<PAGE> 1
As filed with the Securities and Exchange Commission on June 26, 1998
File Nos. 333-18737
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. 4
and
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
Amendment No. 6
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:
____ immediately upon filing pursuant to Rule 485(b)
x on June 29, 1998, pursuant to Rule 485(b)
- ----
60 days after filing pursuant to Rule 485(a)(1)
- ---
75 days after filing pursuant to Rule 485(a)(2)
- ---
on _____________, pursuant to Rule 485(a)
- ---
----------
Please Send Copy of Communications to:
DAVID A. HEARTH, 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
Part A - Combined Prospectus for
METROPOLITAN WEST TOTAL RETURN BOND FUND
METROPOLITAN WEST LOW DURATION BOND FUND
METROPOLITAN WEST SHORT-TERM INVESTMENT FUND
METROPOLITAN WEST ALPHATRAK 500 FUND
Part B - Combined Statement of Additional Information for
METROPOLITAN WEST TOTAL RETURN BOND FUND
METROPOLITAN WEST LOW DURATION BOND FUND
METROPOLITAN WEST SHORT-TERM INVESTMENT FUND
METROPOLITAN WEST ALPHATRAK 500 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
Metropolitan West AlphaTrak 500 Fund
<TABLE>
<CAPTION>
LOCATION IN THE
N-1A REGISTRATION STATEMENT
ITEM NO. ITEM BY HEADING
- -------- ---- ----------
<S> <C> <C>
1. Cover Page Cover Page
2. Synopsis "Summary of Expenses and Example" and "Prospectus Summary"
3. Condensed Financial "Financial Highlights": Total Return Bond Fund; Low Duration Bond Fund
Information
4. General Description Cover Page, "Prospectus Summary," "Investment Objectives and Policies,"
of Registrant "Securities and Techniques Used by the Funds," "Investment Risks," "Principal
Investment Restrictions," and "Organization and Management"
5. Management of "Investment Objectives and Policies," "Securities and Techniques Used by the
the Fund 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 and Tax Status" and "General
Other Securities Information"
7. Purchase of Securities "How to Purchase Shares," "How to Redeem Shares"
Being Offered
8. Redemption or "How to Redeem Shares"
Repurchase
9. Pending Legal Not Applicable
Proceedings
</TABLE>
Page 3
<PAGE> 4
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
Metropolitan West AlphaTrak 500 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 Trust"
Securities
16. Investment Advisory "Management"
and Other Services
17. Brokerage Allocation "Management"
18. Capital Stock and "General Information About the
Other Securities 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"
Page 4
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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
Metropolitan West AlphaTrak 500 Fund
------------------------------------------------------------
Page 5
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METROPOLITAN WEST FUNDS PROSPECTUS
10880 WILSHIRE BOULEVARD
SUITE 2020
LOS ANGELES, CALIFORNIA 90024 JUNE 29, 1998
==============================================================================
METROPOLITAN WEST FUNDS (THE "TRUST"), IS AN OPEN-END, MANAGEMENT INVESTMENT
COMPANY CONSISTING OF FOUR SEPARATE DIVERSIFIED PORTFOLIOS (THE "FUNDS"), EACH
OF WHICH IS A SEPARATE MUTUAL FUND.
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 Fund's dollar-weighted average maturity
will exceed its portfolio duration.
LOW DURATION BOND FUND
Seeks to maximize current income, consistent with preservation of capital.
Capital appreciation is a secondary consideration of the Fund. The Fund
invests in a diversified portfolio of fixed-income securities of varying
maturities with a portfolio duration of up to three years. The Fund's
dollar-weighted average maturity will exceed its portfolio duration.
SHORT-TERM INVESTMENT FUND
Seeks to maximize current income, consistent with the preservation of capital.
Capital appreciation is a secondary consideration of the Fund. The Fund
invests in a diversified portfolio of fixed-income securities of varying
maturities with a portfolio duration of up to one year. The Fund's
dollar-weighted average maturity will exceed its portfolio duration.
ALPHATRAK 500 FUND
Seeks to achieve a total return that exceeds the total return of the Standard
& Poor's 500 Index ("S&P 500 Index"). The Fund invests in S&P 500 Index
futures contracts backed by a diversified portfolio of fixed-income securities
of varying maturities with a portfolio duration of up to three years. The
Fund's dollar-weighted average maturity will exceed its portfolio duration.
- --------------------------------------------------------------------------------
This Prospectus provides you with the basic information you should know before
investing in any of the Funds. You should read it and keep it for future
reference. A Statement of Additional Information dated June 29, 1998, as may
be revised, containing additional information about the Trust and each Fund
has been filed with the Securities and Exchange Commission and is incorporated
by reference in its entirety into this Prospectus. You may obtain a copy of
the Statement of Additional Information without charge by calling (800)
241-4671 or writing to the Funds at 10880 Wilshire Boulevard, Suite 2020, Los
Angeles, California 90024. If you are viewing the electronic version of this
prospectus through an online computer service, you may request a printed
version free of charge by calling (800) 241-4671.
Information about the Funds may be obtained through the
following Internet address: www.mws.com.
Shares of the Funds are not deposits or obligations of, or guaranteed or
endorsed by, any bank, nor are they federally insured by the Federal Deposit
Insurance Corporation, the Federal Reserve Board or any other agency.
Investment in a Fund's shares involves risk, including the possible loss of
principal.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
There can be no assurance that the investment objective of any Fund will be
achieved.
Metropolitan West Funds
10880 Wilshire Boulevard, Suite 2020
Los Angeles, California 90024
(310) 446-7727
June 29, 1998
<PAGE> 7
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TABLE OF CONTENTS
- --------------------------------------------------------------------------------
SUMMARY OF EXPENSES..........................................................3
FINANCIAL HIGHLIGHTS.........................................................4
ADVISER INVESTMENT RETURNS...................................................5
PROSPECTUS SUMMARY...........................................................6
INVESTMENT OBJECTIVES AND POLICIES...........................................7
SECURITIES AND TECHNIQUES USED BY THE FUNDS.................................11
PRINCIPAL INVESTMENT RESTRICTIONS...........................................16
ORGANIZATION AND MANAGEMENT.................................................17
HOW TO PURCHASE SHARES......................................................20
HOW TO REDEEM SHARES........................................................21
DIVIDENDS AND TAX STATUS....................................................22
PERFORMANCE INFORMATION.....................................................23
GENERAL INFORMATION.........................................................24
APPENDIX -- DESCRIPTION OF RATINGS..........................................24
The application for investing in the Metropolitan West Funds is included in
this prospectus.
2
<PAGE> 8
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SUMMARY OF EXPENSES
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The following information is provided in order to assist you in
understanding the various costs and expenses that you will bear directly or
indirectly as an investor in the Funds. These are the expenses, including the
estimated other expenses, of each Fund for the first full year of operations.
Please note that the expenses for the AlphaTrak 500 Fund include the basic,
maximum and minimum management fees payable to Metropolitan West Asset
Management, LLC (the "Adviser") under the Fund's Investment Advisory
Agreement.
SHAREHOLDER TRANSACTION EXPENSES
<TABLE>
<S> <C>
Maximum Sales Load Imposed on Purchases.................................None
Maximum Sales Load Imposed on Reinvested Dividends......................None
Deferred Sales Load..................................................None
Redemption Fees .....................................................None
Exchange Fees........................................................None
</TABLE>
Investment dealers and other firms may independently charge additional fees
for shareholder transactions or for advisory services. Please see their
materials for details.
Shareholders effecting transactions via wire transfer may be required to pay
fees, including the wire fee and other fees, that will be deducted directly
from redemption proceeds.
ANNUAL FUND OPERATING EXPENSES*
(AS A PERCENTAGE OF AVERAGE NET ASSETS)
<TABLE>
<CAPTION>
Total Low Short-Term AlphaTrak AlphaTrak AlphaTrak
Return Duration Investment 500 Fund 500 Fund 500 Fund
Bond Fund Bond Fund Fund (basic) (maximum) (minimum)
--------- --------- ---- ------- --------- ---------
<S> <C> <C> <C> <C> <C>
Management fees**............................. .55% .48% .40% .35% .70% --%
Rule 12b-1 expenses***........................ None None None None None None
Other expenses after expense reimbursement.... .10% .10% .10% .20% .20% .20%
---- ---- ---- ---- ---- ----
Total Fund operating expenses after expense
reimbursement.............................. .65% .58% .50% .55% .90% .20%
==== ==== ==== ==== ==== ====
</TABLE>
- ------------------
*Expenses for the Total Return Bond Fund and Low Duration Bond Fund are
based on actual expenses and expense limitations for the fiscal year ended
March 31, 1998. Expenses for the other Funds are estimated. Although not
required to do so, the Adviser has agreed to limit the annual operating
expenses of the Total Return Bond Fund to .65%, the Low Duration Bond Fund to
.58%, the Short-Term Investment Fund to .50% and the AlphaTrak 500 Fund (by
limiting "other expenses" to .20% and assuming the maximum management fee) to
.90% of each Fund's respective average net assets. The ratios of total
operating expenses to average net assets before the Adviser's voluntary
limitation were as follows for the Funds that have commenced operations: Total
Return Bond Fund - 1.99% (1.44% other expenses); and Low Duration Bond Fund -
.93% (.45% other expenses). Absent the voluntary limitation, the ratios of
total operating expenses to average net assets are estimated as follows for
the Funds that have not commenced operations as of this date: Short-Term
Investment Fund - .90% (.50% other expenses); and AlphaTrak 500 Fund - .95%
(.60% other expenses, assuming the basic fee applies without adjustment). In
subsequent years, overall operating expenses for each Fund may not fall below
the applicable percentage limitation until the Adviser has been fully
reimbursed for fees reduced or expenses paid it under the Investment Advisory
Agreement. Each Fund will reimburse the Adviser in the three following years
if operating expenses (before reimbursement) are less than the applicable
percentage limitation charged to the Fund.
** The management fee paid to the Adviser for providing advisory
services to the AlphaTrak 500 Fund consists of a basic annual fee of .35% of
the Fund's average net assets and a performance adjustment. The actual fee
paid to the Adviser may be higher or lower than the basic fee. See "Management
Fees" for additional information about the fee calculation.
*** 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. Currently, the Board of Trustees of the Trust is waiving these fees
for the Funds and the Adviser is paying for distribution expenses out of its
own resources.
3
<PAGE> 9
- --------------------------------------------------------------------------------
EXAMPLE
- --------------------------------------------------------------------------------
You would pay the following expenses on a $1,000 investment,
assuming:
<TABLE>
<CAPTION>
(1) 5% annual return; and Return Duration Investment 500 Fund 500 Fund 500 Fund
(2) redemption at the end of each time period Bond Fund Bond Fund Fund (basic) (maximum) (minimum)
----------- ----------- ------------ ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
One Year........................................ $ 7 $ 6 $ 5 $ 6 $ 9 $ 2
Three Years..................................... $21 $19 $16 $18 $29 $ 6
Five Years ..................................... $37 $32 NA NA NA NA
Ten Years ...................................... $84 $72 NA NA NA NA
</TABLE>
The example assumes that the Adviser will limit the annual operating expenses
of each Fund to the total shown. The example should not be considered a
representation of past or future expenses; actual Fund expenses may be greater
or less than those shown. The assumption in the Example of a 5% annual return
is required by regulations of the Securities and Exchange Commission
applicable to all mutual funds and does not represent the projected or actual
performance of any Fund. See "Organization and Management."
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
The following financial information for the period ended March 31, 1998 was
audited by Deloitte & Touche LLP, whose report, dated May 13, 1998, appears in
the 1998 Annual Report of the Funds.
<TABLE>
<CAPTION>
SELECTED PER-SHARE DATA FOR THE YEAR ENDED MARCH 31, 1998: Total Return Bond Fund Low Duration Bond Fund
---------------------- ----------------------
<S> <C> <C>
Net asset value, beginning of period $10.00 $10.00
------ ------
Income from Investment Operations:
Net investment income 0.73 0.65
Net realized and unrealized gain on investments 0.60 0.19
---- ----
Total from investment operations 1.33 0.84
---- ----
Less Distributions:
Dividends from net investment income (0.73) (0.65)
Distributions from net capital gains on investments (0.11) (0.01)
------ ------
Total distributions (0.84) (0.66)
------ ------
Net asset value, end of period $10.49 $10.18
====== ======
Total return 13.71% 8.71%
Ratios/Supplemental Data:
Net assets, end of period (in thousands) $24,983 $135,313
Ratio of Expenses to Average Net Assets:
Before expense reimbursement 1.99% 0.93%
After expense reimbursement 0.65% 0.58%
Ratio of Net Income to Average Net Assets:
Before expense reimbursement 6.05% 6.37%
After expense reimbursement 7.39% 6.72%
Portfolio turnover rate 225% 102%
</TABLE>
4
<PAGE> 10
- --------------------------------------------------------------------------------
ADVISER INVESTMENT RETURNS
- --------------------------------------------------------------------------------
LOW DURATION ASSETS
Set forth in the table below is certain performance data provided by the
Adviser relating to a performance record of the Adviser for at least six
investment advisory accounts (the "Low Duration Accounts"), during the period
August 1, 1996 through December 31, 1996, utilizing the specific investment
approach specified for the Low Duration Bond Fund under "Investment Objectives
and Policies." The Low Duration Accounts constitute all of the accounts
managed by the Adviser that have an identical or substantially similar
investment objective or investment approach as the Low Duration Bond Fund. The
Low Duration Accounts were not subject to the same types of expenses to which
the Low Duration Bond Fund is subject, nor to the diversification
requirements, specific tax restrictions and investment limitations imposed on
the Low Duration Bond Fund by the Investment Company Act of 1940, as amended.
From May 18, 1993 through July 31, 1996 performance data is for the Hotchkis
and Wiley Low Duration Bond Fund that Tad Rivelle and Laird Landmann, now
Managing Director-Chief Investment Officer and Managing Director of the
Adviser, respectively, personally managed in their capacities as principals
and Co-Directors of Fixed Income for Hotchkis and Wiley. The Low Duration
Accounts and the Hotchkis and Wiley Low Duration Bond Fund are collectively
called the "Low Duration Assets." The Low Duration Assets have been managed
with investment objectives and investment policies and strategies
substantially similar to those to be employed by Mr. Rivelle and Mr. Landmann
in managing the Low Duration Bond Fund. The results presented are not intended
to predict or suggest the return to be experienced by the Low Duration Bond
Fund or the return an investor might achieve by investing in the Low Duration
Bond Fund. Investors should not rely on the following performance data as an
indication of future performance of the Adviser or of the Low Duration Bond
Fund.
<TABLE>
<CAPTION>
TOTAL RETURN OF LOW DURATION ASSETS
- -----------------------------------------------------------------------------------------------------------------------------------
AUGUST 1, JANUARY
1996- 1, YEAR ENDED DECEMBER 31,
DECEMBER 1996- --------------------------
1996 31, JULY 31,
(FULL YEAR) 1996* 1996 1995 1994 1993**
----------- ---------- ---------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Low Duration Assets................................... 6.67% 3.89% 2.68% 12.75% 5.23% 7.14%
Performance Record
Merrill Lynch 1-3 Year U.S. Treasury Index............ 4.98% 3.19% 1.75% 11.00% 0.57% 2.62%
- -----------------------------------------------------------------------------------------------------------------------------------
<FN>
* Performance results, for this period are for Low Duration Accounts which Mr. Rivelle and Mr. Landmann personally managed for
Metropolitan West Securities, Inc., an affiliate of the Adviser, while the Adviser was in formation.
** From May 18, 1993
</TABLE>
Please read the following important notes concerning the Low Duration Assets.
1. Performance before August 1, 1996 was calculated using the standard total
return formula required by the Securities and Exchange Commission ("SEC") for
all mutual funds.
2. The results for the Low Duration Accounts reflect both income and capital
appreciation or depreciation (total return). Returns are time-weighted and net
of all applicable fees and expenses.
3. Annual rate of return for the Low Duration Accounts is calculated using the
modified Dietz method, which is defined as the portfolio gain (including all
realized and unrealized gains and losses as well as all income) over the
average capital for the period. Average capital is the beginning market value
plus/minus weighted subscriptions/redemptions. Calculation is done monthly,
but is subject to revaluation during the month when there is a cash flow that
exceeds 10% of the beginning market value of the Low Duration Accounts.
4. The Merrill Lynch 1 - 3 year U.S. Treasury Index is an unmanaged index of
U.S. Treasury securities with maturities of 1 to 3 years. The U.S. Treasury
securities included in this Index will differ substantially from the
securities in the Low Duration Fund.
ENHANCED EQUITY INDEX ASSETS
Set forth in the table below is certain performance data provided by the
Adviser relating to a performance record of the Adviser for one investment
advisory account (the "Enhanced Equity Index Account") during the period
September 30, 1997 through May
5
<PAGE> 11
31, 1998, utilizing the specific investment approach specified for the
AlphaTrak 500 Fund under "Investment Objectives and Policies." The Enhanced
Equity Index Account constitutes the only account managed by the Adviser that
has an identical or substantially similar investment objective or investment
approach as the AlphaTrak 500 Fund. The Enhanced Equity Index Account was not
subject to the same types of expenses to which the AlphaTrak 500 Fund is
subject, nor to the diversification requirements, specific tax restrictions
and investment limitations imposed on the AlphaTrak 500 Fund by the Investment
Company Act of 1940, as amended. The performance of the Enhanced Equity Index
Account may have been adversely affected had it been subject to the same
expenses, restrictions and limitations. The Adviser believes that any adverse
effect would not have been significant. The results presented are not intended
to predict or suggest the return to be experienced by the AlphaTrak 500 Fund
or the return an investor might achieve by investing in the AlphaTrak 500
Fund. Investors should not rely on the following performance data as an
indication of future performance of the Adviser or of the AlphaTrak 500 Fund.
<TABLE>
<CAPTION>
TOTAL RETURN OF ENHANCED EQUITY INDEX ACCOUNT
- ----------------------------------------------------------------------------------------------------------------------------------
SINCE INCEPTION
(SEPTEMBER 30, 1997 TO JANUARY 1, 1998 TO SEPTEMBER 30, 1997 TO
MAY 31, 1998) MAY 31, 1998 DECEMBER 31, 1997
------------------- ------------ -----------------
<S> <C> <C> <C>
Enhanced Equity Index Account.......................... 17.12% 13.48% 3.20%
Performance Record
S&P 500 Index.......................................... 16.26% 13.02% 2.87%
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
Please read the following important notes concerning the Enhanced Equity Index
Account.
1. The results for the Enhanced Equity Index Account reflects both income and
capital appreciation or depreciation (total return). Returns are time-weighted
and net of all applicable fees and expenses.
2. Annual rate of return for the Enhanced Equity Index Account is calculated
using the modified Dietz method, which is defined as the portfolio gain
(including all realized and unrealized gains and losses as well as all income)
over the average capital for the period. Average capital is the beginning
market value plus/minus weighted subscriptions/redemptions. Calculation is
done monthly, but is subject to revaluation during the month when there is a
cash flow that exceeds 10% of the beginning market value of the Enhanced
Equity Index Account.
3. See "Investment Objectives and Policies--AlphaTrak 500 Fund" for a
description of the S&P 500 Index.
SPECIAL NOTE CONCERNING ADVISER INVESTMENT RETURNS: Investors should note that
the Funds will compute and disclose their average annual compounded rate of
return using the standard formula set forth in SEC rules, which differs in
certain respects from returns for the Accounts noted above. The SEC total
return calculation method calls for computation and disclosure of an average
annual compounded rate of return for one, five and ten year periods or shorter
periods from inception. The SEC formula provides a rate of return that equates
a hypothetical initial investment of $1,000 to an ending redeemable value. The
returns shown for the Accounts are net of advisory fees in accordance with the
SEC calculation formula, which requires that returns be shown for the Funds be
net of advisory fees as well as all other applicable Fund operating expenses.
Performance was calculated on a trade date basis.
- --------------------------------------------------------------------------------
PROSPECTUS SUMMARY
- --------------------------------------------------------------------------------
INVESTMENT OBJECTIVES AND POLICIES
Each Fund has its own investment objective. See "Investment Objectives and
Policies" for a full discussion of the objectives of each Fund. The investment
objective of each Fund is fundamental and may not be changed without
shareholder approval.
THE INVESTMENT ADVISER
The Adviser, Metropolitan West Asset Management, LLC, is a registered
investment adviser organized as a California limited liability company in
1996. The Adviser managed approximately $2 billion of fixed-income investments
as of March 31, 1998 on behalf of institutional clients and the Funds. The
Adviser is owned in part by Metropolitan West Securities, Inc., a registered
investment adviser and broker-dealer. The Adviser is in the business of
furnishing investment advice to institutional clients and the Funds. The
Adviser's affiliate, Metropolitan West Securities, Inc.
6
<PAGE> 12
("MWS"), has managed fixed-income investments since 1992. MWS managed
approximately $14.9 billion for its clients as of March 31, 1998.
