<PAGE> 1
As filed with the Securities and Exchange Commission
on April 30, 1998
Registration No. 333-14191
811-07863
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [ X ]
PRE-EFFECTIVE AMENDMENT NO. [ ]
POST-EFFECTIVE AMENDMENT NO. 3 [ X ]
AND/OR
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [ X ]
AMENDMENT NO. 4 [ 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, Treasurer
103 Bellevue Parkway
Wilmington, Delaware 19809
(Name and Address of Agent for Service)
COPIES TO:
CATHY O'KELLY
VEDDER, PRICE, KAUFMAN & KAMMHOLZ
222 N. LASALLE
CHICAGO, ILLINOIS 60601
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It is proposed that this filing will become effective (check appropriate box):
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[ X ] immediately upon filing pursuant to [ ] on (date) pursuant
paragraph (b) of Rule 485. to paragraph (b) of Rule 485.
[ ] 60 days after filing pursuant to [ ] on (date) pursuant to
paragraph (a)(1) of Rule 485. paragraph (a)(1) of Rule 485.
[ ] 75 days after filing pursuant to [ ] on (date) pursuant to
paragraph (a)(2) of Rule 485. paragraph (a)(2) of Rule 485.
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If appropriate, check the following box:
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[ ] This post-effective amendment designates a new effective date for a
previously filed post-effective amendment.
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<PAGE> 2
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 . . . . . . . . . . . Financial Highlights
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 or 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; General Information
Item 17. Brokerage Allocation and Other Practices . . . . . . . Investment Objectives and Policies
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 . . . . . . . . . . . . . . . . . . . . . Management
Item 22. Calculation of Performance Data . . . . . . . . . . . Performance Information
Item 23. Financial Statements . . . . . . . . . . . . . . . . . Financial Statements
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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.
<PAGE> 3
PACIFIC INNOVATIONS TRUST
Dated May 1, 1998
<PAGE> 4
PROSPECTUS INVESTMENT PORTFOLIOS OFFERED
BY PACIFIC INNOVATIONS TRUST
MAY 1, 1998
- --------------------------------------------------------------------------------
THE PACIFIC INNOVATIONS SERIES OF FUNDS CONSISTS OF EIGHT 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, AS AMENDED (THE "1940 ACT"). SHARES OF THE FUNDS MAY BE
OFFERED AND SOLD ONLY TO SEPARATE ACCOUNTS ("SEPARATE ACCOUNTS") OF PACIFIC LIFE
INSURANCE COMPANY ("PACIFIC LIFE"), 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 -- Global Value Fund
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Bank of America National Trust Savings Association ("Bank of America" or
the "Manager"), a wholly-owned subsidiary of BankAmerica Corporation
("BankAmerica") serves as the Funds' investment manager. Based in San Francisco,
California, Bank of America and its affiliates have over $67 billion under
management, of which $19 billion is in mutual funds. Scudder Kemper Investments,
Inc., Wellington Management Company, LLP and Robertson, Stephens Investment
Management, L.P. (each a "Subadviser" and collectively, the "Subadvisers") serve
as subadvisers to the Managed Bond Fund, the International Fund and the Global
Value 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") and other
required information that has been filed with the U.S. Securities and Exchange
Commission (the "SEC"). To obtain a free copy, call (800) 722-5558. The SAI
dated May 1, 1998, as it may be revised from time to time, is incorporated by
reference into this Prospectus. The SEC maintains a Web site
(http://www.sec.gov) that contains the SAI, material incorporated by reference
and other information regarding registrants that file electronically with the
SEC.
Shares of the Funds are not bank deposits or obligations of, or guaranteed
or endorsed by, BankAmerica Corporation 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. There
can be no assurance that the Money Market Fund will be able to maintain a stable
net asset value of $1.00 per share.
------------------------
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 SEC 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.
<PAGE> 5
CONTENTS
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PAGE
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FINANCIAL HIGHLIGHTS........................................ 3
THE FUNDS AT A GLANCE....................................... 4
FUND INVESTMENTS
Investment Objectives and Policies........................ 5
Common Investment Policies................................ 9
Ratings................................................... 16
Diversification and Changes in Investment Policies........ 16
Other Investment Practices, Considerations and Risk
Factors................................................ 17
THE BUSINESS OF THE FUNDS
Fund Management........................................... 18
Expenses.................................................. 18
Manager and Subadvisers................................... 18
Other Service Providers................................... 20
Fee Waivers............................................... 21
MORE ON THE FUNDS' SHARES
How to Buy Shares......................................... 22
How to Redeem Shares...................................... 22
How are Shares Priced?.................................... 22
Can I Exchange My Investments From One Fund to Another?... 22
Dividends and Distributions............................... 22
TAX INFORMATION............................................. 23
DESCRIPTION OF SHARES
About the Trust........................................... 23
Voting Rights............................................. 23
Outstanding Shares........................................ 23
MEASURING PERFORMANCE
Prior Performance of The Manager and Subadvisers.......... 24
Distributor: Manager:
Provident Distributors, Inc. Bank of America National
Four Falls Corporate Center Trust and Savings Association
6th Floor 555 California Street
West Conshohocken, PA 19428-2961 Suite 2600
San Francisco, CA 94104
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2
<PAGE> 6
The table below sets forth certain supplementary information concerning the
investment results of the Funds (except the Global Value Fund, which was not in
operation during the period covered) for the period indicated. The information
contained in the Financial Highlights has been audited by KPMG Peat Marwick LLP,
independent auditors of each Fund, whose unqualified report on the financial
statements containing such information is incorporated by reference into the
SAI. The Financial Highlights should be read in conjunction with the financial
statements, notes thereto and the unqualified report of the independent
auditors. Copies of the Trust's SAI and Annual Report to Shareholders may be
obtained without charge by calling (800) 722-5558.
PACIFIC INNOVATIONS TRUST
FINANCIAL HIGHLIGHTS
FOR THE PERIOD FROM MARCH 1, 1997(1) TO
DECEMBER 31, 1997 (AUDITED)
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MONEY MARKET MANAGED CAPITAL BLUE CHIP MID-CAP AGGRESSIVE INTERNATIONAL
FUND BOND FUND INCOME FUND FUND EQUITY FUND GROWTH FUND FUND
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Net Asset Value, beginning of
period......................... $ 1.00 $ 10.00 $ 10.00 $ 10.00 $ 10.00 $ 10.00 $ 10.00
------- ------- ------- ------- ------- ------- -------
Net investment income (loss)..... 0.04 0.49 0.17 0.06 0.05 (0.03) 0.09
Net realized and unrealized gain
on investments and foreign
currency transactions.......... 0.00 0.15 1.30 2.27 2.73 1.76 (0.01)
------- ------- ------- ------- ------- ------- -------
Total from investment
operations..................... 0.04 0.64 1.47 2.33 2.78 1.73 0.08
------- ------- ------- ------- ------- ------- -------
Dividends from net investment
income......................... (0.04) (0.49) (0.17) (0.06) (0.05) -- (0.09)
------- ------- ------- ------- ------- ------- -------
Distributions from net capital
gains.......................... -- -- (0.14) -- (0.06) (0.92) --
Distributions in excess of net
capital gains.................. -- -- (0.10) (0.03) (0.02) (0.10) (0.19)
------- ------- ------- ------- ------- ------- -------
Total distributions.............. (0.04) (0.49) (0.41) (0.09) (0.13) (1.02) (0.28)
------- ------- ------- ------- ------- ------- -------
Net Asset Value, end of period... $ 1.00 $ 10.15 $ 11.06 $ 12.24 $ 12.65 $ 10.71 $ 9.80
======= ======= ======= ======= ======= ======= =======
Total return..................... 4.22% 6.59% 14.75% 23.27% 27.80% 17.65% 0.56%
======= ======= ======= ======= ======= ======= =======
Net assets, end of period (in
thousands)..................... $ 6,699 $11,758 $17,671 $19,910 $11,148 $ 9,405 $ 9,036
======= ======= ======= ======= ======= ======= =======
Ratio of expenses to average net
assets:
After fee waivers and
reimbursements............... 0.60%* 0.75%* 0.87%* 0.94%* 0.94%* 1.03%* 1.24%*
======= ======= ======= ======= ======= ======= =======
Before fee waivers and
reimbursements............... 1.47%* 1.39%* 1.52%* 1.53%* 1.62%* 1.73%* 3.19%*
======= ======= ======= ======= ======= ======= =======
Ratio of net investment income to
average net assets:
After fee waivers and
reimbursements............... 5.00%* 6.12%* 3.24%* 1.00%* 0.66%* (0.53%)* 1.39%*
======= ======= ======= ======= ======= ======= =======
Before fee waivers and
reimbursements............... 4.13%* 5.48%* 2.59%* 0.41%* (0.02%)* (1.23%)* (0.56%)*
======= ======= ======= ======= ======= ======= =======
Average Commission Rate
Paid(2)...................... -- -- -- $0.0359 $0.0419 $0.0456 $0.0203
======= ======= ======= ======= ======= ======= =======
Portfolio turnover rate.......... -- 104.36% 44.98% 44.93% 55.74% 99.05% 53.23%
======= ======= ======= ======= ======= ======= =======
</TABLE>
- --------------------------------------------------------------------------------
(1) Commenced operations on March 1, 1997.
(2) Represents total commissions paid on portfolio securities divided by the
total number of shares purchased or sold on which commissions are charged.
* Annualized.
3
<PAGE> 7
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 begin on
the next page, and related information.
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PRIMARY INVESTMENTS
(UNDER NORMAL
FUND OBJECTIVE CIRCUMSTANCES) MANAGER/SUBADVISER
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Money Market Liquidity and current Short-term debt Bank of America
income consistent with obligations issued or
preservation of capital guaranteed by U.S.
Government, its
agencies, authorities
or instrumentalities
- ----------------------------------------------------------------------------------------------------
Managed Bond Interest income and Investment grade, Bank of America/Scudder
capital appreciation intermediate and longer Kemper Investments,
term bonds. Inc.
- ----------------------------------------------------------------------------------------------------
Capital Income Total investment Convertible bonds and Bank of America
return, comprised of convertible preferred
current income and stocks
capital appreciation
- ----------------------------------------------------------------------------------------------------
Blue Chip Long-term capital Blue chip stocks Bank of America
appreciation
- ----------------------------------------------------------------------------------------------------
Mid-Cap Equity Capital appreciation; Stocks of companies Bank of America
income is a secondary with medium market
consideration capitalizations
- ----------------------------------------------------------------------------------------------------
Aggressive Growth Maximum capital Common stocks and Bank of America
appreciation securities convertible
into common stocks of
companies with smaller
market capitalizations
- ----------------------------------------------------------------------------------------------------
International Long-term capital Foreign equity Bank of
growth securities America/Wellington
Management Company, LLP
- ----------------------------------------------------------------------------------------------------
Global Value Long-term growth using Foreign and U.S. common Bank of
a value methodology stocks of issuers with America/Robertson,
market capitalizations Stephens & Company
of $1 billion or more Investment Management,
L.P.
- ----------------------------------------------------------------------------------------------------
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4
<PAGE> 8
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 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 SEC, 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 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 Fund were required to liquidate any of them it
might not be able to do so advantageously; accordingly, the 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 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
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 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.
INVESTMENT POLICIES. The Managed Bond Fund, which is subadvised by Scudder
Kemper Investments, Inc. ("Scudder Kemper"), 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.
5
<PAGE> 9
The 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 Ratings Group ("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
Kemper. 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
under "Common Investment Policies," below.
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 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" by a NRSRO, or
that if the investment is unrated it will be deemed of comparable quality by the
Manager. These ratings are described under "Common Investment Policies," below.
