<PAGE> 1
As filed with the Securities and Exchange File Nos. 333-18737
Commission on October 30, 1997 811-07989
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
Post-Effective Amendment No. 2
and
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
Amendment No. 4
METROPOLITAN WEST FUNDS
(Exact Name of Registrant as Specified in its Charter)
10880 Wilshire Blvd., Suite 2020
Los Angeles, California 90024
(Address of Principal Executive Office)
(310) 446-7727
(Registrant's Telephone Number, Including Area Code)
Scott B. Dubchansky
10880 Wilshire Blvd., Suite 2020
Los Angeles, California 90024
(Name and Address of Agent for Service)
-------------------------
It is proposed that this filing will become effective:
---
X immediately upon filing pursuant to Rule 485(b)
---
on _______________, pursuant to Rule 485(b)
---
60 days after filing pursuant to Rule 485(a)
---
on _______________, pursuant to Rule 485(a)
---
Pursuant to Rule 24f-2 under the Investment Company Act of 1940, the
Registrant is registering an indefinite number of securities under the
Securities Act of 1933. Registrant will file a Notice pursuant to Rule 24f-2
within 90 days after its fiscal year end.
---------
Please Send Copy of Communications to:
DAVID A. HEARTH, ESQ.
BRUCE W. MAISEL, ESQ.
Paul, Hastings, Janofsky & Walker, LLP
345 California Street
San Francisco, California 94104-2635
(415) 835-1600
Page 1
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METROPOLITAN WEST FUNDS
CONTENTS OF REGISTRATION STATEMENT
This registration statement contains the following documents:
Facing Sheet
Contents of Registration Statement
Cross - Reference Sheets for Metropolitan West Funds
Supplement to Prospectus dated October 30, 1997
Part A - Combined Prospectus dated April 9, 1997 for
METROPOLITAN WEST TOTAL RETURN BOND FUND
METROPOLITAN WEST LOW DURATION BOND FUND
METROPOLITAN WEST SHORT-TERM INVESTMENT FUND
(Prospectus is Incorporated by Reference.)
Part B - Combined Statement of Additional Information dated April
9, 1997, Revised as of October 30, 1997 for
METROPOLITAN WEST TOTAL RETURN BOND FUND
METROPOLITAN WEST LOW DURATION BOND FUND
METROPOLITAN WEST SHORT-TERM INVESTMENT FUND
Part C - Other Information
Signature Page
Exhibits
Page 2
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METROPOLITAN WEST FUNDS
CROSS REFERENCE SHEETS
FORM N-1A
PART A: INFORMATION REQUIRED IN PROSPECTUS
------------------------------------------
(COMBINED PROSPECTUS FOR METROPOLITAN WEST FUNDS)
Metropolitan West Total Return Bond Fund
Metropolitan West Low Duration Bond Fund
Metropolitan West Short-Term Investment Fund
LOCATION IN THE
N-1A REGISTRATION STATEMENT
ITEM NO. ITEM BY HEADING
- -------- ---- ----------
1. Cover Page Cover Page
2. Synopsis "Summary of Expenses and Example" and
"Prospectus Summary"
3. Condensed Financial "Financial Highlights": Total Return
Information Bond Fund; Low Duration Bond Fund
4. General Description Cover Page, "Prospectus Summary,"
of Registrant "Investment Objectives and Policies,"
"Securities and Techniques Used by the
Funds," "Investment Risks," "Principal
Investment Restrictions," and
"Organization and Management"
5. Management of "Investment Objectives and Policies,"
the Fund "Securities and Techniques Used by the
Funds,"
"Organization and Management" and "How to
Purchase Shares"
5A. Management's Discussion Not Applicable
of Fund Performance
6. Capital Stock and "Organization and Management," "Dividends
Other Securities and Tax Status" and "General Information"
7. Purchase of Securities "How to Purchase Shares," "How to Redeem
Being Offered Shares"
8. Redemption or "How to Redeem Shares"
Repurchase
9. Pending Legal Not Applicable
Proceedings
Language indicated as being shown by strike out in the typeset document is
enclosed in double brackets "[[" and "]]" in the electronic format.
Page 3
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PART B: INFORMATION REQUIRED IN
STATEMENT OF ADDITIONAL INFORMATION
(COMBINED STATEMENT OF ADDITIONAL INFORMATION FOR METROPOLITAN WEST FUNDS)
Metropolitan West Total Return Bond Fund
Metropolitan West Low Duration Bond Fund
Metropolitan West Short-Term Investment Fund
LOCATION IN THE
N-1A REGISTRATION STATEMENT
ITEM NO. ITEM BY HEADING
- -------- ---- ----------
10. Cover Page Cover Page
11. Table of Contents Table of Contents
12. General Information Cover Page and "Management"
and History
13. Investment Objectives "Investment Objectives and
Policies"
14. Management of the "Management"
Registrant
15. Control Persons and "Management" and "General
Principal Holders of Information About the
Securities Trust"
16. Investment Advisory "Management"
and Other Services
17. Brokerage Allocation "Management"
18. Capital Stock and "General Information About
Other Securities the Trust"
19. Purchase, Redemption "Net Asset Value"
and Pricing of
Securities Being
Offered
20. Tax Status "Dividends and Tax Status"
21. Underwriters "Distributor"
22. Calculation of "Performance Information"
Performance Data
23. Financial Statements "Financial Statements"
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SUPPLEMENT DATED OCTOBER 30, 1997
TO
PROSPECTUS DATED APRIL 9, 1997
METROPOLITAN WEST FUNDS
TOTAL RETURN BOND FUND
LOW DURATION BOND FUND
The following information supplements the information contained in the Funds'
Prospectus dated April 9, 1997.
FINANCIAL HIGHLIGHTS
- --------------------
The following are unaudited "Financial Highlights" of TOTAL RETURN BOND FUND and
LOW DURATION BOND FUND for the period ended September 30, 1997. The table below
sets forth financial data for one share of capital stock outstanding for the
period presented.
<TABLE>
<CAPTION>
TOTAL RETURN LOW DURATION
BOND FUND BOND FUND
Six Months Ended Six Months Ended
September 30, 1997* September 30, 1997*
(Unaudited) (Unaudited)
<S> <C> <C>
Net Asset Value, Beginning of Period $ 10.00 $ 10.00
---------- ----------
Income from Investment Operations:
Net investment income 0.34 0.31
Net realized and unrealized gain on investments 0.43 0.17
---------- ----------
Total from Investment Operations 0.77 0.48
---------- ----------
Less Distributions:
Dividends from net investment income (0.34) (0.31)
---------- ----------
Total Distributions (0.34) (0.31)
---------- ----------
Net Asset Value, End of Period $ 10.43 $ 10.17
========== ==========
Total Return (not annualized) 7.76% 4.88%
Ratios/Supplemental Data:
Net Assets, end of period (in thousands) $ 14,810 $ 55,417
Ratio of Expenses to Average Net Assets
Before expense reimbursement 2.40% - 1.02% -
After expense reimbursement 0.65% - 0.58% -
Ratio of Net Income to Average Net Assets
Before expense reimbursement 5.46% - 6.24% -
After expense reimbursement 7.21% - 6.68% -
Portfolio Turnover Rate 112% 110%
Average Commission Rate Paid N/A N/A
</TABLE>
* The Funds commenced operations on March 31, 1997.
- - Annualized.
Page 1
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PART A
COMBINED PROSPECTUS
METROPOLITAN WEST FUNDS
-----------------------
Metropolitan West Total Return Bond Fund
Metropolitan West Low Duration Bond Fund
Metropolitan West Short-Term Investment Fund
------------------------------------------------------------
The Prospectus for the Total Return Bond Fund, Low Duration Bond Fund (the
"Funds") and Short-Term Investment Fund dated April 9, 1997, is incorporated
herein by reference to the Prospectus filed pursuant to Rule 497(c) filed with
the U.S. Securities and Exchange Commission on April 23, 1997. The Prospectus is
supplemented by the Financial Highlights as of September 30, 1997 filed herein
to comply with the Funds' undertaking to file a post-effective amendment
containing reasonably current financial statements which need not be certified
within four to six months of its effective date or commencement of operations,
whichever is later.
Page 5
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PART B
COMBINED STATEMENT OF ADDITIONAL INFORMATION
METROPOLITAN WEST FUNDS
-----------------------
Metropolitan West Total Return Bond Fund
Metropolitan West Low Duration Bond Fund
Metropolitan West Short-Term Investment Fund
------------------------------------------------------------
Page 6
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METROPOLITAN WEST FUNDS
STATEMENT OF ADDITIONAL INFORMATION
April 9, 1997
As Revised October 30, 1997
This Statement of Additional Information is not a prospectus, and it
should be read in conjunction with the Prospectus dated April 9, 1997, as
supplemented October 30, 1997, which includes Metropolitan West Total Return
Bond Fund (the "TOTAL RETURN BOND FUND"), Metropolitan West Low Duration Bond
Fund (the "LOW DURATION BOND FUND") and Metropolitan West Short-Term Investment
Fund (the "SHORT-TERM INVESTMENT FUND"). Copies of the Prospectus may be
obtained at no charge from the Trust by writing to Metropolitan West Funds,
10880 Wilshire Boulevard, Suite 2020, Los Angeles, CA 90024. In this Statement
of Additional Information, the Total Return Bond Fund, the Low Duration Bond
Fund and the Short-Term Investment Fund may be referred to collectively as "the
Funds" or individually as "a Fund." Metropolitan West Asset Management, LLC (the
"Adviser") is the investment adviser to the Funds.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Cross reference
to page in the
prospectus for the Funds
------------------------
<S> <C> <C>
Investment Objectives and Policies B-2 6
Investment Restrictions B-2 13
Repurchase Agreements B-3 9
U.S. Government Securities B-3 8
Corporate Debt Securities B-4 8
Convertible Securities B-4 6
Mortgage-Related Securities B-5 10
Asset-Backed Securities B-8 8
Risk Factors Relating to Investing in Mortgage-Related and B-8 12
Asset-Backed Securities
Duration B-8 7
Derivative Instruments B-9 11
Foreign Securities B-13 9
Foreign Currency Options and Related Risks B-14 11
Forward Foreign Currency Exchange Contracts B-15 11
Risk Factors Relating to Investing in High-Yield Securities B-17 12
Illiquid Securities B-17 13
Management B-18 13
Trustees and Officers B-xx xx
Control Persons and Principal Holders of Securities B-xx xx
Portfolio Transactions and Brokerage B- 14
Administrator B- 14
Distributor B- 14
Share Marketing Plan B- 14
Net Asset Value B- 16
Dividends and Tax Status B- 18
Performance Information B- 18
General Information About the Trust B- 20
Additional Information B-
Financial Statements B- 20
</TABLE>
Page B-1
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INVESTMENT OBJECTIVES AND POLICIES
----------------------------------
The investment objective of the TOTAL RETURN BOND FUND is to maximize
long-term total return.
The investment objective of the LOW DURATION BOND FUND is to maximize
current income, consistent with preservation of capital. Capital appreciation is
a secondary consideration of the Fund.
The investment objective of the SHORT-TERM INVESTMENT FUND is to
maximize current income, consistent with the preservation of capital. Capital
appreciation is a secondary consideration of the Fund.
The portfolio, and strategies with respect to the composition of each
Fund, are described in the Funds' prospectus.
INVESTMENT RESTRICTIONS
Each Fund has adopted the following restrictions (in addition to those
indicated in the prospectus) as fundamental policies, which may not be changed
without the favorable vote of the holders of a "majority" of that Fund's
outstanding voting securities, as defined in the Investment Company Act of 1940,
as amended (the "1940 Act"). Under the 1940 Act, the vote of the holders of a
"majority" of a Fund's outstanding voting securities means the vote of the
holders of the lesser of (i) 67% of the shares of the Fund represented at a
meeting at which the holders of more than 50% of its outstanding shares are
represented or (ii) more than 50% of the outstanding shares.
Except as noted, no Fund may:
1. Purchase any security, other than obligations of the U.S.
Government, its agencies, or instrumentalities ("U.S.
Government securities"), if as a result: (i) with respect to
75% of its total assets, more than 5% of the Fund's total
assets (determined at the time of investment) would then be
invested in securities of a single issuer, or (ii) more than
25% of the Fund's total assets (determined at the time of
investment) would be invested in one or more issuers having
their principal business activities in a single industry.
2. Purchase securities on margin (but any Fund may obtain such
short-term credits as may be necessary for the clearance of
transactions), provided that the deposit or payment by a Fund
of initial or maintenance margin in connection with futures or
options is not considered the purchase of a security on
margin.
3. Make short sales of securities or maintain a short position,
unless at all times when a short position is open it owns an
equal amount of such securities or securities convertible into
or exchangeable, without payment of any further consideration,
for securities of the same issue as, and equal in amount to,
the securities sold short (short sale against-the-box), and
unless not more than 25% of the Fund's net assets (taken at
current value) is held as collateral for such sales at any one
time.
4. Issue senior securities, borrow money or pledge its assets,
except that any Fund may borrow from a bank for temporary or
emergency purposes in amounts not exceeding 10% (taken at the
lower of cost or current value) of its total assets (not
including the amount borrowed) and pledge its assets to secure
such borrowings. The Funds may borrow from banks or enter into
reverse repurchase agreements and pledge assets in connection
therewith, but only if immediately after each borrowing there
is asset coverage of at least 300%.
5. Purchase any security (other than U.S. Government securities)
if as a result, with respect to 75% of the Fund's total
assets, the Fund would then hold more than 10% of the
outstanding voting securities of an issuer.
Page B-2
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6. Act as an underwriter except to the extent that, in connection
with the disposition of portfolio securities, it may be deemed
to be an underwriter under certain Federal securities laws.
7. Make investments for the purpose of exercising control or
management.
8. Participate on a joint or joint and several basis in any
trading account in securities.
In addition, the Trust has adopted the following non-fundamental
policies so that no Fund will: (a) invest in securities of any issuer if, to the
knowledge of the Trust, any officer or Trustee of the Trust or managing director
of the Adviser owns more than 1/2 of 1% of the outstanding securities of such
issuer, and such Trustees and managing directors who own more than 1/2 of 1% own
in the aggregate more than 5% of the outstanding securities of such issuer; (b)
invest in interests in oil, gas, or other mineral leases or exploration of
development programs, although it may invest in the common stocks of companies
which invest in or sponsor such programs; (c) invest more than 15% of its total
assets in restricted securities, excluding restricted securities eligible for
resale pursuant to Rule 144A under the Securities Act of 1933, as amended
("Securities Act") that have been determined to be liquid pursuant to procedures
adopted by the Board of Trustees, provided that the total amount of Fund assets
invested in restricted securities will not exceed 15% of total assets; and (d)
purchase securities of other investment companies, except in connection with a
merger, consolidation, reorganization or other acquisition of assets, unless
immediately thereafter not more than (i) 3% of the total outstanding voting
stock of such company would be owned by the Fund, (ii) 5% of the Fund's total
assets would be invested in any one such company, and (iii) 10% of the Fund's
total assets would be invested in such securities.
REPURCHASE AGREEMENTS
A repurchase transaction occurs when, at the time a Fund purchases a
security, that Fund also resells it to a vendor (normally a commercial bank or
broker-dealer) and must deliver the security (and/or securities substituted for
them under the repurchase agreement) to the vendor on an agreed-upon date in the
future. Such securities, including any securities so substituted, are referred
to as the "Resold Securities." The resale price is in excess of the purchase
price in that it reflects an agreed-upon market interest rate effective for the
period of time during which the Fund's money is invested in the Resold
Securities. The majority of these transactions run from day to day, and the
delivery pursuant to the resale typically will occur within one to five days of
the purchase. The Fund's risk is limited to the ability of the vendor to pay the
agreed-upon sum at the delivery date; in the event of bankruptcy or other
default by the vendor, there may be possible delays and expenses in liquidating
the instrument purchased, decline in its value and loss of interest. The Adviser
will consider the creditworthiness of any vendor of repurchase agreements.
Repurchase agreements can be considered as loans "collateralized" by the Resold
Securities, and are defined as "loans" in the 1940 Act. The return on such
collateral may be more or less than that from the repurchase agreement. The
Resold Securities will be marked to market every business day so that the value
of the collateral is at least equal to the value of the loan, including the
accrued interest earned thereon. All Resold Securities will be held by the
Fund's custodian either directly or through a securities depository (tri-party
repurchase agreement) or the Federal Reserve book-entry system.
U.S. GOVERNMENT SECURITIES
U.S. Government agencies or instrumentalities which issue or guarantee
securities include, but are not limited to, the Federal National Mortgage
Association, Government National Mortgage Association, Federal Home Loan Banks,
Federal Home Loan Mortgage Corporation, Federal Intermediate Credit Banks,
Federal Land Banks, Tennessee Valley Authority, Inter-American Development Bank,
Asian Development Bank, Student Loan Marketing Association and the International
Bank for Reconstruction and Development.
Page B-3
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Except for U.S. Treasury securities, obligations of U.S. Government
agencies and instrumentalities may or may not be supported by the full faith and
credit of the United States. Some are backed by the right of the issuer to
borrow from the Treasury; others by discretionary authority of the U.S.
Government to purchase the agencies' obligations; while still others, such as
the Student Loan Marketing Association, are supported only by the credit of the
instrumentality. In the case of securities not backed by the full faith and
credit of the United States, the investor must look principally to the agency or
instrumentality issuing or guaranteeing the obligation for ultimate repayment,
and may not be able to assert a claim against the United States itself in the
event the agency or instrumentality does not meet its commitment. Each Fund will
invest in securities of such instrumentality only when the Adviser is satisfied
that the credit risk with respect to that instrumentality is acceptable.
The Funds may invest in component parts of the U.S. Treasury notes or
bonds, namely, either the principal of such Treasury obligations or one of the
interest payments scheduled to be paid on such obligations. These obligations
may take the form of (i) Treasury obligations from which the interest coupons
have been stripped, (ii) the interest coupons that are stripped, (iii)
book-entries at a Federal Reserve member bank representing ownership of Treasury
obligation components, or (iv) receipts evidencing the component parts
(principal or interest) of Treasury obligations that have not actually been
stripped. Such receipts evidence ownership of component parts of Treasury
obligations (principal or interest) purchased by a third party (typically an
investment banking firm) and held on behalf of the third party in physical or
book-entry form by a major commercial bank or trust company pursuant to a
custody agreement with the third party. These custodial receipts are known by
various names, including "Treasury Receipts," "Treasury Investment Growth
Receipts" (TIGRs) and "Certificates of Accrual on Treasury Securities" (CATS),
and are not issued by the U.S. Treasury, therefore they are not U.S. Government
securities, although the underlying bonds represented by these receipts are debt
obligations of the U.S. Treasury.
CORPORATE DEBT SECURITIES
A Fund's investments in U.S. dollar or foreign currency-denominated
corporate debt securities of domestic or foreign issuers are limited to
corporate debt securities (corporate bonds, debentures, notes or other similar
corporate debt instruments) which meet the minimum ratings criteria set forth
for the Fund, or, if unrated, which are in the Adviser's opinion comparable in
quality to corporate debt securities in which the Fund may invest. The rate of
return or return of principal on some debt obligations may be linked or indexed
to the level of exchange rates between the U.S. dollar and a foreign currency or
currencies.
