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HORACE MANN MUTUAL FUNDS
SMALL CAP GROWTH FUND
INTERNATIONAL EQUITY FUND
SOCIALLY RESPONSIBLE FUND
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 three separate
diversified investment portfolios: the Small Cap Growth Fund, the International
Equity Fund and the Socially Responsible 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 Insurance Company. Fund shares may be
purchased or redeemed at net asset value.
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 portfolio of equity securities of United
States based companies, which are determined to be socially responsible pursuant
to criteria set forth in this Prospectus.
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 March 10, 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 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 15 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 March 10, 1997.
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TABLE OF CONTENTS
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The Trust, the Funds, and Their
Investment Objectives and Policies.............................. 1
Small Cap Growth Fund........................................ 1
International Equity Fund.................................... 1
Socially Responsible Fund.................................... 2
Fundamental Investment Limitations.............................. 3
Types of Investments and Associated
Risks........................................................... 3
Management...................................................... 7
Investment Adviser and Manager, Horace Mann Investors, Inc... 7
The Sub-Advisers............................................. 8
Small Cap Growth Fund.................................... 8
International Equity Fund................................ 8
Socially Responsible Fund................................ 9
General.................................................. 9
Custodian and Fund Accounting Agent.......................... 9
Transfer Agent and Dividend Paying Agent..................... 9
Investment Return............................................ 9
Purchases and Redemptions....................................... 14
Dividends, Distributions and
Federal Taxes................................................... 14
Voting Rights................................................... 14
Shareholders Inquiries.......................................... 15
Additional Information.......................................... 15
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THE TRUST, THE FUNDS, AND 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 an agreement with PNC Equity
Advisors Company to act as the subadviser for the Small Cap Growth Fund and has
entered into an agreement 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 "Management."
The investment objective 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.
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.
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 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 (Russell 2000 Growth Index) and a
capitalization below $1 billion.
The Small Cap 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 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.
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, 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
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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.
SOCIALLY RESPONSIBLE FUND
The Socially Responsible Fund seeks 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, in the
opinion of the subadviser, 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 initial 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.
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," and in this
regard, the Fund 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.
Although certain "strategic transactions" may be used to enhance potential
gain, the Socially Responsible Fund 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 the Fund's total assets would then be
committed
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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 Fund 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 the Fund's
net assets, not including any in-the-money amount on any such options in
computing such 5%. The Fund will comply with applicable regulatory requirements
when implementing these "strategic transactions."
FUNDAMENTAL INVESTMENT LIMITATIONS
A Fund's investment policies may be changed by the Fund's Board of Trustees
without shareholder approval. However, shareholders will be given at least 30
days' notice before any such change. No assurance can be provided that a Fund
will achieve its investment objective.
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" which are set forth in the
Statement of Additional Information.
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 reduce such risk.
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 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 away,
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.
EQUITY SECURITIES -- During normal market conditions each 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
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common or preferred stock; stock purchase warrants and rights; equity interests
in trusts and partnerships; and depositary receipts of companies. Under normal
market conditions the Small Cap Growth Fund will invest at least 90% of its
total assets in equity securities of smaller-capitalized organizations (less
than $1 billion at the time of investment). These organizations will normally
have more limited product lines, market and financial resources and will be
dependent upon a more limited management group than larger capitalized
companies. Under normal market conditions the Socially Responsible Fund will
invest at least 85% of the value of its total assets in equity securities.
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.
ADRS, EDRS, AND GDRS -- Each 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. 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."
OPTIONS AND FUTURES CONTRACTS -- To the extent consistent with its
investment objective, each 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, each 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 hedging
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 bona fide hedging purposes is 5% or
less of its net assets.
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
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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.
A 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 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 a 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 rages 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."
LIQUIDITY MANAGEMENT -- Pending investment, to meet anticipated redemption
requests, or as a temporary defensive measure if its subadviser determines that
market conditions warrant, a 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, dollar denominated obligations of foreign
issuers, 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 may mature within two
years from the date of settlement.
WHEN-ISSUED PURCHASES AND FORWARD COMMITMENTS -- Each Fund 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.
REPURCHASE AGREEMENTS -- 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 credit worthiness of all entities with
which it proposes to enter into repurchase agreements, and will seek to assure
that each arrangement is adequately collateralized.
