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As filed with the Securities and Exchange Commission
on February 21, 1997
Registration No. 333-14191
811-07863
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [ X ]
PRE-EFFECTIVE AMENDMENT NO. 1 [ X ]
POST-EFFECTIVE AMENDMENT NO. __ [ ]
AND/OR
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [ X ]
AMENDMENT NO. 1 [ X ]
(Check appropriate box or boxes)
PACIFIC INNOVATIONS TRUST,
A DELAWARE BUSINESS TRUST
(Exact Name of Registrant as Specified in Charter)
103 Bellevue Parkway
Wilmington, Delaware 19809
(Address of Principal Executive Offices, including Zip Code)
Jay F. Nusblatt
103 Bellevue Parkway
Wilmington, Delaware 19809
(Name and Address of Agent for Service)
COPIES TO:
MICHAEL GLAZER CATHY O'KELLY
PAUL, HASTINGS, JANOFSKY & WALKER VEDDER, PRICE, KAUFMAN & KAMMHOLZ
555 S. FLOWER STREET 222 N. LASALLE
LOS ANGELES, CALIFORNIA 90071 CHICAGO, ILLINOIS 60695
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APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING:
AS SOON AS PRACTICABLE FOLLOWING EFFECTIVE DATE.
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The Registrant hereby amends this registration statement on such date or dates
as may be necessary to delay its effective date until the Registrant shall file
a further amendment which specifically states that this registration statement
shall thereafter become effective in accordance with Section 8(a) of the
Securities Act of 1933 or until the registration statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
_________________________________________
Pursuant to Rule 24f-2 under the Investment Company Act of 1940, Registrant has
registered under the Securities Act of 1933 an indefinite number of shares of
beneficial interest. In accordance with Rule 24f-2, Registrant intends to file
its initial Rule 24f-2 Notice within the time period required by Rule 24f-2.
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PACIFIC INNOVATIONS TRUST,
A DELAWARE BUSINESS TRUST
CROSS REFERENCE SHEET
(AS REQUIRED BY RULE 495)
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N-1A ITEM NO. LOCATION
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PART A
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Item 1. Cover Page . . . . . . . . . . . . . . . . . . . . . Cover Page
Item 2. Synopsis . . . . . . . . . . . . . . . . . . . . . . The Funds at a Glance
Item 3. Condensed Financial Information . . . . . . . . . . . Not Applicable
Item 4. General Description of Registrant . . . . . . . . . . Cover Page; Fund Investments; The Business of the Funds;
Description of Shares
Item 5. Management of Fund . . . . . . . . . . . . . . . . . The Business of the Funds
Item 5A. Management's Discussion of Fund Performance . . . . . Not Applicable
Item 6. Capital Stock and Other Securities . . . . . . . . . Description of Shares; More on the Funds' Shares; Tax
Information
Item 7. Purchase of Securities Being Offered . . . . . . . . More on the Funds' Shares
Item 8. Redemption of Repurchase . . . . . . . . . . . . . . More on the Funds' Shares
Item 9. Pending Legal Proceedings . . . . . . . . . . . . . . Not Applicable
PART B
Item 10. Cover Page . . . . . . . . . . . . . . . . . . . . . . Cover Page
Item 11. Table of Contents . . . . . . . . . . . . . . . . . . Table of Contents
Item 12. General Information and History . . . . . . . . . . . Not Applicable
Item 13. Investment Objectives and Policies . . . . . . . . . . Investment Objectives and Policies
Item 14. Management of the Fund . . . . . . . . . . . . . . . . Management
Item 15. Control Persons and Principal Holders of Securities . General Information
Item 16. Investment Advisory and Other Services . . . . . . . . Management
Item 17. Brokerage Allocation and Other Practices . . . . . . . Management
Item 18. Capital Stock and Other Securities . . . . . . . . . . General Information
Item 19. Purchase, Redemption and Pricing of Securities
Being Offered . . . . . . . . . . . . . . . . . . Additional Purchase and Redemption Information
Item 20. Tax Status . . . . . . . . . . . . . . . . . . . . . . Additional Information Concerning Taxes
Item 21. Underwriters . . . . . . . . . . . . . . . . . . . . . General Information
Item 22. Calculation of Performance Data . . . . . . . . . . . General Information
Item 23. Financial Statements . . . . . . . . . . . . . . . . . Financial Statements
</TABLE>
PART C
Information required to be included in Part C is set forth under the
appropriate item, so numbered, in Part C to the Registration Statement.
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PROSPECTUS INVESTMENT PORTFOLIOS OFFERED
BY PACIFIC INNOVATIONS TRUST
MARCH 1, 1997
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THE PACIFIC INNOVATIONS SERIES OF FUNDS CONSISTS OF SEVEN FUNDS OFFERED BY
PACIFIC INNOVATIONS TRUST, A DELAWARE BUSINESS TRUST WHICH IS AN OPEN-END
MANAGEMENT INVESTMENT COMPANY (THE "TRUST") REGISTERED UNDER THE INVESTMENT
COMPANY ACT OF 1940 (THE "1940 ACT"). SHARES OF THE FUNDS MAY BE OFFERED AND
SOLD ONLY TO SEPARATE ACCOUNTS ("SEPARATE ACCOUNTS") OF PACIFIC MUTUAL LIFE
INSURANCE COMPANY ("PACIFIC MUTUAL") TO SERVE AS THE INVESTMENT MEDIUM FOR
VARIABLE ANNUITY CONTRACTS (COLLECTIVELY, "CONTRACTS"). BY THIS PROSPECTUS, THE
TRUST IS OFFERING SHARES IN THE FOLLOWING FUNDS (EACH A "FUND" AND,
COLLECTIVELY, THE "FUNDS"):
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- Money Market Fund - Mid-Cap Equity Fund
- Managed Bond Fund - Aggressive Growth Fund
- Capital Income Fund - International Fund
- Blue Chip Fund
</TABLE>
Bank of America National Trust and Savings Association ("Bank of America"
or the "Manager") serves as the Funds' manager. Based in San Francisco,
California, Bank of America and its affiliates have over $50 billion under
management, of which over $14 billion is in mutual funds. Scudder, Stevens &
Clark, Inc. and Wellington Management Company, LLP (each a "Subadviser" and,
collectively, the "Subadvisers") serve as subadvisers to the Managed Bond Fund
and International Fund, respectively.
This Prospectus describes concisely the information about the Funds and the
Trust that you should know before investing. Please read it carefully and retain
it for future reference. More information about the Funds and the Trust is
contained in a Statement of Additional Information (the "SAI") that has been
filed with the Securities and Exchange Commission. To obtain a free copy, call
(800) 722-5558. The SAI dated March 1, 1997, as it may be revised from time to
time, is incorporated by reference into this Prospectus.
Shares of the Funds are not bank deposits or obligations of, or guaranteed
or endorsed by, Bank of America or any of its affiliates and are not federally
insured by, guaranteed by, obligations of or otherwise supported by the U. S.
Government, the Federal Deposit Insurance Corporation, the Federal Reserve Board
or any other governmental agency. Investment in a Fund involves investment risk,
including the possible loss of principal amount invested.
------------------------
THIS PROSPECTUS SHOULD BE READ IN CONJUNCTION WITH THE PROSPECTUS OF THE
SEPARATE ACCOUNT, WHICH ACCOMPANIES THIS PROSPECTUS. BOTH PROSPECTUSES SHOULD BE
READ CAREFULLY AND RETAINED FOR FUTURE REFERENCE.
LIKE ALL MUTUAL FUNDS, THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR
HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
This Prospectus is part of a Registration Statement that has been filed
with the Securities and Exchange Commission in Washington, D.C. under the
Securities Act of 1933. This Prospectus does not constitute an offer in any
State in which, or to any person to whom, such offering may not lawfully be
made.
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CONTENTS
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PAGE
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THE FUNDS AT A GLANCE................................................................. 3
FUND INVESTMENTS
Investment Objectives and Policies.................................................. 4
Common Investment Policies.......................................................... 8
Diversification and Changes in Investment Policies.................................. 16
Other Investment Practices and Considerations....................................... 16
THE BUSINESS OF THE FUNDS
Fund Management..................................................................... 18
Expenses............................................................................ 18
Service Providers................................................................... 18
Fee Waivers......................................................................... 20
MORE ON THE FUNDS' SHARES
How to Buy Shares................................................................... 20
How to Redeem Shares................................................................ 20
How are Shares Priced?.............................................................. 21
Can I Exchange My Investments From One Fund to Another?............................. 21
Dividends and Distributions......................................................... 21
TAX INFORMATION
Tax Information..................................................................... 22
MEASURING PERFORMANCE
Measuring Performance............................................................... 22
Prior Performance of The Manager and Subadvisers.................................... 22
DESCRIPTION OF SHARES
Description of Shares............................................................... 23
APPENDIX A
Corporate Bond and Other Ratings.................................................... A-1
Distributor: Manager:
Concord Financial Group, Inc. Bank of America National Trust
3435 Stelzer Road and Savings Association
Columbus, OH 43219-3035 555 California Street
San Francisco, CA 94104
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2
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THE FUNDS AT A GLANCE
A summary of the highlights of the Pacific Innovations Series of Funds
appears below. This chart is only a summary. You should also read the complete
descriptions of each Fund's investment objectives and policies, which begins on
the next page, and related information.
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PRIMARY INVESTMENTS INVESTMENT ADVISER
(UNDER NORMAL OR
FUND OBJECTIVE CIRCUMSTANCES) SUBADVISER
<S> <C> <C> <C>
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Money Market Liquidity and Short-term debt Bank of America
current income obligations issued
consistent with or guaranteed by
preservation of U.S. Government, its
capital agencies,
authorities or
instrumentalities
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Managed Bond Interest income and Investment grade, Scudder, Stevens &
capital appreciation intermediate and Clark, Inc.
longer term bonds.
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Capital Income Total investment Convertible bonds Bank of America
return, comprised of and convertible
current income and preferred stocks
capital appreciation
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Blue Chip Long-term capital Blue chip stocks Bank of America
appreciation
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Mid-Cap Equity Capital appreciation Stocks of companies Bank of America
with medium market
capitalizations
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Aggressive Growth Maximum capital Common stocks and Bank of America
appreciation securities
convertible into
common stocks of
companies with
smaller market
capitalizations
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International Long-term capital Foreign equity Wellington
growth securities Management Company,
LLP
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3
<PAGE> 6
FUND INVESTMENTS
INVESTMENT OBJECTIVES AND POLICIES
This section describes the investment objectives and policies of each Fund.
There can be no assurance that any Fund will achieve its investment objective.
MONEY MARKET FUND
INVESTMENT OBJECTIVE. The investment objective of the Money Market Fund is
to provide liquidity and as high a level of current income as is consistent with
the preservation of capital.
INVESTMENT POLICIES. The Money Market Fund invests primarily in short-term
debt obligations issued or guaranteed as to interest and principal by the U.S.
Government, its agencies, authorities or instrumentalities and in repurchase
agreements with respect to such obligations.
The Money Market Fund invests at least 95% of its total assets, measured at
the time of purchase, in a diversified portfolio of dollar denominated money
market securities that are rated in the highest rating category for short term
instruments, or, if not rated, are determined by the Manager to be of equivalent
quality. The Fund may invest up to 5% of its total assets, measured at the time
of investment, in money market securities that are in the second-highest rating
category for short-term debt obligations, or, if not rated, are determined by
the Manager to be of equivalent quality. Assets of the Fund will be invested in
securities with remaining maturities of thirteen months or less as defined by
the Securities and Exchange Commission, and the dollar-weighted average
portfolio maturity of the Fund will not exceed 90 days. The Fund attempts to
maintain a stable net asset value of $1.00 per share, although there can be no
assurance that it will be able to do so.
The Money Market Fund may purchase certain U.S. Government agency
securities (such as guaranteed notes of the Federal Aviation Administration,
Department of Defense, Bureau of Indian Affairs and Private Export Funding
Corporation) which often provide higher yields than are available from the more
common types of government-backed investments. However, such specialized
investments may only be available from a few sources, in limited amounts, or
only in very large denominations; they may also require specialized capability
in portfolio servicing and in legal matters related to government guarantees.
While frequently offering attractive yields, the limited-activity markets of
many of these securities mean that if the Money Market Fund were required to
liquidate any of them it might not be able to do so advantageously; accordingly,
the Money Market Fund intends normally to hold such securities to maturity or
pursuant to repurchase agreements, and to limit its investment in such
securities (as well as repurchase agreements maturing in more than seven days)
to not more than 10% of the Fund's net assets.
The Money Market Fund may invest in "stripped" securities, which are U.S.
Treasury bonds and notes the unmatured interest coupons of which have been
separated from the underlying principal obligation. Stripped securities are zero
coupon obligations that are normally issued at a discount to their "face value,"
and may exhibit greater price volatility than ordinary debt securities because
of the manner in which their principal and interest are returned to investors. A
number of securities firms and banks have stripped the interest coupons and
resold them in custodian receipt programs with different names such as Treasury
Income Growth Receipts ("TIGRs") and Certificates of Accrual on Treasury
Securities ("CATS"). Privately-issued stripped securities such as TIGRs and CATS
are not themselves guaranteed by the U.S. Government, but the future payment of
principal or interest on U.S. Treasury obligations which they represent is so
guaranteed. The Money Market Fund may invest no more than 35% of its assets in
stripped securities.
In addition to the foregoing investment policies, and subject to the
requirements set forth above and in the SAI, the Money Market Fund may invest in
accordance with other policies discussed below under "Common Investment
Policies."
MANAGED BOND FUND
INVESTMENT OBJECTIVE. The investment objective of the Managed Bond Fund is
to provide interest income and capital appreciation.
4
<PAGE> 7
INVESTMENT POLICIES. The Managed Bond Fund, which is subadvised by Scudder,
Stevens & Clark, Inc. ("Scudder"), invests in a diversified portfolio of
investment grade intermediate and longer term securities, which consist of
domestic and foreign corporate and governmental fixed income obligations,
mortgage-backed securities, collateralized mortgage obligations ("CMOs"), asset
backed securities, municipal securities and cash equivalents. Under normal
circumstances, at least 65% of the Fund's net assets will be invested in
investment grade bonds. Under normal market conditions, the average duration of
the Fund's portfolio will be between two and five years.
The Managed Bond Fund may invest up to 35% of its total assets in
securities that are not rated "investment grade" -- that is, not rated within
the four highest rating categories by a nationally recognized statistical rating
organization ("NRSRO") such as Standard & Poor's Corporation ("S&P"), Duff &
Phelps Credit Co. ("D&P"), Fitch Investors Service, Inc. ("Fitch") or Moody's
Investor Service, Inc. ("Moody's"). The Fund intends that the securities it
purchases will be rated at least "BB" by S&P, D&P or Fitch or "Ba" by Moody's,
or that if the investment is unrated it will be deemed of comparable quality by
Scudder. Securities rated "BB" or "Ba" have speculative characteristics and
present greater risks as to the timely payment of principal and interest than
investment grade securities. (See "Other Investment Practices and
Considerations -- Certain Risk Factors" below.) These ratings are described in
Appendix A to this Prospectus.
Interest income is expected to be the primary basis for investment return
from an investment in the Fund, and capital appreciation the secondary basis.
The Fund will attempt to achieve capital appreciation by moderate market timing
in response to anticipated interest rate changes. The Fund will also attempt to
take advantage of undervalued sectors while selling bonds in overvalued sectors.
However, since investments will normally consist of bonds and mortgage-backed
securities, the Fund's ability to achieve capital appreciation is limited.
In addition to the foregoing investment policies, the Managed Bond Fund may
invest in accordance with other policies discussed below under "Common
Investment Policies."
CAPITAL INCOME FUND
INVESTMENT OBJECTIVE. The Capital Income Fund seeks to provide investors
with a total investment return, comprised of current income and capital
appreciation, consistent with prudent investment risk.
INVESTMENT POLICIES. The Capital Income Fund invests in a diversified
portfolio consisting principally of convertible bonds and convertible preferred
stocks ("Convertible Securities") of domestic issuers.
The Convertible Securities held in the Fund's portfolio will, for the most
part, be securities issued by U.S. issuers. Under normal circumstances at least
65% of its total assets will be invested in Convertible Securities. Up to 15% of
its total assets also may be held in Eurodollar Convertible Securities. In
addition to Convertible Securities, and subject to the investment policy above,
the Fund also may invest in securities issued or guaranteed by the U.S.
Government (and its agencies and instrumentalities), nonconvertible bonds and
dividend-paying equity securities that are consistent with the Fund's investment
objective, and money market securities.
Similar to straight debt obligations, convertible securities pay a fixed
rate of interest and return principal at maturity; unlike straight debt, they
may be converted into a set amount of corporate common stock. When investing in
such Convertible Securities the Fund is looking for the opportunity, through the
conversion feature, to participate in the capital appreciation of the common
stock into which the Convertible Securities are convertible, while earning
higher current income than is available from the common stock. Investors should
note that the Fund may convert its Convertible Securities when conditions are
not necessarily favorable for their disposition or because of developments with
respect to the issuers or trading markets of such Convertible Securities.
Convertible Securities acquired by the Fund that are rated below investment
grade, or that are not rated, have speculative characteristics and present
greater risks as to the timely payment of principal and interest (or dividends)
than investment grade securities. (See "Other Investment Practices and
Considerations -- Certain Risk Factors" below.) The Fund intends that the
Convertible Securities it purchases will be rated at least "B"
5
<PAGE> 8
by a NRSRO, or that if the investment is unrated it will be deemed of comparable
quality by Bank of America. These ratings are described in Appendix A to this
Prospectus. The Fund is intended for long term investors who can accept the
risks associated with investments in high yield securities and should not
constitute a complete investment program.
In addition to the foregoing investment policies, the Capital Income Fund
may invest in accordance with other policies discussed below under "Common
Investment Policies."
BLUE CHIP FUND
INVESTMENT OBJECTIVE. The Blue Chip Fund seeks long-term capital
appreciation.
INVESTMENT POLICIES. The Blue Chip Fund invests in stocks included in
either the Dow Jones Industrial Average ("DJIA") or the Standard and Poor's 500
Index ("S&P 500"); however, up to 15% of its total assets may be invested in
stocks that are not included in these indices. Under normal circumstances at
least 65% of the Fund's total assets will be invested in blue chip stocks. The
S&P 500 is an unmanaged index of 500 widely held stocks and the DJIA is an
average of 30 actively traded blue chip stocks. Although the DJIA and S&P 500
are comprised principally of the common stocks of domestic issuers, they may
also include some American Depositary Receipts ("ADRs"). ADRs are
dollar-denominated receipts for the shares of a foreign-based corporation held
by a U.S. bank and traded in U.S. markets.
In addition to the foregoing investment policies, the Blue Chip Fund may
invest in accordance with other policies discussed below under "Common
Investment Policies."
MID-CAP EQUITY FUND
INVESTMENT OBJECTIVE. The Mid-Cap Equity Fund seeks capital appreciation.
Income is a secondary consideration.
INVESTMENT POLICIES. The Mid-Cap Equity Fund invests in common stocks of
domestic companies with market capitalizations (aggregate market price of
outstanding publicly-traded shares) from $300 million to $3 billion at the time
of purchase, and in ADRs evidencing ownership of underlying securities of
foreign issuers of similar size. Under normal circumstances at least 65% of the
Fund's total assets will be invested in mid-cap stocks.
In addition to the foregoing investment policies, the Mid-Cap Equity Fund
may invest in accordance with other policies discussed below under "Common
Investment Policies."
AGGRESSIVE GROWTH FUND
INVESTMENT OBJECTIVE. The Aggressive Growth Fund seeks maximum capital
appreciation.
INVESTMENT POLICIES. The Aggressive Growth Fund invests in a diversified
portfolio of securities comprised mainly of common stocks and securities
convertible into common stocks. Under normal circumstances at least 65% of the
Fund's total assets will consist of common stocks of domestic, small-capitalized
companies, that Bank of America expects will achieve above average growth in
earnings and price. Small-capitalized companies generally have limited product
lines, markets and financial resources, are dependent upon a limited management
group and their market capitalization will normally range from $50 million to
$1.5 billion. As a result of the Fund's investments, an investment in the Fund
involves greater risks than portfolios that invest in less volatile stocks (see
"Other Investment Practices and Considerations -- Certain Risk Factors" below).
While the Fund intends to invest primarily in common stock and securities
convertible into such stock, its policy is flexible as to the proportion of its
assets that will be invested in common stocks, and the proportion may be changed
without shareholder approval. However, as a matter of fundamental policy, not
less than 65% of the Fund's total assets will be invested in equity securities
(except during temporary defensive periods). The Fund may invest up to 20% of
its total assets in securities issued by foreign issuers. Such investments will
be made either directly in such issuers or indirectly through ADRs or closed-end
investment companies. Investments in closed-end investment companies will be
limited to 10% or less of the Fund's total assets. The
6
<PAGE> 9
Fund is intended for aggressive long-term investors seeking above average gains
who are willing to accept the greater risks associated with investment in
small-capitalized companies and should not constitute a complete investment
program.
In addition to the foregoing investment policies, the Aggressive Growth
Fund may invest in accordance with other policies discussed below under "Common
Investment Policies."
INTERNATIONAL FUND
INVESTMENT OBJECTIVE. The International Fund seeks long-term capital
growth.
INVESTMENT POLICIES. The International Fund, which is subadvised by
Wellington Management Company, LLP ("Wellington Management"), invests during
normal market conditions at least 80% of its total assets in equity securities
of companies that are domiciled or have their principal activities in countries
outside the United States. Normally the Fund will invest in equity securities of
companies in at least three different foreign countries, subject to certain
further diversification requirements described under "Common Investment
Policies -- Foreign Securities." The domicile or the location of the principal
activities of a company will be the country under whose laws the company is
organized, in which the principal trading market for the equity securities
issued by the company is located, or in which the company has over half of its
assets or derives over half of its revenues or profits. Equity securities in
which the Fund may invest consist of common stocks, preferred stocks, securities
convertible into common stocks or preferred stocks, and warrants to purchase
such securities. The Fund may also invest in futures and options for purposes of
adjusting country exposure and for hedging or income enhancement purposes.
In connection with its investments in foreign securities, the Fund may
purchase and sell foreign currencies on a spot or forward basis. Such
transactions will be entered into (i) to lock in a particular foreign exchange
rate pending settlement of a purchase or sale of a foreign security or pending
the receipt of interest, principal or dividend payments on a foreign security
held by the Fund ("transaction hedging"), (ii) to hedge against a decline in the
value, in U.S. dollars or in another currency, of a foreign currency in which
securities held by the Fund are denominated ("position hedging"), or (iii) as
part of a foreign index futures and options strategy. A forward currency
contract is an obligation to purchase or sell a currency against another
currency at a future date at a price set at the time the contract is entered
into. Although forward contracts typically will involve the purchase or sale of
foreign currency against the dollar, the Fund may also purchase or sell one
foreign currency forward against another foreign currency. There are certain
markets where it is not possible to engage in effective foreign currency
hedging. Employing currency hedging strategies does not eliminate fluctuations
in the prices of portfolio securities or prevent losses if the prices of such
securities decline. Such strategies involve some transactional expenses for the
Fund. They also involve the risk that anticipated currency movements will not be
predicted accurately and the Fund's total return could be adversely affected as
a result.
The Fund may invest up to 20% of its total assets (at the time of purchase)
in convertible bonds and debt securities. These debt obligations include U.S.
Government and foreign government securities and corporate debt securities,
including Samurai and Yankee bonds and Eurobonds. The Fund will limit its
purchase of debt securities to investment grade obligations. The Fund may also
invest, without limitation, in securities of foreign issuers in the form of ADRs
or other similar securities evidencing ownership of underlying securities issued
by foreign issuers. ADRs purchased for the Fund will be included as part of the
80% of assets in foreign equity securities. These securities may not necessarily
be denominated in the same currency as the securities underlying the ADRs.
In addition to the foregoing investment policies, the International Fund
may invest in accordance with other policies described below under "Common
Investment Policies." An investment in non-U.S. securities involves certain
risks which may not be present in a fund which invests solely in U.S. issuers,
as discussed below under "Other Investment Practices and
Considerations -- Certain Risk Factors."
You may also refer to the SAI for further information about the Funds'
investment policies.
7
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COMMON INVESTMENT POLICIES
CASH EQUIVALENTS. With the exception of the Money Market Fund, for
temporary defensive purposes (for example, when Bank of America or a Subadviser
believes such a position is warranted by uncertain or unusual market conditions,
or when liquidity is required to meet unusually high redemption requests), each
Fund may invest without limitation in cash equivalents such as money market
instruments (including short-term bank time deposits, certificates of deposit,
bankers' acceptances, obligations issued or guaranteed by the U.S. Government,
its agencies or instrumentalities, and commercial paper issued by U.S. and
foreign issuers which is rated at the time of purchase at least Prime-2 by
Moody's or A-2 by S&P) and, subject to the investment limitations described
below, shares of other open-end investment companies which seek to maintain a
$1.00 net asset value per share ("money market funds"). With the exception of
the Money Market Fund, under normal market conditions, no more than 10% of a
Fund's net assets will be invested in cash equivalents.
U.S. GOVERNMENT OBLIGATIONS. Each Fund may invest in U.S. Government
obligations. Investments in U.S. Treasury securities are backed by the "full
faith and credit" of the U.S. Government. Such securities include Treasury
bills, Treasury notes and Treasury bonds. Obligations of certain agencies and
instrumentalities of the U.S. Government, such as the Small Business
Administration, are backed by the full faith and credit of the U.S. Government;
others, like obligations of the Federal National Mortgage Association ("FNMA"),
are backed by the discretionary authority of the U.S. Government to purchase the
agency's obligations; and still others, including obligations of the Student
Loan Marketing Association, are backed solely by the issuer's credit. There is
no assurance that the U.S. Government would support a U.S. Government-sponsored
entity if it were not required to do so by law.
WHEN-ISSUED PURCHASES, FORWARD COMMITMENTS AND DELAYED SETTLEMENTS. Each
Fund may purchase securities on a "when-issued" basis and may purchase or sell
securities on a "forward commitment" or "delayed settlement" basis. When-issued
securities are securities purchased for delivery beyond the normal settlement
date at a stated price and yield. Forward commitments involve a commitment by a
Fund to purchase or sell particular securities with payment and delivery taking
place at a future date (perhaps one or two months later). Delayed settlement
describes a securities transaction in a secondary market for which settlement
will occur sometime in the future. When-issued and forward commitment
transactions permit a Fund to lock in a price or yield on a security it owns or
intends to purchase or sell, regardless of changes in interest rates.
When-issued, forward commitment and delayed settlement transactions, however,
involve the risk that the yield or price obtained in a transaction may be less
favorable than the yield or price available in the market when the securities
delivery takes place. Each Fund's activities in these transactions are not
expected to exceed 10% of the value of the Fund's total assets, measured at the
time of investment, absent unusual market conditions. However, for temporary
purposes such as to facilitate redemptions, up to 25% of the value of a Fund's
net assets may be invested in such securities. The Funds do not intend to engage
in these transactions for speculative purposes but only in furtherance of their
investment objectives.
FIXED-INCOME SECURITIES. Each Fund may invest in fixed income securities.
The standards for investment in such securities by the Money Market Fund are
described above under "Investment Objectives and Policies -- Money Market Fund."
Fixed income securities, particularly corporate bonds, acquired by the other
Funds will be investment grade at the time of purchase, except that the Managed
Bond Fund may invest up to 35% of its total assets in lower rated securities and
the Capital Income Fund may invest in securities rated at least B by a NRSRO.
Investment grade debt securities ordinarily carry lower rates of interest than
lower quality debt securities with similar maturities. While bonds rated
investment grade are regarded as having adequate capacity to pay interest and
repay principal, adverse economic conditions, changing circumstances, or
circumstances not known or adequately taken into account by the rating agency
could lead to a weakened capacity to pay interest and repay principal. Bonds
with the lowest investment grade rating (i.e., BBB or Baa) do not have
outstanding investment characteristics and may have speculative characteristics
as well. Unrated securities will be purchased only if Bank of America or its
Subadvisers believe that they are of comparable quality to the rated securities
in which the Funds may invest.
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If fixed income securities purchased by the Blue Chip, Mid-Cap Equity,
Aggressive Growth, International Fund or by the Managed Bond Fund with respect
to 65% of its portfolio, subsequently fall below investment grade, the Fund will
seek to dispose of the securities in an orderly and prudent manner, normally
over a period of approximately 30 to 90 days. If the rating of a fixed income
security held by the Capital Income or International Fund falls below investment
grade, or if the rating of a fixed income security held by the Managed Bond Fund
falls below BB, the Fund will not be obligated to dispose of such security and
may continue to hold the security if, in the opinion of Bank of America or its
Subadviser, such investment is considered appropriate under the circumstances.
Yields on fixed income securities depend on a variety of factors, including
the general conditions of the money and bond markets, the size of a particular
offering, the maturity of the obligation, and the rating of the issue. Debt
obligations with longer maturities tend to produce higher yields and are
generally subject to potentially greater capital appreciation and depreciation
than obligations with shorter maturities. The market prices of debt obligations
vary depending on available yields. An increase in interest rates will generally
reduce the value of such portfolio investments, and a decline in interest rates
will generally increase the value of such portfolio investments.
NON-INVESTMENT GRADE SECURITIES. The Capital Income and Managed Bond Funds
may invest in securities rated below investment grade or in comparable unrated
securities. While any investment carries some risk, some of the risks associated
with lower-rated securities are different from the risks associated with
investment grade securities. The risk of loss through default is greater because
lower-rated securities are usually unsecured and are often subordinate to an
issuer's other obligations. Additionally, the issuers of these securities
frequently have high debt levels and are thus more sensitive to changing
economic conditions, individual corporate developments and rising interest
rates. Consequently, the market price of these securities, and the net asset
value of the Funds' shares, may be quite volatile.
RELATIVE YOUTH OF LOWER-RATED SECURITIES MARKET. Because the market for
lower-rated securities, at least in its present size and form, is relatively
new, there remains some uncertainty about its performance level under adverse
market and economic environments. An economic downturn or increase in interest
rates could have a negative impact on both the market for lower-rated securities
(resulting in a greater number of bond defaults) and the value of lower-rated
securities held in a Fund's portfolio.
SENSITIVITY TO INTEREST RATE AND ECONOMIC CHANGES. The economy and interest
rates can affect lower-rated securities differently than other securities. For
example, the prices of lower-rated securities are more sensitive to adverse
economic changes or individual corporate developments than are the prices of
higher-rated investments. Also, during an economic downturn or a period in which
interest rates are rising significantly, highly leveraged issuers may experience
financial difficulties, which in turn would adversely affect their ability to
service their principal and interest payment obligations, meet projected
business goals and obtain financing. If the issuer of a security defaults, the
Fund may incur additional expenses to seek recovery. In addition, periods of
economic uncertainty would likely result in increased volatility for the market
prices of lower-rated securities as well as a Fund's net asset value. In
general, both the prices and yields of lower-rated securities will fluctuate.
LIQUIDITY AND VALUATION. In certain circumstances it may be difficult to
determine a security's fair value due to a lack of reliable objective
information. Such instances may occur when there is not an established secondary
market for the security or the security is thinly traded. As a result, a Fund's
valuation of a security and the price it is actually able to obtain when it
sells the security could differ. Adverse publicity and investor perceptions,
whether or not based on fundamental analysis, may decrease the values and
liquidity of lower-rated securities held by a Fund, especially in a thinly
traded market. Illiquid or restricted securities held by a Fund may involve
special registration responsibilities, liabilities and costs, and could involve
other liquidity and valuation difficulties.
CONGRESSIONAL PROPOSALS. Current laws, as well as pending proposals, may
have a material impact on the market for lower-rated securities.
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CREDIT RATINGS. S&P, Moody's and other nationally recognized statistical
rating organizations evaluate the safety of a lower-rated security's principal
and interest payments, but do not address market value risk. Because the ratings
by the rating agencies may not always reflect current conditions and events, in
addition to using recognized rating agencies and other sources, Bank of America
and Scudder perform their own analyses of the issuers whose lower-rated
securities the Funds purchase. Because of this, a Fund's performance may depend
more on the Manager's or Subadviser's own credit analysis than is the case for
mutual funds investing in higher rated securities. In selecting such securities,
Bank of America or Scudder considers factors such as those relating to the
creditworthiness of issuers, the ratings and performance of the securities, the
protections afforded the securities and the diversity of the Fund's portfolio.
Bank of America or Scudder monitors the issuers of lower-rated securities held
in a Fund's portfolio for their ability to make required principal and interest
payments, as well as in an effort to control the liquidity of the Fund's
portfolio so that it can meet redemption requests. If a portfolio security
undergoes a rating revision, a Fund may continue to hold the security if Bank of
America or Scudder determines such retention is warranted.
