MITCHELL HUTCHINS AGGRESSIVE PORTFOLIO
MITCHELL HUTCHINS MODERATE PORTFOLIO
MITCHELL HUTCHINS CONSERVATIVE PORTFOLIO
51 WEST 52ND STREET
NEW YORK, NEW YORK 10019-6114
STATEMENT OF ADDITIONAL INFORMATION
The three funds named above are diversified series of Mitchell Hutchins
Portfolios ("Trust"), a professionally managed, open-end management investment
company. The funds seek to achieve their investment objectives by investing in a
number of other PaineWebber mutual funds ("underlying funds").
The investment adviser, administrator and distributor for each fund is
Mitchell Hutchins Asset Management Inc. ("Mitchell Hutchins"), a wholly owned
asset management subsidiary of PaineWebber Incorporated ("PaineWebber"). As
distributor for the funds, Mitchell Hutchins has appointed PaineWebber to serve
as the exclusive dealer for the sale of fund shares.
Portions of the funds' Annual Report to Shareholders are incorporated by
reference into this Statement of Additional Information ("SAI"). The Annual
Report accompanies this SAI. You may obtain an additional copy of the funds'
Annual Report by calling toll-free 1-800-647-1568.
This SAI is not a prospectus and should be read only in conjunction with
the funds' current Prospectus dated September 30, 1999. A copy of the Prospectus
may be obtained by calling any PaineWebber Financial Advisor or correspondent
firm, or by calling toll-free 1-800-647-1568. This SAI is dated September 30,
1999.
TABLE OF CONTENTS
PAGE
The Funds and Their Investment Policies .............................. 2
The Funds' Investments, Related Risks and Limitations................. 2
Underlying Funds' Investment Policies................................. 5
Underlying Funds--Strategies Using Derivative Instruments............. 23
Organization; Trustees, Officers and Principal Holders
of Securities....................................................... 33
Investment Advisory, Administration and Distribution
Arrangements........................................................ 39
Portfolio Transactions................................................ 43
Reduced Sales Charges, Additional Exchange and Redemption
Information and Other Services...................................... 46
Conversion of Class B Shares.......................................... 51
Valuation of Shares................................................... 51
Performance Information............................................... 51
Taxes................................................................. 56
Other Information..................................................... 57
Financial Statements.................................................. 59
Appendix.............................................................. 60
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THE FUNDS AND THEIR INVESTMENT POLICIES
MITCHELL HUTCHINS AGGRESSIVE PORTFOLIO'S investment objective is long-term
growth of capital. The fund invests primarily in equity mutual funds. It also
invests, to a lesser extent, in bond mutual funds.
MITCHELL HUTCHINS MODERATE PORTFOLIO'S investment objective is total
return by investing. The fund invests in a combination of equity and bond mutual
funds.
MITCHELL HUTCHINS CONSERVATIVE PORTFOLIO'S investment objective is to seek
income and, secondarily, growth of capital. The fund invests primarily in bond
mutual funds. It also invests, to a lesser extent, in equity mutual funds.
Each fund may also invest directly in short-term bonds and money market
instruments for cash management purposes or for temporary defensive purposes.
Each fund also may invest up to 15% of its net assets in illiquid securities and
may borrow for temporary or emergency purposes, but not in excess of 33 1/3% of
its total assets.
THE FUNDS' INVESTMENTS, RELATED RISKS AND LIMITATIONS
The following supplements the information contained in the Prospectus
concerning the funds' investment policies and limitations. Except as otherwise
indicated in the Prospectus or this SAI, there are no policy limitations on the
funds' ability to use the investments or techniques discussed in these
documents.
DIRECT INVESTMENTS IN SECURITIES. Each fund 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 fund's investments in these
securities, together with its investments in PaineWebber Cashfund, an underlying
fund that is 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 fund may invest without
limit in these securities.
MONEY MARKET INSTRUMENTS. Money market instruments are short-term debt
obligations and similar securities and include: (1) securities issued or
guaranteed as to interest and principal by the U.S. government or one of its
agencies or instrumentalities; (2) debt obligations of U.S. banks, savings
associations, insurance companies and mortgage bankers, (3) commercial paper and
other short-term obligations of corporations, partnerships, trusts and similar
entities; and (4) repurchase agreements regarding any of the foregoing. Money
market instruments include longer-term bonds that have variable interest rates
or other special features that give them the financial characteristics of
short-term debt. In addition, the funds may hold cash and may invest in
participation interests in the money market securities mentioned above.
U.S. GOVERNMENT SECURITIES. U.S. government securities include direct
obligations of the U.S. Treasury (such as Treasury bills, notes or bonds) and
obligations issued or guaranteed by the U.S. government as to principal and
interest (but not as to market value) by the U.S. government, its agencies or
its instrumentalities (collectively, "U.S. government securities"). U.S.
government securities may be backed by the full faith and credit of the U. S.
government or supported primarily or solely by the creditworthiness of the
government-related issuer or, in the case of mortgage-backed securities, by
pools of assets. U.S. government securities are described in greater detail in
"Underlying Funds--Investment Policies" below.
REPURCHASE AGREEMENTS. Repurchase agreements are transactions in which a
fund purchases securities or other obligations from a bank or securities dealer
(or its affiliate) and simultaneously commits to resell them to the counterparty
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 obligations.
A fund maintains custody of the underlying obligations prior to their
repurchase, either through its regular custodian or through a special
"tri-party" custodian or sub-custodian that maintains separate accounts for both
the fund and its counterparty. Thus, the obligation of the counterparty to pay
the repurchase price on the date agreed to or upon demand is, in effect, secured
by such obligations. Repurchase agreements carry certain risks not associated
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with direct investments in securities, including a possible decline in the
market value of the underlying obligations. If their value becomes less than the
repurchase price, plus any agreed-upon additional amount, the counterparty 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
obligations and the price that was paid by a fund upon acquisition is accrued as
interest and included in its net investment income. Repurchase agreements
involving obligations other than U.S. government securities (such as commercial
paper and corporate bonds) may be subject to special risks and may not have the
benefit of certain protections in the event of the counterparty's insolvency. If
the seller or guarantor becomes insolvent, the fund may suffer delays, costs and
possible losses in connection with the disposition of collateral. Each fund
intends to enter into repurchase agreements only with counterparties in
transactions believed by Mitchell Hutchins to present minimum credit risks.
ILLIQUID SECURITIES. Each fund may invest up to 15% of its net assets in
illiquid securities, although the funds 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 fund 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 established by the funds' 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."
INVESTMENT LIMITATIONS OF THE FUNDS
FUNDAMENTAL LIMITATIONS. The following fundamental investment limitations
cannot be changed for a fund without the affirmative vote of the lesser of (a)
more than 50% of the outstanding shares of the fund or (b) 67% or more of the
shares of the fund present at a shareholders' meeting if more than 50% of the
outstanding shares of the fund 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 fund will not:
(1) purchase any security if, as a result of that purchase, 25% or more of
the fund'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
fund 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 ("Investment Company Act"), and then not in
excess of 33 1/3% of the fund'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 fund 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 fund might be considered an underwriter under the
federal securities laws in connection with its disposition of portfolio
securities.
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(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 fund 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 fund may purchase, sell or enter
into financial options and futures, forward and spot currency contracts, swap
transactions and other financial contracts or derivative instruments.
(7) purchase securities of any one issuer if, as a result, more than 5% of
the fund's total assets would be invested in securities of that issuer or the
fund would own or hold more than 10% of the outstanding voting securities of
that issuer, except that up to 25% of the fund'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 fund will not:
(1) invest more than 15% of its net assets in illiquid securities.
(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 fund 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 fund 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 Investment Company 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 funds 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 funds 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 SAI.
In accordance with each fund's investment program as set forth in the
Prospectus, a fund may invest more than 25% of its assets in any one underlying
fund. However, each underlying fund in which a fund 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.
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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, 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 SAI.
EQUITY SECURITIES. Equity securities include common stocks, most preferred
stocks and securities that are convertible into them, including common stock
purchase warrants and rights, equity interests in trusts, partnerships, joint
ventures or similar enterprises and depository receipts. Common stocks are the
most familiar type of equity security. They represent an equity (ownership)
interest in a corporation.
Preferred stock has certain fixed income features, like a bond, but
actually it is equity that is senior to a company's common stock. Convertible
securities include debentures, notes and preferred equity securities, 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. Depository receipts typically are issued by banks or trust
companies and evidence ownership of underlying equity securities.
While past performance does not guarantee future results, equity
securities historically have provided the greatest long-term growth potential in
a company. However, their prices generally fluctuate more than other securities
and reflect changes in a company's financial condition and in overall market and
economic conditions. Common stocks generally represent the riskiest investment
in a company. It is possible that a fund may experience a substantial or
complete loss on an individual equity investment. While this is possible with
bonds, it is less likely.
BONDS. Bonds are fixed or variable rate debt obligations, including notes,
debentures, and similar instruments and securities, including money market
instruments. Mortgage- and asset-backed securities are types of bonds, and
certain types of income-producing, non-convertible preferred stocks may be
treated as bonds for investment purposes. Bonds generally are used by
corporations, governments and other issuers to borrow money from investors. The
issuer pays the investor a fixed or variable rate of interest and normally must
repay the amount borrowed on or before maturity. Many preferred stocks and some
bonds are "perpetual" in that they have no maturity date.
Bonds are subject to interest rate risk and credit risk. Interest rate
risk is the risk that interest rates will rise and that, as a result, bond
prices will fall, lowering the value of a fund's investments in bonds. In
general, bonds having longer durations are more sensitive to interest rate
changes than are bonds with shorter durations. Credit risk is the risk that an
issuer may be unable or unwilling to pay interest and/or principal on the bond,
or that a market may become less confident as to the issuer's ability or
willingness to do so. Credit risk can be affected by many factors, including
adverse changes in the issuer's own financial condition or in economic
conditions.
CONVERTIBLE SECURITIES. A convertible security is a bond, 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 or dividends until the convertible security
matures or is redeemed, converted or exchanged. 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. While
no securities investment is without some risk, investments in convertible
securities generally entail less risk than the issuer's common stock. However,
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.
WARRANTS. Warrants are securities permitting, but not obligating, holders
to subscribe for other securities. 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
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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.
CREDIT RATINGS; NON-INVESTMENT GRADE BONDS. Moody's Investors Service,
Inc. ("Moody's"), Standard & Poor's, a division of The McGraw-Hill Companies,
Inc. ("S&P"), and other rating agencies are private services that provide
ratings of the credit quality of bonds and certain other securities. A
description of the ratings assigned to corporate bonds by Moody's and S&P is
included in the Appendix to this SAI. The process by which Moody's and S&P
determine ratings for mortgage-backed securities includes consideration of the
likelihood of the receipt by security holders of all distributions, the nature
of the underlying assets, the credit quality of the guarantor, if any, and the
structural, legal and tax aspects associated with these securities. Not even the
highest such ratings represent an assessment of the likelihood that principal
prepayments will be made by obligors on the underlying assets 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. References to rated bonds include
bonds that are not rated by a rating agency but that Mitchell Hutchins or the
applicable sub-adviser determines to be of comparable quality.
Credit ratings attempt to evaluate the safety of principal and interest
payments, but they do not evaluate the volatility of a bond's value or its
liquidity and do not guarantee the performance of the issuer. Rating agencies
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. There is a risk that rating agencies may downgrade
the rating of a bond. Subsequent to a bond's purchase by an underlying fund, it
may cease to be rated or its rating may be reduced below the minimum rating
required for purchase by the fund. 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, bonds with the same maturity, interest rate and rating
may have different market prices.
In addition to ratings assigned to individual bond issues, Mitchell
Hutchins or the applicable sub-adviser analyzes interest rate trends and
developments that may affect individual issuers, including factors such as
liquidity, profitability and asset quality. The yields on bonds 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.
Investment grade bonds are rated in one of the four highest rating
categories by Moody's or S&P, comparably rated by another rating agency or
considered of comparable quality by Mitchell Hutchins or the applicable
sub-adviser. Moody's considers bonds rated Baa (its lowest investment grade
rating) to have speculative characteristics. This means that changes in economic
conditions or other circumstances are more likely to lead to a weakened capacity
to make principal and interest payments than is the case for higher rated bonds.
High yield bonds (commonly known as "junk bonds") are non-investment grade
bonds. This means they are rated Ba or lower by Moody's, BB or lower by S&P,
comparably rated by another rating agency or determined by Mitchell Hutchins or
the sub-adviser to be of comparable quality. Bonds rated D by S&P are in payment
default or such rating is assigned upon the filing of a bankruptcy petition or
the taking of a similar action if payments on an obligation are jeopardized.
Bonds rated C by Moody's are in the lowest rated class and can be regarded as
having extremely poor prospects of attaining any real investment standing.
An underlying fund's investments in non-investment grade bonds entail
greater risk than its investments in higher rated bonds. Non-investment grade
bonds are considered predominantly speculative with respect to the issuer's
ability to pay interest and repay principal and may involve significant risk
exposure to adverse conditions. Non-investment grade bonds generally offer a
higher current yield than that available for investment grade issues; however,
they involve higher risks, in that they are especially sensitive to adverse
changes in general economic conditions and in the industries in which the
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issuers are engaged, to changes in the financial condition of the issuers and to
price fluctuations in response to changes in interest rates. During periods of
economic downturn or rising interest rates, highly leveraged issuers may
experience financial stress which could adversely affect their ability to make
payments of interest and principal and 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.
The risk of loss due to default by such issuers is significantly greater because
such securities frequently are unsecured by collateral and will not receive
payment until more senior claims are paid in full.
The market for non-investment grade bonds, especially those of foreign
issuers, has expanded rapidly in recent years, which has been a period of
generally expanding growth and lower inflation. These securities will be
susceptible to greater risk when economic growth slows or reverses and when
inflation increases or deflation occurs. This has been reflected in recent
volatility in emerging market securities. In the past, many lower rated bonds
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 bonds rose dramatically. However, those higher yields
did not reflect the value of the income stream that holders of such securities
expected. Rather, they reflected the risk that holders of such securities could
lose a substantial portion of their value due to the issuers' financial
restructurings or defaults by the issuers. There can be no assurance that those
declines will not recur.
The market for non-investment grade bonds generally is thinner and less
active than that for higher quality securities, which may limit a fund's ability
to sell such securities 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 values and liquidity of
non-investment grade bonds, especially in a thinly traded market.
U.S. GOVERNMENT SECURITIES include direct obligations of the U.S. Treasury
(such as Treasury bills, notes or bonds) and obligations issued or guaranteed as
to principal and interest (but not as to market value) by the U.S. government,
its agencies or its instrumentalities. U.S. government securities include
mortgage-backed securities issued or guaranteed by government agencies or
government-sponsored enterprises. Other U.S. government securities may be backed
by the full faith and credit of the U.S. government or supported primarily or
solely by the creditworthiness of the government-related issuer or, in the case
of mortgage-backed securities, by pools of assets.
