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MITCHELL HUTCHINS PORTFOLIOS
1285 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019
STATEMENT OF ADDITIONAL INFORMATION
The Portfolios described below (each a "Portfolio" and, collectively,
"Portfolios") are diversified series of Mitchell Hutchins Portfolios
("Trust"), an open-end management investment company organized as a Delaware
business trust. The Portfolios seek to achieve their investment objectives by
investing in a number of other PaineWebber mutual funds ("Underlying Funds").
MITCHELL HUTCHINS AGGRESSIVE PORTFOLIO seeks long-term growth of capital by
investing the majority of its assets in equity mutual funds.
MITCHELL HUTCHINS MODERATE PORTFOLIO seeks total return by investing its
assets in a combination of equity and bond mutual funds.
MITCHELL HUTCHINS CONSERVATIVE PORTFOLIO seeks income and, secondarily,
growth of capital by investing the majority of its assets in bond mutual
funds.
Mitchell Hutchins Asset Management Inc. ("Mitchell Hutchins"), an asset
management subsidiary of PaineWebber Incorporated ("PaineWebber"), is the
investment adviser, administrator and distributor for each Portfolio. As
distributor, Mitchell Hutchins has appointed PaineWebber to serve as the
exclusive dealer for the sale of the Portfolio shares.
This Statement of Additional Information is not a prospectus and should be
read only in conjunction with the Portfolios' current Prospectus dated January
9, 1998. A copy of the Prospectus may be obtained by calling any PaineWebber
investment executive or correspondent firm, or by calling toll-free 1-800-647-
1568. This Statement of Additional Information is dated January 9, 1998.
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PORTFOLIOS--INVESTMENT POLICIES AND RESTRICTIONS
The following supplements the information contained in the Prospectus
concerning the investment policies and limitations of the Portfolios. Except
as otherwise indicated in the Prospectus or this Statement of Additional
Information, there are no policy limitations on the Portfolios' ability to use
the investments or techniques discussed in these documents.
DIRECT INVESTMENTS IN SECURITIES. As stated in the Prospectus, in addition
to investing in the Underlying Funds, each Portfolio may invest directly in
short-term U.S. government securities, commercial paper and other short-term
corporate obligations and other money market instruments, including repurchase
agreements. Under normal conditions, each Portfolio's investments in these
securities, together with its investments in PaineWebber Cashfund, one of the
underlying funds and a money market fund, is not expected to exceed 20% of its
total assets. However, when Mitchell Hutchins believes that unusual market or
economic conditions warrant a temporary defensive posture, each Portfolio may
invest without limit in these securities.
Repurchase Agreements. Repurchase agreements are transactions in which a
Portfolio purchases securities from a bank or recognized securities dealer and
simultaneously commits to resell the securities to the bank or dealer at an
agreed-upon date or upon demand and at a price reflecting a market rate of
interest unrelated to the coupon rate or maturity of the purchased securities.
The Portfolio maintains custody of the underlying securities prior to their
repurchase; thus, the obligation of the bank or dealer to pay the repurchase
price on the date agreed to or upon demand is, in effect, secured by such
securities. If the value of these securities is less than the repurchase
price, plus any agreed-upon additional amount, the other party to the
agreement must provide additional collateral so that at all times the
collateral is at least equal to the repurchase price, plus any agreed-upon
additional amount. The difference between the total amount to be received upon
repurchase of the securities and the price that was paid by a Portfolio upon
acquisition is accrued as interest and included in its net investment income.
Repurchase agreements carry certain risks not associated with direct
investments in securities, including possible declines in the market value of
the underlying securities and delays and costs to a Portfolio if the other
party to a repurchase agreement becomes insolvent.
The Portfolios intend to enter into repurchase agreements only with banks
and dealers in transactions believed by Mitchell Hutchins to present minimal
credit risks in accordance with guidelines established by the Trust's board of
trustees ("board"). Mitchell Hutchins reviews and monitors the
creditworthiness of those institutions under the board's general supervision.
Money Market Instruments. Money market instruments may include securities
issued or guaranteed by the U.S. government, its agencies or
instrumentalities, investment grade commercial paper and other short-term
corporate obligations, bank certificates of deposit, bankers' acceptances and
repurchase agreements secured by any of the foregoing.
U.S. Government Securities. The Portfolios may invest in various direct
obligations of the U.S. Treasury and obligations issued or guaranteed by the
U.S. government or one of its agencies or instrumentalities (collectively,
"U.S. government securities"). Among the U.S. government securities that may
be held by the Portfolios are securities that are supported by the full faith
and credit of the United States, securities that are supported by the right of
the issuer to borrow from the U.S. Treasury and securities that are supported
solely by the credit of the instrumentality. U.S. government securities are
described in greater detail in "Underlying Funds--Investment Policies" below.
ILLIQUID SECURITIES. Each Portfolio may invest up to 15% of its net assets
in illiquid securities, although the Portfolios intend to use this
authorization only in connection with their investment of cash reserves in
short-term securities. The term "illiquid securities" for this purpose means
securities that cannot be disposed of within seven days in the ordinary course
of business at approximately the amount at which a Portfolio has valued the
securities and includes, among other things, repurchase agreements maturing in
more than seven days and restricted securities other than those Mitchell
Hutchins has determined to be liquid pursuant to guidelines
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established by the Trust's board. More information about illiquid securities
and the circumstances under which restricted securities can be determined to
be liquid is provided below in "Underlying Funds--Investment Policies,
Illiquid Securities". If the amount of a Portfolio's net assets invested in
illiquid securities increases to more than 15% as a result of a change in the
values of its investments or its amount of total assets, the Portfolio will
engage in an orderly disposition to bring its holdings of such securities to
no more than 15% of its net assets.
Other Investments. Although their fundamental and non-investment limitations
(described below) do not prohibit the Portfolios from purchasing or selling
financial options and futures, forward and spot currency contracts, swap
transactions and other financial contracts or derivative instruments or from
engaging in short sales of securities the Portfolios own (short sales "against
the box"), the Portfolios will not engage in these transactions during the
coming year.
INVESTMENT LIMITATIONS OF THE PORTFOLIOS
FUNDAMENTAL LIMITATIONS. The following fundamental investment limitations
cannot be changed for a Portfolio without the affirmative vote of the lesser
of (a) more than 50% of the outstanding shares of the Portfolio or (b) 67% or
more of the shares of the Portfolio present at a shareholders' meeting if more
than 50% of the outstanding shares of the Portfolio are represented at the
meeting in person or by proxy. Except with respect to fundamental investment
limitation (2), if a percentage restriction is adhered to at the time of an
investment or transaction, a later increase or decrease in percentage
resulting from a change in values of portfolio securities or amount of total
assets will not be considered a violation of any of the foregoing limitations.
Each Portfolio will not:
(1) purchase any security if, as a result of that purchase, 25% or more
of the Portfolio's total assets would be invested in securities of issuers
having their principal business activities in the same industry, except
that this limitation does not apply to securities issued or guaranteed by
the U.S. government, its agencies or instrumentalities or to municipal
securities, and except that the Portfolio will invest 25% or more of its
total assets in the securities of other investment companies.
(2) issue senior securities or borrow money, except as permitted under
the Investment Company Act of 1940 ("1940 Act") and then not in excess of
33 1/3% of the Portfolio's total assets (including the amount of the senior
securities issued but reduced by any liabilities not constituting senior
securities) at the time of the issuance or borrowing, except that the
Portfolio may borrow up to an additional 5% of its total assets (not
including the amount borrowed) for temporary or emergency purposes.
(3) make loans, except through loans of portfolio securities or through
repurchase agreements, provided that for purposes of this restriction, the
acquisition of bonds, debentures, other debt securities or instruments, or
participations or other interests therein and investments in government
obligations, commercial paper, certificates of deposit, bankers'
acceptances or similar instruments will not be considered the making of a
loan.
(4) engage in the business of underwriting securities of other issuers,
except to the extent that the Portfolio might be considered an underwriter
under the federal securities laws in connection with its disposition of
portfolio securities.
(5) purchase or sell real estate, except that investments in securities
of issuers that invest in real estate and investments in mortgage-backed
securities, mortgage participations or other instruments supported by
interests in real estate are not subject to this limitation, and except
that the Portfolio may exercise rights under agreements relating to such
securities, including the right to enforce security interests and to hold
real estate acquired by reason of such enforcement until that real estate
can be liquidated in an orderly manner.
(6) purchase or sell physical commodities unless acquired as a result of
owning securities or other instruments, but the Portfolio may purchase,
sell or enter into financial options and futures, forward and spot currency
contracts, swap transactions and other financial contracts or derivative
instruments.
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(7) purchase securities of any one issuer if, as a result, more than 5%
of the Portfolio's total assets would be invested in securities of that
issuer or the Portfolio would own or hold more than 10% of the outstanding
voting securities of that issuer, except that up to 25% of the Portfolio's
total assets may be invested without regard to this limitation, and except
that this limitation does not apply to securities issued or guaranteed by
the U.S. government, its agencies and instrumentalities or to securities
issued by other investment companies.
NON-FUNDAMENTAL LIMITATIONS. The following investment restrictions may be
changed by the board without shareholder approval.
Each Portfolio will not:
(1) invest more than 15% of its net assets in illiquid securities, a term
which means securities that cannot be disposed of within seven days in the
ordinary course of business at approximately the amount at which the
Portfolio has valued the securities and includes, among other things,
repurchase agreements maturing in more than seven days.
(2) purchase portfolio securities while borrowings in excess of 5% of its
total assets are outstanding.
(3) purchase securities on margin, except for short-term credit necessary
for clearance of portfolio transactions and except that the Portfolio may
make margin deposits in connection with its use of financial options and
futures, forward and spot currency contracts, swap transactions and other
financial contracts or derivative instruments.
(4) engage in short sales of securities or maintain a short position,
except that the Portfolio may (a) sell short "against the box" and (b)
maintain short positions in connection with its use of financial options
and futures, forward and spot currency contracts, swap transactions and
other financial contracts or derivative instruments.
(5) purchase securities of other investment companies, except to the
extent permitted by the 1940 Act or under the terms of an exemptive order
granted by the Securities and Exchange Commission ("SEC") and except that
this limitation does not apply to securities received or acquired as
dividends, through offers of exchange, or as a result of reorganization,
consolidation, or merger.
Notwithstanding the foregoing investment limitations, the Portfolios may
invest in Underlying Funds that have adopted investment limitations that may
be more or less restrictive than those listed above. As a result, the
Portfolios may engage indirectly in investment strategies that are prohibited
under the investment limitations listed above. The investment limitations and
other investment policies and restrictions of each Underlying Fund are
described in its prospectus and statement of additional information.
In accordance with each Portfolio's investment program as set forth in the
Prospectus, a Portfolio may invest more than 25% of its assets in any one
Underlying Fund. However, each Underlying Fund in which a Portfolio may invest
(other than PaineWebber Low Duration U.S. Government Income Fund and
PaineWebber U.S. Government Income Fund) will not concentrate more than 25% of
its total assets in any one industry.
UNDERLYING FUNDS--INVESTMENT POLICIES
The following supplements the information contained in the Prospectus
concerning the investment policies and limitations of the Underlying Funds.
With respect to certain Underlying Funds, Mitchell Hutchins has retained one
or more sub-advisers ("Sub-Adviser" or "Sub-Advisers"), who are identified by
name in the Prospectus. More information about the investment policies and
restrictions and the investment limitations of each Underlying Fund is set
forth in its prospectus and statement of additional information.
YIELD FACTORS AND RATINGS. Moody's Investors Service, Inc. ("Moody's"),
Standard & Poor's, a division of The McGraw-Hill Companies, Inc. ("S&P"), and
other nationally recognized rating organizations ("NRSROs") are private
services that provide ratings of the credit quality of debt obligations. A
description of
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the ratings assigned to corporate debt obligations by Moody's and S&P is
included in the Appendix to this Statement of Additional Information. The
process by which S&P and Moody's determine ratings for mortgage- and asset-
backed securities includes consideration of the likelihood of the receipt by
security holders of all distributions, the nature of the underlying
securities, the credit quality of the guarantor, if any, and the structural,
legal and tax aspects associated with such securities. Not even the highest
such ratings represent an assessment of the likelihood that principal
prepayments will be made by mortgagors or the degree to which such prepayments
may differ from that originally anticipated, nor do such ratings address the
possibility that investors may suffer a lower than anticipated yield or that
investors in such securities may fail to recoup fully their initial investment
due to prepayments.
The Underlying Funds may use these ratings in determining whether to
purchase, sell or hold a security. It should be emphasized, however, that
ratings are general and are not absolute standards of quality. Consequently,
securities with the same maturity, interest rate and rating may have different
market prices. Also, NRSROs may fail to make timely changes in credit ratings
in response to subsequent events so that an issuer's current financial
condition may be better or worse than the rating indicates. The rating
assigned to a security by a NRSRO does not reflect an assessment of the
volatility of the security's market value or of the liquidity of an investment
in the security. Subsequent to its purchase by an Underlying Fund, an issue of
debt obligations may cease to be rated or its rating may be reduced below the
minimum rating required for purchase by that Underlying Fund.
The yields on bonds and other debt securities in which the Underlying Funds
invest are dependent on a variety of factors, including general money market
conditions, general conditions in the bond market, the financial condition of
the issuer, the size of the offering, the maturity of the obligation and its
rating. There is a wide variation in the quality of bonds, both within a
particular classification and between classifications. An issuer's obligations
under its bonds are subject to the provisions of bankruptcy, insolvency and
other laws affecting the rights and remedies of bond holders or other
creditors of an issuer; litigation or other conditions may also adversely
affect the power or ability of issuers to meet their obligations for the
payment of interest and principal on their bonds.
Below-investment-grade debt securities are debt securities that are not
rated at the time of purchase within one of the four highest grades assigned
by S&P or Moody's, comparably rated by another NRSRO or determined by Mitchell
Hutchins or the applicable Sub-Adviser to be of comparable quality. These
securities are also commonly referred to as "junk bonds." Lower-rated debt
securities generally offer a higher current yield than that available for
investment grade issues; however, they involve higher risks. Lower-rated
securities may be less sensitive to interest rate changes than higher-rated
investments, but are more sensitive to adverse market conditions. During an
economic downturn or period of rising interest rates, their issuers may
experience financial stress that adversely affects their ability to pay
interest and repay principal and may increase the possibility of default. In
addition, such issuers may not have more traditional methods of financing
available to them and may be unable to repay debt at maturity by refinancing.
Lower-rated bonds are frequently unsecured by collateral and will not receive
payment until more senior claims are paid in full. The prices for lower-rated
bonds often are more volatile than those of higher-rated securities in
response to market conditions. The market for these bonds is thinner and less
active, which may limit the Underlying Fund's ability to sell them at fair
value in response to changes in the economy or financial markets. Adverse
publicity and investor perceptions, whether or not based on fundamental
analysis, may also decrease the value and liquidity of lower-rated securities,
especially in a thinly traded market.
The market for lower-rated debt securities has expanded rapidly in recent
years, and its growth generally paralleled a long economic expansion. In the
past, many lower-rated debt securities experienced substantial price declines,
reflecting an expectation that many issuers of such securities might
experience financial difficulties. As a result, the yields on lower-rated debt
securities rose dramatically. However, such higher yields did not reflect the
value of the income stream that holders of such securities expected, but
rather the risk that holders of such securities could lose a substantial
portion of their value as a result of the issuers' financial restructurings or
defaults. There can be no assurance that such declines will not recur.
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U.S. GOVERNMENT SECURITIES. The Underlying Funds may invest in various
direct obligations of the U.S. Treasury and obligations issued or guaranteed
by the U.S. government or one of its agencies or instrumentalities. Among the
U.S. government securities that may be held by the Underlying Funds are
securities that are supported by the full faith and credit of the United
States, only securities that are supported by the right of the issuer to
borrow from the U.S. Treasury and securities that are supported solely by the
credit of the instrumentality. Certain Underlying Funds may invest in
mortgage-backed securities issued or guaranteed by the U.S. government, its
agencies and instrumentalities. These securities are described below under
"Underlying Funds--Investment Policies--Mortgage-Backed Securities."
Certain Underlying Funds may invest in exchange rate-related U.S. government
securities. Such securities are indexed to specific foreign currency exchange
rates and generally provide that the interest rate and/or principal amount
will be adjusted upwards or downwards (but not below zero) to reflect changes
in the exchange rate between two currencies while the obligations are
outstanding. While such securities offer the potential for an attractive rate
of return, they also entail the risk of loss of principal.
ASSET-BACKED SECURITIES. Asset-backed securities have structural
characteristics similar to mortgage-backed securities, as discussed in more
detail below. However, the underlying assets are not first lien mortgage loans
or interests therein, but include assets such as motor vehicle installment
sale contracts, other installment sale contracts, home equity loans, leases of
various types of real and personal property and receivables from revolving
credit (credit card) agreements. Such assets are securitized through the use
of trusts or special purpose corporations. Payments or distributions of
principal and interest may be guaranteed up to a certain amount and for a
certain time period by a letter of credit or pool insurance policy issued by a
financial institution unaffiliated with the issuer, or other credit
enhancements may be present.
MORTGAGE-BACKED SECURITIES. Mortgage-backed securities represent direct or
indirect participations in, or are secured by and payable from, mortgage loans
secured by real property and include single- and multi-class pass-through
securities and collateralized mortgage obligations. Multi-class pass-through
securities and collateralized mortgage obligations are collectively referred
to herein as CMOs. U.S. government mortgage-backed securities include
mortgage-backed securities issued or guaranteed as to the payment of principal
and interest (but not as to market value) by the Government National Mortgage
Association ("Ginnie Mae"), Fannie Mae (also known as the Federal National
Mortgage Association) or Freddie Mac (also known as the Federal Home Loan
Mortgage Corporation). Other mortgage-backed securities are issued by private
issuers, generally originators of and investors in mortgage loans, including
savings associations, mortgage bankers, commercial banks, investment bankers
and special purpose entities (collectively, "Private Mortgage Lenders").
Payments of principal and interest (but not the market value) of such private
mortgage-backed securities may be supported by pools of mortgage loans or
other mortgage-backed securities that are guaranteed, directly or indirectly,
by the U.S. government or one of its agencies or instrumentalities, or they
may be issued without any government guarantee of the underlying mortgage
assets but with some form of non-government credit enhancement. New types of
mortgage-backed securities are developed and marketed from time to time and,
consistent with their investment policies and limitations, the Underlying
Funds expect to invest in these new types of mortgage-backed securities that
Mitchell Hutchins or the applicable Sub-Adviser believes may assist in
achieving the Underlying Fund's investment objective. Similarly, an Underlying
Fund may invest in mortgage-backed securities issued by new or existing
governmental or private issuers other than those identified herein.
Ginnie Mae Certificates. Ginnie Mae guarantees certain mortgage pass-through
certificates ("Ginnie Mae certificates") that are issued by Private Mortgage
Lenders and that represent ownership interests in individual pools of
residential mortgage loans. These securities are designed to provide monthly
payments of interest and principal to the investor. Timely payment of interest
and principal is backed by the full faith and credit of the U.S. government.
Each mortgagor's monthly payments to his lending institution on his
residential mortgage are "passed through" to certificate holders such as an
underlying Fund. Mortgage pools consist of whole mortgage loans or
participations in loans. The terms and characteristics of the mortgage
instruments are generally uniform within a pool but may vary among pools.
Lending institutions that originate mortgages for the pools are subject
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to certain standards, including credit and other underwriting criteria for
individual mortgages included in the pools.
Fannie Mae Certificates. Fannie Mae facilitates a national secondary market
in residential mortgage loans insured or guaranteed by U.S. government
agencies and in privately insured or uninsured residential mortgage loans
(sometimes referred to as "conventional mortgage loans" or "conventional
loans") through its mortgage purchase and mortgage-backed securities sales
activities. Fannie Mae issues guaranteed mortgage pass-through certificates
("Fannie Mae certificates"), which represent pro rata shares of all interest
and principal payments made and owed on the underlying pools. Fannie Mae
guarantees timely payment of interest and principal on Fannie Mae
certificates. The Fannie Mae guarantee is not backed by the full faith and
credit of the U.S. government.
Freddie Mac Certificates. Freddie Mac also facilitates a national secondary
market for conventional residential and U.S. government-insured mortgage loans
through its mortgage purchase and mortgage-backed securities sales activities.
Freddie Mac issues two types of mortgage pass-through securities: mortgage
participation certificates ("PCs") and guaranteed mortgage certificates
("GMCs"). Each PC represents a pro rata share of all interest and principal
payments made and owed on the underlying pool. Freddie Mac generally
guarantees timely monthly payment of interest on PCs and the ultimate payment
of principal, but it also has a PC program under which it guarantees timely
payment of both principal and interest. GMCs also represent a pro rata
interest in a pool of mortgages. These instruments, however, pay interest
semi-annually and return principal once a year in guaranteed minimum payments.
The Freddie Mac guarantee is not backed by the full faith and credit of the
U.S. government.