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REVERSE REPURCHASE AGREEMENTS AND OTHER BORROWINGS -- The Small Cap Growth
Fund is authorized to borrow money. If the securities held by the 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. Borrowings may be made by
the Small Cap Growth Fund through reverse repurchase agreements under which the
Fund sells portfolio securities to financial institutions such as banks and
broker-dealers and agrees to repurchase them at a particular date and price.
The Fund may use the proceeds of 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 the Fund may decline below the price of the securities the Fund is obligated
to repurchase and that the securities may not be returned to the Fund. During
the time a reverse repurchase agreement is outstanding, the Fund will maintain a
segregated account with the Fund's custodian containing cash, U.S. Government or
other appropriate liquid securities having a value at least equal to the
repurchase price. The Fund's 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 the Fund's total
assets, the Fund will not make any investments.
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 Small Cap Growth Fund may
also invest in securities issued by other investment companies with similar
objectives. 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. Securities of other
investment companies will be acquired within limits prescribed by the Investment
Company Act of 1940. 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.
SECURITIES LENDING -- A 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. A Fund
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.
ILLIQUID SECURITIES -- No Fund will knowingly invest more than 15% of the
value of its 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. Each
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. These securities will
not be considered illiquid so long as it is determined by the adviser or
subadvisor 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.
FOREIGN SECURITIES -- Global investing involves economic and political
considerations not typically found in U.S. markets. These considerations, which
may favorably or unfavorably affect the International 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
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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 subadviser seek to mitigate the risks
associated with these considerations through diversification and active
professional management.
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS -- The International Equity
Fund may enter into forward foreign currency exchange contracts ("forward
contracts") to the extent of 15% of the value of its 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 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 within a specified range of
prices.
The International Equity Fund may also enter into foreign currency futures
contracts and foreign currency options to the extent of 15% of the value of its
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 the Fund from adverse changes in the
relationship between the U.S. dollar and foreign currencies. The 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 the Fund than if it
had not engaged in forward contracts, foreign currency futures contracts and
foreign currency options.
PORTFOLIO TURNOVER RATES -- Under normal market conditions, it is expected
that the annual portfolio turnover rate for each Fund will not exceed 150%. 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 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.
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.
7
<PAGE>
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 over $2.8
billion of assets. Further, each Fund is advised by a subadviser that, as
noted below, has substantial experience in managing the assets of registered
investment companies.
Each Fund pays Investors advisory fees at the end of each month. These
fees 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.
Small Cap Growth Fund 1.4% of Net
Assets
International Equity Fund 1.1% of Net
Assets
Socially Responsible Fund .95% of Net
Assets
These advisory fees are higher than the fees charged by most mutual funds.
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
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 Sub-Advisory Agreement with Investors. PEAC is responsible
for managing the Fund, subject to the discretion of the Board of Trustees and
the Adviser. PEAC has approximately $2.4 billio under management and manages,
among other accounts, four other investment company portfolios and three bank
common trust funds.
For such services, Investors pays PEAC at the annual rate of up to 1.00% of
the Fund's average daily net assets for the respective month.
William J. Wykle manages the Small Cap Growth Fund. 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 Sub-Advisory Agreement with Investors.
SSC is responsible for managing the Fund, subject to the discretion of the Board
of Trustees and the Adviser. 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 at the annual rate of up to .70% of
the Fund's average daily net assets for the respective month.
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 Scudder'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
Scudder in 1981.
Joan Gregory, Portfolio Manager, focuses on stock selection, a role she has
played since she joined
8
<PAGE>
Scudder in 1992. Ms. Gregory, who joined the team in 1994, has been involved
with 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 at the annual rate of up to .55% of
the Fund's average daily net assets for the respective month.
The Socially Responsible Fund also 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 also believes its
team approach benefits Fund investors by bringing together many disciplines and
leveraging SSC's extensive resources.
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
Scudder 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 Scudder 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.
GENERAL. Under the terms of each Sub-Advisory 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.
CUSTODIAN AND FUND ACCOUNTING AGENT:
State Street Bank and Trust Company
225 Franklin Street
Boston, Massachusetts 02110
TRANSFER AGENT AND DIVIDEND PAYING AGENT:
Horace Mann Service Corporation
One Horace Mann Plaza
Box 4657
Springfield, Illinois 62715-4657
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, an 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.
Comparison of a Fund's total return with alternative investments 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 contract charges that are not reflected in the 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. In addition, past performance is not indicative
of future results.