CONVERTIBLE SECURITIES
The Funds may invest in convertible securities of domestic or foreign
issuers, that meet the ratings criteria set forth in the Prospectus. A
convertible security is a fixed-income security (a bond or preferred stock)
which may be converted at a stated price within a specific period of time into a
certain quantity of common stock or other equity securities of the same or a
different issuer. Convertible securities rank senior to common stock in a
corporation's capital structure but are usually subordinated to similar
non-convertible securities. While providing a fixed-income stream (generally
higher in yield than the income derivable from common stock but lower than that
afforded by a similar non-convertible security), a convertible security also
offers an investor the opportunity, through its conversion feature, to
participate in the capital attendant upon a market price advance in the
convertible security's underlying common stock.
In general, the market value of a convertible security is at least the
higher of its "investment value" (i.e., its value as a fixed-income security) or
its "conversion value" (i.e., its value upon conversion into its underlying
stock). As a fixed-income security, a convertible security tends to increase in
market value when interest rates decline and tends to decrease in value when
interest rates rise. However, the price of a convertible security is also
influenced by the market value of the security's underlying stock. The price of
a convertible security tends to increase as the market value of the underlying
stock rises, whereas it tends to decrease as the market value of the underlying
stock declines. While no securities investment is without some risk, investments
in convertible securities generally entail less risk than investments in the
stock of the same issuer.
Page B-4
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MORTGAGE-RELATED SECURITIES
The Funds may invest in residential or commercial mortgage-related
securities, including mortgage pass-through securities, collateralized mortgage
obligations ("CMOs"), adjustable rate mortgage securities, CMO residuals,
stripped mortgage-related securities, floating and inverse floating rate
securities and tiered index bonds.
MORTGAGE PASS-THROUGH SECURITIES: Mortgage pass-through securities
represent interests in pools of mortgages in which payments of both principal
and interest on the securities are generally made monthly, in effect "passing
through" monthly payments made by borrowers on the residential or commercial
mortgage loans which underlie the securities (net of any fees paid to the issuer
or guarantor of the securities). Mortgage pass-through securities differ from
other forms of debt securities, which normally provide for periodic payment of
interest in fixed amounts with principal payments at maturity or specified call
dates. Early payment of principal on mortgage pass-through securities (arising
from prepayments of principal due to the sale of underlying property,
refinancing, or foreclosure, net of fees and costs which may be incurred) may
expose a Fund to a lower rate of return upon reinvestment of principal. Also, if
a security subject to repayment has been purchased at a premium, in the event of
prepayment, the value of the premium would be lost.
There are currently three types of mortgage pass-through securities,
(i) those issued by the U.S. Government or one of its agencies or
instrumentalities, such as the Government National Mortgage Association
("GNMA"), the Federal National Mortgage Association ("FNMA") and the Federal
Home Loan Mortgage Corporation ("FHLMC"); (ii) those issued by private issuers
that represent an interest in or are collateralized by pass-through securities
issued or guaranteed by the U.S. Government or one of its agencies or
instrumentalities; and (iii) those issued by private issuers that represent an
interest in or are collateralized by whole mortgage loans or pass-through
securities without a government guarantee but usually having some form of
private credit enhancement.
GNMA is a wholly-owned United States Government corporation within the
Department of Housing and Urban Development. GNMA is authorized to guarantee,
with the full faith and credit of the United States Government, the timely
payment of principal and interest on securities issued by the institutions
approved by GNMA (such as savings and loan institutions, commercial banks and
mortgage banks), and backed by pools of FHA-insured or VA-guaranteed mortgages.
Obligations of FNMA and FHLMC are not backed by the full faith and
credit of the United States Government. In the case of obligations not backed by
the full faith and credit of the United States Government, a Fund must look
principally to the agency issuing or guaranteeing the obligation for ultimate
repayment. FNMA and FHLMC may borrow from the U.S. Treasury to meet their
obligations, but the U.S. Treasury is under no obligation to lend to FNMA or
FHLMC.
Private mortgage pass-through securities are structured similarly to
GNMA, FNMA and FHLMC mortgage pass-through securities and are issued by
originators of and investors in mortgage loans, including depository
institutions, mortgage banks, investment banks and special purpose subsidiaries
of the foregoing. Pools created by private mortgage pass-through issuers
generally offer a higher rate of interest than government and government-related
pools because there are no direct or indirect government or agency guarantees of
payments in the private pools. However, timely payment of interest and principal
of these pools may be supported by various forms of insurance or guarantees,
including individual loan, title, pool and hazard insurance and letters of
credit. The insurance and guarantees are issued by governmental entities,
private insurers and the mortgage poolers. The insurance and guarantees and the
credit worthiness of the issuers thereof will be considered in determining
whether a mortgage-related security meets the Funds' investment quality
standards. There can be no assurance that the private insurers or guarantors can
meet their obligations under the insurance policies or guarantee arrangements.
Private mortgage pass-through securities may be bought without insurance or
guarantees if, through an examination of the loan experience and practices of
the originator/services and poolers, the Adviser determines that the securities
meet the Funds' quality standards.
Page B-5
<PAGE> 13
COLLATERALIZED MORTGAGE OBLIGATIONS: CMOs are debt obligations
collateralized by residential or commercial mortgage loans or residential or
commercial mortgage pass-through securities. Interest and prepaid principal are
generally paid monthly. CMOs may be collateralized by whole mortgage loans or
private mortgage pass-through securities but are more typically collateralized
by portfolios of mortgage pass-through securities guaranteed by GNMA, FHLMC or
FNMA. The issuer of a series of CMOs may elect to be treated for tax purposes as
a Real Estate Mortgage Investment Conduit ("REMIC"). All future references to
CMOs shall also be deemed to include REMICs.
CMOs are structured into multiple classes, each bearing a different
stated maturity. Monthly payment of principal received from the pool of
underlying mortgages, including prepayments, is first returned to investors
holding the shortest maturity class. Investors holding the longer maturity
classes usually receive principal only after shorter classes have been retired.
An investor may be partially protected against a sooner than desired return of
principal because of the sequential payments.
Certain issuers of CMOs are not considered investment companies
pursuant to a rule recently adopted by the Securities and Exchange Commission
("SEC"), and the Funds may invest in the securities of such issuers without the
limitations imposed by the 1940 Act on investments by the Fund in other
investment companies. In addition, in reliance on an earlier SEC interpretation,
the Fund's investments in certain other qualifying CMOs, which cannot or do not
rely on the rule, are also not subject to the limitation of the 1940 Act on
acquiring interests in other investment companies. In order to be able to rely
on the SEC's interpretation, issuers of these CMOs must be unmanaged, fixed
asset issuers, that (a) invest primarily in mortgage-backed securities, (b) do
not issue redeemable securities, (c) operate under general exemptive orders
exempting them from all provisions of the 1940 Act and (d) are not registered or
regulated under the 1940 Act as investment companies. To the extent that the
Funds select CMOs that cannot rely on the rule or do not meet the above
requirements, the Funds may not invest more than 10% of their assets in all such
entities and may not acquire more than 3% of the voting securities of any single
entity.
The Funds also may invest in, among other things, parallel pay CMOs,
Planned Amortization Class CMOs ("PAC bonds"), sequential pay CMOs, and floating
rate CMOs. Parallel pay CMOs are structured to provide payments of principal on
each payment date to more than one class. PAC bonds generally require payments
of a specified amount of principal on each payment date. Sequential pay CMOs
generally pay principal to only one class while paying interest to several
classes. Floating rate CMOs are securities whose coupon rate fluctuates
according to some formula related to an existing mortgage index or rate. Typical
indices would include the eleventh district cost- of-funds index, the London
Interbank Offered Rate, one-year Treasury yields, and ten-year Treasury yields.
ADJUSTABLE RATE MORTGAGE SECURITIES: Adjustable rate mortgage
securities ("ARMs") are pass-through securities collateralized by mortgages with
adjustable rather than fixed rates. ARMs eligible for inclusion in a mortgage
pool generally provide for a fixed initial mortgage interest rate for either the
first three, six, twelve, thirteen, 36, or 60 scheduled monthly payments.
Thereafter, the interest rates are subject to periodic adjustment based on
changes to a designated benchmark index.
The ARMs contain maximum and minimum rates beyond which the mortgage
interest rate may not vary over the lifetime of the security. In addition,
certain ARMs provide for additional limitations on the maximum amount by which
the mortgage interest may be adjusted for any single adjustment period. In the
event that market rates of interest rise more rapidly to levels above that of
the ARM's maximum rate, the ARM's coupon may represent a below market rate of
interest. In these circumstances, the market value of the ARM security will
likely have fallen.
Some ARMs contain limitations on changes in the required monthly
payment. In the event that a monthly payment is not sufficient to pay the
interest accruing on an ARM, any such excess interest is added to the principal
balance of the mortgage loan, which is repaid through future monthly payments.
If the monthly payment for such an instrument exceeds the sum of the interest
accrued at the applicable mortgage interest rate and the principal payment
required at such point to amortize the outstanding principal balance over the
remaining term of the loan, the excess is then utilized to reduce the
outstanding principal balance of the ARM.
Page B-6
<PAGE> 14
CMO RESIDUALS: CMO residuals are derivative mortgage securities issued
by agencies or instrumentalities of the U.S. Government or by private
originators of, or investors in, mortgage loans, including savings and loan
associations, homebuilders, mortgage banks, commercial banks, investment banks,
and special purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of
CMOs is applied first to make required payments of principal and interest on the
CMOs and second to pay the related administrative expenses of the issuer. The
residual in a CMO structure generally represents the interest in any excess cash
flow remaining after making the foregoing payments. Each payment of such excess
cash flow to a holder of the related CMO residual represents income and/or a
return of capital. The amount of residual cash flow resulting from a CMO will
depend on, among other things, the characteristics of the mortgage assets, the
coupon rate of each class of CMO, prevailing interest rates, the amount of
administrative expenses and the prepayment experience on the mortgage assets. In
part, the yield to maturity on the CMO residuals is extremely sensitive to
prepayments on the related underlying mortgage assets, in the same manner as an
interest-only ("IO") class of stripped mortgage-related securities. See
"Stripped Mortgage- Related Securities" below. In addition, if a series of a CMO
includes a class that bears interest at an adjustable rate, the yield to
maturity on the related CMO residual will also be extremely sensitive to changes
in the level of the index upon which interest rate adjustments are based. As
described below with respect to stripped mortgage-related securities, in certain
circumstances a Fund may fail to recoup its initial investment in a CMO
residual.
CMO residuals are generally purchased and sold by institutional
investors through several investment banking firms acting as brokers or dealers.
The CMO residual market has recently developed and CMO residuals currently may
not have the liquidity of other more established securities trading in other
markets. Transactions in CMO residuals are generally completed only after
careful review of the characteristics of the securities in question. In
addition, CMO residuals may or, pursuant to an exemption therefrom, may not have
been registered under the Securities Act. CMO residuals, whether or not
registered under the Securities Act, may be subject to certain restrictions on
transferability, and may be deemed "illiquid" and subject to a Fund's
limitations on investment in illiquid securities.
STRIPPED MORTGAGE-RELATED SECURITIES: Stripped mortgage-related
securities ("SMBS") are derivative multi- class mortgage securities. SMBS may be
issued by agencies or instrumentalities of the U.S. Government, or by private
originators of, or investors in, mortgage loans, including savings and loan
associations, mortgage banks, commercial banks, investment banks, and special
purpose entities of the foregoing.
SMBS are usually structured with two classes that receive different
proportions of the interest and principal distributions on a pool of mortgage
assets. A common type of SMBS will have one class receiving some of the interest
and most of the principal from the mortgage assets, while the other class will
receive most of the interest and the remainder of the principal. In the most
extreme case, one class will receive all of the interest, (the IO class), while
the other class will receive all of the principal (the principal-only or "PO"
class). The yield to maturity on an IO class is extremely sensitive to the rate
of principal payments (including prepayments) on the related underlying mortgage
assets, and a rapid rate of principal payments may have a material adverse
effect on a Fund's yield to maturity from these securities. If the underlying
mortgage assets experience greater than anticipated prepayments of principal, a
Fund may fail to fully recoup its initial investment in these securities even if
the security is in one of the highest rating categories.
Although SMBS are purchased and sold by institutional investors through
several investment banking firms acting as brokers or dealers, these securities
were only recently introduced. As a result, established trading markets have not
yet been fully developed and accordingly, these securities may be deemed
"illiquid" and subject to a Fund's limitations on investment in illiquid
securities. See "Securities and Techniques Used by the Funds-Mortgage-Related
Securities" in the Prospectus.
Page B-7
<PAGE> 15
INVERSE FLOATERS: An inverse floater is a debt instrument with a
floating or variable interest rate that moves in the opposite direction to the
interest rate on another security or index level. Changes in the interest rate
on the other security or index inversely affect the residual interest rate paid
on the inverse floater, with the result that the inverse floater's price will be
considerably more volatile than that of a fixed-rate bond. Inverse floaters may
experience gains when interest rates fall and may suffer losses in periods of
rising interest rates. The market for inverse floaters is relatively new.
TIERED INDEX BONDS: Tiered index bonds are relatively new forms of
mortgage-related securities. The interest rate on a tiered index bond is tied to
a specified index or market rate. So long as this index or market rate is below
a predetermined "strike" rate, the interest rate on the tiered index bond
remains fixed. If, however, the specified index or market rate rises above the
"strike" rate, the interest rate of the tiered index bond will decrease. Thus,
under these circumstances, the interest rate on a tiered index bond, like an
inverse floater, will move in the opposite direction of prevailing interest
rates, with the result that the price of the tiered index bond may be
considerably more volatile than that of a fixed-rate bond.
ASSET-BACKED SECURITIES
The Funds may invest in various types of asset-backed securities.
Through the use of trusts and special purpose corporations, various types of
assets, primarily automobile and credit card receivables and home equity loans,
are being securitized in pass-through structures similar to the mortgage
pass-through or in a pay-through structure similar to the CMO structure.
Investments in these and other types of asset-backed securities must be
consistent with the investment objectives and policies of the Funds.
RISK FACTORS RELATING TO INVESTING IN MORTGAGE-RELATED AND ASSET-BACKED
SECURITIES
The yield characteristics of mortgage-related and asset-backed
securities differ from traditional debt securities. Among the major differences
are that interest and principal payments are made more frequently, usually
monthly, and that principal may be prepaid at any time because the underlying
mortgage loans or other assets generally may be prepaid at any time. As a
result, if the Funds purchase such a security at a premium, a prepayment rate
that is faster than expected will reduce yield to maturity, while a prepayment
rate that is slower than expected will have the opposite effect of increasing
yield to maturity. Alternatively, if the Funds purchase these securities at a
discount, faster than expected prepayments will increase, while slower than
expected prepayments will reduce, yield to maturity. The Funds may invest a
portion of their assets in derivative mortgage-related securities which are
highly sensitive to changes in prepayment and interest rates. The Adviser will
seek to manage these risks (and potential benefits) by diversifying its
investments in such securities and through hedging techniques.
During periods of declining interest rates, prepayment of mortgages
underlying mortgage-related securities can be expected to accelerate.
Accordingly, a Fund's ability to maintain positions in high-yielding
mortgage-related securities will be affected by reductions in the principal
amount of such securities resulting from such prepayments, and its ability to
reinvest the returns of principal at comparable rates is subject to generally
prevailing interest rates at that time. Prepayments may also result in the
realization of capital losses with respect to higher yielding securities that
had been bought at a premium or the loss of opportunity to realize capital gains
in the future from possible future appreciation.
Asset-backed securities involve certain risks that are not posed by
mortgage-related securities, resulting mainly from the fact that asset-backed
securities do not usually contain the complete benefit of a security interest in
the related collateral. For example, credit card receivables generally are
unsecured and the debtors are entitled to the protection of a number of state
and Federal consumer credit laws, some of which may reduce the ability to obtain
full payment. In the case of automobile receivables, due to various legal and
economic factors, proceeds from repossessed collateral may not always be
sufficient to support payments on these securities.
Page B-8
<PAGE> 16
DURATION
In selecting fixed-income securities for the Funds, the Adviser makes
use of the concept of duration. Duration is a measure of the expected life of a
fixed-income security that was developed as a more precise alternative to the
concept of "term to maturity." Duration incorporates a bond's yield, coupon
interest payments, final maturity and call features into one measure.
Most debt obligations provide interest ("coupon") payments in addition
to a final ("par") payment at maturity. Some obligations also have call
provisions. Depending on the relative magnitude of these payments, the market
values of debt obligations may respond differently to changes in the level and
structure of interest rates.
Traditionally, a debt security's "term to maturity" has been used as a
proxy for the sensitivity of the security's price to changes in interest rates
(which is the "interest rate risk" or "volatility" of the security). However,
"term to maturity" measures only the time until a debt security provides its
final payment, taking no account of the pattern of the security's payments prior
to maturity. Duration is a measure of the expected life of a fixed-income
security on a present value basis. Duration takes the length of the time
intervals between the present time and the time that the interest and principal
payments are scheduled or, in the case of a callable bond, expected to be
received, and weights them by the present values of the cash to be received at
each future point in time. For any fixed-income security with interest payments
occurring prior to the payment of principal, duration is always less than
maturity. In general, all other things being the same, the lower the stated or
coupon rate of interest of a fixed-income security, the longer the duration of
the security; conversely, the higher the stated or coupon rate of interest of a
fixed-income security, the shorter the duration of the security.
Futures, options and options on futures have durations, which, in
general, are closely related to the duration of the securities which underlie
them. Holding long futures or call option positions (backed by a segregated
account of cash and cash equivalents) will lengthen a Fund's duration by
approximately the same amount that holding an equivalent amount of the
underlying securities would.
Short futures or put option positions have durations roughly equal to
the negative of the duration of the securities that underlie those positions,
and have the effect of reducing portfolio duration by approximately the same
amount that selling an equivalent amount of the underlying securities would.
There are some situations where even the standard duration calculation
does not properly reflect the interest rate exposure of a security. For example,
floating and variable rate securities often have final maturities of ten or more
years; however, their interest rate exposure corresponds to the frequency that
coupon is reset. Another example where the interest rate exposure is not
properly captured by duration is the case of mortgage pass-through securities.
The stated final maturity of such securities is generally 30 years, but current
prepayment rates are more critical in determining the securities' interest rate
exposure. In these and other similar situations, the Adviser will use more
sophisticated analytical techniques that incorporate the economic life of a
security into the determination of its interest rate exposure.
DERIVATIVE INSTRUMENTS
As indicated in the Prospectus, to the extent consistent with their
investment objectives and policies, the Funds may purchase and write call and
put options on securities, securities indexes and on foreign currencies and
enter into futures contracts and use options on futures contracts. The Funds
also may enter into swap agreements with respect to foreign currencies, interest
rates and securities indexes. The Funds may use these techniques to hedge
against changes in interest rates, foreign currency exchange rates, or
securities prices or as part of their overall investment strategies. Each Fund
will maintain segregated accounts consisting of cash, U.S. Government
securities, or other high grade debt obligations (or, as permitted by applicable
regulation, enter into certain offsetting positions) to cover its obligations
under options and futures contracts to avoid leveraging of the Fund.
Page B-9
<PAGE> 17
OPTIONS ON SECURITIES AND ON SECURITIES INDEXES: A Fund may purchase
put options on securities to protect holdings in an underlying or related
security against a substantial decline in market value. A Fund may purchase call
options on securities 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. A Fund may sell put or call options it has
previously purchased, which could 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. A Fund may
write a call or put option only if the option is "covered" by the Fund holding a
position in the underlying securities or by other means which would permit
immediate satisfaction of the Fund's obligation as writer of the option. Prior
to exercise or expiration, an option may be closed out by an offsetting purchase
or sale of an option of the same series.
The purchase and writing of options involves certain risks. During the
option period, the covered call writer 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 sum of the premium and exercise price, but, as
long as its obligation as a writer continues, 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 a Fund seeks to close out an option position.