MANAGEMENT FEE
For its services, the Adviser receives a fee, accrued daily and paid monthly,
at the following annual percentages of average daily net assets: Total Return
Bond Fund--.55%; Low Duration Bond Fund--.48%; and Short-Term Investment
Fund--.40%. As compensation for its services to the AlphaTrak 500 Fund only,
the Fund pays the Adviser an advisory fee that consists of two components. The
first component is a basic fee equal to an annual rate of .35% of the Fund's
average daily net assets. The second component is a performance fee adjustment
that can increase or decrease the basic fee by as much as .35% depending on
the performance of the Fund compared to the S&P 500 Index. See "Organization
and Management - The Adviser" for a description of the adjustment formula.
INVESTMENT RISKS
Like all investments, an investment in each Fund involves certain risks. The
securities held by the Funds and the value of the Funds' shares will fluctuate
with market and other economic conditions, so that investors' shares, when
redeemed, may be worth more or less than their original cost. See "Investment
Risks" for a further discussion of certain risks.
MINIMUM PURCHASE
The minimum initial investment in a Fund is $5,000. For retirement plan
investments the minimum initial investment is $1,000. The Funds may waive
minimum investment requirements for shareholders investing through certain
fund networks or other financial intermediaries. In such cases, the minimums
associated with the policies and programs of the fund network or financial
intermediary shall apply.
OFFERING PRICE
Shares are offered at their net asset value without a sales charge and may be
redeemed at their net asset value on any business day. See "How To Purchase
Shares" and "How To Redeem Shares."
DIVIDENDS AND DISTRIBUTIONS
Each Fund expects to declare dividends daily and pay them monthly to
shareholders, except the AlphaTrak 500 Fund, which expects to declare and pay
dividends quarterly. 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.
Dividends and capital gain distributions (net of any required tax withholding)
are automatically reinvested in additional shares at the net asset value per
share on the reinvestment date unless the shareholder has previously requested
in writing to the Transfer Agent that payment be made in cash.
- --------------------------------------------------------------------------------
INVESTMENT OBJECTIVES AND POLICIES
- --------------------------------------------------------------------------------
GENERAL
The following descriptions are designed to help you choose the Fund that best
fits your investment objective. You may want to pursue more than one objective
by investing in more than one Fund. Each Fund's investment objective is a
fundamental policy, which cannot be changed without the approval of a majority
of the Fund's outstanding voting securities, as defined in the Investment
Company Act of 1940, as amended (the "1940 Act"). There can be no assurance
that any objective will be met. In addition, each Fund may use certain types
of investments and investing techniques that are described under the caption
"Securities and Techniques Used by the Funds." For a discussion of certain
risks associated with an investment in the Funds, including their use of
derivatives, see "Investment Risks."
Metropolitan West Asset Management, LLC (the "Adviser") acts as investment
adviser to each Fund.
THE TOTAL RETURN BOND FUND
The investment objective of the TOTAL RETURN BOND FUND is to seek 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
from two to eight years. The meaning of "duration" is explained below under
"Investment Policies of the Funds." The dollar-weighted average maturity of
the portfolio of the Fund is expected to range from two to fifteen years.
Portfolio holdings will be concentrated in areas of the bond market (based on
quality, sector, coupon or maturity) which the Adviser believes to be
relatively undervalued. The Adviser views bonds to mean any interest-bearing
security that obligates the issuer to pay the holder specified sums of money
on specified dates (or at maturity) and generally requires the issuer to repay
the principal amount of the loan at maturity.
THE LOW DURATION BOND FUND
The investment objective of the LOW DURATION BOND FUND is to seek to maximize
current income, consistent with preservation of capital. The Fund invests in a
diversified portfolio of fixed-income securities of varying maturities with a
portfolio duration of up to three years. The meaning of "duration" is
explained below under "Investment Policies of the Funds." The dollar-weighted
average maturity of the portfolio of the Fund is expected to range from one to
five
7
<PAGE> 13
years. The total rate of return for this Fund is expected to exhibit less
volatility than that of a longer duration fixed-income fund such as the TOTAL
RETURN BOND FUND.
SHORT-TERM INVESTMENT FUND
The investment objective of the SHORT-TERM INVESTMENT FUND is to seek to
maximize current income, consistent with preservation of capital. The Fund
invests in a portfolio of fixed-income securities of varying maturities with a
portfolio duration of up to one year. The meaning of "duration" is explained
below under "Investment Policies of the Funds." The Fund's dollar-weighted
average maturity will exceed its portfolio duration. The total rate of return
for this Fund is expected to exhibit less volatility than that of the longer
duration TOTAL RETURN BOND FUND or the LOW DURATION BOND FUND.
ALPHATRAK 500 FUND
The investment objective of the ALPHATRAK 500 FUND is to seek to achieve a
total return that exceeds the total return of the S&P 500 Index. The Fund is
not designed for investors that are sensitive to taxable gains. This Fund will
recognize most gains, if any, in each taxable year and is most suitable for
tax-deferred or non-taxable investors such as IRAs and employee benefit plans.
Under normal market conditions, the Fund will invest in S&P 500 Index futures
contracts with a contractual or "notional" value substantially equal to the
Fund's total assets. To make these investments the Fund will need to make
margin deposits with futures commission merchants (broker-dealers for futures
contracts) with a total value equal to approximately 4% of the notional value
of the futures contracts. The Fund will normally invest the rest of its assets
in a portfolio of fixed-income securities of varying maturities with a
portfolio duration of up to three years. The meaning of "duration" is
explained below under "Investment Policies of the Funds." These fixed-income
securities will be used to support the Fund's obligations under the futures
contracts to the extent required by the 1940 Act.
As a alternative to investing in S&P 500 Index futures, the Fund may
occasionally invest in other S&P 500 Index derivatives, or in the stocks that
comprise the S&P 500 Index and in other mutual funds that are designed to
track the performance of the S&P 500 Index. See "Investment Policies of the
Funds" for a discussion of these possible investments by the Fund. The Adviser
expects that the S&P 500 Index futures contracts or similar derivatives used
by the Fund will track the price performance of the S&P 500 Index, and the
active management of the fixed-income portfolio backing the futures contracts
will provide the opportunity to enhance the total return of the Fund. There
is, however, no guarantee that such results will be achieved. The ability of
the Fund to match or exceed the performance of the S&P 500 Index will depend
on whether the performance of its fixed-income portfolio exceeds the costs of
investing in S&P 500 Index futures contracts and the Fund's other fees and
expenses. Typically, the Fund will be invested in S&P 500 Index derivatives
and occasionally S&P 500 Index stocks and mutual funds with a total value
approximately equal to its total assets (even when the S&P 500 Index is
declining), and thus the Fund is expected to display volatility similar to
that of the S&P 500 Index. Although S&P 500 Index derivatives are used by many
investors, which generally results in a liquid market for those instruments,
from time to time liquidity may be limited. Limited liquidity could adversely
affect the Fund and prevent it from closing an unfavorable position while
remaining obligated to meet increasing margin requirements. See "Investment
Risks-- Risks of Using Certain Derivatives."
The S&P 500 Index consists of 500 stocks chosen by Standard & Poor's for
market size, liquidity and industry group representation. It is a market-value
weighted unmanaged index (stock price times number of shares outstanding),
with each stock's weight in the S&P 500 Index proportionate to its market
value. The Fund is neither sponsored by, nor affiliated with, Standard &
Poor's.
INVESTMENT POLICIES OF THE FUNDS
Portfolio Securities. The TOTAL RETURN BOND FUND, THE LOW DURATION BOND FUND,
THE SHORT-TERM INVESTMENT FUND and the ALPHATRAK 500 FUND (the "Funds") will
attempt to achieve their objectives by investing in the following types of
securities that may be issued by domestic or foreign entities: (i) U.S.
Government securities; (ii) corporate debt securities, including bonds, notes
and debentures; (iii) corporate and asset-backed commercial paper; (iv)
mortgage- and other asset-backed securities, including CMOs and REMICs; (v)
variable and floating rate debt securities (including inverse floaters); (vi)
subordinated corporate, mortgage, and asset-backed securities; (vii)
structured debentures, bonds and notes; (viii) bank certificates of deposit;
(ix) fixed time deposits and bankers' acceptances; (x) repurchase agreements
and reverse repurchase agreements; (xi) debt securities that are convertible
into or exchangeable for equity securities ("convertible securities"); (xii)
preferred equity securities; (xiii) obligations of foreign governments or
their subdivisions, agencies and instrumentalities; (xiv) obligations of
international agencies (such as the Agency for International Development) or
supranational entities; and (xv) privately placed and Rule 144A securities.
There is no limitation on the percentage of a Fund's assets that may be
committed to any of these types of securities, except to the extent that a
security may be deemed to be illiquid. See "Securities and Techniques Used by
the Funds."
In addition to the securities above, the ALPHATRAK 500 FUND may invest all of
its assets in the following equity derivative instruments (and in liquid
assets backing its investments in these derivatives): (i) S&P 500 Index
futures contracts; (ii) Mini S&P 500 Index futures contracts ("E-Mini"); (iii)
options on the S&P 500 Index and S&P futures; (iv) swap agreements involving
the S&P 500 Index. When the above listed S&P 500 Index derivatives appear to
be overvalued
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relative to the S&P 500 Index, the Fund may invest up to 100% in the common
stocks that comprise the S&P 500 Index. The Fund would not purchase all 500
issues, but would purchase a basket of common stocks represented in the S&P
500 Index that, in the opinion of the Adviser, will track the movements in the
S&P 500 Index. The Fund may also invest up to 25% of its total assets in these
stocks indirectly by purchasing interests in one or more mutual funds, asset
pools or trusts that invest in such stocks. During the several months
following commencement of operations, the Fund may invest up to 25% of its
assets in one or more money market mutual funds if its limited asset size does
not permit sufficient satisfactory investment in fixed-income securities in
the Adviser's judgment. The Fund would pay the additional fees and expenses of
any mutual funds or asset pools in which it invests, resulting in an
additional layer of management fees and expenses for shareholders in the Fund.
Positions in S&P 500 Index futures and options will be entered into only to
the extent they constitute permissible positions for the Fund according to
applicable rules of the Commodity Futures Trading Commission ("CFTC"). At
times, the Adviser may be constrained in its ability to use S&P 500 Index
derivatives either by requirements of the Internal Revenue Code or by an
unanticipated inability to close positions when it would be most advantageous
to do so. For more information about S&P 500 Index derivatives, see
"Investment Risks-- Risks of Using Certain Derivatives."
Credit Ratings. Under normal circumstances, the TOTAL RETURN BOND FUND will
invest at least 80% of its net assets in debt instruments rated at least (i)
Baa3 by Moody's Investor's Service ("Moody's") or BBB- by Standard & Poor's
Rating Group ("S&P"), Fitch Investors Services, Inc. ("Fitch") or Duff &
Phelps Credit Rating Co. ("Duff & Phelps"), (ii) A-2 by S&P, P-2 by Moody's,
F-2 by Fitch or D-2 by Duff & Phelps for short-term debt obligations
("Investment Grade Securities"), or (iii) of comparable quality to Investment
Grade Securities as determined by the Adviser in the case of unrated
securities. Up to 20% of the TOTAL RETURN BOND FUND'S net assets may be
invested in securities rated below Investment Grade Securities but rated B or
higher by one of the nationally recognized statistical rating organizations
or, if unrated, of comparable quality in the opinion of the Adviser.
Under normal circumstances, the LOW DURATION BOND FUND and the SHORT-TERM
INVESTMENT FUND each will invest at least 70% of its net assets in securities
rated at least: (i) A by Moody's, S&P, Fitch or Duff & Phelps, (ii) A-2 by
S&P, P-2 by Moody's, F-2 by Fitch or D-2 by Duff & Phelps for short-term debt
obligations ("Highly Rated Securities"), or (iii) of comparable quality to
Highly Rated Securities as determined by the Adviser in the case of unrated
securities. Up to 20% of the LOW DURATION BOND FUND'S and the SHORT- TERM
INVESTMENT FUND'S net assets may be invested in securities rated below Highly
Rated Securities but with ratings equal at least to Investment Grade
Securities by one of the nationally recognized statistical rating
organizations or, if unrated, of comparable quality in the opinion of the
Adviser. Up to 10% of the LOW DURATION BOND FUND'S and the SHORT-TERM
INVESTMENT FUND'S net assets may be invested in securities rated below
Investment Grade Securities but rated B or higher by one of the nationally
recognized statistical rating organizations or, if unrated, of comparable
quality in the opinion of the Adviser.
Under normal circumstances, the ALPHATRAK 500 FUND will invest at least 85% of
its net assets in debt instruments rated at least of comparable quality to
Investment Grade Securities or of comparable quality to Investment Grade
Securities as determined by the Adviser in the case of unrated securities. Up
to 15% of the ALPHATRAK 500 FUND's net assets may be invested in securities
rated below Investment Grade Securities but rated B or higher by one of the
nationally recognized statistical rating organizations or, if unrated, of
comparable quality in the opinion of the Adviser.
Securities rated Baa are considered by Moody's to have speculative
characteristics. For Baa/BBB rated securities, changes in economic conditions
or other circumstances are more likely to lead to a weakened capacity to make
principal and interest payments than is the case with higher grade securities.
Securities rated below BBB or Baa are judged to be predominantly speculative
with respect to their capacity to pay interest and repay principal in
accordance with the terms of their obligations and are commonly known as "junk
bonds." See "Investment Risks--Risks of Investing in Fixed-Income Securities."
After its purchase by one of the Funds, a security may be assigned a lower
rating or cease to be rated. This would not require the Fund to sell the
security, but the Adviser will consider such an event in determining whether
the Fund should continue to hold the security in the portfolio.
Each Fund may invest up to 10% of its net assets in emerging market foreign
securities, which are generally considered to be of a credit quality below
investment grade.
Each Fund may invest up to 25% of its total assets in securities of foreign
issuers that are denominated in U.S. dollars. Investment in securities of
foreign issuers that are not denominated in U.S. dollars by the Funds will be
limited to a maximum of 15% of each Fund's total assets.
Duration. The Funds each invest in a diversified portfolio of fixed-income
securities of varying maturities with a different portfolio "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, call and put features and prepayment exposure into one measure.
Traditionally, a fixed-income security's "term to maturity" has been used as a
proxy for the sensitivity of the security's price to changes in interest rates
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<PAGE> 15
(which is the "interest rate risk" or "volatility" of the security). However,
"term to maturity" measures only the time until a fixed-income 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 time intervals between the
present time and the time that the interest and principal payments are
scheduled or, in the case of a mortgage-backed, asset-backed, or 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 ordinarily less than maturity. In general, all other things being
equal, 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. There are some situations where even the standard
duration calculation does not properly reflect the interest rate exposure of a
security. 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. A Fund's
computation of duration is based on estimated rather than known factors. Thus,
there can be no assurance that a particular portfolio duration will at all
times be achieved by a Fund.
Duration is used in the management of the Funds as a tool to measure interest
rate risk. For example, a Fund with a 2-year duration would be expected to
change in value 2% for every 1% move in interest rates. Assuming an expected
average duration of .75 years for the SHORT-TERM INVESTMENT FUND, a 1% decline
in interest rates would cause the Fund to gain .75% in value; likewise, a 1%
rise in interest would produce a decline of .75% in the Fund's value. Assuming
an expected average duration of 2 years for the LOW DURATION BOND FUND, a 1%
decline in interest rates would cause the Fund to gain 2% in value; likewise,
a 1% rise in interest rates would produce a decline of 2% in the Fund's value.
Assuming an expected average duration of 4.5 years for the TOTAL RETURN BOND
FUND, a 1% decline in interest rates would cause the Fund to gain 4.5% in
value; likewise, a 1% rise in interest rates would produce a decline of 4.5%
in the Fund's value. Assuming an expected duration of .75 years for the
ALPHATRAK 500 FUND, a 1% decline in interest rates would cause the Fund to
gain .75% in value; likewise, a 1% rise in interest rates would produce a .75%
decline in the value of the FUND. It should be noted, however, that the above
assumptions (regarding the ALPHATRAK 500 FUND) do not reflect any changes in
S&P 500 Index futures contracts, other derivatives or S&P 500 Index stocks
that may be held by the Fund. Other factors such as changes in credit quality,
prepayments, the shape of the yield curve and liquidity affect the net asset
value of the Funds and may be correlated with changes in interest rates. These
factors can exacerbate swings in the Fund's share prices during periods of
volatile interest rate changes.
For a more detailed discussion of duration, see "Investment Objectives and
Policies--Duration" in the Statement of Additional Information.
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SECURITIES AND TECHNIQUES USED BY THE FUNDS
- --------------------------------------------------------------------------------
The following provides a summary of the securities and techniques used by the
Funds. The Statement of Additional Information contains more detailed
information about these investments and the risks associated with them.
U.S. GOVERNMENT SECURITIES
The Funds may invest in U.S. Government securities. U.S. Government securities
include direct obligations issued by the United States Treasury, such as
Treasury bills, certificates of indebtedness, notes, bonds and component parts
of notes or bonds (including the principal of such obligations or the interest
payments scheduled to be paid on such obligations). U.S. Government securities
also include securities issued or guaranteed by U.S. Government agencies and
instrumentalities that issue or guarantee securities, including, but not
limited to, the Federal National Mortgage Association ("FNMA"), Government
National Mortgage Association ("GNMA"), Federal Home Loan Banks, Federal
Financing Bank, and Student Loan Marketing Association.
Funds may also invest in Treasury Receipts. Treasury Receipts are not issued
by the United States Treasury and, therefore, they are not U.S. Government
securities.
All Treasury securities are backed by the full faith and credit of the United
States. 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,
such as the Federal Home Loan Banks, are backed by the right of the agency or
instrumentality to borrow from the Treasury. Others, such as securities issued
by FNMA, are supported only by the credit of the instrumentality and not by
the Treasury. If the securities are not backed by the full faith and credit of
the United States, the owner of the securities must look principally to the
agency issuing the obligation for repayment and may not be able to assert a
claim against the United States if the agency or instrumentality does not meet
its commitment.
Among the U.S. Government securities that may be purchased by the Funds are
certain "mortgage-backed securities" of GNMA, the Federal Home Loan Mortgage
Corporation ("FHLMC") and FNMA. See the discussion under
"Mortgage-Related Securities."
CORPORATE AND OTHER OBLIGATIONS
The Funds may invest in corporate debt securities, variable and floating rate
debt securities and corporate commercial paper in the rating categories
described above. Floating rate securities normally have a rate of interest
which is set as a specific percentage of a designated base rate, such as the
rate on Treasury bonds or bills or the prime rate at a major commercial bank.
The interest rate on floating rate securities changes periodically when there
is a change in the designated base rate. Variable rate securities provide for
a specified periodic adjustment in the interest rate based on prevailing
market rates.
The Funds may invest in corporate debt securities with contractual call
provisions that permit the seller of the security to repurchase the security
at a pre-determined price. The market price typically reflects the presence of
a call provision.
Structured debentures and structured notes are hybrid instruments with
characteristics of both bonds and swap agreements. Like a bond, these
securities make regular coupon payments and generally have fixed principal
amounts. However, the coupon payments are typically tied to a swap agreement
which can be affected by changes in a variety of factors such as exchange
rates, the shape of the yield curve and foreign interest rates. Because of
these factors, structured debentures and structured notes can display price
behavior that is more volatile than and often not correlated to other
fixed-income securities.
The Funds may also invest in inverse floaters and tiered index bonds. An
inverse floater is a type of derivative that bears 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 of 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. Tiered index bonds
are also a type of derivative instrument. 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 on the tiered index bond
will decrease. In general, the interest rates on tiered index bonds and
inverse floaters move in the opposite direction of prevailing interest rates.
The market for inverse floaters and tiered index bonds is relatively new.
These corporate debt obligations may have characteristics similar to those of
mortgage-related securities, but corporate debt obligations, unlike
mortgage-related securities, are not subject to prepayment risk other than
through contractual call provisions which generally impose a penalty for
prepayment.
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ASSET-BACKED SECURITIES
The Funds may invest in securities with principal and interest payouts backed
by, or supported by, any of various types of assets. These assets typically
include receivables related to the purchase of automobiles, credit card loans,
and home equity loans. These securities generally take the form of a
structured type of security, including pass-through, pay-through, and stripped
interest payout structures.
FOREIGN SECURITIES
Each Fund has the right to invest in foreign securities. Foreign economies may
differ from the U.S. economy; individual foreign companies may differ from
domestic companies in the same industry; and foreign currencies may be
stronger or weaker than the U.S. dollar. The Adviser believes that the ability
to invest abroad will enable the Funds to take advantage of these differences
when they are favorable.
Fixed-income securities that may be purchased by the Funds include debt
obligations issued or guaranteed by foreign governments, their subdivisions,
agencies or instrumentalities, or by supranational entities that have been
constituted by the governments of several countries to promote economic
development, such as The World Bank and The Asian Development Bank. Foreign
investment in certain foreign government debt is restricted or controlled to
varying degrees.
