<PAGE> 1
As filed with the Securities and Exchange Commission File Nos. 333-18737
on July 27, 1999 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. 6
and
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
Amendment No. 8
METROPOLITAN WEST FUNDS
(Exact Name of Registrant as Specified in its Charter)
11766 Wilshire Blvd., Suite 1580
Los Angeles, California 90025
(Address of Principal Executive Office)
(310) 966-8900
(Registrant's Telephone Number, Including Area Code)
Scott B. Dubchansky
11766 Wilshire Blvd., Suite 1580
Los Angeles, California 90025
(Name and Address of Agent for Service)
It is proposed that this filing will become effective:
X immediately upon filing pursuant to Rule 485(b)
__ on July 27, 1999, 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> 2
METROPOLITAN WEST FUNDS
CONTENTS OF REGISTRATION STATEMENT
This registration statement contains the following documents:
Facing Sheet
Contents of Registration Statement
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> 3
------------------------------------------------------------
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> 4
METROPOLITAN WEST FUNDS
-------------------------------
TOTAL RETURN BOND FUND
LOW DURATION BOND FUND
SHORT-TERM INVESTMENT FUND
ALPHATRAK 500 FUND
-------------------------------
PROSPECTUS
July 27, 1999
THIS PROSPECTUS CONTAINS ESSENTIAL INFORMATION FOR ANYONE CONSIDERING AN
INVESTMENT IN THESE FUNDS. PLEASE READ THIS DOCUMENT CAREFULLY AND RETAIN IT FOR
FUTURE REFERENCE.
THE SECURITIES AND EXCHANGE COMMISSION HAS NOT APPROVED OR DISAPPROVED THESE
SECURITIES OR PASSED UPON THE ADEQUACY OR ACCURACY OF THIS PROSPECTUS. IT IS A
CRIMINAL OFFENSE TO STATE OR SUGGEST OTHERWISE.
-----------------------------
Metropolitan West Asset Management, LLC
Investment Adviser
------------------------------
<PAGE> 5
Metropolitan West Funds
Table of Contents
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
RISK/RETURN SUMMARY AND FUND EXPENSES.....................................................................................1
Total Return Bond Fund.................................................................................................1
Low Duration Bond Fund.................................................................................................6
Short-Term Investment Fund............................................................................................11
AlphaTrak 500 Fund....................................................................................................15
FURTHER INFORMATION ABOUT................................................................................................20
INVESTMENT OBJECTIVES, POLICIES AND RISKS................................................................................20
General...............................................................................................................20
Duration..............................................................................................................20
Portfolio Turnover....................................................................................................20
Risks of Investing in Emerging Market and Other Foreign Securities....................................................20
Risks of Investing in Fixed-income Securities.........................................................................21
Risks of Using Certain Derivatives....................................................................................21
Year 2000.............................................................................................................21
Adviser Performance -- Predecessor Accounts...........................................................................22
ORGANIZATIONAL AND MANAGEMENT............................................................................................26
The Adviser...........................................................................................................26
Portfolio Managers....................................................................................................26
Management Fees and Other Expenses....................................................................................26
SHAREHOLDER INFORMATION..................................................................................................28
How To Purchase Shares................................................................................................28
How To Redeem Shares..................................................................................................29
Dividends and Tax Status..............................................................................................30
FINANCIAL HIGHLIGHTS.....................................................................................................32
</TABLE>
- --------------------------------------------------------------------------------
<PAGE> 6
- --------------------------------------------------------------------------------
RISK/RETURN SUMMARY AND FUND EXPENSES
- --------------------------------------------------------------------------------
TOTAL RETURN BOND FUND
INVESTMENT OBJECTIVE, STRATEGIES AND RISKS
Objective: The Total Return Bond Fund seeks to
maximize long-term total return.
Principal Investment Strategies: The Fund invests in a diversified
portfolio of fixed-income securities of
varying maturities issued by domestic
and foreign corporations and governments
(and their agencies and
instrumentalities) with a portfolio
duration of two to eight years. The
meaning of "duration" is explained below
under "Investment Policies of the
Funds." The dollar-weighted average
maturity of the Fund's portfolio is
expected to range from two to fifteen
years. The Fund's portfolio may include
bonds, notes, mortgage-related and
asset-backed securities and money-market
securities. These investments may have
interest rates that are fixed, variable
or floating.
The Adviser will concentrate the Fund's
portfolio holdings in areas of the bond
market (based on quality, sector, coupon
or maturity) that the Adviser believes
to be relatively undervalued.
Under normal circumstances, the Fund
will invest at least 80% of its net
assets in investment grade securities.
These are debt securities rated at least
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"), or 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, or
securities of comparable quality to
investment grade securities as
determined by the Adviser in the case of
unrated securities. Up to 20% of the
Fund's net assets may be invested in
securities rated below investment grade
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.
The Fund may invest a portion of its
assets in foreign securities
(denominated in U.S. dollars or foreign
currencies), including emerging market
foreign securities.
Principal Investment Risks: Because the values of the Fund's
investments will change with market
conditions, so will the value of your
investment in the
1
<PAGE> 7
Fund. You could lose money on your
investment in the Fund or the Fund could
underperform other investments. This
Fund has the potential for greater
return and loss than a shorter duration
fund like the Low Duration Bond Fund.
The values of the Fund's investments
change in response to movements in
interest rates. If rates rise, the
values of debt securities generally
fall. The longer the average duration of
the Fund's investment portfolio, the
greater the change in value. The values
of any of the Fund's investments may
also decline in response to events
affecting the issuer or its credit
rating. The lower rated debt securities
in which the Fund may invest are
considered speculative and are subject
to greater volatility and risk of loss
than investment grade securities,
particularly in deteriorating economic
conditions. The value of some
mortgage-related securities in which the
Fund invests also may fall because of
unanticipated levels of principal
prepayments that can occur when interest
rates decline.
The value of the Fund's investments in
foreign securities also depends on
changing currency values, different
political and economic environments and
other overall economic conditions in the
countries where the Fund invests.
Emerging market debt securities tend to
be of lower credit quality and subject
to greater risk of default than higher
rated securities from more developed
markets.
2
<PAGE> 8
PERFORMANCE
The charts on this page show how the Fund has performed and provide
some indication of the risks of investing in the Fund by showing the performance
of the Fund's shares during its first complete calendar year of operations. The
bar chart shows changes in the year-to-year performance of the Fund. The table
below it compares the performance of the Fund over time to the Lehman Brothers
Aggregate Bond Index, an unmanaged index of all investment grade bonds with a
total amount outstanding in excess of $25 million that have at least one year to
maturity.
Both charts assume reinvestment of dividends and distributions. Of
course, past performance does not indicate how the Fund will perform in the
future.
Year-by-Year Total Returns
9.93%
[bar graph]
------------------------------
1998
During the period covered by this total return chart, the Fund's highest
quarterly return was 4.23% (for the quarter ended September 30, 1998); and the
lowest quarterly return was 0.34% (for the quarter ended December 31, 1998).
Average Annual Total Returns
(For the periods ending December 31, 1998)*
<TABLE>
<CAPTION>
----------------------------------------------------
Past Since Performance
Year Inception Inception
----------------------------------------------------
<S> <C> <C> <C>
Total Return Bond Fund 9.93% 12.52% March 31, 1997
----------------------------------------------------
Lehman Brothers Aggregate Bond Index 8.67% 10.89% March 31, 1997
- ------------------------------------------------------------------------------------------------
</TABLE>
* For the period January 1, 1999 through June 30, 1999 the aggregate
(non-annualized) total return of the Fund was 0.39% versus - 1.38% for
the Lehman Brothers Aggregate Bond Index.
3
<PAGE> 9
FEES AND EXPENSES
As an investor in the Fund, you will pay the following expenses. The
Fund has no sales, redemption, exchange or account fees, although some
institutions may charge you a fee for shares you buy through them. Annual Fund
operating expenses are paid out of Fund assets, and are reflected in the share
price.
ANNUAL FUND OPERATING EXPENSES
(FEES PAID FROM FUND ASSETS)
<TABLE>
<S> <C>
Management fees 0.55%
- ------------------------------------------------------------------------------------- ---------------------
Rule 12b-1 expenses(1) None
- ------------------------------------------------------------------------------------- ---------------------
Other expenses 0.42%
- ------------------------------------------------------------------------------------- ---------------------
Total annual Fund operating expenses 0.97%
- ------------------------------------------------------------------------------------- ---------------------
Fee reduction and/or expense reimbursement(2) 0.32%
- ------------------------------------------------------------------------------------- ---------------------
Net expenses(2) 0.65%
- ------------------------------------------------------------------------------------- ---------------------
</TABLE>
(1) The Fund has adopted a Rule 12b-1 plan but has not yet charged any fees
under the plan.
(2) Metropolitan West Asset Management, LLC (the "Adviser") has contractually
agreed to reduce its fees and/or absorb expenses, and to pay for the Fund's
distribution expenses, to limit the Fund's total annual operating expenses
(excluding interest, taxes and extraordinary expenses) to 0.65%. This
contract has a one- year term, renewable at the end of each fiscal year.
<PAGE> 10
EXAMPLE
Use this table to compare fees and expenses of the Fund with those of
other funds. It illustrates the amount of fees and expenses you would pay
assuming the following:
- $10,000 initial investment in the Fund
- 5% annual return
- redemption at the end of each period
- no changes in the Fund's operating expenses
Although your actual costs may be higher or lower, based on these
assumptions your costs would be:
<TABLE>
----------------------------------- ------------- ------------- ------------ -------------
1 3 5 10
Year Years Years Years
<S> <C> <C> <C> <C>
$66 $276 $504 $1,157
----------------------------------- ------------- ------------- ------------ -------------
</TABLE>
5
<PAGE> 11
LOW DURATION BOND FUND
INVESTMENT OBJECTIVE, STRATEGIES AND RISKS
Objective: The LOW DURATION BOND FUND seeks to
maximize current income, consistent with
preservation of capital.
Principal Investment Strategies: The Fund invests in a diversified
portfolio of fixed- income securities of
varying maturities issued by domestic
and foreign corporations and governments
(and their agencies and
instrumentalities) 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 Fund's portfolio is
expected to range from one to five
years. The Fund's portfolio may include
bonds, notes, mortgage-related and
asset-backed securities and money-market
securities. These investments may have
interest rates that are fixed, variable
or floating.
Under normal circumstances, the Fund
will invest at least 70% of its net
assets in highly rated securities. These
are debt securities rated at least A by
Moody's, S&P, Fitch or Duff & Phelps, or
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, or securities of
comparable quality to highly rated
securities as determined by the Adviser
in the case of unrated securities. Up to
20% of the Fund's net assets may be
invested in securities rated below
highly rated securities but rated at
least investment grade 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 Fund's net
assets may be invested in securities
rated below investment grade 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.
The Fund may invest a portion of its
assets in foreign securities
(denominated in U.S. dollars or foreign
currencies) including emerging market
foreign securities.
Principal Investment Risks: Because the values of the Fund's
investments will change with market
conditions, so will the value of your
investment in the Fund. You could lose
money on your investment in the Fund or
the Fund could underperform other
investments. The Adviser expects that
this Fund will typically display lower
changes in value, return and risk of
loss than a longer-duration fixed-income
fund such as the TOTAL RETURN BOND FUND.