Furthermore, if trading restrictions or suspensions are imposed on the options
markets, a Fund may be unable to close out a position.
As mentioned above, there are several risks associated with
transactions in options on securities and on indexes. For example, there are
significant differences between the securities and options markets that could
result in an imperfect correlation between these markets, causing a given
transaction not to achieve its objectives. A decision as to whether, when and
how to use options involves the exercise of skill and judgment, and even a
well-conceived transaction may be unsuccessful to some degree because of market
behavior or unexpected events.
There can be no assurance that a liquid market will exist when a Fund
seeks to close out an option position. If a Fund were unable to close out an
option that it had purchased on a security, it would have to exercise the option
in order to realize any profit or the option may expire worthless. If a Fund
were unable to close out a covered call option that it had written on a
security, it would not be able to sell the underlying security unless the option
expired without exercise.
If trading were suspended in an option purchased by a Fund, the Fund
would not be able to close out the option. If restrictions on exercise were
imposed, the Fund might be unable to exercise an option it had purchased. Except
to the extent that a call option on an index written by the Fund is covered by
an option on the same index purchased by the Fund, movements in the index may
result in a loss to the Fund; however, such losses may be mitigated by changes
in the value of the Fund's securities during the period the option was
outstanding.
Page B-10
<PAGE> 18
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS: A Fund may use
interest rate, foreign currency or index futures contracts, as specified for
that Fund in the Prospectus. An interest rate, foreign currency or index futures
contract provides for the future sale by one party and purchase by another party
of a specified quantity of a financial instrument, foreign currency or the cash
value of an index at a specified price and time. A futures contract on an index
is an agreement pursuant to which two parties agree to take or make delivery of
an amount of cash equal to the difference between the value of the index at the
close of the last trading day of the contract and the price at which the index
contract was originally written. Although the value of an index might be a
function of the value of certain specified securities, no physical delivery of
these securities is made. A public market exists in futures contracts covering
several indexes as well as a number of financial instruments and foreign
currencies, including: the S&P 500; the S&P 100; the NYSE composite; U.S.
Treasury bonds; U.S. Treasury notes; GNMA Certificates; three-month U.S.
Treasury bills; 90-day commercial paper; bank certificates of deposit; the
Australian dollar; the Canadian dollar; the British pound; the German mark; the
Japanese yen; the French franc; the Swiss franc; the Mexican peso; and certain
multinational currencies, such as the European Currency Unit. It is expected
that other future contracts will be developed and traded in the future.
A Fund may purchase and write call and put options on futures. Options
on futures possess many of the same characteristics as options on securities and
indexes (discussed above). An option on a futures contract gives the holder the
right, in return for the premium paid, to assume a long position (call) or short
position (put) in a futures contract at a specified exercise price at any time
during the period of the option. Upon exercise of a call option, the holder
acquires a long position in the futures contract and the writer is assigned the
opposite short position. In the case of a put option, the opposite is true.
Each Fund will use futures contracts and options on futures contracts
in accordance with the rules of the Commodity Futures Trading Commission
("CFTC"). For example, a Fund might use futures contracts to hedge against
anticipated changes in interest rates that might adversely affect either the
value of the Fund's securities or the price of the securities which the Fund
intends to purchase. A Fund's hedging activities may include sales of futures
contracts as an offset against the effect of expected increases in interest
rates, and purchases of futures contracts as an offset against the effect of
expected declines in interest rates. Although other techniques could be used to
reduce a Fund's exposure to interest rate fluctuations, the Fund may be able to
hedge its exposure more effectively and perhaps at a lower cost by using futures
contracts and options on futures contracts.
A Fund will only enter into futures contracts and options on futures
contracts which are standardized and traded on a U.S. or foreign exchange, board
of trade, or similar entity, or quoted on an automated quotation system.
When a purchase or sale of a futures contract is made by a Fund, the
Fund is required to deposit with its custodian (or broker, if legally permitted)
a specified amount of cash or U.S. Government securities ("initial margin"). The
margin required for a futures contract is set by the exchange on which the
contract is traded and may be modified during the term of the contract. The
initial margin is in the nature of a performance bond or good faith deposit on
the futures contract which is returned to the Fund upon termination of the
contract, assuming all contractual obligations have been satisfied. Each Fund
expects to earn interest income on its initial margin deposits. A futures
contract held by a Fund is valued daily at the official settlement price of the
exchange on which it is traded. Each day the Fund pays or receives cash, called
"variation margin," equal to the daily change in value of the futures contract.
This process is known as "marking to market." Variation margin does not
represent a borrowing or loan by a Fund but is instead a settlement between the
Fund and the broker of the amount one would owe the other if the futures
contract expired. In computing daily net asset value, each Fund will mark to
market its open futures positions.
A Fund is also required to deposit and maintain margin with respect to
put and call options on futures contracts written by it. Such margin deposits
will vary depending on the nature of the underlying futures contract (and the
related margin requirements), the current market value of the option, and other
futures positions held by the Fund.
Page B-11
<PAGE> 19
Although some futures contracts call for making or taking delivery of
the underlying securities, generally these obligations are closed out prior to
delivery by offsetting purchases or sales of matching futures contracts (same
exchange, underlying security or index and delivery month). If an offsetting
purchase price is less than the original sale price, the Fund realizes a capital
gain, or if it is more, the Fund realizes a capital loss. Conversely, if an
offsetting sale price is more than the original purchase price, the Fund
realizes a capital gain, or if it is less, the Fund realizes a capital loss. The
transaction costs must also be included in these calculations.
LIMITATIONS ON USE OF FUTURES AND OPTIONS THEREON: When purchasing a
futures contract, a Fund will maintain with its custodian (and mark-to-market on
a daily basis) cash, U.S. Government securities, or other highly liquid debt
securities that, when added to the amounts deposited with a futures commission
merchant as margin, are equal to the market value of the futures contract.
Alternatively, the Fund may "cover" its position by purchasing a put option on
the same futures contract with a strike price as high or higher than the price
of the contract held by the Fund.
When selling a futures contract, a Fund will maintain with its
custodian (and mark-to-market on a daily basis) liquid assets that, when added
to the amount deposited with a futures commission merchant as margin, are equal
to the market value of the instruments underlying the contract. Alternatively,
the Fund may "cover" its position by owning the instruments underlying the
contract (or, in the case of an index futures contract, a portfolio with a
volatility substantially similar to that of the index on which the futures
contract is based), or by holding a call option permitting the Fund to purchase
the same futures contract at a price no higher than the price of the contract
written by the Fund (or at a higher price if the difference is maintained in
liquid assets with the Trust's custodian).
When selling a call option on a futures contract, a Fund will maintain
with its custodian (and mark-to-market on a daily basis) cash, U.S. Government
securities, or other highly liquid debt securities that, when added to the
amounts deposited with a futures commission merchant as margin, equal the total
market value of the futures contract underlying the call option. Alternatively,
the Fund may cover its position by entering into a long position in the same
futures contract at a price no higher than the strike price of the call option,
by owning the instruments underlying the futures contract, or by holding a
separate call option permitting the Fund to purchase the same futures contract
at a price not higher than the strike price of the call option sold by the Fund.
When selling a put option on a futures contract, a Fund will maintain
with its custodian (and mark-to-market on a daily basis) cash, U.S. Government
securities, or other highly liquid debt securities that equal the purchase price
of the futures contract, less any margin on deposit. Alternatively, the Fund may
cover the position either by entering into a short position in the same futures
contract, or by owning a separate put option permitting it to sell the same
futures contract so long as the strike price of the purchased put option is the
same or higher than the strike price of the put option sold by the Fund.
In order to comply with current applicable regulations of the CFTC
pursuant to which the Funds avoid being deemed a "commodity pool operator," the
Funds are limited in their futures trading activities to positions which
constitute "bona fide hedging" positions within the meaning and intent of
applicable CFTC rules, or to non-hedging positions for which the aggregate
initial margin and premiums will not exceed 5% of the liquidation value of the
Fund's assets.
The requirements for qualification for tax purposes as a regulated
investment company also may limit the extent to which a Fund may enter into
futures contracts, options thereon or forward contracts. See "Dividends and Tax
Status."
Page B-12
<PAGE> 20
RISKS ASSOCIATED WITH FUTURES AND OPTIONS ON FUTURES CONTRACTS: There
are several risks associated with the use of futures contracts and options on
futures contracts as hedging techniques. A purchase or sale of a futures
contract may result in losses in excess of the amount invested in the futures
contract. There can be no guarantee that there will be a correlation between
price movements in the hedging vehicle and in the Fund securities being hedged.
In addition, there are significant differences between the securities and
futures markets that could result in an imperfect correlation between the
markets, causing a given hedge not to achieve its objectives. The degree of
imperfection of correlation depends on circumstances such as variation in
speculative market demand for futures and options on futures, including
technical influences in futures trading and options on futures, and differences
between the financial instruments being hedged and the instruments underlying
the standard contracts available for trading in such respects as interest rate
levels, maturities, and creditworthiness of issuers. A decision as to whether,
when and how to hedge involves the exercise of skill and judgment, and even a
well-conceived hedge may be unsuccessful to some degree because of market
behavior or unexpected interest rate trends.
Futures exchanges may limit the amount of fluctuation permitted in
certain futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of the
current trading session. Once the daily limit has been reached in a futures
contract subject to the limit, no more trades may be made on that day at a price
beyond that limit. The daily limit governs only price movements during a
particular trading day and therefore does not limit potential losses because the
limit may work to prevent the liquidation of unfavorable positions. For example,
futures prices have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby preventing prompt
liquidation of positions and subjecting some holders of futures contracts to
substantial losses.
There can be no assurance that a liquid market will exist when a Fund
seeks to close out a futures contract or an option on a futures position, and
that Fund would remain obligated to meet margin requirements until the position
is closed. In addition, many of the contracts discussed above are relatively new
instruments without a significant trading history. As a result, there can be no
assurance that an active secondary market will develop or continue to exist.
ADDITIONAL RISKS OF OPTIONS ON SECURITIES, FUTURES CONTRACTS, OPTIONS
ON FUTURES CONTRACTS, AND FORWARD CURRENCY EXCHANGE CONTRACTS AND OPTIONS
THEREON: Options on securities, futures contracts, options on futures contracts,
forward currency exchange contracts and options may be traded on foreign
exchanges. These transactions may not be regulated as effectively as similar
transactions in the United States; may not involve a clearing mechanism and
related guarantees; and are subject to the risk of governmental actions
affecting trading in, or the prices of, foreign securities. The value of such
positions also could be adversely affected by (i) other complex foreign
political, legal and economic factors, (ii) lesser availability than in the
United States of data on which to make trading decisions, (iii) delays in the
Funds' ability to act upon economic events occurring in foreign markets during
non-business hours in the United States, and (iv) lesser trading volume.
FOREIGN SECURITIES
The Funds may also invest in fixed-income securities of issuers located
in emerging foreign markets. Emerging markets generally include every country in
the world other than the United States, Canada, Japan, Australia, Malaysia, New
Zealand, Hong Kong, Singapore and most Western European countries. In
determining what countries constitute emerging markets, the Adviser will
consider, among other things, data, analysis and classification of countries
published or disseminated by the International Bank for Reconstruction and
Development (the "World Bank") and the International Financial Corporation.
Currently, investing in many emerging markets may not be desirable or feasible,
because of the lack of adequate custody arrangements for a Fund's assets, overly
burdensome repatriation and similar restrictions, the lack of organized and
liquid securities markets, unacceptable political risks or other reasons. As
opportunities to invest in securities in emerging markets develop, the Funds
expect to expand and further broaden the group of emerging markets in which they
invest.
Page B-13
<PAGE> 21
From time to time, emerging markets have offered the opportunity for
higher returns in exchange for a higher level of risk. Accordingly, the Adviser
believes that each Fund's ability to invest in emerging markets throughout the
world may enable the achievement of results superior to those produced by funds,
with similar objectives to those of the Funds, that invest solely in securities
in developed markets. There is no assurance that any Fund will achieve these
results.
The Funds may invest in the following types of emerging market
fixed-income securities: (a) fixed-income securities issued or guaranteed by
governments, their agencies, instrumentalities or political subdivisions, or by
government-owned, controlled or sponsored entities, including central banks
(collectively, "Sovereign Debt"), including Brady Bonds (described below); (b)
interests in issuers organized and operated for the purpose of restructuring the
investment characteristics of Sovereign Debt; (c) fixed-income securities issued
by banks and other business entities; and (d) fixed-income securities
denominated in or indexed to the currencies of emerging markets. Fixed-income
securities held by the Funds may take the form of bonds, notes, bills,
debentures, bank debt obligations, short-term paper, loan participations,
assignments and interests issued by entities organized and operated for the
purpose of restructuring the investment characteristics of any of the foregoing.
There is no requirement with respect to the maturity of fixed-income securities
in which the Funds may invest.
The Funds may invest in Brady Bonds and other Sovereign Debt of
countries that have restructured or are in the process of restructuring
Sovereign Debt pursuant to the Brady Plan. "Brady Bonds" are debt securities
issued under the framework of the Brady Plan, an initiative announced by former
U.S. Treasury Secretary Nicholas F. Brady in 1989 as a mechanism for debtor
nations to restructure their outstanding external commercial bank indebtedness.
In restructuring its external debt under the Brady Plan framework, a debtor
nation negotiates with its existing bank lenders as well as multilateral
institutions such as the World Bank and the International Monetary Fund ("IMF").
The Brady Plan framework, as it has developed, contemplates the exchange of
commercial bank debt for newly issued Brady Bonds. Brady Bonds may also be
issued in respect of new money being advanced by existing lenders in connection
with the debt restructuring. The World Bank and/or the IMF support the
restructuring by providing funds pursuant to loan agreements or other agreements
which enable the debtor nation to collateralize the new Brady Bonds or to
repurchase outstanding bank debt at a discount.
Emerging market fixed-income securities generally are considered to be
of a credit quality below investment grade, even though they often are not rated
by any nationally recognized statistical rating organizations. Investment in
emerging market fixed-income securities will be allocated among various
countries based upon the Adviser's analysis of credit risk and its consideration
of a number of factors, including: prospects for relative economic growth among
the different countries in which the Funds may invest; expected levels of
inflation; government policies influencing business conditions; the outlook for
currency relationships; and the range of the individual investment opportunities
available to international investors. The Adviser's emerging market sovereign
credit analysis includes an evaluation of the issuing country's total debt
levels, currency reserve levels, net exports/imports, overall economic growth,
level of inflation, currency fluctuation, political and social climate and
payment history. Particular fixed-income securities will be selected based upon
credit risk analysis of potential issuers, the characteristics of the security
and interest rate sensitivity of the various debt issues available with respect
to a particular issuer, analysis of the anticipated volatility and liquidity of
the particular debt instruments, and the tax implications to the Fund. The
emerging market fixed-income securities in which the Funds may invest are not
subject to any minimum credit quality standards.
Page B-14
<PAGE> 22
FOREIGN CURRENCY OPTIONS AND RELATED RISKS
The Funds may take positions in options on foreign currencies to hedge
against the risk of foreign exchange rate fluctuations on foreign securities the
Funds hold in their portfolios or intend to purchase. For example, if a Fund
were to enter into a contract to purchase securities denominated in a foreign
currency, it could effectively fix the maximum U.S. dollar cost of the
securities by purchasing call options on that foreign currency. Similarly, if a
Fund held securities denominated in a foreign currency and anticipated a decline
in the value of that currency against the U.S. dollar, it could hedge against
such a decline by purchasing a put option on the currency involved. The markets
in foreign currency options are relatively new, and a Fund's ability to
establish and close out positions in such options is subject to the maintenance
of a liquid secondary market. There can be no assurance that a liquid secondary
market will exist for a particular option at any specific time. In addition,
options on foreign currencies are affected by all of those factors that
influence foreign exchange rates and investments generally.
The quantities of currencies underlying option contracts represent odd
lots in a market dominated by transactions between banks, and as a result extra
transaction costs may be incurred upon exercise of an option.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations be firm or revised on a
timely basis. Quotation information is generally representative of very large
transactions in the interbank market and may not reflect smaller transactions
where rates may be less favorable. Option markets may be closed while
round-the-clock interbank currency markets are open, and this can create price
and rate discrepancies.
RISKS OF OPTIONS TRADING: The Funds may effectively terminate their
rights or obligations under options by entering into closing transactions.
Closing transactions permit a Fund to realize profits or limit losses on its
options positions prior to the exercise or expiration of the option. The value
of a foreign currency option depends on the value of the underlying currency
relative to the U.S. dollar. Other factors affecting the value of an option are
the time remaining until expiration, the relationship of the exercise price to
market price, the historical price volatility of the underlying currency and
general market conditions. As a result, changes in the value of an option
position may have no relationship to the investment merit of a foreign security.
Whether a profit or loss is realized on a closing transaction depends on the
price movement of the underlying currency and the market value of the option.
Options normally have expiration dates of up to nine months. The
exercise price may be below, equal to or above the current market value of the
underlying currency. Options that expire unexercised have no value, and a Fund
will realize a loss of any premium paid and any transaction costs. Closing
transactions may be effected only by negotiating directly with the other party
to the option contract, unless a secondary market for the options develops.
Although the Funds intend to enter into foreign currency options only with
dealers which agree to enter into, and which are expected to be capable of
entering into, closing transactions with the Funds, there can be no assurance
that a Fund will be able to liquidate an option at a favorable price at any time
prior to expiration. In the event of insolvency of the counter-party, a Fund may
be unable to liquidate a foreign currency option. Accordingly, it may not be
possible to effect closing transactions with respect to certain options, with
the result that a Fund would have to exercise those options that it had
purchased in order to realize any profit.
Page B-15
<PAGE> 23
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
The Funds may use forward contracts to protect against uncertainty in
the level of future exchange rates. The Funds will not speculate with forward
contracts or foreign currency exchange rates.
A Fund may enter into forward contracts with respect to specific
transactions. For example, when a Fund enters into a contract for the purchase
or sale of a security denominated in a foreign currency, or when a Fund
anticipates the receipt in a foreign currency of dividend or interest payments
on a security that it holds, the Fund may desire to "lock" in the U.S. dollar
price of the security or the U.S. dollar equivalent of the payment, by entering
into a forward contract for the purchase or sale, for a fixed amount of U.S.
dollars or foreign currency, of the amount of foreign currency involved in the
underlying transaction. A Fund will thereby be able to protect itself against a
possible loss resulting from an adverse change in the relationship between the
currency exchange rates during the period between the date on which the security
is purchased or sold, or on which the payment is declared, and the date on which
such payments are made or received.
A Fund also may use forward contracts in connection with portfolio
positions to lock in the U.S. dollar value of those positions, to increase the
Fund's exposure to foreign currencies that the Adviser believes may rise in
value relative to the U.S. dollar or to shift the Fund's exposure to foreign
currency fluctuations from one country to another. For example, when the Adviser
believes that the currency of a particular foreign country may suffer a
substantial decline relative to the U.S. dollar or another currency, it may
enter into a forward contract to sell the amount of the former foreign currency
approximating the value of some or all of the Funds' portfolio securities
denominated in such foreign currency. This investment practice generally is
referred to as "cross-hedging" when another foreign currency is used.
The precise matching of the forward contract amounts and the value of
the securities involved will not generally be possible because the future value
of such securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date the forward contract
is entered into and the date it matures. Accordingly, it may be necessary for a
Fund to purchase additional foreign currency on the spot (i.e., cash) market
(and bear the expense of such purchase) if the market value of the security is
less than the amount of foreign currency the Fund is obligated to deliver and if
a decision is made to sell the security and make delivery of the foreign
currency. Conversely, it may be necessary to sell on the spot market some of the
foreign currency received upon the sale of the portfolio security if its market
value exceeds the amount of foreign currency the Fund is obligated to deliver.