9
<PAGE>
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, and which has investment objectives,
policies, strategies and risks substantially similar to those of the Horace Mann
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 Horace Mann 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 Horace Mann Small Cap Growth Fund are
estimated to be 1.425%. 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 1.007%. Had the maximum
total operating expenses for the Horace Mann Small Cap Fund been used to
calculate the performance, 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 Horace Mann 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 Horace Mann
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 Horace Mann 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 does not reflect the deduction of a 4.5% front end sales
charge for the Compass Capital Portfolio. The Horace Mann 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.
<TABLE>
<CAPTION>
Average Annual Total Returns/(1)/
Year or Periods Compass Capital
Ended 12/31/96 Portfolio Russell 2000/(2)/
-------------- -------------- -----------------
<S> <C> <C>
One Year................... 31.13% 11.26%
Three Years................ 26.48% 12.47%
From Inception (9/14/93)... 25.19% N/A
</TABLE>
10
<PAGE>
- -----------------
/(1)/ Service providers for the Compass Capital Portfolio have voluntarily
waived certain expenses of the portfolio; otherwise the portfolio's total
operating expenses would have been 1.69% and the performance quoted would
have been lower.
/(2)/ Total return data is presented for each period. The Russell 2000 Growth
Index is an unmanaged securities index composed of those Russell 2000
securities with a greater-than-average growth orientation. The Russell
2000 Growth Index reflects the investment of income dividends and capital
gain distributions, if any, but does not reflect fees, brokerage
commissions or other expenses of investing. The Russell 2000 Growth Index
is an unmanaged securities index, and an investment cannot be made
directly in the Russell 2000 Growth Index.
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
Horace Mann 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 Horace Mann 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 maximum total operating expenses for the
Horace Mann International Equity Fund are estimated to be 1.129%. 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 .711%. 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 Horace Mann 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
Horace Mann 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 Horace Mann
International Equity Fund may
11
<PAGE>
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.
<TABLE>
<CAPTION>
Average Annual Total Returns
Scudder
Year or Periods International MSCI EAFE
Ended 12/31/96 Portfolio Index/(1)/
-------------- ------------- -----------
<S> <C> <C>
One Year................. 14.78% 6.05%
Three Years.............. 8.14% 8.32%
Five Years............... 11.05% 8.15%
From Inception (5/1/87).. 9.93% 8.42%
</TABLE>
- ---------------
/(1)/ Total return data is presented for each period. The Morgan Stanley Capital
International (MSCI) Europe, Australia, the Far East (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 do not reflect fees, brokerage
commissions or other expenses of investing. Investment cannot be made
directly into the 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 ("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 Horace Mann 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, 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 Horace Mann
Socially Responsible Fund. However, the Horace Mann Socially Responsible Fund
differs from the accounts in the Scudder Socially Responsive Composite in
certain ways, none of which
12
<PAGE>
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 Horace Mann
Socially Responsible Fund. The performance of the Scudder Socially Responsive
Composite is presented net of the estimated maximum total operating expenses for
the Horace Mann Socially Responsible Fund of .975%. 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 .557%.
The Scudder Socially Responsive Composite performance data does not represent
the past, present or future performance of the Horace Mann 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 Horace Mann 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.
<TABLE>
<CAPTION>
Average Annual Total Returns
Scudder Socially
Year or Periods Responsive
Ended 12/31/96 Composite S&P 500/(1)/
-------------- ---------------- ------------
<S> <C> <C>
One Year................... 21.90% 22.96%
Three Years................ 18.49% 19.67%
Five Years................. 15.75% 15.22%
From Inception (12/31/89).. 14.51% 15.29%
</TABLE>
- -------------
/(1)/ Total return data is presented for each period. The Standard & Poor's 500
Stock Index 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 index.
13
<PAGE>
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.
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
Investment Company Act of 1940, redemption proceeds are paid on or before the
fifth business day following the date the request for redemption is received.
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 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 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.
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.
14
<PAGE>
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 (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 March 1, 1997, Horace Mann Life Insurance Company Separate Account
owned 100% of the outstanding shares of each Fund. Since these separate
accounts' voting rights are passed through to contract owners and participants,
HMLIC itself does not exercise voting control.