The values of the Fund's investments
fluctuate in response to movements in
interest rates. If rates rise, the
values of debt
6
<PAGE> 12
securities generally fall. The longer
the average duration of the Fund's
investment portfolio, the greater the
change in value. The values of any of
the Fund's investments may also decline
in response to events affecting the
issuer or its credit rating. The lower
rated debt securities in which the Fund
may invest are considered speculative
and are subject to greater volatility
and risk of loss than investment grade
securities, particularly in
deteriorating economic conditions. The
value of some mortgage-related
securities in which the Fund invests
also may fall because of unanticipated
levels of principal prepayments that can
occur when interest rates decline.
The value of the Fund's investments in
foreign securities also depends on
changing currency values, different
political and economic environments and
other overall economic conditions in the
countries where the Fund invests.
Emerging market debt securities tend to
be of lower credit quality and subject
to greater risk of default than higher
rated securities from more developed
markets.
7
<PAGE> 13
PERFORMANCE
The charts on this page show how the Fund has performed and provide
some indication of the risks of investing in the Fund by showing the performance
of the Fund's shares during its first complete calendar year of operations. The
bar chart shows changes in the year-to-year performance of the Fund. The table
below it compares the performance of the Fund over time to the Merrill Lynch 1-3
Year U.S. Treasury Index, an unmanaged index of all U.S. Treasury securities
with maturities of 1-3 years.
Both charts assume reinvestment of dividends and distributions. Of
course, past performance does not indicate how the Fund will perform in the
future.
Year-by-Year Total Returns
6.68%
[bar graph]
------------------------------
1998
During the period covered by this total return chart, the Fund's highest
quarterly return was 2.48% (for the quarter ended December 31, 1998); and the
lowest quarterly return was 0.32% (for the quarter ended September 30, 1998).
Average Annual Total Returns
(For the periods ending December 31, 1998)*
<TABLE>
<CAPTION>
Past Since Performance
Year Inception Inception
---------- ------------ ----------------------
<S> <C> <C> <C>
Low Duration Bond Fund 6.68% 7.74% March 31, 1997
---------- ------------ ----------------------
Merrill Lynch 1-3 Year 7.00% 7.42% March 31, 1997
U.S. Treasury Index
- ----------------------------------- ---------- ------------ ----------------------
</TABLE>
* For the period January 1, 1999 through June 30, 1999, the aggregate
(non-annualized) total return of the Fund was 3.33% versus 1.17% for
the Merrill Lynch 1-3 year U.S. Treasury Index.
8
<PAGE> 14
FEES AND EXPENSES
As an investor in the Fund, you will pay the following expenses. The
Fund has no sales, redemption, exchange or account fees, although some
institutions may charge you a fee for shares you buy through them. Annual Fund
operating expenses are paid out of Fund assets, and are reflected in the share
price.
ANNUAL FUND OPERATING EXPENSES
(FEES PAID FROM FUND ASSETS)
<TABLE>
<S> <C>
Management fees 0.48%
- ------------------------------------------------------------------------------------- ---------------------
Rule 12b-1 expenses(1) None
- ------------------------------------------------------------------------------------- ---------------------
Other expenses 0.22%
- ------------------------------------------------------------------------------------- ---------------------
Total annual Fund operating expenses 0.70%
- ------------------------------------------------------------------------------------- ---------------------
Fee reduction and/or expense reimbursement(2) 0.12%
- ------------------------------------------------------------------------------------- ---------------------
Net expenses(2) 0.58%
- ------------------------------------------------------------------------------------- ---------------------
</TABLE>
(1) The Fund has adopted a Rule 12b-1 plan but has not yet charged any
fees under the plan.
(2) The Adviser has contractually agreed to reduce its fees and/or absorb
expenses, and to pay for the Fund's distribution expenses, to limit
the Fund's total annual operating expenses (excluding interest, taxes
and extraordinary expenses) to 0.58%. This contract has a one-year
term, renewable at the end of each fiscal year.
9
<PAGE> 15
EXAMPLE
Use this table to compare fees and expenses of the Fund with those of
other funds. It illustrates the amount of fees and expenses you would pay
assuming the following:
- $10,000 initial investment in the Fund
- 5% annual return
- redemption at the end of each period
- no changes in the Fund's operating expenses
Although your actual costs may be higher or lower, based on these
assumptions your costs would be:
<TABLE>
<CAPTION>
----------------------------------- ------------- ------------- ------------ -------------
1 3 5 10
Year Years Years Years
<S> <C> <C> <C> <C>
$59 $211 $377 $857
----------------------------------- ------------- ------------- ------------ -------------
</TABLE>
10
<PAGE> 16
SHORT-TERM INVESTMENT FUND
SHARES OF THE SHORT-TERM INVESTMENT FUND ARE NOT CURRENTLY AVAILABLE FOR
PURCHASE. INVESTMENT OBJECTIVE, STRATEGIES AND RISKS
Objective: The SHORT-TERM INVESTMENT FUND seeks to
maximize current income, consistent with
preservation of capital.
Principal Investment Strategies: The Fund invests in a portfolio of
fixed-income securities of varying
maturities issued by domestic and
foreign corporations and governments
(and their agencies and
instrumentalities) 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 portfolio
maturity will normally exceed one year.
The Fund's portfolio may include bonds,
notes, mortgage-related and asset-backed
securities and money-market securities.
These investments may have interest
rates that are fixed, variable or
floating.
Under normal circumstances, the Fund
will invest at least 70% of its net
assets in highly rated securities. These
are debt securities rated at least A by
Moody's, S&P, Fitch or Duff & Phelps, or
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, or securities of
comparable quality to highly rated
securities as determined by the Adviser
in the case of unrated securities. Up to
20% of the Fund's net assets may be
invested in securities rated below
highly rated securities but rated at
least investment grade 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 Fund's net
assets may be invested in securities
rated below investment grade 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.The Fund may invest a portion of
its assets in foreign securities
(denominated in U.S. dollars or foreign
currencies) including emerging market
foreign securities.
Principal Investment Risks: Because the values of the Fund's
investments will fluctuate with market
conditions, so will the value of your
investment in the Fund. You could lose
money on your investment in the Fund or
the Fund could underperform other
investments. The Adviser expects that
this Fund will typically display
relatively lower changes in value,
return and risk of loss than the longer
duration TOTAL RETURN FUND and LOW
DURATION FUND.
11
<PAGE> 17
The values of the Fund's investments
fluctuate in response to movements in
interest rates. If rates rise, the
values of debt securities generally
fall. The longer the average maturity of
the Fund's investment portfolio, the
greater the change in value. The values
of any of the Fund's investments may
also decline in response to events
affecting the issuer or its credit
rating. The lower rated debt securities
in which the Fund invests are considered
speculative and are subject to greater
volatility and risk of loss than
investment grade securities,
particularly in deteriorating economic
conditions. The value of some
mortgage-related securities in which the
Fund invests also may fall because of
unanticipated levels of principal
prepayments that can occur when interest
rates decline.
The value of the Fund's investments in
foreign securities also depends on
changing currency values, different
political and economic environments and
other overall economic conditions in the
countries where the Fund invests.
Emerging market debt securities tend to
be of lower credit quality and subject
to greater risk of default than higher
rated securities from more developed
markets.
12
<PAGE> 18
PERFORMANCE
Fund performance results have not been provided because the Short-Term
Investment Fund has not yet commenced operations.
FEES AND EXPENSES
As an investor in the Fund, you will pay the following expenses. The
Fund has no sales, redemption, exchange or account fees, although some
institutions may charge you a fee for shares you buy through them. Annual Fund
operating expenses are paid out of Fund assets, and are reflected in the share
price.
ANNUAL FUND OPERATING EXPENSES
(FEES PAID FROM FUND ASSETS)
<TABLE>
<S> <C>
Management fees 0.40%
- ------------------------------------------------------------------------------------- ---------------------
Rule 12b-1 expenses(1) None
- ------------------------------------------------------------------------------------- ---------------------
Other expenses 0.50%
- ------------------------------------------------------------------------------------- ---------------------
Total annual Fund operating expenses 0.90%
- ------------------------------------------------------------------------------------- ---------------------
Fee reduction and/or expense reimbursement(2) 0.40%
- ------------------------------------------------------------------------------------- ---------------------
Net expenses(2) 0.50%
- ------------------------------------------------------------------------------------- ---------------------
</TABLE>
(1) The Fund has adopted a Rule 12b-1 plan but has not yet charged
any fees under the plan.
(2) Expenses are estimates only. The Adviser has contractually agreed
to reduce its fees and/or absorb expenses, and to pay for the
Fund's distribution expenses, to limit the Fund's total annual
operating expenses (excluding interest, taxes and extraordinary
expenses) to 0.50%. This contract has a one-year term, renewable
at the end of each fiscal year.
13
<PAGE> 19
EXAMPLE
Use this table to compare fees and expenses of the Fund with those of
other funds. It illustrates the amount of fees and expenses you would pay
assuming the following:
- $10,000 initial investment in the Fund
- 5% annual return
- redemption at the end of each period
- no changes in the Fund's operating expenses
Although your actual costs may be higher or lower, based on these
assumptions your costs would be:
------------- ------------
1 3
Year Years
$51 $246
------------- ------------
14
<PAGE> 20
ALPHATRAK 500 FUND
INVESTMENT OBJECTIVE, STRATEGIES AND RISKS
Objective: The AlphaTrak 500 Fund seeks to achieve
a total return that exceeds the total
return of the S&P 500 Index.
Principal Investment Strategies: The Fund is an enhanced S&P 500 Index
fund that combines non-leveraged
investments in S&P 500 Index futures
with a fixed income portfolio. The
Adviser will actively manage the
fixed-income portfolio in an effort to
produce an investment return that, when
combined with the Fund's return on the
S&P 500 Index futures, will exceed the
total return of the S&P 500 Index.
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. The Fund will
need to make margin deposits with
futures commission merchants
(broker-dealers for futures contracts)
with a total value equal to
approximately 4-5% of the notional value
of the futures contracts and invest the
rest of its assets in a diversified
portfolio of fixed-income securities of
varying maturities issued by domestic
and foreign corporations and governments
(and their agencies and
instrumentalities) with a portfolio
duration of up to three years. The
meaning of "duration" is explained below
under "Investment Policies of the
Funds." The Fund's dollar-weighted
average maturity is normally expected to
exceed three years. The Fund's portfolio
may include bonds, notes,
mortgage-related and asset-backed
securities and money-market securities.
These investments may have interest
rates that are fixed, variable or
floating.
Under normal circumstances, the Fund
will invest at least 85% of its net
assets in debt instruments rated at
least investment grade or debt
securities of comparable quality to
investment grade securities as
determined by the Adviser in the case of
unrated securities. Up to 15% of the
Fund's net assets may be invested in
securities rated below investment grade
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.
The Fund may invest a portion of its
assets in foreign securities
(denominated in U.S. dollars or foreign
currencies) including emerging market
foreign securities.
15
<PAGE> 21
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.
