<PAGE>
STEIN ROE
INSTITUTIONAL CLIENT FUNDS
PROSPECTUS
NOV. 1, 2000
STEIN ROE INSTITUTIONAL CLIENT HIGH YIELD FUND
ALTHOUGH THESE SECURITIES HAVE BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE
COMMISSION, THE COMMISSION HAS NOT APPROVED OR DISAPPROVED ANY SHARES OFFERED IN
THIS PROSPECTUS OR DETERMINED WHETHER THIS PROSPECTUS IS TRUTHFUL OR COMPLETE.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<PAGE>
3 The Fund
Investment Goal
Principal Investment Strategies
Principal Investment Risks
Fund Performance
Your Expenses
7 Financial Highlights
8 Your Account
Purchasing Shares
Determining Share Price
Selling Shares
Fund Policy on Trading of Fund Shares
Dividends and Distributions
11 Other Investments and Risks
Initial Public Offerings
Mortgage-Backed Securities
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 Advisor
Portfolio Manager
Master/Feeder Fund Structure
Please keep this prospectus as your reference manual.
2
<PAGE>
THE FUND
INVESTMENT GOAL The Fund seeks its total return by investing for a high level of
current income and capital growth.
PRINCIPALINVESTMENT STRATEGIES The Fund invests all of its assets in SR&F High
Yield Portfolio (the "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.
Although the Portfolio will invest primarily in debt securities, the
Portfolio may invest in equity securities to seek capital appreciation.
Equity securities include common stocks, preferred stocks, warrants and
debt securities convertible into common stocks.
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 principal risks of investing in the Fund
are described below. There are many circumstances (including additional
risks that are not described here) which could prevent the Fund from
achieving its investment goals. You may lose money by investing in the
Fund.
3
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Management risk means that the advisor's stock and bond selections and
other investment decisions might produce losses or cause the Fund to
underperform when compared to other funds with similar investment
goals. Market risk means that security prices in a market, sector or
industry may move down. Downward movements will reduce the value of
your investment. Because of market risk, there is no guarantee that the
Fund will achieve its investment goals or perform favorably compared
with competing funds.
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 with 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 and in some cases a decrease in income.
Lower-rated debt securities, commonly referred to as "junk bonds",
involve greater risk of loss due to credit deterioration and are less
liquid, especially during periods of economic uncertainty or change,
than high-quality debt securities. Lower-rated debt securities have the
added risk that the issuer of the security may default and not make
payment of interest or principal.
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
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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 deposit in a bank 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, 1999. The returns include the reinvestment of dividends and
distributions. As with all mutual funds, past performance is no
guarantee of future results.
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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, 1999, and provides an indication of the
risks of investing in the Fund.
[bar chart]
1998 4.90%
1999 8.98%
[/bar chart]
[ ] Institutional Client High Yield Fund
The Fund's year-to-date total return through Sept. 30, 2000, was 4.78%.
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.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDING DEC. 31, 1999
----------------------------
SINCE INCEPTION
1 YR (FEB. 14, 1997)
---- ---------------
<S> <C> <C>
Institutional Client High Yield Fund 8.98 9.48
%
Merrill Lynch High Yield Master II Index* 2.51 5.65
% %
</TABLE>
*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.
6
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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.
<TABLE>
<CAPTION>
ANNUAL FUND OPERATING EXPENSES(a)
(expenses that are deducted from Fund assets)
---------------------------------------------
<S> <C>
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
----
%
</TABLE>
(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) The Portfolio pays a management fee of 0.50% and the Fund pays an
administrative fee of 0.15%.
