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THE HORACE MANN MUTUAL FUNDS
The Horace Mann Mutual Funds (the "Trust") is an open-end, diversified
management investment company registered under the Investment Company Act of
1940, which offers units of beneficial ownership ("shares") in seven separate
investment portfolios: Growth Fund, Small Cap Growth Fund, International
Equity Fund, Socially Responsible Fund, Balanced Fund, Income Fund and Short-
Term Investment Fund. These funds collectively are referred to as the "Funds."
The Funds issue shares that are continually offered for sale and are available
exclusively as funding vehicles for the variable annuity contracts of Horace
Mann Life Insurance Company. Fund shares may be purchased or redeemed at net
asset value.
The primary investment objective of the Growth Fund is long-term capital
growth; conservation of principal and production of income are secondary
objectives. The Growth Fund invests primarily in common stocks.
The investment objective of the Small Cap Growth Fund is long-term capital
appreciation. The Small Cap Growth Fund invests primarily in a portfolio of
equity securities of small cap companies with earnings growth potential.
The investment objective of the International Equity Fund is long-term
growth of capital primarily through a diversified portfolio of marketable
foreign equity securities.
The investment objectives of the Socially Responsible Fund are long-term
growth of capital, current income and growth of income. The Socially
Responsible Fund invests primarily in a diversified portfolio of equity
securities of United States-based companies, which are determined to be
socially responsible pursuant to criteria set forth in this prospectus.
The investment objective of the Balanced Fund is to realize a high long-term
total rate of return consistent with prudent investment risks. The Balanced
Fund's assets are invested in a mix of common stocks, debt securities and
money market instruments.
The primary investment objective of the Income Fund is to achieve a long-
term total rate of return in excess of the U.S. bond market over a full market
cycle. The Income Fund invests primarily in debt securities.
The primary investment objective of the Short-Term Investment Fund is to
realize maximum current income to the extent consistent with liquidity.
Preservation of principal is a secondary objective. The Short-Term Investment
Fund attempts to realize its objectives through investments in short-term debt
instruments; it is not a money market fund and does not maintain a constant
net asset value per share.
As a result of the market risk inherent in any investment, there is no
assurance that any Fund will meet its investment objectives.
This Prospectus sets forth concisely the information a prospective investor
should know before investing. Additional information about the Funds has been
filed with the Securities and Exchange Commission in a Statement of Additional
Information, dated May 1, 1997, which is incorporated herein by reference and
may be amended from time to time. The Statement of Additional Information is
available upon request, without charge, by writing to the Horace Mann Mutual
Funds, P.O. Box 4657, Springfield, Illinois 62708-4657, by sending a
telefacsimile (FAX) transmission to (217) 527-2307, or by telephoning (217)
789-2500 or (800) 999-1030 (toll-free). The Table of Contents of the Statement
of Additional Information appears on page 18 of this Prospectus.
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 SHOULD BE READ AND RETAINED FOR FUTURE REFERENCE.
The date of this Prospectus is May 1, 1997.
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TABLE OF CONTENTS
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TOPIC PAGE
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THE TRUST, THE FUNDS, THEIR INVESTMENT OBJECTIVES AND POLICIES............. 1
Growth Fund.............................................................. 1
Small Cap Growth Fund.................................................... 1
International Equity Fund................................................ 2
Socially Responsible Fund................................................ 2
Balanced Fund............................................................ 3
Income Fund.............................................................. 3
Short-Term Investment Fund............................................... 4
TYPES OF INVESTMENTS AND ASSOCIATED RISKS.................................. 4
MANAGEMENT................................................................. 10
Investment Adviser and Manager, Horace Mann Investors, Inc............... 10
The Subadvisers.......................................................... 11
Growth Fund............................................................ 11
Small Cap Growth Fund.................................................. 12
International Equity Fund.............................................. 12
Socially Responsible Fund.............................................. 12
Balanced Fund.......................................................... 12
Income Fund............................................................ 13
Short-Term Investment Fund............................................. 13
General................................................................ 13
Transfer Agent and Dividend Paying Agent................................. 13
Custodian and Fund Accounting Agent...................................... 13
Investment Return........................................................ 13
Other Information On The Performance Of PNC Equity Advisors Company...... 14
Other Information On The Performance Of Scudder, Stevens & Clark......... 14
PURCHASES AND REDEMPTIONS.................................................. 16
DIVIDENDS, DISTRIBUTIONS AND FEDERAL TAXES................................. 16
VOTING RIGHTS.............................................................. 17
PUBLIC SHAREHOLDER COMMUNICATIONS.......................................... 17
SHAREHOLDERS' INQUIRIES.................................................... 17
ADDITIONAL INFORMATION..................................................... 18
APPENDIX A................................................................. A-1
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CONDENSED FINANCIAL INFORMATION
The condensed financial information for the Growth Fund, Balanced Fund,
Income Fund and Short-Term Investment Fund under the heading "Financial
Highlights" in the Funds' 1996 Annual Report and the Report of Independent
Auditors thereon, is incorporated herein by reference. Additional information
about the Funds' performance, including Management's Discussion and Analysis,
is also contained in the 1996 Annual Report which accompanies this Prospectus.
Additional copies of the Annual Report may be obtained without charge by
writing to the Horace Mann Mutual Funds, P.O. Box 4657, Springfield, Illinois
62708-4657, by sending a request by telefacsimile (FAX) transmission to (217)
527-2307, or by telephoning (217) 789-2500 or (800) 999-1030 (toll-free).
Financial information for the Small Cap Growth Fund, International Equity Fund
and Socially Responsible Fund is located in the Statement of Additional
Information in the section entitled "Financial Statements."
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THE TRUST, THE FUNDS, THEIR INVESTMENT OBJECTIVES AND POLICIES
The Trust was organized as a Delaware business trust under a Declaration of
Trust dated November 7, 1996. The Declaration of Trust permits the Trust to
offer shares of separate funds. All consideration received by the Trust for
shares of any fund and all assets of such fund belong to that fund and would
be subject to liabilities related thereto. The Trust reserves the right to
create and issue shares of funds in addition to the Funds described herein.
Horace Mann Investors, Inc. ("Investors") serves as each Fund's investment
adviser and manager. Investors has entered into agreements with Wellington
Management Company, LLP to act as the subadviser for the Growth Fund, Balanced
Fund, Income Fund and Short-Term Investment Fund, with PNC Equity Advisors
Company to act as the subadviser for the Small Cap Growth Fund and with
Scudder, Stevens & Clark, Inc. to act as the subadviser for the International
Equity Fund and the Socially Responsible Fund. Additional information about
each adviser is under the heading "Management."
The investment objectives and policies of each Fund are described below.
Prospective purchasers should recognize that there are risks in the ownership
of any security and that there can be no assurance that the objectives of the
Funds will be realized.
Each Fund seeks to attain its objective by pursuing investment policies that
call for investments in certain types of securities and by employing various
investment strategies. These investment policies and strategies may be changed
without shareholder approval. However, each Fund will not, as a matter of
policy, change its investment policies without notice to its shareholders.
Each Fund has also adopted certain fundamental investment limitations that,
along with its objective, may be changed only with the approval of a "majority
of the outstanding shares of a Fund."
Supplemental information on the investment policies as well as a description
of the investment restrictions of each Fund are contained in the Statement of
Additional Information.
GROWTH FUND
The investment objective of the Growth Fund is long-term capital growth.
Secondary objectives are conservation of principal and production of income.
The Growth Fund ordinarily invests substantially all of its assets in common
stocks of domestic companies of various sizes and operating histories, both
listed and unlisted, in a variety of industries. The Growth Fund may also
invest in preferred stocks. Additionally, up to 10% of the Growth Fund's
assets may be invested in U.S. dollar-denominated securities of foreign
issuers, including common stock, preferred stock, convertible securities and
American Depository Receipts. The Fund will not invest in securities subject
to restrictions on disposition under
the Securities Act of 1933 (the "1933 Act") or purchase securities not freely
marketable.
To achieve its objectives of long-term capital growth, conservation of
principal and production of income, the Growth Fund employs a "Value-Yield"
strategy in making investments. "Value-Yield" investing concentrates on stocks
which sell at low prices relative to certain measures of company value such as
the price/earnings ratio and the price/book ratio. These stocks also tend to
have above-average dividend yields.
The Growth Fund may also invest a portion of its assets in fixed-income
securities. The investment policies of the Growth Fund limit fixed-income
investments to those debt securities described below for the Income Fund
except the debt securities in which the Growth Fund may invest must be (i)
rated within the four highest ratings as determined by Moody's Investors
Service, Inc. ("Moody's") or by Standard and Poor's Corporation ("S&P") and
(ii) U.S. dollar-denominated. The Growth Fund may invest up to 10% of its
total assets in U.S. dollar-denominated foreign debt securities within the
three highest ratings as determined by Moody's or S&P category 1(d) under
"Income Fund."
The Growth Fund may make interim investments in short-term debt instruments
in order to generate a return on otherwise idle cash. If a market decline is
expected, the Growth Fund may sell its portfolio securities and invest all or
part of the proceeds in investment grade corporate bonds, debentures,
preferred stock and U.S. Government securities, or it may retain funds in the
form of cash or cash equivalents.
SMALL CAP GROWTH FUND
The Small Cap Growth Fund seeks long-term capital appreciation. The Fund
ordinarily invests substantially all of its assets in small cap equity
securities (less than $1 billion at the time of investment) with earnings
growth potential. Such securities would be considered by the subadviser to
have favorable and above-average earnings growth prospects, that is,
securities with growth rate estimates in excess of the average for the Fund's
benchmark, the Russell 2000 Growth Index. The Russell 2000 Growth Index is
composed of those Russell 2000 securities with a greater-than-average growth
orientation. Securities in this index generally have higher price-to-book and
price-earnings ratios than those in the Russell 2000 Value Index. Under normal
market conditions, the Fund will invest at least 90% of its assets in equity
securities of smaller-capitalized organizations. These organizations will
normally have more limited product lines, markets and financial resources and
will be dependent upon more limited management groups than larger-capitalized
companies.
Pending investment, to meet anticipated redemption requests or as a
temporary defensive measure if its subadviser determines that market
conditions warrant, the Fund may also invest without limitation in high
quality money market instruments. High quality money market instruments
include U.S. Government obligations; U.S. Government agency obligations; U.S.
dollar-denominated obligations of foreign
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issuers issued in the U.S.; bank obligations, including U.S. subsidiaries and
branches of foreign banks; corporate obligations; commercial paper; repurchase
agreements and obligations of supranational organizations. Generally, such
obligations will mature within one year from the date of settlement, but they
may mature within two years from the date of settlement.
INTERNATIONAL EQUITY FUND
The International Equity Fund seeks long-term growth of capital primarily
through diversified holdings of marketable foreign equity investments. The
Fund invests in companies, wherever organized, which do business primarily
outside the United States. The Fund intends to diversify investments among
several countries and to have represented in its holdings business activities
in not less than three different countries. The Fund does not intend to
concentrate investments in any particular industry.
The International Equity Fund invests primarily in equity securities of
established companies that the subadviser believes have favorable
characteristics and that are listed on foreign exchanges. It may also invest
in fixed-income securities of foreign governments and companies. However,
management intends to maintain a portfolio consisting primarily of equity
securities. Investing in foreign securities may involve a greater degree of
risk than investing in domestic securities due to the possibility of exchange
rate fluctuations and exchange controls, less publicly available information,
more volatile markets, less securities regulation, less favorable tax
provisions, war and expropriation. The net asset value of the shares of the
Fund will increase or decrease with changes in the market price of the Fund's
investments and changes in foreign currency exchange rates. (See "Types of
Investments and Associated Risks--Foreign Securities.")
The International Equity Fund has no present intention of altering its
general policy of being primarily invested under normal conditions in foreign
securities. However, in the event of exceptional conditions abroad, the Fund
may temporarily invest all or a portion of its assets in Canadian or U.S.
Government obligations or currencies, or securities of companies incorporated
in and having their principal activities in Canada or the United States.
The International Equity Fund may, for hedging purposes, purchase forward
foreign currency exchange contracts, foreign currency options and futures
contracts and foreign currencies in the form of bank deposits. The Fund may
also purchase other foreign money market instruments, including, but not
limited to, bankers' acceptances, certificates of deposit, commercial paper,
short-term government and corporate obligations and repurchase agreements. The
Fund may also engage in so-called "Strategic Transactions." See "Types of
Investments and Associated Risks--Strategic Transactions."
SOCIALLY RESPONSIBLE FUND
The Socially Responsible Fund seeks to achieve long-term growth of capital,
current income and growth of income. It pursues these objectives through a
diversified portfolio composed primarily of marketable equity securities. The
Socially Responsible Fund seeks to achieve these objectives by investing in
socially responsive companies which the subadviser determines:
(a) Do not produce tobacco products;
(b) Do not produce alcoholic beverages;
(c) Do not own and/or operate casinos or manufacture gaming devices;
(d) Do not produce pornographic materials;
(e) Do not produce nuclear weapons or guidance and/or delivery systems
specifically for nuclear weapons;
(f) By popular standards, maintain non-discriminatory employment practices
throughout a company's facilities; and
(g) By popular standards, maintain environmental policies, practices and
procedures which are currently acceptable, or which are exhibiting
improvement.
In addition, except during the initial start-up period or pending the
reinvestment of proceeds from the sale or disposition of the Fund's portfolio
securities or the distribution of assets upon termination of the Fund,
substantially all and at least 85% of the Fund's total assets will, under
normal circumstances, be invested in equity securities of companies which are
of at least average financial quality but which are currently undervalued
relative to either their peer group, the markets or their fundamental outlook,
and whose dividend yields at the time of purchase are at least 20% higher than
the dividend yield of the S&P 500 Index.
While the Fund emphasizes investments in U.S. chartered companies, it can
commit up to 25% of the Fund's total assets to equity securities issued by
non-U.S. chartered companies which meet the criteria applicable to domestic
investments. In addition, from time to time, for temporary defensive purposes,
when the Fund's subadviser feels such a position is advisable in light of
economic or market conditions, the Fund may invest a portion of its assets in
cash and cash equivalents.
The above investment limitations or policies are applied at the time
investment securities are purchased.
In the course of pursuing its investment objectives, the Socially
Responsible Fund may engage in so-called "strategic transactions." See "Types
of Investments and Associated Risks--Strategic Transactions."
Pending investment, to meet anticipated redemption requests, or as a
temporary defensive measure if its subadviser determines that market
conditions warrant, the Fund may also
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invest without limitation in high quality money market instruments. High
quality money market instruments include U.S. Government obligations; U.S.
Government agency obligations; U.S. dollar-denominated obligations of foreign
issuers issued in the U.S.; bank obligations, including U.S. subsidiaries and
branches of foreign banks; corporate obligations; commercial paper; repurchase
agreements and obligations of supranational organizations. Generally, such
obligations will mature within one year from the date of settlement, but they
may mature within two years from the date of settlement.
BALANCED FUND
The investment objective of the Balanced Fund is to realize a high long-term
total rate of return consistent with prudent investment risks. Total rate of
return consists of current income including dividends, interest, discount
accruals and capital appreciation.
The Balanced Fund seeks to attain this objective through a selective mix of
investments in common stocks, bonds and other debt instruments. The Balanced
Fund holds the same kinds of stocks and bonds held separately by the Growth
Fund and Income Fund. For a description of the types of stocks in which the
Balanced Fund is permitted to invest, see "The Trust, the Funds, Their
Investment Objectives and Policies--Growth Fund" and for a description of the
types of bonds (and other types of fixed-income securities) in which the
Balanced Fund is permitted to invest, see "The Trust, the Funds, Their
Investment Objectives and Policies--Income Fund."
The mix of investments in the Balanced Fund is regularly adjusted between
stocks and bonds to capitalize on perceived variations in return potential
produced by the changing financial market and economic conditions. This
mixture of stocks and bonds reduces the volatility of investment returns while
still providing the potential for higher long-term total returns that can only
be achieved by including some exposure to stocks. As a matter of investment
policy, 50% to 75% of the Balanced Fund's total assets will be invested in
stocks and 25% to 50% of the value of its assets will be invested in bonds.
The policies with regard to credit quality, duration and maturity, as well as
the percentage limitations on investments, associated with the Income Fund
apply to the portion of the Balanced Fund's assets that are invested in fixed-
income securities.
Up to 100% of the Balanced Fund's total assets may be invested temporarily
in short-term debt instruments for defensive purposes, such as responding to
adverse securities market or economic conditions. Additionally, no more than
10% of the Fund's net assets may be invested in illiquid securities or
invested in restricted securities, except securities subject to resale under
Rule 144A under the 1933 Act. Major changes in investment mix may occur
several times within a year or over several years, depending upon market and
economic conditions.
INCOME FUND
The investment objective of the Income Fund is to achieve a long-term total
rate of return in excess of the U.S. bond market over a full market cycle. The
Fund will use the Lehman Brothers Aggregate Bond Index (the "Index") to
represent the U.S. bond market. The Index covers the U.S. investment grade
fixed-rate bond market, including government and corporate securities, agency
mortgage pass-through securities and asset-backed securities. The Index
includes only investment grade instruments, while the Income Fund may invest
up to 25% of its assets in non-investment grade instruments.
The Income Fund seeks to attain its objective through the following
investment policies:
1. At least 75% of the Income Fund's total assets are invested in:
(a) publicly offered debt securities, including mortgage-backed and other
asset-backed securities, within the four highest ratings as determined by
Moody's or by S&P;
(b) securities issued or guaranteed by the U.S. Government or its
agencies;
(c) publicly offered debt securities issued or guaranteed by a national
or state bank or bank holding company within the four highest ratings as
determined by both Moody's and S&P;
(d) U.S. dollar-denominated debt obligations of foreign governments,
foreign corporations, foreign branches of U.S. banks, and foreign banks
limited to the three highest ratings as determined by Moody's or S&P at the
time of purchase and that do not exceed 15% of the Income Fund's total
assets;
(e) Non-U.S. dollar-denominated debt obligations of foreign issuers
limited to the highest rating as determined by Moody's or S&P at the time
of purchase, are fully hedged back into U.S. dollars, and do not exceed 15%
of the Income Fund's total assets;
(f) commercial paper having a rating within the two highest grades as
determined by both Moody's and S&P;
(g) repurchase and reverse repurchase agreements involving any of the
above instruments, provided that the market value of the underlying
security is at least 102% of the price of the repurchase agreement;
(h) time deposits with maturities less than seven days; or
(i) cash or cash equivalents.
2. Up to 25% of the Income Fund's total assets may be invested in preferred
stocks and obligations not described above, including convertible securities,
securities carrying warrants to purchase equity securities and U.S. dollar-
denominated non-investment grade debt obligations of U.S. and non-U.S.
issuers.
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The Income Fund will not invest in common stocks directly, but may retain up
to 25% of its total assets in common stocks acquired upon conversion of
convertible debt securities or preferred stock, or upon exercise of warrants
acquired with debt securities.
At least 75% of the Income Fund's total assets are normally invested in
investment grade debt obligations of U.S. and non-U.S. issuers. Up to 25% of
the Fund's total assets may be invested in non-investment grade debt
securities, also known as "junk bonds." While these debt securities may offer
higher yields than investment grade debt securities, lower quality securities
involve greater risks. See "High Yield (High Risk) Securities" for a
discussion of these risks. In the aggregate, the Income Fund may invest up to
25% of its total assets in derivatives. Currently, the Fund intends to limit
its investment in derivatives pursuant to guidelines adopted by the Fund's
Board of Directors. Generally, the average duration and average maturity of
the U.S. portion of the portfolio will range between +/-25% of the Index's
duration. There are no maximum maturity limits on individual securities. The
average quality of the overall portfolio will always be "A" or better, with
the specific rating at any particular time reflective of relative valuations
among the quality sectors. To the extent the Fund invests in non-U.S. dollar-
denominated debt securities, these obligations will be fully hedged. For a
more complete description of the considerations involved with foreign
investing and related currency hedging strategies, see "Foreign Securities"
and "Forward Foreign Currency Exchange Contracts." For a more complete
description of ratings of debt securities, see Appendix A of the Statement of
Additional Information.
During periods of volatility or when an unusual decline in the value of
long-term obligations is anticipated, for defensive purposes, the Income Fund
may place a larger portion of its assets in cash and short-term obligations.
The Income Fund's holdings of short-term obligations and equity securities
during such periods may temporarily exceed an aggregate total of 25% of the
Income Fund's total assets. Moreover, as a matter of investment policy, the
Income Fund will not invest more than 10% of its net assets in illiquid
securities or invest in restricted securities, except securities subject to
resale under Rule 144A under the 1933 Act. Instead of holding its entire
portfolio to maturity, the Income Fund will engage in portfolio trading when
trading will help achieve its investment objective. Portfolio turnover is
expected to be moderate.
SHORT-TERM INVESTMENT FUND
The investment objective of the Short-Term Investment Fund is to realize
maximum current income to the extent consistent with liquidity. Preservation
of principal is a secondary objective. The Short-Term Investment Fund is not a
money market fund and does not maintain a stable net asset value per share.
The Short-Term Investment Fund seeks to attain its objectives by investing
in the following types of short-term debt instruments with maturities
generally not exceeding one year. The Short-Term Investment Fund invests in:
1. U.S. Treasury Bills and other obligations of or guaranteed by the U.S.
Government or its agencies;
2. obligations (including certificates of deposit, time deposits with
maturities less than seven days, or bankers' acceptances) of major U.S. banks;
3. commercial paper within the two highest ratings as determined by Moody's
or S&P;
4. U.S. dollar-denominated debt obligations of foreign governments, foreign
corporations, foreign branches of U.S. banks, and foreign banks limited to the
three highest ratings as determined by Moody's or S&P and that do not exceed
10% of the Short-Term Investment Fund's total assets;
5. publicly traded bonds, debentures and notes with a rating within the four
highest grades as determined by Moody's or S&P;
6. repurchase and reverse repurchase agreements involving any of the above
instruments; or
7. cash or cash equivalents.
For a more complete description of ratings of commercial paper, see Appendix
A of the Statement of Additional Information.
The Short-Term Investment Fund attempts to maximize return of its portfolio
by trading to take advantage of changing money market conditions and trends.
The Short-Term Investment Fund also trades to take advantage of disparities in
yield relationships between money market instruments. This procedure may
increase or decrease the portfolio yield depending on the subadviser's ability
to correctly time and execute these transactions. The Short-Term Investment
Fund intends generally to purchase securities that mature within one year, but
will not purchase securities with maturities that exceed two years except for
securities subject to repurchase agreements and reverse repurchase agreements.
The Short-Term Investment Fund will not invest in securities subject to
restriction on disposition under the 1933 Act or purchase securities not
freely marketable.
TYPES OF INVESTMENTS AND ASSOCIATED RISKS
Investments in any type of security are subject to varying degrees of market
risk, financial risk and, in some cases, reinvestment risk. Although the Funds
are subject to these risks, their investment policies and restrictions are
designed to manage such risk. Further, each Fund exercises due care in the
selection of its portfolio securities.
MARKET RISK is the potential for fluctuations in the price of the security
because of market factors. For equity securities, market risk is the
possibility of a change in price caused by stock market price changes; for
debt securities, market risk is the
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possibility that the price will fall because of changing interest rates. In
general, debt securities' prices vary inversely with changes in interest
rates. If interest rates rise, bond prices generally fall; if interest rates
fall, bond prices generally rise. In addition, for a given change in interest
rates, longer-maturity bonds fluctuate more in price (gaining or losing more
in value) than shorter-maturity bonds.
FINANCIAL RISK is based on the financial situation of the issuer. For equity
securities, financial risk is the possibility that the price of the security
will fall because of poor earnings performance by the issuer. For debt
securities, financial risk is the possibility that a bond issuer will fail to
make timely payments of interest or principal to a fund. The financial risk of
a fund depends on the credit quality of its underlying securities. In general,
the lower the credit quality of a fund's securities, the higher a fund's
yield, all other factors such as maturity being equal.
REINVESTMENT RISK is the possibility that, during periods of falling
interest rates, a debt security with a high stated interest rate will be
prepaid (or "called") prior to its expected maturity date. If during periods
of falling interest rates a debt security with a high stated interest rate is
called, the unanticipated proceeds would likely be invested at lower interest
rates, and the fund's income may decline. Call provisions, which may lead to
reinvestment risk, are most common for intermediate- and long-term municipal,
corporate and mortgage-backed securities. To the extent securities subject to
call were acquired at a premium, the potential for appreciation in the event
of a decline in interest rates may be limited and may even result in losses.
In addition to the risks generally associated with investing, there are
risks particular to certain types of investments. The following provides
additional information on various types of instruments in which the Funds may
invest and their associated risks. A Fund may not buy all these instruments to
the extent permitted unless it believes that doing so will help the Fund
achieve its objectives.