U.S. government securities also include separately traded principal and
interest components of securities issued or guaranteed by the U.S. Treasury,
which are traded independently under the Separate Trading of Registered Interest
and Principal of Securities ("STRIPS") program. Under the STRIPS programs, the
principal and interest components are individually numbered and separately
issued by the U.S. Treasury.
Treasury inflation protected securities ("TIPS") are Treasury bonds on
which the principal value is adjusted daily in accordance with changes in the
Consumer Price Index. Interest on TIPS is payable semi-annually on the adjusted
principal value. The principal value of TIPS would decline during periods of
deflation, but the principal amount payable at maturity would not be less than
the original par amount. If inflation is lower than expected while a fund holds
TIPS, the fund may earn less on the TIPS than it would on conventional Treasury
bonds. Any increase in the principal value of TIPS is taxable in the year the
increase occurs, even though holders do not receive cash representing the
increase at that time.
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 sales
contracts, other installment sales 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 interests in pools of underlying mortgage loans that are secured by
real property. U.S. government mortgage-backed securities are issued or
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guaranteed as to the payment of principal and interest (but not as to market
value) by Ginnie Mae (also known as the Government National Mortgage
Association), Fannie Mae (also known as the Federal National Mortgage
Association), Freddie Mac (also known as the Federal Home Loan Mortgage
Corporation) or other government sponsored enterprises. Other domestic
mortgage-backed securities are sponsored or issued by private entities,
generally originators of and investors in mortgage loans, including savings
associations, mortgage bankers, commercial banks, investment bankers and special
purposes 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. Foreign mortgage-backed
securities may be issued by mortgage banks and other private or governmental
entities outside the United States and are supported by interests in foreign
real estate.
Mortgage-backed securities may be composed of one or more classes and may
be structured either as pass-through securities or collateralized debt
obligations. Multiple-class mortgage-backed securities are referred to herein as
"CMOs." Some CMOs are directly supported by other CMOs, which in turn are
supported by mortgage pools. Investors typically receive payments out of the
interest and principal on the underlying mortgages. The portions of these
payments that investors receive, as well as the priority of their rights to
receive payments, are determined by the specific terms of the CMO class. CMOs
involve special risk and evaluating them requires special knowledge.
A major difference between mortgage-backed securities and traditional
bonds is that interest and principal payments are made more frequently (usually
monthly) and that principal may be repaid at any time because the underlying
mortgage loans may be prepaid at any time. When interest rates go down and
homeowners refinance their mortgages, mortgage-backed securities may be paid off
more quickly than investors expect. When interest rates rise, mortgage-backed
securities may be paid off more slowly than originally expected. Changes in the
rate or "speed" of these prepayments can cause the value of mortgage-backed
securities to fluctuate rapidly.
Mortgage-backed securities also may decrease in value as a result of
increases in interest rates and, because of prepayments, may benefit less than
other bonds from declining interest rates. Reinvestments of prepayments may
occur at lower interest rates than the original investment, thus adversely
affecting an underlying fund's yield. Actual prepayment experience may cause the
yield of a mortgage-backed security to differ from what was assumed when the
underlying fund purchased the security. Prepayments at a slower rate than
expected may lengthen the effective life of a mortgage-backed security. The
value of securities with longer effective lives generally fluctuates more widely
in response to changes in interest rates than the value of securities with
shorter effective lives.
CMO classes may be specially structured in a manner that provides any of a
wide variety of investment characteristics, such as yield, effective maturity
and interest rate sensitivity. As market conditions change, however, and
particularly during periods of rapid or unanticipated changes in market interest
rates, the attractiveness of the CMO classes and the ability of the structure to
provide the anticipated investment characteristics may be significantly reduced.
These changes can result in volatility in the market value, and in some
instances reduced liquidity, of the CMO class.
Certain classes of CMOs and other mortgage-backed securities are
structured in a manner that makes them extremely sensitive to changes in
prepayment rates. Interest-only ("IO") and principal-only ("PO") classes are
examples of this. IOs are entitled to receive all or a portion of the interest,
but none (or only a nominal amount) of the principal payments, from the
underlying mortgage assets. If the mortgage assets underlying an IO experience
greater than anticipated principal prepayments, then the total amount of
interest payments allocable to the IO class, and therefore the yield to
investors, generally will be reduced. In some instances, an investor in an IO
may fail to recoup all of his or her initial investment, even if the security is
government issued or guaranteed or is rated AAA or the equivalent. Conversely,
PO classes are entitled to receive all or a portion of the principal payments,
but none of the interest, from the underlying mortgage assets. PO classes are
purchased at substantial discounts from par, and the yield to investors will be
reduced if principal payments are slower than expected. Some IOs and POs, as
well as other CMO classes, are structured to have special protections against
the effects of prepayments. These structural protections, however, normally are
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effective only within certain ranges of prepayment rates and thus will not
protect investors in all circumstances. Inverse floating rate CMO classes also
may be extremely volatile. These classes pay interest at a rate that decreases
when a specified index of market rates increases.
The market for privately issued mortgage-backed securities is smaller and
less liquid than the market for U.S. government mortgage-backed securities.
Foreign mortgage-backed securities markets are substantially smaller than U.S.
markets, but have been established in several countries, including Germany,
Denmark, Sweden, Canada and Australia, and may be developed elsewhere. Foreign
mortgage-backed securities generally are structured differently than domestic
mortgage-backed securities, but they normally present substantially similar
investment risks as well as the other risks normally associated with foreign
securities.
During 1994, the value and liquidity of many mortgage-backed securities
declined sharply due primarily to increases in interest rates. There can be no
assurance that such declines will not recur. The market value of certain
mortgage-backed securities, including IO and PO classes of mortgage-backed
securities, can be extremely volatile, and these securities may become illiquid.
Mitchell Hutchins or the applicable sub-adviser seeks to manage an underlying
fund's investments in mortgage-backed securities so that the volatility of its
portfolio, taken as a whole, is consistent with its investment objective.
Management of portfolio duration is an important part of this. However,
computing the duration of mortgage-backed securities is complex. See, "--
Duration." If Mitchell Hutchins or the sub-adviser does not compute the duration
of mortgage-backed securities correctly, the value of the underlying fund's
portfolio may be either more or less sensitive to changes in market interest
rates than intended. In addition, if market interest rates or other factors that
affect the volatility of securities held by an underlying fund change in ways
that Mitchell Hutchins or the sub-adviser does not anticipate, the underlying
fund's ability to meet its investment objective may be reduced.
More information concerning these mortgage-backed securities and the
related risks of investments therein is set forth below. New types of
mortgage-backed securities are developed and marketed from time to time and,
consistent with their investment limitations, the underlying funds expect to
invest in those new types of mortgage-backed securities that Mitchell Hutchins
or the applicable sub-adviser believe may assist the underlying funds in
achieving their investment objectives. Similarly, the underlying funds 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 certificateholders such as the underlying
funds. 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 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
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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 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." These credit enhancements do not protect investors from changes in
market value.
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 underlying funds to pay the debt service on the CMOs or to make
scheduled distributions on the multi-class mortgage pass-through securities.
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 semi-annual 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 interest-only ("IO") class, 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.
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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) loss protection. Loss protection
relates to 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. Loss protection 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. An underlying fund 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.
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 are 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
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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 an underlying fund's yield.
ADJUSTABLE RATE MORTGAGE AND FLOATING RATE MORTGAGE-BACKED SECURITIES --
Adjustable rate mortgage ("ARM") securities are mortgage-backed securities
(sometimes referred to as ARMs) 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. 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, ARMs generally do not increase in value as much as
fixed rate securities. ARMs represent a right to receive interest payments at a
rate that is adjusted to reflect the interest earned on a pool of adjustable
rate mortgage loans. These mortgage loans 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
adjustable rate mortgage loans specify limitations on the maximum amount by
which the mortgage interest rate may adjust for any single adjustment period.
These mortgage loans 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 adjustable rate mortgage loan. Borrowers
under these mortgage loans experiencing negative amortization may take longer to
build up their equity in the underlying property and may be more likely to
default.
Adjustable rate mortgage loans 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 these mortgage loans 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 adjustable
rate mortgage loans might decrease. The rate of prepayments with respect to
adjustable rate mortgage loans has fluctuated in recent years.
The rates of interest payable on certain adjustable rate mortgage loans,
and therefore on certain ARM 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 securities supported by adjustable rate
mortgage loans 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 securities still tend to be less
sensitive to interest rate fluctuations than fixed-rate securities.
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. As with ARM
securities, interest rate adjustments on floating rate mortgage-backed
securities may be based on indices that lag behind market interest rates.
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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 debt security on
a present value basis. Duration incorporates the debt security's yield, coupon
interest payments, final maturity and call features into one measure and is one
of the underlying fundamental tools used by Mitchell Hutchins or, where
applicable, a sub-adviser in portfolio selection and yield curve positioning an
underlying fund's investments in debt securities. Duration 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.
Duration takes the length of the time intervals between the present time
and the time that the interest and principal payments are scheduled or, in the
case of a callable debt security, expected to be made, and weights them by the
present values of the cash to be received at each future point in time. For any
debt security with interest payments occurring prior to the payment of
principal, duration is always less than maturity. For example, depending on 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.
Duration allows Mitchell Hutchins or a sub-adviser to make certain
predictions as to the effect that changes in the level of interest rates will
have on the value of an underlying fund's portfolio of debt securities. For
example, when the level of interest rates increases by 1%, a debt security
having a positive duration of three years generally will decrease by
approximately 3%. Thus, if Mitchell Hutchins or a sub-adviser calculates the
duration of an underlying fund's portfolio of bonds as three years, it normally
would expect the portfolio to change in value by approximately 3% for every 1%
change in the level of interest rates. However, various factors, such as changes
in anticipated prepayment rates, qualitative considerations and market supply
and demand, can cause particular securities to respond somewhat differently to
changes in interest rates than indicated in the above example. Moreover, in the
case of mortgage-backed and other complex securities, duration calculations are
estimates and are not precise. This is particularly true during periods of
market volatility. Accordingly, the net asset value of an underlying fund's
portfolio of bonds may vary in relation to interest rates by a greater or lesser
percentage than indicated by the above example.
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 will lengthen portfolio 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.
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
or a sub-adviser 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.
INVESTING IN FOREIGN SECURITIES. Investing in foreign securities involves
more risks than investing in the United States. The value of foreign securities
is subject to economic and political developments in the countries where the
companies operate and to changes in foreign currency values. Investments in
foreign securities involve risks relating to political, social and economic
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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 may include expropriation, confiscatory taxation, withholding taxes on
interest and/or dividends, limitations on the use of or transfer of 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. In those European countries that have begun using the Euro as a common
currency unit, individual national economies may be adversely affected by the
inability of national governments to use monetary policy to address their own
economic or political concerns.
Securities of many foreign companies may be less liquid and their prices
more volatile than securities of comparable 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 a fund 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. Additionally, the costs of investing
outside the United States are frequently higher than those in the United States.
These costs include relatively higher brokerage commissions and foreign custody
expenses.
Securities of foreign issuers may not be registered with the SEC, and the
issuers thereof may not 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. ADRs are receipts typically issued
by a U.S. bank or trust company evidencing ownership of the underlying
securities. They generally are in registered form, are denominated in U.S.
dollars and are designed for use in the U.S. securities markets. EDRs are
European receipts evidencing a similar arrangement, may be denominated in other
currencies and are designed for use in European securities markets. GDRs are
similar to EDRs and are designed for use in several international financial
markets. For purposes of each underlying fund's investment policies, depository
receipts generally are deemed to have the same classification as the underlying
securities they represent. Thus, a depository receipt representing ownership of
common stock will be treated as common stock.
ADRs are publicly traded on exchanges or over-the-counter in the United
States and are issued through "sponsored" or "unsponsored" arrangements. In a
sponsored ADR arrangement, the foreign issuer assumes the obligation to pay some
or all of the depository's transaction fees, whereas under an unsponsored
arrangement, the foreign issuer assumes no obligations and the depository's
transaction fees are paid directly by the ADR holders. In addition, less
information is available in the United States about an unsponsored ADR than
about a sponsored ADR.
The underlying funds that invest outside the United States 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. However, from time to
time, foreign securities may be difficult to liquidate rapidly without
significantly depressing the price of such securities. Although each underlying
fund will endeavor to achieve the best net results in effecting its portfolio
transactions, transactions on foreign exchanges are usually subject to fixed
commissions that are generally higher than negotiated commissions on U.S.
transactions. There is generally less government supervision and regulation of
exchanges and brokers in foreign countries than in the United States.
Foreign markets have different clearance and settlement procedures, and in
certain markets there have been times when settlements have failed to keep pace
with the volume of securities transactions, making it difficult to conduct such
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transactions. Delays in settlement could result in temporary periods when assets
of an underlying fund are uninvested and no return is earned thereon. The
inability of an underlying fund to make intended security purchases due to
settlement problems could cause the underlying 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.
Investment income and gains on certain foreign securities in which the
underlying funds may invest may be subject to foreign withholding or other taxes
that could reduce the return on these securities. Tax treaties between the
United States and certain foreign countries, however, may reduce or eliminate
the amount of foreign taxes to which the underlying funds would be subject. In
addition, substantial limitations may exist in certain countries with respect to
the underlying funds' ability to repatriate investment capital or the proceeds
of sales of securities.
FOREIGN CURRENCY RISKS. Currency risk is the risk that changes in foreign
exchange rates may reduce the U.S. dollar value of an underlying fund's foreign
investments. An underlying fund's share value may change significantly when its
investments are denominated in foreign currencies. Generally, currency exchange
rates are determined by supply and demand in the foreign exchange markets and
the relative merits of investments in different countries. Currency exchange
rates also can be affected by the intervention of the U.S. and foreign
governments or central banks, the imposition of currency controls, speculation,
devaluation or other political or economic developments inside and outside the
United States.
Each underlying fund values its assets daily in U.S. dollars and does not
intend to convert its holdings of foreign currencies to U.S. dollars on a daily
basis. From time to time an underlying fund's foreign currencies may 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, an underlying fund
could suffer a loss of some or all of the amounts deposited. Each underlying
fund may convert foreign currency to U.S. dollars from time to time.
The value of the assets of an underlying fund as measured in U.S. dollars
may be affected favorably or unfavorably by fluctuations in currency rates and
exchange control regulations. Further, an underlying fund may incur costs in
connection with conversions between various currencies. Currency exchange
dealers realize a profit based on the difference between the prices at which
they are buying and selling various currencies. Thus, a dealer normally will
offer to sell a foreign currency to an underlying fund at one rate, while
offering a lesser rate of exchange should an underlying fund desire immediately
to resell that currency to the dealer. Each underlying fund conducts its
currency exchange transactions either on a spot (I.E., cash) basis at the spot
rate prevailing in the foreign currency exchange market, or through entering
into forward, futures or options contracts to purchase or sell foreign
currencies.