The Funds may invest in fixed-income securities of issuers located in emerging
foreign markets. Such markets generally include every country in the world
other than the U.S., Canada, Japan, Australia, Malaysia, New Zealand, Hong
Kong, Singapore, Korea and most Western European countries. From time to time,
emerging markets have offered the opportunity for higher returns but involve a
higher level of risk. Accordingly, the Adviser believes that the Funds'
limited ability to invest in emerging markets throughout the world may enable
the Funds to obtain a wider range of attractive investment opportunities.
Emerging market securities include securities issued or guaranteed by
governments, their agencies, instrumentalities or central banks ("sovereign
debt"); securities of issuers organized and operated to restructure the
investment characteristics of sovereign debt; securities of banks and other
business entities; and securities denominated in or indexed to currencies of
emerging markets. These securities include "Brady Bonds," which afford
emerging market countries a means to restructure their outstanding commercial
bank debt. Foreign governmental issuers of debt or the governmental
authorities that control repayment of the debt may be unable or unwilling to
repay principal or pay interest when due and all or a portion of the interest
payments and/or principal repayment with respect to Brady Bonds may be
uncollateralized.
Emerging market securities are generally considered to be of a credit quality
below investment grade, even though they often are not rated by any nationally
recognized statistical rating organizations. The Adviser seeks to reduce the
risk associated with emerging market securities by limiting the amount of such
securities held by the Funds, by the depth of its own credit analysis, and
evaluation of political, economic, currency and other factors that may be
pertinent.
There are risks in investing in emerging market and other
foreign securities. See "Investment Risks--Risks of Investing
in Emerging Market and Other Foreign Securities."
REPURCHASE AGREEMENTS
Each Fund may enter into repurchase agreements involving U.S. Government
securities or other collateral including mortgage-related products or
corporate securities with commercial banks or broker-dealers, whereby the
seller of a security agrees to repurchase the security from the Fund on an
agreed-upon date in the future. While each Fund intends to be fully
collateralized as to such agreements, and the collateral will be marked to
market daily, if the person obligated to repurchase from the Fund defaults,
there may be delays and expenses in liquidating the securities subject to the
repurchase agreement, a decline in their value and a loss of interest income.
REVERSE REPURCHASE AGREEMENTS
The Funds may enter into reverse repurchase agreements, whereby a Fund sells
securities concurrently with entering into an agreement to repurchase those
securities at a later date at a fixed price. During the reverse repurchase
agreement period, the Fund continues to receive principal and interest
payments on those securities. Reverse repurchase agreements are speculative
techniques involving leverage and are considered borrowings by the Fund for
purposes of the percentage limitations applicable to borrowings.
BORROWING
As a fundamental policy, a Fund may borrow for temporary, emergency or
investment purposes up to 10% of its total assets. This borrowing may be
unsecured. Borrowing subjects a Fund to interest costs which may or may not be
recovered by appreciation of the securities purchased, and can exaggerate the
effect on net asset value of any increase or decrease in the market value of a
Fund's portfolio. This is the speculative factor known as leverage.
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LOANS OF PORTFOLIO SECURITIES
For the purpose of achieving income, a Fund may lend its portfolio securities,
provided: (i) the loan is secured continuously by collateral consisting of
short-term, high quality debt securities, including U.S. Government
securities, negotiable certificates of deposit, bankers' acceptances or
letters of credit, maintained on a daily marked-to-market basis in an amount
at least equal to the current market value of the securities loaned; (ii) the
Fund may at any time call the loan and obtain the return of the securities
loaned; (iii) the Fund will receive any interest or dividends paid on the
loaned securities; and (iv) the aggregate market value of securities loaned
will not at any time exceed one-third of the total assets of the Fund.
WHEN-ISSUED SECURITIES
The Funds may purchase securities on a when-issued or delayed-delivery basis,
generally in connection with an underwriting or other offering. When-issued
and delayed-delivery transactions occur when securities are bought with
payment for and delivery of the securities scheduled to take place at a future
time, beyond normal settlement dates, generally from 15 to 45 days after the
transaction. The price that the Fund is obligated to pay on the settlement
date may be different from the market value on that date. While securities may
be sold prior to the settlement date, the Funds intend to purchase such
securities with the purpose of actually acquiring them, unless a sale would be
desirable for investment reasons. At the time the Fund makes a commitment to
purchase a security on a when-issued basis, it will record the transaction and
reflect the value of the security each day in determining the Fund's net asset
value. The Fund will also designate liquid securities, marked-to-market daily,
equal in value to its obligations for when-issued securities.
SHORT SALES
If a Fund anticipates that the price of a security will decline, it may sell
the security "short" and borrow the same security from a broker or other
institution to complete the sale. The Fund may make a profit or loss depending
upon whether the market price of the security decreases or increases between
the date of the short sale and the date on which the Fund must replace the
borrowed security. Until the security is replaced, the Fund generally is
required to pay to the lender amounts equal to any interest which accrues
during the period of the loan. To borrow the security, the Fund also may be
required to pay a premium, which would also increase the cost of the security
sold. The proceeds of the short sale will be retained by the broker (or by the
Fund's custodian in a special custody account), to the extent necessary to
meet the margin requirements, until the short position is closed out.
Until the Fund closes its short position or replaces the borrowed security,
the Fund will designate liquid securities at such a level that (i) the amount
deposited in the account plus the amount deposited with the broker as
collateral will equal the current value of the security sold short and (ii)
the amount designated plus the amount deposited with the broker as collateral
will not be less than the market value of the security at the time it was sold
short.
A Fund may not make short sales of securities or maintain a short position if
more than 25% of the Fund's net assets (taken at current value) are held as
collateral for such sales at any one time.
MORTGAGE-RELATED SECURITIES
The Funds may invest in mortgage-related securities, including mortgage
pass-through securities and collateralized mortgage obligations. Mortgage
pass-through securities are securities representing interests in pools of
mortgages in which payments of both interest and principal on the securities
are generally made monthly, in effect "passing through" monthly payments made
by the individual borrowers on the residential mortgage loans which underlie
the securities (net of fees paid to the issuer or guarantor of the
securities). For a discussion of certain risks associated with investment in
mortgage-related securities, including their volatility, see "Investment
Risks--Risks of Investing in Fixed Income Securities."
Payment of principal and interest on some mortgage-related securities (but not
the market value of the securities 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.
Collateralized mortgage obligations ("CMOs"), including CMOs that have elected
to be treated for federal income tax purposes as Real Estate Mortgage
Investment Conduits ("REMICs"), are hybrid instruments with characteristics of
both bonds and mortgage pass-through securities. Similar to a bond, interest
and prepaid principal on a CMO are paid, in most cases, monthly. CMOs may be
collateralized by whole mortgage loans but are more typically collateralized
by portfolios of securities guaranteed by GNMA, FHLMC or FNMA or of mortgage
pass-through securities created by non-governmental issuers. CMOs are
structured into multiple classes, with each class bearing a different stated
maturity. Monthly payments of principal, including prepayments, are first
returned to investors holding the shortest maturity class.
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Investors holding the longer maturity classes receive principal only after
earlier classes have been retired.
Other mortgage-related securities include those that directly or indirectly
represent a participation in or are secured by and payable from mortgage loans
on real property, such as CMO residuals, stripped mortgage-backed securities,
variable rate securities (including inverse floaters), or tiered index bonds
and may be structured in classes with rights to receive varying proportions of
principal and interest. Stripped mortgage-backed securities are derivative,
multi-class mortgage securities. 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). The yields to
maturity on IOs and POs are 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.
Conversely, if the underlying mortgage assets experience less than expected
prepayments of principal, the yield on POs could be materially adversely
affected. 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.
CMOs and other mortgage-related securities that are issued or guaranteed by
the U.S. Government or by any of its agencies or instrumentalities will be
considered U.S. Government securities for purposes of applying a Fund's
diversification tests. Generally, the entity that has the ultimate
responsibility for the payment of interest and principal on a security is
deemed to be the issuer of an obligation.
OTHER DERIVATIVE INSTRUMENTS
In addition to the asset-backed securities and mortgage-related securities
(including tiered index bonds and inverse floaters) which may be purchased by
the Funds, the Funds may utilize (and the emphasizes) certain other financial
instruments with performance derived from the performance of an underlying
asset ("derivatives"). The Funds might not employ any of the strategies
described below, and no assurance can be given that any strategy used will
succeed. The Funds may purchase and write call and put options on securities,
securities indices and on foreign currencies, and enter into futures contracts
and use options on futures contracts. The Funds also may enter into swap
agreements with other institutional investors with respect to foreign
currencies, interest rates, and securities indices. 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 designated assets consisting of cash, U.S.
Government securities, equity securities or other liquid, unencumbered assets,
marked-to-market daily (or, as permitted by applicable regulation, enter into
certain offsetting positions), to cover its obligations under options, futures
contracts and swap agreements to avoid leveraging of the Fund. The value of
some derivative investments in which the Funds invest may be particularly
sensitive to changes in prevailing interest rates or securities prices. A
Fund's ability to successfully utilize these instruments may depend in part on
the Adviser's ability to forecast correctly the movement of interest rates and
other economic factors. Should the Adviser incorrectly forecast those factors,
and take positions in derivative instruments contrary to prevailing market
trends, the Funds could lose value and experience substantial volatility. See
"Investment Risks - Risks of Using Certain Derivatives."
The Funds may buy or sell interest rate futures contracts, options on interest
rate futures contracts and options on debt securities for the purpose of
hedging against changes in the value of securities which a Fund owns or
anticipates purchasing due to anticipated changes in interest rates. The Funds
also may engage in currency exchange transactions by means of buying or
selling foreign currency on a spot basis, entering into forward foreign
currency exchange contracts, and buying and selling foreign currency options,
futures and options on futures. Foreign currency exchange transactions may be
entered into for the purpose of hedging against foreign currency exchange risk
arising from the Funds' investment or anticipated investment in securities
denominated in foreign currencies.
A Fund will not enter into futures contracts or options thereon for
non-hedging purposes if, immediately thereafter, the aggregate initial margin
deposits on the Fund's futures positions and premiums paid for options thereon
(excluding "in-the-money" amounts) would exceed 5% of the liquidation value of
the Fund's total assets. There is no other percentage limitation on a Fund's
use of options, futures and options thereon, except for the limitation on
foreign currency option contracts described below.
Also, the Funds may enter into interest rate, index and currency exchange rate
swap agreements to attempt to obtain a particular desired return at a lower
cost than if the Fund had invested directly in an instrument that yielded that
desired return. In a standard swap agreement, two parties agree to exchange
the returns (or differentials in rates of return) earned or realized on a
particular predetermined investment or investments. Swap agreements are
subject to the Funds' overall limit that no more than 15% of net assets may be
invested in illiquid securities, and a Fund will not enter into a
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<PAGE> 20
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.
The Funds may purchase foreign currency options or enter into forward foreign
currency exchange contracts for the purpose of hedging against the effect that
currency fluctuations will have on the value of Fund liabilities, such as
known or expected redemptions or the payment of any declared dividends. No
Fund will enter into foreign currency option contracts if the premiums on such
options exceed 5% of the Fund's total assets. See "Investment Objectives and
Policies--Derivative Instruments" in the Statement of Additional Information.
The may purchase or sell S&P 500 Index futures or other stock index futures,
options on stock index futures, and swap agreements involving payments related
to a stock index or basket of stocks, subject to the limits described above.
See "Investment Objectives and Policies-Derivative Instruments" in the
Statement of Additional Information.
PORTFOLIO TURNOVER
Portfolio securities are sold whenever the Adviser believes it appropriate,
regardless of how long the securities have been held. Each Fund's investment
program emphasizes active portfolio management with a sensitivity to
short-term market trends and price changes in individual securities.
Accordingly, the Funds expect to take frequent trading positions, resulting in
portfolio turnover that may exceed those of most investment companies of
comparable size. Portfolio turnover generally involves some expense to the
Funds, including brokerage commissions, dealer markups and other transaction
costs, and may result in the recognition of capital gains that may be
distributed to shareholders. Generally, portfolio turnover in excess of 100%
is considered high and increases such costs. The annual portfolio turnover is
expected to be approximately 250% for the TOTAL RETURN BOND FUND, 150% for the
LOW DURATION BOND FUND and 300% for the ALPHATRAK 500 FUND. The Adviser will
not necessarily limit portfolio turnover to these levels. See "Financial
Highlights" for past turnover rates.
- --------------------------------------------------------------------------------
INVESTMENT RISKS
- --------------------------------------------------------------------------------
The investment practices described above involve certain risks. The net asset
value of any Funds may increase or decrease for many reasons. These include
changes in the market prices of portfolio securities, the success or failure
(and the associated costs) of investment strategies used by the Adviser in
seeking to achieve a Fund's investment objective, and the payment of dividends
and distributions to shareholders. The following provides a summary of the
more significant risks associated with investing in the Funds. The Statement
of Additional Information contains more detailed information about these
investments and the risks that are associated with them.
RISKS OF INVESTING IN EMERGING MARKET AND OTHER
FOREIGN SECURITIES
Investments in emerging market and other foreign securities involve certain
risk considerations not typically associated with investing in securities of
U.S. issuers, including: (a) currency devaluations and other currency exchange
rate fluctuations; (b) political uncertainty and instability; (c) more
substantial government involvement in the economy; (d) higher rates of
inflation; (e) less government supervision and regulation of the securities
markets and participants in those markets; (f) controls on foreign investment
and limitations on repatriation of invested capital and on a Fund's ability to
exchange local currencies for U.S. dollars; (g) greater price volatility,
substantially less liquidity and significantly smaller capitalization of
securities markets; (h) absence of uniform accounting and auditing standards;
(i) generally higher commission expenses; (j) delay in settlement of
securities transactions; and (k) greater difficulty in enforcing shareholder
rights and remedies.
RISKS OF INVESTING IN FIXED-INCOME SECURITIES
The Funds are subject primarily to interest rate and credit risk. Interest
rate risk is the potential for a decline in bond prices due to rising interest
rates. In general, bond prices vary inversely with interest rates. The change
in bond price depends on several factors, including the bond's maturity date.
In general, bonds with longer maturities are more sensitive to changes in
interest rates than bonds with shorter maturities. Credit risk is the
possibility that a bond issuer will fail to make timely payments of interest
or principal to a Fund.
The Funds may invest in mortgage- and asset-backed securities. The yield
characteristics of mortgage-backed and asset backed securities differ from
traditional debt securities. Among the major differences are that interest and
principal payments are made more frequently, usually monthly, and that
principal may be prepaid at any time because the underlying mortgage loans or
other assets generally may be prepaid at any time. As a result, if a Fund
purchases such a security at a premium, a prepayment rate that is faster than
expected will reduce yield to maturity, while a prepayment rate that is slower
than expected will have the opposite effect of increasing yield to maturity.
Alternatively, if a Fund purchases these securities at a discount, faster than
expected prepayments will increase yield to maturity, while slower than
expected prepayments will reduce yield to maturity. Although the extent of
prepayments on a pool of mortgage loans depends on various economic and other
factors, as a general rule, prepayments on fixed-rate mortgage loans will
increase
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<PAGE> 21
during a period of falling interest rates and decrease during a period of
rising interest rates. Asset-backed securities, although less likely to
experience the same prepayment rates as mortgage-backed securities, may
respond to certain of the same factors influencing prepayments, while at other
times different factors will predominate.
Mortgage-backed securities and asset-backed securities may decrease in value
as a result of increases in interest rates and may benefit less than other
fixed-income securities from declining interest rates because of the risk of
prepayment.
The Funds may invest in stripped mortgage- or asset-backed securities, which
receive differing proportions of the interest and principal payments from the
underlying assets. The market value of such securities generally is more
sensitive to changes in prepayment and interest rates than is the case with
traditional mortgage- and asset-backed securities, and in some cases the
market value may be extremely volatile. With respect to certain stripped
securities, such as IO and PO classes, a rate of prepayment that is faster or
slower than anticipated may result in a Fund failing to recover all or a
portion of its investment, even though the securities are rated investment
grade. Certain of the stripped mortgage- and asset-backed securities held by
the Funds are considered to be illiquid under guidelines established by the
Trustees.
The Funds may invest a portion of their assets in non-investment grade debt
securities, commonly referred to as "junk bonds." Low-rated and comparable
unrated securities, while generally offering higher yields than investment
grade securities with similar maturities, involve greater risks, including the
possibility of default or bankruptcy. They are regarded as speculative with
respect to the issuer's capacity to pay interest and to repay principal. The
market values of certain of these securities tend to be more sensitive to
individual corporate development and changes in economic conditions than
higher quality bonds. In addition, low-rated and comparable unrated securities
tend to be less marketable than higher-quality debt securities because the
market for them is not as broad or active. The lack of a liquid secondary
market may have an adverse effect on market price and a Fund's ability to sell
particular securities.
RISKS OF USING CERTAIN DERIVATIVES
Participation in the options or futures markets involves investment risks and
transaction costs to which a Fund would not be subject absent the use of these
strategies. If the Adviser's predictions of movements in the direction of the
securities and interest rate markets are inaccurate, the adverse consequences
to a Fund may leave the Fund in a worse position than if such strategies were
not used. Risks inherent in the use of options, futures contracts and options
on futures contracts include: (i) dependence on the Adviser's ability to
predict correctly movements in the direction of interest rates and securities
prices; (ii) imperfect correlation between the price of options and futures
contracts and options thereon and movements in the prices of the securities
being hedged; (iii) the fact that skills needed to use these strategies are
different from those needed to select portfolio securities; (iv) the absence
of a liquid secondary market for any particular instrument at any time; (v)
the possible need to defer closing out certain hedged positions to avoid
adverse tax consequences; and (vi) the possible inability of a Fund to
purchase or sell a portfolio security at a time that otherwise would be
favorable for it to do so, or the possible need for the Fund to sell the
security at a disadvantageous time, due to the requirement that the Fund
maintain "cover" or collateral securities in connection with hedging
transactions. The loss from investing in futures transactions and other
derivatives is potentially unlimited. There also is no assurance that a liquid
secondary market will exist for futures contracts and options thereon in which
a Fund may invest. See "Investment Objectives and Policies--AlphaTrak 500
Fund; Investment Policies of the Funds" for information about S&P 500 Index
futures and derivatives used by the AlphaTrak 500 Fund and related risks. See
also "Investment Objectives and Policies--Derivative Instruments" in the
Statement of Additional Information.
- --------------------------------------------------------------------------------
PRINCIPAL INVESTMENT RESTRICTIONS
- --------------------------------------------------------------------------------
Each Fund is subject to certain investment restrictions that are fundamental
policies. Fundamental policies are those that cannot be changed without the
approval of a majority (as defined in the 1940 Act) of that Fund's outstanding
voting securities. Each Fund's investment objective is a fundamental policy.
Among its fundamental policies, a Fund may not (i) with respect to 75% of its
total assets, invest more than 5% of its total assets (determined at the time
of investment) in securities of any one issuer (other than U.S. Government
securities and mutual funds) (ii) with respect to 75% of its total assets,
purchase more than 10% of the outstanding voting securities of any one issuer
(other than mutual funds) or (iii) invest more than 25% of its total assets
(determined at the time of investment) in one or more issuers having their
principal business activities in a single industry. Additional information
about each Fund's investment restrictions is contained in the Statement of
Additional Information. As a matter of operating policy (though not a
fundamental policy), the Funds limit investments in illiquid securities to no
more than 15% of the value of their net assets. Illiquid securities include:
(i) securities for which there is no readily available market; (ii) securities
which may be subject to legal restrictions (so-called "restricted securities")
other than Rule 144A securities noted below; (iii) repurchase agreements
having more than seven days to maturity; (iv) fixed time deposits subject to
withdrawal penalties (other than those with
16
<PAGE> 22
a term of less than seven days); and (v) foreign securities subject to
repatriation restrictions on the sale proceeds other than minor settlement
procedures. Restricted securities do not include those which meet the
requirements of Rule 144A under the Securities Act of 1933, as amended, and
which the Trustees have determined to be liquid based on the applicable
trading markets and the availability of reliable price information.
- --------------------------------------------------------------------------------
ORGANIZATION AND MANAGEMENT
- --------------------------------------------------------------------------------
ORGANIZATION AND VOTING RIGHTS
The Trust was organized on December 9, 1996 as a Delaware business trust.
Beneficial interests in the Trust shall at all times be divided into an
unlimited number of shares, with a par value of $.01 per share. The Trust is a
diversified open-end, management investment company currently consisting of
three separate series. The Trust's Board Of Trustees decides matters of
general policy and reviews the activities of the Adviser. The Trust's officers
conduct and supervise the daily business operations of the Trust. Each Fund is
a series of shares of the Trust, having separate assets and liabilities. The
Board of Trustees may, at its own discretion, create additional series of
shares and classes within series.
Generally, the Funds will not hold an annual meeting of shareholders unless
required by the 1940 Act. Shareholders have one vote per dollar net asset
value of shares owned. Matters submitted to shareholders must be approved by
the requisite vote of each Fund, unless it is clear that the interests of each
Fund in the matter are identical or the matter does not affect a Fund. At the
request of the holders of at least 10% of the shares, the Trust will hold a
meeting to vote on the removal of a Trustee, which can occur by a vote of more
than two-thirds of the outstanding shares. Shareholders holding the lesser of
$25,000 worth or one percent of a Fund's shares may then advise the Trustees
in writing that they wish to communicate with other shareholders for the
purpose of requesting a meeting to remove a Trustee. The Trustees will then,
if requested by the applicants, mail at the applicants' expense the
applicants' communications to all other shareholders.
