional expenses.
Each purchase order for the Fund must be accepted by an
authorized officer of the Trust or its authorized agent and is not
binding until accepted and entered on the books of the Fund. Once
your purchase order has been accepted, you may not cancel or
revoke it; you may, however, redeem the shares. The Trust
reserves the right not to accept any purchase order that it
determines not to be in the best interests of the Trust or of the
Fund's shareholders. Each purchase of the Fund's shares is made
at its net asset value next determined after receipt of an order
in good form, including receipt of payment by the Fund.
Fund shares may be redeemed any day the New York Stock
Exchange ("NYSE") is open at the net asset value next calculated
after a redemption order is received and accepted by the Trust.
Redemption instructions may not be cancelled or revoked once they
have been received and accepted by the Trust. The Trust cannot
accept a redemption request that specifies a particular date or
price for redemption or any special conditions. Because the
redemption price you receive depends upon the Fund's net asset
value per share at the time of redemption, it may be more or less
than the price you originally paid for the shares and may result
in a realized capital gain or loss. The Trust will generally mail
payment for shares redeemed within seven days after proper
instructions are received.
Net asset value is determined on days on which the New York
Stock Exchange (the "NYSE") is open for trading. The NYSE is
regularly closed on Saturdays and Sundays and on New Year's Day,
the third Monday in January, the third Monday in February, Good
Friday, the last Monday in May, Independence Day, Labor Day,
Thanksgiving, and Christmas. If one of these holidays falls on a
Saturday or Sunday, the NYSE will be closed on the preceding
Friday or the following Monday, respectively. Net asset value
will not be determined on days when the NYSE is closed unless, in
the judgment of the Board of Trustees, net asset value should be
determined on any such day, in which case the determination will
be made at 3:00 p.m., Central time.
The Trust reserves the right to suspend or postpone
redemptions of shares of its series during any period when: (a)
trading on the NYSE is restricted, as determined by the Securities
and Exchange Commission, or the NYSE is closed for other than
customary weekend and holiday closings; (b) the Securities and
Exchange Commission has by order permitted such suspension; or (c)
an emergency, as determined by the Securities and Exchange
Commission, exists, making disposal of portfolio securities or
valuation of net assets of a series not reasonably practicable.
The Trust intends to pay all redemptions in cash and is
obligated to redeem shares of its series solely in cash up to the
lesser of $250,000 or one percent of the net assets of the Fund
during any 90-day period for any one shareholder. However,
redemptions in excess of such limit may be paid wholly or partly
by a distribution in kind of securities. If redemptions were made
in kind, the redeeming shareholders might incur transaction costs
in selling the securities received in the redemptions.
Due to the relatively high cost of maintaining smaller
accounts, the Trust reserves the right to redeem shares in any
account for their then-current value (which will be promptly paid
to the investor) if at any time the shares in the account do not
have a value of at least $250,000. An investor will be notified
that the value of his account is less than the minimum and allowed
at least 30 days to bring the value of the account up to at least
$250,000 before the redemption is processed. The Agreement and
Declaration of Trust also authorizes the Trust to redeem shares
under certain other circumstances as may be specified by the Board
of Trustees.
MANAGEMENT
The Board of Trustees of the Trust has overall management
responsibility for the Trust and the Fund. The following table
sets forth certain information with respect to trustees and
officers of the Trust:
Name, Age; Address; Position(s) held with the Trust. Principal
occupation(s) during past five years
William D. Andrews, 52; One South Wacker Drive, Chicago, IL 60606
(4); Executive Vice-President. Executive vice president of Stein
Roe & Farnham Incorporated ("Stein Roe")
John A. Bacon Jr., 72; 4N640 Honey Hill Road, Box 296, Wayne, IL
60184 (3)(4); Trustee. Private investor
Christine Balzano, 34; 245 Summer Street, Boston, MA 02210; Vice-
President. Senior vice president of Liberty Funds Services, Inc.;
formerly vice president and assistant vice president
William W. Boyd, 72; 2900 Golf Road, Rolling Meadows, IL 60008
(2)(3)(4); Trustee. Chairman and director of Sterling Plumbing
(manufacturer of plumbing products)
Kevin M. Carome, 43; One Financial Center, Boston, MA 02111 (4);
Executive Vice-President; Assistant Secretary. Senior vice
president, legal, Liberty Funds Group LLC (an affiliate of Stein
Roe) since Jan. 1999; general counsel and secretary of Stein Roe
since Jan. 1998; associate general counsel and vice president of
Liberty Financial Companies, Inc. (the indirect parent of Stein
Roe) through Jan. 1999
J. Kevin Connaughton, 35; 245 Summer Street, Boston, MA 02210 (4);
Vice-President; Treasurer. Vice president of Colonial Management
Associates, Inc. ("CMA") , since February 1998; senior tax
manager, Coopers & Lybrand, LLP from April 1996 to January 1998;
vice president, 440 Financial Group/First Data Investor Services
Group prior thereto
Lindsay Cook, 47; 600 Atlantic Avenue, Boston, MA 02210 (1)(2)(4);
Trustee. Executive vice president of Liberty Financial Companies,
Inc. since March 1997; senior vice president prior thereto
Michael G. Fisher, 30; 245 Summer Street, Boston, MA 02210 (4);
Vice-President. Tax manager with Liberty Funds Group since Oct.
1998; tax manager with PricewaterhouseCoopers LLC prior thereto
Stephen E. Gibson, 46; One Financial Center, Boston, MA 02111 (4);
President. Vice chairman of Stein Roe since Aug. 1998; chairman,
CEO, president and director of Liberty Funds Group since Dec.
1998; chairman of the Colonial Group from July 1998 to Dec. 1998;
president of the Colonial Group from Dec. 1996 to Dec. 1998;
chairman of Colonial Management Associates, Inc. since Dec. 1998;
CEO, president and director of Colonial Management Associates
since July 1996; managing director of Putnam Financial Services
from June 1992 through June 1996
Douglas A. Hacker, 43; P.O. Box 66100, Chicago, IL 60666 (3)(4);
Trustee/Manager. Senior vice president and chief financial
officer of UAL, Inc. (airline)
Loren A. Hansen, 51; One South Wacker Drive, Chicago, IL 60606
(4); Executive Vice-President. Chief investment officer/equity of
Colonial Management Associates, Inc. since 1997; executive vice
president of Stein Roe since Dec. 1995; vice president of The
Northern Trust (bank) prior thereto
Timothy J. Jacoby, 47; One Financial Center, Boston, MA 02111 (4);
Senior Vice-President. Fund treasurer for Liberty Funds Group LLC
since Sept. 1996 and chief financial officer since Aug. 1997;
senior vice president of Fidelity Investments prior thereto
Janet Langford Kelly, 41; One Kellogg Square, Battle Creek, MI
49016 (3)(4); Trustee. Executive vice president-corporate
development, general counsel and secretary of Kellogg Company
since Sept. 1999; senior vice president, secretary and general
counsel of Sara Lee Corporation (branded, packaged, consumer-
products manufacturer) from 1995 to Aug. 1999; partner of Sidley &
Austin (law firm) prior thereto
Michael T. Kennedy, 37; One South Wacker Drive, Chicago, IL 60606
(4); Vice-President. Senior vice president of Stein Roe
Gail D. Knudsen, 37; 245 Summer Street, Boston, MA 02210 (4);
Vice-President; Controller. Vice president and assistant
controller of CMA
Stephen F. Lockman, 38; One South Wacker Drive, Chicago, IL 60606
(4); Vice-President. Senior vice president, portfolio manager,
and credit analyst of Stein Roe
Lynn C. Maddox, 58; One South Wacker Drive, Chicago, IL 60606;
Vice-President. Senior vice president of Stein Roe
Mary D. McKenzie, 45; One Financial Center, Boston, MA 02111 (4);
Vice-President. President of Liberty Funds Services, Inc.