SPECIAL CHARACTERISTICS OF EMERGING MARKET SECURITIES AND SOVEREIGN DEBT
EMERGING MARKET INVESTMENTS. The special risks of investing in foreign
securities are heightened when emerging markets are involved. For example, many
emerging market currencies recently have experienced significant devaluations
relative to the U.S. dollar. Emerging market countries typically have economic
and political systems that are less fully developed and can be expected to be
less stable than those of developed countries. Emerging market countries may
have policies that restrict investment by foreigners, and there is a higher risk
of government expropriation or nationalization of private property. The
possibility of low or nonexistent trading volume in the securities of companies
in emerging markets also may result in a lack of liquidity and in price
volatility. Issuers in emerging markets typically are subject to a greater
degree of change in earnings and business prospects than are companies in
developed markets.
INVESTMENT AND REPATRIATION RESTRICTIONS -- Foreign investment in the
securities markets of several emerging market countries is restricted or
controlled to varying degrees. These restrictions may limit an underlying fund's
investment in these countries and may increase its expenses. For example,
certain countries may require governmental approval prior to investments by
foreign persons in a particular company or industry sector or limit investment
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by foreign persons to only a specific class of securities of a company, which
may have less advantageous terms (including price) than securities of the
company available for purchase by nationals. Certain countries may restrict or
prohibit investment opportunities in issuers or industries deemed important to
national interests. In addition, the repatriation of both investment income and
capital from some emerging market countries is subject to restrictions, such as
the need for certain government consents. Even where there is no outright
restriction on repatriation of capital, the mechanics of repatriation may affect
certain aspects of an underlying fund's operations. These restrictions may in
the future make it undesirable to invest in the countries to which they apply.
In addition, if there is a deterioration in a country's balance of payments or
for other reasons, a country may impose restrictions on foreign capital
remittances abroad. An underlying fund could be adversely affected by delays in,
or a refusal to grant, any required governmental approval for repatriation, as
well as by the application to it of other restrictions on investments even if
that income and gain were distributed to its shareholders.
If, because of restrictions on repatriation or conversion, an underlying
fund were unable to distribute substantially all of its net investment income
and net short-term and long-term capital gains within applicable time periods,
the underlying fund would be subject to federal income and/or excise taxes that
would not otherwise be incurred and could cease to qualify for the favorable tax
treatment afforded to regulated investment companies under the Internal Revenue
Code. In that case, it would become subject to federal income tax on all of its
income and net gains.
SOCIAL, POLITICAL AND ECONOMIC FACTORS -- Many emerging market countries
may be subject to a greater degree of social, political and economic instability
than is the case in the United States. Any change in the leadership or policies
of these countries may halt the expansion of or reverse any liberalization of
foreign investment policies now occurring. Such instability may result from,
among other things, the following: (i) authoritarian governments or military
involvement in political and economic decision making, and changes in government
through extra-constitutional means; (ii) popular unrest associated with demands
for improved political, economic and social conditions; (iii) internal
insurgencies; (iv) hostile relations with neighboring countries; and (v) ethnic,
religious and racial disaffection. Such social, political and economic
instability could significantly disrupt the financial markets in those countries
and elsewhere and could adversely affect the value of an underlying fund's
assets. In addition, there may be the possibility of asset expropriations or
future confiscatory levels of taxation affecting an underlying fund.
The economies of many emerging markets are heavily dependent upon
international trade and are accordingly affected by protective trade barriers
and the economic conditions of their trading partners, principally the United
States, Japan, China and the European Community. The enactment by the United
States or other principal trading partners of protectionist trade legislation,
reduction of foreign investment in the local economies and general declines in
the international securities markets could have a significant adverse effect
upon the securities markets of these countries. In addition, the economies of
some countries are vulnerable to weakness in world prices for their commodity
exports, including crude oil.
FINANCIAL INFORMATION AND LEGAL STANDARDS -- Issuers in emerging market
countries generally are subject to accounting, auditing and financial standards
and requirements that differ, in some cases significantly, from those applicable
to U.S. issuers. In particular, the assets and profits appearing on the
financial statements of an emerging market issuer may not reflect its financial
position or results of operations in the way they would be reflected had the
financial statements been prepared in accordance with U.S. generally accepted
accounting principles. In addition, for an issuer that keeps accounting records
in local currency, inflation accounting rules may require, for both tax and
accounting purposes, that certain assets and liabilities be restated on the
issuer's balance sheet in order to express items in terms of currency of
constant purchasing power. Inflation accounting may indirectly generate losses
or profits. Consequently, financial data may be materially affected by
restatements for inflation and may not accurately reflect the real condition of
those issuers and securities markets.
In addition, existing laws and regulations are often inconsistently
applied. As legal systems in some of the emerging market countries develop,
foreign investors may be adversely affected by new laws and regulations, changes
to existing laws and regulations and preemption of local laws and regulations by
national laws. In circumstances where adequate laws exist, it may not be
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possible to obtain swift and equitable enforcement of the law.
FOREIGN SOVEREIGN DEBT. Sovereign debt includes bonds that are issued by
foreign governments or their agencies, instrumentalities or political
subdivisions or by foreign central banks. Sovereign debt also may be issued by
quasi-governmental entities that are owned by foreign governments but are not
backed by their full faith and credit or general taxing powers. Investment in
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. A country whose exports are concentrated in a
few commodities could be vulnerable to a decline in the international price of
such commodities. 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. Another
factor bearing on the ability of a country to repay sovereign debt is the level
of the country's international reserves. Fluctuations in the level of these
reserves can affect the amount of foreign exchange readily available for
external debt payments and, thus, could have a bearing on the capacity of the
country to make payments on its sovereign debt.
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 or the sub-adviser manages an
underlying fund's portfolio 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 the underlying funds to suffer a loss of interest or principal on
any of its sovereign debt holdings.
With respect to sovereign debt of emerging market issuers, investors
should be aware that certain emerging market countries are among the largest
debtors to commercial banks and foreign governments. Some emerging market
countries have from time to time declared moratoria on the payment of principal
and interest on external debt.
Some emerging market countries have experienced difficulty in servicing
their sovereign debt on a timely basis which led to defaults on certain
obligations and the restructuring of certain indebtedness. Restructuring
arrangements have included, among other things, reducing and rescheduling
interest and principal payments by negotiating new or amended credit agreements
or converting outstanding principal and unpaid interest to Brady Bonds
(discussed below), and obtaining new credit to finance interest payments.
Holders of sovereign debt, including the underlying funds, may be requested to
participate in the rescheduling of such debt and to extend further loans to
sovereign debtors. The interests of holders of sovereign debt could be adversely
affected in the course of restructuring arrangements or by certain other factors
referred to below. Furthermore, some of the participants in the secondary market
for sovereign debt may also be directly involved in negotiating the terms of
these arrangements and may, therefore, have access to information not available
to other market participants. Obligations arising from past restructuring
agreements may affect the economic performance and political and social
stability of certain issuers of sovereign debt. There is no bankruptcy
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proceeding by which sovereign debt on which a sovereign has defaulted may be
collected in whole or in part.
Foreign investment in certain sovereign debt is restricted or controlled
to varying degrees. These restrictions or controls may at times limit or
preclude foreign investment in such sovereign debt and increase the costs and
expenses of an underlying fund. Certain countries in which an underlying fund
may invest require governmental approval prior to investments by foreign
persons, limit the amount of investment by foreign persons in a particular
issuer, limit the investment by foreign persons only to a specific class of
securities of an issuer that may have less advantageous rights than the classes
available for purchase by domiciliaries of the countries or impose additional
taxes on foreign investors. Certain issuers may require governmental approval
for the repatriation of investment income, capital or the proceeds of sales of
securities by foreign investors. In addition, if a deterioration occurs in a
country's balance of payments the country could impose temporary restrictions on
foreign capital remittances. An underlying fund could be adversely affected by
delays in, or a refusal to grant, any required governmental approval for
repatriation of capital, as well as by the application to the underlying fund of
any restrictions on investments. Investing in local markets may require an
underlying fund to adopt special procedures, seek local government approvals or
take other actions, each of which may involve additional costs to the underlying
fund.
BRADY BONDS -- Brady Bonds are sovereign bonds 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 underlying 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.
Brady Bonds have been issued only in recent years, 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, an underlying fund will
purchase Brady Bonds in which the price and yield to the investor reflect market
conditions at the time of purchase.
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 until 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 that would have then been due on the Brady Bonds in the
normal course. Interest payments on Brady Bonds may be wholly uncollateralized
or 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
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countries issuing Brady Bonds, investments in Brady Bonds are to be viewed as
speculative. An underlying fund may purchase Brady Bonds with no or limited
collateralization, 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.
INVESTMENTS IN OTHER INVESTMENT COMPANIES. The underlying funds may invest
in securities of other investment companies, subject to Investment Company Act
limitations which at present restrict these investments in the aggregate to no
more than 10% of a fund's total assets. The shares of other investment companies
are subject to the management fees and other expenses of those underlying funds,
and the purchase of shares of some investment companies requires the payment of
sales loads and sometimes 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 expenses with respect to all its
investments, including the securities of other investment companies. Each
underlying fund may invest in the shares of other investment companies when, in
the judgment of Mitchell Hutchins or the applicable sub-adviser, the potential
benefits of such investment outweigh the payment of any management fees and
expenses and, where applicable, premium or sales load.
ZERO COUPON AND OTHER OID SECURITIES; PIK SECURITIES. Zero coupon
securities are securities on which no periodic interest payments are made but
instead are sold at a deep discount from their face value. The buyer of these
securities receives a return by the gradual appreciation of the security, which
results from the fact that it will be paid at face value on a specified maturity
date. There are many types of zero coupon securities. Some are issued in zero
coupon form, including Treasury bills, notes and bonds that have been stripped
of (separated from) their unmatured interest coupons (unmatured interest
payments) and receipts or certificates representing interests in such stripped
debt obligations and coupons. Others are created by brokerage firms that strip
the coupons from interest-paying bonds and sell the principal and the coupons
separately.
Other securities may be sold with original issue discount ("OID"), a term
that means the securities are issued at a price that is lower than their value
at maturity, even though interest on the securities may be paid prior to
maturity. In addition, payment-in-kind ("PIK") securities pay interest in
additional securities, not in cash. OID and PIK securities usually trade at a
discount from their face value.
Zero coupon securities are generally more sensitive to changes in interest
rates than debt obligations of comparable maturities that make current interest
payments. This means that when interest rates fall, the value of zero coupon
securities rises more rapidly than securities paying interest on a current
basis. However, when interest rates rise, their value falls more dramatically.
Other OID securities and PIK securities also are subject to greater fluctuations
in market value in response to changing interest rates than bonds of comparable
maturities that make current distributions of interest in cash.
Federal tax law requires that the holder of a zero coupon security or
other OID security include in gross income each year the OID that accrues on the
security for the year, even though the holder receives no interest payment on
the security during the year. Similarly, while PIK securities may pay interest
in the form of additional securities rather than cash, that interest must be
included in an underlying fund's current income. These distributions would have
to be made from the underlying fund's cash assets or, if necessary, from the
proceeds of sales of portfolio securities. An underlying fund would not be able
to purchase additional securities with cash used to make those distributions,
and its current income and the value of its shares would ultimately be reduced
as a result.
Certain zero coupon securities 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. This technique is frequently used by
private investment banking organizations with U.S. Treasury bonds to create CATS
(Certificate of Accrual Treasury Securities), TIGRs (Treasury Income Growth
Receipts) and similar securities. 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.
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LOAN PARTICIPATIONS AND ASSIGNMENTS. PaineWebber Investment Grade Income
Fund and PaineWebber High Income Fund may each 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, government or other entity
and one or more financial institutions ("Lenders"). These investments are
expected in most instances to be in the form of participations
("Participations") in Loans or assignments ("Assignments") of all or a portion
of Loans from third parties. Participations typically result in the 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 an underlying 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 both the borrower and the
Lender that is selling the Participation. In the event of the insolvency of the
selling Lender, the underlying fund may be treated as a general creditor of that
Lender and may not benefit from any set-off between the Lender and the borrower.
An underlying fund will acquire Participations only if Mitchell Hutchins or the
applicable sub-adviser determines that the selling Lender is creditworthy.
When an underlying fund purchases Assignments from Lenders, it acquires
direct rights against the borrower on the Loan. In an Assignment, the underlying
fund is entitled to receive payments directly from the borrower and, therefore,
does not depend on the selling bank to pass these payments onto the underlying
fund. However, because Assignments are arranged through private negotiations
between potential assignees and assignors, the rights and obligations acquired
by the 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
Securities Act of 1933, as amended ("Securities Act"), and thus may be subject
to an underlying fund's limitation on investment in illiquid securities. Because
there may be no liquid market for such securities, such securities may be sold
only to a limited number of institutional investors. The lack of a liquid
secondary market could 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 underlying fund's liquidity needs or
in response to a specific economic event, such as a deterioration in the
creditworthiness of the borrower.
ILLIQUID SECURITIES. The term "illiquid securities" for purposes of the
Prospectus and SAI 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 over-the-counter options, repurchase agreements maturing in more than
seven days and restricted securities other than those Mitchell Hutchins or the
applicable sub-adviser has determined are liquid pursuant to guidelines
established by the board. The assets used as cover for over-the-counter options
written by the underlying funds will be considered illiquid unless the
over-the-counter options are sold to qualified dealers who agree that the
underlying funds may repurchase any over-the-counter options they write at a
maximum price to be calculated by a formula set forth in the option agreements.
The cover for an over-the-counter 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 and principal only classes of mortgage-backed
securities generally are considered illiquid. However, interest only and
principal only 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 or the sub-adviser has determined that
they are liquid pursuant to guidelines established by the board. To the extent
an underlying fund invests in illiquid securities, it may not be able to readily
liquidate such investments and may have to sell other investments if necessary
to raise cash to meet its obligations. The lack of a liquid secondary market for
illiquid securities may make it more difficult for an underlying fund to assign
a value to those securities for purposes of valuing its portfolio and
calculating its net asset value.
Restricted securities are not registered under the Securities Act and may
be sold only in privately negotiated or other exempted transactions or after a
Securities Act registration statement has become effective. Where registration
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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 an underlying 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 held by a fund that may trade outside the United States are
freely tradeable in the country in which they are principally traded, they
generally are not considered illiquid, even if they are restricted in the United
States. A large institutional market has developed for many U.S. and foreign
securities that are not registered under the Securities 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 under the Securities Act, which establishes a "safe harbor"
from the registration requirements of that 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 affect adversely the marketability of such
portfolio securities, and the underlying fund might be unable to dispose of such
securities promptly or at favorable prices.
The board 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 bids 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 board.