THE ADVISER
General. The Adviser is located at 10880 Wilshire Blvd., Suite 2020, Los
Angeles, California 90024, and acts as the investment adviser to the Funds and
generally administers the affairs of the Trust. Subject to the direction and
control of the Board of Trustees, the Adviser supervises and arranges the
purchase and sale of securities held in the portfolios of the Funds. The
Adviser, Metropolitan West Asset Management, LLC, is a registered investment
adviser organized as a California limited liability company in 1996. The
Adviser managed approximately $2 billion of fixed-income investments as of
March 31, 1998 on behalf of institutional clients and the Funds. The Adviser
is owned in part by Metropolitan West Securities, Inc. ("MWS"), a registered
investment adviser and broker-dealer. The Adviser is in the business of
furnishing investment advice to institutional clients and the Funds. The
Adviser's affiliate, MWS, has managed fixed-income investments since 1992. MWS
managed approximately $14.9 billion for its clients as of March 31, 1998. The
portfolio managers for the Funds also serve as portfolio managers with MWS
pending the transition of certain client accounts to the Adviser.
The Funds could be adversely affected if the computer systems used by the
Adviser and the Funds' other service providers do not properly process and
calculate date-related information from and after January 1, 2000. While year
2000- related computer problems could have a negative effect on the Funds, the
Adviser is working to avoid such problems and to obtain assurances from
service providers that they are taking similar steps.
Advisory Fees. Under the Investment Advisory Agreement relating to the Total
Return Bond Fund, the Trust pays the Adviser a fee, computed daily and payable
monthly, at an annual rate of .55% of the Fund's average daily net assets.
Under the Investment Advisory Agreement relating to the Low Duration Bond
Fund, the Trust pays the Adviser a fee, computed daily and payable monthly, at
an annual rate of .48% of the Fund's average daily net assets.
Under the Investment Advisory Agreement relating to the Short-Term Investment
Fund, the Trust pays the Adviser a fee, computed daily and payable monthly, at
an annual rate of .40% of the Fund's average daily net assets.
Under the Investment Advisory Agreement relating to the AlphaTrak 500 Fund,
the Trust pays the Adviser a basic fee of .35% of the Fund's average daily net
assets. The basic fee may be adjusted upward or downward (by up to .35% of the
Fund's average daily net assets), depending on whether, and to what extent,
the investment performance of the AlphaTrak 500 Fund, for the relevant
performance period, exceeds or is exceeded by, the performance of the S&P 500
Index over the
17
<PAGE> 23
same period. The performance period consists of the prior three calendar
months. Each .10% of difference of the Fund's performance compared to the
performance of the S&P 500 Index plus 1.00% is multiplied by a performance
adjustment of .035%, up to a maximum adjustment of .35% (as an annual rate).
Thus, an annual excess performance difference of 2.00% or more between the
Fund and the S&P 500 Index would result in an annual maximum performance
adjustment of .35%. This formula requires that the Fund's performance exceed
the performance of the S&P 500 Index by at least 1.00% before any upward
adjustment is made to the basic fee. The Fund's performance may still exceed
the S&P 500 Index's performance (but by less than 1.00%) and a reduction in
the basic fee would occur.
Here are examples of how the adjustment would work (using annual rates):
<TABLE>
<CAPTION>
AlphaTrak
Fund 500 S&P Total
(before 500 Basic Fee Adv.
adv. fee) Index Fee Adj. Fee
--------- ----- --- ---- ---
<S> <C> <C> <C> <C>
8.00% 8.00% .35% (.35)% --%
9.00% 8.00% .35% -- .35%
9.50% 8.00% .35% .18% .53%
-8.00% -10.00% .35% .35% .70%
</TABLE>
The Fund's performance is calculated based on its net asset value per share
after expenses but before the advisory fee. For purposes of calculating the
performance adjustment, any dividends or capital gains distributions paid by
the Fund are treated as if those distributions were reinvested in Fund shares
at the net asset value per share as of the record date for payment. The
performance record for the S&P 500 Index is based on the change in value of
that index, and is adjusted for any cash distributions from the companies
whose securities comprise the S&P 500 Index.
Because the adjustment to the basic fee is based on the comparative
performance of the Fund and the record of the S&P 500 Index, the controlling
factor (regarding the adjustment to the basic fee) is not whether the Fund's
performance is up or down, but whether it is up or down more or less than the
performance record of the S&P 500 Index. Moreover, the comparative investment
record of the Fund is based solely on the relevant performance period without
regard to the cumulative performance over a longer or shorter period.
The performance period initially used for calculating any performance
adjustment to the basic fee will begin when the Fund's operations commence and
will increase by each succeeding month until a total of three months has been
reached. Thus, the first performance period will be one month, the second
period will be two months and the third and later periods will be three
months. The advisory fee and any adjustment are calculated once per month (but
accrued daily based on the prior adjustment) and the entire advisory fee
normally is paid monthly. Shareholders should note that it is possible for
high past performance to result in a daily advisory fee accrual or monthly
advisory fee payment by the Fund that is higher than lower current performance
would otherwise produce.
Rule 12b-1 Fee. The Funds have a Share Marketing Plan or "12b-1 Plan" under
which they may finance activities primarily intended to sell shares, provided
the categories of expenses are approved in advance by the board and the
expenses paid under the plan were incurred within the last 12 months and
accrued while the plan is in effect. Expenditures by a fund under the plan may
not exceed .25% of its average net assets annually (all of which may be for
service fees). See "Summary of Expenses".
Other Expenses. In addition to the fee payable to the Adviser, each Fund is
responsible for its operating expenses including; (i) interest and taxes; (ii)
brokerage commissions; (iii) insurance premiums; (iv) compensation and
expenses of the Trust's Trustees other than those affiliated with the Adviser;
(v) legal and audit expenses; (vi) fees and expenses of the Fund's custodian
and any subcustodian, shareholder servicing or transfer agent and accounting
services agent; (vii) expenses incident to the issuance of its shares,
including issuance on the payment of, or reinvestment of, dividends; (viii)
fees and expenses incident to the registration under federal or state
securities laws of the Trust or its shares; (ix) expenses of preparing,
printing and mailing reports and notices and proxy material to shareholders of
the Trust; (x) all other expenses incident to holding meetings of the Trust's
shareholders; (xi) dues or assessments of or contributions to the Investment
Company Institute or any successor; and (xii) such non-recurring expenses as
may arise, including litigation affecting the Trust and the legal obligations
not covered by insurance for which the Trust may have to indemnify its
officers and Trustees.
Compensation of Other Parties. The Adviser may in its discretion and out of
its own funds compensate third parties for the sale and marketing of the
Funds. The Advisor also may use its own funds to sponsor seminars and
educational programs on the Funds for financial intermediaries and
shareholders.
Although not required to do so, the Adviser has voluntarily agreed to limit
the annual expenses of the TOTAL RETURN BOND FUND to .65%, the LOW DURATION
BOND FUND to .58%, the SHORT-TERM INVESTMENT FUND to .50% and the ALPHATRAK
500 FUND (by limiting other expenses to .20% and assuming the maximum
management fee) to .90% of those Funds' respective average net assets. The
Adviser will give shareholders at least 30 days' notice of any decision to
change this policy.
The Adviser also manages individual investment advisory accounts. The Adviser
reduces the fees charged to individual advisory accounts by the amount of the
investment advisory
18
<PAGE> 24
fee charged to that portion of the client's assets invested in any Fund.
The Investment Advisory Agreement permits the Adviser to allocate brokerage
based on sales of shares of Funds managed by the Adviser. No such allocation
has been made to date.
THE ADMINISTRATOR
First Data Investor Services Group, Inc. ("Investor Services Group"), a wholly
owned subsidiary of First Data Corporation, serves as Administrator to the
Trust pursuant to an Administration Agreement. The principal business address
of Investor Services Group is 4400 Computer Drive, Westboro, Massachusetts
01581.
THE DISTRIBUTOR
FPS Broker Services, Inc., 3200 Horizon Drive, P.O. Box 61503, King of
Prussia, Pennsylvania 19406-0903 serves as principal underwriter to the Trust
pursuant to an Underwriting Agreement.
PORTFOLIO MANAGERS
The portfolio managers who have day-to-day responsibility for the management
of the Funds' portfolios are listed below, together with their biographical
information for the past five years.
SCOTT B. DUBCHANSKY has been the Chief Executive Officer of the Adviser since
August 1996. 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. Mr. Dubchansky, together with Mr. Rivelle, manages the
SHORT- TERM INVESTMENT FUND.
STEPHEN KANE, CFA has been a portfolio manager with the Adviser since August
1996. From November 1995 until July 1996, Mr. Kane was a portfolio manager
with Hotchkis and Wiley in Los Angeles. From July 1992 until October 1995 he
was an account manager with PIMCO in Newport Beach, California. Before then,
Mr. Kane was a Merchant Banking Associate with Union Bank in Los Angeles,
California. Mr. Kane, together with Messrs. Landmann and Rivelle, manages the
TOTAL RETURN BOND FUND and the ALPHATRAK 500 FUND.
LAIRD R. LANDMANN has been a Managing Director and portfolio manager with the
Adviser since August 1996. From November 1992 until July 1996 Mr. Landmann was
a principal and Co-Director of Fixed Income with Hotchkis and Wiley in Los
Angeles. Before then, he was a portfolio manager with PIMCO in Newport Beach,
California. Mr. Landmann, together with Messrs. Kane and Rivelle, manages the
TOTAL RETURN BOND FUND, the LOW DURATION BOND FUND and the ALPHATRAK 500 FUND.
TAD RIVELLE has been the Chief Investment Officer and a Managing Director with
the Adviser since August 1996. From November 1992 until July 1996, Mr. Rivelle
was a principal and Co-Director of Fixed Income with Hotchkis and Wiley in Los
Angeles. Before then, he was a portfolio manager with PIMCO in Newport Beach,
California. Mr. Rivelle, together with Messrs. Kane and Landmann, manages the
TOTAL RETURN BOND FUND, the LOW DURATION BOND FUND and the ALPHATRAK 500 FUND.
Mr. Rivelle, together with Mr. Dubchansky, also manages the SHORT-TERM
INVESTMENT FUND.
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<PAGE> 25
- --------------------------------------------------------------------------------
HOW TO PURCHASE SHARES
- --------------------------------------------------------------------------------
The minimum initial investment in each Fund is $5,000. For retirement plan
investments the initial minimum is $1,000. The Trust and the Transfer Agent
reserve the right to reject any order and to waive its minimum investment
requirements for shareholders investing through certain fund networks or other
financial intermediaries. In such cases, the minimums associated with the
policies and programs of the fund network or financial intermediary shall
apply. Investors may invest in any Fund by wiring the amount to be invested to
Metropolitan West Funds.
Wire to: UMB Bank, N.A.
ABA #10-10-00695 for First Data Investor
Services Group, Inc.
Account Number 98-7037-071-9
FBO (Name of Fund)
Shareholder name and account number
The shareholder's bank may impose a fee for investments by wire. The Fund or
the Transfer Agent will not be responsible for the consequences of delays,
including delays in the banking or Federal Reserve wire systems. Wires
received after the close of the New York Stock Exchange will be considered
received by the next business day.
To ensure propert credit, prior to wiring any funds the shareholder must call
(800) 241-4671 to give notification of the wire and to get an account number
assigned if the wire is an initial investment. In addition, if the wire
represents an initial investment, the investor must mail an application form,
by regular mail, to the Transfer Agent at the following address:
Metropolitan West Funds
c/o First Data Investor Services Group, Inc.
3200 Horizon Drive
P.O. Box 61503
King of Prussia, Pennsylvania 19406-0903
Investors may also purchase shares by sending a check payable to Metropolitan
West Funds, together with the application form to the address above.
Checks should be drawn on a U.S. bank and must be payable in U.S. dollars.
Shares of a Fund will be purchased for the account of the investor at the net
asset value next determined after receipt by the Transfer Agent, or an
authorized sub-agent, of the investor's wire or check. In the event a check is
not honored by the investor's bank, the investor will be liable for any loss
sustained by the Fund, as well as a $20 service charge imposed by the Transfer
Agent. Forms for additional contributions by check or change of address are
provided on account statements.
The Trust will only accept a check when the Trust is the primary payee. The
Trust may also accept orders from selected brokers, dealers and other
qualified institutions, with payment made to the Fund at a later time. The
Adviser is responsible for insuring that such payment is made on a timely
basis. Investors may be charged a fee if they effect transactions through a
broker or agent.
The Adviser may make payments out of its own resources to dealers and other
persons who distribute shares of the Funds.
Shareholder inquiries should be directed to the Trust, c/o First Data Investor
Services Group, Inc., P.O. Box 61583, King of Prussia, PA 19406-0903.
The Trust does not consider the U.S. Postal Service or other independent
delivery service to be its agent. Therefore, deposit in the mail or with such
service does not constitute receipt by the Transfer Agent.
NET ASSET VALUE
The net asset value per share of each Fund is determined on each day that
banks are open for business and the New York Stock Exchange is open for
trading, as of the close of regular trading on the New York Stock Exchange
(currently 4:00 p.m., Eastern time). The net asset value per share is the
value of the Fund's assets, less its liabilities, divided by the number of
shares of the Fund outstanding. The value of a Fund's portfolio securities is
determined on the basis of the market value of such securities or, if market
quotations are not readily available, at fair value under guidelines
established by the Trustees. Short-term investments maturing in less than 60
days are valued at amortized cost which the Board has determined to equal fair
value. The daily net asset value may not reflect the closing market price for
all futures contracts held by the Funds because the markets for certain
futures will close shortly after the time net asset value is calculated. See
"Net Asset Value" in the Statement of Additional Information for further
information.
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<PAGE> 26
- --------------------------------------------------------------------------------
HOW TO REDEEM SHARES
- --------------------------------------------------------------------------------
REGULAR REDEMPTION
A shareholder may redeem shares at any time by delivering instructions by
regular mail to the Transfer Agent or selected brokers, dealers and other
qualified institutions. If you would like to send a package via overnight mail
to the Trust, c/o the Transfer Agent, the address is: 3200 Horizon Drive, P.O.
Box 61503, King of Prussia, Pennsylvania 19406-0903.
The redemption request should identify the Fund and the account number,
specify the number of shares to be redeemed and be signed by all registered
owners exactly as the account is registered, and it will not be accepted
unless it contains all required documents. The shares will be redeemed at the
net asset value next determined after receipt of the request by the Transfer
Agent or other agent of the Funds. A redemption of shares is a sale of shares
and a shareholder may realize a taxable gain or loss.
If the proceeds of any redemption (a) exceed $50,000, (b) are paid to a person
other than the owner of record, or (c) are sent to an address or bank account
other than shown on the Transfer Agent's records, the signature(s) on the
redemption request must be guaranteed by a commercial bank or trust company in
the United States, a member firm of the National Association of Securities
Dealers, Inc., or other eligible guarantor institution. A notary public is not
an acceptable guarantor.
Additional documentation may be required for the redemption of shares held in
corporate, partnership or fiduciary accounts. In case of any questions, please
contact the Funds in advance.
Redemptions will be processed only on a day during which the New York Stock
Exchange and banks are open for business. Investors who purchase shares by
check or money order will not have redemption requests processed until there
is reasonable belief that the check or money order has cleared, which may take
up to 15 calendar days after the purchase order.
TELEPHONE REDEMPTION
You may redeem shares by telephone and have the proceeds wired to the bank
account as stated on the Transfer Agent's records. In order to redeem by
telephone, you must select the appropriate box on the Account Application. In
order to arrange for telephone redemptions or change payment instructions
after an account has been opened or to change the bank account or address
designated to receive redemption proceeds, a written request must be sent to
the Trust. The request must be signed by each shareholder of the account with
the signature guarantees as described above. Once this feature has been
requested, shares may be redeemed by calling Investor Services at (800)
241-4671 and giving the account name, account number, and amount of the
redemption. Joint accounts require only one shareholder to call. If redemption
proceeds are to be mailed or wired to the shareholder's bank account, the bank
involved must be a commercial bank located within the United States.
If an investor redeems shares by telephone and requests wire payment, payment
of the redemption proceeds will normally be made in federal funds on the next
business day provided that the redemption order is received by the Transfer
Agent before the relevant Fund's net asset value is calculated for the day.
There may be a charge of up to $10 for all wire redemptions.
The Funds reserve the right to reject any redemption request and the
redemption privilege may be modified or terminated at any time on 30-days'
notice to shareholders. In an effort to prevent unauthorized or fraudulent
redemption requests by telephone, the Trust and the Transfer Agent employ
reasonable procedures specified by the Funds to confirm that such instructions
are genuine. Among the procedures used to determine authenticity, investors
electing to redeem or exchange by telephone will be required to provide their
account number or other identifying information. All such telephone
transactions will be tape recorded and confirmed in writing to the
shareholder. The Trust may implement other procedures from time to time. If
reasonable procedures are not implemented, the Trust and/or the Transfer Agent
may be liable for any loss due to unauthorized or fraudulent transactions. In
all other cases, the shareholder is liable for any loss for unauthorized
transactions. In periods of severe market or economic conditions, the
telephone redemption of shares may be difficult to implement and shareholders
should redeem shares by writing to the Transfer Agent at the address listed
above. If for any other reason a shareholder is unable to redeem by telephone,
shareholders should redeem shares by writing to the Transfer Agent at the
address listed above.
TELEPHONE EXCHANGE
Shareholders are permitted to exchange their shares in a Fund for shares of
other Funds in the Trust, provided that such shares may legally be sold in the
state of the investor's residence, the shareholder has selected the
appropriate box on the Account Application. In order to arrange for telephone
exchange after an account has been opened, a written request must be sent to
the Transfer Agent at its address listed above. The request must be signed by
each shareholder of the account, with the signatures guaranteed as described
above. Shares exchanged for shares of another Fund will be priced at their
respective net asset values. In order to request an exchange by telephone, an
investor must give the account name, account number and the amount or number
of shares to be exchanged. An exchange of shares is treated for federal income
tax purposes as a redemption (sale) of shares given in
21
<PAGE> 27
exchange by the shareholder and an exchanging shareholder may, therefore,
realize a taxable gain or loss in connection with the exchange.
Exchange requests should be directed to the Transfer Agent at 1-800-241-4671.
Shares subject to an exchange must have a current value of at least $1,000.
The Funds reserve the right to reject any exchange request and the exchange
privilege may be modified or terminated at any time on 30-days' notice to
shareholders. In periods of severe market or economic conditions, the
telephone exchange of shares may be difficult to implement and shareholders
should exchange shares by writing to the Transfer Agent at the address listed
above.
In an effort to prevent unauthorized or fraudulent exchange requests by
telephone, the Trust and the Transfer Agent employ reasonable procedures
specified by the Funds to confirm that such instructions are genuine. Among
the procedures used to determine authenticity, investors electing to exchange
by telephone will be required to provide their account number. All such
telephone transactions will be tape recorded and confirmed in writing to the
shareholder. The Trust may implement other procedures from time to time. If
reasonable procedures are not implemented, the Trust and/or the Transfer Agent
may be liable for any loss due to unauthorized or fraudulent transactions. In
all other cases, the shareholder is liable for any loss for unauthorized
transactions.
PAYMENTS
After the Transfer Agent has received the redemption request and all proper
documents, payment for shares tendered will generally be made within three
business days. Payment may be delayed under unusual circumstances, as
specified in the 1940 Act.
REDEMPTION IN KIND
If the Board of Trustees determines that it would be detrimental to the best
interests of the remaining shareholders of any Fund to make payment wholly in
cash, the Fund may pay the redemption price in part by a distribution in kind
of readily marketable securities from the portfolio of that Fund, in lieu of
cash. The Trust has elected to be governed by Rule 18f-1 under the 1940 Act
pursuant to which each Fund is obligated to redeem shares solely in cash up to
the lesser of $250,000 or one percent of the net asset value of the Fund
during any 90-day period for any one shareholder. Should redemptions by any
shareholder exceed such limitation the Fund will have the option of redeeming
the excess in cash or in kind. If shares are redeemed in kind, the redeeming
shareholder would incur brokerage costs in converting the assets into cash.
REDEMPTIONS OF SMALL ACCOUNTS
A Fund may redeem all of the shares of any shareholder whose account has
declined to a net asset value of less than $500, as a result of a transfer or
redemption, at the net asset value determined as of the close of business on
the business day preceding the sending of the proceeds of such redemption. The
Trust would give shareholders whose shares were being redeemed 60-days' prior
written warning in which to purchase sufficient shares to avoid such
redemption.
REPURCHASES
The Trust may accept orders for the repurchase of its shares from certain
qualified institutions. Such an institution may charge the shareholder a fee
for its services. The Trust may also waive or modify its requirements as to
proper form for such institutions.