CONVERTIBLE SECURITIES. The Managed Bond, Capital Income, Aggressive Growth
and International Funds may invest in Convertible Securities. Convertible
Securities are generally non-investment grade and have unique investment
characteristics because they generally have higher yields than common stocks,
generally are less subject to a decline in value than their underlying common
stocks because of their fixed income characteristics, and generally provide for
the potential of capital appreciation if the market value of their underlying
common stock increases. Because Convertible Securities purchased by the
International Fund are acquired in substantial part for their equity
characteristics, they are not subject to minimum rating requirements. An issuer
of a Convertible Security may have the option to redeem it at a price
established in the Convertible Security's governing instruments. If a
Convertible Security held by a Fund is called for redemption, the Fund will
either have to permit the redemption, convert the Convertible Security into the
underlying common stock or sell the Convertible Security to a third party. Any
of these actions could adversely affect the Fund's ability to attain its
objective. A Fund would convert a Convertible Security either to permit the
orderly disposition of the investment or when it has reached maturity or been
called for redemption. A Fund might also convert a Convertible Security if the
underlying common stock's dividend rate were to increase above the yield on the
Convertible Security.
Eurodollar Convertibles, in which the Capital Income and International
Funds may invest up to 15% of their respective total assets, are fixed income
securities of a U.S. or foreign issuer that are issued in U.S. dollars outside
of the U.S. and are convertible into or exchangeable for specified equity
securities. Eurodollar Convertibles in which the Capital Income Fund invests
will be convertible into or exchangeable for foreign equity securities.
VARIABLE AND FLOATING RATE INSTRUMENTS. The Money Market, Managed Bond,
Capital Income, Blue Chip, Mid-Cap Equity, Aggressive Growth and International
Funds may invest in variable and floating rate instruments, which may include
master demand notes. Although payable on demand by a Fund, master demand notes
may not be marketable. Consequently, the ability to redeem such notes may depend
on the borrower's ability to pay, which will be monitored by Bank of America or
a Subadviser. Such notes will be purchased only from domestic corporations that
either (a) are rated Aa or better by Moody's or AA or better by S&P, (b) have
commercial paper rated at least Prime-2 by Moody's or A-2 by S&P, (c) are backed
by a bank letter of credit or (d) are determined by the Manager or a Subadviser
to be of a quality comparable to securities described in either clause (a) or
(b).
DERIVATIVES. "Derivatives" is a broad term which may be used to describe
many investment instruments whose values are derived, at least in part, from the
value of another underlying asset or reference instrument. Some derivative
instruments have simple structures and others have intricate components and
terms. Some are more volatile, and some have equal or less volatility, than the
asset or reference instrument upon whose value the derivative is based. If used
to leverage a portfolio, derivatives could magnify risk. However, the Funds are
not permitted to engage in leveraging transactions. Derivatives are often used
by the Manager or Subadvisers to hedge positions, defray the risks of interest
rate or currency changes and reduce portfolio or market risk.
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Each Fund has its own authorizations to use prescribed instruments, which
may include options, forward foreign currency contracts, foreign currency
options, spread transactions, futures contracts and options thereon, foreign
futures, mortgage-related securities, CMOs, stripped mortgage-backed securities
and other asset-backed securities. Each of the Funds has the authority to use
some type of derivative instrument. The strategy employed and the magnitude of
the position maintained will determine the level of risk a Fund may assume by
utilizing derivative instruments. The types and investment techniques employed
with respect to the derivative instruments which are most commonly purchased and
sold by the Funds are included among the descriptions below and in the SAI.
MORTGAGE-BACKED SECURITIES. The Managed Bond, Capital Income, Blue Chip,
Mid-Cap Equity and Aggressive Growth Funds may invest in mortgage-backed
securities. Mortgage-backed securities such as Government National Mortgage
Association ("GNMA"), FNMA and Federal Home Loan Mortgage Corporation ("FHLMC")
securities consist of interests in pools of real estate mortgage loans with
varying guarantees with respect to principal and interest, but not market value,
by the U.S. Government or by one of its agencies or instrumentalities. These
securities are more fully described in the SAI. A risk associated with
mortgage-backed securities is early paydown resulting from refinancing of the
underlying mortgages which is similar to the risk that corporate bonds might be
called by the issuer if the bond interest rate is higher than currently
prevailing interest rates. The rate of such prepayments, and hence the life of
the security, will primarily be a function of current market rates. In periods
of falling interest rates, the rate of prepayments tends to increase. During
such periods, the reinvestment of prepayment proceeds will generally be at lower
rates than the rates on the prepaid obligations.
Such Funds may also invest in mortgage-related securities which are issued
by private entities such as investment banking firms and companies related to
the construction industry. The privately issued mortgage-related securities in
which the Funds may invest include, but are not limited to: (i) privately issued
securities which are collateralized by pools of mortgages in which some
mortgages are guaranteed as to payment of principal and interest by an agency,
instrumentality or sponsored enterprise of the U.S. Government; (ii) privately
issued securities which are collateralized by pools of mortgages in which such
mortgages are guaranteed as to the payment of principal and interest by the
issuer and such guarantee is collateralized by U.S. Government securities; and
(iii) other privately issued securities in which the proceeds of the issuance
are invested in mortgage-backed securities and which mortgage-related securities
are supported as to the payment of the principal and interest by the credit of
any agency, instrumentality or sponsored enterprise of the U.S. Government.
COLLATERALIZED MORTGAGE OBLIGATIONS. The Managed Bond and Aggressive Growth
Funds may invest in CMOs, which are hybrids between mortgage-backed bonds and
mortgage pass-through securities. Similar to a bond, interest and prepaid
principal on CMOs are paid, in most cases, semiannually. CMOs may be
collateralized by whole mortgage loans but are more typically collateralized by
portfolios of mortgage passthrough securities guaranteed by GNMA, FHLMC, or
FNMA, and their income streams.
ASSET-BACKED SECURITIES. The Managed Bond and Aggressive Growth Funds may
invest in asset-backed securities, which consist of undivided fractional
interests in pools of mortgages, consumer loans or receivables held in a trust.
Examples include certificates for automobile receivables ("CARs") and credit
card receivables ("CARDs"). Payments of principal and interest on the mortgages,
loans or receivables are passed through to certificate holders. Asset-backed
securities may be issued by either governmental or non-governmental entities.
Payment on asset-backed securities of private issuers is typically supported by
some form of credit enhancement, such as a letter of credit, surety bond,
limited guaranty, or subordination. The extent of credit enhancement varies, but
usually amounts to only a fraction of the asset-backed security's par value
until exhausted. Ultimately, asset-backed securities are dependent upon payment
of the mortgages, consumer loans or receivables by individuals, and the
certificate holder frequently has no recourse to the entity that originated the
loans or receivables.
The assets underlying asset-backed securities may be prepaid with the
result of shortening the certificates' weighted average life. Prepayment rates
vary widely and may be affected by changes in market interest rates. It is not
possible to accurately predict the average life of a particular pool of
mortgages, loans or
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receivables. The proceeds of prepayments received by a Fund must be reinvested
in securities whose yields reflect interest rates prevailing at the time. Thus,
a Fund's ability to maintain a portfolio which includes high-yielding
asset-backed securities will be adversely affected to the extent reinvestments
are in lower yielding securities. The actual maturity and realized yield will
therefore vary based upon the prepayment experience of the underlying asset pool
and prevailing interest rates at the time of prepayment. Also, while the
secondary market for certain asset-backed securities is ordinarily quite liquid,
in times of financial stress the secondary market may not be as liquid as the
market for other types of securities, which could make valuing or liquidating
such securities difficult.
EQUITY SECURITIES. The Capital Income, Blue Chip, Mid-Cap Equity,
Aggressive Growth and International Funds may invest in equity securities,
including common and preferred stocks and securities convertible into such
stocks of domestic and foreign companies with small, medium and large market
capitalizations (public market price times total outstanding shares). While
equity securities have historically experienced a higher level of volatility due
to market fluctuations than fixed income securities, they have also historically
provided higher levels of total return. In addition, investments in companies
with smaller market capitalizations involve greater risk than investments in
larger, more established companies, including more volatile market price
movements.
FOREIGN SECURITIES. Subject to its investment objectives and policies
stated above, the International Fund will invest in debt and equity securities
of foreign issuers that may or may not be publicly traded in the United States.
In addition, the Managed Bond, Capital Income and Aggressive Growth Funds may
invest in such securities, and all Funds except the Money Market Fund may invest
indirectly in foreign securities through ADRs. It is currently the intention of
the Aggressive Growth Fund to invest no more than 20% of its total assets at the
time of purchase in securities of foreign issuers (including ADRs), of which up
to 10% of such total assets may be invested in debt obligations of foreign
issuers. The Managed Bond Fund's direct investments in issuers of foreign
securities (excluding ADRs) will not exceed 25% of its total assets at the time
of purchase.
Such securities may include, subject to the further investment limitations
stated under "Investment Company Securities," below, shares of closed-end
investment companies that invest primarily in securities of foreign issuers.
Foreign debt securities may include Yankee bonds (dollar-denominated bonds sold
in the United States by non-U.S. issuers), Eurobonds (bonds issued in a country
and sometimes a currency other than the country of the issuer) and Samurai Bonds
(yen denominated bonds issued in Japan by non-Japanese borrowers). Except for
the Managed Bond Fund, a Fund's investment limitations regarding its investments
in foreign securities also apply to investments in Depositary Receipts.
Investments in foreign securities by a Fund, whether made directly or
indirectly, also involve certain inherent risks, including political or economic
instability of the issuer or the country of issue, the difficulty of predicting
international trade patterns, changes in foreign currency exchange rates and the
possibility of adverse changes in investment or exchange control regulations.
There is typically less publicly available information about a foreign company
than about a U.S. company. Moreover, these companies may be subject to less
stringent reserve, auditing and reporting requirements than their U.S.
counterparts. Additionally, foreign stock markets are generally not as developed
or efficient as those in the U.S., and in most foreign markets volume and
liquidity are less than in the U.S. Fixed commissions on foreign stock exchanges
are also generally higher than the negotiated commissions on U.S. exchanges, and
there is generally less government supervision and regulation of foreign stock
exchanges, brokers and companies than in the U.S. There is also the possibility
that foreign governments could expropriate assets or levy confiscatory taxes,
set limitations on the removal of assets or suffer adverse diplomatic
developments.
Each Fund that invests in foreign securities is subject to guidelines for
diversification of foreign security investments imposed by California insurance
authorities. Foreign investments will be allocated to at least five countries if
at least 80% of a Fund's net assets is invested in foreign securities. In
addition, a Fund may not invest more than 20% of its net assets in any one
country, except that a Fund may invest up to 35% of its net assets in one of the
following countries: Australia, Canada, France, Japan, the United Kingdom or
Germany.
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The Funds may exceed these limitations to the extent permitted by the California
Insurance authorities. The California diversification guidelines are more fully
described in the SAI.
DEPOSITARY RECEIPTS. All Funds except the Money Market Fund may invest in
ADRs, and the International Fund may invest in various other types of Depositary
Receipts, such as American Depositary Shares ("ADSs"), European Depositary
Receipts ("EDRs"), Global Depositary Receipts ("GDRs"), Global Depositary
Certificates ("GDCs") and International Depositary Receipts ("IDRs"). ADRs and
ADSs typically are issued by a United States bank or trust company and evidence
ownership of underlying securities issued by a foreign corporation. EDRs, which
are sometimes referred to as Continental Depositary Receipts ("CDRs"), GDRs,
GDCs and IDRs are typically issued by foreign banks or trust companies, although
they also may be issued by United States banks or trust companies, and evidence
ownership of underlying securities issued by either a foreign or a United States
corporation. Depositary Receipts may be available for investment through
"sponsored" or "unsponsored" facilities. A sponsored facility is established
jointly by the issuer of the security underlying the receipt and a depository,
whereas an unsponsored facility may be established by a depository without
participation by the issuer of the receipt's underlying security. Holders of an
unsponsored Depositary Receipt generally bear all the costs of the unsponsored
facility. The depository of an unsponsored facility frequently is under no
obligation to distribute shareholder communications received from the issuer of
the deposited security or to pass through to the holders of the receipts voting
rights with respect to the deposited securities.
OPTIONS. Each Fund except the Money Market Fund may enter into options
transactions. Put options and call options may be purchased by each of such
Funds on securities; by the Blue Chip, Mid-Cap Equity, and Aggressive Growth
Funds on stock indices; and by the Aggressive Growth and International Funds on
foreign currencies. In addition, the International Fund may sell, or "write,"
covered put options on securities, securities indices and foreign currencies.
Covered call options may be written by the Managed Bond, Capital Income, Blue
Chip, Mid-Cap Equity, Aggressive Growth and International Funds on securities;
by the Blue Chip, Aggressive Growth and International Funds on securities
indices; and by the International Fund on foreign currencies. All such options
transactions will be on U.S. securities traded on U.S. exchanges, except that
the International Fund's options transactions may be on U.S. or foreign
exchanges and in over-the-counter markets.
A call option for a particular security gives the purchaser of the option
the right to buy, and a writer the obligation to sell, the underlying security
at the stated exercise price at any time prior to the expiration of the option,
regardless of the market price of the security. The premium paid to the writer
is the consideration for undertaking the obligations under the option contract.
A put option for a particular security gives the purchaser the right to sell the
underlying security at the stated exercise price at any time prior to the
expiration date of the option, regardless of the market price of the security.
In contrast to an option on a particular security, an option on a stock index or
currency provides the holder with the right to receive or obligation to make a
cash settlement upon exercise of the option.
Options trading is a highly specialized activity and carries greater than
ordinary investment risk. Purchasing options may result in the complete loss of
the amounts paid as premiums to the writer of the option. In writing a covered
call option, a Fund gives up the opportunity to profit from an increase in the
market price of the underlying security above the exercise price (except to the
extent the premium represents such a profit). Moreover, the Fund will not be
able to sell the underlying security on which a call option has been written
until the option expires or is exercised or the Fund closes out the option. In
addition, except to the extent that a call option written by a Fund on a
particular index is covered by an option on the same index purchased by the
Fund, movements in the index may cause the Fund to incur a loss, although such
loss might be lessened to the extent that the value of the securities held by
the Fund changed during the time the option was outstanding. In writing a
covered put option, a Fund must retain the assets underlying the option until
the option expires or is exercised or the Fund closes out the option. For
additional information relating to options transactions and the particular risks
thereof, please refer to the SAI.
A Fund will write options only if Bank of America or its Subadvisers
believe a liquid secondary market will exist on a national securities exchange
for options of the same series, thus permitting the Fund to close out
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its option position. There is no assurance that a liquid secondary market will
exist on an exchange for a particular option or at any particular time. In fact,
for some options no secondary market on an exchange may exist at all. If a Fund
cannot close out an option, it will not be able to sell the securities
underlying the option until the option expires or is exercised. Furthermore, a
Fund's ability to engage in transactions in options may be limited by IRS
requirements on its gross income from certain securities, including options and
futures contracts, held by the Fund for less than three months. Bank of America
does not believe that transactions in options will significantly affect the
Funds' ability to comply with IRS requirements. The times of day that options on
particular securities, indices or currencies are sold may not be the same as
those during which the securities, indices or currencies themselves are traded,
which means that significant activity could occur in the markets for the
underlying securities or indices that would not be reflected in the options
markets.
FUTURES AND RELATED OPTIONS. Each Fund except the Money Market Fund may
enter into futures transactions (and related options transactions) as a hedge
against anticipated interest rate fluctuations or changes resulting from market
conditions in the values of the securities that a Fund holds in its portfolio or
intends to purchase or sell, where the transactions are economically appropriate
for the reduction of risks inherent in the ongoing management of the Fund's
portfolio, or for income enhancement. Each of such Funds may purchase and sell
futures contracts and may purchase options on futures contracts. In addition,
the Capital Income Fund may write (sell) options on futures contracts.
Such futures and related options may be on interest rates (Managed Bond,
Capital Income, and International Funds), stock indices (Blue Chip, Mid-Cap
Equity, Capital Income, Aggressive Growth, and International Funds), and foreign
currencies (Aggressive Growth and International Funds). Such futures contracts
and related options will be traded on U.S. or foreign exchanges and in
over-the-counter markets.
The Funds may be subject to additional risks associated with futures
contracts, such as the possibility that the Manager's or Subadviser's forecasts
of market values and other factors are not correct, imperfect correlation
between a Fund's hedging instrument and the asset or liability being hedged,
default by the other party to the transaction, and inability to close out a
position because of the lack of a liquid market. In addition to the possibility
that there may be an imperfect correlation, or no correlation at all, between
movements in a futures contract and the securities being hedged, the price of
futures contracts may not correlate perfectly with movement in the cash market
due to certain market distortions. As a result of these factors, a correct
forecast of general market trends or interest rate movements by the Manager or
Subadviser still may not result in a successful hedging transaction over a short
time frame. More information regarding futures contracts and related options,
including the costs and risks related to such instruments, is included in the
SAI.
INVESTMENT COMPANY SECURITIES. Each Fund may invest in securities of money
market funds as a temporary defensive measure, when market conditions are
uncertain or unusual, or for other purposes. Each Fund may also invest in
securities issued by other investment companies, including those which invest in
foreign securities of the type in which the Funds are authorized to invest. No
more than 10% of the value of a Fund's total assets will be invested in
securities of other investment companies, with no more than 5% of its total
assets invested in the securities of any one investment company (except that a
Fund may invest the greater of 5% of its net assets or $2.5 million in the
securities of a money market mutual fund advised by Bank of America). In
addition, a Fund may hold no more than 3% of the outstanding voting stock of any
other investment company.
As the shareholder of another investment company, a Fund would bear, along
with other shareholders, its pro rata portion of the other investment company's
expenses, including advisory fees. However, Bank of America will reduce its
advisory fees to the Funds by the amount of any advisory fees of such other
investment company borne by the Funds. Such expenses are in addition to the
expenses a Fund pays in connection with its own operations.
REPURCHASE AGREEMENTS. Each Fund may buy securities subject to the seller's
agreement to repurchase them at an agreed upon time and price. These
transactions are known as repurchase agreements. The Funds will enter into
repurchase agreements only with financial institutions (such as banks and
broker-dealers) deemed creditworthy by Bank of America or a Subadviser, under
guidelines approved by the Company's Board of Trustees. It is intended that such
agreements will not have maturities longer than 60 days. During the
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term of any repurchase agreement, the seller must maintain the value of the
securities subject to the agreement in an amount that is greater than the
repurchase price. Bank of America or its Subadvisers monitor that value to make
sure that it is maintained. Should the seller default on its obligations under
the agreement or the value of the security fall below the repurchase price, the
Fund would be exposed to possible loss due to adverse market action or delays
connected with the disposition of the underlying obligations. Repurchase
agreements are considered to be loans under the 1940 Act.
REVERSE REPURCHASE AGREEMENTS. Each Fund may borrow money for temporary
purposes by entering into transactions called reverse repurchase agreements.
Under these agreements, a Fund sells portfolio securities to financial
institutions (such as banks and broker-dealers) and agrees to buy them back
later at an agreed upon time and price. When a Fund enters into a reverse
repurchase agreement, it places in a separate custodial account either liquid
assets or other high-grade debt securities which have a value equal to or
greater than the repurchase price. The account is monitored by Bank of America
or its Subadvisers to make sure that an appropriate value is maintained. Reverse
repurchase agreements involve the risk that the value of portfolio securities a
Fund relinquishes may decline below the price the Fund must pay when the
transaction closes. Interest paid by a Fund in connection with a reverse
repurchase agreement will reduce the net investment income of such Fund. The
Funds will only enter into reverse repurchase agreements to avoid the need to
sell portfolio securities to meet redemption requests. Reverse repurchase
agreements are considered to be borrowings under the 1940 Act. Borrowings may
magnify the potential for gain or loss on amounts invested, resulting in an
increase in the speculative character of a Fund's outstanding shares. A Fund's
investment in reverse repurchase agreements, together with its investment in
when-issued, forward commitment and delayed settlement transactions, is normally
limited to 10% of the Fund's total assets measured at the time of investment.
However, for temporary purposes such as to facilitate redemptions, up to 25% of
a Fund's total assets may be invested in reverse repurchase agreements.
SECURITIES LENDING. In order to earn additional income, each Fund other
than the Money Market Fund may lend portfolio securities to banks,
broker-dealers or other financial institutions that Bank of America or its
Subadvisers consider to be of good standing. Borrowers of portfolio securities
may not be affiliated directly or indirectly with the Trust or the particular
Fund. If the borrower should become bankrupt, however, a Fund could experience
delays in recovering its securities. A securities loan will only be made when,
in the judgment of Bank of America or its Subadvisers, the possible reward from
the loan justifies the possible risks. In addition, such loans will not be made
by a Fund if, as a result, the value of securities loaned exceeds 1/3 of the
Fund's total assets. Securities loans will be fully collateralized by U.S.
Government securities or cash equivalents.
ILLIQUID SECURITIES. No Fund will invest more than 15% (10% for the Money
Market Fund) of the value of its net assets (determined at the time of
acquisition) in securities that are illiquid. If, after the time of acquisition,
events cause a Fund to exceed this limit, the Fund will take steps to reduce the
aggregate amount of illiquid securities as soon as is reasonably practicable.
The Trust intends that the investments in securities that are not registered
under the Securities Act of 1933 (the "1933 Act") but may be purchased by
institutional buyers under Rule 144A and for which a liquid trading market
exists as determined by the Board of Trustees (or Bank of America or its
Subadvisers pursuant to guidelines adopted by the Board), will not be subject to
the limitation on illiquid securities. This investment practice could have the
effect of increasing the level of illiquidity in the Funds during any period
that institutional buyers under Rule 144A became uninterested in purchasing
these restricted securities.
Each Fund may also invest in commercial paper issued in reliance on the
so-called "private placement" exemption from registration afforded by Section
4(2) of the 1933 Act ("Section 4(2) paper"). Section 4(2) paper is restricted as
to disposition under the Federal securities laws and generally is sold to
institutional investors such as the Funds that agree to purchase the paper for
investment and not with a view to public distribution. Any resale by the
purchaser must be in an exempt transaction. Section 4(2) paper normally is
resold to other institutional investors through or with the assistance of the
issuer or investment dealers that make a market in Section 4(2) paper. Section
4(2) paper will not be subject to the Funds' 15% (10% for the Money Market Fund)
limitation on illiquid securities where the Board of Trustees (or Bank of
America or its Subadvisers pursuant to the guidelines adopted by the Board)
determines that a liquid trading market exists.
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SECURITIES ISSUED BY BANK OF AMERICA AND AFFILIATES. The Funds will not
invest in instruments or securities issued by Bank of America or any of its
affiliates (except that a Fund may invest the greater of 5% of its net assets or
$2.5 million in a money market mutual fund advised by Bank of America).
PORTFOLIO TURNOVER. The Funds' investment practices may result in portfolio
turnover greater than 100%. Higher rates of turnover may require payment of
brokerage commissions and impose other transaction costs on the Funds. Although
no commissions are paid on bond transactions, purchases and sales are at net
prices which reflect dealers' mark-ups and mark-downs, and a higher portfolio
turnover rate for bond investments will result in the payment of more dealer
mark-ups and mark-downs than would otherwise be the case. Anticipated turnover
rates will not be a limiting factor in making investment decisions for the
Funds. The anticipated annual turnover rates for the Funds are as follows:
Managed Bond Fund, 40%; Capital Income Fund, 85%; Blue Chip Fund, 100%; Mid-Cap
Equity Fund, 100%; Aggressive Growth Fund, 100%; and International Fund, 75%.
DIVERSIFICATION AND CHANGES IN INVESTMENT POLICIES
Each Fund is diversified, so that, with respect to 75% of the total assets
of the Fund, it may not invest more than 5% of its total assets (taken at market
value at the time of investment) in securities of any one issuer, except that
this restriction does not apply to U.S. Government securities.
The investment objective of each Fund and its status as a diversified
portfolio are "fundamental" matters that may not be changed without the approval
of the holders of a majority of the Fund's outstanding shares as defined in the
1940 Act. A Fund's investment policies may be changed by the Trust's Board of
Trustees without the affirmative vote of the Fund's outstanding shares. However,
the Funds are subject to investment restrictions described in the SAI, some of
which are designated as fundamental matters which may not be changed without
shareholder approval.
OTHER INVESTMENT PRACTICES AND CONSIDERATIONS
INVESTMENT DECISIONS. Bank of America and each Subadviser places orders for
the purchase and sale of assets it manages with brokers and dealers selected by
and in its discretion. In executing such transactions, Bank of America or the
Subadviser seeks to obtain the best price and execution for the Funds, but a
Fund may pay higher than the lowest available commission rates when Bank of
America or the Subadviser believes it is reasonable to do so in light of the
value of the brokerage and research services provided by the broker effecting
the transaction. The selection of such brokers, however, will be made in
accordance with Section 28(e) of the Securities Exchange Act of 1934. Section
28(e) requires an investment adviser to make a good faith determination that the
commissions paid to a broker are reasonable in relation to the value of the
brokerage and research services provided by such broker, viewed in terms of
either that particular transaction or the adviser's overall responsibilities
with respect to the accounts as to which it exercises investment discretion.
Investment decisions for a particular Fund are made independently from
those for other investment companies and accounts managed by Bank of America and
its Subadvisers and their affiliated entities. Such other investment companies
and accounts may also invest in the same securities as a Fund. When a purchase
or sale of the same security is made at substantially the same time on behalf of
a Fund and another investment company or account, available investments or
opportunities for sales will be equitably allocated pursuant to procedures of
Bank of America or its Subadviser. In some instances, this investment procedure
may adversely affect the price paid or received by such Fund or the size of the
position obtained or sold by the Fund.
In allocating the purchase and sale orders for investment securities
involving the payment of brokerage commissions or dealer concessions, Bank of
America or a Subadviser may consider the sale of Fund shares by broker-dealers
and other financial institutions (including affiliates of Bank of America or its
Subadviser to the extent permitted by law), provided the Manager or Subadviser
believes the quality of the transaction and the price to a Fund are not less
favorable than what they would be with any other qualified firm.
CERTAIN RISK FACTORS. Although investing in any mutual fund has certain
inherent risks, including the risks described above, the Funds described below
are subject to certain additional risks.
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CAPITAL INCOME FUND. The Capital Income Fund will invest principally in
Convertible Securities, which may be rated below "investment grade" or unrated.
These securities are subject to the risk considerations described above under
"Certain Investment Policies -- Non-Investment Grade Securities."
MANAGED BOND FUND. The Managed Bond Fund will invest principally in
investment grade intermediate and longer-term fixed income securities. Fixed
income securities are subject to interest rate risk, as the value of such
securities will vary inversely with changes in interest rates. Thus, during
periods of rising interest rates, the market value of the Fund's portfolio
securities, and the value of the Fund's shares, can be expected to decline,
which may reduce the total return to shareholders from an investment in the
Fund. Fixed income securities are also subject to additional risks described
above under "Certain Investment Policies -- Fixed Income Securities."
The Managed Bond Fund may invest in securities rated below "investment
grade" or unrated. These securities are subject to the risk considerations
described under "Certain Investment Practices -- Non-Investment Grade
Securities."
AGGRESSIVE GROWTH FUND. An investment in the Aggressive Growth Fund may
have even greater risks than investments in most other types of mutual funds.
This Fund is not a complete investment program, and it may not be appropriate
for an investor if he or she cannot bear financially the loss of at least a
significant portion of his or her investment. The Fund's net asset value per
share is subject to rapid and substantial changes because greater risk is
assumed in seeking maximum growth. The securities of the small-capitalized
companies which the Fund expects to emphasize may be subject to more abrupt or
erratic market movements than larger more established companies, both because
the securities typically are traded in lower volume and because the issuers
typically are subject to a greater degree to changes in earnings and prospects.
Many of the securities which Bank of America believes would have the greatest
growth potential may be considered highly speculative. Additionally, such
securities may not be traded every day or in the volume typical of trading on a
national securities exchange. As a result, the disposition by the Fund of
portfolio securities, to meet redemptions or otherwise, may require the Fund to
sell these securities at a discount from market prices, to sell during periods
when such disposition is not desirable, or to make many small sales over a
lengthy period of time.
The Aggressive Growth Fund's investments in foreign securities are subject
to the risk considerations described above under "Certain Investment
Policies -- Foreign Securities."
INTERNATIONAL FUND. The International Fund invests principally in foreign
securities, which are subject to the risk considerations described above under
"Certain Investment Policies -- Foreign Securities."
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<PAGE> 20
THE BUSINESS OF THE FUNDS
FUND MANAGEMENT
The business affairs of the Trust are managed under the general supervision
of its Board of Trustees, under the laws of the State of Delaware. Information
about the Trustees and officers of the Trust is included in the SAI under
"Management."
EXPENSES
The Funds bear all costs of their operations. Operating expenses borne by
the Funds include taxes, interest, brokerage fees and commissions, fees and
expenses of the independent Trustees, the Manager's fees, custodial and transfer
agency fees, certain insurance premiums, outside auditing and legal expenses,
costs of shareholder reports, proxies and meetings and any extraordinary
expenses. The Funds' expenses also include Securities and Exchange Commission
fees, costs of maintaining the Trust's legal status as a trust, costs of
preparing and printing prospectuses and statements of additional information for
regulatory purposes and for distribution to shareholders, and certain support
servicing fees. Except as noted in this Prospectus, the service contractors bear
all expenses in connection with the performance of their services and the Funds
bear the expenses incurred in their operations.
SERVICE PROVIDERS
MANAGER. Bank of America serves as the Funds' Manager. Bank of America is a
subsidiary of BankAmerica Corporation, a registered bank holding company. Its
principal offices are located at 555 California Street, San Francisco,
California 94104.
Formed in 1904, Bank of America is a national banking association that
provides commercial banking and trust business through an extensive system of
branches across the western United States. Bank of America's principal banking
affiliates operate branches in ten U.S. states as well as corporate banking and
business credit offices in major U.S. cities. In addition, it has corporate
offices and representative offices in 36 foreign countries.
In its management agreement, Bank of America has agreed to manage the
Funds' investments and to be responsible for, place orders for, and make
decisions with respect to, all purchases and sales of the Funds' securities. The
management agreement also provides that Bank of America may, in its discretion,
provide advisory services through its own employees or employees of one or more
of its affiliates that are under the common control and management of Bank of
America's parent, BankAmerica Corporation. Bank of America may also employ a
subadviser, provided that Bank of America remains fully responsible to the Funds
for the acts and omissions of the subadviser.
Ed Cassens, Senior Portfolio Manager with Bank of America, is primarily
responsible for the day-to-day investment activities of the Capital Income Fund.
Mr. Cassens is a Chartered Financial Analyst and has been associated since 1966
with BofA Capital Management, Inc. and Seattle-First National Bank, a subsidiary
of Seafirst Corporation which is controlled by BankAmerica Corporation. Mr.
Cassens currently manages Bank of America's EBT Convertible Securities Trust,
Bank of America's Equity Income Fund, and the Pacific Horizon Capital Income
Fund.
Bank of America Illinois' Investment Advisors Division is responsible for
the day-to-day investment activities of the Blue Chip Fund and Mid-Cap Equity
Fund. Its investment management team is headed by James Miller, Executive Vice
President and Chief Investment Officer of BofA Illinois (a wholly owned
subsidiary of BankAmerica Corporation). Mr. Miller has been the manager of the
Pacific Horizon Blue Chip Fund since May 1995 and has been associated with BofA
Illinois Investment Management (and its predecessor Continental Bank) since
1988. Mr. Miller is a Chartered Financial Analyst, a member of the Association
of Investment Management and Research, and a former Director of the Investment
Analysts Society of Chicago.
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<PAGE> 21
Scott A. Billeadeau is primarily responsible for the day-to-day investment
activities of the Aggressive Growth Fund. Mr. Billeadeau, a Chartered Financial
Analyst and a Senior Portfolio Manager with Bank of America, has been associated
with Bank of America since 1991. He is currently the manager of the Pacific
Horizon Aggressive Growth Fund and is also responsible for research and
portfolio management of two of Bank of America's commingled accounts, the EBT
Aggressive Equity Fund and Aggressive Equity Fund G, as well as individual
accounts.
For its services as Manager, Bank of America is entitled to receive fees
from the Funds equal to the following percentages of the average net assets of
each Fund on an annual basis: Money Market Fund, 0.22%; Managed Bond Fund,
0.37%; Capital Income Fund, 0.48%; Blue Chip Fund, 0.53%; Mid-Cap Equity Fund,
0.53%; Aggressive Growth Fund, 0.61%; and International Fund, 0.66%. These fees
may be reduced pursuant to undertakings by Bank of America. (See the information
below in the section entitled "Fee Waivers.")