Private, RTC and Similar Mortgage-Backed Securities. Mortgage-backed
securities issued by Private Mortgage Lenders are structured similarly to CMOs
issued or guaranteed by Ginnie Mae, Fannie Mae and Freddie Mac. Such mortgage-
backed securities may be supported by pools of U.S. government- or agency-
insured or -guaranteed mortgage loans or by other mortgage-backed securities
issued by a government agency or instrumentality, but they generally are
supported by pools of conventional (i.e., non-government-guaranteed or -
insured) mortgage loans. Since such mortgage-backed securities normally are
not guaranteed by an entity having the credit standing of Ginnie Mae, Fannie
Mae and Freddie Mac, they normally are structured with one or more types of
credit enhancement. See "--Types of Credit Enhancement" below. These credit
enhancements do not protect investors from changes in market value.
The Resolution Trust Corporation ("RTC"), which was organized by the U.S.
government in connection with the savings and loan crisis, held assets of
failed savings associations as either a conservator or receiver for such
associations, or it acquired such assets in its corporate capacity. These
assets included, among other things, single family and multi-family mortgage
loans, as well as commercial mortgage loans. In order to dispose of such
assets in an orderly manner, RTC established a vehicle registered with the SEC
through which it sold mortgage-backed securities. RTC mortgage-backed
securities represent pro rata interests in pools of mortgage loans that RTC
held or had acquired, as described above, and are supported by one or more of
the types of private credit enhancements used by Private Mortgage Lenders.
Collateralized Mortgage Obligations and Multi-Class Mortgage Pass-
Throughs. CMOs are debt obligations that are collateralized by mortgage loans
or mortgage pass-through securities (such collateral collectively being called
"Mortgage Assets"). CMOs may be issued by Private Mortgage Lenders or by
government entities such as Fannie Mae or Freddie Mac. Multi-class mortgage
pass-through securities are interests in trusts that are comprised of Mortgage
Assets and that have multiple classes similar to those in CMOs. Unless the
context indicates otherwise, references herein to CMOs include multi-class
mortgage pass-through securities. Payments of principal of, and interest on,
the Mortgage Assets (and in the case of CMOs, any reinvestment income thereon)
provide the funds to pay debt service on the CMOs or to make scheduled
distributions on the multi-class mortgage pass-through securities.
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In a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of CMO, also referred to as a "tranche," is issued at a specific
fixed or floating coupon rate and has a stated maturity or final distribution
date. Principal prepayments on the Mortgage Assets may cause CMOs to be
retired substantially earlier than their stated maturities or final
distribution dates. Interest is paid or accrued on all classes of a CMO (other
than any principal only or "PO" class) on a monthly, quarterly or semiannual
basis. The principal and interest on the Mortgage Assets may be allocated
among the several classes of a CMO in many ways. In one structure, payments of
principal, including any principal prepayments, on the Mortgage Assets are
applied to the classes of a CMO in the order of their respective stated
maturities or final distribution dates so that no payment of principal will be
made on any class of the CMO until all other classes having an earlier stated
maturity or final distribution date have been paid in full. In some CMO
structures, all or a portion of the interest attributable to one or more of
the CMO classes may be added to the principal amounts attributable to such
classes, rather than passed through to certificateholders on a current basis,
until other classes of the CMO are paid in full.
Parallel pay CMOs are structured to provide payments of principal on each
payment date to more than one class. These simultaneous payments are taken
into account in calculating the stated maturity date or final distribution
date of each class, which, as with other CMO structures, must be retired by
its stated maturity date or final distribution date but may be retired
earlier.
Some CMO classes are structured to pay interest at rates that are adjusted
in accordance with a formula, such as a multiple or fraction of the change in
a specified interest rate index, so as to pay at a rate that will be
attractive in certain interest rate environments but not in others. For
example, an inverse floating rate CMO class pays interest at a rate that
increases as a specified interest rate index decreases but decreases as that
index increases. For other CMO classes, the yield may move in the same
direction as market interest rates--i.e., the yield may increase as rates
increase and decrease as rates decrease but may do so more rapidly or to a
greater degree. The market value of such securities generally is more volatile
than that of a fixed rate obligation. Such interest rate formulas may be
combined with other CMO characteristics. For example, a CMO class may be an
"inverse IO," on which the holders are entitled to receive no payments of
principal and are entitled to receive interest at a rate that will vary
inversely with a specified index or a multiple thereof.
Types of Credit Enhancement. To lessen the effect of failures by obligors on
Mortgage Assets to make payments, mortgage-backed securities may contain
elements of credit enhancement. Such credit enhancement falls into two
categories: (1) liquidity protection and (2) protection against losses
resulting after default by an obligor on the underlying assets and collection
of all amounts recoverable directly from the obligor and through liquidation
of the collateral. Liquidity protection refers to the provision of advances,
generally by the entity administering the pool of assets (usually the bank,
savings association or mortgage banker that transferred the underlying loans
to the issuer of the security), to ensure that the receipt of payments on the
underlying pool occurs in a timely fashion. Protection against losses
resulting after default and liquidation ensures ultimate payment of the
obligations on at least a portion of the assets in the pool. Such protection
may be provided through guarantees, insurance policies or letters of credit
obtained by the issuer or sponsor, from third parties, through various means
of structuring the transaction or through a combination of such approaches.
The Underlying Funds will not pay any additional fees for such credit
enhancement, although the existence of credit enhancement may increase the
price of a security. Credit enhancements do not provide protection against
changes in the market value of the security. Examples of credit enhancement
arising out of the structure of the transaction include "senior-subordinated
securities" (multiple class securities with one or more classes subordinate to
other classes as to the payment of principal thereof and interest thereon,
with the result that defaults on the underlying assets are borne first by the
holders of the subordinated class), creation of "spread accounts" or "reserve
funds" (where cash or investments, sometimes funded from a portion of the
payments on the underlying assets, are held in reserve against future losses)
and "over-collateralization" (where the scheduled payments on, or the
principal amount of, the underlying assets exceed that required to make
payment of the securities and pay any servicing or other fees). The degree of
credit enhancement provided for each issue generally is based on historical
information regarding the level of credit risk associated with the underlying
assets. Delinquency or loss in excess of that anticipated could adversely
affect the return on an investment in such a security.
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Special Characteristics of Mortgage- and Asset-Backed Securities. The yield
characteristics of mortgage- and asset-backed securities differ from those of
traditiona1 debt securities. Among the major differences are that interest and
principal payments are made more frequently, usually monthly, and that
principal may be prepaid at any time because the underlying mortgage loans or
other obligations generally may be prepaid at any time. Prepayments on a pool
of mortgage loans are influenced by a variety of economic, geographic, social
and other factors, including changes in mortgagors' housing needs, job
transfers, unemployment, mortgagors' net equity in the mortgaged properties
and servicing decisions. Generally, however, prepayments on fixed-rate
mortgage loans will increase during a period of falling interest rates and
decrease during a period of rising interest rates. Similar factors apply to
prepayments on asset-backed securities, but the receivables underlying asset-
backed securities generally are of a shorter maturity and thus less likely to
experience substantial prepayments. Such securities, however, often provide
that for a specified time period the issuers will replace receivables in the
pool that are repaid with comparable obligations. If the issuer is unable to
do so, repayment of principal on the asset-backed securities may commence at
an earlier date. Mortgage- and asset-backed securities may decrease in value
as a result of increases in interest rates and may benefit less than other
fixed-income securities from declining interest rates because of the risk of
prepayment.
The rate of interest on mortgage-backed securities is lower than the
interest rates paid on the mortgages included in the underlying pool due to
the annual fees paid to the servicer of the mortgage pool for passing through
monthly payments to certificateholders and to any guarantor, and due to any
yield retained by the issuer. Actual yield to the holder may vary from the
coupon rate, even if adjustable, if the mortgage-backed securities are
purchased or traded in the secondary market at a premium or discount. In
addition, there is normally some delay between the time the issuer receives
mortgage payments from the servicer and the time the issuer makes the payments
on the mortgage-backed securities, and this delay reduces the effective yield
to the holder of such securities.
Yields on pass-through securities are typically quoted by investment dealers
and vendors based on the maturity of the underlying instruments and the
associated average life assumption. The average life of pass-through pools
varies with the maturities of the underlying mortgage loans. A pool's term may
be shortened by unscheduled or early payments of principal on the underlying
mortgages. Because prepayment rates of individual pools vary widely, it is not
possible to predict accurately the average life of a particular pool. In the
past, a common industry practice was to assume that prepayments on pools of
fixed rate 30-year mortgages would result in a 12-year average life for the
pool. At present, mortgage pools, particularly those with loans with other
maturities or different characteristics, are priced on an assumption of
average life determined for each pool. In periods of declining interest rates,
the rate of prepayment tends to increase, thereby shortening the actual
average life of a pool of mortgage-related securities. Conversely, in periods
of rising interest rates, the rate of prepayment tends to decrease, thereby
lengthening the actual average life of the pool. However, these effects may
not be present, or may differ in degree, if the mortgage loans in the pools
have adjustable interest rates or other special payment terms, such as a
prepayment charge. Actual prepayment experience may cause the yield of
mortgage-backed securities to differ from the assumed average life yield.
Reinvestment of prepayments may occur at lower interest rates than the
original investment, thus adversely affecting the yield of an Underlying Fund.
Additional Information on Adjustable Rate Mortgage and Floating Rate
Mortgage-Backed Securities. Adjustable rate mortgage ("ARM") securities are
mortgage-backed securities that represent a right to receive interest payments
at a rate that is adjusted to reflect the interest earned on a pool of
mortgage loans bearing variable or adjustable rates of interest (such mortgage
loans are referred to as "ARMs"). Floating rate mortgage-backed securities are
classes of mortgage-backed securities that have been structured to represent
the right to receive interest payments at rates that fluctuate in accordance
with an index but that generally are supported by pools comprised of fixed-
rate mortgage loans.
Because the interest rates on ARM and floating rate mortgage-backed
securities are reset in response to changes in a specified market index, the
values of such securities tend to be less sensitive to interest rate
fluctuations than the values of fixed-rate securities. As a result, during
periods of rising interest rates, ARMs generally do not decrease in value as
much as fixed rate securities. Conversely, during periods of declining rates,
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ARMs generally do not increase in value as much as fixed rate securities. ARM
mortgage-backed securities represent a right to receive interest payments at a
rate that is adjusted to reflect the interest earned on a pool of ARMs. ARMs
generally specify that the borrower's mortgage interest rate may not be
adjusted above a specified lifetime maximum rate or, in some cases, below a
minimum lifetime rate. In addition, certain ARMs specify limitations on the
maximum amount by which the mortgage interest rate may adjust for any single
adjustment period. ARMs also may limit changes in the maximum amount by which
the borrower's monthly payment may adjust for any single adjustment period. In
the event that a monthly payment is not sufficient to pay the interest
accruing on the ARM, any such excess interest is added to the mortgage loan
("negative amortization"), which is repaid through future payments. If the
monthly payment exceeds the sum of the interest accrued at the applicable
mortgage interest rate and the principal payment that would have been
necessary to amortize the outstanding principal balance over the remaining
term of the loan, the excess reduces the principal balance of the ARM.
Borrowers under ARMs experiencing negative amortization may take longer to
build up their equity in the underlying property and may be more likely to
default.
ARMs also may be subject to a greater rate of prepayments in a declining
interest rate environment. For example, during a period of declining interest
rates, prepayments on ARMs could increase because the availability of fixed
mortgage loans at competitive interest rates may encourage mortgagors to
"lock-in" at a lower interest rate. Conversely, during a period of rising
interest rates, prepayments on ARMs might decrease. The rate of prepayments
with respect to ARMs has fluctuated in recent years.
The rates of interest payable on certain ARMs, and, therefore, on certain
ARM mortgage-backed securities, are based on indices, such as the one-year
constant maturity Treasury rate, that reflect changes in market interest
rates. Others are based on indices, such as the 11th District Federal Home
Loan Bank Cost of Funds Index ("COFI"), that tend to lag behind changes in
market interest rates. The values of ARM mortgage-backed securities supported
by ARMs that adjust based on lagging indices tend to be somewhat more
sensitive to interest rate fluctuations than those reflecting current interest
rate levels, although the values of such ARM mortgage-backed securities still
tend to be less sensitive to interest rate fluctuations than fixed-rate
securities.
As with ARM mortgage-backed securities, interest rate adjustments on
floating rate mortgage-backed securities may be based on indices that lag
behind market interest rates. Interest rates on floating rate mortgage-backed
securities generally are adjusted monthly. Floating rate mortgage-backed
securities are subject to lifetime interest rate caps, but they generally are
not subject to limitations on monthly or other periodic changes in interest
rates or monthly payments.
DURATION. Duration is a measure of the expected life of a fixed income
security that was developed as a more precise alternative to the concept "term
to maturity." Traditionally, a debt security's "term to maturity" has been
used as a proxy for the sensitivity of the security's price to changes in
interest rates (which is the "interest rate risk" or "volatility" of the
security). However, "term to maturity" measures only the time until a debt
security provides for a final payment, taking no account of the pattern of the
security's payments prior to maturity.
For any fixed income security with interest payments occurring prior to the
payment of principal, duration is always less than maturity. For example,
depending upon its coupon and the level of market yields, a Treasury note with
a remaining maturity of five years might have a duration of 4.5 years. For
mortgage-backed and other securities that are subject to prepayments, put or
call features or adjustable coupons, the difference between the remaining
stated maturity and the duration is likely to be much greater.
Futures, options and options on futures have durations that, in general, are
closely related to the duration of the securities that underlie them. Holding
long futures or call option positions (backed by a segregated account of cash
and cash equivalents) will lengthen a security's duration by approximately the
same amount as would holding an equivalent amount of the underlying
securities. Short futures or put options have durations roughly equal to the
negative duration of the securities that underlie these positions, and have
the effect of reducing portfolio duration by approximately the same amount as
would selling an equivalent amount of the underlying securities.
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There are some situations in which the standard duration calculation does
not properly reflect the interest rate exposure of a security. For example,
floating and variable rate securities often have final maturities of ten or
more years; however, their interest rate exposure corresponds to the frequency
of the coupon reset. Another example where the interest rate exposure is not
properly captured by the standard duration calculation is the case of
mortgage-backed securities. The stated final maturity of such securities is
generally 30 years, but current prepayment rates are critical in determining
the securities' interest rate exposure. In these and other similar situations,
Mitchell Hutchins and the applicable Sub-Advisers will use more sophisticated
analytical techniques that incorporate the economic life of a security into
the determination of its duration and, therefore, its interest rate exposure.
ZERO COUPON, OID AND PIK BONDS. Federal tax law requires that the holder of
a bond with original issue discount ("OID") accrue a portion of the OID on the
bond as income each year, even though the holder may receive no interest
payment on the bond during the year. Accordingly, although an investing
Underlying Fund will receive no payments on its zero coupon bonds prior to
their maturity or disposition, it will have income attributable to such bonds.
Similarly, while payment-in-kind ("PIK") bonds may pay interest in the form of
additional securities rather than cash, that interest must be included in an
Underlying Fund's annual gross income.
To qualify for pass-through federal income tax treatment as a regulated
investment company, an Underlying Fund must distribute substantially all of
its net investment income each year, including non-cash income. Accordingly,
each Underlying Fund will be required to include in its dividends an amount
equal to the income attributable to its zero coupon, other OID and PIK bonds.
See "Taxes." Those dividends will be paid from the cash assets of an
Underlying Fund or by liquidation of portfolio securities, if necessary, at a
time when the Underlying Fund otherwise might not have done so.
Certain zero coupon bonds are U.S. Treasury notes and bonds that have been
stripped of their unmatured interest coupon receipts or interests in such U.S.
Treasury securities or coupons. The staff of the SEC currently takes the
position that "stripped" U.S. government securities that are not issued
through the U.S. Treasury are not U.S. government securities. This technique
is frequently used with U.S. Treasury bonds to create CATS (Certificates of
Accrual Treasury Securities), TIGRs (Treasury Income Growth Receipts) and
similar securities. As long as the SEC takes this position, "CATS" and
"TIGRs", which are not issued through the U.S. Treasury, will not be counted
as U.S. government securities for purposes of the 65% investment requirement
applicable to PaineWebber U.S. Government Income Fund and PaineWebber Low
Duration U.S. Government Income Fund.
FOREIGN AND EMERGING MARKET SECURITIES. Investments in foreign securities
involve risks relating to political, social and economic developments abroad,
as well as risks resulting from the differences between the regulations to
which U.S. and foreign issuers and markets are subject. These risks are
greater for emerging market securities and may include expropriation,
confiscatory taxation, withholding taxes on interest and/or dividends,
currency devaluation, limitations on the use of or transfer of Underlying Fund
assets and political or social instability or diplomatic developments.
Moreover, individual foreign economies may differ favorably or unfavorably
from the U.S. economy in such respects as growth of gross national product,
rate of inflation, capital reinvestment, resource self-sufficiency and balance
of payments position. Securities of many foreign companies may be less liquid
and their prices more volatile than securities of comparable U.S. companies.
Many foreign securities may be difficult to liquidate rapidly without
significantly depressing the price of such securities. There may be less
publicly available information concerning foreign issuers of securities held
by the Underlying Funds than is available concerning U.S. companies.
Transactions in foreign securities may be subject to less efficient settlement
practices. Foreign securities trading practices, including those involving
securities settlement where Underlying Fund assets may be released prior to
receipt of payment, may expose the Underlying Funds to increased risk in the
event of a failed trade or the insolvency of a foreign broker-dealer. Legal
remedies for defaults and disputes may have to be pursued in foreign courts,
whose procedures differ substantially from those of U.S. courts.
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These risks are greater for emerging market securities than for securities
of foreign issuers in more developed markets. Disclosure and regulatory
standards for securities traded in emerging markets are less stringent than in
the U.S. and other major markets. There also may be a lower level of
monitoring and regulation of emerging markets and the activities of investors
in such markets, and enforcement of existing regulations may be extremely
limited. In certain emerging markets, there have been times when settlements
have failed to keep pace with the volume of securities transactions, making it
difficult to conduct such transactions. Delays in settlement could result in
temporary periods when the assets of an Underlying Fund are uninvested and no
return is earned thereon. The inability of an Underlying Fund to make intended
portfolio security purchases due to settlement problems could cause the Fund
to miss attractive investment opportunities. Inability to dispose of a
portfolio security due to settlement problems could result either in losses to
the Underlying Fund due to subsequent declines in the value of such portfolio
security or, if the Underlying Fund has entered into a contract to sell the
security, could result in possible liability to the purchaser.
To the extent that the Underlying Funds hold securities of foreign issuers,
these securities may not be registered with the SEC, nor may the issuers
thereof be subject to its reporting requirements. Accordingly, there may be
less publicly available information concerning foreign issuers of securities
held by the Underlying Funds than is available concerning U.S. companies.
Foreign companies are not generally subject to uniform accounting, auditing
and financial reporting standards or to other regulatory requirements
comparable to those applicable to U.S. companies.
The Underlying Funds may invest in foreign securities by purchasing
depository receipts, including American Depository Receipts ("ADRs"), European
Depository Receipts ("EDRs") and Global Depository Receipts ("GDRs"), or other
securities convertible into securities of issuers based in foreign countries.
These securities may not necessarily be denominated in the same currency as
the securities into which they may be converted. Generally, ADRs, in
registered form, are denominated in U.S. dollars and are designed for use in
the U.S. securities markets. EDRs are similar to ADRs, but may be denominated
in other currencies and are designed for use in European securities markets.
ADRs are receipts typically issued by a U.S. bank or trust company evidencing
ownership of the underlying securities. GDRs are similar to EDRs and are
designed for use in several international markets. For purposes of each
Underlying Fund's investment policies, ADRs, EDRs and GDRs are deemed to have
the same classification as the underlying securities they represent. Thus, an
ADR, EDR or GDR representing ownership of common stock will be treated as
common stock.
The Underlying Funds anticipate that their brokerage transactions involving
foreign securities of companies headquartered in countries other than the
United States will be conducted primarily on the principal exchanges of such
countries. Transactions on foreign exchanges are usually subject to fixed
commissions that are generally higher than negotiated commissions on U.S.
transactions, although each Underlying Fund will endeavor to achieve the best
net results in effecting its portfolio transactions. There is generally less
government supervision and regulation of exchanges and brokers in foreign
countries than in the United States.
From time to time, investments in other investment companies may be the most
effective available means by which the Underlying Funds may invest in
securities of issuers in certain countries. Investment in such investment
companies may involve the payment of management expenses and, in connection
with some purchases, sales loads, and payment of substantial premiums above
the value of such companies' portfolio securities. At the same time, an
Underlying Fund would continue to pay its own management fees and other
expenses. The Underlying Funds may invest in these investment funds and in
registered investment companies subject to the provisions of the 1940 Act,
except that each Underlying Fund will not purchase securities of registered
open-end investment companies or registered unit investment trusts in reliance
on section 12(d)(1)(F) or (12)(d)(1)(G) of the 1940 Act.
Investment income on certain foreign securities in which the Underlying
Funds may invest, and gains realized on the disposition thereof, may be
subject to foreign income, withholding or other taxes that could reduce the
yield and/or total return on these securities. Tax treaties between the United
States and foreign countries, however, may reduce or eliminate the amount of
foreign taxes to which the Underlying Funds would be subject.
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FOREIGN SOVEREIGN DEBT. Investment by the Underlying Funds in debt
securities issued by foreign governments and their political subdivisions or
agencies ("Sovereign Debt") involves special risks. The issuer of the debt or
the governmental authorities that control the repayment of the debt may be
unable or unwilling to repay principal and/or interest when due in accordance
with the terms of such debt, and the Underlying Funds may have limited legal
recourse in the event of a default.
