VAN DEVENTER & HOCH
AMERICAN VALUE FUND
PROSPECTUS
MARCH 1, 1999
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VAN DEVENTER & HOCH AMERICAN VALUE FUND,
A SERIES OF ADVISORS SERIES TRUST
Van Deventer & Hoch American Value Fund is a value-oriented stock fund. The
Fund seeks to provide investors with capital appreciation and current income.
As with all mutual funds, the Securities and Exchange Commission doesn't
guarantee that the information in this prospectus is accurate or complete, nor
has it approved or disapproved of these securities. Any representation to the
contrary is a criminal offense.
The date of this prospectus is March 1, 1999
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VAN DEVENTER & HOCH AMERICAN VALUE FUND'S INVESTMENT GOAL
High total investment return consisting of capital appreciation and income.
VAN DEVENTER & HOCH AMERICAN VALUE FUND'S PRINCIPAL INVESTMENT STRATEGIES
The Fund primarily invests in common stocks of U.S. companies. In selecting
investments, the Advisor generally looks for companies that it believes have
shown financial soundness and are undervalued in the market. Although the Fund
emphasizes investments in common stocks, it may invest in high quality
short-term money market instruments. Among other things, the Advisor considers
the following in deciding to buy stocks for the Fund's portfolio:
+ events that could lead to an increase in the price of a stock
+ high potential reward compared to potential risk and
+ temporary drops in the price of a stock due to market overreaction
PRINCIPAL RISKS OF INVESTING IN VAN DEVENTER & HOCH AMERICAN VALUE FUND
There is the risk that you could lose money on your investment in the Van
Deventer & Hoch American Value Fund. This could happen if any of the following
events happen:
+ The stock market goes down
+ Interest rates go up
+ Value stocks fall out of favor with the stock market
+ The market continues indefinitely to undervalue the stocks in the Fund's
portfolio
+ The stocks in the Fund's portfolio turn out not to be undervalued after all
because the Fund's initial evaluation of the stock was mistaken
WHO MAY WANT TO INVEST IN VAN DEVENTER & HOCH AMERICAN VALUE FUND
The Fund may be appropriate for investors who:
+ Are pursuing a long-term goal such as retirement
+ Want to diversify their investment portfolio by investing in a mutual fund
that uses the value approach in picking stocks
+ Are willing to accept higher short-term risk along with higher potential
for long-term total return
The Fund may not be appropriate for investors who:
+ Need regular income or stability of principal
+ Are pursuing a short-term goal or investing emergency reserves
+ Wish to have the equity portion of their portfolio invested in growth
stocks
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FEES AND EXPENSES OF THE FUND
This table describes the fees and expenses that you may pay if you buy and hold
shares of Van Deventer & Hoch American Value Fund.
SHAREHOLDER FEES
(fees paid directly from your investment)
Maximum sales charge (load) imposed on purchases
(as a percentage of offering price).................................... None
Maximum deferred sales charge (load)
(as a percentage of the lower of original purchase
price or redemption proceeds) None
ANNUAL FUND OPERATING EXPENSES
(expenses that are deducted from Fund assets)*
Management Fees.......................................................... 0.70%
Distribution and Service (12b-1) Fees.................................... 0.00%
Other Expenses........................................................... 1.87%
Total Annual Fund Operating Expenses..................................... 2.57%
----
Fee Reduction and/or Expense Reimbursement.......................... 1.25%
Net Expenses............................................................. 1.32%
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* The Advisor has contractually agreed to reduce its fees and/or pay expenses of
the Fund to insure that the Fund's Total Fund Operating Expenses will not exceed
1.32% of its average daily net assets. Through 1998, the Advisor agreed to waive
additional fees to ensure that the Fund's Total Fund Operating Expenses did not
exceed 1.05%.
EXAMPLE
This example is intended to help you compare the costs of investing in the
Van Deventer & Hoch American Value Fund with the cost of investing in other
mutual funds.
The Example assumes that you invest $10,000 in the Fund for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Example also assumes that your investment has a 5% return each year and that the
Fund's operating expenses remain the same. Although your actual costs may be
higher or lower, under the assumptions, your costs would be:
One Year ..................... $134
Three Years................... $418
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INVESTMENT OBJECTIVE, PRINCIPAL INVESTMENT STRATEGIES AND RELATED RISKS
The Fund's investment goal is to provide investors with high total investment
return consisting of capital appreciation and income.
The Fund invests primarily in common stock of U.S. companies. The Fund generally
will invest in companies with a market capitalization of more than $200 million.
The Fund may also invest a portion of its assets in high quality short-term
money market instruments.
The Advisor uses the value style in selecting stocks for the Fund's portfolio.
In seeking to identify undervalued companies, the Advisor looks for companies
that it believes have greater value than is shown in the companies' financial
statements, such as:
+ companies with substantial tangible assets such as land, timber, oil and
other natural resources
+ companies with important brand names, patents, franchises or other
intangible assets
+ companies that are considered to be unattractive by other investors
+ companies that are unpopular with the financial press
In addition to a company's valuation, the Advisor looks for companies that it
believes are financially sound. In seeking to do this, the Advisor considers the
following:
+ companies whose balance sheets show strong capitalization
+ companies that can generate large cash flows
+ companies that are not strongly leveraged
+ companies that have the ability to pay their debts
+ companies that have a history of paying dividends
In general the Fund buys stocks that appear to be undervalued and considers
selling them when they appear overvalued.
Under normal market conditions, the Fund will stay fully invested in stocks.
However, the Fund may depart from its principal investment strategies by making
short-term investments in cash equivalents in response to adverse market,
economic or political conditions. This may result in the Fund not achieving its
investment objective.
In keeping with its investment approach, the Advisor does not frequently buy and
sell securities. This means that the Fund has a low rate of portfolio turnover.
This has the potential to make the Fund a tax efficient investment. This results
in the realization and distribution to shareholders of lower capital gains,
which would be considered tax efficient. The lack of frequent trading also leads
to lower transaction costs, which could offer higher performance.
RISKS OF INVESTING IN THE VAN DEVENTER & HOCH
AMERICAN VALUE FUND
The principal risks of investing in the Fund that may adversely affect the
Fund's net asset value or total return are discussed above in "Principal risks
of investing in Van Deventor & Hoch American Value Fund." These risks are
discussed in more detail below.
MARKET RISK. The risk that the market value of a security may move up and down,
sometimes rapidly and unpredictably. These fluctuations may cause a security to
be worth less than the price originally paid for it, or less than it was worth
at an earlier time. Market risk may affect a single issuer, industry, sector of
the economy or the market as a whole.
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MANAGEMENT RISK. The risk that a strategy used by the Advisor may fail to
produce the intended result.
VALUATION RISK. The risk that the Fund has valued certain of its securities at a
higher price than it can sell them for.
OPPORTUNITY RISK. The risk of missing out on an investment opportunity because
the assets necessary to take advantage of it are tied up in less advantageous
investments.
YEAR 2000 RISK. The risk that the Fund's operations could be disrupted by year
2000-related computer system problems. Although the Fund's service providers are
taking steps to address this issue, there may still be some risk of adverse
effects.
INVESTMENT ADVISOR
Van Deventer & Hoch, founded in 1969, is the investment advisor to the Fund. The
investment advisor's address is 800 North Brand Boulevard, Suite 300, Glendale,
CA 91203. The investment advisor currently manages $1.5 billion in assets for
individual and institutional investors. The investment advisor provides advice
on buying and selling securities. The investment advisor also furnishes the Fund
with office space and certain administrative services and provides most of the
personnel needed by the Fund. For its services, the Fund pays the investment
advisor a monthly management fee based upon the average daily net assets of the
Fund at the annual rate of 0.70%.
Portfolio Manager
Richard Trautwein, Executive Vice President of the Advisor, has been responsible
for the day-to-day management of the Fund's portfolio since its inception. Mr.
Trautwein was portfolio manager of the Fund's two predecessor funds since their
inception. Mr. Trautwein joined the Advisor in 1972. He heads the Advisor's
portfolio group and is a member of its investment policy committee.
SHAREHOLDER INFORMATION
HOW TO BUY SHARES
There are several ways to purchase shares of the Fund. An Application Form,
which accompanies this Prospectus, is used if you send money directly to the
Fund by mail or by wire. If you have questions about how to invest, or about how
to complete the Application Form, please call an account representative at
1-800-548-7787. To open an account by wire or to open a retirement plan account,
call 1-800-548-7787 for instructions. You may also buy shares of the Fund
through your financial representative. After your account is open, you may add
to it at any time.
You may send money to the Fund by mail. All purchases by check should be in U.S.
dollars. Third party checks and cash will not be accepted. If you wish to invest
by mail, simply complete the Application Form and mail it with a check (made
payable to the Van Deventer & Hoch American Value Fund) to the Fund at the
following address:
Van Deventer & Hoch American Value Fund
P.O. Box 419372
Kansas City, MO 64141-6372
You may make regular investments through automatic periodic deductions from your
bank checking or savings account. If you wish to invest on a periodic basis,
when opening your Fund account complete the Automatic Investment Plan section of
the Application Form and mail it to the Fund at the address listed above.
Current shareholders may choose at any time to enroll in the Automatic
Investment Plan. Call the Transfer Agent at 1-800-548-7787 for instructions.
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You may buy shares of the Fund through an investment broker, dealer or financial
intermediary, if your investment representative has made arrangements with the
Fund. Your broker, dealer or financial intermediary is responsible for sending
your money to the Fund promptly after placing the order to purchase shares. The
Fund may cancel the order if payment is not received promptly. Your broker,
dealer or financial intermediary may charge you a fee for placing purchase
orders.
You may open a Fund account with $1,000. You may add to your account at any time
with as little as $100. The minimum investment requirements may be waived from
time to time by the Fund.
HOW TO SELL SHARES
You may sell (redeem) your Fund shares on any day the Fund is open for business
either directly to the Fund or through your investment representative.
REDEMPTIONS BY MAIL
You may redeem your shares by simply sending a written request to the Fund. You
should give your account number and state whether you want all or some of your
shares redeemed. The letter should be signed by all of the shareholders whose
names appear in the account registration. You should send your redemption
request to the Transfer Agent at the following address:
Van Deventer & Hoch American Value Fund
P.O. Box 419372
Kansas City, MO 64144-6372
REDEMPTION BY TELEPHONE.
Unless you indicate otherwise on your Application Form, you may redeem some or
all of your shares by telephone. You may redeem by calling the Transfer Agent at
1-800-548-7787 before the close of trading on the New York Stock Exchange
("NYSE"). This is normally 4:00 p.m. Eastern time. Redemption proceeds will be
mailed to the address that appears on the Transfer Agent's records. If you sell
shares worth more than $25,000, the proceeds will be wired to the bank account
on the Transfer Agent's records. Wire charges, if any, will be deducted from
your redemption proceeds. Telephone redemptions cannot be made if you notify the
Transfer Agent of a change of address within 30 days before the redemption
request. You may not use the telephone redemption for retirement accounts.
You may also make regular withdrawals on an automatic basis. Call the Transfer
Agent at 1-800-548-7787 for instructions.
Certain redemption requests require that the signature or signatures on the
account will have to be guaranteed. Call the Transfer Agent at 1-800-548-7787
for further details.
If you did not purchase your shares with a certified check, the Fund may delay
payment of your redemption proceeds until your check has cleared. Additionally,
you may not redeem shares by telephone until 15 calendar days after the purchase
date of the shares. If you purchased your shares through the Automated Clearing
House (ACH), you may not redeem those shares until your payment clears, which
may take 7 business days or longer.
The Fund may redeem the shares in your account if the value of your account is
less than $500 as a result of redemptions you have made. This does not apply to
retirement plan or Uniform Gifts or Transfers to Minors Act accounts. You will
be notified that the value of your account is less than $500 before the Fund
makes an involuntary redemption. You will then have 30 days in which to make an
additional investment to bring the value of your account to at least $500 before
the Fund takes any action.
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The Fund has the right to pay redemption proceeds in whole or in part by a
distribution of securities from the Fund's portfolio. It is not expected that
the Fund would do so except in unusual circumstances.
PRICING OF FUND SHARES
The price of Fund shares is based on the Fund's net asset value. The net asset
value of the Fund's shares is determined by dividing the Fund's assets, minus
its liabilities, by the number of shares outstanding. The Fund's assets are the
market value of securities held in its portfolio, plus any cash and other
assets. The Fund's liabilities are fees and expenses it owes. The number of Fund
shares outstanding is the amount of shares which have been issued to
shareholders. The price you will pay to buy Fund shares or the amount you will
receive when you sell your Fund shares is based on the net asset value next
calculated after your order is received in proper form.
The net asset value of shares of each class of the Fund's shares is determined
as of the close of regular trading on the NYSE. This is normally 4:00 p.m.,
Eastern time. Fund shares will not be priced on days that the NYSE is closed for
trading. The net asset value of Fund shares may also be determined on days the
NYSE is closed or at times other than 4:00 p.m. if the Board of Trustees decides
it is necessary.
DIVIDENDS AND DISTRIBUTIONS
The Fund will make distributions of dividends and capital gains, if any,
annually, usually after the end of the Fund's fiscal year. Because of its
investment strategies, the Fund expects that its distributions will primarily
consist of capital gains.
You can choose from three distribution options: (1) reinvest all distributions
in additional Fund shares; (2) receive distributions from net investment income
in cash or by ACH to a pre-established bank account while reinvesting capital
gains distributions in additional Fund shares; or (3) receive all distributions
in cash or by ACH. If you wish to change your distribution option, write to the
Transfer Agent before the payment of the distribution. If you do not select an
option when you open your account, all distributions will be reinvested in Fund
shares. You will receive a statement confirming reinvestment of distributions in
additional Fund shares promptly following the quarter in which the reinvestment
occurs.
If a check representing a Fund distribution is not cashed within a specified
period, the Transfer Agent will notify you that you have the option of
requesting another check or reinvesting the distribution in the Fund. If the
Transfer Agent does not receive your election, the distribution will be
reinvested in the Fund. Similarly, if the Fund or the Transfer Agent sends you
correspondence returned as "undeliverable," distributions will automatically be
reinvested in the Fund.
TAX CONSEQUENCES
Dividends are taxable to you as ordinary income. The rate you pay on capital
gain distributions will depend on how long the Fund held the securities that
generated the gains, not on how long you owned your Fund shares. You will be
taxed in the same manner whether you receive your dividends and capital gain
distributions in cash or reinvest them in additional Fund shares.
If you sell your Fund shares, it is considered a taxable event for you.
Depending on the purchase price and the sale price of the shares you sell, you
may have a gain or a loss on the transaction. You are responsible for any tax
liabilities generated by your transaction.
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DISTRIBUTION ARRANGEMENTS
The Fund has adopted a distribution plan under rule 12b-1 that allows the Fund
to pay distribution (12b-1 fees) and other fees for the sale and distribution of
its shares and for services provided to its shareholders. The distribution fee
is 0.25% of the Fund's average daily net assets which is payable to the Advisor,
as Distribution Coordinator. Because these fees are paid out of the Fund's
assets on an on-going basis, over time these fees will increase the cost of your
investment and may cost you more than paying other types of sales charges.
FINANCIAL HIGHLIGHTS
The financial highlights table is intended to help you understand the Fund's
financial performance since its inception. Certain information reflects
financial results for a single Fund share. The total returns in the table
represent the rate that an investor would have lost on an investment in the Fund
(assuming reinvestment of all dividends and distributions). The information has
been audited by McGladrey & Pullen, LLP, whose report, along with the Fund's
financial statements, are included in the annual report, which is available upon
request.
For a capital share outstanding throughout the period
- --------------------------------------------------------------------------------
May 1, 1998*
through
October 31, 1998
- --------------------------------------------------------------------------------
Net asset value, beginning ..................................... $ 14.96
Income from investment operations:
Net investment income .......................................... 0.10
Net realized and unrealized loss on investments ................ (1.26)
Total from investment operations ............................... (1.16)
Net asset value, end of period ................................. $ 13.80
Total return** ................................................. (7.75%)
Ratios/supplemental data:
Net assets, end of period (millions) ........................... $13.024
Ratio of expenses to average net assets+ ....................... 1.04%
Ratio of expenses to average net assets before reimbursements+ . 2.57%
Ratio of net investment income to average net assets+ .......... 1.53%
Portfolio turnover rate ........................................ 19.88%
* Commencement of the Fund.
** Not Annualized.
+ Annualized.
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VAN DEVENTER & HOCH AMERICAN VALUE FUND,
A SERIES OF ADVISORS SERIES TRUST
For investors who want more information about the Fund, the following documents
are available free upon request:
ANNUAL REPORT: Additional information about the Fund's investments is available
in the Fund's annual report to shareholders. In the Fund's annual report, you
will find a discussion of the market conditions and investment strategies that
significantly affected the Fund's performance during its last fiscal year.
STATEMENT OF ADDITIONAL INFORMATION (SAI): The SAI provides more detailed
information about the Fund and is incorporated into this prospectus.
You can get free copies of the annual report and the SAI, request other
information and discuss your questions about the Fund by contacting the Fund at
1-800-548-7787.
You can review and copy information including the Fund's annual report and SAI
at the Public Reference Room of the Securities and Exchange Commission in
Washington, D.C. You can obtain information on the operation of the Public
Reference Room by calling 1-800-SEC-0330. You can get text-only copies:
For a fee, by writing to the Public Reference Room of the Commission,
Washington, DC 20549-6009 or by calling 1-800-SEC-0330.
Free of charge from the Commission's Internet website at http://www.sec.gov
(Investment Company Act file no. 811-7959)
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ADVISER
Van Deventer & Hoch
800 North Brand Blvd., Suite 300
Glendale, CA 91203
DISTRIBUTOR
First Fund Distributors, Inc.
4455 East Camelback Road, Suite 261E
Phoenix, AZ 85018
CUSTODIAN
United Missouri Bank, N.A.
928 Grand Blvd.
Kansas City, MO 64106
TRANSFER AGENT
National Financial Data Services
330 West 9th Street
Kansas City, MO 64105
AUDITORS
McGladrey & Pullen
555 Fifth Avenue, 8th Floor
New York, NY 10017-2416
LEGAL COUNSEL
Paul, Hastings, Janofsky & Walker, LLP
345 California Street, 29th Floor
San Francisco, CA 94104
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STATEMENT OF ADDITIONAL INFORMATION
DATED MARCH 1, 1999
VAN DEVENTER& HOCH AMERICAN VALUE FUND
800 NORTH BRAND BOULEVARD, SUITE 300
GLENDALE, CA 91230
This Statement of Additional Information ("SAI") is not a prospectus, and it
should be read in conjunction with the Prospectus dated March 1, 1999, as may be
revised, of the VAN DEVENTER & HOCH AMERICAN VALUE FUND (the "Fund"), a series
of Advisors Series Trust (the "Trust"). Van Deventer & Hoch (the "Advisor") is
the advisor to the Fund. A copy of the Fund's Prospectus may be obtained by
contacting First Fund Distributors, Inc., the Fund's distributor (the
"Distributor"), at the above-listed address; telephone 1-800-548-7787.