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.
Principal Investment Risks: Because the values of the Fund's
investments will change with market
conditions, so will the value of your
investment in the Fund. You could lose
money on your investment in the Fund or
the Fund could underperform other
investments. The Adviser expects that
this Fund will typically experience the
same changes in value and risk of loss
as the general stock market reflected in
the S&P 500 Index.
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.
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. The Fund
could lose the entire amount invested in
these futures. The Fund could also face
potentially unlimited losses from other
types of futures and derivatives.
The values of the Fund's fixed income
investments change in response to
movements in interest rates. If rates
rise, the values of debt securities
generally fall. The longer the average
duration of the Fund's investment
portfolio, the greater the change in
value. The values of any of the Fund's
investments in debt securities may also
decline in response to events affecting
the issuer or its credit rating. The
lower rated debt securities in which the
Fund invests are considered speculative
and are subject to greater volatility
and risk of loss than investment grade
securities, particularly in
deteriorating economic conditions. The
value of some mortgage-related
securities in which the Fund invests
also may fall because of
16
<PAGE> 22
unanticipated levels of principal
prepayments that can occur when interest
rates decline.
The value of the Fund's investments in
foreign securities also depends on
changing currency values, different
political and economic environments and
other overall economic conditions in the
countries where the Fund invests.
Emerging market debt securities tend to
be of lower credit quality and subject
to greater risk of default than higher
rated securities from more developed
markets.
17
<PAGE> 23
PERFORMANCE
The ALPHATRAK 500 FUND commenced operations on June 29, 1998. Fund
performance results have not been provided because it has not yet been in
existence for a full calendar year.
FEES AND EXPENSES
As an investor in the Fund, you will pay the following expenses. The
Fund has no sales, redemption, exchange or account fees, although some
institutions may charge you a fee for shares you buy through them. Annual Fund
operating expenses are paid out of Fund assets, and are reflected in the share
price.
Past Actual
ANNUAL FUND OPERATING EXPENSES
(FEES PAID FROM FUND ASSETS)
Management fees(1) 0.52%
Rule 12b-1 expenses(2) None
Other expenses 2.87%
Total annual Fund operating expenses 3.39%
Fee reduction and/or expense reimbursement(3) 2.67%
Net expenses(3) 0.72%
- ----------------------------------------------------------- ---------------
(1) The management fee paid to the Adviser for providing services to the
Fund consists of a basic annual fee of 0.35% of the Fund's average net
assets and a performance adjustment, resulting in a minimum fee of 0%
and a maximum fee of 0.70%.
(2) The Fund has adopted a Rule 12b-1 plan but has not yet charged any
fees under the plan.
(3) The Adviser has contractually agreed to reduce its fees and/or absorb
expenses, and to pay for the Fund's distribution expenses and to limit
the Fund's total annual operating expenses (excluding interest, taxes
and extraordinary expenses) to 0.90% by limiting "other expenses" to
0.20% and assuming the maximum management fee. This contract has a
one-year term, renewable at the end of each fiscal year. Assuming the
amount of other expenses and fee reduction and/or expense
reimbursement shown above, net expenses would have been 0.20% assuming
the minimum management fee, 0.55% assuming the basic fee and 0.90%
assuming the maximum management fee.
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<PAGE> 24
EXAMPLE
Use this table to compare fees and expenses of the Fund with those of
other funds. It illustrates the amount of fees and expenses you would pay
assuming the following:
- $10,000 initial investment in the Fund
- 5% annual return
- redemption at the end of each period
- no changes in the Fund's operating expenses
Although your actual costs may be higher or lower, based on these
assumptions your costs would be:
------------- ------------ ------------- -------------
1 3 5 10
Year Years Years Years
$73 $790 $1,529 $3,476
------------- ------------ ------------- -------------
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<PAGE> 25
- --------------------------------------------------------------------------------
FURTHER INFORMATION ABOUT
INVESTMENT OBJECTIVES, POLICIES AND RISKS
- --------------------------------------------------------------------------------
GENERAL
The Fund descriptions set forth in the Risk/Return Summary section of this
Prospectus 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. 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 in more detail in the
Statement of Additional Information.
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 to determine 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 fixed-income security provides its final payment, taking no account
of the pattern of the security's payments prior to maturity. Duration is used in
the management of the Funds as a tool to measure interest rate risk. For
example, a Fund with a portfolio duration of 2 years would be expected to change
in value 2% for every 1% move in interest rates. For a more detailed discussion
of duration, see "Investment Objectives and Policies--Duration" 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 over 100% is considered high and increases these costs. The
Adviser does not view turnover as an important consideration in managing the
Funds and does not strive to limit portfolio turnover. See "Financial
Highlights" for past turnover rates.
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.
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<PAGE> 26
RISKS OF INVESTING IN FIXED-INCOME SECURITIES
Other than the risks presented for the Alpha Trak 500 Fund from its use of
futures, 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 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 options and futures transactions. The Fund could
lose the entire amount it invests in futures. The loss from investing in other
derivatives is potentially unlimited. There also is no assurance that a liquid
secondary market will exist for futures contracts and options in which a Fund
may invest.
YEAR 2000
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. Additionally, a Fund's performance
could be hurt by the failure of a computer system of a company or governmental
unit that issues securities in which the Fund invests.
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<PAGE> 27
ADVISER PERFORMANCE -- PREDECESSOR ACCOUNTS
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." This performance data for the Adviser is not the performance of any
Fund in this prospectus. The Low Duration Accounts constituted 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.
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<PAGE> 28
Total Return of Low Duration Assets
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
August 1,
1996- January 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%
</TABLE>
- --------------------------------------------------------------------------------
* 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
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.
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<PAGE> 29
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 31, 1998, utilizing the specific investment approach specified
for the AlphaTrak 500 Fund under "Investment Objectives and Policies." This
performance data for the Adviser is not the performance of any Fund in this
prospectus. The Enhanced Equity Index Account constituted 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.
24
<PAGE> 30
TOTAL RETURN OF ENHANCED EQUITY INDEX ACCOUNT
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SINCE INCEPTION JANUARY 1, 1998 TO SEPTEMBER 30, 1997
(SEPTEMBER 30, 1997 MAY 31, 1998 TO
TO ------------ DECEMBER 31, 1997
MAY 31, 1998) ------------------
-------------
<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 "Risk/Return Summary--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 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.
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<PAGE> 31
- --------------------------------------------------------------------------------
ORGANIZATIONAL AND MANAGEMENT
- --------------------------------------------------------------------------------
THE ADVISER
Metropolitan West Asset Management, LLC, with principal offices at 11766
Wilshire Blvd., Suite 1580, Los Angeles, California 90025, 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 and other
assets held in the portfolios of the Funds. The Adviser is a registered
investment adviser organized in 1996. The Adviser managed approximately $3.5
billion of fixed-income investments as of March 31, 1999 on behalf of
institutional clients and the Funds. The Adviser is majority-owned by its key
executives, with a minority ownership stake held by Metropolitan West Financial,
Inc. ("MWF"), a registered investment adviser. MWF's affiliate, Metropolitan
West Securities, Inc. ("MWS"), has managed fixed-income investments since
1992. MWS managed approximately $15 billion for its clients as of March 31,
1999.
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.
MANAGEMENT FEES AND OTHER EXPENSES
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
same period. The performance period consists of the prior three calendar months.
Each .10% of difference of the Fund's
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<PAGE> 32
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):
AlphaTrak
500 Fund S&P Total
(before 500 Basic Fee Adv.
adv. fee) Index Fee Adj. Fee
--------- ----- --- ---- ---
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%
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 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).
Currently, the Board of Directors of the Funds have waived these fees for the
Funds, and the Adviser has contractually agreed, through March 31, 2000, to pay
the Funds' distribution expenses out of its own resources.
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 and
for providing services to shareholders. The Adviser also may use its own funds
to sponsor seminars and educational programs on the Funds for financial
intermediaries and shareholders.
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 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 211 South Gulph Road, P.O. Box 61767, King of
Prussia, Pennsylvania 19406.
THE DISTRIBUTOR
First Data Distributors, Inc., 4400 Computer Drive, Westboro, Massachusetts
01581, serves as principal underwriter to the Trust pursuant to an Underwriting
Agreement.
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<PAGE> 33
- --------------------------------------------------------------------------------
SHAREHOLDER INFORMATION
- --------------------------------------------------------------------------------
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 will apply.
Investors may invest in any Fund by wiring the amount to be invested to
Metropolitan West Funds.
Wire to: Boston Safe Deposit & Trust
ABA No. 01-10-01234 for First Data Investor
Services Group, Inc.
Account No. 011835
Credit: (Name of Fund)
FBO: (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 proper credit, before wiring any funds the shareholder must call (800)
241-4671 to notify us of the wire and to get an account number assigned if the
wire is an initial investment. Also, 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.
211 South Gulph Road
P.O. Box 61767
King of Prussia, Pennsylvania 19406
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. If 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 buy or sell Fund shares through a broker or agent.
Shareholder inquiries should be directed to the Trust, c/o First Data Investor
Services Group, Inc., P.O. Box 61767, King of Prussia, PA 19406.
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 other
service does not constitute receipt by the Transfer Agent.
BY PAYMENT IN KIND
In certain situations, Fund shares may be purchased by tendering payment in kind
in the form of securities. Any securities used to buy Fund shares must be
readily marketable, their acquisition consistent with the Fund's objective and
otherwise acceptable to the Adviser. Prior to making such a purchase, you should
call the Adviser to determine if the securities you wish to use to make a
purchase are appropriate.
PURCHASES THROUGH AN INVESTMENT BROKER OR DEALER
You may buy and sell shares of the Funds through certain brokers (and their
agents) that have made arrangements with the Funds to sell their shares. When
you place your order with such a broker or its authorized agent, your order is
treated as if you had placed it directly with the Funds' Transfer Agent, and you
will pay or receive the next price calculated by the Funds. The broker (or
agent) holds your shares in an omnibus account in the broker' (or agent') name,
and the broker (or agent) maintains your individual ownership records. The Funds
may pay the broker or its agent for maintaining these records as well as
providing other shareholder services. The broker (or its agent) may charge you a
fee for handling your order. The broker (or agent) is responsible for processing
your order correctly and promptly, keeping you advised regarding the status of
your individual account, confirming your
28
<PAGE> 34
transactions and ensuring that you receive copies of the Funds' prospectus.
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 (usually 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.
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 61767, King of Prussia, Pennsylvania 19406.
The redemption request should identify the Fund and the account number, specify
the number of shares or dollar amount 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' 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 by calling (800) 241-4671.
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.
EXCHANGES OF SHARES
Shareholders are permitted to exchange their shares in a Fund for shares of
other Funds in the Trust, provided that those shares may legally be sold in the
state of the investor's residence and the shareholder has selected the
appropriate box on the Account Application. Shares subject to an exchange must
have a current value of at least $1,000. An exchange of shares is treated for
federal income tax purposes as a redemption (sale) of shares given in exchange
by the shareholder and an exchanging shareholder may, therefore, realize a
taxable gain or loss in connection with the exchange. Shares exchanged for
shares of another Fund will be priced at their respective net asset values.