SUBADVISERS. As authorized by its management agreement, Bank of America has
employed Subadvisers to manage certain of the Funds, as described below. In its
subadvisory agreement with Bank of America, each Subadviser has agreed to manage
the investments of the Fund for which it has been employed and to be responsible
for, place orders for, and make decisions with respect to, all purchases and
sales of the Fund's securities. Each Subadviser's fee described below is paid by
Bank of America, and may be reduced pursuant to undertakings by the Subadviser.
(See the information below in the section entitled "Fee Waivers.")
SCUDDER, STEVENS & CLARK, INC. Bank of America has employed Scudder,
Stevens & Clark, Inc. to manage the investments of the Managed Bond Fund.
Scudder was founded in 1919. Today the firm manages in excess of $90 billion for
many private accounts and over 50 mutual fund portfolios.
Thomas M. Poor and Davis B. Clayson, Managing Director and Vice President,
respectively of Scudder, will manager the Managed Bond Fund. Mr. Poor, a
Chartered Financial Analyst, is the Product Leader of the Firm's Limited
Volatility Bond Product and is responsible for the policy, coordination and
promotion of this Product. He joined the firm in 1970 and manages several
institutional bond portfolios and four mutual funds, including the Scudder Short
Term Bond and the Scudder Managed GIC Trust. Mr. Clayson is a member of the
firm's Limited Volatility Bond team and has been with Scudder since 1994. Prior
to that he was Director of Marketing and Client Services at Interinvest
Corporation, a global money management firm.
WELLINGTON MANAGEMENT COMPANY, LLP. Bank of America has employed Wellington
Management Company, LLP to manage the investments of the International Fund.
Wellington is one of America's oldest and largest independent investment
management firms. It serves as investment adviser to more than 300 institutional
clients and over 100 mutual fund portfolios covering a wide range of investment
styles, and has over $119 billion in discretionary client assets under
management.
Wellington Management's Global Equity Strategy Group, a group of global
portfolio managers and senior investment professionals headed by Trond
Skramstad, manages the International Fund. Mr. Skramstad joined Wellington
Management in 1993 as the firm's Director of International Equity Investments.
Prior to joining Wellington Management, Mr. Skramstad was a Principal at
Scudder.
PACIFIC MUTUAL LIFE INSURANCE COMPANY. Pacific Mutual provides support
services to the Funds and acts as the Funds' Transfer Agent. In its support
services agreement, Pacific Mutual has agreed to coordinate matters relating to
the operation of the Separate Accounts with the operation of the Funds
(including the Fund's Custodian, record keeping agents, accountant, attorneys
and others), maintain appropriate books and records of the Separate Accounts as
required by law, arrange for the distribution of Fund proxy materials and
periodic reports to Contract owners, address inquiries and provide information
to the Contract owners which relate to Fund matters, tabulate Contract owner
voting for proxies, and coordinate the preparation of certain documents with the
Securities and Exchange Commission and other federal and state regulatory
authorities. In its agreement with the Trust, Pacific Mutual serves as the
Trust's transfer agent.
FUND ACCOUNTANT AND SUB-ADMINISTRATOR. PFPC Inc. ("PFPC") provides fund
accounting services to the Funds. In this capacity, PFPC has agreed to provide
certain accounting services to the Funds including calculation of the net asset
value of the Funds, dividends and capital gains distributions to shareholders.
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Under its management agreement, Bank of America has also agreed to provide
statistical and research data, data processing services, and clerical services,
and coordinate the preparation of reports to shareholders of the Funds and the
SEC. Pursuant to the authority granted in its management agreement, Bank of
America has retained PFPC as Sub-Administrator to perform certain administrative
services for the Trust, such as preparing and filing various periodic regulatory
reports, preparing tax returns, coordinating certain of the Trust's contractual
relationships and assisting with Fund compliance monitoring. Bank of America
bears all fees and expenses charged by PFPC for sub-administration services.
DISTRIBUTOR. The Fund's shares are sold on a continuous basis and
distributed through BISYS Fund Services Limited Partnership (the "Distributor").
The Distributor is an indirect, wholly owned subsidiary of The BISYS Group, Inc.
and is located at 3435 Stelzer Road, Columbus, Ohio 43219-3035.
CUSTODIAN. PNC Bank, N.A., 200 Stevens Drive, Lester, Pennsylvania, 19113
serves as the Custodian of the Fund.
FEE WAIVERS
Bank of America and Pacific Mutual have voluntarily agreed to waive fees
and reimburse Fund operating expenses to ensure that the operating expenses for
each Fund (other than interest, taxes, brokerage commissions and other portfolio
transaction expenses, capital expenditures and extraordinary expenses) will not
exceed the following percentages of the average net assets of each Fund on an
annual basis: Money Market Fund, 0.60%; Managed Bond Fund, 0.75%; Capital Income
Fund, 0.87%; Blue Chip Fund, 0.94%; Mid-Cap Equity Fund, 0.94%; Aggressive
Growth Fund, 1.03%; and International Fund, 1.24%. Bank of America and Pacific
Mutual will pro-rata, waive their fees with respect to Fund operating expenses
other than 0.02% for sub-administration services on an annual basis. If this
waiver is not sufficient to reduce expenses below the levels set forth above,
Pacific Mutual will, to the extent necessary, subsidize each Fund to permit each
such Fund to meet its target expense ratio. However, at such time as the
annualized expenses of a Fund are less than the expense limitation for such Fund
set forth above, the obligation to provide further fee waivers, reimbursements
or subsidies will cease, even if the expenses of the Fund subsequently increase
above such levels.
Expenses can also be reduced by voluntary fee waivers and expense
reimbursements by Bank of America and other service providers. Periodically,
during the course of the Funds' fiscal year, Bank of America and other service
providers may prospectively choose not to receive fee payments and/or may assume
certain of the Funds' expenses as a result of competitive pressures and in order
to preserve and protect the business and reputation of Bank of America. However,
Bank of America and other service providers retain the ability to discontinue
such fee waivers and expense reimbursements at any time.
MORE ON THE FUNDS' SHARES
HOW TO BUY SHARES
Shares of the Funds are not sold directly to the general public. Shares of
the Funds are currently offered only for purchase by the Separate Accounts to
serve as an investment medium for the Contracts issued or administered by
Pacific Mutual. For information on purchase of a Contract, consult the
prospectus for the Separate Accounts.
HOW TO REDEEM SHARES
Shares of any Portfolio may be redeemed on any business day upon receipt of
a request for redemption from the insurance company whose Separate Account owns
the shares. Redemptions are effected at the per share net asset value next
determined after receipt of the redemption request. Redemption proceeds
ordinarily
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will be paid within seven days following receipt of instructions in proper form
or any sooner period required by law.
HOW ARE SHARES PRICED?
Shares are purchased at their public offering price, which is based upon a
Fund's net asset value per share. Each Fund calculates its net asset value
("NAV") as follows:
<TABLE>
<S> <C> <C>
(Value of Fund Assets) - (Fund Liabilities)
--------------------------------------------
NAV = Number of Outstanding Shares
</TABLE>
Net asset value is determined as of the end of regular trading hours on the
New York Stock Exchange (the "Exchange") (normally 4:00 p.m. Eastern time) on
days the Exchange is open.
In computing net asset values, the Money Market Fund uses the amortized
asset method of valuation as described in the SAI, and each of the other Funds
uses the following procedures: A Fund's investments in securities that are
primarily traded on a domestic exchange or traded on the NASDAQ National Market
System are valued at the last sale price on the exchange or market where
primarily traded or listed or, if there is no recent sale price available, at
the mean between the closing bid and ask prices. Securities not so traded are
valued at the last current bid quotation if market quotations are available.
Except for short-term securities with remaining maturities of 60 days or less
("Short-Term Securities"), fixed income securities are valued by using market
quotations, or independent pricing services that use prices provided by market
makers or estimates of market values obtained from yield data relating to
instruments or securities with similar characteristics. Short-Term Securities
are valued at amortized cost, which approximates market value. Equity options
are valued at the last sale price unless the bid price is higher or the asked
price is lower, in which event such bid or asked price is used. Futures
contracts and options thereon are valued at the settlement price established
each day by the board of trade or exchange on which they are traded. Other
securities and assets are valued at fair value as determined in good faith
pursuant to procedures adopted by the Board of Trustees. Trading in foreign
securities is generally completed prior to the end of regular trading on the
Exchange. Trading may occur in foreign securities, however, on Saturdays and
U.S. holidays and at other times when the Exchange is closed. As a result, there
may be delays in reflecting changes in the market values of foreign securities
in the calculation of the net asset value of a Fund. For further information
about valuing securities, see the SAI. For voice recorded information call (800)
938-4798.
CAN I EXCHANGE MY INVESTMENT FROM ONE FUND TO ANOTHER?
Contract owners do not deal directly with the Trust to purchase, redeem, or
exchange shares of a Fund, and Contract owners should refer to the Prospectus
for the Separate Accounts for information on the allocation of purchase payments
and on transfers of accumulated value among options available under the
Contract.
DIVIDENDS AND DISTRIBUTIONS
Dividends of net investment income are declared daily and paid monthly by
the Money Market Fund, declared and paid monthly by the Managed Bond Fund, and
declared and paid at least annually by the other Funds. Each Fund's net capital
gain, if any, is distributed at least annually, on or about the last day of
December. All dividends and distributions of each Fund are automatically
reinvested in additional shares of the Fund at the Fund's net asset value as of
the payment date for the dividend unless the shareholder (Separate Account)
properly elects to receive cash in respect of dividends payable in cash or in
additional Fund shares.
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TAX INFORMATION
Each Fund intends to qualify each year as a "regulated investment company"
for federal income tax purposes and to meet all other requirements necessary for
it to be relieved of federal income taxes on income and gains it distributes to
the Separate Accounts. Internal Revenue Service regulations applicable to the
Separate Accounts generally require that portfolios that serve as the funding
vehicles solely for such Separate Accounts invest no more than 55% of the value
of their assets in one investment, 70% in two investments, 80% in three
investments and 90% in four investments. Alternatively, a portfolio will be
treated as meeting these requirements for any quarter of its taxable year if, as
of the close of such quarter, the portfolio meets the diversification
requirements applicable to regulated investment companies (see "Additional
Information Concerning Taxes" in the SAI) and no more than 55% of the value of
its total assets consists of cash and cash items (including receivables), U.S.
government securities and securities of other regulated investment companies.
Each of the Funds intends to comply with these requirements.
Fund transactions in foreign currencies and hedging activities will likely
produce a difference between book income and taxable income. This difference may
cause a portion of a Fund's income distributions to constitute a return of
capital for tax purposes or require a Fund to make distributions exceeding book
income to qualify as a regulated investment company for tax purposes.
Reference is made to the Prospectus for the Separate Accounts and Contracts
for information regarding the Federal income tax treatment of distributions to
the Separate Accounts. See "Additional Information Concerning Taxes" in the SAI
for more information on taxes.
MEASURING PERFORMANCE
From time to time, the Trust may advertise each Fund's "total return" and,
if applicable, its "yield" or "effective yield." These figures will not reflect
any fees and charges made pursuant to the terms of the Contracts funded by the
Separate Accounts that invest in shares of the Funds. Fund performance
information will be presented only in conjunction with performance information
for the Contracts. Purchasers of Contracts issued by Pacific Mutual should
recognize that such fees and charges will reduce the yield and total return to
Contract owners.
Since a Fund's performance will fluctuate, it should not be compared with
bank deposits, savings accounts and similar investments that often provide an
agreed or guaranteed fixed yield for a stated period of time. Performance is
generally a function of the kind and quality of the instruments in a portfolio,
portfolio maturity, operating expenses and market conditions.
Performance information should be considered in light of a Fund's
investment objectives and policies, the characteristics of the Fund, and the
market conditions during the given time period, and should not be considered as
a representation of what may be achieved in the future. For a description of the
methods used to determine yield and total return for the Funds, see the SAI.
PRIOR PERFORMANCE OF THE MANAGER AND SUBADVISERS
The tables in Appendix B set forth composite performance data relating to
the historical performance of common trust funds, mutual funds and/or
institutional private accounts managed by the Bank of America and the
Subadvisers, that have investment objectives, policies, strategies and risks
substantially similar to those of the Funds. The data is provided to illustrate
the past performance of Bank of America and the Subadvisers in managing
substantially similar accounts and does not represent the performance of the
Funds. Investors should not consider this performance data as an indication of
future performance of the Funds or of Bank of America and the Subadvisers.
The figures shown for the Money Market Fund reflect the performance of a
comparable Pacific Horizon Fund managed by Bank of America. The performance of
the Aggressive Growth, Blue Chip, Capital Income, Mid-Cap Equity and Managed
Bond Funds reflect the adjusted total return performance of composites of
private accounts, common trust funds and mutual funds managed by the Manager or
the Subadvisers. The
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<PAGE> 25
tables reflect performance on composites of all advisory accounts (collectively
such accounts are referred to as "comparable accounts") that have substantially
similar, although not necessarily identical, investment objectives, policies and
strategies to those employed by the Manager and Subadvisers. The performance
figures for the composites are based on gross results that are adjusted to
reflect the anticipated expenses of the pertinent Fund. The performance figures
for all of the comparable accounts also reflect the inclusion of any dividends
and interest income received, the deduction of any brokerage commissions, and
other related portfolio transaction expenses which are generally reflected as
part of the cost of a security.
Because of the differences in computation methods, such as the method or
frequency of reinvesting dividends or measuring gains, the data shown below may
not be precisely comparable to performance data for the Funds. In addition, the
performance data for the private accounts may not be representative of the
pertinent Fund insofar as the management of the Fund is affected by the Fund's
obligation to redeem its shares upon request and to meet diversification
requirements, specific tax restrictions and investment limitations imposed on
the Funds by the 1940 Act or Subchapter M of the Internal Revenue Code. If the
asset size of the comparable accounts varies from that of the pertinent Fund,
this might reduce the comparability of the Fund's performance to that of the
comparable accounts. In addition, the Funds' current and future investments are
not and will not necessarily be identical to those of the comparable accounts.
The investment results of the composites presented are unaudited and are
not intended to predict or suggest the returns that might be experienced by the
Funds or an individual investor investing in such Funds. Investors should also
be aware that the use of a methodology different from that used in Appendix B to
calculate performance could result in different performance data.
DESCRIPTION OF SHARES
THE TRUST IS A DELAWARE BUSINESS TRUST
THAT WAS ORGANIZED ON SEPTEMBER 25, 1996.
ABOUT THE TRUST
The Trust's charter authorizes the Board of Trustees to issue an unlimited
number of shares of beneficial interest.
Shares representing beneficial interests in a Fund are entitled to
participate in the dividends and distributions declared by the Board of Trustees
and in the net distributable assets of the Fund on liquidation. The Funds'
shares have no preemptive rights and only such conversion and exchange rights as
the Board may grant in its discretion. When issued for payment as described in
this Prospectus, a Fund's shares will be fully paid and non-assessable.
VOTING RIGHTS
Shareholders are entitled to one vote for each full share held and
fractional votes for fractional shares held, unless a different allocation of
voting rights is required under applicable law for an open-end investment
company that serves as an investment medium for variable insurance products.
Additionally, shareholders will vote in the aggregate and not by series, except
as required by law or when permitted by the Board of Trustees. For a further
discussion of voting rights, see the prospectus for the applicable Contract.
The Funds do not presently intend to hold annual meetings of shareholders
to elect trustees or for other business unless and until such time as less than
a majority of the trustees holding office has been elected by the shareholders.
At that time, the trustees then in office will call a shareholders' meeting for
the election of trustees. Under certain circumstances, however, shareholders
have the right to call a shareholder meeting to consider the removal of one or
more trustees. Such meetings will be held when requested by the shareholders of
10% or more of the Trust's outstanding shares of beneficial interest. Each Fund
will assist in shareholder
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<PAGE> 26
communications in such matters to the extent required by law and the Trust's
undertaking with the Securities and Exchange Commission.
OUTSTANDING SHARES
As of the date of this Prospectus, all of the outstanding shares of the
Funds were owned by Pacific Mutual and Pacific Financial Asset Management
Corporation, a wholly owned subsidiary of Pacific Mutual.
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<PAGE> 27
APPENDIX A
CORPORATE BOND RATINGS
Excerpts from Moody's description of its corporate bond ratings:
Aaa -- judged to be the best quality, carry the smallest degree of investment
risk and are generally referred to as "gilt edge"; Aa -- judged to be of high
quality by all standards; A -- deemed to have many favorable investment
attributes and considered as upper medium grade obligations; Baa -- considered
as medium grade obligations, i.e. they are neither highly protected nor poorly
secured; Ba, B, Caa, Ca, C -- protection of interest and principal payments is
questionable (Ba indicates some speculative elements, B represents bonds that
generally lack characteristics of the desirable investment, Caa represents bonds
which are in poor standing, Ca represents a high degree of speculation and C
represents the lowest rated class of bonds); Caa, Ca and C bonds may be in
default.
A Standard & Poor's corporate debt rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. Debt rated
AAA has the highest rating assigned by Standard & Poor's. Capacity to pay
interest and repay principal is considered to be extremely strong. Debt rated AA
is considered to have a very strong capacity to pay interest and to repay
principal and differs from the highest rated issues only in small degree. Debt
rated A is considered to have a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in a higher rated
category. Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas such issues normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and to repay
principal for debt in this category than in higher rated categories. Debt rated
BB, B, CCC, CC or C is regarded, on balance, as predominately speculative with
respect to capacity to pay interest and repay principal in accordance with the
terms of the obligations. BB indicates the lowest degree of speculation and C
the highest degree of speculation. While such debt will likely have some quality
and protective characteristics, these are outweighed by large uncertainties or
major risk exposures to adverse conditions. Debt rated CI is reserved for income
bonds on which no interest is being paid. Debt rated D is in default, and
payment of interest and/or repayment of principal is in arrears. 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.
COMMERCIAL PAPER RATINGS
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt considered short-term in the relevant
market. The designation A-1 indicates the degree of safety regarding timely
payment is considered to be strong. Those issues determined to possess extremely
strong safety characteristics are denoted with a plus (+) sign designation.
Moody's commercial paper ratings are opinions of the ability of issuers to repay
punctually promissory obligations not having an original maturity in excess of 9
months. The rating Prime-1 is the highest commercial paper rating assigned by
Moody's. Issuers rated Prime-1 (or related supporting institutions) are
considered to have a superior capacity for repayment of short-term promissory
obligations.
UNRATED SECURITIES
Unrated securities are securities which have not been rated by a nationally
recognized statistical rating organization.
A-1
<PAGE> 28
APPENDIX B
The following performance data is NOT the performance of the Money Market,
Managed Bond, Capital Income, Blue Chip, Mid-Cap Equity, Aggressive Growth or
International Funds, but that of comparable accounts, and does not reflect the
deduction for separate account charges. The performance figures for the
composites are based upon gross results that are reduced to reflect the
anticipated expenses of the pertinent Fund. This data should not be taken as an
indication of the future performance of the Funds.
Total Return from Comparable Accounts to the Funds for the years shown:
<TABLE>
<CAPTION>
MONEY MANAGED CAPITAL BLUE MID-CAP AGGRESSIVE
MARKET BOND INCOME CHIP EQUITY GROWTH INTERNATIONAL
------ ------- ------ ----- ------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
1991................... --% 16.36% 31.45% 32.96% --% 83.25% 14.66%
1992................... --% 6.93% 15.05% 5.33% --% (0.33)% (5.67)%
1993................... --% 9.79% 20.85% 12.15% 15.21% 16.66% 32.37%
1994................... 4.67% (3.07)% (7.39)% (1.02)% (1.65)% (10.75)% (2.91)%
1995................... 5.22% 14.51% 23.63% 38.47% 32.31% 33.77% 13.09%
1996................... 3.58% 2.68% 18.73% 24.52% 22.58% 26.95% 12.60%
Average Annual
(Estimate)........... 4.49% 7.66% 16.38% 17.86% 16.43% 21.58% 9.98%
</TABLE>
B-1
<PAGE> 29
PACIFIC INNOVATIONS TRUST
STATEMENT OF ADDITIONAL INFORMATION
MARCH 1, 1997
<TABLE>
<S> <C>
MONEY MARKET FUND MID-CAP EQUITY FUND
MANAGED BOND FUND AGGRESSIVE GROWTH FUND
CAPITAL INCOME FUND INTERNATIONAL FUND
BLUE CHIP FUND
</TABLE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
The Trust............................................................................. 1
Investment Objectives and Policies.................................................... 2
Additional Purchase and Redemption Information........................................ 19
Additional Information Concerning Taxes............................................... 21
Management............................................................................ 24
Performance Information............................................................... 27
General Information................................................................... 29
Appendix A: Ratings................................................................... A-1
Appendix B: Futures Contracts......................................................... B-1
</TABLE>
This Statement of Additional Information supplements the Prospectus
offering of shares of the Money Market Fund, Managed Bond Fund, Capital Income
Fund, Blue Chip Fund, Mid-Cap Equity Fund, Aggressive Growth Fund, and
International Fund (each a "Fund" and, collectively, the "Funds"). Each Fund is
a series of Pacific Innovations Trust, a Delaware Business Trust which is a
registered open-end management investment company (the "Trust").
This Statement of Additional Information, which is incorporated by
reference in its entirety into the Prospectus, should be read only in
conjunction with the Prospectus for the Funds, dated March 1, 1997, as it may
from time to time be revised.
Because this Statement of Additional Information is not itself a
prospectus, no investment in shares of any Fund should be made solely upon the
information contained herein. Copies of the Prospectus for the Funds to which
this Statement of Additional Information relates may be obtained by calling
Pacific Mutual at 800-722-5558. Capitalized terms used but not defined herein
have the same meaning as in the Prospectus.
THE TRUST
The Trust was organized on September 25, 1996 as a Delaware business trust.
It is a series company that currently consists of the following investment
portfolios or Funds: the Money Market Fund, Managed Bond Fund, Capital Income
Fund, Blue Chip Fund, Mid-Cap Equity Fund, Aggressive Growth Fund and
International Fund. Each Fund has its own investment objective and policies.
The investment adviser to each Fund is Bank of America National Trust and
Savings Association ("Bank of America" or "investment adviser"). Scudder,
Stevens & Clark, Inc. and Wellington Management Company, LLP (each a
"Subadviser" and, collectively, the "Subadvisers") serve as subadvisers to the
Managed Bond Fund and International Fund, respectively.
Shares of the Funds may be sold only to separate accounts ("Separate
Accounts") of Pacific Mutual Life Insurance Company ("Pacific Mutual") to serve
as investment vehicles for variable annuity contracts issued
-1-
<PAGE> 30
by Pacific Mutual (the "Contracts"). It is possible at some later date that
shares of the Funds may be offered and sold to separate accounts funding
variable life insurance policies issued by Pacific Mutual.
Pacific Financial Asset Management, a wholly owned subsidiary of Pacific
Mutual, which will be the owner of Fund shares held by the Separate Account,
will invest in such shares in accordance with instructions received from the
owners of the Contracts. Contract owners should consider that the investment
experience of the Fund or Funds they select will affect the value of and the
benefits provided under the Contracts. See the prospectus for the Separate
Accounts for a discussion of the relationship between increases or decreases in
the net asset value of the Funds (and any distributions of such shares) and the
benefits provided under the Contracts.
INVESTMENT OBJECTIVES AND POLICIES
The following discussion supplements the discussion of the investment
objective and policies for each Fund appearing in the Prospectus. There can be
no assurance that the investment objective of any Fund will be achieved.
PORTFOLIO TRANSACTIONS
The portfolio turnover rate described in the Prospectus is calculated by
dividing the lesser of the cost of purchases or the proceeds of sales of
portfolio securities for the year by the monthly average value of the portfolio
securities. The calculation excludes all securities whose maturities at the time
of acquisition were one year or less. Portfolio turnover may vary greatly from
year to year as well as within a particular year, and may also be affected by
cash requirements for redemptions of shares. Portfolio turnover will not be a
limiting factor in making portfolio decisions.
Subject to the general supervision and oversight of the Trust's Board of
Trustees, Bank of America is responsible for, makes decisions with respect to,
and places orders for all purchases and sales of portfolio securities for each
Fund, except where Bank of America has selected certain persons to provide
investment advisory services to a particular Fund (see discussion below under
"Management").
Transactions on stock exchanges involve the payment of negotiated brokerage
commissions. There is generally no stated commission in the case of securities
traded in the over-the-counter market through market-makers, but the price
includes an undisclosed commission or mark-up. The cost of securities purchased
from underwriters includes an underwriting commission or concession, and the
prices at which securities are purchased from and sold to dealers include a
dealer's mark-up or mark-down.
In executing portfolio transactions and selecting brokers or dealers, it is
the Trust's policy to seek the best overall terms available. The Management
Agreement between the Trust and Bank of America, and the Subadvisory Agreement
among the Trust, Bank of America and each Subadviser, each provides that, in
assessing the best overall terms available for any transaction, Bank of America
or its Subadviser shall consider factors it deems relevant, including the
breadth of the market in the security, the price of the security, the financial
condition and execution capability of the broker or dealer, and the
reasonableness of the commission, if any, for the specific transaction and on a
continuing basis. In addition, the Management Agreement and each Subadvisory
Agreement authorizes Bank of America or its Subadvisers, subject to the approval
of the Board of Trustees of the Trust, to cause the Trust to pay a broker-dealer
which furnishes brokerage and research services a higher commission than that
which might be charged by another broker-dealer for effecting the same
transaction, provided that such commission is deemed reasonable in terms of
either that particular transaction or the overall responsibilities of Bank of
America or the Subadvisers to the accounts over which it exercises investment
discretion. Brokerage and research services may include: (1) advice as to the
value of securities, the advisability of investing in, purchasing or selling
securities and the availability of securities or purchasers or sellers of
securities; and (2) analyses and reports concerning industries, securities,
economic factors and trends, portfolio strategy and the performance of accounts.
It is possible that certain of the brokerage and research services received
will primarily benefit one or more other investment companies or other accounts
for which Bank of America or its Subadvisers exercise
-2-
<PAGE> 31
investment discretion. Conversely, the Trust or any given Fund may be the
primary beneficiary of the brokerage or research services received as a result
of portfolio transactions effected for such other accounts or investment
companies. Brokerage and research services so received are in addition to and
not in lieu of services required to be performed by Bank of America and its
Subadvisers and do not reduce the advisory fee payable to Bank of America or its
Subadvisers. Such services may be useful to Bank of America and its Subadvisers
in serving both the Trust and other clients and, conversely, services obtained
by the placement of business of other clients may be useful to Bank of America
and its Subadvisers in carrying out its obligations to the Trust.
In connection with their investment management services provided to the
Funds, Bank of America and its subadvisers will not acquire certificates of
deposit or other securities issued by itself or its affiliates. Portfolio
securities in general may be purchased from and sold to affiliates of the Trust,
Bank of America, its Subadvisers and their affiliates acting as syndicate
member, market-maker, broker, dealer, or in any other similar capacity, provided
such purchase, sale or dealing is permitted under the Investment Company Act of
1940 (the "1940 Act") and the rules thereunder.
A Fund may participate, if and when practicable, in bidding for the
purchase of securities of the U.S. Government and its agencies and
instrumentalities directly from an issuer in order to take advantage of the
lower purchase price available to members of a bidding group. A Fund will engage
in this practice only when Bank of America or its Subadvisers, in their sole
discretion subject to guidelines adopted by the Board of Trustees of the Trust,
believe such practice to be in the interest of the Funds. In addition, to the
extent permitted by law, Bank of America and its Subadvisers may aggregate the
securities to be sold or purchased on behalf of the Funds with those to be sold
or purchased for other investment companies or common trust funds in order to
obtain best execution.
INVESTMENT POLICIES FOR THE MONEY MARKET FUND
The investment objective and investment policies of the Money Market Fund
are described in the Prospectus. The following description presents more
detailed information on investment policies that apply to the Fund, and is
intended to supplement the information provided in the Prospectus. A money
market instrument will be considered to be highest quality (1) if the instrument
(or other comparable short-term instrument of the same issuer) is rated in the
highest rating category (e.g., Aaa or Prime-1 by Moody's Investors Service, Inc.
("Moody's"), AAA or A-1 by Standard & Poor's Corporation ("S&P")) by (i) any two
national recognized statistical rating organizations ("NRSROs") or, (ii) if
rated by only one NRSRO, by that NRSRO and whose acquisition is approved or
ratified by the Board of Trustees; (2) if, for an instrument with a remaining
maturity of 13 months or less that was long term at the time of issuance, it is
issued by an issuer that has short-term debt obligations of comparable maturity,
priority, and security, and that are rated in the highest rating category by (i)
any two NRSROs or, (ii) if rated by only one NRSRO, by that NRSRO, and whose
acquisition is approved or ratified by the Board of Trustees; or (3) an unrated
security that is of comparable quality to a security in the highest rating
category as determined by Bank of America, and unless it is a U.S. Government
security, whose acquisition is approved or ratified by the Board of Trustees.
With respect to 5% of its total assets, measured at the time of investment, the
Fund may also invest in money market instruments that are in the second-highest
rating category for short-term obligations (e.g., rated Aa or Prime-2 by Moody's
or AA or A-2 by S&P). A money market instrument will be considered to be in the
second highest rating category under the criteria described above with respect
to instruments considered highest quality, as applied to instruments in the
second-highest rating category.
The Fund may not invest more than 5% of its total assets, measured at the
time of investment, in securities of any one issuer that are of the highest
quality, except that this limitation shall not apply to U.S. Government
securities and repurchase agreements thereon. The Fund may not invest more than
the greater of 1% of its total assets or $1,000,000, measured at the time of
investment, in securities of any one issuer that are in the second-highest
rating category, except that this limitation shall not apply to U.S. Government
securities. In the event that an instrument acquired by the Fund is downgraded
or otherwise ceases to be of the quality that is eligible for the Fund, Bank of
America, under procedures approved by the Board of Trustees (or the Board of
Trustees itself if the investment adviser becomes aware an unrated security is
downgraded below
-3-
<PAGE> 32
high quality and the investment adviser does not dispose of the security or it
does not mature within five business days) will promptly reassess whether such
security presents minimal credit risk and determine whether or not to retain the
instrument.
TYPES OF OBLIGATIONS, INVESTMENT RISKS, AND OTHER INVESTMENT INFORMATION
The following discussion supplements the discussion of Trust investments in
the Prospectus.
BANK CERTIFICATES OF DEPOSIT, BANKERS' ACCEPTANCES AND TIME
DEPOSITS. Certificates of deposit, bankers' acceptances and time deposits are
eligible investments for each of the Funds except the Money Market Fund, as
described in the Prospectus. Certificates of deposit are negotiable certificates
issued against funds deposited in a commercial bank for a definite period of
time and earning a specified return. Bankers' acceptances are negotiable drafts
or bills of exchange, normally drawn by an importer or exporter to pay for
specific merchandise, which are "accepted" by a bank, meaning, in effect, that
the bank unconditionally agrees to pay the face value of the instrument at
maturity. Certificates of deposit and bankers' acceptances will be obligations
of domestic or foreign banks or financial institutions with total assets at the
time of purchase in excess of $2.5 billion (including assets of both domestic
and foreign branches).
Instruments issued by foreign banks or financial institutions may be
subject to investment risks that are different in some respects from the risks
associated with instruments issued by comparable U.S. issuers. Such risks
include future political and economic developments, the possible imposition of
withholding taxes by the particular country in which the issuer is located on
interest income payable on the instruments, the possible seizure or
nationalization of foreign deposits, the possible establishment of exchange
controls, or the adoption of other foreign governmental restrictions which might
adversely affect the payment of principal and interest on these instruments.
Domestic banks and foreign banks are subject to different governmental
regulations with respect to the amount and types of loans which may be made and
interest rates which may be charged. In addition, the profitability of the
banking industry depends largely upon the availability and cost of funds for the
purpose of financing lending operations under prevailing money market
conditions. General economic conditions as well as exposure to credit losses
arising from possible financial difficulties of borrowers play an important part
in the operations of the banking industry.
As a result of federal and state laws and regulations, domestic banks are,
among other things, required to maintain specified levels of reserves, limited
in the amount which they can loan to a single borrower, and subject to other
regulations designed to promote financial soundness. However, such laws and
regulations do not necessarily apply to foreign bank obligations.
In addition to purchasing certificates of deposit and bankers' acceptances,
to the extent permitted under their respective investment objectives and
policies stated in the Prospectus, each Fund may make interest-bearing time or
other interest-bearing deposits in commercial or savings banks. Time deposits
are non-negotiable deposits maintained at a banking institution for a specified
period of time at a specified interest rate.