REPURCHASE AGREEMENTS. Repurchase agreements are transactions in which an
underlying fund purchases securities or other obligations from a bank or
securities dealer (or its affiliate) and simultaneously commits to resell them
to the counterparty 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 obligations. An underlying fund maintains custody of the
underlying obligations prior to their repurchase, either through its regular
custodian or through a special "tri-party" custodian or sub-custodian that
maintains separate accounts for both the underlying fund and its counterparty.
Thus, the obligation of the counterparty to pay the repurchase price on the date
agreed to or upon demand is, in effect, secured by such obligations. Repurchase
agreements carry certain risks not associated with direct investments in
securities, including a possible decline in the market value of the underlying
obligations. If their value becomes less than the repurchase price, plus any
agreed-upon additional amount, the counterparty 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 obligations and the price
that was paid by an underlying fund upon acquisition is accrued as interest and
included in its net investment income. Repurchase agreements involving
obligations other than U.S. government securities (such as commercial paper and
corporate bonds) may be subject to special risks and may not have the benefit of
certain protections in the event of the counterparty's insolvency. If the seller
or guarantor becomes insolvent, the underlying fund may suffer delays, costs and
possible losses in connection with the disposition of collateral. Each
underlying fund intends to enter into repurchase agreements only with
counterparties in transactions believed by Mitchell Hutchins to present minimum
credit risks.
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REVERSE REPURCHASE AGREEMENTS. Reverse repurchase agreements involve the
sale of securities held by an underlying fund subject to its agreement to
repurchase the securities at an agreed-upon date or upon demand and at a price
reflecting a market rate of interest. Reverse repurchase agreements are subject
to each underlying fund's limitation on borrowings. While a reverse repurchase
agreement is outstanding, an underlying fund will maintain, in a segregated
account with its custodian, cash or liquid securities, marked to market daily,
in an amount at least equal to its obligations under the reverse repurchase
agreement.
Reverse repurchase agreements involve the risk that the buyer of the
securities sold by an underlying fund might be unable to deliver them when that
underlying fund seeks to repurchase. If the buyer of securities under a reverse
repurchase agreement files for bankruptcy or becomes insolvent, such buyer or
trustee or receiver may receive an extension of time to determine whether to
enforce that underlying fund's obligation to repurchase the securities, and the
underlying fund's use of the proceeds of the reverse repurchase agreement may
effectively be restricted pending such decision.
TEMPORARY AND DEFENSIVE INVESTMENTS; MONEY MARKET INVESTMENTS. Each
underlying fund may invest in money market investments for temporary or
defensive purposes or as part of its normal investment program. Such investments
include, among other things, (1) securities issued or guaranteed by the U.S.
government or one of its agencies or instrumentalities, (2) debt obligations of
banks, savings and loan institutions, insurance companies and mortgage bankers,
(3) commercial paper and notes, including those with variable and floating rates
of interest, (4) debt obligations of foreign branches of U.S. banks, U.S.
branches of foreign banks and foreign branches of foreign banks, (5) debt
obligations issued or guaranteed by one or more foreign governments or any of
their political subdivisions, agencies or instrumentalities, including
obligations of supranational entities, (6) bonds issued by foreign issuers, (7)
repurchase agreements and (8) other investment companies that invest exclusively
in money market instruments.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. Each underlying fund may
purchase securities on a "when-issued" basis or may purchase or sell securities
for delayed delivery, that is, for issuance or delivery to the underlying fund
later than the normal settlement date for such securities at a stated price and
yield. When issued securities include TBA ("to be announced") securities. TBA
securities, which are usually mortgage-backed securities, are purchased on a
forward commitment basis with an approximate principal amount and no defined
maturity date. The actual principal amount and maturity date are determined upon
settlement when the specific mortgage pools are assigned. An underlying fund
generally would not pay for such securities or start earning interest on them
until they are received. However, when an underlying fund undertakes a
when-issued or delayed-delivery obligation, it immediately assumes the risks of
ownership, including the risks of price fluctuation. Failure of the issuer to
deliver a security purchased by an underlying fund on a when-issued or
delayed-delivery basis may result in the underlying fund's incurring or missing
an opportunity to make an alternative investment. Depending on market
conditions, an underlying fund's when-issued and delayed-delivery purchase
commitments could cause its net asset value per share to be more volatile,
because such securities may increase the amount by which the underlying fund's
total assets, including the value of when-issued and delayed-delivery securities
held by that underlying fund, exceeds its net assets.
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 an underlying fund's net asset value. When an underlying fund
commits to purchase securities on a when-issued or delayed delivery basis, its
custodian segregates assets to cover the amount of the commitment. An underlying
fund 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 underlying fund.
LENDING OF PORTFOLIO SECURITIES. Each underlying fund is authorized to
lend its portfolio securities in an amount up to 33 1/3% of its total assets to
broker-dealers or institutional investors that Mitchell Hutchins deems
qualified. Lending securities enables an underlying fund to earn additional
income, but could result in a loss or delay in recovering these securities. The
borrower of an underlying fund's portfolio securities must maintain acceptable
collateral with that underlying fund's custodian in an amount, marked to market
daily, at least equal to the market value of the securities loaned, plus accrued
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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. Each underlying fund may reinvest
any cash collateral in money market investments or other short-term liquid
investments. 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 of its loans at any time. Each
underlying fund may pay reasonable fees in connection with a loan and may pay
the borrower or placing broker a negotiated portion of the interest earned on
the reinvestment of cash held as collateral. An underlying fund will receive
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 underlying fund's
interest.
Pursuant to procedures adopted by the board governing each underlying
fund's securities lending program, PaineWebber has been retained to serve as
lending agent for each underlying fund. The boards also have authorized the
payment of fees (including fees calculated as a percentage of invested cash
collateral) to PaineWebber for these services. Each board periodically reviews
all portfolio securities loan transactions for which PaineWebber acted as
lending agent. PaineWebber also has been approved as a borrower under each
underlying fund's securities lending program.
SHORT SALES "AGAINST THE BOX." Each underlying fund 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, in a segregated account
with its custodian, 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."
An underlying fund might make a short sale "against the box" 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 the underlying fund or a security convertible into or
exchangeable for a security owned by the underlying fund. In such case, any loss
in the 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 an 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.
SEGREGATED ACCOUNTS. When an underlying fund enters into certain
transactions that involve obligations to make future payments to third parties,
including the purchase of securities on a when-issued or delayed delivery basis
and reverse repurchase agreements, 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 underlying fund's obligation or commitment under
such transactions. As described below under "Strategies Using Derivative
Instruments," segregated accounts may also be required in connection with
certain transactions involving options, futures or forward currency contracts
and swaps.
UNDERLYING FUNDS--STRATEGIES
USING DERIVATIVE INSTRUMENTS
GENERAL DESCRIPTION OF DERIVATIVE INSTRUMENTS. Mitchell Hutchins or the
applicable sub-adviser may use a variety of financial instruments ("Derivative
Instruments"), including certain options, futures contracts (sometimes referred
to as "futures"), and options on futures contracts, to attempt to hedge each
underlying fund's portfolio and also to attempt to enhance income or return or
realize gains and (for underlying funds that invest in bonds) to manage the
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duration of its portfolio. For underlying funds that are permitted to invest
outside the United States, Mitchell Hutchins or the sub-adviser also may use
forward currency contracts, foreign currency options and futures and options on
foreign currency futures. Underlying funds that invest primarily in bonds also
may enter into interest rate swap transactions. 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, each underlying fund's use of these instruments will place at risk a
much smaller portion of its assets. PaineWebber Cashfund does not use these
Derivative Instruments. The particular Derivative Instruments used by the other
underlying funds are described below.
The underlying funds might not use any derivative instruments or
strategies, and there can be no assurance that using any strategy will succeed.
If Mitchell Hutchins or a sub-adviser is incorrect in its judgment on market
values, interest rates or other economic factors in using a derivative
instrument or strategy, an underlying fund may have lower net income and a net
loss on the investment.
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 or at specified
times or at the expiration of the option, depending on the type of option
involved. The writer of the call option, who receives 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 or at specified times or at the expiration of the option,
depending on the type of option involved. 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 bonds 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.
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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 USING DERIVATIVE INSTRUMENTS. 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 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 transactions costs. Alternatively, an underlying fund might
be able to offset the price increase by closing out an appreciated call option
and realizing a gain.
An underlying fund may purchase and write (sell) straddles on securities
or indices of securities. A long straddle is a combination of a call and a put
option purchased on the same security or on the same futures contract, where the
exercise price of the put is equal to the exercise price of the call. An
underlying fund might enter into a long straddle when Mitchell Hutchins or a
sub-adviser believes it likely that the prices of the securities will be more
volatile during the term of the option than the option pricing implies. A short
straddle is a combination of a call and a put written on the same security where
the exercise price of the put is equal to the exercise price of the call. An
underlying fund might enter into a short straddle when Mitchell Hutchins or a
sub-adviser believes it unlikely that the prices of the securities will be as
volatile during the term of the option as the option pricing implies.
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 bonds may be used to hedge either
individual securities or broad fixed income market sectors.
Income strategies using Derivative Instruments may include the writing of
covered options to obtain the related option premiums. Return or gain strategies
may include using Derivative Instruments to increase or decrease an underlying
fund's exposure to different asset classes without buying or selling the
underlying instruments. An underlying fund also may use derivatives to simulate
full investment by the underlying fund while maintaining a cash balance for
underlying fund management purposes (such as to provide liquidity to meet
anticipated shareholder sales of underlying fund shares and for underlying fund
operating expenses).
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 may be limited by tax
considerations. See "Taxes."
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In addition to the products, strategies and risks described below and in
the Prospectus, Mitchell Hutchins and the sub-advisers may discover additional
opportunities in connection with Derivative Instruments and with hedging,
income, return and gain strategies. These new opportunities may become available
as regulatory authorities broaden the range of permitted transactions and as new
Derivative Instruments and techniques are developed. Mitchell Hutchins or the
applicable sub-adviser may utilize these opportunities for an underlying fund to
the extent that they are consistent with the underlying fund's investment
objective and permitted by its investment limitations and applicable regulatory
authorities. The underlying funds' Prospectus or SAI will be supplemented to the
extent that new products or techniques involve materially different risks than
those described below or in the Prospectus.
SPECIAL RISKS OF STRATEGIES USING DERIVATIVE INSTRUMENTS. The use of
Derivative Instruments 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 the applicable sub-adviser to predict movements of the
overall securities, interest rate or currency exchange 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 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 that are 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 affecting the markets in which Derivative
Instruments are traded, rather than the value of the investments being hedged.
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 of the Derivative
Instrument. Moreover, if the price of the Derivative Instrument declined by more
than the increase in the price of the security, the 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
underlying 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
counterparty to enter into a transaction closing out the position. Therefore,
there is no assurance that any hedging 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, currencies or other options or futures contracts or (2)
cash or liquid securities, with a value sufficient at all times to cover its
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potential obligations to the extent not covered as provided in (1) above. Each
underlying fund will comply with SEC guidelines regarding cover for such
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, committing a large portion of an
underlying fund's assets to cover positions or to segregated accounts could
impede portfolio management or the underlying fund's ability to meet redemption
requests or other current obligations.
OPTIONS. The underlying funds may purchase put and call options, and write
(sell) covered put or call options on securities in which they invest and
related indices. Underlying funds that may invest outside the United States also
may purchase put and call options and write covered options on foreign
currencies. The purchase of call options may serve as a long hedge, and the
purchase of put options may serve as a short hedge. In addition, an underlying
fund may also use options to attempt to enhance return or realize gains by
increasing or reducing its exposure to an asset class without purchasing or
selling the underlying securities. Writing covered put or call options can
enable an underlying fund to enhance income by reason of the premiums paid by
the purchasers of such options. 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 over-the-counter options written by
an underlying fund would 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. Generally, over-the-counter options on bonds are
European-style options. This means that the option can only be exercised
immediately prior to its expiration. This is in contrast to American-style
options that may be exercised at any time. There are also other types of options
that may be exercised on certain specified dates before expiration.
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.
The underlying funds may purchase and write both exchange-traded and
over-the-counter options. Currently, many options on equity securities are
exchange-traded. Exchange markets for options on bonds and foreign currencies
exist but are relatively new, and these instruments are primarily traded on the
over-the-counter 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, over-the-counter options are contracts between an
underlying fund and its counterparty (usually a securities dealer or a bank)
with no clearing organization guarantee. Thus, when an underlying fund purchases
or writes an over-the-counter option, it relies on the counterparty to make or
take delivery of the underlying investment upon exercise of the option. Failure
by the counterparty 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.
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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 over-the-counter options only by negotiating
directly with the counterparty, or by a transaction in the secondary market if
any such market exists. Although the underlying funds will enter into
over-the-counter options only with counterparties 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
over-the-counter option position at a favorable price prior to expiration. In
the event of insolvency of the counterparty, an underlying fund might be unable
to close out an over-the-counter 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 underlying fund would be unable to sell the investment used as cover
for the written option until the option expires or is exercised.
An underlying fund may purchase and write put and call options on indices
in much the same manner as the more traditional options discussed above, except
the index options may serve as a hedge against overall fluctuations in a
securities market (or market sector) rather than anticipated increases or
decreases in the value of a particular security.
LIMITATIONS ON THE USE OF OPTIONS. The underlying funds' use of options is
governed by the following guidelines, which can be changed by the board without
shareholder vote:
(1) An underlying fund may purchase a put or call option, including any
straddle or spread, 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 its net assets.
(3) The aggregate premiums paid on all options (including options on
securities, foreign currencies and securities indices and options on futures
contracts) purchased by an underlying fund that are held at any time will not
exceed 20% of its net assets.
FUTURES. The underlying funds may purchase and sell securities index
futures contracts, interest rate futures contracts, debt security index futures
contracts and (for those underlying funds that invest outside the United States)
foreign currency futures contracts. 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. In addition, an
underlying fund may purchase or sell futures contracts or purchase options
thereon to increase or reduce its exposure to an asset class without purchasing
or selling the underlying securities, either as a hedge or to enhance return or
realize gains.
Futures strategies also can be used to manage the average duration of an
underlying fund's portfolio. If Mitchell Hutchins or the applicable sub-adviser
wishes to shorten the average duration of an underlying fund's portfolio, the
underlying fund may sell a futures contract or a call option thereon, or
purchase a put option on that futures contract. If Mitchell Hutchins or the
sub-adviser wishes to lengthen the average duration of the underlying fund's
portfolio, the underlying fund may buy a futures contract or a call option
thereon, or sell a put option thereon.
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An underlying fund may also write put options on futures contracts while
at the same time purchasing call options on the same futures contracts in order
synthetically to create a long futures contract position. Such options would
have the same strike prices and expiration dates. An underlying fund will engage
in this strategy only when it is more advantageous to it than purchasing the
futures contract.
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 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
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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.
LIMITATIONS ON THE USE OF FUTURES AND RELATED OPTIONS. The underlying
funds' use of futures and related options is governed by the following
guidelines, which can be changed by the board 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 its net assets.