TELEPHONE TRANSACTIONS
You may redeem shares by telephone and have the proceeds wired to the bank
account as stated on the Transfer Agent's records. You may also exchange shares
by telephone. In order to redeem or exchange shares by telephone, you must
select the appropriate box on the Account Application. In order to arrange for
telephone redemptions or exchanges 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 or exchanged by calling Investor Services at (800) 241-4671 and
giving the account name, account number, and amount of the redemption or
exchange. 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
29
<PAGE> 35
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. 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.
The Funds reserve the right to reject any telephone redemption or exchange
request and the redemption or exchange privilege may be modified or terminated
at any time on 30-days' notice to shareholders. In an effort to prevent
unauthorized or fraudulent redemption or 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 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 or exchange 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
or exchange by telephone, shareholders should redeem or exchange shares by
writing to the Transfer Agent at the address listed above.
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 or made partly in-kind with marketable
securities under unusual circumstances, as specified in the 1940 Act.
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.
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.
REPORTS TO SHAREHOLDERS
Each Fund's fiscal year ends on March 31. Each Fund will issue to its
shareholders semi-annual and annual reports. In addition, shareholders will
receive quarterly statements of the status of their accounts reflecting all
transactions having taken place within that quarter. In order to reduce
duplicate mailings and printing costs, the Trust will provide one annual or
semi-annual report and annual prospectus per household. Information regarding
the tax status of income dividends and capital gains distributions will be
mailed to shareholders on or before January 31st of each year. Account tax
information will also be sent to the IRS.
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 will notify each shareholder after the close of its fiscal year of both
the
30
<PAGE> 36
dollar amount and the tax status of that year's distributions.
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.
31
<PAGE> 37
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
The financial highlights table is intended to help you understand each Fund's
financial performance for the period of the Fund's operations. Certain
information reflects financial results for a single Fund share. The total
returns in the table represent the rate that an investor would have earned on an
investment in the Fund (assuming reinvestment of all dividends and
distributions). This information has been audited by Deloitte & Touche LLP,
whose report, along with the Fund's financial statements, are included in the
annual report, which is available upon request.
<TABLE>
<CAPTION>
Selected Per-Share Data For the Year Ended March 31: Total Return Low Duration AlphaTrak
Bond Fund Bond Fund 500 Fund*
--------------------------------------------------------------------
1999 1998 1999 1998 1999
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period $ 10.49 $ 10.00 $ 10.18 $ 10.00 $ 10.00
Income from Investment Operations:
Net investment income 0.71 0.73 0.66 0.65 0.44
Net realized and unrealized gain on investments 0.19 0.60 (0.02) 0.19 1.22
Total from investment operations 0.90 1.33 0.64 0.84 1.66
Less Distributions:
Dividends from net investment income (0.71) (0.73) (0.66) (0.65) (0.26)
Distributions from net capital gains or investments (0.15) (0.11) (0.01) (0.01) (0.00)
Total Distributions (0.86) (0.84) (0.67) (0.66) (0.26)
Net asset value, end of period $ 10.53 $ 10.49 $ 10.15 $ 10.18 $ 11.40
Total return (not annualized) 8.84% 13.71% 6.54% 8.71% 17.28%
Ratios/Supplemental Data:
Net assets, end of period (in thousands) $115,233 $24,983 $235,337 $135,313 $8,104
Ratio of Expenses to Average Net Assets:
Before expense reimbursement 0.97% 1.99% 0.70% 0.93% 3.39%+
After expense reimbursement 0.65% 0.65% 0.58% 0.58% 0.72%+
Ratio of Net Income to Average Net Assets:
Before expense reimbursement 6.60% 6.05% 6.49% 6.37% 4.14%+
After expense reimbursement 6.92% 7.39% 6.61% 6.72% 6.81%+
Portfolio turnover rate 136% 235% 73% 102% 74%+
</TABLE>
* The AlphaTrak 500 Fund commenced operations on June 29, 1998.
+ Annualized
32
<PAGE> 38
- --------------------------------------------------------------------------------
For more information about Metropolitan West Funds the following documents are
available free upon request:
ANNUAL/SEMIANNUAL REPORTS:
The Funds' annual and semiannual reports to shareholders contain detailed
information about the Funds' portfolios. The annual report includes a discussion
of the market conditions and investment strategies that significantly affected
the Funds' performance during their last fiscal year.
STATEMENT OF ADDITIONAL INFORMATION (SAI):
The SAI provides more detailed information about the Funds, including operations
and investment policies. It is incorporated by reference and is legally
considered a part of this Prospectus.
You can get free copies of the reports and the SAI, or request other information
and discuss your questions about the Funds, by contacting us at:
METROPOLITAN WEST FUNDS
11766 WILSHIRE BOULEVARD, SUITE 1580
LOS ANGELES, CALIFORNIA 90025
800- 241-4671
You can also review the Fund's reports and SAI at the Public Reference Room of
the Securities and Exchange Commission. In addition, you can get text-only
copies:
- For a fee, by writing the Public Reference Section of the Commission,
Washington, D.C. 20549-6009 or calling 1-800-SEC-0330
- Free from the Commission's Website at http://www.sec.gov.
Investment Company Act file No. 811- 07989
33
<PAGE> 39
------------------------------------------------------------
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> 40
METROPOLITAN WEST FUNDS
STATEMENT OF ADDITIONAL INFORMATION
July 27, 1999
This Statement of Additional Information is not a prospectus, and it
should be read in conjunction with the Prospectus dated July 27, 1999, 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 by writing to Metropolitan West Funds, 11766 Wilshire Boulevard, Suite
1580, Los Angeles, CA 90025. 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. Each Fund is a separate,
diversified series of Metropolitan West Funds (the "Trust"). Incorporated by
reference herein are the financial statements of the Funds contained in the
Funds' Annual Report to Shareholders for the fiscal year ended March 31, 1999,
including the Auditors' Report dated April 30, 1999. Copies of the Funds' Annual
and Semiannual Reports to shareholders are available, upon request, by calling
(800) 241-4671, or by writing to Metropolitan West Funds, 11766 Wilshire Blvd.,
Suite 1580, Los Angeles, California 90025.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
<S> <C>
THE TRUST......................................................................................................Page B-3
INVESTMENT OBJECTIVES AND POLICIES.............................................................................Page B-3
INVESTMENT RESTRICTIONS...............................................................................Page B-3
SECURITIES AND TECHNIQUES USED BY THE FUNDS....................................................................Page B-4
GENERAL .............................................................................................Page B-4
CREDIT RATINGS........................................................................................Page B-5
DURATION .............................................................................................Page B-5
REPURCHASE AGREEMENTS.................................................................................Page B-6
REVERSE REPURCHASE AGREEMENTS.........................................................................Page B-6
U.S. GOVERNMENT SECURITIES............................................................................Page B-6
CORPORATE DEBT AND OTHER OBLIGATIONS..................................................................Page B-7
CONVERTIBLE SECURITIES................................................................................Page B-7
LOANS OF PORTFOLIO SECURITIES.........................................................................Page B-8
WHEN-ISSUED SECURITIES................................................................................Page B-8
MORTGAGE-RELATED SECURITIES...........................................................................Page B-8
ASSET-BACKED SECURITIES..............................................................................Page B-11
RISK FACTORS RELATING TO INVESTING IN MORTGAGE-RELATED AND ASSET-BACKED SECURITIES
...........................................................................................Page B-11
DERIVATIVE INSTRUMENTS...............................................................................Page B-12
FOREIGN SECURITIES...................................................................................Page B-19
RISK FACTORS RELATING TO INVESTING IN HIGH-YIELD SECURITIES..........................................Page B-20
ILLIQUID SECURITIES..................................................................................Page B-20
BORROWING............................................................................................Page B-21
MANAGEMENT....................................................................................................Page B-21
TRUSTEES AND OFFICERS................................................................................Page B-21
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES..................................................Page B-23
PORTFOLIO TRANSACTIONS AND BROKERAGE.................................................................Page B-26
INVESTMENT ADVISORY SERVICES.........................................................................Page B-27
ADMINISTRATOR........................................................................................Page B-28
CUSTODIAN AND TRANSFER AGENT.........................................................................Page B-28
DISTRIBUTOR..........................................................................................Page B-28
SHARE MARKETING PLAN.................................................................................Page B-28
</TABLE>
Page B-1
<PAGE> 41
<TABLE>
<CAPTION>
<S> <C>
NET ASSET VALUE...............................................................................................Page B-29
REDEMPTION IN KIND............................................................................................Page B-30
DIVIDENDS AND TAX STATUS......................................................................................Page B-30
PERFORMANCE INFORMATION.......................................................................................Page B-32
FURTHER INFORMATION ABOUT THE TRUST...........................................................................Page B-33
ADDITIONAL INFORMATION........................................................................................Page B-33
LEGAL OPINION........................................................................................Page B-33
AUDITORS ............................................................................................Page B-33
LICENSE TO USE NAME..................................................................................Page B-34
OTHER INFORMATION....................................................................................Page B-34
FINANCIAL STATEMENTS..........................................................................................Page B-34
APPENDIX -- DESCRIPTION OF RATINGS............................................................................Page B-35
</TABLE>
Page B-2
<PAGE> 42
THE TRUST
The Trust was organized on December 9, 1996 as a Delaware business
trust. The Trust is a diversified open-end, management investment company
currently consisting of four separate series. Each series has only one class of
shares of beneficial interest, with a par value of $0.01 per share. 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.
INVESTMENT OBJECTIVES AND POLICIES
The investment objective of each Fund is described in the Prospectus.
The portfolio, and strategies with respect to the composition of each
Fund, are described in the 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 of
that purchase: (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 of that purchase, 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-3
<PAGE> 43
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 exception 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 interests in oil, gas, or other
mineral leases or exploration of development programs, although it may invest in
the common stocks of companies that invest in or sponsor such programs; (b)
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; and (c)
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 or this Statement of Additional Information, but
not more than 3% of the total outstanding stock of such company would be owned
by the Fund and its affiliates.
SECURITIES AND TECHNIQUES USED BY THE FUNDS
The following provides more detailed information about securities and
techniques used by the Funds and the risks associated with them.
GENERAL
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 (see "Mortgage Related Securities"); (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.
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
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 substantially 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.
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.
Because each Fund may invest up to 25% of its total assets in money
market mutual funds or mutual funds that invest in stocks, investors should know
that a Fund would pay the additional fees and expenses of a mutual fund
investment. This would result in an additional layer of management fees and
expenses for shareholders in a Fund.
Page B-4
<PAGE> 44
CREDIT RATINGS
The Prospectus describes the permissible range of credit ratings for
the securities in which each Fund is permitted to invest. 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."
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.
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 on a present value basis. 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. 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 before
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.
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.
Assuming an expected average duration of .75 years for the Short-term
Investment Fund or AlphaTrak 500 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. 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. 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. Other
factors such as changes in credit
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quality, prepayments, the shape of the yield curve and liquidity affect the net
asset value of the Funds and may becorrelated with changes in interest rates.
These factors can increase swings in the Fund's share prices during periods of
volatile interest rate changes.
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.
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.
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.