The projection of short-term currency market movements is extremely difficult,
and the successful execution of a short-term hedging strategy is highly
uncertain. Forward contracts involve the risk that anticipated currency
movements will not be accurately predicted, causing the Fund to sustain losses
on these contracts and transaction costs. A Fund may enter into forward
contracts or maintain a net exposure to such contracts only if (1) the
consummation of the contracts would not obligate the Fund to deliver an amount
of foreign currency in excess of the value of the Fund's portfolio securities or
other assets denominated in that currency or (2) the Fund maintains cash, U.S.
Government securities or liquid, high-quality debt securities in a segregated
account in an amount not less than the value of the Fund's total assets
committed to the consummation of the contracts. Under normal circumstances,
consideration of the prospect for currency parities will be incorporated into
the longer term investment decisions made with regard to overall diversification
strategies. However, the Adviser believes it is important to have the
flexibility to enter into such forward contracts when it determines that the
best interests of a Fund will be served.
At or before the maturity date of a forward contract that requires a
Fund to sell a currency, the Fund may either sell a portfolio security and use
the sale proceeds to make delivery of the currency or retain the security and
offset its contractual obligation to deliver the currency by purchasing a second
contract pursuant to which the Fund will obtain, on the same maturity date, the
same amount of the currency that it is obligated to deliver. Similarly, a Fund
may close out a forward contract requiring it to purchase a specified currency
by entering into a second contract entitling it to sell the same amount of the
same currency on the maturity date of the first contract. The Fund would realize
a gain or loss as a result of entering into such an offsetting forward contract
under either circumstance to the extent the exchange rate between the currencies
involved moved between the execution dates of the first and second contracts.
Page B-16
<PAGE> 24
The cost to the Fund of engaging in forward contracts varies with
factors such as the currencies involved, the length of the contract period and
the market conditions then prevailing. Because forward contracts are usually
entered into on a principal basis, no fees or commissions are involved. The use
of forward contracts does not eliminate fluctuations in the prices of the
underlying securities the Fund owns or intends to acquire, but it does fix a
rate of exchange in advance. In addition, although forward contracts limit the
risk of loss due to a decline in the value of the hedged currencies, at the same
time they limit any potential gain that might result should the value of the
currencies increase.
Although the Funds value their assets daily in terms of U.S. dollars,
they do not intend to convert holdings of foreign currencies into U.S. dollars
on a daily basis. The Funds may convert foreign currency from time to time, and
investors should be aware of the costs of currency conversion. Although foreign
exchange dealers do not charge a fee for conversion, they do realize a profit
based on the difference between the prices at which they are buying and selling
various currencies. Thus, a dealer may offer to sell a foreign currency to a
Fund at one rate, while offering a lesser rate of exchange should the Fund
desire to resell that currency to the dealer.
SWAP AGREEMENTS: The Funds may enter into interest rate, index and
currency exchange rate swap agreements for purposes of attempting to obtain a
particular desired return at a lower cost to the Fund than if the Fund had
invested directly in an instrument that yielded the desired return. Swap
agreements are two party contracts entered into primarily by institutional
investors for periods ranging from a few weeks to more than one year. In a
standard "swap" transaction, two parties agree to exchange the returns (or
differentials in rates of return) earned or realized on particular predetermined
investments or instruments. The gross returns to be exchanged or "swapped"
between the parties are calculated with respect to a "notional amount," i.e.,
the return on or increase in value of a particular dollar amount invested at a
particular interest rate, in a particular foreign currency, or in a "basket" of
securities representing a particular index. The "notional amount" of the swap
agreement is only a fictive basis on which to calculate the obligations which
the parties to a swap agreement have agreed to exchange. A Fund's obligations
(or rights) under a swap agreement will generally be equal only to the net
amount to be paid or received under the agreement based on the relative values
of the positions held by each party to the agreement (the "net amount"). A
Fund's obligations under a swap agreement will be accrued daily (offset against
any amounts owing to the Fund) and any accrued but unpaid net amounts owed to a
swap counter-party will be covered by the maintenance of a segregated account
consisting of cash, U.S. Government securities, or high grade debt obligations,
to avoid any potential leveraging of the Fund's portfolio. A Fund will not enter
into a swap agreement with any single party if the net amount owed or to be
received under existing contracts with that party would exceed 5% of the Fund's
assets.
Whether a Fund's use of swap agreements will be successful in
furthering its investment objective of total return will depend on the Adviser's
ability correctly to predict whether certain types of investments are likely to
produce greater returns than other investments. Because they are two party
contracts and because they may have terms exceeding seven days, swap agreements
may be considered to be illiquid. Moreover, a Fund bears the risk of loss of the
amount expected to be received under a swap agreement in the event of the
default or bankruptcy of a swap agreement counter-party. The Adviser will cause
a Fund to enter into swap agreements only with counter-parties that would be
eligible for consideration as repurchase agreement counter-parties. Restrictions
imposed by the Internal Revenue Code of 1986, as amended (the "Code") may limit
the Funds' ability to use swap agreements. The swaps market is a relatively new
market and is largely unregulated. It is possible that developments in the swaps
market, including potential government regulation, could adversely affect a
Fund's ability to terminate existing swap agreements or to realize amounts to be
received under such agreements.
Page B-17
<PAGE> 25
RISK FACTORS RELATING TO INVESTING IN HIGH-YIELD SECURITIES
Lower-rated or unrated (i.e. high-yield) securities are more likely to
react to developments affecting market risk (such as interest rate sensitivity,
market perception of creditworthiness of the issuer and general market
liquidity) and credit risk (such as the issuer's inability to meet its
obligations) than are more highly rated securities, which react primarily to
movements in the general level of interest rates. The Adviser considers both
credit risk and market risk in making investment decisions for the Funds.
Investors should carefully consider the relative risk of investing in high-yield
securities and understand that such securities are not generally meant for
short-term trading.
The amount of high-yield securities outstanding proliferated in the
1980's in conjunction with the increase in merger and acquisition and leveraged
buyout activity. Under adverse economic conditions, there is a risk that highly
leveraged issuers may be unable to service their debt obligations upon maturity.
In addition, the secondary market for high-yield securities, which is
concentrated in relatively few market makers, may not be as liquid as the
secondary market for more highly rated securities. Under adverse market or
economic conditions, the secondary market for high-yield securities could
contract further, independent of any specific adverse changes in the condition
of a particular issuer. As a result, the Adviser could find it more difficult to
sell these securities or may be able to sell the securities only at prices lower
than if such securities were widely traded. Prices realized upon the sale of
such lower-rated or unrated securities, under these circumstances, may be less
than the prices used in calculating the Funds' net asset value.
Lower-rated or unrated debt obligations present risks based on payment
expectations. If an issuer calls the obligation for redemption, a Fund may have
to replace the security with a lower yielding security, resulting in a decreased
return for investors. If a Fund experiences unexpected net redemptions, it may
be forced to sell its higher- rated securities, resulting in a decline in the
overall credit quality of the Fund's portfolio and increasing the exposure of
the Fund to the risks of high-yield securities.
ILLIQUID SECURITIES
A Fund may not invest more than 15% of its net assets in repurchase
agreements which have a maturity of longer than seven days or in other illiquid
securities, including securities that are illiquid by virtue of the absence of a
readily available market (either within or outside of the United States) or
legal or contractual restrictions of resale. Historically, illiquid securities
have included securities subject to contractual or legal restrictions on resale
because they have not been registered under the Securities Act, securities which
are otherwise not readily marketable and repurchase agreements have a maturity
of longer than seven days. Securities which have not been registered under the
Securities Act are referred to as private placements or restricted securities
and are purchased directly from the issuer or in the secondary market. Mutual
funds do not typically hold a significant amount of these restricted or other
illiquid securities because of the potential for delays on resale and
uncertainty in valuation. Limitations on resale may have an adverse effect on
the marketability of portfolio securities and a mutual fund might be unable to
dispose of restricted or other illegal securities promptly or at reasonable
prices and might thereby experience difficulty satisfying redemptions within
seven days. A mutual fund might also have to register such restricted securities
in order to dispose of them resulting in additional expense and delay. Adverse
market conditions could impede such a public offering of securities. Currently
the Funds may invest in securities issued in private placements.
In recent years, however, a large institutional market has developed
for certain securities that are not registered under the Securities Act,
including repurchase agreements, commercial paper, foreign securities, municipal
securities, convertible securities and corporate bonds and notes. Institutional
investors depend on an efficient institutional market in which the unregistered
security can be readily resold or on an issuer's ability to honor a demand for
repayment. The fact that there are contractual or legal restrictions on resale
to the general public or to certain institutions may not be indicative of the
liquidity of such investments.
Page B-18
<PAGE> 26
Rule 144A under the Securities Act allows for a broader institutional
trading market for securities otherwise subject to restriction on resale to the
general public. Rule 144A established a "safe harbor" from the registration
requirements of the Securities Act for resales of certain securities to
qualified institutional buyers. The Adviser anticipates that the market for
certain restricted securities such as institutional commercial paper and foreign
securities will expand further as a result of this rule and the development of
automated systems for the trading, clearance and settlement of unregistered
securities of domestic and foreign issuers, such as the PORTAL System sponsored
by the National Association of Securities Dealers, Inc.
Restricted securities eligible for resale pursuant to Rule 144A under
the Securities Act and commercial paper for which there is a readily available
market will not be deemed to be illiquid. The Adviser will monitor the liquidity
of such restricted securities subject to the supervision of the Trustees. In
reaching liquidity decisions, the Adviser will consider, inter alia, the
following factors: (1) the frequency of trades and quotes for the security; (2)
the number of dealers wishing to purchase or sell the security and the number of
other potential purchasers; (3) dealer undertakings to make a market in the
security; and (4) the nature of the security and the nature of the marketplace
trades (e.g. the time needed to dispose of the security, the method of
soliciting offers and the mechanics of the transfer). In addition, in order for
commercial paper that is issued in reliance on Section 4(2) of the Securities
Act to be considered liquid, (i) it must be rated in one or two of the highest
rating categories by at least two nationally recognized statistical rating
organizations ("NRSRO"), or if only one NRSRO rates the securities, by that
NRSRO, or, if unrated, be of comparable quality in the view of the Adviser, and
(ii) it must not be "traded flat" (i.e., without accrued interest) or in default
as to principal or interest. Investing in Rule 144A securities could have the
effect of increasing the level of Fund illiquidity to the extent that qualified
institutional buyers become, for a time, uninterested in purchasing these
securities. Repurchase agreements subject to demand are deemed to have a
maturity equal to the notice period.
Page B-19
<PAGE> 27
MANAGEMENT
----------
TRUSTEES AND OFFICERS
The Trustees and officers of the Trust are:
<TABLE>
<CAPTION>
POSITION PRINCIPAL OCCUPATIONS
NAME AND ADDRESS AGE WITH THE TRUST DURING PAST FIVE YEARS
- ---------------- --- -------------- ----------------------
<S> <C> <C> <C>
Scott B. Dubchansky* 36 Chief Executive Mr. Dubchansky served as Managing
10880 Wilshire Blvd., Suite 2020 Officer and Trustee Director-Fixed Income of Metropolitan West
Los Angeles, CA 90024 Securities, Inc. from August, 1996 through
December, 1996 while the Adviser was in
formation. From August, 1992 through
August, 1996, Mr. Dubchansky was a
Senior Vice President of Donaldson
Lufkin Jenrette in the Fixed Income
division. Prior to August, 1992, Mr.
Dubchansky was Senior Vice President
fixed income sales at Kidder Peabody and
responsible for fixed income sales to
institutional clients.
Keith T. Holmes* 44 Trustee Mr. Holmes has been a partner of the law
2121 Avenue of the Stars, firm King, Purtich, Holmes, Paterio &
22nd Floor Berliner (and its predecessor firm King,
Los Angeles, CA 90067 Purtich & Holmes) since 1992. Mr. Holmes
practices corporate finance and real estate
law. Mr. Holmes' firm has performed legal
services for the Adviser and its affiliates.
Martin Luther King III 39 Trustee Since 1980, Mr. King has been engaged as an
P.O. Box 50608 independent motivational lecturer. From
Atlanta, GA 30314 January 1987 until November 1993, Mr. King
was County Commissioner for Fulton County
in Atlanta, Georgia.
Daniel D. Villanueva 59 Trustee Mr. Villanueva is the Chairman and
1999 Avenue of the Stars, Managing Director of Bastion Capital
No. 2960 Corporation (investments).
Los Angeles, CA 90067
James Michael Lippman 39 Trustee Since 1990, Mr. Lippman has been the
11766 Wilshire Boulevard President of JRK Asset Management, Inc., a
Los Angeles, CA 90025 real estate firm that is primarily engaged in
owning and operating multi-family and
hotel properties. From 1990 to 1993, Mr.
Lippman was Managing Director of The
Signature Group, a real estate
investment fund.
- -------------------
<FN>
* "Interested" Trustee, as defined in the 1940 Act, due to the relationship
indicated with the Adviser.
</TABLE>
Page B-20
<PAGE> 28
The Trust does not pay salaries to any of its Officers or fees to any
of its Trustees who are affiliated with the Adviser. Dis-interested Trustees
receive an annual retainer of 3,000 and $750 for each meeting of the Board of
Trustees attended.
For information as to ownership of shares by officers and Trustees of
the Trust, see below under [["General Information About the Trust."]] "CONTROL
PERSONS AND PRINCIPAL HOLDERS OF SECURITIES."
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
As of October 20, 1997, the Trustees and officers of the Trust,
individually and as a group, owned beneficially less than 1% of the outstanding
shares of the TOTAL RETURN BOND FUND and LOW DURATION BOND FUND and of the
Trust.
As of October 20, 1997, the following persons owned beneficially more
than 5% of the outstanding voting shares of the:
FUND PERCENT OWNERSHIP
TOTAL RETURN BOND FUND:
Clark College Fund 26.73%
Portland, OR
Charles Schwab & Co. 25.18%
San Francisco, CA
Edward R. Hall Share "A" Trust 17.67%
Portland, OR
Nike, Inc. 401(k) 12.66%
Chicago, IL
McRae Foundation, Inc. 8.39%
Jackson, MS
LOW DURATION BOND FUND:
MJ Murdock Charitable Trust 28.84%
Pittsburgh, PA
Charles Schwab & Co. 25.16%
San Francisco, CA
McKinsey Master Retirement Trust 24.03%
New York, NY
Clark College Fund 5.17%
Portland, OR
Language indicated as being shown by strike out in the typeset document is
enclosed in double brackets "[[" and "]]" in the electronic format.
Page B-21
<PAGE> 29
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Investment Advisory Agreement states that in connection with its
duties to arrange for the purchase and sale of securities held in the portfolio
of each Fund by placing purchase and sale orders for that Fund, the Adviser
shall select such broker-dealers ("brokers") as shall, in the Adviser's
judgment, implement the policy of the Trust to achieve "best execution", i.e.,
prompt and efficient execution at the most favorable securities price. In making
such selection, the Adviser is authorized in the Agreement to consider the
reliability, integrity and financial condition of the broker. (It is the
Adviser's current practice generally to pay brokerage commissions at rates
determined by the Adviser, based on the Adviser's assessment of the difficulty
of execution.)
The Adviser is also authorized by the Agreement to consider whether the
broker provides brokerage and/or research services to the Funds and/or other
accounts of the Adviser. The Agreement states that the commissions paid to
brokers may be higher than another broker would have charged if a good faith
determination is made by the Adviser that the commission is reasonable in
relation to the services provided, viewed in terms of either that particular
transaction or the Adviser's overall responsibilities as to the accounts as to
which it exercises investment discretion and that the Adviser shall use its
judgment in determining that the amount of commissions paid are reasonable in
relation to the value of brokerage and research services provided and need not
place or attempt to place a specific dollar value on such services or on the
portion of commission rates reflecting such services. The Agreement provides
that to demonstrate that such determinations were in good faith, and to show the
overall reasonableness of commissions paid, the Adviser shall be prepared to
show that commissions paid (i) were for purposes contemplated by the Agreement;
(ii) were for products or services which provide lawful and appropriate
assistance to the Adviser's decision-making process; and (iii) were within a
reasonable range as compared to the rates charged by brokers to other
institutional investors as such rates may become known from available
information. The Adviser is also authorized to consider sales of shares of each
Fund and/or of any other investment companies for which the Adviser acts as
Adviser as a factor in the selection of brokers to execute brokerage and
principal transactions, subject to the requirements of "best execution," as
defined above.
The research services discussed above may be in written form or through
direct contact with individuals and may include information as to particular
companies and securities as well as market, economic, or institutional areas and
information assisting the Trust in the valuation of the Funds' investments. The
research which the Adviser receives for the Funds' brokerage commissions,
whether or not useful to a Fund, may be useful to the Adviser in managing the
accounts of the Adviser's other advisory clients. Similarly, the research
received for the commissions of such accounts may be useful to any Fund.
In the over-the-counter market, securities are generally traded on a
"net" basis with dealers acting as principal for their own accounts without a
stated commission although the price of the security usually includes a profit
to the dealer. Money market instruments usually trade on a "net" basis as well.
On occasion, certain money market instruments may be purchased by the Funds
directly from an issuer in which case no commissions or discounts are paid. In
underwritten offerings, securities are purchased at a fixed price which includes
an amount of compensation to the underwriter, generally referred to as the
underwriter's concession or discount.
Page B-22
<PAGE> 30
ADMINISTRATOR
The Funds have an Administration Agreement with FPS Services, Inc. (the
"Administrator"), with offices at 3200 Horizon Drive, P.O. Box 61503, King of
Prussia, Pennsylvania 19406-0903. The Administration Agreement provides that the
Administrator will prepare and coordinate reports and other materials supplied
to the Trustees; prepare and/or supervise the preparation and filing of all
securities filings, periodic financial reports, prospectuses, statements of
additional information, marketing materials, tax returns, shareholder reports
and other regulatory reports or filings required of the Funds; prepare all
required filings necessary to maintain the Funds' qualifications and/or
registrations to sell shares in all states where each Fund currently does, or
intends to do, business; coordinate the preparation, printing and mailing of all
materials (e.g., Annual Reports) required to be sent to shareholders; coordinate
the preparation and payment of Fund-related expenses; monitor and oversee the
activities of the Funds' servicing agents (i.e., transfer agent, custodian, fund
accountants, etc.); review and adjust as necessary each Fund's daily expense
accruals; and perform such additional services as may be agreed upon by the
Funds and the Administrator. For its services, the Administrator receives an
annual fee of .0015% of the first $50 million of the Trust's average daily net
assets, .0010 % of the next $50 million and .0005% over $100 million, subject to
a minimum annual fee of $55,000.
DISTRIBUTOR
FPS Broker Services, Inc. (the "Distributor"), a broker-dealer
affiliated with the Administrator, acts as each Fund's principal underwriter in
a continuous public offering of the Fund's shares. After its initial term of two
years, the Underwriting Agreement between the Funds, the Adviser and the
Distributor continues in effect for periods not exceeding one year if approved
at least annually by (i) the Board of Trustees or the vote of a majority of the
outstanding shares of each Fund (as defined in the 1940 Act) and (ii) a majority
of the Trustees who are not parties to such agreement or interested persons of
any such party, in each case cast in person at a meeting called for the purpose
of voting on such approval. The Distribution Agreement may be terminated without
penalty by the parties thereto upon 60-days' written notice, and is
automatically terminated in the event of its assignment as defined in the 1940
Act.