Sovereign Debt differs from debt obligations issued by private entities in
that, generally, remedies for defaults must be pursued in the courts of the
defaulting party. Legal recourse is, therefore, somewhat diminished. Political
conditions, especially a sovereign entity's willingness to meet the terms of
its debt obligations, are of considerable significance. Also, there can be no
assurance that the holders of commercial bank debt issued by the same
sovereign entity may not contest payments to the holders of Sovereign Debt in
the event of default under commercial bank loan agreements.
A sovereign debtor's willingness or ability to repay principal and interest
due in a timely manner may be affected by, among other factors, its cash flow
situation, the extent of its foreign reserves, the availability of sufficient
foreign exchange on the date a payment is due, the relative size of the debt
service burden to the economy as a whole, the sovereign debtor's policy toward
principal international lenders and the political constraints to which a
sovereign debtor may be subject. Increased protectionism on the part of a
country's trading partners, or political changes in those countries, could
also adversely affect its exports. Such events could diminish a country's
trade account surplus, if any, or the credit standing of a particular local
government or agency.
The occurrence of political, social or diplomatic changes in one or more of
the countries issuing Sovereign Debt could adversely affect the Underlying
Funds' investments. Political changes or a deterioration of a country's
domestic economy or balance of trade may affect the willingness of countries
to service their Sovereign Debt. While Mitchell Hutchins and the Sub-Advisers
manage the Underlying Funds' portfolios in a manner that is intended to
minimize the exposure to such risks, there can be no assurance that adverse
political changes will not cause an Underlying Fund to suffer a loss of
interest or principal on any of its holdings.
BRADY BONDS. Brady Bonds are Sovereign Debt securities issued under the
framework of the Brady Plan, an initiative announced by former U.S. Treasury
Secretary Nicholas F. Brady in 1989 as a mechanism for debtor nations to
restructure their outstanding external commercial bank indebtedness. In
restructuring its external debt under the Brady Plan framework, a debtor
nation negotiates with its existing bank lenders as well as multilateral
institutions such as the International Monetary Fund ("IMF"). The Brady Plan
framework, as it has developed, contemplates the exchange of commercial bank
debt for newly issued Brady Bonds. Brady Bonds may also be issued in respect
of new money being advanced by existing lenders in connection with the debt
restructuring. The World Bank and the IMF support the restructuring by
providing funds pursuant to loan agreements or other arrangements which enable
the debtor nation to collateralize the new Brady Bonds or to repurchase
outstanding bank debt at a discount.
There can be no assurance that the circumstances regarding the issuance of
Brady Bonds by particular debtor nations will not change. Investors should
recognize that Brady Bonds have been issued only recently, and accordingly do
not have a long payment history. Agreements implemented under the Brady Plan
to date are designed to achieve debt and debt-service reduction through
specific options negotiated by a debtor nation with its creditors. As a
result, the financial packages offered by each country differ. The types of
options have included the exchange of outstanding commercial bank debt for
bonds issued at 100% of face value of such debt, which carry a below-market
stated rate of interest (generally known as par bonds), bonds issued at a
discount from the face value of such debt (generally known as discount bonds),
bonds bearing an interest rate which increases over time and bonds issued in
exchange for the advancement of new money by existing lenders. Regardless of
the stated face amount and stated interest rate of the various types of Brady
Bonds, the Underlying Fund will purchase Brady Bonds in secondary markets, as
described below, in which the price and yield to the investor reflect market
conditions at the time of purchase.
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Certain Brady Bonds have been collateralized as to principal due at maturity
by U.S. Treasury zero coupon bonds with maturities equal to the final maturity
of such Brady Bonds. Collateral purchases are financed by the IMF, the World
Bank and the debtor nations' reserves. In the event of a default with respect
to collateralized Brady Bonds as a result of which the payment obligations of
the issuer are accelerated, the U.S. Treasury zero coupon obligations held as
collateral for the payment of principal will not be distributed to investors,
nor will such obligations be sold and the proceeds distributed. The collateral
will be held by the collateral agent to the scheduled maturity of the
defaulted Brady Bonds, which will continue to be outstanding, at which time
the face amount of the collateral will equal the principal payments which
would have then been due on the Brady Bonds in the normal course. In addition,
interest payments on certain types of Brady Bonds may be collateralized by
cash or high grade securities in amounts that typically represent between 12
and 18 months of interest accruals on these instruments, with the balance of
the interest accruals being uncollateralized. Brady Bonds are often viewed as
having several valuation components: (1) the collateralized repayment of
principal, if any, at final maturity, (2) the collateralized interest
payments, if any, (3) the uncollateralized interest payments and (4) any
uncollateralized repayment of principal at maturity (these uncollateralized
amounts constitute the "residual risk"). In light of the residual risk of
Brady Bonds and, among other factors, the history of defaults with respect to
commercial bank loans by public and private entities of countries issuing
Brady Bonds, investments in Brady Bonds are to be viewed as speculative. The
Underlying Funds may purchase Brady Bonds with no or limited
collateralizations and will be relying for payment of interest and (except in
the case of principal collateralized Brady Bonds) repayment of principal
primarily on the willingness and ability of the foreign government to make
payment in accordance with the terms of the Brady Bonds. Brady Bonds issued to
date are purchased and sold in secondary markets through U.S. securities
dealers and other financial institutions and are generally maintained through
European transnational securities depositories.
FOREIGN CURRENCY TRANSACTIONS. Although the Underlying Funds value their
assets daily in U.S. dollars, they do not intend to convert their holdings of
foreign currencies to U.S. dollars on a daily basis. The Underlying Funds'
foreign currencies generally will be held as "foreign currency call accounts"
at foreign branches of foreign or domestic banks. These accounts bear interest
at negotiated rates and are payable upon relatively short demand periods. If a
bank became insolvent, the Underlying Funds could suffer a loss of some or all
of the amounts deposited. The Underlying Funds may convert foreign currency to
U.S. dollars from time to time. Although foreign exchange dealers generally do
not charge a stated commission or fee for conversion, the prices posted
generally include a "spread," which is the difference between the prices at
which the dealers are buying and selling foreign currencies.
CONVERTIBLE SECURITIES. A convertible security is a bond, debenture, note,
preferred stock or other security that may be converted into or exchanged for
a prescribed amount of common stock of the same or a different issuer within a
particular period of time at a specified price or formula. A convertible
security entitles the holder to receive interest paid or accrued on debt or
the dividend paid on preferred stock until the convertible security matures or
is redeemed, converted or exchanged. Before conversion, convertible securities
have characteristics similar to non-convertible debt securities in that they
ordinarily provide a stable stream of income with generally higher yields than
those of common stocks of the same or similar issuers. Convertible securities
rank senior to common stock in a corporation's capital structure but are
usually subordinated to comparable non-convertible securities. While no
securities investment is without some risk, investments in convertible
securities generally entail less risk than the issuer's common stock, although
the extent to which such risk is reduced depends in large measure upon the
degree to which the convertible security sells above its value as a fixed
income security. Convertible securities have unique investment characteristics
in that they generally (1) have higher yields than common stocks, but lower
yields than comparable non-convertible securities, (2) are less subject to
fluctuation in value than the underlying stock because they have fixed income
characteristics and (3) provide the potential for capital appreciation if the
market price of the underlying common stock increases.
The value of a convertible security is a function of its "investment value"
(determined by its yield comparison with the yields of other securities of
comparable maturity and quality that do not have a conversion privilege) and
its "conversion value" (the security's worth, at market value, if converted
into the underlying
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common stock). The investment value of a convertible security is influenced by
changes in interest rates, with investment value declining as interest rates
increase and increasing as interest rates decline. The credit standing of the
issuer and other factors also may have an effect on the convertible security's
investment value. The conversion value of a convertible security is determined
by the market price of the underlying common stock. If the conversion value is
low relative to the investment value, the price of the convertible security is
governed principally by its investment value and generally the conversion
value decreases as the convertible security approaches maturity. To the extent
the market price of the underlying common stock approaches or exceeds the
conversion price, the price of the convertible security will be increasingly
influenced by its conversion value. In addition, a convertible security
generally will sell at a premium over its conversion value determined by the
extent to which investors place value on the right to acquire the underlying
common stock while holding a fixed income security.
A convertible security may be subject to redemption at the option of the
issuer at a price established in the convertible security's governing
instrument. If a convertible security held by an Underlying Fund is called for
redemption, that Underlying Fund will be required to permit the issuer to
redeem the security, convert it into the underlying common stock or sell it to
a third party.
WARRANTS. Warrants are securities permitting, but not obligating, their
holder to subscribe for other securities or commodities. Warrants do not carry
with them the right to dividends or voting rights with respect to the
securities that they entitle their holder to purchase, and they do not
represent any rights in the assets of the issuer. As a result, warrants may be
considered more speculative than certain other types of investments. In
addition, the value of a warrant does not necessarily change with the value of
the underlying securities, and a warrant ceases to have value if it is not
exercised prior to its expiration date.
ILLIQUID SECURITIES. The Underlying Funds may invest up to 10% or 15% of
their net assets in illiquid securities. The term "illiquid securities" for
this purpose means securities that cannot be disposed of within seven days in
the ordinary course of business at approximately the amount at which an
Underlying Fund has valued the securities and includes, among other things,
purchased OTC options, repurchase agreements maturing in more than seven days
and restricted securities other than those Mitchell Hutchins or a Sub-Adviser,
as applicable, have determined are liquid pursuant to guidelines established
by each Underlying Fund's board of trustees or board of directors (each
sometimes referred to as a "board"). The assets used as cover for OTC options
written by the Underlying Funds will be considered illiquid unless the OTC
options are sold to qualified dealers who agree that a Fund may repurchase any
OTC option it writes at a maximum price to be calculated by a formula set
forth in the option agreement. The cover for an OTC option written subject to
this procedure would be considered illiquid only to the extent that the
maximum repurchase price under the formula exceeds the intrinsic value of the
option. Under current SEC guidelines, interest-only ("IO") and principal-only
("PO") classes of mortgage-backed securities, in which certain Underlying
Funds may invest, are considered illiquid. However, IO and PO classes of
fixed-rate mortgage-backed securities issued by the U.S. government or one of
its agencies or instrumentalities will not be considered illiquid if Mitchell
Hutchins has determined that they are liquid pursuant to guidelines
established by the applicable board.
Restricted securities are not registered under the Securities Act of 1933
("1933 Act") and may be sold only in privately negotiated or other exempt
transactions or after a 1933 Act registration statement has become effective.
Where registration is required, an Underlying Fund may be obligated to pay all
or part of the registration expenses and a considerable period may elapse
between the time of the decision to sell and the time a Fund may be permitted
to sell a security under an effective registration statement. If, during such
a period, adverse market conditions were to develop, an Underlying Fund might
obtain a less favorable price than prevailed when it decided to sell.
However, not all restricted securities are illiquid. To the extent that
foreign securities are freely tradeable in the country in which they are
principally traded, they are not considered illiquid for an Underlying Fund
that may invest in securities in that country even if the securities are
restricted in the United States. Moreover, in recent years a large
institutional market has developed for many U.S. and foreign securities that
are not registered
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under the 1933 Act. Institutional investors generally will not seek to sell
these instruments to the general public but, instead, will often depend either
on an efficient institutional market in which such unregistered securities can
be readily resold or on an issuer's ability to honor a demand for repayment.
Therefore, the fact that there are contractual or legal restrictions on resale
to the general public or certain institutions is not dispositive of the
liquidity of such investments.
Institutional markets for restricted securities also have developed as a
result of Rule 144A, which establishes a "safe harbor" from the registration
requirements of the 1933 Act for resales of certain securities to qualified
institutional buyers. Such markets include automated systems for the trading,
clearance and settlement of unregistered securities of domestic and foreign
issuers, such as the PORTAL System sponsored by the National Association of
Securities Dealers, Inc. An insufficient number of qualified institutional
buyers interested in purchasing Rule 144A-eligible restricted securities held
by an Underlying Fund, however, could adversely affect the marketability of
such portfolio securities and the Fund might be unable to dispose of such
securities promptly or at favorable prices.
Each board of the Underlying Funds has delegated the function of making day-
to-day determinations of liquidity to Mitchell Hutchins or the applicable Sub-
Adviser pursuant to guidelines approved by the board. Mitchell Hutchins or the
Sub-Adviser takes into account a number of factors in reaching liquidity
decisions, including (1) the frequency of trades for the security, (2) the
number of dealers that make quotes for the security, (3) the number of dealers
that have undertaken to make a market in the security, (4) the number of other
potential purchasers and (5) the nature of the security and how trading is
effected (e.g., the time needed to sell the security, how offers are solicited
and the mechanics of transfer). Mitchell Hutchins or the Sub-Adviser monitors
the liquidity of restricted securities in each Underlying Fund's portfolio and
reports periodically on such decisions to the applicable board.
REPURCHASE AGREEMENTS. Repurchase agreements are transactions in which an
Underlying Fund purchases securities from a bank or recognized securities
dealer and simultaneously commits to resell the securities to the bank or
dealer at an agreed-upon date or upon demand and at a price reflecting a
market rate of interest unrelated to the coupon rate or maturity of the
purchased securities. The Underlying Fund maintains custody of the underlying
securities prior to their repurchase; thus, the obligation of the bank or
dealer to pay the repurchase price on the date agreed to or upon demand is, in
effect, secured by such securities. If the value of these securities is less
than the repurchase price, plus any agreed-upon additional amount, the other
party to the agreement must provide additional collateral so that at all times
the collateral is at least equal to the repurchase price, plus any agreed-upon
additional amount. The difference between the total amount to be received upon
repurchase of the securities and the price that was paid by an Underlying Fund
upon acquisition is accrued as interest and included in its net investment
income.
The Underlying Funds intend to enter into repurchase agreements only with
banks and dealers in transactions believed by Mitchell Hutchins or a Sub-
Adviser to present minimal credit risks in accordance with guidelines
established by the applicable board. Mitchell Hutchins reviews and monitors
the creditworthiness of those institutions under each board's general
supervision.
REVERSE REPURCHASE AGREEMENTS. Most of the Underlying Funds may enter into
reverse repurchase agreements with banks and securities dealers. Such
agreements involve the sale of securities held by the Underlying Fund subject
to the Fund's agreement to repurchase the securities at an agreed-upon date or
upon demand and at a price reflecting a market rate of interest. Such
agreements are considered to be borrowings and may be entered into only for
temporary or emergency purposes. While a reverse repurchase agreement is
outstanding, the Underlying Fund's custodian segregates assets to cover the
Fund's obligations under the reverse repurchase agreement. See "Underlying
Funds--Investment Policies--Segregated Accounts."
LENDING OF PORTFOLIO SECURITIES. Each Underlying Fund is authorized to lend
up to 33 1/3% of its total assets to broker-dealers or institutional investors
that Mitchell Hutchins deems qualified, but only when the borrower maintains
acceptable collateral with that Underlying Fund's custodian in an amount,
marked to market
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daily, at least equal to the market value of the securities loaned, plus
accrued interest and dividends. Acceptable collateral is limited to cash, U.S.
government securities and irrevocable letters of credit that meet certain
guidelines established by Mitchell Hutchins. In determining whether to lend
securities to a particular broker- dealer or institutional investor, Mitchell
Hutchins will consider, and during the period of the loan will monitor, all
relevant facts and circumstances, including the creditworthiness of the
borrower. Each Underlying Fund will retain authority to terminate any loans at
any time. Each Underlying Fund may pay reasonable fees in connection with a
loan and may pay a negotiated portion of the interest earned on the cash held
as collateral to the borrower or placing broker. Each Underlying Fund will
receive reasonable interest on the loan or a flat fee from the borrower and
amounts equivalent to any dividends, interest or other distributions on the
securities loaned. Each Underlying Fund will regain record ownership of loaned
securities to exercise beneficial rights, such as voting and subscription
rights, when regaining such rights is considered to be in the Fund's interest.
Pursuant to procedures adopted by an Underlying Fund's board governing its
securities lending program, PaineWebber serves as lending agent for that
Underlying Fund. The boards have also authorized the payment of fees
(including fees calculated as a percentage of invested cash collateral) to
PaineWebber for these services. The board of each Underlying Fund periodically
reviews all portfolio securities loan transactions of that Underlying Fund for
which PaineWebber acted as lending agent.
SHORT SALES "AGAINST THE BOX." Each Underlying Fund other than PaineWebber
Cashfund may engage in short sales of securities it owns or has the right to
acquire at no added cost through conversion or exchange of other securities it
owns (short sales "against the box"). To make delivery to the purchaser in a
short sale, the executing broker borrows the securities being sold short on
behalf of an Underlying Fund, and that Underlying Fund is obligated to replace
the securities borrowed at a date in the future. When an Underlying Fund sells
short, it establishes a margin account with the broker effecting the short
sale, and deposits collateral with the broker. In addition, the Underlying
Fund maintains with its custodian, in a segregated account, the securities
that could be used to cover the short sale. Each Underlying Fund incurs
transaction costs, including interest expense, in connection with opening,
maintaining and closing short sales "against the box."
The Underlying Funds might make a short sale "against the box" in order to
hedge against market risks when Mitchell Hutchins or a Sub-Adviser believes
that the price of a security may decline, thereby causing a decline in the
value of a security owned by a Fund or a security convertible into or
exchangeable for a security owned by the Fund. In such case, any loss in an
Underlying Fund's long position after the short sale should be reduced by a
corresponding gain in the short position. Conversely, any gain in the long
position after the short sale should be reduced by a corresponding loss in the
short position. The extent to which gains or losses in the long position are
reduced will depend upon the amount of the securities sold short relative to
the amount of the securities the Underlying Fund owns, either directly or
indirectly, and in the case where the Underlying Fund owns convertible
securities, changes in the investment values or conversion premiums of such
securities. As a result of the Taxpayer Relief Act of 1997, short sales
"against the box" no longer may be used to defer the recognition of gain for
federal income tax purposes. See "Taxes."
LOAN PARTICIPATIONS AND ASSIGNMENTS. PaineWebber Investment Grade Income
Fund and PaineWebber High Income Fund each may invest up to 5% of its net
assets, and PaineWebber Global Income Fund may invest without limitation, in
secured or unsecured fixed or floating rate loans ("Loans") arranged through
private negotiations between a borrowing corporation and one or more financial
institutions ("Lenders"). These Underlying Funds' investments in Loans are
expected in most instances to be in the form of participations
("Participations") in Loans and assignments ("Assignments") of all or a
portion of Loans from third parties. Participations typically result in an
Underlying Fund's having a contractual relationship only with the Lender, not
with the borrower. An Underlying Fund has the right to receive payments of
principal, interest and any fees to which it is entitled only from the Lender
selling the Participation and only upon receipt by the Lender of the payments
from the borrower. In connection with purchasing Participations, an Underlying
Fund generally has no direct right to enforce compliance by the borrower with
the terms of the loan agreement relating to the Loan, nor any rights of set-
off against the borrower, and the Fund may not directly benefit from any
collateral supporting the Loan in which it has purchased the Participation. As
a result, an Underlying Fund assumes the credit risk of
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both the borrower and the Lender that is selling the Participation. In the
event of the insolvency of the Lender selling a Participation, an Underlying
Fund may be treated as a general creditor of the Lender and may not benefit
from any set-off between the Lender and the borrower. The Underlying Funds
will acquire Participations only if the Lender interpositioned between the
Fund and the borrower is determined by Mitchell Hutchins to be creditworthy.
When an Underlying Fund purchases Assignments from Lenders, it acquires
direct rights against the borrower on the Loan. However, because Assignments
are arranged through private negotiations between potential assignees and
assignors, the rights and obligations acquired by an Underlying Fund as the
purchaser of an Assignment may differ from, and be more limited than, those
held by the assigning Lender.
Assignments and Participations are generally not registered under the 1933
Act and thus are subject to each Underlying Fund's limitation on investment in
illiquid securities. Because there is no liquid market for such securities,
the Underlying Funds anticipate that such securities could be sold only to a
limited number of institutional investors. The lack of a liquid secondary
market will have an adverse impact on the value of such securities and on an
Underlying Fund's ability to dispose of particular Assignments or
Participations when necessary to meet the Fund's liquidity needs or in
response to a specific economic event, such as a deterioration in the
creditworthiness of the borrower.
SEGREGATED ACCOUNTS. When an Underlying Fund enters into certain
transactions to make future payments to third parties, it will maintain with
an approved custodian in a segregated account cash or liquid securities,
marked to market daily, in an amount at least equal to the Fund's obligation
or commitment under such transactions. As described below under "Underlying
Funds--Hedging and Other Strategies Using Derivative Instruments," segregated
accounts may also be required in connection with certain transactions
involving options, futures contracts and forward currency contracts, swaps or
similar instruments.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. As stated in the Prospectus,
each Underlying Fund may purchase securities on a "when-issued" or delayed
delivery basis. A security purchased on a when-issued or delayed delivery
basis is recorded as an asset on the commitment date and is subject to changes
in market value, generally based upon changes in the level of interest rates.