(2) The aggregate premiums paid on all options (including options on
securities, foreign currencies and securities indices and options on futures
contracts) purchased by each underlying fund that are held at any time will not
exceed 20% of its net assets.
(3) The aggregate margin deposits on all futures contracts and options
thereon held at any time by each underlying fund will not exceed 5% of its total
assets.
FOREIGN CURRENCY HEDGING STRATEGIES--SPECIAL CONSIDERATIONS. Each
underlying fund that may invest outside the United States 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 the underlying fund's 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.
An underlying fund 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 considered expensive. In such
cases, the underlying fund 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. In addition, an underlying fund may use forward currency
contracts to shift 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 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.
30
<PAGE>
Settlement of Derivative Instruments 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. Underlying funds that may invest outside the
United States may enter into forward currency contracts to purchase or sell
foreign currencies for a fixed amount of 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.
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 counterparty to make or take delivery of the underlying
currency at the maturity of the contract. Failure by the counterparty to do so
would result in the loss of any expected benefit of the transaction.
As is the case with futures contracts, parties to forward currency
contracts can enter into offsetting closing transactions, similar to closing
transactions on futures, by entering into an instrument identical to the
instrument purchased or sold, but in the opposite direction. 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 counterparty. 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 counterparty, 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
that may invest outside the United States 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.
SWAP TRANSACTIONS. An underlying fund may enter into swap transactions,
which include swaps, caps, floors and collars relating to interest rates,
currencies, securities or other instruments. Interest rate swaps 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
31
<PAGE>
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. Currency swaps, caps, floors and collars are similar to
interest rate swaps, caps, floors and collars, but they are based on currency
exchange rates rather than interest rates. Equity swaps or other swaps relating
to securities or other instruments are also similar, but they are based on
changes in the value of the underlying securities or instruments. For example,
an equity swap might involve an exchange of the value of a particular security
or securities index in a certain notional amount for the value of another
security or index or for the value of interest on that notional amount at a
specified fixed or variable rate.
An underlying fund may enter into interest rate swap transactions to
preserve a return or spread on a particular investment or portion of its bond
portfolio or to protect against any increase in the price of securities it
anticipates purchasing at a later date. An underlying fund may use interest rate
swaps, caps, floors and collars as a hedge on either an asset-based or
liability-based basis, depending on whether it is hedging its assets or its
liabilities. Interest rate swap transactions are subject to risks comparable to
those described above with respect to other derivatives strategies.
An underlying fund will usually enter into swaps on a net basis, I.E., the
two payment streams are netted out, with the fund receiving or paying, as the
case may be, only the net amount of the two payments. Since segregated accounts
will be established with respect to such transactions, Mitchell Hutchins
believes such obligations do not constitute senior securities and, accordingly,
will not treat them as being subject to an underlying fund's borrowing
restrictions. The net amount of the excess, if any, of the underlying fund's
obligations over its entitlements with respect to each swap will be accrued on a
daily basis, and appropriate 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 swaps that are not entered into
on a net basis.
An underlying fund will enter into interest rate swap transactions only
with banks and recognized securities dealers or their respective affiliates
believed by Mitchell Hutchins to present minimal credit risk in accordance with
guidelines established by the fund's board. If there is a default by the other
party to such a transaction, the 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.
32
<PAGE>
ORGANIZATION; TRUSTEES, OFFICERS
AND PRINCIPAL HOLDERS OF SECURITIES
The Trust was formed on August 9, 1996, as a business trust under the laws
of Delaware and has three operating series. The Trust is governed by a board of
trustees, which is authorized to establish additional series and to issue an
unlimited number of shares of beneficial interest of each existing or future
series, par value $0.001 per share. The board oversees each fund's operations.
The trustees and executive officers of the Trust, their ages, business
addresses and principal occupations during the past five years are:
<TABLE>
<CAPTION>
<S> <C> <C>
NAME AND ADDRESS; AGE POSITION WITH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ------------------- ----------------------------------------
Margo N. Alexander*+; 52 Trustee and President Mrs. Alexander is chairman (since March 1999),
chief executive officer and a director of
Mitchell Hutchins (since January 1995), and an
executive vice president and a director of
PaineWebber (since March 1984). Mrs. Alexander
is president and a director or trustee of 32
investment companies for which Mitchell
Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
Richard Q. Armstrong; 64 Trustee Mr. Armstrong is chairman and principal of
R.Q.A. Enterprises R.Q.A. Enterprises (management consulting firm)
One Old Church Road (since April 1991 and principal occupation since
Unit #6 March 1995). Mr. Armstrong was chairman of
Greenwich, CT 06830 the board, chief executive officer and co-owner
of Adirondack Beverages (producer and
distributor of soft drinks and sparkling/still
waters) (October 1993-March 1995). He was a
partner of The New England Consulting Group
(management consulting firm) (December
1992-September 1993). He was managing director
of LVMH U.S. Corporation (U.S. subsidiary of the
French luxury goods conglomerate, 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 31
investment companies for which Mitchell
Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
E. Garrett Bewkes, Jr.**+; 73 Trustee and Mr. Bewkes is a director of Paine Webber
Chairman of the Group Inc. ("PW Group") (holding company of
Board of Trustees 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 Interstate Bakeries Corporation. Mr.
Bewkes is a director or trustee of 35 investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates serves as
investment adviser.
33
<PAGE>
<S> <C> <C>
NAME AND ADDRESS; AGE POSITION WITH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ------------------- ----------------------------------------
Richard R. Burt; 52 Trustee Mr. Burt is chairman of IEP Advisors, Inc.
1275 Pennsylvania (international investments and consulting
Ave, N.W. firm) (since March 1994) and a partner of
Washington, DC 20004 McKinsey & Company (management consulting firm)
(since 1991). He is also a director of
Archer-Daniels-Midland Co. (agricultural
commodities), Hollinger International Co.
(publishing), Homestake Mining Corp. (gold
mining), Powerhouse Technologies Inc. (provides
technology to gaming and wagering industry) and
Weirton Steel Corp. (makes and finishes steel
products). He was the chief negotiator in the
Strategic Arms Reduction Talks with the former
Soviet Union (1989-1991) and the U.S. Ambassador
to the Federal Republic of Germany (1985-1989).
Mr. Burt is a director or trustee of 31
investment companies for which Mitchell
Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
Mary C. Farrell**+; 49 Trustee Ms. Farrell is a managing director, 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 Economic 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 23 investment companies for which
Mitchell Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Meyer Feldberg; 57 Trustee Mr. Feldberg is Dean and Professor of
Columbia University Management of the Graduate School of Business,
101 Uris Hall Columbia University. Prior to 1989, he was
New York, NY 10027 president of the Illinois Institute of
Technology. Dean Feldberg is also a director of
Primedia, Inc. (publishing), Federated
Department Stores, Inc. (operator of department
stores) and Revlon, Inc. (cosmetics). Dean
Feldberg is a director or trustee of 34
investment companies for which Mitchell
Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
George W. Gowen; 70 Trustee Mr. Gowen is a partner in the law firm of
666 Third Avenue Dunnington, Bartholow & Miller. Prior to
New York, NY 10017 May 1994, he was a partner in the law firm of
Fryer, Ross & Gowen. Mr. Gowen is a director or
trustee of 34 investment companies for which
Mitchell Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
34
<PAGE>
<S> <C> <C>
NAME AND ADDRESS; AGE POSITION WITH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ------------------- ----------------------------------------
Frederic V. Malek; 62 Trustee Mr. Malek is chairman of Thayer Capital Partners
1455 Pennsylvania (merchant bank). From January 1992 to
Ave, N.W. November 1992, he was campaign manager of
Suite 350 Bush-Quayle `92. From 1990 to 1992, he was vice
Washington, DC 20004 chairman and, from 1989 to 1990, he was
president of Northwest Airlines Inc. and NWA
Inc. (holding company of Northwest Airlines
Inc.). Prior to 1989, he was employed by the
Marriott Corporation (hotels, restaurants,
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 Aegis
Communications, Inc. (tele-services), American
Management Systems, Inc. (management consulting
and computer related services), Automatic Data
Processing, Inc. (computing services), CB
Richard Ellis, Inc. (real estate services), FPL
Group, Inc. (electric services), Global Vacation
Group (packaged vacations), HCR/Manor Care, Inc.
(health care) and Northwest Airlines Inc. Mr.
Malek is a director or trustee of 31 investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates serves as
investment adviser.
Carl W. Schafer; 63 Trustee Mr. Schafer is president of the Atlantic
66 Witherspoon Foundation (charitable foundation supporting
Street, #1100 mainly oceanographic exploration and research).
Princeton, NJ 08542 He is a director of Base Ten Systems, Inc.
(software), Roadway Express, Inc. (trucking),
The Guardian Group of Mutual Funds, the Harding,
Loevner Funds, Evans Systems, Inc. (motor fuels,
convenience store and diversified company),
Electronic Clearing House, Inc., (financial
transactions processing), Frontier Oil
Corporation and Nutraceutix, Inc. (biotechnology
company). Prior to January 1993, he was chairman
of the Investment Advisory Committee of the
Howard Hughes Medical Institute. Mr. Schafer is
a director or trustee of 31 investment companies
for which Mitchell Hutchins, PaineWebber or one
of their affiliates serves as investment
adviser.
Brian M. Storms*+; 45 Trustee Mr. Storms is president and chief operating
officer of Mitchell Hutchins (since March 1999).
Prior to March 1999, he was president of
Prudential Investments (1996-1999). Prior to
joining Prudential, he was a managing director
at Fidelity Investments. Mr. Storms is a
director or trustee of 31 investment companies
for which Mitchell Hutchins, PaineWebber or one
of their affiliates serves as investment
adviser.
35
<PAGE>
<S> <C> <C>
NAME AND ADDRESS; AGE POSITION WITH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ------------------- ----------------------------------------
T. Kirkham Barneby*; 53 Vice President Mr. Barneby is a managing director and chief
investment officer--quantitative investments of
Mitchell Hutchins. Prior to September 1994, he
was a senior vice president at Vantage Global
Management. Mr. Barneby is a vice president of
seven investment companies for which Mitchell
Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
John J. Lee**; 31 Vice President and Mr. Lee is a vice president and a manager of the
Assistant Treasurer mutual fundfinance department of Mitchell
Treasurer Hutchins. Prior to September 1997, he
was an audit manager in the financial services
practice of Ernst & Young LLP. Mr. Lee is a vice
president and assistant treasurer of 32
investment companies for which Mitchell
Hutchins, PaineWebber or one of their affiliates
serves as an investment adviser.
Kevin J. Mahoney**; 34 Vice President and Mr. Mahoney is a first vice president and a
Assistant Treasurer senior manager of the mutual fund finance
department of Mitchell Hutchins. From August
1996 through March 1999, he was the manager of
the mutual fund internal control group of
Salomon Smith Barney. Prior to August 1996, he
was an associate and assistant treasurer for
BlackRock Financial Management L.P. Mr. Mahoney
is a vice president and assistant treasurer of
32 investment companies for which Mitchell
Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
Dennis McCauley*; 52 Vice President Mr. McCauley is a managing director and chief
investment officer--fixed income of Mitchell
Hutchins. Prior to December 1994, he was
director of fixed income investments of IBM
Corporation. Mr. McCauley is a vice president of
22 investment companies for which Mitchell
Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
Ann E. Moran**; 42 Vice President and Ms. Moran is a vice president and a manager of
Assistant Treasurer the mutual fund finance department of Mitchell
Hutchins. Ms. Moran is a vice president and
assistant treasurer of 32 investment companies
for which Mitchell Hutchins, PaineWebber or one
of their affiliates serves as investment
adviser.
Dianne E. O'Donnell **; 47 Vice President and Ms. O'Donnell is a senior vice president and
Secretary deputy general and Secretary counsel of Mitchell
Hutchins. Ms. O'Donnell is a vice president and
secretary of 31 investment companies and a vice
president and assistant secretary of one
investment company for which Mitchell Hutchins,
PaineWebber or one of their affiliates serves as
investment adviser.
Emil Polito*; 38 Vice President Mr. Polito is a senior vice president and
director of operations and control for Mitchell
Hutchins. Mr. Polito is a vice president of 32
investment companies for which Mitchell
Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
36
<PAGE>
<S> <C> <C>
NAME AND ADDRESS; AGE POSITION WITH TRUST BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ------------------- ----------------------------------------
Victoria E. Schonfeld**; 48 Vice President Ms. Schonfeld is a managing director and general
counsel of Mitchell Hutchins since May 1994 and
a senior vice president of PaineWebber since
July 1995. Ms. Schonfeld is a vice president of
31 investment companies and a vice president and
secretary of one investment company for which
Mitchell Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Paul H. Schubert**; 36 Vice President Mr. Schubert is a senior vice president of the
Treasurer mutual fund finance department of Mitchell
Hutchins. Mr. Schubert is a vice president and
treasurer of 32 investment companies for which
Mitchell Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Barney A. Taglialatela**; 38 Vice President and Mr. Taglialatela is a vice president and a
Assistant Treasurer manager of the mutual fund finance department of
Mitchell Hutchins. Prior to February 1995, he
was a manager of the mutual fund finance
division of Kidder Peabody Asset Management,
Inc. Mr. Taglialatela is a vice president and
assistant treasurer of 32 investment companies
for which Mitchell Hutchins, PaineWebber or one
of their affiliates serves as investment
adviser.
Mark A. Tincher*; 43 Vice President Mr. Tincher is a managing director and chief
investment officer--equities of Mitchell
Hutchins. Prior to March 1995, he was a vice
president and directed the U.S. funds management
and equity research areas of Chase Manhattan
Private Bank. Mr. Tincher is a vice president of
13 investment companies for which Mitchell
Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
Keith A. Weller**; 38 Vice President and Mr. Weller is a first vice president and
Assistant Secretary 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 31 investment companies
for which Mitchell Hutchins, PaineWebber or one
of their affiliates serves as investment
adviser.
- -------------
* The business address of each listed person is 51 West 52nd Street, New York, New York
10019-6114.
** The business address of each listed person is 1285 Avenue of the Americas, New York, New York
10019.
+ Mrs. Alexander, Mr. Bewkes, Ms. Farrell and Mr. Storms are "interested persons" of the Trust
and each fund as defined in the Investment Company Act by virtue of their positions with
Mitchell Hutchins, PaineWebber, and/or PW Group.
</TABLE>
The Trust pays trustees who are not "interested persons" of the Trust
$1,000 annually for each fund and $150 per fund 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
37
<PAGE>
fund. Because PaineWebber and Mitchell Hutchins perform substantially all the
services necessary for the operation of the Trust and each fund, 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.
The table below includes certain information related to the compensation
of the current trustees who held office with the Trust during the fiscal year
ended May 31, 1999, and the total compensation of those trustees from all
PaineWebber funds during the 1998 calendar year.