COMMERCIAL PAPER AND SHORT-TERM NOTES. The Money Market Fund may invest in
U.S. dollar denominated commercial paper and short-term notes in accordance with
the policies described above under "Investment Policies for the Money Market
Fund." The other Funds may also invest in commercial paper and short-term notes.
Commercial paper consists of unsecured promissory notes issued by domestic and
foreign corporations. Except as noted below with respect to variable and
floating rate instruments, issues of commercial paper and short-term notes will
normally have maturities of less than nine months and fixed rates of return,
although such instruments may have maturities of up to one year.
Commercial paper and short-term notes will consist of issues rated at the
time of purchase A-2 or higher by Standard & Poor's Corporation ("S&P"), Prime-2
or higher by Moody's Investors Service, Inc. ("Moody's"), or similarly rated by
another nationally recognized statistical rating organization ("NRSRO") or, if
unrated, will be determined by Bank of America or its Subadvisers to be of
comparable quality under procedures established by the Board of Trustees of the
Trust. These rating symbols are described in Appendix A.
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<PAGE> 33
REPURCHASE AGREEMENTS. Each Fund is permitted to enter into repurchase
agreements with respect to its portfolio securities. Pursuant to such
agreements, a Fund acquires securities from financial institutions, such as
banks and broker-dealers, which are considered to be creditworthy, subject to
the seller's agreement to repurchase and the agreement of the Fund to resell
such securities at a mutually agreed upon date and price. Repurchase agreements
maturing in more than seven days will be considered illiquid for purposes of the
Funds' limitations on investment in illiquid securities. The Funds are not
permitted to enter into repurchase agreements with Bank of America, the
Subadvisers, or their affiliates. The repurchase price generally equals the
price paid by a Fund plus interest negotiated on the basis of current short-term
rates (which may be more or less than the rate on the underlying portfolio
security). Securities subject to repurchase agreements will be held by the
custodian of the Fund or in the Federal Reserve/Treasury Book-Entry System. The
seller under a repurchase agreement will be required to maintain the value of
the underlying securities at an amount greater than the repurchase price. If the
seller defaulted on its repurchase obligation, a Fund would suffer a loss
because of adverse market action or to the extent that the proceeds from a sale
of the underlying securities were less than the repurchase price under the
agreement. Bankruptcy or insolvency of such a defaulting seller may cause the
particular Fund's rights with respect to such securities to be delayed or
limited. Repurchase agreements are considered to be loans by a Fund under the
1940 Act.
GOVERNMENT OBLIGATIONS. Each Fund is permitted to make investments in U.S.
Government obligations. Such obligations include Treasury bills, certificates of
indebtedness, notes and bonds, and issues of government agencies or
instrumentalities such as the Government National Mortgage Association, Export-
Import Bank of the United States, Tennessee Valley Authority, Farmers Home
Administration, Federal Home Loan Banks, Federal Intermediate Credit Banks,
Federal Farm Credit Banks, Federal Land Banks, Federal Housing Administration,
Federal National Mortgage Association, Federal Home Loan Mortgage Corporation,
and the Student Loan Marketing Association. Treasury bills have maturities of
one year or less, Treasury notes have maturities of one to ten years, Treasury
bonds generally have maturities of more than ten years and all are direct
obligations of or guaranteed by the U.S. Government. Some of other obligations
referred to above, such as those of the Government National Mortgage
Association, are supported by the full faith and credit of the U.S. Treasury;
others, such as those of the Export-Import Bank of the United States, are
supported by the right of the issuer to borrow from the Treasury; others, such
as those of the Federal National Mortgage Association, are supported by the
discretionary authority of the U.S. Government to purchase the agency's
obligations; still others, such as those of the Student Loan Marketing
Association, are supported only by the credit of the instrumentality. No
assurance can be given that the U.S. Government would provide financial support
to U.S. Government sponsored instrumentalities if it is not obligated to do so
by law.
The Managed Bond and International Funds may also invest in sovereign debt
obligations of foreign countries. A sovereign debtor's willingness or ability to
repay principal and interest in a timely manner may be affected by a number of
factors, including its cash flow situation, the extent of its foreign reserves,
the availability of sufficient foreign exchange on the date a payment is due,
the relative size of the debt service burden to the economy as a whole, the
sovereign debtor's policy toward principal international lenders and the
political constraints to which it may be subject.
VARIABLE AND FLOATING RATE INSTRUMENTS. Each Fund may acquire variable and
floating rate instruments, including master demand notes which permit a Fund to
invest fluctuating amounts which may change daily without penalty. Such
instruments are frequently not rated by credit rating agencies. However, in
determining the creditworthiness of unrated variable and floating rate
instruments and their eligibility for purchase by a Fund, Bank of America or its
Subadvisers will consider the earning power, cash flow and other liquidity
ratios of the issuers of such instruments (which include financial,
merchandising, bank holding and other companies) and will monitor their
financial condition. An active secondary market may not exist with respect to
particular variable or floating rate instruments purchased by a Fund. The
absence of such an active secondary market could make it difficult to dispose of
a variable or floating rate instrument in the event the issuer of the instrument
defaulted on its payment obligation or during periods that the Fund is not
entitled to
-5-
<PAGE> 34
exercise its demand rights, and the Fund could, for these or other reasons,
suffer a loss to the extent of the default. Investments in illiquid variable and
floating rate instruments (instruments which are not payable upon seven days'
notice and do not have active trading markets) are subject to a Fund's
fundamental limitation on investment in illiquid securities. Variable and
floating rate instruments may be secured by bank letters of credit.
MUNICIPAL SECURITIES. The Managed Bond Fund may invest, from time to time,
in obligations issued by state and local government issuers ("Municipal
Securities"). The purchase of Municipal Securities may be advantageous when, as
a result of prevailing economic, regulatory or other circumstances, the
performance of such securities, on a pre-tax basis, is comparable to that of
corporate or U.S. Government obligations.
The two principal classifications of Municipal Securities which may be held
by the Fund are "general obligation" securities and "revenue" securities.
General obligation securities are secured by the issuer's pledge of its full
faith, credit and taxing power for the payment of principal and interest.
Revenue securities are payable only from the revenues derived from a particular
facility or class of facilities or, in some cases, from the proceeds of a
special excise tax or other specific revenue source such as the user of the
facility being financed. Private activity bonds held by the Fund are in most
cases revenue securities and are not payable from unrestricted revenues of the
issuer. Private activity bonds are issued by or on behalf of public authorities
to finance various privately operated facilities. Consequently, the credit
quality of such private activity bonds is usually directly related to the credit
standing of the corporate user of the facility involved. The Fund may also hold
"moral obligation" securities, which are normally issued by special purpose
public authorities. If the issuer of moral obligation securities is unable to
meet its debt service obligations from current revenues, it may draw on a
reserve fund, the restoration of which is a moral commitment but not a legal
obligation of the state or municipality which created the issuer.
CONVERTIBLE SECURITIES AND WARRANTS. The Capital Income, Aggressive Growth,
Managed Bond and International Funds may invest in securities which may be
exchanged for, converted into, or exercised to acquire a predetermined number of
shares of the issuer's common stock at the option of the holder during a
specified time period. Convertible preferred securities generally pay interest
or dividends and provide for participation in the appreciation of the underlying
common stock but have a lower level of risk because the yield is higher and the
security is senior to common stock. The value of a convertible security is a
function of its "investment value" (determined by its yield in comparison with
the yields of other securities of comparable maturity and quality that do not
have a conversion privilege) and its "conversion value" (the security's worth,
at market value, if converted into the underlying common stock). The credit
standing of the issuer and other factors may also affect the investment value of
convertible security. The conversion value of a convertible security is
determined by the market price of the underlying common stock. If the conversion
value is low relative to the investment value, the price of the convertible
security is governed principally by its investment value. To the extent the
market price of the underlying common stock approaches or exceeds conversion
price, the price of the convertible security will be increasingly influenced by
its conversion value. Like other debt securities, the market value of a
convertible security tends to vary inversely with the level of interest rates;
the value of the security declines if interest rates increase and increases as
interest rates decline. Convertible securities may be subject to redemption at
the option of the issuer at a price established in the instrument governing the
convertible security. If a convertible security held by a Fund is called for
redemption, the Fund will be required to permit the issuer to redeem the
security, convert it into the underlying common stock or sell it to a third
party.
The International Fund may invest in warrants or rights (valued at the
lower of cost or market) to purchase securities; and the Capital Income and
Managed Bond Funds may acquire warrants or rights as part of a unit or attached
to securities at the time of purchase. Warrants may be considered speculative in
that they have no voting rights, pay no dividends, and have no rights with
respect to the assets of the corporation issuing them. Warrants basically are
options to purchase equity securities at a specific price valid for a specific
period of time. They do not represent ownership of the securities, but only the
right to buy them. Warrants differ from call options in that warrants are issued
by the issuer of the security which may be purchased on their exercise, whereas
call options may be written or issued by anyone. The prices of warrants do not
necessarily move parallel to the prices of the underlying securities.
-6-
<PAGE> 35
ILLIQUID SECURITIES. No Fund may invest more than 15% of the value of its
net assets (10% in the case of the Money Market Fund) in securities that at the
time of purchase have legal or contractual restrictions on resale, repurchase
agreement maturing in more than seven days, or assets which are otherwise
illiquid. Bank of America or its Subadvisers will monitor the amount of illiquid
securities in the Funds' portfolios, under the supervision of the Board of
Trustees, to ensure compliance with the Funds' investment restrictions.
Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act, securities which are otherwise not readily
marketable and repurchase agreements having a maturity of longer than seven
days. Securities which have not been registered under the Securities Act of 1933
(the "Securities Act") are referred to as private placement or restricted
securities and are purchased directly from the issuer or in the secondary
market. Mutual funds do not typically hold a significant amount of these
restricted or other illiquid securities because of the potential for delays on
resale and uncertainty in valuation. Limitations on resale may have an adverse
effect on the marketability of portfolio securities and the Fund might be unable
to dispose of restricted or other illiquid securities promptly or at reasonable
prices and might thereby experience difficulty satisfying redemption within
seven days. The Fund might also have to register such restricted securities in
order to dispose of them, resulting in additional expense and delay. Adverse
market conditions could impede such a public offering of securities.
In recent years, however, a large institutional market has developed for
certain securities that are not registered under the Securities Act, including
repurchase agreements, commercial paper, foreign securities, municipal
securities and corporate bonds and notes. Institutional investors depend on an
efficient institutional market in which the unregistered security can be readily
resold or on an issuer's ability to honor a demand for repayment. The fact that
there are contractual or legal restrictions on resale to the general public or
to certain institutions may not be indicative of the liquidity of such
investments. If such securities are subject to purchase by institutional buyers
in accordance with Rule 144A promulgated by the Commission under the Securities
Act, or are issued in reliance on Section 4(2) of the Securities Act of 1933,
Bank of America or its Subadvisers may determine, pursuant to guidelines
established by the Board of Trustees, that such securities are not illiquid
securities notwithstanding their legal or contractual restrictions on resale. In
all other cases, however, securities subject to restrictions on resale will be
deemed illiquid.
MORTGAGE-BACKED SECURITIES. The Managed Bond, Capital Income, Blue Chip,
Mid-Cap Equity and Aggressive Growth Funds may invest in mortgage-backed
securities issued by governmental and non-governmental entities (such as banks,
savings and loans, and private mortgage insurance companies). Mortgage-backed
securities are derivative interests in pools of mortgage loans made to U.S.
residential home buyers, including mortgage loans made by savings and loan
institutions, mortgage bankers, commercial banks and others. Pools of mortgage
loans are assembled as securities for sale to investors by various governmental,
government-related and private organizations. The Funds may also invest in debt
securities which are secured with collateral consisting of U.S. mortgage-related
securities, and in other types of U.S. mortgage-related securities.
Mortgage-backed securities issued by non-governmental entities may be supported
up to certain amounts and for certain time periods by credit enhancements such
as letters of credit, pool and hazard insurance and/or guarantees of a financial
institution (such as a bank or insurance company) unaffiliated with the issuers.
Interests in pools of mortgage-related securities differ from other forms
of debt securities, which normally provide for periodic payment of interest in
fixed amounts with principal payments at maturity or specified call dates.
Instead, these securities provide a monthly payment which consists of both
interest and principal payments. In effect, these payments are a "pass-through"
of the monthly payments made by the individual borrowers on their residential
mortgage loans, net of any fees paid to the issuer or guarantor of such
securities. Additional payments are caused by repayments of principal resulting
from the sale of the underlying residential property, refinancing or
foreclosure, net of fees or costs which may be incurred. Some mortgage-related
securities (such as securities issued by the Government National Mortgage
Association) are described
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<PAGE> 36
as "modified pass-throughs." These securities entitle the holder to receive all
interest and principal payments owed on the mortgage pool, net of certain fees,
at the scheduled payment dates regardless of whether or not the mortgagor
actually makes the payment.
The principal governmental guarantor of U.S. mortgage-related securities is
the Government National Mortgage Association ("GNMA"). GNMA is a wholly-owned
United States Government corporation within the Department of Housing and Urban
Development. GNMA is authorized to guarantee, with the full faith and credit of
the United States Government, the timely payment of principal and interest on
securities issued by institutions approved by GNMA (such as savings and loan
institutions, commercial banks and mortgage bankers) and backed by pools of
mortgages insured by the Federal Housing Agency or guaranteed by the Veterans
Administration.
Government-related guarantors include the Federal National Mortgage
Association ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC").
FNMA is a government-sponsored corporation owned entirely by private
stockholders and subject to general regulation by the Secretary of Housing and
Urban Development. FNMA purchases conventional residential mortgages not insured
or guaranteed by any government agency from a list of approved seller/services
which includes state and federally chartered savings and loan associations,
mutual savings banks, commercial banks and credit unions and mortgage bankers.
FHLMC is a government-sponsored corporation created to increase availability of
mortgage credit for residential housing and owned entirely by private
stockholders. FHLMC issues participation certificates which represent interests
in conventional mortgages from FHLMC's national portfolio. Pass-through
securities issued by FNMA are guaranteed as to timely payment of principal and
interest by FNMA and participant certificates issued by FHLMC are guaranteed as
to timely payment of interest and ultimate payment of principal, respectively,
but are not backed by the full faith and credit of the United States Government.
Although the underlying mortgage loans in a pool may have maturities of up
to 30 years, the actual average life of the pool certificates typically will be
substantially less because the mortgages will be subject to normal principal
amortization and may be prepaid prior to maturity. Prepayment rates vary widely
and may be affected by changes in market interest rates. In periods of falling
interest rates, the rate of prepayment tends to increase, thereby shortening the
actual average life of the pool certificates; therefore, during periods of
declining interest rates, mortgage-backed securities may be less effective at
"locking in" yields than typical bonds of similar maturities. Conversely, when
interest rates are rising, the rate of prepayments tends to decrease, thereby
lengthening the actual average life of the certificates. Accordingly, it is not
possible to predict accurately the average life of a particular pool.
COLLATERALIZED MORTGAGE OBLIGATIONS ("CMOS"). The Managed Bond and
Aggressive Growth Funds may invest in CMOs, which are a hybrid between a
mortgage-backed bond and a mortgage pass-through security. Like a bond, interest
is paid, in most cases, semiannually. CMOs may be collateralized by whole
mortgage loans, but are more typically collateralized by portfolios of mortgage
pass-through securities guaranteed by GNMA, FNMA, FHLMC or equivalent foreign
entities.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life depend upon the prepayment experience
of the collateral. CMOs provide for a modified form of call protection through a
de facto breakdown of the underlying pool of mortgages according to how quickly
the loans are repaid. Monthly payment of principal received from the pool of
underlying mortgages, including prepayments, is first returned to the investors
holding the shortest maturity class. Investors holding the longer maturity
classes received principal only after the first class has been retired.
Unscheduled or early repayment of principal on mortgage passthrough securities
may expose the Fund to a lower rate of return upon reinvestment of principal.
ASSET-BACKED SECURITIES. The Managed Bond and Aggressive Growth Funds may
invest in other types of asset-backed securities (i.e., other than
mortgage-backed securities discussed above). Non-mortgage-backed securities
include interests in pools of receivables, such as motor vehicle installment
purchase obligations and credit card receivables. Such securities are generally
issued as pass-through certificates, which represent undivided factual ownership
interest in the underlying pools of assets. Such securities may also be debt
instruments, which are also known as collateralized obligations and are
generally issued as the debt of a
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special purpose entity organized solely for the purpose of owning such assets
and issuing such debt. Non-mortgage-backed securities are not issued or
guaranteed by the U.S. Government or its agencies or instrumentalities; however,
the payment of principal and interest on such obligations may be guaranteed up
to certain amounts and for certain time periods by a letter of credit issued by
a financial institution (such as a bank or insurance company) unaffiliated with
the issuer of such securities.
The purchase of asset-backed securities raises considerations peculiar to
the financing of the instruments underlying such securities. For example, most
organizations that issue asset-backed securities relating to motor vehicle
installment purchase obligations perfect their interests in the respective
obligations only by filing a financing statement and by having the servicer of
the obligations, which is usually the originator, take custody thereof. In such
circumstances, if the servicer were to sell the same obligations to another
party, in violation of its duty not to do so, there is a risk that such party
could acquire an interest in the obligation superior to that of the holders of
the asset-backed securities. Also, although most such obligations grant a
security interest in the motor vehicle being financed, in most states the
security interest in a motor vehicle must be noted on the certificate of title
to protect such security interest against competing claims of other parties.
Because of the large number of vehicles involved, however, the certificate of
title to each vehicle financed, pursuant to the obligations underlying the
asset-backed securities, usually is not amended to reflect the assignment of the
seller's security interest for the benefit of the holders of the asset-backed
securities. There is the possibility, therefore, that recoveries on repossessed
collateral may not, in some cases, be available to support payments on those
securities. In addition, various state and federal laws give the motor vehicle
owner the right to assert against the holder of the owner's obligation certain
defenses such owner would have against the seller of the motor vehicle. The
assertion of such defenses could reduce payments on the related asset-backed
securities.
Insofar as credit card receivables are concerned, credit card holders are
entitled to the protection of a number of state and federal consumer credit
laws, many of which give such holders the right to set off certain amounts
against balances owed on the credit card, thereby reducing the amount paid on
such receivables. In addition, unlike most other asset-backed securities, credit
card receivables are unsecured obligations of the card holder.
Asset-backed securities may be subject to greater risk of default during
periods of economic downturn than other instruments. Also, while the secondary
market for certain asset-backed securities is ordinarily quite liquid, in times
of financial stress the secondary market may not be as liquid as the market for
other types of securities, which could result in the Fund's experiencing
difficulty in valuing or liquidating such securities.
BORROWING. Each Fund may borrow up to certain limits. A Fund may not borrow
if, as a result of such borrowing, the total amount of all money borrowed by the
Fund exceeds 10% of the value of its net assets (at the time of such borrowing),
or if borrowing for temporary purposes such as to facilitate redemptions, 25% of
the value of its total assets. This borrowing may be unsecured. Borrowing may
exaggerate the effect on net asset value of any increase or decrease in the
market value of a Fund's portfolio. Money borrowed will be subject to interest
costs which may or may not be recovered by appreciation of the securities
purchased. A Fund also may be required to maintain minimum average balances in
connection with such borrowing or to pay a commitment or other fee to maintain a
line of credit; either of these requirements would increase the cost of
borrowing over the stated interest rate.
Reverse repurchase agreements will be included as borrowing subject to the
borrowing limitations described above.
OPTIONS. Each Fund (except the Money Market Fund) may purchase put and call
options. Such options may relate to particular securities or to various stock
indices. The Funds currently intend that the aggregate premiums paid for such
options will not exceed 2% of the value of a Fund's net assets (5% for the
Capital Income, International and Aggressive Growth Funds).
Options trading is a highly specialized activity which entails greater than
ordinary investment risks. Regardless of how much the market price of the
underlying security or index increases or decreases, the option buyer's risk is
limited to the amount of the original premium paid for the purchase of the
option plus
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transaction costs. However, options may be more volatile than the underlying
instruments, and therefore, on a percentage basis, an investment in options may
be subject to greater fluctuation than an investment in the underlying
instruments themselves. A listed call option for a particular security gives the
purchaser of the option the right to buy from a clearing corporation, and a
writer has the obligation to sell to the clearing corporation, the underlying
security at the stated exercise price at any time prior to the expiration of the
option, regardless of the market price of the security. The premium paid to the
writer is in consideration for undertaking the obligations under the option
contract. A listed put option gives the purchaser the right to sell to a
clearing corporation the underlying security at the stated exercise price at any
time prior to the expiration date of the option, regardless of the market price
of the security. A Fund will continue to receive interest or dividend income on
the securities underlying such puts until they are exercised by the Fund.
In contrast to an option on a particular security, an option on a stock
index provides the holder with the right to make or receive a cash settlement
upon exercise of the option. The amount of this settlement will be equal to the
difference between the closing price of the index at the time of exercise and
the exercise price of the option expressed in dollars, times a specified
multiple.
The Managed Bond, Capital Income, Blue Chip, Mid-Cap Equity, Aggressive
Growth and International Funds are permitted to write call options if they are
"covered." In the case of a call option on a security, the option is "covered"
if a Fund owns the security underlying the call or has an absolute and immediate
right to acquire that security without additional cash consideration (or, if
additional cash consideration is required, cash, cash equivalents or liquid
portfolio securities in such amount as are held in a segregated account by its
custodian) upon conversion or exchange of other securities held by it. For a
call option on an index, the option is covered if a Fund maintains with its
custodian cash, cash equivalents or liquid portfolio securities equal to the
contract value. A call option is also covered if a Fund holds a call on the same
security or index as the call written where the exercise price of the call held
is (i) equal to or less than the exercise price of the call written, or (ii)
greater than the exercise price of the call written provided the difference is
maintained by the Fund in cash or cash equivalents in a segregated account with
its custodian.
The principal reason for writing call options on a securities portfolio is
the attempt to realize, through the receipt of premiums, a greater current
return than would be realized on the securities alone. In return for the
premium, the covered option writer gives up the opportunity for profit from a
price increase in the underlying security above the exercise price so long as
his obligation as a writer continues, but retains the risk of loss should the
price of the security decline. Unlike one who owns securities not subject to an
option, the covered option writer has no control over when it may be required to
sell its securities, since it may be assigned an exercise notice at any time
prior to the expiration of its obligation as a writer.
If a Fund desires to sell a particular security it owns, on which it has
written an option, the Fund will seek to effect a closing purchase transaction
prior to, or concurrently with, the sale of the security. In order to close out
a covered call option position, a Fund will enter into a "closing purchase
transaction" -- the purchase of a call option on a security or stock index with
the same exercise price and expiration date as the call option which it
previously wrote on the same security or index. If a Fund is unable to effect a
closing purchase transaction, it will not be able to sell a security on which a
call option has been written until the option expires or the Fund delivers the
underlying security upon exercise.
The International Fund is also permitted to write covered put options. A
put option is covered if the Fund maintains with its custodian cash, cash
equivalents or liquid portfolio securities equal to the contract value. A put
option is also covered if the Fund holds a put on the same underlying security
or index as the put written where the exercise price of the put held is (i)
equal to or greater than the exercise price of the put written, or (ii) less
than the exercise of the put written provided the difference is maintained by
the Fund in cash or cash equivalents in a segregated account with its custodian.
The principal reason for writing put options is the attempt to realize
additional current return through the receipt of premiums. In return for the
premium, the Fund bears the risk of loss should the price of the security
increase. As in the case of covered call options, the covered put option writer
has no control over when it may be required to pay the exercise price, since it
may be assigned an exercise notice at any time prior to the expiration of its
obligation as a writer.
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If the Fund desires to terminate its obligation pursuant to a put option it
has written, the Fund will seek to effect a closing purchase transaction, in the
same manner as a closing purchase transaction for a call option written by the
Fund. If the Fund is unable to effect a closing purchase transaction, it will
not be able to use the assets segregated to cover the option for other purposes
until the option expires or the Fund delivers the purchase price of the
securities which are the subject of the option.
When a Fund purchases a put or call option, the premium paid by it is
recorded as an asset of the Fund. When a Fund writes an option, an amount equal
to the net premium (the premium less the commission) received by the Fund is
included in the liability section of the statement of assets and liabilities as
a deferred credit. The amount of this asset or deferred credit will be
subsequently marked-to-market to reflect the current value of the option
purchased or written. The current value of the traded option is the last sale
price or, in the absence of a sale, the average of the closing bid and asked
prices. If an option purchased by a Fund expires unexercised, the Fund realizes
a loss equal to the premium paid. If a Fund enters into a closing sale
transaction on an option purchased by it, the Fund will realize a gain if the
premium received by it on the closing transaction is more than the premium paid
to purchase the option, or a loss if it is less. Moreover, because increases in
the market price of an option will generally reflect (although not necessarily
in direct proportion) increases in the market price of the underlying security
any loss resulting from a closing purchase transaction is likely to be offset in
whole or in part by appreciation of the underlying security owned by the Fund.
If an option written by a Fund expires on the stipulated expiration date or if
the Fund enters into a closing purchase transaction, it will realize a gain (or
loss if the cost of a closing purchase transaction exceeds the net premium
received when the option is sold) and the deferred credit related to such option
will be eliminated. If an option written by a Fund is exercised, the proceeds of
the sale will be increased by the net premium originally received and the Fund
will realize a gain or loss.
As noted previously, there are several risks associated with transactions
in options on securities and indices. For example, there are significant
differences between the securities and options markets that could result in an
imperfect correlation between these markets, causing a given transaction not to
achieve its objectives. In addition, a liquid secondary market for particular
options, may be absent for reasons which include the following: there may be
insufficient trading interest in certain options; restrictions may be imposed by
a national securities exchange ("Exchange") on opening transactions or closing
transactions or both; trading halts, suspensions or other restrictions may be
imposed with respect to particular classes or series of options or underlying
securities; unusual or unforeseen circumstances may interrupt normal operations
on an Exchange; the facilities of an Exchange or the Options Clearing
Corporation may not at all times be adequate to handle current trading volume;
or one or more Exchanges could, for economic or other reasons, decide or be
compelled at some future date to discontinue the trading of options (or a
particular class or series of options), in which event the secondary market on
that Exchange (or in that class or series of options) would cease to exist,
although outstanding options that had been issued by the Options Clearing
Corporation as a result of trades on that Exchange would continue to be
exercisable in accordance with their terms.
A decision as to whether, when and how to use options involves the exercise
of skill and judgment, and even a well-conceived transaction may be unsuccessful
to some degree because of market behavior or unexpected events.
FUTURES AND RELATED OPTIONS. Each Fund (except the Money Market Fund) may
enter into futures transactions and related options transactions. A futures
contract is a bilateral agreement pursuant to which two parties agree to take or
make delivery of a specified quantity of financial instruments (such as GNMA
certificates or Treasury bonds) or an amount of cash equal to a specified dollar
amount times the difference between the value of a specified stock index (which
assigns relative values to the common stocks included in the index) at the close
of the last trading day of the contract and the price at which the futures
contract is originally struck. No physical delivery of the underlying securities
is normally made.
A Fund may not purchase or sell futures contracts and purchase related
options unless immediately after any such transaction the aggregate initial
margin that is required to be posted by that Fund under the rules of the
exchange on which the futures contract (or futures option) is traded, plus any
premiums paid by the Fund on its open futures options positions, does not exceed
5% of the Fund's total assets, after taking into account
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<PAGE> 40
any unrealized profits and losses on the Fund's open contracts and excluding the
amount that a futures option is "in-the-money" at the time of purchase. An
option to buy a futures contract is "in-the-money" if the then current purchase
price of the contract that is subject to the option is less than the exercise or
strike price; an option to sell a futures contract is "in-the-money" if the
exercise or strike price exceeds the then current purchase price of the contract
that is the subject of the option.
There are several risks in connection with the use of futures contracts by
a Fund as a hedging devise. One risk arises because of the imperfect correlation
between movements in the price of the futures contract and movements in the
price of the securities which are the subject of hedge. The price of the futures
contract may move more than or less than the price of the securities being
hedged. If the price of the futures contract moves less than the price of the
securities which are the subject of the hedge, the hedge will not be fully
effective but, if the price of the securities being hedged has moved in an
unfavorable direction, the Fund would be in a better position than if it had not
hedged at all. If the price of the securities being hedged has moved in a
favorable direction, this advantage will be partially offset by the loss on the
futures contract. If the price of the futures contract moves more than the price
of the hedged securities, the Fund will experience either a loss or gain on the
futures contract which will not be completely offset by movements in the price
of the securities which are the subject of the hedge.
It is also possible that, where a Fund has sold futures contracts to hedge
its portfolio against a decline in the market, the market may advance and the
value of securities held in the Fund may decline. If this occurred, the Fund
would lose money on the futures contract and also experience a decline in value
in its portfolio securities.
In addition to the possibility that there may be an imperfect correlation,
or no correlation at all, between movements in a futures contract and the
securities being hedged, the price of futures contracts may not correlate
perfectly with movement in the cash market due to certain market distortions. As
a result of these factors, a correct forecast of general market trends or
interest rate movements by Bank of America or its Subadviser may still not
result in a successful hedging transaction over a short time frame.
Positions in futures contracts may be closed out only on an exchange or
board of trade which provides a secondary market for such futures contracts.
Although the Funds intend to purchase or sell futures contracts only on
exchanges or boards of trade where there appear to be active secondary markets,
there is no assurance that a liquid secondary market on any exchange or board of
trade will exist for any particular contract or at any particular time. In such
event, it may not be possible to close a futures investment position, and in the
event of adverse price movements, a Fund would continue to be required to make
daily cash payments of variation margin. The liquidity of a secondary market in
a futures contract may in addition be adversely affected by "daily price
fluctuation limits" established by commodity exchanges which limit the amount of
fluctuation in a futures contract price during a single trading day. Once the
daily limit has been reached in the contract, no trades may be entered into at a
price beyond the limit, thus preventing the liquidation of open futures
positions.
For additional information concerning futures and options thereon, please
see Appendix B to this Statement of Additional Information.
The following discussion on foreign currency risks relates to the
Aggressive Growth and International Funds.
FOREIGN CURRENCY TRANSACTIONS. The Aggressive Growth and International
Funds may engage in foreign currency forward contracts, options and futures
transactions.
CURRENCY RISKS. The exchange rates between the U.S. dollar and foreign
currencies are a function of such factors as supply and demand in the currency
exchange markets, international balances of payments, governmental intervention,
speculation and other economic and political conditions. Although each Fund
values its assets daily in U.S. dollars, the Fund may not convert its holdings
of foreign currencies to U.S. dollars daily. The Fund may incur conversion costs
when it converts its holdings to another currency. Foreign exchange dealers may
realize a profit on the difference between the price at which the Fund buys and
sells currencies. The Fund will engage in foreign currency exchange transactions
in connection with its portfolio
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<PAGE> 41
investments. The Fund will conduct its foreign currency exchange transactions
either on a spot (i.e., cash) basis at the spot rate prevailing in the foreign
currency exchange market or through forward contracts to purchase or sell
foreign currencies.
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS. The Fund may enter into
forward currency exchange contracts in order to protect against a possible loss
resulting from an adverse change in the relationship between the U.S. dollar and
a foreign currency involved in an underlying transaction. However, forward
foreign currency exchange contracts may limit potential gains which could result
from a positive change in such currency relationships. The Investment Adviser
believes that it is important to have the flexibility to enter into forward
foreign currency exchange contracts whenever the Investment Adviser or
Subadviser determines that it is in the Fund's best interest to do so. The Fund
will not speculate in foreign currency exchange.
The Fund will not enter into forward currency exchange contracts or
maintain a net exposure in such contracts which it would be obligated to deliver
an amount of foreign currency in excess of the value of its portfolio securities
or other assets denominated in that currency or, in the case of a "cross-hedge"
denominated in a currency or currencies that the investment adviser or
subadvisers believe will tend to be closely correlated with that currency with
regard to price movements. Generally, the Fund will not enter into a forward
foreign currency exchange contract with a term longer than one year.
FOREIGN CURRENCY OPTIONS. A foreign currency option provides the option
buyer with the right to buy or sell a stated amount of foreign currency at the
exercise price on a specified date or during the option period. The owner of a
call option has the right, but not the obligation, to buy the currency.
Conversely, the owner of a put option has the right, but not the obligation, to
sell the currency. When the option is exercised, the seller (i.e., writer) of
the option is obligated to fulfill the terms of the sold option. However, either
the seller or the buyer may, in the secondary market, close its position during
the option period at any time prior to expiration.
A call option on foreign currency generally rises in value if the
underlying currency appreciates in value, and a put option on a foreign currency
generally rises in value if the underlying currency depreciates in value.