ADRS, EDRS AND GDRS--The Small Cap Growth Fund, International Equity Fund
and Socially Responsible Fund may invest in both sponsored and unsponsored
American Depository Receipts ("ADRs"), European Depository Receipts ("EDRs"),
Global Depository Receipts ("GDRs") and other similar global instruments. The
Growth Fund and Balanced Fund may invest in ADRs. ADRs typically are issued by
an American bank or trust company and evidence ownership of underlying
securities issued by a foreign corporation. EDRs, which are sometimes referred
to as Continental Depository Receipts, are receipts issued in Europe,
typically by foreign banks and trust companies, that evidence ownership of
either foreign or domestic underlying securities. GDRs are depository receipts
structured like global debt issues to facilitate trading on an international
basis. Unsponsored ADR, EDR and GDR programs are organized independently and
without the cooperation of the issuer of the underlying securities. As a
result, available information concerning the issuer may not be as current as
for sponsored ADRs, EDRs and GDRs, and the prices of unsponsored ADRs, EDRs
and GDRs may be more volatile than if such instruments were sponsored by the
issuer. Investments in ADRs, EDRs and GDRs present additional investment
considerations as described below under "Foreign Investments."
EQUITY SECURITIES--During normal market conditions, the Growth Fund, Small
Cap Growth Fund, International Equity Fund and Socially Responsible Fund will
invest primarily in equity securities. The Funds will invest primarily in
equity securities of U.S. issuers, except the International Equity Fund, which
will invest primarily in foreign issuers. Equity securities include common
stock and preferred stock (including convertible preferred stock); bonds,
notes and debentures convertible into common or preferred stock; stock
purchase warrants and rights; equity interests in trusts and partnerships; and
depositary receipts of companies.
FOREIGN SECURITIES--The Growth Fund, International Growth Fund, Socially
Responsible Fund, Balanced Fund, Income Fund and Short-Term Fund may invest in
foreign securities. Global investing involves economic and political
considerations not typically found in U.S. markets. These considerations,
which may favorably or unfavorably affect a Fund's performance, include
changes in exchange rates and exchange rate controls (which may include
suspension of the ability to transfer currency from a given country), costs
incurred in conversions between currencies, non-negotiable brokerage
commissions, different accounting standards, lower trading volume and greater
market volatility, the difficulty of enforcing obligations in other countries,
less securities regulation, different tax provisions (including withholding on
interest and dividends paid to the Fund), war expropriation, political and
social instability, and diplomatic developments. Further, the settlement
period of securities transactions in foreign markets may be longer than in
domestic markets. These considerations generally are more of a concern in
developing countries. For example, the possibility of political upheaval and
the dependence on foreign economic assistance may be greater in these
countries than in developed countries. The adviser and subadvisers seek to
mitigate the risks associated with these considerations through
diversification and active professional management. For a more detailed
description of foreign securities, see the Statement of Additional
Information--Appendix B.
FORWARD FOREIGN AND CURRENCY EXCHANGE CONTRACTS--The Small Cap Growth Fund
and International Equity Fund may invest in foreign currencies. The Balanced
Fund and Income Fund may each enter into forward foreign currency exchange
contracts ("forward contracts") to the extent of 15% of the value of their
respective total assets, for hedging purposes. A forward contract is a
contract individually negotiated and privately traded by currency traders and
their customers. A forward contract involves an obligation to purchase or sell
a specific
5
<PAGE>
currency for an agreed price at a future date, which may be any fixed number
of days from the date of the contract. The agreed price may be fixed or with a
specified range of prices.
The Balanced Fund and Income Fund also may each enter into foreign currency
futures contracts and foreign currency options to the extent of 15% of the
value of their respective total assets, for hedging purposes. Foreign currency
futures contracts are standardized contracts traded on commodities exchanges
which involve an obligation to purchase or sell a predetermined amount of
currency at a predetermined date at a specified price. The purpose of entering
into these contracts is to minimize the risk to a Fund from adverse changes in
the relationship between the U.S. dollar and foreign currencies. A Fund may
purchase and sell options on foreign currencies for hedging purposes in a
manner similar to that of transactions in forward contracts. Unanticipated
changes in currency prices may result in poorer overall performance for a Fund
than if it had not engaged in forward contracts, foreign currency futures
contracts and foreign currency options. For a more detailed description of
foreign currencies, see the Statement of Additional Information--Appendix B.
HIGH-YIELD (HIGH-RISK) SECURITIES--The Balanced Fund and Income Fund may
invest in high-yield (high-risk) debt securities. High-yield (high-risk)
securities, also referred to as "junk bonds," are those securities that are
rated lower than investment-grade and unrated securities of comparable
quality. Although these securities generally offer higher yields than
investment-grade securities with similar maturities, lower-quality securities
involve greater risks, including the possibility of default or bankruptcy. In
general, they are regarded to be predominantly speculative with respect to the
issuer's capacity to pay interest and repay principal. Other potential risks
associated with investing in high-yield securities include: substantial
market-price volatility resulting from changes in interest rates, changes in
or uncertainty about economic conditions and changes in the actual or
perceived ability of the issuer to meet its obligations; greater sensitivity
of highly leveraged issuers to adverse economic changes and individual-issuer
developments; subordination to the prior claims of other creditors; and
adverse publicity and changing investor perceptions about these securities.
As with any other asset in a Fund's portfolio, any reduction in the value of
such securities as a result of the factors listed above would be reflected in
the net asset value of a Fund. In addition, a Fund that invests in lower-
quality securities may incur additional expenses to the extent it is required
to seek recovery upon a default in the payment of principal and interest on
its holdings. As a result of the associated risks, successful investments in
high-yield (high-risk) securities will be more dependent on the adviser's and
subadviser's credit analysis than generally would be the case with investments
in investment-grade securities. Lower-quality securities tend to be less
liquid than higher-quality debt securities because the market for them is not
as broad or active. The lack of a liquid secondary market may have an adverse
effect on market price and a Fund's ability to sell particular securities. For
a description of ratings, see Appendix A. For a more detailed description of
high-yield (high-risk) securities, see the Statement of Additional
Information--Appendix B.
ILLIQUID SECURITIES--The Balanced Fund and Income Fund each may invest up to
10% of their respective net assets in securities that are illiquid. Variable
and floating rate instruments that cannot be disposed of within seven days and
repurchase agreements and time deposits that do not provide for payment within
seven days after notice, without taking a reduced price, are subject to these
limits. The Small Cap Growth Fund, International Equity Fund, Socially
Responsible Fund, Balanced Fund and Income Fund may purchase securities which
are not registered under the Securities Act of 1933 (the "1933 Act") but which
can be sold to "qualified institutional buyers" in accordance with Rule 144A
under the 1933 Act if they are determined to be liquid. Any such security will
be considered liquid so long as it is determined by the subadviser that an
adequate trading market exists for that security. This investment practice
could have the effect of increasing the level of illiquidity in a Fund during
any period that qualified institutional buyers become uninterested in
purchasing these restricted securities. As a matter of operating policy, each
Fund will purchase only Rule 144A securities that carry registration rights,
will invest only in Rule 144A securities that are deemed to be liquid and will
limit its investment in Rule 144A securities to 20% of each Fund's net assets.
The Growth Fund and Short-Term Investment Fund may not invest in restricted
securities or securities not fully marketable.
INVESTMENT COMPANIES--In connection with the management of its daily cash
position, the Small Cap Growth Fund may invest in securities issued by other
investment companies which invest in short-term debt securities and which seek
to maintain a $1.00 net asset value per share. The International Equity Fund
may purchase shares of investment companies investing primarily in foreign
securities, including so-called "country funds." Country funds have portfolios
consisting exclusively of securities of issuers located in one foreign
country. As a shareholder of another investment company, a Fund would bear,
along with other shareholders, its pro rata portion of the other company's
expenses, including advisory fees. These expenses would be in addition to the
expenses each bears directly in connection with its own operations.
MORTGAGE-BACKED SECURITIES--The Balanced Fund and Income Fund may invest in
mortgage-backed securities. Mortgage-backed securities represent interests in
pools of mortgage loans made by lenders such as commercial banks and savings
and loan institutions. Pools of mortgage loans are assembled for sale to
investors by various government-related organizations. The principal
government guarantor of mortgage-backed securities is the Government National
Mortgage Association ("GNMA"). GNMA is authorized to guarantee,
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<PAGE>
with the full faith and credit of the U.S. Government, the timely payment of
principal and interest on GNMA securities. Mortgage loans are pooled by
various other governmental entities including the Federal Home Loan Mortgage
Corporation ("FHLMC") and the Federal National Mortgage Association ("FNMA").
FHLMC is a corporate instrumentality of the U.S. Government and FNMA is a
government-sponsored corporation owned entirely by private stockholders.
Mortgage-backed securities differ from traditional debt securities. Among
the major differences are that interest and principal payments are made more
frequently, usually monthly, and that principal may be prepaid at any time
because the underlying mortgage loans generally may be prepaid at any time.
Since prepayment rates vary widely, it is not possible to accurately predict
the average maturity of a particular mortgage-backed pool; however, statistics
published by the Federal Housing Authority indicate that the average life of
mortgages with 25- to 30-year maturities (the type of mortgages backing the
vast majority of mortgage-backed securities) is approximately 12 years.
Mortgage-backed securities may decrease in value as a result of increases in
interest rates and may benefit less than other fixed-income securities from
declining interest rates because of the risk of prepayment. For a more
detailed description of mortgage-backed securities, see the Statement of
Additional Information--Appendix B.
COLLATERALIZED MORTGAGE OBLIGATIONS (CMOS) AND MULTICLASS PASS-THROUGH
SECURITIES--CMOs are debt obligations collateralized by mortgage loans or
mortgage pass-through securities. Typically, CMOs are collateralized by GNMA,
FNMA or FHLMC Certificates, but also may be collateralized by whole loans or
private mortgage pass-through securities ("Mortgage Assets"). Multiclass pass-
through securities are equity interests held in a trust composed of Mortgage
Assets. Payments of principal and of interest on the Mortgage Assets, and any
reinvestment income thereon, provide the capital to pay debt service on the
CMOs or make scheduled distributions on the multiclass pass-through
securities. CMOs may be issued by agencies or instrumentalities of the U.S.
Government or by private originators of, or investors in, mortgage loans,
including depository institutions, mortgage banks, investment banks and
special purpose subsidiaries of the foregoing.
In a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of CMOs is issued at a specific fixed or floating coupon rate and
has a stated maturity or final distribution date. Principal prepayments on the
Mortgage Assets may cause the CMOs to be retired substantially earlier than
their stated maturities or final distribution dates. Interest is paid or
accrues on all classes of CMOs on a monthly, quarterly or semi-annual basis.
The principal of and interest on the Mortgage Assets may be allocated among
the several classes of a CMO series in a number of different ways. Generally,
the purpose of the allocation of the cash flow of a CMO to the various classes
is to obtain a more predictable cash flow to the individual class than exists
with the underlying collateral of the CMO. As a general rule, the more
predictable the cash flow to a particular CMO the lower the anticipated yield
will be on that class at the time of issuance relative to prevailing market
yields on mortgage-backed securities.
The Balanced Fund and Income Fund also may invest in, among other things,
parallel pay CMOs and Planned Amortization Cost CMOs ("PAC Bonds"). Parallel
pay CMOs are structured to provide payments of principal on each payment date
to more than one class. These simultaneous payments are taken into account in
calculating the stated maturity date or final distribution date of each class,
which, as with other CMO structures, must be retired by its stated maturity
date or final distribution date but may be retired earlier. PAC Bonds
generally require payments of a specified amount of principal on each payment
date. PAC Bonds always are parallel pay CMOs with the required principal
payment on such securities having the highest priority after interest has been
paid to all classes.
ASSET-BACKED SECURITIES--The Balanced Fund and Income Fund may invest in
asset-backed securities. Asset-backed securities are pooled in pass-through
structures similar to the mortgage pass-through structures described above.
Through the use of trusts and special purpose corporations, various types of
assets, primarily automobile and credit card receivables, are pooled and
securitized. Asset-backed securities generally do not have the benefit of the
same security interest in the related collateral as is the case with mortgage-
backed securities. There is the possibility that recoveries on repossessed
collateral may not, in some cases, be available to support payments on these
securities.
Asset-backed securities present certain risks that are not presented by
mortgage-backed securities. Credit card receivables are generally unsecured
and the debtors are entitled to the protection of a number of state and
federal consumer credit laws, some of which may reduce the ability to obtain
full payment. In the case of automobile receivables, the securities interest
in the underlying automobiles are often not transferred when the pool is
created, with the resulting possibility that the collateral could be resold.
In general, these types of loans are of shorter average life than mortgage
loans and are less likely to have substantial prepayments. For a more detailed
description of asset-backed securities, see the Statement of Additional
Information--Appendix B.
RISK FACTORS RELATING TO INVESTING IN MORTGAGE-BACKED AND ASSET-BACKED
SECURITIES--The yield characteristics of mortgage-backed and asset-backed
securities differ from traditional debt securities. Among the major
differences are that interest and principal payments are made more frequently,
usually monthly, and that principal may be prepaid at any time because the
underlying mortgage loans or other assets generally may be prepaid at any
time. As a result, if a portfolio purchases such a security at a premium, a
prepayment rate that is faster than expected will reduce yield to maturity,
while a prepayment rate that is slower than expected will have the opposite
effect of increasing yield to maturity. Alternatively,
7
<PAGE>
if a fund purchases these securities at a discount, faster than expected
prepayments will increase, while slower than expected prepayments will reduce,
yield to maturity. In addition, mortgage-backed securities which are secured
by manufactured (mobile) homes and multi-family residential properties, such
as GNMA and FNMA certificates, are subject to a higher risk of default than
are other types of mortgage-backed securities.
Although the extent of prepayments on a pool of mortgage loans depends on
various economic and other factors, as a general rule prepayments on fixed-
rate mortgage loans will increase during a period of falling interest rates
and decrease during a period of rising interest rates. Accordingly, amounts
available for reinvestment by a portfolio are likely to be greater during a
period of declining interest rates and, as a result, are likely to be
reinvested at lower interest rates than during a period of rising interest
rates. Asset-backed securities, although less likely to experience the same
prepayment rates as mortgage-backed securities, may respond to certain of the
same factors influencing prepayments, while at other times different factors
will predominate. Mortgage-backed securities and asset-backed securities may
decrease in value as a result of increases in interest rates and may benefit
less than other fixed-income securities from declining interest rates because
of the risk of prepayment.
ADJUSTABLE RATE MORTGAGE SECURITIES--The Balanced Fund and Income Fund may
invest in adjustable rate mortgage securities. Adjustable rate mortgage
securities are pass-through mortgage securities collateralized by mortgages
with adjustable rather than fixed rates. For a more detailed description of
adjustable rate mortgage securities, see the Statement of Additional
Information--Appendix B.
OPTIONS AND FUTURES CONTRACTS--To the extent consistent with their
respective investment objectives, the Small Cap Growth Fund, International
Equity Fund and Socially Responsible Fund may write covered call options, buy
put options, buy call options and write secured put options for the purpose of
hedging or earning additional income, which may be deemed speculative or, with
respect to the International Equity Fund, cross-hedging. These options may
relate to particular securities, financial instruments, foreign currencies,
stock or bond indices or the yield differential between two securities, and
may or may not be listed on a securities exchange and may or may not be issued
by the Options Clearing Corporation. Options trading is a highly specialized
activity that entails greater than ordinary investment risks. In addition,
unlisted options are not subject to the protections afforded purchasers of
listed options issued by the Options Clearing Corporation, which performs the
obligations of its members if they default.
To the extent consistent with its investment objective, the Small Cap Growth
Fund, the International Equity Fund and the Socially Responsible Fund may also
invest in futures contracts and options on futures contracts to commit funds
awaiting investment in stocks or maintain cash liquidity or for other risk
management purposes. The value of a Fund's contracts may equal or exceed 100%
of the Fund's total assets, although a Fund will not purchase or sell a
futures contract unless immediately afterwards the aggregate amount of margin
deposits on its existing futures positions plus the amount of premiums paid
for related futures options entered into for other than risk management
purposes is 5% or less of its net assets. For a more detailed description of
options and futures, see the Statement of Additional Information--Appendix B.
Futures contracts obligate a Fund, at maturity, to take or make delivery of
securities, the cash value of a securities index or a stated quantity of a
foreign currency. A Fund may sell a futures contract in order to offset an
expected decrease in the value of its portfolio positions that might otherwise
result from a market decline or currency exchange fluctuation. A Fund may do
so either to hedge the value of its securities portfolio as a whole, or to
protect against declines occurring prior to sales of securities in the value
of the securities to be sold. In addition, a Fund may utilize futures
contracts in anticipation of changes in the composition of its holdings or in
currency exchange rates.
The Small Cap Growth Fund, International Equity Fund and Socially
Responsible Fund may purchase and sell call and put options on futures
contracts traded on an exchange or board of trade. When a Fund purchases an
option on a futures contract, it has the right to assume a position as a
purchaser or a seller of a futures contract at a specified exercise price
during the option period. When a Fund sells an option on a futures contract,
it becomes obligated to sell or buy a futures contract if the option is
exercised. In connection with a Fund's position in a futures contract or
related option, the Fund will create a segregated account of liquid high grade
assets or will otherwise cover its position in accordance with applicable SEC
requirements.
The primary risks associated with the use of futures contracts and options
are: (a) the imperfect correlation between the change in market value of the
instruments held by a Portfolio and the price of the futures contract or
option; (b) possible lack of liquid secondary market for a futures contract
and the resulting inability to close a futures contract when desired; (c)
losses caused by unanticipated market movements, which are potentially
unlimited; and (d) a subadviser's inability to predict correctly the direction
of securities prices, interest rates, currency exchange rates and other
economic factors.
The Funds intend to comply with the regulations of the Commodity Futures
Trading Commission exempting the Funds from registration as a "commodity pool
operator."
PORTFOLIO TURNOVER RATES--Under normal market conditions, it is expected
that the annual portfolio turnover rate for the Small Cap Growth Fund,
International Equity Fund and Socially Responsible Fund will, generally not
exceed 150% and for the Growth Fund, Balanced Fund and Income Fund will
generally not exceed 100%. A Fund's annual portfolio turnover rate will not,
however, be a factor preventing a sale or purchase when the adviser or
subadviser believes investment considerations warrant such sale or purchase. A
Fund's portfolio turnover may vary greatly from year to year as well as within
a
8
<PAGE>
particular year. High portfolio turnover in any year may make it more
difficult to comply with the requirements of Subchapter M of the Internal
Revenue Code, and may generate additional dealer mark-ups or underwriting
commissions as well as other transaction costs, including correspondingly
higher annual brokerage commissions.
REPURCHASE AGREEMENTS--Each Fund may invest in repurchase agreements. The
Growth Fund, Balanced Fund, Income Fund and Short-Term Investment Fund will
not enter into repurchase agreements if, as a result, more than 10% of the
Fund's total assets would be subject to repurchase agreements maturing in more
than seven days. Repurchase agreements are instruments under which a Fund
acquires ownership of a security and the seller agrees, at the time of the
sale, to repurchase the security at a mutually agreed upon time and price,
thereby determining the yield during a Fund's holding period. A Fund entering
into a repurchase agreement is exposed to the risk that the other party to the
agreement may be unable to keep its commitment to repurchase. In that event, a
Fund may incur disposition costs in connection with liquidating the collateral
(i.e., the underlying security). Moreover, if bankruptcy proceedings are
commenced with respect to the selling party, receipt of the value of the
collateral may be delayed or substantially limited and a loss may be incurred
if the collateral securing the repurchase agreement declines in value during
the bankruptcy proceedings. The Funds believe that these risks are not
material inasmuch as each Fund will evaluate the creditworthiness of all
entities with which it proposes to enter into repurchase agreements, and will
seek to assure that each arrangement is adequately collateralized. For a more
detailed description of repurchase agreements, see the Statement of Additional
Information--Appendix B.
REVERSE REPURCHASE AGREEMENTS AND OTHER BORROWINGS--Each Fund is authorized
to borrow money. If the securities held by a Fund should decline in value
while borrowings are outstanding, the net asset value of the Fund's
outstanding shares will decline in value by proportionately more than the
decline in value suffered by the Fund's securities. Each Fund may borrow
through reverse repurchase agreements under which a Fund sells portfolio
securities to financial institutions such as banks and broker-dealers and
agrees to repurchase them at a particular date and price. A Fund may use the
proceeds of the reverse repurchase agreements to purchase other securities
either maturing or under an agreement to resell on a date simultaneous with or
prior to the expiration of the reverse repurchase agreement. This use of
reverse repurchase agreements may be regarded as leveraging and, therefore,
speculative. Reverse repurchase agreements involve the risks that the interest
income earned in the investment of the proceeds will be less than the interest
expense, that the market value of the securities sold by a Fund may decline
below the price of the securities a Fund is obligated to repurchase and that
the securities may not be returned to a Fund. During the time a reverse
repurchase agreement is outstanding, a Fund will maintain a segregated account
with its custodian containing cash, U.S. Government or other appropriate liquid
high-grade debt securities having a value at least equal to the repurchase
price. For the Small Cap Growth Fund, International Equity Fund and Socially
Responsible Fund, reverse repurchase agreements, together with any other
borrowings, will not exceed, in the aggregate, 33 1/3% of the value of its
total assets. In addition, whenever borrowings exceed 5% of a Fund's total
assets, these Funds will not make any additional investments. For the Growth
Fund, Balanced Fund, Income Fund and Short-Term Investment Fund, repurchase
agreements, together with other borrowings, will not exceed 15% of a Fund's
total assets taken at market value. If the asset coverage for such borrowings
falls below 300%, these Funds will reduce, within three days, the amount of its
borrowings to provide for 300% asset coverage. The Growth Fund, Balance Fund,
Income Fund and Short-Term Investment Fund will repay all borrowings before
making additional investments. For a more detailed description of reverse
repurchase agreements, see the Statement of Additional Information--Appendix B.
SECURITIES LENDING--The Small Cap Growth Fund, International Equity Fund and
Socially Responsible Fund may seek additional income by lending securities on
a short-term basis. The securities lending agreements will require that the
loans be secured by collateral in cash, U.S. Government securities or
irrevocable bank letters of credit maintained on a current basis equal in
value to at least the market value of the loaned securities. These Funds may
not make such loans in excess of 33 1/3% of the value of its total assets.
Securities loans involve risks of delay in receiving additional collateral or
in recovering the loaned securities, or possibly loss of rights in the
collateral if the borrower of the securities becomes insolvent. The Growth
Fund, Balanced Fund, Income Fund and Short-Term Investment Fund may not make
loans to other persons, except by the purchase of obligations in which the
Fund is authorized to invest.
STRATEGIC TRANSACTIONS--The International Equity Fund and Socially
Responsible Fund may engage in so-called "strategic transactions," and in this
regard, the Funds may purchase and sell exchange-listed and over-the-counter
put and call options on securities, on securities indices and on other
financial instruments, purchase and sell financial futures contracts and
options thereon, enter into various interest rate transactions such as swaps,
caps, floors or collars, enter into various currency transactions such as
currency forward contracts, currency futures contracts, currency swaps or
options on currencies or currency futures, purchase and sell derivatives and
other similar instruments, and engage in other similar or related investment
techniques or strategies. Any or all of these investment techniques or
strategies may be used at any time and there is no particular technique or
strategy that dictates the use of one technique or strategy rather than
another, as use of any "strategic transaction" is a function of numerous
variables, including market conditions.
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<PAGE>
Although certain "strategic transactions" may be used to enhance potential
gain, the Funds will not enter into any "strategic transactions" for non-
hedging purposes if, as a result of entering into any such transactions, more
than 5% of a Fund's total assets would then be committed for non-hedging
purposes. "Strategic transactions" involving financial futures and options
thereon will be purchased, sold or entered into only for bona fide hedging,
risk management or portfolio management purposes and not for speculative
purposes, and with respect to transactions which do not qualify as hedging
transactions within the meaning of applicable regulations of the Commodity
Futures Trading Commission, the Funds will not enter into futures contracts or
related options if, as a result of entering into such futures contracts or
related options, the aggregate initial margin and premiums for establishing
all such positions exceed 5% of the fair market value of such Fund's net
assets, not including any in-the-money amount on any such options in computing
such 5%. The Funds will comply with applicable regulatory requirements when
implementing these "strategic transactions." For a more detailed description
of strategic transactions, see the Statement of Additional Information--
Appendix B.
U.S. GOVERNMENT OBLIGATIONS--Each Fund may invest in U.S. Government
obligations. U.S. Government obligations are direct obligations of the U.S.
Government and are supported by the full faith and credit of the U.S.
Government. U.S. Government agency securities are issued or guaranteed by U.S.