TABLE OF CONTENTS
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Investment Objective and Policies B- 2
Portfolio Transactions and Brokerage B-24
Portfolio Turnover B-25
Determination of Net Asset Value B-26
Purchase and Redemption of Fund Shares B-26
Management B-30
Distribution Plan B-35
Dividends and Distributions B-36
Tax Matters B-37
Performance Information B-44
General Information B-47
Appendix A B-49
Appendix B B-51
B-1
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INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to seek to maximize total return,
consisting of capital appreciation (both realized and unrealized) and income, by
investing primarily in the equity securities of well-established U.S. companies.
There is no assurance that the Fund will achieve its objective. The Fund is
classified as a "diversified" fund under federal securities laws. The discussion
below supplements information contained in the Fund's Prospectus as to
investment policies of the Fund.
In addition to the risks associated with particular types of securities, which
are discussed below, the Fund is subject to general market risks. The Fund
invests primarily in common stocks. The market risks associated with stocks
include the possibility that the entire market for common stocks could suffer a
decline in price over a short or even an extended period. This could affect the
net asset value of your Fund shares. The U.S. stock market tends to be cyclical,
with periods when stock prices generally rise and periods when stock prices
generally decline.
EQUITY SECURITIES. The equity securities in which the Fund invests generally
consist of common stock, preferred stock and securities convertible into or
exchangeable for common or preferred stock. Under normal market conditions, at
least 65% of the value of the Fund's total assets will be invested in the equity
securities of U.S. companies. The Fund may invest in companies without regard to
market capitalization, although it generally does not expect to invest in
companies with market capitalizations of less than $200 million. The securities
in which the Fund invests are expected to be either listed on an exchange or
traded in an over-the-counter market.
SMALL COMPANIES. Some of the securities in which the Fund may invest may be of
smaller companies. The securities of smaller companies often trade less
frequently and in more limited volume, and may be subject to more abrupt or
erratic price movements, than securities of larger, more established companies.
Such companies may have limited product lines, markets or financial resources,
or may depend on a limited management group.
PREFERRED STOCK. A preferred stock is a blend of the characteristics of a bond
and common stock. It can offer the higher yield of a bond and has priority over
common stock in equity ownership, but does not have the seniority of a bond and,
unlike common stock, its participation in the issuer's growth may be limited.
Preferred stock has preference over common stock in the receipt of dividends and
in any residual assets after payment to creditors should the issuer by
dissolved. Although the dividend is set at a fixed annual rate, in some
circumstances it can be changed or omitted by the issuer.
CONVERTIBLE SECURITIES. The Fund may invest in convertible securities, which are
securities generally offering fixed interest or dividend yields which may be
converted either at a stated price or stated rate for common or preferred stock.
Although to a lesser extent than with fixed-income securities generally, the
market value of convertible securities tends to decline as interest rates
increase, and increase as interest rates decline. Because of the conversion
feature, the market value of convertible securities also tends to vary with
fluctuations in the market value of the underlying common or preferred stock.
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FOREIGN SECURITIES. The Fund may invest up to 20% of its total assets in foreign
securities, including American Depositary Receipts ("ADRs"), which are described
below. The Fund expects that its investments in foreign issuers, if any, will
generally be in companies which generate substantial revenues from U.S.
operations and which are listed on U.S. securities exchanges. Since foreign
securities are normally denominated and traded in foreign currencies, the values
of the Fund's foreign investments may be influenced by currency exchange rates
and exchange control regulations. There may be less information publicly
available about foreign issuers than U.S. issuers, and they are not generally
subject to accounting, auditing and financial reporting standards and practices
comparable to those in the U.S. Foreign securities may be less liquid and more
volatile than comparable U.S. securities. Foreign settlement procedures and
trade regulations may involve certain expenses and risks. One risk would be the
delay in payment or delivery of securities or in the recovery of the Fund's
assets held abroad. It is possible that nationalization or expropriation of
assets, imposition of currency exchange controls, taxation by withholding Fund
assets, political or financial instability and diplomatic developments could
affect the value of the Fund's investments in certain foreign countries. Foreign
laws may restrict the ability to invest in certain issuers or countries and
special tax considerations will apply to foreign securities. The risks can
increase if the Fund invests in emerging market securities.
AMERICAN DEPOSITARY RECEIPTS. The Fund may invest its assets in securities of
foreign issuers in the form of ADRs, which are securities representing
securities of foreign issuers. The Fund treats ADRs as interests in the
underlying securities for purposes of its investment policies. The Fund will
limit its investment in ADRs not sponsored by the issuer of the underlying
securities to no more than 5% of the value of its net assets (at the time of
investment). A purchaser of an unsponsored ADR may not have unlimited voting
rights and may not receive as much information about the issuer of the
underlying securities as with a sponsored ADR.
ECU OBLIGATIONS. The specific amounts of currencies comprising the ECU may be
adjusted by the Council of Ministers of the European Community to reflect
changes in relative values of the underlying currencies. The Trustees do not
believe that such adjustments will adversely affect holders of ECU-denominated
securities or the marketability of such securities.
SUPRANATIONAL OBLIGATIONS. Supranational organizations, include organizations
such as The World Bank, which was chartered to finance development projects in
developing member countries; the European Community, which is a twelve-nation
organization engaged in cooperative economic activities; the European Coal and
Steel Community, which is an economic union of various European nations steel
and coal industries; and the Asian Development Bank, which is an international
development bank established to lend funds, promote investment and provide
technical assistance to member nations of the Asian and Pacific regions.
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OTHER INVESTMENT COMPANIES. Apart from being able to invest all of its
investable assets in anotherinvestment company having substantially the same
investment objectives and policies, the Fund may invest up to 10% of its total
assets in shares of other investment companies when consistent with its
investment objective and policies, subject to applicable regulatory limitations.
As a shareholder in an investment company, the Fund bears its ratable share of
that investment company's expenses, including advisory and administration fees.
These fees are in addition to the advisory and other fees charged to
shareholders of the Fund. Additional fees may be charged by other investment
companies.
CORPORATE REORGANIZATIONS. The Fund may invest in securities for which a tender
or exchange offer has been made or announced and in securities of companies for
which a merger, consolidation, liquidation or similar reorganization proposal
has been announced if, in the judgment of its Advisor, there is a reasonable
prospect of capital appreciation significantly greater than the added portfolio
turnover expenses inherent in the short-term nature of such transactions. In
general, securities that are the subject of a tender or exchange offer or
proposal sell at a premium to their historic market price immediately prior to
the announcement of the offer or proposal. The increased market price of these
securities may also discount what the stated or appraised value of the security
would be if the contemplated action were approved or consummated. These
investments may be advantageous when the discount significantly overstates the
risk of the contingencies involved; significantly undervalues the securities,
assets or cash to be received by shareholders of the prospective portfolio
company as a result of the contemplated transaction; or fails adequately to
recognize the possibility that the offer or proposal may be replaced or
superseded by an offer or proposal of greater value. The principal risk is that
such offers or proposals may not be consummated within the time and under the
terms contemplated at the time of investment, in which case, unless such offers
or proposals are replaced by equivalent or increased offers or proposals which
are consummated, the Fund may sustain a loss. The evaluation of these
contingencies requires unusually broad knowledge and experience on the part of
the Advisor who must appraise not only the value of the issuer and its component
businesses as well as the assets or securities to be received as a result of the
contemplated transaction, but also the financial resources and business
motivation of the offer or as well as the dynamics of the business climate when
the offer or proposal is in progress. Investments in reorganization securities
may tend to increase the turnover ratio of the Fund and increase its brokerage
and other transaction expenses.
ILLIQUID SECURITIES. For purposes of its limitation on investments in illiquid
securities, the Fund may elect to treat as liquid, in accordance with procedures
established by the Board of Trustees, certain investments in restricted
securities for which there may be a secondary market of qualified institutional
buyers as contemplated by Rule 144A under the Securities Act of 1933 (the
"Securities Act") and commercial obligations issued in reliance on the so-called
"private placement" exemption from registration afforded by Section 4(2) of the
Securities Act ("Section 4(2) paper"). Rule 144A provides an exemption from the
registration requirements of the Securities Act for the resale of certain
restricted securities to qualified institutional buyers. Section 4(2) paper is
restricted as to disposition under the federal securities laws, and generally is
sold to institutional investors such as the Fund who agree that they are
purchasing the paper for investment and not with a view to public distribution.
Any resale of Section 4(2) paper by the purchaser must be in an exempt
transaction.
B-4
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One effect of Rule 144A and Section 4(2) is that certain restricted securities
may now be liquid, though there is no assurance that a liquid market for Rule
144A securities or Section 4(2) paper will develop or be maintained. The
Trustees have adopted policies and procedures for the purpose of determining
whether securities that are eligible for resale under Rule 144A and Section 4(2)
paper are liquid or illiquid for purposes of the limitation on investment in
illiquid securities.
WARRANTS AND RIGHTS. The Fund may invest up to 5% of the total value of its
assets (at the time of investment) in warrants or rights (other than those
acquired in units or attached to other securities) which entitle the holder to
buy equity securities at a specific price during or at the end of a specific
period of time. Warrants basically are options to purchase equity securities at
a specified price for a specific period of time. Their prices do not necessarily
move parallel to the prices of the underlying securities. Rights are similar to
warrants but normally have a shorter duration and are distributed directly by
the issuer to shareholders. Rights and warrants have no voting rights, receive
no dividends and have no rights with respect to the assets of the issuer.
SECURITIES LOANS. The Fund is permitted to lend its securities to broker-dealers
and other institutional investors in order to generate additional income. Such
loans of portfolio securities may not exceed one-third of the value of the
Fund's total assets. In connection with such loans, the Fund will receive
collateral consisting of cash, cash equivalents, U.S. Government securities or
irrevocable letters of credit issued by financial institutions. Such collateral
will be maintained at all times in an amount equal to at least 102% of the
current market value plus accrued interest of the securities loaned. The Fund
can increase its income through the investment of such collateral. The Fund
continues to be entitled to the interest payable or any dividend-equivalent
payments received on a loaned security and, in addition, to receive interest on
the amount of the loan. However, the receipt of any dividend-equivalent payments
by the Fund on a loaned security from the borrower will not qualify for the
dividends-received deduction. Such loans will be terminable at any time upon
specified notice. The Fund might experience risk of loss if the institutions
with which it has engaged in portfolio loan transactions breach their agreements
with the Fund. The risks in lending portfolio securities, as with other
extensions of secured credit, consist of possible delays in receiving additional
collateral or in the recovery of the securities or possible loss of rights in
the collateral should the borrower experience financial difficulty. Loans will
be made only to firms deemed by the Advisor to be of good standing and will not
be made unless, in the judgment of the Advisor, the consideration to be earned
from such loans justifies the risk.
BORROWING MONEY. The Fund is authorized to borrow money from time to time for
temporary, extraordinary or emergency purposes or for clearance of transactions
in amounts not to exceed 33- 1/3% of the value of its total assets at the time
of such borrowings. The use of borrowing by the Fund involves special risk
considerations that may not be associated with other funds having similar
objectives and policies. Since substantially all of the Fund's assets fluctuate
in value, while the interest obligation resulting from a borrowing will be fixed
by the terms of the Fund's agreement with its lender, the net asset value per
share of the Fund will tend to increase more when its portfolio securities
increase in value and to decrease more when its portfolio assets decrease in
value than would otherwise be the case if the Fund did not borrow funds. In
addition, interest costs on borrowings may fluctuate with changing market
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rates of interest and may partially offset or exceed the return earned on
borrowed funds. Under adverse market conditions, the Fund might have to sell
portfolio securities to meet interest or principal payments at a time when
fundamental investment considerations would not favor such sales. The Fund is
required to designate specific liquid assets with its custodian equal to the
amount it has borrowed.
FORWARD COMMITMENTS. The Fund pay purchase securities for delivery at a future
date. In order to invest the Fund's assets immediately, while awaiting delivery
of securities purchased on a forward commitment basis, short-term obligations
that offer same-day settlement and earnings will normally be purchased. When a
commitment to purchase a security on a forward commitment basis is made,
procedures are established consistent with the General Statement of Policy of
the Securities and Exchange Commission concerning such purchases. Since that
policy currently recommends that an amount of the Fund's assets equal to the
amount of the purchase be held aside or segregated to be used to pay for the
commitment, a separate account of the Fund consisting of liquid assets equal to
the amount of the Fund's commitments will be established at the Fund's custodian
bank. For the purpose of determining the adequacy of the securities in the
account, the deposited securities will be valued at market value. If the market
value of such securities declines, additional liquid assets will be placed in
the account daily so that the value of the account will equal the amount of such
commitments by the Fund.
Although it is not intended that such purchases would be made for speculative
purposes, purchases of securities on a forward commitment basis may involve more
risk than other types of purchases. Securities purchased on a forward commitment
basis and the securities held in the Fund's portfolio are subject to changes in
value based upon the public's perception of the issuer and changes, real or
anticipated, in the level of interest rates. Purchasing securities on a forward
commitment basis can involve the risk that the yields available in the market
when the delivery takes place may actually be higher or lower than those
obtained in the transaction itself. On the settlement date of the forward
commitment transaction, the Fund will meet its obligations from then available
cash flow, sale of securities held in the separate account, sale of other
securities or, although it would not normally expect to do so, from sale of the
forward commitment securities themselves (which may have a value greater or
lesser than the Fund's payment obligations). The sale of securities to meet such
obligations may result in the realization of capital gains or losses.
To the extent the Fund engages in forward commitment transactions, it will do so
for the purpose of acquiring securities consistent with its investment objective
and policies and not for the purpose of investment leverage, and settlement of
such transactions will be within 90 days from the trade date.
STAND-BY COMMITMENTS. In a put transaction, the Fund acquires the right to sell
a security at an agreed upon price within a specified period prior to its
maturity date, and a stand-by commitment entitles the Fund to same-day
settlement and to receive an exercise price equal to the amortized cost of the
underlying security plus accrued interest, if any, at the time of exercise.
Stand-by commitments are subject to certain risks, which include the inability
of the issuer of the commitment to pay for the securities at the time the
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commitment is exercised, the fact that the commitment is not marketable by the
Fund, and that the maturity of the underlying security will generally be
different from that of the commitment.
ZERO COUPON, PAYMENT-IN-KIND AND STRIPPED OBLIGATIONS. The principal and
interest components of United States Treasury bonds with remaining maturities of
longer than ten years are eligible to be traded independently under the Separate
Trading of Registered Interest and Principal of Securities ("STRIPS") program.
Under the STRIPS program, the principal and interest components are separately
issued by the United States Treasury at the request of depository financial
institutions, which then trade the component parts separately. The interest
component of STRIPS may be more volatile than that of United States Treasury
bills with comparable maturities. Zero coupon obligations are sold at a
substantial discount from their value at maturity and, when held to maturity,
their entire return, which consists of the amortization of discount, comes from
the difference between their purchase price and maturity value. Because interest
on a zero coupon obligation is not distributed on a current basis, the
obligation tends to be subject to greater price fluctuations in response to
changes in interest rates than are ordinary interest-paying securities with
similar maturities. The value of zero coupon obligations appreciates more than
such ordinary interest-paying securities during periods of declining interest
rates and depreciates more than such ordinary interest-paying securities during
periods of rising interest rates. Under the stripped bond rules of the Internal
Revenue Code of 1986 (the "Code"), investments by the Fund in zero coupon
obligations will result in the accrual of interest income on such investments in
advance of the receipt of the cash corresponding to such income.
Zero coupon securities may be created when a dealer deposits a U.S. Treasury or
federal agency security with a custodian and then sells the coupon payments and
principal payment that will be generated by this security separately.
Proprietary receipts, such as Certificates of Accrual on Treasury Securities,
Treasury Investment Growth Receipts and generic Treasury Receipts, are examples
of stripped U.S. Treasury securities separated into their component parts
through such custodial arrangements.
Payment-in-kind ("PIK") bonds are debt obligations which provide that the issuer
thereof may, at its option, pay interest on such bonds in cash or in the form of
additional debt obligations. Such investments benefit the issuer by mitigating
its need for cash to meet debt service, but also require a higher rate of return
to attract investors who are willing to defer receipt of such cash. Such
investments experience greater volatility in market value due to changes in
interest rates than debt obligations which provide for regular payments of
interest. The Fund will accrue income on such investments for tax and accounting
purposes, as required, which is distributable to shareholders and which, because
no cash is received at the time of accrual, may require the liquidation of other
portfolio securities to satisfy the Fund's distribution obligations.
SHORT-TERM INVESTMENTS
Although the Fund invests primarily in equity securities, it may invest up to
25% of the value of its total assets in high quality, short-term money market
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instruments, repurchase agreements and cash. The Fund may make substantial
temporary investments in investment grade U.S. debt securities and invest
without limit in money market instruments when the Advisor believes a defensive
posture is warranted.
BANK OBLIGATIONS. Investments in bank obligations are limited to those of U.S.
banks (including their foreign branches) which have total assets at the time of
purchase in excess of $1 billion and the deposits of which are insured by either
the Bank Insurance Fund or the Savings Association Insurance Fund of the Federal
Deposit Insurance Corporation, and foreign banks (including their U.S. branches)
having total assets in excess of $10 billion (or the equivalent in other
currencies), and such other U.S. and foreign commercial banks which are judged
by the Adviser to meet comparable credit standing criteria. Bank obligations
include negotiable certificates of deposit, bankers' acceptances, fixed time
deposits and deposit notes. A certificate of deposit is a short-term negotiable
certificate issued by a commercial bank against funds deposited in the bank and
is either interest-bearing or purchased on a discount basis. A bankers'
acceptance is a short-term draft drawn on a commercial bank by a borrower,
usually in connection with an international commercial transaction. The borrower
is liable for payment as is the bank, which unconditionally guarantees to pay
the draft at its face amount on the maturity date. Fixed time deposits are
obligations of branches of United States banks or foreign banks which are
payable at a stated maturity date and bear a fixed rate of interest. Although
fixed time deposits do not have a market, there are no contractual restrictions
on the right to transfer a beneficial interest in the deposit to a third party.
Fixed time deposits subject to withdrawal penalties and with respect to which
the Fund cannot realize the proceeds thereon within seven days are deemed
"illiquid" for the purposes of its restriction on investments in illiquid
securities. Deposit notes are notes issued by commercial banks which generally
bear fixed rates of interest and typically have original maturities ranging from
eighteen months to five years.
Banks are subject to extensive governmental regulations that may limit both the
amounts and types of loans and other financial commitments that may be made and
the interest rates and fees that may be charged. The profitability of this
industry is largely dependent upon the availability and cost of capital funds
for the purpose of financing lending operations under prevailing money market
conditions. Also, general economic conditions play an important part in the
operations of this industry and exposure to credit losses arising from possible
financial difficulties of borrowers might affect a bank's ability to meet its
obligations. Bank obligations may be general obligations of the parent bank or
may be limited to the issuing branch by the terms of the specific obligations or
by government regulation. Investors should also be aware that securities of
foreign banks and foreign branches of United States banks may involve foreign
investment risks in addition to those relating to domestic bank obligations.