<TABLE>
<CAPTION>
COMPENSATION TABLE+
TOTAL COMPENSATION FROM
AGGREGATE COMPENSATION THE TRUST AND THE FUND
NAME OF PERSON, POSITION FROM THE TRUST* COMPLEX**
------------------------ --------------- ---------
<S> <C> <C> <C>
Richard Q. Armstrong,
Trustee..................... $ 5,430 $ 101,372
Richard R. Burt,
Trustee..................... 5,340 101,372
Meyer Feldberg,
Trustee..................... 7,409 116,222
George W. Gowen,
Trustee..................... 4,980 108,272
Frederic V. Malek,
Trustee..................... 5,430 101,372
Carl W. Schafer,
Trustee..................... 5,430 101,372
</TABLE>
- --------------------
+ Only independent board members are compensated by the PaineWebber funds and
identified above; board members who are "interested persons," as defined by
the Investment Company Act, do not receive compensation from the funds.
* Represents fees paid to each trustee from the Trust for the year ended May
31, 1999.
** Represents total compensation paid during the calendar year ended December
31, 1998 to each board member by 31 investment companies (33 in the case of
Messrs. Feldberg and Gowen) for which Mitchell Hutchins, PaineWebber or one of
their affiliates served as investment adviser. No fund within the PaineWebber
fund complex has a bonus, pension, profit sharing or retirement plan.
38
<PAGE>
PRINCIPAL HOLDERS OF SECURITIES
The following shareholders are shown in the Trust's records as owning more
than 5% of a class of Conservative Portfolio's shares:
NUMBER AND PERCENTAGE OF
FUND AND SHAREHOLDER SHARES BENEFICIALLY OWNED AS OF
NAME AND ADDRESS* AUGUST 31, 1999
- ----------------- ---------------
CONSERVATIVE PORTFOLIO
PaineWebber FBO 24,468
Wilfred Robinson Class B shares 7.10%
Richard J. Agostini 20,135
Class B shares 5.84%
----------------------
* The shareholders listed may be contacted c/o Mitchell Hutchins Asset
Management, Inc., 51 West 52nd Street, New York, NY 10019-6114.
INVESTMENT ADVISORY AND DISTRIBUTION ARRANGEMENTS
INVESTMENT ADVISORY ARRANGEMENTS. Mitchell Hutchins acts as the investment
adviser and administrator to each fund pursuant to a contract ("Advisory
Contract") with the Trust dated January 9, 1998. Under the Advisory Contract,
each fund pays Mitchell Hutchins a fee, computed daily and paid monthly, at the
annual rate of 0.35% of its average daily net assets.
During the fiscal year ended May 31, 1999 and the period February 24, 1998
(commencement of operations) to May 31, 1998, Mitchell Hutchins earned (or
accrued) advisory fees in the following amounts:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED FISCAL PERIOD ENDED
MAY 31, 1999 MAY 31, 1998*
------------ -------------
<S> <C> <C>
Aggressive $ 20,903 $ 2,560
Portfolio.................. (all of which was waived) (all of which was waived)
39,597 4,531
Moderate Portfolio......... (all of which was waived) (all of which was waived)
13,968 1,408
Conservative Portfolio..... (all of which was waived) (all of which was waived)
----------------------
* February 24, 1998 (commencement of operations) to May 31, 1998.
</TABLE>
Under the terms of the Advisory Contract, each fund bears all of its
expenses incurred in its operation that are not specifically assumed by Mitchell
Hutchins. General expenses of the Trust not readily identifiable as belonging to
a particular fund are allocated among the appropriate funds by or under the
direction of the board in such manner as the board deems fair and equitable.
Expenses borne by each fund include the following: (1) the cost (including
brokerage commissions) of securities purchased or sold by the fund and any
losses incurred in connection therewith; (2) fees payable to and expenses
incurred on behalf of the funds by Mitchell Hutchins; (3) organizational
expenses; (4) filing fees and expenses relating to the registration and
qualification of the fund'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 Investment Company 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
39
<PAGE>
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 fund 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 fund; (15) fees,
voluntary assessments and 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 fund 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 with respect to a fund at any
time without penalty by the Trust's board or by vote of the holders of a
majority of the fund's outstanding voting securities on 60 days' written notice
to Mitchell Hutchins, or by Mitchell Hutchins on 60 days' written notice to the
fund.
NET ASSETS. The following table shows the approximate net assets as of
August 31, 1999, 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.
INVESTMENT CATEGORY NET ASSETS
- ------------------- $ MIL
-----
Domestic (excluding Money Market).................... $ 7,939.9
Global............................................... 4,537.1
Equity/Balanced...................................... 7,677.7
Fixed Income (excluding Money Market)................ 4,799.3
Taxable Fixed Income............................... 3,290.8
Tax-Free Fixed Income.............................. 1,508.5
Money Market Funds................................... 35,356.5
PERSONAL 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 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 funds and other Mitchell
Hutchins advisory clients.
DISTRIBUTION ARRANGEMENTS. Mitchell Hutchins acts as the distributor of
each class of shares of each fund 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 fund. Shares of each fund are offered continuously. Under separate
exclusive dealer agreements between Mitchell Hutchins and PaineWebber relating
to each class of shares of each fund (collectively, "Exclusive Dealer
Agreements"), Paine Webber and its correspondent firms sell the funds' 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 Investment Company Act (each, respectively, a "Class A Plan,"
"Class B Plan" and "Class C Plan" and, collectively, "Plans"), each fund 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 fund. Under the Class B Plan and Class C Plan, each fund pays
Mitchell Hutchins a distribution fee, accrued daily and payable monthly, at the
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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 funds 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 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 fund 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 fund 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
fund'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 fund's
shares will not be used to subsidize the sale of any other class of that fund's
shares.
The funds paid (or accrued) the following service and/or distribution fees
to Mitchell Hutchins under the Class A, Class B and Class C Plans during the
fiscal year ended May 31, 1999:
AGGRESSIVE MODERATE CONSERVATIVE
PORTFOLIO PORTFOLIO PORTFOLIO
--------- --------- ---------
Class A.................... $ 4,478 $ 4,816 $ 1,619
Class B.................... 19,521 53,778 26,620
Class C.................... 22,195 39,979 5,079
Mitchell Hutchins estimates that it and its parent corporation,
PaineWebber, incurred the following shareholder service-related and
distribution-related expenses with respect to the funds during the fiscal year
ended May 31, 1999:
<TABLE>
<CAPTION>
AGGRESSIVE MODERATE CONSERVATIVE
PORTFOLIO PORTFOLIO PORTFOLIO
--------- --------- ---------
<S> <C> <C> <C> <C>
CLASS A
-------
Marketing and advertising................................ $ 27,625 $ 17,601 $ 14,620
Amortization of commissions.............................. 0 0 0
Printing of prospectuses and SAIs........................ 165 173 60
Branch network costs allocated and interest expense...... 22,815 13,341 11,594
Service fees paid to PaineWebber Financial Advisors...... 1,713 1,844 620
AGGRESSIVE MODERATE CONSERVATIVE
PORTFOLIO PORTFOLIO PORTFOLIO
--------- --------- ---------
CLASS B
-------
Marketing and advertising................................ $ 31,007 $ 49,345 $ 59,450
Amortization of commissions.............................. 6,788 19,082 9,413
Printing of prospectuses and SAIs........................ 187 479 252
Branch network costs allocated and interest expense...... 23,774 39,945 50,374
Service fees paid to PaineWebber Financial Advisors...... 1,868 5,152 2,548
41
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AGGRESSIVE MODERATE CONSERVATIVE
PORTFOLIO PORTFOLIO PORTFOLIO
--------- --------- ---------
CLASS C
-------
Marketing and advertising................................ $ 35,424 $ 37,410 $ 15,182
Amortization of commissions.............................. 6,373 11,494 1,297
Printing of prospectuses and SAIs........................ 216 367 64
Branch network costs allocated and interest expense...... 26,917 26,665 12,376
Service fees paid to PaineWebber Financial Advisors...... 2,123 3,832 648
</TABLE>
"Marketing and advertising" includes various internal costs allocated by
Mitchell Hutchins to its efforts at distributing fund shares. These internal
costs encompass office rent, salaries and other overhead expenses of various
departments and areas of operations of Mitchell Hutchins. "Branch network costs
allocated and interest expense" consist of an allocated portion of the expenses
of various PaineWebber departments involved in the distribution of each fund's
shares, including the PaineWebber retail branch system.
In approving the funds' overall Flexible PricingSM system of distribution,
the board considered several factors, including that implementation of Flexible
PricingSM 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 fund and attracting new investors and
assets to the fund to the benefit of the fund and its shareholders, (2)
facilitate distribution of the funds' shares and (3) maintain the competitive
position of the funds in relation to other funds that have implemented or are
seeking to implement similar distribution arrangements.
In approving the Class A Plan for each fund, 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 Financial Advisors and correspondent
firms, resulting in greater growth of the fund than might otherwise be the case,
(3) the advantages to the shareholders of economies of scale resulting from
growth in the fund's assets and potential continued growth, (4) the services
provided to the fund 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 fund, 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 fund purchase payments and instead having the entire amount of
their purchase payments immediately invested in fund shares, (3) Mitchell
Hutchins' belief that the ability of PaineWebber Financial Advisors 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
Financial Advisors and correspondent firms, resulting in greater growth of the
fund than might otherwise be the case, (4) the advantages to the shareholders of
economies of scale resulting from growth in the fund's assets and potential
continued growth, (5) the services provided to the fund 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
Financial Advisors, 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 fund, 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 fund purchase payments and
instead having the entire amount of their purchase payments immediately invested
in fund 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
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<PAGE>
the ability of PaineWebber Financial Advisors and correspondent firms to receive
sales 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 Financial Advisors and
correspondent firms, resulting in greater growth to the fund than might
otherwise be the case, (4) the advantages to the shareholders of economies of
scale resulting from growth in the fund's assets and potential continued growth,
(5) the services provided to the fund 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 Financial
Advisors 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 (where applicable) and advisory
fees that are calculated based upon a percentage of the average net assets of
each fund and would increase if the Plan were successful and the fund attained
and maintained significant asset levels.
Under the Distribution Contract between the Trust and Mitchell Hutchins
for the Class A shares for the periods shown, Mitchell Hutchins earned the
following approximate amounts of sales charges and retained the following
approximate amounts, net of concessions to PaineWebber as exclusive dealer:
FISCAL YEAR ENDED PERIOD ENDED
MAY 31,1999 MAY 31, 1998*
----------- ------------
AGGRESSIVE PORTFOLIO
Earned..................... $ 489,382 $ 50,393
Retained................... 47,984 31,244
MODERATE PORTFOLIO
Earned..................... 21,895 59,932
Retained................... 13,643 37,158
CONSERVATIVE PORTFOLIO
Earned..................... 11,404 13,243
Retained................... 7,068 8,211
------------------
* February 24, 1998 (commencement of operations) to May 31, 1998.
For the fiscal year ended May 31, 1999, Mitchell Hutchins earned and
retained the following contingent deferred sales charges paid upon certain
redemptions of Class A, Class B and Class C shares:
AGGRESSIVE MODERATE CONSERVATIVE
PORTFOLIO PORTFOLIO PORTFOLIO
--------- --------- ---------
Class A......................... $ 0 $ 0 $ 0
Class B......................... 840,208 31,873 6,942
Class C......................... 67,709 2,176 1,649
PORTFOLIO TRANSACTIONS
All orders for the purchase or sale of portfolio securities for the funds
(normally shares of the underlying funds) are placed on behalf of a particular
fund by Mitchell Hutchins. A fund 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 fund purchases
short-term U.S. government securities or commercial paper directly, it may
43
<PAGE>
purchase such securities in dealer transactions, which generally include a
"spread," as explained below. For the fiscal year ended May 31, 1999 and the
period February 24, 1998 (commencement of operations) to May 31, 1998, the funds
paid no brokerage commission.
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 over-the-counter 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 funds and the underlying funds have no obligation to deal with any
broker or group of brokers in the execution of portfolio transactions. The funds
and the underlying funds contemplate that, consistent with the policy of
obtaining the best net results, brokerage transactions may be conducted through
PaineWebber. The board of the funds and each underlying fund has adopted
procedures in conformity with Rule 17e-1 under the Investment Company 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 funds 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. For the fiscal year ended May 31, 1999 and the fiscal period ended
May 31, 1998, the funds paid no brokerage commissions to PaineWebber or any
other affiliate of Mitchell Hutchins.
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 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.
In selecting brokers, Mitchell Hutchins or a sub-adviser will consider the
full range and quality of a broker's services. Consistent with the interests of
the funds or underlying funds and subject to the review of the board, Mitchell
Hutchins or a sub-adviser may cause a fund to purchase and sell portfolio
securities through brokers who provide Mitchell Hutchins or the sub-adviser with
brokerage or research services. The funds may pay 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 or the sub-adviser to that fund and its other clients.
Research services obtained from brokers may include written reports,
pricing and appraisal services, analysis of issues raised in proxy statements,
educational seminar, subscriptions, portfolio attribution and monitoring
services, and computer hardware, software and access charges which are directly
related to investment research. Research services may be received in the form of
written reports, online services, telephone contacts and personal meetings with
security analysts, economists, corporate and industry spokespersons and
government representatives.
For the fiscal year ended May 31, 1999, Mitchell Hutchins directed no
portfolio transactions to brokers chosen because they provided research
services.
For purchases or sales with broker-dealer firms which act as principal,
Mitchell Hutchins or the applicable sub-adviser seeks best execution. Although
Mitchell Hutchins or a sub-adviser may receive certain research or execution
services in connection with these transactions, it will not purchase securities
44
<PAGE>
at a higher price or sell securities at a lower price than would otherwise be
paid if no weight were attributed to the services provided by the executing
dealer. Mitchell Hutchins or a sub-adviser may engage in agency transactions in
over-the-counter equity and debt securities in return for research and execution
services. These transactions are entered into only pursuant to procedures that
are designed to ensure 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.
Research services and information received from brokers or dealers are
supplemental to Mitchell Hutchins' or the sub-adviser's own research efforts
and, when utilized, are subject to internal analysis before being incorporated
into their own investment processes. Information and research services furnished
by brokers or dealers through which or with which a fund effects 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 it advises may be used in advising the funds or underlying
funds.
Investment decisions for a fund 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 fund or an
underlying fund and one or more accounts. In those cases, simultaneous
transactions are inevitable. Purchases or sales are then averaged as to price
and allocated between that fund or underlying fund and the other account(s) as
to amount according to a formula deemed equitable to the fund or underlying fund
and the other account(s). While in some cases this practice could have a
detrimental effect upon the price or value of the security as far as a funds or
underlying fund is concerned, or upon its ability to complete its entire order,
in other cases it is believed that coordination and the ability to participate
in volume transactions will benefit the fund.
The funds 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 their boards pursuant to
Rule 10f-3 under the Investment Company 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 funds or underlying funds.