Jane M. Naeseth, 49; One South Wacker Drive, Chicago, IL 60606;
Vice-President. Senior vice president of Stein Roe
Charles R. Nelson, 57; Department of Economics, University of
Washington, Seattle, WA 98195 (3)(4); Trustee. Van Voorhis
Professor of Political Economy of the University of Washington
Nicholas Norton, 40; 12100 East Iliff Avenue, Aurora, CO 80014
(4); Vice-President. Senior vice president of Liberty Funds
Services, Inc. since Aug. 1999; vice president of Scudder Kemper,
Inc. from May 1994 to Aug. 1999
Nicolette D. Parrish, 49; One South Wacker Drive, Chicago, IL
60606 (4); Vice-President; Assistant Secretary. Senior legal
assistant and assistant secretary of Stein Roe
Thomas C. Theobald, 62; Suite 1300, 222 West Adams Street,
Chicago, IL 60606 (3)(4); Trustee. Managing director, William
Blair Capital Partners (private equity fund)
Heidi J. Walter, 32; One South Wacker Drive, Chicago, IL 60606
(4); Vice-President; Secretary. Vice president of Stein Roe since
March 1998; senior legal counsel for Stein Roe since Feb. 1998;
legal counsel for Stein Roe from March 1995 to Jan. 1998;
associate with Beeler Schad & Diamond, PC (law firm) prior thereto
______________________
(1) Trustee who is an "interested person" of the Trust and of
Stein Roe, as defined in the Investment Company Act of 1940.
(2) Member of the Executive Committee of the Board of Trustees,
which is authorized to exercise all powers of the Board with
certain statutory exceptions.
(3) Member of the Audit Committee of the Board, which makes
recommendations to the Board regarding the selection of
auditors and confers with the auditors regarding the scope and
results of the audit.
(4) This person holds the corresponding officer or trustee
position with SR&F Base Trust.
Certain of the trustees and officers of the Fund and the
Portfolio are trustees or officers of other investment companies
managed by Stein Roe; and some of the officers are also officers
of Liberty Funds Distributor, Inc., the Fund's distributor.
Officers and trustees affiliated with Stein Roe serve without
any compensation from the Trust. In compensation for their
services to the Trust, trustees who are not "interested persons"
of the Trust or Stein Roe are paid an annual retainer plus an
attendance fee for each meeting of the Board or standing committee
thereof attended. The Trust has no retirement or pension plan.
The following table sets forth compensation paid during the fiscal
year ended June 30, 1999 to each of the trustees:
Compensation from the
Stein Roe Fund Complex*
-----------------------
Aggregate Compensation Total Average
Name of Trustee from the Trust Compensation Per Series
- ------------------- -------------------- ------------ ----------
Thomas W. Butch** -0- -0- -0-
Lindsay Cook -0- -0- -0-
John A. Bacon Jr.** $1,550 $101,150 $2,199
William W. Boyd 1,400 102,300 2,224
Douglas A. Hacker 1,300 87,700 1,907
Janet Langford Kelly 1,300 97,200 2,113
Charles R. Nelson 1,400 102,100 2,220
Thomas C. Theobald 1,300 97,200 2,113
_______________
*At June 30, 1999, the Stein Roe Fund Complex consisted of one
series of the Trust, four series of Liberty-Stein Roe Funds
Income Trust, four series of Liberty-Stein Roe Funds Municipal
Trust, 12 series of Liberty-Stein Roe Funds Investment Trust,
five series of Liberty-Stein Roe Advisor Trust, five series of
SteinRoe Variable Investment Trust, 12 portfolios of SR&F Base
Trust, Liberty-Stein Roe Advisor Floating Rate Fund, Liberty-
Stein Roe Institutional Floating Rate Income Fund, and Stein Roe
Floating Rate Limited Liability Company.
**Mr. Butch served as a trustee until Nov. 3, 1998 and Mr. Bacon
was elected a trustee effective Nov. 3, 1998
FINANCIAL STATEMENTS
Please refer to the June 30, 1999 Financial Statements
(statements of assets and liabilities and schedule of investments
as of June 30, 1999 and the statement of operations, changes in
net assets, and notes thereto) and the report of independent
auditors contained in the Fund's June 30, 1999 Annual Report. The
Financial Statements and the report of independent auditors (but
no other material from the Annual Report) are incorporated herein
by reference. The Annual Report may be obtained at no charge by
telephoning 800-338-2550.
PRINCIPAL SHAREHOLDERS
As of July 30, 1999, the only persons known by the Trust to
own of record or "beneficially" 5% or more of outstanding shares
of the Fund within the definition of that term as contained in
Rule 13d-3 under the Securities Exchange Act of 1934 were as
follows:
Approximate % of
Outstanding
Name and Address Shares Held
Covenant Benevolent Institution
5145 North California
Chicago, IL 60625 31.8%
Fireman's Annuity & Benefit Fund of Chicago
1 North Franklin Street, Suite 2550
Chicago, IL 60606 41.8%
John W. Anderson Foundation
402 Wall Street
Valparaiso, IN 46383 9.2%
National City Bank, Trustee
Akron General Medical Center
Defined Benefit Pension Trust
P.O. Box 94984
Cleveland, OH 44101 6.5%
GFS Holding, Inc.
333 Fiftieth Street, SW
P.O. Box 1787
Grand Rapids, MI 49501 8.5%
As of July 30, 1999, 5,650,857 shares, or approximately 99.9%
of outstanding shares, were held by clients of Stein Roe in their
client accounts. Stein Roe may have discretionary authority over
such shares and, accordingly, they could be deemed to be owned
"beneficially" by Stein Roe under Rule 13d-3. However, Stein Roe
disclaims actual beneficial ownership of such shares. No shares
were held by trustees and officers of the Trust.
INVESTMENT ADVISORY AND OTHER SERVICES
Stein Roe & Farnham Incorporated provides administrative
services to the Fund and the Portfolio and portfolio management
services to the Portfolio. Stein Roe is a wholly owned subsidiary
of SteinRoe Services Inc. ("SSI"), the Fund's transfer agent,
which is a wholly owned subsidiary of Liberty Financial Companies,
Inc. ("Liberty Financial"), which is a majority owned subsidiary
of Liberty Corporate Holdings, Inc., which is a wholly owned
subsidiary of LFC Holdings, Inc., which is a wholly owned
subsidiary of Liberty Mutual Equity Corporation, which is a wholly
owned subsidiary of Liberty Mutual Insurance Company. Liberty
Mutual Insurance Company is a mutual insurance company,
principally in the property/casualty insurance field, organized
under the laws of Massachusetts in 1912.