Although purchasing a foreign currency option can protect the Fund against an
adverse movement in the value of a foreign currency, the option will not limit
the movement in the value of such currency. For example, if the Fund was holding
securities denominated in a foreign currency that was appreciating and had
purchased a foreign currency put to hedge against a decline in the value of the
currency, the Fund would not have to exercise its put option. Likewise, if the
Fund were to enter into a contract to purchase a security denominated in foreign
currency and, in conjunction with that purchase, were to purchase a foreign
currency call option to hedge against a rise in value of the currency, and if
the value of the currency instead depreciated between the date of purchase and
the settlement date, the Fund would not have to exercise its call. Instead, the
Fund could acquire in the spot market the amount of foreign currency needed for
settlement.
SPECIAL RISKS ASSOCIATED WITH FOREIGN CURRENCY OPTIONS. Buyers and sellers
of foreign currency options are subject to the same risks that apply to options
generally. In addition, there are certain risks associated with foreign currency
options. The markets in foreign currency options are relatively new, and the
Fund's ability to establish and close out positions on such options is subject
to the maintenance of a liquid secondary market. Although the Fund will not
purchase or write such options unless and until, in the opinion of the
Investment Adviser or Subadviser, the market for them has developed sufficiently
to ensure that the risks in connection with such options are not greater than
the risks in connection with the underlying currency, there can be no assurance
that a liquid secondary market will exist for a particular option at any
specific time.
In addition, options on foreign currencies are affected by all of those
factors that influence foreign exchange rates and investments generally. The
value of a foreign currency option depends upon the value of the underlying
currency relative to the U.S. dollar. As a result, the price of the option
position may vary with changes in the value of either or both currencies and may
have no relationship to the investment merits of a foreign security. Because
foreign currency transactions occurring in the interbank market involve
substantially larger amounts than those that may be involved in the use of
foreign currency options, investors may be disadvantaged by having to deal in an
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.
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There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirements that quotations available through
dealers or other market sources be firm or revised on a timely basis. Available
quotation information is generally representative of very large transactions in
the interbank market and thus may not reflect relatively smaller transactions
(i.e., less than $1 million) where rates may be less favorable. The interbank
market in foreign currencies is a global, around-the-clock market. To the extent
that the U.S. option markets are closed while the markets for the underlying
currencies remain open, significant price and rate movements may take place in
the underlying markets that cannot be reflected in the options markets until
they reopen.
FOREIGN CURRENCY FUTURES TRANSACTIONS. By using foreign currency futures
contracts and options on such contracts, the International Fund may be able to
achieve many of the same objectives as it would through the use of forward
foreign currency exchange contracts. The International Fund may be able to
achieve these objectives possibly more effectively and at a lower cost by using
futures transactions instead of forward foreign currency exchange contracts.
SPECIAL RISKS ASSOCIATED WITH FOREIGN CURRENCY FUTURES CONTRACTS AND
RELATED OPTIONS. Buyers and sellers of foreign currency futures contacts are
subject to the same risks that apply to the use of futures generally. In
addition, there are risks associated with foreign currency futures contracts and
their use as a hedging device similar to those associated with options on
currencies, as described above.
Options on foreign currency futures contracts may involve certain
additional risks. Trading options on foreign currency futures contracts is
relatively new. The ability to establish and close out positions on such options
is subject to the maintenance of a liquid secondary market. To reduce this risk,
the Fund will not purchase or write options on foreign currency futures
contracts unless and until, in the opinion of the Investment Adviser or
Subadviser, the market for such options has developed sufficiently that the
risks in connection with such options are not greater than the risks in
connection with transactions in the underlying foreign currency futures
contracts. Compared to the purchase or sale of foreign currency futures
contracts, the purchase of call or put options on futures contracts involves
less potential risk to the Fund because the maximum amount at risk is the
premium paid for the option (plus transaction costs). However, there may be
circumstances when the purchase of a call or put option on a futures contract
would result in a loss, such as when there is no movement in the price of the
underlying currency or futures contract.
WHEN-ISSUED SECURITIES, FORWARD COMMITMENTS AND DELAYED SETTLEMENTS. Each
Fund may purchase securities on a "when-issued" basis and may purchase or sell
securities on a "forward commitment" or "delayed settlement" basis. "Delayed
settlement" describes a securities transaction in the secondary market for which
settlement will occur sometime in the future.
When a Fund agrees to purchase securities on a when-issued, forward
commitment or delayed settlement basis, its custodian will set aside cash or
liquid portfolio securities equal to the amount of the commitment in a separate
account. During the time that the Fund is obligated to purchase such securities
it will maintain in a segregated account U.S. Government securities, high-grade
debt obligations, marketable equity securities, and/or cash or cash equivalents
sufficient to satisfy a purchase commitment. In such a case, a Fund may be
required subsequently to place additional assets in the separate account in
order to assure that the value of the account remains equal to the amount of the
commitment. It may be expected that the net assets of a Fund will fluctuate to a
greater degree when it sets aside portfolio securities to cover such purchase
commitments than when it sets aside cash. The Funds do not intend to engage in
these transactions for speculative purposes but only in furtherance of their
investment objectives. Because a Fund will set aside cash or liquid portfolio
securities to satisfy its purchase commitments in the manner described, its
liquidity and the ability of the investment adviser to manage it may be affected
in the event the forward commitments and commitments to purchase when-issued or
delayed settlement securities ever exceeded 25% of the value of the Fund's net
assets.
A Fund will purchase securities on a when-issued, forward commitment or
delayed settlement basis only with the intention of completing the transaction.
If deemed advisable as a matter of investment strategy, however, a Fund may
dispose of or renegotiate a commitment after it is entered into, and may sell
securities it has committed to purchase before those securities are delivered to
the Fund on the settlement date.
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When a Fund engages in when-issued, forward commitment and delayed
settlement transactions, it relies on the other party to consummate the trade.
Failure of such party to do so may result in the Fund's incurring a loss or
missing an opportunity to obtain a price considered to be advantageous.
The market value of the securities underlying a when issued purchase or
forward commitment and delayed settlement transaction and any subsequent
fluctuations in their market value is taken into account when determining the
market value of a Fund starting on the day the Fund agrees to purchase the
securities. A Fund does not earn interest on the securities it has committed to
purchase until they are paid for and delivered on the settlement date.
SECURITIES LENDING. Each Fund except the Money Market Fund may lend its
securities to brokers, dealers and financial institutions, provided (1) the loan
is secured continuously by collateral consisting of U.S. Government securities
or cash or letters of credit which is marked to the market daily to ensure that
each loan is fully collateralized at all times; (2) the Fund involved may call
the loan at any time upon reasonable notice; (3) the Fund will receive any
interest or dividends paid on the securities loaned; and (4) the aggregate
market value of securities loaned will not at any time exceed certain specified
limits of the total assets of the Fund.
A Fund will earn income on the collateral for lending its securities. In
connection with lending securities, a Fund may pay reasonable finders,
administrative and custodial fees. Loans of securities involve a risk that the
borrower may fail to return the securities or may fail to provide additional
collateral.
Although the Funds reserve the right to lend their securities, none of the
Funds have any current intention of doing so in the foreseeable future.
SMALL CAPITALIZATION SECURITIES. Each Fund except the Money Market, Blue
Chip and Mid-Cap Equity Funds, particularly the Aggressive Growth Fund, may hold
common stock of companies with relatively small market capitalizations that Bank
of America or its Subadviser expects will experience above-average growth in
earnings and price. Some of these companies have limited product lines, markets
and financial resources and will be dependent upon a limited management group.
Examples of possible investments include emerging growth companies employing new
technology, initial public offerings of companies offering high growth
potential, or other corporations offering good potential for high growth in
market value. The securities of small companies may be subject to more abrupt or
erratic market movements than larger, more established companies both because
the securities typically are traded in lower volume and because the issuers
typically are subject to a greater degree to changes in earnings and prospects.
Some of the securities owned by certain of the Funds may be traded only in
the over-the-counter market or on a regional securities exchange, may be listed
only in the quotation service commonly known as the "pink sheets," and may not
be traded every day or in the volume typical of trading on a national securities
exchange. As a result, the disposition by the Funds of portfolio securities, to
meet redemptions or otherwise, may require a Fund to sell these securities at a
discount from market prices, to sell during periods when such disposition is not
desirable, or to make many small sales over a lengthy period of time.
PREFERRED STOCK. The Capital Income and International Funds may invest in
preferred stocks. Generally, preferred stock has a specified dividend and ranks
after bonds and before common stocks in its claim on income for dividend
payments and on assets should the issuer be liquidated. While most preferred
stocks pay a dividend, a Fund may purchase preferred stock where the issuer has
omitted, or is in danger of omitting, payment of its dividend. Such investments
would be made primarily for their capital appreciation potential.
FOREIGN INVESTMENTS. The Managed Bond, Capital Income, Aggressive Growth
and International Funds may invest directly in foreign securities subject to the
limits set forth in the Prospectus. In considering whether to invest in the
securities of a foreign company, Bank of America or a Subadviser considers such
factors as the characteristics of the particular company, differences between
economic trends and the performance of securities markets within the U.S. and
those within other countries, and also factors relating the general economic,
governmental and social conditions of the country or countries where the company
is located.
The Managed Bond, Capital Income and International Funds may purchase debt
obligations issued or guaranteed by governments (including states, provinces or
municipalities) of countries other than the United
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States, or by their agencies, authorities or instrumentalities. The Funds may
also purchase debt obligations issued or guaranteed by supranational entities
organized or supported by several national governments, such as the
International Bank for Reconstruction and Development (the "World Bank"), the
Inter-American Development Bank, the Asian Development Bank and the European
Investment Bank. In addition, the Funds may purchase debt obligations of foreign
corporations or financial institutions, such as Yankee bonds (dollar-denominated
bonds sold in the United States by non-U.S. issuers), Samurai bonds
(yen-denominated bonds sold in Japan by non-Japanese issuers) and Euro bonds
(bonds not issued in the country (and possibly the currency of the country) of
the issuer).
The Funds' investments will be allocated among securities denominated in
the currencies of a number of foreign countries and, within each such country,
among different types of debt securities. The percentage of assets invested in
securities of a particular country or denominated in a particular currency will
vary in accordance with Bank of America's or a Subadviser's assessment of the
country's gross domestic product, purchasing power parity and market
capitalization and the relationship of a country's currency to the United States
dollar. Fundamental economic strength, credit quality and interest rate trends
will be the principal factors considered by Bank of America or a Subadviser in
determining whether to increase or decrease the emphasis placed upon a
particular type of security within a Fund's portfolio.
Securities transactions conducted outside the U.S. may not be regulated as
rigorously as in the U.S., may not involve a clearing mechanism and related
guarantees, and are subject to the risk of governmental actions affecting
trading in, or the prices of, foreign securities, currencies and other
instruments. The value of such positions also could be adversely affected by:
(i) other complex foreign political, legal and economic factors, (ii) lesser
availability than in the U.S. of data on which to make trading decisions, (iii)
delays in a Fund's ability to act upon economic events occurring in foreign
markets during non-business hours in the U.S., (iv) the imposition of different
exercise and settlement terms and procedures and the margin requirements than in
the U.S., and (v) lower trading volume and liquidity.
In accordance with regulations of the California Department of Insurance,
the International Fund will invest in the securities of issuers domiciled or
primarily traded in at least five foreign countries if the Fund has invested at
least 80% of its net assets in foreign issuers. If the Fund has invested less
than 20% of its net assets in foreign issuers, then all of such investment may
be in issuers domiciled or primarily traded in one country. If the Fund has
invested at least 20% but less than 40% of its net assets in foreign issuers,
then such investment must be allocated to issuers domiciled or primarily traded
in at least two foreign countries. Similarly, if the Fund has invested at least
40% but less than 60% of its net assets invested in foreign issuers, such
investment must be allocated to at least three foreign countries. Foreign
investments must be allocated to at least four foreign countries if such
investments comprise at least 60% but less than 80% of the Fund's net assets.
The Fund will not invest more than 20% of its net assets in securities of
issuers domiciled or primarily traded in any one country, except that the Fund
may invest up to 35% of its net assets in issuers domiciled or primarily traded
in any one of the following countries: Australia, Canada, France, Japan, the
United Kingdom, or Germany. The Fund may exceed these limits to the extent
permitted by the California insurance authorities. The Fund is not subject to
any limit upon investment in issuers domiciled or primarily traded in the United
States.
DURATION
Duration is a measure of average life of a bond on a present value basis,
which was developed to incorporate a bond's yield, coupons, final maturity and
call features into one measure. Duration is one of the fundamental tools that
may be used by the Investment Adviser or Subadviser in fixed income security
selection. In this discussion, the term "bond" is generally used to connote any
type of debt instrument.
Most notes and bonds have provided interest ("coupon") payments in addition
to a final ("par") payment at maturity. Some obligations also feature call
provisions. Depending on the relative magnitude of these payments, debt
obligations may respond differently to changes in the level and structure of
interest rates. Traditionally, a debt security's "term to maturity" has been
used as a proxy for the sensitivity of the securities price to changes in
interest rates (which is the "interest rate risk" or "volatility" of the
security). However,
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<PAGE> 45
"term to maturity" measures only the time until a debt security provides its
final payment, taking no account of the pattern of the security's payments prior
to maturity.
Duration is a measure of the average life of a fixed-income security on a
present value basis. Duration takes the length of time intervals between the
present time and the time that the interest and principal payments are
scheduled, or, in the case of a callable bond, expected to be received, and
weights them by the present values of the cash to be received at each future
point in time. For any fixed-income security with interest payments occurring
prior to the payments of principal duration is always less than maturity. In
general, all other things being the same, the lower stated or coupon rate of
interest of a fixed income security, the longer the duration of the security;
conversely, the higher the stated or coupon rate of interest of a fixed-income
security, the shorter the duration of the security.
Although frequently used, the "term of maturity" of a bond is not a useful
measure of the longevity of a bond's cash flow because it refers only to the
time remaining to the repayment of principal or corpus and disregards earlier
coupon payments. Thus, for example, three bonds with the same maturity may not
have the same investment characteristics (such as risk or repayment time). One
bond may have large coupon payments early in its life, whereas another may have
payments distributed evenly throughout its life. Some bonds (such as zero coupon
bonds) make no coupon payments until maturity. Clearly, an investor
contemplating investing in these bonds should consider not only the final
payment or sum of payments on the bond, but also the timing and magnitude of
payments in order to make an accurate assessment of each bond. Maturity, or the
term to maturity does not provide a prospective investor with a clear
understanding of the time profile of cash flows over the life of a bond.
Another way of measuring the longevity of a bond's cash flow is to compute
a simple average time to payment, where each year is weighted by the number of
dollars the bond pays that year. This concept is termed the "dollar-weighted
mean waiting time," indicating that it is a measure of the average time to
payment of a bond's cash flow. The critical shortcoming of this approach is that
it assigns equal weight to each dollar paid over the life of a bond, regardless
of when the dollar is paid. Since the present value of a dollar decreases with
the amount of time which must pass before it is paid, a better method might be
to weight each year by the present value of the dollars paid that year. This
calculation puts the weights on a comparable basis and creates a definition of
longevity which is known as duration.
A bond's duration depends on three variables: (i) the maturity of the bond;
(ii) the coupon payments attached to the bond; and (iii) the bond's yield to
maturity. Yield to maturity, or investment return as used here, represents the
approximate return an investor purchasing a bond may expect if he holds that
bond to maturity. In essence, Yield to maturity is the rate of interest, which,
if applied to the purchase price of a bond, would be capable of exactly
reproducing the entire time schedule of future interest and principal payments.
Increasing the size of the coupon payments on a bond, while leaving the
maturity and yield unchanged, will reduce the duration of the bond. This follows
from the fact that because bonds with higher coupon payments pay relatively more
of their cash flows sooner, they have shorter durations. Increasing the yield to
maturity on a bond (e.g., by reducing its purchase price), while leaving the
terms to maturity and coupon payments unchanged, also reduces the duration of
the bond. Because a higher yield leads to lower present values for more distant
payments relative to earlier payments, and, to relatively lower weights attached
to the years remaining to those payments, the duration of the bond is reduced.
There are some situations where event 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 duration is mortgage pass-throughs. The stated final maturity is
generally 30 years but current prepayment rates are more critical in determining
the securities' interest rate exposure. In these and other similar situations,
the Investment Adviser or Subadviser will use more sophisticated analytical
techniques which incorporate the economic life of a security into the
determination of its interest rate exposures.
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<PAGE> 46
OTHER INVESTMENT LIMITATIONS
The following is a list of restrictions and fundamental policies that may
not be changed for any Fund without the affirmative vote of the holders of a
majority of the Fund's outstanding shares (as defined below under "General
Information -- Miscellaneous").
None of the Funds may:
1. Purchase securities (except securities issued by the U.S.
Government, its agencies or instrumentalities) if, as a result, more than
5% of its total assets will be invested in the securities of any one issuer
or it would own more than 10% of the voting securities of such issuer,
except that (a) up to 25% of its total assets may be invested without
regard to these limitations, and (b) assets may be invested in the
securities of one or more diversified management investment companies to
the extent permitted by the 1940 Act.
2. Purchase any securities that would cause more than 25% of the value
of the Fund's total assets at the time of such purchase to be invested in
the securities of one or more issuers conducting their principal activities
in the same industry, provided that (a) there is no limitation with respect
to investments in obligations issued or guaranteed by the U.S. Government,
its agencies and instrumentalities, (b) assets may be invested in the
securities of one or more diversified management investment companies to
the extent permitted by the 1940 Act, and (c) this limitation does not
apply to investments by the Money Market Fund in repurchase agreements.
3. Issue senior securities, except in connection with permissible
borrowings and futures and options transactions.
4. Underwrite any issue of securities, except when, in connection with
the disposition of portfolio securities, it may be deemed to be an
underwriter under federal securities laws.
5. Purchase or sell real estate. However, a Fund may, to the extent
appropriate to its investment objective, purchase securities secured by
real estate or interests therein, and securities issued by companies
investing in real estate or interests therein.
6. Borrow money for any Fund except for temporary emergency purposes
and then only in an amount not exceeding 10% of the value of the total
assets of that Fund, except that a Fund may borrow up to 25% of its total
assets when such borrowing is required to meet Fund redemptions. Borrowing
shall, for purposes of this paragraph, include reverse repurchase
agreements. Any borrowings, other than reverse repurchase agreements, will
be from banks.
7. Make loans, except that a Fund (a) may purchase or hold debt
instruments, certificates of deposit, commercial paper, bankers'
acceptances, fixed time deposits and repurchase agreements, pursuant to its
investment objectives and policies, and (b) may lend portfolio securities
against collateral consisting of cash or securities of the U.S. Government
and its agencies and instrumentalities, which are consistent with its
permitted investments, in an amount not exceeding 1/3 of the Fund's total
assets.
The following is a list of non-fundamental restrictions and operating
policies that may be changed by the Board of Trustees for any Fund without
approval of the Fund's shareholders:
None of the Funds may:
1. Pledge, mortgage or hypothecate the assets of the Fund except in
connection with permissible borrowings and futures and options
transactions.
2. Invest the assets of any Fund in securities that are not readily
marketable or in securities with legal or contractual restrictions on
resale (including repurchase agreements maturing in more than seven days)
to any extent greater than 15% of the value of the net assets of the Fund
(10% for the Money Market Fund). It is not intended that securities
purchased by a Fund in an offering exempt from registration in reliance on
Rule 144A or 4(2) Commercial Paper under the Securities Act and for which a
liquid trading market exists, as determined by the Board of Trustees of
such Fund or by Bank of
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<PAGE> 47
America or a Subadviser (pursuant to guidelines adopted by the Board), be
included within this limitation.
3. Purchase on margin or sell short, except that this limitation shall
not apply to transactions in options or futures contracts.
4. Purchase securities of any other open-end or closed-end investment
company, except (a) by purchase in the open market where no commission or
profit to a sponsor or dealer results from the purchase other than the
customary broker's commission, (b) in connection with a merger,
consolidation, acquisition or reorganization, and (c) assets may be
invested in the securities of one or more diversified management investment
companies to the extent permitted by the 1940 Act.
5. Purchase or sell commodities or commodity contracts, other than
futures contracts and options thereon as described in the Prospectus or
SAI, as amended from time to time. This limitation does not apply to
foreign currency transactions, including forward currency contracts.
6. Purchase securities of companies for the purpose of exercising
control.
7. Purchase securities on margin, except for the use of short term
credit necessary for clearance of purchases and sales of portfolio
securities. This does not apply to margin deposits in connection with
options, futures contracts and options thereon.
* * *
If a percentage restriction is satisfied at the time of investment, a later
increase or decrease in such percentage resulting from a change in asset value
will not constitute a violation of such restriction.
In accordance with the current views of the Staff of the SEC and as a
matter of non-fundamental policy that may be changed without a vote of
shareholders or interestholders, the Funds treat all supranational organizations
as a single industry and each foreign government (and all of its agencies) as a
separate industry.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
The price paid for purchases and redemptions of shares of the Funds is the
net asset value per share, which is calculated once daily at the close of
trading (currently 4:00 p.m. New York time) each day the New York Stock Exchange
is open. The New York Stock Exchange is currently closed on weekends and on the
following holidays: New Year's Day, President's Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving, and Christmas Day. The offering price
is effective for orders received by the Transfer Agent prior to the time of
determination of net asset value.
The net asset value of a Fund share is calculated by dividing (i) the value
of the securities held by the Fund, plus any cash or other assets, minus all
liabilities (including accrued estimated expenses on an annual basis), by (ii)
the total number of shares of the Fund outstanding. The value of the investments
and assets of the Fund is determined each business day in accordance with
certain procedures described below.
MONEY MARKET FUND
The Money Market Fund uses the amortized cost method of valuation in
computing the net asset value of its shares for purposes of sales and
redemptions. Under this method the Fund values each of its portfolio securities
at cost on the date of purchase and thereafter assumes a constant proportionate
amortization of any discount or premium until maturity of the security. As a
result the value of a portfolio security for purposes of determining net asset
value normally does not change in response to fluctuating interest rates. While
the amortized cost method seems to provide certainty in portfolio valuation, it
may result in periods during which values, as determined by amortized cost, are
higher or lower than the amount the Fund would receive if it sold its portfolio
securities. The market value of the securities in the Fund can be expected to
vary inversely with changes in prevailing interest rates. Thus, if interest
rates have increased from the time a security was purchased, such security, if
sold, might be sold at a price less than its amortized cost. Similarly, if
interest rates
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<PAGE> 48
have declined from the time a security was purchased, such security, if sold,
might be sold at a price greater than its amortized cost. In either instance, if
the security is held to maturity, no gain or loss will be realized.
In connection with its use of amortized cost valuation, the Fund limits the
dollar-weighted average maturity of its portfolio to not more than 90 days and
does not purchase an instrument with a remaining maturity of greater than 397
calendar days (except for longer agency floating rate instruments with interest
reset dates at least every thirteen months). The Board of Trustees has also
established, pursuant to rules promulgated by the SEC, procedures that are
intended to stabilize the Fund's net asset value per share for purposes of sales
and redemptions at $1.00. Such procedures include the determination, at such
intervals as the Board deems appropriate, of the extent, if any, to which the
Fund's net asset value per share calculated by using available market quotations
deviates from $1.00 per share. In the event such deviation exceeds 1/2 of 1% the
Board will promptly consider what action, if any, should be initiated. If the
Board believes that the amount of any deviation may result in material dilution
or other unfair results to investors or existing shareholders, it will take
steps as it considers appropriate to eliminate or reduce to the extent
reasonably practicable any such dilution or unfair results. These steps may
include selling portfolio instruments prior to maturity, shortening the Fund's
average portfolio maturity, withholding or reducing dividends, reducing the
number of the Fund's outstanding shares without monetary consideration or
determining net asset value per share by using available market quotations. If
the Fund reduces the number of its outstanding shares without monetary
consideration it will mail written notice to shareholders at least three
business days before the redemption and in the notice will state the reason for
the redemption and the fact that the redemption may result in a capital loss to
shareholders.
OTHER FUNDS. Except for debt securities with remaining maturities of 60
days or less, the following assets held by the Funds (other than the Money
Market Fund) for which market quotations are available are valued as follows:
(a) U.S. Government and agency obligations are valued based upon bid quotations
from the Federal Reserve Bank for identical or similar obligations; and (b)
short-term money market instruments (such as certificates of deposit, bankers'
acceptances and commercial paper) are most often valued by bid quotations or by
reference to bid quotations of available yields for similar instruments of
issuers with similar credit ratings. The Board of Trustees of the Trust has
determined that the values obtained using the procedures described above
represent the fair values of the securities valued by such procedures. Most of
these prices are obtained by PFPC Inc. from a service that collects and
disseminates such market prices. Bid quotations for short-term money market
instruments reported by such service are the bid quotations reported to it by
major dealers in such instruments.
The valuation of options is described above in the section entitled
"Investment Objectives and Policies: Types of Obligations, Investment Risks, and
Other Investment Information -- Options."
Debt securities held by the Funds with remaining maturities of 60 days or
less are valued on the basis of amortized cost, which provides stability of net
asset value. Under this valuation method, the security is initially valued at
cost on the date of purchase or, in the case of securities purchased with more
than 60 days remaining to maturity and to be valued on the amortized cost basis
only during the final 60 days of its maturity, the market value on the 61st day
prior to maturity. Thereafter the Funds assume a constant proportionate
amortization in value until maturity of any discount or premium regardless of
the impact of fluctuating interest rates on the market value of the security,
unless the Board of Trustees determines that amortized cost no longer represents
fair value. The Funds will monitor the market value of these investments for the
purpose of ascertaining whether any such circumstances exist.
Trading in securities on foreign securities exchanges and over-the-counter
markets is normally completed well before the close of business day in New York.
In addition, foreign securities trading may not take place on all business days
in New York, and may occur in various foreign markets on days which are not
business days in New York and on which net asset value is not calculated. The
calculation of net asset value may not take place contemporaneously with the
determination of the prices of portfolio securities used in such calculation.
Events affecting the values of portfolio securities that occur between the time
their prices are determined and the close of the New York Stock Exchange will
not be reflected in the calculation of net asset value unless the Board of
Trustees determines that the particular event would materially affect net asset
value, in which case
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an adjustment will be made. Information that becomes known to the Trust or its
agents after the time that net asset value is calculated on any business day may
be assessed in determining net asset value after the time of the receipt of
information, but will not be used retroactively to adjust such prices determined
earlier or on a prior day.
Assets or liabilities initially expressed in terms of foreign currencies
are translated prior to the next determination of the net asset value into U.S.
dollars at the spot exchange rates at 12:00 noon New York time or at such other
rates as Bank of America may determine to be appropriate in computing net asset
value.
PRICING SERVICES. When approved by the Board of Trustees, certain
securities may be valued on the basis of valuations provided by an independent
pricing service when such prices are believed to reflect the fair market value
of such securities. These securities may include those that have no available
recent market value, have few outstanding shares and, therefore, infrequent
trades, or for which there is a lack of consensus on the value, with quoted
prices covering a wide range. The lack of consensus might result from relatively
unusual circumstances, such as no trading in the security for long periods of
time, or a company's involvement in merger or acquisition activity, with widely
varying valuations placed on the company's assets or stock. Prices provided by
an independent pricing service may be determined without exclusive reliance on
quoted prices and may take into account appropriate factors such as
institutional-size trading in similar groups of securities, yield, quality,
coupon rate, maturity, type of issue, trading characteristics and other market
data.
In the absence of an ascertainable market value, assets are valued at their
fair value as determined using methods and procedures reviewed and approved by
the Board of Trustees.
ADDITIONAL INFORMATION CONCERNING TAXES
FEDERAL TAXES
Each Fund will be treated as a separate corporate entity under the Internal
Revenue Code of 1986, as amended (the "Code"), and intends to qualify as a
"regulated investment company." By following this policy, each Fund expects to
eliminate or reduce to a nominal amount the federal income taxes to which it may
be subject. If for any taxable year a Fund does not qualify for the special
federal tax treatment afforded regulated investment companies, all of the Fund's
taxable income would be subject to tax at regular corporate rates (without any
deduction for distributions to shareholders).
Qualification as a regulated investment company under the Code requires,
among other things, that each Fund distribute to its shareholders an amount
equal to at least the sum of 90% of its investment company taxable income (if
any) and 90% of its tax-exempt income (if any), net of certain deductions for
each taxable year. In general, a Fund's taxable income will include the revenues
derived from dividends, interest, and short-term capital gains (the excess of
net short-term capital gain over net long-term capital loss), adjusted for
certain items, and excluding the excess of any net long-term capital gain for
the taxable year over the net short-term capital loss, if any, for such year. A
Fund will be taxed on its undistributed investment company taxable income, if
any. Each Fund intends to distribute at least 90% of its investment company
taxable income (if any) for each taxable year.
Qualification as a regulated investment company under the Code also
requires that each Fund (a) derive at least 90% of its gross income from
dividends, interest, payments with respect to securities loans, and gains from
the sale or other disposition of securities or foreign currencies, or other
income (including, but not limited to, gains from options, futures or forward
contracts) derived with respect to its business of investing in such securities
or currencies; and (b) diversify its holdings so that, at the end of each fiscal
quarter, (i) at least 50% of the market value of the Fund's assets is
represented by cash, U.S. Government securities and securities of other
regulated investment companies, and other securities (for purposes of this
calculation generally limited, in respect of any one issuer, to an amount not
greater than 5% of the Fund's assets and 10% of the outstanding voting
securities of such issuer) and (ii) not more than 25% of the value of its assets
is invested in the securities of any one issuer (other than U.S. Government or
foreign government securities or the securities
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<PAGE> 50
of other regulated investment companies), or two or more issuers which the Trust
controls and which are determined to be engaged in the same or similar trades or
businesses.
A Fund will not be treated as a regulated investment company under the Code
if 30% or more of the Fund's gross income for a taxable year is derived from
gains realized on the sale or other disposition of the following investments
held for less than three months: (1) stock and securities (as defined in section
2(a)(36) of the 1940 Act); (2) options, futures and forward contracts other than
those on foreign currencies; and (3) foreign currencies (and options, futures
and forward contracts on foreign currencies) that are not directly related to a
Fund's principal business of investing in stock and securities (and options and
futures with respect to stocks and securities). Interest (including original
issue discount and accrued market discount) received by a Fund upon maturity or
disposition of a security held for less than three months will not be treated as
gross income derived from the sale or other disposition of such security within
the meaning of this requirement. Any other income that is attributable to
realized market appreciation, however, will be treated as gross income from the
sale or other disposition of securities for this purpose. With respect to
covered call options, if the call is exercised by the holder, the premium and
the price received on exercise constitute the proceeds of sale, and the
difference between the proceeds and the cost of the securities subject to the
call is capital gain or loss. Premiums from expired call options written by a
Fund and net gains from closing purchase transactions are treated as short-term
capital gains for federal income tax purposes, and losses on closing purchase
transactions are short-term capital losses. See Appendix B -- "Accounting and
Tax Treatment" for a general discussion of the federal tax treatment of futures
contracts, related options thereon and other financial instruments, including
their treatment under the 30% test.
In addition, each Fund must satisfy the diversification requirements of
Section 817(h) of the Code. In general, for a Fund to meet these investment
diversification requirements, Treasury regulations require that no more than 55%
of the total value of the assets of the Fund may be represented by any one
investment, no more than 70% by two investments, no more than 80% by three
investments and no more than 90% by four investments. Generally, for purposes of
the regulations, all securities of the same issuer are treated as a single
investment. With respect to U.S. Government securities (including any security
that is issued, guaranteed or insured by the United States or an instrumentality
of the United States), each governmental agency or instrumentality is treated as
a separate issuer. Compliance with the regulations is tested on the last day of
each calendar year quarter. There is a 30 day period after the end of each
calendar year quarter in which to cure any non-compliance.
Dividends paid by a Fund from ordinary income, and distributions of the
Fund's net realized short-term capital gains, are treated as ordinary income in
the hands of a Separate Account shareholder. Under the Code, any distributions
designated as being made from net capital gains will be treated as long-term
capital gains in the hands of a Separate Account, regardless of the holding
period of such Separate Account. Such distributions of net capital gains will be
designated by the Fund as a capital gains distribution in a written notice to
its shareholders which accompanies the distribution payment. Any loss on the
sale of Fund shares held for less than six months will be treated as a long-term
capital loss for federal tax purposes to the extent a Separate Account receives
net capital gain distributions on such shares.
A 4% non-deductible excise tax is imposed on regulated investment companies
that fail currently to distribute specific percentages of their ordinary taxable
income and capital gain net income (excess of capital gains over capital
losses). To avoid the tax, a Fund must distribute (or be deemed to have
distributed) during each calendar year (i) at least 98% of its ordinary income
(not taking into account any capital gains or losses) for the calendar year,
(ii) at least 98% of its capital gains in excess of capital losses for the
twelve month period ending on October 31 of the calendar year (adjusted for
certain ordinary losses), and (iii) all ordinary income and capital gains for
previous years that were not distributed during such years. Each Fund intends to
make sufficient distributions or deemed distributions of its ordinary taxable
income and any capital gain net income prior to the end of each calendar year to
avoid liability for this excise tax.