Government-sponsored enterprises and federal agencies. Some of these
securities are backed by the full faith and credit of the U.S. Government;
others are backed by the agency's right to borrow a specified amount from the
U.S. Treasury; and still others, while not guaranteed directly or indirectly
by the U.S. Government, are backed with collateral in the form of cash,
Treasury securities or debt instruments that the lending institution has
acquired through its lending activities. For a more detailed description of
U.S. Government obligations, see the Statement of Additional Information--
Appendix B.
WHEN-ISSUED PURCHASES AND FORWARD COMMITMENTS--The Small Cap Growth Fund,
International Equity Fund, Socially Responsible Fund, Balanced Fund and Income
Fund each may purchase securities on a "when-issued" basis and may purchase or
sell securities on a "forward commitment" basis. These transactions 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),
and permit a Fund to lock in a price or yield on a security it owns or intends
to purchase, regardless of future changes in interest rates. When-issued and
forward commitment transactions involve the risk, however, that the price or
yield obtained in a transaction may be less favorable than the price or yield
available in the market when the securities delivery takes place. Each Fund's
when-issued purchases and forward commitments are not expected to exceed 25%
of the value of its total assets absent unusual market conditions. The Funds
do not intend to engage in when-issued purchases and forward commitments for
speculative purposes but only in furtherance of their investment objectives.
For a more detailed description of when-issued purchases and forward
commitments, see the Statement of Additional Information--Appendix B.
MANAGEMENT
The overall responsibility for the supervision of the affairs of the Funds
vests in the Board of Trustees. As described below, the Board has contracted
with others to provide certain services to the Funds.
INVESTMENT ADVISER AND MANAGER, HORACE MANN INVESTORS, INC.
The Trust employs Horace Mann Investors, Inc. ("Investors") to manage the
investment and reinvestment of the assets of the Funds and to continuously
review, supervise and administer the Funds' investment programs. Additionally,
Investors provides for the management of the business affairs of each Fund
including, but not limited to, office space, secretarial and clerical
services, bookkeeping services, wire and telephone communications services and
other services of this nature necessary for the proper management of each
Fund's business affairs.
Investors, located at One Horace Mann Plaza, Springfield, Illinois 62715-
0001, is registered with the Securities and Exchange Commission as a broker-
dealer and is a member of the National Association of Securities Dealers, Inc.
("NASD"). Investors and Allegiance Life Insurance Company ("ALIC") are wholly
owned subsidiaries of Horace Mann Educators Corporation ("HMEC"). Horace Mann
Life Insurance Company ("HMLIC"), which sponsors HMLIC's separate accounts, is
a wholly owned subsidiary of ALIC.
Investors is a newly registered investment adviser and has not previously
advised a registered investment company; however, its personnel are
responsible for overseeing the investment of Horace Mann Life Insurance
Company's $2.8 billion of assets. Further, each Fund is advised by a
subadviser pursuant to an Investment Sub Advisory Agreement with Investors
(the "Sub Advisory Agreement") and, as noted below, each subadviser has
substantial experience in managing the assets of registered investment
companies.
As compensation for its services, the Small Cap Growth Fund, International
Equity Fund and Socially Responsible Fund each pay Investors a monthly
management fee. The management fees provided by the contract with Investors
are higher than the management fees charged by most mutual funds. This is
true, in part, because each of the Funds, particularly the Small Cap Growth
Fund, incurs above average expenses for research and advice due to the
specialized nature of these Funds' investment portfolios.
The contractual fees are:
<TABLE>
<S> <C>
Small Cap Growth Fund....................................... 1.40% of Net Assets
International Equity Fund................................... 1.10% of Net Assets
Socially Responsible Fund................................... .95% of Net Assets
</TABLE>
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<PAGE>
However, for the first year of operations, Investors is voluntarily reducing
these management fees by .40%. The actual fees to be charged, net of the
portion waived, for the Socially Responsible and International Equity Funds
are less than the fees actually charged by most other funds of a similar type.
The actual management fees to be charged are accrued daily and are
calculated by applying the following annual percentage rate to the Fund's
average daily net assets for the respective month. The fees during the first
year of operations net of waivers are:
SMALL CAP GROWTH FUND
1.00% on the first $25,000,000
0.75% on all assets over $25,000,000
INTERNATIONAL EQUITY FUND
During the first six months
0.35% on the first $40,000,000
0.25% on the next $60,000,000
0.225% on all assets over $100,000,000
During the second six months
0.525% on the first $40,000,000
0.375% on the next $60,000,000
0.3375% on all assets over $100,000,000
SOCIALLY RESPONSIBLE FUND
0.55% on the first $20,000,000
0.45% on the next $20,000,000
0.30% on the next $60,000,000
0.275% on all assets over $100,000,000
In addition, for the first year of operations, Investors is voluntarily
reimbursing each Fund for all ordinary operating expenses other than trustees'
fees.
As compensation for its services, the Growth Fund, Balanced Fund, Income
Fund and Short-Term Investment Fund each pay Investors a two-part advisory fee
at the end of each month. Under part one, each Fund's fee is accrued daily and
is calculated on a pro rata basis by applying the following annual percentage
rates to the aggregate of all four Funds' daily net assets for the respective
month:
PART 1:
<TABLE>
<CAPTION>
NET ASSETS RATE
----------------------- -----
<S> <C> <C>
Growth Fund
Balanced Fund On initial $100 million .250%
Income Fund Over $100 million .200%
Short-Term Investment Fund
</TABLE>
PART 2:
For part two, each Fund's advisory fee is accrued daily and is calculated by
applying the following annual percentage rates to the average daily net assets
of each Fund for the respective month.
<TABLE>
<CAPTION>
NET ASSSETS RATE
----------------------- ------
<S> <C> <C>
Growth Fund On initial $100 million 0.400%
On next $100 million 0.300%
Over $200 million 0.250%
Balanced Fund On initial $100 million 0.325%
On next $100 million 0.275%
On next $300 million 0.225%
Over $500 million 0.200%
Income Fund On initial $100 million 0.250%
On next $100 million 0.200%
Over $200 million 0.150%
Short-Term Investment Fund On initial $100 million 0.125%
On next $100 million 0.100%
Over $200 million 0.075%
</TABLE>
The Investment Advisory Agreement authorizes Investors (subject to the
discretion and control of the Funds' Board of Trustees) to select the brokers
or dealers that will execute the purchases and sales of portfolio securities
and requires Investors to use its best efforts to obtain the best available
price and most favorable execution.
The Funds will bear the expenses related to their legal, custodial,
independent accounting and auditing, transfer agent, registrars' and other
agents' services; costs related to reports, notices and proxy material;
compensation and expenses of independent Trustees; stock issuance expenses;
brokers' commissions; taxes and fees payable to governmental agencies; and
expenses of shareholders' and Trustees' meetings.
THE SUBADVISERS
GROWTH FUND. Wellington Management Company, LLP ("Wellington Management"), a
registered investment adviser, serves as the investment subadviser of the
Growth Fund pursuant to a Subadvisory Agreement with Investors. Wellington
Management is responsible for managing the Fund, subject to the direction of
the Board of Trustees and Investors. Wellington Management has approximately
$140 billion under management and manages over 80 investment companies.
For such services, Investors pays Wellington Management a percentage rate
based on the Fund's average daily net assets for the respective month. The
rates are as follows:
<TABLE>
<CAPTION>
NET ASSETS RATE
- ---------- ------
<S> <C>
On initial $100 million.................................................. 0.400%
On next $100 million..................................................... 0.300%
Over $200 million........................................................ 0.250%
</TABLE>
John R. Ryan, CFA, Senior Vice President and Managing Partner of Wellington
Management, began providing investment advice to the Growth Fund and stock
portion of the Balanced Fund on November 1, 1989, and assumed primary
11
<PAGE>
responsibility for the day-to-day investment management of the Growth Fund and
stock portion of the Balanced Fund on December 1, 1992. Mr. Ryan has been a
portfolio manager with Wellington Management's Value/Yield investment team
since 1981 and has held the position of Senior Vice President of Wellington
Management since 1987. Mr. Ryan became a Managing Partner of the firm on
January 1, 1996.
SMALL CAP GROWTH FUND. PNC Equity Advisors Company ("PEAC"), a registered
investment adviser, serves as the investment subadviser of the Small Cap
Growth Fund pursuant to a Subadvisory Agreement with Investors. PEAC is
responsible for managing the Fund, subject to the direction of the Board of
Trustees and Investors. PEAC has approximately $2.5 billion under management
and manages four other investment company portfolios.
For such services, Investors pays PEAC a percentage rate based on the Fund's
average daily net assets for the respective month. The rates are as follows:
<TABLE>
<CAPTION>
NET ASSETS RATE
- ---------- -----
<S> <C>
On initial $25,000,000.................................................... 1.00%
Over $25,000,000.......................................................... 0.75%
</TABLE>
William J. Wykle manages the portfolio. He has been an investment manager
with PEAC since 1995 and has been an investment manager with PNC Bank,
National Association since 1986.
INTERNATIONAL EQUITY FUND. Scudder, Stevens & Clark, Inc. ("SSC"), a
registered investment adviser, serves as the investment subadviser of the
International Equity Fund pursuant to a Subadvisory Agreement with Investors.
SSC is responsible for managing the Fund, subject to the direction of the
Board of Trustees and Investors. SSC has over $100 billion under management
and manages over 50 mutual fund portfolios, including 10 non-U.S. investment
companies.
For such services, Investors pays SSC a percentage rate based on the Fund's
average daily net assets for the respective month. The rates are as follows:
<TABLE>
<CAPTION>
NET ASSETS RATE
- ---------- ------
<S> <C>
DURING THE FIRST SIX MONTHS:
On initial $40,000,000................................................... 0.35%
On next $60,000,000...................................................... 0.25%
Over $100,000,000........................................................ 0.225%
</TABLE>
<TABLE>
<S> <C>
DURING THE SECOND SIX MONTHS:
On initial $40,000,000.................................................. 0.525%
On next $60,000,000..................................................... 0.375%
Over $100,000,000....................................................... 0.3375%
</TABLE>
<TABLE>
<S> <C>
THEREAFTER:
On initial $40,000,000.................................................... 0.70%
On next $60,000,000....................................................... 0.50%
Over $100,000,000......................................................... 0.45%
</TABLE>
The International Equity Fund is managed by a team of SSC investment
professionals who each play an important role in the Fund's management
process. Team members work together to develop investment strategies and
select securities for the Fund's portfolio. They are supported by SSC's large
staff of economists, research analysts, traders and other investment
specialists who work in SSC's offices across the United States and abroad. SSC
believes its team approach benefits Fund investors by bringing together many
disciplines and leveraging SSC's extensive resources.
Lead Portfolio Manager Carol L. Franklin joined SSC's international
portfolio management team in 1986 and is responsible for setting the Fund's
investment strategy and overseeing security selection for the Fund's
portfolio. Ms. Franklin, who has 19 years of experience in finance and
investing, joined SSC in 1981.
Joan Gregory, Portfolio Manager, focuses on stock selection, a role she has
played since she joined SSC in 1992. Ms. Gregory, who joined the team in 1994,
has been involved in investment in global and international stocks as an
assistant portfolio manager since 1989.
SOCIALLY RESPONSIBLE FUND. SSC also serves as the investment subadviser of
the Socially Responsible Fund.
For such services, Investors pays SSC a percentage rate based on the Fund's
average daily net assets for the respective month. The rates are as follows:
<TABLE>
<CAPTION>
NET ASSETS RATE
- ---------- ------
<S> <C>
On initial $20,000,000................................................... 0.55%
On next $20,000,000...................................................... 0.45%
On next $60,000,000...................................................... 0.30%
Over $100,000,000........................................................ 0.275%
</TABLE>
Lori J. Ensinger and Robert T. Hoffman will manage the portfolio.
Lori J. Ensinger joined SSC in 1993 as a member of the portfolio team of the
Growth & Income Equity Management Group. Lori is a co-manager of the SSC and
AARP Growth & Income Funds, manager of the Socially Responsive Equity Trust,
and also contributes to the investment decision-making for institutional
portfolios. She also has primary client service responsibilities for
institutional clients. Prior to joining SSC, Lori was a Senior Portfolio
Manager at Prudential Securities Investment Management where she managed
portfolios for institutions and individuals.
Robert T. Hoffman joined SSC in 1990. Since then he has been involved in all
aspects of investment decision-making for the Growth and Income Equity
Management Group and currently directs the investment management of all assets
managed under the Growth and Income approach.
BALANCED FUND. Wellington Management Company, LLP ("Wellington Management"),
a registered investment adviser, serves as the investment subadviser of the
Balanced Fund
12
<PAGE>
pursuant to a Subadvisory Agreement with Investors. Wellington Management is
responsible for managing the Fund, subject to the direction of the Board of
Trustees and Investors. Wellington Management has approximately $140 billion
under management and manages over 80 investment companies.
For such services, Investors pays Wellington Management a percentage rate
based on the Fund's average daily net assets for the respective month. The
rates are as follows:
<TABLE>
<CAPTION>
NET ASSETS RATE
- ---------- ------
<S> <C>
On initial $100 million.................................................. 0.325%
On next $100 million..................................................... 0.275%
On next $300 million..................................................... 0.225%
Over $500 million........................................................ 0.200%
</TABLE>
John R. Ryan manages the stock portion of the Balanced Fund and Robert D.
Payne manages the bond portion of Balanced Fund. See "The Subadvisers--Growth
Fund" and "--Income Fund."
INCOME FUND. Wellington Management Company, LLP ("Wellington Management"), a
registered investment adviser, serves as the investment subadviser of the
Income Fund pursuant to a Subadvisory Agreement with Investors. Wellington
Management is responsible for managing the Fund, subject to the direction of
the Board of Trustees and Investors. Wellington Management has approximately
$140 billion under management and manages over 80 investment companies.
For such services, Investors pays Wellington Management a percentage rate
based on the Fund's average daily net assets for the respective month. The
rates are as follows:
<TABLE>
<CAPTION>
NET ASSETS RATE
- ---------- ------
<S> <C>
On initial $100 million.................................................. 0.250%
On next $100 million..................................................... 0.200%
Over $200 million........................................................ 0.150%
</TABLE>
Robert D. Payne, CFA, Senior Vice President of Wellington Management,
assumed primary responsibility for the day-to-day investment management of the
Income Fund and the bond portion of the Balanced Fund on March 10, 1997. Mr.
Payne has been a portfolio manager with Wellington Management's fixed-income
group since 1972 and held the position of Vice President from 1972 until he
was promoted to Senior Vice President of Wellington Management in January
1996.
SHORT-TERM INVESTMENT FUND. Wellington Management Company, LLP ("Wellington
Management"), a registered investment adviser, serves as the investment
subadviser of the Short-Term Investment Fund pursuant to a Subadvisory
Agreement with Investors. Wellington Management is responsible for managing
the Fund, subject to the direction of the Board of Trustees and Investors.
Wellington Management has approximately $140 billion under management and
manages over 80 investment companies.
For such services, Investors pays Wellington Management a percentage rate
based on the Fund's average daily net assets for the respective month. The
rates are as follows:
<TABLE>
<CAPTION>
NET ASSETS RATE
- ---------- ------
<S> <C>
On initial $100 million.................................................. 0.125%
On next $100 million..................................................... 0.100%
Over $200 million........................................................ 0.075%
</TABLE>
John C. Keogh, Senior Vice President of Wellington Management, began
providing investment advice to the Short-Term Investment Fund on November 1,
1989 and assumed primary responsibility for the day-to-day investment
management of the Short-Term Investment Fund on September 1, 1991. Mr. Keogh
has been a portfolio manager with Wellington Management's fixed income group
since 1985 and held the position of Vice President from 1984 until he was
promoted to Senior Vice President of Wellington Management in January 1994.
GENERAL. Under the terms of each Subadvisory Agreement, the subadviser
manages its respective Funds, selects investments and places all orders for
purchases and sales of the Fund's securities, subject to the general
supervision of the Board of Trustees and Investors.
TRANSFER AGENT AND DIVIDEND PAYING AGENT
Horace Mann Service Corporation
One Horace Mann Plaza
P.O. Box 4657
Springfield, Illinois 62708-4657
CUSTODIAN AND FUND ACCOUNTING AGENT
State Street Bank and Trust Company
225 Franklin Street
Boston, Massachusetts 02110
INVESTMENT RETURN
The total return from an investment in a Fund is measured by the
distributions received (assuming reinvestment), plus or minus the change in
the net asset value per share for a given period. A total return percentage
may be calculated by dividing the value of a share at the end of the period
(including reinvestment of distributions) by the value of the share at the
beginning of the period and subtracting one. For a given period, average
annual total return may be calculated by finding the average annual compounded
rate that would equate a hypothetical $1,000 investment to the ending
redeemable value.
When comparing a Fund's total return with alternative investments,
purchasers should consider differences between the Fund and the alternative
investments, the periods and methods used in calculation of the return being
compared, and the impact of taxes on alternative investments. Purchasers
should also understand that Fund shares may not be purchased directly and are
available only to fund variable annuity contracts issued by Horace Mann Life
Insurance Company, which include
13
<PAGE>
contract charges that are not reflected in a Fund's total return calculation.
Therefore, the actual investment return to an annuity contract owner, after
deduction of annuity contract charges, will be less than the investment return
of the Fund. Of course, past performance is not necessarily indicative of
future results.
OTHER INFORMATION ON THE PERFORMANCE OF PNC EQUITY ADVISORS COMPANY
The table below sets forth performance information relating to the Compass
Capital Small Cap Growth Equity Portfolio-Investor A Shares ("Compass Capital
Portfolio"), which is also managed by PEAC. The Compass Capital Portfolio is a
portfolio of an open-end management investment company registered under the
Investment Company Act of 1940, as amended (the "1940 Act"), and which has an
investment objective, and investment policies, strategies and risks
substantially similar to those of the Small Cap Growth Fund.
The performance data for the Compass Capital Portfolio is included to
provide investors with the performance record for an account substantially
similar to the Small Cap Growth Fund. In addition, performance information
from the Russell 2000 Growth Index ("Russell 2000") has been included for
comparison. The actual total operating expenses of the Compass Capital
Portfolio were 1.33% for the fiscal year ended September 30, 1996, and vary
from year to year. The maximum total
operating expenses for the Small Cap Growth Fund are estimated to be 4.32%.
However, from time to time, Investors may voluntarily waive fees and reimburse
certain expenses. For the first year of operations, the annual total operating
expenses are estimated to be 1.34%. Had the maximum total operating expenses
for the Small Cap Fund been used to calculate the performance of the Compass
Capital Portfolio, the performance of the Compass Capital Portfolio would have
been lower.
The Compass Capital Portfolio performance data does not represent the past,
present or future performance of the Small Cap Growth Fund. Past performance
is no guarantee of future results; investors should not consider this
performance data as an indication of future performance of the Small Cap
Growth Fund or of PEAC. Share prices and investment returns will fluctuate
reflecting market conditions and cash flows, as well as changes in company-
specific fundamentals of portfolio securities. Consequently, investments in
either the Compass Capital Portfolio or the Small Cap Growth Fund may be worth
more or less than their original cost at the time of redemption. The
performance presentation is not audited.
All returns presented were calculated on a total return basis and include
all dividends and interest, accrued income and realized and unrealized gains
and losses. Performance reflects the deduction of a 4.5% front-end sales
charge for the Compass Capital Portfolio. The Small Cap Growth Fund does not
have a front-end sales charge. All returns also reflect the brokerage costs
borne by the Compass Capital Portfolio for all periods presented. The use of a
different methodology to calculate performance could result in different
performance data.
AVERAGE ANNUAL TOTAL RETURNS(/1/)(/2/)
<TABLE>
<CAPTION>
COMPASS
YEAR OR PERIODS CAPITAL RUSSELL
ENDED 3/31/97 PORTFOLIO(/3/) 2000(/4/)
- --------------- -------------- ---------
<S> <C> <C>
One Year............................................... (10.64%) (5.82%)
Three Years............................................ 17.88% 9.90%
From Inception (9/14/93)............................... 14.41% N/A
</TABLE>
(/1/) Service providers for the Compass Capital Portfolio have voluntarily
waived certain expenses of the portfolio; without such waivers the portfolio's
total operating expenses would have been 1.69% for the fiscal year ended
9/30/96 and the performance quoted would have been lower.
(/2/) Total Return Calculation--The Fund commenced operations on September 14,
1993. Class A shares were introduced on September 15, 1993. In accordance with
Securities and Exchange Commission policy, performance information presented
for Class A shares prior to their introduction date does not reflect service
and distribution fees and certain other expenses borne by Class A shares
which, if reflected, would reduce the performance quoted. Investors should
note that the information presented for Class A shares prior to their
introduction is based upon historical expenses of the predecessor class, which
do not reflect the actual expenses that an investor would incur as a holder of
Class A shares of the Fund.
(/3/) Had the sales charge not been reflected, the performance figures for the
one year, three years and since inception periods would have been (6.43%),
19.69% and 16.03%, respectively.
(/4/) Total return data is presented for each period. The Russell 2000 is an
unmanaged securities index composed of those Russell 2000 securities with a
greater-than-average growth orientation. The Russell 2000 reflects the
reinvestment of dividends and capital gain distributions, if any, but does not
reflect fees, brokerage commissions or other expenses of investing. The
Russell 2000 is an unmanaged securities index, and an investment cannot be
made directly in the Russell 2000.
OTHER INFORMATION ON THE PERFORMANCE OF SCUDDER, STEVENS & CLARK
INTERNATIONAL EQUITY PERFORMANCE. The table below sets forth performance
information relating to the International Portfolio of the Scudder Variable
Life Investment Fund ("Scudder International Portfolio") that is also managed
by SSC. The Scudder International Portfolio is a portfolio of an open-end
management investment company registered under the 1940 Act and which has
investment objectives, policies, strategies and risks substantially similar to
those of the International Equity Fund.
The performance data for the Scudder International Portfolio is included to
provide investors with the performance record for an account substantially
similar to the International Equity Fund. In addition, performance information
from the Morgan Stanley Capital International Europe, Australia, Far East
Index ("MSCI EAFE Index") has been included for comparison. The actual total
operating expenses of the Scudder International Portfolio were 1.05% in 1996,
and vary from year to year. The
14
<PAGE>
maximum total operating expenses for the International Equity Fund are
estimated to be 4.30%. However, from time to time, Investors may voluntarily
waive fees and reimburse certain expenses. For the first year of operations,
the annual total operating expenses are estimated to be 1.04%. Had the maximum
total operating expenses for the Horace Mann International Equity Fund been
used to calculate performance, performance would have been lower.
The Scudder International Portfolio performance data does not represent the
past, present or future performance of the International Equity Fund. Past
performance is no guarantee of future results; investors should not consider
this performance data as an indication of future performance of the
International Equity Fund or of SSC. Share prices and investment returns will
fluctuate reflecting market conditions and cash flows, as well as changes in
company-specific fundamentals of portfolio securities. Consequently,
investments in either the Scudder International Portfolio or the International
Equity Fund may be worth more or less than their original cost at the time of
redemption. The performance presentation is not audited.
All returns presented were calculated on a total return basis and include
all dividends and interest, accrued income and realized and unrealized gains
and losses. All returns also reflect the brokerage costs borne by the Scudder
International Portfolio for all periods presented. The use of a different
methodology to calculate performance could result in different performance
data.
AVERAGE ANNUAL TOTAL RETURNS
<TABLE>
<CAPTION>
SCUDDER
INTERNATIONAL MSCI EAFE
YEAR OR PERIODS ENDED 3/31/97 PORTFOLIO INDEX(/1/)
- ------------------------------------------------------- ------------- ----------
<S> <C> <C>
One Year............................................... 12.00% 1.45%
Three Years............................................ 9.10% 6.53%
Five Years............................................. 12.44% 10.57%
From Inception (5/1/87)................................ 9.90% N/A
Ten Years.............................................. N/A 6.01%
</TABLE>
(/1/) Total return data is presented for each period. The MSCI EAFE Index is
an unmanaged capitalization weighted measure of stock markets in Europe,
Australia, and the Far East. Index returns assume dividends reinvested net of
withholding tax, and unlike Fund returns, do not reflect fees or expenses.
Returns reflect the investment of income dividends and capital gain
distributions, if any, but does not reflect fees, brokerage commissions or
other expenses of investing. Investment cannot be made directly into the MSCI
EAFE Index.