PORTFOLIO TURNOVER. The funds' 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 fund'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. For the periods
shown, the funds' portfolio turnover rates were:
FISCAL YEAR ENDED FISCAL PERIOD ENDED
MAY 31, 1999 MAY 31, 1998*
------------ -------------
Aggressive Portfolio.............. 104% 6%
Moderate Portfolio................ 88% 13%
Conservative Portfolio............ 83% 11%
- -------------------
* February 24, 1998 (commencement of operations) to May 31, 1999.
45
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REDUCED SALES CHARGES, ADDITIONAL EXCHANGE AND REDEMPTION
INFORMATION AND OTHER SERVICES
WAIVERS OF SALES CHARGES/CONTINGENT DEFERRED SALES CHARGES -- CLASS A
SHARES. The following additional sales charge waivers are available for Class A
shares if you:
o Purchase shares through a variable annuity offered only to qualified
plans. For investments made pursuant to this waiver, Mitchell Hutchins
may make payments out of its own resources to PaineWebber and to the
variable annuity's sponsor, adviser or distributor in a total amount not
to exceed l% of the amount invested;
o Acquire shares through an investment program that is not sponsored by
PaineWebber or its affiliates and that charges participants a fee for
program services, provided that the program sponsor has entered into a
written agreement with PaineWebber permitting the sale of shares at net
asset value to that program. For investments made pursuant to this
waiver, Mitchell Hutchins may make a payment to PaineWebber out of its
own resources in an amount not to exceed 1% of the amount invested. For
subsequent investments or exchanges made to implement a rebalancing
feature of such an investment program, the minimum subsequent investment
requirement is also waived;
o Acquire shares in connection with a reorganization pursuant to which the
fund acquires substantially all of the assets and liabilities of another
fund in exchange solely for shares of the acquiring fund; or
o Acquire shares in connection with the disposition of proceeds from the
sale of shares of Managed High Yield Plus Fund Inc. that were acquired
during the fund's initial public offering of shares and that meet
certain other conditions described in its prospectus
In addition, reduced sales charges on Class A shares are available through
the combined purchase plan or through rights of accumulation described below.
Class A share purchases of $1 million or more are not subject to an initial
sales charge; however, if a shareholder sells these shares within one year after
purchase, a contingent deferred sales charge of 1% of the offering price or the
net asset value of the shares at the time of sale by the shareholder, whichever
is less, is imposed. This contingent deferred sales charged is waived if you are
eligible to invest in certain offshore investment pools offered by PaineWebber,
your shares are sold before March 31, 2000 and the proceeds are used to purchase
interests in one or more of these pools (see below).
COMBINED PURCHASE PRIVILEGE-CLASS A SHARES. Investors and eligible groups
of related fund investors may combine purchases of Class A shares of the funds
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 funds 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 fund 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);
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<PAGE>
(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 fund investors (as defined above) are permitted to purchase
Class A shares of the funds 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 fund 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.
REINSTATEMENT PRIVILEGE-CLASS A SHARES. Shareholders who have redeemed
Class A shares of a fund may reinstate their account without a sales charge 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, although a loss arising out of a
redemption will not be deductible under certain circumstances. See "Taxes"
below.
WAIVERS OF CONTINGENT DEFERRED SALES CHARGES-CLASS B SHARES. The maximum
5% contingent deferred sales charge applies to sales of shares during the first
year after purchase. The charge generally declines by 1% annually, reaching zero
after six years. 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 sole 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.
PURCHASES OF CLASS Y SHARES THROUGH THE PACE MULTI ADVISOR PROGRAM. An
investor who participates in the PACE Multi Advisor Program is eligible to
purchase Class Y shares. The PACE Multi Advisor Program is an advisory program
sponsored by PaineWebber that provides comprehensive investment services,
including investor profiling, a personalized asset allocation strategy using an
appropriate combination of funds, and a quarterly investment performance review.
Participation in the PACE Multi Advisor Program is subject to payment of an
advisory fee at the effective maximum annual rate of 1.5% of assets. Employees
of PaineWebber and its affiliates are entitled to a waiver of this fee. Please
contact your PaineWebber Financial Advisor or PaineWebber's correspondent firms
for more information concerning mutual funds that are available through the PACE
Multi Advisor Program.
PURCHASES OF CLASS A SHARES THROUGH THE PAINEWEBBER INSIGHTONESM Program.
Investors who purchase shares through the PaineWebber InsightOnesm Program are
eligible to purchase Class A shares without a sales load. The PaineWebber
InsightOnesm Program offers a non-discretionary brokerage account to PaineWebber
clients for an asset-based fee at an annual rate of up to 1.50% of the assets in
the account. Account holders may purchase or sell certain investment products
without paying commissions or other markups/markdowns.
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NON-RESIDENT ALIEN WAIVER OF CONTINGENT DEFERRED SALES CHARGE FOR CLASS A,
B AND C SHARES. Until March 31, 2000, investors who are non-resident aliens will
be able to sell their fund shares without incurring a contingent deferred sales
charge, if they use the sales proceeds to immediately purchase shares of certain
offshore investment pools available through PaineWebber. The fund will waive the
contingent deferred sales charge that would otherwise apply to a sale of Class
A, Class B or Class C shares of the fund. Fund shareholders who want to take
advantage of this waiver should review the offering documents of the offshore
investment pools for further information, including investment minimums, and
fees and expenses. Shares of the offshore investment pools are available only in
those jurisdictions where the sale is authorized and are not available to any
U.S. person, including, but not limited to, any citizen or resident of the
United States, and U.S. partnership or U.S. trust, and are not available to
residents of certain other countries. For more information on how to take
advantage of the deferred sales charge waiver, investors should contact their
PaineWebber Financial Advisors.
ADDITIONAL EXCHANGE AND REDEMPTION INFORMATION. As discussed in the
Prospectus, eligible shares of the funds 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 fund temporarily delays or ceases the sales
of its shares because it is unable to invest amounts effectively in accordance
with the fund's investment objective, policies and restrictions.
If conditions exist that make cash payments undesirable, each fund
reserves the right to honor any request for redemption by making payment in
whole or in part in securities chosen by the fund and valued in the same way as
they would be valued for purposes of computing the fund's net asset value. If
payment is made in securities, a shareholder may incur brokerage expenses in
converting these securities into cash.
The funds may suspend redemption privileges or postpone the date of
payment during any period (1) when the New York Stock Exchange is closed or
trading on the New York Stock Exchange 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 fund 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 fund's securities at the time.
SERVICE ORGANIZATIONS. A fund may authorize service organizations, and
their agents, to accept on its behalf purchase and redemption orders that are in
"good form." A fund will be deemed to have received these purchase and
redemption orders when a service organization or its agent accepts them. Like
all customer orders, these orders will be priced based on the fund's net asset
value next computed after receipt of the order by the service organizations or
their agents. Service organizations may include retirement plan service
providers who aggregate purchase and redemption instructions received from
numerous retirement plans or plan participants.
AUTOMATIC INVESTMENT PLAN. PaineWebber offers an automatic investment plan
with a minimum initial investment of $1,000 through which a fund will deduct $50
or more on a monthly, quarterly, semi-annual or annual basis from the investor's
bank account to invest directly in the fund. 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 fund'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. The systematic withdrawal plan allows
investors to set up monthly, quarterly (March, June, September and December),
semi-annual (June and December) or annual (December) withdrawals from their
PaineWebber Mutual Fund accounts. Minimum balances and withdrawals vary
according to the class of shares:
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o Class A and Class C shares. Minimum value of fund shares is $5,000;
minimum withdrawals of $100.
o Class B shares. Minimum value of fund shares is $10,000; minimum
monthly, quarterly, and semi-annual and annual withdrawals of $100,
$200, $300 and $400, respectively.
Withdrawals under the systematic withdrawal plan will not be subject to a
contingent deferred sales charge if the investor withdraws no more than 12% of
the value of the fund account when the investor signed up for the Plan (for
Class B shares, annually; for Class A and Class C shares, during the first year
under the Plan). Shareholders who elect to receive dividends or other
distributions in cash may not participate in this 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 fund 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 the minimum values specified
above. Purchases of additional shares of a fund 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, semi-annual and annual plans, PaineWebber will arrange for
redemption by the funds of sufficient fund shares to provide the withdrawal
payments specified by participants in the funds' 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. 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. 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 PFPC. Shareholders may request the
forms needed to establish a systematic withdrawal plan from their PaineWebber
Financial Advisors, correspondent firms or PFPC at 1-800-647-1568.
INDIVIDUAL RETIREMENT ACCOUNTS. Self-directed IRAs are available through
PaineWebber in which purchases of PaineWebber mutual funds and other investments
may be made. Investors considering establishing an IRA should review applicable
tax laws and should consult their tax advisers.
TRANSFER OF ACCOUNTS. If investors holding shares of a fund in a
PaineWebber brokerage account transfer their brokerage accounts to another firm,
the fund shares will be moved to an account with PFPC. However, if the other
firm has entered into a selected dealer agreement with Mitchell Hutchins
relating to the fund, the shareholder may be able to hold fund shares in an
account with the other firm.
PAINEWEBBER RMA RESOURCE ACCUMULATION PLANSM
PAINEWEBBER RESOURCE MANAGEMENT ACCOUNT(REGISTERED) (RMA(REGISTERED))
Shares of PaineWebber mutual funds, including the funds (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.
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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 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:
o 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;
o comprehensive year-end summary statements that provide information on
account activity for use in tax planning and tax return
preparation;
o 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. AN INVESTMENT IN A MONEY
MARKET FUND IS NOT INSURED OR GUARANTEED BY THE FEDERAL DEPOSIT
INSURANCE CORPORATION OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH A
MONEY MARKET FUND SEEKS TO PRESERVE THE VALUE OF YOUR INVESTMENT AT
$1.00 PER SHARE, IT IS POSSIBLE TO LOSE MONEY BY INVESTING IN A MONEY
MARKET FUND.
o 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;
o 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;
o unlimited electronic funds transfers and bill payment service for an
additional fee;
o 24-hour access to account information through toll-free numbers, and
more detailed personal assistance during business hours from the RMA
Service Center;
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o expanded account protection to the net equity securities balance in
the event of the liquidation of PaineWebber. This protection does not
apply to shares of PW Funds that are held at PFPC and not through
PaineWebber; and
o 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 fund will automatically convert to Class A shares of
that fund, 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.
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 fund determines the net asset values per share separately for each
class of shares, normally as of the close of regular trading (usually 4:00 p.m.,
Eastern time) on the New York Stock Exchange on each Business Day, which is
defined as each Monday through Friday when the New York Stock Exchange is open.
Prices will be calculated earlier when the New York Stock Exchange closes early
because trading has been halted for the day. Currently the New York Stock
Exchange 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 fund shares is determined. The
funds 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 fund'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.
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<PAGE>
TOTAL RETURN CALCULATIONS. Average annual total return quotes
("Standardized Return") used in each fund's Performance Advertisements are
calculated according to the following formula:
P(1 + T)n(SUPERSCRIPT) = 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.
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 funds 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 funds calculate Non-Standardized Return
for specified periods of time by assuming an investment of $1,000 in fund shares
and 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.
The following tables show performance information for each class of the
funds' shares for the periods indicated.
AGGRESSIVE PORTFOLIO
CLASS CLASS A CLASS B CLASS C CLASS Y
- ----- ------- ------- ------- -------
(INCEPTION DATE) 2/24/98 2/24/98 2/24/98 2/24/98
- ---------------- ------- ------- ------- -------
Year ended May 31, 1999
Standardized Return*............. (5.99)% (7.14)% (3.29)% (1.33)%
Non-Standardized Return.......... (1.57)% (2.32)% (2.32)% (1.33)%
Inception to May 31, 1999:
Standardized Return*............. (2.40)% (3.72)% 0.27% 2.54%
Non-Standardized Return.......... 2.21% 1.28% 1.27% 2.54%
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MODERATE PORTFOLIO
CLASS CLASS A CLASS B CLASS C CLASS Y
- ----- 2/24/98 2/24/98 2/24/98 2/24/98
(INCEPTION DATE) ------- ------- ------- -------
- ----------------
Year ended May 31, 1999
Standardized Return*............. (2.74%) (3.81%) 0.12% 2.08%
Non-Standardized Return.......... 1.85% 1.14% 1.11% 2.08%
Inception to May 31, 1999:
Standardized Return*............. 0.48% (0.49%) 3.64% 4.46%
Non-Standardized Return.......... 4.21% 3.44% 3.42% 4.46%
CONSERVATIVE PORTFOLIO
CLASS CLASS A CLASS B CLASS C CLASS Y
- ----- 2/24/98 2/24/98 2/24/98 2/24/98
(INCEPTION DATE) ------- ------- ------- -------
- ----------------
Year ended May 31, 1999*
Standardized Return*............. 0.67% (0.49%) 4.02% 5.61%
Non-Standardized Return.......... 5.38% 4.51% 4.77% 5.61%
Inception to May 31, 1999:
Standardized Return*............. 2.46% 1.52% 5.13% 6.52%
Non-Standardized Return.......... 6.27% 5.44% 5.71% 6.52%
* All Standardized Return figures for Class A shares reflect deduction of
the current maximum sales charge of 4.5% (4.0% for Conservative
Portfolio). All Standardized Return figures for Class B and Class C shares
reflect deduction of the applicable contingent deferred sales charges
imposed on a redemption of shares held for the period.
YIELD. Yields used in Moderate Portfolio's and Conservative Portfolio's
Performance Advertisements are calculated by dividing the fund'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 the other classes of shares) at the end of the Period.
Yield quotations are calculated according to the following formula:
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.
Except as noted below, in determining interest income earned during the
Period (variable "a" in the above formula), a fund calculates interest earned on
each debt obligation held by it or an underlying fund 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
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<PAGE>
(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 fund or an underlying fund, interest earned during the Period is then
determined by totaling 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 fund's current maximum 4.5% (4%
for Conservative fund) initial sales charge on Class A shares is included.
The following table shows the 30-day yield for each class of Moderate
Portfolio and Conservative Portfolio for the 30 days period ended May 31, 1999.
CLASS A CLASS B CLASS C CLASS Y
------- ------- ------- -------
MODERATE PORTFOLIO:....... 2.10% 1.44% 1.45% 2.44%
CONSERVATIVE PORTFOLIO:... 3.75% 3.15% 3.41% 4.15%
OTHER INFORMATION. In Performance Advertisements, the funds 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 Smith Barney Non-U.S. Dollar Index, the
Salomon Smith Barney Non-U.S. World Government Bond Index, the Salomon Smith
Barney World Government Index, other similar Salomon Smith Barney indices or
components thereof and changes in the Consumer Price Index as published by the
U.S. Department of Commerce. The funds 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
funds 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 funds 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 fund investment are reinvested in
additional fund shares, any future income or capital appreciation of a fund
would increase the value, not only of the original fund investment, but also of
the additional fund shares received through reinvestment. As a result, the value
of a fund investment would increase more quickly than if dividends or other
distributions had been paid in cash.