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 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. A
blue chip stock is a common stock of a well established, nationally known
company that
6
<PAGE> 10
has a long record of profitability and a reputation for quality management,
products and services. 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.
In addition to the foregoing investment policies, the 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 American Depository Receipts ("ADRs") evidencing ownership
of underlying securities of foreign issuers of similar size. 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. 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 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 and convertible securities of
domestic, small-capitalized companies, that the Manager 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 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 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
7
<PAGE> 11
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 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."
GLOBAL VALUE FUND
INVESTMENT OBJECTIVE. The Global Value Fund seeks long-term growth of
capital employing a value methodology.
INVESTMENT POLICIES. The Global Value Fund, which is subadvised by
Robertson, Stephens & Company Investment Management, L.P. ("RSIM"), employs a
traditional value methodology to invest in equity securities primarily of
companies with market capitalizations of $1 billion or more. This traditional
value methodology combines balance sheet analysis with cash flow analysis. In
selecting investments for the Fund, RSIM will, at its discretion, (1) perform
fundamental research focusing on business analysis, (2) observe how management
allocates capital, (3) strive to understand the unit economics of the business
of the company, (4) key on the cash flow rate of return on capital employed, (5)
discern the sources and uses of cash, (6) consider how management is
compensated, and (7) ask how the stock market is pricing the entire company.
Although the Fund will seek to invest principally in common stocks, it may also
invest in preferred stocks, warrants, and debt securities if RSIM believes they
would help achieve the Fund's objective. Under normal circumstances, the Fund
will invest at least 65% of its assets in equity securities selected using the
value methodology described above.
The Fund may invest in securities of companies located anywhere in the
world, if RSIM believes they are consistent with the Fund's investment
objective. Under normal circumstances, the Fund's assets will be invested in
securities of issuers located in at least three countries, one of which may be
the United States. The Fund will consider an issuer of securities to be located
in a country if it has a principal office in that country, if it derives 50% or
more of its total revenues from business in that country, or if its equity
securities are traded principally on a securities exchange in that country. The
Fund is a non-diversified mutual fund.
In addition to the policies discussed above, the Fund may invest in the
following: (1) securities issued by small companies; (2) securities principally
traded in foreign markets; (3) debt securities, including "zero-coupon" and
"payment-in-kind" bonds; and (4) foreign currency transactions. The Fund may
also (1) borrow money by means of reverse repurchase agreements, (2) buy and
sell call and put options, (2) buy and sell index futures contracts ("index
futures") and options on index futures and on indices (or may purchase
investments whose values are based on the value from time to time of one or more
securities indices) for hedging purposes, (3) lend portfolio securities to
broker-dealers and (4) enter into repurchase agreements.
In addition to the foregoing investment policies, the 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. As a non-diversified fund, the Fund may involve an increased risk of
loss over
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that of a diversified fund. See the section entitled, "Diversification and
Changes in Investment Policies" for details regarding a non-diversified fund.
You may also refer to the SAI for further information about the Funds'
investment policies.
COMMON INVESTMENT POLICIES
CASH EQUIVALENTS. With the exception of the Money Market Fund, for
temporary defensive purposes (for example, when the Manager 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 and Global Value Funds, under normal market conditions, no more
than 10% of a Fund's net assets will be invested in cash equivalents. No more
than 35% of the Global Value Fund's net assets may 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 issuer's credit and 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. 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 an 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 the Manager or a
Subadviser believe that they are of comparable quality to the rated securities
in which the Funds may invest.
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, International or Global Value Funds falls
below
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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 the
Manager or a 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 each Fund's 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.
Credit Ratings. S&P, Moody's and other NRSROs 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 NRSROs and other
sources, the Manager and Scudder Kemper 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 Scudder Kemper's own
credit analysis than is the case for mutual funds investing in higher rated
securities. In selecting such securities, the Manager and Scudder Kemper
consider 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. The Manager and Scudder
Kemper monitor the issuers of lower-rated securities held in a Fund's portfolio
in order to assess the issuer's 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 the
Manager or Scudder Kemper determine such retention is warranted.
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CONVERTIBLE SECURITIES. The Managed Bond, Capital Income, Aggressive
Growth, International and Global Value 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 and Global Value Funds 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, International and
Global Value 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, International and
Global Value 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
the Manager 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 may be used by
the Manager or a Subadviser in an attempt to hedge positions, defray the risks
of interest rate or currency changes and reduce portfolio or market risk.
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, Aggressive Growth and Global Value 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.
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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, Aggressive Growth,
and Global Value 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, Aggressive Growth and Global
Value 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 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, International and Global Value Funds may invest in equity
securities, including common and preferred stocks and securities convertible
into such stocks of domestic and foreign companies. While equity securities have
historically experienced a higher level of volatility than fixed-income
securities, due to market fluctuations, they have also historically provided
higher levels of total return. The Capital Income, Mid-Cap Equity,
International, Global Value Funds, and in particular, the Aggressive Growth
Fund, invest in companies with smaller market capitalizations (aggregate market
price of outstanding publicly-traded shares). Investments in companies with
smaller market capitalizations generally involve greater risk than investments
in larger, more established companies, including the risk of more volatile
market price movements.
FOREIGN SECURITIES. Subject to their investment objectives and policies
stated above, the International and Global Value Funds will invest in debt and
equity securities of foreign issuers that may or may not be publicly traded in
the United States. The International and Global Value Funds' investments will be
allocated in a minimum of three different countries at all times and no more
than 50% of portfolio assets will be invested in any one second tier country and
no more than 25% of portfolio assets in any one third tier country. First tier
countries are Australia, Canada, France, Germany, Japan, the United Kingdom, and
the United States. Second tier countries are all countries not in the first or
third tier. Third tier countries are countries identified as "emerging" or
"developing" by the International Bank for Reconstructions and Development
("World Bank") or International Finance Corporation. In addition, the Managed
Bond, Capital Income and Aggressive Growth Funds may invest in debt and equity
securities of foreign issuers that may or may not be publicly traded in the
U.S., 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
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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. The Capital Income Fund will invest no more than 15% of
its total assets in Eurodollar Convertibles, which 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.
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.
DEPOSITARY RECEIPTS. All Funds except the Money Market Fund may invest in
ADRs, and the International and Global Value Funds 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, 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 option
transactions. Put options and call options may be purchased by (i) the Blue
Chip, Mid-Cap Equity and Global Value Funds on securities, (ii) the Aggressive
Growth and Global Value Fund on stock indices, and (iii) the Aggressive Growth,
International and Global Value Funds on foreign currencies. In addition, the
International and Global Value Funds may sell, or "write," covered put options
on securities, securities indices and foreign currencies. Covered call options
may be written by (i) the Managed Bond, Capital Income, Blue Chip, Mid-Cap
Equity, Aggressive Growth, International and Global Value Funds on securities,
(ii) the Blue Chip, Aggressive Growth and International Funds on securities
indices, and (iii) the International and Global Value Funds on foreign
currencies. All such options transactions will be on U.S. securities traded on
U.S. exchanges, except that the International and Global Value Funds' 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
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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 the Manager or a Subadviser believes a
liquid secondary market will exist on a national securities exchange for options
of the same series, thus permitting the Fund to close out 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. 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, International and Global Value
Funds), and foreign currencies (Aggressive Growth, International and Global
Value 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 a 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 a 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 the Manager). 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 investment management fees.
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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 the Manager or a Subadviser, under
guidelines approved by the Trust's Board of Trustees. It is intended that such
agreements will not have maturities longer than 60 days. During the 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.
The Manager or a Subadviser 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 the Manager or a
Subadviser 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. For
temporary purposes, such as to facilitate redemptions, up to 33 1/3% of a Fund's
total assets may be invested in reverse repurchase agreements.
SECURITIES LENDING. In order to earn additional income, each Fund, except
the Money Market Fund, may lend portfolio securities to banks, broker-dealers or
other financial institutions that the Manager 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 the
Manager 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 33 1/3% of the Fund's total
assets (including any collateral received in connection with such loans).
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 under the 1933 Act ("Rule 144A") and for
which a liquid trading market exists as determined by the Board of Trustees (or
the Manager 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 the Manager or
its Subadvisers pursuant to the guidelines adopted by the Board) determines that
a liquid trading market exists.
SECURITIES ISSUED BY THE MANAGER. The Funds will not invest in instruments
or securities issued by the Manager 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 the Manager).
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<PAGE> 19
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. Turnover rates will
not be a limiting factor in making investment decisions for the Funds. The
portfolio turnover rates for the Fund for the period from March 1, 1997
(commencement of operations) through December 31, 1997, as set forth in the
Financial Highlights section, were as follows: Managed Bond Fund, 104.36%;
Capital Income Fund, 44.98%; Blue Chip Fund, 44.93%; Mid-Cap Equity Fund,
55.74%; Aggressive Growth Fund, 99.05%; and International Fund, 53.23%. The
anticipated annual turnover rate for the Global Value Fund is expected to exceed
100%.
RATINGS
CORPORATE BOND RATINGS. The following are 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 corporate debt rating by S&P 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 S&P. 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 commercial paper rating by S&P 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 NRSRO.
Further ratings descriptions may be found in Appendix A of the SAI.
DIVERSIFICATION AND CHANGES IN INVESTMENT POLICIES
With the exception of the Global Value Fund, 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 obligations. The Global Value Fund is a
non-diversified fund and may invest its assets in a more limited number of
issuers than a diversified fund. Under the Internal Revenue Code of 1986, as
amended, an investment company, including a non-diversified investment
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<PAGE> 20
company, generally may not invest more than 25% of its assets in obligations of
any one issuer other than U.S. Government obligations and, with respect to 50%
of its total assets, a non-diversified fund may not invest more than 5% of its
total assets in the securities of any one issuer (except U.S. Government
securities). Thus, the Global Value Fund may invest up to 25% of its total
assets in the securities of each of any two issuers. This practice involves an
increased risk of loss to the Global Value Fund if the market value of a
security should decline or its issuer was otherwise not able to meet its
obligations. Irrespective of the foregoing, no more than 55% of a Fund's assets
may be represented by any one investment, no more than 70% may be represented by
any two investments, no more than 80% by any three investments and no more than
90% by any four investments. All securities of the same issuer are treated as a
single investment. In this regard, each Government agency, including the
Treasury, is deemed to be a separate issuer. Additionally, with respect to the
entire portfolio, no more than 5% and 10% of the Fund's total assets will be
invested in the securities of any one issuer in a third tier country and a
second tier country, respectively.
The investment objective of each Fund and each Fund's diversification
classification 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, CONSIDERATIONS AND RISK FACTORS
INVESTMENT DECISIONS. The Manager 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, the Manager or a 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 the Manager or a
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 the Manager 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
adopted by the Manager or each 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, the Fund
may instruct the Manager or a Subadviser to direct brokerage transactions in
consideration of the sale of Fund shares by broker-dealers and other financial
institutions (including affiliates of the Manager or a Subadviser to the extent
permitted by law), provided the Manager or a Subadviser believes the quality of
the transaction and the price to the 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.
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
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<PAGE> 21
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 sensitive to a greater degree to changes in earnings and
prospects. Many of the securities which the Manager 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
"Common Investment Policies -- Foreign Securities."
GLOBAL VALUE FUND. The Global Value Fund invests in foreign securities,
which are subject to the risk considerations described above under "Common
Investment Policies -- Foreign Securities." As a non-diversified fund, the Fund
may involve an increased risk of loss if the market value of a security should
decline or its issuer was otherwise not able to meet is obligations. See the
section entitled, "Diversification and Changes in Investment Policies" for
further clarification regarding a non-diversified fund.