COMMERCIAL PAPER. Commercial paper consists of short-term (usually from 1 to 270
days) unsecured promissory notes issued by corporations in order to finance
their current operations. A variable amount master demand note (which is a type
of commercial paper) represents a direct borrowing arrangement involving
periodically fluctuating rates of interest under a letter agreement between a
commercial paper issuer and an institutional lender pursuant to which the lender
may determine to invest varying amounts.
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REPURCHASE AGREEMENTS. The Fund will enter into repurchase agreements only with
member banks of the Federal Reserve System and securities dealers believed
creditworthy, and only if fully collateralized by securities in which the Fund
is permitted to invest. Under the terms of a typical repurchase agreement, the
Fund would acquire an underlying instrument for a relatively short period
(usually not more than one week) subject to an obligation of the seller to
repurchase the instrument and the Fund to resell the instrument at a fixed price
and time, thereby determining the yield during the Fund's holding period. This
procedure results in a fixed rate of return insulated from market fluctuations
during such period. A repurchase agreement is subject to the risk that the
seller may fail to repurchase the security. Repurchase agreements are considered
under the 1940 Act to be loans collateralized by the underlying securities. All
repurchase agreements entered into by the Fund will be fully collateralized at
all times during the period of the agreement in that the value of the underlying
security will be at least equal to 102% of the amount of the loan, including the
accrued interest thereon, and the Fund or its custodian or sub-custodian will
have possession of the collateral, which the Board of Trustees believes will
give it a valid, perfected security interest in the collateral. Whether a
repurchase agreement is the purchase and sale of a security or a collateralized
loan has not been conclusively established. This might become an issue in the
event of the bankruptcy of the other party to the transaction. In the event of
default by the seller under a repurchase agreement construed to be a
collateralized loan, the underlying securities would not be owned by the Fund,
but would only constitute collateral for the seller's obligation to pay the
repurchase price. Therefore, the Fund may suffer time delays and incur costs in
connection with the disposition of the collateral. The Board of Trustees
believes that the collateral underlying repurchase agreements may be more
susceptible to claims of the seller's creditors than would be the case with
securities owned by the Fund. Repurchase agreements maturing in more than seven
days are treated as illiquid for purposes of the Fund's restrictions on
purchases of illiquid securities. Repurchase agreements are also subject to the
risks described below with respect to stand-by commitments.
REVERSE REPURCHASE AGREEMENTS. Reverse repurchase agreements involve the sale of
securities held by the Fund with an agreement to repurchase the securities at an
agreed upon price and date. The repurchase price is generally equal to the
original sales price plus interest. Reverse repurchase agreements are usually
for seven days or less and cannot be repaid prior to their expiration dates.
Reverse repurchase agreements involve the risk that the market value of the
portfolio securities transferred may decline below the price at which the Fund
is obliged to purchase the securities.
U.S. GOVERNMENT SECURITIES. U.S. Government Securities include (1) U.S. Treasury
obligations, which generally differ only in their interest rates, maturities and
times of issuance, including: U.S. Treasury bills (maturities of one year or
less), U.S. Treasury notes (maturities of one to ten years) and U.S. Treasury
bonds (generally maturities of greater than ten years); and (2) obligations
issued or guaranteed by U.S. Government agencies and instrumentalities which are
supported by any of the following: (a) the full faith and credit of the U.S.
Treasury, (b) the right of the issuer to borrow any
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amount listed to a specific line of credit from the U.S. Treasury, (c)
discretionary authority of the U.S. Government to purchase certain obligations
of the U.S. Government agency or instrumentality or (d) the credit of the agency
or instrumentality. Agencies and instrumentalities of the U.S. Government
include but are not limited to: Federal Land Banks, Federal Financing Banks,
Banks for Cooperatives, Federal Intermediate Credit Banks, Farm Credit Banks,
Federal Home Loan Banks, Federal Home Loan Mortgage Corporation, Federal
National Mortgage Association, Student Loan Marketing Association, United States
Postal Service, Chrysler Corporate Loan Guarantee Board, Small Business
Administration, Tennessee Valley Authority and any other enterprise established
or sponsored by the U.S. Government. Certain U.S. Government Securities,
including U.S. Treasury bills, notes and bonds, Government National Mortgage
Association certificates and Federal Housing Administration debentures, are
supported by the full faith and credit of the United States. Other U.S.
Government Securities are issued or guaranteed by federal agencies or government
sponsored enterprises and are not supported by the full faith and credit of the
United States. These securities include obligations that are supported by the
right of the issuer to borrow from the U.S. Treasury, such as obligations of the
Federal Home Loan Banks, and obligations that are supported by the
creditworthiness of the particular instrumentality, such as obligations of the
Federal National Mortgage Association or Federal Home Loan Mortgage Corporation.
For a description of certain obligations issued or guaranteed by U.S. Government
agencies and instrumentalities, see Appendix A.
In addition, certain U.S. Government agencies and instrumentalities issue
specialized types of securities, such as guaranteed notes of the Small Business
Administration, Federal Aviation Administration, Department of Defense, Bureau
of Indian Affairs and Private Export Funding Corporation, which often provide
higher yields than are available from the more common types of government-backed
instruments. However, such specialized instruments may only be available from a
few sources, in limited amounts, or only in very large denominations; they may
also require specialized capability in portfolio servicing and in legal matters
related to government guarantees. While they may frequently offer attractive
yields, the limited-activity markets of many of these securities means that, if
the Fund were required to liquidate any of them, it might not be able to do so
advantageously; accordingly, the Fund normally holds such securities to maturity
or pursuant to repurchase agreements, and would treat such securities (including
repurchase agreements maturing in more than seven days) as illiquid for purposes
of its limitation on investment in illiquid securities.
FLOATING AND VARIABLE RATE SECURITIES; PARTICIPATION CERTIFICATES. The
securities in which the Fund may be invested include participation certificates
issued by a bank, insurance company or other financial institution in securities
owned by such institutions or affiliated organizations ("Participation
Certificates"). A Participation Certificate gives the Fund an undivided interest
in the security in the proportion that the Fund's participation interest bears
to the total principal amount of the security and generally provides the demand
feature described below. Each Participation Certificate is backed by an
irrevocable letter of credit or guaranty of a bank (which may be the bank
issuing the Participation Certificate, a bank issuing a confirming letter of
credit to that of the issuing bank, or a bank serving as agent of the issuing
bank with respect to the possible repurchase of the Participation Certificate)
or insurance policy of an insurance company that the Board of Trustees of the
Trust has determined meets the prescribed quality standards for the Fund.
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The Fund may have the right to sell the Participation Certificate back to the
institution and draw on the letter of credit or insurance on demand after the
prescribed notice period, for all or any part of the full principal amount of
the Fund's participation interest in the security, plus accrued interest. The
institutions issuing the Participation Certificates would retain a service and
letter of credit fee and a fee for providing the demand feature, in an amount
equal to the excess of the interest paid on the instruments over the negotiated
yield at which the Participation Certificates were purchased by the Fund. The
total fees would generally range from 5% to 15% of the applicable prime rate or
other short-term rate index. With respect to insurance, the Fund will attempt to
have the issuer of the participation certificate bear the cost of any such
insurance, although the Fund retains the option to purchase insurance if deemed
appropriate. Obligations that have a demand feature permitting the Fund to
tender the obligation to a foreign bank may involve certain risks associated
with foreign investment. The Fund's ability to receive payment in such
circumstances under the demand feature from such foreign banks may involve
certain risks such as future political and economic developments, the possible
establishment of laws or restrictions that might adversely affect the payment of
the bank's obligations under the demand feature and the difficulty of obtaining
or enforcing a judgment against the bank.
The Advisor has been instructed by the Board of Trustees to monitor on an
ongoing basis the pricing, quality and liquidity of the floating and variable
rate securities held by the Fund, including Participation Certificates, on the
basis of published financial information and reports of the rating agencies and
other bank analytical services to which the Fund may subscribe. Although these
instruments may be sold by the Fund, it is intended that they be held until
maturity.
Past periods of high inflation, together with the fiscal measures adopted to
attempt to deal with it, have seen wide fluctuations in interest rates,
particularly "prime rates" charged by banks. While the value of the underlying
floating or variable rate securities may change with changes in interest rates
generally, the floating or variable rate nature of the underlying floating or
variable rate securities should minimize changes in value of the instruments.
Accordingly, as interest rates decrease or increase, the potential for capital
appreciation and the risk of potential capital depreciation is less than would
be the case with a portfolio of fixed rate securities. The Fund's portfolio may
contain floating or variable rate securities on which stated minimum or maximum
rates, or maximum rates set by state law, limit the degree to which interest on
such floating or variable rate securities may fluctuate; to the extent it does,
increases or decreases in value may be somewhat greater than would be the case
without such limits. Because the adjustment of interest rates on the floating or
variable rate securities is made in relation to movements of the applicable
banks' "prime rates" or other short-term rate adjustment indices, the floating
or variable rate securities are not comparable to long-term fixed rate
securities. Accordingly, interest rates on the floating or variable rate
securities may be higher or lower than current market rates for fixed rate
obligations of comparable quality with similar maturities.
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The maturity of variable rate securities is deemed to be the longer of (a) the
notice period required before the Fund is entitled to receive payment of the
principal amount of the security upon demand, or (b) the period remaining until
the security's next interest rate adjustment.
INVESTMENT GRADE DEBT SECURITIES. Investment grade debt securities are
securities rated in the category BBB or higher by Standard & Poor's Ratings
Group ("S&P"), or Baa or higher by Moody's Investors Service, Inc. ("Moody's")
or the equivalent by another nationally recognized securities rating
organization, or, if unrated, determined by the Advisor to be of comparable
quality. Such debt securities are regarded as having an adequate capacity to
repay principal and pay interest. Whereas they normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to repay principal and pay interest
for bonds in this category than for higher rated categories. For descriptions of
the securities ratings of Moody's, S&P and Fitch Investors Service, Inc.
("Fitch"), see Appendix B.
DERIVATIVE AND RELATED TRANSACTIONS
INTRODUCTION. Although the Fund has no current intention to do so, it may employ
derivative and related instruments as tools in the management of portfolio
assets. Put briefly, a "derivative" instrument may be considered a security or
other instrument which derives its value from the value or performance of other
instruments or assets, interest or currency exchange rates, or indexes. For
instance, derivatives include futures, options, forward contracts, structured
notes and various over-the-counter instruments.
Like other investment tools or techniques, the impact of using derivatives
strategies or similar instruments depends to a great extent on how they are
used. Derivatives are generally used by portfolio managers in three ways: first,
to reduce risk by hedging (offsetting) an investment position; second, to
substitute for another security particularly where it is quicker, easier and
less expensive to invest in derivatives; and lastly, to speculate or enhance
portfolio performance. When used prudently, derivatives can offer several
benefits, including easier and more effective hedging, lower transaction costs,
quicker investment and more profitable use of portfolio assets. However,
derivatives also have the potential to significantly magnify risks, thereby
leading to potentially greater losses for the Fund.
The Fund may invest its assets in derivative and related instruments subject
only to the Fund's investment objective and policies and the requirement that
the Fund maintain segregated accounts consisting of cash or other liquid assets
(or, as permitted by applicable regulation, enter into certain offsetting
positions) to cover its obligations under such instruments with respect to
positions where there is no underlying portfolio asset so as to avoid leveraging
the Fund.
The value of some derivative or similar instruments in which the Fund may invest
may be particularly sensitive to changes in prevailing interest rates or other
economic factors, and--like other investments of the Fund--the ability of the
Fund to successfully utilize these instruments may depend in part upon the
ability of the Adviser to forecast interest rates and other economic factors
correctly. If the Adviser inaccurately forecasts such factors and has taken
positions in derivative or similar instruments contrary to prevailing market
trends, the Fund could be exposed to the risk of a loss.
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Set forth below is an explanation of the various derivatives strategies and
related instruments the Fund may employ along with risks or special attributes
associated with them. This discussion is intended to provide useful information
to prospective investors.
RISK FACTORS. As explained more fully below and in the discussions of particular
strategies or instruments, there are a number of risks associated with the use
of derivatives and related instruments. There can be no guarantee that there
will be a correlation between price movements in a hedging vehicle and in the
portfolio assets being hedged. An incorrect correlation could result in a loss
on both the hedged assets in the Fund and the hedging vehicle so that the
portfolio return might have been greater had hedging not been attempted. This
risk is particularly acute in the case of "cross-hedges" between currencies. The
Advisor may inaccurately forecast interest rates, market values or other
economic factors in utilizing a derivatives strategy. In such a case, the Fund
may have been in a better position had it not entered into such strategy.
Hedging strategies, while reducing risk of loss, can also reduce the opportunity
for gain. In other words, hedging usually limits both potential losses as well
as potential gains. Strategies not involving hedging may increase the risk to
the Fund. Certain strategies, such as yield enhancement, can have speculative
characteristics and may result in more risk to the Fund than hedging strategies
using the same instruments. There can be no assurance that a liquid market will
exist at a time when the Fund seeks to close out an option, futures contract or
other derivative or related position. Many exchanges and boards of trade limit
the amount of fluctuation permitted in option or futures contract prices during
a single day; once the daily limit has been reached on particular contract, no
trades may be made that day at a price beyond that limit. In addition, certain
instruments are relatively new and without a significant trading history. As a
result, there is no assurance that an active secondary market will develop or
continue to exist. Finally, over-the-counter instruments typically do not have a
liquid market. Lack of a liquid market for any reason may prevent the Fund from
liquidating an unfavorable position. Activities of large traders in the futures
and securities markets involving arbitrage, "program trading," and other
investment strategies may cause price distortions in these markets. In certain
instances, particularly those involving over-the-counter transactions, forward
contracts there is a greater potential that a counter-party or broker may
default or be unable to perform on its commitments. In the event of such a
default, the Fund may experience a loss. In transactions involving currencies,
the value of the currency underlying an instrument may fluctuate due to many
factors, including economic conditions, interest rates, governmental policies
and market forces.
SPECIFIC USES AND STRATEGIES. Set forth below are explanations of various
strategies involving derivatives and related instruments which may be used by
the Fund.
OPTIONS ON SECURITIES, SECURITIES INDICES AND DEBT INSTRUMENTS. The Fund may
purchase, sell or exercise call and put options on (a) securities, (b)
securities indices, and (c) debt instruments.
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Although in most cases these options will be exchange-traded, the Fund may also
purchase, sell or exercise over-the-counter options. Over-the-counter options
differ from exchange-traded options in that they are two-party contracts with
price and other terms negotiated between buyer and seller. As such,
over-the-counter options generally have much less market liquidity and carry the
risk of default or nonperformance by the other party.
One purpose of purchasing put options is to protect holdings in an underlying or
related security against a substantial decline in market value. One purpose of
purchasing call options is to protect against substantial increases in prices of
securities the Fund intends to purchase pending its ability to invest in such
securities in an orderly manner. The Fund may also use combinations of options
to minimize costs, gain exposure to markets or take advantage of price
disparities or market movements. For example, the Fund may sell put or call
options it has previously purchased or purchase put or call options it has
previously sold. These transactions may result in a net gain or loss depending
on whether the amount realized on the sale is more or less than the premium and
other transaction costs paid on the put or call option which is sold. The Fund
may write a call or put option in order to earn the related premium from such
transactions. Prior to exercise or expiration, an option may be closed out by an
offsetting purchase or sale of a similar option. The Fund will not write
uncovered options.
In addition to the general risk factors noted above, the purchase and writing of
options involve certain special risks. During the option period, the Fund
writing a covered call (i.e., where the underlying securities are held by the
Fund) has, in return for the premium on the option, given up the opportunity to
profit from a price increase in the underlying securities above the exercise
price, but has retained the risk of loss should the price of the underlying
securities decline. The writer of an option has no control over the time when it
may be required to fulfill its obligation as a writer of the option. Once an
option writer has received an exercise notice, it cannot effect a closing
purchase transaction in order to terminate its obligation under the option and
must deliver the underlying securities at the exercise price.
If a put or call option purchased by the Fund is not sold when it has remaining
value, and if the market price of the underlying security, in the case of a put,
remains equal to or greater than the exercise price or, in the case of a call,
remains less than or equal to the exercise price, the Fund will lose its entire
investment in the option. Also, where a put or call option on a particular
security is purchased to hedge against price movements in a related security,
the price of the put or call option may move more or less than the price of the
related security. There can be no assurance that a liquid market will exist when
the Fund seeks to close out an option position. Furthermore, if trading
restrictions or suspensions are imposed on the options markets, the Fund may be
unable to close out a position.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS. The Fund may purchase or
sell (i) interest-rate futures contracts, (ii) futures contracts on specified
instruments or indices, and (iii) options on these futures contracts ("futures
options"). The futures contracts and futures options may be based on various
instruments or indices in which the Fund may invest such as foreign currencies,
certificates of deposit, Eurodollar time deposits, securities indices, economic
indices (such as the Consumer Price Indices compiled by the U.S. Department of
Labor).
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Futures contracts and futures options may be used to hedge portfolio positions
and transactions as well as to gain exposure to markets. For example, the Fund
may sell a futures contract--or buy a futures option--to protect against a
decline in value, or reduce the duration, of portfolio holdings. Likewise, these
instruments may be used where the Fund intends to acquire an instrument or enter
into a position. For example, the Fund may purchase a futures contract--or buy a
futures option--to gain immediate exposure in a market or otherwise offset
increases in the purchase price of securities or currencies to be acquired in
the future. Futures options may also be written to earn the related premiums.
When writing or purchasing options, the Fund may simultaneously enter into other
transactions involving futures contracts or futures options in order to minimize
costs, gain exposure to markets, or take advantage of price disparities or
market movements. Such strategies may entail additional risks in certain
instances. The Fund may engage in cross-hedging by purchasing or selling futures
or options on a security or currency different from the security or currency
position being hedged to take advantage of relationships between the two
securities or currencies.
Investments in futures contracts and options thereon involve risks similar to
those associated with options transactions discussed above. The Fund will only
enter into futures contracts or options on futures contracts which are traded on
a U.S. or foreign exchange or board of trade, or similar entity, or quoted on an
automated quotation system.
ADDITIONAL RESTRICTIONS ON THE USE OF FUTURES AND OPTION CONTRACTS. The Fund is
not a "commodity pool" (i.e., a pooled investment vehicle which trades in
commodity futures contracts and options thereon and the operator of which is
registered with the CFTC, and futures contracts and futures options will be
purchased, sold or entered into only for bona fide hedging purposes, provided
that the Fund may enter into such transactions for purposes other than bona fide
hedging if, immediately thereafter, the sum of the amount of its initial margin
and premiums on open contracts and options would not exceed 5% of the
liquidation value of the Fund's portfolio, provided, further, that, in the case
of an option that is in-the-money, the in-the-money amount may be excluded in
calculating the 5% limitation.
When the Fund purchases a futures contract, an amount of liquid assets will be
segregated with the Fund's custodian or sub-custodian so that the amount so
segregated, plus the initial deposit and variation margin held in the account of
its broker, will at all times equal the value of the futures contract, thereby
insuring that the use of such futures is unleveraged.
FORWARD CONTRACTS. The Fund may use foreign currency and interest-rate forward
contracts for various purposes as described below.