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OTHER TAX INFORMATION
Contract owners should refer to the prospectus for the Separate Accounts
and Contracts for information regarding the federal income tax treatment of
distributions made by the Funds to the Separate Accounts and the circumstances
under which distributions may be made from the Separate Accounts to Contract
owners.
The Trust may be subject to state or local taxes in certain states where it
is deemed to be doing business. Further, the state tax treatment of the Trust
and of Pacific Mutual, with respect to investments made by its Separate Accounts
in the Funds, may differ from federal tax treatment. Appropriate tax advisers
should be consulted with respect to such questions arising under federal, state
and local tax law.
The foregoing discussion of federal income taxation is based on tax laws
and regulations which are in effect on the date of this Statement of Additional
Information. Such laws and regulations may be changed by legislative or
administrative action. This discussion is only a summary of some of the
important tax considerations generally affecting purchasers of Fund shares. No
attempt is made to present a detailed explanation of the federal income tax
treatment of the Funds or their shareholders, and this discussion is not
intended as a substitute for careful tax planning. Accordingly, potential
purchasers of Fund shares should consult their tax advisers with specific
reference to their own tax situation.
-23-
<PAGE> 52
MANAGEMENT
TRUSTEES AND OFFICERS OF THE TRUST
The trustees and officers of the Trust, their addresses, and principal
occupations during the past five years are:
<TABLE>
<CAPTION>
POSITION PRINCIPAL OCCUPATIONS
NAME AND ADDRESS WITH COMPANY AND AGE
- ---------------------------------- --------------------- ---------------------------------------------------------
<S> <C> <C>
Edward S. Bottum Trustee/Chairman Managing Director, Chase Franklin Corporation (venture
c/o Chase Franklin Corporation capital firm) since 1990; Trustee, Time Horizon Funds
100 S. Wacker Drive (since 1995); formerly Vice Chairman of Continental Bank
Chicago, IL 60606 N.A. (retired 1990); formerly Trustee, 231 Funds
(February 1993 to August 1995). Age: 63.
William P. Carmichael Trustee Trustee, Time Horizon Funds (since 1995); formerly Senior
808 S. Garfield Vice President, Sara Lee Corporation (1992 to 1993);
Hinsdale, IL 60521 formerly Treasurer, Senior Vice President and Chief
Financial Officer, Beatrice Company (1987 to 1990);
formerly Trustee, 231 Funds (registered investment
company) (February 1993 to August 1995). Age: 53.
Robert E. Greeley Trustee Chairman, Page Mill Asset Management (a private
Page Mill Asset Management investment company) since 1991; Director, Pacific Horizon
433 California Street Funds, Inc. (since 1994), Morgan Grenfell Small Cap Fund
Suite 900 (since 1986); Trustee, Master Investment Trust Series I
San Francisco, CA 94104 (since 1993), Master Investment Trust, Series II (since
1993), Time Horizon Funds (since 1995), (registered
investment companies); formerly Director, Bunker Hill
Income Securities, Inc. (1989 to 1994), Trustee,
SunAmerica Fund Group (previously Equitec Siebel Fund
Group), 1984 to 1992 (registered investment companies);
formerly Director, Manager, Corporate Investments,
Hewlett Packard Company from 1979 to 1991. Age: 65.
Harold T. Joanning Trustee Retired. Formerly Executive Vice President, Finance and
3621 Sausalito Drive Administration, Pacific Mutual Life Insurance Company
Corona del Mar, CA 92625 (1980 to 1991). Age: 69.
John Privat Trustee Director, Seafirst Retirement Funds (since 1993)
8852 NE 24th Street (registered investment company); Trustee, Time Horizon
Bellevue, WA 98004 Funds (since 1995). Age: 62.
J. David Huber President President, BISYS Fund Services, Inc. since 1996, (prior
Concord Financial Group, Inc. thereto, Senior Vice President of Client Services, BISYS
3435 Stelzer Road Fund Services, Inc., since 1987); President, Time Horizon
Columbus, OH 43219 Funds, Master Investment Trust, Series I and Master
Investment Trust, Series II (since 1995); President,
Pacific Horizon Funds (since 1996). Age: 50.
Irimga McKay Vice President Senior Vice President, July 1995 to date, BISYS Fund
Concord Financial Group, Inc. Services, Inc.; Vice President, Pacific Horizon Funds,
1230 Columbia St. Master Investment Trust, Series II and Seafirst
San Diego, CA 92101 Retirement Funds (since 1993); First Vice President,
Concord Corporation (November 1988 to April 1995). Age:
36.
Stephanie L. Blaha Vice President Director of Client Services, BISYS Fund Services, Inc.,
Concord Financial Group, Inc. March 1995 to date; Vice President, Time Horizon Funds,
3435 Stelzer Road Seafirst Retirement Funds, Master Investment Trust,
Columbus, OH 43219 Series I and Master Investment Trust, Series II (since
1996); Assistant Vice President, Pacific Horizon Funds
(since 1996); Assistant Vice President of Concord
Financial Group, Inc. (October 1991 to March 1995);
Account Manager, AT&T Transtech, Mutual Fund Division,
July 1989 to October 1991. Age: 37.
George O. Martinez Secretary Senior Vice President and Director of Legal and
Concord Financial Group, Inc. Compliance Services (since April 1995), BISYS Fund
3435 Stelzer Road Services, Inc.; Secretary, Time Horizon Funds (since
Columbus, OH 43219 1996), Assistant Secretary, Pacific Horizon Funds and
Master Investment Trust, Series II (since 1995); prior
thereto, Vice President and Associate General Counsel,
Alliance Capital Management, L.P. Age: 37.
Kevin L. Martin Treasurer Vice President, Financial Administration, BISYS Fund
Concord Financial Group, Inc. Services, Inc. February 1996 to present, Treasurer,
3435 Stelzer Road Seafirst Retirement Funds and Time Horizon Funds (since
Columbus, OH 43219 1996); Audit Manager, Ernst & Young LLP (1985-1996). Age:
33.
</TABLE>
-24-
<PAGE> 53
<TABLE>
<CAPTION>
POSITION PRINCIPAL OCCUPATIONS
NAME AND ADDRESS WITH COMPANY AND AGE
- ---------------------------------- --------------------- ---------------------------------------------------------
<S> <C> <C>
Lisa Ling Assistant Treasurer Registration and Compliance Officer, November 1995 to
Concord Financial Group, Inc. date, BISYS Fund Services, Inc., Assistant Treasurer,
3435 Stelzer Road Pacific Horizon Funds, Master Investment Trust, Series
Columbus, OH 43219 II, Seafirst Retirement Funds and Time Horizon Funds
(since 1996); Financial Services Manager, Federated
Investors, Inc. (from 1991 to October 1995). Age: 36.
Cathy G. O'Kelly Assistant Secretary Partner in the Law Firm of Vedder, Price, Kaufman &
Vedder, Price, Kaufman & Kammholz Kammholz. Age: 43.
222 South LaSalle St.
Chicago, IL 60601
</TABLE>
The Board does not have an Executive or Audit Committee.
Each trustee receives an estimated aggregate annual retainer of $6,000 per
Fund plus $1,000 per day for each full day devoted to travel in connection with
each meeting attended, for his or her services as trustee of all of the Funds of
the Trust and Edward S. Bottum receives an additional $2,000 per annum as
Chairman of the Board. Each independent trustee will also be reimbursed for
out-of-pocket expenses incurred as a trustee. The following table sets forth the
aggregate compensation expected to be paid by the Trust for the fiscal year
ended December 31, 1997, to the trustees who are not affiliated with Bank of
America or the Subadvisers and the aggregate compensation paid to such trustees
for services on the Trust's Board and that of all other funds in the "Trust
complex" (as defined in Schedule 14A under the Securities Exchange Act of 1934):
<TABLE>
<CAPTION>
PENSION OR TOTAL
RETIREMENT COMPENSATION
AGGREGATE BENEFITS ACCRUED ESTIMATED ANNUAL FROM THE TRUST
COMPENSATION AS PART OF FUND BENEFITS UPON AND
NAME FROM THE TRUST EXPENSES RETIREMENT FUND COMPLEX
- --------------------------------------- -------------- ---------------- ---------------- --------------
<S> <C> <C> <C> <C>
Edward S. Bottum, Chairman & Trustee... $ 12,000 $0 $0 $ 22,000
William P. Carmichael, Trustee......... $ 10,000 $0 $0 $ 20,000
Robert E. Greeley, Trustee............. $ 10,000 * -- $ 51,500
Harold T. Joanning, Trustee............ $ 10,000 $0 $0 $ 10,000
John Privat, Trustee................... $ 10,000 -- -- $ 25,000
</TABLE>
- ---------------
* For the fiscal year ended Feb. 29, 1996, Pacific Horizon Funds, Inc. accrued
on the part of all of its Directors an aggregate of $134,760 in retirement
benefits.
As of the date of this Statement of Additional Information, the trustees
and officers of the Trust, as a group, own less than 1% of the outstanding
shares of each of the Funds.
MANAGER
Pursuant to a Management Agreement with the Trust, Bank of America has
agreed to provide investment advisory and administrative services to the Trust
as described in the Prospectus.
In providing management services to the Trust, Bank of America may use the
services of officers who are employees of trust departments of Bank of America.
Bank of America may also use officers, and utilize the facilities, of wholly
owned subsidiaries and other affiliates of Bank of America or its parent
corporation in providing management services to the Trust.
The Management Agreement will continue in effect until October 31, 1998 and
thereafter will be extended for successive one year periods with respect to a
particular Fund, provided that each such extension is specifically approved (a)
by vote of a majority of those members of the Board of Trustees of the Trust who
are not parties to the Management Agreement or "interested persons" (as defined
in the 1940 Act) of any such party, cast in person at a meeting called for the
purpose of voting on such approval, and (b) by the Board of Trustees of the
Trust or by vote of a "majority of the outstanding voting securities" of the
Funds. The Management Agreement may be terminated at any time without cause upon
giving 60 days' prior written notice to Bank of America.
The Management Agreement provides that Bank of America will not be liable
for any error of judgment or mistake of law or for any loss suffered in
connection with the performance of the investment advisory
-25-
<PAGE> 54
agreements, except a loss resulting from a breach of fiduciary duty with respect
to the receipt of compensation for services or a loss resulting from willful
misfeasance, bad faith or negligence in the performance of its duties or from
reckless disregard by it of its duties and obligations thereunder.
THE GLASS-STEAGALL ACT AND PROPOSED LEGISLATION
The Glass-Steagall Act, among other things, prohibits banks from engaging
in the business of underwriting securities, although national and
state-chartered banks generally are permitted to purchase and sell securities
upon the order and for the account of their customers. In 1971, the United
States Supreme Court held in Investment Company Institute v. Camp that the
Glass-Steagall Act prohibits a national bank from operating a fund for the
collective investment of managing agency accounts. Subsequently, the Board of
Governors of the Federal Reserve System (the "Board") issued a regulation and
interpretation to the effect that the Glass-Steagall Act and such decision
forbid a bank holding company registered under the Federal Bank Holding Company
Act of 1956 (the "Holding Company Act"), or any non-bank affiliate thereof, from
sponsoring, organizing or controlling a registered, open-end investment company
continuously engaged in the issuance of its shares, but do not prohibit such a
holding company or affiliate from acting as investment adviser, transfer agent
and custodian to such an investment company. In 1981, the United States Supreme
Court held in Board of Governors of the Federal Reserve System v. Investment
Company Institute that the Board did not exceed its authority under the Holding
Company Act when it adopted its regulation and interpretation authorizing bank
holding companies and their non-bank affiliates to act as investment advisers to
registered closed-end investment companies.
Bank of America believes that if the question were properly presented, a
court should hold that Bank of America may perform the services for the Trust
contemplated by the Management Agreement, as described in the Prospectus and
this Statement of Additional Information, without violating the Glass-Steagall
Act or other applicable banking law or regulations. It should be noted, however,
that no court has yet decided whether a national bank may perform services
comparable to those performed by Bank of America and that future changes in
either federal or state statutes and regulations relating to permissible
activities of banks or trust companies and their subsidiaries or affiliates, as
well as further judicial or administrative decisions or interpretations of
present and future statutes and regulations, could prevent Bank of America from
continuing to perform such services for the Trust or from continuing to purchase
Fund shares for the accounts of its customers.
As noted previously, the Funds are distributed by BISYS Fund Services
Limited Partnership. If current restrictions under the Glass-Steagall Act
preventing a bank from sponsoring, organizing, controlling, or distributing
shares of an investment company were relaxed, the Trust expects that Bank of
America would offer to perform some or all of the services now provided by BISYS
Fund Services Limited Partnership. From time to time, legislation modifying such
restriction has been introduced in Congress which, if enacted, would permit a
bank holding company to establish a non-bank subsidiary having the authority to
organize, sponsor and distribute shares of an investment company. If this or
similar legislation were enacted, the Funds and the Trust expects that Bank of
America's parent bank holding company would consider using one of its non-bank
subsidiaries to provide some or all of the services now provided by BISYS Fund
Services Limited Partnership. It is not possible, of course, to predict whether
or in what form such legislation might be enacted or the terms upon which Bank
of America or such a non-bank affiliate might offer to provide services for
consideration by the Trust's Board of Trustees.
SUBADVISERS
The Management Agreement authorizes Bank of America to use the services of
any person Bank of America believes will be appropriate and helpful to it in
performing its duties to the Trust under this Agreement. Pursuant to this
authority, Bank of America has selected Scudder, Stevens & Clark, Inc.
("Scudder") to provide investment advisory services to the Managed Bond Fund,
and Wellington Management Company, LLP ("Wellington Management") to provide
investment advisory services to the International Fund.
-26-
<PAGE> 55
For their services, the Subadvisers are entitled to receive fees from Bank
of America equal to the following annual percentages of the Funds' average daily
net assets: Managed Bond Fund -- Scudder will receive .20% of the first $25
million, .15% of the next $25 million, and .10% of average daily net assets in
excess of $50 million; International Fund -- Wellington Management will receive
.40% of the first $50 million, .30% of the next $100 million, .25% of the next
$350 million, and .20% of average daily net assets in excess of $500 million.
Each Subadvisory Agreement contains provisions regarding annual renewal and
termination similar to those of the Management Agreement.
DISTRIBUTOR
Concord Financial Group, Inc. (the "Distributor") acts as distributor of
the shares of the Trust pursuant to a Distribution Agreement with the Trust. The
Distributor is an indirect wholly owned subsidiary of The BISYS Group, Inc. The
Distributor's principal offices are at 3435 Stelzer Road, Columbus, Ohio 43218.
Shares are sold on a continuous basis and distributed through the Distributor.
The Distributor has agreed to use its best efforts to solicit orders for the
sale of the Trust's shares, but it is not obliged to sell any particular amount
of shares. The Distribution Agreement will continue in effect with respect to
each Fund until October 31, 1998. Thereafter, if not terminated, the
Distribution Agreement will continue automatically for successive terms of one
year, provided that such continuance is specifically approved at least annually
(a) by a vote of a majority of those members of the Board of Trustees of the
Trust who are not parties to the Distribution Agreement or "interested persons"
(as defined in the 1940 Act) of any such party, cast in person at a meeting
called for the purpose of voting on such approval, and (b) by the Board of
Trustees of the Trust or by vote of a "majority of the outstanding voting
securities" of the Funds.
The Distribution Agreement may be terminated by the Trust at any time with
respect to a Fund, without the payment of any penalty, by vote of a majority of
the entire Board of Trustees of the Trust or by a vote of a "majority of the
outstanding voting securities" of such Fund on 60 days' written notice to the
Distributor, or by the Distributor at any time, without the payment of any
penalty, on 90 days' written notice to the Trust. The Distribution Agreement
will automatically and immediately terminate in the event of its "assignment"
(as defined in the 1940 Act) or purported assignment.
The Distributor does not receive any compensation under the Distribution
Agreement. In accordance with the terms of the Distribution Agreement, the Trust
has agreed to indemnify the Distributor, to the extent permitted by applicable
law, against certain liabilities under the Securities Act of 1933.
PERFORMANCE INFORMATION
The discussion of performance information for the Funds presented below
does not take into account the fees and charges which a Contract owner may incur
at the level of the Separate Accounts or directly under the Contract.
Accordingly, Contract owners should note that any performance figures computed
in accordance with the procedures described below must be further reduced by the
fees and charges incurred at the Separate Account and Contract levels.
Performance for the Funds will not be advertised or included in sales literature
unless accompanied by comparable information for a Separate Account to which the
Fund offers its shares.
YIELD AND TOTAL RETURN
YIELD CALCULATIONS FOR MONEY MARKET FUND. Current yield for the Money
Market Fund will be based on the change in the value of a hypothetical
investment (exclusive of capital charges) over a particular 7-day period, less a
pro-rata share of Fund expenses accrued over that period (the "base period"),
and stated as a percentage of the investment at the start of the base period
(the "base period return"). The base period return is then annualized by
multiplying by 365/7, with the resulting yield figure carried to at least the
nearest hundredth of one percent. "Effective yield" for the Money Market Fund
assumes that all dividends received during an annual period have been
reinvested. Calculation of "effective yield" begins with the same "base
-27-
<PAGE> 56
period return" used in calculation of yield, which is then annualized to reflect
weekly compounding pursuant to the following formula:
Effective yield = [(Base Period Return + 1) (To the power of 365/7)]-1
YIELD CALCULATIONS FOR OTHER FUNDS. The yield for Funds other than the
Money Market Fund is calculated by dividing the net investment income per share
(as described below) earned by the Fund during a 30-day (or one month) period by
the maximum offering price per share on the last day of the period and
annualizing the result on a semi-annual basis by adding one to the quotient,
raising the sum to the power of six, subtracting one from the result and then
doubling the difference. The Fund's net investment income per share earned
during the period is based on the average daily number of shares outstanding
during the period entitled to receive dividends and includes dividends and
interest earned during the period minus accrued expenses, net of reimbursements.
This calculation can be expressed as follows:
a-b
-----
Yield = 2 [( cd + 1)6 - 1]
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursements).
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends.
d = maximum offering price per share on the last day of the
period.
For the purpose of determining net investment income earned during the
period (variable "a" in the formula), dividend income on equity securities is
recognized by accruing 1/360 of the stated dividend rate of the security each
day. Except as noted below, interest earned on debt obligations is calculated by
computing the yield to maturity of each obligation based on the market value of
the obligation (including actual accrued interest) at the close of business on
the last business day of each month, or, with respect to obligations purchased
during the month, the purchase price (plus actual accrued interest), and
dividing the result by 360 and multiplying the quotient by the market value of
the obligation (including actual accrued interest) in order to determine the
interest income on the obligation for each day of the subsequent month that the
obligation is held. For purposes of this calculation, it is assumed that each
month contains 30 days. The maturity of an obligation with a call provision is
the next call date on which the obligation reasonably may be expected to be
called or, if none, the maturity date. With respect to debt obligations
purchased at a discount or premium, the formula generally calls for amortization
of the discount or premium. The amortization schedule will be adjusted monthly
to reflect changes in the market values of such debt obligations.
Interest earned on tax-exempt obligations that are issued without original
issue discount and have a current market discount is calculated by using the
coupon rate of interest instead of the yield to maturity. In the case of
tax-exempt obligations that are issued with original issue discount but which
have discounts based on current market value that exceed the then-remaining
portion of the original issue discount (market discount), the yield to maturity
is the imputed rate based on the original issue discount calculation. On the
other hand, in the case of tax-exempt obligations that are issued with original
issue discount but which have the discounts based on current market value that
are less than the then-remaining portion of the original issue discount (market
premium), the yield to maturity is based on the market value.
With respect to mortgage or other receivables-backed obligations which are
expected to be subject to monthly payments of principal and interest ("pay
downs"), (a) gain or loss attributable to actual monthly pay downs are accounted
for as an increase or decrease to interest income during the period; and (b) a
Fund may elect either (i) to amortize the discount and premium on the remaining
security, based on the cost of the security, to the weighted average maturity
date, if such information is available, or to the remaining term of the
security, if any, if the weighted average maturity date is not available, or
(ii) not to amortize discount or premium on the remaining security.
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<PAGE> 57
Undeclared earned income will be subtracted from the maximum offering price
per share (variable "d" in the formula). Undeclared earned income is the net
investment income which, at the end of the base period, has not been declared as
a dividend, but is reasonably expected to be and is declared and paid as a
dividend shortly thereafter.
TOTAL RETURN CALCULATIONS. The Funds compute their average annual total
returns by determining the average annual compounded rates of return during
specified periods that equate the initial amount invested in a particular Fund
to the ending redeemable value of such investment in the Fund. This is done by
dividing the ending redeemable value of a hypothetical $1,000 initial payment by
$1,000 and raising the quotient to a power equal to one divided by the number of
years (or fractional portion thereof) covered by the computation and subtracting
one from the result. This calculation can be expressed as follows:
T = [(ERV/P)1/n - 1]
Where: T = average annual total return.
ERV = ending redeemable value at the end of the period covered by
the computation of a hypothetical $1,000 payment made at the
beginning of the period.
P = hypothetical initial payment of $1,000.
n = period covered by the computation, expressed in terms of
Years.
The Funds compute their aggregate total returns by determining the
aggregate rates of return during specified periods that likewise equate the
initial amount invested in a particular Fund to the ending redeemable value of
such investment in the Fund. The formula for calculating aggregate total return
is as follows:
aggregate total return = [(ERV - 1)]
The calculations of average annual total return and aggregate total return
assume the reinvestment of all dividends and capital gain distributions on the
reinvestment dates during the period. The ending redeemable value (variable
"ERV" in each formula) is determined by assuming complete redemption of the
hypothetical investment, the deduction of a proportional share of all Trust
expenses on an annual basis, and the deduction of all nonrecurring charges at
the end of the period covered by the computations.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Trust is an open-end management investment company organized as a
Delaware business trust. The Trust's Declaration of Trust authorizes the Board
of Trustees to issue an unlimited number of full and fractional shares of
beneficial interest.
Shares have no preemptive rights and only such conversion or exchange
rights as the Board may grant in its discretion. When issued for payment as
described in the Prospectus, the Trust's shares will be fully paid and
non-assessable. For information concerning possible restrictions upon the
transferability of the Trust's shares and redemption provisions with respect to
such shares, see "Additional Purchase and Redemption Information" above.
Shareholders are entitled to one vote for each full share held, and
fractional votes for fractional shares held, and will vote in the aggregate and
not by class or series except as otherwise required by the 1940 Act or other
applicable law or when permitted by the Board of Trustees. Shares have
cumulative voting rights to the extent they may be required by applicable law.
Rule 18f-2 under the 1940 Act provides that any matter required to be
submitted to the holders of the outstanding voting securities of an investment
company, such as the Trust, shall not be deemed to have been
-29-
<PAGE> 58
effectively acted upon unless approved by a majority of the outstanding shares
of each Fund affected by the matter. Under Rule 18f-2 the approval of an
investment advisory agreement or any change in a fundamental investment policy
would be effectively acted upon with respect to a Fund only if approved by a
majority of the outstanding shares of such Fund. However, the rule also provides
that the ratification of independent public accountants, the approval of
principal underwriting contracts and the election of directors may be
effectively acted upon by shareholders of the Trust voting without regard to
particular Funds.
Unless otherwise provided by law (for example, by Rule 18f-2 discussed
above) or by the Trust's Declaration of Trust, the Trust may take or authorize
any action upon the favorable vote of the holders of more than 50% of the shares
of the Trust.
The Declaration of Trust of the Trust provide that obligations of the Trust
are not binding upon its Trustees, officers, employees and agents individually
and that the Trustees, officers, employees and agents will not be liable to the
Trust or its investors for any action or failure to act, but nothing in the
Declaration of Trust protects a Trustee, officer, employee or agent against any
liability to the Trust or its investors to which the Trustee, officer, employee
or agent would otherwise be subject by reason of willful misfeasance, bad faith,
gross negligence, or reckless disregard of his or her duties. The Declaration of
Trust also provides that the debts, liabilities, obligations and expenses
incurred, contracted for or existing with respect to a Fund shall be enforceable
against the assets and property of such Fund only, and not against the assets or
property of any other Fund or the investors therein.
REPORTS
Contract owners will receive unaudited semi-annual reports describing the
Trust's investment operations and annual financial statements audited by
independent auditors. Copies of the Trust's annual reports to shareholders may
be obtained at no charge by writing or telephoning the Trust at (800) 722-5558.
SUPPORT SERVICES AGREEMENT
Pursuant to an agreement between the Trust and Pacific Mutual, Pacific
Mutual provides support services to the Trust for a fee of .16% of average daily
net assets annually. Such support services include: coordinating matters related
to the Separate Accounts, maintaining books and records of the Separate
Accounts, and preparing necessary documents for filing with the SEC and other
federal and state regulatory authorities as may be required.
CUSTODIAN, SUB-ADMINISTRATOR AND FUND ACCOUNTING AGENT
Pursuant to a Custodian Agreement between PNC Bank, N.A. ("PNC Bank") and
the Trust, PNC Bank serves as custodian for the Funds. As custodian of the
Trust's assets, PNC Bank: (i) maintains a separate account or accounts in the
name of the respective Funds; (ii) holds and disburses portfolio securities;
(iii) makes receipts and disbursements of money; (iv) collects and receives
income and other payments and distributions on account of portfolio securities;
and (v) makes periodic reports concerning their duties.
Pursuant to a Subcustodian Agreement among PNC Bank, the Fund and Barclays
Bank PLC ("Barclays"), Barclays maintains the Trust's foreign securities
holdings. Barclays may hold the foreign securities at its principal office in
the United Kingdom or at any branch of Barclays or other bank or depository with
which Barclays or its subcustodians may contract, which is an eligible foreign
subcustodian or depository, subject to the approval of the Board.
In addition, Bank of America has contracted with PFPC Inc. ("PFPC"), which
is an indirect wholly owned subsidiary of PNC Bank Corp., to provide the Funds
with certain subadministration services, and the Trust has contracted with PFPC
to provide the Funds with certain accounting services pursuant to a Sub-
Administration and Accounting Services Agreement. Under the Sub-Administration
and Accounting Services Agreement, PFPC has agreed to provide certain
subadministration, accounting, bookkeeping, pricing, dividend, distribution
calculation, and disbursing services with respect to the Trust. The monthly fees
charged by PFPC under the Fund Sub-Administration and Accounting Agreement for
sub-administration services are
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<PAGE> 59
paid by the Manager. The monthly fees charged by PFPC under the
Sub-Administration and Accounting Services Agreement for accounting services are
paid by the Funds.
Pacific Mutual is transfer agent for the Funds.
COUNSEL
Vedder, Price, Kaufman & Kammholz serves as counsel to the Trust.
INDEPENDENT AUDITORS
KPMG Peat Marwick LLP has been selected as independent auditors of each
Fund.
CAPITALIZATION
Pacific Mutual paid the Trust's expenses in connection with the Trust's
organization and establishment of the initial seven Funds.
FINANCIAL STATEMENTS
The Statements of Assets and Liabilities of the Funds as of February 7,
1997 and the report of KPMG Peat Marwick LLP thereon, appear at the end of this
Statement of Additional Information. Such Statements of Assets and Liabilities
have been included herein in reliance upon such report given upon their
authority as experts in accounting and auditing.
MISCELLANEOUS
As used in the Prospectus and this Statement of Additional Information, a
"vote of a majority of the outstanding shares of a Fund, means the affirmative
vote of the lesser of (a) more than 50% of the outstanding interests or shares
of a Fund, or (b) 67% of the interests or shares of a Fund present at a meeting
at which more than 50% of the outstanding interests or shares of a Fund are
represented in person or by proxy.
The Prospectus relating to the Funds and this Statement of Additional
Information omit certain information contained in the Trust's registration
statement filed with the SEC. Copies of the registration statement, including
items omitted herein, may be obtained from the Commission by paying the charges
prescribed under its rules and regulations.
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<PAGE> 60
PACIFIC INNOVATIONS TRUST
STATEMENTS OF ASSETS AND LIABILITIES
FEBRUARY 7, 1997
<TABLE>
<CAPTION>
MONEY MANAGED CAPITAL BLUE MID-CAP AGGRESSIVE
MARKET BOND INCOME CHIP EQUITY GROWTH INTERNATIONAL
FUND FUND FUND FUND FUND FUND FUND
------- ------- ------- ------ ------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Cash................................. $99,940 $ 10 $ 10 $ 10 $ 10 $ 10 $ 10
------- ------ ------ ------ ------ ------ ------
NET ASSETS............................. $99,940 $ 10 $ 10 $ 10 $ 10 $ 10 $ 10
======= ====== ====== ====== ====== ====== ======
NET ASSETS REPRESENTED BY:
Paid-In Capital
(Unlimited Number of Shares
Without Par Value Authorized)..... $99,940 $ 10 $ 10 $ 10 $ 10 $ 10 $ 10
======= ====== ====== ====== ====== ====== ======
SHARES OUTSTANDING..................... 99,940 1 1 1 1 1 1
======= ====== ====== ====== ====== ====== ======
NET ASSET VALUE PER SHARE.............. $ 1.00 $10.00 $ 10.00 $10.00 $10.00 $10.00 $ 10.00
</TABLE>
See Accompanying Notes to the Statements of Assets and Liabilities
-32-
<PAGE> 61
PACIFIC INNOVATIONS TRUST
NOTES TO STATEMENTS OF ASSETS AND LIABILITIES
FEBRUARY 7, 1997
1. Pacific Innovations Trust (the "Trust"), a Delaware Business Trust, is
registered under the Investment Company Act of 1940, as amended, as an
open-end management investment company. The Trust operates as a series
company comprising seven funds: Money Market Fund, Managed Bond Fund, Capital
Income Fund, Blue Chip Fund, Mid-Cap Equity Fund, Aggressive Growth Fund, and
International Fund. As of the date of this report, operations have been
limited to organizational matters and the issuance of initial shares to
Pacific Mutual Life Insurance Company.
2. Bank of America National Trust and Savings Association, a subsidiary of
BankAmerica Corporation, serves as the Fund's investment adviser. Scudder,
Stevens & Clark, Inc. and Wellington Management Company, LLP serve as
subadvisers to the Managed Bond Fund and International Fund, respectively.
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INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholder
The Pacific Innovations Trust:
We have audited the accompanying statements of assets and liabilities of
the Money Market Fund, Managed Bond Fund, Capital Income Fund, Blue Chip Fund,
Mid-Cap Equity Fund, Aggressive Growth Fund, and International Fund as of
February 7, 1997. All such funds constitute the Pacific Innovations Trust. These
financial statements are the responsibility of the Trust's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the statements of assets and liabilities are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the statement of assets and
liabilities. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
statement of asset and liabilities presentation. We believe that our audit of
the statements of assets and liabilities provides a reasonable basis for our
opinion.
In our opinion, the statements of assets and liabilities referred to above
present fairly, in all material respects, the financial position of each of the
funds constituting the Pacific Innovations Trust as of February 7, 1997, in
conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Los Angeles, California
February 11, 1997
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APPENDIX A
COMMERCIAL PAPER RATINGS
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. The following summarizes the rating categories used by Standard and
Poor's for commercial paper:
"A-1" -- Issue's degree of safety regarding timely payment is strong. Those
issues determined to possess extremely strong safety characteristics are denoted
"A-1+."
"A-2" -- Issue's capacity for timely payment is satisfactory. However, the
relative degree of safety is not as high as for issues designated "A-1."
"A-3" -- Issue has an adequate capacity for timely payment. It is, however,
somewhat more vulnerable to the adverse effects of changes and circumstances
than an obligation carrying a higher designation.
"B" -- Issue has only a speculative capacity for timely payment.
"C" -- Issue has a doubtful capacity for payment.
"D" -- Issue is in payment default.
Moody's commercial paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of 9 months. The following summarizes the rating categories used by
Moody's for commercial paper:
"Prime-1" -- Issuer or related supporting institutions are considered to
have a superior capacity for repayment of short-term promissory obligations.
Principal repayment capacity will normally be evidenced by the following
characteristics: leading market positions in well established industries; high
rates of return on funds employed; conservative capitalization structures with
moderate reliance on debt and ample asset protection; broad margins in earning
coverage of fixed financial charges and high internal cash generation; and well
established access to a range of financial markets and assured sources of
alternate liquidity.