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 SEC 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.
MANAGER AND SUBADVISERS
MANAGER. Bank of America National Trust and Savings Association ("Bank of
America" or the "Manager") serves as the Funds' investment manager. The Manager
is a subsidiary of BankAmerica Corporation, a registered bank holding company.
Its principal offices are located at 555 California Street, San Francisco, Suite
2600, California 94104.
Formed in 1904, the Manager is a national banking association that provides
commercial banking and trust business through an extensive system of branches
across the western United States. The Manager'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 37 foreign countries.
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On June 8, 1997, BankAmerica Corporation ("BankAmerica"), the parent of
Bank of America entered into an Agreement and Plan of Merger with Robertson,
Stephens & Company Group, L.L.C. and Robertson, Stephens & Company, Inc.,
pursuant to which each of those entities were merged into a wholly-owned
subsidiary of BankAmerica. Upon consummation of those mergers on October 1,
1997, BankAmerica became the owner of the entire beneficial interest in RSIM.
As of March 1, 1998, BankAmerica consolidated Bank of America's investment
advisory division with RSIM. Bank of America informed the Trust that virtually
all of the investment advisory, administrative, support and supervisory
personnel at Bank of America who are responsible for providing services to the
Trust became authorized to act on behalf of RSIM. No change in the investment
advisory personnel or the research and support personnel servicing the Trust
occurred as a result of the consolidation. As a part of the consolidation, on
February 3, 1998, the Board of Trustees approved the assumption by RSIM of the
management between the Trust and Bank of America with respect to each Fund of
the Trust.
On April 13, 1998, BankAmerica and NationsBank Corp. announced a definitive
agreement to merge and form a new holding company to be named BankAmerica
Corporation. The merger is anticipated to close by the end of 1998, however, it
is subject to a number of contingencies, including shareholder and regulatory
approvals. Following the announcement of the merger, BankAmerica restructured
its investment advisory business. On April 29, 1998, the Board of Trustees
approved the assumption by Bank of America of the management agreement with
respect to each Fund of the Trust. RSIM and Bank of America informed the Trust
that no change in the investment advisory personnel or the research and support
personnel servicing the Trust would occur as a result of this restructuring.
In its management agreement, the Manager 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 the Manager may, in its discretion, provide
investment management services through its own employees or employees of one or
more of its affiliates that are under the common control and management of the
Manager's parent, BankAmerica. The Manager may also employ a subadviser,
provided that the Manager remains fully responsible to the Funds for the acts
and omissions of the subadviser.
Ed Cassens, Senior Portfolio Manager with RSIM, 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 with various entities
of BankAmerica Corporation since 1966, including BofA Capital Management, Inc.,
Seattle First National Bank (a subsidiary of Seafirst Corporation, which is
controlled by BankAmerica Corporation) and RSIM. 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's 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. Mr. Miller has been the manager of the
Pacific Horizon Blue Chip Fund since May 1995 and has been associated with the
Bank's Investment Advisors Division 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.
Effective March 19, 1998, James L. Callinan is responsible for managing the
Aggressive Growth Fund. Mr. Callinan has managed the Robertson Stephens Emerging
Growth Fund since July 1996. From 1986 until June 1996, Mr. Callinan was
employed by Putnam Investments, where, beginning in June 1994, he served as
portfolio manager of the Putnam OTC Emerging Growth Fund. Mr. Callinan received
an A.B. in economics from Harvard College, an M.S. in accounting from New York
University, an M.B.A. from Harvard Business School, and is a Chartered Financial
Analyst.
For its services the Manager 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%; International Fund, 0.66%; and Global Value Fund, .77%.
These fees may be reduced pursuant to undertakings by the Manager. (See the
information below in the section entitled "Fee Waivers.")
SUBADVISERS. As authorized by its management agreement, the Manager has
employed the Subadvisers to manage certain of the Funds, as described below. In
its subadvisory agreement with the Manager, 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. Under current net asset levels, each Subadviser
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<PAGE> 23
is entitled to receive the following percentages of the average net assets of
the following funds: Managed Bond Fund, 0.20%; and International Fund, 0.40%.
(See "Management -- Subadvisers" in the SAI). Each Subadviser's fee is paid by
the Manager, and may be reduced pursuant to undertakings by the Subadviser. (See
the information below in the section entitled "Fee Waivers.")
SCUDDER KEMPER INVESTMENTS, INC. Scudder Kemper, 345 Park Avenue, New York,
New York is the Subadviser for the Managed Bond Fund. Scudder Kemper is
approximately 70% indirectly owned by Zurich Insurance Company, with the balance
owned by Scudder Kemper's officers and employees. Scudder Kemper is one of the
largest investment managers in the country with more than $200 billion under
management and has engaged in the management of investment funds for more than
seventy years.
Effective January 1, 1998, William M. Hutchinson (Senior Vice President),
Kristin L. Bradbury (Vice President) and Susan R. Martland (Vice President) of
Scudder Kemper manage the Managed Bond Fund.
The management team is headed by William M. Hutchinson. In addition to
heading the portfolio management team for the Managed Bond Fund, Mr. Hutchinson
is responsible for the portfolio management of domestic institutional bond
portfolios managed in the Boston office of Scudder Kemper. He is also a senior
portfolio manager of core fixed income portfolios and the product leader for
limited volatility (intermediate) and long duration bond management for Scudder
Kemper. Mr. Hutchinson joined Scudder in 1986 and has managed pension, endowment
and mutual fund portfolios. After three years as a naval officer, Mr. Hutchinson
spent 12 years with Connecticut General Life Insurance Company (CIGNA), where he
established a public bond credit research unit and managed institutional total
return bond portfolios. Mr. Hutchinson received a BS from Lehigh University in
1969 and an MBA from the University of Michigan in 1971.
Kristin L. Bradbury is a portfolio manager in the Bond Group of Scudder
Kemper. Located in the San Francisco office of Scudder Kemper, she has over ten
years of experience in the investment industry. Prior to joining Scudder Kemper
in 1993, she was a member of the investment department in a large West Coast
insurance company. Ms. Bradbury has portfolio management responsibility for a
number of institutional fixed income accounts. She received BA degrees in
Business Economics and Sociology from the University of California at Santa
Barbara in 1986. In 1989, Ms. Bradbury received an MBA from the University of
California at Irvine. She is a Chartered Financial Analyst and a member of the
Security Analysts of San Francisco.
Susan R. Martland has specialized in the management of Limited Volatility
bond portfolios since 1992. She joined Scudder Kemper in 1982 following ten
years of management experience. Ms. Martland received a BA from Smith College in
1971 and an MBA from Boston University School of Management in 1982.
WELLINGTON MANAGEMENT COMPANY, LLP. The Manager has employed Wellington
Management, 75 State Street, Boston, Massachusetts 02109 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 $132 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.
ROBERTSON, STEPHENS & COMPANY INVESTMENT MANAGEMENT, L.P. RSIM, 555
California Street, San Francisco, California, is the Subadviser for the Global
Value Fund. RSIM, a California partnership formed in 1993, and its affiliates
have in excess of $5 billion under management in public and private investment
funds.
Mr. Andrew P. Pilara, Jr. is responsible for managing the Global Value
Fund. In addition to managing this fund, he also manages several Robertson
Stephens Mutual Funds including the Partners and the Global Natural Resources
Funds. Since August 1993 he has been a member of The Contrarian Fund management
team. Mr. Pilara has been involved in the securities business for over 25 years.
Prior to joining RSIM, he was President of Pilara Associates, an investment
management firm he established in 1974.
OTHER SERVICE PROVIDERS
PACIFIC LIFE INSURANCE COMPANY. Pacific Life provides support services to
the Funds and acts as the Funds' Transfer Agent. In its support services
agreement, Pacific Life, formerly known as Pacific Mutual Life Insurance
Company, has
20
<PAGE> 24
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 SEC and other federal and state
regulatory authorities. Pacific Life's principal business address is 700 Newport
Center Drive, Newport Beach, California, 92660.
FUND ACCOUNTANT AND SUB-ADMINISTRATOR. PFPC Inc. ("PFPC") provides fund
accounting services to the Funds, including calculation of the net asset value
of the Funds, dividends and capital gains distributions to shareholders.
Under its management agreement, the Manager 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 the Management Agreement, the Manager
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. The Manager bears
all fees and expenses charged by PFPC for sub-administration services.
DISTRIBUTOR. The Funds' shares are sold on a continuous basis and
distributed through Provident Distributors, Inc. (the "Distributor"). The
Distributor is located at Four Falls Corporate Center, 6(th) Floor, West
Conshohocken, Pennsylvania, 19428-2961.
CUSTODIAN. PNC Bank, N.A., 200 Stevens Drive, Lester, Pennsylvania, 19113
serves as the custodian of the Fund.
YEAR 2000 COMPLIANCE
An issue has emerged in the investment services industry and for the
economy overall regarding how existing application software programs and
operating systems can accommodate the date value for the year 2000. Many
existing application software products in the marketplace were designed only to
accommodate a two-digit date position, which represents the year (e.g., "95" is
stored on the system and represents the year 1995). As a result, the year 1999
(i.e., "99") could be the maximum date value these systems will be able to
accurately process. The Trust has been assured by the Manager and the other
service providers that they do not believe that the Trust will be materially
adversely affected by year 2000. Nevertheless, the inability of the Manager and
the other service providers to successfully address year 2000 issues could
result in interruptions in the Trust's business and have a material adverse
impact on the Trust's operations.
FEE WAIVERS
The Manager and Pacific Life 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%; International Fund, 1.24%; and Global Value Fund, 1.29%. The
Manager and Pacific Life 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 Life 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 the Manager and other service providers. Periodically, during
the course of the Funds' fiscal year, the Manager 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 the Manager. However, the
Manager and other service providers retain the ability to discontinue such fee
waivers and expense reimbursements at any time.
21
<PAGE> 25
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 Life. 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 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 ("NAV") per share. Each Fund calculates its NAV as
follows:
<TABLE>
<S> <C> <C>
(Value of Fund Assets) - (Fund Liabilities)
-------------------------------------------
NAV =
Number of Outstanding Shares
</TABLE>
NAV 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 the event that the New York Stock Exchange closes early,
the Fund normally will deem the closing price of each Portfolio's assets to be
the price of those assets at 4:00 p.m., Eastern time.
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 reported sale price or, if none is available, the mean
between the current quoted bid and asked prices provided by investment dealers.
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 Trust's Board of Trustees. In determining
the fair value of securities, the Trust may consider available information that
becomes known after 4:00 p.m. Eastern time, and the values that are determined
will be deemed to be the price at 4:00 p.m. Eastern time. 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.
CAN I EXCHANGE MY INVESTMENTS 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 and paid daily 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
22
<PAGE> 26
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.
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 federal income tax purposes or require a Fund to make distributions
exceeding book income to qualify as a regulated investment company for federal
income 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.
DESCRIPTION OF SHARES
ABOUT THE TRUST
The Trust is a Delaware business trust that was organized on September 25,
1996. 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 communications in such matters to the extent required
by law and the Trust's undertaking with the SEC.
OUTSTANDING SHARES
As of the date of this Prospectus, all of the outstanding shares of the
Funds were owned by Pacific Life and Pacific Asset Management LLC, a wholly
owned subsidiary of Pacific Life.
23
<PAGE> 27
MEASURING PERFORMANCE
PERFORMANCE OF THE FUNDS
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 Life 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.