(c) The Fund's advisor has voluntarily agreed to reimburse the Fund for
certain expenses so that the total annual fund operating expenses
(exclusive of distribution and service fees, brokerage commissions,
interest, taxes and extraordinary expenses, if any) will not exceed
0.50%. As a result, the actual management fee would be 0.18% and
total annual fund operating expenses would be 0.50%. 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
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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:
<TABLE>
<CAPTION>
EXPENSE EXAMPLE
1 yr 3 yrs 5 yrs 10 yrs
---- ----- ----- ------
<S> <C> <C> <C> <C>
Institutional Client High Yield Fund $99 $309 $536 $1,190
---- ----- ----- ------
</TABLE>
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<PAGE>
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
<TABLE>
<CAPTION>
PER SHARE DATA
Period
For years ending ending
June 30, June 30,
-------- --------
2000 1999 1998 1997(a)
<S> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $ 9.85 $ 10.65 $ 10.21 $ 10.00
INCOME FROM INVESTMENT OPERATIONS
Net investment income 1.04 0.87 0.88 0.33
Net realized and unrealized gain (loss) 1.00 (0.49) 0.58 0.21
--------
TOTAL FROM INVESTMENT OPERATIONS 0.04 0.38 1.46 0.54
DISTRIBUTIONS
Net investment income (1.06) (0.87) (0.88) (0.33)
In excess of net investment income (0.02)
Net realized gains (0.03) (0.31) (0.14) --
TOTAL DISTRIBUTIONS (1.11) (1.18) (1.02) (0.33)
NET ASSET VALUE, END OF PERIOD $ 8.78 $ 9.85 $ 10.65 $ 10.21
Ratio of net expenses to average net assets (b) 0.50%(b) 0.50% 0.50% 0.50%(d)
-------- -------- -------- --------
Ratio of net investment income to average net
assets (c) 11.15%(b) 8.72% 8.31% 8.76%(d)
-------- -------- -------- --------
Portfolio turnover rate (e) 144% 296% 426% 168%
-------- -------- -------- --------
Total return (c) 0.37%(b) 4.20% 14.88% 5.48%
Net assets, end of period (000,s) $ 51,130 $ 55,395 $ 35,157 $ 24,674
</TABLE>
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(a) From commencement of operations on February 14, 1997.
(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%,
0.97% and 1.28% for the year ended June 30, 2000, 1999 and 1998,
respectively, and 2.59% for the period ended June 30, 1997.
(c) Computed with the effect of Stein Roe's expense reimbursement.
(d) Annualized.
(e) Reflects the turnover rate for the Portfolio.
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<PAGE>
YOUR ACCOUNT
PURCHASING SHARES You will not pay a sales charge when you purchase Fund shares.
Your purchases are made at the net asset value 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.
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 The Fund's share price is its net asset value
next determined. Net asset value is the difference between the values
of the Fund's assets and liabilities divided by the number of shares
outstanding. We determine net asset value at the close of regular
trading on the New York Stock Exchange (NYSE) -- normally 4 p.m.
Eastern 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
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<PAGE>
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 net asset value 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.
FUND POLICY ON TRADING OF FUND SHARES
The Fund does not permit short-term or excessive trading. Excessive
purchases, redemptions or exchanges of Fund shares disrupt portfolio
management and increase Fund expenses. In order to promote the best
interests of the Fund, the Fund reserves the right to reject any
purchase order or exchange request, particularly from market timers or
investors who, in the advisor's opinion, have a pattern of short-term
or excessive trading or whose trading has been or may be
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<PAGE>
disruptive to the Fund. The Fund into which you would like to exchange
also may reject your request.
DIVIDENDSAND DISTRIBUTIONS The Fund declares dividends daily and pays them
monthly, and any capital gains (including short-term capital gains) at
least annually.
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.
13
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<TABLE>
<CAPTION>
TRANSACTION TAX STATUS
<S> <C>
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
</TABLE>
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.
14
<PAGE>
OTHER INVESTMENTS AND RISKS
The Fund's principal investment strategies and their associated risks
are described above. This section describes other investments the
Portfolio may make and the risks associated with them. In seeking to
achieve its investment goals, the Portfolio may invest in various types
of securities and engage in various investment techniques which are not
the principal focus of the Fund and therefore are not described in this
prospectus. These types of securities and investment practices are
identified and discussed in the Fund's Statement of Additional
Information, which you may obtain free of charge (see back cover).