WITHHOLDINGS; REPORTING
The Fund may be required to withhold federal income tax, at a rate of 31%,
from proceeds of redemptions, if the shareholder is subject to backup
withholding. Failure to provide a certified tax identification number at the
time an account is opened will cause tax to be withheld. A Fund also may be
required to report redemptions to the Internal Revenue Service.
- --------------------------------------------------------------------------------
DIVIDENDS AND TAX STATUS
- --------------------------------------------------------------------------------
The Funds (except the ALPHATRAK 500 FUND) expect to declare dividends daily
and pay them monthly to shareholders. The ALPHATRAK 500 FUND expects to
declare and pay dividends to shareholders quarterly.
Distributions from net realized short-term gains, if any, and distributions
from any net capital gains realized through October 31st of each year and not
previously paid out will be paid out after that date; each Fund may also pay
supplemental distributions after the end of the Fund's fiscal year. Dividends
and distributions are paid in full and fractional shares of each Fund based on
the net asset value per share at the close of business on the ex-dividend
date, unless the shareholder requests, in writing to the Trust, payment in
cash. The Trust
22
<PAGE> 28
will notify each shareholder after the close of its fiscal year of both the
dollar amount and the tax status of that year's distributions.
Each Fund has elected and intends to continue to qualify (except for the newer
Funds that intend to elect and qualify) to be treated as a regulated
investment company under Subchapter M of the Internal Revenue Code of 1980, 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 provided that at least 90% of its net investment income earned in
the fiscal year is distributed.
The Taxpayers Relief Act, which was signed into law on August 5, 1997, was the
most wide-ranging tax legislation since 1986. Several provisions affect the
taxation of capital gains.
The Taxpayers Relief Act lowered the tax rate for long-term capital gains from
28% to 20%, but increased the holding period of assets from more than one year
to more than 18 months. For persons in the 15% income tax bracket, the new
rate is 10%.
Realized gains from capital assets held more than one year, but
eighteen months or less, will be taxed at a 28% rate. These
gains are called "mid-term" capital gains.
Also, capital gains in property held for more than five years will be eligible
for an 18% tax rate, but this only applies to assets acquired after December
31, 2000; therefore, a shareholder will not benefit from this provision until
the year 2006.
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 the
relevant type of capital gains to the shareholders regardless of the length of
time a shareholder has owned his shares.
Dividends, interest and gains received by a Fund may be subject to withholding
and other taxes imposed by foreign countries. Tax conventions between certain
countries and the U.S. may reduce or eliminate these foreign taxes.
Distributions will be taxable in the year in which they are received, except
for certain distributions received in January, which will be taxable as if
received the prior December. Shareholders of a Fund will be informed annually
of the amount and nature of the Fund's distributions, including the portions,
if any, that qualify for the dividends-received deduction, that are capital
gain distributions, and that are a return of capital.
Additional information about taxes is set forth in the Statement of Additional
Information. The foregoing discussion has been prepared by the management of
the Funds, and does not purport to be a complete description of all tax
implications of an investment in a Fund. Shareholders should consult their own
advisors concerning the application of federal, state and local tax laws to
their particular situations.
- --------------------------------------------------------------------------------
PERFORMANCE INFORMATION
- --------------------------------------------------------------------------------
From time to time the Funds may quote average annual total return
("standardized return") in advertisements or promotional materials.
Advertisements and promotional materials reflecting standardized return
("performance advertisements") will show percentage rates reflecting the
average annual change in the value of an assumed initial investment in a Fund
at the end of one-, five- and ten-year periods. If such periods have not yet
elapsed, data will be given as of the end of a shorter period corresponding to
the duration of the Fund. Standardized return assumes the reinvestment of all
dividends and capital gain distributions.
The Funds also may refer in advertising and promotional materials to yield. A
Fund's yield shows the rate of income that a Fund earns on its investments,
expressed as a percentage of the net asset value of Fund shares. A Fund
calculates yield by determining the income it earned from its portfolio
investments for a specified 30-day period (net of expenses), dividing such
income by the average number of Fund shares outstanding, and expressing the
result as an annualized percentage based on the net asset value at the end of
that 30-day period. Yield accounting methods differ from the methods used for
other accounting purposes; accordingly, a Fund's yield may not equal the
dividend income actually paid to investors or the income reported in the
Fund's financial statements.
In addition to standardized return, performance advertisements also may
include other total return performance data ("non-standardized return").
Non-standardized return may be quoted for the same or different periods as
those for which standardized return is quoted and may consist of aggregate or
average annual percentage rate of return, actual year-by-year rates or any
combination thereof. Further performance information is contained in the
Funds' annual reports to shareholders, which may be obtained without cost.
All data included in performance advertisements will reflect past performance
and are not indicative of future results. The
23
<PAGE> 29
investment return and principal value of an investment in a Fund will
fluctuate, and an investor's proceeds upon redeeming Fund shares may be more
or less than the original cost of the shares.
- --------------------------------------------------------------------------------
GENERAL INFORMATION
- --------------------------------------------------------------------------------
Shareholder Report and Inquiries. Shareholders will receive annual financial
statements, which are examined by the Funds' independent auditors, Deloitte &
Touche LLP, as well as unaudited semi-annual financial statements. Unless
otherwise requested, only one copy of each shareholder report or other
material sent to shareholders will be sent to each household or address
regardless of the number of shareholders or accounts at that household or
address. Shareholder inquiries should be addressed to Metropolitan West Funds,
First Data Investor Services Group, Inc., P.O. Box 61503, King of Prussia,
Pennsylvania 19406-0903, (800) 241-4671.
- --------------------------------------------------------------------------------
APPENDIX -- DESCRIPTION OF RATINGS
- --------------------------------------------------------------------------------
MOODY'S INVESTORS SERVICE
BOND RATINGS:
"Aaa"--Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt-edged." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized
are most unlikely to impair the fundamentally strong position of such issues.
"Aa"--Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high-grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long term risks appear somewhat larger than in Aaa
securities.
Moody's applies numerical modifiers "l", "2" and "3" in each generic rating
classification from Aa through B. The modifier "l" indicates that the
obligation ranks in the higher end of its generic rating category; the
modifier "2" indicates a mid-range ranking; and the modifier "3" indicates
that the company ranks in the lower end of that generic rating category.
"A"--Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper medium-grade obligations. Factors giving
security to principal and interest are considered adequate but elements may be
present which suggest a susceptibility to impairment some time in the future.
"Baa"--Bonds which are rated Baa are considered as medium-grade obligations
(i.e., they are neither highly protected nor poorly secured). Interest
payments and principal security appear adequate for the present but certain
protective elements may be lacking or may be characteristically unreliable
over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
"Ba"--Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate, and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
"B"--Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
SHORT-TERM DEBT RATINGS:
Moody's short-term debt ratings are opinions regarding the ability of issuers
to repay punctually senior debt obligations. These obligations have an
original maturity not exceeding one year, unless explicitly noted.
"P-1"--Issuers rated "Prime-l" or "P-1" (or supporting institutions) have a
superior ability for repayment of senior short-term debt obligations.
"P-2"--Issuers rated "Prime-2" or "P-2" (or supporting institutions) have a
strong ability for repayment of senior short-term debt obligations.
BOND RATINGS:
"AAA"--Debt rated AAA has the highest rating assigned by
S&P. Capacity to pay interest and repay principal is extremely
strong.
"AA"--Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the highest rated
24
<PAGE> 30
issues only in small degree.
"A"--Debt rated A has a strong capacity to pay interest and repay principal,
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher-rated categories.
"BBB"--Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher-rated categories.
Debt rated BB and B is regarded as having predominantly speculative
characteristics with respect to capacity to pay interest and repay principal.
While such debt will likely have some quality and protective characteristics,
these are outweighed by large uncertainties or major exposures to adverse
conditions.
COMMERCIAL PAPER RATINGS:
An S&P commercial paper rating is a current assessment of the likelihood of
timely payment of debt considered short-term in the relevant market.
"A-1"--This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus (+) designation.
"A-2"--Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated A-1.
FITCH INVESTORS SERVICES, INC.
BOND RATINGS:
The following summarizes the ratings used by Fitch for corporate bonds:
"AAA"--Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest and
repay principal, which is unlikely to be affected by reasonably foreseeable
events.
"AA"--Bonds considered to be investment grade and of very high credit quality.
The obligor's ability to pay interest and repay principal is very strong,
although not quite as strong as bonds rated "AAA." Because bonds rated in the
"AAA" and "AA" categories are not significantly vulnerable to foreseeable
future developments, short-term debt of these issuers is generally rated
"F-1+."
"A"--Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions
and circumstances than bonds with higher ratings.
"BBB"--Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay is considered to be
adequate. Adverse changes in economic conditions and circumstances, however,
are more likely to have adverse impact on these bonds and, therefore, impair
timely payment. The likelihood that the ratings of these bonds will fall below
investment grade is higher than for bonds with higher ratings.
"BB"--Bonds are considered speculative. The obligor's ability to pay interest
and repay principal may be affected over time by adverse economic changes.
However, business and financial alternatives can be identified, which could
assist the obligor in satisfying its debt service requirements.
"B"--Bonds are considered highly speculative. While bonds in this class are
currently meeting debt service requirements, the probability of continued
timely payment of principal and interest reflects the obligor's limited margin
of safety and the need for reasonable business and economic activity
throughout the life of the issue.
Plus (+) Minus (-)--Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the "AAA" category.
SHORT-TERM DEBT RATINGS:
"F-1+"--Exceptionally Strong Credit Quality. Issues assigned
this rating are regarded as having the strongest degree of
assurance for timely payment.
"F-1"--Very Strong Credit Quality. Issues assigned this rating
reflect an assurance of timely payment only slightly less in
degree than issues rated "F-1+."
"F-2"--Good Credit Quality. Issues assigned this rating have a satisfactory
degree of assurance for timely payment, but the margin of safety is not as
great as for issues assigned "F-1+" or "F-1" ratings.
DUFF & PHELPS CREDIT RATING CO.
BOND RATINGS:
The following summarizes the ratings used by Duff & Phelps for long-term debt:
"AAA"--Highest credit quality. The risk factors are negligible,
being only slightly more than for risk-free U.S. Treasury debt.
"AA+," "AA," "AA-"--High credit quality. Protection factors are strong. Risk
is modest but may vary slightly from time to
25
<PAGE> 31
time because of economic conditions.
"A+," "A," "A-"--Protection factors are average but adequate. However, risk
factors are more variable and greater in periods of economic stress.
"BBB+," "BBB," "BBB-"--Below average protection factors but still considered
sufficient for prudent investment. Considerable variability in risk during
economic cycles.
"BB+," "BB," "BB-"--Below investment grade but deemed likely to meet
obligations when due. Present or prospective financial protection factors
fluctuate according to industry conditions or company fortunes. Overall
quality may move up or down frequently within this category.
"B+," "B," "B-"--Below investment grade and possessing risk that obligations
will not be met when due. Financial protection factors will fluctuate widely
according to economic cycles, industry conditions and/or company fortunes.
Potential exists for frequent changes in the rating within this category or
into a higher or lower rating grade.
SHORT-TERM DEBT RATINGS:
"D-1+"--Highest certainty of timely payment. Short-term liquidity, including
internal operating factors and/or access to alternative sources of funds, is
outstanding and safety is just below risk-free U.S. Treasury short-term
obligations.
"D-1"--Very high certainty of timely payment. Liquidity
factors are excellent and supported by good fundamental
protection factors. Risk factors are minor.
"D-1-"--High certainty of timely payment. Liquidity factors
are strong and supported by good fundamental protection
factors. Risk factors are very small.
"D-2"--Good certainty of timely payment. Liquidity factors and company
fundamentals are sound. Although ongoing funding needs may enlarge total
financing requirements, access to capital markets is good. Risk factors are
small.
26
<PAGE> 32
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:
First Data Investor Services Group, 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
San Francisco, California 94104-2635
<PAGE> 33
------------------------------------------------------------
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
Metropolitan West AlphaTrak 500 Fund
------------------------------------------------------------
Page 6
<PAGE> 34
METROPOLITAN WEST FUNDS
STATEMENT OF ADDITIONAL INFORMATION
June 29, 1998
This Statement of Additional Information is not a prospectus, and it
should be read in conjunction with the Prospectus dated June 29, 1998, as
supplemented from time to time, which includes Metropolitan West Total Return
Bond Fund (the "TOTAL RETURN BOND FUND"), Metropolitan West Low Duration Bond
Fund (the "LOW DURATION BOND FUND"), Metropolitan West Short-Term Investment
Fund (the "SHORT-TERM INVESTMENT FUND") and Metropolitan West AlphaTrak 500 Fund
(the "ALPHATRAK 500 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, the
Short-Term Investment Fund and the AlphaTrak 500 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>
<S> <C>
INVESTMENT OBJECTIVES AND POLICIES................................................................Page B-2
INVESTMENT RESTRICTIONS......................................................................Page B-2
REPURCHASE AGREEMENTS........................................................................Page B-3
U.S. GOVERNMENT SECURITIES...................................................................Page B-3
CORPORATE DEBT SECURITIES....................................................................Page B-4
CONVERTIBLE SECURITIES.......................................................................Page B-4
MORTGAGE-RELATED SECURITIES..................................................................Page B-4
ASSET-BACKED SECURITIES......................................................................Page B-7
RISK FACTORS RELATING TO INVESTING IN MORTGAGE-RELATED AND ASSET-BACKED SECURITIES...........Page B-7
DURATION.....................................................................................Page B-8
DERIVATIVE INSTRUMENTS.......................................................................Page B-8
FOREIGN SECURITIES..........................................................................Page B-13
FOREIGN CURRENCY OPTIONS AND RELATED RISKS..................................................Page B-14
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS.................................................Page B-14
RISK FACTORS RELATING TO INVESTING IN HIGH-YIELD SECURITIES.................................Page B-15
ILLIQUID SECURITIES.........................................................................Page B-16
MANAGEMENT.......................................................................................Page B-18
TRUSTEES AND OFFICERS.......................................................................Page B-18
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES.........................................Page B-19
PORTFOLIO TRANSACTIONS AND BROKERAGE........................................................Page B-20
INVESTMENT ADVISORY SERVICES................................................................Page B-21
ADMINISTRATOR...............................................................................Page B-21
CUSTODIAN AND TRANSFER AGENT................................................................Page B-22
DISTRIBUTOR.................................................................................Page B-22
SHARE MARKETING PLAN........................................................................Page B-22
DIVIDENDS AND TAX STATUS.........................................................................Page B-23
PERFORMANCE INFORMATION..........................................................................Page B-25
GENERAL INFORMATION ABOUT THE TRUST..............................................................Page B-26
ADDITIONAL INFORMATION...........................................................................Page B-27
FINANCIAL STATEMENTS.............................................................................Page B-27
</TABLE>
Page B-1
<PAGE> 35
INVESTMENT OBJECTIVES AND POLICIES
The investment objective of the TOTAL RETURN BOND FUND is to seek to
maximize long-term total return.
The investment objective of the LOW DURATION BOND FUND is to seek 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 seek
to maximize current income, consistent with the preservation of capital. Capital
appreciation is a secondary consideration of the Fund.
The investment objective of the ALPHATRAK 500 FUND is to seek to
achieve a total return that exceeds the total return of the S&P 500 Index ("S&P
500 Index").
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") or mutual funds, 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.
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.
Page B-2
<PAGE> 36
8. Participate on a joint or joint and several basis in any
trading account in securities, except to the extent the Fund
has received an exemptive order from the Securities and
Exchange Commission permitting such account.
9. Invest in commodities; except that the Fund may invest in
futures contracts or options on futures contracts (a) for bona
fide hedging purposes within the meaning of regulations of the
Commodity Futures Trading Commission "CFTC"), or (b) for other
than bona fide hedging purposes if, as a result thereof, no
more than 5% of that Fund's total assets (taken at market
value at the time of entering into the contract) would be
committed to initial deposits and premiums on open futures
contracts and options on such contracts (excluding
in-the-money amounts). (This is an operating policy that may
be changed without shareholder approval, consistent with
applicable regulations.)
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 net
assets in illiquid 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 net assets; and (d)
purchase securities of other investment companies, except in connection with a
merger, consolidation, reorganization or other acquisition of assets or except
as disclosed in the Prospectus, unless immediately thereafter not more than (i)
3% of the total outstanding voting stock of such company would be owned by the
Fund, (ii) except as disclosed in the Prospectus, 5% of the Fund's total assets
would be invested in any one such company, and (iii) except as disclosed in the
Prospectus, 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.
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.
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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.
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.
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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.
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.
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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.
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 ("SMRS") are derivative multi-class mortgage securities. SMRS 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.
SMRS 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 SMRS 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
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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 SMRS 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.
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.
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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 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 designated assets consisting of cash, U.S. Government securities,
or other liquid debt or equity securities (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.
OPTIONS ON SECURITIES AND ON SECURITIES INDEXES: A Fund may purchase
put options on securities to seek 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 seek 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's 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.
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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.
RISKS ASSOCIATED WITH OPTIONS ON SECURITIES AND INDEXES. 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.
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 a
number of indexes as well as financial instruments and foreign currencies,
including: the S&P 500; the S&P 100; the S&P Midcap 400; the Nikkei 225; 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; Eurodollar 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 ("ECU"). It is expected that other futures contracts
will be developed and traded in the future.
A Fund may purchase and write call and put futures options. Futures
options possess many of the same characteristics as options on securities and
indexes (discussed above). A futures option 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 applicable rules of the CFTC under which the Trust and
the Funds avoid being deemed a "commodity pool" and the Adviser being deemed a
"commodity pool operator." Accordingly, each Fund intends generally to limit its
use of futures contracts and futures options as described below under
"Limitations on Use of Futures and Futures Options."
Except for the AlphaTrak 500 Fund, the Funds generally will use futures
for hedging purposes only. The AlphaTrak 500 Fund uses futures in an effort to
achieve total return greater than the S&P 500, as described in the Prospectus.
With respect to hedging
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transactions, 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 futures options.
A Fund will only enter into futures contracts and futures options that
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 assets determined to be liquid by the Adviser in
accordance with procedures established by the Board of Trustees ("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. Margin requirements on foreign exchanges may be different than U.S.
exchanges. 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 initial margin requirements), the current market value of the option,
and other futures positions held by the Fund.
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.
The Funds may write covered straddles consisting of a call and a put
written on the same underlying futures contract. A straddle will be covered when
sufficient assets are deposited to meet the Funds' immediate obligations. A Fund
may use the same liquid assets to cover both the call and put options where the
exercise price of the call and put are the same, or the exercise price of the
call is higher than that of the put. In such cases, the Funds will also
designate liquid assets equivalent to the amount, if any, by which the put is
"in the money."
LIMITATIONS ON USE OF FUTURES AND FUTURES OPTIONS. Except for the
AlphaTrak 500 Fund, the Funds generally will enter into positions in futures
contracts and related options only for "bona fide hedging" purposes. With
respect to positions in futures and related options that do not constitute bona
fide hedging positions, a Fund will not enter into a futures contract or futures
option contract if, immediately thereafter, the aggregate initial margin
deposits relating to such positions plus premiums paid by it for open futures
option positions, less the amount by which any such options are "in-the-money,"
would exceed 5% of the Fund's net assets. A call option is "in-the-money" if the
value of the futures contract that is the subject of the option exceeds the
exercise price. A put option is "in-the-money" if the exercise price exceeds the
value of the futures contract that is the subject of the option.
When purchasing a futures contract, a Fund will designate (and
mark-to-market on a daily basis) assets determined to be liquid by the Adviser
in accordance with procedures established by the Board of Trustees, 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 designate (and
mark-to-market on a daily basis) assets determined to be liquid by the Adviser
in accordance with procedures established by the Board of Trustees, that 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
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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) assets determined to be
liquid by the Adviser in accordance with procedures established by the Board of
Trustees, 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) assets determined to be
liquid by the Adviser in accordance with procedures established by the Board of
Trustees, 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.
To the extent that securities with maturities greater than one year are
used to establish and collateralize or cover a Fund's obligations under futures
contracts and related options, such use will not eliminate the risk of a form of
leverage, which may tend to exaggerate the effect on net asset value of any
increase or decrease in the market value of a Fund's portfolio, and may require
liquidation of portfolio positions when it is not advantageous to do so.
However, any potential risk of leverage resulting from the use of securities
with maturities greater than one year may be mitigated by the overall duration
limit on a Fund's portfolio securities. Thus, the use of a longer-term security
may require a Fund to hold offsetting short-term securities to balance the
Fund's portfolio such that the Fund's duration does not exceed the maximum
permitted for the Fund in the Prospectus.
The requirements for qualification as a regulated investment company
also may limit the extent to which a Fund may enter into futures, futures
options or forward contracts. See "Dividends and Tax Status."