Total Return for the Funds from March 1, 1997 (commencement of operations)
through December 31, 1997:
<TABLE>
<CAPTION>
FUND PERFORMANCE
-----------------------------------------------------------------------------------------
MONEY MANAGED CAPITAL BLUE MID-CAP AGGRESSIVE GLOBAL
MARKET BOND INCOME CHIP EQUITY GROWTH INTERNATIONAL VALUE
FUND FUND FUND FUND FUND FUND FUND FUND
------ ------- ------- ----- ------- ---------- ------------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1997.................... 4.22% 6.59% 14.75% 23.27% 27.80% 17.65% 0.56% N/A
</TABLE>
The performance data quoted above represents past performance and is no
indication of future results. The return and value of an investment in a Fund
will fluctuate so that shares, when redeemed, may be worth less than their
original cost.
PRIOR PERFORMANCE OF THE MANAGER AND SUBADVISERS IN COMPOSITES OF SIMILARLY
MANAGED ACCOUNTS
The Funds commenced operations on March 1, 1997 and, consequently, do not
have a long-term operating history. The table below sets forth composite
performance history of common trust funds, mutual funds (including the Funds'
performance as of March 1, 1997) and/or institutional private accounts managed
by the Manager 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 the Manager and the Subadvisers
in managing substantially similar accounts but does not represent the
performance of the Funds. Investors should not rely upon this performance data
as an indication of the future performance of the Funds or of the Manager and
the Subadvisers.
The table reflects performance composites of all 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 of similarly managed
accounts are based on gross results that are adjusted to reflect the anticipated
expenses of the pertinent Fund. The performance figures for all of the
composites of similarly managed 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 common trust funds and the private accounts may not be
representative of the pertinent Fund because those accounts are not subject to
the obligation to redeem 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, which,
if imposed, could have adversely affected the performance. In addition, 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
composites of similarly managed accounts. Moreover, the Funds' current and
future investments are not and will not necessarily be identical to those of the
composites of similarly managed accounts.
24
<PAGE> 28
The investment results presented below 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 to calculate these composites
could result in different performance data.
THE FOLLOWING PERFORMANCE DATA IS NOT THE PERFORMANCE OF THE MONEY MARKET,
MANAGED BOND, CAPITAL INCOME, BLUE CHIP, MID-CAP EQUITY, AGGRESSIVE GROWTH,
INTERNATIONAL OR GLOBAL VALUE FUNDS, BUT THAT OF COMPARABLE ACCOUNTS, AND DOES
NOT REFLECT THE DEDUCTION FOR SEPARATE ACCOUNT CHARGES.
Total Return for composites of similarly managed accounts for the years
shown:
<TABLE>
<CAPTION>
COMPOSITE PERFORMANCE
--------------------------------------------------------------------------------------------
MONEY MANAGED CAPITAL BLUE MID-CAP AGGRESSIVE
MARKET BOND INCOME CHIP EQUITY GROWTH
COMPOSITE(1) COMPOSITE(2) COMPOSITE(3) COMPOSITE(4) COMPOSITE(5) COMPOSITE(6)
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
1991................. --% 16.36% 31.45% 32.96% --% 83.25%
1992................. --% 6.93% 15.05% 5.33% --% (0.33)%
1993................. --% 9.79% 20.85% 12.15% 15.21% 16.66%
1994................. 4.67% (3.07)% (7.39)% (1.02)% (1.65)% (10.75)%
1995................. 5.22% 14.51% 23.63% 38.47% 32.31% 33.77%
1996................. 3.58% 2.68% 18.73% 24.52% 22.58% 26.95%
1997(9).............. 5.09% 7.96% 17.96% 28.55% 34.25% 21.55%
Average Annual
Return(10)......... 4.49% 7.66% 16.38% 17.86% 16.43% 21.58%
<CAPTION>
COMPOSITE PERFORMANCE
-------------------------------
GLOBAL
INTERNATIONAL VALUE
COMPOSITE(7) COMPOSITE(8)
---------------- ------------
<S> <C> <C>
1991................. 14.66% N/A
1992................. (5.67)% N/A
1993................. 32.37% N/A
1994................. (2.91)% N/A
1995................. 13.09% N/A
1996................. 12.60% N/A
1997(9).............. 0.67% 27.34%
Average Annual
Return(10)......... 9.98% 27.34%
</TABLE>
- ---------------
(1) The total return figures shown for the Money Market Fund represent actual
performance of a similar money market mutual fund managed by the Manager
for the periods 1991 to 1996 and actual performance of the Money Market
Fund for the period 1997.
(2) The total return figures shown for the Managed Bond Fund reflect the
adjusted total return performance of privately managed accounts managed by
Scudder Kemper for the period 1991 to 1996 and actual performance of the
Managed Bond Fund for the period 1997.
(3) The total return figures shown for the Capital Income Fund reflect adjusted
total return performance of similar mutual funds and common trust funds
managed by the Manager for the periods 1991 to 1996 and actual performance
of the Capital Income Fund for the period 1997.
(4) The total return figures shown for the Blue Chip Fund reflect the adjusted
total return performance of common trust funds and privately managed
accounts managed by the Manager for the periods 1991 to 1996 and actual
performance of the Blue Chip Fund for the period 1997.
(5) The total return figures shown for the Mid-Cap Equity Fund reflect the
adjusted total return performance of common trust funds and privately
managed accounts managed by the Manager for the periods 1991 to 1996 and
actual performance of the Mid-Cap Equity Fund for the period 1997.
(6) The total return figures shown for the Aggressive Growth Fund reflect
adjusted total return performance of similar mutual funds, common trust
funds and privately managed accounts managed by the Manager for the periods
1991 to 1996 and actual performance for the Aggressive Growth Fund for the
period 1997.
(7) The total return figures shown for the International Fund reflect the
adjusted total return performance of similar mutual funds managed by
Wellington Management for the periods 1991 to 1996 and actual performance
of the International Fund for the period 1997.
(8) The total return figures shown for the Global Value Fund represents actual
performance of a similar mutual fund managed by RSIM for the period 1997.
(9) The total return figures for 1997 are annualized from the period March 1,
1997 through December 31, 1997 for the Money Market, Managed Bond, Capital
Income, Blue Chip, Mid-Cap Equity, Aggressive Growth and International
Funds and annualized from the period April 1, 1997 through December 31,
1997 for the Global Value Fund.
(10) The "Average Annual Return" for the Composites are derived from performance
of both composites of similarly managed accounts and actual fund
performance.
25
<PAGE> 29
PACIFIC INNOVATIONS TRUST
STATEMENT OF ADDITIONAL INFORMATION
MAY 1, 1998
<TABLE>
<S> <C>
MONEY MARKET FUND MID-CAP EQUITY FUND
MANAGED BOND FUND AGGRESSIVE GROWTH FUND
CAPITAL INCOME FUND INTERNATIONAL FUND
BLUE CHIP FUND GLOBAL VALUE FUND
</TABLE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
The Trust................................................... 1
Investment Objectives and Policies.......................... 2
Additional Purchase and Redemption Information.............. 18
Additional Information Concerning Taxes..................... 19
Management.................................................. 22
Performance Information..................................... 25
General Information......................................... 27
Financial Statements........................................
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, International
Fund and Global Value Fund (each a "Fund" and, collectively, the "Funds"). Each
Fund is a series of Pacific Innovations Trust, a Delaware business trust and a
registered open-end management investment company (the "Trust").
This Statement of Additional Information ("SAI"), which is incorporated by
reference in its entirety into the Prospectus, should be read only in
conjunction with the Prospectus for the Funds, dated May 1, 1998, 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 SAI relates may be obtained by calling Pacific Life 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, International
Fund and Global Value Fund. Each Fund has its own investment objective and
policies.
Bank of America National Trust & Savings Association ("Bank of America" or
the "Manager"), a wholly owned subsidiary of BankAmerica Corp., serves as the
investment manager for all of the Funds. Scudder Kemper Investments, Inc.,
Wellington Management Company, LLP and Robertson, Stephens Investment
Management, L.P. (each a "Subadviser" and, collectively, the "Subadvisers")
serve as subadvisers to the Managed Bond Fund, International Fund and Global
Value Fund, respectively.
Shares of the Funds may be sold only to separate accounts ("Separate
Accounts") of Pacific Life Insurance Company ("Pacific Life") to serve as
investment vehicles for variable annuity contracts issued by Pacific Life (the
-1-
<PAGE> 30
"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 Life.
Pacific Life, on behalf of each Separate Account, and Pacific Asset
Management LLC ("PAM"), a wholly owned subsidiary of Pacific Life, own 100% of
the Funds' shares. Each 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 each 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, the Manager or a Subadviser makes decisions with respect to, and
places orders for all purchases and sales of portfolio securities for each Fund.
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 the Manager and each Subadvisory Agreement among
the Trust, the Manager and a Subadviser, provide that, in assessing the best
overall terms available for any transaction, the Manager 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 the Manager or a
Subadviser, 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 the Manager 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 the Manager or its Subadvisers exercise 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 the Manager and its Subadvisers and do not reduce the investment
management fee payable to the Manager or its Subadvisers. Such services may be
useful to the Manager 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 the Manager and its Subadvisers in carrying out its
obligations to the Trust.
In connection with their investment management services provided to the
Funds, the Manager and its Subadvisers will not acquire certificates of deposit
or other securities issued by itself or its affiliates. Portfolio securities in
general may
-2-
<PAGE> 31
be purchased from and sold to affiliates of the Trust, the Manager, 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, as amended
(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 the Manager 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, the Manager 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 Ratings Group ("S&P")) by (i) any
two nationally 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 the Manager, 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, the
Manager, under procedures approved by the Board of Trustees (or the Board of
Trustees itself if the Manager becomes aware an unrated security is downgraded
below high quality and the Manager 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
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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. Each Fund except the Money Market
Fund may 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 S&P, Prime-2 or higher by Moody's, or
similarly rated by another NRSRO or, if unrated, will be determined by the
Manager 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.
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 the Manager, its affiliates
or the Subadvisers, and 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 ("GNMA"),
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 "FNMA", Federal Home Loan Mortgage
Corporation ("FHLMC"), and the Student Loan Marketing Association ("SLMA").
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 the other obligations referred to above, such as those of
GNMA, 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
FNMA,
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are supported by the discretionary authority of the U.S. Government to purchase
the agency's obligations; still others, such as those of SLMA, 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, International and Global Value 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, the Manager 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 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, International and Global Value 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 a 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
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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 and Global Value Funds 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.
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
agreements maturing in more than seven days, or assets which are otherwise
illiquid. The Manager 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 of 1933 (the "1933 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
1933 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 1933 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 Securities and Exchange
Commission ( the "SEC") under the 1933 Act, or are issued in reliance on Section
4(2) of the 1933 Act, the Manager 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, Aggressive Growth and Global Value 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
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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 GNMA) are described 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
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 FNMA and the 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, Aggressive
Growth and Global Value 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 receive 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, Aggressive Growth and Global
Value 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 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.
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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 33 1/3% of the value of its total assets (at the time of such
borrowing). 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 are considered borrowings and are 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, Aggressive Growth and Global Value 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 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.
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The Managed Bond, Capital Income, Blue Chip, Mid-Cap Equity, Aggressive
Growth, International and Global Value 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 and Global Value Funds are 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.
If a 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.
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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 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 device. 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 the 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 the Manager or its Subadvisers 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
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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 SAI.
The following discussion on foreign currency risks relates to the
Aggressive Growth, International and Global Value Funds.
FOREIGN CURRENCY TRANSACTIONS. The Aggressive Growth, International and
Global Value 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 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 Manager believes that
it is important to have the flexibility to enter into forward foreign currency
exchange contracts whenever the Manager 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 Manager or a Subadviser 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
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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 Manager 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.