The directors of Stein Roe are Kenneth R. Leibler, C. Allen
Merritt, Jr., and Thomas W. Butch. Mr. Leibler is President and
Chief Executive Officer of Liberty Financial; Mr. Merritt is Chief
Operating Officer of Liberty Financial; and Mr. Butch is President
of Stein Roe's Mutual Funds division. The business address of
Messrs. Leibler and Merritt is Federal Reserve Plaza, Boston, MA
02210; and that of Mr. Butch is One South Wacker Drive, Chicago,
IL 60606.
Stein Roe and its predecessor have been providing investment
advisory services since 1932. Stein Roe acts as investment
adviser to wealthy individuals, trustees, pension and profit
sharing plans, charitable organizations, and other institutional
investors. As of June 30, 1999, Stein Roe managed over $22.2
billion in assets: over $6.3 billion in equities and over $15.9
billion in fixed income securities (including $1 billion in
municipal securities). The $22.2 billion in managed assets
included over $9.2 billion held by mutual funds managed by Stein
Roe (approximately 15% of the mutual fund assets were held by
clients of Stein Roe). These mutual funds were owned by over
282,000 shareholders. The $9.2 billion in mutual fund assets
included over $679 million in over 42,000 IRA accounts. In
managing those assets, Stein Roe utilizes a proprietary computer-
based information system that maintains and regularly updates
information for approximately 7,500 companies. Stein Roe also
monitors over 1,400 issues via a proprietary credit analysis
system. At June 30, 1999, Stein Roe employed 18 research analysts
and 54 account managers. The average investment-related
experience of these individuals was 17 years.
In return for its services, Stein Roe is entitled to receive
a monthly administrative fee from the Fund and a monthly
management fee from the Portfolio. The table below shows the
annual rates of such fees as a percentage of average net assets
(shown in millions), gross fees paid for the three most recent
fiscal years, and any expense reimbursements by Stein Roe:
<TABLE>
<CAPTION>
Current Rates
(as a % of Year Ended Year Ended Period Ended
Fund Type average net assets) 6/30/99 6/30/98 6/30/97
- ---------- ------------------ --------------------------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Fund Administrative fee .150% up to $500 million,
.125% thereafter $ 67,734 $ 46,114 $ 6,454
Reimbursement Expenses exceeding .50% 211,888 240,886 90,036
Portfolio Management fee .500% up to $500 million,
.475% thereafter 419,766 307,472 52,997
</TABLE>
Stein Roe provides office space and executive and other
personnel to the Fund and bears any sales or promotional expenses.
The Fund pays all expenses other than those paid by Stein Roe,
including but not limited to printing and postage charges,
securities registration and custodian fees, and expenses
incidental to its organization.
The Fund's administrative agreement provides that Stein Roe
shall reimburse the Fund to the extent that its total annual
expenses (including fees paid to Stein Roe, but excluding taxes,
interest, brokers' commissions and other normal charges incident
to the purchase and sale of portfolio securities, and expenses of
litigation to the extent permitted under applicable state law)
exceed the applicable limits prescribed by any state in which
shares of the Fund are being offered for sale to the public;
however, such reimbursement for any fiscal year will not exceed
the amount of the fees paid by the Fund under that agreement for
such year. In addition, in the interest of further limiting the
Fund's expenses, Stein Roe may waive its fees and/or absorb
certain its expenses. Any such reimbursements will enhance the
yield of the Fund.
The Portfolio's management agreement provides that neither
Stein Roe nor any of its directors, officers, stockholders (or
partners of stockholders), agents, or employees shall have any
liability to SR&F Base Trust or any shareholder for any error of
judgment, mistake of law or any loss arising out of any
investment, or for any other act or omission in the performance by
Stein Roe of its duties under the agreement, except for liability
resulting from willful misfeasance, bad faith or gross negligence
on Stein Roe's part in the performance of its duties or from
reckless disregard by Stein Roe of its obligations and duties
under that agreement.
Any expenses that are attributable solely to the
organization, operation, or business of a series of the Trust are
paid solely out of the assets of that series. Any expenses
incurred by the Trust that are not solely attributable to a
particular series are apportioned in such manner as Stein Roe
determines is fair and appropriate, unless otherwise specified by
the Board of Trustees.
Bookkeeping and Accounting Agreement
Pursuant to a separate agreement with the Trust, Stein Roe
receives a fee for performing certain bookkeeping and accounting
services. For these services, Stein Roe receives an annual fee of
$25,000 per series plus .0025 of 1% of average net assets over $50
million. During the fiscal years ended June 30, 1999, 1998 and
1997, Stein Roe received aggregate fees of $25,000, $24,999 and
$9,524, respectively, for services performed under this agreement.
DISTRIBUTOR
Shares of the Fund are distributed by Liberty Funds
Distributor, Inc. ("Distributor"), One Financial Center, Boston,
MA 02111, under a Distribution Agreement. The Distributor is a
subsidiary of Colonial Management Associates, Inc., which is an
indirect subsidiary of Liberty Financial.
The Distribution Agreement continues in effect from year to
year, provided such continuance is approved annually (1) by a
majority of the trustees or by a majority of the outstanding
voting securities of the Trust, and (2) by a majority of the
trustees who are not parties to the Agreement or interested
persons of any such party. The Trust has agreed to pay all
expenses in connection with registration of its shares with the
Securities and Exchange Commission and auditing and filing fees in
connection with registration of its shares under the various state
blue sky laws and assumes the cost of preparation of prospectuses
and other expenses.
As agent, the Distributor offers Fund shares to investors in
states where the shares are qualified for sale, at net asset
value, without sales commissions or other sales load to the
investor. No sales commission or "12b-1" payment is paid by the
Fund. The distributor offers shares only on a best-efforts basis.
TRANSFER AGENT
SteinRoe Services Inc. ("SSI"), One South Wacker Drive,
Chicago, IL 60606, is the agent of the Trust for the transfer of
shares, disbursement of dividends, and maintenance of shareholder
accounting records. For performing these services, SSI receives
from the Fund a fee based on an annual rate of .05 of 1% of its
average daily net assets. The Board of Trustees believes the
charges by SSI are comparable to those of other companies
performing similar services. (See Investment Advisory and Other
Services.) Under a separate agreement, SSI provides certain
investor accounting services to the Portfolio.
CUSTODIAN
State Street Bank and Trust Company (the "Bank"), 225
Franklin Street, Boston, MA 02101, is the custodian for the Trust
and SR&F Base Trust. It is responsible for holding all securities
and cash, receiving and paying for securities purchased,
delivering against payment securities sold, receiving and
collecting income from investments, making all payments covering
expenses, and performing other administrative duties, all as
directed by authorized persons. The Bank does not exercise any
supervisory function in such matters as purchase and sale of
portfolio securities, payment of dividends, or payment of
expenses.