Approval by the Fund's shareholders is not required to modify or change
any of the Fund's investment goals or investment strategies.
INITIAL PUBLIC OFFERINGS The Portfolio may invest a portion of its assets in
certain types of equity securities including securities offered during
a company's initial public offering (IPO). An IPO is the sale of a
company's securities to the public for the first time. The market price
of a security the Portfolio buys in an IPO may change substantially
from the price the Portfolio paid, soon after the IPO ends. In the
short term, the price change may significantly increase or decrease the
Fund's total return, and therefore its performance history, after an
IPO investment. This is especially so when the Fund's assets are small.
However, should the Fund's assets increase, the results of an IPO
investment will not cause the Fund's performance history to change as
much. Although companies can be of any size or age at the time of their
IPO, they are often smaller in size and have a limited operating
history which could create greater market volatility for the
securities. The advisor intends to limit the Portfolio's IPO
investments to issuers whose debt securities the Portfolio already
owns, or issuers which the advisor has specially researched before the
IPO. The Portfolio does not intend to invest more than 5% of its assets
15
<PAGE>
in IPOs and does not intend to buy them for the purpose of immediately
selling (also known as flipping) the security after its public
offering.
MORTGAGE-BACKED SECURITIES Mortgage-backed securities, 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 Asset-backed securities are interests in pools of debt
securities backed by various types of loans such as credit card, auto
and home equity loans. These securities involve prepayment risk, which
is the possibility that the underlying debt may be refinanced or
prepaid prior to maturity during periods of declining interest rates.
During periods of rising interest rates, asset-backed securities have a
high risk of declining in price because the declining prepayment rates
effectively increase the maturity of the securities. A decline in
interest rates may lead to a faster rate of repayment on asset-backed
securities and, therefore, cause the Portfolio to earn a lower interest
rate on reinvestment. In addition, the potential impact of prepayment
on the price of an asset-backed security may be difficult to predict
and result in greater volatility.
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<PAGE>
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.
PORTFOLIOTURNOVER 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. The Portfolio generally intends to
purchase securities for long-term investment, although to a limited
extent, it may purchase securities in anticipation of relatively
short-term price gains. 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.
TEMPORARYDEFENSIVE POSITIONS At times, the advisor may determine that adverse
market conditions make it desirable to temporarily suspend the Fund's
normal investment activities. During such times, the Portfolio may, but
is not required to, invest in cash or high-quality, short-term debt
securities without limit. Taking a temporary defensive position may
prevent the Fund from
17
<PAGE>
achieving its investment goals.
INTERFUNDLENDING 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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<PAGE>
THE FUND'S MANAGEMENT
INVESTMENT ADVISOR 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,
2000, the Fund and Portfolio 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 advisor. 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.
PORTFOLIOMANAGER 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.
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)
which has investment goals 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.
19
<PAGE>
20
<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:
Liberty-Stein Roe Funds Trust: 811-07997
- Stein Roe Institutional Client High Yield Fund
LIBERTY FUNDS DISTRIBUTOR, INC.
DIR-01/140D-0900
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STATEMENT OF ADDITIONAL INFORMATION DATED NOV. 1, 2000
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, 2000 and any supplements thereto. Financial
statements, which are contained in the Fund's June 30, 2000 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
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Page
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General Information and History.................................................................... 3
Investment Policies................................................................................ 4
Portfolio Investments and Strategies............................................................... 4
Investment Restrictions............................................................................ 19
Additional Investment Considerations............................................................... 21
Purchases and Redemptions.......................................................................... 22
Management......................................................................................... 23
Financial Statements............................................................................... 27
Principal Shareholders............................................................................. 27
Investment Advisory and Other Services............................................................. 27
Distributor........................................................................................ 30
Transfer Agent..................................................................................... 30
Custodian.......................................................................................... 30
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Independent Auditors............................................................................... 31
Portfolio Transactions............................................................................. 31
Additional Income Tax Considerations............................................................... 36
Investment Performance............................................................................. 36
Master Fund/Feeder Fund: Structure and Risk Factors................................................ 40
Appendix--Ratings.................................................................................. 42
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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.