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 and Global Value Funds
may potentially be able to achieve these objectives 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 generally apply to the use of futures. 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 Manager 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
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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.
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 has any current intention of doing so in the foreseeable future.
SMALL CAPITALIZATION SECURITIES. The Capital Income, Mid-Cap Equity,
International, Global Value Funds, and, in particular, the Aggressive Growth
Fund, may each hold common stock of companies with relatively small market
capitalizations that the Manager or a 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, International and Global Value 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,
International and Global Value 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, the Manager 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.
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and those within other countries, as well as factors relating to the general
economic, governmental and social conditions of the country or countries where
the company is located.
The Managed Bond, Capital Income, International and Global Value Funds may
purchase debt obligations issued or guaranteed by governments (including states,
provinces or municipalities) of countries other than the United 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 the Manager'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 the Manager 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 margin requirements than in the
U.S., and (v) lower trading volume and liquidity.
INDEXED SECURITIES
The Global Value Fund may purchase securities whose prices are indexed to
the prices of other securities, securities indices, currencies, precious metals,
or other commodities, or other financial indicators. Indexed securities
typically, but not always, are debt securities or deposits whose value at
maturity or coupon rate is determined by reference to a specific instrument or
statistic. Gold-indexed securities, for example, typically provide for a
maturity value that depends on the price of gold, resulting in a security whose
price tends to rise and fall together with gold prices. Currency-indexed
securities typically are short-term to intermediate-term debt securities whose
maturity values or interest rates are determined by reference to the values of
one or more specified foreign currencies, and may offer higher yields than U.S.
dollar-denominated securities of equivalent issuers. Currency-indexed securities
may be positively or negatively indexed; that is, their maturity value may
increase when the specified currency value increases, resulting in a security
whose price characteristics are similar to a put option on the underlying
currency. Currency-indexed securities also may have prices that depend on the
values of a number of different foreign currencies relative to each other.
The performance of indexed securities depends, to a great extent, on the
performance of the security, currency, commodity or other instrument to which
they are indexed, and also may be influenced by interest rate-changes in the
U.S. and abroad. At the same time, indexed securities are subject to the credit
risks associated with the issuer of the security, and their values may decline
substantially if the issuer's creditworthiness deteriorates. Recent issuers of
indexed securities have included banks, corporations, and certain U.S.
Government agencies.
SHORT SALES
The Global Value Fund may seek to hedge investments or realize additional
gains through short sales. Short sales are transactions in which the Fund sells
a security it does not own, in anticipation of a decline in the market value of
that security. To complete such a transaction, the Fund must borrow the security
to make delivery to the buyer. The Fund then is obligated to replace the
security borrowed by purchasing it at the market price at or prior to the time
of replacement. The price at such time may be more or less than the price at
which the security was sold by the Fund. Until the security is replaced, the
Fund is required to repay the lender any dividends or interest that accrue
during the period of the loan. To borrow the security, the Fund also may be
required to pay a premium, which would increase the cost of the security sold.
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The net proceeds of the short sale will be retained by the broker (or by the
Fund's custodian in a special custody account), to the extent necessary to meet
margin requirements, until the short position is closed out. The Fund also will
incur transaction costs in effecting short sales.
The Fund will incur a loss as a result of the short sale if the price of
the security increases between the date of the short sale and the date on which
the Fund replaces the borrowed security. The Fund will realize a gain if the
security declines in price between those dates. The amount of any gain will be
decreased, and the amount of any loss increased, by the amount of the premium,
dividends, interest or expense the Fund may be required to pay in connection
with a short sale. An increase in the value of a security sold short by the Fund
over the price at which it was sold short will result in a loss to the Fund, and
there can be no assurance that the Fund will be able to close out the position
at any particular time or at an acceptable price.
ZERO-COUPON DEBT SECURITIES AND PAY-IN-KIND SECURITIES
Zero-coupon securities in which the Global Value Fund may invest are debt
obligations which are generally issued at a discount and payable in full at
maturity, and which do not provide for current payments of interest prior to
maturity. Zero-coupon securities usually trade at a deep discount from their
face or par value and are subject to greater market value fluctuations from
changing interest rates than debt obligations of comparable maturities which
make current distributions of interest. As a result, the net asset value of
shares of a Fund investing in zero-coupon securities may fluctuate over a
greater range than shares of other mutual funds investing in securities making
current distributions of interest and having similar maturities.
When debt obligations have been stripped of their unmatured interest
coupons by the holder, the stripped coupons are sold separately. The principal
or corpus is sold at a deep discount because the buyer receives only the right
to receive a future fixed payment on the security and does not receive any
rights to periodic cash interest payments. Once stripped or separated, the
corpus and coupons may be sold separately. Typically, the coupons are sold
separately or grouped with other coupons with like maturity dates and sold in
such bundled form. Purchasers of stripped obligations acquire, in effect,
discount obligations that are economically identical to the zero-coupon
securities issued directly by the obligor.
Zero-coupon securities allow an issuer to avoid the need to generate cash
to meet current interest payments. Even though zero-coupon securities do not pay
current interest in cash, the Fund is nonetheless required to accrue interest
income on them and to distribute the amount of that interest at least annually
to shareholders. Thus, the Fund could be required at times to liquidate other
investments in order to satisfy its distribution requirement.
The Global Value Fund also may purchase pay-in-kind securities. Pay-in-kind
securities pay all or a portion of their interest or dividends in the form of
additional securities.
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 Manager or a 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 to indicate the sensitivity of the securities price to changes in interest
rates (which is the "interest rate risk" or "volatility" of the security).
However, "term to maturity" measures only the time until a debt security
provides 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.
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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 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
Manager or a Subadviser will use more sophisticated analytical techniques which
incorporate the economic life of a security into the determination of its
interest rate exposures.
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. With exception of the Global Value Fund, 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.
The Global Value Fund may not 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 securities of any one
issuer, except that (a) up to 50% of its total assets may be invested
without regard to these limitations, however, with respect to the entire
portfolio, no more than 5% and 10% of the Fund's total asset will be
invested in the securities of any one issuer in a third tier country and a
second tier country, respectively, 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.
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<PAGE> 45
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 purposes, including
to meet Fund redemptions, and then only in an amount not exceeding 33 1/3%
of such Fund's total assets. 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 Section 4(2) under the 1933 Act and for which a liquid trading
market exists, as determined by the Board of Trustees of such Fund or by
the Manager or a Subadviser (pursuant to guidelines adopted by the Board),
be included within this limitation.
3. With exception of the Global Value Fund, sell short.
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.
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<PAGE> 46
* * *
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 4:00 p.m. Eastern
time each day the New York Stock Exchange is open. The New York Stock Exchange
usually closes for trading at 4:00 p.m. Eastern time. In the event that the New
York Stock Exchange closes early, the Fund normally will deem the closing price
of each Portfolio's assets to be the price of those assets at 4:00 p.m. Eastern
time. The New York Stock Exchange is currently closed on weekends and on the
following holidays: New Year's Day, Martin Luther King, Jr. Day, Presidents'
Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving,
Christmas Day, and on the preceding Friday or subsequent Monday when one of
these holidays falls on a Saturday or Sunday. 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. In determining the fair value of securities,
the Fund may consider available information including information that becomes
known after 4:00 p.m. Eastern time, and the values that are determined will be
deemed to be the price at 4:00 p.m. Eastern time.
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 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 a 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.
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<PAGE> 47
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 NAV 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 NAV unless the Board of Trustees determines that the
particular event would materially affect NAV, in which case an adjustment will
be made. Information that becomes known to the Trust or its agents after the
time NAV is calculated on any business day may be assessed in determining NAV
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 NAV into U.S. dollars at
the spot exchange rates at 12:00 noon New York time or at such other rates as
the Manager may determine to be appropriate in computing net asset value.
PRICING SERVICES. When approved by the Board of Trustees of the Trust,
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
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<PAGE> 48
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 total 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 total assets and 10% of the outstanding voting
securities of such issuer) and (ii) not more than 25% of the value of its total
assets is invested in the securities of any one issuer (other than U.S.
Government or the securities of other regulated investment companies), or two or
more issuers which the Fund controls and which are determined to be engaged in
the same or similar trades or businesses.
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 income tax purposes to the extent a Separate Account
received net capital gain distributions on such shares.
A 4% non-deductible excise tax is imposed on regulated investment companies
that fail to distribute currently 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 or in subsequent
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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<PAGE> 49
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 Life, 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 federal 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.
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<PAGE> 50
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 and Chairman Managing Director, Chase Franklin Corporation (venture
c/o Chase Franklin Corporation capital firm) since 1990; Director, Kellwood Corporation
100 S. Wacker Drive (women's apparel manufacturer); Trustee, Time Horizon Funds
Chicago, IL 60606 (since 1995); formerly Vice Chairman of Continental Bank
N.A. (retired 1990); formerly Trustee, 231 Funds (February
1993 to August 1995). Age: 64.
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 and President and Chairman, Page Mill Asset Management (a
Page Mill Asset Management President private investment company) since 1987; Director, Pacific
433 California Street Horizon Funds, Inc. (since 1993), Morgan Grenfell Small Cap
Suite 900 Fund (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: 66.
Harold T. Joanning Trustee Retired. Formerly Executive Vice President, Finance and
3621 Sausalito Drive Administration, Pacific Mutual Life Insurance Company (1980
Corona del Mar, CA 92625 to 1991). Age: 69.
John Privat Trustee Director, Seafirst Retirement Funds (since 1993) (registered
8852 NE 24th Street investment company); Trustee, Time Horizon Funds (since
Bellevue, WA 98004 1995). Age: 63.
Stephen M. Wynne Vice President Executive Vice President and Chief Accounting Officer (since
Executive Vice President, PFPC 1993) and Senior Vice President and Chief Accounting Officer
Inc. (1991 to 1993), PFPC Inc.; Executive Vice President, PFPC
400 Bellevue Parkway International (since 1995); Vice President and Chief
Wilmington, DE 19809 Accounting Officer, PNC Institutional Management Corp.
(since 1987). Age: 41.
Cathy G. O'Kelly Secretary Partner in the Law Firm of Vedder, Price, Kaufman &
Vedder, Price, Kaufman & Kammholz Kammholz. Age: 44.
222 North LaSalle St.
Chicago, IL 60601
Jay F. Nusblatt Treasurer Vice President and Director of Fund Accounting and
Vice President, PFPC Inc. Administration, PFPC Inc. (since 1993); formerly Assistant
103 Bellevue Parkway Vice President, Fund/Plan Services, Inc. (1989 to 1993).
Wilmington, DE 19809 Age: 36.
Gary M. Gardner, Esquire Assistant Secretary Chief Counsel -- Mutual Funds, PNC Bank (since 1994);
Chief Counsel -- Mutual Funds, Associate General Counsel, The Boston Company, Inc. (1992 to
PNC Bank 1994); General Counsel, SunAmerica Asset Management Inc.
1600 Market Street, 28th Floor (1986 to 1992). Age: 46.
Philadelphia, PA 19103
J. Robert Dugan, Esquire Assistant Secretary Counsel -- Mutual Funds, PNC Bank (since 1993); Associate,
Counsel -- Mutual Funds, PNC Bank Drinker Biddle and Reath (1990 to 1993). Age: 32.
1600 Market Street, 28th Floor
Philadelphia, PA 19103
</TABLE>
The Board does not have an Executive or Audit Committee.
- ---------------
* "Interested person" as defined in the 1940 Act by reason of his position as
President of the Trust.