SHARE MARKETING PLAN
The Trust has adopted has adopted a Share Marketing Plan (or Rule 12b-1
Plan) (the "12-b-1 Plan") with respect to the Funds Pursuant to Rule 12b-1 under
the 1940 Act. The Adviser serves as the distribution coordinator under the 12b-1
Plan and, as such, receives for disbursement any fees paid by the Funds pursuant
to the 12b-1 Plan.
On April 1, 1997, the Board of Trustees of the Trust, including a
majority of the Trustees who are not interested persons of the Trust and who
have no direct or indirect financial interest in the operation of the 12b-1 Plan
or in any agreement related to the 12b-1 Plan (the "Independent Trustees")
adopted the 12b-1 Plan.
Under the 12b-1 Plan, each Funds pays distribution fees to the Adviser
at an annual rate of up to 0.25% of the Fund's aggregate average daily net
assets to reimburse the Adviser for its expenses in connection with the
promotion and distribution of the shares. The Funds and the Adviser presently
are waiving all Rule 12b-1 fees. The Funds would notify shareholders in writing
at least 30 days before rescinding that waiver.
The 12b-1 Plan provides that the Adviser may use the Rule 12b-1
distribution fees received from a Fund only to pay for the distribution expenses
of that Fund. Distribution fees are accrued daily and paid monthly, and are
charged as expenses of the shares as accrued.
A Fund's shares are not obligated under the 12b-1 Plan to pay any
distribution expense in excess of the distribution fee. Thus, if the 12b-1 Plan
were terminated or otherwise not continued, no amounts (other than current
amounts accrued but not yet paid) would be owed to the Adviser.
Page B-23
<PAGE> 31
The 12b-1 Plan provides that it shall continue in effect from year to
year provided that a majority of the Board of Trustees of the Trust, including a
majority of the Independent Trustees, vote annually to continue the 12b-1 Plan.
The 12b-1 Plan (and any distribution agreement between the Trust, the
Distributor or the Adviser and a selling agent) may be terminated without
penalty upon at least 60-days' notice by the Distributor or the Adviser, or by
the Trust by vote of a majority of the Independent Trustees, or by vote of a
majority of the outstanding shares (as defined in the 1940 Act).
All distribution fees paid by the Funds under the 12b-1 Plan will be
paid in accordance with Conduct Rule 2830 of the National Association of
Securities Dealers, Inc., as such Rule may change from time to time. Pursuant to
the 12b-1 Plan, the Board of Trustees will review at least quarterly a written
report of the distribution expenses incurred by the Adviser on behalf of each
Fund. In addition, as long as the 12b-1 Plan remains in effect, the selection
and nomination of Trustees who are not interested persons (as defined in the
Investment Company Act) of the Trust shall be made by the Trustees then in
office who are not interested persons of the Trust.
NET ASSET VALUE
---------------
As indicated in the Prospectus, the net asset value per share of each
Fund's shares will be determined at the close of the New York Stock Exchange
(the "NYSE") (currently 4:00 p.m. New York time) on each day that the NYSE is
open for trading and banks are open for business. The NYSE annually announces
the days on which it will not be open for trading; the most recent announcement
indicates that it will not be open on the following days: New Year's Day, Martin
Luther King Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving Day and Christmas Day. Banks are also closed on
Columbus Day and Veterans' Day. However, the NYSE and banks may close on days
not included in that announcement. Also, no Fund is required to compute its net
asset value on any day on which no order to purchase or redeem its shares is
received.
Fixed-income securities which are traded on a national securities
exchange will be valued at the last sale price or, if there was no sale on such
day, at the average of readily available closing bid and asked prices on such
exchange. However, securities with a demand feature exercisable within one to
seven days are valued at par. [[Prices for fixed income securities may be based
on quotations received from one or more market makers in the securities, or on
evaluations from pricing services.]] The Funds receive pricing information from
Interactive Data Corporation ("IDC") and other independent pricing vendors. IDC
and others, including Merrill Lynch, Bloomberg and Muller, are regarded as some
of the more common sources of readily available pricing information for
fixed-income securities. Prices provided by IDC and other private vendors also
may be based on quotations from one or more market makers.
The Funds use a benchmark pricing system to the extent prices for
securities are either inaccurate (such as when the prices are different from
recent known market transactions) or are not available from IDC or another
pricing source. For a security priced using this system, the Adviser initially
selects a benchmark composed of a relevant U.S. Treasury security and a
multiplier or divisor that the Adviser believes would together best reflect
changes in the market value of the security. The Adviser adjusts the value of
the security daily based on changes to the market price of the assigned
benchmark. Once each month the Adviser obtains from one or more dealers an
independent review of prices produced by the benchmark system as well as a
review of the benchmark selected to adjust the price. Although the Adviser
believes that benchmark pricing is the most reliable method for pricing
securities not priced by IDC or others, there is no assurance that the benchmark
price reflects the actual price for which a Fund could sell a security. The
accuracy of benchmark pricing depends on the judgment of one or more market
makers regarding a security's market price, as well as the choice of the
appropriate benchmark, subject to review by the Adviser. The benchmark pricing
system is continuously reviewed by the Adviser and implemented according to the
pricing policy reviewed by the Board of Trustees.
Debt securities which mature in less than 60 days are valued at
amortized cost (unless the Board of Trustees determines that this method does
not represent fair value), if their original maturity was 60 days or less or by
amortizing the value as of the 61st day prior to maturity, if their original
term to maturity exceeded 60 days.
Language indicated as being shown by strike out in the typeset document is
enclosed in double brackets [[" and "]] in the electronic format.
Page B-24
<PAGE> 32
[[In determining the net asset value of each Fund's shares, equity
securities that are listed on a securities exchange (whether domestic or
foreign) or quoted by the Nasdaq Stock Market are valued at the last sale price
on that day as of the close of regular trading on the NYSE (which is currently
4:00 p.m., New York time), or, in the absence of recorded sales, at the average
of readily closing bid and asked prices on the NYSE or Nasdaq. Unlisted equity
securities that are not included on Nasdaq are valued at the average of the
quoted bid and asked prices in the over-the-counter market.]]
Options, futures contracts and options thereon which are traded on
exchanges are valued at their last sale or settlement price as of the close of
the exchanges or, if no sales are reported, at the average of the quoted bid and
asked prices as of the close of the exchange.
Trading in securities listed on foreign securities exchanges or
over-the-counter markets is normally completed before the close of regular
trading on the NYSE. In addition, foreign securities trading may not take place
on all business days in New York and may occur on days on which the NYSE is not
open. In addition, foreign currency exchange rates are generally determined
prior to the close of trading on the NYSE. Events affecting the value of foreign
securities and currencies will not be reflected in the determination of net
asset value unless the Board of Trustees determines that the particular event
would materially affect net asset value, in which case an adjustment will be
made. Investments quoted in foreign currency are valued daily in U.S. dollars on
the basis of the foreign currency exchange rate prevailing at the time of
valuation. Foreign currency exchange transactions conducted on a spot basis are
valued at the spot rate prevailing in the foreign exchange market.
Securities and other assets [[for which market quotations are not
readily available are]] that cannot be valued as described above will be valued
at their fair value as determined by the Adviser under guidelines established by
and under the general supervision and responsibility of the Board of Trustees.
DIVIDENDS AND TAX STATUS
------------------------
Each Fund intends to elect and qualify to be treated as a regulated
investment company under Subchapter M of the Code. Qualification as a regulated
investment company requires, among other things, that (a) at least 90% of a
Fund's annual gross income, without offset for losses from the sale or other
disposition of securities, be derived from interest, dividends, payments with
respect to securities loans, and gains from the sale or other disposition of
securities, foreign currencies or options (including forward contracts) thereon;
(b) a Fund derive less than 30% of its annual gross income from gains (without
offset for losses) from the sale or other disposition of securities or options
thereon held for less than three months; and (c) a Fund diversify its holdings
so that, at the end of each quarter of the taxable year, (i) at least 50% of the
market value of the Fund's assets is represented by cash, U.S. Government
securities, securities of other regulated investment companies and other
securities limited in respect of any one issuer to an amount not greater than 5%
of the Fund's assets and 10% of the outstanding voting securities of such
issuer, and (ii) not more than 25% of the value of its assets is invested in the
securities of any one issuer (other than U.S. Government securities). In
addition, in order to qualify as a regulated investment company a Fund must
distribute to its shareholders at least 90% of its net investment income, other
than net capital gains, earned in each year. As such, and by complying with the
applicable provisions of the Code, a Fund will not be subject to Federal income
tax on taxable income (including realized capital gains) that it distributes to
shareholders in accordance with the timing requirements of the Code.
A Fund must pay an excise tax to the extent it does not distribute to
its shareholders during each calendar year at least 98% of its ordinary income
for that calendar year, 98% of its capital gains over capital losses for the
one-year period ending October 31 in such calendar year, and all undistributed
ordinary income and capital gains for the preceding respective one-year period.
The Funds intend to meet these distribution requirements to avoid excise tax
liability. The Funds also intend to continue distributing to shareholders all of
the excess of net long-term capital gain over net short-term capital loss on
sales of securities. If the net asset value of shares of a Fund should, by
reason of a distribution of realized capital gains, be reduced below a
shareholder's cost, such distribution would to that extent be a return of
capital to that shareholder even though taxable to the shareholder, and a sale
of shares by a shareholder at net asset value at that time would establish a
capital loss for Federal income tax purposes.
Language indicated as being shown by strike out in the typeset document is
enclosed in double brackets "[[" and "]]" in the electronic format.
Page B-25
<PAGE> 33
In determining the extent to which a Fund's dividends may be eligible
for the 70% dividends received deduction by corporate shareholders, interest
income, capital gain net income, gain or loss from Section 1256 contracts
(described below), dividend income from foreign corporations and income from
other sources will not constitute qualified dividends. Corporate shareholders
should consult their tax advisers regarding other requirements applicable to the
dividends received deduction.
The use of hedging strategies, such as entering into futures contracts
and forward contracts and purchasing options, involves complex rules that will
determine the character and timing of recognition of the income received in
connection therewith by the Funds. Income from foreign currencies (except
certain gains therefrom that may be excluded by future regulations) and income
from transactions in options, futures contracts and forward contracts derived by
a Fund with respect to its business of investing in securities or foreign
currencies will qualify as permissible income under Subchapter M of the Code.
For accounting purposes, when a Fund purchases an option, the premium
paid by the Fund is recorded as an asset and is subsequently adjusted to the
current market value of the option. Any gain or loss realized by a Fund upon the
expiration or sale of such options held by the Fund generally will be capital
gain or loss.
Any security, option, or other position entered into or held by a Fund
that substantially diminishes the Fund's risk of loss from any other position
held by the Fund may constitute a "straddle" for Federal income tax purposes. In
general, straddles are subject to certain rules that may affect the amount,
character and timing of a Fund's gains and losses with respect to straddle
positions by requiring, among other things, that the loss realized on
disposition of one position of a straddle be deferred until gain is realized on
disposition of the offsetting position; that the Fund's holding period in
certain straddle positions not begin until the straddle is terminated (possibly
resulting in the gain being treated as short-term capital gain rather than
long-term capital gain); and that losses recognized with respect to certain
straddle positions, which would otherwise constitute short-term capital losses,
be treated as long-term capital losses. Different elections are available to a
Fund that may mitigate the effects of the straddle rules.
Certain options, futures contracts and forward contracts that are
subject to Section 1256 of the Code ("Section 1256 Contracts") and that are held
by a Fund at the end of its taxable year generally will be required to be
"marked to market" for Federal income tax purposes, that is, deemed to have been
sold at market value. Sixty percent of any net gain or loss recognized on these
deemed sales and 60% of any net gain or loss realized from any actual sales of
Section 1256 Contracts will be treated as long-term capital gain or loss, and
the balance will be treated as short-term capital gain or loss.
A Fund may be subject to foreign withholding taxes on dividends and
interest earned with respect to securities of foreign corporations. A Fund may
invest in the stock of foreign investment companies that may be treated as
"passive foreign investment companies" ("PFICs") under the Code. Certain other
foreign corporations, not operated as investment companies, may nevertheless
satisfy the PFIC definition. A portion of the income and gains that a Fund
derives from PFIC stock may be subject to a non-deductible Federal income tax at
the Fund level. In some cases, a Fund may be able to avoid this tax by electing
to be taxed currently on its share of the PFIC's income, whether or not such
income is actually distributed by the PFIC. Each Fund will endeavor to limit its
exposure to the PFIC tax by investing in PFICs only where the election to be
taxed currently will be made. Because it is not always possible to identify a
foreign issuer as a PFIC in advance of making the investment, a Fund may incur
the PFIC tax in some instances.
Page B-26
<PAGE> 34
Under Section 988 of the Code, gains or losses attributable to
fluctuations in exchange rates which occur between the time a Fund accrues
interest or other receivables or accrues expenses or other liabilities
denominated in a foreign currency and the time the Fund actually collects such
receivables or pays such liabilities are treated as ordinary income or loss.
Similarly, gains or losses on forward foreign currency exchange contracts (other
than forward foreign currency exchange contracts that are governed by Section
1256 of the Code and for which no election is made) or dispositions of debt
securities denominated in a foreign currency attributable to fluctuations in the
value of the foreign currency between the date of acquisition of the security
and the date of disposition are also treated as ordinary gain or loss. These
gains and losses, referred to as "Section 988" gains or losses, increase or
decrease the amount of a Fund's investment company taxable income available to
be distributed to its shareholders as ordinary income, rather than increasing or
decreasing the Fund's net capital gain. If a Fund's Section 988 losses exceed
other investment company taxable income during a taxable year, the Fund would
not be able to make any ordinary dividend distributions, or distributions made
before the losses were realized would be recharacterized as a return of capital
to shareholders, rather than as an ordinary dividend, reducing the basis of each
shareholder's shares.
Any loss realized on a sale, redemption or exchange of shares of a Fund
by a shareholder will be disallowed to the extent the shares are replaced within
a 61-day period (beginning 30 days before the disposition of shares). Shares
received in connection with the payment of a dividend by a Fund constitute a
replacement of shares.
The above discussion and the related discussion in the prospectus are
not intended to be complete discussions of all applicable Federal tax
consequences of an investment in a Fund. [[Heller Ehrman White & McAuliffe]]
Paul, Hastings Janofsky & Walker, LLP has expressed no opinion in respect
thereof. Nonresident aliens and other foreign persons are subject to different
tax rules, and may be subject to United States Federal income tax withholding of
up to 30% on certain payments received from a Fund. Shareholders are advised to
consult with their own tax advisers concerning the application of Federal,
state, local, and foreign taxes to an investment in a Fund.
PERFORMANCE INFORMATION
-----------------------
TOTAL RETURN: Average annual total return quotations used in the Funds'
advertising and promotional materials are calculated according to the following
formula:
P(1 + T) to the nth power = ERV
where P equals a hypothetical initial payment of $1000; T equals
average annual total return; n equals the number of years; and ERV equals the
ending redeemable value at the end of the period of a hypothetical $1000
payment made at the beginning of the period.
Under the foregoing formula, the time periods used in advertising will
be based on rolling calendar quarters, updated to the last day of the most
recent quarter prior to submission of the advertising for publication. Average
annual total return, or "T" in the above formula, is computed by finding the
average annual compounded rates of return over the period that would equate the
initial amount invested to the ending redeemable value. Average annual total
return assumes the reinvestment of all dividends and distributions.
Language indicated as being shown by strike out in the typeset document is
enclosed in double brackets "[[" and "]]" in the electronic format.
Page B-27
<PAGE> 35
YIELD: Annualized yield quotations used in a Fund's advertising and
promotional materials are calculated by dividing the Fund's income for a
specified 30-day period, net of expenses, by the average number of shares
outstanding during the period, and expressing the result as an annualized
percentage (assuming semi-annual compounding) of the net asset value per share
at the end of the period. Yield quotations are calculated according to the
following formula:
YIELD = 2 [ (a-b + 1) to the 6th power - 1]
---
cd
where a equals dividends and interest earned during the period; b
equals expenses accrued for the period, net of reimbursements; c equals the
average daily number of shares outstanding during the period that are entitled
to receive dividends; and d equals the maximum offering price per share on the
last day of the period.
Except as noted below, in determining net investment income earned
during the period ("a" in the above formula), a Fund calculates interest earned
on each debt obligation held by it during the period by (1) computing the
obligation's yield to maturity, based on the market value of the obligation
(including actual accrued interest) on the last business day of the period or,
if the obligation was purchased during the period, the purchase price plus
accrued interest; (2) dividing the yield to maturity by 360; and (3)
multiplying the resulting quotient by the market value of the obligation
(including actual accrued interest). Once interest earned is calculated in this
fashion for each debt obligation held by the Fund, net investment income is
then determined by totaling all such interest earned.
For purposes of these calculations, the maturity of an obligation with
one or more call provisions is assumed to be the next date on which the
obligation reasonably can be expected to be called or, if none, the maturity
date.
OTHER INFORMATION: Each Fund's performance data quoted in advertising
and other promotional materials represents past performance and is not intended
to predict or indicate future results. The return and principal value of an
investment in a Fund will fluctuate, and an investor's redemption proceeds may
be more or less than the original investment amount. In advertising and
promotional materials a Fund may compare its performance with data published by
Lipper Analytical Services, Inc. ("Lipper") or CDA Investment Technologies,
Inc. ("CDA"). The Fund also may refer in such materials to mutual fund
performance rankings and other data, such as comparative asset, expense and fee
levels, published by Lipper or CDA. Advertising and promotional materials also
may refer to discussions of the Fund and comparative mutual fund data and
ratings reported in independent periodicals including, but not limited to, The
Wall Street Journal, Money Magazine, Forbes, Business Week, Financial World and
Barron's.
GENERAL INFORMATION ABOUT THE TRUST
-----------------------------------
The Declaration of Trust permits the Trustees to issue an unlimited
number of full and fractional shares of beneficial interest and to divide or
combine the shares into a greater or lesser number of shares without thereby
changing the proportionate beneficial interest in each Fund. Each share
represents an interest in a Fund proportionately equal to the interest of each
other share. Upon the Trust's liquidation, all shareholders would share pro
rata in the net assets of the Fund in question available for distribution to
shareholders. If they deem it advisable and in the best interest of
shareholders, the Board of Trustees may create additional classes of shares
which differ from each other only as to dividends. Each of such classes has or
will have a designation including the word "Series." Income and operating
expenses not specifically attributable to a particular Fund are allocated
fairly among the Funds by the Trustees, generally on the basis of the relative
net assets of each Fund.
The Declaration of Trust provides that the Trustees will not be liable
for errors of judgment or mistakes of fact or law, but nothing in the
Declaration of Trust protects a Trustee against any liability to which he would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his
office. The Declaration of Trust also provides that the Trust shall, upon
request, assume the defense of any claim made against any shareholder for any
act or obligation of the Trust and satisfy any judgment thereon.
Page B-28
<PAGE> 36
The Trust's custodian is responsible for holding the Funds' assets and
acts as the Trust's accounting services agent. Subcustodians provide custodial
services for assets of the Trust held outside the U.S. The Trust's independent
accountants examine the Trust's financial statements and assist in the
preparation of certain reports to the Securities and Exchange Commission.
ADDITIONAL INFORMATION
----------------------
LEGAL OPINION
The validity of the shares offered by the Prospectus will be passed
upon by [[Heller, Ehrman, White & McAuliffe, 333 Bush Street]] Paul, Hastings,
Janofsky & Walker, LLP, 345 California Street, San Francisco, California
94104.
AUDITORS
The annual financial statements of the Funds will be audited by
Deloitte & Touche LLP, independent public accountant for the Funds.