Foreign currency exchange rates may fluctuate significantly over short periods
of time. They generally are determined by the forces of supply and demand in the
foreign exchange markets and the relative merits of investments in different
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countries, actual or perceived changes in interest rates and other complex
factors, as seen from an international perspective. The Fund may invest in
securities denominated in foreign currencies and may, in addition to buying and
selling foreign currency futures contracts and options on foreign currencies and
foreign currency futures, enter into forward foreign currency exchange contracts
to reduce the risks or otherwise take a position in anticipation of changes in
foreign exchange rates. A forward foreign currency exchange contract involves an
obligation to purchase or sell a specific currency at a future date, which may
be a 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. By entering into a forward
foreign currency contract, the Fund "locks in" the exchange rate between the
currency it will deliver and the currency it will receive for the duration of
the contract. As a result, the Fund reduces its exposure to changes in the value
of the currency it will deliver and increases its exposure to changes in the
value of the currency it will exchange into. The effect on the value of the Fund
is similar to selling securities denominated in one currency and purchasing
securities denominated in another. Transactions that use two foreign currencies
are sometimes referred to as "cross-hedges."
The Fund may enter into these contracts for the purpose of hedging against
foreign exchange risk arising from the Fund's investments r anticipated
investments in securities denominated in foreign currencies. The Fund may also
enter into these contracts for purposes of increasing exposure to a foreign
currency or to shift exposure to foreign currency fluctuations from one country
to another.
The Fund may also use forward contracts to hedge against changes in interest
rates, increase exposure to a market or otherwise take advantage of such
changes. An interest-rate forward contract involves the obligation to purchase
or sell a specific debt instrument at a fixed price at a future date.
INTEREST RATE AND CURRENCY TRANSACTIONS. The Fund may employ currency and
interest rate management techniques, including transactions in options
(including yield curve options), futures, options on futures, forward foreign
currency exchange contracts, currency options and futures and currency and
interest rate swaps. The aggregate amount of the Fund's net currency exposure
will not exceed the total net asset value of its portfolio. However, to the
extent that the Fund is fully invested while also maintaining currency
positions, it may be exposed to greater combined risk.
The Fund will only enter into interest rate and currency swaps on a net basis,
i.e., the two payment streams are netted out, with the Fund receiving or paying,
as the case may be, only the net amount of the two payments. Interest rate and
currency swaps do not involve the delivery of securities, the underlying
currency, other underlying assets or principal. Accordingly, the risk of loss
with respect to interest rate and currency swaps is limited to the net amount of
interest or currency payments that the Fund is contractually obligated to make.
If the other party to an interest rate or currency swap defaults, the Fund's
risk of loss consists of the net amount of interest or currency payments that
the Fund is contractually entitled to receive. Since interest rate and currency
swaps are individually negotiated, the Fund expects to achieve an acceptable
degree of correlation between their portfolio investments and their interest
rate or currency swap positions. The Fund may hold foreign currency received in
connection with investments in foreign securities when it would be beneficial to
convert such currency into U.S. dollars at a later date, based on anticipated
changes in the relevant exchange rate.
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The Fund may purchase or sell without limitation as to a percentage of its
assets forward foreign currency exchange contracts when the Advisor anticipates
that the foreign currency will appreciate or depreciate in value, but securities
denominated in that currency do not present attractive investment opportunities
and are not held by the Fund. In addition, the Fund may enter into forward
foreign currency exchange contracts in order to protect against adverse changes
in future foreign currency exchange rates. The Fund may engage in cross-hedging
by using forward contracts in one currency to hedge against fluctuations in the
value of securities denominated in a different currency if the Advisor believe
that there is a pattern of correlation between the two currencies. Forward
contracts may reduce the potential gain from a positive change in the
relationship between the U.S. Dollar and foreign currencies. Unanticipated
changes in currency prices may result in poorer overall performance for the Fund
than if it had not entered into such contracts. The use of foreign currency
forward contracts will not eliminate fluctuations in the underlying U.S. dollar
equivalent value of the prices of or rates of return on the Fund's foreign
currency denominated portfolio securities and the use of such techniques will
subject the Fund to certain risks.
The matching of the increase in value of a forward contract and the decline in
the U.S. dollar equivalent value of the foreign currency denominated asset that
is the subject of the hedge generally will not be precise. In addition, the Fund
may not always be able to enter into foreign currency forward contracts at
attractive prices, and this will limit the Fund's ability to use such contract
to hedge or cross-hedge its assets. Also, with regard to the Fund's use of
cross-hedges, there can be no assurance that historical correlations between the
movement of certain foreign currencies relative to the U.S. dollar will
continue. Thus, at any time poor correlation may exist between movements in the
exchange rates of the foreign currencies underlying the Fund's cross-hedges and
the movements in the exchange rates of the foreign currencies in which the
Fund's assets that are the subject of such cross-hedges are denominated.
The Fund may enter into interest rate and currency swaps to the maximum allowed
limits under applicable law. The Fund will typically use interest rate swaps to
shorten the effective duration of its portfolio. Interest rate swaps involve the
exchange by the Fund with another party of their respective commitments to pay
or receive interest, such as an exchange of fixed rate payments for floating
rate payments. Currency swaps involve the exchange of their respective rights to
make or receive payments in specified currencies.
MORTGAGE-RELATED SECURITIES
The Fund may purchase mortgage-backed securities--i.e., securities representing
an ownership interest in a pool of mortgage loans issued by lenders such as
mortgage bankers, commercial banks and savings and loan associations. Mortgage
loans included in the pool--but not the security itself--may be insured by the
Government National Mortgage Association or the Federal Housing Administration
or guaranteed by the Federal National Mortgage Association, the Federal Home
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Loan Mortgage Corporation or the Veterans Administration. Mortgage-backed
securities provide investors with payments consisting of both interest and
principal as the mortgages in the underlying mortgage pools are paid off.
Although providing the potential for enhanced returns, mortgage-backed
securities can also be volatile and result in unanticipated losses.
The average life of a mortgage-backed security is likely to be substantially
less than the original maturity of the mortgage pools underlying the securities.
Prepayments of principal by mortgagors and mortgage foreclosures will usually
result in the return of the greater part of the principal invested far in
advance of the maturity of the mortgages in the pool. The actual rate of return
of a mortgage-backed security may be adversely affected by the prepayment of
mortgages included in the mortgage pool underlying the security.
The Fund may invest in shares of real estate investment trusts ("REITs"), which
are pooled investment vehicles which invest primarily in income-producing real
estate or real estate related loans or interests. REITs are generally classified
as equity REITs or mortgage REITs. Equity REITs invest the majority of their
assets directly in real property and derive income primarily from the collection
of rents. Equity REITs can also realize capital gains by selling properties that
have appreciated in value. Mortgage REITs invest the majority of their assets in
real estate mortgages and derive income from the collection of interest
payments. The value of equity trusts will depend upon the value of the
underlying properties, and the value of mortgage trusts will be sensitive to the
value of the underlying loans or interests.
The Fund may also invest in securities representing interests in collateralized
mortgage obligations ("CMOs"), real estate mortgage investment conduits
("REMICs") and in pools of certain other asset-backed bonds and mortgage
pass-through securities. Like a bond, interest and prepaid principal are paid,
in most cases, monthly. CMOs may be collateralized by whole mortgage loans but
are more typically collateralized by portfolios of mortgage pass-through
securities guaranteed by the U.S. Government, or U.S. Government-related
entities, and their income streams.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral. Monthly payment of principal received from the
pool of underlying mortgages, including prepayments, are allocated to different
classes in accordance with the terms of the instruments, and changes in
prepayment rates or assumptions may significantly affect the expected average
life and value of a particular class.
REMICs include governmental and/or private entities that issue a fixed pool of
mortgages secured by an interest in real property. REMICs are similar to CMOs in
that they issue multiple classes of securities. REMICs issued by private
entities are not U.S. Government securities and are not directly guaranteed by
any government agency. They are secured by the underlying collateral of the
private issuer.
The Advisor expects that governmental, government-related or private entities
may create mortgage loan pools and other mortgage-related securities offering
mortgage pass-through and mortgage-collateralized investments in addition to
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those described above. The mortgages underlying these securities may include
alternative mortgage instruments, that is, mortgage instruments whose principal
or interest payments may vary or whose terms to maturity may differ from
customary long-term fixed-rate mortgages. The Fund may also invest in debentures
and other securities of real estate investment trusts. As new types of
mortgage-related securities are developed and offered to investors, the Fund may
consider making investments in such new types of mortgage-related securities.
DOLLAR ROLLS. Under a mortgage "dollar roll," the Fund sells mortgage-backed
securities for delivery in the current month and simultaneously contracts to
repurchase substantially similar (same type, coupon and maturity) securities on
a specified future date. During the roll period, the Fund forgoes principal and
interest paid on the mortgage-backed securities. The Fund is compensated by the
difference between the current sales price and the lower forward price for the
future purchase (often referred to as the "drop") as well as by the interest
earned on the cash proceeds of the initial sale. The Fund may only enter into
covered rolls. A "covered roll" is a specific type of dollar roll for which
there is an offsetting cash position which matures on or before the forward
settlement date of the dollar roll transaction. At the time the Fund enters into
a mortgage "dollar roll," it will establish a segregated account with its
custodian bank in which it will maintain liquid assets equal in value to its
obligations in respect of dollar rolls, and accordingly, such dollar rolls will
not be considered borrowings. Mortgage dollar rolls involve the risk that the
market value of the securities the Fund is obligated to repurchase under the
agreement may decline below the repurchase price. In the event the buyer of
securities under a mortgage dollar roll files for bankruptcy or becomes
insolvent, the Fund's use of proceeds of the dollar roll may be restricted
pending a determination by the other party, or its trustee or receiver, whether
to enforce the Fund's obligation to repurchase the securities.
ASSET-BACKED SECURITIES. The Fund may invest in asset-backed securities,
including conditional sales contracts, equipment lease certificates and
equipment trust certificates. The Advisor expects that other asset-backed
securities (unrelated to mortgage loans) will be offered to investors in the
future. Several types of asset-backed securities already exist, including, for
example, "Certificates for Automobile Receivables SM" or "CARSSM" ("CARS"). CARS
represent undivided fractional interests in a trust whose assets consist of a
pool of motor vehicle retail installment sales contracts and security interests
in the vehicles securing the contracts. Payments of principal and interest on
CARS are passed-through monthly to certificate holders, and are guaranteed up to
certain amounts and for a certain time period by a letter of credit issued by a
financial institution unaffiliated with the trustee or originator of the CARS
trust. An investor's return on CARS may be affected by early prepayment of
principal on the underlying vehicle sales contracts. If the letter of credit is
exhausted, the CARS trust may be prevented from realizing the full amount due on
a sales contract because of state law requirements and restrictions relating to
foreclosure sales of vehicles and the obtaining of deficiency judgments
following such sales or because of depreciation, damage or loss of a vehicle,
the application of federal and state bankruptcy and insolvency laws, the failure
of servicers to take appropriate steps to perfect the CARS trust's rights in the
underlying loans and the servicers' sale of such loans to bona fide purchasers,
giving rise to interests in such loans superior to those of the CARS trust, or
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other factors. As a result, certificate holders may experience delays in
payments or losses if the letter of credit is exhausted. The Fund also may
invest in other types of asset-backed securities. In the selection of other
asset-backed securities, the Advisor will attempt to assess the liquidity of the
security giving consideration to the nature of the security, the frequency of
trading in the security, the number of dealers making a market in the security
and the overall nature of the marketplace for the security.
STRUCTURED PRODUCTS. The Fund may invest in interests in entities organized and
operated solely for the purpose of restructuring the investment characteristics
of certain other investments. This type of restructuring involves the deposit
with or purchase by an entity, such as a corporation or trust, or specified
instruments (such as commercial bank loans) and the issuance by that entity of
one or more classes of securities ("structured products") backed by, or
representing interests in, the underlying instruments. The cash flow on the
underlying instruments may be apportioned among the newly issued structured
products to create securities with different investment characteristics such as
varying maturities, payment priorities and interest rate provisions, and the
extent of the payments made with respect to structured products is dependent on
the extent of the cash flow on the underlying instruments. The Fund may invest
in structured products which represent derived investment positions based on
relationships among different markets or asset classes.
The Fund may also invest in other types of structured products, including, among
others, inverse floaters, spread trades and notes linked by a formula to the
price of an underlying instrument. Inverse floaters have coupon rates that vary
inversely at a multiple of a designated floating rate (which typically is
determined by reference to an index rate, but may also be determined through a
dutch auction or a remarketing agent or by reference to another security) (the
"reference rate"). As an example, inverse floaters may constitute a class of
CMOs with a coupon rate that moves inversely to a designated index, such as
LIBOR (London Interbank Offered Rate) or the Cost of Funds Index. Any rise in
the reference rate of an inverse floater (as a consequence of an increase in
interest rates) causes a drop in the coupon rate while any drop in the reference
rate of an inverse floater causes an increase in the coupon rate. A spread trade
is an investment position relating to a difference in the prices or interest
rates of two securities where the value of the investment position is determined
by movements in the difference between the prices or interest rates, as the case
may be, of the respective securities. When the Fund invests in notes linked to
the price of an underlying instrument, the price of the underlying security is
determined by a multiple (based on a formula) of the price of such underlying
security. A structured product may be considered to be leveraged to the extent
its interest rate varies by a magnitude that exceeds the magnitude of the change
in the index rate 15 of interest. Because they are linked to their underlying
markets or securities, investments in structured products generally are subject
to greater volatility than an investment directly in the underlying market or
security. Total return on the structured product is derived by linking return to
one or more characteristics of the underlying instrument. Because certain
structured products of the type in which the Fund may invest may involve no
credit enhancement, the credit risk of those structured products generally would
be equivalent to that of the underlying instruments. The Fund may invest in a
class of structured products that is either subordinated or unsubordinated to
the right of payment of another class. Subordinated structured products
typically have higher yields and present greater risks than unsubordinated
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structured products. Although the Fund's purchase of subordinated structured
products would have similar economic effect to that of borrowing against the
underlying securities, the purchase will not be deemed to be leverage for
purposes of the Fund's fundamental investment limitation related to borrowing
and leverage.
Certain issuers of structured products may be deemed to be "investment
companies" as defined in the 1940 Act. As a result, the Fund's investments in
these structured products may be limited by the restrictions contained in the
1940 Act. Structured products are typically sold in private placement
transactions, and there currently is no active trading market for structured
products. As a result, certain structured products in which the Fund invests may
be deemed illiquid and subject to its limitation on illiquid investments.
Investments in structured products generally are subject to greater volatility
than an investment directly in the underlying market or security. In addition,
because structured products are typically sold in private placement
transactions, there currently is no active trading market for structured
products.
INVESTMENT RESTRICTIONS
The Fund has adopted the following investment restrictions that may not be
changed without approval by a "majority of the outstanding shares" of the Fund
which, as used in this SAI, means the vote of the lesser of (a) 67% or more of
the shares of the Fund represented at a meeting, if the holders of more than 50%
of the outstanding shares of the Fund are present or represented by proxy, or
(b) more than 50% of the outstanding shares of the Fund.
Whenever the Trust is requested to vote on a fundamental policy of the Fund, the
Trust will hold a meeting of shareholders of the Fund and will cast its votes as
instructed by the shareholders of the Fund.
The Fund may not:
(1) borrow money, except that the Fund may borrow money for temporary or
emergency purposes, or by engaging in reverse repurchase transactions, in an
amount not exceeding 33-1/3% of the value of its total assets at the time when
the loan is made and may pledge, mortgage or hypothecate no more than 1/3 of its
net assets to secure such borrowings. Any borrowings representing more than 5%
of the Fund's total assets must be repaid before the Fund may make additional
investments;
(2) make loans, except that the Fund may: (a) purchase and hold debt instruments
(including without limitation, bonds, notes, debentures or other obligations and
certificates of deposit, bankers' acceptances and fixed time deposits) in
accordance with its investment objectives and policies; (b) enter into
repurchase agreements with respect to portfolio securities; and (c) lend
portfolio securities with a value not in excess of one-third of the value of its
total assets;
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(3) purchase the securities of any issuer (other than securities issued or
guaranteed by the U.S. government or any of its agencies or instrumentalities,
or repurchase agreements secured thereby) if, as a result, more than 25% of the
Fund's total assets would be invested in the securities of companies whose
principal business activities are in the same industry. Notwithstanding the
foregoing, with respect to the Fund's permissible futures and options
transactions in U.S. Government securities, positions in such options and
futures shall not be subject to this restriction;
(4) purchase or sell physical commodities unless acquired as a result of
ownership of securities or other instruments but this shall not prevent the Fund
from (a) purchasing or selling options and futures contracts or from investing
in securities or other instruments backed by physical commodities or (b)
engaging in forward purchases or sales of foreign currencies or securities;
(5) purchase or sell real estate unless acquired as a result of ownership of
securities or other instruments (but this shall not prevent the Fund from
investing insecurities or other instruments backed by real estate or securities
of companies engaged in the real estate business). Investments by the Fund in
securities backed by mortgages on real estate or in marketable securities of
companies engaged in such activities are not hereby precluded;
(6) issue any senior security (as defined in the 1940 Act), except that (a) the
Fund may engage in transactions that may result in the issuance of senior
securities to the extent permitted under applicable regulations and
interpretations of the 1940 Act or an exemptive order; (b) the Fund may acquire
other securities, the acquisition of which may result in the issuance of a
senior security, to the extent permitted under applicable regulations or
interpretations of the 1940 Act; and (c) subject to the restrictions set forth
above, the Fund may borrow money as authorized by the 1940 Act. For purposes of
this restriction, collateral arrangements with respect to permissible options
and futures transactions, including deposits of initial and variation margin,
are not considered to be the issuance of a senior security; or
(7) underwrite securities issued by other persons except insofar as the Fund may
technically be deemed to be an underwriter under the Securities Act of 1933 in
selling a portfolio security.
(8) The Fund may not, with respect to 75% of its assets, hold more than 10% of
the outstanding voting securities of any issuer or invest more than 5% of its
assets in the securities of any one issuer (other than obligations of the U.S.
Government, its agencies and instrumentalities).
In addition, as a matter of fundamental policy, notwithstanding any other
investment policy or restriction, the Fund may seek to achieve its investment
objective by investing all of its investable assets in another investment
company having substantially the same investment objective and policies as the
Fund. For purposes of investment restriction (5) above, real estate includes
Real Estate Limited Partnerships.
For purposes of investment restriction (3) above, industrial development bonds,
where the payment of principal and interest is the ultimate responsibility of
companies within the same industry, are grouped together as an "industry."
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Investment restriction (3) above, however, is not applicable to investments by
the Fund in municipal obligations where the issuer is regarded as a state, city,
municipality or other public authority since such entities are not members of an
"industry." Supranational organizations are collectively considered to be
members of a single "industry" for purposes of restriction (3) above.
In addition, the Fund is subject to the following non-fundamental restrictions
which may be changed without shareholder approval:
(1) The Fund may not make short sales of securities, other than short sales
"against the box," or purchase securities on margin except for short-term
credits necessary for clearance of portfolio transactions, provided that this
restriction will not be applied to limit the use of options, futures contracts
and related options, in the manner otherwise permitted by the investment
restrictions, policies and investment program of the Fund.