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.
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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)
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-
----------
(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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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.
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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.
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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.
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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.
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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.)
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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
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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
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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
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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
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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.
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 as-
--------
(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.
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sume 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
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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
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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.
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
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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.
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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.
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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
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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)
(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;
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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.
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(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.
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
--------
(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.
21
<PAGE>
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.
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.
22
<PAGE>
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:
<TABLE>
<CAPTION>
POSITION(S) HELD PRINCIPAL OCCUPATION(S)
NAME, AGE; ADDRESS WITH THE TRUST DURING PAST FIVE YEARS
------------------ -------------- ----------------------
<S> <C> <C>
William D. Andrews, 53; Executive Vice- Executive vice president of Stein Roe & Farnham
One South Wacker Drive, President Incorporated ("Stein Roe")
Chicago, IL 60606 (4)
John A. Bacon Jr., 73; Trustee Private investor
4N640 Honey Hill Road,
Box 296, Wayne, IL 60184
(3)(4)
Christine Balzano, 35; Vice-President Senior vice president of Liberty Funds Services, Inc.;
245 Summer Street, formerly vice president and assistant vice president
Boston, MA 02210
</TABLE>
23
<PAGE>
<TABLE>
<S> <C> <C>
William W. Boyd, 73; Trustee Chairman and director of Sterling Plumbing
2900 Golf Road, Rolling (manufacturer of plumbing products)
Meadows, IL 60008
(2)(3)(4)
Kevin M. Carome, 44; One Executive Senior vice president, legal, Liberty Funds Group LLC (an
Financial Center, Boston, MA Vice-President affiliate of Stein Roe) since Jan. 1999; general counsel and
02111(4) 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
Denise E. Chasmer, 32; Vice President Employee of Liberty Funds Services, Inc. and assistant
12100 East Iliff Avenue vice president of Stein Roe since November 1999;
Aurora, CO 80014 (4) manager with Scudder Kemper Investments from
October 1995 to November 1999; assistant manager
with Scudder Kemper prior thereto
Lindsay Cook, 48; Trustee Executive vice president of Liberty Financial
600 Atlantic Avenue, Companies, Inc. since March 1997; senior vice
Boston, MA 02210 president prior thereto
(1)(2)(4)
Stephen E. Gibson, 48; One President Director of Stein Roe since September 2000; President and
One Financial Center Vice Chairman of Stein Roe since January 2000 (formerly
Boston, MA 02111 (4) Assistant Chairman from August 1998 to January 2000); President
of Stein Roe Funds
since November 1999;
President of Liberty
Funds since June
1998; Chairman of
the Board since July
1998, CEO and
President since
December 1996 and
Director since July
1996 of Colonial
Management
Associates, Inc.