SOCIALLY RESPONSIBLE GROWTH AND INCOME PERFORMANCE. The table below sets
forth performance information relating to the Scudder Socially Responsive
Growth & Income Equity Only Composite ("Scudder Socially Responsive
Composite"). The performance data for the Scudder Socially Responsive
Composite is included to provide investors with the performance record for a
composite of accounts managed in a similar manner as the Socially Responsible
Fund. In addition, performance information from the Standard & Poor's 500
Stock Index ("S&P 500") has been included for comparison. The Scudder Socially
Responsive Composite currently is a composite of eight separately managed
accounts that are managed by SSC. The Scudder Socially Responsive Composite is
not registered under the 1940 Act, and thus, was not subject to certain
investment and operational restrictions imposed by the 1940 Act. If the
product had been registered under the 1940 Act or subject to certain
restrictions imposed by the Internal Revenue Code, the performance noted below
might have been lower. The Scudder Socially Responsive Composite is composed
of accounts with investment objectives, policies, strategies and risks similar
to those of the Socially Responsible Fund. However, the Socially Responsible
Fund differs from the accounts in the Scudder Socially Responsive Composite in
certain ways, none of which Investors or SSC believe would cause a significant
change in investment results. While the eight accounts in the composite are
managed following SSC's growth and income investment style, each account has
socially responsible screens that are used to exclude certain types of
industries as investment options. Each account uses screens that are somewhat
modified from those used by the Socially Responsible Fund. The performance of
the Scudder Socially Responsive Composite is presented net of the estimated
maximum total operating expenses for the Socially Responsible Fund of 3.87%.
However, from time to time, Investors may voluntarily waive fees and reimburse
certain expenses. For the first year of operations, the annual total operating
expenses are estimated to be .89%.
The Scudder Socially Responsive Composite performance data does not
represent the past, present or future performance of the Socially Responsible
Fund. Past performance is no guarantee of future results; investors should not
consider this performance data as an indication of future performance of the
Socially Responsible Fund or of SSC. Principal value and investment returns
will fluctuate reflecting market conditions and cash flows, as well as changes
in company-specific fundamentals of portfolio securities. Consequently, the
account value of accounts in the Scudder Socially Responsive Composite or
investments in the Socially Responsible Fund may be worth more or less than
their original cost at the time of redemption. The performance presentation is
not audited.
All returns presented were calculated on a total return basis and include
all dividends and interest, accrued income and realized and unrealized gains
and losses. All returns also reflect the brokerage costs borne by the accounts
within the Scudder Socially Responsive Composite for all periods presented.
The use of a different methodology to calculate performance could result in
different performance data.
15
<PAGE>
AVERAGE ANNUAL TOTAL RETURNS
<TABLE>
<CAPTION>
SCUDDER
SOCIALLY
RESPONSIVE S&P
YEAR OR PERIODS ENDED 3/31/97 COMPOSITE 500(/1/)
- ------------------------------------------------------------ ---------- --------
<S> <C> <C>
One Year.................................................... 18.70% 19.83%
Three Years................................................. 21.51% 22.30%
Five Years.................................................. 17.50% 16.42%
From Inception (12/31/89)................................... 15.37% N/A
Ten Years................................................... N/A 13.38%
</TABLE>
(/1/) Total return data is presented for each period. The S&P 500 is an
unmanaged index considered to be generally representative of the U.S. stock
market. Index returns assume dividends reinvested net of withholding tax.
Investment cannot be made directly into the S&P 500.
PURCHASES AND REDEMPTIONS
Shares of each Fund are currently sold only to HMLIC separate accounts. In
the event that HMLIC establishes additional separate accounts, shares of these
Funds may be made available for purchase by such additional separate accounts.
Previously, shares of the Growth Fund were available to the public. While
Growth Fund shares may no longer be purchased by the general public, existing
public shareholders may acquire additional shares through the automatic
reinvestment of dividends and distributions in accordance with Revenue Ruling
82-55.
Each Fund sells and redeems its shares at net asset value per share, without
a sales or redemption charge. The net asset value of each Fund's shares is
determined on each day the New York Stock Exchange ("NYSE") is open for
trading at the close of the NYSE (normally 3:00 p.m. Central Time). The
computation is made by dividing the net assets by the number of outstanding
shares. Net assets are equal to the total assets of the Fund less its
liabilities. A purchase is effected at the price based on the next calculation
of net asset value per share after receipt of a request. A security listed or
traded on an exchange is valued at its last sales price on the exchange where
it is principally traded. In the absence of a current quotation, the security
is valued at the mean between the last bid and asked prices on the exchange.
Securities traded over-the-counter are valued at the last current bid price.
Debt securities that have a remaining maturity of 60 days or less are valued
at cost, plus or minus any amortized discount or premium. When market
quotations are not available, securities are valued at fair value as
determined in good faith by the Board of Trustees.
Except in extraordinary circumstances and as permissible under the 1940 Act,
redemption proceeds are paid on or before the fifth business day following the
date the request for redemption is received.
REDEMPTION OF GROWTH FUND SHARES BY EXISTING PUBLIC SHAREHOLDERS--The Growth
Fund will redeem shares from public shareholders at the net asset value per
share next determined after receipt of a redemption request. If stock
certificates have been issued, the signature of each party must be guaranteed
by an officer of a commercial bank or trust company or a member of the New
York Stock Exchange. If certificates are lost, the shareholder will need to
submit an Affidavit of Loss form with the signature(s) notarized if 100 or
less shares are surrendered, and a Lost Instrument Bond will be required if
over 100 shares are surrendered. A Lost Instrument Bond can be obtained from
an insurance carrier. The cost for this bond must be paid by the shareholder.
If no certificates have been issued to the shareholder, redemption may be
accomplished by signing a written request. The request should be sent to the
Horace Mann Growth Fund, Inc., P.O. Box 4657, Springfield, Illinois 62708-4657
and should identify the account by number and the name(s) in which the account
is registered. The request must be signed exactly as the account is
registered. On a jointly held account, all owners must sign.
All redemption requests by mail should be sent certified mail with return
receipt requested. Provided the request is received in good form, payment for
shares redeemed will be made by the Fund within three business days of the
receipt.
SYSTEMATIC CASH WITHDRAWAL PLAN--When a Growth Fund public shareholder has
accumulated $5,000 or more of Growth Fund shares in his or her account, shares
may be withdrawn automatically through the Systematic Cash Withdrawal Plan
(the "Plan"). A shareholder may receive checks monthly, quarterly,
semiannually or annually in any amount requested, but not less than $25. A
Plan application is available, upon request, from the transfer agent. The
value of a public shareholder's account is determined at the net asset value
on the date a Plan application is received by the Growth Fund. Payments under
the Plan will be made either on the 1st or 15th of the month as selected by
the shareholder. A sufficient number of shares will be redeemed from the
shareholder's account to provide funds for payments made under the Plan, thus
reducing the shareholder's account value. Depending on the amount and
frequency of withdrawals, payments under the Plan may exhaust the
shareholder's account. There is no redemption charge with respect to the
shares redeemed from the shareholder's account. A Plan may be terminated upon
written request.
DIVIDENDS, DISTRIBUTIONS AND FEDERAL TAXES
Each Fund normally follows the practice of declaring and distributing
substantially all its net investment income and any net short-term and long-
term capital gains at least annually. All dividends or distributions paid on
Fund shares held by a separate account, net of separate account contract
charges, are automatically reinvested in shares of the respective Fund at the
net asset value determined on the dividend payment date.
Under the Internal Revenue Code ("Code"), Horace Mann Life Insurance Company
is taxed as a life insurance company and the operations of its separate
accounts are taxed as part of its total operations. Under current
interpretations of existing
16
<PAGE>
federal income tax law, investment income and capital gains of separate
accounts are not subject to federal income tax to the extent applied to
increase the value of variable annuity contracts. Tax consequences to variable
annuity contract holders are described in a separate prospectus issued by the
Horace Mann Life Insurance Company.
Each Fund intends to qualify as a regulated investment company under
subchapter M of the Code. As a result, with respect to any fiscal year in
which a Fund distributes all its net investment income and net realized
capital gains, that Fund will not be subject to federal income tax. Subchapter
M includes requirements relating to the diversification of investments, which
are in addition to the diversification requirements contained in Section
817(h) of the Code and the 1940 Act. Each applicable law's diversification
requirement could require the sale of assets of a Fund, at a time when it
would not otherwise be advisable to do so.
Public shareholders of the Growth Fund may elect to receive cash dividends
and will be notified of the amount and type of distribution. If a shareholder
elects to receive a cash dividend and the dividend check is returned by the
postal service, attempts will be made to locate the shareholder. If the
attempts to locate are unsuccessful, the shareholder's dividend option will be
changed to reinvestment. When new shares are added to a Growth Fund public
shareholder's account through the reinvestment of dividends or when
distributions occur (which dividends will be taxable to the shareholder
whether paid in cash or reinvested in additional shares), a confirmation
statement is sent to the public shareholder showing the number of shares that
were credited or debited to the account, the net asset value per share and the
total number of shares in the account. A dividend or capital gains
distribution will reduce the per share net asset value by the amount of the
dividend or distribution. Shortly after the end of each year, Growth Fund
shareholders will be informed of the amount of and the federal income tax
treatment of all distributions made during the year. If not otherwise subject
to tax on their income, public shareholders will not be required to pay tax on
amounts distributed to them. Shareholders must determine for themselves the
applicability of state and local taxes to dividends and distributions received
on Growth Fund shares.
The Growth Fund may be required to withhold federal income tax at a rate of
31% from dividend and redemption payments made to any public shareholder who
fails to furnish a certified taxpayer identification number ("TIN") or when
the Internal Revenue Service notifies the Growth Fund that the shareholder has
provided the Growth Fund with an incorrect TIN or failed to properly report
certain income for federal income tax purposes. Any withheld amount can be
credited against the shareholder's federal income tax obligation.
The preceding is a brief summary of certain of the relevant federal income
tax considerations. The Statement of Additional Information includes a more
detailed discussion. This discussion is not intended, even as supplemented by
the Statement of Additional Information, as a complete explanation or a
substitute for careful tax planning and consultation with individual tax
advisers.
VOTING RIGHTS
Each Fund is authorized by the Declaration of Trust to issue an unlimited
number of shares. Shares of each Fund are of the same class with equal rights
and privileges. Each share is entitled to vote on all matters submitted to a
vote of shareholders. The shares of each Fund are fully paid and non-
assessable and have no preference as to conversion, exchange, dividends,
retirement or other features. The shares of each Fund have no pre-exemptive
rights. The shares of each Fund have noncumulative voting rights, which means
that the holders of more than 50% of the shares voting for the election of
trustees can elect 100% of the trustees if they choose to do so.
Each person with voting rights will be provided with reports and proxy
materials relating to the applicable Fund(s). To be entitled to vote, a
shareholder (either a public shareholder of the Growth Fund or an insurance
company separate account) must have been a shareholder on the record date. The
number of Fund shares for which a shareholder may vote is determined by
dividing the value of an interest in a Fund by the net asset value of one
share of the Fund, as of the same date.
As of April 1, 1997, Horace Mann Life Insurance Company Separate Account
owned approximately 76.0%, 28.9%, 16.15%, 5.99%, 95.68%, 95.87%, and 87.13% of
the outstanding shares of the Growth Fund, Small Cap Growth Fund,
International Equity Fund, Socially Responsible Fund, Balanced Fund, Income
Fund and Short-Term Investment Fund, respectively. Horace Mann Life Insurance
Company Separate Account B held approximately 5.17% of the Growth Fund. Horace
Mann Life Insurance Company Allegiance Separate Account A held approximately
1.59% of the Growth Fund. Since these separate accounts' voting rights are
passed through to contract owners and participants, HMLIC itself does not
exercise voting control.
PUBLIC SHAREHOLDER COMMUNICATIONS
To ensure receipt of communications related to investments in the Growth
Fund, public shareholders must notify the Growth Fund of address changes.
Notice of a change in address may be sent to the Horace Mann Growth Fund, P.O.
Box 4657, Springfield, Illinois 62708-4657. Shareholders may also provide
notice of an address change by sending a telefacsimile (FAX) transmission to
(217) 527-2307 or by calling (217) 789-2500 or (800) 999-1030 (toll-free).
SHAREHOLDERS' INQUIRIES
For questions concerning investments in the Funds through HMLIC's annuity
contracts, call HMLIC's toll-free customer service number, (800) 999-1030.
Written questions should be sent by mail to Horace Mann Life Insurance Company
17
<PAGE>
at P.O. Box 4657, Springfield, Illinois 62708-4657 or by telefacsimile (FAX)
transmission to (217) 527-2307.
Growth Fund public shareholders may contact the Growth Fund by calling (800)
999-1030 or (217) 789-2500. Written questions concerning a Growth Fund public
shareholder's account may be sent by mail to Horace Mann Growth Fund, P.O. Box
4657, Springfield, Illinois 62708-4657 or by telefacsimile (FAX) transmission
to (217) 527-2307.
ADDITIONAL INFORMATION
A copy of the Statement of Additional Information providing more detailed
information about the Funds is available, without charge, upon request. The
Table of Contents of this Statement follows:
<TABLE>
<CAPTION>
TOPIC PAGE
- ----- ----
<S> <C>
Investment Policies........................................................ 2
Growth Fund.............................................................. 2
Small Cap Growth Fund.................................................... 3
International Equity Fund................................................ 3
Socially Responsible Fund................................................ 3
Balanced Fund............................................................ 3
Income Fund.............................................................. 3
Short-Term Investment Fund............................................... 3
Investment Restrictions.................................................... 3
Income Fund-Benchmark...................................................... 7
Management of the Funds.................................................... 8
Board of Trustees........................................................ 8
Officers................................................................. 9
Compensation Table......................................................... 10
Investment Advisory Agreements............................................. 10
Subadvisers................................................................ 12
Brokerage Allocation....................................................... 13
Other Services............................................................. 14
Fund Pricing Agreements.................................................. 14
Custodial Agreement...................................................... 14
Transfer and Dividend Paying Agent....................................... 14
Independent Auditors..................................................... 14
Purchase, Redemption and Pricing of Fund Shares............................ 15
Tax Status................................................................. 15
Control Persons and Principal Holders of Securities........................ 18
General Information........................................................ 19
Financial Statements....................................................... 19
Appendix A--Description of Commercial Paper and Bond Ratings............... A-1
Appendix B--Description of Securities and Risks............................ B-1
</TABLE>
To receive, without charge, a copy of the 1996 Annual Report of the Horace
Mann Family of Funds and/or a copy of the Statement of Additional Information
for the Horace Mann Mutual Funds, please complete the following request form
and mail it to the address indicated below, or send it by telefacsimile (FAX)
transmission to (217) 527-2307 or telephone (217) 789-2500 or (800) 999-1030
(toll-free).
HORACE MANN MUTUAL FUNDS
P.O. BOX 4657
SPRINGFIELD, ILLINOIS 62708-4657
- -- -- -- -- -- -- -- -- -- -- -- -- --
- -- -- -- -- -- -- --
Please provide free of charge the following information:
1996 Annual Report of the Horace Mann Mutual Funds
Statement of Additional Information dated May 1, 1997 for the Horace Mann
Mutual Funds.
Please mail the above documents to:
-----------------------------
(Name)
-----------------------------
(Address)
-----------------------------
(City/State/Zip)
- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- --
- -- -- -- -- -- -- -- -- -- -- -- -- --
18
<PAGE>
APPENDIX A
- --------------------------------------------------------------------------------
RATINGS OF DEBT OBLIGATIONS:
<TABLE>
<CAPTION>
MOODY'S STANDARD &
INVESTORS POOR'S RATINGS
SERVICE, INC. GROUP DEFINITION
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
LONG-TERM Aaa AAA Highest quality
Aa AA High quality
A A Upper medium grade
Baa BBB Medium grade
Ba BB Low Grade
B B Speculative
Caa,Ca,C CCC,CC,C Submarginal
D D Probably in default
- ------------------------------------------------------------------------------------------------
Moody's S&P
- ------------------------------------------------------------------------------------------------
SHORT-TERM MIG1/VMIG1 Best quality SP-1+ Very strong quality
- ------------------------------------------------------------------------------------------------
MIG2/VMIG2 High quality SP-1 Strong quality
- ------------------------------------------------------------------------------------------------
MIG3/VMIG3 Favorable quality SP-2 Satisfactory grade
- ------------------------------------------------------------------------------------------------
MIG4/VMIG4 Adequate quality
- ------------------------------------------------------------------------------------------------
SG Speculative grade SP-3 Speculative grade
- ------------------------------------------------------------------------------------------------
COMMERCIAL PAPER P-1 Superior quality A-1+ Extremely strong quality
- ------------------------------------------------------------------------------------------------
A-1 Strong quality
- ------------------------------------------------------------------------------------------------
P-2 Strong quality A-2 Satisfactory quality
- ------------------------------------------------------------------------------------------------
P-3 Acceptable quality A-3 Adequate quality
- ------------------------------------------------------------------------------------------------
B Speculative quality
- ------------------------------------------------------------------------------------------------
Not Prime C Doubtful quality
- ------------------------------------------------------------------------------------------------
</TABLE>
A-1
<PAGE>
DRAFT
STATEMENT OF ADDITIONAL INFORMATION
HORACE MANN MUTUAL FUNDS
This Statement of Additional Information is not a prospectus, but should be read
in conjunction with the current Prospectus, dated May 1, 1997. A copy of the
Prospectus may be obtained by writing to the Horace Mann Mutual Funds, P.O. Box
4657, Springfield, Illinois 62708-4657, by sending a telefacsimile (FAX)
transmission to (217) 527-2307, or by telephoning (217) 789-2500 or (800) 999-
1030 (toll-free).
May 1, 1997
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Topic Page
- ----- ----
<S> <C>
Investment Policies........................................... 1
Growth Fund.............................................. 1
Small Cap Growth Fund.................................... 1
International Equity Fund................................ 1
Socially Responsible Fund................................ 1
Balanced Fund............................................ 1
Income Fund.............................................. 1
Short-Term Investment Fund............................... 1
Investment Restrictions....................................... 2
Income Fund - Benchmark....................................... 5
Management of the Funds....................................... 5
Board of Trustees........................................ 5
Officers................................................. 6
Compensation Table............................................ 6
Investment Advisory Agreements................................ 7
Subadvisers.............................................. 8
Brokerage Allocation.......................................... 9
Other Services................................................ 10
Fund Pricing Agreements.................................. 10
Custodial Agreement...................................... 10
Transfer and Dividend Paying Agent....................... 11
Independent Auditors..................................... 11
PURCHASE, REDEMPTION AND PRICING OF FUND SHARES............... 11
TAX STATUS.................................................... 11
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES........... 14
GENERAL INFORMATION........................................... 15
FINANCIAL STATEMENTS.......................................... 15
APPENDIX A: DESCRIPTION OF COMMERCIAL PAPER AND BOND RATINGS.. A-1
APPENDIX B: DESCRIPTION OF SECURITIES AND RISKS............... B-1
</TABLE>
2
<PAGE>
INVESTMENT POLICIES
GROWTH FUND
The portfolio investments of the Growth Fund are not concentrated in any one
industry or group of industries but are varied according to what is judged
advantageous under varying economic conditions. While the portfolio is
diversified by investment in a cross-section of businesses and industries, the
Growth Fund follows a policy of flexibility. The Growth Fund does not invest in
companies for the purpose of exercising control of management. Moreover, the
Growth Fund purchases only marketable securities.
It is the policy of the Growth Fund to purchase and hold securities believed to
have potential for long-term capital growth. Investment income is a secondary
consideration in the selection of portfolio securities. The Growth Fund does
not buy and sell for short-term trading profits. Therefore, portfolio changes
usually are accomplished gradually. However, Fund management is not restricted
and may effect short-term transactions when subsequent events make an investment
undesirable for long-term holding.
For 1995 and 1996, the Growth Fund's portfolio turnover rates were 64.59% and
67.63%, respectively. Although it is impossible to predict with certainty the
Growth Fund's ongoing portfolio turnover rate, the subadviser expects that under
normal circumstances it will be less than 100% each year.
SMALL CAP GROWTH FUND
There is no turnover information for the Small Cap Growth Fund as it has been in
existence less than one year.
INTERNATIONAL EQUITY FUND
There is no turnover information for the International Fund as it has been in
existence less than one year.
SOCIALLY RESPONSIBLE FUND
There is no turnover information for the Socially Responsible Fund as it has
been in existence less than one year.
BALANCED FUND
During 1995 and 1996, the Balanced Fund's portfolio turnover rates were 64.80%
and 72.10%, respectively. The annual turnover rates of the common stock portion
of the Balanced Fund's portfolio for 1995 and 1996 were 64.27% and 67.80%,
respectively, and for the bond portion for 1995 and 1996 were 65.81% and
81.24%, respectively. Although it is impossible to predict with certainty the
Balanced Fund's ongoing portfolio turnover rate, the subadviser expects
that under normal circumstances it will be less than 100% each year. During
periods of rapidly changing interest rates, however, the turnover rate may be
greater than 100%. This results from the subadviser's desire to optimize rates
of return during such periods.
INCOME FUND
During 1995 and 1996, the Income Fund's portfolio turnover rates were 74.53% and
112.60%, respectively. Although it is impossible to predict with certainty the
Income Fund's ongoing portfolio turnover rate, the subadviser expects that under
normal circumstances it will be less than 100% each year. During periods of
rapidly changing interest rates, however, the turnover rate may be greater than
100%. This results from the subadviser's desire to optimize rates of return
during such periods.
SHORT-TERM INVESTMENT FUND
There is no turnover information for the Short-Term Fund as it holds its
securities for less than one year.
3
<PAGE>
INVESTMENT RESTRICTIONS
Each Fund operates under its respective fundamental investment restrictions, set
forth below, which, along with each Fund's objective, cannot be changed without
the approval of a "majority of the outstanding voting securities." A "majority
of the outstanding voting securities" of a Fund is defined in the Investment
Company Act of 1940 to mean the lesser of (i) 67% of the Fund's shares present
at a meeting where more than 50% of the outstanding shares are present in person
or by proxy or (ii) more than 50% of the Fund's outstanding shares.
The Growth Fund, Balanced Fund, Income Fund and Short-Term Investment Fund each
may not:
(1) purchase securities other than the securities in which a Fund is authorized
to invest;
(2) issue senior securities except that a Fund may borrow money or enter into
reverse repurchase agreements in an amount not to exceed 15% of its total
assets taken at market value and then only for short-term credits as may be
necessary for the clearance of transactions and from banks as a temporary
measure for extraordinary or emergency purposes (moreover, in the event
that the asset coverage for such borrowings may fall below 300%, the Fund
will reduce, within three days, the amount of its borrowings in order to
provide for 300% asset coverage); a Fund will not borrow to increase income
(leveraging) but only to facilitate redemption requests that might
otherwise require untimely dispositions of the Fund's portfolio securities;
a Fund will repay all borrowings before making additional investments, and
interest paid on borrowings will reduce net income;
(3) make loans to other persons (except by the purchase of obligations in which
the Fund is authorized to invest); provided, however, that the Fund will
not enter into repurchase agreements if, as a result thereof, more than 10%
of the total assets of the Fund (taken at current value) would be subject
to repurchase agreements maturing in more than seven (7) days;
(4) purchase the securities of any issuer (other than obligations issued or
guaranteed as to principal and interest by the Government of the United
States, its agencies or instrumentalities) if, as a result, (a) more than
5% of the Fund's total assets (taken at current value) would be invested in
the securities of that issuer, or (b) a Fund would hold more than 10% of
any class of securities of that issuer (for this purpose, all debt
obligations of an issuer maturing in less than one year are treated as a
single class of securities);
(5) write, or invest in, straddle or spread options or invest in interests in
oil, gas or other mineral exploration or development programs;
(6) purchase securities on margin or sell any securities short;
(7) invest in the securities of any issuer, any of whose officers, directors or
security holders is an officer of a Fund if at the time of or after such
purchase any officer or director of that Fund would own more than l/2 of 1%
of the securities of that issuer or if that Fund's officers and directors
together would own more than 5% of the securities of that issuer;
4
<PAGE>
(8) purchase any securities that would cause more than 25% of the value of a
Fund's total net assets at the time of purchase to be invested in the
securities of one or more issuers conducting their principal business
activities in the same industry, provided that there is no limitation with
respect to investments in U.S. Treasury Bills, other obligations issued or
guaranteed by the federal government, its agencies and instrumentalities,
certificates of deposit, commercial paper and bankers' acceptances, or any
obligations of U.S. branches of foreign banks and foreign branches of U.S.
banks, except as these investments may be limited by the Treasury
regulations under section 817(h) of the Internal Revenue Code;
(9) invest more than 5% of the value of the Fund's total assets at the time of
investment in the securities of any issuer or issuers which have records of
less than three years continuous operation, including the operation of any
predecessor, but this limitation does not apply to securities issued or
guaranteed as to interest and principal by the United States Government or
its agencies or instrumentalities;
(10) mortgage, pledge or hypothecate its assets except in an amount up to 15%
(10% so long as the Fund's shares are registered for sale in certain
states) of the value of the Fund's total assets but only to secure
borrowings for temporary or emergency purposes;
(11) purchase or sell real estate, real estate investment trust securities,
commodities or commodity contracts;
(12) invest in companies for the purpose of exercising control; or
(13) invest in securities of other investment companies, except as they may be
acquired as part of a merger, consolidation or acquisition of assets.