Thus, fluctuation in the value of the security from the time of the commitment
date will affect a Fund's net asset value. When an Underlying Fund agrees to
purchase securities on a when-issued or delayed delivery basis, its custodian
segregates assets to cover the amount of the commitment. See "Underlying
Funds--Investment Policies--Segregated Accounts." An Underlying Fund purchases
when-issued securities only with the intention of taking delivery, but may
sell the right to acquire the security prior to delivery if Mitchell Hutchins
or a Sub-Adviser, as applicable, deems it advantageous to do so, which may
result in a gain or loss to the Fund.
UNDERLYING FUNDS--HEDGING AND OTHER STRATEGIES USING DERIVATIVE INSTRUMENTS
GENERAL DESCRIPTION OF DERIVATIVE INSTRUMENTS. Mitchell Hutchins and the
Sub-Advisers may use a variety of financial contracts ("Derivative
Instruments"), including certain options, futures contracts (sometimes
referred to as "futures") and options on futures contracts to attempt to hedge
the portfolio of each Underlying Fund (other than PaineWebber Cashfund).
Certain Underlying Funds also may use these derivative instruments to attempt
to enhance income or return, including shifting an Underlying Fund's exposure
from one asset class to another. Certain Underlying Funds also may hedge their
portfolios by entering into certain swaps or other interest rate protection
transactions and by using forward currency contracts. An Underlying Fund may
enter into transactions involving one or more types of Derivative Instruments
under which the full value of its portfolio is at risk. Under normal
circumstances, however, an Underlying Fund's use of these Derivative
Instruments will place at risk a much smaller portion of its assets. The
particular Derivative Instruments used by the Underlying Funds are described
below.
OPTIONS ON SECURITIES AND FOREIGN CURRENCIES--A call option is a short-term
contract pursuant to which the purchaser of the option, in return for a
premium, has the right to buy the security or currency underlying the option
at a specified price at any time during the term of the option. The writer of
the call option, who receives
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the premium, has the obligation, upon exercise of the option during the option
term, to deliver the underlying security or currency against payment of the
exercise price. A put option is a similar contract that gives its purchaser,
in return for a premium, the right to sell the underlying security or currency
at a specified price during the option term. The writer of the put option, who
receives the premium, has the obligation, upon exercise of the option during
the option term, to buy the underlying security or currency at the exercise
price.
OPTIONS ON SECURITIES INDICES--A securities index assigns relative values to
the securities included in the index and fluctuates with changes in the market
values of those securities. A securities index option operates in the same way
as a more traditional securities option, except that exercise of a securities
index option is effected with cash payment and does not involve delivery of
securities. Thus, upon exercise of a securities index option, the purchaser
will realize, and the writer will pay, an amount based on the difference
between the exercise price and the closing price of the securities index.
SECURITIES INDEX FUTURES CONTRACTS--A securities index futures contract is a
bilateral agreement pursuant to which one party agrees to accept, and the
other party agrees to make, delivery of an amount of cash equal to a specified
dollar amount times the difference between the securities index value at the
close of trading of the contract and the price at which the futures contract
is originally struck. No physical delivery of the securities comprising the
index is made. Generally, contracts are closed out prior to the expiration
date of the contract.
INTEREST RATE AND FOREIGN CURRENCY FUTURES CONTRACTS--Interest rate and
foreign currency futures contracts are bilateral agreements pursuant to which
one party agrees to make, and the other party agrees to accept, delivery of a
specified type of debt security or currency at a specified future time and at
a specified price. Although such futures contracts by their terms call for
actual delivery or acceptance of debt securities or currency, in most cases
the contracts are closed out before the settlement date without the making or
taking of delivery.
OPTIONS ON FUTURES CONTRACTS--Options on futures contracts are similar to
options on securities or currency, except that an option on a futures contract
gives the purchaser the right, in return for the premium, to assume a position
in a futures contract (a long position if the option is a call and a short
position if the option is a put), rather than to purchase or sell a security
or currency, at a specified price at any time during the option term. Upon
exercise of the option, the delivery of the futures position to the holder of
the option will be accompanied by delivery of the accumulated balance that
represents the amount by which the market price of the futures contract
exceeds, in the case of a call, or is less than, in the case of a put, the
exercise price of the option on the future. The writer of an option, upon
exercise, will assume a short position in the case of a call and a long
position in the case of a put.
FORWARD CURRENCY CONTRACTS--A forward currency contract involves an
obligation to purchase or sell a specific currency at a specified future date,
which may be any fixed number of days from the contract date agreed upon by
the parties, at a price set at the time the contract is entered into.
GENERAL DESCRIPTION OF STRATEGIES. Hedging strategies can be broadly
categorized as "short hedges" and "long hedges." A short hedge is a purchase
or sale of a Derivative Instrument intended partially or fully to offset
potential declines in the value of one or more investments held in an
Underlying Fund's portfolio. Thus, in a short hedge an Underlying Fund takes a
position in a Derivative Instrument whose price is expected to move in the
opposite direction of the price of the investment being hedged. For example,
an Underlying Fund might purchase a put option on a security to hedge against
a potential decline in the value of that security. If the price of the
security declined below the exercise price of the put, an Underlying Fund
could exercise the put and thus limit its loss below the exercise price to the
premium paid plus transaction costs. In the alternative, because the value of
the put option can be expected to increase as the value of the underlying
security declines, an Underlying Fund might be able to close out the put
option and realize a gain to offset the decline in the value of the security.
Conversely, a long hedge is a purchase or sale of a Derivative Instrument
intended partially or fully to offset potential increases in the acquisition
cost of one or more investments that an Underlying Fund intends to acquire.
Thus, in a long hedge, an Underlying Fund takes a position in a Derivative
Instrument whose price is expected to move in
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the same direction as the price of the prospective investment being hedged.
For example, an Underlying Fund might purchase a call option on a security it
intends to purchase in order to hedge against an increase in the cost of the
security. If the price of the security increased above the exercise price of
the call, an Underlying Fund could exercise the call and thus limit its
acquisition cost to the exercise price plus the premium paid and transaction
costs. Alternatively, an Underlying Fund might be able to offset the price
increase by closing out an appreciated call option and realizing a gain.
Derivative Instruments on securities generally are used to hedge against
price movements in one or more particular securities positions that an
Underlying Fund owns or intends to acquire. Derivative Instruments on stock
indices, in contrast, generally are used to hedge against price movements in
broad equity market sectors in which an Underlying Fund has invested or
expects to invest. Derivative Instruments on debt securities may be used to
hedge either individual securities or broad fixed income market sectors.
Income strategies include the writing of covered options to obtain the
related option premiums. Return strategies include the use of Derivative
Instruments to increase or reduce an Underlying Fund's exposure to an asset
class without buying or selling the underlying instruments.
The use of Derivative Instruments is subject to applicable regulations of
the SEC, the several options and futures exchanges upon which they are traded
and the Commodity Futures Trading Commission ("CFTC"). In addition, an
Underlying Fund's ability to use Derivative Instruments will be limited by tax
considerations. See "Taxes."
In addition to the products, strategies and risks described below and in the
Prospectus, Mitchell Hutchins and the Sub-Advisers expect to discover
additional opportunities in connection with options, futures contracts and
other derivative instruments and hedging techniques. These new opportunities
may become available as Mitchell Hutchins or the Sub-Advisers develop new
techniques, as regulatory authorities broaden the range of permitted
transactions and as new options, futures contracts, foreign currency contracts
or other derivative instruments and techniques are developed. Mitchell
Hutchins or a Sub-Adviser, as applicable, may utilize these opportunities for
an Underlying Fund to the extent that they are consistent with the Fund's
investment objective and permitted by its investment limitations and
applicable regulatory authorities. An Underlying Fund's prospectus or
statement of additional information will be supplemented to the extent that
new products or techniques involve materially different risks than those
described below or in its prospectus.
SPECIAL RISKS OF HEDGING STRATEGIES. The use of Derivative Instruments in
hedging strategies involves special considerations and risks, as described
below. Risks pertaining to particular Derivative Instruments are described in
the sections that follow.
(1) Successful use of most Derivative Instruments depends upon the
ability of Mitchell Hutchins or a Sub-Adviser, as applicable, to predict
movements of the overall securities and interest rate markets, which
requires different skills than predicting changes in the prices of
individual securities. While Mitchell Hutchins and the Sub-Advisers are
experienced in the use of Derivative Instruments, there can be no assurance
that any particular hedging strategy adopted will succeed.
(2) There might be imperfect correlation, or even no correlation, between
price movements of a Derivative Instrument and price movements of the
investments being hedged. For example, if the value of a Derivative
Instrument used in a short hedge increased by less than the decline in
value of the hedged investment, the hedge would not be fully successful.
Such a lack of correlation might occur due to factors unrelated to the
value of the investments being hedged, such as speculative or other
pressures on the markets in which Derivative Instruments are traded. The
effectiveness of hedges using Derivative Instruments on indices will depend
on the degree of correlation between price movements in the index and price
movements in the securities being hedged.
(3) Hedging strategies, if successful, can reduce risk of loss by wholly
or partially offsetting the negative effect of unfavorable price movements
in the investments being hedged. However, hedging strategies can also
reduce opportunity for gain by offsetting the positive effect of favorable
price movements in the hedged investments. For example, if an Underlying
Fund entered into a short hedge because Mitchell Hutchins or a Sub-Adviser
projected a decline in the price of a security in that Underlying Fund's
portfolio, and the price of that security increased instead, the gain from
that increase might be wholly or partially offset by a decline in the price
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of the Derivative Instrument. Moreover, if the price of the Derivative
Instrument declined by more than the increase in the price of the security,
that Underlying Fund could suffer a loss. In either such case, the
Underlying Fund would have been in a better position had it not hedged at
all.
(4) As described below, an Underlying Fund might be required to maintain
assets as "cover," maintain segregated accounts or make margin payments
when it takes positions in Derivative Instruments involving obligations to
third parties (i.e., Derivative Instruments other than purchased options).
If the Underlying Fund was unable to close out its positions in such
Derivative Instruments, it might be required to continue to maintain such
assets or accounts or make such payments until the positions expired or
matured. These requirements might impair an Underlying Fund's ability to
sell a portfolio security or make an investment at a time when it would
otherwise be favorable to do so, or require that the Fund sell a portfolio
security at a disadvantageous time. An Underlying Fund's ability to close
out a position in a Derivative Instrument prior to expiration or maturity
depends on the existence of a liquid secondary market or, in the absence of
such a market, the ability and willingness of a contra party to enter into
a transaction closing out the position. Therefore, there is no assurance
that any position can be closed out at a time and price that is favorable
to an Underlying Fund.
COVER FOR STRATEGIES USING DERIVATIVE INSTRUMENTS. Transactions using
Derivative Instruments, other than purchased options, expose the Underlying
Funds to an obligation to another party. An Underlying Fund will not enter
into any such transactions unless it owns either (1) an offsetting ("covered")
position in securities, other options or futures contracts or (2) cash and
liquid securities, with a value sufficient at all times to cover its potential
obligations to the extent not covered as provided in (1) above. Each
Underlying Fund will comply with SEC guidelines regarding cover for these
transactions and will, if the guidelines so require, set aside cash or liquid
securities in a segregated account with its custodian in the prescribed
amount.
Assets used as cover or held in a segregated account cannot be sold while
the position in the corresponding Derivative Instrument is open, unless they
are replaced with similar assets. As a result, the commitment of a large
portion of an Underlying Fund's assets to cover or segregated accounts could
impede portfolio management or the Fund's ability to meet redemption requests
or other current obligations.
OPTIONS. Certain of the Underlying Funds may purchase put and call options,
and write (sell) covered put or call options on securities on which they are
permitted to invest and indices of those securities. Those Underlying Funds
that are permitted to invest in foreign securities denominated in foreign
currencies also may purchase put and call options on foreign currencies. The
purchase of call options serves as a long hedge, and the purchase of put
options serves as a short hedge. Writing covered call options serves as a
limited short hedge, because declines in the value of the hedged investment
would be offset to the extent of the premium received for writing the option.
However, if the security appreciates to a price higher than the exercise price
of the call option, it can be expected that the option will be exercised and
the affected Underlying Fund will be obligated to sell the security at less
than its market value. Writing covered put options serves as a limited long
hedge because increases in the value of the hedged investment would be offset
to the extent of the premium received for writing the option. However, if the
security depreciates to a price lower than the exercise price of the put
option, it can be expected that the put option will be exercised and the
Underlying Fund will be obligated to purchase the security at more than its
market value. The securities or other assets used as cover for OTC options
written by an Underlying Fund will be considered illiquid to the extent
described under "Underlying Funds--Investment Policies--Illiquid Securities."
The value of an option position will reflect, among other things, the
current market value of the underlying investment, the time remaining until
expiration, the relationship of the exercise price to the market price of the
underlying investment, the historical price volatility of the underlying
investment and general market conditions. Options normally have expiration
dates of up to nine months. Options that expire unexercised have no value.
An Underlying Fund may effectively terminate its right or obligation under
an option by entering into a closing transaction. For example, an Underlying
Fund may terminate its obligation under a call or put option that it had
written by purchasing an identical call or put option; this is known as a
closing purchase transaction. Conversely, an Underlying Fund may terminate a
position in a put or call option it had purchased by writing an identical put
or call option; this is known as a closing sale transaction. Closing
transactions permit an Underlying Fund to realize profits or limit losses on
an option position prior to its exercise or expiration.
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The Underlying Funds may purchase and write both exchange-traded and OTC
options. Exchange markets for options on debt securities and foreign
currencies exist but are relatively new, and these instruments are primarily
traded on the OTC market. Exchange-traded options in the United States are
issued by a clearing organization affiliated with the exchange on which the
option is listed which, in effect, guarantees completion of every exchange-
traded option transaction. In contrast, OTC options are contracts between an
Underlying Fund and its contra party (usually a securities dealer or a bank)
with no clearing organization guarantee. Thus, when an Underlying Fund
purchases or writes an OTC option, it relies on the contra party to make or
take delivery of the underlying investment upon exercise of the option.
Failure by the contra party to do so would result in the loss of any premium
paid by the Underlying Fund as well as the loss of any expected benefit of the
transaction.
Generally, the OTC debt options or foreign currency options used by the
Underlying Funds are European-style options. This means that the option is
only exercisable immediately prior to its expiration. This is in contrast to
American-style options, which are exercisable at any time prior to the
expiration date of the option.
The Underlying Funds' ability to establish and close out positions in
exchange-listed options depends on the existence of a liquid market. The
Underlying Funds intend to purchase or write only those exchange-traded
options for which there appears to be a liquid secondary market. However,
there can be no assurance that such a market will exist at any particular
time. Closing transactions can be made for OTC options only by negotiating
directly with the contra party, or by a transaction in the secondary market if
any such market exists. Although the Underlying Funds will enter into OTC
options only with contra parties that are expected to be capable of entering
into closing transactions with the Underlying Funds, there is no assurance
that an Underlying Fund will in fact be able to close out an OTC option
position at a favorable price prior to expiration. In the event of insolvency
of the contra party, an Underlying Fund might be unable to close out an OTC
option position at any time prior to its expiration.
If an Underlying Fund were unable to effect a closing transaction for an
option it had purchased, it would have to exercise the option to realize any
profit. The inability to enter into a closing purchase transaction for a
covered put or call option written by the Underlying Fund could cause material
losses because the Fund would be unable to sell the investment used as cover
for the written option until the option expires or is exercised.
LIMITATIONS ON THE USE OF OPTIONS. The use of options is governed by the
following guidelines, which can be changed by the board of each Underlying
Fund without shareholder vote:
(1) Each Underlying Fund may purchase a put or call option, including any
straddles or spreads, only if the value of its premium, when aggregated
with the premiums on all other options held by the Underlying Fund, does
not exceed 5% of its total assets.
(2) The aggregate value of securities underlying put options written by
an Underlying Fund determined as of the date the put options are written
will not exceed 50% of that Underlying Fund's net assets.
(3) The aggregate premiums paid on all options (including options on
securities, foreign currencies and stock and bond indices and options on
futures contracts) purchased by an Underlying Fund that are held at any
time will not exceed 20% of that Underlying Fund's net assets.
FUTURES. The Underlying Funds may purchase and sell futures contracts that
are related to securities in which they are permitted to invest, such as
securities index futures contracts for Underlying Funds that invest in equity
securities, interest rate futures contracts for Underlying Funds that invest
in bonds and foreign currency futures contracts for Underlying Funds that
invest in securities that are denominated in foreign currencies. An Underlying
Fund may also purchase put and call options, and write covered put and call
options, on futures in which it is allowed to invest. The purchase of futures
or call options thereon can serve as a long hedge, and the sale of futures or
the purchase of put options thereon can serve as a short hedge. Writing
covered call options on futures contracts can serve as a limited short hedge,
and writing covered put options on futures contracts can serve as a limited
long hedge, using a strategy similar to that used for writing covered options
on securities or indices.
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No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract an Underlying Fund is required to deposit in a
segregated account with its custodian, in the name of the futures broker
through whom the transaction was effected, "initial margin" consisting of
cash, obligations of the United States or obligations that are fully
guaranteed as to principal and interest by the United States, in an amount
generally equal to 10% or less of the contract value. Margin must also be
deposited when writing a call option on a futures contract, in accordance with
applicable exchange rules. Unlike margin in securities transactions, initial
margin on futures contracts does not represent a borrowing, but rather is in
the nature of a performance bond or good-faith deposit that is returned to an
Underlying Fund at the termination of the transaction if all contractual
obligations have been satisfied. Under certain circumstances, such as periods
of high volatility, an Underlying Fund may be required by an exchange to
increase the level of its initial margin payment, and initial margin
requirements might be increased generally in the future by regulatory action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of each Underlying Fund's obligations to or from
a futures broker. When an Underlying Fund purchases an option on a future, the
premium paid plus transaction costs is all that is at risk. In contrast, when
an Underlying Fund purchases or sells a futures contract or writes a call
option thereon, it is subject to daily variation margin calls that could be
substantial in the event of adverse price movements. If an Underlying Fund has
insufficient cash to meet daily variation margin requirements, it might need
to sell securities at a time when such sales are disadvantageous.
Holders and writers of futures positions and options on futures can enter
into offsetting closing transactions, similar to closing transactions on
options, by selling or purchasing, respectively, an instrument identical to
the instrument held or written. Positions in futures and options on futures
may be closed only on an exchange or board of trade that provides a secondary
market. The Underlying Funds intend to enter into futures transactions only on
exchanges or boards of trade where there appears to be a liquid secondary
market. However, there can be no assurance that such a market will exist for a
particular contract at a particular time.
Under certain circumstances, futures exchanges may establish daily limits on
the amount that the price of a future or related option can vary from the
previous day's settlement price; once that limit is reached, no trades may be
made that day at a price beyond the limit. Daily price limits do not limit
potential losses because prices could move to the daily limit for several
consecutive days with little or no trading, thereby preventing liquidation of
unfavorable positions.
If an Underlying Fund were unable to liquidate a futures or related options
position due to the absence of a liquid secondary market or the imposition of
price limits, it could incur substantial losses. An Underlying Fund would
continue to be subject to market risk with respect to the position. In
addition, except in the case of purchased options, an Underlying Fund would
continue to be required to make daily variation margin payments and might be
required to maintain the position being hedged by the future or option or to
maintain cash or securities in a segregated account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or related options might not
correlate perfectly with movements in the prices of the investments being
hedged. For example, all participants in the futures and related options
markets are subject to daily variation margin calls and might be compelled to
liquidate futures or related options positions whose prices are moving
unfavorably to avoid being subject to further calls. These liquidations could
increase price volatility of the instruments and distort the normal price
relationship between the futures or options and the investments being hedged.
Also, because initial margin deposit requirements in the futures market are
less onerous than margin requirements in the securities markets, there might
be increased participation by speculators in the futures markets. This
participation also might cause temporary price distortions. In addition,
activities of large traders in both the futures and securities markets
involving arbitrage, "program trading" and other investment strategies might
result in temporary price distortions.
23
<PAGE>
LIMITATIONS ON THE USE OF FUTURES AND RELATED OPTIONS. The use of futures
and related options is governed by the following guidelines, which can be
changed by the applicable board for each Underlying Fund without shareholder
vote:
(1) To the extent an Underlying Fund enters into futures contracts and
options on futures positions that are not for bona fide hedging purposes
(as defined by the CFTC), the aggregate initial margin and premiums on
those positions (excluding the amount by which options are "in-the-money")
may not exceed 5% of that Underlying Fund's net assets.
(2) The aggregate premiums paid on all options (including options on
securities, foreign currencies and stock or bond indices and options on
futures contracts) purchased by an Underlying Fund that are held at any
time will not exceed 20% of that Underlying Fund's net assets.
(3) The aggregate margin deposits on all futures contracts and options
thereon held at any time by an Underlying Fund will not exceed 5% of its
total assets.
FOREIGN CURRENCY HEDGING STRATEGIES--SPECIAL CONSIDERATIONS. Those
Underlying Funds that invest in securities that are denominated in foreign
currencies may use options and futures on foreign currencies, as described
above, and forward currency contracts, as described below, to hedge against
movements in the values of the foreign currencies in which their portfolio
securities are denominated. Such currency hedges can protect against price
movements in a security an Underlying Fund owns or intends to acquire that are
attributable to changes in the value of the currency in which it is
denominated. Such hedges do not, however, protect against price movements in
the securities that are attributable to other causes.