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
at 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>
Page
----
<S> <C>
Investment Restrictions......................................... 2
Management of the Funds......................................... 3
Board of Trustees.......................................... 3
Officers................................................... 4
Investment Advisory Agreements.................................. 5
Brokerage Allocation............................................ 6
Other Services.................................................. 7
Types of Investments and Associated Risks....................... 7
Purchase, Redemption and Pricing of Fund Shares................. 22
Tax Status...................................................... 22
Control Persons and Principal Holders of Securities............. 25
General Information............................................. 25
Report of Independent Auditors.................................. 26
Statements of Net Assets........................................ 27
Appendix A...................................................... A-1
</TABLE>
To receive, without charge, a copy of the 1996 Annual Report of the Horace
Mann Life Insurance Company Separate Account and/or a copy of the Statement of
Additional Information for Horace Mann Life Insurance Company Separate Account,
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 LIFE INSURANCE COMPANY
P.O. BOX 4657
SPRINGFIELD, ILLINOIS 62708-4657
________________________________________________________________________________
- -----------------------------------------------------------------------------
Please provide free of charge the following information:
_____ 1996 Annual Report of the Horace Mann Life Insurance Company Separate
Account.
_____ Statement of Additional Information dated March 10, 1997 for the Horace
Mann Mutual Funds.
_____ Statement of Additional Information dated May 1, 1996 for the Horace
Mann Life Insurance Company Separate Account.
Please mail the above documents to:
__________________________________________________________________________
(Name)
__________________________________________________________________________
Address)
__________________________________________________________________________
(City/State/Zip)
- ----------------------------------------------------------------------------
________________________________________________________________________________
15
<PAGE>
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 March 10, 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).
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Investment Restrictions......................................... 2
Management of the Funds......................................... 3
Board of Trustees.......................................... 3
Officers................................................... 4
Investment Advisory Agreements.................................. 5
Brokerage Allocation............................................ 6
Other Services.................................................. 7
Types of Investments and Associated Risks....................... 7
International Equity Fund and Socially Responsible Fund.... 7
Small Cap Growth Fund...................................... 16
Purchase, Redemption and Pricing of Fund Shares................. 22
Tax Status...................................................... 22
Control Persons and Principal Holders of Securities............. 25
General Information............................................. 25
Report of Independent Auditors.................................. 26
Statements of Net Assets........................................ 27
Appendix A...................................................... A-1
</TABLE>
March 10, 1997
<PAGE>
INVESTMENT RESTRICTIONS
Each Fund operates under the following fundamental investment restrictions
which, along with each Fund's objective, cannot be changed without the approval
of a "majority of the outstanding voting securities," which 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 (2) more than 50% of the Fund's outstanding
shares. A Fund 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
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.
Each Fund is also subject to the following non-fundamental restrictions and
policies, which may be changed by the Board of Trustees. The 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
2
<PAGE>
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.
MANAGEMENT OF THE FUNDS
A listing of the Trustees and Officers of the Trust, their ages, 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 (Age 50) (1, 2, 3), -- Trustee; Director, Horace Mann Growth
Fund, Inc., Horace Mann Income Fund, Inc., Horace Mann Balanced Fund, Inc. and
Horace Mann Short-Term Investment Fund, Inc.; 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 (Age 48) (1, 3, 4), -- Trustee and Chairman of the Board;
Director, Horace Mann Growth Fund, Inc., Horace Mann Income Fund, Inc., Horace
Mann Balanced Fund, Inc. and Horace Mann Short-Term Investment Fund, Inc.;
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 (Age 71) (2), -- Trustee; Director, Horace Mann Growth Fund, Inc.,
Horace Mann Income Fund, Inc., Horace Mann Balanced Fund, Inc. and Horace Mann
Short-Term Investment Fund, Inc.; Executive Director (Retired), Minnesota
Education Association; formerly Director, Horace Mann Educators Corporation
(1968-1983).
RICHARD D. LANG (Age 65), Trustee; Executive Director, Vermont National
Education Association.
*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 (Age 55) (4), -- Trustee; Director, Horace Mann Growth Fund,
Inc., Horace Mann Income Fund, Inc., Horace Mann Balanced Fund, Inc. and Horace
Mann Short-Term Investment Fund, Inc.; member, Cincinnati Board of Education;
Director and Vice President, Greater Cincinnati School Employer Credit Union;
teacher (Retired), Walnut Hills High School; former Director, Horace Mann Growth
Fund, 1974 to 1983
*GEORGE J. ZOCK (Age 46) (1, 2, 3), -- Trustee and President; Director and
President, Horace Mann Growth Fund, Inc., Horace Mann Income Fund, Inc., Horace
Mann Balanced Fund, Inc. and Horace Mann Short-Term Investment Fund, Inc.;
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.