RISKS ASSOCIATED WITH FUTURES AND FUTURES OPTIONS. There are several
risks associated with the use of futures contracts and futures options 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 variations in speculative market demand for futures and
futures options on securities, including technical influences in futures trading
and futures options, 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 at a time
when a Fund seeks to close out a futures contract or a futures option 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,
and options on currencies may be traded on foreign exchanges. Such transactions
may not be regulated as effectively as similar transactions in the
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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 Trust's ability to act upon economic
events occurring in foreign markets during non-business hours in the United
States, (iv) the imposition of different exercise and settlement terms and
procedures and margin requirements than in the United States, and (v) lesser
trading volume.
SWAP AGREEMENTS. The Funds may enter into interest rate, index and
currency exchange rate swap agreements. These transactions are entered into in a
attempt to obtain a particular return when it is considered desirable to do so,
possibly at a lower cost to a Fund than if the Fund had invested directly in an
instrument that yielded that 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, which
may be adjusted for an interest factor. The gross returns to be exchanged or
"swapped" between the parties are generally 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. Forms
of swap agreements include interest rate caps, under which, in return for a
premium, one party agrees to make payments to the other to the extent that
interest rates exceed a specified rate, or "cap"; interest rate floors, under
which, in return for a premium, one party agrees to make payments to the other
to the extent that interest rates fall below a specified rate, or "floor"; and
interest rate collars, under which a party sells a cap and purchases a floor or
vice versa in an attempt to protect itself against interest rate movements
exceeding given minimum or maximum levels.
Most swap agreements entered into by the Funds would calculate the
obligations of the parties to the agreement on a "net basis." Consequently, a
Fund's current 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 current 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 counterparty will be covered by the
maintenance of a designated account consisting of assets determined to be liquid
by the Adviser in accordance with procedures established by the Board of
Trustees, to avoid any potential leveraging of the Fund's portfolio. Obligations
under swap agreements so covered will not be construed to be "senior securities"
for purposes of the Fund's investment restriction concerning senior securities.
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 objectives will depend on the Adviser's ability to
predict correctly 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 of greater than 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 counterparty. The Funds will enter into swap
agreements only with counterparties that meet certain standards of
creditworthiness (generally, such counterparties would have to be eligible
counterparties under the terms of the Funds' repurchase agreement guidelines).
Certain restrictions imposed on the Funds 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.
Certain swap agreements are exempt from most provisions of the
Commodity Exchange Act ("CEA") and, therefore, are not regulated as futures or
commodity option transactions under the CEA, pursuant to regulations approved by
the CFTC. To qualify for this exemption, a swap agreement must be entered into
by "eligible participants," which includes the following, provided the
participants' total assets exceed established levels: a bank or trust company,
savings association or credit union, insurance company, investment company
subject to regulation under the 1940 Act, commodity pool, corporation,
partnership, proprietorship, organization, trust or other entity, employee
benefit plan, governmental entity, broker-dealer, futures commission merchant,
natural person, or regulated foreign person. To be eligible, natural persons and
most other entities must have total assets exceeding $10 million; commodity
pools and employee benefit plans must have assets exceeding $5 million. In
addition, an eligible swap transaction must meet three conditions. First, the
swap agreement may not be part of a fungible class of agreements that are
standardized as to their material economic terms. Second, the creditworthiness
of parties with actual or potential obligations under the swap agreements must
be a material consideration in entering into or determining the terms of the
swap agreement, including pricing, cost or credit enhancement terms. Third, swap
agreements may not be entered into and traded on or through a multilateral
transaction execution facility.
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This exemption is not exclusive, and participants may continue to rely
on existing exclusions for swaps, such as the Policy Statement issued in July
1989 which recognized a safe harbor for swap transactions from regulation as
futures or commodity option transactions under the CEA or its regulations. The
Policy Statement applies to swap transactions settled in cash that (1) have
individually tailored terms, (2) lack exchange-style offset and the use of a
clearing organization or margin system, (3) are undertaken in conjunction with a
line of business, and (4) are not marketed to the public.
STRUCTURED NOTES. Structured notes are derivative debt securities, the
interest rate or principal of which is determined by an unrelated indicator.
Indexed securities include structured notes as well as securities other than
debt securities, the interest rate or principal of which is determined by an
unrelated indicator. Indexed securities may include a multiplier that multiplies
the indexed element by a specified factor and, therefore, the value of such
securities may be very volatile. To the extent a Fund invests in these
securities, however, the Adviser analyzes these securities in its overall
assessment of the effective duration of the Fund's portfolio in an effort to
monitor the Fund's interest rate risk.
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.
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
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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.
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.
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
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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 designates liquid
assets 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.
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.
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
Page B-15
<PAGE> 49
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.
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.
Page B-16
<PAGE> 50
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-17
<PAGE> 51
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* 38 Chairman, Mr. Dubchansky has been the Chief Executive Officer
10880 Wilshire Blvd., Suite 2020 President and of the Adviser since August 1996. From August 1992 through
Los Angeles, CA 90024 Chief Executive August 1996, Mr. Dubchansky was a Senior Vice President of
Officer 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* 46 Trustee Mr. Holmes has been a partner of the law firm King, Purtich,
2121 Avenue of the Stars, Holmes, Paterno & Berliner (and its predecessor firm King,
22nd Floor Purtich & Holmes) since 1992. Mr. Holmes
Los Angeles, CA 90067 practices corporate finance and real estate law. Mr.
Holmes' firm has performed legal services for the Adviser and
its affiliates.
Martin Luther King III 41 Trustee Since 1980, Mr. King has been engaged as an independent
P.O. Box 50608 motivational lecturer. From January 1987 until November
Atlanta, GA 30314 1993, Mr. King was County Commissioner for Fulton County in
Atlanta, Georgia.
James M. Lippman 41 Trustee Since 1990, Mr. Lippman has been the President of JRK
11766 Wilshire Boulevard Asset Management, Inc., a real estate firm that is primarily
Los Angeles, CA 90025 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.
Daniel D. Villanueva 61 Trustee Mr. Villanueva is the Chairman and Managing Director of
1999 Avenue of the Stars, Bastion Capital Corporation (investments).
No. 2960
Los Angeles, CA 90067
Richard H. Schweitzer 33 Treasurer and Since 1996, Mr. Schweitzer has been the Chief Financial
10880 Wilshire Blvd., Suite 2020 Principal Accounting Officer of Metropolitan West Securities, Inc. From 1995 to
Los Angeles, CA 90024 and Financial Officer 1996, Mr. Schweitzer was a Senior Investment Analyst with
Astra Management of Beverly Hills. From 1992 until 1995, he
was an Investment Analyst with the Pilgrim Group in Century
City.
Lara Mulpagano -- Secretary and Ms. Mulpagano is an employee of Metropolitan West
10880 Wilshire Blvd., Suite 2020 Assistant Treasurer Securities, Inc.
Los Angeles, CA 90024
<FN>
- -------------------
* "Interested" Trustee, as defined in the 1940 Act, due to the relationship
indicated with the Adviser.
</TABLE>
Page B-18
<PAGE> 52
The Trust does not pay salaries to any of its Officers or fees to any
of its Trustees who are affiliated with the Adviser. Disinterested Trustees
receive an annual retainer of $3,000 and $750 for each meeting of the Board of
Trustees attended.
The total compensation paid by the Trust to each Trustee during the
fiscal year ended March 31, 1998 is set forth below:
<TABLE>
<CAPTION>
Total Compensation
Name of Trustee From the Trust
--------------- ------------------
<S> <C>
Scott B. Dubchansky None
Keith T. Holmes None
Martin Luther King III $4,500
James M. Lippman $4,500
Daniel D. Villanueva $4,500
</TABLE>
For information as to ownership of shares by officers and Trustees of
the Trust, see below under "CONTROL PERSONS AND PRINCIPAL HOLDERS OF
SECURITIES."
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
As of May 31, 1998, 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 May 31, 1998, the following persons owned beneficially more than
5% of the outstanding voting shares of the following:
<TABLE>
<CAPTION>
FUND PERCENT OWNERSHIP
---- -----------------
TOTAL RETURN BOND FUND:
<S> <C>
Charles Schwab & Co. Inc. Special 30.92%
Custody Acct FBO Customers
Attention: Mutual Funds
101 Montgomery Street
San Francisco, California 94104
Bob & Co. 12.39%
P.O. Box 1809
Boston, Massachusetts 02105
Enele Co. 12.27%
FBO Clark College Fund
1211 S.W. 5th Avenue, Suite 1900
Portland, Oregon 97204
Virg & Co. 9.60%
Attention: Mutual Funds Department
P.O. Box 9800
Calabasas, California 91302
</TABLE>
Page B-19
<PAGE> 53
<TABLE>
<S> <C>
USBN of Oregon 7.73%
Custodian Edward R. Hall Share A Trust
Attention: Mutual Funds PL 6
P.O. Box 3168
Portland, Oregon 97208-3168
Northern Trust Co. 7.46%
Trust Nike Inc. 401k
P.O. Box 92956
Chicago, Illinois 60675
LOW DURATION BOND FUND:
Charles Schwab & Co. Inc. Special 18.01%
Custody Acct FBO Customers
Attention: Mutual Funds
101 Montgomery Street
San Francisco, California 94104
Mayo Foundation 17.63%
200 First Street S.W.
Rochester, Minnesota 55905
McKinsey Master Retirement Trust 13.79%
c/o McKinsey & Co.
55 East 52nd Street
New York, New York 10022
Bost & Co. 13.10%
FBO MJ Murdock Charitable Trust
Mutual Funds Operations
P.O. Box 3198
Pittsburgh, Pennsylvania 15230-3198
Pacific Century Trust 9.50%
Trst Retirement Plan for Pilots
of Hawaiian Airlines Inc.
P.O. Box 888
Honolulu, Hawaii 96808
</TABLE>
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.
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
Page B-20
<PAGE> 54
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 Abest 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 may receive 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.
For the fiscal year ended March 31, 1998, brokerage commissions (as
opposed to dealer mark-ups) paid by the Funds were as follows: Total Return Bond
Fund -- None; Low Duration Bond Fund -- None.
INVESTMENT ADVISORY SERVICES
Under the Investment Advisory Agreement relating to the Funds, 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 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. As compensation for its services to the AlphaTrak 500
Fund only, the Fund pays the Adviser an advisory fee that consists of two
components. The first component is a basic fee equal to an annual rate of .35%
of the Fund's average daily net assets. The second component is a performance
fee adjustment that can increase or decrease the basic fee by as much as .35%
depending on the performance of the Fund compared to the S&P 500 Index. 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 year
ended March 31, 1998, were as follows:
<TABLE>
<CAPTION>
Investment Advisory Fees
Advisory Contractual Reduced and Expenses
Fee Rate Advisory Fees Reimbursed by Adviser
-------- ------------- ---------------------
<S> <C> <C> <C>
Total Return Bond Fund 0.55% $ 74,072 $181,479
Low Duration Bond Fund 0.48% $285,202 $209,717
</TABLE>
The Adviser may recoup advisory fees reduced and expenses reimbursed to the
Funds within the three years following such reduction or reimbursement if
operating expenses (before reduction and reimbursement) are less than the
applicable expense limitation.
ADMINISTRATOR
The Funds have an Administration Agreement with First Data Investor
Services Group, Inc. ("Investor Services Group" or 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
Page B-21
<PAGE> 55
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 .15% of the first $50 million of the Trust's average
daily net assets, .10 % of the next $50 million and .05% over $100 million,
subject to a minimum annual fee of $55,000 (and $12,000 for each additional
series after the first). For the fiscal year ended March 31, 1998, the
administrative fees paid by the Total Return Bond Fund and the Low Duration Bond
Fund totaled $48,576 and $52,311, respectively.
CUSTODIAN AND TRANSFER AGENT
Investor Services Group also serves as the coordinator for custody
services provided by the custodian for the Funds under a Custody Administration
and Agency Agreement. The Bank of New York serves as the Funds' custodian under
a separate Custody Agreement. The Administrator serves as the transfer agent for
the Funds under a Transfer Agent Services Agreement.
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.
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 NASD Regulation, 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
Page B-22
<PAGE> 56
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") (generally 4:00 p.m. New York time, but the NYSE sometimes closes
earlier) 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. 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.
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 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 has elected and intends to continue to qualify to be treated
as a regulated investment company under Subchapter M of the Code, except for the
AlphaTrak 500 Fund that intends to elect and qualify for that treatment.
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
Page B-23
<PAGE> 57
gains from the sale or other disposition of securities, foreign currencies or
options (including forward contracts) thereon; and (b) 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. 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.
The Taxpayer Relief Act (the "Relief Act") reduced the maximum tax on
long-term capital gains from 28% to 20% for taxpayers in all brackets except for
those in the 15% bracket, whose maximum rate will be 10% on those gains. It also
lengthened the required holding period to obtain the lower rate from more than
12 months to more than 18 months.
For tax years beginning after December 31, 2000, additional rules
apply. For taxpayers in the 15% tax bracket, a new low rate of 8% (instead of
10%) will apply to gains from the sale of assets held for more than 5 years. For
taxpayers in higher tax brackets, the top rate on those gains will drop from 20%
to 18%. The date that the 5-year holding period starts, however, is different
for the two groups.
Corporate shareholders are eligible to deduct 70% of dividends received
from domestic corporations. The Funds pass through this benefit to their
corporate shareholders subject to limitations under Section 854 of the Code. The
dividends-received deduction is allowed to a corporate shareholder only if the
shareholder satisfies a 46-day holding period for the dividend-paying stock (or
a 91-day period for certain dividends on preferred stock). The 46-day (91-day)
holding period generally does not include any time in which the shareholder is
protected from the risk of loss otherwise inherent in the ownership of an equity
interest. The Relief Act provided that the taxpayer must satisfy the holding
period requirement with respect to each dividend. This determination is made by
looking at the 90-day (180-day) period starting 45 days (90 days) before the
ex-date. The 46 days (91 days) do not have to be consecutive and do not include
any day in which risk of loss is diminished.
A Fund must satisfy the above holding period requirements in order to
pass through this benefit to its corporate shareholders. In addition, a
corporate shareholder of a Fund must also satisfy the holding period requirement
with respect to its Fund Shares. 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
Page B-24
<PAGE> 58
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 not being treated as 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 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 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.
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. 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 AT" in the above formula, is computed by finding the
average annual compounded rates of return over the period that would equate the
initial
Page B-25
<PAGE> 59
amount invested to the ending redeemable value. Average annual total return
assumes the reinvestment of all dividends and distributions.
Average annual total returns for the one year period ended March 31,
1998 and for the period from inception on March 31, 1997 through that date were
as follows: Total Return Bond Fund -- 13.71%, 13.71%; Low Duration Bond Fund --
8.71%, 8.71%.
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.
Yield for the Total Return Bond Fund for the 30-day period ended March
31, 1998 was 6.86% and for the Low Duration Bond Fund was 6.31%.
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
Page B-26
<PAGE> 60
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.
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 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
Audited financial statements and the accompanying and incorporated by
reference Auditors' Report for the fiscal year ended March 31, 1998 for the
TOTAL RETURN BOND FUND and the LOW DURATION BOND FUND, as contained in the
Annual Report to Shareholders for the fiscal year ended March 31, 1998, are
incorporated herein by reference to that report.
Page B-27
<PAGE> 61
----------------------------------------------------
PART C
OTHER INFORMATION
---------------------------------------------------
<PAGE> 62
METROPOLITAN WEST FUNDS
--------------
FORM N-1A
--------------
PART C
--------------
<TABLE>
<S> <C>
Item 24. Financial Statements and Exhibits
(a) Financial Statements:
Included in Part A:
Financial Highlights for TOTAL RETURN
BOND FUND and LOW DURATION BOND FUND for
the fiscal year ended March 31, 1998.
Included in the 1998 Annual Report to Shareholders:
Annual Report for TOTAL RETURN BOND FUND and LOW DURATION BOND FUND
(i) Schedules of Portfolio Investments at March 31, 1998;
(ii) Statements of Assets and Liabilities at March 31, 1998;
(iii) Statements of Operations for the year ended March 31, 1998;
(iv) Statements of Changes in Net Assets for the year ended March 31, 1998;
(v) Financial Highlights for the year ended March 31, 1998;
(vi) Notes to Financial Statements for the year ended March 31, 1998; and
(vii) Independent Auditors' Report dated May 13, 1998.
(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) Investment Management Agreement, as amended -- Filed herewith.
(6) Form of Underwriting Agreement (incorporated by reference to Pre-Effective Amendment No. 2
to the Registration Statement filed on March 28, 1997 ["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).
</TABLE>
Page 2
<PAGE> 63
<TABLE>
<S> <C> <C>
(9)(C) Form of Transfer Agent Services Agreement (incorporated by reference to Pre-Effective
Amendment No. 2).
(10)(A) For TOTAL RETURN BOND FUND and LOW DURATION BOND FUND: 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"]).
(10)(B) For ALPHATRAK 500 FUND: Consent and Opinion of Counsel as to legality of shares -- Filed herewith.
(11) Consent of Independent Public Accountants -- 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) Share Marketing Plan (Rule 12b-1 Plan), as amended -- Filed herewith.
(16) Performance Computation - Not Applicable.
(27) Financial Data Schedules -- Filed herewith.
</TABLE>
Item 25. Persons Controlled by or Under Common Control with Registrant.
Metropolitan West Asset Management, LLC, a California limited liability
company, is the investment adviser for each series of the Registrant (the
"Adviser"). Metropolitan West Securities, Inc., a California corporation
("MWS"), is a member of the Adviser. Also members of the Adviser 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, Russell S. Gould and Roland R. Moos. MWS is registered with the
Securities and Exchange Commission as an investment adviser and a broker-dealer.
Item 26. Number of Holders of Securities
<TABLE>
<CAPTION>
NUMBER OF RECORD HOLDERS
TITLE OF CLASS AS OF MAY 31, 1998
-------------- -------------------------
Shares of Beneficial Interest par value $0.001 of:
<S> <C>
TOTAL RETURN BOND FUND 62
LOW DURATION BOND FUND 86
</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
Page 3
<PAGE> 64
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 Rivelle and Laird R.
Landmann is set forth in Part B under "Management."
Item 29. Principal Underwriter.
(a) FPS Broker Services, Inc. ("FPSB"), in addition to acting as
distributor for the Funds' shares, is the principal
underwriter for the Registrant's securities and also
currently acts as principal underwriter for the following
investment companies or series thereof:
The Bjurman Funds
Focus Trust, Inc.
The Govett Funds, Inc.
IAA Trust Mutual Funds
Matthews International Funds
McM Funds
Polynous Growth Fund
Smith Breeden Series Fund
Smith Breeden Short Duration U.S. Government Fund
Smith Breeden Trust
The Sports Fund Trust
The Stratton Funds, Inc.
Stratton Growth Fund, Inc.
Stratton Monthly Dividend Shares, Inc.
Stratton Small Cap Yield Fund
Trainer, Wortham First Mutual Funds
(b) The following information is furnished with respect to the
officers of FPSB:
<TABLE>
<CAPTION>
NAME AND PRINCIPAL POSITION AND OFFICES WITH POSITIONS AND OFFICES
BUSINESS ADDRESS UNDERWRITER 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
</TABLE>
Page 4
<PAGE> 65
<TABLE>
<CAPTION>
<S> <C> <C>
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
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>
FPSB is wholly owned by FinDaSub, Inc. Mr. James W. Stratton is a control person
of FinDaSub, Inc. and may therefore be considered to be a control person of the
underwriter. Mr. Stratton is Chairman of Stratton Management Company, a
registered investment adviser, with its principal place of business located at
Plymouth Meeting Executive Campus, 610 West Germantown Pike, Suite 300, Plymouth
Meeting, Pennsylvania 19462.
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, First Data Investor Services Group, 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.
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 5
<PAGE> 66
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the Investment
Company Act of 1940, the Registrant certifies that it meets all of the
requirements for effectiveness of this Amendment pursuant to Rule 485(b) under
the Securities Act of 1933, as amended, and that 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 26th day of June, 1998.
Metropolitan West Funds
By: /s/ Scott B. Dubchansky*
----------------------------------
Scott B. Dubchansky
Chairman of the Board of Trustees,
President and Principal Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this
Post-Effective Amendment to its Registration Statement has been signed below
by the following persons in the capacities and on the date indicated.
<TABLE>
<CAPTION>
<S> <C> <C>
/s/ Scott B. Dubchansky* Chairman of the Board of Trustees, June 26, 1998
- ------------------------ President and Principal Executive Officer
Scott B. Dubchansky
/s/ Richard Schweitzer* Principal Treasurer and June 26, 1998
- ----------------------- Accounting and Financial Officer
Richard Schweitzer
/s/ Keith T. Holmes* Trustee June 26, 1998
- --------------------
Keith T. Holmes
/s/ Martin Luther King III* Trustee June 26, 1998
- ---------------------------
Martin Luther King III
/s/ Daniel D. Villanueva* Trustee June 26, 1998
- -------------------------
Daniel D. Villanueva
/s/ James M. Lippman* Trustee June 26, 1998
- --------------------
James M. Lippman
*by /s/ David A. Hearth
- ------------------------
David A. Hearth, Attorney-in-Fact
pursuant to Power of Attorney
previously filed
</TABLE>
Page 6
<PAGE> 67
Exhibit(s) Index
Exhibit No. Document
- ----------- --------
(5) Investment Management Agreement, as amended.