Portfolio securities purchased in the U.S. are maintained in
the custody of the Bank or of other domestic banks or
depositories. Portfolio securities purchased outside of the U.S.
are maintained in the custody of foreign banks and trust companies
that are members of the Bank's Global Custody Network and foreign
depositories ("foreign sub-custodians"). Each of the domestic and
foreign custodial institutions holding portfolio securities has
been approved by the Board of Trustees in accordance with
regulations under the Investment Company Act of 1940.
Each Board of Trustees reviews, at least annually, whether it
is in the best interests of the Fund, the Portfolio, and their
shareholders to maintain assets in each custodial institution.
However, with respect to foreign sub-custodians, there can be no
assurance that it, and the value of its shares, will not be
adversely affected by acts of foreign governments, financial or
operational difficulties of the foreign sub-custodians,
difficulties and costs of obtaining jurisdiction over, or
enforcing judgments against, the foreign sub-custodians, or
application of foreign law to the foreign sub-custodial
arrangements. Accordingly, an investor should recognize that the
non-investment risks involved in holding assets abroad are greater
than those associated with investing in the United States.
The Fund and the Portfolio may invest in obligations of the
Bank and may purchase or sell securities from or to the Bank.
INDEPENDENT AUDITORS
The independent auditors for the Trust and the Portfolio are
Ernst & Young LLP, 200 Clarendon Street, Boston, MA 02116. The
independent auditors audit and report on the annual financial
statements, review certain regulatory reports and the federal
income tax returns, and perform other professional accounting,
auditing, tax and advisory services when engaged to do so by the
applicable Trust.
PORTFOLIO TRANSACTIONS
Stein Roe places the orders for the purchase and sale of
portfolio securities and options and futures contracts for its
clients, including private clients and mutual fund clients
("Clients"). Purchases and sales of portfolio securities are
ordinarily transacted with the issuer or with a primary market
maker acting as principal or agent for the securities on a net
basis, with no brokerage commission being paid by a Portfolio.
Transactions placed through dealers reflect the spread between the
bid and asked prices. Occasionally, a Portfolio may make
purchases of underwritten issues at prices that include
underwriting discounts or selling concessions.
Stein Roe's overriding objective in selecting brokers and
dealers to effect portfolio transactions is to seek the best
combination of net price and execution. The best net price,
giving effect to brokerage commissions, if any, is an important
factor in this decision; however, a number of other judgmental
factors may also enter into the decision. These factors include
Stein Roe's knowledge of negotiated commission rates currently
available and other current transaction costs; the nature of the
security being purchased or sold; the size of the transaction; the
desired timing of the transaction; the activity existing and
expected in the market for the particular security;
confidentiality; the execution, clearance and settlement
capabilities of the broker or dealer selected and others
considered; Stein Roe's knowledge of the financial condition of
the broker or dealer selected and such other brokers and dealers;
and Stein Roe's knowledge of actual or apparent operation problems
of any broker or dealer.
Recognizing the value of these factors, Stein Roe may cause a
Client to pay a brokerage commission in excess of that which
another broker may have charged for effecting the same
transaction. Stein Roe has established internal policies for the
guidance of its trading personnel, specifying minimum and maximum
commissions to be paid for various types and sizes of transactions
and effected for Clients in those cases where Stein Roe has
discretion to select the broker or dealer by which the transaction
is to be executed. Stein Roe has discretion for all trades of the
Portfolios. Transactions which vary from the guidelines are
subject to periodic supervisory review. These guidelines are
reviewed and periodically adjusted, and the general level of
brokerage commissions paid is periodically reviewed by Stein Roe.
Evaluations of the reasonableness of brokerage commissions, based
on the factors described in the preceding paragraph, are made by
Stein Roe's trading personnel while effecting portfolio
transactions. The general level of brokerage commissions paid is
reviewed by Stein Roe, and reports are made annually to the Board
of Trustees.
Stein Roe maintains and periodically updates a list of
approved brokers and dealers which, in Stein Roe's judgment, are
generally capable of providing best price and execution and are
financially stable. Stein Roe's traders are directed to use only
brokers and dealers on the approved list, except in the case of
Client designations of brokers or dealers to effect transactions
for such Clients' accounts. Stein Roe generally posts certain
Client information on the "Alert" broker database system as a
means of facilitating the trade affirmation and settlement
process.
It is Stein Roe's practice, when feasible, to aggregate for
execution as a single transaction orders for the purchase or sale
of a particular security for the accounts of several Clients, in
order to seek a lower commission or more advantageous net price.
The benefit, if any, obtained as a result of such aggregation
generally is allocated pro rata among the accounts of Clients
which participated in the aggregated transaction. In some
instances, this may involve the use of an "average price"
execution wherein a broker or dealer to which the aggregated order
has been given will execute the order in several separate
transactions during the course of a day at differing prices and,
in such case, each Client participating in the aggregated order
will pay or receive the same price and commission, which will be
an average of the prices and commissions for the several separate
transactions executed by the broker or dealer.
Stein Roe sometimes makes use of an indirect electronic
access to the New York Stock Exchange's "SuperDOT" automated
execution system, provided through a NYSE member floor broker, W&D
Securities, Inc., a subsidiary of Jeffries & Co., Inc.,
particularly for the efficient execution of smaller orders in NYSE
listed equities. Stein Roe sometimes uses similar arrangements
through Billings & Co., Inc. and Driscoll & Co., Inc., floor
broker members of the Chicago Stock Exchange, for transactions to
be executed on that exchange. In using these arrangements, Stein
Roe must instruct the floor broker to refer the executed
transaction to another brokerage firm for clearance and
settlement, as the floor brokers do not deal with the public.
Transactions of this type sometimes are referred to as "step-in"
or "step-out" transactions. The brokerage firm to which the
executed transaction is referred may include, in the case of
transactions effected through W&D Securities, brokerage firms
which provide Stein Roe investment research or related services.
Stein Roe places certain trades for the Portfolios through
its affiliate AlphaTrade, Inc. ("ATI"). ATI is a wholly owned
subsidiary of Colonial Management Associates, Inc. ATI is a fully
disclosed introducing broker that limits its activities to
electronic execution of transactions in listed equity securities.
The Portfolios pay ATI a commission for these transactions. The
Funds and the Portfolios have adopted procedures consistent with
Investment Company Act Rule 17e-1 governing such transactions.
Certain of Stein Roe's officers also serve as officers, directors
and/or employees of ATI.
Consistent with the Rules of Fair Practice of National
Securities Dealers, Inc. and subject to seeking best executing and
such other policies as the trustees of the Funds may determine,
Stein Roe may consider sales of shares of each of the Funds as a
factor in the selection of broker-dealers to execute such mutual
fund securities transactions.
Investment Research Products and Services Furnished by Brokers and
Dealers
Stein Roe engages in the long-standing practice in the money
management industry of acquiring research and brokerage products
and services ("research products") from broker-dealer firms in
return directing trades for Client accounts to those firms. In
effect, Stein Roe is using the commission dollars generated from
these Client accounts to pay for these research products. The
money management industry uses the term "soft dollars" to refer to
this industry practice. Stein Roe may engage in soft dollar
transactions on trades for those Client accounts for which Stein
Roe has the discretion to select the brokers-dealer.