The Growth Fund and Short-Term Investment Fund each may not:
(14) underwrite the securities of other issuers, purchase securities subject to
restrictions on disposition under the Securities Act of 1933 (so called
"restricted securities") or purchase securities not freely marketable.
The Balanced Fund and Income Fund each may not:
(15) Underwrite the securities of other issuers, invest more than 10% of its net
assets in illiquid securities or invest in securities subject to
restriction on disposition under the Securities Act of 1933, except for
securities eligible for resale pursuant to Rule 144A under the Securities
Act of 1933.
The Small Cap Growth Fund, International Equity Fund and Socially Responsible
Fund each may not:
(1) act as an underwriter of securities, except insofar as it may be deemed an
underwriter for purposes of the Securities Act of 1933 on disposition of
securities acquired subject to legal or contractual restrictions on resale;
(2) purchase or sell real estate (although it may purchase securities secured
by real estate or interests therein, or securities issued by companies
which invest in real estate or interests therein), commodities, or
commodity contracts, except that it may enter into (a) futures and options
on futures and (b) forward currency contracts;
(3) make loans, but this restriction shall not prevent the Fund from (a) buying
a part of an issue of bonds, debentures, or other obligations, (b)
investing in repurchase agreements, or (c) lending portfolio
5
<PAGE>
securities, provided that it may not lend securities if, as a result, the
aggregate value of all securities loaned would exceed 33 1/3% of its total
assets (taken at market value at the time of such loan);
(4) borrow, except that it may (a) borrow up to 33-1/3% of its total assets,
taken at market value at the time of such borrowing, as a temporary measure
for extraordinary or emergency purposes, but not to increase portfolio
income (the total of reverse repurchase agreements and such borrowings
will not exceed 33-1/3% of its total assets, and the Fund will not purchase
additional securities when its borrowings, less proceeds receivable from
sales of portfolio securities, exceed 5% of its total assets) and (b) enter
into transactions in options, futures, and options on futures;
(5) invest in a security if 25% or more of its total assets (taken at market
value at the time of a particular purchase) would be invested in the
securities of issuers in any particular industry, except that this
restriction does not apply to securities issued or guaranteed by the U.S.
Government or its agencies or instrumentalities; or
(6) issue any senior security except to the extent permitted under the
Investment Company Act of 1940.
The Small Cap Growth Fund, International Equity Fund and Socially Responsible
Funds are also subject to the following nonfundamental restrictions and
policies, which may be changed by the Board of Trustees. Each Fund may
not:
(a) invest in companies for the purpose of exercising control or management;
(b) purchase, except for securities acquired as part of a merger, consolidation
or acquisition of assets, more than 3% of the stock of another investment
company or purchase stock of other investment companies equal to more than
5% of the Fund's total assets (valued at time of purchase) in the case of
any one other investment company and 10% of such assets (valued at time of
purchase) in the case of all other investment companies in the
aggregate;
(c) mortgage, pledge, or hypothecate its assets, except as may be necessary in
connection with permitted borrowings or in connection with options,
futures, and options on futures;
(d) purchase securities on margin (except for use of short-term credits as are
necessary for the clearance of transactions), or sell securities short
unless (i) the Fund owns or has the right to obtain securities equivalent
in kind and amount to those sold short at no added cost or (ii) the
securities sold are "when issued" or "when distributed" securities which
the Fund expects to receive in a recapitalization, reorganization, or other
exchange for securities the Fund contemporaneously owns or has the right to
obtain and provided that transactions in options, futures, and options on
futures are not treated as short sales;
(e) invest more than 15% of its net assets (taken at market value at the time
of a particular investment) in illiquid securities, including repurchase
agreements maturing in more than seven days;and
(f) hedge by purchasing put and call options, futures contracts, or derivative
instruments on securities, in an aggregate amount equivalent to more than
10% of its total assets.
6
<PAGE>
For the Balanced Fund and Income Fund, the Board has adopted guidelines
regarding investment in derivatives (such as CMOs), which among other things,
establish certain minimum criteria for the types of derivative securities that
may be purchased. Under such guidelines, fixed income derivatives purchased for
the Funds must have low to moderate volatility and must perform consistently
across a wide range of interest rate scenarios. They also must exhibit little
excess interest rate risk relative to Treasuries of comparable duration.
Income Fund - Benchmark
The Lehman Brothers Aggregate Index covers the U.S. investment grade fixed rate
bond market, including government and corporate securities, agency mortgage
pass-through securities, and asset-backed securities. These major sectors are
subdivided into more specific indices that are calculated and reported on a
regular basis.
To qualify for inclusion in the Aggregate Index, a bond or
security must meet certain criteria:
* It must have at least one year to final maturity regardless of call
features. Asset-backed securities must have a remaining average life of at
least one year while mortgages must have a weighted average maturity (WAM)
of at least one year. There is no limit on final maturity; bonds with 50-
and 100-year maturities may be included in the Aggregate Index.
* It must have at least $100 million par amount outstanding. The amount
outstanding may differ from the original issue size due to various factors,
including reopenings, sinking schedules, partial calls, and prepayments.
* It must be rated investment grade (Baa3 or better) by Moody's Investors
Service (unless it is a U.S. government or agency security, which are
generally not formally rated). If a Moody's rating is unavailable, then the
Standard and Poor's Corporation rating is used. If neither is available,
then the Fitch Investor's Service rating is used. This implies that the
index may include bonds that are split-rated. A bond rated Baa3 by Moody's
and BB+ by S & P would be included; however, if Moody's assigns a rating
below investment grade the bond will be excluded even if the S&P or Fitch
rating is BBB- or better.
* It must be fixed rate, although it can carry a coupon that steps up or
changes according to a predetermined schedule. Adjustable or floating rate
securities with periodic coupon changes based on changes in market rates are
excluded. Stripped securities created from coupon securities are excluded,
while the underlying coupon security is included. Zero coupon bonds may be
included. Medium-term notes are included only if they were underwritten
issues and meet other eligibility criteria.
* It must be dollar-denominated and nonconvertible. All corporate and asset-
backed securities must be registered with the Securities and Exchange
Commission (SEC).
* It must be publicly issued. Private placement securities including 144A
securities are excluded.
Generally speaking, the Aggregate Index does not include securities with
esoteric or one-of-a-kind features such as structured notes or range notes with
coupons that depend on movements in market rates.
MANAGEMENT OF THE FUNDS
A listing of the Trustees and Officers of the Trust, their ages, their principal
occupations for the past five years and their affiliation with other companies
affiliated with Horace Mann Life Insurance Company is presented below.
Correspondence with any Trustee or Officer may be addressed to the offices of
the Funds at P.O. Box 4657, Springfield, Illinois 62708-4657.
BOARD OF TRUSTEES
*A. THOMAS ARISMAN (1, 2, 3), Age 50, Trustee; Senior Vice President, Horace
Mann Life Insurance Company and Horace Mann Service Corporation; Director and
President, Horace Mann Investors, Inc.; and positions with Horace Mann Educators
Corporation and its subsidiaries.
*LARRY K. BECKER (1, 3, 4), Age 48, Trustee and Chairman of the Board; Director,
Executive Vice President, and Chief Financial Officer, Horace Mann Life
Insurance Company and Horace Mann Service Corporation; Director, Horace Mann
Investors, Inc.; and positions with Horace Mann Educators Corporation and its
subsidiaries.
A. L. GALLOP (2), Age 71, Trustee; Executive Director (Retired), Minnesota
Education Association; formerly Director, Horace Mann Educators Corporation
(1968-1983).
RICHARD D. LANG, Age 65, Trustee; Executive Director (Retired), Vermont National
Education Association; formerly member of Horace Mann Educators Corporation
Educator Advisory Board.
*EDWARD L. NAJIM, Age 53, Trustee; Director and Executive Vice President, Horace
Mann Life Insurance Company and Horace Mann Service Corporation; and positions
with Horace Mann Educators Corporation and its subsidiaries.
HARRIET A. RUSSELL (4), Age 54, Trustee; member, Cincinnati Board of Education;
Director and Vice President, Greater Cincinnati School Employer Credit Union;
teacher (Retired), Walnut Hills High School; formerly Director, Horace Mann
Growth Fund, 1974 to 1983.
*GEORGE J. ZOCK (1, 2, 3), Age 46, Trustee and President; Director, Senior Vice
President and Treasurer, Horace Mann Life Insurance Company and Horace Mann
Service Corporation; Director, Horace Mann Investors, Inc.; and positions with
Horace Mann Educators Corporation and its subsidiaries.
_____________________
*Trustee is considered an "interested person" as that term is defined in the
Investment Company Act of 1940.
7
<PAGE>
(1) Member of Executive Committee - Unless otherwise provided by resolution of
the Board, this committee may exercise all of the powers of the Board when
the Board is not in session, except as otherwise stated in the Trust's By-
Laws.
(2) Member of Audit/Insurance Committee - This committee serves as the Board's
liaison with the Trust's independent auditors, reviews the financial
operation of the Funds, and makes periodic reports of these reviews to the
Board, along with appropriate recommendations regarding the proper and
efficient financial operation of the Funds. Additional responsibilities
include the review and assurance of the adequacy of insurance coverage for
the Trust.
(3) Member of Securities Committee - This committee coordinates and
communicates with the Trust's investment adviser on behalf of the Board,
reviews and oversees investment management activities, makes
recommendations to the Board on changes in the investment guidelines,
recommends changes or adjustments to the investment advisory agreement,
creates and revises standards of investment performance, and advises the
Board on investment issues.
(4) Member of Nominating Committee - This committee is responsible for the
selection of appropriate, qualified persons as director nominees to be
presented to Trust shareholders for their consideration. The committee has
no formal policy with respect to prospective director nominees recommended
by shareholders, but shareholders are free to make recommendations.
OFFICERS
ANN M. CAPARROS, Age 44, Secretary and Ethics Compliance Officer; Director, Vice
President, and Corporate Secretary, Horace Mann Life Insurance Company and
Horace Mann Service Corporation; Secretary, Horace Mann Investors, Inc.; and
positions with Horace Mann Educators Corporation and its subsidiaries; prior to
March 1994, was associated with John Deere Insurance Group and Affiliates
serving as Vice President and General Counsel.
ROGER W. FISHER, Age 44, Controller; Vice President and Controller, Horace Mann
Life Insurance Company and Horace Mann Service Corporation; Controller, Horace
Mann Investors, Inc.; and positions with Horace Mann Educators Corporation and
its subsidiaries.
WILLIAM J. KELLY, Age 50, Treasurer and Regulatory Compliance Officer;
Treasurer, Horace Mann Investors, Inc.; Vice President, Horace Mann Life
Insurance Company; and Vice President-Transfer Agent, Horace Mann Service
Corporation.
The Officers of the Trust receive remuneration from Horace Mann Service
Corporation. The Trust does not pay any remuneration to its officers. The Trust
pays each Independent Trustee a $1,000 annual retainer, $1,000 for each meeting
of the Trust, $200 for each committee meeting and $500 for each telephonic
meeting. For the fiscal year ended December 31, 1996, the Independent Trustees
fees totaled $1,200 for each Fund.
COMPENSATION TABLE
8
<PAGE>
The following table sets forth the estimated compensation to be earned from the
Trust for the fiscal year ended December 31, 1997 by trustees who are not
affiliated with Horace Mann Investors, Inc., the adviser.
<TABLE>
<CAPTION>
Estimated
Aggregate Pension Retirement Annual Benefits Total
Compensation Benefits Accrued as Upon Compensation
Trustee from the Trust Part of Fund Expenses Retirement For The Complex
------- -------------- --------------------- --------------- ---------------
<S> <C> <C> <C> <C>
A.L. Gallop $5,200 N/A N/A $5,200
Richard D. $4,000 N/A N/A $4,000
Lang
Harriet A. $5,000 N/A N/A $5,000
Russell
</TABLE>
As of the date of this Statement of Additional Information, the Trustees and
Officers of the Trust held in the aggregate directly and beneficially less than
1% of the outstanding shares of Growth Fund. Trustees and Officers do not
directly own any shares of Income Fund, Balanced Fund or Short-Term Fund;
however, they may invest indirectly in the Growth Fund, Income Fund, Balanced
Fund and/or Short-Term Fund through annuity contracts issued by Horace Mann Life
Insurance Company and the 401(k) plan of Horace Mann Service Corporation.
INVESTMENT ADVISORY AGREEMENTS
As stated in the Prospectus, Horace Mann Investors, Inc. ("Investors") is the
Trust's investment adviser and manager. Pursuant to an investment advisory and
management agreement, the Adviser acts as the Trust's adviser, manages its
investments, administers its business affairs, furnishes office facilities and
equipment, provides clerical, bookkeeping and administrative services, provides
shareholder and information services and permits any of its principals or
employees to serve without compensation as trustees or officers of the Trust if
elected to such positions. In addition to the management advisory fee, each
portfolio pays the expenses of its operations, including a portion of the
Trust's general administrative expenses, allocated on the basis of the Fund's
net asset value. Expenses that will be borne directly by the Funds include, but
are not limited to, the following: the fees and expenses of independent
auditors, counsel, custodian and transfer agent, costs of reports and notices to
shareholders, stationery, printing, postage, costs of calculating net asset
value, brokerage commissions or transaction costs, taxes, registration fees, the
fees and expenses of qualifying the Trust and its share of distribution under
Federal and state securities laws and membership dues in the Investment Company
Institute or any similar organization.
The investment advisory and management agreement continues in effect for each
Fund from year to year for so long as its continuation is approved at least
annually (a) by a majority of the trustees who are not parties to such agreement
or interested persons of any such party except in their capacity as trustees of
the Fund and (b) by the shareholders of the Fund or the Board of Trustees. The
agreement may be terminated at any time upon 60 days notice by either party; the
Trust may so terminate the agreement either by vote of the Board of Trustees or
by a majority vote of the outstanding voting shares of the subject Fund if the
Adviser were determined to have breached the agreement. The agreement would
terminate automatically upon assignment.
9
<PAGE>
The investment advisory and management agreement provides that neither Investors
nor any of its directors, officers, stockholders, agents or employees shall have
any liability to the Trust or any Shareholder of the Trust for any error of
judgement, mistake of law, or any loss arising out of any investment, or for any
other act or omission in the performance by Investors of its duties under the
agreement except for liability resulting from willful misfeasance, bad faith, or
negligence on its part in the performance of its duties or from reckless
disregard by it of its obligations and duties under the Agreement.
As compensation for its services, the Small Cap Growth Fund, International
Equity Fund and Socially Responsible Fund each pay Investors a management fee
that is computed daily and paid monthly based on a percentage of each Fund's
average daily net assets as follows:
<TABLE>
<CAPTION>
% of average daily net assets
-----------------------------
<S> <C>
Small Cap Growth Fund 1.4%
International Equity Fund 1.1%
Socially Responsible Fund .95%
</TABLE>
As compensation for its services, the Growth Fund, Balanced Fund, Income Fund
and Short-Term Investment Fund each pay Investors a two-part management fee at
the end of each month.
Part 1:
Under part one, each Fund's fee is accrued daily and is calculated on a pro rata
basis by applying the following annual percentage rates to the aggregate of all
four Funds' daily net assets for the respective month:
Net Assets Rate
---------- ----
Growth Fund
Balanced Fund Over $100 million .200%
Income Fund On initial $100 million .250%
Short-Term Investment Fund
Part 2:
Under part two, each Fund's fee is accrued daily and is calculated by
applying the following annual percentage rates to the average daily net assets
of each Fund for the respective month:
<TABLE>
<CAPTION>
Net Assets Rate
---------- ----
<S> <C> <C>
Growth Fund On initial $100 million .400%
On next $100 million .300%
Over $200 million .250%
Balanced Fund On initial $100 million .325%
On next $100 million .275%
On next $300 million .225%
Over $500 million .200%
Income Fund On initial $100 million .250%
On next $100 million .200%
Over $200 million .150%
Short-Term Fund On initial $100 million .125%
On next $100 million .100%
Over $200 million .075%
</TABLE>
For the fiscal year ended December 31, 1996, the Growth Fund, Balanced Fund,
Income Fund and Short-Term Investment Fund paid Investors $741,749, $544,797,
$22,734 and $2,355, respectively, for its services as busness manager. The Small
Cap Growth Fund, International Equity Fund and Socially Responsible Fund
commenced operations on March 10, 1997.
SUBADVISERS--Each of the Investment Subadvisory Agreements provides that
neither the subadviser nor any of its directors, officers, stockholders, agents
or employees shall have any liability to the Fund or any shareholder of the
Fund for any error of judgment, mistake of law, or any loss arising out of any
investment, or for any other act or omission in the performance by the
subadviser of its duties under the Agreement except for liability resulting from
willful misfeasance, bad faith, or negligence on its part in the performance
of its duties or from reckless disregard by it of its obligations and duties
under the Agreement. Each of the Investment Subadvisory Agreements continue for
the same term as the advisory agreement and are subject to the same requirements
for renewal.
For the services provided, Investors pays each Subadviser a monthly fee
at an annual rate based on average daily net assets of each Fund in accordance
with the following schedule:
<TABLE>
<CAPTION>
Net Assets Rate
---------- ----
<S> <C> <C>
Small Cap Growth Fund
On the first $25 million 1.00%
On assets over $25 million .75%
International Equity Fund
(during the first six months of operations)
On the first $40 million .35%
On assets over $40 million .25%
(after the first six months of operations) .70%
On the first $40 million .50%
On assets over $40 million
Socially Responsible Fund
</TABLE>
10
<PAGE>
<TABLE>
NET ASSETS RATE
---------- ----
<S> <C> <C>
On the first $20 million .55%
On the next $20 million .45%
On assets over $40 million .30%
Growth Fund On initial $100 million .400%
On next $100 million .300%
Over $200 million .250%
Balanced Fund On initial $100 million .325%
On next $100 million .275%
On next $300 million .225%
Over $500 million .200%
Income Fund On initial $100 million .250%
On next $100 million .200%
Over $200 million .150%
Short-Term Fund On initial $100 million .125
On next $100 million .100%
Over $200 million .075%
</TABLE>
For the fiscal year ended December 31, 1996, the Growth Fund, Income Fund,
Balanced Fund and Short-Term Investment Fund paid Wellington Management
$1,094,197, $741,213, $27,300 and $1,396, respectively, for its investment
management services. The Small Cap Growth Fund, International Equity Fund and
Socially Responsible Fund commenced operations on March 10, 1997.
BROKERAGE ALLOCATION
The Investment Advisory Agreements and the Investment Subadvisory Agreements
authorize Investors and the subadvisers, respectively (collectively the
"Advisers") (subject to the discretion and control of the Trust's Board of
Trustees) to select the brokers or dealers that will execute the purchases and
sales of portfolio securities and direct the Advisers to use their best efforts
to obtain the best available price and most favorable execution. Subject to
policies established by the Trustees of the Trust, the Advisers may also be
authorized to effect individual securities transactions at commission rates in
excess of the minimum commission rates available, if an Adviser determines in
good faith that such amount of commission is reasonable in relation to the value
of the brokerage or research services provided, viewed in terms of either the
particular transaction or the Adviser's overall responsibilities with respect
to the Fund and other clients.
In placing portfolio transactions,each of the Advisers will use its best
judgment to choose the broker most capable of providing the brokerage services
necessary to obtain best available price and most favorable execution. The full
range and quality of brokerage services available will be considered in making
these determinations. In those instances where it is reasonably determined that
more than one broker can offer the brokerage services needed to obtain the best
available price and most favorable execution, consideration may be given to
those brokers which supply investment research and other services in addition to
execution services. Such services may include factual and statistical
information or other items of supplementary research assistance. Each of the
Advisers considers such information useful in the performance of its obligations
under the advisory agreements, but is unable to determine the amount by which
such services may reduce its expenses. In addition, within the parameters of
achieving best price and execution, brokerage services may be used to generate
commission credits which are used to pay for pricing agent and custodial
services. See, "Other Services - Fund Pricing Agreements and Custodial
Agreement."
Some securities considered for investment by a Fund may also be appropriate for
other funds and/or clients served by the Advisers. To assure fair treatment of
each fund and all clients of the Advisers in situations in which two or more
clients' accounts participate simultaneously in a buy or sell program involving
the same security, such transactions will be allocated among the Funds and
clients in a manner deemed equitable by the Advisers.
The Growth Fund paid brokerage fees of $458,195, $522,990 and $800,459 in the
fiscal years ended December 31, 1994, 1995 and 1996, respectively; the Balanced
Fund paid brokerage fees of $237,952, $269,217 and $379,354 for those same
respective periods. The Income Fund and the Short-Term Fund paid no brokerage
fees.
11
<PAGE>
Where multiple brokers are deemed to be able to provide best execution,
brokerage commissions may be allocated to such brokers on the basis of their
ability to provide research. For the fiscal year ended December 31, 1996, the
Growth fund and Balanced Fund paid commissions dollars to such brokers in the
amount of $36,244 and $14,574, respectively. Total brokerage fees paid during a
year will vary with turnover rates.
OTHER SERVICES
FUND PRICING AGREEMENTS - Effective January 1, 1997, the Trust entered into an
agreement with State Street Bank and Trust Company ("State Street"), a national
banking association located at 225 Franklin Street, Boston, Massachusetts 02110,
to calculate the daily net asset value per share for each Fund and to maintain
certain required accounting records.
The Growth and Balanced Funds may compensate State Street Bank for these
services directly or through a commission credit arrangement with Frank Russell
Securities, Inc. The Adviser places trades for the Growth and Balanced Funds
with Frank Russell Securities, Inc., subject to its obligation to obtain the
best available price and most favorable execution. Investors directly
compensates State Street for pricing and accounting services provided to the
Short-Term Investment Fund.
CUSTODIAL AGREEMENT - State Street Bank also serves as custodian of the assets
of each Fund, including foreign securities through a subcustodian relationship.
Under the Custodial Agreement, State Street maintains each Fund's portfolio
securities, administers the purchases and sales of portfolio securities,
collects interest and dividends and other distributions made on portfolio
securities, and performs such other ministerial duties outlined in the Custodial
Agreement.
The Growth and Balanced Funds may compensate State Street for these services
directly or through a commission credit arrangement with Frank Russell
Securities, Inc. The Adviser places trades for the Growth and Balanced Funds
with Frank Russell Securities, Inc., subject to its obligation to obtain the
best available price and most favorable execution.
12
<PAGE>
TRANSFER AND DIVIDEND PAYING AGENT - Horace Mann Service Corporation ("HMSC"),
One Horace Mann Plaza, Springfield, Illinois 62715-0001, acts as the transfer
agent and dividend disbursing agent for each Fund and is paid a fee based on the
number of accounts outstanding. HMSC is a wholly-owned subsidiary of Horace Mann
Educators Corporation ("HMEC"). "Horace Mann" is a registered service mark of
HMEC. The Funds have been given limited permission to use that service mark in
its name, subject to HMEC's right to revoke that permission.
INDEPENDENT AUDITORS - KPMG Peat Marwick LLP, 303 East Wacker Drive, Chicago,
Illinois 60601, serves as the Trust's independent auditors. KPMG Peat Marwick
LLP performs an annual audit of the financial statements of each Fund and
provides accounting advice and services related to Securities and Exchange
Commission filings throughout the year.
PURCHASE, REDEMPTION AND PRICING OF FUND SHARES
Each Fund sells and redeems its shares at net asset value per share, without a
sales or redemption charge. No minimum purchase or redemption amounts apply. The
daily net asset value of each Fund's shares is determined by dividing the net
assets by the number of outstanding shares. Net assets are equal to the total
assets of the Fund less its liabilities. The price at which a purchase is
effected is based on the next calculated net asset value after the order is
received at the home office, One Horace Mann Plaza, Springfield, Illinois 62715-
0001. A security listed or traded on an exchange is valued at its last sales
price on the exchange where it is principally traded. In the absence of a
current quotation, the security is valued at the mean between the last bid and
asked prices on the exchange. Securities traded over-the-counter are valued at
the last current bid price. Trading in securities on exchanges and over-the-
counter markets in Europe and the Far East is normally completed at various
times prior to 3:00 p.m. Chicago time, the current closing time of the New York
Stock Exchange. Trading on foreign exchanges may not take place on every date
the New York Stock Exchange is open. Conversely, trading in various foreign
markets may take place on days when the New York Stock Exchange is not open and
on other days when the International Equity Fund's net asset value is not
calculated. Consequently, calculation of the net asset value for the
International Equity Fund may not occur at the same time as determination of the
most current market prices of the securities included in the calculation; and
the value of the net assets held by the International Equity Fund may be
significantly affected on days when shares are not available for purchase or
redemption.