LICENSE TO USE NAME
Metropolitan West Securities, Inc. has granted the Trust and each Fund
the right to use the designation "Metropolitan West" in its name, and has
reserved the right to withdraw its consent to the use of such designation
under certain conditions, including the termination of the Adviser as the
Funds' investment adviser. Metropolitan West also has reserved the right to
license others to use this designation, including any other investment
company.
OTHER INFORMATION
The Prospectus and this Statement of Additional Information, together,
do not contain all of the information set forth in the Registration Statement
of Metropolitan West Funds filed with the Securities and Exchange Commission.
Certain information is omitted in accordance with rules and regulations of the
Commission. The Registration Statement may be inspected at the Public
Reference Room of the Commission at Room 1024, 450 Fifth Street, N.W.,
Judiciary Plaza, Washington, D.C. 20549, and copies thereof may be obtained
from the Commission at prescribed rates.
FINANCIAL STATEMENTS
--------------------
Statements of Assets and Liabilities for the TOTAL RETURN BOND FUND and
the LOW DURATION BOND FUND, as of March 27, 1997 and accompanying notes,
together with the Independent Auditor's Report dated March 27, 1997, are
attached to this Statement of Additional Information.
Unaudited semi-annual financial statements for the TOTAL RETURN BOND
FUND and LOW DURATION BOND FUND, including the notes thereto, dated as of
September 30, 1997, are attached to this Statement of Additional Information.
Language indicated as being shown by strike out in the typeset document is
enclosed in double brackets "[[" and "]]" in the electronic format.
Page B-29
<PAGE> 37
METROPOLITAN WEST FUNDS
STATEMENTS OF ASSETS AND LIABILITIES
MARCH 27, 1997
<PAGE> 38
METROPOLITAN WEST FUNDS
STATEMENTS OF ASSETS AND LIABILITIES
MARCH 27, 1997
<TABLE>
<CAPTION>
ASSETS
TOTAL RETURN LOW DURATION
BOND FUND BOND FUND
<S> <C> <C>
Cash $ 50,000 $ 50,000
Deferred Organization Costs 17,500 17,500
-------- --------
Total Assets 67,500 67,500
LIABILITIES
Accrued Expenses 17,500 17,500
-------- --------
Net Assets $ 50,000 $ 50,000
======== ========
Fund shares (unlimited authorization - $0.01 par value)
5,000 outstanding shares of beneficial interest of
each Fund
Net asset value $ 10.00 $ 10.00
======== ========
</TABLE>
<PAGE> 39
METROPOLITAN WEST FUNDS
Statements of Assets and Liabilities
March 27, 1997
1. Organization
------------
The Metropolitan West Funds (the "Trust") was organized as a Delaware
Business Trust under a Trust Instrument dated December 9, 1996 and is
registering under the Investment Company Act of 1940, as amended, as an
open-end investment company to consist of three separate diversified
portfolios (the "Funds"), each of which is a separate mutual fund. The
Funds are the Total Return Bond fund, Low duration Bond Fund and the
Short-Term Investment Fund. The Funds have not commenced operations
except those related to organizational matters and the sale of initial
shares of beneficial interest to the initial shareholders in the Total
Return Bond Fund and the Low Duration Bond Fund.
It is the intention of the Funds to qualify and elect treatment as
"regulated investment companies" under Subchapter M of the Internal
Revenue Code of 1986, as amended (the "Code"), by complying with the
provisions available to certain investment companies as defined in
applicable sections of the Code, and to make distributions of taxable
income to shareholders sufficient to relieve the Funds from all, or
substantially all, federal income tax.
The preparation of the accompanying financial statements in conformance
with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amount of
assets and liabilities at the date of the financial statements. Actual
results may differ from these estimates.
2. Investment Advisory, Management, Distribution and Shareholder Servicing
-----------------------------------------------------------------------
Agreements
----------
The Trust has entered into the following service agreements:
An Investment Advisory Agreement pursuant to which Metropolitan West
Asset Management, LLC (the "Adviser") will act as the investment
adviser to the Funds. For providing investment advisory services, the
Adviser receives a fee,
<PAGE> 40
accrued daily and paid monthly, at the following annual percentages of
average daily net assets: Total Return Bond Fund - 0.55%, Low Duration
Bond Fund - 0.48%, and Short-Term Investment Fund - 0.40%. The Adviser
has voluntarily agreed to limit the annual operating expenses of the
Total Return Bond Fund to 0.65%, the Low Duration Bond Fund to 0.58%
and the Short-Term Investment Fund to 0.50% of each Fund's respective
average net assets.
An Administration Agreement pursuant to which FPS Services, Inc.
("FPS") will provide the Trust with overall management services.
Subject to a minimum fee of $55,000 per year for the first portfolio
and $12,000 per year for each additional portfolio or class, the Trust
agrees to pay FPS each month a fee at the annual rate of 0.15% on the
first $50 million of average net assets of the Trust, 0.10% on the next
$50 million, and 0.05% on average net assets greater than $100 million
for these administrative services.
A Distribution Services Agreement pursuant to which FPS Broker
Services, Inc. will serve as the Fund's distributor. The Funds have
adopted a Rule 12b-1 plan to pay for distribution expenses. The Funds
may charge up to an annual rate of .25% of average net assets but
currently are waiving all Rule 12b-1 fees.
A Transfer Agent Services Agreement and Accounting Services Agreement
pursuant to which FPS will act as the transfer agent and fund
accounting service provider for the Trust, respectively.
3. Deferred Organizational Costs
-----------------------------
Organizational costs have been capitalized by the Funds and are being
amortized on a straight line basis over 60 months commencing with
operations. In the event any of the initial shares are redeemed by the
holder thereof during the period that the Funds are amortizing its
organizational costs, the redemption proceeds payable to the holder
thereof by the Funds will be reduced by the unamortized organizational
costs in the same ratio as the number of initial shares being redeemed
bears to the number of initial shares outstanding at the time of the
redemption.
<PAGE> 41
4. Transactions with Affiliates
----------------------------
The Adviser intends to pay $35,000 of organization costs on behalf of
the Funds.
Certain officers and/or trustees of the Trust are also officers of the
Adviser. The Trust pays each unaffiliated Trustee a fee for attendance
at quarterly, interim and committee meetings. Compensation of officers
and affiliated Trustees of the Trust is paid by the Adviser.
5. Disclosure of Credit Risk
-------------------------
Cash is held at The Bank of New York. The Funds have a policy of
reviewing, as considered necessary, the credit standing of each bank
with which it conducts business.
<PAGE> 42
Independent Auditors' Report
To the Shareholders and Board of Trustees of the Metropolitan West Funds:
We have audited the accompanying statements of assets and liabilities of the
Metropolitan West Total Return Bond Fund and the Metropolitan West Low Duration
Bond Fund (the "Funds") as of March 27, 1997. These financial statements are the
responsibility of the Funds' management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements present fairly, in all material
respects, the financial position of the Metropolitan West Total Return Bond Fund
and the Metropolitan West Low Duration Bond Fund as of March 27, 1997, in
conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Los Angeles, California
March 27, 1997
<PAGE> 43
(Metropolitan West Funds Logo)
SEMI-ANNUAL REPORT
(Unaudited)
September 30, 1997
<PAGE> 44
October 28, 1997
Dear Shareholder,
We are pleased to enclose the semi-annual report for the Metropolitan West Low
Duration and Total Return Bond Funds for the period ending September 30, 1997.
From the inception of the Funds on March 31, 1997, i.e., 6 days after the
Federal Reserve raised short term interest rates, through September 30, 1997 the
interest rate environment has been favorable to bond investors. Yields on
two-year Treasury securities have fallen from 6.41% on March 31, 1997 to 5.78%
at month-end September. Ten-year Treasury yields have fallen from 6.91% to 6.11%
over the same period. This downward move of 63 and 80 basis points respectively
has had a positive impact on the Net Asset Values of our Funds. The Low Duration
Bond Fund Net Asset Value closed at 10.17 and the Total Return Bond Fund Net
Asset Value closed at 10.43.
In addition, performance versus our benchmark indices was also strong. The Low
Duration Bond Fund has returned an absolute 4.88% for the 6-month period versus
the Merrill Lynch 1-3 Year U.S. Treasury Index return of 4.21% over the same
period. The Total Return Bond Fund returned 7.77% while the Lehman Aggregate
Index performance for the same period was 7.14%.
We welcome all of our new shareholders to the Funds and appreciate your support
and confidence in our style of fixed income management. The portfolio managers
of Metropolitan West Asset Management, LLC, (the adviser to the Funds) led by
Tad Rivelle, Laird Landmann and Stephen Kane are pleased with their initial
efforts to create high quality, highly diversified portfolios.
As always, our philosophy is to maintain open and frequent communications with
our shareholders. Feel free to contact us at (310) 446-7727 if you have any
comments, questions or suggestions.
Sincerely,
Scott Dubchansky
President & Trustee
<PAGE> 45
TOTAL RETURN BOND FUND
SCHEDULE OF PORTFOLIO INVESTMENTS
SEPTEMBER 30,1997
(UNAUDITED)
<TABLE>
<CAPTION>
FACE AMOUNT VALUE
------------- ----------
<S> <C> <C> <C> <C>
BONDS--86.68%
ASSET BACKED--l.02%
Household Affinity Credit Card Master Trust I 1994-2 B 7.200 12/15/99 $ 150,000 $ 150,765
----------
CORPORATES--32.11%
BANKS--9.89%
Advanta National Bank 6.020 11/13/97 300,000 299,791
Capital One Bank 8.125 03/01/00 250,000 259,777
MBNA Corp. (FRN)(MTN) 6.069 06/17/02 500,000 499,161
Skandinavinska Enskilda Banken (FRN) 6.781 06/29/49 400,000 406,770
----------
1,465,499
----------
BROKERAGE SERVICES--4.26%
Lehman Brothers Holdings, Inc. (FRN)(MTN) 6.319 03/17/07 400,000 401,840
Salomon, Inc. (FRN)(MTN) 6.075 04/05/99 230,000 229,118
----------
630,958
----------
ELECTRIC UTILITIES--8.66%
Alabama Power Co. 9.000 12/01/24 300,000 332,227
Arkansas Power & Light Co. 8.750 03/01/26 400,000 417,123
Long Island Lighting Co. 8.900 07/15/19 500,000 532,752
----------
1,282,102
----------
INDUSTRIAL--4.26%
Cemex S.A. 10.750 07/15/00 350,000 376,496
RJR Nabisco, Inc. 8.300 04/15/99 250,000 255,107
----------
631,603
----------
SOVEREIGN--2.19%
Republic of Argentina (FRN) 6.750 03/31/05 339,500 324,053
----------
TELECOMMUNICATIONS--2.85%
GTECorp 8.500 04/01/17 400,000 421,492
----------
TOTAL CORPORATES 4,755,707
----------
MORTGAGE-BACKED--27.90%
NON-AGENCY MORTGAGE-BACKED--16.24%
Blackrock Capital Finance L.P. 1997-R2 AP (FRN) 4.760 10/25/35 168,622 167,532
Citicorp Mortgage Securities, Inc. 1992-20 A4 7.500 01/25/07 127,854 128,791
Collateralized Mortgage Obligation Trust 57 D 9.900 02/01/19 164,326 180,136
DLJ Mortgage Acceptance Corp. 1994-Q8 IIS (IO) 1.871 05/25/24 2,725,302 115,978
GE Capital Mortgage Services, Inc. 1994-6 A11 6.500 04/25/24 500,000 448,290
Independent National Mortgage Corp. 1995-N A5 7.500 10/25/25 300,000 304,731
Nomura Asset Securities Corp. 1994-4A 2IO(IO) 1.394 09/25/24 11,080,802 327,161
Northwestern Acceptance Corp. IA 2 (FRN) 13.324 02/20/18 221,452 244,583
Residential Funding Mortgage Securities I 1993-S42 A10 8.300 10/25/08 163,955 162,290
Resolution Trust Corp. 1995-2 B6 (FRN) 6.684 05/25/29 224,378 214,438
Structured Mortgage Asset Residential Trust 1991-7 I(IO) 14.313 12/25/22 470,590 111,765
----------
2,405,695
----------
U.S. AGENCY MORTGAGE-BACKED--11.66%
Fannie Mae 1997-37 Z 9.000 06/18/27 140,629 140,949
Freddie Mac 1164 O (IO) 6.391 11/15/06 1,495,136 230,251
Freddie Mac 1552 Q (FRN) 13.750 10/15/22 227,786 247,401
Freddie Mac 1433 SE 10.150 11/15/22 95,942 98,437
Freddie Mac 1950 SM (FRN) 15.400 04/15/27 375,000 362,051
Freddie Mac 1951 SD (FRN) 16.500 04/15/27 300,000 297,243
Freddie Mac 1963 SB (FRN) 15.600 06/15/27 350,000 350,656
----------
1,726,988
----------
TOTAL MORTGAGE-BACKED 4,132,683
----------
</TABLE>
<PAGE> 46
TOTAL RETURN BOND FUND
SCHEDULE OF PORTFOLIO INVESTMENTS
SEPTEMBER 30,1997
(UNAUDITED)
<TABLE>
<CAPTION>
FACE AMOUNT VALUE
------------- ------------
<S> <C> <C> <C> <C>
U.S. GOVERNMENTS--25.65%
U.S. AGENCY--O.93%
Fannie Mae (Strip) 0.000 10/09/19 600,000 $ 137,786
U.S. TREASURY--24.72%
U.S. Treasury Notes 6.500 05/31/02 370,000 377,284
U.S. Treasury Notes 5.750 08/15/03 879,000 865,816
U.S. Treasury Notes 8.125 08/15/19 1,050,000 1,249,829
U.S. Treasury Notes 6.750 08/15/26 1,125,000 1,168,243
------------
3,661,172
------------
TOTAL U.S. GOVERNMENTS 3,798,958
------------
TOTAL BONDS (COST $12,631,514) 12,838,113
------------
CASH EQUIVALENTS--14.30%
COMMERCIAL PAPER--14.30%
American Bankers Insurance Group 5.800 10/09/97 424,000 423,454
Cox Communications, Inc. 5.700 10/24/97 500,000 498,179
CSX Corp. 5.700 11/03/97 400,000 397,910
Occidental Petroleum Corp. 5.700 10/21/97 450,000 448,575
Whirlpool Corp. 5.680 10/23/97 350,000 348,785
------------
TOTAL CASH EQUIVALENTS (Cost $2,1l6,9O3) 2,116,903
------------
TOTAL INVESTMENTS--100.98% (Cost $14,748,417*) 14,955,016
------------
LIABILITIES, LESS CASH AND OTHER ASSETS--(O.98)% (144,561)
------------
NET ASSETS--100.00% 14,810,455
============
*Cost for Federal income tax purposes is $14,748,417 and net
unrealized appreciation consists of:
Gross unrealized appreciation 260,969
Gross unrealized depreciation (54,370)
----------
Net unrealized appreciation 206,599
==========
(FRN): Floating rate note - The rate disclosed is that in effect at September 30, 1997.
(IO): Interest only
(MTN): Medium term note
</TABLE>
See accompanying notes to financial statements.
<PAGE> 47
LOW DURATION BOND FUND
SCHEDULE OF PORTFOLIO INVESTMENTS
SEPTEMBER 30,1997
(UNAUDITED)
<TABLE>
<CAPTION>
FACE AMOUNT VALUE
--------------- ------------
<S> <C> <C> <C> <C>
BONDS--74.46%
ASSET BACKED SECURITIES--O.85%
Contimortgage Home Equity Loan Trust 1994-4 A6 8.270 12/15/24 $ 78,359 $ 81,887
Olympic Automobile Receivables Trust 1994-B A2 6.850 06/15/01 384,243 387,974
------------
469,861
------------
CORPORATES--38.02%
BANKS--11.88%
Advanta National Bank (FRN) 5.880 10/10/97 500,000 499,949
Advanta National Bank 6.020 11/13/97 1,400,000 1,398,948
Capital One Bank 8.125 02/27/98 900,000 907,966
Capital One Bank 8.125 03/01/00 675,000 701,398
First USA Bank 6.125 10/30/97 100,000 99,998
Kansallis-Osake-Pankki (FRN) 7.830 09/30/43 1,000,000 1,030,800
MBNA Corp. (FRN)(MTN) 6.039 09/13/01 825,000 824,107
Skandinavinska Enskilda Banken (FRN) 6.781 06/29/49 1,100,000 1,118,617
------------
6,581,783
------------
BROKERAGE SERVICES--6.31%
Lehman Brothers Holdings, Inc. (FRN) (MTN) 6.319 03/17/07 1,600,000 1,607,360
Salomon, Inc. (FRN)(MTN) 6.700 12/01/98 100,000 100,141
Salomon, Inc. (FRN)(MTN) 6.200 02/15/99 1,800,000 1,791,332
------------
3,498,833
------------
ELECTRIC UTILITIES--3.44%
Arkansas Power & Light Co. 8.750 03/01/26 600,000 625,685
Long Island Lighting Co. 8.900 07/15/19 1,200,000 1,278,606
------------
1,904,291
------------
FINANCE--2.16%
AT&T Capital Corp. (MTN) 5.850 01/05/99 500,000 498,903
Heller Financial Corp. (FRN)(MTN) 5.720 04/21/99 100,000 99,824
Taubman Realty Group, Ltd. (FRN)(MTN) 6.619 07/26/99 600,000 600,779
------------
1,199,506
------------
INDUSTRIAL--4.93%
Cemex S.A. 10.750 07/15/00 1,400,000 1,505,984
RJR Nabisco, Inc. 7.625 09/01/00 1,000,000 1,023,705
Valassis Inserts, Inc. 9.375 03/15/99 100,000 103,235
Westinghouse Credit Corp. (MTN) 9.040 06/01/98 100,000 101,666
------------
2,734,590
------------
INSURANCE--O.18%
American Bankers Insurance Group (FRN)(MTN) 6.400 04/12/00 100,000 100,954
------------
SOVEREIGN--5.35%
Republic of Argentina (FRN) 6.750 03/31/05 1,164,000 1,111,038
Republic of Finland 9.625 04/01/28 1,750,000 1,850,842
------------
2,961,880
------------
TELECOMMUNICATIONS--3.77%
GTE Corp. 8.500 04/01/17 1,600,000 1,685,968
Telecommunications, Inc. (MTN) 7.140 02/03/98 400,000 401,697
------------
2,087,665
------------
TOTAL CORPORATES 21,069,502
------------
MORTGAGE-BACKED--30.52%
NON-AGENCY MORTGAGE-BACKED--17.03%
Blackrock Capital Finance L.P. 1997-R2 AP (FRN) 4.760 10/25/35 674,488 670,130
Capstead Securities Corp. IV 1992-11 1B 7.875 08/25/22 543,312 555,629
Citicorp Mortgage Securities, Inc. 1992-20 A4 7.500 01/25/07 1,278,543 1,287,915
Citicorp Mortgage Securities, Inc. 1994-3 A12 9.000 02/25/24 253,150 251,845
DLJ Mortgage Acceptance Corp. 1994-Q8 IIS (IO) 1.871 05/25/24 15,297,866 651,016
Northwestern Acceptance Corp. IA 2 (FRN) 13.324 02/20/18 959,626 1,059,859
Resolution Trust Corp. 1992-C6 B 7.700 07/25/24 1,029,895 1,037,413
</TABLE>
<PAGE> 48
LOW DURATION BOND FUND
SCHEDULE OF PORTFOLIO INVESTMENTS
SEPTEMBER 30, 1997
(UNAUDITED)
<TABLE>
<CAPTION>
FACE AMOUNT VALUE
------------- ------------
<S> <C> <C> <C> <C>
NON-AGENCY MORTGAGE-BACKED--(CONTINUED)
Ryland Acceptance Corp. IV 28 1 11.500 12/25/16 $ 1,289,159 $ 1,401,860
Ryland Mortgage Securities Corp. 1993-3 2E 6.713 08/25/08 592,528 594,039
Ryland Mortgage Securities Corp. III 1992 D 1A (FRN) 7.963 09/25/22 1,554,759 1,584,153
SLH Mortgage Trust 1990-1 G 9.600 03/25/21 341,117 346,571
------------
9,440,430
------------
U.S. AGENCY MORTGAGE-BACKED--13.49%
Fannie Mae 1993-202 SJ 9.000 11/25/23 176,000 170,423
Fannie Mae 1993-206 SD (FRN) 10.000 11/25/23 1,500,000 1,454,532
Fannie Mae 1997-37 Z 9.000 06/18/27 703,145 704,745
Freddie Mac 1164 O (IO) 6.391 11/15/06 1,495,136 230,251
Freddie Mac 1933 V 8.000 11/15/25 941,108 946,773
Freddie Mac 1950 SM (FRN) 16.500 04/15/27 300,000 297,243
Freddie Mac 1963 SB (FRN) 15.600 06/15/27 650,000 651,219
Freddie Mac Gold 21 SG 9.386 10/25/23 460,749 467,356
Freddie Mac Gold 41 ZB 8.250 04/25/24 617,868 614,933
Government National Mortgage Association 1996-20 G 7.500 08/20/19 91,634 93,443
Government National Mortgage Association Pool 2286 8.500 09/20/26 556,264 578,514
Government National Mortgage Association Pool 2326 8.500 11/20/26 92,394 96,090
Government National Mortgage Association Pool 2345 8.500 12/20/26 1,125,670 1,170,696
------------
7,476,218
------------
TOTAL MORTGAGE-BACKED 16,916,648
------------
U.S. GOVERNMENTS--5.07%
U.S. TREASURY--5.07%
U.S. Treasury Notes 6.500 05/31/02 2,500,000 2,549,220
U.S. Treasury Notes 6.750 08/15/26 250,000 259,609
------------
2,808,829
------------
TOTAL BONDS (COST $40,928,140) 41,264,840
------------
CASH EQUIVALENTS--24.58%
COMMERCIAL PAPER--24.58%
American Bankers Insurance Group 5.720 10/16/97 700,000 698,332
Boston Scientific Corp. 5.760 10/17/97 1,645,000 1,640,789
Cox Communications, Inc. 5.700 10/24/97 800,000 797,087
CSX Corp. 5.700 11/03/97 1,000,000 994,775
Green Tree Financial Corp. 5.680 10/27/97 1,500,000 1,493,847
Houston Industries, Inc. 5.730 10/09/97 900,000 898,854
Kerr-McGee Credit Corp. 5.800 10/24/97 430,000 428,407
Levi Strauss & Co. 5.750 11/14/97 2,200,000 2,184,539
Occidental Petroleum Corp. 5.700 10/21/97 1,500,000 1,495,250
Texas Utilities Co. 5.720 10/15/97 1,500,000 1,496,663
Whirlpool Corp. 5.700 11/12/97 1,500,000 1,490,025
------------
TOTAL CASH EQUIVALENTS (COST $13,618,568) 13,618,568
------------
TOTAL INVESTMENTS--99.04% (COST $54,546,708*) 54,883,408
------------
CASH AND OTHER ASSETS, LESS LIABILITIES--O.96% 533,825
------------
------------
NET ASSETS--100.00% 55,417,233
============
NOTES TO SCHEDULE OF INVESTMENTS
Cost for Federal income tax purposes is $54,546,708 and net unrealized
appreciation consists of:
Gross unrealized appreciation 410,691
Gross unrealized depreciation (73,991)
----------
Net unrealized appreciation 336,700
==========
(FRN): Floating rate note - The rate disclosed is that in effect at September 30, 1997.