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(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 Trust, and makes periodic reports of these reviews to the
Board, along with appropriate recommendations regarding the proper and
efficient financial operation of the Trust. 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 and subadvisers 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 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; Secretary
and Ethics Compliance Officer, Horace Mann Growth Fund, Inc., Horace Mann Income
Fund, Inc., Horace Mann Balanced Fund, Inc. and Horace Mann Short-Term
Investment Fund, Inc.; 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 1994, was associated with John Deere
Insurance Group and Affiliates serving as Vice President and General
Counsel.
ROGER W. FISHER (Age 44), -- Controller; Controller, Horace Mann Growth Fund,
Inc., Horace Mann Income Fund, Inc., Horace Mann Balanced Fund, Inc. and Horace
Mann Short-Term Investment Fund, Inc.; Vice President and Controller, Horace
Mann Life Insurance Company and Horace Mann Service Company; 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 and Regulatory Compliance Officer, Horace Mann Growth Fund, Inc.,
Horace Mann Income Fund, Inc., Horace Mann Balanced Fund, Inc., Horace Mann
Short-Term Investment Fund, Inc. and 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 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, $500 for each telephonic meeting
and reimbursement for travel expenses.
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.
4
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<TABLE>
<CAPTION>
Pension
Retirement
Aggregate Benefits Accrued Estimated Annual Total
Compensation as Part of Fund Benefits Upon Compensation
Trustee from the Trust Expenses Retirement For The Complex
-------- -------------- -------- ---------- ---------------
<S> <C> <C> <C> <C>
A.L. Gallop $5,200 N/A N/A $5,200
Richard D. Lang $4,200 N/A N/A $4,200
Harriet A. Russell $5,200 N/A N/A $5,200
</TABLE>
INVESTMENT ADVISORY AGREEMENTS
INVESTMENT ADVISER. As stated in the Prospectus, Horace Mann Investors, Inc.
("Adviser") 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 shares
for distribution under Federal and state securities laws and membership dues in
the Investment Company Institute or any similar organization.
The advisory 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 majority
vote of the outstanding shares of the affected Fund. The agreement may also be
terminated at any time either by vote of the Board of Trustees or by 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.
The advisory agreement provides that neither the Adviser 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 judgment, mistake
of law, or any loss arising out of any investment, or for any other act or
omission in the performance by the Adviser 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.
For the services and facilities furnished to each portfolio, the Trust pays
the Adviser an advisory fee, which is computed daily and paid monthly. The
Small Cap Growth Fund pays an advisory fee at a rate of 1.4% of the Fund's
average daily net assets. The International Growth Fund pays an advisory fee at
a rate of 1.1% of the Fund's average daily net assets. The Socially Responsible
Fund pays an advisory fee at a rate of .95% of the Fund's average daily net
assets.
SUBADVISERS. Each of the Investment Sub-Advisory Agreements continues for the
same term as the advisory agreement and is subject to the same requirements for
renewal. Each of the Investment Sub-Advisory Agreements
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<PAGE>
provides that neither the subadviser 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 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.
For the services provided the Adviser 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:
Small Cap Growth Fund
1.00% on the first $25 million
.75% on assets over $25 million
International Equity Fund
(during the first six months of operations)
.35% of the first $40 million
.25% on assets over $40 million
(after the first six months of operations)
.70% of the first $40 million
.50% on assets over $40 million
Socially Responsible Fund
.55% of the first $20 million
.45% of the next $20 million
.30% on assets over $40 million
BROKERAGE ALLOCATION
The Investment Advisory Agreement and the Investment Sub-Advisory
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 the expenses. In addition, within the parameters of
achieving best
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<PAGE>
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 an Adviser. To assure fair treatment of
each Fund and all clients of the Adviser 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 Adviser.
OTHER SERVICES
FUND PRICING AGREEMENTS -- The Trust has 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.
CUSTODIAL AGREEMENT -- State Street serves as custodian of the assets of each
Fund, including foreign securities through a sub-custodian 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.
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 Trust has been given limited permission to use that service mark in
its names, 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 auditor. 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.
TYPES OF INVESTMENTS AND ASSOCIATED RISKS
INTERNATIONAL EQUITY FUND AND SOCIALLY RESPONSIBLE FUND
FOREIGN SECURITIES. Each Fund is intended to provide individual and
institutional investors with an opportunity to invest a portion of their assets
in a diversified group of securities of companies, wherever organized, which do
business primarily outside the U.S., and foreign governments. The Adviser
believes that diversification of assets on an international basis decreases the
degree to which events in any one country, including the U.S., will affect an
investor's entire investment holdings. In certain periods since World War II,
many leading foreign economies and foreign stock market indices have grown more
rapidly than the U.S. economy and leading U.S. stock market indices, although
there can be no assurance that this will be true in the future. Because of each
Fund's investment policy, each Fund is not intended to provide a complete
investment program for an investor.