The ability to direct brokerage for a Client account belongs
to the Client and not to Stein Roe. When a Client grants Stein
Roe the discretion to select broker-dealers for Client trades,
Stein Roe has a duty to seek the best combination of net price and
execution. Stein Roe faces a potential conflict of interest with
this duty when it uses Client trades to obtain soft dollar
products. This conflict exists because Stein Roe is able to use
the soft dollar products in managing its Client accounts without
paying cash ("hard dollars") for the product. This reduces Stein
Roe's expenses.
Moreover, under a provision of the federal securities laws
applicable to soft dollars, Stein Roe is not required to use the
soft dollar product in managing those accounts that generate the
trade. Thus, the Client accounts that generate the brokerage
commission used to acquire the soft dollar product may not benefit
directly from that product. In effect, those accounts are cross
subsidizing Stein Roe's management of the other accounts that do
benefit directly from the product. This practice is explicitly
sanctioned by a provision of the Securities Exchange Act of 1934,
which creates a "safe harbor" for soft dollar transactions
conducted in a specified manner. Although it is inherently
difficult, if not impossible, to document, Stein Roe believes that
over time most, if not all, Clients benefit from soft dollar
products such that cross subsidizations even out.
Stein Roe attempts to reduce or eliminate this conflict by
directing Client trades for soft dollar products only if Stein Roe
concludes that the broker-dealer supplying the product is capable
of providing a combination of the best net price and execution on
the trade. As noted above, the best net price, while significant,
is one of a number of judgmental factors Stein Roe considers in
determining whether a particular broker is capable of providing
the best net price and execution. Stein Roe may cause a Client
account to pay a brokerage commission in a soft dollar trade in
excess of that which another broker-dealer might have charged for
the same transaction.
Stein Roe acquires two types of soft dollar research
products: (i) proprietary research created by the broker-dealer
firm executing the trade and (ii) other products created by third
parties that are supplied to Stein Roe through the broker-dealer
firm executing the trade.
Proprietary research consists primarily of traditional
research reports, recommendations and similar materials produced
by the in house research staffs of broker-dealer firms. This
research includes evaluations and recommendations of specific
companies or industry groups, as well as analyses of general
economic and market conditions and trends, market data, contacts
and other related information and assistance. Stein Roe's
research analysts periodically rate the quality of proprietary
research produced by various broker-dealer firms. Based on these
evaluations, Stein Roe develops target levels of commission
dollars on a firm-by-firm basis. Stein Roe attempts to direct
trades to each firm to meet these targets.
Stein Roe also uses soft dollars to acquire products created
by third parties that are supplied to Stein Roe through broker-
dealers executing the trade (or other broker-dealers who "step in"
to a transaction and receive a portion of the brokerage commission
for the trade). These products include the following:
* Database Services-comprehensive databases containing current
and/or historical information on companies and industries.
Examples include historical securities prices, earnings
estimates, and SEC filings. These services may include software
tools that allow the user to search the database or to prepare
value-added analyses related to the investment process (such as
forecasts and models used in the portfolio management process).
* Quotation/Trading/News Systems-products that provide real time
market data information, such as pricing of individual
securities and information on current trading, as well as a
variety of news services.
* Economic Data/Forecasting Tools-various macro economic
forecasting tools, such as economic data and economic and
political forecasts for various countries or regions.
* Quantitative/Technical Analysis-software tools that assist in
quantitative and technical analysis of investment data.
* Fundamental Industry Analysis-industry-specific fundamental
investment research.
* Fixed Income Security Analysis-data and analytical tools that
pertain specifically to fixed income securities. These tools
assist in creating financial models, such as cash flow
projections and interest rate sensitivity analyses, that are
relevant to fixed income securities.
* Other Specialized Tools-other specialized products, such as
specialized economic consulting analyses and attendance at
investment oriented conferences.
Many third-party products include computer software or on-
line data feeds. Certain products also include computer hardware
necessary to use the product.
Certain of these third party services may be available
directly from the vendor on a hard dollar basis. Others are
available only through broker-dealer firms for soft dollars.
Stein Roe evaluates each product to determine a cash ("hard
dollars") value of the product to Stein Roe. Stein Roe then on a
product-by-product basis targets commission dollars in an amount
equal to a specified multiple of the hard dollar value to the
broker-dealer that supplies the product to Stein Roe. In general,
these multiples range from 1.25 to 1.85 times the hard dollar
value. Stein Roe attempts to direct trades to each firm to meet
these targets. (For example, if the multiple is 1.5:1.0, assuming
a hard dollar value of $10,000, Stein Roe will target to the
broker-dealer providing the product trades generating $15,000 in
total commissions.)
The targets that Stein Roe establishes for both proprietary
and for third party research products typically will reflect
discussions that Stein Roe has with the broker-dealer providing
the product regarding the level of commissions it expects to
receive for the product. However, these targets are not binding
commitments, and Stein Roe does not agree to direct a minimum
amount of commissions to any broker-dealer for soft dollar
products. In setting these targets, Stein Roe makes a
determination that the value of the product is reasonably
commensurate with the cost of acquiring it. These targets are
established on a calendar year basis. Stein Roe will receive the
product whether or not commissions directed to the applicable
broker-dealer are less than, equal to or in excess of the target.
Stein Roe generally will carry over target shortages and excesses
to the next year's target. Stein Roe believes that this practice
reduces the conflicts of interest associated with soft dollar
transactions, since Stein Roe can meet the non-binding
expectations of broker-dealers providing soft dollar products over
flexible time periods. In the case of third party products, the
third party is paid by the broker-dealer and not by Stein Roe.
Stein Roe may enter into a contract with the third party vendor to
use the product. (For example, if the product includes software,
Stein Roe will enter into a license to use the software from the
vendor.)
In certain cases, Stein Roe uses soft dollars to obtain
products that have both research and non-research purposes.
Examples of non-research uses are administrative and marketing
functions. These are referred to as "mixed use" products. As of
the date of this SAI, Stein Roe acquires two mixed use products.
These are (i) a fixed income security data service and (ii) a
mutual fund performance ranking service. In each case, Stein Roe
makes a good faith evaluation of the research and non-research
uses of these services. These evaluations are based upon the time
spent by Firm personnel for research and non-research uses. Stein
Roe pays the provider in cash ("hard dollars") for the non-
research portion of its use of these products.
Stein Roe may use research obtained from soft dollar trades
in the management of any of its discretionary accounts. Thus,
consistent with industry practice, Stein Roe does not require that
the Client account that generates the trade receive any benefit
from the soft dollar product obtained through the trade. As noted
above, this may result in cross subsidization of soft dollar
products among Client accounts. As noted therein, this practice
is explicitly sanctioned by a provision of the Securities Exchange
Act of 1934, which creates a "safe harbor" for soft dollar
transactions conducted in a specified manner.
In certain cases, Stein Roe will direct a trade to one
broker-dealer with the instruction that it execute the trade and
pay over a portion of the commission from the trade to another
broker-dealer who provides Stein Roe with a soft dollar research
product. The broker-dealer executing the trade "steps out" of a
portion of the commission in favor of the other broker-dealer
providing the soft dollar product. Stein Roe may engage in step
out transactions in order to direct soft dollar commissions to a
broker-dealer which provides research but may not be able to
provide best execution. Brokers who receive step out commissions
typically are brokers providing a third party soft dollar product
that is not available on a hard dollars basis. Stein Roe has not
engaged in step out transactions as a manner of compensating
broker-dealers that sell shares of investment companies managed by
Stein Roe.