(10)(B) For ALPHATRAK 500 FUND: Consent and Opinion of Counsel as to
the legality of shares.
(11) Independent Auditors' Consent
(15) Share Marketing Plan (Rule 12b-1 Plan), as amended.
(27) Financial Data Schedules
Page 7
<PAGE> 1
Exhibit 5
METROPOLITAN WEST FUNDS
INVESTMENT MANAGEMENT AGREEMENT
-------------------------------
THIS INVESTMENT MANAGEMENT AGREEMENT (this "Agreement") is
made as of the 31st day of March, 1997, as amended and restated on May 18, 1998,
by and between Metropolitan West Funds a Delaware business trust (hereinafter
called the "Trust"), on behalf of each series of the Trust listed in APPENDIX A
hereto, as may be amended from time to time (hereinafter referred to
individually as a "Fund" and collectively as the "Funds") and Metropolitan West
Asset Management LLC, a California limited liability company (hereinafter called
the "Manager").
WITNESSETH:
WHEREAS, the Trust is an open-end management investment
company, registered as such under the Investment Company Act of 1940, as amended
(the "1940 Act"); and
WHEREAS, the Manager is registered as an investment adviser
under the Investment Advisers Act of 1940, as amended, and is engaged in the
business of supplying investment advice, investment management and
administrative services, as an independent contractor; and
WHEREAS, the Trust desires to retain the Manager to render
advice and services to the Funds pursuant to the terms and provisions of this
Agreement, and the Manager is interested in furnishing said advice and services;
and
WHEREAS, this Agreement has been amended and restated in order
to (i) make explicit the requirement that the disinterested Trustees of the
Trust must approve any recoupment of contingent deferred expense reimbursements
and any contingent deferred management fees now permitted under Section 8(d) of
the Agreement, and (ii) eliminate obsolete references to expense limitations
under state law;
NOW, THEREFORE, in consideration of the covenants and the
mutual promises hereinafter set forth, the parties hereto, intending to be
legally bound hereby, mutually agree as follows:
1. APPOINTMENT OF MANAGER. The Trust hereby employs the
Manager and the Manager hereby accepts such employment, to render investment
advice and management services with respect to the assets of the Funds for the
period and on the terms set forth in this Agreement, subject to the supervision
and direction of the Trust's Board of Trustees.
1
<PAGE> 2
2. DUTIES OF MANAGER.
(a) GENERAL DUTIES. The Manager shall act as
investment manager to the Funds and shall supervise investments of the Funds on
behalf of the Funds in accordance with the investment objectives, programs and
restrictions of the Funds as provided in the Trust's governing documents,
including, without limitation, the Trust's Agreement and Declaration of Trust
and By-Laws, or otherwise and such other limitations as the Trustees may impose
from time to time in writing to the Manager. Without limiting the generality of
the foregoing, the Manager shall: (i) furnish the Funds with advice and
recommendations with respect to the investment of each Fund's assets and the
purchase and sale of portfolio securities for the Funds, including the taking of
such other steps as may be necessary to implement such advice and
recommendations; (ii) furnish the Funds with reports, statements and other data
on securities, economic conditions and other pertinent subjects which the
Trust's Board of Trustees may reasonably request; (iii) manage the investments
of the Funds, subject to the ultimate supervision and direction of the Trust's
Board of Trustees; (iv) provide persons satisfactory to the Trust's Board of
Trustees to act as officers and employees of the Trust and the Funds (such
officers and employees, as well as certain trustees, may be trustees, directors,
officers, partners, or employees of the Manager or its affiliates) but not
including personnel to provide limited administrative services to the Fund not
typically provided by the Fund's administrator under separate agreement; and (v)
render to the Trust's Board of Trustees such periodic and special reports with
respect to each Fund's investment activities as the Board may reasonably
request.
(b) BROKERAGE. The Manager shall place orders for the
purchase and sale of securities either directly with the issuer or with a broker
or dealer selected by the Manager. In placing each Fund's securities trades, it
is recognized that the Manager will give primary consideration to securing the
most favorable price and efficient execution, so that each Fund's total cost or
proceeds in each transaction will be the most favorable under all the
circumstances. Within the framework of this policy, the Manager may consider the
financial responsibility, research and investment information, and other
services provided by brokers or dealers who may effect or be a party to any such
transaction or other transactions to which other clients of the Manager may be a
party.
It is also understood that it is desirable for the Funds that
the Manager have access to investment and market research and securities and
economic analyses provided by brokers and others. It is also understood that
brokers providing such services may execute brokerage transactions at a higher
cost to the Funds than might result from the allocation of brokerage to other
brokers on the basis of seeking the most favorable price and efficient
execution. Therefore, the purchase and sale of securities for the Funds may be
made with brokers who provide such research and analysis, subject to review by
the Trust's Board of Trustees from time to time with respect to the extent and
continuation of this practice to determine whether each Fund benefits, directly
or indirectly, from such practice. It is understood by both parties that the
Manager may select broker-dealers for the execution of the Funds' portfolio
transactions who provide research and analysis as the Manager may lawfully and
appropriately use in its investment management
2
<PAGE> 3
and advisory capacities, whether or not such research and analysis may also be
useful to the Manager in connection with its services to other clients.
On occasions when the Manager deems the purchase or sale of a
security to be in the best interest of one or more of the Funds as well as of
other clients, the Manager, to the extent permitted by applicable laws and
regulations, may aggregate the securities to be so purchased or sold in order to
obtain the most favorable price or lower brokerage commissions and the most
efficient execution. In such event, allocation of the securities so purchased or
sold, as well as the expenses incurred in the transaction, will be made by the
Manager in the manner it considers to be the most equitable and consistent with
its fiduciary obligations to the Funds and to such other clients.
(c) ADMINISTRATIVE SERVICES. The Manager shall
oversee the administration of the Funds' business and affairs although the
provision of administrative services, to the extent not covered by subparagraphs
(a) or (b) above, is not the obligation of the Manager under this Agreement.
Notwithstanding any other provisions of this Agreement, the Manager shall be
entitled to reimbursement from the Funds for all or a portion of the reasonable
costs and expenses, including salary, associated with the provision by Manager
of personnel to render administrative services to the Funds.
3. BEST EFFORTS AND JUDGMENT. The Manager shall use its best
judgment and efforts in rendering the advice and services to the Funds as
contemplated by this Agreement.
4. INDEPENDENT CONTRACTOR. The Manager shall, for all purposes
herein, be deemed to be an independent contractor, and shall, unless otherwise
expressly provided and authorized to do so, have no authority to act for or
represent the Trust or the Funds in any way, or in any way be deemed an agent
for the Trust or for the Funds. It is expressly understood and agreed that the
services to be rendered by the Manager to the Funds under the provisions of this
Agreement are not to be deemed exclusive, and the Manager shall be free to
render similar or different services to others so long as its ability to render
the services provided for in this Agreement shall not be impaired thereby.
5. MANAGER'S PERSONNEL. The Manager shall, at its own expense,
maintain such staff and employ or retain such personnel and consult with such
other persons as it shall from time to time determine to be necessary to the
performance of its obligations under this Agreement. Without limiting the
generality of the foregoing, the staff and personnel of the Manager shall be
deemed to include persons employed or retained by the Manager to furnish
statistical information, research, and other factual information, advice
regarding economic factors and trends, information with respect to technical and
scientific developments, and such other information, advice and assistance as
the Manager or the Trust's Board of Trustees may desire and reasonably request.
6. REPORTS BY FUNDS TO MANAGER. Each Fund will from time to
time furnish to the Manager detailed statements of its investments and assets,
and information as to its
3
<PAGE> 4
investment objective and needs, and will make available to the Manager such
financial reports, proxy statements, legal and other information relating to
each Fund's investments as may be in its possession or available to it, together
with such other information as the Manager may reasonably request.
7. EXPENSES.
(a) With respect to the operation of each Fund, the
Manager is responsible for (i) the compensation of any of the Trust's trustees,
officers, and employees who are affiliates of the Manager (but not the
compensation of employees performing services in connection with expenses which
are the Fund's responsibility under Subparagraph 7(b) below), (ii) the expenses
of printing and distributing the Funds' prospectuses, statements of additional
information, and sales and advertising materials (but not the legal, auditing or
accounting fees attendant thereto) to prospective investors (but not to existing
shareholders), and (iii) providing office space and equipment reasonably
necessary for the operation of the Funds.
(b) Each Fund is responsible for and has assumed the
obligation for payment of all of its expenses, other than as stated in
Subparagraph 7(a) above, including but not limited to: fees and expenses
incurred in connection with the issuance, registration and transfer of its
shares; brokerage and commission expenses; all expenses of transfer, receipt,
safekeeping, servicing and accounting for the cash, securities and other
property of the Trust for the benefit of the Funds including all fees and
expenses of its custodian, shareholder services agent and accounting services
agent; interest charges on any borrowings; costs and expenses of pricing and
calculating its daily net asset value and of maintaining its books of account
required under the 1940 Act; taxes, if any; expenditures in connection with
meetings of each Fund's shareholders and Board of Trustees that are properly
payable by the Fund; salaries and expenses of officers and fees and expenses of
members of the Trust's Board of Trustees or members of any advisory board or
committee who are not members of, affiliated with or interested persons of the
Manager; insurance premiums on property or personnel of each Fund which inure to
its benefit, including liability and fidelity bond insurance; the cost of
preparing and printing reports, proxy statements, prospectuses and statements of
additional information of the Fund or other communications for distribution to
existing shareholders; legal, auditing and accounting fees; trade association
dues; fees and expenses (including legal fees) of registering and maintaining
registration of its shares for sale under federal and applicable state and
foreign securities laws; all expenses of maintaining and servicing shareholder
accounts, including all charges for transfer, shareholder recordkeeping,
dividend disbursing, redemption, and other agents for the benefit of the Funds,
if any; and all other charges and costs of its operation plus any extraordinary
and non-recurring expenses, except as herein otherwise prescribed.
(c) To the extent the Manager incurs any costs by
assuming expenses which are an obligation of a Fund as set forth herein, such
Fund shall promptly reimburse the Manager for such costs and expenses, except to
the extent the Manager has otherwise agreed to bear such expenses. To the extent
the services for which a Fund is obligated to pay are
4
<PAGE> 5
performed by the Manager, the Manager shall be entitled to recover from such
Fund to the extent of the Manager's actual costs for providing such services.
8. INVESTMENT ADVISORY AND MANAGEMENT FEE.
(a) Each Fund shall pay to the Manager, and the
Manager agrees to accept, as full compensation for all administrative and
investment management and advisory services furnished or provided to such Fund
pursuant to this Agreement, a management fee at the annual rate set forth in the
Fee Schedule attached hereto as APPENDIX A, as may be amended in writing from
time to time by the Trust and the Manager.
(a) The management fee shall be accrued daily by each
Fund and paid to the Manager on the first business day of the succeeding month.
(c) The initial fee under this Agreement shall be
payable on the first business day of the first month following the effective
date of this Agreement and shall be prorated as set forth below. If this
Agreement is terminated before the end of any month, the fee to the Manager
shall be prorated for the portion of any month in which this Agreement is in
effect which is not a complete month according to the proportion which the
number of calendar days in the month during which the Agreement is in effect
bears to the number of calendar days in the month, and shall be payable within
ten (10) days after the date of termination.
(d) The Manager may reduce any portion of the
compensation or reimbursement of expenses due to it pursuant to this Agreement
and may agree to make payments to limit the expenses which are the
responsibility of a Fund under this Agreement. Any such reduction or payment
shall be applicable only to such specific reduction or payment and shall not
constitute an agreement to reduce any future compensation or reimbursement due
to the Manager hereunder or to continue future payments. Any such reduction will
be agreed to prior to accrual of the related expense or fee and will be
estimated daily and reconciled and paid on a monthly basis. Any fee withheld
pursuant to this paragraph from the Manager shall be reimbursed by the
appropriate Fund to the Manager in the first, second or third (or any
combination thereof) fiscal year next succeeding the fiscal year of the
withholding to the extent approved by the Trust's disinterested Trustees if the
aggregate expenses for the next succeeding fiscal year, second succeeding fiscal
year or third succeeding fiscal year do not exceed the expense limitation to
which the Manager has agreed. The Manager may elect to seek reimbursement for
the oldest reductions and waivers before payment by a Fund of fees or expenses
for the current year.
(e) The Manager may agree not to require payment of
any portion of the compensation or reimbursement of expenses otherwise due to it
pursuant to this Agreement prior to the time such compensation or reimbursement
has accrued as a liability of the Fund. Any such agreement shall be applicable
only with respect to the specific items covered thereby and
5
<PAGE> 6
shall not constitute an agreement not to require payment of any future
compensation or reimbursement due to the Manager hereunder.
9. FUND SHARE ACTIVITIES OF MANAGER'S OFFICERS AND EMPLOYEES.
The Manager agrees that neither it nor any of its officers or employees shall
take any short position in the shares of the Funds. This prohibition shall not
prevent the purchase of such shares by any of the officers or bona fide
employees of the Manager or any trust, pension, profit-sharing or other benefit
plan for such persons or affiliates thereof, at a price not less than the net
asset value thereof at the time of purchase, as allowed pursuant to rules
promulgated under the 1940 Act.
10. CONFLICTS WITH TRUST'S GOVERNING DOCUMENTS AND APPLICABLE
LAWS. Nothing herein contained shall be deemed to require the Trust or the Funds
to take any action contrary to the Trust's Agreement and Declaration of Trust,
By-Laws, or any applicable statute or regulation, or to relieve or deprive the
Board of Trustees of the Trust of its responsibility for and control of the
conduct of the affairs of the Trust and Funds.
11. MANAGER'S LIABILITIES.
(a) In the absence of willful misfeasance, bad faith,
gross negligence, or reckless disregard of the obligations or duties hereunder
on the part of the Manager, the Manager shall not be subject to liability to the
Trust or the Funds or to any shareholder of the Funds for any act or omission in
the course of, or connected with, rendering services hereunder or for any losses
that may be sustained in the purchase, holding or sale of any security by the
Funds.
(b) The Funds shall indemnify and hold harmless the
Manager and the partners, members, officers and employees of the Manager and its
general partner (any such person, an "Indemnified Party") against any loss,
liability, claim, damage or expense (including the reasonable cost of
investigating and defending any alleged loss, liability, claim, damage or
expenses and reasonable counsel fees incurred in connection therewith) arising
out of the Indemnified Party's performance or non-performance of any duties
under this Agreement provided, however, that nothing herein shall be deemed to
protect any Indemnified Party against any liability to which such Indemnified
Party would otherwise be subject by reason of willful misfeasance, bad faith or
gross negligence in the performance of duties hereunder or by reason of reckless
disregard of obligations and duties under this Agreement.
(c) No provision of this Agreement shall be construed
to protect any Trustee or officer of the Trust, or officer of the Manager (or
its managers), from liability in violation of Sections 17(h) and (i) of the 1940
Act.
12. NON-EXCLUSIVITY. The Trust's employment of the Manager is
not an exclusive arrangement, and the Trust may from time to time employ other
individuals or entities to furnish it with the services provided for herein. If
this Agreement is terminated with respect to
6
<PAGE> 7
any Fund, this Agreement shall remain in full force and effect with respect to
all other Funds listed on APPENDIX A hereto, as the same may be amended.
13. TERM. This Agreement shall become effective at the time
the Trust's initial Registration Statement under the Securities Act of 1933 with
respect to the shares of the Trust is declared effective by the Securities and
Exchange Commission and shall remain in effect for a period of two (2) years,
unless sooner terminated as hereinafter provided. This Agreement shall continue
in effect thereafter for additional periods not exceeding one (l) year so long
as such continuation is approved for each Fund at least annually by (i) the
Board of Trustees of the Trust or by the vote of a majority of the outstanding
voting securities of each Fund and (ii) the vote of a majority of the Trustees
of the Trust who are not parties to this Agreement nor interested persons
thereof, cast in person at a meeting called for the purpose of voting on such
approval.
14. TERMINATION. This Agreement may be terminated by the Trust
on behalf of any one or more of the Funds at any time without payment of any
penalty, by the Board of Trustees of the Trust or by vote of a majority of the
outstanding voting securities of a Fund, upon sixty (60) days' written notice to
the Manager, and by the Manager upon sixty (60) days' written notice to a Fund.
15. TERMINATION BY ASSIGNMENT. This Agreement shall terminate
automatically in the event of any transfer or assignment thereof, as defined in
the 1940 Act.
16. TRANSFER, ASSIGNMENT. This Agreement may not be
transferred, assigned, sold or in any manner hypothecated or pledged without the
affirmative vote or written consent of the holders of a majority of the
outstanding voting securities of each Fund.
17. SEVERABILITY. If any provision of this Agreement shall be
held or made invalid by a court decision, statute or rule, or shall be otherwise
rendered invalid, the remainder of this Agreement shall not be affected thereby.
18. DEFINITIONS. The terms "majority of the outstanding voting
securities" and "interested persons" shall have the meanings as set forth in the
1940 Act.
19. NOTICE OF DECLARATION OF TRUST. The Manager agrees that
the Trust's obligations under this Agreement shall be limited to the Funds and
to their assets, and that the Manager shall not seek satisfaction of any such
obligation from the shareholders of the Funds nor from any trustee, officer,
employee or agent of the Trust or the Funds.
20. CAPTIONS. The captions in this Agreement are included for
convenience of reference only and in no way define or limit any of the
provisions hereof or otherwise affect their construction or effect.
7
<PAGE> 8
21. GOVERNING LAW. This Agreement shall be governed by, and
construed in accordance with, the laws of the State of California without giving
effect to the conflict of laws principles thereof; provided that nothing herein
shall be construed to preempt, or to be inconsistent with, any federal law,
regulation or rule, including the 1940 Act and the Investment Advisers Act of
1940 and any rules and regulations promulgated thereunder.
IN WITNESS WHEREOF, the parties hereto have caused this
Agreement to be duly executed and attested by their duly authorized officers,
all on the day and year first above written.
METROPOLITAN WEST FUNDS METROPOLITAN WEST ASSET
MANAGEMENT, LLC
By: By:
----------------------- ------------------------
Title: Title:
-------------------- ---------------------
8
<PAGE> 9
APPENDIX A to
Investment Management
Agreement
FEE SCHEDULE
------------
<TABLE>
<CAPTION>
Effective
Name of Fund Applicable Fee Date
- ------------ -------------- ----
<S> <C> <C>
Metropolitan West Total Return Bond Fund 0.55% March 31, 1997
Metropolitan West Low Duration Bond Fund 0.48% March 31, 1997
Metropolitan West Short-Term Investment Fund 0.40% --
Metropolitan West AlphaTrak Fund 0.35% plus or minus up to 0.35%1/ June 30, 1998
-
</TABLE>
METROPOLITAN WEST FUNDS METROPOLITAN WEST ASSET
MANAGEMENT, LLC
By: By:
------------------------------ -------------------------------
Title: Title:
--------------------------- -----------------------------
- --------
1/ The basic fee of 0.35% may be adjusted upward or downward (by up to .35% of
the Fund's average daily net assets), depending on whether, and to what extent,
the investment performance of the AlphaTrak Fund, for the relevant performance
period, exceeds or is exceeded by, the performance of the S&P 500 over the same
period. The performance period consists of the current month and the prior two
months. Each .10% of difference of the Fund's performance compared to the
performance of the S&P 500 plus 1.00% is multiplied by a performance adjustment
of .035%, up to a maximum adjustment of .35% (as an annual rate).
The Fund's performance is calculated based on its net asset value per share
after expenses but before the advisory fee. For purposes of calculating the
performance adjustment, any dividends or capital gains distributions paid by the
Fund are treated as if those distributions were reinvested in Fund shares at the
net asset value per share as of the record date for payment. The performance
record for the S&P 500 is based on the change in value of that index, and is
adjusted for any cash distributions from the companies whose securities comprise
the S&P 500.
The performance period initially used for calculating any performance adjustment
to the basic fee will begin when the Fund's operations commence and will
increase by each succeeding month until a total of three months has been
reached. Thus, the first performance period will be one month, the second period
will be two months and the third and later periods will be three months. The
performance fee adjustment is calculated once per month (but is accrued daily on
an estimated basis using the prior adjustment).
9
<PAGE> 1
Exhlibit 10(B)
LAW OFFICES OF
PAUL, HASTINGS, JANOFSKY & WALKER LLP
A LIMITED LIABILITY PARTNERSHIP INCLUDING PROFESSIONAL CORPORATIONS
345 CALIFORNIA STREET
SAN FRANCISCO, CALIFORNIA 94104-2635
TELEPHONE (415) 835-1600
FACSIMILE (415) 217-5333
INTERNET www.phjw.com
June 17, 1998
Metropolitan West Funds
10880 Wilshire Boulevard, Suite 2020
Los Angeles, California 90024
RE: METROPOLITAN WEST FUNDS: METROPOLITAN WEST ALPHATRAK FUND
Ladies and Gentlemen:
We have acted as counsel to Metropolitan West Funds, a
Delaware business trust (the "Trust"), in connection with Post-Effective
Amendment Nos. 3 and 4 to the Trust's Registration Statement on Form N-1A filed
with the Securities and Exchange Commission (the "Post-Effective Amendments")
and relating to the issuance by the Trust of an indefinite number of $.01 par
value shares of beneficial interest (the "Shares") of one series of the Trust,
the Metropolitan West AlphaTrak Fund (the "Fund").