(formerly executive
vice president from
July 1996 to
December 1996); CEO,
Financial Center,
Boston, MA president
and director of
Liberty Funds Group
since December
1998(formerly
Director, CEO and
President of the
Colonial Group from
December 1996 to
December 1998);
managing director of
Marketing of Putnam
Investments from
June 1992 through
July 1996
Douglas A. Hacker, 44; Trustee/Manager Senior vice president and chief financial officer of
P.O. Box 66100, UAL, Inc. (airline)
Chicago, IL 60666 (3)(4)
Loren A. Hansen, 52; Executive Vice- Chief investment officer/equity of Colonial
One South Wacker Drive, President Management Associates, Inc. since 1997; executive vice
Chicago, IL 60606 (4) president of Stein Roe since Dec. 1995; vice president
of The Northern Trust (bank) prior thereto
Janet Langford Kelly, 42; Trustee Executive vice president-corporate development,
One Kellogg Square, general counsel and secretary of Kellogg Company
Battle Creek, MI 49016 since Sept. 1999; senior vice president, secretary and
(3)(4) general counsel of Sara Lee Corporation (branded,
packaged, consumer-products manufacturer) from 1995
to Aug. 1999; partner of Sidley & Austin (law firm)
prior thereto
</TABLE>
24
<PAGE>
<TABLE>
<S> <C> <C>
Michael T. Kennedy, 38; Vice-President Senior vice president of Stein Roe
One South Wacker Drive,
Chicago, IL 60606 (4)
Gail D. Knudsen, 38; Vice-President Vice president and assistant controller of CMA
245 Summer Street,
Boston, MA 02210 (4)
Stephen F. Lockman, 39; Vice-President Senior vice president, portfolio manager, and credit
One South Wacker Drive, analyst of Stein Roe
Chicago, IL 60606 (4)
Pamela A. McGrath, 47: Senior Vice Treasurer and Senior Vice President of the Stein Roe Funds
One Financial Center President since May 2000; Treasurer and Chief Financial Officer of
Boston, MA 02111 (4) the Liberty Funds; Treasurer of Liberty All-Star Funds since
April 2000;
Treasurer,
Chief
Financial
Officer of
the Liberty
Funds Group
since
December
1999 and
Senior Vice
President
since April
2000; Chief
Financial
Officer,
Treasurer
and Senior
Vice
President of
Colonial
Management
Associates
since
December
1999; Senior
Vice
President
and Director
of Offshore
Accounting
for Putnam
Investments,
Inc., from
May 1998 to
October
1999;
Managing
Director of
Scudder
Kemper
Investments
from
October,
1984 to
December
1997.
Mary D. McKenzie, 46; Vice-President President of Liberty Funds Services, Inc.
One Financial Center,
Boston, MA 02111 (4)
Jane M. Naeseth, 50; One Vice-President Senior vice president of Stein Roe
South Wacker Drive,
Chicago, IL 60606
Charles R. Nelson, 58; Trustee Van Voorhis Professor of Political Economy of the
Department of Economics, University of Washington
University of Washington,
Seattle, WA 98195 (3)(4)
Nicholas Norton, 41; Vice-President Senior vice president of Liberty Funds Services, Inc.
12100 East Iliff Avenue, since Aug. 1999; vice president of Scudder Kemper, Inc.
Aurora, CO 80014 (4) from May 1994 to Aug. 1999
Joseph R. Palombo, 47; One Trustee and Trustee and Chairman of the Board since October 2000;
Financial Center Chairman of Director of Stein Roe since September, 2000; Executive Vice
MA 02111 (4) the Board President of the Stein Roe Funds since May 2000; Vice President
of the Colonial Funds since April 1999; Executive Vice President
and Director of Colonial Management Associates since April
1999; Executive Vice President and Chief Administrative
Officer of the Liberty
Funds Group since April
1999; Chief Operating
Officer, Putnam Mutual
Funds from 1994 to 1998.
Thomas C. Theobald, 63; Trustee Managing director, William Blair Capital Partners
Suite 1300, 222 West (private equity fund)
Adams Street, Chicago, IL
60606 (3)(4)
</TABLE>
(1) Trustee who is an "interested person" of the Trust and of Stein Roe, as
defined in the Investment Company Act of 1940.
25
<PAGE>
(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, 2000 and the calendar year ended December 31, 1999 to each of the trustees:
<TABLE>
<CAPTION>
Total Compensation
Aggregate Compensation From the Fund Complex
From the Fund for the Paid to the Trustees for
Fiscal Year Ended the Calendar Year Ended
Trustee June 30, 2000 December 31, 1999*
------- ---------------------- ------------------------
<S> <C> <C>
Lindsay Cook -0- -0-
John A. Bacon Jr. 1,400 $ 103,450
William W. Boyd 1,500 109,950
Douglas A. Hacker 1,400 93,950
Janet Langford Kelly 1,400 103,450
Charles R. Nelson 1,500 108,050
Thomas C. Theobald 1,400 103,450
</TABLE>
--------------
* At June 30, 2000, 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.