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, Student Loan Marketing Association. Federal Home Loan
Mortgage Corporation, Federal Intermediate Credit Banks, Federal Land Banks,
Tennessee Valley Authority, Inter-American Development Bank, Asian Development
Bank 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.
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."
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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 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.
The Funds may invest in structured debentures and structured notes.
These 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.
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. These
criteria are described in the Prospectus. 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,
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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.
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 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. 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
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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.
MORTGAGE PASS-THROUGH SECURITIES: Mortgage pass-through securities
represent interests in pools of mortgages in which payments of both principal
and interest on the securities are generally made monthly, in effect "passing
through" monthly payments made by borrowers on the residential or commercial
mortgage loans which underlie the securities (net of any fees paid to the issuer
or guarantor of the securities). Mortgage pass-through securities differ from
other forms of debt securities, which normally provide for periodic payment of
interest in fixed amounts with principal payments at maturity or specified call
dates. Early payment of principal on mortgage pass-through securities (arising
from prepayments of principal due to the sale of underlying property,
refinancing, or foreclosure, net of fees and costs which may be incurred) may
expose a Fund to a lower rate of return upon reinvestment of principal. Also, if
a security subject to repayment has been purchased at a premium, in the event of
prepayment, the value of the premium would be lost.
There are currently three types of mortgage pass-through securities,
(i) those issued by the U.S. Government or one of its agencies or
instrumentalities, such as the Government National Mortgage Association
("GNMA"), the Federal National Mortgage Association ("FNMA") and the Federal
Home Loan Mortgage Corporation ("FHLMC"); (ii) those issued by private issuers
that represent an interest in or are collateralized by pass-through securities
issued or guaranteed by the U.S. Government or one of its agencies or
instrumentalities; and (iii) those issued by private issuers that represent an
interest in or are collateralized by whole mortgage loans or pass-through
securities without a government guarantee but usually having some form of
private credit enhancement.
GNMA is a wholly-owned United States Government corporation within the
Department of Housing and Urban Development. GNMA is authorized to guarantee,
with the full faith and credit of the United States Government, the timely
payment of principal and interest on securities issued by the institutions
approved by GNMA (such as savings and loan institutions, commercial banks and
mortgage banks), and backed by pools of FHA-insured or VA-guaranteed mortgages.
Obligations of FNMA and FHLMC are not backed by the full faith and
credit of the United States Government. In the case of obligations not backed by
the full faith and credit of the United States Government, a Fund must look
principally to the agency issuing or guaranteeing the obligation for ultimate
repayment. FNMA and FHLMC may borrow from the U.S. Treasury to meet their
obligations, but the U.S. Treasury is under no obligation to lend to FNMA or
FHLMC.
Private mortgage pass-through securities are structured similarly to
GNMA, FNMA and FHLMC mortgage pass-through securities and are issued by
originators of and investors in mortgage loans, including depository
institutions, mortgage banks, investment banks and special purpose subsidiaries
of the foregoing. Pools created by private mortgage pass-through issuers
generally offer a higher rate of interest than government and government-related
pools because there are no direct or indirect government or agency guarantees of
payments in the private pools. However, timely payment of interest and principal
of these pools may be supported by various forms of insurance or guarantees,
including individual loan, title, pool and hazard insurance and letters of
credit. The insurance and guarantees are issued by governmental entities,
private insurers and the mortgage poolers. The insurance and guarantees and the
credit worthiness of the issuers thereof will be considered in determining
whether a mortgage-related security meets the Funds' investment quality
standards. There can be no assurance that the private insurers or guarantors can
meet their obligations under the insurance policies or guarantee arrangements.
Private mortgage pass-through securities may be bought without insurance or
guarantees if, through an examination of the loan experience and practices of
the originator/services and poolers, the Adviser determines that the securities
meet the Funds' quality standards.
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. 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 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.
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Certain issuers of CMOs are not considered investment companies
pursuant to a rule recently adopted by the Securities and Exchange Commission
("SEC"), and the Funds may invest in the securities of such issuers without the
limitations imposed by the 1940 Act on investments by the Fund in other
investment companies. In addition, in reliance on an earlier SEC interpretation,
the Fund's investments in certain other qualifying CMOs, which cannot or do not
rely on the rule, are also not subject to the limitation of the 1940 Act on
acquiring interests in other investment companies. In order to be able to rely
on the SEC's interpretation, issuers of these CMOs must be unmanaged, fixed
asset issuers, that (a) invest primarily in mortgage-backed securities, (b) do
not issue redeemable securities, (c) operate under general exemptive orders
exempting them from all provisions of the 1940 Act and (d) are not registered or
regulated under the 1940 Act as investment companies. To the extent that the
Funds select CMOs that cannot rely on the rule or do not meet the above
requirements, the Funds may not invest more than 10% of their assets in all such
entities and may not acquire more than 3% of the voting securities of any single
entity.
The Funds also may invest in, among other things, parallel pay CMOs,
Planned Amortization Class CMOs ("PAC bonds"), sequential pay CMOs, and floating
rate CMOs. Parallel pay CMOs are structured to provide payments of principal on
each payment date to more than one class. PAC bonds generally require payments
of a specified amount of principal on each payment date. Sequential pay CMOs
generally pay principal to only one class while paying interest to several
classes. Floating rate CMOs are securities whose coupon rate fluctuates
according to some formula related to an existing mortgage index or rate. Typical
indices would include the eleventh district cost- of-funds index, the London
Interbank Offered Rate, one-year Treasury yields, and ten-year Treasury yields.
ADJUSTABLE RATE MORTGAGE SECURITIES: Adjustable rate mortgage
securities ("ARMs") are pass-through securities collateralized by mortgages with
adjustable rather than fixed rates. ARMs eligible for inclusion in a mortgage
pool generally provide for a fixed initial mortgage interest rate for either the
first three, six, twelve, thirteen, 36, or 60 scheduled monthly payments.
Thereafter, the interest rates are subject to periodic adjustment based on
changes to a designated benchmark index.
The ARMs contain maximum and minimum rates beyond which the mortgage
interest rate may not vary over the lifetime of the security. In addition,
certain ARMs provide for additional limitations on the maximum amount by which
the mortgage interest may be adjusted for any single adjustment period. In the
event that market rates of interest rise more rapidly to levels above that of
the ARM's maximum rate, the ARM's coupon may represent a below market rate of
interest. In these circumstances, the market value of the ARM security will
likely have fallen.
Some ARMs contain limitations on changes in the required monthly
payment. In the event that a monthly payment is not sufficient to pay the
interest accruing on an ARM, any such excess interest is added to the principal
balance of the mortgage loan, which is repaid through future monthly payments.
If the monthly payment for such an instrument exceeds the sum of the interest
accrued at the applicable mortgage interest rate and the principal payment
required at such point to amortize the outstanding principal balance over the
remaining term of the loan, the excess is then utilized to reduce the
outstanding principal balance of the ARM.
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,
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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 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. 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.
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 securities issued by trusts and special purpose
corporations 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 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.
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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.
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 AlphaTrak 500 Fund
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
(including net proceeds from purchases and redemptions of Fund shares that have
not settled but are expected to timely settle in the usual way),
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.
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.
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.
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
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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. In addition to any hedging, the AlphaTrak 500 Fund
uses futures in an effort to achieve total return greater than the S&P 500
Index, as described in the Prospectus. With respect to hedging 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.
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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. 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.
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 (or for the benefit of) 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 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
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added to the amounts deposited with (or for the benefit of) 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 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
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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.
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 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.
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
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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 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.
No Fund will enter into foreign currency option contracts if the
premiums on such options exceed 5% of the Fund's total assets.
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
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security or the U.S. dollar equivalent of the payment, by entering into a
forward contract for the purchase or sale, for a fixed amount of U.S. dollars or
foreign currency, of the amount of foreign currency involved in the underlying
transaction. A Fund will thereby be able to protect itself against a possible
loss resulting from an adverse change in the relationship between the currency
exchange rates during the period between the date on which the security is
purchased or sold, or on which the payment is declared, and the date on which
such payments are made or received.
A Fund also may use forward contracts in connection with portfolio
positions to lock in the U.S. dollar value of those positions, to increase the
Fund's exposure to foreign currencies that the Adviser believes may rise in
value relative to the U.S. dollar or to shift the Fund's exposure to foreign
currency fluctuations from one country to another. For example, when the Adviser
believes that the currency of a particular foreign country may suffer a
substantial decline relative to the U.S. dollar or another currency, it may
enter into a forward contract to sell the amount of the former foreign currency
approximating the value of some or all of the Funds' portfolio securities
denominated in such foreign currency. This investment practice generally is
referred to as "cross-hedging" when another foreign currency is used.
The precise matching of the forward contract amounts and the value of
the securities involved will not generally be possible because the future value
of such securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date the forward contract
is entered into and the date it matures. Accordingly, it may be necessary for a
Fund to purchase additional foreign currency on the spot (i.e., cash) market
(and bear the expense of such purchase) if the market value of the security is
less than the amount of foreign currency the Fund is obligated to deliver and if
a decision is made to sell the security and make delivery of the foreign
currency. Conversely, it may be necessary to sell on the spot market some of the
foreign currency received upon the sale of the portfolio security if its market
value exceeds the amount of foreign currency the Fund is obligated to deliver.
The projection of short-term currency market movements is extremely difficult,
and the successful execution of a short-term hedging strategy is highly
uncertain. Forward contracts involve the risk that anticipated currency
movements will not be accurately predicted, causing the Fund to sustain losses
on these contracts and transaction costs. A Fund may enter into forward
contracts or maintain a net exposure to such contracts only if (1) the
consummation of the contracts would not obligate the Fund to deliver an amount
of foreign currency in excess of the value of the Fund's portfolio securities or
other assets denominated in that currency or (2) the Fund 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.
Page B-18
<PAGE> 58
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 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 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
Page B-19
<PAGE> 59
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.
RISK FACTORS RELATING TO INVESTING IN HIGH-YIELD SECURITIES
Lower-rated or unrated (i.e. high-yield) securities are more likely to
react to developments affecting market risk (such as interest rate sensitivity,
market perception of creditworthiness of the issuer and general market
liquidity) and credit risk (such as the issuer's inability to meet its
obligations) than are more highly rated securities, which react primarily to
movements in the general level of interest rates. The Adviser considers both
credit risk and market risk in making investment decisions for the Funds.
Investors should carefully consider the relative risk of investing in high-yield
securities and understand that such securities are not generally meant for
short-term trading.
The amount of high-yield securities outstanding proliferated in the
1980's in conjunction with the increase in merger and acquisition and leveraged
buyout activity. Under adverse economic conditions, there is a risk that highly
leveraged issuers may be unable to service their debt obligations upon maturity.
In addition, the secondary market for high-yield securities, which is
concentrated in relatively few market makers, may not be as liquid as the
secondary market for more highly rated securities. Under adverse market or
economic conditions, the secondary market for high-yield securities could
contract further, independent of any specific adverse changes in the condition
of a particular issuer. As a result, the Adviser could find it more difficult to
sell these securities or may be able to sell the securities only at prices lower
than if such securities were widely traded. Prices realized upon the sale of
such lower-rated or unrated securities, under these circumstances, may be less
than the prices used in calculating the Funds' net asset value.