(2) The Fund may not purchase or sell interests in oil, gas or mineral leases.
(3) The Fund may not invest more than 15% of its net assets in illiquid
securities.
(4) The Fund may not write, purchase or sell any put or call option or any
combination thereof, provided that this shall not prevent (a) the writing,
purchasing or selling of puts, calls or combinations thereof with respect to
portfolio securities; or (b) with respect to the Fund's permissible futures and
options transactions, the writing, purchasing, ownership, holding or selling of
futures and options positions or of puts, calls or combinations thereof with
respect to futures.
(5) Except as specified above, the Fund may invest up to 5% of its total assets
in the securities of any one investment company, but may not own more than 3% of
the securities of any one investment company or invest more than 10% of its
total assets in the securities of other investment companies.
It is the Advisor's position that proprietary strips, such as CATS and TIGRS,
are United States Government securities. However, the Fund has been advised that
the staff of the Securities and Exchange Commission's Division of Investment
Management does not consider these to be United States Government securities, as
defined under the 1940 Act. Therefore, the Fund has adopted the SEC position
following SEC staff recommendations in this area.
For purposes of the Fund's investment restrictions, the issuer of a tax-exempt
security is deemed to be the entity (public or private) ultimately responsible
for the payment of the principal of and interest on the security. If a
percentage or rating restriction on investment or use of assets set forth herein
or in the Prospectus is adhered to at the time a transaction is effected, later
changes in percentage resulting from any cause other than actions by the Fund
will not be considered a violation. If the value of the Fund's holdings of
illiquid securities at any time exceeds the percentage limitation applicable at
the time of acquisition due to subsequent fluctuations in value or other
reasons, the Board of Trustees will consider what actions, if any, are
appropriate to maintain adequate liquidity.
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PORTFOLIO TRANSACTIONS AND BROKERAGE
Specific decisions to purchase or sell securities for the Fund are made by the
portfolio manager who is an employee of the Advisor and who is appointed and
supervised by senior officers of the Advisor. Changes in the Fund's investments
are reviewed by the Board of Trustees of the Trust. The portfolio manager may
serve other clients of the Advisor in a similar capacity.
Under the advisory agreement, the Advisor uses its best efforts to seek to
execute portfolio transactions at prices which, under the circumstances, result
in total costs or proceeds being the most favorable to the Fund. In assessing
the best overall terms available for any transaction, the Advisor considers all
factors it deems relevant, including the breadth of the market in the security,
the price of the security, the financial condition and execution capability of
the broker or dealer, research services provided to the Advisor, and the
reasonableness of the commissions, if any, both for the specific transaction and
on a continuing basis. The Advisor is not required to obtain the lowest
commission or the best net price for the Fund on any particular transaction, and
is not required to execute any order in a fashion preferential to other accounts
it manages.
Debt securities are traded principally in the over-the-counter market through
dealers acting on their own account and not as brokers. In the case of
securities traded in the over-the-counter market (where no stated commissions
are paid but the prices include a dealer's markup or markdown), the Advisor
normally seeks to deal directly with the primary market makers unless, in its
opinion, best execution is available elsewhere. In the case of securities
purchased from underwriters, the cost of such securities generally includes a
fixed underwriting commission or concession. From time to time, soliciting
dealer fees are available to the Advisor on the tender of the Fund's portfolio
securities in so-called tender or exchange offers. Such soliciting dealer fees
are in effect recaptured for the Fund by the Advisor. At present, no other
recapture arrangements are in effect.
Under the advisory agreement and as permitted by Section 28(e) of the Securities
Exchange Act of 1934, the Advisor may cause the Fund to pay a broker-dealer
which provides brokerage and research services to the Advisor, the Fund and/or
other accounts for which the Advisor exercises investment discretion an amount
of commission for effecting a securities transaction for the Fund in excess of
the amount other broker-dealers would have charged for the transaction if the
Advisor determines in good faith that the greater commission is reasonable in
relation to the value of the brokerage and research services provided by the
executing broker-dealer viewed in terms of either a particular transaction or
its overall responsibilities to accounts over which the Advisor exercises
investment discretion. Not all of such services are useful or of value in
advising the Fund. The Advisor reports to the Board of Trustees regarding
overall commissions paid by the Fund and their reasonableness in relation to the
benefits to the Fund. The term "brokerage and research services" includes advice
as to the value of securities, the advisability of investing in, purchasing or
selling securities, and the availability of securities or of purchasers or
sellers of securities, furnishing analyses and reports concerning issues,
industries, securities, economic factors and trends, portfolio strategy and the
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performance of accounts, and effecting securities transactions and performing
functions incidental thereto such as clearance and settlement.
The management fees that the Fund pays to the Advisor will not be reduced as a
consequence of the Advisor's receipt of brokerage and research services. To the
extent the Fund's portfolio transactions are used to obtain such services, the
brokerage commissions paid by the Fund will exceed those that might otherwise be
paid by an amount which cannot be presently determined. Such services generally
would be useful and of value to the Advisor serving one or more of its other
clients and, conversely, such services obtained by the placement of brokerage
business of other clients generally would be useful to the Advisor in carrying
out its obligations to the Fund. While such services are not expected to reduce
the expenses of the Advisor, the Advisor would, through use of the services,
avoid the additional expenses which would be incurred if the Advisor should
attempt to develop comparable information through its own staff.
In certain instances, there may be securities that are suitable for the Fund as
well as one or more of the Advisor's other clients. Investment decisions for the
Fund and for other clients are made with a view to achieving their respective
investment objectives. It may develop that the same investment decision is made
for more than one client or that a particular security is bought or sold for
only one client even though it might be held by, or bought or sold for, other
clients. Likewise, a particular security may be bought for one or more clients
when one or more clients are selling that same security. Some simultaneous
transactions are inevitable when several clients receive investment advice from
the same investment advisor, particularly when the same security is suitable for
the investment objectives of more than one client. When the Fund or other
clients are simultaneously engaged in the purchase or sale of the same security,
the securities are allocated among clients in a manner believed to be equitable
to each. It is recognized that in some cases this system could have a
detrimental effect on the price or volume of the security as far as the Fund is
concerned. However, it is believed that the ability of the Fund to participate
in volume transactions will generally produce better executions for the Fund.
For the period May 1, 1998 through October 31, 1998, the Fund paid $10,632 in
brokerage commissions.
It is not anticipated that any portfolio transactions will be executed with the
Advisor or the Shareholder Servicing Agent, or with any affiliate of the Advisor
or a Shareholder Servicing Agent, acting either as principal or as broker.
PORTFOLIO TURNOVER
The frequency of the Fund's portfolio transactions--the portfolio turnover
rate--will vary from year to year depending upon market conditions. Because a
high turnover rate (100% or more) may increase transaction costs and the
possibility of taxable short-term gains, the Advisor will weigh the added costs
of short-term investment against anticipated gains. The Fund will engage in
portfolio trading if its Advisor believes a transaction, net of costs (including
custodian charges), will help it achieve its investment objective. Since the
Fund invests in both equity and debt securities, the Fund applies this policy
with respect to both the equity and debt portions of its portfolio. For the
period May 1 through October 31, 1998, the Fund had a portfolio turnover rate of
19.88%.
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DETERMINATION OF NET ASSET VALUE
Equity securities in the Fund's portfolio are valued at the last sale price on
the exchange on which they are primarily traded or on the NASDAQ National Market
System, or at the last quoted bid price for securities in which there were no
sales during the day or for other unlisted (over-the-counter) securities not
reported on the NASDAQ National Market System. Bonds and other fixed income
securities (other than short-term obligations, but including listed issues) in
the Fund's portfolio are valued on the basis of valuations furnished by a
pricing service, the use of which has been approved by the Board of Trustees. In
making such valuations, the pricing service utilizes both dealer-supplied
valuations and electronic data processing techniques that take into account
appropriate factors such as institutional-size trading in similar groups of
securities, yield, quality, coupon rate, maturity, type of issue, trading
characteristics and other market data, without exclusive reliance upon quoted
prices or exchange or over-the-counter prices, since such valuations are
believed to reflect more accurately the fair value of such securities.
Short-term obligations which mature in 60 days or less are valued at amortized
cost, which constitutes fair value as determined by the Board of Trustees.
Futures and option contracts that are traded on commodities or securities
exchanges are normally valued at the settlement price on the exchange on which
they are traded. Portfolio securities (other than short-term obligations) for
which there are no such quotations or valuations are valued at fair value as
determined in good faith by or at the direction of the Board of Trustees.
Interest income on long-term obligations in the Fund's portfolio is determined
on the basis of coupon interest accrued plus amortization of discount (the
difference between acquisition price and stated redemption price at maturity)
and premiums (the excess of purchase price over stated redemption price at
maturity). Interest income on short-term obligations is determined on the basis
of interest and discount accrued less amortization of premium.
As of the date of this SAI, the New York Stock Exchange ("NYSE") is open for
trading every weekday except for the following holidays: New Year's Day, Martin
Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving Day and Christmas Day.
PURCHASE AND REDEMPTION OF FUND SHARES
The information provided below supplements the information contained in the
Fund's Prospectus regarding the purchase and redemption of Fund shares.
HOW TO BUY SHARES
You may purchase shares of the Fund from selected securities brokers, dealers or
financial intermediaries. Investors should contact these agents directly for
appropriate instructions, as well as information pertaining to accounts and any
service or transaction fees that may be charged by those agents. Purchase orders
B-26
<PAGE>
through securities brokers, dealers and other financial intermediaries are
effected at the next-determined net asset value after receipt of the order by
such agent before the Fund's daily cutoff time. Orders received after that time
will be purchased at the next-determined net asset value.
Buying shares through the Automatic Investment Plan
You can make regular investments of $100 or more per transaction through
automatic periodic deductions from your bank checking or savings account.
Shareholders electing to start this Systematic Investment Plan when opening an
account should complete the Automatic Investment Plan section of the Account
Application. Current shareholders may begin such a plan at any time by sending a
signed letter and a deposit slip or voided check to the Transfer Agent. Call the
Transfer Agent at (800) 548-7787 for complete instructions.
The public offering price of Fund shares is the net asset value. The Fund
receives the net asset value. Shares are purchased at the public offering price
next determined after the Transfer Agent receives your order in proper form. In
most cases, in order to receive that day's public offering price, the Transfer
Agent must receive your order in proper form before the close of regular trading
on the New York Stock Exchange ("NYSE"). If you buy shares through your
investment representative, the representative must receive your order before the
close of regular trading on the NYSE to receive that day's public offering
price. Orders are in proper form only after funds are converted to U.S. funds.
Orders paid by check and received by 2:00 p.m., Eastern Time, will generally be
available for the purchase of shares the following business day.
If you are considering redeeming or transferring shares to another person
shortly after purchase, you should pay for those shares with a certified check
to avoid any delay in redemption or transfer. Otherwise the Fund may delay
payment until the purchase price of those shares has been collected or, if you
redeem by telephone, until 15 calendar days after the purchase date. To
eliminate the need for safekeeping, the Fund will not issue certificates for
your shares unless you request them.
The Trust reserves the right in its sole discretion (i) to suspend the continued
offering of the Fund's shares, (ii) to reject purchase orders in whole or in
part when in the judgment of the Advisor or the Distributor such rejection is in
the best interest of the Fund, and (iii) to reduce or waive the minimum for
initial and subsequent investments for certain fiduciary accounts or under
circumstances where certain economies can be achieved in sales of the Fund's
shares.
HOW TO SELL SHARES
You can sell your Fund shares any day the NYSE is open for regular trading,
either directly to the Fund or through your investment representative. The Fund
will forward redemption proceeds or redeem shares for which it has collected
payment of the purchase price.
B-27
<PAGE>
Payments to shareholders for shares of the Fund redeemed directly from the Fund
will be made as promptly as possible but no later than seven days after receipt
by the Fund's Transfer Agent of the written request in proper form, with the
appropriate documentation as stated in the Prospectus, except that the Fund may
suspend the right of redemption or postpone the date of payment during any
period when (a) trading on the NYSE is restricted as determined by the SEC or
the NYSE is closed for other than weekends and holidays; (b) an emergency exists
as determined by the SEC making disposal of portfolio securities or valuation of
net assets of the Fund not reasonably practicable; or (c) for such other period
as the SEC may permit for the protection of the Fund's shareholders. At various
times, the Fund may be requested to redeem shares for which it has not yet
received confirmation of good payment; in this circumstance, the Fund may delay
the redemption until payment for the purchase of such shares has been collected
and confirmed to the Fund.
SELLING SHARES DIRECTLY TO THE FUND
Send a signed letter of instruction to the Transfer Agent, along with any
certificates that represent shares you want to sell. The price you will receive
is the next net asset value calculated after the Fund receives your request in
proper form. In order to receive that day's net asset value, the Transfer Agent
must receive your request before the close of regular trading on the NYSE.
SELLING SHARES THROUGH YOUR INVESTMENT REPRESENTATIVE
Your investment representative must receive your request before the close of
regular trading on the NYSE to receive that day's net asset value. Your
investment representative will be responsible for furnishing all necessary
documentation to the Transfer Agent, and may charge you for its services. If you
sell shares having a net asset value of $100,000 a signature guarantee is
required.
If you want your redemption proceeds sent to an address other than your address
as it appears on the Transfer Agent's records, a signature guarantee is
required. The Fund may require additional documentation for the sale of shares
by a corporation, partnership, agent or fiduciary, or a surviving joint owner.
Contact the Transfer Agent for details.
Signature guarantees may be obtained from a bank, broker-dealer, credit union
(if authorized under state law), securities exchange or association, clearing
agency or savings institution. A notary public cannot provide a signature
guarantee.
DELIVERY OF PROCEEDS
The Fund generally sends you payment for your shares the business day after your
request is received in proper form, assuming the Fund has collected payment of
the purchase price of your shares. Under unusual circumstances, the Fund may
suspend redemptions, or postpone payment for more than seven days, as permitted
by federal securities law.
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<PAGE>
TELEPHONE REDEMPTIONS
Telephone transaction privileges are made available to shareholders
automatically upon opening an account unless the privilege is declined in the
Account Application. Upon receipt of any instructions or inquiries by telephone
from a shareholder or, if held in a joint account, from either party, or from
any person claiming to be the shareholder, the Fund or its agent is authorized,
without notifying the shareholder or joint account parties, to carry out the
instructions or to respond to the inquiries, consistent with the service options
chosen by the shareholder or joint shareholders in his or their latest Account
Application or other written request for services, including purchasing or
redeeming shares of the Fund and depositing and withdrawing monies from the bank
account specified in the Bank Account Registration section of the shareholder's
latest Account Application or as otherwise properly specified to the Fund in
writing.
The Transfer Agent will employ these and other reasonable procedures to confirm
that instructions communicated by telephone are genuine; if it fails to employ
reasonable procedures, the Fund may be liable for any losses due to unauthorized
or fraudulent instructions. An investor agrees, however, that to the extent
permitted by applicable law, neither the Fund nor its agents will be liable for
any loss, liability, cost or expense arising out of any redemption request,
including any fraudulent or unauthorized request. For information, consult the
Transfer Agent.
During periods of unusual market changes and shareholder activity, you may
experience delays in contacting the Transfer Agent by telephone. In this event,
you may wish to submit a written redemption request, as described in the
Prospectus, or contact your investment representative. The Telephone Redemption
Privilege is not available if you were issued certificates for shares that
remain outstanding. The Telephone Redemption Privilege may be modified or
terminated without notice.
AUTOMATIC WITHDRAWAL
You can make regular withdrawals of $50 or more monthly, quarterly or
semiannually. A minimum account balance of $5,000 is required to establish an
automatic withdrawal plan. Call the Transfer Agent at (800) 548-7787 for
complete instructions.
REDEMPTIONS-IN-KIND
Subject to compliance with applicable regulations, the Fund has reserved the
right to pay the redemption price of its shares, either totally or partially, by
a distribution in kind of readily marketable portfolio securities (instead of
cash). The securities so distributed would be valued at the same amount as that
assigned to them in calculating the net asset value for the shares being sold.
If a shareholder received a distribution in kind, the shareholder could incur
brokerage or other charges in converting the securities to cash. The Trust has
filed an election under Rule 18f-1 committing to pay in cash all redemptions by
a shareholder of record up to amounts specified by the rule (approximately
$250,000).
B-29
<PAGE>
MANAGEMENT
The overall management of the business and affairs of the Trust is vested with
its Board of Trustees. The Board approves all significant agreements between the
Trust and persons or companies furnishing services to it, including the
agreements with the Advisor, Administrator, Custodian and Transfer Agent. The
day to day operations of the Trust are delegated to its officers, subject to the
Fund's investment objectives and policies and to general supervision by the
Board of Trustees.
<TABLE>
<CAPTION>
<S> <C> <C>
NAME, ADDRESS AND AGE POSITION PRINCIPAL OCCUPATION DURING PAST FIVE YEARS
- --------------------- -------- -------------------------------------------
Walter E. Auch, Sr. Trustee Director, Nicholas-Applegate Mutual Funds,
(born 1921) Brinson Place Funds (since 1994), Smith Barney
6001 N. 62nd Place Trak Fund, Pimco Advisors, L.P., Semele Land
Paradise Valley, AZ 85153 Fund II and Legend Properties
Eric M. Banhazl* Trustee, Senior Vice President, Investment Company
(born 1957) President and Administration, LLC; Vice President, First Fund
2020 E. Financial Way Treasurer Distributors, Inc.; RNC Mutual Fund Group;
Glendora, CA 91741 RNC Mutual Fund Group; Treasurer, Guinness
Flight Investment Funds, Inc.
Donald E. O'Connor Trustee Financial Consultant; Director, The Parnassus
(born 1936) Fund and The Parnassus Income Fund; formerly
1700 Taylor Avenue Executive Vice President and Chief Operating
Fort Washington, MD 10744 Officer of ICI Mutual Insurance Company
(until January 1997)
George T. Wofford III Trustee Vice President, Information Services, Federal
(born 1939) Home Loan Bank of San Francisco (since March
305 Glendora Circle 1993)
Danville, CA 94526
Steven J. Paggioli Vice Executive Vice President, Robert H. Wadsworth &
(born 1950) President Associates, Inc., Investment Company
915 Broadway Administration, LLC; Vice President, First Fund
New York, NY 10010 Distributors, Inc.; President and Trustee,
Professionally Managed Portfolios; Trustee,
Managers Funds
Robert H. Wadsworth Vice President, Robert H. Wadsworth & Associates,
(born 1940) President Inc., Investment Company Administration, LLC
4455 E. Camelback Rd. and First Fund Distributors, Inc.; Vice President,
Suite 261-E Professionally Managed Portfolios; President,
Phoenix, AZ 85018 Guinness Flight Investment Funds, Inc.;
Director, Germany Fund, Inc., New Germany
Fund, Inc., Central European Equity Fund, Inc.
and Deutsche Funds, Inc.