The Underlying Funds might seek to hedge against changes in the value of a
particular currency when no Derivative Instruments on that currency are
available or such Derivative Instruments are more expensive than certain other
hedging instruments. In such cases, the Underlying Funds may hedge against
price movements in that currency by entering into transactions using
Derivative Instruments on another currency or a basket of currencies, the
value of which Mitchell Hutchins or the applicable Sub-Adviser believes will
have a positive correlation to the value of the currency being hedged. The
risk that movements in the price of the Derivative Instrument will not
correlate perfectly with movements in the price of the currency being hedged
is magnified when this strategy is used.
The value of Derivative Instruments on foreign currencies depends on the
value of the underlying currency relative to the U.S. dollar. Because foreign
currency transactions occurring in the interbank market might involve
substantially larger amounts than those involved in the use of such Derivative
Instruments, an Underlying Fund could be disadvantaged by having to deal in
the odd lot market (generally consisting of transactions of less than $1
million) for the underlying foreign currencies at prices that are less
favorable than for round lots.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations available through
dealers or other market sources be firm or revised on a timely basis.
Quotation information generally is representative of very large transactions
in the interbank market and thus might not reflect odd-lot transactions where
rates might be less favorable. The interbank market in foreign currencies is a
global, round-the-clock market. To the extent the U.S. options or futures
markets are closed while the markets for the underlying currencies remain
open, significant price and rate movements might take place in the underlying
markets that cannot be reflected in the markets for the Derivative Instruments
until they reopen.
Settlement of hedging transactions involving foreign currencies might be
required to take place within the country issuing the underlying currency.
Thus, the Underlying Funds might be required to accept or make delivery of the
underlying foreign currency in accordance with any U.S. or foreign regulations
regarding the maintenance of foreign banking arrangements by U.S. residents
and might be required to pay any fees, taxes and charges associated with such
delivery assessed in the issuing country.
FORWARD CURRENCY CONTRACTS. An Underlying Fund that invests in securities
denominated in foreign currencies may enter into forward currency contracts to
purchase or sell foreign currencies for a fixed amount of
24
<PAGE>
U.S. dollars or another foreign currency. Such transactions may serve as long
hedges--for example, an Underlying Fund may purchase a forward currency
contract to lock in the U.S. dollar price of a security denominated in a
foreign currency that the Underlying Fund intends to acquire. Forward currency
contract transactions may also serve as short hedges--for example, an
Underlying Fund may sell a forward currency contract to lock in the U.S.
dollar equivalent of the proceeds from the anticipated sale of a security
denominated in a foreign currency.
As noted above, an Underlying Fund also may seek to hedge against changes in
the value of a particular currency by using forward contracts on another
foreign currency or a basket of currencies, the value of which Mitchell
Hutchins or a Sub-Adviser believes will have a positive correlation to the
values of the currency being hedged. In addition, an Underlying Fund may use
forward currency contracts to shift its exposure to foreign currency
fluctuations from one country to another. For example, if an Underlying Fund
owned securities denominated in a foreign currency and Mitchell Hutchins or
the Sub-Adviser believed that currency would decline relative to another
currency, it might enter into a forward contract to sell an appropriate amount
of the first foreign currency, with payment to be made in the second foreign
currency. Transactions that use two foreign currencies are sometimes referred
to as "cross hedging." Use of a different foreign currency magnifies the risk
that movements in the price of the Derivative Instrument will not correlate or
will correlate unfavorably with the foreign currency being hedged.
The cost to an Underlying Fund of engaging in forward currency contracts
varies with factors such as the currency involved, the length of the contract
period and the market conditions then prevailing. Because forward currency
contracts are usually entered into on a principal basis, no fees or
commissions are involved. When an Underlying Fund enters into a forward
currency contract, it relies on the contra party to make or take delivery of
the underlying currency at the maturity of the contract. Failure by the contra
party to do so would result in the loss of any expected benefit of the
transaction.
As is the case with futures contracts, holders and writers of forward
currency contracts can enter into offsetting closing transactions, similar to
closing transactions on futures, by selling or purchasing, respectively, an
instrument identical to the instrument purchased or sold. Secondary markets
generally do not exist for forward currency contracts, with the result that
closing transactions generally can be made for forward currency contracts only
by negotiating directly with the contra party. Thus, there can be no assurance
that an Underlying Fund will in fact be able to close out a forward currency
contract at a favorable price prior to maturity. In addition, in the event of
insolvency of the contra party, an Underlying Fund might be unable to close
out a forward currency contract at any time prior to maturity. In either
event, the Underlying Fund would continue to be subject to market risk with
respect to the position, and would continue to be required to maintain a
position in the securities or currencies that are the subject of the hedge or
to maintain cash or securities in a segregated account.
The precise matching of forward currency contract amounts and the value of
the securities involved generally will not be possible because the value of
such securities, measured in the foreign currency, will change after the
foreign currency contract has been established. Thus, an Underlying Fund might
need to purchase or sell foreign currencies in the spot (cash) market to the
extent such foreign currencies are not covered by forward contracts. The
projection of short-term currency market movements is extremely difficult, and
the successful execution of a short-term hedging strategy is highly uncertain.
LIMITATIONS ON THE USE OF FORWARD CURRENCY CONTRACTS. An Underlying Fund may
enter into forward currency contracts or maintain a net exposure to such
contracts only if (1) the consummation of the contracts would not obligate the
Underlying Fund to deliver an amount of foreign currency in excess of the
value of the position being hedged by such contracts or (2) the Underlying
Fund segregates with its custodian cash or liquid securities in an amount not
less than the value of its total assets committed to the consummation of the
contract and not covered as provided in (1) above, as marked to market daily.
INTEREST RATE PROTECTION TRANSACTIONS. Certain Underlying Funds may enter
into interest rate protection transactions, including interest rate swaps and
interest rate caps, floors and collars. Interest rate swap transactions
25
<PAGE>
involve an agreement between two parties to exchange payments that are based,
for example, on variable and fixed rates of interest and that are calculated
on the basis of a specified amount of principal (the "notional principal
amount") for a specified period of time. Interest rate cap and floor
transactions involve an agreement between two parties in which the first party
agrees to make payments to the counterparty when a designated market interest
rate goes above (in the case of a cap) or below (in the case of a floor) a
designated level on predetermined dates or during a specified time period.
Interest rate collar transactions involve an agreement between two parties in
which payments are made when a designated market interest rate either goes
above a designated ceiling level or goes below a designated floor level on
predetermined dates or during a specified time period.
The Underlying Funds expect to enter into interest rate protection
transactions to preserve a return or spread on a particular investment or
portion of its portfolio or to protect against any increase in the price of
securities it anticipates purchasing at a later date. The Underlying Funds
intend to use these transactions as a hedge and not as a speculative
investment. Interest rate protection transactions are subject to risks
comparable to those described above with respect to other hedging strategies.
An Underlying Fund may enter into interest rate swaps, caps, floors and
collars on either an asset-based or liability-based basis, depending on
whether it is hedging its assets or its liabilities, and will usually enter
into interest rate swaps on a net basis, i.e., the two payment streams are
netted out, with the Underlying Fund receiving or paying, as the case may be,
only the net amount of the two payments. Inasmuch as these interest rate
protection transactions are entered into for good faith hedging purposes, and
inasmuch as segregated accounts will be established with respect to such
transactions, Mitchell Hutchins, the applicable Sub-Advisers and the
Underlying Funds believe such obligations do not constitute senior securities
and, accordingly, will not treat them as being subject to the Underlying
Funds' borrowing restrictions. The net amount of the excess, if any, of an
Underlying Fund's obligations over its entitlements with respect to each
interest rate swap will be accrued on a daily basis, and appropriate
Underlying Fund assets having an aggregate net asset value at least equal to
the accrued excess will be maintained in a segregated account as described
above in "Underlying Funds--Investment Policies--Segregated Accounts." The
Underlying Fund also will establish and maintain such segregated accounts with
respect to its total obligations under any interest rate swaps that are not
entered into on a net basis and with respect to any interest rate caps,
collars and floors that are written by the Underlying Fund.
The Underlying Funds will enter into interest rate protection transactions
only with banks and recognized securities dealers believed by Mitchell
Hutchins or the applicable Sub-Adviser to present minimal credit risk in
accordance with guidelines established by each Underlying Fund's board. If
there is a default by the other party to such a transaction, the Underlying
Fund will have to rely on its contractual remedies (which may be limited by
bankruptcy, insolvency or similar laws) pursuant to the agreements related to
the transaction.
The swap market has grown substantially in recent years with a large number
of banks and investment banking firms acting both as principals and as agents
utilizing standardized swap documentation. Caps, floors and collars are more
recent innovations for which documentation is less standardized, and
accordingly, they are less liquid than swaps.
26
<PAGE>
TRUSTEES AND OFFICERS; PRINCIPAL HOLDERS OF SECURITIES
The trustees and executive officers of the Trust, their ages, business
addresses and principal occupations during the past five years are:
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE THE TRUST OTHER DIRECTORSHIPS
---------------------- ------------- --------------------
<C> <C> <S>
Margo N. Alexander*; 50 Trustee and Mrs. Alexander is president,
President chief executive officer and a
director of Mitchell Hutchins
(since January 1995) and also an
executive vice president and a
director of PaineWebber. Mrs.
Alexander is president and a di-
rector or trustee of 29 invest-
ment companies for which Mitch-
ell Hutchins or PaineWebber
serves as investment adviser.
Richard Q. Armstrong; 62 Trustee Mr. Armstrong is chairman and
78 West Brother Drive principal of RQA Enterprises
Greenwich, CT 06830 (management consulting firm)
(since April 1991 and principal
occupation since March 1995).
Mr. Armstrong is also a director
of HiLo Automotive, Inc. He was
chairman of the board, chief ex-
ecutive officer and co-owner of
Adirondack Beverages (producer
and distributor of soft drinks
and sparkling/still waters) (Oc-
tober 1993-March 1995). Mr. Arm-
strong was a partner of the New
England Consulting Group (man-
agement consulting firm) (Decem-
ber 1992-September 1993). He was
managing director of LVMH U.S.
Corporation (U.S. subsidiary of
the French luxury goods conglom-
erate, Louis Vuitton Moet
Hennessey Corporation) (1987-
1991) and chairman of its wine
and spirits subsidiary,
Schieffelin & Somerset Company
(1987-1991). Mr. Armstrong is a
director or trustee of 28 in-
vestment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
E. Garrett Bewkes, Jr.*; Trustee and Mr. Bewkes is a director of
71 Chairman of the Paine Webber Group Inc. ("PW
Board of Trustees Group") (holding company of
PaineWebber and Mitchell
Hutchins). Prior to December
1995, he was a consultant to PW
Group. Prior to 1988, he was
chairman of the board, president
and chief executive officer of
American Bakeries Company. Mr.
Bewkes is a director of Inter-
state Bakeries Corporation and
NaPro BioTherapeutics, Inc. Mr.
Bewkes is a director of trustee
of 29 investment companies for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE THE TRUST OTHER DIRECTORSHIPS
---------------------- ------------- --------------------
<C> <C> <S>
Richard R. Burt; 50 Trustee Mr. Burt is chairman of IEP Ad-
1275 Pennsylvania Ave., visors, Inc. (international in-
N.W. vestments and consulting firm)
Washington, D.C. 20004 (since March 1994) and a part-
ner of McKinsey & Company (man-
agement consulting firm) (since
1991). He is also a director of
American Publishing Company and
Archer-Daniels-Midland Co. (ag-
ricultural commodities). He was
the chief negotiator in the
Strategic Arms Reduction Talks
with the former Soviet Union
(1989-1991) and the U.S. Ambas-
sador to the Federal Republic
of Germany (1985-1989). Mr.
Burt is a director or trustee
of 28 investment companies for
which Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
Mary C. Farrell*; 48 Trustee Ms. Farrell is a managing di-
rector, senior investment
strategist and member of the
Investment Policy Committee of
PaineWebber. Ms. Farrell joined
PaineWebber in 1982. She is a
member of the Financial Women's
Association and Women's Eco-
nomic Roundtable, and appears
as a regular panelist on Wall
$treet Week with Louis
Rukeyser. She also serves on
the Board of Overseers of New
York University's Stern School
of Business. Ms. Farrell is a
director or trustee of 28 in-
vestment companies for which
Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
Meyer Feldberg; 55 Trustee Mr. Feldberg is Dean and Pro-
Columbia University fessor of Management of the
101 Uris Hall Graduate School of Business,
New York, New York 10027 Columbia University. Prior to
1989, he was president of the
Illinois Institute of Technolo-
gy. Dean Feldberg is also a di-
rector of K-III Communications
Corporation, Federated Depart-
ment Stores, Inc. and Revlon,
Inc. Dean Feldberg is a direc-
tor or trustee of 28 investment
companies for which Mitchell
Hutchins or PaineWebber serves
as investment adviser.
George W. Gowen; 68 Trustee Mr. Gowen is a partner in the
666 Third Avenue law firm of Dunnington,
New York, New York 10017 Bartholow & Miller. Prior to
May 1994, he was a partner in
the law firm of Fryer, Ross &
Gowen. Mr. Gowen is a director
of Columbia Real Estate Invest-
ments, Inc. Mr. Gowen is a di-
rector or trustee of 28 invest-
ment companies for which Mitch-
ell Hutchins or PaineWebber
serves as investment adviser.
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE THE TRUST OTHER DIRECTORSHIPS
---------------------- ------------- --------------------
<C> <C> <S>
Frederic V. Malek; 61 Trustee Mr. Malek is chairman of Thayer
1455 Pennsylvania Capital Partners (merchant
Avenue, N.W. bank). From January 1992 to No-
Suite 350 vember 1992, he was campaign
Washington, D.C. 20004 manager of Bush-Quayle '92.
From 1990 to 1992, he was vice
chairman and, from 1989 to
1990, he was president of
Northwest Airlines Inc., NWA
Inc. (holding company of North-
west Airlines Inc.) and Wings
Holdings Inc. (holding company
of NWA Inc.). Prior to 1989, he
was employed by the Marriott
Corporation (hotels, restau-
rants, airline catering and
contract feeding), where he
most recently was an executive
vice president and president of
Marriott Hotels and Resorts.
Mr. Malek is also a director of
American Management Systems,
Inc. (management consulting and
computer-related services), Au-
tomatic Data Processing Inc.,
CB Commercial Group, Inc. (real
estate services), Choice Hotels
International (hotel and hotel
franchising), FPL Group, Inc.
(electric services), Integra,
Inc. (bio-medical), Manor Care,
Inc. (health care), National
Education Corporation and
Northwest Airlines Inc. Mr.
Malek is a director or trustee
of 28 investment companies for
which Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
Carl W. Schafer; 61 Trustee Mr. Schafer is president of the
P.O. Box 1164 Atlantic Foundation (charitable
Princeton, NJ 08542 foundation supporting mainly
oceanographic exploration and
research). He also is a direc-
tor of Roadway Express, Inc.
(trucking), The Guardian Group
of Mutual Funds, Evans Systems,
Inc. (a motor fuels, conve-
nience store and diversified
company), Electronic Clearing
House, Inc. (financial transac-
tions processing), Wainoco Oil
Corporation and Nutraceutix,
Inc. (biotechnology). Prior to
January 1993, Mr. Schafer was
chairman of the Investment Ad-
visory Committee of the Howard
Hughes Medical Institute. Mr.
Schafer is a director or
trustee of 28 investment compa-
nies for which Mitchell
Hutchins or PaineWebber serves
as investment adviser.
T. Kirkham Barneby; 51 Vice President Mr. Barneby is a managing di-
rector and chief investment of-
ficer--quantitative investments
of Mitchell Hutchins. Prior to
September 1994, he was a senior
vice president at Vantage
Global Management. Prior to
June 1993, he was a senior vice
president at Mitchell Hutchins.
Mr. Barneby is a vice president
of five investment companies
for which Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE THE TRUST OTHER DIRECTORSHIPS
---------------------- ------------- --------------------
<C> <C> <S>
Dennis McCauley; 51 Vice President Mr. McCauley is a managing di-
rector and chief investment of-
ficer--fixed income of Mitchell
Hutchins. Prior to December
1994, he was director of fixed
income investments of IBM Cor-
poration. Mr. McCauley is a
vice president of 18 investment
companies for which Mitchell
Hutchins or PaineWebber serves
as investment adviser.
Ann E. Moran; 40 Vice President and Ms. Moran is a vice president
Assistant Treasurer and a manager of the mutual
fund finance division of Mitch-
ell Hutchins. Ms. Moran is a
vice president and assistant
treasurer of 29 investment com-
panies for which Mitchell
Hutchins or PaineWebber serves
as investment adviser.
Dianne E. O'Donnell; 45 Vice President and Ms. O'Donnell is a senior vice
Secretary president and deputy general
counsel of Mitchell Hutchins.
Ms. O'Donnell is a vice presi-
dent and secretary of 28 in-
vestment companies and vice
president and assistant secre-
tary for one investment company
which Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
Emil Polito; 37 Vice President Mr. Polito is a senior vice
president and director of oper-
ations and control for Mitchell
Hutchins. From March 1991 to
September 1993 he was director
of the Mutual Funds Sales Sup-
port and Service Center for
Mitchell Hutchins and
PaineWebber. Mr. Polito is a
vice president for 29 invest-
ment companies for which Mitch-
ell Hutchins or PaineWebber
serves as investment adviser.
Victoria E. Schonfeld; Vice President Ms. Schonfeld is a managing di-
47 rector and general counsel of
Mitchell Hutchins. Prior to May
1994, she was a partner in the
law firm of Arnold & Porter.
Ms. Schonfeld is a vice presi-
dent of 28 investment companies
and vice president and secre-
tary for one investment company
for which Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
Paul H. Schubert; 35 Vice President and Mr. Schubert is a first vice
Treasurer president and the director of
the mutual fund finance divi-
sion of Mitchell Hutchins. From
August 1992 to August 1994, he
was a vice president of Black-
Rock Financial Management L.P.
Mr. Schubert is a vice presi-
dent and treasurer of 29 in-
vestment companies for which
Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
</TABLE>
30
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE THE TRUST OTHER DIRECTORSHIPS
---------------------- ------------- --------------------
<C> <C> <S>
Barney A. Taglialatela; Vice President and Mr. Taglialatela is a vice
36 Assistant Treasurer president and a manager of the
mutual fund finance division of
Mitchell Hutchins. Prior to
February 1995, he was a manager
of the mutual fund finance di-
vision of Kidder Peabody Asset
Management, Inc. Mr.
Taglialatela is a vice presi-
dent and assistant treasurer of
29 investment companies for
which Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
Mark A. Tincher; 42 Vice President Mr. Tincher is a managing di-
rector and chief investment of-
ficer--equities of Mitchell
Hutchins. Prior to March 1995,
he was a vice president and di-
rected the U.S. funds manage-
ment and equity research areas
of Chase Manhattan Private
Bank. Mr. Tincher is a vice
president of 13 investment com-
panies for which Mitchell
Hutchins or PaineWebber serves
as investment adviser.
Keith A. Weller; 36 Vice President and Mr. Weller is a first vice
Assistant Secretary president and associate general
counsel of Mitchell Hutchins.
Prior to May 1995, he was an
attorney in private practice.
Mr. Weller is a vice president
and assistant secretary of 28
investment companies for which
Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
Ian W. Williams; 40 Vice President and Mr. Williams is a vice presi-
Assistant Treasurer dent and a manager of the mu-
tual fund finance division of
Mitchell Hutchins. Mr. Williams
is a vice president and assis-
tant treasurer of 29 investment
companies for which Mitchell
Hutchins or PaineWebber serves
as investment adviser.
</TABLE>
- --------
* Unless otherwise indicated, the business address of each listed person is
1285 Avenue of the Americas, New York, New York 10019. Mrs. Alexander, Mr.
Bewkes and Ms. Farrell are "interested persons" of the Trust as defined in
the 1940 Act by virtue of their positions with PW Group, PaineWebber and/or
Mitchell Hutchins.
The Trust pays trustees who are not "interested persons" of the Trust
("disinterested members") $1,000 annually for each Portfolio and $150 for each
board meeting and each separate meeting of a board committee. Accordingly, the
Trust pays each such trustee $3,000 annually for its three series, plus any
additional amounts due for board or committee meetings. Each chairman of the
audit and contract review committees of individual funds within the
PaineWebber fund complex receives additional compensation aggregating $15,000
annually. All trustees are reimbursed for any expenses incurred in attending
meetings. Trustees and officers own in the aggregate less than 1% of the
outstanding shares of each Portfolio. Because PaineWebber and Mitchell
Hutchins perform substantially all the services necessary for the operation of
the Trust and each Portfolio, the Trust requires no employees. No officer,
director or employee of Mitchell Hutchins or PaineWebber presently receives
any compensation from the Trust for acting as a trustee or officer.
31
<PAGE>
The table below shows the estimated compensation to be paid to each trustee
during the current fiscal year and the total compensation of those trustees
for all PaineWebber funds during the calendar year ended December 31, 1997.