In connection with this opinion, we have assumed the
authenticity of all records, documents and instruments submitted to us as
originals, the genuineness of all signatures, the legal capacity of all natural
persons, and the conformity to the originals of all records, documents, and
instruments submitted to us as copies. We have based our opinion on the
following:
(a) the Trust's Agreement and Declaration of Trust dated
December 9, 1996 (the "Declaration of Trust"), and the Trust's Certificate of
Trust as filed with the Secretary of State of Delaware on December 9, 1996,
certified to us by an officer of the Trust as being true and complete and in
effect on the date hereof;
(b) the By-laws of the Trust certified to us by an officer of
the Trust as being true and complete and in effect on the date hereof ;
<PAGE> 2
(c) resolutions of the Trustees of the Trust adopted at a
meeting on May 18, 1998, authorizing the establishment of the Fund and the
issuance of the Shares;
(d) the Post-Effective Amendments; and
(e) a certificate of an officer of the Trust as to certain
factual matters relevant to this opinion.
Our opinion below is limited to the federal law of the United
States of America and the business trust law of the State of Delaware. We are
not licensed to practice law in the State of Delaware, and we have based our
opinion below solely on our review of Chapter 38 of Title 12 of the Delaware
Code and the case law interpreting such Chapter as reported in Delaware Code
Annotated. We have not undertaken a review of other Delaware law or of any
administrative or court decisions in connection with rendering this opinion. We
disclaim any opinion as to any law other than that of the United States of
America and the business trust law of the State of Delaware as described above,
and we disclaim any opinion as to any statute, rule, regulation, ordinance,
order or other promulgation of any regional or local governmental authority.
Based on the foregoing and our examination of such questions
of law as we have deemed necessary and appropriate for the purpose of this
opinion, and assuming that (i) all of the Shares will be issued and sold for
cash at the per-share public offering price on the date of their issuance in
accordance with statements in the Trust's Prospectus included in the
Post-Effective Amendments and in accordance with the Declaration of Trust, (ii)
all consideration for the Shares will be actually received by the Trust, and
(iii) all applicable securities laws will be complied with, it is our opinion
that, when issued and sold by the Trust, the Shares will be legally issued,
fully paid and nonassessable.
This opinion is rendered to you in connection with the
Post-Effective Amendments and is solely for your benefit. This opinion may not
be relied upon by you for any other purpose or relied upon by any other person,
firm, corporation or other entity for any purpose, without our prior written
consent. We disclaim any obligation to advise you of any developments in areas
covered by this opinion that occur after the date of this opinion.
<PAGE> 3
Metropolitan West Funds
June 17, 1998
Page 3
We hereby consent to (i) the reference to our firm as Legal
Counsel in the Prospectus included in the Post-Effective Amendments, and (ii)
the filing of this opinion as an exhibit to Post-Effective Amendment No. 4.
Very truly yours,
/s/ PAUL, HASTINGS, JANOFSKY & WALKER LLP
<PAGE> 1
Exhibit (11)
CONSENT OF INDEPENDENT AUDITORS
THE METROPOLITAN WEST FUNDS:
We consent to (a) the use in this Post-Effective Amendment No. 4 to Registration
Statement No. 333-18737 on Form N-1A of our report dated May 13, 1998 appearing
in the Financial Statements, which are included in Part B, the Statement of
Additional Information of such Registration Statement, (b) the reference to us
under the heading "Financial Highlights" in the Prospectus, which is a part of
such Registration Statement and (c) the references to us under the heading
"General Information" in such Statement of Additional Information.
DELOITTE & TOUCHE LLP
June 26, 1998
<PAGE> 1
EXHIBIT 15
METROPOLITAN WEST FUNDS
SHARE MARKETING PLAN
--------------------
(Rule 12b-1 Plan)
This Share Marketing Plan (the "Plan") is adopted in
accordance with Rule 12b-1 (the "Rule") under the Investment Company Act of
1940, as amended (the "Act"), by METROPOLITAN WEST FUNDS, a Delaware business
trust (the "Trust"), with respect to each series of its shares named on EXHIBIT
A hereto (each such series, a "Fund"). The Plan has been approved by a majority
of the Trust's Board of Trustees, 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 Plan (the "independent Trustees"), cast in
person at a meeting called for the purpose of voting on the Plan.
In reviewing the Plan, the Board of Trustees considered the
proposed range and nature of payments and terms of the Investment Management
Agreement between the Trust on behalf of each Fund and Metropolitan West Asset
Management, LLC (the "Adviser") and the nature and amount of other payments,
fees and commissions that may be paid to the Adviser, its affiliates and other
agents of the Trust. The Board of Trustees, including the independent Trustees,
concluded that the proposed overall compensation of the Adviser and its
affiliates was fair and not excessive.
In its considerations, the Board of Trustees also recognized
that uncertainty may exist from time to time with respect to whether payments to
be made by the Trust to the Adviser, as the initial "distribution coordinator,"
or other firms under agreements with respect to a Fund may be deemed to
constitute impermissible distribution expenses. As a general rule, an investment
company may not finance any activity primarily intended to result in the sale of
its shares, except pursuant to the Rule. Accordingly, the Board of Trustees
determined that the Plan also should provide that payments by the Trust and
expenditures made by others out of monies received from the Trust which are
later deemed to be for the financing of any activity primarily intended to
result in the sale of Fund shares shall be deemed to have been made pursuant to
the Plan.
The approval of the Board of Trustees included a determination
that in the exercise of the Trustees' reasonable business judgment and in light
of their fiduciary duties, there is a reasonable likelihood that the Plan will
benefit the Trust, the Fund to which the Plan applies and its shareholders.
The provisions of the Plan are:
-1-
<PAGE> 2
1. ANNUAL FEE. The Trust will pay to Adviser, as the Funds'
distribution coordinator, an annual fee for the Adviser's services in such
capacity including its expenses in connection with the promotion and
distribution of the Fund's shares and related shareholder servicing
(collectively, "Distribution Expenses"). The annual fee paid to Adviser under
the Plan will be calculated daily and paid monthly by each Fund on the first day
of each month based on the average daily net assets of each Fund, as follows:
an annual rate of up to 0.25%.
2. DISTRIBUTION EXPENSES IN EXCESS OF OR LESS THAN AMOUNT OF
FEE. All Distribution Expenses in excess of the fee rates provided for in this
Plan may be carried forward and resubmitted in a subsequent fiscal year provided
that (i) Distribution Expenses cannot be carried forward for more than three
years following initial submission; and (ii) the Trust's Board of Trustees has
made a determination at the time of initial submission that the Distribution
Expenses are appropriate to be reimbursed. The fees paid by the Trust on behalf
of each Fund shall be refundable if in any given year the fees are greater than
the Distribution Expenses for that year. Distribution expenses will be paid on a
first-in, first-out basis.
3. EXPENSES COVERED BY THE PLAN. The fee paid under Section 1
of the Plan may be used to pay for any expenses primarily intended to result in
the sale of the Fund's shares ("distribution services"), including, but not
limited to: (a) costs of payments, including incentive compensation, made to
agents for and consultants to Adviser, any affiliate of the Adviser or the
Trust, including pension administration firms that provide distribution and
shareholder related services and broker-dealers that engage in the distribution
of the Fund's shares; (b) payments made to, and expenses of, persons who provide
support services in connection with the distribution of a Fund's shares and
servicing of a Fund's shareholders, including, but not limited to, personnel of
Adviser, office space and equipment, telephone facilities, answering routine
inquiries regarding the Fund, processing shareholder transactions and providing
any other shareholder services not otherwise provided by the Trust's transfer
agency or other servicing arrangements; (c) all payments made pursuant to the
form of Distribution Agreement attached hereto as Exhibit B; (d) costs relating
to the formulation and implementation of marketing and promotional activities,
including, but not limited to, direct mail promotions and television, radio,
newspaper, magazine and other mass media advertising; (e) costs of printing and
distributing prospectuses, statements of additional information and reports of
the Fund to prospective shareholders of the Fund; (f) costs involved in
preparing, printing and distributing sales literature pertaining to the Fund;
and (g) costs involved in obtaining whatever information, analyses and reports
with respect to marketing and promotional activities that the Trust may, from
time to time, deem advisable. Such expenses shall be deemed incurred whether
paid directly by Adviser as distribution coordinator or by a third party to the
extent reimbursed therefor by Adviser.
4. WRITTEN REPORTS. Adviser shall furnish to the Board of
Trustees of the Trust, for its review, on a quarterly basis, a written report of
the monies paid to it under the Plan with respect to each Fund, and shall
furnish the Board of Trustees of the Trust with such other information as the
Board of Trustees may reasonably request in connection with the payments made
under the Plan in order to enable the Board of Trustees to make an informed
determination of whether the Plan should be continued as to each Fund.
-2-
<PAGE> 3
5. TERMINATION. The Plan may be terminated as to any Fund at
any time, without penalty, by vote of a majority of the outstanding voting
securities of a Fund or by the vote of a majority of the independent Trustees,
and any Distribution Agreement under the Plan may be likewise terminated on not
more than sixty (60) days' written notice. Once terminated, no further payments
shall be made under the Plan notwithstanding the existence of any unreimbursed
current or carried forward Distribution Expenses.
6. AMENDMENTS. The Plan and any Distribution Agreement may not
be amended to increase materially the amount to be spent for distribution and
servicing of Fund shares pursuant to Section 1 hereof without approval by a
majority of the outstanding voting securities of a Fund. All material amendments
to the Plan and any Distribution Agreement entered into with third parties shall
be approved by the independent Trustees cast in person at a meeting called for
the purpose of voting on any such amendment. The Adviser may assign its
responsibilities and liabilities under the Plan to another party who agrees to
act as "distribution coordinator" for the Trust with the consent of a majority
of the independent Trustees.
7. SELECTION OF INDEPENDENT TRUSTEES. So long as the Plan is
in effect, the selection and nomination of the Trust's independent Trustees
shall be committed to the discretion of such independent Board of Trustees.
8. EFFECTIVE DATE OF PLAN. The Plan shall take effect at such
time as it has received requisite Trustee and shareholder approval and, unless
sooner terminated, shall continue in effect for a period of more than one year
from the date of its execution only so long as such continuance is specifically
approved at least annually by the Board of Trustees of the Trust, including the
independent Trustees, cast in person at a meeting called for the purpose of
voting on such continuance.
9. PRESERVATION OF MATERIALS. The Trust will preserve copies
of the Plan, any agreements relating to the Plan and any report made pursuant to
Section 5 above, for a period of not less than six years (the first two years in
an easily accessible place) from the date of the Plan, agreement or report.
10. MEANINGS OF CERTAIN TERMS. As used in the Plan, the terms
"interested person" and "majority of the outstanding voting securities" will be
deemed to have the same meaning that those terms have under the Act and the
rules and regulations under the Act, subject to any exemption that may be
granted to the Trust under the Act by the Securities and Exchange Commission.
-3-
<PAGE> 4
This Plan and the terms and provisions thereof are hereby
accepted and agreed to by the Trust and Adviser, as distribution coordinator, as
evidenced by their execution hereof, as of this 31st day of March 1997, and
amended on May 18, 1998.
METROPOLITAN WEST FUNDS
By:
-------------------------------------
Title:
----------------------------------
METROPOLITAN WEST ASSET
MANAGEMENT, LLC,
as Distribution Coordinator
By:
-------------------------------------
Title:
----------------------------------
-4-
<PAGE> 5
Exhibit A
---------
<TABLE>
<CAPTION>
Maximum Effective
Name of Fund Fee Date
- ------------ --- ----
<S> <C> <C>
Metropolitan West Total Return Fund 0.25% March 31, 1997
Metropolitan West Low Duration Fund 0.25% March 31, 1997
Metropolitan West AlphaTrak Fund 0.25% June 30, 1998
</TABLE>
METROPOLITAN WEST FUNDS
By:
--------------------------------------
Title:
-----------------------------------
METROPOLITAN WEST ASSET
MANAGEMENT, LLC,
as Distribution Coordinator
By:
--------------------------------------
Title:
-----------------------------------
-5-
<PAGE> 6
Exhibit B
---------
METROPOLITAN WEST FUNDS
-----------------------
Share Marketing Agreement
EXHIBIT ONLY
- -----------------------------------
- -----------------------------------
- -----------------------------------
- -----------------------------------
Ladies and Gentlemen:
This Share Marketing Agreement has been adopted pursuant to
Rule 12b-1 under the Investment Company Act of 1940, as amended (the "Company
Act"), by METROPOLITAN WEST FUNDS, a Delaware business trust (the "Trust"), on
behalf of various series of the Trust (each series, a "Fund"), as governed by
the terms of a Share Marketing Plan (Rule 12b-1 Plan) (the "Plan").
The Plan has been approved by a majority of the Trustees who
are not interested persons of the Trust or the Funds and who have no direct or
indirect financial interest in the operation of the Plan (the "independent
Trustees"), cast in person at a meeting called for the purpose of voting on such
Plan. Such approval included a determination that in the exercise of the
reasonable business judgment of the Board of Trustees and in light of the
Trustees' fiduciary duties, there is a reasonable likelihood that the Plan will
benefit each Fund and its shareholders.
1. To the extent you provide eligible shareholder services of the type
identified in the Plan to the Funds identified in the attached Schedule (the
"Schedule"), we shall pay you a monthly fee based on the average net asset value
of Fund shares during any month which are attributable to customers of your
firm, at the rate set forth on the Schedule.
2. In no event may the aggregate annual fee paid to you
pursuant to the Schedule exceed ____ percent of the value of the net assets of
each Fund held in your customers' accounts which are eligible for payment
pursuant to this Agreement (determined in the same
-6-
<PAGE> 7
manner as the Fund uses to compute its net assets as set forth in its then
effective Prospectus), without approval by a majority of the outstanding shares
of each Fund.
3. You shall furnish us and the Trust with such information as
shall reasonably be requested by the Trust's Board of Trustees with respect to
the services performed by you and the fees paid to you pursuant to the Schedule.
4. We shall furnish to the Board of Trustees of the Trust, for
its review, on a quarterly basis, a written report of the amounts expended under
the Plan by us with respect to each Fund and the purposes for which such
expenditures were made.
5. You agree to make shares of the Funds available only (a) to
your customers or entities that you service at the net asset value per share
next determined after receipt of the relevant purchase instruction or (b) to
each such Fund itself at the redemption price for shares, as described in each
Fund's then-effective Prospectus.
6. No person is authorized to make any representations
concerning a Fund or shares of a Fund except those contained in each Fund's
then-effective Prospectus or Statement of Additional Information and any such
information as may be released by a Fund as information supplemental to such
Prospectus or Statement of Additional Information.
7. Additional copies of each such Prospectus or Statement of
Additional Information and any printed information issued as supplemental to
each such Prospectus or Statement of Additional Information will be supplied by
each Fund to you in reasonable quantities upon request.
8. In no transaction shall you have any authority whatever to
act as agent of the Funds and nothing in this Agreement shall constitute you or
the Fund the agent of the other. You are not authorized to act as an underwriter
of shares of the Funds or as a dealer in shares of the Funds.
9. All communications to the Funds shall be sent to:
Metropolitan West Asset Management, LLC, as Distribution Coordinator for the
Funds, 10880 Wilshire Boulevard, Suite 2020, Los Angeles, California 90024. Any
notice to you shall be duly given if mailed or telegraphed to you at your
address as indicated in this Agreement.
10. This Agreement may be terminated by us or by you, by the
vote of a majority of the Trustees of the Trust who are independent Trustees, or
by a vote of a majority of the outstanding shares of a Fund, on sixty (60) days'
written notice, all without payment of any penalty. It shall also be terminated
automatically by any act that terminates the Plan.
11. The provisions of the Plan between the Trust and us,
insofar as they relate to you, are incorporated herein by reference.
This Agreement shall take effect on the date indicated below,
and the terms and provisions thereof are hereby accepted and agreed to by us as
evidenced by our execution hereof.
-7-
<PAGE> 8
METROPOLITAN WEST ASSET MANAGEMENT, LLC,
Distribution Coordinator
By: EXHIBIT ONLY
------------------
Authorized Officer
Dated:
-----------------------
Agreed and Accepted:
- ----------------------------
(Name)
By: ________________________
(Authorized Officer)
-8-
<PAGE> 9
METROPOLITAN WEST FUNDS
----------
SCHEDULE TO SHARE MARKETING AGREEMENT
BETWEEN METROPOLITAN WEST ASSET MANAGEMENT, LLC
AS DISTRIBUTION COORDINATOR
AND
----------
(Name)
Pursuant to the provisions of the Share Marketing Agreement
between the above parties with respect to Metropolitan West Funds, Metropolitan
West Asset Management, LLC, as Distribution Coordinator, shall pay a monthly fee
to the above-named party based on the average net asset value of shares of each
Fund during the previous calendar month the sales of which are attributable to
the above-named party, as follows:
Fund Fee
---- ---
-9-
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0001028621
<NAME> METROPOLITAN WEST FUNDS
<SERIES>
<NUMBER> 2
<NAME> METROPOLITAN WEST TOTAL RETURN BOND FUND
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-START> APR-01-1997
<PERIOD-END> MAR-31-1998
<INVESTMENTS-AT-COST> 24,215,644
<INVESTMENTS-AT-VALUE> 24,310,455
<RECEIVABLES> 1,230,430
<ASSETS-OTHER> 35,850
<OTHER-ITEMS-ASSETS> 104,757
<TOTAL-ASSETS> 25,681,482
<PAYABLE-FOR-SECURITIES> 653,366
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 45,099
<TOTAL-LIABILITIES> 698,465
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 24,662,150
<SHARES-COMMON-STOCK> 2,376,576
<SHARES-COMMON-PRIOR> 5,000
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 226,066
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 94,801
<NET-ASSETS> 24,983,017
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 1,086,045
<OTHER-INCOME> 0
<EXPENSES-NET> 87,539
<NET-INVESTMENT-INCOME> 998,506
<REALIZED-GAINS-CURRENT> 398,295
<APPREC-INCREASE-CURRENT> 94,801
<NET-CHANGE-FROM-OPS> 1,491,602
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 998,506
<DISTRIBUTIONS-OF-GAINS> 172,229
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 2,520,599
<NUMBER-OF-SHARES-REDEEMED> 234,369
<SHARES-REINVESTED> 90,346
<NET-CHANGE-IN-ASSETS> 24,933,017
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 74,072
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 269,018
<AVERAGE-NET-ASSETS> 13,506,492
<PER-SHARE-NAV-BEGIN> 10.00
<PER-SHARE-NII> .73
<PER-SHARE-GAIN-APPREC> .60
<PER-SHARE-DIVIDEND> .73
<PER-SHARE-DISTRIBUTIONS> .11
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 10.49
<EXPENSE-RATIO> .65
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0001028621
<NAME> METROPOLITAN WEST FUNDS
<SERIES>
<NUMBER> 1
<NAME> METROPOLITAN WEST LOW DURATION BOND FUND
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-START> APR-01-1997
<PERIOD-END> MAR-31-1998
<INVESTMENTS-AT-COST> 134,290,416
<INVESTMENTS-AT-VALUE> 134,608,610
<RECEIVABLES> 6,570,426
<ASSETS-OTHER> 30,620
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 141,209,656
<PAYABLE-FOR-SECURITIES> 2,554,332
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 3,342,328
<TOTAL-LIABILITIES> 5,896,660
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 134,791,962
<SHARES-COMMON-STOCK> 13,284,111
<SHARES-COMMON-PRIOR> 5,000
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 202,839
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 318,194
<NET-ASSETS> 135,312,995
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 4,347,279
<OTHER-INCOME> 0
<EXPENSES-NET> 344,619
<NET-INVESTMENT-INCOME> 4,002,660
<REALIZED-GAINS-CURRENT> 306,941
<APPREC-INCREASE-CURRENT> 318,194
<NET-CHANGE-FROM-OPS> 4,627,795
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 4,002,660
<DISTRIBUTIONS-OF-GAINS> 104,102
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 16,152,929
<NUMBER-OF-SHARES-REDEEMED> 3,264,068
<SHARES-REINVESTED> 395,250
<NET-CHANGE-IN-ASSETS> 135,262,995
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 285,202
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 554,336
<AVERAGE-NET-ASSETS> 59,509,004
<PER-SHARE-NAV-BEGIN> 10.00
<PER-SHARE-NII> .65
<PER-SHARE-GAIN-APPREC> .19
<PER-SHARE-DIVIDEND> .65
<PER-SHARE-DISTRIBUTIONS> .01
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 10.18
<EXPENSE-RATIO> .58
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