For the last three fiscal years, the Portfolio paid no
brokerage commissions on futures transactions or any other
transactions.
The Board has reviewed the legal developments pertaining to
and the practicability of attempting to recapture underwriting
discounts or selling concessions when portfolio securities are
purchased in underwritten offerings. The Board has been advised
by counsel that recapture by a mutual fund currently is not
permitted under the Rules of the Association of the National
Association of Securities Dealers ("NASD").
The Trust has arranged for its custodian to act as a
soliciting dealer to accept any fees available to the custodian as
a soliciting dealer in connection with any tender offer for
portfolio securities. The custodian will credit any such fees
received against its custodial fees.
During the last fiscal year, the Portfolio held no securities
issued by its regular broker-dealers or the parent of such broker-
dealer that derives more than 15% of gross revenue from
securities-related activities.
ADDITIONAL INCOME TAX CONSIDERATIONS
The Fund intends to qualify under Subchapter M of the
Internal Revenue Code and to comply with the special provisions of
the Internal Revenue Code that relieve it of federal income tax to
the extent of net investment income and capital gains currently
distributed to shareholders.
Because capital gain distributions reduce net asset value, if
a shareholder purchases shares shortly before a record date, he
will, in effect, receive a return of a portion of his investment
in such distribution. The distribution would nonetheless be
taxable to him, even if the net asset value of shares were reduced
below his cost. However, for federal income tax purposes the
shareholder's original cost would continue as his tax basis.
The Fund expects that none of its dividends will qualify for
the deduction for dividends received by corporate shareholders.
INVESTMENT PERFORMANCE
The Fund may quote yield figures from time to time. "Yield"
is computed by dividing the net investment income per share earned
during a 30-day period (using the average number of shares
entitled to receive dividends) by the net asset value per share on
the last day of the period. The Yield formula provides for
semiannual compounding which assumes that net investment income is
earned and reinvested at a constant rate and annualized at the end
of a six-month period.
6
The Yield formula is as follows: YIELD = 2[((a-b/cd) +1) -
1].
Where: a = dividends and interest earned during the period
(For this purpose, the Fund will recalculate the
yield to maturity based on market value of each
portfolio security on each business day on which net
asset value is calculated.)
b = expenses accrued for the period (net of
reimbursements).
c = the average daily number of shares outstanding
during the period that were entitled to receive
dividends.
d = the ending net asset value of the Fund for the
period.
For example, the Yield of the Fund for the 30-day period ended
June 30, 1999 was 9.55%.
--------------
The Fund may quote total return figures from time to time. A
"Total Return" on a per share basis is the amount of dividends
received per share plus or minus the change in the net asset value
per share for a period. A "Total Return Percentage" may be
calculated by dividing the value of a share at the end of a period
(including reinvestment of distributions) by the value of the
share at the beginning of the period and subtracting one. For a
given period, an "Average Annual Total Return" may be computed by
finding the average annual compounded rate that would equate a
hypothetical initial amount invested of $1,000 to the ending
redeemable value.
n
Average Annual Total Return is computed as follows: ERV = P(1+T)
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000
payment made at the beginning of the period at the
end of the period (or fractional portion).
For example, for a $1,000 investment in the Fund, the "Total
Return," the "Total Return Percentage," and the "Average Annual
Total Return" at June 30, 1999 were:
Total Return Average Annual
Total Return Percentage Total Return
---------------------------------------------------------
1 year $1,042 4.20% 4.20%
Life of Fund*
______________
*Since commencement of operations on Feb. 14, 1997.
Investment performance figures assume reinvestment of all
dividends and distributions and do not take into account any
federal, state, or local income taxes which shareholders must pay
on a current basis. They are not necessarily indicative of future
results. The performance of the Fund is a result of conditions in
the securities markets, portfolio management, and operating
expenses. Although investment performance information is useful
in reviewing the Fund's performance and in providing some basis
for comparison with other investment alternatives, it should not
be used for comparison with other investments using different
reinvestment assumptions or time periods.
The Fund may note its mention in newspapers, magazines, or
other media from time to time. However, the Fund assumes no
responsibility for the accuracy of such data. Newspapers and
magazines that might mention the Fund include, but are not limited
to, the following:
Architectural Digest
Arizona Republic
Atlanta Constitution
Associated Press
Barron's
Bloomberg
Boston Herald
Business Week
Chicago Tribune
Chicago Sun-Times
Cleveland Plain Dealer
CNBC
CNN
Crain's Chicago Business
Consumer Reports
Consumer Digest
Dow Jones Newswire
Fee Advisor
Financial Planning
Financial World
Forbes
Fortune
Fund Action
Fund Decoder
Gourmet
Individual Investor
Investment Adviser
Investment Dealers' Digest
Investor's Business Daily
Kiplinger's Personal Finance Magazine
Knight-Ridder
Lipper Analytical Services
Los Angeles Times
Louis Rukeyser's Wall Street
Money
Morningstar
Mutual Fund Market News
Mutual Fund News Service
Mutual Funds Magazine
Newsweek
The New York Times
No-Load Fund Investor
Pension World
Pensions and Investment
Personal Investor
Physicians Financial News
Jane Bryant Quinn (syndicated column)
The San Francisco Chronicle
Securities Industry Daily
Smart Money
Smithsonian
Strategic Insight
Time
Travel & Leisure
USA Today
U.S. News & World Report
Value Line
The Wall Street Journal
The Washington Post
Working Women
Worth
Your Money
In advertising and sales literature, the Fund may compare its
yield and performance with that of other mutual funds, indexes or
averages of other mutual funds, indexes of related financial
assets or data, and other competing investment and deposit
products available from or through other financial institutions.
The composition of these indexes or averages differs from that of
the. Comparison of the Fund to an alternative investment should
be made with consideration of differences in features and expected
performance. All of the indexes and averages noted below will be
obtained from the indicated sources or reporting services, which
the Fund believes to be generally accurate.
The Fund may compare its performance to the Consumer Price
Index (All Urban), a widely-recognized measure of inflation.
The performance of the Fund may be compared to the following
benchmarks:
CS First Boston High Yield Index
ICD High Yield Index
Lehman High Yield Bond Index
Lehman High Yield Corporate Bond Index
Merrill Lynch High-Yield Master Index
Morningstar Corporate Bond (General) Average
Salomon Brothers Extended High Yield Market Index
Salomon Brothers High Yield Market Index
The Morningstar averages are unweighted averages of total
return performance of mutual funds as classified, calculated, and
published by this independent service that monitors the
performance of mutual funds. The Fund may also use comparative
performance as computed in a ranking by this service or category
averages and rankings provided by another independent service.
Should this service reclassify the Fund to a different category or
develop (and place it into) a new category, it may compare its
performance or rank against other funds in the newly-assigned
category (or the average of such category) as published by the
service.