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
price can be greater than in the U.S. Fixed commissions on some foreign
securities
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<PAGE>
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 each 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 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 each Fund seeks to mitigate the risks associated
with the foregoing considerations through continuous professional
management.
FOREIGN CURRENCIES. Because investments in foreign securities usually will
involve currencies of foreign countries, and because 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 a
Fund as measured in U.S. dollars may be affected favorably or unfavorably by
changes in foreign currency exchange rates and exchange control regulations, and
a 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.
STRATEGIC TRANSACTIONS AND DERIVATIVES. Each Fund may, but is 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 the 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, each Fund 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 a Fund's portfolio resulting from securities markets or currency exchange
rate fluctuations, to protect a 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
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 Transactions is a function of numerous
variables including market conditions. The ability of a Fund to utilize these
Strategic Transactions successfully will depend on the Adviser's ability to
predict pertinent market movements, which cannot be assured. Each Fund will
comply with applicable regulatory
8
<PAGE>
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 Adviser'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 a 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 a 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 transactions 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 it tends 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. Put options and call options typically
have similar structural characteristics and operational mechanics regardless of
the underlying instrument 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, as
described below under "Use of Segregated and Other Special Accounts".
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, a 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 while a European style put or
call option may be exercised only upon expiration or during a fixed period prior
thereto. Each 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
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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 (or 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.
OTC options are purchased from or sold to securities dealers, financial
institutions or other parties ("Counterparties") through direct bilateral
agreement with the Counterparty. In contrast 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. Each
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. Each
Fund expects generally to enter into OTC options that have cash settlement
provisions, although it is 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 Adviser 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. Each 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-l from S&P or P-l 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.
Each Fund 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
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described below as long as the call is outstanding. Even though each Fund will
receive the option premium to help protect it against loss, a call sold by a
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 a Fund to hold a security or instrument
which it might otherwise have sold.
Each Fund may purchase and sell put options on securities including U.S.
Treasury and agency securities, mortgage-backed securities, foreign sovereign
debt, corporate debt securities, equity 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. A Fund will not sell put options if, as a result, more than 50% of
the Fund's assets would be required to be segregated to cover its potential
obligations under such put options other than options on futures. In selling put
options, there is a risk that a Fund may be required to buy the underlying
security at a disadvantageous price above the market price.
GENERAL CHARACTERISTICS OF FUTURES. Each 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 each 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.
Each Fund's 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 a Fund. If
a Fund exercises an option on a futures contract 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.
A Fund 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 the 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.
OPTIONS ON SECURITIES INDICES AND OTHER FINANCIAL INDICES. Each Fund 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
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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. Each Fund 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. Each Fund may enter into currency transactions with
Counterparties which have received (or the guarantors of the obligations which
have received) a credit rating of A-l or P-l 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.
Each Fund's 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.
A Fund will not enter into a transaction to hedge currency exposure to an
extent greater, after netting 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.
Each Fund 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 the 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, each Fund may also engage in proxy
hedging. Proxy hedging is often used when the currency to which a 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 the 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 Adviser considers
that the Austrian schilling is correlated to the German deutschemark (the "D-
mark"), a Fund holds securities denominated in schillings and the Adviser
believes that the value of schillings will decline against the U.S. dollar, the
Adviser 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 the 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.
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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. Each Fund 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 Adviser, it is in the best interests of the 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 into based on the Adviser's judgment that the combined strategies will
reduce risk or otherwise more effectively achieve the desired portfolio
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 Socially Responsible Fund may enter are interest rate, currency and
index swaps and the purchase or sale of related caps, floors and collars. Each
Fund expects 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. Each Fund intends 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 changes 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.
A Fund 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 Adviser
and the Fund 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 its borrowing restrictions.
A Fund 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, a Fund may have contractual remedies pursuant to the agreements
related to the transaction. The swap market has grown substantially in recent
years with a large number of banks and investment banking firms acting both as
principals and as agents utilizing standardized swap documentation. As a
result, the swap market
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has become relatively liquid. Caps, floors and collars are more recent
innovations for which standardized documentation has not yet been fully
developed and, accordingly, they are less liquid than swaps.