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<PAGE> 51
For his or her services as trustee of all of the Funds of the Trust, each
trustee receives an estimated aggregate annual retainer of $6,000 with a fee of
$1,000 for each day of board meetings attended in person plus $500 for each
telephone board meeting attended. Edward S. Bottum receives an additional $2,000
per annum as Chairman of the Board. Each 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, 1998, to the trustees who are not affiliated with the Manager
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 TRUST COMPLEX
---- -------------- ---------------- ---------------- --------------
<S> <C> <C> <C> <C>
Edward S. Bottum, Chairman & Trustee............ $15,000 $0 $0 $ 29,125
William P. Carmichael, Trustee.................. $10,000 $0 $0 $ 20,000
Robert E. Greeley, Trustee...................... $13,500 * * $116,730
Harold T. Joanning, Trustee..................... $13,500 $0 $0 $ 13,500
John Privat, Trustee............................ $10,000 $0 $0 $ 20,000
</TABLE>
- ---------------
* As of the fiscal year ended Feb. 28, 1998, Pacific Horizon Funds, Inc. had
accrued on the part of all of its Directors an aggregate of $284,393.27 in
retirement benefits.
The "Trust Complex" consists of the Trust, Master Investment Trust, Series
I, Time Horizon Funds, the Pacific Horizon Funds, Inc. and the Seafirst
Retirement Funds, which were merged into the Pacific Horizon Funds on June 23,
1997.
As of April 2, 1998 the trustees and officers of the Trust, as a group,
owned less than 1% of the outstanding shares of each of the Funds.
MANAGER
Pursuant to two management agreements with the Trust (the "Management
Agreements"), 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 Agreements 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 Agreements 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 Agreements may be terminated at any time without cause
upon giving 60 days' prior written notice to the Manager.
The Management Agreements provide that the Manager 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 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.
For the services provided and the expenses assumed pursuant to the
Management Agreements the Trust shall pay the Manager a fee, computed daily and
payable monthly, at the following annual rates of .22% of the average net assets
of the Money Market Fund; .37% of the average net assets of the Managed Bond
Fund; .48% of the average net assets of the Capital Income Fund; .53% of the
average net assets of the Mid-Cap Equity Fund; .53% of the average net assets of
the Blue Chip Fund; .61% of the average net assets of the Aggressive Growth
Fund; .66% of the average net assets of the International Fund; and .77% of the
average net assets of the Global Value Fund. Such fee as is attributable to each
Fund shall be a separate (and not joint or joint and several) obligation of each
such Fund.
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For the period March 1, 1997 (commencement of operations) December 31,
1997, the following advisory fees were paid or payable to Bank of America, the
former manager, by the Money Market, Managed Bond, Capital Income, Mid-Cap
Equity, Blue Chip, Aggressive Growth, International and Global Value Funds:
<TABLE>
<CAPTION>
FOR THE PERIOD
MARCH 1, 1997
(COMMENCEMENT OF
OPERATIONS) TO
DECEMBER 31, 1997
-----------------
<S> <C>
Money Market Fund........................................... $10,690
Managed Bond Fund........................................... $22,724
Capital Income Fund......................................... $40,004
Blue Chip Fund.............................................. $47,469
Mid-Cap Equity Fund......................................... $33,233
Aggressive Growth Fund...................................... $35,507
International Fund.......................................... $37,725
Global Value Fund........................................... N/A
</TABLE>
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 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 of Governors 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.
The Manager believes that if the question were properly presented, a court
should hold that the Manager may perform the services for the Trust contemplated
by the Management Agreements, as described in the Prospectus and this SAI,
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 the
Manager 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 the Manager 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 Provident Distributors,
Inc. (the "Distributor"). 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 the Manager
would offer to perform some or all of the services now provided by the
Distributor. 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 expect that the Manager'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 the Distributor. It is not possible, of
course, to predict whether or in what form such legislation might be enacted or
the terms upon which the Manager or such a non-bank affiliate might offer to
provide services for consideration by the Trust's Board of Trustees.
SUBADVISERS
The Management Agreements authorize the Manager to use the services of any
person the Manager believes will be appropriate and helpful to it in performing
its duties to the Trust under the Management Agreements. Pursuant to this
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authority, the Manager has selected Scudder Kemper Investments, Inc. ("Scudder
Kemper") to provide investment advisory services to the Managed Bond Fund,
Wellington Management Company, LLP ("Wellington Management") to provide
investment advisory services to the International Fund and Robertson, Stephens
Investment Management, L.P. ("RSIM") to provide investment advisory services to
the Global Value Fund.
For their services, the Subadvisers are entitled to receive fees from the
Manager equal to the following annual percentages of the Funds' average daily
net assets: Managed Bond Fund -- Scudder Kemper 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; and Global Value Fund -- RSIM will receive a fee at the annual rate of
.40% of the average net assets of the Global Value Fund.
Each Subadvisory Agreement contains provisions regarding annual renewal and
termination similar to those of the Management Agreements.
DISTRIBUTOR
Provident Distributors, Inc. (the "Distributor") acts as distributor of the
shares of the Trust pursuant to a Distribution Agreement with the Trust. The
Distributor's principal offices are at Four Falls Corporate Center, 6th Floor,
West Conshohocken, PA, 19428-2961. 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.
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
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yield" begins with the same "base 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
The current yield for the Money Market Fund for the 7-day period ended
December 31, 1997 was 5.02%. The effective yield for the Money Market Fund for
the 7-day period ended December 31, 1997 was 5.15%.
For the 30-day period ended December 31, 1997, the yield for the Money
Market Fund was 5.12%.
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.
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.
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For the 30-day period ended December 31, 1997, the yields for the Managed
Bond Fund, Capital Income Fund, Blue Chip Fund, Mid-Cap Equity Fund and
Aggressive Growth Fund were 5.19%, 3.20%, 0.85%, 0.73% and (0.64)%,
respectively. Yield is not calculated for the International Fund.
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/P - 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.
The aggregate total returns (not annualized) for the period beginning March
1, 1997 (commencement of operations) through December 31, 1997 for the Money
Market Fund, Managed Bond Fund, Capital Income Fund, Blue Chip Fund, Mid-Cap
Equity Fund, Aggressive Growth Fund and International Fund were 4.22%, 6.59%,
14.75%, 23.27%, 27.80%, 17.65% and 0.56%, respectively.
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 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
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<PAGE> 56
and the election of trustees 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 report 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 Life, Pacific Life
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 its duties.
Pursuant to a Subcustodian Agreement among PNC Bank, the Fund and Morgan
Stanley Trust Company ("Morgan"), Morgan maintains the Trust's foreign
securities holdings. Morgan may hold the foreign securities at its principal
office in the United States or at any branch of Morgan or other bank or
depository with which Morgan or its subcustodians may contract, which is an
eligible foreign subcustodian or depository, subject to the approval of the
Board.
In addition, RSIM 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 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 Life serves as transfer agent for the Funds.
COUNSEL
Vedder, Price, Kaufman & Kammholz serves as counsel to the Trust.
INDEPENDENT AUDITORS
Price Waterhouse LLP serves as independent auditors of each Fund.
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<PAGE> 57
CAPITALIZATION
Pacific Life paid the Trust's expenses in connection with the Trust's
organization and establishment of the initial seven Funds.
FINANCIAL STATEMENTS
The Annual Report for the Trust for the fiscal year ended December 31, 1997
(the "Annual Report") accompanies this Statement of Additional Information. The
financial statements and notes thereto in the Annual Report are incorporated
into this Statement of Additional Information by reference, and have been
audited by KPMG Peat Marwick LLP, whose report thereon also appears in the
Annual Report and is also incorporated herein by reference. No other parts of
the Annual Report are incorporated by reference herein. Such financial
statements have been incorporated herein in reliance on the report of KPMG Peat
Marwick LLP, independent auditors, given on the authority of said firm as
experts in auditing and accounting.
MISCELLANEOUS
As of April 2, 1998 Pacific Life and PAM beneficially owned the following
percentages of the outstanding shares of the Funds respectively: 16.82% and
83.18% of the Money Market Fund; 60.28% and 39.72% of the Managed Bond Fund;
69.70% and 30.30% of the Capital Income Fund; 72.44% and 27.56% of the Blue Chip
Fund; 46.77% and 53.23% of the Mid-Cap Equity Fund; 40.54% and 59.46% of the
Aggressive Growth Fund; and 45.18% and 54.82% of the International Fund. Pacific
Life and PAM would exercise voting rights attributable to any shares of the
Trust owned by them in accordance with voting instructions received by owners of
the Contracts issued by Pacific Life. To this extent, as of April 2, 1998
Pacific Life and PAM did not exercise control over any Fund.
As of April 2, 1998 no variable contract owner had an interest with respect
to 5% or more of the outstanding shares of a Fund.
As used in the Prospectus and this SAI, 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 SAI 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 SEC by paying the charges prescribed under its rules and regulations.
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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.
"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.
A-1
<PAGE> 59
"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.
"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.
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<PAGE> 60
"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.
"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
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<PAGE> 61
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 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.
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<PAGE> 62
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.
"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.
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<PAGE> 63
"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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<PAGE> 64
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.
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 Manager wishes to fix the current
market value of this portfolio security until
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<PAGE> 65
some point in the future. Assume the portfolio security has a market value of
100, and the Manager 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.
The Manager 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 Manager 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 Manager 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.
The Manager 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, 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
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<PAGE> 66
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>
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>
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<PAGE> 67
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>
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
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<PAGE> 68
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 Manager 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).
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
Manager. 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 Manager. 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.
B-5
<PAGE> 69
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 Manager 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 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 the
Manager 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 the Manager 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
B-6
<PAGE> 70
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 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 or 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
B-7
<PAGE> 71
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, 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.
B-8
<PAGE> 72
PACIFIC INNOVATIONS TRUST,
A DELAWARE BUSINESS TRUST
FORM N-1A
PART C: OTHER INFORMATION
Item 24. Financial Statements and Exhibits.
a. Financial Statements:
(1) Included in Part A hereof:
Financial Highlights for the Money Market, Managed
Bond, Capital Income, Blue Chip, Mid-Cap Equity,
Aggressive Growth and International Funds for the
period March 1, 1997 (commencement of operations)
through December 31, 1997.
(2) Incorporated by reference in Part B hereof:
The Audited Financial Statements and related notes
thereto as well as the Auditor's reports thereon for
each of the Money Market, Managed Bond, Capital
Income, Blue Chip, Mid-Cap Equity, Aggressive Growth
and International Funds for the fiscal period from
March 1, 1997 (commencement of operations) to December
31, 1997 as filed with the Securities and Exchange
Commission pursuant to Rule 30b2-1 of the Investment
Company Act of 1940.
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 Kemper Investments, Inc. (4)
(5.3) Form of Subadvisory Agreement between Bank of America
NT&SA and Wellington Management Company, LLP.(1)
(5.4) Form of Sub-Advisory Agreement between Bank of America
and RSIM with respect to the Global Value Fund.(5)
(6) Distribution Agreement between Registrant and
Provident Distributors, Inc.(3)
(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) Incorporated herein by reference to Registrant's
pre-effective amendment no. 1 to the registration
statement filed on February 21, 1997.
(3) Incorporated herein by reference to Registrant's
post-effective amendment no. 1 to the registration
statement filed on August 29, 1997.
(4) Incorporated herein by reference to Registrant
post-effective amendment no.2 to the registration
statement filed on February 13, 1998.
(5) Filed herewith.
<PAGE> 73
(8.2) Global Custody Agreement between PNC Bank,
N.A. and Morgan Stanley Trust Company.(3)
(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 among Registrant,
Bank of America NT & SA, Provident Distributors, Inc.
and Pacific Mutual Life Insurance Company.(3)
(10) Consent and Opinion of Counsel.
(11.1) Consent of Counsel.