The funds 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
funds' 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 funds are not insured or guaranteed by
the U.S. government and returns and net asset values will fluctuate. The debt
securities held by the funds or the underlying funds may have longer maturities
than most CDs and may reflect interest rate fluctuations for longer term debt
securities. An investment in any fund involves greater risks than an investment
in either a money market fund or a CD.
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The funds 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.
IBBOTSON CHART PLOT POINTS
<TABLE>
<CAPTION>
Chart showing performance of S&P 500, long-term U.S. government bonds,
Treasury Bills and inflation from 1928 through 1998
<S><C> <C> <C> <C> <C>
YEAR COMMON STOCKS LONG-TERM GOV'T BONDS INFLATION/CPI TREASURY BILLS
1928 $22,039 $11,751 $9,553 $11,028
1929 $20,184 $12,153 $9,572 $11,552
1930 $15,158 $12,719 $8,994 $11,831
1931 $8,588 $12,044 $8,138 $11,957
1932 $7,885 $14,072 $7,300 $12,072
1933 $12,142 $14,062 $7,337 $12,108
1934 $11,967 $15,473 $7,486 $12,128
1935 $17,672 $16,243 $7,710 $12,148
1936 $23,667 $17,465 $7,803 $12,170
1937 $15,376 $17,505 $8,045 $12,208
1938 $20,161 $18,473 $7,822 $12,205
1939 $20,079 $19,570 $7,784 $12,208
1940 $18,115 $20,762 $7,859 $12,208
1941 $16,015 $20,955 $8,623 $12,215
1942 $19,273 $21,630 $9,424 $12,248
1943 $24,265 $22,080 $9,721 $12,291
1944 $29,057 $22,700 $9,926 $12,331
1945 $39,645 $25,136 $10,150 $12,372
1946 $36,446 $25,111 $11,993 $12,415
1947 $38,527 $24,453 $13,074 $12,478
1948 $40,646 $25,284 $13,428 $12,579
1949 $48,283 $26,915 $13,186 $12,717
1950 $63,594 $26,931 $13,950 $12,870
1951 $78,869 $25,873 $14,769 $13,061
1952 $93,357 $26,173 $14,899 $13,278
1953 $92,433 $27,126 $14,991 $13,520
1954 $141,071 $29,076 $14,916 $13,636
1955 $185,594 $28,701 $14,971 $13,850
1956 $197,768 $27,097 $15,399 $14,191
1957 $176,449 $29,118 $15,864 $14,636
1958 $252,957 $27,345 $16,144 $14,862
1959 $283,211 $26,727 $16,386 $15,300
1960 $284,542 $30,410 $16,628 $15,707
1961 $361,055 $30,705 $16,740 $16,042
1962 $329,535 $32,820 $16,944 $16,480
1963 $404,669 $33,217 $17,223 $16,994
1964 $471,359 $34,383 $17,428 $17,596
1965 $530,043 $34,627 $17,763 $18,287
1966 $476,721 $35,891 $18,358 $19,158
1967 $591,038 $32,597 $18,916 $19,964
1968 $656,407 $32,512 $19,809 $21,004
1969 $600,613 $30,863 $21,019 $22,386
1970 $624,697 $34,601 $22,173 $23,846
1971 $714,091 $39,179 $22,918 $24,893
1972 $849,626 $41,408 $23,700 $25,849
1973 $725,071 $40,948 $25,785 $27,640
1974 $533,144 $42,730 $28,931 $29,851
55
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$731,474 $46,661 $30,956 $31,582
1976 $905,565 $54,500 $32,442 $33,193
1977 $840,364 $54,118 $34,648 $34,886
1978 $895,828 $53,469 $37,767 $37,398
1979 $1,060,661 $52,827 $42,790 $41,287
1980 $1,404,315 $50,767 $48,096 $45,911
1981 $1,335,504 $51,732 $52,376 $52,660
1982 $1,621,301 $72,631 $54,419 $58,190
1983 $1,986,094 $73,139 $56,487 $63,310
1984 $2,111,218 $84,476 $58,746 $69,515
1985 $2,791,030 $110,664 $60,979 $74,867
1986 $3,307,371 $137,776 $61,649 $79,509
1987 $3,479,354 $134,056 $64,362 $83,882
1988 $4,063,885 $147,060 $67,194 $89,167
1989 $5,344,009 $173,678 $70,285 $96,657
1990 $5,173,001 $184,446 $74,572 $104,196
1991 $6,750,766 $220,044 $76,884 $110,031
1992 $7,270,575 $237,867 $79,114 $113,882
1993 $7,996,906 $281,159 $81,250 $117,185
1994 $8,101,665 $259,229 $83,443 $121,755
1995 $10,507,050 $313,511 $85,404 $126,856
1996 $13,710,736 $337,286 $88,451 $135,380
1997 $18,274,382 $363,828 $90,067 $142,494
1998 $23,495,420 $441,777 $91,513 $149,416
</TABLE>
Source: Stocks, Bonds, Bills and Inflation 1999 Yearbook(TM) Ibbotson Assoc.,
Chi. (annual updates work by Roger G. Ibbotson & Rex A. Sinquefield).
The chart is shown for illustrative purposes only and does not represent
any fund'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 indexes are unmanaged and
are not available for investment.
Over time, although subject to greater risks and higher volatility, stocks
have outperformed all other investments by a wide margin, offering a solid hedge
against inflation. From 1926 to 1998, stocks beat all other traditional asset
classes. A $10,000 investment in the stocks comprising the S&P 500 grew to
$23,495,420, significantly more than any other investment.
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<PAGE>
TAXES
BACKUP WITHHOLDING. Each fund is required to withhold 31% of all
dividends, capital gain distributions and redemption proceeds payable to
individuals and certain other non-corporate shareholders who do not provide the
fund or PaineWebber with a correct taxpayer identification number. Withholding
at that rate also is required from dividends and capital gain distributions
payable to those shareholders who otherwise are subject to backup withholding.
SALE OR EXCHANGE OF FUND SHARES. A shareholder's sale (redemption) of
shares may result in a taxable gain or loss, depending on whether the
shareholder receives more or less than his or her adjusted basis for the shares
(which normally includes any initial sales charge paid on Class A shares). An
exchange of any fund's shares for shares of another PaineWebber mutual fund
generally will have similar tax consequences. In addition, if a fund's shares
are bought within 30 days before or after selling other shares of the fund
(regardless of class) at a loss, all or a portion of that loss will not be
deductible and will increase the basis of the newly purchased shares.
SPECIAL RULE FOR CLASS A SHAREHOLDERS. A special tax rule applies when a
shareholder sells or exchanges Class A shares within 90 days of purchase and
subsequently acquires Class A shares of the same or another PaineWebber mutual
fund without paying a sales charge due to the 365-day reinstatement privilege or
the exchange privilege. In these cases, any gain on the sale or exchange of the
original Class A shares would be increased, or any loss would be decreased, by
the amount of the sales charge paid when those shares were bought, and that
amount would increase the basis of the PaineWebber mutual fund shares
subsequently acquired.
CONVERSION OF CLASS B SHARES. A shareholder will recognize no gain or loss
as a result of a conversion from Class B shares to Class A shares.
QUALIFICATION AS A REGULATED INVESTMENT COMPANY. To continue to qualify
for treatment as a regulated investment company ("RIC") under the Internal
Revenue Code, each fund 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 gain) and must meet several
additional requirements. For each fund these requirements include the following:
(1) the fund 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; (2) at the close of each
quarter of the fund's taxable year, at least 50% of the value of its total
assets must be represented by cash and cash items, U.S. government securities,
securities of other RICs (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 fund'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 fund'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. If a fund failed to qualify for treatment as a RIC for
any taxable year, (a) it would be taxed as an ordinary corporation on its
taxable income for that year without being able to deduct the distributions it
makes to its shareholders and (b) the shareholders would treat all those
distributions, including distributions of net capital gain (the excess of net
long-term capital gain over net short-term capital loss), as dividends (that is,
ordinary income) to the extent of the fund's earnings and profits. In addition,
the fund could be required to recognize unrealized gains, pay substantial taxes
and interest, and make substantial distributions before requalifying for RIC
treatment.
Each fund will invest its assets in shares of underlying funds and money
market and other short-term instruments. Accordingly, each fund'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 fund from the underlying
fund's investment company taxable income (which may include net gains from
certain foreign currency transactions) will be taxable to the fund as ordinary
income to the extent of the underlying fund's earnings and profits, and (2)
distributions paid to a fund 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 fund as long-term capital gains, regardless of how long
the fund has held the underlying fund's shares. If a fund purchases shares of an
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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 fund's
portfolio or otherwise), all or part of the loss will not be deductible by the
fund 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 fund) 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 fund will qualify to pass that benefit through to its
shareholders because of its inability to satisfy that test.
Each fund 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 FUNDS' SHAREHOLDERS. Dividends and other distributions
declared by a fund 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 fund and received by the shareholders on December 31 of that
year even if the distributions are paid by the fund 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 fund'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 fund may not exceed the total of its proportionate share 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 federal alternative minimum tax.
If fund 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 fund's dividends attributable to interest on U.S.
government obligations, including the portion of dividends the fund receives
from underlying funds qualifying as RICs that is attributable to such interest,
may be exempt from state and local income tax.
The foregoing is only a general summary of some of the important federal
tax considerations generally affecting the funds and their shareholders. No
attempt is made to present a complete explanation of the federal tax treatment
of the funds' activities, and this discussion is not intended as a substitute
for careful tax planning. Accordingly, potential investors are urged to consult
their own tax advisers for more detailed information and for information
regarding any state, local or foreign taxes applicable to the funds and to
dividends and other distributions therefrom.
OTHER INFORMATION
DELAWARE BUSINESS TRUST. The Trust is an entity of the type commonly known
as a Delaware business trust. 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 fund could, under certain conflicts of laws jurisprudence in
various states, be held personally liable for the obligations of the Trust or a
fund. However, the trust instrument of the Trust disclaims shareholder liability
for acts or obligations of the Trust or its series (the funds) 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 fund's property for all losses
and expenses of any series shareholder held personally liable for the
obligations of the fund. Thus, the risk of a shareholder's incurring financial
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loss on account of shareholder liability is limited to circumstances in which a
fund 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 fund, the shareholder paying such liability will be entitled to
reimbursement from the general assets of the fund. The trustees intend to
conduct the operations of the funds in such a way as to avoid, as far as
possible, ultimate liability of the shareholders for liabilities of the funds.
CLASSES OF SHARES. A share of each class of a fund represents an identical
interest in that fund's investment portfolio and has the same rights, privileges
and preferences. However, each class may differ with respect to sales charges,
if any, distribution and/or service fees, if any, other expenses allocable
exclusively to each class, voting rights on matters exclusively affecting that
class, and its exchange privilege, if any. The different sales charges and other
expenses applicable to the different classes of shares of the funds will affect
the performance of those classes. Each share of a fund is entitled to
participate equally in dividends, other distributions and the proceeds of any
liquidation of that fund. However, due to the differing expenses of the classes,
dividends and liquidation proceeds on Class A, B, C and Y shares will differ.
VOTING RIGHTS. Shareholders of each fund are entitled to one vote for each
full share held and fractional votes for fractional shares held. Voting rights
are not cumulative and, as a result, the holders of more than 50% of all the
shares of the funds as a group may elect all of the board members of the Trust.
The shares of a fund will be voted together, except that only the shareholders
of a particular class of a fund may vote on matters affecting only that class,
such as the terms of a Rule 12b-1 Plan as it relates to the class. The shares of
each series of the Trust will be voted separately, except when an aggregate vote
of all the series of the Trust is required by law.
The funds do not hold annual meetings. Shareholders of record of no less
than two-thirds of the outstanding shares of the Trust may remove a board member
through a declaration in writing or by vote cast in person or by proxy at a
meeting called for that purpose. A meeting will be called to vote on the removal
of a board member at the written request of holders of 10% of the outstanding
shares of the Trust.
CLASS-SPECIFIC EXPENSES. Each fund may determine to allocate certain of
its expenses (in addition to distribution fees) to the specific classes of the
fund's shares to which those expenses are attributable. For example, a fund's
Class B and Class C shares bear higher transfer agency fees per shareholder
account than those borne by Class A or Class Y 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. 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.
PRIOR NAMES. 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."
CUSTODIAN AND RECORDKEEPING AGENT; TRANSFER AND DIVIDEND AGENT. State
Street Bank and Trust Company, located at One Heritage Drive, North Quincy,
Massachusetts 02171, serves as custodian and recordkeeping agent for each fund.
PFPC Inc., a subsidiary of PNC Bank, N.A., serves as each fund's transfer and
dividend disbursing agent. It is located at 400 Bellevue Parkway, Wilmington, DE
19809.
COUNSEL. The law firm of Kirkpatrick & Lockhart LLP, 1800 Massachusetts
Avenue, N.W., Washington, D.C. 20036-1800, serves as counsel to the funds.
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 fund.
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FINANCIAL STATEMENTS
The funds' Annual Report to Shareholders for the period ended May 31, 1999
is a separate document supplied with this SAI, and the financial statements,
accompanying notes and report of independent auditors appearing therein are
incorporated herein by this reference.
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APPENDIX
RATINGS INFORMATION
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
"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 risk 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 CAA. The modifier 1 indicates that the
obligation ranks in the higher end of its generic rating category, the modifier
2 indicates a mid-range ranking, and the modifier 3 indicates a ranking in the
lower end of that 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 highest rated
obligations 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
least 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; 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
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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 commitment 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.
CI. The rating CI is reserved for income bonds on which no interest is
being paid.
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.
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YOU SHOULD RELY ONLY ON THE
INFORMATION CONTAINED OR REFERRED
TO IN THE PROSPECTUS AND THIS
STATEMENT OF ADDITIONAL
INFORMATION. THE FUNDS AND THEIR
DISTRIBUTOR HAVE NOT AUTHORIZED
ANYONE TO PROVIDE YOU WITH
INFORMATION THAT IS DIFFERENT. THE
PROSPECTUS AND THIS STATEMENT OF
ADDITIONAL INFORMATION IS NOT AN
OFFER TO SELL SHARES OF THE FUNDS
IN ANY JURISDICTION WHERE THE FUNDS
OR THEIR DISTRIBUTOR MAY NOT
LAWFULLY SELL THOSE SHARES.
------------
MITCHELL HUTCHINS AGGRESSIVE
PORTFOLIO
MITCHELL HUTCHINS MODERATE
PORTFOLIO
MITCHELL HUTCHINS CONSERVATIVE
PORTFOLIO
-----------------------------------
Statement of Additional Information
September 30, 1999
-----------------------------------
PAINEWEBBER
(C)1999 PaineWebber Incorporated