26
<PAGE>
FINANCIAL STATEMENTS
Please refer to the June 30, 2000 Financial Statements (statements of
assets and liabilities and schedule of investments as of June 30, 2000 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, 2000 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 September 30, 2000, the Trustees and Officers of the Trust owned as a
group less than 1% of the then outstanding shares of the Fund.
As of September 30, 2000, 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:
<TABLE>
<CAPTION>
NAME AND ADDRESS APPROXIMATE % OF OUTSTANDING SHARES HELD
---------------- ----------------------------------------
<S> <C>
Covenant Benevolent Institution
5145 North California
Chicago, IL 60625
34.32%
Fireman's Annuity & Benefit Fund of Chicago
1 North Franklin Street, Suite 2550
Chicago, IL 60606
45.05%
John W. Anderson Foundation
402 Wall Street
Valparaiso, IN 46383
10.92%
National City Bank, Trustee
Akron General Medical Center
Defined Benefit Pension Trust
P.O. Box 94984
Cleveland, OH 44101
7.04%
</TABLE>
As of September 30, 2000, 3,311,316 shares, or approximately 55% 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. .
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
27
<PAGE>
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 C. Allen Merritt, Jr., J. Andrew Hilbert, Stephen
E. Gibson and Joseph R. Palombo. Mr. Merritt is Chief Operating Officer of
Liberty Financial. Mr. Hilbert is Senior Vice President and Chief Financial
Officer of Liberty Financial. The positions held by Messrs. Gibson and Palombo
are listed above. The business address of Messrs. Merritt and Hilbert is Federal
Reserve Plaza, Boston, MA 02210. The business address of Messrs. Gibson and
Palombo is One Financial Center, Boston, MA 02111.
28
<PAGE>
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 (dollars in
thousands):
<TABLE>
<CAPTION>
YEAR YEAR YEAR
TYPE OF CURRENT RATES (AS A % OF ENDED ENDED ENDED
PAYMENT AVERAGE NET ASSETS) 6/30/00 6/30/99 6/30/98
-------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Fund Administrative .150% up to $500 million,
fee .125% thereafter $81 $68 $46
-------------------------------------------------------------------------------
Reimbursement Expenses exceeding .50% $258 212 241
-------------------------------------------------------------------------------------------
Portfolio Management .500% up to $500 million,
fee .475% thereafter $424 420 307
-------------------------------------------------------------------------------------------
</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.
29
<PAGE>
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, 2000, 1999 and 1998, Stein Roe received aggregate fees (dollars in
thousands) of $ 25 for each year, 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.
30
<PAGE>
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 Fund and 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.
31
<PAGE>
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
32
<PAGE>
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
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<PAGE>
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
34
<PAGE>
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.
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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.
The Yield formula is as follows: YIELD = 2[((a-b/cd) +1)(6) -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.
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<PAGE>
For example, the Yield of the Fund for the 30-day period ended June 30, 2000 was
11.26%.
The Fund may quote total return figures from time to time. A "Total
Return" is your return on an investment which takes into account the change in
value of your investment with distributions reinvested. 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.
Average Annual Total Return is computed as follows: ERV = P(1+T)n
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 "Ending Redeemable
Value," the "Total Return Percentage," and the "Average Annual Total Return" at
June 30, 2000 were:
<TABLE>
<CAPTION>
ENDING AVERAGE
REDEEMABLE TOTAL RETURN ANNUAL TOTAL
VALUE (%) PERCENTAGE (%) RETURN (%)
<S> <C> <C> <C>
1 year 1,004 0.37 0.37
Life of Fund* 1,267 26.68 7.26
</TABLE>
----------
*Since commencement of operations on Feb. 14, 1997.
Performance results reflect any waiver or reimbursement by the Advisor
of expenses. Absent this waiver or reimbursement arrangement, performance
results would have been lower. See Prospectus for details. 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
37
<PAGE>
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.
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<PAGE>
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
39
<PAGE>
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
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<PAGE>
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.
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<PAGE>
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
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<PAGE>
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.
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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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