"Prime-2" -- Issuer or related supporting institutions are considered to
have a strong capacity for repayment of short-term promissory obligations. This
will normally be evidenced by many of the characteristics cited above but to a
lesser degree. Earnings trends and coverage ratios, while sound, will be more
subject to variation. Capitalization characteristics, while still appropriate,
may be more affected by external conditions. Ample alternative liquidity is
maintained.
"Prime-3" -- Issuer or related supporting institutions have an acceptable
capacity for repayment of short-term promissory obligations. The effects of
industry characteristics and market composition may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and the requirement for relatively high financial
leverage. Adequate alternate liquidity is maintained.
"Not Prime" -- Issuer does not fall within any of the Prime rating
categories.
The three rating categories of Duff & Phelps or investment grade commercial
paper are "Duff 1," "Duff 2" and "Duff 3." Duff & Phelps employs three
designations, "Duff 1+," "Duff 1" and "Duff 1-," within the highest rating
category. The following summarizes the rating categories used by Duff & Phelps
for commercial paper:
"Duff 1+" -- Debt possesses highest certainty of timely payment. Short-term
liquidity, including internal operating factors and/or access to alternative
sources of funds, is outstanding, and safety is just below risk-free U.S.
Treasury short-term obligations.
"Duff 1" -- Debt possesses very high certainty of timely payment. Liquidity
factors are excellent and supported by good fundamental protection factors. Risk
factors are minor.
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"Duff 1-" -- Debt possesses high certainty of timely payment. Liquidity
factors are strong and supported by good fundamental protection factors. Risk
factors are very small.
"Duff 2" -- Debt possesses good certainty of timely payment. Liquidity
factors and company fundamentals are sound. Although ongoing funding needs may
enlarge total financing requirements, access to capital markets is good. Risk
factors are small.
"Duff 3" -- Debt possesses satisfactory liquidity, and other protection
factors qualify issue as investment grade. Risk factors are larger and subject
to more variation. Nevertheless, timely payment is expected.
"Duff 4" -- Debt possesses speculative investment characteristics.
"Duff 5" -- Issuer has failed to meet scheduled principal and/or interest
payments.
Fitch short-term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years. The following
summarizes the rating categories used by Fitch for short-term obligations:
"F-1+" -- Securities possess exceptionally strong credit quality. Issues
assigned this rating are regarded as having the strongest degree of assurance
for timely payment.
"F-1" -- Securities possess very strong credit quality. Issues assigned
this rating reflect an assurance of timely payment only slightly less in degree
than issues rated "F-1+."
"F-2" -- Securities possess good credit quality. Issues carrying this
rating have a satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as the "F-1+" and "F-1" categories.
"F-3" -- Securities possess fair credit quality. Issues assigned this
rating have characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause these
securities to be rated below investment grade.
"F-S" -- Securities possess weak credit quality. Issues assigned this
rating have characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial and
economic conditions.
"D" -- Securities are in actual or imminent payment default.
Fitch may also use the symbol "LOC" with its short-term ratings to indicate
that the rating is based upon a letter of credit issued by a commercial bank.
Thomson BankWatch commercial paper ratings assess the likelihood of an
untimely payment of principal or interest of debt having a maturity of one year
or less which is issued by United States commercial banks, thrifts and non-bank
banks; nonUnited States banks; and broker-dealers. The following summarizes the
ratings used by Thomson BankWatch:
"TBW-1" -- This designation represents Thomson BankWatch's highest rating
category and indicates a very high degree of likelihood that principal and
interest will be paid on a timely basis.
"TBW-2" -- This designation indicates that while the degree of safety
regarding timely payment of principal and interest is strong, the relative
degree of safety is not as high as for issues rated "TBW-1."
"TBW-3" -- This designation represents the lowest investment grade category
and indicates that while the debt is more susceptible to adverse developments
(both internal and external) than obligations with higher ratings, capacity to
service principal and interest in a timely fashion is considered adequate.
"TBW-4" -- This designation indicates that the debt is regarded as
non-investment grade and therefore speculative.
IBCA assesses the investment quality of unsecured debt with an original
maturity of less than one year which is issued by bank holding companies and
their principal bank subsidiaries. The following summarizes the rating
categories used by IBCA for short-term debt ratings:
"A1+" -- Obligations are supported by the highest capacity for timely
repayment.
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"A1" -- Obligations are supported by a strong capacity for timely
repayment.
"A2" -- Obligations are supported by a satisfactory capacity for timely
repayment, although such capacity may be susceptible to adverse changes in
business, economic, or financial conditions.
"A3" -- Obligations are supported by an adequate capacity for timely
repayment. Such capacity is more susceptible to adverse changes in business,
economic, or financial conditions than for obligations in higher categories.
"B" -- Obligations' capacity for timely repayment is susceptible to adverse
changes in business, economic, or financial conditions.
"C" -- Obligations have an inadequate capacity to ensure timely repayment.
"D" -- Obligations have a high risk of default or are currently in default.
CORPORATE AND MUNICIPAL LONG-TERM DEBT RATINGS
The following summarizes the ratings used by Standard & Poor's for
corporate and municipal debt:
"AAA" -- This designation represents the highest rating assigned by
Standard & Poor's to a debt obligation and indicates an extremely strong
capacity to pay interest and repay principal.
"AA" -- Debt is considered to have a very strong capacity to pay interest
and repay principal and differs from AAA issues only in small degree.
"A" -- Debt is considered to have a strong capacity to pay interest and
repay principal although such issues are somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than debt in
higher-rated categories.
"BBB" -- Debt is regarded as having an adequate capacity to pay interest
and repay principal. Whereas such issues normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher-rated categories.
"BB," "B," "CCC," "CC," and "C" -- Debt that possesses one of these ratings
is regarded, on balance, as predominantly speculative with respect to capacity
to pay interest and repay principal in accordance with the terms of the
obligation. "BB" indicates the lowest degree of speculation and "C" the highest
degree of speculation. While such debt will likely have some quality and
protective characteristics, these are outweighed by large uncertainties or major
risk exposures to adverse conditions.
"CI" -- This rating is reserved for income bonds on which no interest is
being paid.
"D" -- Debt is in default, and payment of interest and/or repayment of
principal is in arrears.
PLUS (+) OR MINUS (-) -- The ratings from "AA" through "CCC" may be
modified by the addition of a plus or minus sign to show relative standing
within the major rating categories.
The following summarizes the ratings used by Moody's for corporate and
municipal long-term debt:
"Aaa" -- Bonds are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt edge."
Interest payments are protected by a large or 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 are judged to be of high quality by all standards. Together
with the "Aaa" group they comprise what are generally known as high grade bonds.
They are rated lower than the best bonds because margins of protection may not
be as large as in "Aaa" securities or fluctuation of protective elements may be
of greater amplitude or there may be other elements present which make the
long-term risks appear somewhat larger than in "Aaa" securities.
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"A" -- Bonds 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 considered medium-grade obligations, i.e., they are neither
highly protected nor poorly secured. Interest payments and principal security
appear adequate for the present but certain protective elements may be lacking
or may be characteristically unreliable over any great length of time. Such
bonds lack outstanding investment characteristics and in fact have speculative
characteristics as well.
"Ba," "B," "Caa," "Ca," and "C" -- Bonds that possess one of these ratings
provide questionable protection of interest and principal ("Ba" indicates some
speculative elements; "B" indicates a general lack of characteristics of
desirable investment; "Caa" represents a poor standing; "Ca" represents
obligations which are speculative in a high degree; and "C" represents the
lowest rated class of bonds). "Caa," "Ca" and "C" bonds may be in default.
Con. (--) -- Bonds for which the security depends upon the completion of
some act or the fulfillment of some condition are rated conditionally. These are
bonds secured by (a) earnings of projects under construction, (b) earnings of
projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.
Moody's applies numerical modifiers 1, 2 and 3 in each generic
classification from "Aa" to "B" in its bond rating system. The modifier 1
indicates that the security ranks in the higher end of its generic rating
category; the modifier 2 indicates a mid-range ranking; and the modifier 3
indicates that the issue ranks at the lower end of its generic rating category.
The following summarizes the ratings used by Duff & Phelps for corporate
and municipal long-term debt:
"AAA" -- Debt is considered to be of the highest credit quality. The risk
factors are negligible, being only slightly more than for risk-free U.S.
Treasury debt.
"AA" -- Debt is considered of high credit quality. Protection factors are
strong. Risk is modest but may vary slightly from time to time because of
economic conditions.
"A" -- Debt possesses protection factors which are average but adequate.
However, risk factors are more variable and greater in periods of economic
stress.
"BBB" -- Debt possesses below average protection factors but such
protection factors are still considered sufficient for prudent investment.
Considerable variability in risk is present during economic cycles.
"BB," "B," "CCC," "DD," and "DP" -- Debt that possesses one of these
ratings is considered to be below investment grade. Although below investment
grade, debt rated "BB" is deemed likely to meet obligations when due. Debt rated
"B" possesses the risk that obligations will not be met when due. Debt rated
"CCC" is well below investment grade and has considerable uncertainty as to
timely payment of principal, interest or preferred dividends. Debt rated "DD" is
a defaulted debt obligation, and the rating "DP" represents preferred stock with
dividend arrearages.
To provide more detailed indications of credit quality, the "AA," "A,"
"BBB," "BB" and "B" ratings may be modified by the addition of a plus (+) or
minus (-) sign to show relative standing within these major categories.
The following summarizes the highest four ratings used by Fitch for
corporate and municipal bonds:
"AAA" -- Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest and
repay principal, which is unlikely to be affected by reasonably foreseeable
events.
"AA" -- Bonds considered to be investment grade and of very high credit
quality. The obligors ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated "AAA." Because
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bonds rated in the "AAA" and "AA" categories are not significantly vulnerable to
foreseeable future developments, short-term debt of these issuers is generally
rated "F-1+."
"A" -- Bonds considered to be investment grade and of high credit quality.
The obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
"BBB" -- Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is considered
to be adequate. Adverse changes in economic conditions and circumstances,
however, are more likely to have an adverse impact on these bonds, and
therefore, impair timely payment. The likelihood that the ratings of these bonds
will fall below investment grade is higher than for bonds with higher ratings.
"BB," "B," "CCC," "CC," "C," "DDD," "DD," and "D" -- Bonds that possess one
of these ratings are considered by Fitch to be speculative investments. The
ratings "BB" to "C" represent Fitch's assessment of the likelihood of timely
payment of principal and interest in accordance with the terms of obligation for
bond issues not in default. For defaulted bonds, the rating "DDD" to "D" is an
assessment of the ultimate recovery value through reorganization or liquidation.
To provide more detailed indications of credit quality, the Fitch ratings
from and including "AA" to "C" may be modified by the addition of a plus (+) or
minus (-) sign to show relative standing within these major rating categories.
IBCA assesses the investment quality of unsecured debt with an original
maturity of more than one year which is issued by bank holding companies and
their principal bank subsidiaries. The following summarizes the rating
categories used by IBCA for long-term debt ratings:
"AAA" -- Obligations for which there is the lowest expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial such that adverse changes in business, economic or financial
conditions are unlikely to increase investment risk significantly.
"AA" -- Obligations for which there is a very low expectation of investment
risk. Capacity for timely repayment of principal and interest is substantial.
Adverse changes in business, economic or financial conditions may increase
investment risk albeit not very significantly.
"A" -- Obligations for which there is a low expectation of investment risk.
Capacity for timely repayment of principal and interest is strong, although
adverse changes in business, economic or financial conditions may lead to
increased investment risk.
"BBB" -- Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial conditions
are more likely to lead to increased investment risk than for obligations in
higher categories.
"BB," "B," "CCC," "CC," and "C" -- Obligations are assigned one of these
ratings where it is considered that speculative characteristics are present.
"BB" represents the lowest degree of speculation and indicates a possibility of
investment risk developing. "C" represents the highest degree of speculation and
indicates that the obligations are currently in default.
IBCA may append a rating of plus (+) or minus (-) to a rating to denote
relative status within major rating categories.
Thomson BankWatch assesses the likelihood of an untimely repayment of
principal or interest over the term to maturity of long term debt and preferred
stock which are issued by United States commercial banks, thrifts and non-bank
banks; non-United States banks; and broker-dealers. The following summarizes the
rating categories used by Thomson BankWatch for long-term debt ratings:
"AAA" -- This designation represents the highest category assigned by
Thomson BankWatch to long-term debt and indicates that the ability to repay
principal and interest on a timely basis is very high.
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"AA" -- This designation indicates a superior ability to repay principal
and interest on a timely basis with limited incremental risk versus issues rated
in the highest category.
"A" -- This designation indicates that the ability to repay principal and
interest is strong. Issues rated "A" could be more vulnerable to adverse
developments (both internal and external) than obligations with higher ratings.
"BBB" -- This designation represents Thomson BankWatch's lowest investment
grade category and indicates an acceptable capacity to repay principal and
interest. Issues rated "BBB" are, however, more vulnerable to adverse
developments (both internal and external) than obligations with higher ratings.
"BB," "B," "CCC," and "CC," -- These designations are assigned by Thomson
BankWatch to non-investment grade long-term debt. Such issues are regarded as
having speculative characteristics regarding the likelihood of timely payment of
principal and interest. "BB" indicates the lowest degree of speculation and "CC"
the highest degree of speculation.
"D" -- This designation indicates that the long-term debt is in default.
PLUS (+) OR MINUS (-) -- The ratings from "AAA" through "CC" may include a
plus or minus sign designation which indicates where within the respective
category the issue is placed.
MUNICIPAL NOTE RATINGS
A Standard and Poor's rating reflects the liquidity concerns and market
access risks unique to notes due in three years or less. The following
summarizes the ratings used by Standard & Poor's Corporation for municipal
notes:
"SP-1" -- The issuers of these municipal notes exhibit very strong or
strong capacity to pay principal and interest. Those issues determined to
possess overwhelming safety characteristics are given a plus (+) designation.
"SP-2" -- The issuers of these municipal notes exhibit satisfactory
capacity to pay principal and interest.
"SP-3" -- The issuers of these municipal notes exhibit speculative capacity
to pay principal and interest.
Moody's ratings for state and municipal notes and other short-term loans
are designated Moody's Investment Grade ("MIG") and variable rate demand
obligations are designated Variable Moody's Investment Grade ("VMIG"). Such
ratings recognize the differences between short-term credit risk and long-term
risk. The following summarizes the ratings by Moody's Investors Service, Inc.
for short-term notes:
"MIG-1"/"VMIG-1" -- Loans bearing this designation are of the best quality,
enjoying strong protection by established cash flows, superior liquidity support
or demonstrated broad-based access to the market for refinancing.
"MIG-2"/"VMIG-2" -- Loans bearing this designation are of high quality,
with margins of protection ample although not so large as in the preceding
group.
"MIG-3"/"VMIG-3" -- Loans bearing this designation are of favorable
quality, with all security elements accounted for but lacking the undeniable
strength of the preceding grades. Liquidity and cash flow protection may be
narrow and market access for refinancing is likely to be less well established.
"MIG-4"/"VMIG-4" -- Loans bearing this designation are of adequate quality,
carrying specific risk but having protection commonly regarded as required of an
investment security and not distinctly or predominantly speculative.
"SG" -- Loans bearing this designation are of speculative quality and lack
margins of protection.
Fitch uses the short-term ratings described under Commercial Paper Ratings
for municipal notes.
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APPENDIX B
FUTURES CONTRACTS
As stated in the Prospectus, the Funds may enter into futures contracts and
options for hedging purposes. Such transactions are described in this Appendix.
I. INTEREST RATE FUTURES CONTRACTS
USE OF INTEREST RATE FUTURES CONTRACTS. Bond prices are established in both
the cash market and the futures market. In the cash market, bonds are purchased
and sold with payment for the full purchase price of the bond being made in
cash, generally within five business days after the trade. In the futures
market, only a contract is made to purchase or sell a bond in the future for a
set price on a certain date. Historically, the prices for bonds established in
the futures markets have tended to move generally in the aggregate in concert
with the cash market prices and have maintained fairly predictable
relationships. Accordingly, a Fund may use interest rate futures as a defense,
or hedge, against anticipated interest rate changes and not for speculation. As
described below, this would include the use of futures contract sales to protect
against expected increases in interest rates and futures contract purchases to
offset the impact of interest rate declines.
A Fund presently could accomplish a similar result to that which it hopes
to achieve through the use of futures contracts by selling bonds with long
maturities and investing in bonds with short maturities when interest rates are
expected to increase, or conversely, selling short-term bonds and investing in
long-term bonds when interest rates are expected to decline. However, because of
the liquidity that is often available in the futures market the protection is
more likely to be achieved, perhaps at a lower cost and without changing the
rate of interest being earned by a Fund, through using future contracts.
DESCRIPTION OF INTEREST RATE FUTURES CONTRACTS. An interest rate futures
contract sale would create an obligation by a Fund, as seller, to deliver the
specific type of financial instrument called for in the contract at a specific
future time for a specified price. A futures contract purchase would create an
obligation by a Fund, as purchaser, to take delivery of the specific type of
financial instrument at a specific future time at a specific price. The specific
securities delivered or taken, respectively, at settlement date, would not be
determined until at or near that date. The determination would be in accordance
with the rules of the exchange on which the futures contract sale or purchase
was made.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of securities, in most cases the contracts are closed out
before the settlement date without the making or taking of delivery of
securities. Closing out a futures contract sale is effected by the Fund's
entering into a futures contract purchase for the same aggregate amount of the
specific type of financial instrument and the same delivery date. If the price
in the sale exceeds the price in the offsetting purchase, the Fund is paid the
difference and thus realizes a gain. If the offsetting purchase price exceeds
the sale price, the Fund pays the difference and realizes a loss. Similarly, the
closing out of a futures contract purchase is effected by the Fund's entering
into a futures contract sale. If the offsetting sale price exceeds the purchase
price, the Fund realizes a gain, and if the purchase price exceeds the
offsetting sale price, the Fund realizes a loss.
Interest rate futures contracts are traded in an auction environment on the
floors of several exchanges principally, the Chicago Board of Trade and the
Chicago Mercantile Exchange. The Fund would deal only in standardized contracts
on recognized exchanges. Each exchange guarantees performance under contract
provisions through a clearing corporation, a nonprofit organization managed by
the exchange membership.
A public market now exists in futures contracts covering various financial
instruments including long-term United States Treasury bonds and notes;
Government National Mortgage Association (GNMA) modified pass-through
mortgage-backed securities; three-month United States Treasury bills; and
ninety-day commercial paper. A Fund may trade in any futures contract for which
there exists a public market, including, without limitation, the foregoing
instruments.
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EXAMPLES OF FUTURES CONTRACT SALE. A Fund would engage in an interest rate
futures contract sale to maintain the income advantage from continued holding of
a long-term bond while endeavoring to avoid part or all of the loss in market
value that would otherwise accompany a decline in long-term securities prices.
Assume that the market value of a certain security in a stock fund (Portfolio 1)
tends to move in concert with the futures market prices of long-term United
States Treasury bonds ("Treasury bonds"). The adviser wishes to fix the current
market value of this portfolio security until some point in the future. Assume
the portfolio security has a market value of 100, and the adviser believes that,
because of an anticipated rise in interest rates, the value will decline to 95.
A Fund might enter into futures contract sales of Treasury bonds for an
equivalent of 98. If the market value of the portfolio security does indeed
decline from 100 to 95, the equivalent futures market price for the Treasury
bonds might also decline from 98 to 93.
In that case, the five-point loss in the market value of the portfolio
security would be offset by the five-point gain realized by closing out the
futures contract sale. Of course, the futures market price of Treasury bonds
might well decline to more than 93 or to less than 93 because of the imperfect
correlation between cash and futures prices mentioned below.
Bank of America or a Subadviser could be wrong in its forecast of interest
rates and the equivalent futures market price could rise above 98. In this case,
the market value of the portfolio securities, including the portfolio security
being protected, would increase. The benefit of this increase would be reduced
by the loss realized on closing out the futures contract sale.
If interest rate levels did not change, the Fund in the above example might
incur a loss of 2 points (which might be reduced by an off-setting transaction
prior to the settlement date). In each transaction, transaction expenses would
also be incurred.
EXAMPLES OF FUTURES CONTRACT PURCHASE. A Fund would engage in an interest
rate futures contract purchase when it is not fully invested in long-term bonds
but wishes to defer for a time the purchase of long-term bonds in light of the
availability of advantageous interim investments, e.g., shorter-term securities
whose yields are greater than those available on long-term bonds. The Fund's
basic motivation would be to maintain for a time the income advantage from
investing in the short-term securities; the Fund would be endeavoring at the
same time to eliminate the effect of all or part of an expected increase in
market price of the long-term bonds that the Fund may purchase.
For example, assume that the market price of a long-term bond that a Fund
may purchase, currently yielding 10%, tends to move in concert with futures
market prices of Treasury bonds. The adviser wishes to fix the current market
price (and thus 10% yield) of the long-term bond until the time (four months
away in this example) when it may purchase the bond. Assume the long-term bond
has a market price of 100, and the adviser believes that, because of an
anticipated fall in interest rates, the-price will have risen to 105 (and the
yield will have dropped to about 9 1/2%) in four months. The Fund might enter
into futures contract purchases of Treasury bonds for an equivalent price of 98.
At the same time, the Fund would assign a pool of investments in short-term
securities that are either maturing in four months or earmarked for sale in four
months, for purchase of the long-term bond at an assumed market price of 100.
Assume these short-term securities are yielding 15%. If the market price of the
long-term bond does indeed rise from 100 to 105, the equivalent futures market
price for Treasury bonds might also rise from 9 to 103. In that case, the
5-point increase in the price that the Fund pays for the long-term bond would be
offset by the 5-point gain realized by closing out the futures contract
purchases.
Bank of America or a Subadviser could be wrong in its forecast of interest
rates; long-term interest rates might rise to above 10%; and the equivalent
futures market price could fall below 98. If short-term rates at the same time
fall to 10% or below, it is possible that the Fund would continue with its
purchase program for long-term bonds. The market price of available long-term
bonds would have decreased. The benefit of this price decrease, and thus yield
increase, will be reduced by the loss realized on closing out the futures
contract purchase.
If, however, short-term rates remained above available long-term rates, it
is possible that the Fund would discontinue its purchase program for long-term
bonds. The yield on short-term securities in the portfolio,
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including those originally in the pool assigned to the particular long-term
bond, would remain higher than yields on long-term bonds. The benefit of this
continued incremental income will be reduced by the loss realized on closing out
the futures contract purchase. In each transaction, expenses would also be
incurred.
II. STOCK INDEX FUTURES CONTRACTS
A stock index assigns relative values to the stocks included in the index
and the index fluctuates with changes in the market values of the stocks
included. A stock index futures contract is a bilateral agreement pursuant to
which two parties agree to take or make delivery of an amount of cash equal to a
specified dollar amount times the difference between the stock index value
(which assigns relative values to the common stocks included in the index) at
the close of the last trading day of the contract and the price at which the
futures contract is originally struck. No physical delivery of the underlying
stocks in the index is made. Some stock index futures contracts are based on
broad market indices, such as the Standard & Poor's 500 or the New York Stock
Exchange Composite Index. In contrast, certain exchanges offer futures contracts
on narrower market indices, such as the Standard & Poor's 100 or indices based
on an industry or market segment, such as oil and gas stocks. Futures contracts
are traded on organized exchanges regulated by the Commodity Futures Trading
Commission. Transactions on such exchanges are cleared through a clearing
corporation, which guarantees the performance of the parties to each contract.
The Funds will sell stock index futures contracts in order to offset a
decrease in market value of their respective portfolio securities that might
otherwise result from a market decline. The Funds may do so either to hedge the
value of their respective portfolios as a whole, or to protect against declines,
occurring prior to sales of securities, in the value of the securities to be
sold. Conversely, the Funds will purchase stock index futures contracts in
anticipation of purchases of securities. In a substantial majority of these
transactions, the Funds will purchase such securities upon termination of the
long futures position, but a long futures position may be terminated without a
corresponding purchase of securities.
In addition, the Funds may utilize stock index futures contracts in
anticipation of changes in the composition of their respective portfolio
holdings. For example, in the event that a Fund expects to narrow the range of
industry groups represented in its holdings it may, prior to making purchases of
the actual securities, establish a long futures position based on a more
restrictive index, such as an index comprised of securities of a particular
industry group. The Funds may also sell futures contracts in connection with
this strategy, in order to protect against the possibility that the value of the
securities to be sold as part of the restructuring of their respective
portfolios will decline prior to the time of sale.
The following are examples of transactions in stock index futures (net of
commissions and premiums, if any).
ANTICIPATORY PURCHASE HEDGE: BUY THE FUTURE
HEDGE OBJECTIVE: PROTECT AGAINST INCREASING PRICE
<TABLE>
<CAPTION>
FUND FUTURES
- --------------------------------------------- ---------------------------------------------
<S> <C>
-- Day Hedge is Placed --
Anticipate Buying $62,500 Buying 1 Index Futures at 125
Portfolio 2 Value of Futures = $62,500/Contract
-- Day Hedge is Lifted --
Buy Portfolio 2 with Sell 1 Index Futures at 130
Actual Cost = $65,000 Value of Futures = $65,000/Contract
Increase in Purchase Price = $2,500 Gain on Futures = $2,500
</TABLE>
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<PAGE> 72
HEDGING A STOCK FUND: SELL THE FUTURE
HEDGE OBJECTIVE: PROTECT AGAINST DECLINING VALUE OF THE FUND
Factors:
Value of Stock Fund = $1,000,000
Value of Futures Contract = 125 X $500 = $62,500
Fund Beta Relative to the Index = 1.0
<TABLE>
<CAPTION>
FUND FUTURES
- --------------------------------------------- ---------------------------------------------
<S> <C>
-- Day Hedge is Placed --
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
Portfolio 2 Value of Futures = $1,000,000
-- Day Hedge is Lifted --
Portfolio 2-Own Stock with Buy 16 Index Future at 120
Value = $960,000 Value of Futures = $960,000
Loss in Fund Value = $40,000 Gain on Futures = $40,000
</TABLE>
If, however, the market moved in the opposite direction, that is, market
value decreased and a Fund had entered into an anticipatory purchase hedge, or
market value increased and a Fund had hedged its stock portfolio, the results of
the Fund's transactions in stock index futures would be as set forth below.
ANTICIPATORY PURCHASE HEDGE: BUY THE FUTURE
HEDGE OBJECTIVE: PROTECT AGAINST INCREASING PRICE
<TABLE>
<CAPTION>
FUND FUTURES
- --------------------------------------------- ---------------------------------------------
<S> <C>
-- Day Hedge is Placed --
Anticipate Buying $62,500 Buying 1 Index Futures at 125
Portfolio 2 Value of Futures = $62,500/Contract
-- Day Hedge is Lifted --
Buy Portfolio 2 with Sell 1 Index Futures at 120
Actual Cost = $60,000 Value of Futures = $60,000/Contract
Decrease in Purchase Price = $2,500 Loss on Futures = $2,500
</TABLE>
HEDGING A STOCK FUND: SELL THE FUTURE
HEDGE OBJECTIVE: PROTECT AGAINST DECLINING VALUE OF THE FUND
Factors:
Value of Stock Fund = $1,000,000
Value of Futures Contract = 125 X $500 = $62,500
Fund Beta Relative to the Index = 1.0
<TABLE>
<CAPTION>
FUND FUTURES
- --------------------------------------------- ---------------------------------------------
<S> <C>
-- Day Hedge is Placed --
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
Portfolio 2 Value of Futures = $1,000,000
-- Day Hedge is Lifted --
Portfolio 2-Own Stock with Buy 16 Index Future at 130
Value = $1,040,000 Value of Futures = $1,040,000
Gain in Fund Value = $40,000 Loss on Futures = $40,000
</TABLE>
B-4
<PAGE> 73
III. FUTURES CONTRACTS ON FOREIGN CURRENCIES
A futures contract on foreign currency creates a binding obligation on one
party to deliver, and a corresponding obligation on another party to accept
delivery of, a stated quantity of a foreign currency, for an amount fixed in
U.S. dollars. Foreign currency futures may be used by the Fund to hedge against
exposure to fluctuations in exchange rates between the U.S. dollar and other
currencies arising from multinational transactions.
IV. MARGIN PAYMENTS
Unlike when a Fund purchases or sells a security, no price is paid or
received by the Fund upon the purchase or sale of a futures contract. Initially,
the Fund will be required to deposit with the broker or in a segregated account
with the Fund's custodian an amount of cash or cash equivalents, the value of
which may vary but is generally equal to 10% or less of the value of the
contract. This amount is known as initial margin. The nature of initial margin
in futures transactions is different from that of margin in security
transactions in that futures contract margin does not involve the borrowing of
funds by the customer to finance the transactions. Rather, the initial margin is
in the nature of a performance bond or good faith deposit on the contract which
is returned to the Fund upon termination of the futures contract assuming all
contractual obligations have been satisfied. Subsequent payments, called
variation margin, to and from the broker, will be made on a daily basis as the
price of the underlying instruments fluctuates making the long and short
positions in the futures contract more or less valuable, a process known as
marking-to-market. For example, when a Fund has purchased a futures contract and
the price of the contract has risen in response to a rise in the underlying
instruments, that position will have increased in value and the Fund will be
entitled to receive from the broker a variation margin payment equal to that
increase in value. Conversely, where a Fund has purchased a futures contract and
the price of the future contract has declined in response to a decrease in the
underlying instruments, the position would be less valuable and the Fund would
be required to make a variation margin payment to the broker. At any time prior
to expiration of the futures contract, the adviser may elect to close the
position by taking an opposite position, subject to the availability of a
secondary market, which will operate to terminate the Fund's position in the
futures contract. A final determination of variation margin is then made,
additional cash is required to be paid by or released to the Fund, and the Fund
realizes a loss or gain.
V. OPTIONS ON FUTURES CONTRACTS
Each Fund may purchase options on the futures contracts described above. A
futures option gives the holder, in return for the premium paid, the right to
buy (call) from or sell (put) to the writer of the option a futures contract at
a specified price at any time during the period of the option. Upon exercise,
the writer of the option is obligated to pay the difference between the cash
value of the futures contract and the exercise price. Like the buyer or seller
of a futures contract, the holder, or writer, of an option has the right to
terminate its position prior to the scheduled expiration of the option by
selling, or purchasing, an option of the same series, at which time the person
entering into the closing transaction will realize a gain or loss.
Investments in futures options involve some of the same considerations that
are involved in connection with investments in futures contracts (for example,
the existence of a liquid secondary market). In addition, the purchase of an
option also entails the risk that changes in the value of the underlying futures
contract will not be fully reflected in the value of the option purchased.
Depending on the pricing of the option compared to either the futures contract
upon which it is based, or upon the price of the securities being hedged, an
option may or may not be less risky than ownership of the futures contract or
such securities. In general, the market prices of options can be expected to be
more volatile than the market prices on the underlying futures contract.
Compared to the purchase or sale of futures contracts, however, the purchase of
call or put options on futures contracts may frequently involve less potential
risk to the Funds because the maximum amount at risk is the premium paid for the
options (plus transaction costs).
B-5
<PAGE> 74
VI. RISKS OF TRANSACTIONS IN FUTURES CONTRACTS
There are several risks in connection with the use of futures in the Funds
as a hedging device. One risk arises because of the imperfect correlation
between movements in the price of the future and movements in the price of the
securities which are the subject of the hedge. The price of the future may move
more than or less than the price of the securities being hedged. If the price of
the future moves less than the price of the securities which are the subject of
the hedge, the hedge will not be fully effective but, if the price of the
securities being hedged has moved in an unfavorable direction, the Fund would be
in a better position than if it had not hedged at all. If the price of the
securities being hedged has moved in a favorable direction, this advantage will
be partially offset by the loss on the future. If the price of the future moves
more than the price of the hedged securities, the Fund involved will experience
either a loss or gain on the future which will not be completely offset by
movements in the price of the securities which are the subject of the hedge. To
compensate for the imperfect correlation of movements in the price of securities
being hedged and movement in the price of futures contracts, a Fund may buy or
sell futures contracts in a greater dollar amount than the dollar amount of
securities being hedged if the volatility over a particular time period of the
prices of such securities has been greater than the volatility over such time
period of the future, or if otherwise deemed to be appropriate by the investment
adviser. Conversely, a Fund may buy or sell fewer futures contracts if the
volatility over a particular time period of the prices of the securities being
hedged is less than the volatility over such time period of the futures contract
being used, or if otherwise deemed to be appropriate by the adviser. It is also
possible that, where the Fund has sold futures to hedge its portfolio against a
decline in the market, the market may advance and the value of securities held
in the Fund may decline. If this occurred, the Fund would lose money on the
future and also experience a decline in value in its portfolio securities.