EURODOLLAR INSTRUMENTS. Each Fund 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
borrowings. Each Fund 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 a Fund 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 a Fund enters into a forward contract for the purchase or
sale of a security denominated in a particular currency, which requires no
segregation, a currency contract which obligates the 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 a Fund, 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
sellback 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 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 of
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.
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In the case of a futures contract or an option thereon, a Fund 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, each Fund 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 obligation, if any.
Strategic Transactions may be covered by other means when consistent with
applicable regulatory policies. Each Fund 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 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.
Each Fund's 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").
REPURCHASE AGREEMENTS - Repurchase agreements are agreements under which the
purchaser (i.e., 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, the 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. The Funds believe that these risks are not
material inasmuch as the Funds will evaluate the creditworthiness of all
entities with which they propose to enter into repurchase agreements, and will
seek to assure that each such arrangement is adequately collateralized.
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
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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 a Fund with the proceeds of the transaction
may decline below the repurchase price of the securities by the Fund which it 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 Fund's total net assets at the time of initiation.
WARRRANTS - 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 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. Moreover, they are
usually issued by the issuer of the security to which they relate. While
warrants may be traded, there is often no secondary market for them. 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, no Fund will invest more than 5% of its total net assets in
warrants.
CONVERTIBLE PREFERRED STOCKS 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 fail to the extent
represented by that premium.
PREFERRED EQUITY REDEMPTION CUMULATIVE STOCK - Preferred Equity Redemption
Cumulative Stock (PERCS) are a form of convertible preferred stock which
automatically convert into shares of common stock on a predetermined conversion
date. PERCS pay 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.
SMALL CAP GROWTH FUND
REVERSE REPURCHASE AGREEMENTS. The Fund may invest in reverse repurchase
agreements. Reverse repurchase agreements involve the sale of securities held
by the Fund pursuant to the Fund's agreement to repurchase the securities at an
agreed upon price, date and interest rate. Such agreements are considered to be
borrowings under the Investment Company Act of 1940 (the "1940 Act"). While
reverse repurchase transactions are outstanding, the Fund will maintain in a
segregated account liquid assets in an amount at least equal to the market value
of the securities, plus accrued interest, subject to the agreement.
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
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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 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. 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. 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 Fund 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
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Bank of Reconstruction and Development (the "World Bank"), the Asian-American
Development Bank and the Inter-American Development Bank.
SUPRANATIONAL ORGANIZATION OBLIGATIONS. The 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 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 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.
REPURCHASE AGREEMENTS. The Fund may invest in repurchase agreements. The
repurchase price under the repurchase agreements described in the Prospectus
generally equals the price paid by the Fund involved plus
18
<PAGE>
interest negotiated on the basis of current short-term rates (which may be more
or less than the rate on securities underlying the repurchase agreement). The
financial institutions with which the Fund may enter into repurchase agreements
will be banks and non-bank dealers of U.S. Government securities that are listed
on the Federal Reserve Bank of New York's list of reporting dealers, if such
banks and non-bank dealers are deemed creditworthy by the Fund's Adviser or
subadviser. A Fund's Adviser or subadviser will continue to monitor
creditworthiness of the seller under a repurchase agreement, and will require
the seller to maintain during the term of the agreement the value of the
securities subject to the agreement to equal at least the repurchase price
(including accrued interest). In addition, the Fund's Adviser or subadviser
will require that the value of this collateral, after transaction costs
(including loss of interest) reasonably expected to be incurred on a default, be
equal to or greater than the repurchase price (including accrued premium)
provided in the repurchase agreement. The accrued premium is the amount
specified in the repurchase agreement or the daily amortization of the
difference between the purchase price and the repurchase price specified in the
repurchase agreement. The Fund's Adviser or subadviser will mark-to-market
daily the value of the securities. Securities subject to repurchase agreements
will be held by the Fund's custodian (or sub-custodian) in the Federal
Reserve/Treasury book-entry system or by another authorized securities
depository. Repurchase agreements are considered to be loans by the Fund under
the 1940 Act.
INVESTMENT GRADE DEBT OBLIGATIONS. The 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 Fund may enter into
"when-issued" and "forward" commitments, including "TBA" (to be announced)
purchase commitments, to purchase or sell securities at a fixed price at a
future date. When the 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 the 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 the 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 the 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, the Fund expects
that its forward commitments and commitments to purchase when-issued or 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, the 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 the Fund may
realize a taxable capital gain or loss.
When the 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 the Fund's incurring a loss or missing an
opportunity to obtain a price considered to be advantageous.