(IO): Interest only
(MTN): Medium term note
</TABLE>
See accompanying notes to financial statements.
<PAGE> 49
METROPOLITAN WEST FUNDS
STATEMENTS OF ASSETS AND LIABILITIES
SEPTEMBER 30, 1997
(UNAUDITED)
<TABLE>
<CAPTION>
TOTAL RETURN LOW DURATION
BOND FUND BOND FUND
------------- -------------
<S> <C> <C>
ASSETS:
Investments, at value (Cost $14,748,417 and $54,546,708, respectively) (Note 2) $14,955,016 $54,883,408
Cash and cash equivalents (Note 2) 127,844 0
Dividends and interest receivable 186,418 552,842
Receivable for securities sold 322,774 0
Deferred organizational costs (Note 2) 34,076 34,076
Die from Adviser (Note 4) 16,889 0
Other assets 15,745 15,745
----------- -----------
Total assets 15,658,762 55,486,071
----------- -----------
LIABILITIES:
Payable for securities purchased 821,454 0
Die to Adviser 0 8,632
Accrued expenses 26,853 24,174
Other liabilities 0 36,032
----------- -----------
Total liabilities 848,307 68,838
----------- -----------
Net assets $14,810,455 $55,417,233
=========== ===========
NET ASSETS CONSIST OF:
Common stock unlimited shares authorized, $0.01 par value,
1,420,431 and 5,451,362 shares outstanding, respectively $14,539,265 $54,980,468
Accumulated undistributed net realized gain on investments 64,591 100,065
Net unrealized appreciation (depreciation) on investments 206,599 336,700
----------- -----------
$14,810,455 $55,417,233
=========== ===========
NET ASSET VALUE, OFFERING AND REDEMPTION PRICE PER SHARE $10.43 $10.17
=========== ===========
</TABLE>
See accompanying notes to financial statements.
<PAGE> 50
METROPOLITAN WEST FUNDS
STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS ENDED SEPTEMBER 30,1997
(UNAUDITED)
<TABLE>
<CAPTION>
TOTAL RETURN LOW DURATION
BOND FUND BOND FUND
--------- -----------
<S> <C> <C>
INVESTMENT INCOME:
Interest $ 352,751 $ 1,235,664
--------- -----------
Total investment income 352,751 1,235,664
--------- -----------
EXPENSES:
Investment advisory fees (Note 4) 24,657 81,734
Transfer agent fees 7,546 8,384
Administration fees 15,719 17,466
Registration and filing fees 11,550 11,902
Reports to shareholders 2,836 2,927
Custodian fees 8,551 9,501
Accounting services 11,108 12,342
Pricing fees 1,106 3,073
Legal fees 4,567 4,830
Insurance expenses 4,132 4,132
Trustees' fees and expenses 4,111 4,347
Auditing and tax consulting fees 4,567 4,830
Amortization of organizational expenses (Note 2) 3,526 3,526
Miscellaneous expenses 3,654 3,864
--------- -----------
Total operating expenses 107,630 172,858
Expenses waived and reimbursed (Note 4) (78,490) (74,096)
--------- -----------
Net expenses 29,140 98,762
--------- -----------
Net investment income 323,611 1,136,902
--------- -----------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on investments 64,591 100,065
Net change in unrealized appreciation (depreciation) on investments 206,599 336,700
--------- -----------
Net realized and unrealized gain on investments 271,190 436,765
--------- -----------
NET INCREASE IN NET ASSETS FROM OPERATIONS $ 594,801 $ 1,573,667
========= ===========
</TABLE>
See accompanying notes to financial statements.
<PAGE> 51
METROPOLITAN WEST FUNDS
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
TOTAL RETURN LOW DURATION
BOND FUND BOND FUND
------------------ ------------------
SIX MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, 1997 SEPTEMBER 30, 1997
(UNAUDITED) (UNAUDITED)
------------------ ------------------
<S> <C> <C>
OPERATIONS:
Net investment income $ 323,611 $ 1,136,902
Net realized gain on investments 64,591 100,065
Net change in unrealized appreciation (depreciation) on investments 206,599 336,700
------------ ------------
Net increase in net assets resulting from operations 594,801 1,573,667
------------ ------------
DISTRIBUTIONS:
Dividends to shareholders from net investment income (323,611) (1,136,902)
------------ ------------
CAPITAL SHARE TRANSACTIONS:
Proceeds from sale of shares 15,285,025 62,395,891
Shares issued in reinvestment of
dividends and distributions 161,532 802,837
Cost of shares redeemed (957,292) (8,268,260)
------------ ------------
Net increase in net assets resulting from capital share transactions 14,489,265 54,930,468
------------ ------------
Net increase in net assets 14,760,455 55,367,233
Net assets at beginning of period 50,000 50,000
------------ ------------
Net assets at end of period
(including undistributed net investment income of
$0 and $0, respectively) $ 14,810,455 $ 55,417,233
============ ============
</TABLE>
See accompanying notes to financial statements.
<PAGE> 52
METROPOLITAN WEST FUNDS
FINANCIAL HIGHLIGHTS
THE TABLE BELOW SETS FORTH FINANCIAL DATA FOR ONE SHARE OF CAPITAL STOCK
OUTSTANDING THROUGHOUT THE PERIOD PRESENTED.
<TABLE>
<CAPTION>
TOTAL RETURN LOW DURATION
BOND FUND BOND FUND
------------------- ------------------
SIX MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, 1997* SEPTEMBER 30, 1997*
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
------------------- ------------------
Net Asset Value, Beginning of Period $10.00 $10.00
---------- ---------
Income from Investment Operations:
Net investment income 0.34 0.31
Net realized and unrealized gain on investments 0.43 0.17
---------- ---------
Total from Investment Operations 0.77 0.48
---------- ---------
Less Distributions:
Dividends from net investment income (0.34) (0.31)
---------- ---------
Total Distributions (0.34) (0.31)
---------- ---------
Net Asset Value, End of Period $10.43 $10.17
========== =========
Total Return (not annualized) 7.76% 4.88%
Ratios/Supplemental Data:
Net Assets, end of period (in thousands) $14,810 $55,417
Ratio of Expenses to Average Net Assets
Before expense reimbursement 2.40% - 1.02% -
After expense reimbursement 0.65% - 0.58% -
Ratio of Net Income to Average Net Assets
Before expense reimbursement 5.46% - 6.24% -
After expense reimbursement 7.21% - 6.68% -
Portfolio Turnover Rate 112% 110%
Average Commission Rate Paid NA NA
<FN>
* The Funds commenced operations on March 31, 1997.
- Annualized
</TABLE>
See accompanying notes to financial statements.
<PAGE> 53
METROPOLITAN WEST FUNDS
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
(UNAUDITED)
1. SUMMARY OF ORGANIZATION
The Metropolitan West Funds (the "Trust") is an open-end management
investment company organized as a Delaware business trust on December 9,
1996 under the Investment Company Act of 1940, as amended. The Trust
currently consists of three separate diversified portfolios (each a "Fund"
and collectively, the "Funds"): Metropolitan West Total Return Bond Fund
(the "Total Return Bond Fund"), Metropolitan West Low Duration Bond Fund
(the "Low Duration Bond Fund") and the Metropolitan West Short-Term
Investment Fund (the "Short-Term Investment Fund"). The Total Return Bond
Fund and Low Duration Bond Fund commenced investments operations on March
31, 1997. The Short-Term Investment Fund was not operational at September
30, 1997.
The Total Return Bond Fund seeks to maximize long-term total return. The
Fund invests in a diversified portfolio of fixed-income securities of
varying maturities with a portfolio duration of two to eight years. The
dollar-weighted average maturity will exceed its portfolio duration.
The Low Duration Bond Fund and Short-Term Investment Fund seek to maximize
current income, consistent with preservation of capital. Capital
appreciation is a secondary consideration of the Funds. The Funds invest in
a diversified portfolio of fixed-income securities of varying maturities
with a portfolio duration of one to three years in the Low Duration Bond
Fund and up to one year in the Short-Term Investment Fund. The
dollar-weighted average maturity for each Fund will exceed its portfolio
duration.
2. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies consistently
followed by the Funds, except for the Short-Term Investment Fund, in the
preparation of their financial statements in conformity with generally
accepted accounting principles. The preparation of financial statements in
accordance with generally accepted accounting principles requires management
to make estimates and assumptions that affect the reported amounts and
disclosures. Actual results could differ from those estimates.
SECURITY VALUATION:
Fixed-income securities which are traded on a national securities exchange
will be valued at the last sale price or, if there was no sale on such day,
at the average of readily available closing bid and asked prices on such
exchange. However, securities with a demand feature exercisable within one
to seven days are valued at par. Prices for fixed-income securities may be
based on quotations received from one or more market-makers in the
securities, or on evaluations from pricing services. Debt securities which
mature in less than 60 days are valued at amortized cost (unless the Board
of Trustees determines that this method does not represent fair value), if
their original maturity was 60 days or less or by amortizing the value as of
the 61st day prior to maturity, if their original term to maturity exceeded
60 days. Securities and other assets for which market quotations are not
readily available are valued at their fair value as determined by the
Adviser under guidelines established by and under the general supervision
and responsibility of the Board of Trustees.
MORTGAGE-RELATED SECURITIES:
The Funds may invest in mortgage pass-through securities which represent
interests in pools of mortgages in which payments of both principal and
interest on the securities are generally made monthly, in effect "passing
through" monthly payments made by borrowers on the residential or commercial
mortgage loans which underlie the securities (net of any fees paid to the
issuer or guarantor of the securities). Mortgage pass-through securities
differ from other forms of debt securities, which normally provide for
periodic payment of interest in fixed amounts with principal payments at
maturity or specified call dates.
Payment of principal and interest on some mortgage-related securities (but
not the market value of the securities
<PAGE> 54
themselves) may be guaranteed by the full faith and credit of the U.S.
Government (in the case of securities guaranteed by GNMA) or by agencies or
instrumentalities of the U S. Government (in the case of securities
guaranteed by FNMA or the FHLMC, which are supported only by the
discretionary authority of the U.S. Government to purchase the agency's
obligations). Mortgage pass-through securities created by non-governmental
issuers (such as commercial banks, savings and loan institutions, private
mortgage insurance companies, mortgage bankers and other secondary market
issuers) may be supported by various forms of insurance or guarantees,
including individual loan, title, pool and hazard insurance, and letters of
credit, which may be issued by governmental entities, private insurers or
the mortgage poolers.
The Funds may also invest in Collateralized Mortgage Obligations (CMOs).
CMOs are debt obligations collateralized by residential or commercial
mortgage loans or residential or commercial mortgage pass-through
securities. Interest and prepaid principal are generally paid monthly. CMOs
may be collateralized by whole mortgage loans or private mortgage
pass-through securities but are more typically collateralized by portfolios
of mortgage pass-through securities guaranteed by GNMA, FHLMC or FNMA. The
issuer of a series of CMOs may elect to be treated for tax purposes as a
Real Estate Mortgage Investment Conduit ("REMIC"). CMOs are structured into
multiple classes, each bearing a different stated maturity. Monthly payment
of principal received from the pool of underlying mortgages, including
prepayments, is first returned to investors holding the shortest maturity
class. Investors holding the longer maturity classes usually receive
principal only after shorter classes have been retired. An investor may be
partially protected against a sooner than desired return of principal
because of the sequential payments.
The Funds may invest in stripped mortgage-backed securities issued by the
U.S. Government, its agencies and instrumentalities. Stripped
mortgage-backed securities are usually structured with two classes that
receive different proportions of the interest and principal distributions on
a pool of mortgage assets. In certain cases, one class will receive all of
the interest (the interest-only or "IO" class), while the other class will
receive all of the principal (the principal-only or "PO" class). During the
six months ended September 30, 1997, certain interest only securities were
purchased as part of the overall mortgage portfolio holdings. The yield to
maturity on IOs is sensitive to the rate of principal repayments (including
prepayments) on the related underlying mortgage assets, and principal
payments may have a material effect on yield to maturity. If the underlying
mortgage assets experience greater than anticipated prepayments of
principal, a Fund may not fully recoup its initial investment in IOs. Such
securities will be considered liquid only if so determined in accordance
with guidelines established by the Trustees. The Funds also may invest in
stripped mortgage-backed securities that are privately issued. These
securities will be considered illiquid for purposes of each Fund's limit on
illiquid securities.
INVESTMENT INCOME AND SECURITIES TRANSACTIONS:
Dividend income is recorded on the ex-dividend date. Interest income is
accrued daily. Securities transactions are accounted for on the date
securities are purchased or sold. The cost of securities sold is determined
using the first-in-first-out method.
ORGANIZATION COSTS:
Organization costs are being amortized on a straight-line basis over five
years from each Fund's respective commencement of operations.
DISTRIBUTIONS TO SHAREHOLDERS:
Each Fund expects to declare dividends daily and pay them monthly to
shareholders. Distributions of net capital gains, if any, will be made at
least annually. The Board of Trustees may determine to declare dividends and
make distributions more or less frequently.
FEDERAL INCOME TAXES:
The Funds have elected and qualify to be treated as regulated investment
companies under Subchapter M of the Internal Revenue Code of 1986, as
amended (the "Code"). Each Fund is taxed as a separate entity under
Subchapter M and must qualify on a separate basis. If so qualified, each
Fund will not be subject to federal income taxes on its net investment
income and capital gains, if any, realized during any fiscal year which it
distributes to its shareholders
<PAGE> 55
provided that at least 90% of its net investment income earned in the fiscal
year is distributed. All dividends from net investment income together with
distributions of short-term capital gains will be taxable as ordinary income
to the shareholders even though paid in additional shares. Any net capital
gains ("capital gains distributions") distributed to shareholders are
taxable as mid-term or long-term capital gains to the shareholders
regardless of the length of time a shareholder has owned his shares. The
Funds have complied and intend to continue to comply with the requirements
of the Internal Revenue Code applicable to regulated investment companies.
Therefore, no Federal income tax provision is required.
CASH AND CASH EQUIVALENTS:
The Funds have defined cash and cash equivalents as cash in interest bearing
and non-interest bearing accounts.
3. SECURITIES TRANSACTIONS
PURCHASES AND SALES:
Investment transactions for the six months ended September 30, 1997,
excluding temporary short-term investments, were as follows:
<TABLE>
<CAPTION>
PURCHASES PROCEEDS FROM SALES
--------- -------------------
<S> <C> <C>
Total Return Bond Fund $24,197,197 $11,176,308
Low Duration Bond Fund 78,055,909 34,881,874
</TABLE>
The Funds invest excess cash in interest bearing deposits at The Bank of New
York.