Where futures are purchased to hedge against a possible increase in the
price of securities before a Fund is able to invest its cash (or cash
equivalents) in securities (or options) in an orderly fashion, it is possible
that the market may decline instead; if the Fund then concludes not to invest in
securities or options at that time because of concern as to possible further
market decline or for other reasons, the Fund will realize a loss on the futures
contract that is not offset by a reduction in the price of securities purchased.
In instances involving the purchase of futures contracts by a Fund, an
amount of cash and cash equivalents, equal to the market value of the futures
contracts, will be deposited in a segregated account with the Fund's custodian
and/or in a margin account with a broker to collateralize the position and
thereby insure that the use of such futures is unleveraged.
In addition to the possibility that there may be an imperfect correlation,
or no correlation at all, between movements in the futures and the securities
being hedged, the price of futures may not correlate perfectly with movement in
the cash market due to certain market distortions. Rather than meeting
additional margin deposit requirements, investors may close futures contracts
through off-setting transactions which could distort the normal relationship
between the cash and futures markets. Second, with respect to financial futures
contracts, the liquidity of the futures market depends on participants entering
into off-setting transactions rather than making or taking delivery. To the
extent participants decide to make or take delivery, liquidity in the futures
market could be reduced thus producing distortions. Third, from the point of
view of speculators, the deposit requirements in the futures market are less
onerous than margin requirements in the securities market. Therefore, increased
participation by speculators in the futures market may also cause temporary
price distortions. Due to the possibility of price distortion in the futures
market, and because of the imperfect correlation between the movements in the
cash market and movements in the price of futures, a correct forecast of general
market trends or interest rate movements by the adviser may still not result in
a successful hedging transaction over a short time frame.
Positions in futures may be closed out only on an exchange or board of
trade which provides a secondary market for such futures. Although the Funds
intend to purchase or sell futures only on exchanges or boards of trade where
there appear to be active secondary markets, there is no assurance that a liquid
secondary market on any exchange or board of trade will exist for any particular
contract or at any particular time. In such event, it may not be possible to
close a futures investment position, and in the event of adverse price
movements, the Fund would continue to be required to make daily cash payments of
variation margin. However, in the event
B-6
<PAGE> 75
futures contracts have been used to hedge portfolio securities, such securities
will not be sold until the futures contract can be terminated. In such
circumstances, an increase in the price of the securities, if any, may partially
or completely offset losses on the futures contract. However, as described
above, there is no guarantee that the price of the securities will in fact
correlate with the price movements in the futures contract and thus provide an
offset on a futures contract.
Further, it should be noted that the liquidity of a secondary market in a
futures contract may be adversely affected by "daily price fluctuation limits"
established by commodity exchanges which limit the amount of fluctuation in a
futures contract price during a single trading day. Once the daily limit has
been reached in the contract, no trades may be entered into at a price beyond
the limit, thus preventing the liquidation of open futures positions.
Successful use of futures by a Fund is also subject to the ability of Bank
of America or a Subadviser to predict correctly movements in the direction of
the market. For example, if a Fund has hedged against the possibility of a
decline in the market adversely affecting securities held by it and securities
prices increase instead, the Fund will lose part of all of the benefit to the
increased value of its securities which it has hedged because it will have
offsetting losses in its futures positions. In addition, in such situations, if
the Fund has insufficient cash, it may have to sell securities to meet daily
variation margin requirements. Such sales of securities may be, but will not
necessarily be, at increased prices which reflect the rising market. A Fund may
have to sell securities at a time when it may be disadvantageous to do so.
VII. OTHER HEDGING TRANSACTIONS
The Funds presently intend to use interest rate futures contracts, stock
index futures contracts and foreign currency futures contracts in connection
with their hedging activities. Nevertheless, each of the Funds is authorized to
enter into hedging transactions in any other futures contracts which are
currently traded or which may subsequently become available for trading. Such
instruments may be employed in connection with the Funds' hedging strategies if,
in the judgment of Bank of American or a Subadviser, transactions therein are
necessary or advisable.
VIII. ACCOUNTING AND TAX TREATMENT
Accounting for futures contracts and related options will be in accordance
with generally accepted accounting principles.
Generally, futures contracts and options on futures contracts held by a
Fund at the close of the Fund's taxable year will be treated for federal income
tax purposes as sold for their fair market value on the last business day of
such year, a process known as "marking-to-market." Forty percent of any gain or
loss resulting from such constructive sale will be treated as short-term capital
gain or loss and 60% of such gain or loss will be treated as long-term capital
gain or loss without regard to the length of time the Fund holds the futures
contract or option ("the 40%-60% rule"). The amount of any capital gain or loss
actually realized by a Fund in a subsequent sale or other disposition of those
futures contracts or options will be adjusted to reflect any capital gain or
loss taken into account by a Fund in a prior year as a result of the
constructive sale of the contracts. With respect to futures contracts to sell,
which will be regarded as parts of a "mixed straddle" because their values
fluctuate inversely to the values of specific securities held by a Fund, losses
as to such contracts to sell will be subject to certain loss deferral rules
which limit the amount of loss currently deductible on either part of the
straddle to the amount thereof which exceeds the unrecognized gain (if any) with
respect to the other part of the straddle, and to certain wash sales
regulations. Under short sales rules, which will also be applicable, the holding
period of the securities forming part of the straddle will (if they have not
been held for the long-term holding period) be deemed not to begin prior to
termination of the straddle. With respect to certain futures contracts,
deductions for interest and carrying charges will not be allowed.
Notwithstanding the rules described above, with respect to futures contracts to
sell which are properly identified as such, a Fund may make an election which
will exempt (in whole or in part) those identified futures contracts from being
treated for federal income tax purposes as sold on the last business day of the
Fund's taxable year, but gains and losses will be subject to such short sales,
wash sales and loss deferral rules and the requirement to
B-7
<PAGE> 76
capitalize interest and carrying charges. Under Temporary Regulations, a Fund
would be allowed (in lieu of the foregoing) to elect to either (1) offset gains
or losses from portions which are part of a mixed straddle by separately
identifying each mixed straddle to which such treatment applies, or (2)
establish a mixed straddle account for which gains and losses would be
recognized and offset on a periodic basis during the taxable year. Under either
election, the 40%-60% rule will apply to the net gain or loss attributable to
the futures contracts, but in the case of a mixed straddle account election, not
more than 50 percent of any net gain may be treated as long-term and no more
than 40 percent of any net loss may be treated as short-term.
Certain foreign currency contracts entered into by the Funds may be subject
to the "marking-to-market" process but gain or loss will be treated as 100%
ordinary income or loss. To receive such federal income tax treatment, a foreign
currency contract must meet the following conditions: (1) the contract must
require delivery of a foreign currency of a type in which regulated futures
contracts are traded or upon which the settlement value of the contract depends;
(2) the contract must be entered into at arm's length at a price determined by
reference to the price in the interbank market; and (3) the contract must be
traded in the interbank market. The Treasury Department has broad authority to
issue regulations under the provisions respecting foreign currency contracts. As
of the date of this Statement of Additional Information, the Treasury has not
issued any such regulations. Foreign currency contracts entered into by the Fund
may result in the creation of one or more straddles for federal income tax
purposes, in which case certain loss deferral, short sales, and wash sales rules
and the requirement to capitalize interest and carrying charges may apply.
Some investments may be subject to special rules which govern the federal
income tax treatment of certain transactions denominated in terms of a currency
other than the U.S. dollar or determined by reference to the value of one or
more currencies other than the U.S. dollar. The types of transactions covered by
the special rules include the following: (i) the acquisition of, or becoming the
obligor under, a bond or other debt instrument (including, to the extent
provided in Treasury regulations, preferred stock); (ii) the accruing of certain
trade receivables and payables; and (iii) the entering into or acquisition of
any forward contract, futures contract, option and similar financial instrument.
However, regulated futures contracts and non-equity options are generally not
subject to the special currency rules if they are or would be treated as sold
for their fair market value at year-end under the marking-to-market rules unless
an election is made to have such currency rules apply. The disposition of a
currency other than the U.S. dollar by a U.S. taxpayer is also treated as a
transaction subject to the special currency rules. With respect to transactions
covered by the special rules, foreign currency gain or loss is calculated
separately from any gain or loss on the underlying transaction and is normally
taxable as ordinary gain or loss. A taxpayer may elect to treat as capital gain
or loss foreign currency gain or loss arising from certain identified forward
contracts, futures contracts and options that are capital assets in the hands of
the taxpayer and which are not part of a straddle. In accordance with Treasury
regulations, certain transactions subject to the special currency rules that are
part of a "section 988 hedging transaction" (as defined in the Code and the
Treasury regulations) will be integrated and treated as a single transaction or
otherwise treated consistently for purposes of the Code. "Section 988 hedging
transactions" are not subject to the marking-to-market or loss deferral rules
under the Code. It is anticipated that some of the non-U.S. dollar denominated
investments and foreign currency contracts that the Funds may make or may enter
into will be subject to the special currency rules described above. Gain or loss
attributable to the foreign currency component of transactions engaged in by a
Fund which are not subject to special currency rules (such as foreign equity
investments other than certain preferred stocks) will be treated as capital gain
or loss and will not be segregated from the gain or loss on the underlying
transaction.
Qualification as a regulated investment company under the Code requires
that each Fund satisfy certain requirements with respect to the source of its
income during a taxable year. At least 90% of the gross income of each Fund must
be derived from dividends, interests, payments with respect to securities loans,
gains from the sale or other disposition of stock, securities or foreign
currencies, and other income (including but not limited to gains from options,
futures, or forward contracts) derived with respect to the Fund's business of
investing in such stock, securities or currencies. The Treasury Department may
by regulation exclude from qualifying income foreign currency gains which are
not directly related to a Fund's principal business of investing in stock or
securities, or futures with respect to stock or securities. Any income derived
by a Fund from a partnership or trust is treated as derived with respect to the
Fund's business of investing in stock,
B-8
<PAGE> 77
securities or currencies only to the extent that such income is attributable to
items of income which would have been qualifying income if realized by the Fund
in the same manner as by the partnership or trust.
An additional requirement for qualification as a regulated investment
company under the Code is that less than 30% of a Fund's gross income must be
derived from gains realized on the sale or other disposition of the following
investments held for less than three months: (1) stock and securities (as
defined in section 2(a)(36) of the Investment Company Act of 1940); (2) options,
futures and forward contracts other than those on foreign currencies; and (3)
foreign currencies (and options, futures and forward contracts on foreign
currencies) that are not directly related to a Fund's principal business of
investing in stock and securities (and futures with respect to stocks and
securities). With respect to futures contracts and other financial instruments
subject to the marking-to-market rules, the Internal Revenue Service has ruled
in private letter rulings that a gain realized from such a futures contract or
financial instrument will be treated as being derived from a security held for
three months or more (regardless of the actual period for which the contract or
instrument is held) if the gain arises as a result of a constructive sale under
the marking-to-market rules, and will be treated as being derived from a
security held for less than three months only if the contract or instrument is
terminated (or transferred) during the taxable year (other than by reason of
marking-to-market) and less than three months have elapsed between the date the
contract or instrument is acquired and the termination date. In determining
whether the 30% test is met for a taxable year, increases and decreases in the
value of each Fund's futures contracts and other investments that qualify as
part of a "designated hedge," as defined in the Code, may be netted.
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<PAGE> 78
PACIFIC INNOVATIONS TRUST,
A DELAWARE BUSINESS TRUST
FORM N-1A
PART C: OTHER INFORMATION
Item 24. Financial Statements and Exhibits.
a. Financial Statements:
Part A: None
Part B: Registrant's Statements of Assets and Liabilities,
Notes thereon and Report of Independent Auditors
thereon, as of February 7, 1997.
b. Exhibits:
(1.1) Certificate of Trust of Registrant.(1)
(1.2) Declaration of Trust of Registrant.(1)
(2) Bylaws of Registrant.(1)
(3) None.
(4) None.
(5.1) Form of Management Agreement between Registrant and
Bank of America NT&SA.(1)
(5.2) Form of Subadvisory Agreement between Bank of America
NT&SA and Scudder, Stevens & Clark, Inc.(1)
(5.3) Form of Subadvisory Agreement between Bank of America
NT&SA and Wellington Management Company, LLP.(1)
(6) Form of Distribution Agreement between Registrant and
BISYS Fund Services Limited Partnership.(1)
(7) None.
(8.1) Form of Custodian Services Agreement between
Registrant and PNC Bank, N.A.(1)
------------
(1) Incorporated herein by reference to Registrant's initial
registration statement filed on October 15, 1996.
(2) Filed herewith.
<PAGE> 79
(8.2) Form of Global Custody Agreement between PNC Bank,
N.A. and Barclays Bank PLC.(1)
(9.1) Form of Sub-Administration and Accounting Services
Agreement among Registrant, PFPC Inc. and Bank of
America NT&SA.(1)
(9.2) Form of Transfer Agency Agreement between Registrant
and Pacific Mutual Life Insurance Company.(1)
(9.3) Form of Support Services Agreement between Registrant
and Pacific Mutual Life Insurance Company.(1)
(9.4) Form of Participation Agreement between Registrant
and Pacific Mutual Life Insurance Company.(1)
(10) Opinion and Consent of Counsel.(2)
(11) Consent of independent auditors.(2)
(12) Not applicable.
(13) Form of investment letter of initial investor in
Registrant.(2)
(14) None.
(15) None.
(16) Not applicable.
(17) Not applicable.
(18) None.
(19.1) Limited Power of Attorney of Edward S. Bottum.(2)
(19.2) Limited Power of Attorney of William P. Carmichael.(2)
(19.3) Limited Power of Attorney of Robert E. Greeley.(2)
(19.4) Limited Power of Attorney of Harold T. Joanning.(2)
(19.5) Limited Power of Attorney of John P. Privat. (2)
Item 25. Persons Controlled by or Under Common Control with Registrant.
As of February 14, 1997, all of the outstanding shares of
Registrant were held by Pacific Financial Asset Management Corporation, a
subsidiary of Pacific Mutual Life Insurance Company, which may be deemed to
control Registrant for purposes of the Investment Company Act of 1940.
C-2
<PAGE> 80
Item 26. Number of Holders of Securities.
As of February 14, 1997, the number of record holders of
each series of Registrant was as follows:
<TABLE>
<CAPTION>
Title of Series Number of Record Holders
--------------- ------------------------
<S> <C>
Money Market Fund 1
Managed Bond Fund 1
Capital Income Fund 1
Blue Chip Fund 1
Mid-Cap Equity Fund 1
Aggressive Growth Fund 1
International Fund 1
</TABLE>
Item 27. Indemnification.
Article V of Registrant's Declaration of Trust, filed herewith
as Exhibit 1, provides for the indemnification of Registrant's trustees,
officers, employees and agents against liabilities incurred by them in
connection with the defense or disposition of any action or proceeding in which
they may be involved or with which they may be threatened, while in office or
thereafter, by reason of being or having been in such office, except with
respect to matters as to which it has been determined that they acted with
willful misfeasance, bad faith, gross negligence or reckless disregard of the
duties involved in the conduct of their office ("Disabling Conduct").
Registrant intends to obtain from a major insurance carrier a
trustees' and officers' liability policy covering certain types of errors and
omissions.
Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to trustees, officers and controlling
persons of the Registrant pursuant to the foregoing provisions, or otherwise,
the Registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Securities Act and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the Registrant of expenses incurred or paid by a trustee, officer or
controlling person of the Registrant in the successful defense of any action,
suit or proceeding) is asserted by such trustee, officer, or controlling person
in connection with the securities being registered, the Registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
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<PAGE> 81
Item 28. Business and Other Connections of Investment Manager.
(a) Bank of America performs investment management
services for Registrant. Bank of America and its predecessors have been in the
business of managing investments of fiduciary and other accounts since 1904.
In addition to its trust business, Bank of America provides commercial and
consumer banking services.
To the knowledge of Registrant, none of the directors or
officers of Bank of America, except those set forth below, is or has been, at
any time during the past two calendar years, engaged in any other business,
profession, vocation or employment of a substantial nature, except that certain
directors and officers of Bank of America also hold various positions with, and
engage in business for, BankAmerica Corporation (which owns all the outstanding
stock of Bank of America) or other subsidiaries of BankAmerica Corporation.
Set forth below are the names and principal businesses of the directors of Bank
of America and the directors and certain of the senior executive officers of
Bank of America who are engaged in any business, profession, vocation or
employment of a substantial nature other than with BankAmerica Corporation.
C-4
<PAGE> 82
<TABLE>
<CAPTION>
Position with Bank of
America NT&SA Name Principal Occupation Type of Business
----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Director Joseph F. Alibrandi Chairman of the Board Manufacturer of Aerospace
and Chief Executive and Communication Products
Officer, Whittaker
Corporation
Director Jill E. Barad President and Chief Toy Manufacturer
Executive Officer,
Mattel, Inc.
Director Peter B. Bedford Chairman and CEO, California based Real
Bedford Property Estate Investment Trust
Investors, Inc.
Director Andrew F. Brimmer President, Brimmer & Consulting
Co., Inc.
Director Richard A. Clarke Retired Chairman of the Utility Company
Board, Pacific Gas and
Electric Company
Director David A. Coulter Chief Executive Officer, National Bank
Chairman of the
Board and President, Bank
America Corporation and
Bank of America NT&SA
Director Timm F. Crull Chairman, Hallmark Greeting Cards
International
Director Kathleen Feldstein President, Economic Economic Consulting
Studies, Inc.
Director Donald E. Guinn Chairman Emeritus, Telecommunications and
Pacific Telesis Group Diversified Holding
Company
Director Frank L. Hope, Jr. Consulting Architect Architectural and
Engineering Consulting
Director Ignacio E. Lozano, Jr. Chairman, "La Opinion" Newspaper Publishing
Director Walter E. Massey,Ph.D President, Morehouse Higher Education
College
Director John M. Richman Counsel, Wachtell, Law Firm
Lipton, Rosen & Katz
Director Richard M. Rosenberg Retired Chairman of the National Bank
Board and CEO, Bank
America Corporation
and Bank of America
NT&SA
Director A. Michael Spense Dean of the Graduate Higher Education
School of Business,
Stanford University
Director Solomon D. Trujillo President and CEO, Telecommunications
U.S. West Communications
Group
</TABLE>
C-5
<PAGE> 83
<TABLE>
<CAPTION>
Position with Bank of
America NT&SA Name Principal Occupation Type of Business
----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Director Solomon D. Trujillo President and Chief Telecommunications
Executive Officer, US
West Communications
Group
</TABLE>
(b) Scudder, Stevens & Clark, Inc. ("Scudder") is an
investment adviser registered under the Investment Advisers Act of 1940, as
amended (the "Advisers Act"). The list required by this Item 28 of officers
and partners of Scudder, together with any information as to any business
profession, vocation or employment of a substantial nature engaged in by such
officers and partners during the past two years, is incorporated by reference
to Schedules A and D of Form ADV filed by Scudder pursuant to the Advisers Act
(SEC File No. 801-252).
(c) Wellington Management Company, LLP ("Wellington
Management") is an investment adviser registered under the Advisers Act. The
list required by this Item 28 of officers and partners of Wellington
Management, together with any information as to any business profession,
vocation or employment of a substantial nature engaged in by such officers and
partners during the last two years, is incorporated herein by reference to
Schedules A and D of Form ADV filed by Wellington Management pursuant to the
Advisers Act (SEC File No. 801-159089).
Item 29. Principal Underwriters.
(a) Concord Financial Group, Inc. ("Concord") acts as
principal underwriter for the Company. Concord also acts as principal
underwriter or exclusive distributor for the following registered investment
companies: Infinity Funds, Inc., Seafirst Retirement Funds, Pacific Horizon
Funds, Inc. and Time Horizon Funds.
(b) For information as to the business, profession,
vocation or employment of a substantial nature of Concord, its officers and
partners, reference is made to the Form BD filed by Concord (file no. 8-37601),
which is incorporated by reference herein. Information as to the positions or
offices of each of Concord, its officers and partners is as follows:
C-6
<PAGE> 84
<TABLE>
<CAPTION>
Name and Principal Position and Offices with Office with
Business Address* BISYS Registrant
- ------------------ ------------------------- ------------
<S> <C> <C>
Lynn J. Mangum Chairman/CEO None
Irimga McKay President Vice President
Robert J. McMullan Executive Vice President/Treasurer None
Stephen G. Mintos Executive Vice President None
Kevin J. Dell Vice President/General Counsel/Secretary None
Mark J. Rybarczyk Senior Vice President None
George Martinez Senior Vice President Secretary
Dennis Sheehan Senior Vice President None
Dale Smith Vice President None
John Gilliam Vice President None
Michael Burns Vice President None
Annamaria Porcaro Assistant Secretary None
Robert Tuch Assistant Secretary None
</TABLE>
- --------------------
* All addresses: 3435 Stelzer Road, Columbus, Ohio 43219.
(c) Not applicable.
Item 30. Location of Accounts and Records.
(1) Concord Financial Group, Inc., 3435 Stelzer Road, Columbus,
Ohio 43219 (records relating to the Distributor).
(2) Bank of America National Trust and Savings Association, 555
California Street, San Francisco, California 94104 (records
relating to the Manager).
(3) Pacific Mutual Life Insurance Company, 700 Newport Center
Drive, Newport Beach, California 92660 (records relating to
the Transfer Agent).
(4) Vedder, Price, Kaufman & Kammholz, 222 N. LaSalle, 26th Floor,
Chicago, Illinois 60601 (Registrant's Declaration of Trust,
By-Laws and minute books).
(5) PNC Bank, N.A., Broad and Chestnut Streets, Philadelphia,
Pennsylvania 19101 (records relating to the Custodian).
(6) PFPC Inc., 103 Bellevue Parkway, Wilmington, Delaware 19809
(records relating to the Sub-Administration and Accounting
Services Agreement).
Item 31. Management Services.
Not Applicable.
C-7
<PAGE> 85
Item 32. Undertakings.
Registrant hereby undertakes that if it is requested by the
holders of at least 10% of its outstanding shares to call a meeting of
shareholders for the purpose of voting upon the question of removal of a
Trustee, it will do so and will assist in communications with other
shareholders as required by Section 16(c) of the Investment Company Act of
1940.
Registrant hereby undertakes to file a post-effective
amendment using financial statements which need not be certified, within four
to six months from the effective date of this Registration Statement.
Registrant hereby undertakes to furnish each person to whom a
prospectus is delivered with a copy of Registrant's latest annual report to
shareholders, upon request and without charge.
C-8
<PAGE> 86
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and
the Investment Company Act of 1940, the Registrant has duly caused this
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Los Angeles, State of California, on the 20th
day of February, 1997.
PACIFIC INNOVATIONS TRUST,
a Delaware Business Trust
By s/J. David Huber
------------------------
J. David Huber
President, Chief
Executive Officer
Pursuant to the requirements of the Securities Act of 1933,
this Registration Statement has been signed below by the following persons in
the capacities and on the dates indicated.
<TABLE>
<S> <C> <C>
s/J. David Huber President, Chief February 20, 1997
----------------------- Executive Officer
J. David Huber
s/Kevin L. Martin Treasurer, Chief February 20, 1997
----------------------- Financial Officer
Kevin L. Martin and Principal
Accounting Officer
Robert E. Greeley* Trustee February 20, 1997
- ------------------------
Robert E. Greeley
Edward S. Bottum* Trustee February 20, 1997
-----------------------
Edward S. Bottum
William P. Carmichael* Trustee February 20, 1997
-----------------------
William P. Carmichael
Harold T. Joanning* Trustee February 20, 1997
-----------------------
Harold T. Joanning
John Privat* Trustee February 20, 1997
-----------------------
John Privat
*By s/J. David Huber February 20, 1997
------------------------------
J. David Huber
Attorney-in-fact
</TABLE>
<PAGE> 87
EXHIBIT INDEX
PACIFIC INNOVATIONS TRUST,
a Delaware Business Trust
FORM N-1A REGISTRATION STATEMENT
FILE NOS. 333-14191 and 811-07863
<TABLE>
<CAPTION>
Exhibit No. Title of Exhibit
----------- ----------------
<S> <C>
(10) Opinion and Consent of Counsel.
(11) Consent of independent auditors.
(13) Form of investment letter of initial investor in Registrant.
(19.1) Limited Power of Attorney of Edward S. Bottum.
(19.2) Limited Power of Attorney of William P. Carmichael.
(19.3) Limited Power of Attorney of Robert E. Greeley.
(19.4) Limited Power of Attorney of Harold T. Joanning.
(19.5) Limited Power of Attorney of John P. Privat.
</TABLE>
<PAGE> 1
EXHIBIT 99.10
OPINION AND CONSENT OF COUNSEL
[VEDDER, PRICE, KAUFMAN & KAMMHOLZ]
February 20, 1997
Pacific Innovations Trust
103 Bellevue Parkway
Wilmington, Delaware 19809
Board of Trustees:
Reference is made to the Registration Statement on Form N-1A under the
Securities Act of 1933 being filed by Pacific Innovations Trust (the "Trust")
in connection with the proposed public offering of an indefinite number of
units of beneficial interest ("Shares"), in seven authorized series: Money
Market Fund, Managed Bond Fund, Capital Income Fund, Blue Chip Fund, Mid-Cap
Equity Fund; Aggressive Growth Fund; and International Fund (the "Portfolios").
We have assisted the Trust in connection with its organization and have
counseled the Trust regarding subsequent legal matters. Assuming that the
Trust's Declaration of Trust dated September 25, 1996 and the Certificate of
Trust dated September 25, 1996 and the By-Laws of the Trust adopted October 1,
1996 are presently in full force and effect and have not been further amended
in any respect and that the resolutions adopted by the Board of Trustees of the
Trust on December 12, 1996 relating to organizational matters and the issuance
of Shares are presently in full force and effect and have not been amended in
any respect, it is our opinion that upon the issuance of the Shares in
accordance with the Trust Declaration of Trust and the receipt by the
Portfolios of a purchase price not less than the net asset value per Share, the
Shares will be legally issued and outstanding, fully paid and non-assessable.
We hereby consent to the use of this opinion in connection with said
Registration Statement as amended and the prospectus and statement of
additional information relating to said Shares.
Sincerely,
/s/ Vedder, Price, Kaufman & Kammholz
VEDDER, PRICE, KAUFMAN & KAMMHOLZ
<PAGE> 1
EXHIBIT 99.11
Independent Auditors' Consent
The Board of Trustees
The Pacific Innovations Trust:
We consent to the inclusion in The Pacific Innovations Trust's Pre-Effective
Amendment No. 1 to the Registration Statement No. 333-14191 filed on Form N-1A
under the Securities Act of 1933 and Amendment No. 1 to the Registration
Statement No. 811-07863 filed on Form N-1A under the Investment Company Act
of 1940 of our report dated February 11, 1997, on the statements of assets and
liabilities of the Money Market Fund, Managed Bond Fund, Capital Income Fund,
Blue Chip Fund, Mid-Cap Equity Fund, Aggressive Growth Fund, and International
Fund, constituting the Pacific Innovations Trust, as of February 7, 1997.
We also consent to the reference to our firm under the headings "Independent
Auditors" and "Financial Statements" in the Statement of Additional Information.
/s/ KPMG Peat Marwick LLP
KPMG Peat Marwick LLP
Los Angeles, California
February 20, 1997
<PAGE> 1
EXHIBIT 99.13
FORM OF INVESTMENT
LETTER OF INITIAL
INVESTOR IN REGISTRANT
February 7, 1997
Board of Trustees
Pacific Innovations Trust
103 Bellevue Parkway
Wilmington, Delaware 19809
Dear Trustees:
Pacific Financial Asset Management Corporation offers to purchase from
the Pacific Innovations Trust (the "Trust") shares of beneficial interest
("Shares") in each of the Trust's portfolios for an aggregate purchase price of
$100,000 cash as follows:
Money Market Fund: 99,940 Shares at $1.00 per share
Managed Bond Fund: 1 Share at $10.00 per share
Capital Income Fund: 1 Share at $10.00 per share
Blue Chip Fund: 1 Share at $10.00 per share
Mid-Cap Equity Fund: 1 Share at $10.00 per share
Aggressive Growth Fund: 1 Share at $10.00 per share
International Fund: 1 Share at $10.00 per share
All such Shares issued shall be validly issued, fully paid and non-assessable
upon issuance of such Shares and receipt by the Trust of said payment.
These Shares are purchased for investment purposes only and are not
being purchased with any present interest of distributing or reselling the same
to the public, and will be held for the investment of Pacific Financial Asset
Management Corporation.
Sincerely,
PACIFIC FINANCIAL ASSET
MANAGEMENT CORPORATION
By: /s/
-----------------------------------
Accepted and agreed to this
7th day of February, 1997.
PACIFIC INNOVATIONS TRUST
By: /s/ J. DAVID HUBER
-------------------------
J. David Huber, President
<PAGE> 1
EXHIBIT 99.19.1
LIMITED POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned hereby constitutes
J. David Huber, Mark E. Nagle and George O. Martinez, and each of them acting
alone, as his true and lawful attorney-in-fact and agent, with full power of
substitution and resubstitution, for him and in his name, place and stead, in
any and all capacities, to sign the Registration Statement of Pacific
Innovations Trust, a Delaware Business Trust, on Form N-1A under the Securities
Act of 1933, as amended, and the Investment Company Act of 1940, as amended,
and any or all amendments thereto, and to file the same, with all exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorney-in-fact and agent full power
and authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and confirming all
said attorney-in-fact and agent may lawfully do or cause to be done by virtue
hereof.
DATED: October 2, 1996
/s/ EDWARD S. BOTTUM
------------------------------
Print Name: Edward S. Bottum
<PAGE> 1
EXHIBIT 99.19.2
LIMITED POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned hereby constitutes
J. David Huber, Mark E. Nagle and George O. Martinez, and each of them acting
alone, as his true and lawful attorney-in-fact and agent, with full power of
substitution and resubstitution, for him and in his name, place and stead, in
any and all capacities, to sign the Registration Statement of Pacific
Innovations Trust, a Delaware Business Trust, on Form N-1A under the Securities
Act of 1933, as amended, and the Investment Company Act of 1940, as amended,
and any or all amendments thereto, and to file the same, with all exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorney-in-fact and agent full power
and authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and confirming all
said attorney-in-fact and agent may lawfully do or cause to be done by virtue
hereof.
DATED: October 2, 1996
/s/ WILLIAM P. CARMICHAEL
------------------------------
Print Name: William P. Carmichael
<PAGE> 1
EXHIBIT 99.19.3
LIMITED POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned hereby constitutes
J. David Huber, Mark E. Nagle and George O. Martinez, and each of them acting
alone, as his true and lawful attorney-in-fact and agent, with full power of
substitution and resubstitution, for him and in his name, place and stead, in
any and all capacities, to sign the Registration Statement of Pacific
Innovations Trust, a Delaware Business Trust, on Form N-1A under the Securities
Act of 1933, as amended, and the Investment Company Act of 1940, as amended,
and any or all amendments thereto, and to file the same, with all exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorney-in-fact and agent full power
and authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and confirming all
said attorney-in-fact and agent may lawfully do or cause to be done by virtue
hereof.
DATED: October 2, 1996
/s/ ROBERT E. GREELEY
------------------------------
Print Name: Robert E. Greeley
<PAGE> 1
EXHIBIT 99.19.4
LIMITED POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned hereby constitutes
J. David Huber, Mark E. Nagle and George O. Martinez, and each of them acting
alone, as his true and lawful attorney-in-fact and agent, with full power of
substitution and resubstitution, for him and in his name, place and stead, in
any and all capacities, to sign the Registration Statement of Pacific
Innovations Trust, a Delaware Business Trust, on Form N-1A under the Securities
Act of 1933, as amended, and the Investment Company Act of 1940, as amended,
and any or all amendments thereto, and to file the same, with all exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorney-in-fact and agent full power
and authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and confirming all
said attorney-in-fact and agent may lawfully do or cause to be done by virtue
hereof.
DATED: October 2, 1996
/s/ HAROLD T. JOANNING
------------------------------
Print Name: Harold T. Joanning
<PAGE> 1
EXHIBIT 99.19.5
LIMITED POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned hereby constitutes
J. David Huber, Mark E. Nagle and George O. Martinez, and each of them acting
alone, as his true and lawful attorney-in-fact and agent, with full power of
substitution and resubstitution, for him and in his name, place and stead, in
any and all capacities, to sign the Registration Statement of Pacific
Innovations Trust, a Delaware Business Trust, on Form N-1A under the Securities
Act of 1933, as amended, and the Investment Company Act of 1940, as amended,
and any or all amendments thereto, and to file the same, with all exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorney-in-fact and agent full power
and authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and confirming all
said attorney-in-fact and agent may lawfully do or cause to be done by virtue
hereof.
DATED: October 2, 1996
/s/ JOHN P. PRIVAT
------------------------------
Print Name: John P. Privat