The market value of the securities underlying a commitment to purchase
securities, and any subsequent fluctuations in their market value, is taken into
account when determining the market value of the Fund starting on the day the
Fund agrees to purchase the securities. The Fund does not earn interest on the
securities it has committed to purchase until they are paid for and delivered on
the settlement date.
RIGHTS OFFERINGS AND WARRANTS TO PURCHASE. The Fund may participate in
rights offerings and may purchase warrants, 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
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<PAGE>
rights normally have a short life span to expiration. The purchase of rights or
warrants involves the risk that the Fund could lose the purchase value of a
right or warrant if the right to subscribe to additional shares is not exercised
prior to the rights' and warrants' expiration. Also, the purchase of rights
and/or warrants involves the risk that the effective price paid for the right
and/or warrant 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.
FOREIGN CURRENCY TRANSACTIONS. 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. The 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 Fund may enter into forward
foreign currency exchange contracts when deemed advisable by its Adviser or
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 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
Adviser or 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.
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
20
<PAGE>
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.
OPTIONS. Options trading is a highly specialized activity which entails
greater than ordinary investment risks. Options on particular securities may be
more volatile than the underlying securities, and therefore, on a percentage
basis, an investment in the underlying securities themselves. The Fund will
write call options only if they are "covered." In the case of a call option on a
security, the option is "covered" if the Fund owns the security underlying the
call or has an absolute and immediate right to acquire that security without
additional cash consideration (or, if additional cash consideration is required,
liquid assets in such amount as are held in a segregated account by its
custodian) upon conversion or exchange of other securities held by it. For a
call option on an index, the option is covered if the Fund maintains with its
custodian liquid assets equal to the contract value. A call option is also
covered if the Fund holds a call on the same security or index as the call
written where the exercise price of the call held is (i) equal to or less than
the exercise price of the call written, or (ii) greater than the exercise price
of the call written provided the difference is maintained by the Fund in liquid
assets in a segregated account with its custodian.
When a Fund purchases a put option, the premium paid by it is recorded as
an asset of the Fund. When the 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 the Fund expires unexercised, the Fund realizes a loss
equal to the premium paid. If the 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 the Fund expires on
the stipulated expiration date or if the Fund enters into a closing purchase
transaction, it will realize a gain (or loss if the cost of a closing purchase
transaction exceeds the net premium received when the option is sold) and the
deferred credit related to such option will be eliminated. If an option written
by the 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 Options Clearing Corporation may not at all
times be adequate to handle current trading volume; or one or more Exchanges
could, for economic or other reasons, decide or be compelled at some future date
to discontinue the trading of options (or a particular class or series of
options), in which event the secondary market on that Exchange (or in that class
or series of options) would cease to exist, although outstanding options that
had been issued by the Options Clearing Corporation as a result of trades on
that Exchange would continue to be exercisable in accordance with their terms.
FUTURES CONTRACTS AND RELATED OPTIONS. The Fund may invest in futures
contracts and options thereon (interest rate futures contracts or index futures
contracts, as applicable).
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<PAGE>
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.
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 the 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 day 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, each of
the Funds must, among other things, (a) derive at least 90% of its gross income
from dividends, interest,
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<PAGE>
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 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
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<PAGE>
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.
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<PAGE>
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
The following table sets forth, as of February 14, 1997, the holdings of
the shares 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.
<TABLE>
<CAPTION>
Small Cap Growth Fund: Type of Ownership Shares Owned % of Shares Outstanding
- ---------------------- ----------------- ------------ ------------------------
<S> <C> <C> <C>
Horace Mann Life Insurance Company
One Horace Mann Plaza
Springfield, Illinois 62715
Horace Mann Life Insurance
Company Separate Account........ Record 4,000 100%
International Equity Fund:
- --------------------------
Horace Mann Life Insurance Company
One Horace Mann Plaza
Springfield, Illinois 62715
Horace Mann Life Insurance
Company Separate Account........ Record 4,000 100%
Socially Responsible Fund:
- --------------------------
Horace Mann Life Insurance Company
One Horace Mann Plaza
Springfield, Illinois 62715
Horace Mann Life Insurance
Company Separate Account........ Record 4,000 100%
</TABLE>
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,
and 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 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 individual series, except that shares are voted by
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.
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<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 the 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.
KPMG Peat Marwick LLP
Chicago, Illinois
December 30, 1996
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<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.
27
<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
A-1
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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.
A-2