Lower-rated or unrated debt obligations present risks based on payment
expectations. If an issuer calls the obligation for redemption, a Fund may have
to replace the security with a lower yielding security, resulting in a decreased
return for investors. If a Fund experiences unexpected net redemptions, it may
be forced to sell its higher- rated securities, resulting in a decline in the
overall credit quality of the Fund's portfolio and increasing the exposure of
the Fund to the risks of high-yield securities.
ILLIQUID SECURITIES
A Fund may not invest more than 15% of its net assets in repurchase
agreements which have a maturity of longer than seven days or in other illiquid
securities, including securities that are illiquid by virtue of the absence of a
readily available market (either within or outside of the United States) or
legal or contractual restrictions of resale. Historically, illiquid securities
have included securities subject to contractual or legal restrictions on resale
because they have not been registered under the Securities Act, securities which
are otherwise not readily marketable and repurchase agreements have a maturity
of longer than seven days. Securities which have not been registered under the
Securities Act are referred to as private placements or restricted securities
and are purchased directly from the issuer or in the secondary market. Mutual
funds do not typically hold a significant amount of these restricted or other
illiquid securities because of the potential for delays on resale and
uncertainty in valuation. Limitations on resale may have an adverse effect on
the marketability of portfolio securities and a mutual fund might be unable to
dispose of restricted or other illegal securities promptly or at reasonable
prices and might thereby experience difficulty satisfying redemptions within
seven days. A mutual fund might also have to register such restricted securities
in order to dispose of them resulting in additional expense and delay. Adverse
market conditions could impede such a public offering of securities. Currently
the Funds may invest in securities issued in private placements.
In recent years, however, a large institutional market has developed
for certain securities that are not registered under the Securities Act,
including repurchase agreements, commercial paper, foreign securities, municipal
securities, convertible securities and corporate bonds and notes. Institutional
investors depend on an efficient institutional market in which the unregistered
security can be readily resold or on an issuer's ability to honor a demand for
repayment. The fact that there are contractual or legal restrictions on resale
to the general public or to certain institutions may not be indicative of the
liquidity of such investments.
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.
Page B-20
<PAGE> 60
Restricted securities eligible for resale pursuant to Rule 144A under
the Securities Act and commercial paper for which there is a readily available
market will not be deemed to be illiquid. The Adviser will monitor the liquidity
of such restricted securities subject to the supervision of the Trustees. In
reaching liquidity decisions, the Adviser will consider, inter alia, the
following factors: (1) the frequency of trades and quotes for the security; (2)
the number of dealers wishing to purchase or sell the security and the number of
other potential purchasers; (3) dealer undertakings to make a market in the
security; and (4) the nature of the security and the nature of the marketplace
trades (e.g. the time needed to dispose of the security, the method of
soliciting offers and the mechanics of the transfer). In addition, in order for
commercial paper that is issued in reliance on Section 4(2) of the Securities
Act to be considered liquid, (i) it must be rated in one or two of the highest
rating categories by at least two nationally recognized statistical rating
organizations ("NRSRO"), or if only one NRSRO rates the securities, by that
NRSRO, or, if unrated, be of comparable quality in the view of the Adviser, and
(ii) it must not be "traded flat" (i.e., without accrued interest) or in default
as to principal or interest. Investing in Rule 144A securities could have the
effect of increasing the level of Fund illiquidity to the extent that qualified
institutional buyers become, for a time, uninterested in purchasing these
securities. Repurchase agreements subject to demand are deemed to have a
maturity equal to the notice period.
BORROWING
Each 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.
MANAGEMENT
TRUSTEES AND OFFICERS
The Trustees and officers of the Trust are:
<TABLE>
<CAPTION>
YEAR POSITION PRINCIPAL OCCUPATIONS
NAME AND ADDRESS BORN WITH THE TRUST DURING PAST FIVE YEARS
- ---------------- ---- -------------- ----------------------
<S> <C> <C> <C>
Scott B. Dubchansky* 1960 Chairman, Mr. Dubchansky has been the Chief Executive Officer
11766 Wilshire Blvd., Suite 1580 President and of the Adviser since August 1996. From August 1992 through
Los Angeles, CA 90025 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.
Laird R. Landmann* 1964 Trustee Mr. Landmann has been a Managing Director and portfolio
11766 Wilshire Blvd., Suite 1580 manager with the Adviser since August 1996. From
Los Angeles, CA 90025 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.
Keith T. Holmes* 1952 Trustee Mr. Holmes has been a partner of the law firm King,
2121 Avenue of the Stars, Purtich, Holmes, Paterno & Berliner (and its predecessor
22nd Floor firm King, 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 1957 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.
</TABLE>
Page B-21
<PAGE> 61
<TABLE>
<CAPTION>
<S> <C> <C> <C>
James M. Lippman 1957 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 1937 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 1964 Treasurer and Since 1996, Mr. Schweitzer has been the Chief Financial
11440 San Vicente Blvd., 3rd Floor Principal Accounting Officer of Metropolitan West Securities, Inc. ("MWS"), a
Los Angeles, CA 90049 and Financial Officer registered broker-dealer and investment adviser. Since
January 1998 he also has served as the Chief Financial
Officer of Metropolitan West Financial, Inc., which is a
registered investment adviser and the holding company for
MWS and other affiliated companies. From 1995 to 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 1969 Secretary and Since 1996, Ms. Mulpagano has been a Vice President and
11766 Wilshire Blvd., Suite 1580 Assistant Treasurer Assistant Portfolio Manager for the Adviser. From 1993 to
Los Angeles, CA 90025 1996, she was an Assistant Portfolio Manager for the
fixed-income department of Hotchkis & Wiley. From 1991 to
1993, she was a research assistant at Pacific Investment
Management Company (PIMCO).
James E. Menvielle 1972 Assistant Treasurer Since 1998, Mr. Menvielle has been the Assistant for the C
11766 Wilshire Blvd., Suite 1580 Adviser. From 1995 to 1998, he was a Senior Accountant
Los Angeles, CA 90025 with Deloitte & Touche LLP.
</TABLE>
- -------------------
* "Interested" Trustee, as defined in the 1940 Act, due to the relationship
indicated with the Adviser.
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
received an annual retainer of $3,000 and $1,500 for each meeting of the Board
of Trustees attended for the fiscal year ended March 31, 1999. For the fiscal
year ended March 31, 2000, the disinterested Trustees will be paid a retainer of
$6,000 and $1,500 for each meeting of the Board of Trustees attended. Mr. Holmes
will also be compensated according to that schedule. Mr. Holmes is not a
disinterested Trustee because he provides legal services to the Adviser and its
affiliates.
The total compensation paid by the Trust to each Trustee during the
fiscal year ended March 31, 1999 is set forth below:
Page B-22
<PAGE> 62
Total Compensation
Name of Trustee From the Trust
- --------------- --------------
Scott B. Dubchansky None
Laird R. Landmann None
Keith T. Holmes None
Martin Luther King III $9,000
James M. Lippman $9,000
Daniel D. Villanueva $9,000
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 June 30, 1999, the Trustees and officers of the Trust and the
Adviser, 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, except for the ALPHATRAK 500 FUND in which they collectively owned
10%.
As of June 30, 1999, the following persons owned beneficially more than
5% of the outstanding voting shares of the following:
FUND PERCENT OWNERSHIP
TOTAL RETURN BOND FUND:
Charles Schwab & Co. Inc. Special 39%
Custody Acct FBO Customers
Attention: Mutual Funds
101 Montgomery Street
San Francisco, California 94104
FTC & Co. 12%
Datalynx House Account
P.O. Box 173736
Denver, Colorado 82017-3736
Monongahela Valley Hospital Inc. 9%
Attention: Mr. Panza/Accounting
Country Club Road Route 88
Monongahela, Pennsylvania 15063
Page B-23
<PAGE> 63
LOW DURATION BOND FUND:
Mayo Foundation Working Capital 33%
200 1st Street, S.W.
Rochester, Minnesota 55905-0001
Charles Schwab & Co. Inc. Special 16%
Custody Acct FBO Customers
Attention: Mutual Funds
101 Montgomery Street
San Francisco, California 94104
McKinsey Master Retirement Trust 11%
c/o McKinsey & Co.
55 East 52nd Street
New York, New York 10022
First Hawaiian Bank 7%
Trust Hawaii Carpenters Pension Fund
DTD 4/14/96
P.O. Box 3708
Honolulu, Hawaii 96808-0888
Page B-24
<PAGE> 64
Pacific Century Trust 5%
Trust Retirement Plan for Pilots
of Hawaiian Airlines Inc.
A/C 150142495 DTD 1/1/98
P.O. Box 888
Honolulu, Hawaii 96808-0888
ALPHATRAK 500 FUND:
Boston & Co. 70%
FBO MJ Murdock Charitable Trust
A/C MURF4117002
Mutual Funds Operations
135 Santilli Highway
Everett, Massachusetts 02149-1906
Twin Cities Public Television 12%
172 4th Street E
Saint Paul, Minnesota 55101-1400
Firstcinco Rein. 7%
P.O. Box 640
Cincinnati, Ohio 45264-0001
Page B-25
<PAGE> 65
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
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
Page B-26
<PAGE> 66
contemplated by the Agreement; (ii) were for products or services which provide
lawful and appropriate assistance to the Adviser's decision-making process; and
(iii) were within a reasonable range as compared to the rates charged by brokers
to other institutional investors as such rates may become known from available
information. The Adviser is also authorized to consider sales of shares of each
Fund and/or of any other investment companies for which the Adviser acts as
Adviser as a factor in the selection of brokers to execute brokerage and
principal transactions, subject to the requirements of "best execution," as
defined above.
The research services discussed above may be in written form or through
direct contact with individuals and may include information as to particular
companies and securities as well as market, economic, or institutional areas and
information assisting the Trust in the valuation of the Funds' investments. The
research which the Adviser 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 years ended March 31, 1998 and 1999 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 for 1998, $900.00
for 1999; AlphaTrak 500 Fund -- None for 1998, $983.81 for 1999. The Adviser has
not obtained any soft dollar benefits from transactions by the Funds since
inception of the Funds.
INVESTMENT ADVISORY SERVICES
The Adviser, Metropolitan West Asset Management, LLC, with principal
offices at 11766 Wilshire Boulevard, Suite 1580, Los Angeles, California 90025,
is a registered investment adviser organized as a California limited liability
company in 1996.