COMPENSATION TABLE
<TABLE>
<CAPTION>
TOTAL
ESTIMATED COMPENSATION
AGGREGATE FOR THE TRUST
COMPENSATION AND THE FUND
NAME OF PERSON, POSITION FOR THE TRUST(1) COMPLEX(2)
- ------------------------ ---------------- -------------
<S> <C> <C>
Richard Q. Armstrong, Trustee.................... $1,200 $94,885
Richard R. Burt, Trustee......................... 1,200 87,085
Meyer Feldberg, Trustee.......................... 1,300 117,853
George W. Gowen, Trustee......................... 1,200 101,567
Frederic V. Malek, Trustee....................... 1,200 95,845
Carl W. Schafer, Trustee......................... 1,200 94,885
</TABLE>
- --------
Only independent members of the board are compensated for their services as
trustees and identified above; trustees who are "interested person," as
defined by the 1940 Act, do not receive compensation
(1) Estimated for the initial fiscal year of the Trust.
(2) Represents total compensation paid to each trustee during the calendar
year ended December 31, 1997; no fund within the fund complex has a bonus,
pension, profit sharing or retirement plan.
PRINCIPAL HOLDERS OF SECURITIES. Prior to January 9, 1998, Mitchell Hutchins
held all outstanding securities of the Portfolios and thus may be deemed a
controlling person of each Portfolio until additional shareholders purchase
shares.
INVESTMENT ADVISORY AND DISTRIBUTION ARRANGEMENTS
INVESTMENT ADVISORY ARRANGEMENTS. Mitchell Hutchins acts as the investment
adviser and administrator to each Portfolio pursuant to a contract (the
"Advisory Contract") with the Trust. Under the Advisory Contract, each
Portfolio pays Mitchell Hutchins a fee, computed daily and paid monthly, at
the annual rate of 0.35% of average daily net assets.
Under the terms of the Advisory Contract, each Portfolio bears all of its
expenses incurred in its operation that are not specifically assumed by
Mitchell Hutchins. Expenses borne by the Portfolio include the following: (1)
the cost (including brokerage commissions) of securities purchases or sold by
the Portfolio and any losses incurred in connection therewith; (2) fees
payable to and expenses incurred on behalf of the Portfolios by Mitchell
Hutchins; (3) organizational expenses; (4) filing fees and expenses relating
to the registration and qualification of the Portfolio's shares under federal
and state securities laws and maintenance of such registrations and
qualifications; (5) fees and salaries payable to board members and officers
who are not "interested persons" (as defined in the 1940 Act) of the Trust or
Mitchell Hutchins; (6) all expenses incurred in connection with the board
members' services, including travel expenses; (7) taxes (including any income
or franchise taxes) and governmental fees; (8) costs of any liability,
uncollectible items of deposit and other insurance or fidelity bonds; (9) any
costs, expenses or losses arising out of a liability of or claim for damages
or other relief asserted against the Trust or Portfolio for violation of any
law; (10) legal, accounting and auditing expenses, including legal fees of
special counsel for the independent board members; (11) charges of custodians,
transfer agents and other agents; (12) costs of preparing share certificates;
(13) expenses of setting in type and printing prospectuses, statements of
additional information and supplements thereto, reports and proxy materials
for existing shareholders, and costs of mailing such materials to
shareholders; (14) any extraordinary expenses (including fees and
disbursements of counsel) incurred by the Portfolio; (15) fees, voluntary
assessments and
32
<PAGE>
other expenses incurred in connection with membership in investment company
organizations; (16) costs of mailing and tabulating proxies and costs of
meetings of shareholders, the board or any committee thereof; (17) the cost of
investment literature and other publications provided to board members and
officers; and (18) costs of mailing, stationery and communications equipment.
Under the Advisory Contract, Mitchell Hutchins will not be liable for any
error of judgment or mistake of law or for any loss suffered by a Portfolio in
connection with the performance of the Advisory Contract, except a loss
resulting from willful misfeasance, bad faith or gross negligence on the part
of Mitchell Hutchins in the performance of its duties or from reckless
disregard of its duties and obligations thereunder. The Advisory Contract
terminates automatically upon assignment and is terminable at any time without
penalty by the Trust's board or by vote of the holders of a majority of the
Portfolio's outstanding voting securities on 60 days' written notice to
Mitchell Hutchins, or by Mitchell Hutchins on 60 days' written notice to the
Portfolio.
NET ASSETS. The following table shows the approximate net assets as of
November 30, 1997, sorted by category of investment objective, of the
investment companies as to which Mitchell Hutchins serves as adviser or sub-
adviser. An investment company may fall into more than one of the categories
below.
<TABLE>
<CAPTION>
NET ASSETS
INVESTMENT CATEGORY $ MIL
------------------- ----------
<S> <C>
Domestic (excluding Money Market)................................. $ 6,441.3
Global............................................................ 3,312.6
Equity/Balanced................................................... 4,903.2
Fixed Income (excluding Money Market)............................. 4,850.7
Taxable Fixed Income............................................ 3,285.4
Tax-Free Fixed Income........................................... 1,565.3
Money Market Funds................................................ 26,428.7
</TABLE>
PERSONNEL TRADING POLICIES. Mitchell Hutchins personnel may invest in
securities for their own accounts pursuant to a code of ethics that describes
the fiduciary duty owed to shareholders of PaineWebber mutual funds and other
Mitchell Hutchins advisory accounts by all Mitchell Hutchins' directors,
officers and employees, establishes procedures for personal investing and
restricts certain transactions. For example, employee accounts generally must
be maintained at PaineWebber, personal trades in most securities require pre-
clearance and short-term trading and participation in initial public offerings
generally are prohibited. In addition, the code of ethics puts restrictions on
the timing of personal investing in relation to trades by PaineWebber mutual
funds and other Mitchell Hutchins advisory clients.
DISTRIBUTION ARRANGEMENTS. Mitchell Hutchins acts as the distributor of each
class of shares of each Portfolio under separate distribution contracts with
the Trust (collectively, "Distribution Contracts") that require Mitchell
Hutchins to use its best efforts, consistent with its other businesses, to
sell shares of each Portfolio. Shares of each Portfolio are offered
continuously. Under separate exclusive dealer agreements between Mitchell
Hutchins and PaineWebber relating to each class of shares of each Portfolio
(collectively, "Exclusive Dealer Agreements"), PaineWebber and its
correspondent firms sell the Portfolios' shares.
Under separate plans of distribution pertaining to the Class A, Class B and
Class C shares adopted by the Trust in the manner prescribed under Rule 12b-1
under the 1940 Act (each, respectively, a "Class A Plan," "Class B Plan" and
"Class C Plan" and, collectively, "Plans"), each Portfolio pays Mitchell
Hutchins a service fee, accrued daily and payable monthly, at the annual rate
of 0.25% of the average daily net assets of each class of shares for each
respective Portfolio. Under the Class B Plan and Class C Plan, each Portfolio
pays Mitchell Hutchins a distribution fee, accrued daily and payable monthly,
at the annual rate of 0.75% (0.50% for Class C shares of Conservative
Portfolio) of the average daily net assets of that Class. There is no
distribution plan with respect to Class Y shares and the Portfolios pay no
service or distribution fees with respect to their Class Y shares.
Among other things, each Plan provides that (1) Mitchell Hutchins will
submit to the board at least quarterly, and the trustees will review, reports
regarding all amounts expended under the Plan and the purposes
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for which such expenditures were made, (2) the Plan will continue in effect
only so long as it is approved at least annually, and any material amendment
thereto is approved, by the board, including those trustees who are not
"interested persons" of the Trust and who have no direct or indirect financial
interest in the operation of the Plan or any agreement related to the Plan,
acting in person at a meeting called for that purpose, (3) payments by a
Portfolio under the Plan shall not be materially increased without the
affirmative vote of the holders of a majority of the outstanding shares of the
relevant class of that Portfolio and (4) while the Plan remains in effect, the
selection and nomination of trustees who are not "interested persons" of the
Trust shall be committed to the discretion of the trustees who are not
"interested persons" of the Trust.
In reporting amounts expended under the Plans to the board, Mitchell
Hutchins allocates expenses attributable to the sale of each class of each
Portfolio's shares to such class based on the ratio of sales of shares of such
class to the sales of all classes of shares. The fees paid by one class of a
Portfolio's shares will not be used to subsidize the sale of any other class
of that Portfolio's shares.
In approving the Portfolios' overall Flexible PricingSM system of
distribution, the board considered several factors, including that
implementation of Flexible Pricing would (1) enable investors to choose the
purchasing option best suited to their individual situation, thereby
encouraging current shareholders to make additional investments in each
respective Portfolio and attracting new investors and assets to the Portfolio
to the benefit of the Portfolio and its shareholders, (2) facilitate
distribution of the Portfolios' shares and (3) maintain the competitive
position of the Portfolios in relation to other funds that have implemented or
are seeking to implement similar distribution arrangements.
In approving the Class A Plan for each Portfolio, the board considered all
the features of the distribution system, including (1) the conditions under
which initial sales charges would be imposed and the amount of such charges,
(2) Mitchell Hutchins' belief that the initial sales charge combined with a
service fee would be attractive to PaineWebber investment executives and
correspondent firms, resulting in greater growth of the Portfolio than might
otherwise be the case, (3) the advantages to the shareholders of economies of
scale resulting from growth in the Portfolio's assets and potential continued
growth, (4) the services provided to the Portfolio and its shareholders by
Mitchell Hutchins, (5) the services provided by PaineWebber pursuant to its
Exclusive Dealer Agreement with Mitchell Hutchins and (6) Mitchell Hutchins'
shareholder service-related expenses and costs.
In approving the Class B Plan for each Portfolio, the board considered all
the features of the distribution system, including (1) the conditions under
which contingent deferred sales charges would be imposed and the amount of
such charges, (2) the advantage to investors in having no initial sales
charges deducted from Portfolio purchase payments and instead having the
entire amount of their purchase payments immediately invested in Portfolio
shares, (3) Mitchell Hutchins' belief that the ability of PaineWebber
investment executives and correspondent firms to receive sales commissions
when Class B shares are sold and continuing service fees thereafter while
their customers invest their entire purchase payments immediately in Class B
shares would prove attractive to the investment executives and correspondent
firms, resulting in greater growth of the Portfolio than might otherwise be
the case, (4) the advantages to the shareholders of economies of scale
resulting from growth in the Portfolio's assets and potential continued
growth, (5) the services provided to the Portfolio and its shareholders by
Mitchell Hutchins, (6) the services provided by PaineWebber pursuant to its
Exclusive Dealer Agreement with Mitchell Hutchins and (7) Mitchell Hutchins'
shareholder service and distribution-related expenses and costs. The board
also recognized that Mitchell Hutchins' willingness to compensate PaineWebber
and its investment executives, without the concomitant receipt by Mitchell
Hutchins of initial sales charges, was conditioned upon its expectation of
being compensated under the Class B Plan.
In approving the Class C Plan for each Portfolio, the board considered all
the features of the distribution system, including (1) the advantage to
investors in having no initial sales charges deducted from the Portfolio
purchase payments and instead having the entire amount of their purchase
payments immediately invested in Portfolio shares, (2) the advantage to
investors in being free from contingent deferred sales charges upon redemption
for shares held more than one year and paying for distribution on an ongoing
basis, (3) Mitchell Hutchins' belief that the ability of PaineWebber
investment executives and correspondent firms to receive sales
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<PAGE>
compensation for their sales of Class C shares on an ongoing basis, along with
continuing service fees, while their customers invest their entire purchase
payments immediately in Class C shares and generally do not face contingent
deferred sales charges, would prove attractive to the investment executives
and correspondent firms, resulting in greater growth to the Portfolio than
might otherwise be the case, (4) the advantages to the shareholders of
economies of scale resulting from growth in the Portfolio's assets and
potential continued growth, (5) the services provided to the Portfolio and its
shareholders by Mitchell Hutchins, (6) the services provided by PaineWebber
pursuant to its Exclusive Dealer Agreement with Mitchell Hutchins and (7)
Mitchell Hutchins' shareholder and service and distribution-related expenses
and costs. The board also recognized that Mitchell Hutchins' willingness to
compensate PaineWebber and its investment executives without the concomitant
receipt by Mitchell Hutchins of initial sales charges or contingent deferred
sales charges upon redemption, was conditioned upon its expectation of being
compensated under the Class C Plan.
With respect to each Plan, the board considered all compensation that
Mitchell Hutchins would receive under the Plan and the Distribution Contract,
including service fees and, as applicable, initial sales charges, distribution
fees and contingent deferred sales charges. The board also considered the
benefits that would accrue to Mitchell Hutchins under each Plan in that
Mitchell Hutchins would receive service, distribution and advisory fees which
are calculated based upon a percentage of the average net assets of each
Portfolio, which would increase if the Plan were successful and the Portfolio
attained and maintained significant asset levels.
PORTFOLIO TRANSACTIONS
All orders for the purchase or sale of portfolio securities for the
Portfolios (normally shares of the Underlying Funds) are placed on behalf of a
particular Portfolio by Mitchell Hutchins. A Portfolio will not incur any
commissions or sales charges when it invests in shares of the Underlying
Funds, but it may incur such costs if it invests directly in other types of
securities. When a Portfolio purchases short-term U.S. government securities
or commercial paper directly, it may purchase such securities in dealer
transactions, which generally include a "spread," as explained below.
Subject to policies established by each Underlying Fund's board, Mitchell
Hutchins or the applicable Sub-Adviser is responsible for the execution of the
Underlying Fund's portfolio transactions and the allocation of brokerage
transactions. In executing portfolio transactions, Mitchell Hutchins or a Sub-
Adviser seeks to obtain the best net results for an Underlying Fund, taking
into account such factors as the price (including the applicable brokerage
commission or dealer spread), size of order, difficulty of execution and
operational facilities of the firm involved. While Mitchell Hutchins or a Sub-
Adviser generally seeks reasonably competitive commission rates, payment of
the lowest commission is not necessarily consistent with obtaining the best
net results. Prices paid to dealers in principal transactions, through which
most debt securities and some equity securities are traded, generally include
a "spread," which is the difference between the prices at which the dealer is
willing to purchase and sell a specific security at the time. The Underlying
Funds may invest in securities traded in the OTC market and will engage
primarily in transactions directly with the dealers who make markets in such
securities, unless a better price or execution could be obtained by using a
broker.
The Portfolios and the Underlying Funds have no obligation to deal with any
broker or group of brokers in the execution of portfolio transactions. The
Portfolios and the Underlying Funds contemplate that, consistent with the
policy of obtaining the best net results, brokerage transactions may be
conducted through PaineWebber. Each Portfolio and Underlying Fund's board has
adopted procedures in conformity with Rule 17e-1 under the 1940 Act to ensure
that all brokerage commissions paid to PaineWebber are reasonable and fair.
Specific provisions in the Advisory Contract authorize PaineWebber to effect
portfolio transactions for the Portfolios on an exchange and to retain
compensation in connection with such transactions. Any such transactions will
be effected and related compensation paid only in accordance with applicable
SEC regulations.
Transactions in futures contracts are executed through futures commission
merchants ("FCMs"), who receive brokerage commissions for their services. The
Underlying Funds' procedures in selecting FCMs to
35
<PAGE>
execute their transactions in futures contracts, including procedures
permitting the use of PaineWebber, are similar to those in effect with respect
to brokerage transactions in securities.
Consistent with the interests of the Portfolios and the Underlying Funds and
subject to the review of each Portfolio's or Underlying Fund's board, Mitchell
Hutchins or a Sub-Adviser may cause a Portfolio or an Underlying Fund to
purchase and sell portfolio securities from and to dealers or through brokers
who provide that Portfolio or Underlying Fund with research, analysis, advice
and similar services. In return for such services, a Portfolio or Underlying
Fund may pay to those brokers a higher commission than may be charged by other
brokers, provided that Mitchell Hutchins or a Sub-Adviser determines in good
faith that such commission is reasonable in terms either of that particular
transaction or of the overall responsibility of Mitchell Hutchins to that
Portfolio or Underlying Fund and its other clients and that the total
commissions paid by the Portfolio or Underlying Fund will be reasonable in
relation to the benefits to the each over the long term.
For purchases or sales with broker-dealer firms which act as principal,
Mitchell Hutchins or a Sub-Adviser seeks best execution. Although Mitchell
Hutchins or a Sub-Adviser may receive certain research or execution services
in connection with these transactions, they will not purchase securities at a
higher price or sell securities at a lower price than would otherwise be paid
if no weight was attributed to the services provided by the executing dealer.
Moreover, Mitchell Hutchins and a Sub-Adviser will not enter into any explicit
soft dollar arrangements relating to principal transactions and will not
receive in principal transactions the types of services which could be
purchased for hard dollars. Mitchell Hutchins or a Sub-Adviser may engage in
agency transactions in OTC equity and debt securities in return for research
and execution services. These transactions are entered into only in compliance
with procedures ensuring that the transaction (including commissions) is at
least as favorable as it would have been if effected directly with a market-
maker that did not provide research or execution services. These procedures
include Mitchell Hutchins or a Sub-Adviser receiving multiple quotes from
dealers before executing the transactions on an agency basis.
Information and research services furnished by brokers or dealers through
which or with which the Portfolios or Underlying Funds effect securities
transactions may be used by Mitchell Hutchins or a Sub-Adviser in advising
other funds or accounts and, conversely, research services furnished to
Mitchell Hutchins or a Sub-Adviser by brokers or dealers in connection with
other funds or accounts that either of them advises may be used in advising
the Portfolios or Underlying Funds. Information and research received from
brokers or dealers will be in addition to, and not in lieu of, the services
required to be performed by Mitchell Hutchins under the Advisory Contract or a
Sub-Adviser under its contract with Mitchell Hutchins.
Investment decisions for a Portfolio or Underlying Fund and for other
investment accounts managed by Mitchell Hutchins are made independently of
each other in light of differing considerations for the various accounts.
However, the same investment decision may occasionally be made for a Portfolio
or an Underlying Fund and one or more of such accounts. In such cases,
simultaneous transactions are inevitable. Purchases or sales are then averaged
as to price and allocated between that Portfolio or Underlying Fund and such
other account(s) as to amount according to a formula deemed equitable to the
Portfolio or Underlying Fund and such account(s). While in some cases this
practice could have a detrimental effect upon the price or value of the
security as far as the Portfolios or Underlying Funds are concerned, or upon
their ability to complete their entire order, in other cases it is believed
that coordination and the ability to participate in volume transactions will
be beneficial to the Portfolios and Underlying Funds.
The Portfolios and Underlying Funds will not purchase securities that are
offered in underwritings in which PaineWebber is a member of the underwriting
or selling group, except pursuant to procedures adopted by the Trust's and
each Underlying Fund's board pursuant to Rule 10f-3 under the 1940 Act. Among
other things, these procedures require that the spread or commission paid in
connection with such a purchase be reasonable and fair, the purchase be at not
more than the public offering price prior to the end of the first business day
after the date of the public offering and that PaineWebber or any affiliate
thereof not participate in or benefit from the sale to the Portfolios or
Underlying Funds.
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<PAGE>
PORTFOLIO TURNOVER. The Portfolios' annual portfolio turnover rates may vary
greatly from year to year, but they will not be a limiting factor when
management deems portfolio changes appropriate. The portfolio turnover rate is
calculated by dividing the lesser of each Portfolio's annual sales or
purchases of portfolio securities (exclusive of purchases or sales of
securities whose maturities at the time of acquisition were one year or less)
by the monthly average value of securities in the portfolio during the year.
Mitchell Hutchins estimates that each Portfolio's portfolio turnover rate will
be less than 100% during its first fiscal year.
The portfolio turnover rates of the Underlying Funds have ranged from 33% to
359% during their most recent full fiscal years. There can be no assurance
that the portfolio turnover rates of the Underlying Funds will remain within
this range during subsequent fiscal years.
REDUCED SALES CHARGES, ADDITIONAL EXCHANGE AND REDEMPTION
INFORMATION AND OTHER SERVICES
COMBINED PURCHASE PRIVILEGE--CLASS A SHARES. Investors and eligible groups
of related Portfolio investors may combine purchases of Class A shares of the
Portfolios with concurrent purchases of Class A shares of any other
PaineWebber mutual fund and thus take advantage of the reduced sales charges
indicated in the table of sales charges for Class A shares in the Prospectus.
The sales charge payable on the purchase of Class A shares of the Portfolios
and Class A shares of such other funds will be at the rates applicable to the
total amount of the combined concurrent purchases.
An "eligible group of related Portfolio investors" can consist of any
combination of the following:
(a) an individual, that individual's spouse, parents and children;
(b) an individual and his or her Individual Retirement Account ("IRA");
(c) an individual (or eligible group of individuals) and any company
controlled by the individual(s) (a person, entity or group that holds 25%
or more of the outstanding voting securities of a corporation will be
deemed to control the corporation, and a partnership will be deemed to be
controlled by each of its general partners);
(d) an individual (or eligible group of individuals) and one or more
employee benefit plans of a company controlled by individual(s);
(e) an individual (or eligible group of individuals) and a trust created
by the individual(s), the beneficiaries of which are the individual and/or
the individual's spouse, parents or children;
(f) an individual and a Uniform Gifts to Minors Act/Uniform Transfers to
Minors Act account created by the individual or the individual's spouse;
(g) an employer (or group of related employers) and one or more qualified
retirement plans of such employer or employers (an employer controlling,
controlled by or under common control with another employer is deemed
related to that other employer); or
(h) individual accounts related together under one registered investment
adviser having full discretion and control over the accounts. The
registered investment adviser must communicate at least quarterly through a
newsletter or investment update establishing a relationship with all of the
accounts.