</TABLE>
B-30
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
Chris O. Kissack Secretary Employed by Investment Company
(born 1959) Administration, LLC (since July 1996);
4455 E. Camelback Rd. Formerly employed by Bank One, N.A. (from
Suite 261-E August 1995 until July 1996; O'Connor,
Phoenix, AZ 85018 Cavanagh, Anderson, Killingsworth and
Beshears (law firm) (until August 1995)
</TABLE>
- ----------
* Denotes Trustee who is an "interested person" of the Trust under the 1940 Act.
Set forth below is the rate of compensation received by the following Trustees
from all other portfolios of the Trust. This total amount is allocated among the
portfolios. The Trust has no pension or retirement plan. No other entity
affiliated with the Trust pays any compensation to the
Trustees.
NAME AND POSITION AGGREGATE COMPENSATION FROM THE TRUST
- ----------------- -------------------------------------
Walter E. Auch, Sr., Trustee $12,000
Donald E. O'Connor, Trustee $12,000
George T. Wofford III, Trustee $12,000
The Declaration of Trust provides that the Trust will indemnify its Trustees and
officers against liabilities and expenses incurred in connection with litigation
in which they may be involved because of their offices with the Trust, unless,
as to liability to the Trust or its shareholders, it is finally adjudicated that
they engaged in willful misfeasance, bad faith, gross negligence or reckless
disregard of the duties involved in their offices or with respect to any matter
unless it is finally adjudicated that they did not act in good faith in the
reasonable belief that their actions were in the best interest of the Trust. In
the case of settlement, such indemnification will not be provided unless it has
been determined by a court or other body approving the settlement or other
disposition, or by a reasonable determination based upon a review of readily
available facts, by vote of a majority of disinterested Trustees or in a written
opinion of independent counsel, that such officers or Trustees have not engaged
in willful misfeasance, bad faith, gross negligence or reckless disregard of
their duties.
ADVISOR
Van Deventer & Hoch acts as investment advisor to the Fund pursuant to an
Investment Advisory Agreement (the "Advisory Agreement"). Subject to such
policies as the Board of Trustees may determine, the Advisor is responsible for
investment decisions for the Fund. Pursuant to the terms of the Advisory
Agreement, the Advisor provides the Fund with such investment advice and
B-31
<PAGE>
supervision as it deems necessary for the proper supervision of the Fund's
investments. The Advisor continuously provides investment programs and determine
from time to time what securities shall be purchased, sold or exchanged and what
portion of the Fund's assets shall be held uninvested. The Advisor furnishes, at
its own expense, all services, facilities and personnel necessary in connection
with managing the investments and effecting portfolio transactions for the Fund.
The Advisory Agreement will continue in effect from year to year only if such
continuance is specifically approved at least annually by the Board of Trustees
or by vote of a majority of the Fund's outstanding voting securities and by a
majority of the Trustees who are not parties to the Advisory Agreement or
interested persons of any such party, at a meeting called for the purpose of
voting on such Advisory Agreement.
Pursuant to the terms of the Advisory Agreement, the Advisor is permitted to
render services to others. The Advisory Agreement is terminable without penalty
by the Trust on behalf of the Fund on not more than 60 days', nor less than 30
days', written notice when authorized either by a majority vote of the Fund's
shareholders or by a vote of a majority of the Board of Trustees of the Trust,
or by the Advisor on not more than 60 days', nor less than 30 days', written
notice, and will automatically terminate in the event of its "assignment" (as
defined in the 1940 Act). The Advisory Agreement provides that the Advisor under
such agreement shall not be liable for any error of judgment or mistake of law
or for any loss arising out of any investment or for any act or omission in the
execution of portfolio transactions for the Fund, except for wilful misfeasance,
bad faith or gross negligence in the performance of its duties, or by reason of
reckless disregard of its obligations and duties thereunder.
In the event the operating expenses of the Fund, including all investment
advisory and administration fees, but excluding brokerage commissions and fees,
taxes, interest and extraordinary expenses such as litigation, for any fiscal
year exceed the Fund's expense limitation, the Advisor shall reduce its advisory
fee (which fee is described below) to the extent of its share of such excess
expenses. The amount of any such reduction to be borne by the Advisor shall be
deducted from the monthly advisory fee otherwise payable with respect to the
Fund during such fiscal year; and if such amounts should exceed the monthly fee,
the Advisor shall pay to the Fund its share of such excess expenses no later
than the last day of the first month of the next succeeding fiscal year.
In consideration of the services provided by the Advisor pursuant to the
Advisory Agreement, the Advisor is entitled to receive from the Fund an
investment advisory fee computed daily and paid monthly based on a rate equal to
a percentage of the Fund's average daily net assets specified in the Prospectus.
However, the Advisor may voluntarily agree to waive a portion of the fees
payable to it on a month-to-month basis. For the period May 1, 1998
(commencement of operations) through October 31, 1998, the Fund accrued $43,806
in advisory fees, all of which were waived. For the same period, the Advisor
reimbursed the Fund an additional $35,999 in expenses.
ADMINISTRATOR
Pursuant to a separate Administration Agreement (the "Administration
Agreement"), Investment Company Administration, LLC is the administrator of the
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<PAGE>
Fund (the "Administrator"). The Administrator provides certain administrative
services to the Fund, including, among other responsibilities, coordinating the
negotiation of contracts and fees with, and the monitoring of performance and
billing of, the Fund's independent contractors and agents; preparation for
signature by an officer of the Trust of all documents required to be filed for
compliance by the Trust and the Fund with applicable laws and regulations
excluding those of the securities laws of various states; arranging for the
computation of performance data, including net asset value and yield; responding
to shareholder inquiries; and arranging for the maintenance of books and records
of the Fund, and providing, at its own expense, office facilities, equipment and
personnel necessary to carry out its duties. In this capacity, the Administrator
does not have any responsibility or authority for the management of the Fund,
the determination of investment policy, or for any matter pertaining to the
distribution of Fund shares.
Under the Administration Agreement, the Administrator is permitted to render
administrative services to others. The Fund's Administration Agreement will
continue in effect from year to year only if such continuance is specifically
approved at least annually by the Board of Trustees of the Trust or by vote of a
majority of the Fund's outstanding voting securities and, in either case, by a
majority of the Trustees who are not parties to the Administration Agreement or
"interested persons" (as defined in the 1940 Act) of any such party. The
Administration Agreement is terminable without penalty by the Trust on behalf of
the Fund on 60 days' written notice when authorized either by a majority vote of
the Fund's shareholders or by vote of a majority of the Board of Trustees,
including a majority of the Trustees who are not "interested persons" (as
defined in the 1940 Act) of the Trust, or by the Advisor on 60 days' written
notice, and will automatically terminate in the event of their "assignment" (as
defined in the 1940 Act). The Administration Agreement also provide that neither
the Administrator or its personnel shall be liable for any error of judgment or
mistake of law or for any act or omission in the administration of the Fund,
except for willful misfeasance, bad faith or gross negligence in the performance
of its or their duties or by reason of reckless disregard of its or their
obligations and duties under the Administration Agreement.
In consideration of the services provided by the Administrator pursuant to the
Administration Agreement, the Administrator receives from the Fund a fee
computed daily and paid monthly at an annual rate equal to 0.10% of the Fund's
average daily net assets, on an annualized basis for the Fund's then-current
fiscal year. The Administrator may voluntarily waive a portion of the fees
payable to it with respect to the Fund on a month-to-month basis. For the period
May 1, 1998 through October 31, 1998, the Fund paid the Administrator $15,000.
SHAREHOLDER SERVICING AGENTS
The Trust has entered into shareholder servicing agreements with certain
shareholder servicing agents (including the Advisor) under which the shareholder
servicing agents have agreed to provide certain support services to their
customers who beneficially own shares of the Fund. These services include
assisting with purchase and redemption transactions, maintaining shareholder
accounts and records, furnishing customer statements, transmitting shareholder
reports and communications to customers and other similar shareholder liaison
B-33
<PAGE>
services. For performing these services, each shareholder servicing agent
receives an annual fee of up to 0.25% of the average daily net assets of shares
of the Fund held by investors for whom the shareholder servicing agent maintains
a servicing relationship. Shareholder servicing agents may subcontract with
other parties for the provision of shareholder support services.
Shareholder servicing agents may offer additional services to their customers,
such as pre-authorized or systematic purchase and redemption plans. Each
shareholder servicing agent may establish its own terms and conditions,
including limitations on the amounts of subsequent transactions, with respect to
such services. Certain shareholder servicing agents may(although they are not
required by the Trust to do so) credit to the accounts of their customers from
whom they are already receiving other fees an amount not exceeding such other
fees or the fees for their services as shareholder servicing agents.
The Advisor and certain broker-dealers and other shareholder servicing agents
may, at their own expense, provide gifts, such as computer software packages,
guides and books related to investment or additional Fund shares valued up to
$250 to their customers that invest in the funds of the Trust.
The Advisor may, from time to time, at its own expense out of compensation
retained by it from the Fund or other sources available to it, make additional
payments to certain selected dealers or other shareholder servicing agents for
performing administrative services for their customers. These services include
maintaining account records, processing orders to purchase, redeem and exchange
Fund shares and responding to certain customer inquiries. The amount of such
compensation may be up to an additional 0.10% annually of the average net assets
of the Fund attributable to shares of the Fund held by customers of such
shareholder servicing agents. Such compensation does not represent an additional
expense to the Fund or its shareholders, since it will be paid by the Advisor.
The Trust has entered into a shareholder servicing agreement (a "Servicing
Agreement") with National Financial Data Services (the "Shareholder Servicing
Agent") to provide certain services including but not limited to the following:
answer customer inquiries regarding account status and history, the manner in
which purchases and redemptions of shares may be effected for the Fund as to
which the Shareholder Servicing Agent is so acting and certain other matters
pertaining to the Fund; assist shareholders in designating and changing dividend
options, account designations and addresses; provide necessary personnel and
facilities to establish and maintain shareholder accounts and records; assist in
processing purchase and redemption transactions; arrange for the wiring of
funds; transmit and receive funds in connection with customer orders to purchase
or redeem shares; verify and guarantee shareholder signatures in connection with
redemption orders and transfers and changes in shareholder-designated accounts;
furnish (either separately or on an integrated basis with other reports sent to
a shareholder by the Shareholder Servicing Agent) quarterly and year-end
statements and confirmations of purchases and redemptions; transmit, on behalf
of the Fund, proxy statements, annual reports, updated prospectuses and other
communications to shareholders of the Fund; receive, tabulate and transmit to
the Fund proxies executed by shareholders with respect to meetings of
shareholders of the Fund; and provide such other related services as the Fund or
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<PAGE>
a shareholder may request. The Shareholder Servicing Agent may be required to
register pursuant to state securities law.
The Shareholder Servicing Agent may voluntarily agree from time to time to waive
a portion of the fees payable to it under the Servicing Agreement on a
month-to-month basis.
DISTRIBUTION PLAN
The Trust has adopted a separate plan of distribution pursuant to Rule 12b-1
under the 1940 Act (a "Distribution Plan") on behalf of the Fund which provides
that the Fund shall pay for distribution services a distribution fee (the
"Distribution Fee"), including payments to the Advisor, as Distribution
Coordinator, at annual rates not to exceed the amounts set forth in the
Prospectus. The Advisor, as Distribution Coordinator, may use all or any portion
of such Distribution Fee to pay for Fund expenses of printing prospectuses and
reports used for sales purposes, expenses of the preparation and printing of
sales literature and other such distribution-related expenses. For the period
May 1, 1998 through October 31, 1998, $15,900 in 12b-1 fees were accrued, all of
which were waived.
All distribution fees paid by the Fund under the 12b-1 Plan will be paid in
accordance with Article III, Section 26 of the Rules of Fair Practice of the
National Association of Securities Dealers, Inc., as such Section may change
from time to time. Pursuant to the Distribution Plan, the Board of Trustees will
review at least quarterly a written report of the distribution expenses incurred
by the Advisor, as Distribution Coordinator, on behalf of the Fund. In addition,
as long as the Distribution Plan remains in effect, the selection and nomination
of Trustees who are not interested persons (as defined in the 1940 Act) of the
Trust shall be made by the Trustees then in office who are not interested
persons of the Trust.
Shares of the Fund are entitled to exclusive voting rights with respect to
matters concerning the Distribution Plan covering the Fund.
The Distribution Plan provides that it will continue in effect indefinitely if
such continuance is specifically approved at least annually by a vote of both a
majority of the Trustees and a majority of the Trustees who are not "interested
persons" (as defined in the 1940 Act) of the Trust and who have no direct or
indirect financial interest in the operation of the Distribution Plan or in any
agreement related to such Plan ("Qualified Trustees"). The Distribution Plan
requires that the Trust shall provide to the Board of Trustees, and the Board of
Trustees shall review, at least quarterly, a written report of the amounts
expended (and the purposes therefor) under the Distribution Plan. The
Distribution Plan further provides that the selection and nomination of
Qualified Trustees shall be committed to the discretion of the disinterested
Trustees (as defined in the 1940 Act) then in office. The Distribution Plan may
be terminated at any time by a vote of a majority of the Qualified Trustees or
by vote of a majority of the outstanding voting Shares of the Fund (as defined
in the 1940 Act). The Distribution Plan may not be amended to increase
materially the amount of permitted expenses thereunder without the approval of
shareholders and may not be materially amended in any case without a vote of the
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<PAGE>
majority of both the Trustees and the Qualified Trustees. The Fund will preserve
copies of any plan, agreement or report made pursuant to a Distribution Plan for
a period of not less than six years from the date of the Distribution Plan, and
for the first two years such copies will be preserved in an easily accessible
place.
DISTRIBUTION AGREEMENT
The Trust has entered into a Distribution Agreement (the "Distribution
Agreement") with the Distributor, pursuant to which the Distributor acts as the
Fund's exclusive underwriter, provides certain administration services and
promotes and arranges for the sale of the Fund's shares. The Distributor is an
affiliate of the Administrator. The Distribution Agreement provides that the
Distributor will bear the expenses of printing, distributing and filing
prospectuses and statements of additional information and reports used for sales
purposes, and of preparing and printing sales literature and advertisements not
paid for by the Distribution Plan. The Trust pays for all of the expenses for
qualification of the Fund's shares for sale in connection with the public
offering of such shares, and all legal expenses in connection therewith. In
addition, pursuant to the Distribution Agreement, the Distributor provides
certain sub-administration services to the Trust, including providing officers,
clerical staff and office space.
The Distribution Agreement is currently in effect and will continue in effect
with respect to the Fund only if such continuance is specifically approved at
least annually by the Board of Trustees or by vote of a majority of the Fund's
outstanding voting securities and, in either case, by a majority of the Trustees
who are not parties to the Distribution Agreement or "interested persons" (as
defined in the 1940 Act) of any such party. The Distribution Agreement is
terminable without penalty by the Trust on behalf of the Fund on 60 days'
written notice when authorized either by a majority vote of the Fund's
shareholders or by vote of a majority of the Board of Trustees of the Trust,
including a majority of the Trustees who are not "interested persons" (as
defined in the 1940 Act) of the Trust, or by the Distributor on 60 days' written
notice, and will automatically terminate in the event of its "assignment" (as
defined in the 1940 Act). The Distribution Agreement also provides that neither
the Distributor nor its personnel shall be liable for any act or omission in the
course of, or connected with, rendering services under the Distribution
Agreement, except for willful misfeasance, bad faith, gross negligence or
reckless disregard of its obligations or duties.
DIVIDENDS AND DISTRIBUTIONS
The Fund will receive income in the form of dividends and interest earned on its
investments in securities. This income, less the expenses incurred in its
operations, is the Fund's net investment income, substantially all of which will
be declared as dividends to the Fund's shareholders.
The amount of income dividend payments by the Fund is dependent upon the amount
of net investment income received by the Fund from its portfolio holdings, is
not guaranteed and is subject to the discretion of the Board. The Fund does not
pay "interest" or guarantee any fixed rate of return on an investment in its
shares.
B-36
<PAGE>
The Fund also may derive capital gains or losses in connection with sales or
other dispositions of its portfolio securities. Any net gain the Fund may
realize from transactions involving investments held less than the period
required for long-term capital gain or loss recognition or otherwise producing
short-term capital gains and losses (taking into account any carryover of
capital losses from the eight previous taxable years), although a distribution
from capital gains, will be distributed to shareholders with and as a part of
dividends giving rise to ordinary income. If during any year the Fund realizes a
net gain on transactions involving investments held more than the period
required for long-term gain or loss recognition or otherwise producing long-term
capital gains and losses, the Fund will have a net long-term capital gain. After
deduction of the amount of any net short-term capital loss, the balance (to the
extent not offset by any capital losses carried over from the eight previous
taxable years) will be distributed and treated as long-term capital gains in the
hands of the shareholders regardless of the length of time the Fund's shares may
have been held by the shareholders. For more information concerning applicable
capital gains tax rates, see your tax advisor.
Any dividend or distribution paid by the Fund reduces the Fund's net asset value
per share on the date paid by the amount of the dividend or distribution per
share. Accordingly, a dividend or distribution paid shortly after a purchase of
shares by a shareholder would represent, in substance, a partial return of
capital (to the extent it is paid on the shares so purchased), even though it
would be subject to income taxes.
Dividends and other distributions will be made in the form of additional shares
of the Fund unless the shareholder has otherwise indicated. Investors have the
right to change their elections with respect to the reinvestment of dividends
and distributions by notifying the Transfer Agent in writing, but any such
change will be effective only as to dividends and other distributions for which
the record date is seven or more business days after the Transfer Agent has
received the written request.
TAX MATTERS
The following is only a summary of certain additional tax considerations
generally affecting the Fund and its shareholders that are not described in the
Fund's Prospectus. No attempt is made to present a detailed explanation of the
tax treatment of the Fund or its shareholders, and the discussions here and in
the Fund's Prospectus are not intended as substitutes for careful tax planning.
QUALIFICATION AS A REGULATED INVESTMENT COMPANY
The Fund intends to elect to be taxed as a regulated investment company under
Subchapter M of the Code. As a regulated investment company, the Fund is not
subject to federal income tax on the portion of its net investment income (i.e.,
its investment company taxable income, as that term is defined in the Code,
without a deduction for dividends paid ) and net capital gain (i.e., the excess
of net long-term capital gains over net short-term capital losses) that it
distributes to shareholders, provided that it distributes at least 90% of its
net investment income for the taxable year (the "Distribution Requirement"), and
satisfies certain other requirements of the Code that are described below.
Distributions by the Fund made during the taxable year or, under specified
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circumstances, within twelve months after the close of the taxable year, will be
considered distributions of income and gains of the taxable year and can
therefore satisfy the Distribution Requirement.
In addition to satisfying the Distribution Requirement for each taxable year, a
regulated investment company must: derive at least 90% of its gross income from
dividends, interest, certain payments with respect to securities loans, gains
from the sale or other disposition of stock or securities or foreign currencies
(to the extent such currency gains are directly related to the regulated
investment company's principal business of investing in stock or securities) and
other income (including but not limited to gains from options, futures or
forward contracts) derived with respect to its business of investing in such
stock, securities or currencies (the "Income Requirement").