(11.2) Consent of Independent Auditors.
(12) Not applicable.
(13) Form of investment letter of initial investor in
Registrant.(2)
(14) None.
(15) None.
(16) Schedule of Performance Computations.(3)
(17) Financial Data Schedules.(5)
(18) None.
(19.1) Limited Power of Attorney of Edward S. Bottum.(3)
(19.2) Limited Power of Attorney of William P. Carmichael.(3)
(19.3) Limited Power of Attorney of Robert E. Greeley.(3)
(19.4) Limited Power of Attorney of Harold T. Joanning.(3)
(19.5) Limited Power of Attorney of John P. Privat. (3)
Item 25. Persons Controlled by or Under Common Control with Registrant.
As of April 2, 1998, Pacific Life and PAM beneficially
owned the following percentages of the outstanding shares of the Funds
respectively: 16.82% and 83.18% of the Money Market Fund; 60.28% and 39.72% of
the Managed Bond Fund; 69.70% and 30.30% of the Capital Income Fund; 72.44% and
27.56% of the Blue Chip Fund; 46.77% and 53.23% of the Mid-Cap Equity Fund;
40.54% and 59.46% of the Aggressive Growth Fund; and 45.18% and 54.82% of the
International Fund. Pacific Life and PAM would exercise voting rights
attributable to any shares of the Trust owned by them in accordance with voting
instructions received by owners of the Contracts issued by Pacific Life. To this
extent, as of April 2, 1998 Pacific Life and PAM did not exercise control
over any Fund.
As of April 2, 1998 no variable contract owner had an
interest with respect to 5% or more of the outstanding shares of a Fund.
------------
(1) Incorporated herein by reference to Registrant's initial
registration statement filed on October 15, 1996.
(2) Incorporated herein by reference to Registrant's
pre-effective amendment no. 1 to the registration
statement filed on February 21, 1997.
(3) Incorporated herein by reference to Registrant's
post-effective amendment no. 1 to the registration
statement filed on August 29, 1997.
C-2
<PAGE> 74
Item 26. Number of Holders of Securities.
As of April 2, 1998, 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 -2-
Managed Bond Fund -2-
Capital Income Fund -2-
Blue Chip Fund -2-
Mid-Cap Equity Fund -2-
Aggressive Growth Fund -2-
International Fund -2-
</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.
C-3
<PAGE> 75
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> 76
<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 Peter B. Bedford Chairman and CEO, California based Real
Bedford Property Estate Investment Trust
Investors, 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 Walter E. Massey,Ph.D President, Morehouse Higher Education
College
Director John M. Richman Of 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> 77
(b) Scudder Kemper Investments, Inc. ("Scudder Kemper") 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 of
Scudder Kemper, together with any information as to any business profession,
vocation or employment of a substantial nature engaged in by such officers
during the past two years, is incorporated by reference to Schedules A and D of
Form ADV filed by Scudder Kemper 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) Provident Distributors, Inc. (the "Distributor") acts
as principal underwriter for the Company. The Distributor also acts as
principal underwriter or exclusive distributor for the following registered
investment companies: Temporary Investment Fund, Inc., Trust for Federal
Securities, Municipal Fund for Temporary Investment, Municipal Fund for
California Investors and Municipal Fund for New York Investors.
(b) For information as to the business, profession,
vocation or employment of a substantial nature of the Distributor, its officers
and partners, reference is made to the Form BD filed by the Distributor (file
no. 8-46564), which is incorporated by reference herein.
C-6
<PAGE> 78
(c) Not applicable.
Item 30. Location of Accounts and Records.
(1) Provident Distributors, Inc., Four Falls Corporate Center, 6th
Floor, West Conshohocken, Pennsylvania 19428-2961 (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 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 Street, 26th
Floor, Chicago, Illinois 60601 (Registrant's Declaration of
Trust, By-Laws and minute books).
(5) PNC Bank, N.A., 200 Stevens Drive, Lester, Pennsylvania 19113
(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> 79
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 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> 80
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and
the Investment Company Act of 1940, the Registrant certifies that it meets all
of the requirements for effectiveness of this Registration Statement pursuant to
Rule 485(b) under the Securities Act of 1933 and has duly caused this
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Los Angeles, California, on the 30 day of
April, 1998.
PACIFIC INNOVATIONS TRUST,
a Delaware Business Trust
By /s/ Robert E. Greeley
------------------------
Robert E. Greeley
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/Robert E. Greeley President and Trustee, April 30, 1998
------------------------- Chief Executive Officer
Robert E. Greeley
Chairman and Trustee April 30, 1998
-------------------------
Edward S. Bottum*
Trustee April 30, 1998
-------------------------
William P. Carmichael*
Trustee April 30, 1998
-------------------------
Harold T. Joanning*
Trustee April 30, 1998
-------------------------
John Privat*
/s/ Jay F. Nusblatt Treasurer, Chief April 30, 1998
----------------------- Financial Officer
Jay F. Nusblatt and Principal
Accounting Officer
</TABLE>
* Robert E. Greeley signs this document pursuant to powers of attorney filed in
Registrant's post-effective amendment no. 1.
/s/ Robert E. Greeley
- ---------------------------
Robert E. Greeley
<PAGE> 81
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>
5.4 Form of Sub-Advisory Agreement between Bank of
America and RSIM.
10.1 Opinion and Consent of Counsel
11.1 Consent of Counsel
11.2 Consent of Independent Auditor
17.1 Financial Data Schedule for the Money Market Fund.
17.2 Financial Data Schedule for the Managed Bond Fund.
17.3 Financial Data Schedule for the Capital Income Fund.
17.4 Financial Data Schedule for the Blue Chip Fund.
17.5 Financial Data Schedule for the Mid-Cap Equity Fund.
17.6 Financial Data Schedule for the Aggressive Growth
Fund.
17.7 Financial Data Schedule for the International Fund.
</TABLE>
<PAGE> 1
EXHIBIT 5.4
FORM OF
SUB-ADVISORY AGREEMENT
Pacific Innovations Global Value Fund
AGREEMENT, made as of __________ __, 1998, between Bank of America
National Trust and Savings Association, a national banking association
(hereinafter called the "Manager"), and Robertson, Stephens & Company Investment
Management, L.P. (the "Sub-Adviser").
WHEREAS, the Pacific Innovations Global Value Fund (the "Fund") is a
series of Pacific Innovations Trust, a Delaware business trust (the "Trust"), an
open-end, management investment company organized as a business trust under the
laws of the state of Delaware; and
WHEREAS, pursuant to a Management Agreement dated _________ __, 1998
(the "Management Agreement") by and between the Trust and the Manager, the
Manager has agreed to furnish investment management services to the Fund; and
WHEREAS, the Management Agreement specifically authorizes the Manager to
sub-contract investment advisory services on behalf of the Fund to the
Sub-Adviser pursuant to a sub-advisory agreement agreeable to the Trust and
approved in accordance with the provisions of the Declaration of Trust and
Bylaws of the Trust; and
WHEREAS, the Board of Trustees of the Trust has approved this Agreement,
and the Sub-Adviser is willing to furnish such services upon the terms and
conditions herein set forth;
NOW, THEREFORE, in consideration of the premises and mutual covenants
herein contained, it is agreed between the parties hereto as follows:
1. APPOINTMENT.
The Manager hereby appoints the Sub-Adviser to act as sub-investment
adviser with respect to the investment portfolio of the Fund for the period and
on the terms set forth in this Agreement and the Sub-Adviser accepts such
appointment and agrees to furnish the services herein set forth for the
compensation herein provided.
2. SERVICES OF SUB-ADVISER.
Subject to the oversight and supervision of the Manager and the Trust's
Board of Trustees, the Sub-Adviser will provide a continuous investment program
for the Fund, including investment research and management with respect to all
securities, investments, cash and cash equivalents in the portfolio of the Fund.
The Sub-Adviser will determine from time to time what securities and other
investments will be purchased, retained or sold by the Fund. The Sub-Adviser
will provide the services rendered by it under this Agreement in accordance with
the investment criteria and policies established from time to time for the Fund
by the Manager, the investment objective,
<PAGE> 2
policies and restrictions as stated in the Fund's current Prospectus with
respect to the Fund, and resolutions of the Trust's Board of Trustees. Without
limiting the generality of the foregoing, the Sub-Adviser further agrees that it
will maintain all books and records regarding the securities transactions with
respect to the Fund, keep books of account with respect to the Fund and supply
the Trust and its Board of Trustees with reports, statistical data and economic
information as reasonably requested.
3. OTHER COVENANTS.
The Sub-Adviser agrees that it:
(a) will conform with all applicable rules and regulations of the
U.S. Securities and Exchange Commission and will, in addition, conduct its
activities under this Agreement in accordance with other applicable law;
(b) will use the same skill and care in providing services under
this Agreement as it uses in providing services to other investment funds for
which it has investment responsibilities;
(c) will place orders pursuant to its investment determinations
with respect to the Fund with brokers or dealers reasonably acceptable to the
Manager [including its broker-dealer affiliate ___________________ or any
successor to it.] In executing portfolio transactions and selecting brokers or
dealers, the Sub-Adviser will use its best efforts to seek on behalf of the Fund
the best overall terms available. In assessing the best overall terms available
for any transaction, the Sub-Adviser shall consider all factors that 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 any commission or spread, if any, both for the
specific transaction and on a continuing basis. In evaluating the best overall
terms available, and in selecting the broker-dealer to execute a particular
transaction, the Sub-Adviser may also consider the brokerage and research
services as those terms are defined in Section 28(e) of the U.S. Securities
Exchange Act of 1934, (as amended) provided with respect to the Fund or other
accounts over which the Sub-Adviser or an affiliate of the Sub-Adviser exercises
investment discretion. The Sub-Adviser is authorized, subject to the prior
approval of the Manager and the Fund's Board of Trustees to pay to a broker or
dealer who provides such brokerage and research services a commission or spread
for executing a portfolio transaction with respect to the Fund that is in excess
of the amount of commission or spread another broker or dealer would have
charged for effecting that transaction if, but only if, the Sub-Adviser
determines in good faith that such commission or spread was reasonable in
relation to the value of the brokerage and research services provided by such
broker or dealer -- viewed in terms of that particular transaction or in terms
of the overall responsibilities of the Sub-Adviser to the Fund. In no instance
will portfolio securities be purchased from or sold to the Manager, the
Sub-Adviser, or Concord Holding Corporation (or any of its affiliates) acting as
principal or broker, except to the extent permitted by law. In executing
portfolio transactions with respect to the Fund, the Sub-Adviser may, but is not
obligated to the extent permitted by applicable laws and regulations, aggregate
the securities to be sold or purchased with those of its other clients where
such aggregation is not inconsistent with the policies set forth in the Fund's
currently
2
<PAGE> 3
effective Prospectus. In such event the Sub-Adviser will allocate the securities
so purchased or sold, and the expenses incurred in the transaction, in the
manner it considers to be most equitable and consistent with its fiduciary
obligations to the Fund and such other clients;
(d) when the Sub-Adviser makes investment recommendations with
respect to the Fund, its investment advisory personnel will not inquire or take
into consideration whether the issuers of securities proposed for purchase or
sale for the account of the Fund are customers of its, or any of its affiliates'
other departments;
(e) will treat confidentially and as proprietary information of
the Fund all records and other information relative to the Fund and prior or
present Fund interest holders ("Investors") or those persons or entities who
respond to inquiries concerning investment in the Fund and will not use such
records and information for any purpose other than performance of its
responsibilities and duties hereunder or under any other agreement with the
Trust except after prior notification to an approval in writing by the Trust,
which approval shall not be unreasonably withheld and may not be withheld where
the Sub-Adviser may be exposed to civil or criminal contempt proceedings for
failure to comply, when requested to divulge such information by duly
constituted authorities, or when so requested by the Trust. Nothing contained
herein, however, shall prohibit the Sub-Adviser from advertising to or
soliciting the public generally with respect to other products or services,
including, but not limited to, any advertising or marketing via radio,
television, newspapers, magazines or direct mail solicitation, regardless of
whether such advertisement or solicitation may coincidentally include prior or
present Investors or those persons or entities who have responded to inquiries
regarding the Fund, to the extent permitted by applicable law;
(f) will not purchase any securities from or sell any securities
to or engage in any financial transactions with the Manager or any of its
affiliates on behalf of the Fund. Nothing in this subsection shall in any way
prohibit the Sub-Adviser or any of its affiliates from purchasing securities
from, selling securities to or engaging in any other financial transactions with
the Manager or any of its affiliates on behalf of any other accounts managed by
the Sub-Adviser or for the Sub-Adviser's own account; and
(g) will provide the information set forth on Appendix A attached
hereto.