Debt securities that have a remaining maturity of 60 days or less are valued at
cost, plus or minus any amortized discount or premium. Under the amortized cost
method of valuation, the security is initially valued at cost. Then, the Fund
assumes 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. While this method provides certainty in
valuation, it may result in periods during which value, as determined by
amortized cost, is higher or lower than the price that would be received upon
the sale of the security. When market quotations are not available, securities
are valued at fair value as determined in good faith by the Board of Trustees.
TAX STATUS
It is intended that each of the Funds will qualify as a regulated investment
company under the Internal Revenue Code of 1986, as amended ("Code"). In order
to qualify as a regulated investment company under the Code,
13
<PAGE>
each of the Funds must, among other things, (a) derive at least 90% of its gross
income from dividends, interest, payments with respect to securities loans,
gains from the sale or other disposition of stocks, 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 these stocks, securities or foreign currencies; (b) derive less than 30% of
its gross income from the sale or other disposition of stocks, securities or
certain options, futures, or forward contracts held less than three months, (c)
distribute at least 90% of its net investment income which includes short-term
capital gains and (d) diversify its holdings so that, at the end of each fiscal
quarter, (i) at least 50% of the market value of the Fund's assets is
represented by cash and cash items, Government securities, the securities of
other regulated investment companies, and other securities limited in respect of
any one issuer to 5% of the Fund's total assets and to not more than 10% of the
voting securities of that 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
Government securities or the securities of other regulated investment
companies).
The Funds are investment vehicles for the variable contracts of Horace Mann Life
Insurance Company. The separate accounts which maintain the variable contracts
must satisfy quarterly diversification requirements under Section 817(h) of the
Code. These diversification requirements, which apply in addition to the
diversification requirements imposed on the Funds by the Investment Company Act
of 1940, place limitations on the investments of each Fund that can be made in
the securities of certain issuers. If Fund investments are not adequately
diversified under Section 817(h), the earnings of all variable contracts
invested, in whole or in part, in the Fund will be currently taxable to the
variable contract owners.
As a regulated investment company, a Fund is not subject to federal income tax
on its net investment income (including short-term capital gains) if it
distributes all net investment income to its shareholders. A Fund will not be
subject to federal income tax on any net capital gains (the excess of net long-
term capital gains or net short-term capital losses) that are distributed as
capital gain dividends. If, however, shares of a Fund are sold at a loss after
being held six months or less, such loss will be considered a long-term capital
loss to the extent of any capital gains distributions on such shares.
A Fund's options, futures and foreign currency transactions are subject to
special tax provisions that may accelerate or defer recognition of certain gains
or losses, change the character of certain gains or losses, or alter the holding
periods of certain of a Fund's securities.
The mark-to-market rules of the Code may require a Fund to recognize unrealized
gains and losses on certain options and futures held by the Fund at the end of
the fiscal year. Under these provisions, 60% of any capital gain net income or
loss recognized will generally be treated as long-term and 40% as short-term.
However, although certain forward contracts and futures contracts on foreign
currency are marked-to-market, the gain or loss is generally ordinary under
Section 988 of the Code. In addition, the straddle rules of the Code would
require deferral of certain losses realized on positions of a straddle to the
extent that a Fund had unrealized gains in offsetting positions at year end.
Foreign exchange gains and losses realized by the International Equity Fund in
connection with certain transactions that involve foreign currency-denominated
debt securities, certain foreign currency options, foreign currency forward
contracts, foreign currencies, or payables or receivables denominated in a
foreign currency are subject to Section 988 of the Code, which generally causes
such gains and losses to be treated as ordinary
14
<PAGE>
income and losses and may affect the amount, timing, and character of
distributions to shareholders. For example, if the Fund sold a foreign stock or
bond and part of the gain or loss on the sale was attributable to an increase or
decrease in the value of a foreign currency, then the currency gain or loss may
be treated as ordinary income or loss. If such transactions result in higher net
ordinary income, the dividends paid by the Fund will be increased; if the result
of such transactions is lower net ordinary income, a portion of dividends paid
could be classified as a return of capital.
The International Equity Fund may qualify for and make an election permitted
under the "pass through" provisions of Section 853 of the Code, which allows a
regulated investment company to have its foreign tax credit taken by its
shareholders instead of on its own tax return. To be eligible for this credit,
more than 50% of the value of the Fund's total assets at the close of its
taxable year must consist of stock or other securities in foreign corporations,
and the Fund must have distributed at least 90% of its taxable income.
If the International Equity Fund makes this election, it may not take any
foreign tax credit, and may not take a deduction for foreign taxes paid.
However, the Fund is allowed to include the amount of foreign taxes paid in a
taxable year in its dividends paid deduction. Each shareholder would then
include in its gross income, and treat as paid by it, his proportionate share of
the foreign taxes paid by the Fund.
Investment income derived from foreign securities may be subject to foreign
income taxes withheld at the source. Because the amount of a Fund's investments
in various countries will change from time to time, it is not possible to
determine the effective rate of such taxes in advance.
If the U.S. government were to impose any restrictions, through taxation or
other means, on foreign investments by U.S. investors such as those to be made
through the portfolio, the Board of Trustees of the Fund will promptly review
the policies of the International Equity Fund to determine whether significant
changes in its investments are appropriate.
Non-U.S. investors not engaged in a U.S. trade or business with which their
investment in the International Equity Fund is effectively connected will be
subject to U.S. federal income tax treatment that is different from that
described above and in the prospectus. Such investors may be subject to
nonresident alien withholding tax at the rate of 30% (or a lower rate under an
applicable tax treaty) on amounts treated as ordinary dividends from the Fund
and, unless an effective IRS Form W-8 or authorized substitute for Form W-8 is
on file, to 31% backup withholding on certain other payments from the Fund.
Non-U.S. investors should consult their tax advisers regarding such treatment
and the application of foreign taxes to an investment in the Fund.
The above discussion is only an abbreviated summary of the applicable provisions
of the Code and is not intended as tax advice.
15
<PAGE>
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
The following table sets forth, as of April 1, 1997, the holdings of the capital
stock of each of the Funds known by the respective Fund to own, control or hold
with power to vote 5% or more of its outstanding securities. Since the listed
insurance company registered separate accounts' voting rights are passed through
to contract owners, the insurance companies themselves do not exercise voting
control over the shares held in those accounts.
Growth Fund: Type of Shares % of shares
- ------------ Ownership Owned Outstanding
--------- --------- -----------
Horace Mann Life Insurance Company
One Horace Mann Plaza
Springfield, Illinois 62715
(a) Horace Mann Life Insurance Company
Separate Account......................... Record 14,348,988 76.00
(b) Horace Mann Life Insurance Company
Separate Account B....................... Record 976,561 5.17
Small Cap Growth Fund:
- ----------------------
Horace Mann Life Insurance Company
One Horace Mann Plaza
Springfield, Illinois 62715
(a) Horace Mann Life Insurance Company
Separate Account......................... Record 40,645 28.90
(b) Horace Mann Life Insurance Company
(depositor).............................. Record 100,000 71.10
International Equity Fund:
- --------------------------
Horace Mann Life Insurance Company
One Horace Mann Plaza
Springfield, Illinois 62715
(a) Horace Mann Life Insurance Company
Separate Account......................... Record 19,267 16.15
(b) Horace Mann Life Insurance Company
(depositor).............................. Record 100,000 83.85
Socially Responsible Fund:
- --------------------------
Horace Mann Life Insurance Company
One Horace Mann Plaza
Springfield, Illinois 62715
(a) Horace Mann Life Insurance Company
Separate Account......................... Record 6,368 5.99
(b) Horace Mann Life Insurance Company
(depositor).............................. Record 100,000 94.01
Balanced Fund:
- --------------
Horace Mann Life Insurance Company
One Horace Mann Plaza
Springfield, Illinois 62715
(a) Horace Mann Life Insurance
Company Separate Account................. Record 15,599,966 95.68
Income Fund:
- -----------
Horace Mann Life Insurance Company
One Horace Mann Plaza
Springfield, Illinois 62715
(a) Horace Mann Life Insurance Company
Separate Account......................... Record 760,891 95.87
Short-Term Fund:
- ----------------
Horace Mann Life Insurance Company
One Horace Mann Plaza
Springfield, Illinois 62715
(a) Horace Mann Life Insurance Company
Separate Account......................... Record 102,362 87.13
(b) Horace Mann Life Insurance Company
(depositor)............................... Record 10,000 8.51
16
<PAGE>
Horace Mann Life Insurance Company is organized under the laws of the State of
Illinois and is a wholly-owned subsidiary of Allegiance Life Insurance Company,
an Illinois-domiciled life insurance company. One hundred percent of the stock
of Allegiance Life Insurance Company is held by Horace Mann Educators
Corporation, an insurance holding company incorporated in Delaware.
GENERAL INFORMATION
As a business trust, the Trust is not required to hold annual shareholder
meetings. However, special meetings may be called for purposes such as electing
or removing trustees, changing fundamental policies, or approving an investment
advisory contract. If requested to do so by the holders of at least 10% of the
Trust's outstanding shares, the Trust will call a special meeting for the
purpose of voting upon the question of removal of a trustee or trustees and will
assist in the communications with other shareholders as if the Trust were
subject to Section 16(C) of the Investment Company Act of 1940. All shares of
all series of the Trust are voted together in the election of trustees. On any
other matter submitted to a vote of shareholders, shares are voted in the
aggregate and not by the individual series, except that shares are voted by the
individual series when required by the Investment Company Act of 1940 or other
applicable law or when the Board of Trustees determines that the matter affects
only the interests of one or more series, in which case shareholders of the
unaffected series are not entitled to vote on such matters.
FINANCIAL STATEMENTS
The financial statements for the Growth Fund, Balanced Fund, Income Fund and
Short-Term Investment Fund for the year ended December 31, 1996, and the Report
of Independent Auditors thereon, are incorporated herein by reference from the
Funds' Annual Report dated December 31, 1996. A copy of the Annual Report must
be accompanied by or preceded by the Prospectus. Additional copies of the Annual
Report and/or the Reports of Independent Auditors may be obtained, upon request
and without charge, by contacting the offices of the Funds at P.O. Box 4657,
Springfield, Illinois 62708-4657, by sending a telefacsimile (FAX) transmission
to (217) 527-2307, or by telephoning (217) 789-2500 or (800) 999-1030 (toll-
free).
The Small Cap Growth Fund, International Equity Fund and Socially Responsible
Fund are new Funds. The Statements of Net Assets for these Funds are on the
following pages.
17
<PAGE>
REPORT OF INDEPENDENT AUDITORS
------------------------------
The Board of Trustees and Shareholders of
Horace Mann Mutual Funds:
We have audited the accompanying statements of net assets for the Small Cap
Growth Fund, International Equity Fund and Socially Responsible Fund (the
portfolios comprising the Horace Mann Mutual Funds) (the "Fund") as of December
27,1996. These financial statements are the responsibility of the Fund's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. Our
procedures included confirmation of the cash balance as of December 27, 1996, by
correspondence with the custodian. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial positions of the Portfolios as of December
27, 1996 in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
Chicago, Illinois
December 30, 1996
18
<PAGE>
HORACE MANN MUTUAL FUNDS
STATEMENTS OF NET ASSETS
December 27, 1996
<TABLE>
<CAPTION>
Small Cap International Socially
Growth Equity Responsible
Fund Fund Fund
------------------------------------------------
<S> <C> <C> <C>
Assets-
Cash...................................... $40,000 $40,000 $40,000
Total Assets......................... 40,000 40,000 40,000
Net Assets..................................... $40,000 $40,000 $40,000
======= ======= =======
Net Assets Consist of:
Paid in Surplus........................... $40,000 $40,000 $40,000
======= ======= =======
Maximum Offering Price per
Share:
Net Assets Value and Redemption Price
per Share (based upon net assets of
$40,000 and 4,000 shares of beneficial
interest issued and outstanding for
each Fund)............................... $ 10.00 $ 10.00 $ 10.00
======= ======= =======
</TABLE>
Note 1: The Horace Mann Mutual Funds was organized as a Delaware Business Trust
on November 7, 1996. The Trust is comprised of the following portfolios: Small
Cap Growth Fund, International Equity Fund and the Socially Responsible Fund
(the "Portfolios"). None of the portfolios have had operations since that date
other than relating to the issuance of 4,000 no par value shares of beneficial
interest for $40,000 to Horace Mann Life Insurance Company, an affiliated
company. An unlimited number of shares are authorized.
19
<PAGE>
APPENDIX A
DESCRIPTION OF COMMERCIAL PAPER AND BOND RATINGS
COMMERCIAL PAPER RATINGS - Moody's Investors Service, Inc., employs the
designations "Prime-1", "Prime-2" and "Prime-3" to indicate commercial paper
having the highest capacity for timely repayment. Issuers rated PRIME-1 have a
superior capacity for repayment of short-term promissory obligations. Prime-1
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 earnings 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.
Issues rated PRIME-2 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 alternate liquidity is maintained.
Standard & Poor's Corporation's ratings of commercial paper are graded into four
categories ranging from "A" for the highest quality obligations to "D" for the
lowest. A - Issues assigned its highest rating are regarded as having the
greatest capacity for timely payment. Issues in this category are delineated
with numbers 1, 2 and 3 to indicate the relative degree of safety. A-1 - This
designation indicates that the degree of safety regarding timely payment is
either overwhelming or very strong. Those issues determined to possess
overwhelming safety characteristics will be denoted with a plus (+) sign
designation. A-2 - Capacity for timely payments on issues with this designation
is strong. However, the relative degree of safety is not as high as for issues
designated "A-1."
CORPORATE DEBT SECURITIES - Moody's Investors Service, Inc., rates the long-term
debt securities issued by various entities from "Aaa " to "D." Aaa - Best
quality. These securities 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, these changes are most
unlikely to impair the fundamentally strong position of such issues. Aa - High
quality by all standards. They are rated lower than the best bonds because
margins of protection may not be as large as in Aaa securities, fluctuation of
protective elements may be of greater amplitude, or there may be other elements
present that make the long-term risks appear somewhat greater. A - Upper medium
grade obligations. These bonds possess many favorable investment attributes.
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 - Medium grade obligations. 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.
Standard & Poor's Corporation also rates the long-term securities debt of
various entities in categories ranging from "AAA" to "D" according to quality.
AAA - Highest grade. They possess the ultimate degree of protection as to
principal and interest. Marketwise, they move with interest
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rates and provide the maximum safety on all counts. AA - High grade. Generally,
these bonds differ from AAA issues only in a small degree. Here, too, prices
move with the long-term money market. A - Have a strong capacity to pay interest
and repay principal although they are somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions. BBB - Regarded as
having adequate capacity to pay interest and repay principal. These bonds
normally exhibit adequate protection parameters, but adverse economic conditions
or changing circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal than for debt in higher rated categories.
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APPENDIX B
DESCRIPTION OF SECURITIES AND RISKS
This section should be read in conjunction with each Fund's description in the
Prospectus, the section in the Prospectus entitled "Types of Investments and
Associated Risks" and each Fund's fundamental and nonfundamental investment
policies.
REPURCHASE AGREEMENTS - Each Fund may invest in repurchase agreements.
Repurchase agreements are agreements under which a Fund acquires ownership of an
obligation (debt instrument or time deposit) and the seller agrees, at the time
of the sale, to repurchase the obligation at a mutually agreed upon time and
price, thereby determining the yield during the purchaser's holding period. This
results in a fixed rate of return insulated from market fluctuations during such
period. If the seller of a repurchase agreement fails to repurchase this
obligation in accordance with the terms of the agreement, the investing Fund
will incur a loss to the extent that the proceeds on the sale are less than the
repurchase price. Repurchase agreements usually involve United States Government
or federal agency securities and, as utilized by the Funds, include only those
securities in which the Funds may otherwise invest. Repurchase agreements are
for short periods, most often less than 30 days and usually less than one week.
The Funds intend to enter into repurchase agreements only with domestic
commercial and savings banks and savings and loan associations with total assets
of at least one billion dollars, or with primary dealers in United States
Government securities. In addition, the Funds will not enter into repurchase
agreements unless (a) the agreement specifies that the securities purchased, and
interest accrued thereon, will have an aggregate value in excess of the price
paid and (b) the Funds take delivery of the underlying instruments pending
repurchase. In entering into a repurchase agreement, a Fund is exposed to the
risk that the other party to the agreement may be unable to keep its commitment
to repurchase. In that event, a Fund may incur disposition costs in connection
with liquidating the underlying security. Moreover, if bankruptcy proceedings
are commenced with respect to the selling party, receipt of the value of the
collateral may be delayed or substantially limited. The Funds believe that these
risks are not material inasmuch as a Fund will evaluate the creditworthiness of
all entities with which it proposes to enter into repurchase agreements, and
will seek to assure that each such arrangement is adequately collateralized.
REVERSE REPURCHASE AGREEMENTS - Each Fund may invest in reverse repurchase
agreements. Reverse repurchase agreements involve the sale of money market
securities held by a Fund, with an agreement to repurchase the securities at an
agreed upon price, date and interest payment. If it employs reverse repurchase
agreements, a Fund will use the proceeds to purchase other money market
securities and instruments eligible for purchase by that Fund either maturing,
or under an agreement to resell, at a date simultaneous with or prior to the
expiration of the reverse repurchase agreement. At the time it enters into a
reverse repurchase agreement, a Fund will place in a segregated custodial
account securities having a value equal to the repurchase price. A Fund will
generally utilize reverse repurchase agreements when the interest income to be
earned from the investment of the proceeds of the transactions is greater than
the interest expense incurred as a result of the reverse repurchase
transactions. Reverse repurchase agreements involve the risk that the market
value of securities purchased by the Fund with the proceeds of the transaction
may decline below the repurchase price of the securities that the Fund is
obligated to repurchase. As a matter of operating policy, the aggregate amount
of illiquid repurchase and reverse repurchase agreements will not exceed 10% of
any of the Funds' total net assets at the time of initiation.
HIGH-YIELD (HIGH-RISK) SECURITIES -- To the extent a Fund can invest in high-
yield (high-risk) securities, the following sections are applicable. High-yield
(high-risk) securities (hereinafter referred to as "lower-quality securities")
include (i) bonds rated as low as "C" by Moody's Investors Service, Inc.
("Moody's"), Standard & Poor's Ratings Group ("S&P"), or Fitch Investors
Service, Inc. ("Fitch"), or "CCC" by Duff & Phelps, Inc. ("D&P"); (ii)
commercial paper rated as low as "C" by S&P, "Not Prime" by Moody's, or "Fitch
4" by Fitch; and (iii) unrated debt obligations of comparable quality. Lower-
quality securities, while generally offering higher yields than investment grade
securities with similar maturities, involve greater risks, including the
possibility of default or bankruptcy. They are regarded as predominantly
speculative with respect to the issuer's capacity to pay interest and repay
principal. The special risk considerations in connection with investments in
these securities are discussed below.
Effect Of Interest Rates And Economic Changes. All interest-bearing securities
typically experience appreciation when interest rates decline and depreciation
when interest rates rise. The market values of lower-quality and comparable
unrated securities tend to reflect individual corporate developments to a
greater extent than do higher-rated securities, which react primarily to
fluctuations in the general level of interest rates. Lower-quality and
comparable unrated securities also tend to be more sensitive to economic
conditions than are higher-rated securities. As a result, they generally involve
more credit risks than securities in the higher-rated categories. During an
economic downturn or a sustained period of rising interest rates, highly
leveraged issuers of lower-quality and comparable unrated securities may
experience financial stress and may not have sufficient revenues to meet their
payment obligations. The issuer's ability to service its debt obligations may
also be adversely affected by specific corporate developments, the issuer's
inability to meet specific projected business forecasts or the unavailability of
additional financing. The risk of loss due to default by an issuer of these
securities is significantly greater than by issuers of higher-rated securities
because such securities are generally unsecured and are often subordinated to
other creditors. Further, if the issuer of a lower-quality or comparable unrated
security defaulted, a Fund might incur additional expenses to seek recovery.
Periods of economic uncertainty and changes would also generally result in
increased volatility in the market prices of these securities and thus in a
Fund's net asset value.
As previously stated, the value of a lower-quality or comparable unrated
security will decrease in a rising interest rate market, and accordingly, so
will a Fund's net asset value. If a Fund experiences unexpected net redemptions
in such a market, it may be forced to liquidate a portion of its portfolio
securities without regard to their investment merits. Due to the limited
liquidity of lower-quality and comparable unrated securities (discussed below),
a Fund may be forced to liquidate these securities at a substantial discount.
Any such liquidation would force a Fund to sell the more liquid portion of its
portfolio.
Payment Expectations. Lower-quality and comparable unrated securities
typically contain redemption, call or prepayment provisions which permit the
issuer of such securities containing such provisions to, at its discretion,
redeem the securities. During periods of falling interest rates, issuers of
these securities are likely to redeem or prepay the securities and refinance
them with debt securities with a lower interest rate. To the extent an issuer is
able to refinance the securities, or otherwise redeem them, a Fund may have to
replace the securities with a lower-yielding security, which would result in a
lower return for a Fund.
Credit Ratings. Credit ratings issued by credit rating agencies are
designed to evaluate the safety of principal and interest payments of rated
securities. They do not, however, evaluate the market value risk of lower-
quality securities and, therefore, may not fully reflect the true risks of an
investment. In addition, credit rating agencies may or may not make timely
changes in a rating to reflect changes in the economy or in the condition of the
issuer that affect the market value of the security. Consequently, credit
ratings are used only as a preliminary indicator of investment quality.
Investments in lower-quality and comparable unrated obligations will be more
dependent on the Subadvisers' credit analysis than would be the case with
investments in investment-grade debt obligations. The Advisers employ their own
credit research and analysis, which includes a study of existing debt, capital
structure, ability to service debt and to pay dividends, the issuer's
sensitivity to economic conditions, its operating history and the current trend
of earnings. The Subadvisers continually monitor the investments in each Fund's
portfolio and carefully evaluate whether to dispose of or to retain lower-
quality and comparable unrated securities whose credit ratings or credit quality
may have changed.
Liquidity And Valuation. A Fund may have difficulty disposing of certain
lower-quality and comparable unrated securities because there may be a thin
trading market for such securities. Because not all dealers maintain markets in
all lower-quality and comparable unrated securities, there is no established
retail secondary market for many of these securities. The Funds anticipate that
such securities could be sold only to a limited number of dealers or
institutional investors. To the extent a secondary trading market does exist, it
is generally not as liquid as the secondary market for higher-rated securities.
The lack of a liquid secondary market may have an adverse impact on the market
price of the security. As a result, a Fund's net asset value and ability to
dispose of particular securities, when necessary to meet a Fund's liquidity
needs or in response to a specific economic event, may be impacted. The lack of
a liquid secondary market for certain securities may also make it more difficult
for a Fund to obtain accurate market quotations for purposes of valuing a Fund's
portfolio. Market quotations are generally available on many lower-quality and
comparable unrated issues only from a limited number of dealers and may not
necessarily represent firm binds of such dealers or prices for actual sales.
During periods of thin trading, the spread between bid and asked prices is
likely to increase significantly. In addition, adverse publicity and investor
perception, whether or not based on fundamental analysis, may decease the values
and liquidity of lower-quality and comparable unrated securities, especially in
a thinly traded market.
WARRANTS - Each Fund may invest in warrants. Warrants are instruments that
provide the owner with the right to purchase a specified security, usually an
equity security such as common stock, at a specified price (usually
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representing a premium over the applicable market value of the underlying equity
security at the time of the warrant's issuance) and usually during a specified
period of time. While warrants may be traded, there is often no secondary market
for them. Moreover, they are usually issued by the issuer of the security to
which they relate. The Funds will invest in publicly traded warrants only.
Warrants do not have any inherent value. To the extent that the market value of
the security that may be purchased upon exercise of the warrant rises above the
exercise price, the value of the warrant will tend to rise. To the extent that
the exercise price equals or exceeds the market value of such security, the
warrants will have little or no market value. If warrants remain unexercised at
the end of the specified exercise period, they lapse and the investing Fund's
investment in them will be lost. In view of the highly speculative nature of
warrants, as a matter of operating policy, the Growth Fund, International Equity
Fund, Socially Responsible Fund, Balanced Fund, Income Fund and Short-Term
Investment Fund will not invest more than 5% of their total net assets in
warrants.
RIGHTS OFFERINGS - The Small Cap Fund may participate in rights offerings, which
are privileges issued by corporations enabling the owners to subscribe to and
purchase a specified number of shares of the corporation at a specified price
during a specified period of time. Subscription rights normally have a short
life span to expiration. The purchase of rights involves the risk that the Fund
could lose the purchase value of a right if the right to subscribe to additional
shares is not exercised prior to the rights' expiration. Also, the purchase of
rights involves the risk that the effective price paid for the right added to
the subscription price of the related security may exceed the value of the
subscribed security's market price such as when there is no movement in the
level of the underlying security.