RIGHTS OF ACCUMULATIONS--CLASS A SHARES. Reduced sales charges are available
through a right of accumulation, under which investors and eligible groups of
related Portfolio investors (as defined above) are permitted to purchase Class
A shares of the Portfolios among related accounts at the offering price
applicable to the total of (1) the dollar amount then being purchased plus (2)
an amount equal to the then-current net asset value of the purchaser's
combined holdings of Class A Portfolio shares and Class A shares of any other
PaineWebber mutual fund. The purchaser must provide sufficient information to
permit confirmation of his or her holdings, and the acceptance of the purchase
order is subject to such confirmation. The right of accumulation may be
amended or terminated at any time.
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WAIVERS OF SALES CHARGES--CLASS B SHARES. Among other circumstances, the
contingent deferred sales charge on Class B shares is waived where a total or
partial redemption is made within one year following the death of the
shareholder. The contingent deferred sales charge waiver is available where
the decedent is either the individual shareholder or owns the shares with his
or her spouse as a joint tenant with right of survivorship. This waiver
applies only to redemption of shares held at the time of death.
ADDITIONAL EXCHANGE AND REDEMPTION INFORMATION. As discussed in the
Prospectus, eligible shares of the Portfolios may be exchanged for shares of
the corresponding class of most other PaineWebber mutual funds. Shareholders
will receive at least 60 days' notice of any termination or material
modification of the exchange offer, except no notice need be given of an
amendment whose only material effect is to reduce any exchange fee and no
notice need be given if, under extraordinary circumstances, either redemptions
are suspended under the circumstances described below or a Portfolio
temporarily delays or ceases the sales of its shares because it is unable to
invest amounts effectively in accordance with the Portfolio's investment
objective, policies and restrictions.
If conditions exist that make cash payments undesirable, each Portfolio
reserves the right to honor any request for redemption by making payment in
whole or in part in securities chosen by the Portfolio and valued in the same
way as they would be valued for purposes of computing the Portfolio's net
asset value. If payment is made in securities, a shareholder may incur
brokerage expenses in converting these securities into cash.
The Portfolios may suspend redemption privileges or postpone the date of
payment during any period (1) when the New York Stock Exchange ("NYSE") is
closed or trading on the NYSE is restricted as determined by the SEC, (2) when
an emergency exists, as defined by the SEC, that makes it not reasonably
practicable for a Portfolio to dispose of securities owned by it or fairly to
determine the value of its assets or (3) as the SEC may otherwise permit. The
redemption price may be more or less than the shareholder's cost, depending on
the market value of a Portfolio's securities at the time.
AUTOMATIC INVESTMENT PLAN. Participation in the Automatic Investment Plan
enables an investor to use the technique of "dollar cost averaging." When an
investor invests the same dollar amount each month under the Plan, the
investor will purchase more shares when a Portfolio's net asset value per
share is low and fewer shares when the net asset value per share is high.
Using this technique, an investor's average purchase price per share over any
given period will be lower than if the investor purchased a fixed number of
shares on a monthly basis during the period. Of course, investing through the
Automatic Investment Plan does not assure a profit or protect against loss in
declining markets. Additionally, because the Automatic Investment Plan
involves continuous investing regardless of price levels, an investor should
consider his or her financial ability to continue purchases through periods of
both low and high price levels.
SYSTEMATIC WITHDRAWAL PLAN. An investor's participation in the Systematic
Withdrawal Plan will terminate automatically if the "Initial Account Balance"
(a term that means the value of the Portfolio account at the time the investor
elects to participate in the Systematic Withdrawal Plan) less aggregate
redemptions made other than pursuant to the Systematic Withdrawal Plan is less
than $5,000 for Class A and Class C shareholders or $20,000 for Class B
shareholders. Purchases of additional shares of a Portfolio concurrent with
withdrawals are ordinarily disadvantageous to shareholders because of tax
liabilities and, for Class A shares, initial sales charges. On or about the
20th of a month for monthly, quarterly, semiannual or annual plans,
PaineWebber will arrange for redemption by the Portfolios of sufficient
Portfolio shares to provide the withdrawal payments specified by participants
in the Portfolios' Systematic Withdrawal Plan. The payments generally are
mailed approximately five Business Days (defined under "Valuation of Shares")
after the redemption date. Withdrawal payments should not be considered
dividends, but redemption proceeds, with the tax consequences described under
"Dividends & Taxes" in the Prospectus. If periodic withdrawals continually
exceed reinvested dividends and other distributions, a shareholder's
investment may be correspondingly reduced. A shareholder may change the amount
of the systematic withdrawal or terminate participation in the Systematic
Withdrawal Plan at any time without charge or penalty by written instructions
with signatures guaranteed to PaineWebber or PFPC Inc.
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<PAGE>
("Transfer Agent"). Instructions to participate in the plan, change the
withdrawal amount or terminate participation in the plan will not be effective
until five days after written instructions with signatures guaranteed are
received by the Transfer Agent. Shareholders may request the forms needed to
establish a systematic withdrawal plan from their PaineWebber investment
executives, correspondent firms or the Transfer Agent at 1-800-647-1568.
REINSTATEMENT PRIVILEGE--CLASS A SHARES. As described in the Prospectus,
shareholders who have redeemed their Class A shares may reinstate their
account in a Portfolio without a sales charge. Shareholders may exercise the
reinstatement privilege by notifying the Transfer Agent of such desire and
forwarding a check for the amount to be purchased within 365 days after the
date of redemption. The reinstatement will be made at the net asset value per
share next computed after the notice of reinstatement and check are received.
The amount of a purchase under this reinstatement privilege cannot exceed the
amount of the redemption proceeds. Gain on a redemption is taxable regardless
of whether the reinstatement privilege is exercised; however, a loss arising
out of a redemption will not be deductible to the extent the reinstatement
privilege is exercised within 30 days after redemption, and an adjustment will
be made to the shareholder's tax basis for shares acquired pursuant to the
reinstatement privilege. Gain or loss on a redemption also will be adjusted
for federal income tax purposes by the amount of any sales charge paid on
Class A shares, under the circumstances and to the extent described in
"Dividends & Taxes" in the Prospectus.
PAINEWEBBER RMA RESOURCE ACCUMULATION PLANSM
PAINEWEBBER RESOURCE MANAGEMENT ACCOUNT(R) (RMA(R))
Shares of PaineWebber mutual funds, including the Portfolios (each a "PW
Fund" and, collectively, the "PW Funds"), are available for purchase through
the RMA Resource Accumulation Plan ("Plan") by customers of PaineWebber and
its correspondent firms who maintain Resource Management Accounts ("RMA
accountholders"). The Plan allows an RMA accountholder continually to invest
in one or more of the PW Funds at regular intervals, with payment for shares
purchased automatically deducted from the client's RMA account. The client may
elect to invest at monthly or quarterly intervals and may elect either to
invest a fixed dollar amount (minimum $100 per period) or to purchase a fixed
number of shares. A client can elect to have Plan purchases executed on the
first or fifteenth day of the month. Settlement occurs three Business Days
(defined under "Valuation of Shares") after the trade date, and the purchase
price of the shares is withdrawn from the investor's RMA account on the
settlement date from the following sources and in the following order:
uninvested cash balances, balances in RMA money market funds, or margin
borrowing power, if applicable to the account.
To participate in the Plan, an investor must be an RMA accountholder, must
have made an initial purchase of the shares of each PW Fund selected for
investment under the Plan (meeting applicable minimum investment requirements)
and must complete and submit the RMA Resource Accumulation Plan Client
Agreement and Instruction Form available from PaineWebber. The investor must
have received a current prospectus for each PW Fund selected prior to
enrolling in the Plan. Information about mutual fund positions and outstanding
instructions under the Plan are noted on the RMA accountholder's account
statement. Instructions under the Plan may be changed at any time, but may
take up to two weeks to become effective.
The terms of the Plan, or an RMA accountholder's participation in the Plan,
may be modified or terminated at any time. It is anticipated that, in the
future, shares of other PW Funds and/or mutual funds other than the PW Funds
may be offered through the Plan.
PERIODIC INVESTING AND DOLLAR COST AVERAGING. Periodic investing in the PW
Funds or other mutual funds, whether through the Plan or otherwise, helps
investors establish and maintain a disciplined approach to accumulating assets
over time, de-emphasizing the importance of timing the market's highs and
lows. Periodic investing also permits an investor to take advantage of "dollar
cost averaging." By investing a fixed amount in mutual fund shares at
established intervals, an investor purchases more shares when the price is
lower and fewer shares when the price is higher, thereby increasing his or her
earning potential. Of course, dollar cost averaging does not guarantee a
profit or protect against a loss in a declining market, and an investor should
consider his or
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her financial ability to continue investing through periods of both low and
high share prices. However, over time, dollar cost averaging generally results
in a lower average original investment cost than if an investor invested a
larger dollar amount in a mutual fund at one time.
PAINEWEBBER'S RESOURCE MANAGEMENT ACCOUNT. In order to enroll in the Plan,
an investor must have opened an RMA account with PaineWebber or one of its
correspondent firms. The RMA account is PaineWebber's comprehensive asset
management account and offers investors a number of features, including the
following:
. monthly Premier account statements that itemize all account activity,
including investment transactions, checking activity and Gold
MasterCard(R) transactions during the period, and provide unrealized and
realized gain and loss estimates for most securities held in the account;
. comprehensive preliminary 9-month and year-end summary statements that
provide information on account activity for use in tax planning and tax
return preparation;
. automatic "sweep" of uninvested cash into the RMA accountholder's choice
of one of the six RMA money market funds-RMA Money Market Portfolio, RMA
U.S. Government Portfolio, RMA Tax-Free Fund, RMA California Municipal
Money Fund, RMA New Jersey Municipal Money Fund and RMA New York
Municipal Money Fund. Each money market fund attempts to maintain a
stable price per share of $1.00, although there can be no assurance that
it will be able to do so. Investments in the money market funds are not
insured or guaranteed by the U.S. government;
. check writing, with no per-check usage charge, no minimum amount on
checks and no maximum number of checks that can be written. RMA
accountholders can code their checks to classify expenditures. All
canceled checks are returned each month;
. Gold MasterCard, with or without a line of credit, which provides RMA
accountholders with direct access to their accounts and can be used with
automatic teller machines worldwide. Purchases on the Gold MasterCard are
debited to the RMA account once monthly, permitting accountholders to
remain invested for a longer period of time;
. 24-hour access to account information through toll-free numbers, and more
detailed personal assistance during business hours from the RMA Service
Center;
. expanded account protection to $100 million in the event of the
liquidation of PaineWebber. This protection does not apply to shares of
the RMA money market funds or the PW Funds because those shares are held
at the transfer agent and not through PaineWebber; and
. automatic direct deposit of checks into your RMA account and automatic
withdrawals from the account.
The annual account fee for an RMA account is $85, which includes the Gold
MasterCard, with an additional fee of $40 if the investor selects an optional
line of credit with the Gold MasterCard.
CONVERSION OF CLASS B SHARES
Class B shares of a Portfolio will automatically convert to Class A shares
of that Portfolio, based on the relative net asset values per share of each
class, as of the close of business on the first Business Day (as defined under
"Valuation of Shares") of the month in which the sixth anniversary of the
initial issuance of such Class B shares occurs. For the purpose of calculating
the holding period required for conversion of Class B shares, the date of
initial issuance shall mean (i) the date on which such Class B shares were
issued, or (ii) for Class B shares obtained through an exchange, or a series
of exchanges, the date on which the original Class B shares were issued. For
purposes of conversion to Class A shares, Class B shares purchased through the
reinvestment of dividends and other distributions paid in respect of Class B
shares will be held in a separate sub-account. Each time any Class B shares in
the shareholder's regular account (other than those in the sub-account)
convert to Class A shares, a pro rata portion of the Class B shares in the
sub-account will also convert to Class A shares. The portion will be
determined by the ratio that the shareholder's Class B shares converting to
Class A shares bears to the shareholder's total Class B shares not acquired
through dividends and other distributions.
40
<PAGE>
The availability of the conversion feature is subject to the continuing
availability of an opinion of counsel to the effect that the dividends and
other distributions paid on Class A and Class B shares will not result in
"preferential dividends" under the Internal Revenue Code and that the
conversion of shares does not constitute a taxable event. If the conversion
feature ceased to be available, the Class B shares would not be converted and
would continue to be subject to the higher ongoing expenses of the Class B
shares beyond six years from the date of purchase. Mitchell Hutchins has no
reason to believe that this condition for the availability of the conversion
feature will not be met.
VALUATION OF SHARES
Each Portfolio determines the net asset values per share separately for each
class of shares as of the close of regular trading (currently 4:00 p.m.,
Eastern time) on the NYSE on each Business Day, which is defined as each
Monday through Friday when the NYSE is open. Currently the NYSE is closed on
the observance of the following holidays: New Year's Day, Martin Luther King,
Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving Day and Christmas Day.
The value of the shares of each Underlying Fund will be their net asset
value at the time the net asset value of the Portfolio shares is determined.
The Portfolios generally use the amortized cost method of valuation to value
debt obligations with 60 days or less remaining until maturity, unless the
board determines that this does not represent fair value.
PERFORMANCE INFORMATION
Each Portfolio's performance data quoted in advertising and other
promotional materials ("Performance Advertisements") represents past
performance and are not intended to indicate future performance. The
investment return and principal value of an investment will fluctuate so that
an investor's shares, when redeemed, may be worth more or less than their
original cost.
TOTAL RETURN CALCULATIONS. Average annual total return quotes ("Standardized
Return") used in each Portfolio's Performance Advertisements are calculated
according to the following formula:
<TABLE>
<S> <C> <C>
P (1 + T)n = ERV
where: P = a hypothetical initial payment of $1,000 to purchase shares
of a specified class
T = average annual total return of shares of that class
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment at
the beginning of that period.
</TABLE>
Under the foregoing formula, the time periods used in Performance
Advertisements will be based on rolling calendar quarters, updated to the last
day of the most recent quarter prior to submission of the advertisement for
publication. Total return, or "T" in the formula above, is computed by finding
the average annual change in the value of an initial $1,000 investment over
the period. In calculating the ending redeemable value, for Class A shares,
the maximum 4.5% (4% for Conservative Portfolio) sales charge is deducted from
the initial $1,000 payment and, for Class B and Class C shares, the applicable
contingent deferred sales charge imposed on a redemption of Class B or Class C
shares held for the period is deducted. All dividends and other distributions
are assumed to have been reinvested at net asset value.
The Portfolios also may refer in Performance Advertisements to total return
performance data that are not calculated according to the formula set forth
above ("Non-Standardized Return"). The Portfolios calculate Non-Standardized
Return for specified periods of time by assuming an investment of $1,000 in
Portfolio shares and
41
<PAGE>
assuming the reinvestment of all dividends and other distributions. The rate
of return is determined by subtracting the initial value of the investment
from the ending value and by dividing the remainder by the initial value.
Neither initial nor contingent deferred sales charges are taken into account
in calculating Non-Standardized Return; the inclusion of those charges would
reduce the return.
Both Standardized Return and Non-Standardized Return for Class B shares for
periods of over six years will reflect conversion of the Class B shares to
Class A shares at the end of the sixth year.
YIELD. Yields used in Moderate Portfolio's and Conservative Portfolio's
Performance Advertisements are calculated by dividing the Portfolio's interest
income attributable to a class of shares for a 30-day period ("Period"), net
of expenses attributable to such class, by the average number of shares of
such class entitled to receive dividends during the Period and expressing the
result as an annualized percentage (assuming semi-annual compounding) of the
maximum offering price per share (in the case of Class A shares) or the net
asset value per share (in the case of Class B and Class C shares) at the end
of the Period. Yield quotations are calculated according to the following
formula:
<TABLE>
<S> <C> <C>
YIELD = 2 [( a-b/cd +1 ) 6 -1 ]
where: a = interest earned during the Period attributable to a class of
shares
b = expenses accrued for the Period attributable to a class of
shares (net of reimbursements)
c = the average daily number of shares of a class outstanding
during the Period that were entitled to receive dividends
d = the maximum offering price per share (in the case of Class A
shares) or the net asset value per share (in the case of Class
B and Class C shares) on the last day of the Period.
</TABLE>
Except as noted below, in determining interest income earned during the
Period (variable "a" in the above formula), a Portfolio calculates interest
earned on each debt obligation held by it during the Period by (1) computing
the obligation's yield to maturity, based on the market value of the
obligation (including actual accrued interest) on the last business day of the
Period or, if the obligation was purchased during the Period, the purchase
price plus accrued interest and (2) dividing the yield to maturity by 360, and
multiplying the resulting quotient by the market value of the obligation
(including actual accrued interest) to determine the interest income on the
obligation for each day of the period that the obligation is in the portfolio.
Once interest earned is calculated in this fashion for each debt obligation
held by the Portfolio, interest earned during the Period is then determined by
totalling the interest earned on all debt obligations. For purposes of these
calculations, the maturity of an obligation with one or more call provisions
is assumed to be the next date on which the obligation reasonably can be
expected to be called or, if none, the maturity date. With respect to Class A
shares, in calculating the maximum offering price per share at the end of the
Period (variable "d" in the above formula) the Portfolio's current maximum
4.5% (4% for Conservative Portfolio) initial sales charge on Class A shares is
included.
OTHER INFORMATION. In Performance Advertisements, the Portfolios may compare
their Standardized Return and/or their Non-Standardized Return with data
published by Lipper Analytical Services, Inc. ("Lipper"), CDA Investment
Technologies, Inc. ("CDA"), Wiesenberger Investment Companies Service
("Wiesenberger"), Investment Company Data, Inc. ("ICD") or Morningstar Mutual
Funds ("Morningstar"), with the performance of recognized stock and other
indices, including the Standard & Poor's 500 Composite Stock Price Index ("S&P
500"), the Dow Jones Industrial Average ("DJIA"), the International Finance
Corporation Global Total Return Index, the Nasdaq Composite Index, the Russell
2000 Index, the Wilshire 5000 Index, the Lehman Bond Index, the Lehman
Brothers 20+ Year Treasury Bond Index, the Lehman Brothers
Government/Corporate Bond Index, other similar Lehman Brothers indices or
components thereof, 30-year and 10-year U.S. Treasury bonds, the Morgan
Stanley Capital International Perspective Indices, the Morgan Stanley Capital
International Energy Sources Index, the Standard & Poor's Oil Composite Index,
the Morgan Stanley Capital International World Index, the Salomon Brothers
Non-U.S. Dollar Index, the Salomon Brothers Non-U.S.
42
<PAGE>
World Government Bond Index, the Salomon Brothers World Government Index,
other similar Salomon Brothers indices or components thereof and changes in
the Consumer Price Index as published by the U.S. Department of Commerce. The
Portfolios also may refer in such materials to mutual fund performance
rankings and other data, such as comparative asset, expense and fee levels,
published by Lipper, CDA, Wiesenberger, ICD or Morningstar. Performance
Advertisements also may refer to discussions of the Portfolios and comparative
mutual fund data and ratings reported in independent periodicals, including
THE WALL STREET JOURNAL, MONEY MAGAZINE, FORBES, BUSINESS WEEK, FINANCIAL
WORLD, BARRON'S, FORTUNE, THE NEW YORK TIMES, THE CHICAGO TRIBUNE, THE
WASHINGTON POST AND THE KIPLINGER LETTERS. Comparisons in Performance
Advertisements may be in graphic form.
The Portfolios may include discussions or illustrations of the effects of
compounding in Performance Advertisements. "Compounding" refers to the fact
that, if dividends or other distributions on a Portfolio investment are
reinvested in additional Portfolio shares, any future income or capital
appreciation of a Portfolio would increase the value, not only of the original
Portfolio investment, but also of the additional Portfolio shares received
through reinvestment. As a result, the value of a Portfolio investment would
increase more quickly than if dividends or other distributions had been paid
in cash.
The Portfolios may also compare their performance with the performance of
bank certificates of deposit (CDs) as measured by the CDA Certificate of
Deposit Index, the Bank Rate Monitor National Index and the averages of yields
of CDs of major banks published by Banxquote (Registered) Money Markets. In
comparing the Portfolios' performance to CD performance, investors should keep
in mind that bank CDs are insured in whole or in part by an agency of the U.S.
government and offer fixed principal and fixed or variable rates of interest,
and that bank CD yields may vary depending on the financial institution
offering the CD and prevailing interest rates. Shares of the Portfolios are
not insured or guaranteed by the U.S. government and returns and net asset
values will fluctuate. The debt securities held by the Portfolios may have
longer maturities than most CDs and may reflect interest rate fluctuations for
longer term debt securities. An investment in any Portfolio involves greater
risks than an investment in either a money market fund or a CD.
The Portfolios may also compare their performance to general trends in the
stock and bond markets, as illustrated by the following graph prepared by
Ibbotson Associates, Chicago.
[PERFORMANCE CHART APPEARS HERE]
- --------
Source: Stocks, Bonds, Bills and Inflation 1997 Yearbook(TM) Ibbotson Assoc.,
Chi., (annual updates work by Roger G. Ibbotson & Rex A. Sinquefield).