4. INVESTMENT ADVISORY SERVICES
Under the Investment Advisory Agreement relating to the Funds, Metropolitan
West Asset Management, LLC (the "Adviser"), a registered investment adviser,
provides the Funds with investment management services. As compensation for
these services, the Adviser charges the Total Return Bond Fund and the Low
Duration Bond Fund a fee, computed daily and payable monthly, at an annual
rate of 0.55% and 0.48%, respectively, of each Fund's average daily net
assets. Certain officers and trustees of the Funds are also officers and
directors of the Adviser. All officers serve without direct compensation
from the Funds. Investment advisory fees and other transactions with
affiliates, for the six months ended September 30, 1997, were as follows:
<TABLE>
<CAPTION>
EXPENSES
INVESTMENT VOLUNTARY WAIVED AND
ADVISORY EXPENSE ADVISORY REIMBURSED DUE FROM
FEE RATE LIMITATION FEES BY ADVISER ADVISER
-------- ---------- ---- ---------- -------
<S> <C> <C> <C> <C> <C>
Total Return Bond Fund 0.55% 0.65% $24,657 $78,490 $16,889
Low Duration Bond Fund 0.48 0.58 81,734 74,096 0
</TABLE>
5. CAPITAL SHARE TRANSACTIONS:
Each Fund is authorized to issue an unlimited number of shares of beneficial
interest with a par value of $0.01 per share. Transactions in shares of
beneficial interest were as follows:
<TABLE>
<CAPTION>
TOTAL RETURN BOND FUND LOW DURATION BOND FUND
---------------------- ----------------------
For the Six Months Ended For the Six Months Ended
September 30, 1997 (Unaudited) September 30, 1997 (Unaudited)
------------------------------ ------------------------------
<S> <C> <C>
Increase in Fund shares:
Shares outstanding at beginning
of period 5,000 5,000
Shares sold 1,493,052 6,185,618
Shares issued through reinvestment
of dividends 15,597 79,294
Shares redeemed (93,218) (818,550)
----------- ----------
Net increase in Fund shares 1,415,431 5,446,362
----------- ----------
Shares outstanding at end of period 1,420,431 5,451,362
=========== ==========
</TABLE>
<PAGE> 56
BOARD OF TRUSTEES
Scott B. Dubchansky
Keith T. Holmes
Martin Luther King III
James M. Lippman
Daniel D. Villanueva
OFFICERS
Scott B. Dubchansky
Chairman of the Board, President and Principal Executive Officer
Richard H. Schweitzer
Treasurer, Principal Accounting and Financial Officer
Edward Curiel
Secretary and Assistant Treasurer
ADVISER:
Metropolitan West Asset Management, LLC
10880 Wilshire Boulevard, Suite 2020
Los Angeles, California 90024
(310) 446-7727
CUSTODIAN:
The Bank of New York
48 Wall Street
New York, New York 10286
TRANSFER AGENT:
FPS Services, Inc.
3200 Horizon Drive
P.O. Box 61503
King of Prussia, Pennsylvania 19406-0903
(800) 241-4671
AUDITORS:
Deloitte & Touche LLP
1000 Wilshire Boulevard, Suite 1500
Los Angeles, California 90017
DISTRIBUTOR:
FPS Broker Services, Inc.
3200 Horizon Drive
P.O. Box 61503
King of Prussia, Pennsylvania 19406-0903
LEGAL COUNSEL:
Paul, Hastings, Janofsky & Walker LLP
345 California Street, 29th Floor
San Francisco, CA 94104-2635
[LOGO]
FOR ADDITIONAL INFORMATION ABOUT THE
METROPOLITAN WEST FUNDS CALL:
(310) 446-7727 OR
(800) 241-4671 (TOLL-FREE)
This report is submitted for general information of the shareholders of the
Funds. It is not authorized for distribution to prospective investors in the
Funds unless preceded or accompanied by an effective Prospectus which includes
details regarding the Funds' objectives, policies, expenses and other
information.
<PAGE> 57
----------------------------------------------------
PART C
OTHER INFORMATION
---------------------------------------------------
Page 7
<PAGE> 58
METROPOLITAN WEST FUNDS
--------------
FORM N-1A
--------------
PART C
--------------
Item 24. Financial Statements and Exhibits
(a) Financial Statements:
Included in Part A:
Unaudited Financial Highlights for TOTAL RETURN BOND FUND and
LOW DURATION BOND FUND for the period ended September 30, 1997
are included in the Supplement to the Prospectus filed
herewith.
Included in Part B:
Statements of Assets and Liabilities for TOTAL RETURN BOND
FUND and LOW DURATION BOND FUND, as of March 27, 1997
accompanying notes, together with the Independent Auditor's
Report dated March 27, 1997.
Included in Part B:
Unaudited Semi-Annual Report for
TOTAL RETURN BOND FUND and LOW DURATION BOND FUND
(i) Portfolio of Investments at September 30, 1997;
(ii) Statement of Assets and Liabilities at September 30,
1997;
(iii) Statements of Operations for the period ended September
30, 1997; (iv) Statement of Changes in Net Assets for
the period ended September 30, 1997;
(v) Statement of Changes in Net Assets for the period ended
September 30, 1997;
(vi) Financial Highlights for the period ended September 30,
1997; and (vii) Notes to Financial Statements for the
period ended September 30, 1997.
(b) Exhibits:
(1) Agreement and Declaration of Trust (filed as part of the
Registration Statement on Form N-1A filed on December 24,
1996 [the "Registration Statement"]).
(2) By-Laws (filed as part of the Registration Statement).
(3) Voting Trust Agreement - Not applicable.
(4) Specimen Share Certificate - Not applicable.
(5) Form of Investment Management Agreement (filed as part of
the Registration Statement).
Page 1
<PAGE> 59
(6) Form of Underwriting Agreement (incorporated by reference
to Pre-Effective Amendment No. 2 to the Registration
Statement filed on March 28, 1996 ["Pre-Effective
Amendment No. 2"]).
(7) Benefit Plan(s) - Not applicable.
(8)(A) Form of Custody Agreement (incorporated by reference to
Pre-Effective Amendment No. 2).
(8)(B) Form of Custody Administration and Agency Agreement
(incorporated by reference to Pre-Effective Amendment No.
2).
(9)(A) Form of Administration Agreement (incorporated by
reference to Pre-Effective Amendment No. 2).
(9)(B) Form of Accounting Services Agreement (incorporated by
reference to Pre-Effective Amendment No. 2).
(9)(C) Form of Transfer Agent Services Agreement (incorporated by
reference to Pre-Effective Amendment No. 2).
(10) Consent and Opinion of Counsel as to legality of shares
(incorporated by reference to Pre-Effective Amendment No.
1 to the Registration Statement filed on March 18, 1997
["Pre-Effective Amendment No. 1"]).
(11) Consent of Independent Public Accountants [[(incorporated
by reference to Pre-Effective Amendment No. 2).]] -- Filed
herewith.
(12) Financial Statements omitted from Item 23 - Not
applicable.
(13) Form of Subscription Agreement (incorporated by reference
to Pre-Effective Amendment No. 2).
(14) Model Retirement Plan Documents - Not applicable.
(15) Form of Rule 12b-1 Plan (incorporated by reference to
Pre-Effective Amendment No. 1).
(16) Performance Computation - Not Applicable.
(17) Financial Data Schedules -- Filed herewith.
Item 25. Persons Controlled by or Under Common Control with Registrant.
Metropolitan West Asset Management, LLC, a California limited liability
company, is the manager of each series of the Registrant (the "Manager").
Metropolitan West Securities, Inc., a California corporation ("MWS"), is a
member of the Manager. Also members of the Manager are Scott B. Dubchansky, Tad
Rivelle and Laird R. Landmann.
Persons holding more than a five percent beneficial interest in MWS
include Paul C. Chow, Terry M. Crow, Edward E. Curiel, Thomas W. Hayes, Richard
S. Hollander and Roland R. Moos. MWS is registered with the Securities and
Exchange Commission as an investment adviser and a broker-dealer.
Language indicated as being shown by strike out in the typeset document is
enclosed in double brackets "[[" and "]]" in the electronic format.
Page 2
<PAGE> 60
Item 26. Number of Holders of Securities
[[As of March 26, 1997, Scott B. Dubchansky and Tad Rivelle are the only
shareholders of each series of the Registrant.]]
<TABLE>
<CAPTION>
NUMBER OF RECORD HOLDERS
TITLE OF CLASS AS OF OCTOBER 20, 1997
-------------- ----------------------
Shares of Beneficial Interest par value $0.001 of:
<S> <C>
TOTAL RETURN BOND FUND 24
LOW DURATION BOND FUND 47
</TABLE>
Item 27. Indemnification
Article VII of the Agreement and Declaration of Trust empowers the
Trustees of the Trust, to the full extent permitted by law, to purchase with
Trust assets insurance for indemnification from liability and to pay for all
expenses reasonably incurred or paid or expected to be paid by a Trustee or
officer in connection with any claim, action, suit or proceeding in which he or
she becomes involved by virtue of his or her capacity or former capacity with
the Trust.
Article VII of the By-Laws of the Trust provides that the Trust shall
indemnify any person who was or is a party or is threatened to be made a party
to any proceeding by reason of the fact that such person is and other amounts or
was an agent of the Trust, against expenses, judgments, fines, settlement and
other amounts actually and reasonable incurred in connection with such
proceeding if that person acted in good faith and reasonably believed his or her
conduct to be in the best interests of the Trust. Indemnification will not be
provided in certain circumstances, however, including instances of willful
misfeasance, bad faith, gross negligence, and reckless disregard of the duties
involved in the conduct of the particular office involved.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to the Trustees, officers and controlling persons
of the Registrant pursuant to the foregoing provisions or otherwise, the
Registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act of 1933 and is, therefore, unenforceable in the event that a
claim for indemnification against such liabilities (other than the payment by
the Registrant of expenses incurred or paid by a Trustee, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such Trustee, officer or controlling person in
connection with the securities being registered, the Registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act of 1933 and will be governed by the final adjudication of such issue.
Item 28. Business and Other Connections of Investment Adviser.
Information about Scott B. Dubchansky, Tad Rivell and Laird R. Landmann
is set forth in Part B under "Management."
Language indicated as being shown by strike out in the typeset document is
enclosed in double brackets "[[" and "]]" in the electronic format.
Page 3
<PAGE> 61
Item 29. Principal Underwriter.
(a) FPS Broker Services, Inc. is the principal underwriter for the
following investment companies or series thereof:
Bjurman Funds
[[The Brinson Funds]]
[[CT&T Funds]]
Fairport Funds
Farrell Alpha Strategies
Focus Trust, Inc.
Govett Funds
IAA Trust Mutual Funds
Matthews International Funds
McM Funds
Metropolitan West Funds
Polynous Growth Fund
Sage/Tso Trust
Smith Breeden Series Fund
Smith Breeden Short Duration U.S. Government Fund
Smith Breeden Trust
The Stratton Funds, Inc.
Stratton Growth Fund, Inc.
Stratton Monthly Dividend Shares, Inc.
Stratton Small Cap Yield Fund
[[The Timothy Plan]]
Trainer Wortham First Mutual Funds
(b) The following information is furnished with respect to the
officers of FPS Broker Services, Inc.:
<TABLE>
<CAPTION>
NAME AND PRINCIPAL POSITION AND OFFICES WITH POSITIONS AND OFFICES
BUSINESS ADDRESS DISTRIBUTOR WITH REGISTRANT
- ---------------- ----------- ---------------
<S> <C> <C>
Kenneth J. Kempf Director and President None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA 19406-0903
Lynne M. Cannon Vice President and Principal None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA 19406-0903
Rocky C. Cavalieri Director and Vice President None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA 19406-0903
Gerald J. Holland Director, Senior Vice None
3200 Horizon Drive President and Principal
P.O. Box 61503
King of Prussia, PA 19406-0903
</TABLE>
Language indicated as being shown by strike out in the typeset document is
enclosed in double brackets "[[" and "]]" in the electronic format.
Page 4
<PAGE> 62
<TABLE>
<CAPTION>
NAME AND PRINCIPAL POSITION AND OFFICES WITH POSITIONS AND OFFICES
BUSINESS ADDRESS DISTRIBUTOR WITH REGISTRANT
- ---------------- ----------- ---------------
<S> <C> <C>
Joseph M. O'Donnell, Esq. Director and Vice President None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA 19406-0903
Sandra L. Adams Assistant Vice President and None
3200 Horizon Drive Principal
P.O. Box 61503
King of Prussia, PA 19406-0903
Mary P. Efstration Secretary None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA 19406-0903
John H. Leven Treasurer None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA 19406-0903
Bruno DiStefano Principal None
3200 Horizon Drive
P.O. Box 61503
King of Prussia, PA 19406-0903
</TABLE>
James W. Stratton may be considered a control person of the Distributor due to
his direct or indirect ownership of FPS Services, Inc., the Parent of the
Underwriter.
Item 30. Location of Accounts and Records.
The accounts, books, or other documents required to be maintained by
Section 31(a) of the Investment Company Act of 1940 will be kept by the
Registrant's Transfer Agent, FPS Services, Inc., 3200 Horizon Drive, King
Prussia, PA 19406-0903 except those records relating to portfolio transactions
and the basic organizational and Trust documents of the Registrant (see
Subsections (2)(iii), (4), (5), (6), (7), (9), (10) and (11) of Rule 31a-1(b)),
which will be kept by the Registrant at 10880 Wilshire Boulevard, Suite 2020,
Los Angeles, California 90024
Item 31. Management Services.
There are no management-related service contracts not discussed in
Parts A and B.
Item 32. Undertakings.
(a) Registrant hereby undertakes to file a post-effective amendment
including financial statements of [[each series of the Registrant]] Short-Term
Investment Fund, which need not be certified, within four to six months from the
[[effective]] operational date of that [[Registrant's 1933 Act Registration
Statement with respect to shares of each of them]] series.
Language indicated as being shown by strike out in the typeset document is
enclosed in double brackets "[[" and "]]" in the electronic format.
Page 5
<PAGE> 63
(b) Registrant has undertaken to comply with Section 16(a) of the
Investment Company Act of 1940, as amended, which requires the prompt convening
of a meeting of shareholders to elect trustees to fill existing vacancies in the
Registrant's Board of Trustees in the event that less than a majority of the
trustees have been elected to such position by shareholders. Registrant has also
undertaken promptly to call a meeting of shareholders for the purpose of voting
upon the question of removal of any Trustee or Trustees when requested in
writing to do so by the record holders of not less than 10 percent of the
Registrant's outstanding shares and to assist its shareholders in communicating
with other shareholders in accordance with the requirements of Section 16(c) of
the Investment Company Act of 1940, as amended.
<PAGE> 64
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the Investment
Company Act of 1940, the Registrant certifies that it meets all the requirements
for effectiveness of this Amendment under Rule 485(b) under the Securities Act
of 1933, as amended, and that the Registrant has duly caused this Amendment to
its Registration Statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Los Angeles, and State of California
on the 30th day of October, 1997.
Metropolitan West Funds
By: /s/ Scott B. Dubchansky*
----------------------------------
Scott B. Dubchansky
Principal Executive Officer
and Trustee
Pursuant to the requirements of the Securities Act of 1933, this Pre-Effective
Amendment to its Registration Statement has been signed below by the following
person in the capacities and on the date indicated.
<TABLE>
<S> <C> <C>
/s/ Scott B. Dubchansky* Principal Executive Officer October 30, 1997
- ----------------------- and Trustee
Scott B. Dubchansky
/s/ Richard Schweitzer* Principal Financial and October 30, 1997
- ---------------------- Accounting Officer
Richard Schweitzer
/s/ Keith T. Holmes* Trustee October 30, 1997
- -------------------
Keith T. Holmes
/s/ Martin Luther King III* Trustee October 30, 1997
- --------------------------
Martin Luther King III
/s/ Daniel D. Villanueva* Trustee October 30, 1997
- ------------------------
Daniel D. Villanueva
*by /s/ David A. Hearth
------------------------------------
David A. Hearth, Attorney-in-Fact
pursuant to Power of Attorney
previously filed
</TABLE>
<PAGE> 65
Exhibit(s) Index
Exhibit No. Document
- ----------- --------
(11) Independent Auditor's Consent
(27) Financial Data Schedules
<PAGE> 1
Exhibit (11)
CONSENT OF INDEPENDENT AUDITORS
THE METROPOLITAN WEST FUNDS:
We consent to (a) the use in this Post-Effective Amendment No. 2 to Registration
Statement No. 333-18737 on Form N-1A of our report on the statements of assets
and liabilities of the Metropolitan West Total Return Bond Fund and the
Metropolitan West Low Duration Bond Fund (the "Funds") as of March 27, 1997
dated March 27, 1997 appearing in Part B, the Statement of Additional
Information of such Registration Statement, (b) the reference to us under the
heading "General Information" in the Prospectus which is incorporated by
reference to such Registration Statement, and (c) the reference to us under the
heading "Additional Information" in Part B, the Statement of Additional
Information of such Registration Statement.
DELOITTE & TOUCHE LLP
October 24, 1997
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0001028621
<NAME> TOTAL RETURN BOND FUND
<MULTIPLIER> 1
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-1997
<PERIOD-START> APR-01-1997
<PERIOD-END> SEP-30-1997
<EXCHANGE-RATE> 1
<INVESTMENTS-AT-COST> 14,748,417
<INVESTMENTS-AT-VALUE> 14,955,016
<RECEIVABLES> 509,192
<ASSETS-OTHER> 66,710
<OTHER-ITEMS-ASSETS> 127,844
<TOTAL-ASSETS> 15,658,762
<PAYABLE-FOR-SECURITIES> 821,454
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 26,853
<TOTAL-LIABILITIES> 848,307
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 14,539,265
<SHARES-COMMON-STOCK> 1,415,431
<SHARES-COMMON-PRIOR> 5,000
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 64,591
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 206,599
<NET-ASSETS> 14,810,455
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 352,751
<OTHER-INCOME> 0
<EXPENSES-NET> 29,140
<NET-INVESTMENT-INCOME> 323,611
<REALIZED-GAINS-CURRENT> 64,591
<APPREC-INCREASE-CURRENT> 206,599
<NET-CHANGE-FROM-OPS> 594,801
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 323,611
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 1,493,052
<NUMBER-OF-SHARES-REDEEMED> 93,218
<SHARES-REINVESTED> 15,597
<NET-CHANGE-IN-ASSETS> 14,760,455
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 24,657
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 107,630
<AVERAGE-NET-ASSETS> 8,999,748
<PER-SHARE-NAV-BEGIN> 10.00
<PER-SHARE-NII> 0.34
<PER-SHARE-GAIN-APPREC> 0.43
<PER-SHARE-DIVIDEND> 0.34
<PER-SHARE-DISTRIBUTIONS> 0.00
<RETURNS-OF-CAPITAL> 0.00
<PER-SHARE-NAV-END> 10.43
<EXPENSE-RATIO> .65
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0001028621
<NAME> LOW DURATION BOND FUND
<MULTIPLIER> 1
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-1997
<PERIOD-START> APR-01-1997
<PERIOD-END> SEP-30-1997
<EXCHANGE-RATE> 1
<INVESTMENTS-AT-COST> 54,546,708
<INVESTMENTS-AT-VALUE> 54,883,408
<RECEIVABLES> 552,842
<ASSETS-OTHER> 49,821
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 55,486,071
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 68,838
<TOTAL-LIABILITIES> 68,838
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 54,980,468
<SHARES-COMMON-STOCK> 5,446,362
<SHARES-COMMON-PRIOR> 5,000
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 100,065
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 336,700
<NET-ASSETS> 55,417,233
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 1,235,664
<OTHER-INCOME> 0
<EXPENSES-NET> 98,762
<NET-INVESTMENT-INCOME> 1,136,902
<REALIZED-GAINS-CURRENT> 100,065
<APPREC-INCREASE-CURRENT> 336,700
<NET-CHANGE-FROM-OPS> 1,573,667
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 1,136,902
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 6,185,618
<NUMBER-OF-SHARES-REDEEMED> 818,550
<SHARES-REINVESTED> 79,294
<NET-CHANGE-IN-ASSETS> 55,367,233
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 81,734
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 172,858
<AVERAGE-NET-ASSETS> 34,148,346
<PER-SHARE-NAV-BEGIN> 10.00
<PER-SHARE-NII> 0.31
<PER-SHARE-GAIN-APPREC> 0.17
<PER-SHARE-DIVIDEND> 0.31
<PER-SHARE-DISTRIBUTIONS> 0.00
<RETURNS-OF-CAPITAL> 0.00
<PER-SHARE-NAV-END> 10.17
<EXPENSE-RATIO> 0.58
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