In advertising and sales literature, the Fund may also cite
its rating, recognition, or other mention by Morningstar or any
other entity. Morningstar's rating system is based on risk-
adjusted total return performance and is expressed in a star-
rating format. The risk-adjusted number is computed by
subtracting a fund's risk score (which is a function of its
monthly returns less the 3-month T-bill return) from its load-
adjusted total return score. This numerical score is then
translated into rating categories, with the top 10% labeled five
star, the next 22.5% labeled four star, the next 35% labeled three
star, the next 22.5% labeled two star, and the bottom 10% one
star. A high rating reflects either above-average returns or
below-average risk, or both.
Of course, past performance is not indicative of future
results.
----------------
To illustrate the historical returns on various types of
financial assets, the Fund may use historical data provided by
Ibbotson Associates, Inc. ("Ibbotson"), a Chicago-based investment
firm. Ibbotson constructs (or obtains) very long-term (since
1926) total return data (including, for example, total return
indexes, total return percentages, average annual total returns
and standard deviations of such returns) for the following asset
types:
Common stocks
Small company stocks
Long-term corporate bonds
Long-term government bonds
Intermediate-term government bonds
U.S. Treasury bills
Consumer Price Index
---------------
The Fund may also use hypothetical returns to be used as an
example in a mix of asset allocation strategies. One such example
is reflected in the chart below, which shows the effect of tax
deferral on a hypothetical investment. This chart assumes that an
investor invested $2,000 a year on Jan. 1, for any specified
period, in both a Tax-Deferred Investment and a Taxable
Investment, that both investments earn either 6%, 8% or 10%
compounded annually, and that the investor withdrew the entire
amount at the end of the period. (A tax rate of 39.6% is applied
annually to the Taxable Investment and on the withdrawal of
earnings on the Tax-Deferred Investment.)
TAX-DEFERRED INVESTMENT VS. TAXABLE INVESTMENT
<TABLE>
<CAPTION>
INTEREST RATE 6% 8% 10% 6% 8%
10%
Compounding
Years Tax-Deferred Investment Taxable Investment
<S> <C> <C> <C> <C> <C> <C>
30 $124,992 $171,554 $242,340 $109,197 $135,346 $168,852
25 90,053 115,177 150,484 82,067 97,780 117,014
20 62,943 75,543 91,947 59,362 68,109 78,351
15 41,684 47,304 54,099 40,358 44,675 49,514
10 24,797 26,820 29,098 24,453 26,165 28,006
5 11,178 11,613 12,072 11,141 11,546 11,965
1 2,072 2,096 2,121 2,072 2,096 2,121
</TABLE>
Average Life Calculations. From time to time, the Fund may
quote an average life figure for its portfolio. Average life is
the weighted average period over which Stein Roe expects the
principal to be paid, and differs from stated maturity in that it
estimates the effect of expected principal prepayments and call
provisions. With respect to GNMA securities and other mortgage-
backed securities, average life is likely to be substantially less
than the stated maturity of the mortgages in the underlying pools.
With respect to obligations with call provisions, average life is
typically the next call date on which the obligation reasonably
may be expected to be called. Securities without prepayment or
call provisions generally have an average life equal to their
stated maturity.
Dollar Cost Averaging. Dollar cost averaging is an
investment strategy that requires investing a fixed amount of
money in Fund shares at set intervals. This allows you to
purchase more shares when prices are low and fewer shares when
prices are high. Over time, this tends to lower your average cost
per share. Like any investment strategy, dollar cost averaging
can't guarantee a profit or protect against losses in a steadily
declining market. Dollar cost averaging involves uninterrupted
investing regardless of share price and therefore may not be
appropriate for every investor.
MASTER FUND/FEEDER FUND: STRUCTURE AND RISK FACTORS
The Fund (which is a series of the Trust, an open-end
management investment company) seeks to achieve its objective by
investing all of its assets in another mutual fund having an
investment objective identical to that of the Fund. The
shareholders of the Fund approved this policy of permitting the
Fund to act as a feeder fund by investing in the Portfolio.
Please refer to Investment Policies, Portfolio Investments and
Strategies, and Investment Restrictions for a description of the
investment objectives, policies, and restrictions of the Fund and
the Portfolio. The management fees and expenses of the Fund and
the Portfolio are described under Investment Advisory and Other
Services. The Fund bears its proportionate share of the expenses
of the Portfolio.
Stein Roe has provided investment management services in
connection with other mutual funds employing the master
fund/feeder fund structure since 1991.
The Portfolio is a separate series of SR&F Base Trust ("Base
Trust"), a Massachusetts common law trust organized under an
Agreement and Declaration of Trust ("Declaration of Trust") dated
Aug. 23, 1993. The Declaration of Trust of Base Trust provides
that the Fund and other investors in the Portfolio will be liable
for all obligations of the Portfolio that are not satisfied by the
Portfolio. However, the risk of the Fund incurring financial loss
on account of such liability is limited to circumstances in which
liability was inadequately insured and the Portfolio was unable to
meet its obligations. Accordingly, the trustees of the Trust
believe that neither the Fund nor its shareholders will be
adversely affected by reason of the Fund's investing in the
Portfolio.
The Declaration of Trust of Base Trust provides that the
Portfolio will terminate 120 days after the withdrawal of the Fund
or any other investor in the Portfolio, unless the remaining
investors vote to agree to continue the business of the Portfolio.
The trustees of the Trust may vote the Fund's interests in the
Portfolio for such continuation without approval of the Fund's
shareholders.
The common investment objectives of the Funds and the
Portfolios are nonfundamental and may be changed without
shareholder approval, subject, however, to at least 30 days'
advance written notice to the Fund's shareholders.
The fundamental policies of the Fund and the corresponding
fundamental policies of the master Portfolio can be changed only
with shareholder approval. If the Fund, as the Portfolio
investor, is requested to vote on a change in the fundamental
policy of the Portfolio or any other matter pertaining to the
Portfolio (other than continuation of the business of the
Portfolio after withdrawal of another investor), the Fund will
solicit proxies from its shareholders and vote its interest in the
Portfolio for and against such matters proportionately to the
instructions to vote for and against such matters received from
Fund shareholders. The Fund will vote shares for which it
receives no voting instructions in the same proportion as the
shares for which it receives voting instructions. There can be no
assurance that any matter receiving a majority of votes cast by
Fund shareholders will receive a majority of votes cast by all
investors in the Portfolio. If other investors hold a majority
interest in the Portfolio, they could have voting control over the
Portfolio.
In the event that the Portfolio's fundamental policies were
changed so as to be inconsistent with those of the Fund, the Board
of Trustees of the Trust would consider what action might be
taken, including changes to the Fund's fundamental policies,
withdrawal of the Fund's assets from the Portfolio and investment
of such assets in another pooled investment entity, or the
retention of an investment adviser to invest those assets directly
in the Portfolio of securities. The Fund's inability to find a
substitute master fund or comparable investment management could
have a significant impact upon its shareholders' investments. Any
withdrawal of the Fund's assets could result in a distribution in
kind of portfolio securities (as opposed to a cash distribution)
to the Fund. Should such a distribution occur, the Fund would
incur brokerage fees or other transaction costs in converting such
securities to cash. In addition, a distribution in kind could
result in a less diversified portfolio of investments for the Fund
and could affect the liquidity of the Fund.