In general, gain or loss recognized by the Fund on the disposition of an asset
will be a capital gain or loss. However, gain recognized on the disposition of a
debt obligation purchased by the Fund at a market discount (generally, at a
price less than its principal amount) will be treated as ordinary income to the
extent of the portion of the market discount which accrued during the period of
time the Fund held the debt obligation and has not already been included in
income.
Further, the Code also treats as ordinary income, a portion of the capital gain
attributable to a transaction where substantially all of the return realized is
attributable to the time value of the Fund's net investment in the transaction
and: (1) the transaction consists of the acquisition of property by the Fund and
a contemporaneous contract to sell substantially identical property in the
future; (2) the transaction is a straddle within the meaning of Section 1092 of
the Code; (3) the transaction is one that was marketed or sold to the Fund on
the basis that it would have the economic characteristics of a loan but the
interest-like return would be taxed as capital gain; or (4) the transaction is
described as a conversion transaction in the Treasury Regulations. The amount of
the gain recharacterized generally will not exceed the amount of the interest
that would have accrued on the net investment for the relevant period at a yield
equal to 120% of the federal long-term, mid-term, or short-term rate, depending
upon the type of instrument at issue, reduced by an amount equal to: (1) prior
inclusions of ordinary income items from the conversion transaction; and (2) the
capitalized interest on acquisition indebtedness under Code Section 263(g).
Built-in losses will be preserved where the Fund has a built-in loss with
respect to property that becomes a part of a conversion transaction. No
authority exists that indicates that the converted character of the income will
not be passed to the Fund's shareholders.
In general, for purposes of determining whether capital gain or loss recognized
by the Fund on the disposition of an asset is long-term or short-term, the
holding period of the asset may be affected if: (1) the asset is used to close a
"short sale" (which includes for certain purposes the acquisition of a put
option) or is substantially identical to another asset so used; (2) the asset is
otherwise held by the Fund as part of a "straddle" (which term generally
excludes a situation where the asset is stock and the Fund grants a qualified
covered call option (which, among other things, must not be deep-in-the-money)
with respect thereto); or (3) the asset is stock and the Fund grants an
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in-the-money qualified covered call option with respect thereto. In addition,
the Fund may be required to defer the recognition of a loss on the disposition
of an asset held as part of a straddle to the extent of any unrecognized gain on
the offsetting position. Any gain recognized by the Fund on the lapse of, or any
gain or loss recognized by a Fund from a closing transaction with respect to, an
option written by the Fund will be treated as a short-term capital gain or loss.
Transactions that may be engaged in by the Fund (such as regulated futures
contracts, certain foreign currency contracts, and options on stock indexes and
futures contracts) will be subject to special tax treatment as "Section 1256
contracts." Section 1256 contracts are treated as if they are sold for their
fair market value on the last business day of the taxable year, even though a
taxpayer's obligations (or rights) under such contracts have not terminated (by
delivery, exercise, entering into a closing transaction or otherwise) as of such
date. Any gain or loss recognized as a consequence of the year-end deemed
disposition of Section 1256 contracts is taken into account for the taxable year
together with any other gain or loss that was previously recognized upon the
termination of Section 1256 contracts during that taxable year. Any capital gain
or loss for the taxable year with respect to Section 1256 contracts (including
any capital gain or loss arising as a consequence of the year-end deemed sale of
such contracts) is generally treated as 60% long-term capital gain or loss and
40% short-term capital gain or loss. A Fund, however, may elect not to have this
special tax treatment apply to Section 1256 contracts that are part of a "mixed
straddle" with other investments of the Fund that are not Section 1256
contracts.
Treasury Regulations permit a regulated investment company, in determining its
investment company taxable income and net capital gain for any taxable year, to
elect (unless it has made a taxable year election for excise tax purposes as
discussed below) to treat all or any part of any net capital loss, any net
long-term capital loss or any net foreign currency loss incurred after October
31 as if it had been incurred in the succeeding year. You should consult with a
tax specialist to determine the new law's effect on your individual situation.
In addition to satisfying the requirements described above, the Fund must
satisfy an asset diversification test in order to qualify as a regulated
investment company. Under this test, at the close of each quarter of the Fund's
taxable year, at least 50% of the value of the Fund's assets must consist of
cash and cash items, U.S. Government securities, securities of other regulated
investment companies, and securities of other issuers (as to which the Fund has
not invested more than 5% of the value of the Fund's total assets in securities
of such issuer and as to which the Fund does not hold more than 10% of the
outstanding voting securities of such issuer), and no more than 25% of the value
of its total assets may be invested in the securities of any one issuer (other
than U.S. Government securities and securities of other regulated investment
companies), or in two or more issuers which the Fund controls and which are
engaged in the same or similar trades or businesses. Generally, an option (call
or put) with respect to a security is treated as issued by the issuer of the
security not the issuer of the option. However, with regard to forward currency
contracts, there does not appear to be any formal or informal authority which
identifies the issuer of such instrument. For purposes of asset diversification
testing, obligations issued or guaranteed by agencies or instrumentalities of
the U.S. Government such as the Federal Agricultural Mortgage Corporation, the
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Farm Credit System Financial Assistance Corporation, a Federal Home Loan Bank,
the Federal Home Loan Mortgage Association, the Government National Mortgage
Corporation, and the Student Loan Marketing Association are treated as U.S.
Government Securities.
If for any taxable year the Fund does not qualify as a regulated investment
company, all of its taxable income (including its net capital gain) will be
subject to tax at regular corporate rates without any deduction for
distributions to shareholders, and such distributions will be taxable to the
shareholders as ordinary dividends to the extent of the Fund's current and
accumulated earnings and profits. Such distributions generally will be eligible
for the dividends-received deduction in the case of corporate shareholders.
EXCISE TAX ON REGULATED INVESTMENT COMPANIES
A 4% non-deductible excise tax is imposed on a regulated investment company that
fails to distribute in each calendar year an amount equal to 98% of ordinary
taxable income for the calendar year and 98% of capital gain net income for the
one-year period ended on October 31 of such calendar year (or, at the election
of a regulated investment company having a taxable year ending November 30 or
December 31, for its taxable year (a "taxable year election"). The balance of
such income must be distributed during the next calendar year. For the foregoing
purposes, a regulated investment company is treated as having distributed any
amount on which it is subject to income tax for any taxable year ending in such
calendar year.
For purposes of the excise tax, a regulated investment company shall: (1) reduce
its capital gain net income (but not below its net capital gain) by the amount
of any net ordinary loss for the calendar year; and (2) exclude foreign currency
gains and losses incurred after October 31 of any year (or after the end of its
taxable year if it has made a taxable year election) in determining the amount
of ordinary taxable income for the current calendar year (and, instead, include
such gains and losses in determining ordinary taxable income for the succeeding
calendar year).
The Fund intends to make sufficient distributions or deemed distributions of its
ordinary taxable income and capital gain net income prior to the end of each
calendar year to avoid liability for the excise tax. However, investors should
note that the Fund may in certain circumstances be required to liquidate
portfolio investments to make sufficient distributions to avoid excise tax
liability.
FUND DISTRIBUTIONS
The Fund anticipates distributing substantially all of its investment company
taxable income for each taxable year. Such distributions will be taxable to
shareholders as ordinary income and treated as dividends for federal income tax
purposes, but they will qualify for the 70% dividends-received deduction for
corporations only to the extent discussed below.
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The Fund may either retain or distribute to shareholders its net capital gain
for each taxable year. The Fund currently intends to distribute any such
amounts. If net capital gain is distributed and designated as a "capital gain
dividend," it will be taxable to shareholders as long-term capital gain,
regardless of the length of time the shareholder has held his shares or whether
such gain was recognized by the Fund prior to the date on which the shareholder
acquired his shares.
Ordinary income dividends paid by the Fund with respect to a taxable year will
qualify for the 70% dividends-received deduction generally available to
corporations to the extent of the amount of qualifying dividends received by the
Fund from domestic corporations for the taxable year. A dividend received by the
Fund will not be treated as a qualifying dividend (a) if it has been received
with respect to any share of stock that the Fund has held for less than 46 days
(91 days in the case of certain preferred stock), excluding for this purpose
under the rules of Code Section 246(c) (3) and (4): (1) any day more than 45
days (or 90 days in the case of certain preferred stock) after the date on which
the stock becomes ex-dividend, and (2) any period during which the Fund has an
option to sell, is under a contractual obligation to sell, has made and not
closed a short sale of, is the grantor of a deep-in-the-money or otherwise
non-qualified option to buy, or has otherwise diminished its risk of loss by
holding other positions with respect to, such (or substantially identical)
stock; (b) to the extent that the Fund is under an obligation (pursuant to a
short sale or otherwise) to make related payments with respect to positions in
substantially similar or related property; or (c) to the extent the stock on
which the dividend is paid is treated as debt-financed under the rules of Code
Section 246A. Moreover, the dividends-received deduction for a corporate
shareholder may be disallowed or reduced (a) if the corporate shareholder fails
to satisfy the foregoing requirements with respect to its shares of the Fund, or
(b) by application of Code Section 246(b) which in general limits the
dividends-received deduction to 70% of the shareholder's taxable income
(determined without regard to the dividends-received deduction and certain other
items). In the case where the Fund invests all of its assets in a portfolio and
the Fund satisfies the holding period rules pursuant to Code Section 246(c) as
to its interest in the portfolio, a corporate shareholder which satisfies the
foregoing requirements with respect to its shares of the Fund should receive the
dividends-received deduction.
For purposes of the Corporate AMT, the corporate dividends-received deduction is
not itself an item of tax preference that must be added back to taxable income
or is otherwise disallowed in determining a corporation's AMT. However,
corporate shareholders will generally be required to take the full amount of any
dividend received from the Fund into account (without a dividends-received
deduction) in determining its adjusted current earnings.
Investment income that may be received by the Fund from sources within foreign
countries may be subject to foreign taxes withheld at the source. The United
States has entered into tax treaties with many foreign countries which entitle
the Fund to a reduced rate of, or exemption from, taxes on such income. It is
impossible to determine the effective rate of foreign tax in advance since the
amount of the Fund's assets to be invested in various countries is not known.
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Distributions by the Fund that do not constitute ordinary income dividends, or
capital gain dividends will be treated as a return of capital to the extent of
(and in reduction of) the shareholder's tax basis in his or her shares; any
excess will be treated as gain from the sale of his shares, as discussed below.
Distributions by the Fund will be treated in the manner described above
regardless of whether such distributions are paid in cash or reinvested in
additional shares of the Fund (or of another fund). Shareholders receiving a
distribution in the form of additional shares will be treated as receiving a
distribution in an amount equal to the fair market value of the shares received,
determined as of the reinvestment date. In addition, if the net asset value at
the time a shareholder purchases shares of the Fund reflects undistributed net
investment income or recognized capital gain net income, or unrealized
appreciation in the value of the assets of the Fund, distributions of such
amounts will be taxable to the shareholder in the manner described above,
although such distributions economically constitute a return of capital to the
shareholder.
Ordinarily, shareholders are required to take distributions by the Fund into
account in the year in which the distributions are made. However, dividends
declared in October, November or December of any year and payable to
shareholders of record on a specified date in such a month will be deemed to
have been received by the shareholders (and made by the Fund) on December 31 of
such calendar year if such dividends are actually paid in January of the
following year. Shareholders will be advised annually as to the U.S. federal
income tax consequences of distributions made (or deemed made) during the year.
The Fund will be required in certain cases to withhold and remit to the U.S.
Treasury 31% of ordinary income dividends and capital gain dividends, and the
proceeds of redemption of shares, paid to any shareholder (1) who has provided
either an incorrect tax identification number or no number at all, (2) who is
subject to backup withholding by the IRS for failure to report the receipt of
interest or dividend income properly, or (3) who has failed to certify to the
Fund that it is not subject to backup withholding or that it is a corporation or
other "exempt recipient."
SALE OR REDEMPTION OF SHARES
A shareholder will recognize gain or loss on the sale or redemption of shares of
the Fund in an amount equal to the difference between the proceeds of the sale
or redemption and the shareholder's adjusted tax basis in the shares. All or a
portion of any loss so recognized may be disallowed if the shareholder purchases
other shares of the Fund within 30 days before or after the sale or redemption.
In general, any gain or loss arising from (or treated as arising from) the sale
or redemption of shares of the Fund will be considered capital gain or loss and
will be long-term capital gain or loss if the shares were held for longer than
one year. However, any capital loss arising from the sale or redemption of
shares held for six months or less will be disallowed to the extent of the
amount of exempt-interest dividends received on such shares and (to the extent
not disallowed) will be treated as a long-term capital loss to the extent of the
amount of capital gain dividends received on such shares. For this purpose, the
special holding period rules of Code Section 246(c)(3) and (4) (discussed above
in connection with the dividends-received deduction for corporations) generally
will apply in determining the holding period of shares.
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FOREIGN SHAREHOLDERS
Taxation of a shareholder who, as to the United States, is a nonresident alien
individual, foreign trust or estate, foreign corporation, or foreign partnership
("foreign shareholder"), depends on whether the income from the Fund is
"effectively connected" with a U.S. trade or business carried on by such
shareholder.
If the income from the Fund is not effectively connected with a U.S. trade or
business carried on by a foreign shareholder, ordinary income dividends paid to
a foreign shareholder will be subject to U.S. withholding tax at the rate of 30%
(or lower treaty rate) upon the gross amount of the dividend. Such a foreign
shareholder would generally be exempt from U.S. federal income tax on gains
realized on the sale of shares of the Fund, capital gain dividends and
exempt-interest dividends and amounts retained by the Fund that are designated
as undistributed capital gains.
If the income from the Fund is effectively connected with a U.S. trade or
business carried on by a foreign shareholder, then ordinary income dividends,
capital gain dividends, and any gains realized upon the sale of shares of the
Fund will be subject to U.S. federal income tax at the rates applicable to U.S.
citizens or domestic corporations.
In the case of foreign non-corporate shareholders, the Fund may be required to
withhold U.S. federal income tax at a rate of 31% on distributions that are
otherwise exempt from withholding tax (or taxable at a reduced treaty rate)
unless such shareholders furnish the Fund with proper notification of its
foreign status.
The tax consequences to a foreign shareholder entitled to claim the benefits of
an applicable tax treaty may be different from those described herein. Foreign
shareholders are urged to consult their own tax Advisors with respect to the
particular tax consequences to them of an investment in the Fund, including the
applicability of foreign taxes.
STATE AND LOCAL TAX MATTERS
Depending on the residence of the shareholder for tax purposes, distributions
may also be subject to state and local taxes or withholding taxes. Most states
provide that a regulated investment company may pass through (without
restriction) to its shareholders state and local income tax exemptions available
to direct owners of certain types of U.S. government securities (such as U.S.
Treasury obligations). Thus, for residents of these states, distributions
derived from the Fund's investment in certain types of U.S. government
securities should be free from state and local income taxes to the extent that
the interest income from such investments would have been exempt from state and
local income taxes if such securities had been held directly by the respective
shareholders themselves. Certain states, however, do not allow a regulated
investment company to pass through to its shareholders the state and local
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income tax exemptions available to direct owners of certain types of U.S.
government securities unless the regulated investment company holds at least a
required amount of U.S. government securities. Accordingly, for residents of
these states, distributions derived from the Fund's investment in certain types
of U.S. government securities may not be entitled to the exemptions from state
and local income taxes that would be available if the shareholders had purchased
U.S. government securities directly. Shareholders' dividends attributable to the
Fund's income from repurchase agreements generally are subject to state and
local income taxes, although states and regulations vary in their treatment of
such income. The exemption from state and local income taxes does not preclude
states from asserting other taxes on the ownership of U.S. government
securities. To the extent that the Fund invests to a substantial degree in U.S.
government securities which are subject to favorable state and local tax
treatment, shareholders of the Fund will be notified as to the extent to which
distributions from the Fund are attributable to interest on such securities.
Rules of state and local taxation of ordinary income dividends and capital gain
dividends from regulated investment companies may differ from the rules for U.S.
federal income taxation in other respects. Shareholders are urged to consult
their tax Advisors as to the consequences of these and other state and local tax
rules affecting investment in the Fund.
EFFECT OF FUTURE LEGISLATION
The foregoing general discussion of U.S. federal income tax consequences is
based on the Code and the Treasury Regulations issued thereunder as in effect on
the date of this SAI. Statement of Additional Information. Future legislative or
administrative changes (as well as the implementation of recent changes) or
court decisions may significantly change the conclusions expressed herein, and
any such changes or decisions may have a retroactive effect with respect to the
transactions contemplated herein.
PERFORMANCE INFORMATION
From time to time, the Fund may use hypothetical investment examples and
performance information in advertisements, shareholder reports or other
communications to shareholders. Because such performance information is based on
past investment results, it should not be considered as an indication or
representation of the performance of the Fund in the future. From time to time,
the performance and yield of the Fund may be quoted and compared to those of
other mutual funds with similar investment objectives, unmanaged investment
accounts, including savings accounts, or other similar products and to stock or
other relevant indices or to rankings prepared by independent services or other
financial or industry publications that monitor the performance of mutual funds.
For example, the performance of the Fund may be compared to data prepared by
Lipper Analytical Services, Inc. or Morningstar Mutual Funds on Disc, widely
recognized independent services which monitor the performance of mutual funds.
Performance and yield data as reported in national financial publications
including, but not limited to, Money Magazine, Forbes, Barron's, The Wall Street
Journal and The New York Times, or in local or regional publications, may also
be used in comparing the performance and yield of the Fund. The Fund's
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performance may be compared with indices such as the Lehman Brothers
Government/Corporate Bond Index, the Lehman Brothers Government Bond Index, the
Lehman Government Bond 1-3 Year Index and the Lehman Aggregate Bond Index; the
S&P 500 Index, the Dow Jones Industrial Average or any other commonly quoted
index of common stock prices; and the Russell 2000 Index and the NASDAQ
Composite Index. Additionally, the Fund may, with proper authorization, reprint
articles written about the Fund and provide them to prospective shareholders.
The Fund may provide period and average annual "total rates of return." The
"total rate of return" refers to the change in the value of an investment in the
Fund over a period (which period shall be stated in any advertisement or
communication with a shareholder) based on any change in net asset value per
share including the value of any shares purchased through the reinvestment of
any dividends or capital gains distributions declared during such period.
Unlike some bank deposits or other investments which pay a fixed yield for a
stated period of time, the yields and the net asset values of shares of the Fund
will vary based on market conditions, the current market value of the securities
held by the Fund and changes in the Fund's expenses. The Advisor, Shareholder
Servicing Agents, the Administrator, the Distributor and other service providers
may voluntarily waive a portion of their fees on a month-to-month basis. In
addition, the Distributor may assume a portion of the Fund's operating expenses
on a month-to-month basis. These actions would have the effect of increasing the
net income (and therefore the yield and total rate of return) of the classes of
shares of the Fund during the period such waivers are in effect. These factors
and possible differences in the methods used to calculate the yields and total
rates of return should be considered when comparing the yields or total rates of
return of the shares of a Fund to yields and total rates of return published for
other investment companies and other investment vehicles. The Trust is advised
that certain Shareholder Servicing Agents may credit to the accounts of their
customers from whom they are already receiving other fees amounts not exceeding
the Shareholder Servicing Agent fees received, which will have the effect of
increasing the net return on the investment of customers of those Shareholder
Servicing Agents. Such customers may be able to obtain through their Shareholder
Servicing Agents quotations reflecting such increased return.