CONVERTIBLE PREFERRED STOCKS AND DEBT SECURITIES - The Growth Fund,
International Equity Fund, Socially Responsible Fund, Balanced Fund, Income Fund
and Short-Term Investment Fund may invest in convertible preferred stock and
debt securities. Certain preferred stocks and debt securities include conversion
features allowing the holder to convert securities into another specified
security (usually common stock) of the same issuer at a specified conversion
ratio (e.g., two shares of preferred for one share of common stock) at some
specified future date or period. The market value of convertible securities
generally includes a premium that reflects the conversion right. That premium
may be negligible or substantial. To the extent that any preferred stock or debt
security remains unconverted after the expiration of the conversion period, the
market value will fall to the extent represented by that premium.
PREFERRED EQUITY REDEMPTION CUMULATIVE STOCK - The Growth Fund, International
Equity Fund, Socially Responsible Fund, Balanced Fund, Income Fund and Short-
Term Investment Fund may invest in preferred equity redemption cumulative stock.
Preferred Equity Redemption Cumulative Stock (PERCS) is a form of convertible
preferred stock which automatically converts into shares of common stock on a
predetermined conversion date. PERCS pays a fixed annual dividend rate which is
higher than the annual dividend rate of the issuing company's common stock.
However, the terms of PERCS limit an investor's ability to participate in the
appreciation of the common stock (usually capped at approximately 40%).
Predetermined redemption dates and prices set by the company upon the issuance
of the securities provide the mechanism for limiting the price appreciation of
PERCS.
ADJUSTABLE RATE MORTGAGE SECURITIES - The Growth Fund, International Equity
Fund, Socially Responsible Fund, Balanced Fund, Income Fund and Short-Term
Investment Fund may invest in adjustable rate mortgage securities. Adjustable
rate mortgage securities (ARMs), are pass-through mortgage securities
collateralized by mortgages with adjustable rather than fixed rates. ARMs
eligible for inclusion in a mortgage pool generally provide for a fixed initial
mortgage interest rate for either the first three, six, twelve, thirteen,
thirty-six or sixty scheduled monthly payments. Thereafter, the interest rates
are subject to periodic adjustment based on changes to a designated benchmark
index.
ARMs contain maximum and minimum rates beyond which the mortgage interest rate
may not vary over the lifetime of the security. In addition, certain ARMs
provide for limitations on the maximum amount by which the mortgage interest
rate may adjust for any single adjustment period. Alternatively, certain ARMs
contain limitations on changes in the required monthly payment. In the event
that a monthly payment is not sufficient to pay the interest accruing on an ARM,
any such excess interest is added to the principal balance of the mortgage loan,
which is repaid through future monthly payments. If the monthly payment for
such an instrument exceeds the sum of the interest accrued at the applicable
mortgage interest rate and the principal payment required at such point to
amortize the outstanding principal balance over the remaining
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term of the loan, the excess is utilized to reduce the then outstanding
principal balance of the ARM.
TYPES OF CREDIT ENHANCEMENT - Mortgage backed securities and asset-backed
securities are often backed by a pool of assets representing the obligations of
a number of different parties. To lessen the effect of failures by obligers on
underlying assets to make payments, these securities may contain elements of
credit support which fall into two categories: (i) liquidity protection and
(ii) protection against losses resulting from ultimate default by an obligor on
the underlying assets. Liquidity protection refers to the provision of
advances, generally by the entity administering the pool of assets, to seek to
ensure that the receipt of payments on the underlying pool occurs in a timely
fashion. Protection against losses resulting from default seeks to ensure
ultimate payment of the obligations on at least a portion of the assets in the
pool. This protection may be provided through guarantees, insurance policies,
or letters of credit obtained by the issuer or sponsor from third parties,
through various means of structuring the transaction or through a combination of
such approaches. The degree of credit support provided for each issue is
generally based on historical information respecting the level of credit risk
associated with the underlying assets. Delinquencies or losses in excess of
those anticipated could adversely affect the return on an investment in a
security. A Fund will not pay any additional fees for credit support, although
the existence of credit support may increase the price of a security.
FOREIGN SECURITIES - Investors should recognize that investing in foreign
securities involves certain special considerations, including those set forth
below, which are not typically associated with investing in U.S. securities and
which may favorably or unfavorably affect a Fund's performance. As foreign
companies are not generally subject to uniform accounting, auditing and
financial reporting standards, practices and requirements comparable to those
applicable to domestic companies, there may be less publicly available
information about a foreign company than about a domestic company. Many foreign
securities markets, while growing in volume of trading activity, have
substantially less volume than the U.S. market, and securities of some foreign
issuers are less liquid and more volatile than securities of domestic issuers.
Similarly, volume and liquidity in most foreign bond markets is less than in the
U.S. and, at times, volatility of prices can be greater than in the U.S. Fixed
commissions on some foreign securities exchanges and bid-to-asked spreads in
foreign bond markets are generally higher than commissions or bid-to-asked
spreads on U.S. markets, although a Fund will endeavor to achieve the most
favorable net results on its portfolio transactions. There is generally less
government supervision and regulation of securities exchanges, brokers and
listed companies than in the U.S. It may be more difficult for a Fund's agents
to keep currently informed about corporate actions which may affect the
prices
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of portfolio securities. Communications between the U.S. and foreign countries
may be less reliable than within the U.S., thus increasing the risk of delayed
settlements of portfolio transactions or loss of certificates for portfolio
securities. Payment for securities without delivery may be required in certain
foreign markets. In addition, with respect to certain foreign countries, there
is the possibility of expropriation or confiscatory taxation, political or
social instability, or diplomatic developments which could affect U.S.
investments in those countries. Moreover, individual foreign economies may
differ favorably or unfavorably from the U.S. economy in such respects as growth
of gross national product, rate of inflation, capital reinvestment, resource
self-sufficiency and balance of payments position. The management of the Fund
seeks to mitigate the risks associated with the foregoing considerations through
continuous professional management.
Forward Foreign Currency Exchange Contracts. The Small Cap Growth Fund and
International Equity Fund may invest in foreign currencies. The Balanced Fund
and Income Fund may each enter into forward foreign currency exchange contracts
to the extent of 15% of the value of their respective total assets for hedging
purposes. Forward foreign currency exchange contracts involve an obligation to
purchase or sell a specified currency at a future date at a price set at the
time of the contract. Forward currency contracts do not eliminate fluctuations
in the values of Fund securities but rather allow the Fund to establish a rate
of exchange for a future point in time. A Fund may use forward foreign currency
exchange contracts to hedge against movements in the value of foreign currencies
(including the "ECU" used in the European Community) relative to the U.S. dollar
in connection with specific Fund transactions or with respect to Fund positions.
The Small Cap Growth Fund may enter into forward foreign currency exchange
contracts when deemed advisable by its Subadviser under two circumstances.
First, when entering into a contract for the purchase or sale of a security, the
Fund may enter into a forward foreign currency exchange contract for the amount
of the purchase or sale price to protect against variations, between the date
the security is purchased or sold and the date on which payment is made or
received, in the value of the foreign currency relative to the U.S. dollar or
other foreign currency. Second, when the Fund's adviser or subadviser
anticipates that a particular foreign currency may decline relative to the U.S.
dollar or other leading currencies, in order to reduce risk, the Fund may enter
into a forward contract to sell, for a fixed amount, the amount of foreign
currency approximating the value of some or all of the Fund's securities
denominated in such foreign currency. With respect to any forward foreign
currency contract, it will not generally be possible to match precisely the
amount covered by that contract and the value of the securities involved due to
the changes in the values of such securities resulting from market movements
between the date the forward contract is entered into and the date it matures.
In addition, while forward contracts may offer protection from losses resulting
from declines in the value of a particular foreign currency, they also limit
potential gains which might result from increases in the value of such currency.
The Fund will also incur costs in connection with forward foreign currency
exchange contracts and conversions of foreign currencies and U.S. dollars.
The Small Cap Growth Fund may also engage in proxy hedging transactions to
reduce the effect of currency fluctuations on the value of existing or
anticipated holdings of Fund securities. Proxy hedging is often used when the
currency to which the Fund is exposed is difficult to hedge or to hedge against
the dollar. Proxy hedging entails entering into a forward contract to sell a
currency whose changes in value are generally considered to be linked to a
currency or currencies in which some or all of the Fund's securities are, or are
expected to be, denominated, and to buy U.S. dollars. Proxy hedging involves
some of the same risks and considerations as other transactions with similar
instruments. Currency transactions can result in losses to the Fund if the
currency being hedged fluctuates in value to a degree or in a direction that is
not anticipated. In addition, there is the risk that the perceived linkage
between various currencies may not be present or may not be present during the
particular time that the Fund is engaging in proxy hedging. The Fund may also
cross hedge currencies by entering into forward contracts to sell one or more
currencies that are expected to decline in value relative to other currencies to
which the Fund has or in which the Fund expects to have Fund exposure. For
example, the Fund may hold both French government bonds and German government
bonds, and the Subadviser may believe that French francs will deteriorate
against German marks. The Fund would sell French francs to reduce its exposure
to that currency and buy German marks. This strategy would be a hedge against a
decline in the value of French francs, although it would expose the Fund to
declines in the value of the German mark relative to the U.S. dollar.
In general, currency transactions are subject to risks different from those of
other Fund transactions, and can result in greater losses to the Fund than would
otherwise be incurred, even when the currency transactions are used for hedging
purposes. Because investments in foreign securities usually will involve
currencies of foreign countries and to the extent a Fund may hold foreign
currencies and forward contracts, futures contracts and options on foreign
currencies and foreign currency futures contracts, the value of the assets of
such Fund as measured in dollars may be affected favorably or unfavorably by
changes in foreign currency exchange rates and exchange control regulations, and
the Fund may incur costs in connection with conversions between various
currencies. Although each Fund values its assets daily in terms of U.S. dollars,
it does not intend to convert its holdings of foreign currencies into U.S.
dollars on a daily basis. It will do so from time to time, and investors should
be aware of the costs of currency conversion. Although foreign exchange dealers
do not charge a fee for conversion, they do realize a profit based on the
difference (the "spread") between the prices at which they are buying and
selling various currencies. Thus, a dealer may offer to sell a foreign currency
to a Fund at one rate, while offering a lesser rate or exchange should the Fund
desire to resell that currency to the dealer. Each 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 entering
into options or forward or futures contracts to purchase or sell foreign
currencies.
A separate account of the Fund consisting of liquid assets equal to the amount
of the Fund's assets that could be required to consummate forward contracts
entered into under the second circumstances, as set forth above, will be
established with the Fund's custodian. For the purpose of determining the
adequacy of the securities in the account, the deposited securities will be
valued at market or fair value. If the market or fair value of such securities
declines, additional cash or securities will be placed in the account daily so
that the value of the account will equal the amount of such commitments by the
Fund.
STRATEGIC TRANSACTIONS AND DERIVATIVES - The International Equity Fund and
Socially Responsible Fund may, but are not required to, utilize various other
investment strategies as described below to hedge various market risks (such as
interest rates and broad or specific equity or fixed-income market movements),
to manage the effective maturity or duration of fixed-income securities in such
Fund's portfolio, or to enhance potential gain. These strategies may be executed
through the use of derivative contracts. Such strategies are generally accepted
as a part of modern portfolio management and are regularly utilized by many
mutual funds and other institutional investors. Techniques and instruments may
change over time as new instruments and strategies are developed or regulatory
changes occur.
In the course of pursuing these investment strategies, the Funds may purchase
and sell exchange-listed and over-the-counter put and call options on
securities, equity and fixed-income indices and other financial instruments,
purchase and sell financial futures contracts and options thereon, enter into
various interest rate transactions such as swaps, caps, floors or collars, and
enter into various currency transactions such as currency forward contracts,
currency futures contracts, currency swaps or options on currencies or currency
futures (collectively, all the above are called "Strategic Transactions").
Strategic Transactions may be used without limit to attempt to protect against
possible changes in the market value of securities held in or to be purchased
for the Fund's unrealized gains in the value of its portfolio securities, to
facilitate the sale of such securities for investment purposes, to manage the
effective maturity or duration of fixed-income
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securities in a Fund's portfolio, or to establish a position in the
derivatives markets as a temporary substitute for purchasing or selling
particular securities. Some Strategic Transactions may also be used to enhance
potential gain although no more than 5% of a Fund's assets will be committed
to Strategic Transactions entered into for non-hedging purposes. Any or all of
these investment techniques may be used at any time and in any combination, and
there is no particular strategy that dictates the use of one technique rather
than another, as use of any Strategic Transaction is a function of numerous
variables including market conditions. The ability of a Fund to utilize these
Strategic Transactions successfully will depend on the Subadviser's ability to
predict pertinent market movements, which cannot be assured. The Fund will
comply with applicable regulatory requirements when implementing these
strategies, techniques and instruments. Strategic Transactions involving
financial futures and options thereon will be purchased, sold or entered into
only for bona fide hedging, risk management or portfolio management purposes and
not for speculative purposes.
Strategic Transactions, including derivative contracts, have risks associated
with them, including possible default by the other party to the transaction,
illiquidity and, to the extent the Subadviser's view as to certain market
movements is incorrect, the risk that the use of such Strategic Transactions
could result in losses greater than if they had not been used. Use of put and
call options may result in losses to a Fund, force the sale or purchase of
portfolio securities at inopportune times or for prices higher than (in the case
of put options) or lower than (in the case of call options) current market
values, limit the amount of appreciation a Fund can realize on its investments
or cause the Fund to hold a security it might otherwise sell. The use of
currency transactions can result in a Fund incurring losses as a result of a
number of factors including the imposition of exchange controls, suspension of
settlements, or the inability to deliver or receive a specified currency. The
use of options and futures transactions entails certain other risks. In
particular, the variable degree of correlation between price movements of
futures contracts and price movements in the related portfolio position of a
Fund creates the possibility that losses on the hedging instrument may be
greater than gains in the value of the Fund's position. In addition, futures and
options markets may not be liquid in all circumstances and certain over -the-
counter options may have no markets. As a result, in certain markets, a Fund
might not be able to close out a transaction without incurring substantial
losses, if at all. Although the use of futures and options transactons for
hedging should tend to minimize the risk of loss due to a decline in the value
of the hedged position, at the same time they tend to limit any potential gain
which might result from an increase in value of such position. Finally, the
daily variation margin requirements for futures contracts would create a greater
ongoing potential financial risk than would purchases of options, where the
exposure is limited to the cost of the initial premium. Losses resulting from
the use of Strategic Transactions would reduce net asset value, and possibly
income, and such losses can be greater than if the Strategic Transactions had
not been utilized.
General Characteristics of Options. To the extent consistent with their
investment objectives, the Small Cap Growth Fund, International Equity Fund and
Socially Responsible Fund may invest in options. Put options and call options
typically have similar structural characteristics and operational mechanics
regardless of the underlying instruments on which they are purchased or sold.
Thus, the following general discussion relates to each of the particular types
of options discussed in greater detail below. In addition, many Strategic
Transactions involving options require segregation of Fund assets in special
accounts.
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A put option gives the purchaser of the option, upon payment of a premium, the
right to sell, and the writer the obligation to buy, the underlying security,
commodity, index, currency or other instrument at the exercise price. For
instance, the Fund's purchase of a put option on a security might be designed to
protect its holdings in the underlying instrument (or, in some cases, a similar
instrument) against a substantial decline in the market-value by giving the Fund
the right to sell such instrument at the option exercise price. A call option,
upon payment of a premium, gives the purchaser of the option the right to buy,
and the seller the obligation to sell, the underlying instrument at the exercise
price. A Fund's purchase of a call option on a security, financial future,
index currency or other instrument might be intended to protect the Fund against
an increase in the price of the underlying instrument that it intends to
purchase in the future by fixing the price at which it may purchase such
instrument. An American-style put or call option may be exercised at any time
during the option period thereto. A Fund is authorized to purchase and sell
exchange listed options and over-the-counter options ("OTC options"). Exchange
listed options are issued by a regulated intermediary such as the Options
Clearing Corporation ("OCC"), which guarantees the performance of the
obligations of the parties to such options. The discussion below uses the OCC
as an example, but is also applicable to other financial intermediaries.
With certain exceptions, OCC issued and exchange listed options generally settle
by physical delivery of the underlying security or currency, although in the
future cash settlement may become available. Index options and Eurodollar
instruments are cash settled for the net amount, if any, by which the option is
"in-the-money" (i.e., where the value of the underlying instrument exceeds, in
the case of a call option, or is less than, in the case of a put option, the
exercise price of the option) at the time the option is exercised. Frequently,
rather than taking or making delivery of the underlying instrument through the
process of exercising the option, listed options are closed by entering into
offsetting purchase or sale transactions that do not result in ownership of the
new option.
A Fund's ability to close out its position as a purchaser or seller of an OCC
or exchange listed put or call option is dependent, in part, upon the liquidity
of the option market. Among the possible reasons for the absence of a liquid
option market on an exchange are: (i) insufficient trading interest in certain
options; (ii) restrictions on transactions imposed by an exchange; (iii) trading
halts, suspensions or other restrictions imposed with respect to particular
classes or series of options or underlying securities including reaching daily
price limits; (iv) interruption of the normal operations of the OCC or an
exchange; (v) inadequacy of the facilities of an exchange or OCC to handle
current trading volume; or (vi) a decision by one or more exchanges to
discontinue the trading of options for a particular class or series of options,
in which event the relevant market for that option on that exchange would cease
to exist, although outstanding options on that exchange would generally continue
to be exercisable in accordance with their terms.
The hours of trading for listed options may not coincide with the hours during
which the underlying financial instruments are traded. To the extent that the
option markets close before the markets for the underlying financial
instruments, significant price and rate movements can take place in the
underlying markets that cannot be reflected in the option markets.
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OTC options are purchased from or sold to securities dealers, financial
institutions or other parties ("Counterparties") through direct bilateral
agreement with the Counterparty. In contracts to exchange listed options, which
generally have standardized terms and performance mechanics, all the terms of an
OTC option, including such terms as method of settlement, term, exercise price,
premium, guarantees and security, are set by negotiation of the parties. A Fund
will only sell OTC options (other than OTC currency options) that are subject
to a buy-back provision permitting the Fund to require the Counterparty to sell
the option back to the Fund at a formula price within seven days. The Funds
expect generally to enter into OTC options that have cash settlement
provisions, although they are not required to do so.
Unless the parties provide for it, there is no central clearing or guaranty
function in an OTC option. As a result, if the Counterparty fails to make or
take delivery of the security, currency or other instrument underlying an OTC
option it has entered into with a Fund or fails to make a cash settlement
payment due in accordance with the terms of that option, the Fund will lose any
premium it paid for the option as well as any anticipated benefit of the
transaction. Accordingly, the Subadviser must assess the creditworthiness of
each such Counterparty or any guarantor or credit enhancement of the
Counterparty's credit to determine the likelihood that the terms of the OTC
option will be satisfied. A Fund will engage in OTC option transactions only
with U.S. Government securities dealers recognized by the Federal Reserve Bank
of New York as "primary dealers" or broker/dealers, domestic or foreign banks or
other financial institutions which have received (or the guarantors of the
obligation of which have received) a short-term credit rating of A-1 from S&P or
P-1 from Moody's or an equivalent rating from any nationally recognized
statistical rating organization ("NRSRO") or, in the case of OTC currency
transactions, are determined to be of equivalent credit quality by the Adviser.
The staff of the SEC currently takes the position that OTC options purchased by
a Fund, and portfolio securities "covering" the amount of a Fund's obligation
pursuant to an OTC option sold by it (the cost of the sell-back plus the in-the-
money amount, if any), are illiquid, and are subject to the Fund's limitation on
investing no more than 15% of its net assets in illiquid securities.
If a Fund sells a call option, the premium that it receives may serve as a
partial hedge, to the extent of the option premium, against a decrease in the
value of the underlying securities or instruments in its portfolio or will
increase the Fund's income. The sale of put options can also provide income.
The Funds may purchase and sell call options on securities including U.S.
Treasury and agency securities, mortgage-backed securities, corporate debt
securities, equity securities (including convertible securities) and Eurodollar
instruments that are traded on U.S. and foreign securities exchanges and in the
over-the-counter markets, and on securities indices, currencies and futures
contracts. All calls sold by a Fund must be "covered" (i.e., the Fund must
own the securities or futures contract subject to the call) or must meet the
asset segregation requirements described below as long as the call is
outstanding. Even though a Fund will receive the option premium to help
protect it against loss, a call sold by the Fund exposes the Fund during the
term of the option to possible loss of opportunity to realize appreciation in
the market price of the underlying security or instrument and may require the
Fund to hold a security or instrument which it might otherwise have sold.
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<PAGE>
The Funds may purchase and sell put options on securities including U.S.
Treasury and agency securities, mortgage-backed securities, foreign sovereign
debt, corporate debt securities (including convertible securities) and
Eurodollar instruments (whether or not it holds the above securities in its
portfolio), and on securities indices, currencies and futures contracts other
than futures on individual corporate debt and individual equity securities. The
Funds will not sell put options if, as a result, more than 50% of a Fund's
assets would be required to be segregated to cover its potential obligations
under such put options other than those with respect to futures and options
thereon. In selling put options, there is a risk that the Fund may be required
to buy the underlying security at a disadvantageous price above the market
price.
When a Fund purchases a put 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 Fund's 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 sale, the mean between the last bid and asked price.
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 the Fund on the closing transaction is more than the premium paid to purchase
the option, or a loss if it is less. If an option written by a Fund expires on
the stipulated expiration date or if a 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.
There are several risks associated with transactions in options on securities
and indexes. 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,
whether traded over-the-counter or on a national securities exchange
("Exchange"), may be absent for reasons which include the following: there may
be insufficient trading interest in certain options; restrictions may be imposed
by an 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 OCC 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 OCC as
a result of trades on that Exchange would continue to be exercisable in
accordance with their terms.
General Characteristics of Futures. To the extent consistent with their
investment objectives, the Small Cap Growth Fund, International Equity Fund and
Socially Responsible Fund may enter into financial futures contracts or purchase
or sell put and call options on such futures as a hedge against anticipated
interest rate, currency or equity market changes, for duration management and
for risk management purposes. Futures are generally bought and sold on the
commodities exchanges where they are listed with payment of initial and
variation margin as described below. The sale of a futures contract creates a
firm obligation by a Fund, as seller, to deliver to the buyer the specific type
of financial instrument called for in the contract at a specific future time for
a specified price (or, with respect to index futures and Eurodollar instruments,
the net cash amount). Options on futures contracts are similar to options on
securities except that an option on a futures contract gives the purchaser the
right in return for the premium paid to assume a position in a futures contract
and obligates the seller to deliver such position.
The Funds' use of financial futures and options thereon will in all cases be
consistent with applicable regulatory requirements and in particular the rules
and regulations of the Commodity Futures Trading Commission and will be entered
into only for bona fide hedging, risk management (including duration management)
or other portfolio management purposes. Typically, maintaining a futures
contract or selling an option thereon requires a Fund to deposit with a
financial intermediary as security for its obligations an amount of cash or
other specified assets (initial margin) which initially is typically 1% to 10%
of the face amount of the contract (but may be higher in some circumstances).
Additional cash or assets (variation margin) may be required to be deposited
thereafter on a daily basis as the mark to market value of the contract
fluctuates. The purchase of an option on financial futures involves payment of a
premium for the option without any further obligation on the part of the Funds.
If a Fund exercises an option on a futures contracts it will be obligated to
post initial margin (and potential subsequent variation margin) for the
resulting futures position just as it would for any position. Futures contracts
and options thereon are generally settled by entering into an offsetting
transaction but there can be no assurance that the position can be offset prior
to settlement at an advantageous price, nor that delivery will occur.
The Funds will not enter into a futures contract or related option (except for
closing transactions) if, immediately thereafter, the sum of the amount of its
initial margin and premiums on open futures contracts and options thereon would
exceed 5% of a Fund's total assets (taken at current value); however, in the
case of an option that is in-the-money at the time of the purchase, the in-the-
money amount may be excluded in calculating the 5% limitation. The segregation
requirements with respect to futures contracts and options thereon are described
below.
B-8
<PAGE>
Options on Securities Indices and Other Financial Indices. The Funds also may
purchase and sell call and put options on securities indices and other financial
indices and in so doing can achieve many of the same objectives it would achieve
through the sale or purchase of options on individual securities or other
instruments. Options on securities indices and other financial indices are
similar to options on a security or other instrument except that, rather than
settling by physical delivery of the underlying instrument, they settle by cash
settlement, i.e., an option on an index gives the holder the right to receive,
upon exercise of the option, an amount of cash if the closing level of the index
upon which the option is based exceeds, in the case of a call, or is less than,
in the case of a put, the exercise price of the option (except if, in the case
of an OTC option, physical delivery is specified). This amount of cash is equal
to the excess of the closing price of the index over the exercise price of the
option, which also may be multiplied by a formula value. The seller of the
option is obligated, in return for the premium received, to make delivery of
this amount. The gain or loss on an option on an index depends on price
movements in the instruments making up the market, market segment, industry or
other composite on which the underlying index is based, rather than price
movements in individual securities, as is the case with respect to options on
securities.