Each investor in the Portfolio, including the Fund, may add
to or reduce its investment in the Portfolio on each day the NYSE
is open for business. The investor's percentage of the aggregate
interests in the Portfolio will be computed as the percentage
equal to the fraction (i) the numerator of which is the beginning
of the day value of such investor's investment in the Portfolio on
such day plus or minus, as the case may be, the amount of any
additions to or withdrawals from the investor's investment in the
Portfolio effected on such day; and (ii) the denominator of which
is the aggregate beginning of the day net asset value of the
Portfolio on such day plus or minus, as the case may be, the
amount of the net additions to or withdrawals from the aggregate
investments in the Portfolio by all investors in the Portfolio.
The percentage so determined will then be applied to determine the
value of the investor's interest in the Portfolio as of the close
of business.
Base Trust may permit other investment companies and/or other
institutional investors to invest in the Portfolio, but members of
the general public may not invest directly in the Portfolio.
Other investors in the Portfolio are not required to sell their
shares at the same public offering price as the Fund, might incur
different administrative fees and expenses than the Fund, and
might charge a sales commission. Therefore, Fund shareholders
might have different investment returns than shareholders in
another investment company that invests exclusively in the
Portfolio. Investment by such other investors in the Portfolio
would provide funds for the purchase of additional portfolio
securities and would tend to reduce the operating expenses as a
percentage of the Portfolio's net assets. Conversely, large-scale
redemptions by any such other investors in the Portfolio could
result in untimely liquidations of the Portfolio's security
holdings, loss of investment flexibility, and increases in the
operating expenses of the Portfolio as a percentage of its net
assets. As a result, the Portfolio's security holdings may become
less diverse, resulting in increased risk.
Information regarding other investors in the Portfolio may be
obtained by writing to SR&F Base Trust at Suite 3200, One South
Wacker Drive, Chicago, IL 60606, or by calling 800-338-2550.
Stein Roe may provide administrative or other services to one or
more of such investors.
APPENDIX-RATINGS
RATINGS IN GENERAL
A rating of a rating service represents the service's opinion
as to the credit quality of the security being rated. However,
the ratings are general and are not absolute standards of quality
or guarantees as to the creditworthiness of an issuer.
Consequently, Stein Roe believes that the quality of debt
securities should be continuously reviewed and that individual
analysts give different weightings to the various factors involved
in credit analysis. A rating is not a recommendation to purchase,
sell or hold a security because it does not take into account
market value or suitability for a particular investor. When a
security has received a rating from more than one service, each
rating should be evaluated independently. Ratings are based on
current information furnished by the issuer or obtained by the
rating services from other sources that they consider reliable.
Ratings may be changed, suspended or withdrawn as a result of
changes in or unavailability of such information, or for other
reasons.
The following is a description of the characteristics of
ratings used by Moody's Investors Service, Inc. ("Moody's") and
Standard & Poor's ("S&P").
CORPORATE BOND RATINGS
Ratings By Moody's
Aaa. Bonds rated Aaa are judged to be the best quality.
They carry the smallest degree of investment risk and are
generally referred to as "gilt edge." Interest payments are
protected by a large or an exceptionally stable margin and
principal is secure. Although the various protective elements are
likely to change, such changes as can be visualized are more
unlikely to impair the fundamentally strong position of such
bonds.
Aa. Bonds 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 bonds 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 bonds.
A. Bonds 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 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 length of
time. Such bonds lack outstanding investment characteristics and
in fact have speculative characteristics as well.
Ba. Bonds which are rated Ba are judged to have speculative
elements; their future cannot be considered as well assured.
Often the protection of interest and principal payments may be
very moderate and thereby not well safeguarded during both good
and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B. Bonds which are rated B generally lack characteristics of
the desirable investment. Assurance of interest and principal
payments or of maintenance of other terms of the contract over any
long period of time may be small.
Caa. Bonds which are rated Caa are of poor standing. Such
issues may be in default or there may be present elements of
danger with respect to principal or interest.
Ca. Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or
have other marked shortcomings.
C. Bonds which are rated C are the lowest rated class of
bonds and issues so rated can be regarded as having extremely poor
prospects of ever attaining any real investment standing.
NOTE: Moody's applies numerical modifiers 1, 2, and 3 in each
generic rating classification from Aa through B in its corporate
bond rating system. 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.
Ratings By S&P
AAA. Debt rated AAA has the highest rating. Capacity to pay
interest and repay principal is extremely strong.
AA. Debt rated AA has a very strong capacity to pay interest
and repay principal and differs from the highest rated issues only
in small degree.
A. Debt rated A has a strong capacity to pay interest and
repay principal although it is somewhat more susceptible to the
adverse effects of changes in circumstances and economic
conditions than debt in higher rated categories.
BBB. Debt rated BBB is regarded as having an adequate
capacity to pay interest and repay principal. Whereas it normally
exhibits adequate protection parameters, adverse economic
conditions or changing circumstances are more likely to lead to a
weakened capacity to pay interest and repay principal for debt in
this category than for debt in higher rated categories.
BB, B, CCC, CC, and C. Debt rated BB, B, CCC, CC, or C is
regarded, on balance, as predominantly speculative with respect to
capacity to pay interest and repay principal in accordance with
the terms of the obligation. BB indicates the lowest degree of
speculation and C the highest degree of speculation. While such
debt will likely have some quality and protective characteristics,
these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
C1. This rating is reserved for income bonds on which no
interest is being paid.
D. Debt rated D is in default, and payment of interest
and/or repayment of principal is in arrears. The D rating is also
used upon the filing of a bankruptcy petition if debt service
payments are jeopardized.
NOTES:
The ratings from AA to CCC may be modified by the addition of a
plus (+) or minus (-) sign to show relative standing within the
major rating categories. Foreign debt is rated on the same basis
as domestic debt measuring the creditworthiness of the issuer;
ratings of foreign debt do not take into account currency exchange
and related uncertainties.
The "r" is attached to highlight derivative, hybrid, and certain
other obligations that S&P believes may experience high volatility
or high variability in expected returns due to non-credit risks.
Examples of such obligations are: securities whose principal or
interest return is indexed to equities, commodities, or
currencies; certain swaps and options; and interest only and
principal only mortgage securities. The absence of an "r" symbol
should not be taken as an indication that an obligation will
exhibit no volatility or variability in total return.
COMMERCIAL PAPER RATINGS
Ratings By Moody's
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
If an issuer represents to Moody's that its commercial paper
obligations are supported by the credit of another entity or
entities, Moody's, in assigning ratings to such issuers, evaluates
the financial strength of the indicated affiliated corporations,
commercial banks, insurance companies, foreign governments or
other entities, but only as one factor in the total rating
assessment.
Ratings By S&P
A brief description of the applicable rating symbols and
their meaning follows:
A. Issues assigned this highest rating are regarded as
having the greatest capacity for timely payment. Issues in this
category are further refined with the designations 1, 2, and 3 to
indicate the relative degree of safety.
A-1. This designation indicates that the degree of safety
regarding timely payment is very strong. Those issues determined
to possess overwhelming safety characteristics will be denoted
with a plus (+) sign designation.
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