Advertising or communications to shareholders may contain the views of the
Advisor as to current market, economic, trade and interest rate trends, as well
as legislative, regulatory and monetary developments, and may include investment
strategies and related matters believed to be of relevance to the Fund.
Advertisements for the Fund may include references to the asset size of other
funds in the Trust.
AVERAGE ANNUAL TOTAL RETURN
Total return may be stated for any relevant period as specified in the
advertisement or communication. Any statements of total return for the Fund will
be accompanied by information on the Fund's average annual compounded rate of
return over the most recent four calendar quarters and the period from the
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Fund's inception of operations. The Fund may also advertise aggregate and
average total return information over different periods of time. The Fund's
"average annual total return" figures are computed according to a formula
prescribed by the SEC, expressed as follows:
n
P(1 + T) =ERV
Where: P = a hypothetical initial payment of $1,000.
T = average annual total return.
N = number of years.
ERV = Ending Redeemable Value of a hypothetical
$1,000 investment made at the beginning of a
1-, 5-or 10-year period at the end of each
respective period (or fractional portion
thereof), assuming reinvestment of all
dividends and distributions and complete
redemption of the hypothetical investment at
the end of the measuring period.
AGGREGATE TOTAL RETURN
The Fund's "aggregate total return" figures represent the cumulative change in
the value of an investment in the Fund for the specified period and are computed
by the following formula:
ERV -P
------
P
Where: P = a hypothetical initial payment of $10,000.
ERV = Ending Redeemable Value of a hypothetical
$10,000 investment made at the beginning of a
l-, 5-or 10-year period at the end of a 1-,
5-or 10-year period (or fractional portion
thereof), assuming reinvestment of all
dividends and distributions and complete
redemption of the hypothetical investment at
the end of the measuring period.
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The Fund may also from time to time include in advertisements or other
communications a total return figure that is not calculated according to the
formula set forth above in order to compare more accurately the performance of
the Fund with other measures of investment return.
GENERAL INFORMATION
DESCRIPTION OF SHARES, VOTING RIGHTS AND LIABILITIES
Advisors Series Trust is an open-end, non-diversified management investment
company organized as a Delaware business trust under the laws of the State of
Delaware on October 3, 1996. The Trust currently consists of fourteen series of
shares of beneficial interest, par value $0.01 per share. With respect to
certain funds, the Trust may offer more than one class of shares. The Trust has
reserved the right to create and issue additional series or classes. Each share
of a series or class represents an equal proportionate interest in that series
or class with each other share of that series or class. Currently, the Fund has
only one class of shares.
The shares of each series or class participate equally in the earnings,
dividends and assets of the particular series or class. Expenses of the Trust
which are not attributable to a specific series or class are allocated amount
all the series in a manner believed by management of the Trust to be fair and
equitable. Shares have no pre-emptive or conversion rights. Shares when issued
are fully paid and non-assessable, except as set forth below. Shareholders are
entitled to one vote for each share held. Shares of each series or class
generally vote together, except when required under federal securities laws to
vote separately on matters that only affect a particular class, such as the
approval of distribution plans for a particular class.
With respect to shares purchased through a Shareholder Servicing Agent and, in
the event written proxy instructions are not received by the Fund or its
designated agent prior to a shareholder meeting at which a proxy is to be voted
and the shareholder does not attend the meeting in person, the Shareholder
Servicing Agent for such shareholder will be authorized pursuant to an
applicable agreement with the shareholder to vote the shareholder's outstanding
shares in the same proportion as the votes cast by other Fund shareholders
represented at the meeting in person or by proxy.
The Trust is not required to hold annual meetings of shareholders but will hold
special meetings of shareholders of a series or class when, in the judgment of
the Trustees, it is necessary or desirable to submit matters for a shareholder
vote. Shareholders have, under certain circumstances, the right to communicate
with other shareholders in connection with requesting a meeting of shareholders
for the purpose of removing one or more Trustees. Shareholders also have, in
certain circumstances, the right to remove one or more Trustees without a
meeting. No material amendment may be made to the Trust's Declaration of Trust
without the affirmative vote of the holders of a majority of the outstanding
shares of each portfolio affected by the amendment. The Trust's Declaration of
Trust provides that, at any meeting of shareholders of the Trust or of any
series or class, a Shareholder Servicing Agent may vote any shares as to which
such Shareholder Servicing Agent is the agent of record and which are not
represented in person or by proxy at the meeting, proportionately in accordance
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with the votes cast by holders of all shares of that portfolio otherwise
represented at the meeting in person or by proxy as to which such Shareholder
Servicing Agent is the agent of record. Any shares so voted by a Shareholder
Servicing Agent will be deemed represented at the meeting for purposes of quorum
requirements. Shares have no preemptive or conversion rights. Shares, when
issued, are fully paid and non-assessable, except as set forth below. Any series
or class may be terminated (i) upon the merger or consolidation with, or the
sale or disposition of all or substantially all of its assets to, another
entity, if approved by the vote of the holders of two-thirds of its outstanding
shares, except that if the Board of Trustees recommends such merger,
consolidation or sale or disposition of assets, the approval by vote of the
holders of a majority of the series' or class' outstanding shares will be
sufficient, or (ii) by the vote of the holders of a majority of its outstanding
shares, or (iii) by the Board of Trustees by written notice to the series' or
class' shareholders. Unless each series and class is so terminated, the Trust
will continue indefinitely.
The Trust's Declaration of Trust also provides that the Trust shall maintain
appropriate insurance (for example, fidelity bonding and errors and omissions
insurance) for the protection of the Trust, its shareholders, Trustees,
officers, employees and agents covering possible tort and other liabilities.
Thus, the risk of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which both inadequate
insurance existed and the Trust itself was unable to meet its obligations.
FINANCIAL STATEMENTS
The annual report to shareholders for the Fund for the period May 1, 1998
(inception) to October 31, 1998 is a separate document supplied with this SAI
and the financial statements, accompanying notes and report of independent
accountants appearing therein are incorporated by reference in this
SAI.
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APPENDIX A
DESCRIPTION OF CERTAIN OBLIGATIONS ISSUED OR GUARANTEED BY U.S.
GOVERNMENT AGENCIES OR INSTRUMENTALITIES
Federal Farm Credit System Notes and Bonds are bonds issued by a cooperatively
owned nationwide system of banks and associations supervised by the Farm Credit
Administration, an independent agency of the U.S. Government. These bonds are
not guaranteed by the U.S. Government.
Maritime Administration Bonds are bonds issued and provided by the Department of
Transportation of the U.S. Government are guaranteed by the U.S. Government.
FNMA Bonds are bonds guaranteed by the Federal National Mortgage Association.
These bonds are not guaranteed by the U.S. Government.
FHA Debentures are debentures issued by the Federal Housing Administration of
the U.S. Government and are guaranteed by the U.S. Government.
FHA Insured Notes are bonds issued by the Farmers Home Administration of the
U.S. Government and are guaranteed by the U.S. Government.
GNMA Certificates are mortgage-backed securities which represent a partial
ownership interest in a pool of mortgage loans issued by lenders such as
mortgage bankers, commercial banks and savings and loan associations. Each
mortgage loan included in the pool is either insured by the Federal Housing
Administration or guaranteed by the Veterans Administration and therefore
guaranteed by the U.S. Government. As a consequence of the fees paid to GNMA and
the issuer of GNMA Certificates, the coupon rate of interest of GNMA
Certificates is lower than the interest paid on the VA-guaranteed or FHA-insured
mortgages underlying the Certificates. The average life of a GNMA Certificate is
likely to be substantially less than the original maturity of the mortgage pools
underlying the securities. Prepayments of principal by mortgagors and mortgage
foreclosures may result in the return of the greater part of principal invested
far in advance of the maturity of the mortgages in the pool. Foreclosures impose
no risk to principal investment because of the GNMA guarantee. As the prepayment
rate of individual mortgage pools will vary widely, it is not possible to
accurately predict the average life of a particular issue of GNMA Certificates.
The yield which will be earned on GNMA Certificates may vary from their coupon
rates for the following reasons: (a) Certificates may be issued at a premium or
discount, rather than at par; (b) Certificates may trade in the secondary market
at a premium or discount after issuance; (c) interest is earned and compounded
monthly which has the effect of raising the effective yield earned on the
Certificates; and (d) the actual yield of each Certificate is affected by the
prepayment of mortgages included in the mortgage pool underlying the
Certificates. Principal which is so prepaid will be reinvested although possibly
at a lower rate. In addition, prepayment of mortgages included in the mortgage
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pool underlying a GNMA Certificate purchased at a premium could result in a loss
to the Fund. Due to the large amount of GNMA Certificates outstanding and active
participation in the secondary market by securities dealers and investors, GNMA
Certificates are highly liquid instruments. Prices of GNMA Certificates are
readily available from securities dealers and depend on, among other things, the
level of market rates, the Certificate's coupon rate and the prepayment
experience of the pool of mortgages backing each Certificate. If agency
securities are purchased at a premium above principal, the premium is not
guaranteed by the issuing agency and a decline in the market value to par may
result in a loss of the premium, which may be particularly likely in the event
of a prepayment. When and if available, U.S. Government obligations may be
purchased at a discount from face value.
FHLMC Certificates and FNMA Certificates are mortgage-backed bonds issued by the
Federal Home Loan Mortgage Corporation and the Federal National Mortgage
Association, respectively, and are guaranteed by the U.S. Government.
GSA Participation Certificates are participation certificates issued by the
General Services Administration of the U.S. Government and are guaranteed by the
U.S. Government.
New Communities Debentures are debentures issued in accordance with the
provisions of Title IV of the Housing and Urban Development Act of 1968, as
supplemented and extended by Title VII of the Housing and Urban Development Act
of 1970, the payment of which is guaranteed by the U.S. Government.
Public Housing Bonds are bonds issued by public housing and urban renewal
agencies in connection with programs administered by the Department of Housing
and Urban Development of the U.S. Government, the payment of which is secured by
the U.S. Government.
Penn Central Transportation Certificates are certificates issued by Penn Central
Transportation and guaranteed by the U.S. Government.
SBA Debentures are debentures fully guaranteed as to principal and interest by
the Small Business Administration of the U.S. Government.
Washington Metropolitan Area Transit Authority Bonds are bonds issued by the
Washington Metropolitan Area Transit Authority. Some of the bonds issued prior
to 1993 are guaranteed by the U.S. Government.
FHLMC Bonds are bonds issued and guaranteed by the Federal Home Loan Mortgage
Corporation. These bonds are not guaranteed by the U.S. Government.
Federal Home Loan Bank Notes and Bonds are notes and bonds issued by the Federal
Home Loan Bank System and are not guaranteed by the U.S. Government.
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Student Loan Marketing Association ("Sallie Mae") Notes and bonds are notes and
bonds issued by the Student Loan Marketing Association and are not guaranteed by
the U.S. Government.
D.C. Armory Board Bonds are bonds issued by the District of Columbia Armory
Board and are guaranteed by the U.S. Government.
Export-Import Bank Certificates are certificates of beneficial interest and
participation certificates issued and guaranteed by the Export-Import Bank of
the U.S. and are guaranteed by the U.S.
Government.
In the case of securities not backed by the "full faith and credit" of the U.S.
Government, the investor must look principally to the agency issuing or
guaranteeing the obligation for ultimate repayment, and may not be able to
assert a claim against the U.S. Government itself in the event the agency or
instrumentality does not meet its commitments.
Investments may also be made in obligations of U.S. Government agencies or
instrumentalities other than those listed above.
APPENDIX B
DESCRIPTION OF RATINGS
A description of the rating policies of Moody's, S&P and Fitch with respect to
bonds and commercial paper appears below.
MOODY'S INVESTORS SERVICE, INC. CORPORATE BOND RATINGS
Aaa--Bonds which are rated "Aaa" are judged to be of the best quality and carry
the smallest degree of investment risk. Interest payments are protected by a
large or by an exceptionally stable margin, and principal is secure. While the
various protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position of such
issues.
Aa--Bonds which are rated "Aa" are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risks appear somewhat larger than in Aaa securities.
A--Bonds which are rated "A" possess many favorable investment qualities and are
to be considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment sometime in the future.
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Baa--Bonds which are rated "Baa" are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba--Bonds which are rated "Ba" are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B--Bonds which are rated "B" generally lack characteristics of a desirable
investment. Assurance of interest and principal payments or of maintenance and
other terms of the contract over any long period of time may be small.
Caa--Bonds which are rated "Caa" are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca--Bonds which are rated "Ca" represent obligations which are speculative in
high degree. Such issues are often in default or have other marked shortcomings.
C--Bonds which are rated "C" are the lowest rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Moody's applies numerical modifiers "1", "2", and "3" to certain of its rating
classifications. The modifier "1" indicates that the security ranks in the
higher end of its generic rating category; the modifier "2" indicates a
mid-range ranking; and the modifier "3" indicates that the issue ranks in the
lower end of its generic rating category.
Standard & Poor's Ratings Group Corporate Bond Ratings
AAA--This is the highest rating assigned by S&P to a debt obligation and
indicates an extremely strong capacity to repay principal and pay interest.
AA--Bonds rated "AA" also qualify as high quality debt obligations. Capacity to
pay principal and interest is very strong, and differs from "AAA" issues only in
small degree.
A--Bonds rated "A" have a strong capacity to repay principal and pay interest,
although they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB--Bonds rated "BBB" are regarded as having an adequate capacity to repay
principal and pay interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to repay principal and pay interest for
bonds in this category than for higher rated categories.
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BB-B-CCC-CC-C--Bonds rated "BB", "B", "CCC", "CC" and "C" are regarded, on
balance, as predominantly speculative with respect to the issuer's capacity to
pay interest and repay principal in accordance with the terms of the
obligations. BB indicates the lowest degree of speculation and C the highest
degree of speculation. While such bonds will likely have some quality and
protective characteristics, these are outweighed by large uncertainties or major
risk exposures to adverse conditions.
CI--Bonds rated "CI" are income bonds on which no interest is being paid.
D--Bonds rated "D" are in default. The "D" category is used when interest
payments or principal payments are not made on the date due even if the
applicable grace period has not expired unless S&P believes that such payments
will be made during such grace period. The "D" rating is also used upon the
filing of a bankruptcy petition if debt service payments are jeopardized.
The ratings set forth above may be modified by the addition of a plus or minus
to show relative standing within the major rating categories.
MOODY'S INVESTORS SERVICE, INC. COMMERCIAL PAPER RATINGS
Prime-1--Issuers (or related supporting institutions) rated "Prime-1" have a
superior ability for repayment of senior short-term debt obligations. "Prime-1"
repayment ability will often be evidenced by many of 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.
Prime-2--Issuers (or related supporting institutions) rated "Prime-2" have a
strong ability for repayment of senior short-term debt obligations. This will
normally be evidenced by many of the characteristics cited above but to a lesser
degree. Earnings trends and coverage ratios, while sound, will be more subject
to variation. Capitalization characteristics, while still appropriate, may be
more affected by external conditions. Ample alternative liquidity is maintained.
Prime-3--Issuers (or related supporting institutions) rated "Prime-3" have an
acceptable ability for repayment of senior short-term obligations. The effect of
industry characteristics and market compositions may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and the requirement for relatively high financial
leverage. Adequate alternate liquidity is maintained.
Not Prime--Issuers rated "Not Prime" do not fall within any of the Prime rating
categories.
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STANDARD & POOR'S RATINGS GROUP COMMERCIAL PAPER RATINGS
A S&P commercial paper rating is current assessment of the likelihood of timely
payment of debt having an original maturity of no more than 365 days. Ratings
are graded in several categories, ranging from "A-1" for the highest quality
obligations to "D" for the lowest. The four categories are as follows:
A-1--This highest category indicates that the degree of safety regarding timely
payment is strong. Those issues determined to possess extremely strong safety
characteristics are denoted with a plus (+) sign designation.
A-2--Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated "A-1".
A-3--Issues carrying this designation have adequate capacity for timely payment.
They are, however, somewhat more vulnerable to the adverse effects of changes in
circumstances than obligations carrying the higher designations.
B--Issues rated "B" are regarded as having only speculative capacity for timely
payment.
C--This rating is assigned to short-term debt obligations with a doubtful
capacity for payment.
D--Debt rated "D" is in payment default. The "D" rating category is used when
interest payments or principal payments are not made on the date due, even if
the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grace period.
FITCH BOND RATINGS
AAA--Bonds rated AAA by Fitch are considered to be investment grade and of the
highest credit quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by reasonably
foreseeable events.
AA--Bonds rated AA by Fitch are considered to be investment grade and of very
high credit quality. The obligor's ability to pay interest and repay principal
is very strong, although not quite as strong as bonds rated AAA. Because bonds
rated in the AAA and AA categories are not significantly vulnerable to
foreseeable future developments, short-term debt of these issues is generally
rated F-1+ by Fitch.
A--Bonds rated A by Fitch are considered to be investment grade and of high
credit quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
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BBB--Bonds rated BBB by Fitch are considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay interest and repay
principal is considered to be adequate. Adverse changes in economic conditions
and circumstances, however, are more likely to have adverse consequences on
these bonds, and therefore impair timely payment. The likelihood that the
ratings of these bonds will fall below investment grade is higher than for bonds
with higher ratings.
Plus and minus signs are used by Fitch to indicate the relative position of a
credit within a rating category. Plus and minus signs, however, are not used in
the AAA category.
FITCH SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on demand
or have original maturities of generally up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and investment
notes.
The short-term rating places greater emphasis than a long-term rating on the
existence of liquidity necessary to meet the issuer's obligations in a timely
manner.
Fitch's short-term ratings are as follows:
F-1+--Issues assigned this rating are regarded as having the strongest degree of
assurance for timely payment.
F-1--Issues assigned this rating reflect an assurance of timely payment only
slightly less in degree than issues rated F-1+.
F-2--Issues assigned this rating have a satisfactory degree of assurance for
timely payment but the margin of safety is not as great as for issues assigned
F-1+ and F-1 ratings.
F-3--Issues assigned this rating have characteristics suggesting that the degree
of assurance for timely payment is adequate, although near-term adverse changes
could cause these securities to be rated below investment grade.
LOC--The symbol LOC indicates that the rating is based on a letter of credit
issued by a commercial bank.
Like higher rated bonds, bonds rated in the Baa or BBB categories are considered
to have adequate capacity to pay principal and interest. However, such bonds may
have speculative characteristics, and changes in economic conditions or other
circumstances are more likely to lead to a weakened capacity to make principal
and interest payments than is the case with higher grade bonds.
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After purchase by the Fund, a security may cease to be rated or its rating may
be reduced below the minimum required for purchase by the Fund. Neither event
will require a sale of such security by the Fund. However, the Advisor will
consider such event in its determination of whether the Fund should continue to
hold the security. To the extent the ratings given by Moody's, S&P or Fitch may
change as a result of changes in such organizations or their rating systems, the
Fund will attempt to use comparable ratings as standards for investments in
accordance with the investment policies contained in its Prospectus and in this
SAI.