4. SERVICES NOT EXCLUSIVE.
The services furnished by the Sub-Adviser hereunder are deemed not to be
exclusive, and the Sub-Adviser shall be free to furnish similar services to
others so long as its services under this Agreement are not impaired thereby.
The Sub-Adviser will for all purposes herein be deemed to be an independent
contractor and will, unless otherwise expressly authorized, have no authority to
act for or represent the Fund or the Manager in any way or otherwise be deemed
their agent.
3
<PAGE> 4
5. BOOKS AND RECORDS.
The Sub-Adviser hereby agrees that all records that it maintains with
respect to the Fund are the property of the Trust and further agrees to
surrender promptly to the Trust any of such records upon the Trust's request,
copies of which may be retained by the Sub-Adviser. The Sub-Adviser further
agrees to maintain and to preserve the information required pursuant to and for
the periods prescribed by Rule 31a-1 and Rule 31a-2, respectively under the U.S.
Investment Company Act of 1940 (the "1940 Act").
6. EXPENSES.
During the term of this Agreement, the Sub-Adviser will pay all expenses
incurred by it in connection with its activities under this Agreement other than
the cost of securities (including brokerage commissions or spreads and other
transaction costs, if any) purchased or sold with respect to the Fund.
7. COMPENSATION.
For the services provided and the expenses assumed pursuant to this
Agreement, the Manager will pay the Sub-Adviser, and the Sub-Adviser will accept
as full compensation therefor, a fee, computed daily and payable monthly (in
arrears), at the following annual rates based on the total net assets of the
Fund as follows:
The Sub-Adviser acknowledges that it shall not be entitled to any
further compensation from the Manager in respect of the services provided and
expenses assumed by it under this Agreement. The Sub-Adviser's fees hereunder,
and the Sub-Adviser's sole recourse for payment of such fees shall be to the
Manager.
8. REDUCTION OF FEES.
The Manager and the Sub-Adviser hereby agree that the fees of the
Sub-Adviser pursuant to this Agreement shall be subject to reduction or waiver
in the event that the Manager reduces or waives all or a portion of the
Management fee otherwise due to the Manager pursuant to the Management Agreement
in order to permit the Fund to meet its initial target expense ratio of _____ of
1%. To the extent the Fund meets its initial target expense ratio including
partial or full Management fees, the Sub-Adviser shall not be required to waive
fees in order for the Fund to maintain expenses below the target expense ratio.
Such reduction or waiver shall be effective with respect to the Sub-Advisory fee
due hereunder upon thirty (30) days written notice (or facsimile) by the Manager
to the Sub-Adviser. All such reductions of the Management fee pursuant to notice
as provided herein shall be shared by and assessed against the Manager and the
Sub-Adviser equally rather than pro rata. Nothing in this section 8 shall be
interpreted to limit the ability of the Manager and the Sub-Adviser to
voluntarily and immediately waive or reduce any portion of their respective fees
nor shall any such voluntary and immediate fee reduction or waiver be construed
as a waiver
4
<PAGE> 5
by the Sub-Adviser of the notice provision in any future fee reductions or
waivers as provided for herein.
9. LIMITATION OF LIABILITY.
The Sub-Adviser shall not be liable for any error of judgment or mistake
of law or for any loss suffered by the Fund in connection with the performance
of this Agreement, except that the Sub-Adviser shall be liable to the Fund for
any loss resulting from a breach of fiduciary duty by the Sub-Adviser with
respect to the receipt of compensation for services or any loss resulting from
willful misfeasance, bad faith or negligence on the part of the Sub-Adviser in
the performance of its duties or from reckless disregard by it of its
obligations and duties under this Agreement. The Sub-Adviser acknowledges and
agrees that the performance of this Agreement is for the benefit of the Fund,
that the Sub-Adviser is therefore directly liable and responsible to the Fund
for the performance of its obligations hereunder, and that the Fund may enforce
in its own name and for itself such liability and responsibility.
10. DURATION AND TERMINATION.
This Agreement will become effective as of the date hereof and, unless
sooner terminated as provided herein, shall continue in effect until ________
__, 199_. Thereafter, if not terminated, this Agreement shall automatically
continue in effect for successive annual periods ending on _________ __,
provided such continuance is specifically approved at least annually by the vote
of a majority of the Trust's Board of Trustees at a meeting called for the
purpose of voting on such approval. Notwithstanding the foregoing, this
Agreement may be terminated at any time, without the payment of any penalty, by
the Manager or by the Trust (by vote of the Trust's Board of Trustees) on sixty
days' written notice to the Sub-Adviser, or by the Sub-Adviser, on sixty days'
written notice to the Trust, provided that in each such case, notice shall be
given simultaneously to the Manager. In addition, notwithstanding anything
herein to the contrary, in the event of the termination of the Management
Agreement for any reason (whether by the Trust, by the Manager or by operation
of law) this Agreement shall terminate upon the effective date of such
termination of the Management Agreement. This Agreement will immediately
terminate in the event of its assignment. (As used in this Agreement, the term
"assignment" shall have the same meaning as such term has in the 1940 Act.)
11. AMENDMENT OF THIS AGREEMENT.
No provision of this Agreement may be changed, waived, discharged or
terminated orally, but only by an instrument in writing signed by the other
party against which enforcement of the change, waiver, discharge or termination
is sought. No amendment of this Agreement shall be effective until approved by
vote of a majority of the Trust's Trustees.
5
<PAGE> 6
12. MISCELLANEOUS.
The captions in the Agreement are included for convenience of reference
only and in no way define or delimit any of the provisions hereof or otherwise
affect their construction or effect. If any provision of this Agreement shall be
held or made invalid by a court decision, statute, rule or otherwise, the
remainder of this Agreement shall not be affected thereby. This Agreement shall
be binding upon and shall inure to the benefit of the parties hereto and their
respective successors and shall be governed by the internal laws, and not the
law of conflicts, of the State of California, provided that nothing herein will
be construed in a manner inconsistent with the 1940 Act, the Investment
Manager's Act of 1940, as amended, or any rule or regulation of the U.S.
Securities and Exchange Commission thereunder.
13. NAMES.
The names "Fund," "Trust" and the "Board of Trustees" refer respectively
to the Trust created and the Trustees, as trustees but not individually or
personally, acting from time to time under the Declaration of Trust, dated
September 25, 1996, which is hereby referred to and a copy of which is on file
at the principal office of the Trust. The Trustees, officers, employees and
agents of the Trust shall not personally be bound by or liable under any written
obligation, contract, instrument, certificate or other interest or undertaking
of the Trust made by the Trustees or by an officer, employee or agent of the
Trust, in his or her capacity as such, nor shall resort be had to their private
property for the satisfaction of any obligation or claim thereunder.
IN WITNESS WHEREOF, the parties hereto have caused this instrument to be
executed by their officers designated below as of the day and year first above
written.
Bank of America National Trust Robertson, Stephens & Company
and Savings Association Investment Management, L.P.
By: __________________________ By: ________________________________
Title: Title:
6
<PAGE> 7
APPENDIX A
TO SUB-ADVISORY AGREEMENT
1. On at least a monthly basis, the Sub-Adviser will provide to the Manager
within 15 days of the end of the month the following:
- a current schedule of all portfolio securities held by the Fund;
- a schedule of all securities sold by the Fund during the previous
month;
- a schedule of brokerage commissions or other dealer concessions
paid during the previous month and the broker or dealer to whom
such benefit flowed;
- a schedule and description of all repurchase transactions and
reverse repurchase transactions during the previous month and the
counterparties to such transactions;
- a description of the current strategies and tactics to be
employed by the Sub-Adviser on behalf of the Fund; and
- a copy of the Sub-Adviser's monthly review of the Fund's
performance against its benchmark.
2. On a periodic basis the Manager may request and the Sub-Adviser shall
deliver to the Manager within a period of time that is reasonable
depending upon the information requested the following:
- trade tickets evidencing securities trades on behalf of the Fund;
- copies of credit files regarding the issuers of portfolio
securities held by the Fund;
- a description, including any identification numbers similar to
CUSIP, and dealer through which such security was purchased on
behalf of the Fund; and
- a description including any identification numbers similar to
CUSIP and dealer through which such security was purchased/sold
on behalf of the Fund.
<PAGE> 1
EXHIBIT 10.1
OPINION AND CONSENT OF COUNSEL
[VEDDER, PRICE, KAUFMAN & KAMMHOLZ]
April 30, 1998
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 one new authorized series -- Global Value
Fund (the "New Portfolio").
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's Declaration of Trust and the receipt by the New
Portfolio 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,
VEDDER, PRICE, KAUFMAN & KAMMHOLZ
COK
MLW
<PAGE> 1
[VEDDER, PRICE, KAUFMAN & KAMMHOLZ LETTERHEAD]
April 30, 1998
Pacific Innovations Trust
103 Bellevue Parkway
Wilmington, Delaware 18809
Gentlemen and Ladies:
We hereby consent to the reference to our name under the heading
"General Information -- Counsel" in the Statement of Additional Information
contained in Post-Effective Amendment No. 3 to the registration statement on
Form N-1A for Pacific Innovations Trust (File Nos. 33-14191 and 811-07863) and
to the filing of this consent as an exhibit to the registration statement.
Very truly yours,
VEDDER, PRICE, KAUFMAN & KAMMHOLZ
By: /s/ Cathy G. O'Kelly
---------------------------------------
Cathy G. O'Kelly
COK/dd
<PAGE> 1
Independent Auditors' Consent
The Board of Trustees
The Pacific Innovations Trust:
We consent to the reference to our firm under the headings "Financial
Highlights" in the Prospectus and "Financial Statements" in the Statement of
Additional Information.
KPMG Peat Marwick LLP
Los Angeles, California
April 29, 1998
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<PERIOD-END> DEC-31-1997
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<OTHER-ITEMS-LIABILITIES> 18512
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<NET-INVESTMENT-INCOME> 375805
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<EXPENSES-NET> 72508
<NET-INVESTMENT-INCOME> 269863
<REALIZED-GAINS-CURRENT> 201215
<APPREC-INCREASE-CURRENT> 481067
<NET-CHANGE-FROM-OPS> 952145
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<DISTRIBUTIONS-OF-GAINS> (349023)
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<PERIOD-END> DEC-31-1997
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<EXPENSES-NET> 84190
<NET-INVESTMENT-INCOME> 89822
<REALIZED-GAINS-CURRENT> (70076)
<APPREC-INCREASE-CURRENT> 1871526
<NET-CHANGE-FROM-OPS> 1891272
<EQUALIZATION> 0
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