Under the Investment Advisory Agreement relating to the Funds, the
Adviser provides the Funds with investment management services. As compensation
for these services, each Fund pays management fees at an annualized rate of its
average daily assets, as described in the Prospectus. For the fiscal years ended
March 31, 1998 and 1999 the amounts of the advisory fees earned by the Adviser
and the amounts of the reductions in fees and reimbursements of expenses by the
adviser as a result of the expense limitations and fee waivers described in the
Prospectus were as follows:
<TABLE>
<CAPTION>
Fiscal Year ended Fiscal Year ended
March 31, 1999 March 31, 1998
Advisory Fees Advisory Fees
Contractual Reduced and Expenses Contractual Reduced and Expenses
Advisory Fees Reimbursed by Adviser Advisory Fees Reimbursed by Adviser
------------- --------------------- ------------- ---------------------
<S> <C> <C> <C> <C>
TOTAL RETURN BOND FUND $327,412 $190,887 $ 74,072 $181,479
LOW DURATION BOND FUND $928,703 $238,282 $285,202 $209,717
ALPHATRAK 500 FUND $ 13,215 $ 70,260 N/A N/A
</TABLE>
The Adviser has agreed in an Operating Expenses Agreement to limit each Fund's
expenses as described in the Prospectus. That Agreement has a one-year term,
renewable at the end of each fiscal year. Each Fund has agreed to reimburse the
Adviser, for a period of up to three years, for any such payments to the extent
that the Fund's operating expenses are otherwise below its expense cap. This
obligation will not be recorded as a liability on the books of the Fund to the
extent that the total operating expenses of the Fund are at or above the expense
cap. However, if the total operating expenses of a Fund fall below the expense
cap, the reimbursement to the Adviser (up to the cap) will be accrued by the
Fund as a liability if the Adviser seeks to recoup those amounts and the
independent Trustees have approved that reimbursement. Certain officers and
trustees of the Funds are also officers and directors of the Adviser. All
officers serve without direct compensation from the Funds.
Page B-27
<PAGE> 67
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 61767, King of Prussia, Pennsylvania
19406. The Administration Agreement provides that the Administrator will prepare
and coordinate reports and other materials supplied to the Trustees; prepare
and/or supervise the preparation and filing of all securities filings, periodic
financial reports, prospectuses, statements of additional information, marketing
materials, tax returns, shareholder reports and other regulatory reports or
filings required of the Funds; prepare all required filings necessary to
maintain the Funds' qualifications and/or registrations to sell shares in all
states where each Fund currently does, or intends to do, business; coordinate
the preparation, printing and mailing of all materials (e.g., Annual Reports)
required to be sent to shareholders; coordinate the preparation and payment of
Fund-related expenses; monitor and oversee the activities of the Funds'
servicing agents (i.e., transfer agent, custodian, fund accountants, etc.);
review and adjust as necessary each Fund's daily expense accruals; and perform
such additional services as may be agreed upon by the Funds and the
Administrator. For its services, the Administrator receives an annual fee of
.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). The
administrative fees paid by the Total Return Bond Fund and the Low Duration Bond
Fund totaled $48,576 and $52,311, respectively, for the fiscal year ended March
31, 1998, and $51,360 and $158,288, respectively, for the fiscal year ended
March 31, 1999. The administrative fees paid by the AlphaTrak 500 Fund totaled
$2,632 for the fiscal year ended March 31, 1999.
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, 90 Washington Street, New York,
New York 10286, 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
First Data Distributors, Inc. (the "Distributor"), 4400 Computer Drive,
Westboro, Massachusetts 01581, 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 and
shareholder servicing expenses of that Fund. Distribution fees are accrued daily
and paid monthly, and are charged as expenses of the shares as accrued.
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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
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 stated 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. 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 close shortly after the time net asset
value is calculated.
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 reported 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, divisor or margin 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
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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.
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.
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. Each Fund is
taxed as a separate entity under Subchapter M and must qualify on a separate
basis. Qualification as a regulated investment company requires, among other
things, that (a) at least 90% of a Fund's annual gross income, without offset
for losses from the sale or other disposition of securities, be derived from
interest, dividends, payments with respect to securities loans, and gains from
the sale or other disposition of securities, foreign currencies or options
(including forward contracts) thereon; 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. Certain
provisions of the Relief Act have since been changed and further changes not
described in this Statement of Additional Information are possible.
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
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corporate shareholders, interest income, capital gain net income, gain or loss
from Section 1256 contracts (described below), dividend income from foreign
corporations and income from other sources will not constitute qualified
dividends. Corporate shareholders should consult their tax advisers regarding
other requirements applicable to the dividends-received deduction.
The use of hedging strategies, such as entering into futures contracts
and forward contracts and purchasing options, involves complex rules that will
determine the character and timing of recognition of the income received in
connection therewith by the Funds. Income from foreign currencies (except
certain gains therefrom that may be excluded by future regulations) and income
from transactions in options, futures contracts and forward contracts derived by
a Fund with respect to its business of investing in securities or foreign
currencies will qualify as permissible income under Subchapter M of the Code.
For accounting purposes, when a Fund purchases an option, the premium
paid by the Fund is recorded as an asset and is subsequently adjusted to the
current market value of the option. Any gain or loss realized by a Fund upon the
expiration or sale of such options held by the Fund generally will be capital
gain or loss.
Any security, option, or other position entered into or held by a Fund
that substantially diminishes the Fund's risk of loss from any other position
held by the Fund may constitute a "straddle" for federal income tax purposes. In
general, straddles are subject to certain rules that may affect the amount,
character and timing of a Fund's gains and losses with respect to straddle
positions by requiring, among other things, that the loss realized on
disposition of one position of a straddle be deferred until gain is realized on
disposition of the offsetting position; that the Fund's holding period in
certain straddle positions not begin until the straddle is terminated (possibly
resulting in the gain 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
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federal income tax withholding of up to 30% on certain payments received from a
Fund. Shareholders are advised to consult with their own tax advisers concerning
the application of federal, state, local, and foreign taxes to an investment in
a Fund.
PERFORMANCE INFORMATION
TOTAL RETURN: Average annual total return quotations used in the Funds'
advertising and promotional materials are calculated according to the following
formula:
P(1 + T) to the nth power = ERV
where P equals a hypothetical initial payment of $1000; T equals
average annual total return; n equals the number of years; and ERV equals the
ending redeemable value at the end of the period of a hypothetical $1000 payment
made at the beginning of the period.
Under the foregoing formula, the time periods used in advertising will
be based on rolling calendar quarters, updated to the last day of the most
recent quarter prior to submission of the advertising for publication. Average
annual total return, or "T" in the above formula, is computed by finding the
average annual compounded rates of return over the period that would equate the
initial amount invested to the ending redeemable value. Average annual total
return assumes the reinvestment of all dividends and distributions.
The average annual total returns for each Fund for the periods shown
were as follows:
Inception*
Year Ended Through
March 31, 1999 March 31, 1999
-------------- --------------
Total Return Bond Fund 8.84% 11.25%
Low Duration Bond Fund 6.54% 7.62%
AlphaTrak 500 Fund 17.28% 17.28%
*Total return for periods of less than one year are aggregate, not
annualized. The inception dates were: Total Return Bond Fund, March 31,
1997; Low Duration Bond Fund, March 31, 1997; and AlphaTrak 500 Fund,
June 29, 1998.
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.
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Yield for the TOTAL RETURN BOND FUND for the 30-day period ended March
31, 1999 was 6.97% and for the LOW DURATION BOND FUND was 7.06%.
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.
The Funds also may quote or refer to other portfolio or performance statistics
that are intended to reflect historical volatility and other performance
information, including the following: (1) Beta (the covariance of a share in
relation to the rest of the market, with volatility equal to the market having a
beta of 1); (2) R-squared (R2 reflects the degree to which the Fund's movements
are explained by movements in its benchmark index. R2 can range from 0 to 1 with
1 meaning that all movements of a fund are explained by movements of the index);
(3) Alpha (alpha measures the Fund's return relative to an unmanaged portfolio
index and is a general measure of the relative value a portfolio manager has
contributed. A value greater than 0 indicates a positive contribution); and (4)
Correlation coefficient (correlation coefficient provides a measure of how
closely the returns of one variable [the fund] moves with another [the index].
It ranges from -1 to +1, with +1, indicating a perfect positive correlation,
occurring only when the returns of the two variables move exactly at the same
time, in the same direction, and in the same relative magnitude).
FURTHER INFORMATION ABOUT THE TRUST
The Declaration of Trust for the Trust permits the Trustees to issue an
unlimited number of full and fractional shares of beneficial interest and to
divide or combine the shares into a greater or lesser number of shares without
thereby changing the proportionate beneficial interest in each Fund. Each share
represents an interest in a Fund proportionately equal to the interest of each
other share. Upon the Trust's liquidation, all shareholders would share pro rata
in the net assets of the Fund in question available for distribution to
shareholders. If they deem it advisable and in the best interest of
shareholders, the Board of Trustees may create additional classes of shares
which differ from each other only as to dividends. Each of such classes has or
will have a designation including the word "Series." Income and operating
expenses not specifically attributable to a particular Fund are allocated fairly
among the Funds by the Trustees, generally on the basis of the relative net
assets of each Fund.
The Declaration of Trust provides that the Trustees will not be liable
for errors of judgment or mistakes of fact or law, but nothing in the
Declaration of Trust protects a Trustee against any liability to which he would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his
office. The Declaration of Trust also provides that the Trust shall, upon
request, assume the defense of any claim made against any shareholder for any
act or obligation of the Trust and satisfy any judgment thereon.
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 has been 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, 1000 Wilshire Boulevard, Los Angeles, California
90017-2472, independent public accountant for the Funds.
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LICENSE TO USE NAME
Metropolitan West Securities, Inc. and the Adviser have granted the
Trust and each Fund the right to use the designation "Metropolitan West" in its
name, and have reserved the right to withdraw their consent to the use of that
designation under certain conditions, including the termination of the Adviser
as the Funds' investment adviser. They have also 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. It is also available on the SEC's Internet Web site at
http://www.sec.gov. Statements contained in the Prospectus or this SAI as to the
contents of any contract or other document referred to herein or in the
Prospectus are not necessarily complete, and, in each instance, reference is
made to the copy of such contract or other document filed as an exhibit to the
Trust's registration statement, each such statement being qualified in all
respects by that reference.
FINANCIAL STATEMENTS
Audited financial statements and the accompanying Auditors' Report
for the fiscal year ended March 31, 1999 for the Total Return Bond Fund, the Low
Duration Bond Fund and the AlphaTrak 500 Fund, as contained in the Annual Report
to Shareholders for the fiscal year ended March 31, 1999, are incorporated
herein by reference to that report.
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- --------------------------------------------------------------------------------
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.
STANDARD & POOR'S RATING GROUP
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 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.
Page B-35
<PAGE> 75
"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 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.
Page B-36
<PAGE> 76
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.
Page B-37
<PAGE> 77
----------------------------------------------------
PART C
OTHER INFORMATION
---------------------------------------------------
<PAGE> 78
METROPOLITAN WEST FUNDS
--------------
FORM N-1A
--------------
PART C
--------------
Item 23. Exhibits
(a) Agreement and Declaration of Trust (filed as part of
the Registration Statement on Form N-1A filed on
December 24, 1996 [the "Registration Statement"]).
(b) By-Laws (filed as part of the Registration
Statement).
(c) Instruments Defining Rights of Security Holders (not
applicable).
(d) Investment Management Agreement, as amended
(Incorporated by reference to Post-Effective
Amendment No. 4 filed on June 26, 1998
["Post-Effective Amendment No. 4 "]).
(e) 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"]).
(f) Bonus or Profit Sharing Contracts (not applicable).
(g)(1) Form of Custody Agreement (incorporated by reference
to Pre-Effective Amendment No. 2).