Currency Transactions. The Funds may engage in currency transactions with
Counterparties in order to hedge the value of portfolio holdings denominated in
particular currencies against fluctuations in relative value. Currency
transactions include forward currency contracts, exchange listed currency
futures, exchange listed and OTC options on currencies, and currency swaps. A
forward currency contract involves a privately negotiated obligation to purchase
or sell (with delivery generally required) a specific currency at a future date,
which may be any fixed number of days from the date of the contract agreed upon
by the parties, at a price set at the time of the contract. A currency swap is
an agreement to exchange cash flows based on the notional difference among two
or more currencies and operates similarly to an interest rate swap, which is
described below. The Funds may enter into currency transactions with
Counterparties which have received (or the guarantors of the obligations which
have received) a credit rating of A-1 or P-1 by S&P or Moody's, respectively, or
that have an equivalent rating from a NRSRO or are determined to be of
equivalent credit quality by the adviser.
The Funds' dealings in forward currency contracts and other currency
transactions such as futures, options, options on futures and swaps will be
limited to hedging involving either specific transactions or portfolio
positions. Transaction hedging is entering into a currency transaction with
respect to specific assets or liabilities of a Fund, which will generally arise
in connection with the purchase or sale of its portfolio securities or the
receipt of income therefrom. Position hedging is entering into a currency
transaction with respect to portfolio security positions denominated or
generally quoted in that currency.
The Funds will not enter into a transaction to hedge currency exposure to an
extent greater, after all transactions intended wholly or partially to offset
other transactions, than the aggregate market value (at the time of entering
into the transaction) of the securities held in its portfolio that are
denominated or generally quoted in or currently convertible into such currency,
other than with respect to proxy hedging or cross hedging as described below.
B-9
<PAGE>
The Funds may also cross-hedge currencies by entering into transactions to
purchase or sell one or more currencies that are expected to decline in value
relative to other currencies to which a Fund has or in which the Fund expects
to have portfolio exposure.
To reduce the effect of currency fluctuations on the value of existing or
anticipated holdings of portfolio securities, the Funds may also engage in proxy
hedging. Proxy hedging is often used when the currency to which the Fund's
portfolio is exposed is difficult to hedge or to hedge against the dollar. Proxy
hedging entails entering into a commitment or option to sell a currency whose
changes in value are generally considered to be correlated to a currency or
currencies in which some or all of a Fund's portfolio securities are or are
expected to be denominated, in exchange for U.S. dollars. The amount of the
commitment or option would not exceed the value of a Fund's securities
denominated in correlated currencies. For example, if the Subadviser considers
that the Austrian schilling is correlated to the German deutschemark (the
"D-mark"), a Fund holds securities denominated in schillings and if the
Subadviser believes that the value of schillings will decline against the U.S.
dollar, the Subadviser may enter into a commitment or option to sell D-marks and
buy dollars. Currency hedging involves some of the same risks and considerations
as other transactions with similar instruments. Currency transactions can result
in losses to a Fund if the currency being hedged fluctuates in value to a degree
or in a direction that is not anticipated. Further, there is the risk that the
perceived correlation between various currencies may not be present or may not
be present during the particular time that a Fund is engaging in proxy hedging.
If a Fund enters into a currency hedging transaction, the Fund will comply with
the asset segregation requirements described below.
Risks of Currency Transactions. Currency transactions are subject to risks
different from those of other portfolio transactions. Because currency control
is of great importance to the issuing governments and influences economic
planning and policy, purchases and sales of currency and related instruments can
be negatively affected by government exchange controls, blockages and
manipulations or exchange restrictions imposed by governments. These can result
in losses to a Fund if it is unable to deliver or receive currency or funds in
settlement of obligations and could also cause hedges it has entered into to be
rendered useless, resulting in full currency exposure as well as incurring
transaction costs. Buyers and sellers of currency futures are subject to the
same risks that apply to the use of futures generally. Further, settlement of a
currency futures contract for the purchase of most currencies must occur at a
bank based in the issuing nation. Trading options on currency futures is
relatively new, and the ability to establish and close out positions on such
options is subject to the maintenance of a liquid market which may not always be
available. Currency exchange rates may fluctuate based on factors extrinsic to
that country's economy.
Combined Transactions. The Funds may enter into multiple transactions, including
multiple options transactions, multiple futures transactions, multiple currency
transactions (including forward currency contracts) and multiple interest rate
transactions and any combination of futures, options, currency and interest rate
transactions ("component" transactions), instead of a single Strategic
Transaction, as part of a single or combined strategy when, in the opinion of
the Subadviser, it is in the best interests of a Fund to do so. A combined
transaction will usually contain elements of risk that are present in each of
its component transactions. Although combined transactions are normally entered
in to based on the Subadviser's judgment that the combined strategies will
reduce risk or otherwise more effectively achieve the desired portfolio
B-10
<PAGE>
management goal, it is possible that the combination will instead increase such
risks or hinder achievement of the portfolio management objective.
Swaps, Caps, Floors and Collars. Among the Strategic Transactions into which
the Funds may enter are interest rate, currency and index swaps and the purchase
or sale of related caps, floors and collars. The Funds expect to enter into
these transactions primarily to preserve a return or spread on a particular
investment or portion of its portfolio, to protect against currency
fluctuations, as a duration management technique or to protect against any
increase in the price of securities the Fund anticipates purchasing at a later
date. The Funds intend to use these transactions as hedges and not as
speculative investments and will not sell interest rate caps or floors where it
does not own securities or other instruments providing the income stream the
Fund may be obligated to pay. Interest rate swaps involve the exchange by the
Fund with another party of their respective commitments to pay or receive
interest, e.g., an exchange of floating rate payments for fixed rate payments
with respect to a notional amount of principal. A currency swap is an agreement
to exchange cash flows on a notional amount of two or more currencies based on
the relative value differential among them and an index swap is an agreement to
swap cash flows on a notional amount based on change in the values of the
reference indices. The purchase of a cap entitles the purchaser to receive
payments on a notional principal amount from the party selling such cap to the
extent that a specific index exceeds a predetermined interest rate or amount.
The purchase of a floor entitles the purchaser to receive payments on a notional
principal amount from the party selling such floor to the extent that a
specified index falls below a predetermined interest rate or amount. A collar
is a combination of a cap and a floor that preserves a certain return within a
predetermined range of interest rates or values.
The Funds will usually enter into swaps on a net basis, i.e., the two payment
streams are netted out in a cash settlement on the payment date or dates
specified in the instrument, with the Fund receiving or paying, as the case may
be, only the net amount of the two payments. Inasmuch as these swaps, caps,
floors and collars are entered into for good faith hedging purposes, the
Subadviser and the Funds believe such obligations do not constitute senior
securities under the Investment Company Act of 1940, as amended (the "1940
Act"), and, accordingly, will not treat them as being subject to the 1940 Act's
borrowing restrictions. The Funds will not enter into any swap, cap, floor or
collar transaction unless, at the time of entering into such transaction, the
unsecured long-term debt of the Counterparty, combined with any credit
enhancements, is rated at least A by S&P or Moody's or has an equivalent rating
from a NRSRO or is determined to be of equivalent credit quality by the Adviser.
If there is a default by the Counterparty, the Funds may have contractual
remedies pursuant to the agreements related to the transaction.
Eurodollar Instruments. The Funds may make investments in Eurodollar
instruments. Eurodollar instruments are U.S. dollar-denominated futures
contracts or options thereon which are linked to the London Interbank Offered
Rate ("LIBOR"), although foreign currency-denominated instruments are available
from time to time. Eurodollar futures contracts enable purchasers to obtain a
fixed rate for the lending of funds and sellers to obtain a fixed rate for
B-11
<PAGE>
borrowing. The Funds might use Eurodollar futures contracts and options thereon
to hedge against changes in LIBOR, to which many interest rate swaps and fixed
income instruments are linked.
Risks of Strategic Transactions Outside the U.S. When conducted outside the
U.S., Strategic Transactions 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 the 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.
Use of Segregated and Other Special Accounts. Many Strategic Transactions, in
addition to other requirements, require that the Funds segregate liquid, high
grade assets with its custodian to the extent Fund obligations are not otherwise
"covered" through ownership of the underlying security, financial instrument or
currency. In general, either the full amount of any obligation by a Fund to
pay or deliver securities or assets must be covered at all times by the
securities, instruments or currency required to be delivered, or, subject to
any regulatory restrictions, an amount of cash or liquid, high grade securities
at least equal to the current amount of the obligation must be segregated with
the custodian. The segregated assets cannot be sold or transferred unless
equivalent assets are substituted in their place or it is no longer necessary to
segregate them. For example, a call option written by a Fund will require the
Fund to hold the securities subject to the call (or securities convertible into
the needed securities without additional consideration) or to segregate liquid
high grade securities sufficient to purchase and deliver the securities if the
call is exercised. A call option sold by a Fund on an index will require the
Fund to own portfolio securities which correlate with the index or to segregate
liquid, high grade assets equal to the excess of the index value over the
exercise price on a current basis. A put option written by a Fund requires
the Fund to segregate liquid, high grade assets equal to the exercise
price.
Except when the Funds enter into a forward contracts for the purchase or sale of
a security denominated in a particular currency, which requires no segregation,
a currency contract which obligates a Fund to buy or sell currency will
generally require the Fund to hold an amount of that currency or liquid
securities denominated in that currency equal to the Fund's obligations or to
segregate liquid high grade assets equal to the amount of the Fund's obligation.
OTC options entered into by the Funds, including those on securities, currency,
financial instruments or indices and OCC issued and exchange listed index
options, will generally provide for cash settlement. As a result, when a Fund
sells these instruments, it will only segregate an amount of assets equal to its
accrued net obligations, as there is no requirement for payment or delivery of
amounts in excess of the net amount. These amounts will equal 100% of the
exercise price in the case of a non-cash-settled put, the same as an OCC
guaranteed listed option sold by a Fund, or the in-the-money amount plus any
sell-back formula amount in the case of a cash-settled put or call. In addition,
when a Fund sells a call option on an index at a time when the in-the-money
amount exceeds the exercise price, the Fund will segregate, until the option
expires
B-12
<PAGE>
or is closed out, cash or cash equivalents equal in value to such excess. OCC
issued and exchange listed options sold by a Fund other than those above
generally settle with physical delivery, or with an election or either physical
delivery or cash settlement, and the Fund will segregate an amount of assets
equal to the full value of the option. OTC options settling with physical
delivery, or with an election of either physical delivery or cash settlement,
will be treated the same as other options settling with physical delivery.
In the case of a futures contract or an option thereon, the Funds must deposit
initial margin and possible daily variation margin in addition to segregating
assets sufficient to meet its obligation to purchase or provide securities or
currencies, or to pay the amount owed at the expiration of an index-based
futures contract. Such assets may consist of cash, cash equivalents, liquid
debt or equity securities or other acceptable assets.
With respect to swaps, the Funds will accrue the net amount of the excess, if
any, of its obligations over its entitlements with respect to each swap on a
daily basis and will segregate an amount of cash or liquid high grade securities
having a value equal to the accrued excess. Caps, floors and collars require
segregation of assets with a value equal to the Fund's net obligations, if
any.
Strategic Transactions may be covered by other means when consistent with
applicable regulatory policies. The Funds may also enter into offsetting
transactions so that its combined position, coupled with any segregated assets,
equals its net outstanding obligations in related options and Strategic
Transactions. For example, a Fund could purchase a put option if the strike
price of that option is the same as or higher than the strike price of a put
option sold by the Fund. Moreover, instead of segregating assets if a Fund
held a futures or forward contract, it could purchase a put option on the same
futures or forward contract with a strike price as high or higher than the price
of the contract held. Other Strategic Transactions may also be offset in
combinations. If the offsetting transaction terminates at the time of or after
the primary transaction, no segregation is required, but if it terminates prior
to such time, assets equal to any remaining obligation would need to be
segregated.
The Funds' activities involving Strategic Transactions may be limited by the
requirements of Subchapter M of the Internal Revenue Code of 1986, as amended
(the "Code"), for qualification as a regulated investment company. (See "TAX
STATUS").
VARIABLE AND FLOATING RATE INSTRUMENTS - The Small Cap Growth Fund may invest in
variable and floating rate instruments. With respect to purchasable variable and
floating rate instruments, the Adviser or subadviser will consider the earning
power, cash flows and liquidity ratios of the issuers and guarantors of such
instruments and, if the instruments are subject to a demand feature, will
monitor their financial status to meet payment on demand. Such instruments may
include variable amount demand notes that permit the indebtedness thereunder to
vary in addition to providing for periodic adjustments in the interest rate. The
absence of an active secondary market with respect to particular variable and
floating rate instruments could make it difficult for the Fund to dispose of a
variable or floating rate note if the issuer 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 with respect to
such instruments. In determining average-weighted Fund maturity, an instrument
will be deemed to have a maturity equal to either the period remaining until the
next interest rate adjustment or the time the Fund involved can recover payment
of principal as specified in the instrument, depending on the type of instrument
involved.
MONEY MARKET OBLIGATIONS OF DOMESTIC BANKS, FOREIGN BANKS AND FOREIGN BRANCHES
OF U.S. BANKS - The Small Cap Growth Fund may purchase bank obligations, such as
certificates of deposit, bankers' acceptances and time deposits, including
instruments issued or supported by the credit of U.S. or foreign banks or
savings institutions having total assets at the time of purchase in excess of $1
billion. The assets of a bank or savings institution will be deemed to include
the assets of its domestic and foreign branches for purposes of the Fund's
investment policies. Investments in short-term bank obligations may include
obligations of foreign banks and domestic branches of foreign banks, and also
foreign branches of domestic banks.
MORTGAGE-RELATED SECURITIES - The Small Cap Growth Fund, Balanced Fund and
Income Fund may invest in mortgage-related securities. There are a number of
important differences among the agencies and instrumentalities of the U.S.
Government that issue mortgage-related securities and among the securities that
they issue. Mortgage-related securities guaranteed by the Government National
Mortgage Association ("GNMA") include GNMA Mortgage Pass-Through Certificates
(also known as "Ginnie Maes") which are guaranteed as to the timely payment of
principal and interest by GNMA and such guarantee is backed by the full faith
and credit of the United States. GNMA is a wholly-owned U.S. Government
corporation within the Department of Housing and Urban Development. GNMA
certificates also are supported by the authority of GNMA to borrower funds from
the U.S. Treasury to make payments under its guarantee. Mortgage-related
securities issued by the Federal National Mortgage Association ("FNMA") include
FNMA guaranteed Mortgage Pass-Through Certificates (also known as "Fannie Maes")
which are solely the obligations of the FNMA, are not backed by or entitled to
the full faith and credit of the United States and are supported by the right of
the issuer to borrow from the Treasury. FNMA is a government-sponsored
organization owned entirely by private stockholders. Fannie Maes are guaranteed
as to timely payment of principal and interest by FNMA. Mortgage-related
securities issued by the Federal Home Loan Mortgage Corporation ("FHLMC")
include FHLMC Mortgage Participation Certificates (also known as "Freddie Macs"
or "PCs"). FHLMC is a corporate instrumentality of the United States, created
pursuant to an Act of Congress, which is owned entirely by Federal Home Loan
Banks. Freddie Macs are not guaranteed by the United States or by any Federal
Home Loan Banks and do not constitute a debt or obligation of the United States
or of any Federal Home Loan Bank. Freddie Macs entitled the holder to timely
payment of interest, which is guaranteed by the FHLMC. FHLMC guarantees either
ultimate collection or timely payment of all principal payments on the
underlying mortgage loans. When FHLMC does not guarantee timely payment of
principal, FHLMC may remit the amount due on account of its guarantee of
ultimate payment of principal at any time after default on an underlying
mortgage, but in no event later than one year after it becomes payable.
ASSET-BACKED SECURITIES - The Small Cap Growth Fund, Balanced Fund and Income
Fund may invest in asset-backed securities. Asset-backed securities are
generally issued as pass-through certificates, which represent undivided
fractional ownership interests in an underlying pool of assets, or as 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. Asset-backed securities
are often backed by a pool of assets representing the obligations of a number of
different parties.
In general, the collateral supporting asset-backed securities is of shorter
maturity than mortgage-related securities. Like other fixed-income securities,
when interest rates rise the value of an asset-backed security generally will
decline; however, when interest rates decline, the value of an asset-backed
security with prepayment features may not increase as much as that of other
fixed-income securities.
U.S. GOVERNMENT OBLIGATIONS - Examples of the types of U.S. Government
obligations which the Funds may hold include U.S. Treasury bills, Treasury
instruments and Treasury bonds and the obligations of Federal Home Loan Banks,
Federal Farm Credit Banks, Federal Land Banks, the Federal Housing
Administration, the Farmers Home Administration, the Export-Import Bank of the
United States, the Small Business Administration, FNMA, GNMA, the General
Services Administration, the Student Loan Marketing Association, the Central
Bank for Cooperatives, FHLMC, the Federal Intermediate Credit Banks, the
Maritime Administration, the International Bank of Reconstruction and
Development (the "World Bank"), the Asian-American Development Bank and the
Inter-American Development Bank.
SUPRANATIONAL ORGANIZATION OBLIGATIONS - The Small Cap Growth Fund and Socially
Responsible Fund may purchase debt securities of supranational organizations
such as the European Coal and Steel Community, the European Economic Community
and the World Bank, which are chartered to promote economic development.
LEASE OBLIGATIONS - The Small Cap Growth Fund may hold participation
certificates in a lease, an installment purchase contract or a conditional sales
contract ("lease obligations").
The Subadviser will monitor the credit standing of each municipal borrower and
each entity providing credit support and/or a put option relating to lease
obligations. In determining whether a lease obligation is liquid, the Subadviser
will consider, among other factors, the following: (i) whether the lease can be
cancelled; (ii) the degree of assurance that assets represented by the lease
could be sold; (iii) the strength of the lessee's general credit (e.g., its
debt, administrative, economic, and financial characteristics); (iv) the
likelihood that the municipality would discontinue appropriating funding for the
lease property because the property is no longer deemed essential to the
operations of the municipality (e.g., the potential for an "event of
nonappropriation"); (v) legal recourse in the event of failure to appropriate;
(vi) whether the security is backed by a credit enhancement such as insurance
and (vii) any limitations which are imposed on the lease obligor's ability to
utilize substitute property or services other than those covered by the lease
obligation.
Municipal leases, like other municipal debt obligations, are subject to the risk
of non-payment. The ability of issuers of municipal leases to make timely lease
payments may be adversely impacted in general economic downturns and as relative
governmental cost burdens are allocated and reallocated among federal, state and
local governmental units. Such non-payment would result in a reduction of income
to the Fund, and could result in a reduction in the value of the municipal lease
experiencing non-payment and a potential decrease in the net asset value of the
Fund. Issuers of municipal securities might seek protection under the bankruptcy
laws. In the event of bankruptcy of such an issuer, the Fund could experience
delays and limitations with respect to the collection of principal and interest
on such municipal leases and the Fund may not, in all circumstances, be able to
collect all principal and interest to which it is entitled. To enforce its
rights in the event of a default in lease payments, the Fund might take
possession of and manage the assets securing the issuer's obligations on such
securities, which may increase the Fund's operating expenses and adversely
affect the net asset value of the Fund. When the lease contains a non-
appropriation clause, however, the failure to pay would not be a default and the
Fund would not have the right to take possession of the assets. Any income
derived from the Fund's ownership or operation of such assets may not be tax-
exempt. In addition, the Fund's intention to qualify as a "regulated investment
company" under the Internal Revenue Code of 1986, as amended, may limit the
extent to which the Fund may exercise its rights by taking possession of such
assets, because as a regulated investment company the Fund is subject to certain
limitations on its investments and on the nature of its income.
COMMERCIAL PAPER - The Small Cap Growth Fund, Socially Responsible Fund,
Balanced Fund, Income Fund and Short-Term Investment Fund may purchase
commercial paper rated (at the time of purchase) "A-1" by S&P or "Prime-1" by
Moody's or, when deemed advisable by the Fund's adviser or subadviser, "high
quality" issues rated "A-2" or "Prime-2" by S&P or Moody's, respectively. These
ratings symbols are described in Appendix A.
Commercial paper purchasable by the Fund includes "Section 4(2) paper," a term
that includes debt obligations issued in reliance on the "private placement"
exemption from registration afforded by Section 4(2) of the Securities Act of
1933. Section 4(2) paper is restricted as to disposition under the Federal
securities laws, and is frequently sold (and resold) to institutional investors
such as the Fund through or with the assistance of investment dealers who make a
market in the Section 4(2) paper, thereby providing liquidity. Certain
transactions in Section 4(2) paper may qualify for the registration exemption
provided in Rule 144A under the Securities Act of 1933.
INVESTMENT GRADE DEBT OBLIGATIONS. The Growth Fund, Balanced Fund, Income Fund
and Short-Term Investment Fund may invest in "investment grade securities,"
which are securities rated in the four highest rating categories of an NRSRO. It
should be noted that debt obligations rated in the lowest of the top four
ratings (i.e., "Baa" by Moody's or "BBB" by S&P) are considered to have some
speculative characteristics and are more sensitive to economic change than
higher rated securities. See Appendix A to this Statement of Additional
Information for a description of applicable securities ratings.
WHEN-ISSUED PURCHASE AND FORWARD COMMITMENTS. The Small Cap Growth Fund,
International Equity Fund, Socially Responsible Fund, Balanced Fund and Income
Fund may enter into "when-issued" and "forward" commitments, including, for the
Small Cap Growth Fund only, "TBA" (to be announced) purchase commitments, to
purchase or sell securities at a fixed price at a future date. When a Fund
agrees to purchase securities on this basis, the custodian will set aside liquid
assets equal to the amount of the commitment in a separate account. Normally,
the custodian will set aside Fund securities to satisfy a purchase commitment,
and in such a case a Fund may be required subsequently to place additional
assets in the separate account in order to ensure that the value of the account
remains equal to the amount of the Fund's commitments. It may be expected that
the market value of a Fund's net assets will fluctuate to a greater degree when
it sets aside Fund securities to cover such purchase commitments than when it
sets aside cash. Because a Fund's liquidity and ability to manage its Fund might
be affected when it sets aside cash or Fund securities to cover such purchase
commitments, each Fund expects that its forward commitments and commitments to
purchase when-issued or, in the case of the Small Cap Growth Fund, TBA
securities will not exceed 25% of the value of its total assets absent unusual
market conditions.
If deemed advisable as a matter of investment strategy, a Fund may dispose of or
renegotiate a commitment after it has been entered into and may sell securities
it has committed to purchase before those securities are delivered to the Fund
on the settlement date. In these cases, a Fund may realize a taxable capital
gain or loss. When a Fund engages in when-issued, TBA or forward commitment
transactions, it relies on the other party to consummate the trade. Failure of
such party to do so may result in a Fund incurring a loss or missing an
opportunity to obtain a price considered to be advantageous.
The market value of the securities underlying a commitment to purchase
securities, and any subsequent fluctuations in their market value, is taken into
account when determining the market value of each 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.
STAND-BY COMMITMENTS. The Small Cap Growth Fund may invest in stand-by
commitments. Under a stand-by commitment for a Municipal Obligation, a dealer
agrees to purchase at the Fund's option a specified Municipal Obligation at a
specified price. Stand-by commitments for Municipal Obligations may be
exercisable by the Fund at any time before the maturity of the underlying
Municipal Obligations and may be sold, transferred or assigned only with the
instruments involved. It is expected that such stand-by commitments will
generally be available without the payment of any direct or indirect
consideration. However, if necessary or advisable, the Fund may pay for such a
stand-by commitment either separately in cash or by paying a higher price for
Municipal Obligations which are acquired subject to the commitment for Municipal
Obligations (thus reducing the yield to maturity otherwise available for the
same securities). The total amount paid in either manner for outstanding stand-
by commitments for Municipal Obligations held by the Fund will not exceed 1/2 of
1% of the value of the Fund's total assets calculated immediately after each
stand-by commitment is acquired.
Stand-by commitments will only be entered into with dealers, banks and
broker-dealers which, in a subadviser's opinion, present minimal credit risks.
The Fund will acquire stand-by commitments solely to facilitate Fund liquidity
and not to exercise its rights thereunder for trading purposes. Stand-by
commitments will be valued at zero in determining net asset value. Accordingly,
where the Fund pays directly or indirectly for a stand-by commitment, its cost
will be reflected as an unrealized loss for the period during which the
commitment is held by the Fund and will be reflected as a realized gain or loss
when the commitment is exercised or expires.
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