43
<PAGE>
The chart is shown for illustrative purposes only and does not represent any
Portfolio's performance. These returns consist of income and capital
appreciation (or depreciation) and should not be considered an indication or
guarantee of future investment results. Year-to-year fluctuations in certain
markets have been significant and negative returns have been experienced in
certain markets from time to time. Stocks are measured by the S&P 500, an
unmanaged weighted index comprising 500 widely held common stocks and varying
in composition. Unlike investors in bonds and U.S. Treasury bills, common
stock investors do not receive fixed income payments and are not entitled to
repayment of principal. These differences contribute to investment risk.
Returns shown for long-term government bonds are based on U.S. Treasury bonds
with 20-year maturities. Inflation is measured by the Consumer Price Index.
The indices are unmanaged and are not available for investment.
Over time, stocks have outperformed all other investments by a wide margin,
offering a solid hedge against inflation. From 1926 to 1996, stocks beat all
other traditional asset classes. A $10,000 investment in the stocks comprising
the S&P 500 grew to $13,710,736, significantly more than any other investment.
TAXES
TAXATION OF THE PORTFOLIOS. To qualify for treatment as a regulated
investment company ("RIC") under the Internal Revenue Code, each Portfolio
must distribute to its shareholders for each taxable year at least 90% of its
investment company taxable income (consisting generally of net investment
income and net short-term capital gains) ("Distribution Requirement") and must
meet several additional requirements. For each Portfolio these requirements
include the following: (1) the Portfolio must derive at least 90% of its gross
income each taxable year from dividends, interest, payments with respect to
securities loans and gains from the sale or other disposition of securities,
or other income derived with respect to its business of investing in
securities ("Income Requirement"); (2) at the close of each quarter of the
Portfolio's taxable year, at least 50% of the value of its total assets must
be represented by cash and cash items, U.S. government securities, securities
of other RICs (including the Underlying Funds) and other securities, with
these other securities limited, in respect of any one issuer, to an amount
that does not exceed 5% of the value of the Portfolio's total assets and that
does not represent more than 10% of the issuer's outstanding voting
securities; and (3) at the close of each quarter of the Portfolio's taxable
year, not more than 25% of the value of its total assets may be invested in
securities (other than U.S. government securities or the securities of other
RICs, including the Underlying Funds) of any one issuer.
Each Portfolio will invest its assets in shares of Underlying Funds and
money market and other short-term instruments. Accordingly, each Portfolio's
income will consist of distributions from Underlying Funds, net gains realized
from the disposition of Underlying Fund shares and interest. If an Underlying
Fund qualifies for treatment as a RIC under the Internal Revenue Code--each
has done so for its past taxable years and intends to continue to do so for
its current and future taxable years--(1) dividends paid to a Portfolio from
the Underlying Fund's investment company taxable income (which may include net
gains from certain foreign currency transactions) will be taxable to the
Portfolio as ordinary income to the extent of the Underlying Fund's earnings
and profits, and (2) distributions paid to a Portfolio from the Underlying
Fund's net capital gain (that is, the excess of net long-term capital gain
over net short-term capital loss) will be taxable to the Portfolio as long-
term capital gains, regardless of how long the Portfolio has held the
Underlying Fund's shares. If a Portfolio purchases shares of an Underlying
Fund within 30 days before or after redeeming at a loss other shares of that
Underlying Fund (whether pursuant to a rebalancing of the Portfolio's
portfolio or otherwise), all or part of the loss will not be deductible by the
Portfolio and instead will increase its basis for the newly purchased shares.
Although each of PaineWebber Global Income Fund and PaineWebber Global
Equity Fund will be eligible to elect to "pass-through" to its shareholders
(including a Portfolio) the benefit of the foreign tax credit with respect to
any foreign and U.S. possessions income taxes it pays if more than 50% of the
value of its total assets at the close of any taxable year consists of
securities of foreign corporations, no Portfolio will qualify to pass that
benefit through to its shareholders because of its inability to satisfy that
test.
44
<PAGE>
Each Portfolio will be subject to a nondeductible 4% excise tax to the
extent it fails to distribute by the end of any calendar year substantially
all of its ordinary income for that year and capital gain net income for the
one-year period ending on October 31 of that year, plus certain other amounts.
TAXATION OF THE PORTFOLIOS' SHAREHOLDERS. Dividends and other distributions
declared by a Portfolio in October, November or December of any year and
payable to shareholders of record on a date in any of those months will be
deemed to have been paid by the Portfolio and received by the shareholders on
December 31 of that year even if the distributions are paid by the Portfolio
during the following January. Accordingly, those distributions will be taxed
to shareholders for the year in which that December 31 falls.
A portion of the dividends from a Portfolio's investment company taxable
income (whether paid in cash or additional shares) may be eligible for the
dividends-received deduction allowed to corporations. The eligible portion for
any Portfolio may not exceed the total of its shares of the aggregate
dividends received from U.S. corporations by the Underlying Funds in which it
invests that qualify as RICs. However, dividends received by a corporate
shareholder and deducted by it pursuant to the dividends-received deduction
are subject indirectly to the alternative minimum tax.
If Portfolio shares are sold at a loss after being held for six months or
less, the loss will be treated as long-term, instead of short-term, capital
loss to the extent of any capital gain distributions received on those shares.
Investors also should be aware that if shares are purchased shortly before the
record date for any dividend or capital gain distribution, the shareholder
will pay full price for the shares and receive some portion of the price back
as a taxable distribution.
The portion of each Portfolio's dividends attributable to interest on U.S.
government obligations, including the portion of dividends the Portfolio
receives from Underlying Funds qualifying as RICs that is attributable to such
interest, may be exempt from state and local income tax.
OTHER INFORMATION
Prior to August 20, 1997, the Trust's name was "PaineWebber Journey
Portfolios," and prior to July 22, 1997, its name was "PaineWebber Select
Fund." The Trust is a Delaware business trust. The Trust has authority to
issue an unlimited number of shares of beneficial interest. The Trust's board
may, without shareholder approval, divide the authorized shares into an
unlimited number of separate series and may divide the shares of any series
into classes, and the costs of doing so will be borne by the Trust. The Trust
currently consist of four series, each with four classes of shares; three
series currently offer shares to the public.
Although Delaware law statutorily limits the potential liabilities of a
Delaware business trust's shareholders to the same extent as it limits the
potential liabilities of a Delaware corporation, shareholders of a Portfolio
could, under certain conflicts of laws jurisprudence in various states, be
held personally liable for the obligations of the Trust or a Portfolio.
However, the trust instrument of the Trust disclaims shareholder liability for
acts or obligations of the Trust or its series (the Portfolios) and requires
that notice of such disclaimer be given in each written obligation made or
issued by the trustees or by any officers or officer by or on behalf of the
Trust, a series, the trustees or any of them in connection with the Trust. The
trust instrument provides for indemnification from a Portfolio's property for
all losses and expenses of any series shareholder held personally liable for
the obligations of the Portfolio. Thus, the risk of a shareholder's incurring
financial loss on account of shareholder liability is limited to circumstances
in which a Portfolio itself would be unable to meet its obligations, a
possibility which Mitchell Hutchins believes is remote and not material. Upon
payment of any liability incurred by a shareholder solely by reason of being
or having been a shareholder of a Portfolio, the shareholder paying such
liability will be entitled to reimbursement from the general assets of the
Portfolio. The trustees intend to conduct the operations of the Portfolios in
such a way as to avoid, as far as possible, ultimate liability of the
shareholders for liabilities of the Portfolios.
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<PAGE>
Each Portfolio is entitled to participate equally in the dividends and other
distributions and the proceeds of any liquidation except that, due to the
differing expenses borne by the classes, dividends and liquidation proceeds
for each class will likely differ. Shares are fully paid and non-assessable
and have no preemptive or other right to subscribe to any additional shares or
other securities issued by the Trust. Shareholders have non-cumulative voting
rights. A shareholder is entitled to one vote for each full share held and a
proportionate fractional vote for each fractional share held.
Annual shareholder meetings are not required. Special meetings of the
shareholders of any class or any series may be called by the trustees and
shall be called by the trustees upon the written request of shareholders
owning at least ten percent of the outstanding shares of such series or class,
or at least ten percent of the outstanding shares entitled to vote. On matters
requiring shareholder approval, all shares shall be voted by individual series
or class, except (a) when required by the 1940 Act, shares shall be voted in
the aggregate and not by individual series or class, and (b) when the trustees
have determined that the matter affects the interests of more than one series
or class, then the shareholders of all such series or classes shall be
entitled to one vote thereon.
CLASS-SPECIFIC EXPENSES. Each Portfolio may determine to allocate certain of
its expenses (in addition to distribution fees) to the specific classes of the
Portfolio's shares to which those expenses are attributable. For example, a
Portfolio's Class B shares bear higher transfer agency fees per shareholder
account than those borne by Class A or Class C shares. The higher fee is
imposed due to the higher costs incurred by the Transfer Agent in tracking
shares subject to a contingent deferred sales charge because, upon redemption,
the duration of the shareholder's investment must be determined in order to
determine the applicable charge. Moreover, the tracking and calculations
required by the automatic conversion feature of the Class B shares will cause
the Transfer Agent to incur additional costs. Although the transfer agency fee
will differ on a per account basis as stated above, the specific extent to
which the transfer agency fees will differ between the classes as a percentage
of net assets is not certain, because the fee as a percentage of net assets
will be affected by the number of shareholder accounts in each class and the
relative amounts of net assets in each class.
COUNSEL. The law firm of Kirkpatrick & Lockhart LLP, 1800 Massachusetts
Avenue, N.W., Washington, D.C. 20036-1800, serves as counsel to the
Portfolios. Kirkpatrick & Lockhart LLP also acts as counsel to PaineWebber and
Mitchell Hutchins in connection with other matters.
AUDITORS. Ernst & Young LLP, 787 Seventh Avenue, New York, New York 10019,
serves as independent auditors for the Trust and each Portfolio.
46
<PAGE>
FINANCIAL STATEMENTS
MITCHELL HUTCHINS PORTFOLIOS
STATEMENT OF ASSETS AND LIABILITIES
DECEMBER 29, 1997
<TABLE>
<CAPTION>
AGGRESSIVE MODERATE CONSERVATIVE
PORTFOLIO PORTFOLIO PORTFOLIO
---------- --------- ------------
<S> <C> <C> <C>
ASSETS:
Cash................................... $ 40,000 $ 40,000 $ 20,000
Deferred organizational expenses....... 86,333 86,333 86,333
Prepaid expenses....................... 112,765 112,765 112,765
-------- -------- --------
Total assets......................... 239,098 239,098 219,098
-------- -------- --------
LIABILITIES:
Organizational expenses payable........ 86,333 86,333 86,333
Payable to adviser..................... 112,765 112,765 112,765
-------- -------- --------
Total liabilities.................... 199,098 199,098 199,098
-------- -------- --------
Net Assets (beneficial interest, $0.001
par value, issued and outstanding)...... $ 40,000 $ 40,000 $ 20,000
======== ======== ========
CLASS A:
Net Assets............................... $ 10,000 $ 10,000 $ 5,000
Shares outstanding....................... 800 800 400
Net asset value, offering price and
redemption value per share.............. $ 12.50 $ 12.50 $ 12.50
======== ======== ========
CLASS B:
Net Assets............................... $ 10,000 $ 10,000 $ 5,000
Shares outstanding....................... 800 800 400
Net asset value, offering price and
redemption value per share.............. $ 12.50 $ 12.50 $ 12.50
======== ======== ========
CLASS C:
Net Assets............................... $ 10,000 $ 10,000 $ 5,000
Shares outstanding....................... 800 800 400
Net asset value, offering price and
redemption value per share.............. $ 12.50 $ 12.50 $ 12.50
======== ======== ========
CLASS Y:
Net Assets............................... $ 10,000 $ 10,000 $ 5,000
Shares outstanding....................... 800 800 400
Net asset value, offering price and
redemption value per share.............. $ 12.50 $ 12.50 $ 12.50
======== ======== ========
</TABLE>
See accompanying notes to financial statement.
47
<PAGE>
NOTES TO FINANCIAL STATEMENTS
MITCHELL HUTCHINS PORTFOLIOS
ORGANIZATION
Mitchell Hutchins Aggressive Portfolio, Mitchell Hutchins Moderate Portfolio
and Mitchell Hutchins Conservative Portfolio (collectively "the Portfolios")
are diversified series of Mitchell Hutchins Portfolios (the "Trust"), an open-
end management investment company organized as a Delaware business trust on
August 9, 1996. The Portfolios have had no operations other than the sale of
shares on December 29, 1997 to Mitchell Hutchins Asset Management Inc.
("Mitchell Hutchins"), the investment adviser and an asset management
subsidiary of PaineWebber Incorporated ("PaineWebber"), as follows:
<TABLE>
<CAPTION>
AGGRESSIVE MODERATE CONSERVATIVE
PORTFOLIO PORTFOLIO PORTFOLIO
SHARES $ SHARES $ SHARES $
---------- ------- --------- ------- ------------ ------
<S> <C> <C> <C> <C> <C> <C>
Class A 800 $10,000 800 $10,000 400 $5,000
Class B 800 $10,000 800 $10,000 400 $5,000
Class C 800 $10,000 800 $10,000 400 $5,000
Class Y 800 $10,000 800 $10,000 400 $5,000
</TABLE>
The Portfolios currently offer four classes of shares. Each class,
respectively, represents assets of each Portfolio, respectively, and the
classes are identical except for differences in ongoing service fees and
certain transfer agency expenses. The trustees of the Trust have authority to
issue an unlimited number of shares of beneficial shares, par value $0.001 per
share. Costs incurred in connection with the organization and initial
registration fees of the Trust will be paid initially by Mitchell Hutchins;
however, the Trust will reimburse Mitchell Hutchins for such costs. Such
organizational costs, estimated at $259,000, have been allocated among the
Portfolios and will be deferred and amortized by the Portfolios on the
straight line method over a period not to exceed 60 months from the date the
Portfolios commence investment operations. If any initial shares are redeemed
by any holder thereof during the amortization period, the redemption proceeds
shall be reduced by the pro rata portion of unamortized expenses which the
number of shares redeemed bears to the number of initial shares then
outstanding.
MANAGEMENT AGREEMENT
Mitchell Hutchins acts as the investment adviser and administrator to each
Portfolio pursuant to a contract (the "Advisory Contract") with the Trust
dated January 9, 1998. Under the Advisory Contract, each Portfolio pays
Mitchell Hutchins a fee, computed daily and paid monthly, at an annual rate of
0.35% of each Portfolio's average daily net assets. Through each Portfolio's
first year of operations, Mitchell Hutchins has agreed to voluntarily waive
0.25% of its fee and reimburse other Portfolio expenses. This expense
reimbursement does not include 12b-1 service and distribution fees and
extraordinary expenses.
DISTRIBUTION ARRANGEMENTS
Mitchell Hutchins is the distributor of each Portfolio's shares and has
appointed PaineWebber as the exclusive dealer for the sale of those shares.
Under the distribution plan for Class A, Class B and Class C shares ("Class A
Plan," "Class B Plan" and "Class C Plan" collectively, "Plans"), Class B
shares and Class C shares pay monthly distribution fees at the annual rate of
0.75% (0.50% for Class C shares of the Conservative Portfolio) of the average
daily net assets. Each class (other than Class Y shares) pays Mitchell
Hutchins monthly service fees at the annual rate of 0.25% of the average daily
net assets. There is no distribution plan with respect to the Portfolios'
Class Y shares.
48
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Trustees and Shareholders of
Mitchell Hutchins Portfolios
We have audited the accompanying statement of assets and liabilities of
Mitchell Hutchins Portfolios (comprising, respectively, Mitchell Hutchins
Aggressive Portfolio, Mitchell Hutchins Moderate Portfolio and Mitchell
Hutchins Conservative Portfolio) (the "Trust") as of December 29, 1997. This
statement of assets and liabilities is the responsibility of the Trust's
management. Our responsibility is to express an opinion on this statement of
assets and liabilities based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the statement of assets and
liabilities is free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the statement
of assets and liabilities. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall statement of assets and liabilities presentation. We
believe that our audit provides a reasonable basis for our opinion.
In our opinion, the statement of assets and liabilities referred to above
presents fairly, in all material respects, the financial position of Mitchell
Hutchins Portfolios at December 29, 1997, in conformity with generally
accepted accounting principles.
/s/ Ernst & Young LLP
ERNST & YOUNG LLP
New York, New York
December 30, 1997
49
<PAGE>
APPENDIX
DESCRIPTION OF MOODY'S CORPORATE BOND RATINGS
Aaa. Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
a "gilt edged." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized
are most unlikely to impair the fundamentally strong position of such issues;
Aa. Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long term risks appear somewhat larger than in Aaa
securities; A. Bonds which are rated A possess many favorable investment
attributes and are to be considered as upper medium-grade obligations. Factors
giving security to principal and interest are considered adequate but elements
may be present which suggest a susceptibility to impairment sometime in the
future; Baa. Bonds which are rated Baa are considered as medium-grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payment and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics as
well; Ba. Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class; B. Bonds which are rated B
generally lack characteristics of the desirable investment. Assurance of
interest and principal payments or of maintenance of other terms of the
contract over any long period of time may be small; Caa. Bonds which are rated
Caa are of poor standing. Such issues may be in default or there may be
present elements of danger with respect to principal or interest; Ca. Bonds
which are rated Ca represent obligations which are speculative in a high
degree. Such issues are often in default or have other marked shortcomings; C.
Bonds which are rated C are the lowest rated class of bonds, and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Note: Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category, the modifier 2 indicates a mid-range ranking, and the
modifier 3 indicates that the issue ranks in the lower end of its generic
rating category.
DESCRIPTION OF S&P CORPORATE DEBT RATINGS
AAA. An obligation rated AAA has the highest rating assigned by S&P. The
obligor's capacity to meet its financial commitment on the obligation is
extremely strong; AA. An obligation rated AA differs from the higher rated
issues only in small degree. The obligor's capacity to meet its financial
commitment on the obligation is very strong; A. An obligation rated A is
somewhat more susceptible to the adverse effects of changes in circumstances
and economic conditions than obligations in higher rated categories. However,
the obligor's capacity to meet its financial commitment on the obligation is
still strong; BBB. An obligation rated BBB exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet its
financial commitment on the obligation; BB, B, CCC, CC, C. Obligations rated
BB, B, CCC, CC and C are regarded as having significant speculative
characteristics. BB indicates the lowest degree of speculation and C the
highest. While such obligations will likely have some quality and protective
characteristics, these may be outweighed by large uncertainties or major
exposures to adverse conditions.
"BB." An obligation rated "BB" is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial, or economic conditions which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
A-1
<PAGE>
"B." An obligation rated "B" is more vulnerable to nonpayment than
obligations rated "BB", but the obligor currently has the capacity to meet its
financial commitment on the obligation. Adverse business, financial, or
economic conditions will likely impair the obligor's capacity or willingness
to meet its financial commitment on the obligation.
"CCC." An obligation rated "CCC" is currently vulnerable to nonpayment and
is dependent upon favorable business, financial and economic conditions for
the obligor to meet its financial commitments on the obligation. In the event
of adverse business, financial, or economic conditions, the obligor is not
likely to have the capacity to meet its financial commitment on the
obligation.
"CC." An obligation rated "CC" is currently highly vulnerable to nonpayment.
"C." The "C" rating may be used to cover a situation where a bankruptcy
petition has been filed or similar action has been taken, but payments on this
obligation are being continued.
"D." An obligation rated "D" is in payment default. The "D" rating category
is used when payments on an obligation are not made on the date due even if
the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grace period. The "D" rating also will be
used upon the filing of a bankruptcy petition or the taking of a similar
action if payments on an obligation are jeopardized.
Plus (+) or Minus (-): 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.
r. This symbol is attached to the ratings of instruments with significant
noncredit risks. It highlights risks to principal or volatility of expected
returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe prepayment risk--such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
A-2
<PAGE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THE PROSPECTUS OR IN THIS STATEMENT OF
ADDITIONAL INFORMATION IN CONNECTION WITH THE OFFERING MADE BY THE PROSPECTUS
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY THE PORTFOLIOS OR THEIR DISTRIBUTOR. THE
PROSPECTUS AND THIS STATEMENT OF ADDITIONAL INFORMATION DO NOT CONSTITUTE AN
OFFERING BY THE PORTFOLIOS OR BY THE DISTRIBUTOR IN ANY JURISDICTION IN WHICH
SUCH OFFERING MAY NOT LAWFULLY BE MADE.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Portfolios--Investment Policies And Restrictions......................... 2
Underlying Funds--Investment Policies.................................... 4
Underlying Funds -- Hedging And Other Strategies Using Derivative
Instruments............................................................. 18
Trustees And Officers; Principal Holders Of Securities................... 27
Investment Advisory And Distribution Arrangements........................ 32
Portfolio Transactions................................................... 35
Reduced Sales Charges, Additional Exchange And Redemption Information And
Other Services.......................................................... 37
Conversion Of Class B Shares............................................. 40
Valuation Of Shares...................................................... 41
Performance Information.................................................. 41
Taxes.................................................................... 44
Other Information........................................................ 45
Financial Statements..................................................... 47
Notes to Financial Statements............................................ 48
Appendix................................................................. A-1
</TABLE>
(C) 1998 PaineWebber Incorporated
MITCHELL HUTCHINS
PORTFOLIOS
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Statement of Additional Information
January 9, 1998
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PAINEWEBBER