(g)(2) Form of Custody Administration and Agency Agreement
(incorporated by reference to Pre-Effective
Amendment No. 2).
(h)(1) Form of Administration Agreement (incorporated by
reference to Pre-Effective Amendment No. 2).
(h)(2) Form of Accounting Services Agreement (incorporated
by reference to Pre-Effective Amendment No. 2).
(h)(3) Form of Transfer Agent Services Agreement
(incorporated by reference to Pre-Effective
Amendment No. 2).
(h)(4) Operating Expenses Agreement.
(i)(1) 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"]).
(i)(2) For ALPHATRAK 500 FUND: Consent and Opinion of
Counsel as to legality of shares (incorporated by
reference to Post-Effective Amendment No. 4).
(j) Consent of Independent Public Accountants.
(k) Financial Statements omitted from Item 22 (not
applicable).
(l) Form of Subscription Agreement (incorporated by
reference to Pre-Effective Amendment No. 2).
(m) Share Marketing Plan (Rule 12b-1 Plan), as amended
(incorporated by reference to Post-Effective
Amendment No. 4).
(n) Financial Data Schedules (not applicable).
<PAGE> 79
(o) Rule 18f-3 Plan - Not applicable.
Item 24. 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 Financial, Inc., a California corporation ("MWF"),
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 MWF
include Paul C. Chow, Terry M. Crow, Edward E. Curiel, Thomas W. Hayes, Richard
S. Hollander, Russell S. Gould and Roland R. Moos. MWF is registered with the
Securities and Exchange Commission as an investment adviser.
Item 25. Indemnification
Article VII of the Agreement and Declaration of Trust empowers the
Trustees of the Trust, to the full extent permitted by law, to purchase with
Trust assets insurance for indemnification from liability and to pay for all
expenses reasonably incurred or paid or expected to be paid by a Trustee or
officer in connection with any claim, action, suit or proceeding in which he or
she becomes involved by virtue of his or her capacity or former capacity with
the Trust.
Article VII of the By-Laws of the Trust provides that the Trust shall
indemnify any person who was or is a party or is threatened to be made a party
to any proceeding by reason of the fact that such person is and other amounts or
was an agent of the Trust, against expenses, judgments, fines, settlement and
other amounts actually and reasonable incurred in connection with such
proceeding if that person acted in good faith and reasonably believed his or her
conduct to be in the best interests of the Trust. Indemnification will not be
provided in certain circumstances, however, including instances of willful
misfeasance, bad faith, gross negligence, and reckless disregard of the duties
involved in the conduct of the particular office involved.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to the Trustees, officers and controlling persons
of the Registrant pursuant to the foregoing provisions or otherwise, the
Registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act of 1933 and is, therefore, unenforceable in the event that a
claim for indemnification against such liabilities (other than the payment by
the Registrant of expenses incurred or paid by a Trustee, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such Trustee, officer or controlling person in
connection with the securities being registered, the Registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act of 1933 and will be governed by the final adjudication of such issue.
Item 26. Business and Other Connections of Investment Adviser.
Information about Scott B. Dubchansky, Tad Rivelle and Laird R.
Landmann is set forth in Part A under "Organization and Management -- Portfolio
Managers."
Item 27. Principal Underwriter.
(a) First Data Distributors, Inc. ("FDD "), 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 Galaxy Fund
Galaxy Fund II
The Galaxy VIP Fund
Alleghany Funds (f/k/a CT&T Funds)
Wilshire Target Funds, Inc.
The Potomac Funds
Panorama Trust
First Choice Funds Trust
<PAGE> 80
Undiscovered Managers Fund
LKCM Funds
BT Insurance Funds Trust
ABN AMRO Funds (f/k/a Rembrandt Funds)
IBJ Funds Trust
ICM Series Trust
Forward Funds, Inc.
Light Index Funds, Inc.
WorldWide Index Funds
Weiss, Peck & Greer Funds Trust
Weiss, Peck & Greer International Fund
WPG Growth Fund
WPG Growth and Income Fund
WPG Tudor Fund
RWB/WPG U.S. Large Stock Fund
Tomorrow Funds Retirement Trust
The Govett Funds, Inc.
IAA Trust Growth Fund, Inc.
IAA Trust Asset Allocation Fund, Inc.
IAA Trust Tax Exempt Bond Fund, Inc.
IAA Trust Taxable Fixed Income Series Fund, Inc.
Matthews International Funds
McM Funds
Metropolitan West Funds
Smith Breeden Series Fund
Smith Breeden Trust
The Stratton Funds, Inc.
Stratton Growth Fund, Inc.
Stratton Monthly Dividend REIT Shares, Inc.
Trainer Wortham First Mutual Funds
(b) The information required by this Item 27 with respect to
each director, officer or partner of First Data Distributors, Inc. is
incorporated herein by reference to Form BD filed with the Securities and
Exchange Commission pursuant to the Securities Exchange Act of 1934 (SEC File
No. 8-45467).
(c) Not applicable.
Item 28. 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, 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 11766 Wilshire
Boulevard, Suite 1580, Los Angeles, California 90025
Item 29. Management Services.
There are no management-related service contracts not discussed in
Parts A and B.
Item 30. 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
<PAGE> 81
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> 82
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the Investment
Company Act of 1940, the Registrant certifies that this Amendment meets all of
the requirements to become effective under Rule 485(b) of the Securities Act of
1933 and 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 23rd day of July, 1999.
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, July 23, 1999
- ----------------------- President and Principal Executive Officer
Scott B. Dubchansky
/s/ Richard Schweitzer* Principal Treasurer and July 23, 1999
- ----------------------- Accounting and Financial Officer
Richard Schweitzer
/s/ Keith T. Holmes* Trustee July 23, 1999
- --------------------
Keith T. Holmes
/s/ Laird R. Landmann* Trustee July 23, 1999
- ----------------------
Laird R. Landmann
/s/ Martin Luther King III* Trustee July 23, 1999
- ---------------------------
Martin Luther King III
/s/ Daniel D. Villanueva* Trustee July 23, 1999
- -------------------------
Daniel D. Villanueva
/s/ James M. Lippman* Trustee July 23, 1999
- ---------------------
James M. Lippman
</TABLE>
*by /s/ David A. Hearth
-------------------
David A. Hearth, Attorney-in-Fact
pursuant to Power of Attorney
previously filed
<PAGE> 83
File Nos. 333-18737
811-07989
METROPOLITAN WEST FUNDS
LIST OF EXHIBITS
Exhibit Description
23(h)(4) Operating Expenses Agreement
23(j) Consent of Independent Public Accountants
<PAGE> 1
- --------------------------------------------------------------------------------
Exhibit 23(h)(4) Operating Expenses Agreement
- --------------------------------------------------------------------------------
<PAGE> 2
OPERATING EXPENSES AGREEMENT
THIS OPERATING EXPENSES AGREEMENT (the "Agreement") is effective as of
the 1st day of April, 1999, 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 limited liability
company organized and existing under the laws of the State of California
(hereinafter called the "Manager").
WITNESSETH:
WHEREAS, the Manager renders advice and services to the Funds pursuant
to the terms and provisions of an Investment Management Agreement between the
Trust and the Manager, dated March 31, 1997 and amended and restated on May 18,
1998 (the "Investment Management Agreement"); and
WHEREAS, the Funds are responsible for, and have assumed the obligation
for, payment of certain expenses pursuant to Subparagraph 7(b) of the Investment
Management Agreement that have not been assumed by the Manager; and
WHEREAS, the Manager desires to limit the Funds' respective Operating
Expenses (as that term is defined in Paragraph 2 of this Agreement) pursuant to
the terms and provisions of this Agreement, and the Trust (on behalf of the
Funds) desires to allow the Manager to implement those limits;
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
<PAGE> 3
1. LIMIT ON OPERATING EXPENSES. The Manager hereby agrees to limit each
Fund's Operating Expenses to the respective annual rate of total Operating
Expenses specified for that Fund in APPENDIX A of this Agreement.
2. DEFINITION. For purposes of this Agreement, the term "Operating
Expenses" with respect to a Fund is defined to include all expenses necessary or
appropriate for the operation of the Fund including the Manager's investment
advisory or management fee under Paragraph 8 of the Investment Management
Agreement, and other expenses described in Paragraph 7 of the Investment
Management Agreement, but does not include any Rule 12b-1 fees, front-end or
contingent deferred loads, taxes, interest, dividend expenses, brokerage
commissions, expenses incurred in connection with any merger or reorganization
or extraordinary expenses such as litigation.
3. REIMBURSEMENT OF FEES AND EXPENSES. The Manager, under Subparagraph
8(d) of the Investment Management Agreement, retains its right to receive
reimbursement of reductions of its investment management fee and Operating
Expenses paid by it that are not its responsibility under Paragraph 7 of the
Investment Management Agreement.
4. TERM. This Agreement shall become effective on the date specified
herein and shall remain in effect for a period of one (1) year, unless sooner
terminated as provided in Paragraph 5 of this Agreement. This Agreement shall
continue in effect thereafter for additional periods not exceeding one (1) year
so long as such continuation is approved for each Fund at least annually by the
Board of Trustees of the Trust (and separately by the disinterested Trustees of
the Trust).
5. TERMINATION. This Agreement may be terminated at any time, and
without payment of any penalty, by either the Trust or by the Board of Trustees
of the Trust, on behalf of any one or more of the Funds, upon sixty (60) days'
written notice to the Manager.
2
<PAGE> 4
The Manager may decline to renew this Agreement by written notice to the Trust
at least thirty (30) days before its annual expiration date.
6. ASSIGNMENT. This Agreement and all rights and obligations hereunder
may not be assigned without the written consent of the other party.
7. 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.
8. 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 of effect.
9. 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 Investment Company Act of 1940, as amended, and the
Investment Advisers Act of 1940, as amended, 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: ____________________________
3
<PAGE> 5
APPENDIX A
Fund Operating Expense Limit
- ---- -----------------------
- - Metropolitan West Total Return Bond Fund 0.65%
- - Metropolitan West Low Duration Bond Fund 0.58%
- - Metropolitan West Short-Term Investment Fund 0.50%
- - Metropolitan West AlphaTrak 500 Fund* 0.90%
*Assumes the maximum management fee of 0.70%.
4
<PAGE> 1
- --------------------------------------------------------------------------------
Exhibit 23(j) Consent of Independent Public Accountants
- --------------------------------------------------------------------------------
<PAGE> 2
INDEPENDENT AUDITORS' CONSENT
The Metropolitan West Funds:
We consent to (a) the use in this Post-Effective Amendment No. 6 to Registration
Statement No. 333-18737 and in this Amendment No. 8 to Registration Statement
No. 811-07989 under the Investment Company Act of 1940 on Form N-1A of our
report dated April 30, 1999 regarding the Metropolitan West Total Return Bond
Fund, the Metropolitan West Low Duration Bond Fund, and the Metropolitan West
AlphaTrak 500 Fund as of March 31, 1999 incorporated by reference 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 part of such Registration Statement, and (c) the reference to us under the
heading "Additional Information" in Part B, the Statement of Additional
Information of such Registration Statement.
July 26, 1999
Los Angeles, California
