LAZARD RETIREMENT SERIES, INC.
30 Rockefeller Plaza
New York, New York 10112
(800) 887-4929
STATEMENT OF ADDITIONAL INFORMATION
MAY 1, 2000
As Revised, June 1, 2000
Lazard Retirement Series, Inc. (the "Fund") is a no-load,
open-end management investment company known as a mutual fund. This Statement of
Additional Information, which is not a prospectus, supplements and should be
read in conjunction with the current Prospectus of the Fund, dated May 1, 2000,
as it may be revised from time to time, relating to the following eight
portfolios (individually, a "Portfolio" and collectively, the "Portfolios"):
Lazard Retirement Equity Portfolio Lazard Retirement International
Lazard Retirement Small Cap Portfolio Small Cap Portfolio
Lazard Retirement Global Equity Lazard Retirement Emerging
Portfolio Markets Portfolio
Lazard Retirement International Equity Lazard Retirement International
Portfolio Fixed-Income Portfolio
Lazard Retirement Strategic
Yield Portfolio
SHARES OF THE PORTFOLIOS ARE OFFERED ONLY TO VARIABLE ANNUITY AND
VARIABLE LIFE INSURANCE SEPARATE ACCOUNTS ESTABLISHED BY INSURANCE COMPANIES
("PARTICIPATING INSURANCE COMPANIES") TO FUND VARIABLE ANNUITY CONTRACTS AND
VARIABLE LIFE INSURANCE POLICIES (COLLECTIVELY, "POLICIES") AND QUALIFIED
PENSION AND RETIREMENT PLANS AND ACCOUNTS PERMITTING ACCUMULATION OF ASSETS ON A
TAX-DEFERRED BASIS (COLLECTIVELY, "ELIGIBLE PLANS") OUTSIDE THE SEPARATE ACCOUNT
CONTEXT.
To obtain a copy of the Fund's Prospectus, please write or call
the Fund at the address and telephone number given above.
The Fund's most recent Annual Report and Semi-Annual Report to
Shareholders are separate documents supplied with this Statement of Additional
Information, and the financial statements, accompanying notes and report of
independent auditors appearing in the Annual Report are incorporated by
reference into this Statement of Additional Information.
--------------------------------------------------------------------------------
TABLE OF CONTENTS
Page
--------------------------------------------------------------------------------
Description of the Fund and Portfolios 3
Investment Restrictions 24
Management 26
Determination of Net Asset Value 31
Portfolio Transactions 32
Buying and Selling Shares 35
Distribution and Servicing Plan 36
Dividends and Distributions 38
Taxation 38
Performance Information 41
Information About the Fund and Portfolios 43
Counsel and Independent Auditors 46
Additional Information 46
Appendix 47
2
<PAGE>
DESCRIPTION OF THE FUND AND PORTFOLIOS
The Fund is a Maryland corporation organized on February 13,
1997. Each Portfolio is a separate portfolio of the Fund, an open-end management
investment company, known as a mutual fund. Each Portfolio is a non-diversified
investment company, which means that the proportion of the Portfolio's assets
that may be invested in the securities of a single issuer is not limited by the
Investment Company Act of 1940, as amended (the "1940 Act").
Lazard Asset Management, a division of Lazard Freres & Co. LLC
("Lazard"), serves as the investment manager (the "Investment Manager") to each
of the Portfolios.
Lazard is the distributor of each Portfolio's shares.
CERTAIN PORTFOLIO SECURITIES
The following information supplements and should be read in
conjunction with the Fund's Prospectus.
DEPOSITARY RECEIPTS. (All Portfolios) Each Portfolio may invest
in the securities of foreign issuers in the form of American Depositary Receipts
("ADRs") and Global Depositary Receipts ("GDRs"). These securities may not
necessarily be denominated in the same currency as the securities into which
they may be converted. ADRs are receipts typically issued by a United States
bank or trust company which evidence ownership of underlying securities issued
by a foreign corporation. GDRs are receipts issued outside the United States,
typically by non-United States banks and trust companies that evidence ownership
of either foreign or domestic securities. Generally, ADRs in registered form are
designed for use in the United States securities markets and GDRs in bearer form
are designed for use outside the United States.
These securities may be purchased through "sponsored" or
"unsponsored" facilities. A sponsored facility is established jointly by the
issuer of the underlying security and a depositary. A depositary may establish
an unsponsored facility without participation by the issuer of the deposited
security. Holders of unsponsored depositary receipts generally bear all the
costs of such facilities and the depositary of an unsponsored facility
frequently is under no obligation to distribute shareholder communications
received from the issuer of the deposited security or to pass through voting
rights to the holders of such receipts in respect of the deposited securities.
FOREIGN GOVERNMENT OBLIGATIONS; SECURITIES OF SUPRANATIONAL
ENTITIES. (All Portfolios) Each Portfolio may invest in obligations issued or
guaranteed by one or more foreign governments or any of their political
subdivisions, agencies or instrumentalities that are determined by the
Investment Manager to be of comparable quality to the other obligations in which
the Portfolio may invest. Supranational entities include international
organizations designated or supported by governmental entities to promote
economic reconstruction or development and international banking institutions
and related government agencies. Examples
3
<PAGE>
include the International Bank for Reconstruction and Development (the World
Bank), the European Coal and Steel Community, the Asian Development Bank and the
InterAmerican Development Bank.
CONVERTIBLE SECURITIES. (All Portfolios) Convertible securities
may be converted at either a stated price or stated rate into underlying shares
of common stock. Convertible securities have characteristics similar to both
fixed-income and equity securities. Convertible securities generally are
subordinated to other similar but non-convertible securities of the same issuer,
although convertible bonds, as corporate debt obligations, enjoy seniority in
right of payment to all equity securities, and convertible preferred stock is
senior to common stock, of the same issuer. Because of the subordination
feature, however, convertible securities typically have lower ratings than
similar non-convertible securities.
Although to a lesser extent than with fixed-income securities,
the market value of convertible securities tends to decline as interest rates
increase and, conversely, tends to increase as interest rates decline. In
addition, because of the conversion feature, the market value of convertible
securities tends to vary with fluctuations in the market value of the underlying
common stock. A unique feature of convertible securities is that as the market
price of the underlying common stock declines, convertible securities tend to
trade increasingly on a yield basis, and so may not experience market value
declines to the same extent as the underlying common stock. When the market
price of the underlying common stock increases, the prices of the convertible
securities tend to rise as a reflection of the value of the underlying common
stock. While no securities investments are without risk, investments in
convertible securities generally entail less risk than investments in common
stock of the same issuer.
Convertible securities provide for a stable stream of income with
generally higher yields than common stocks, but there can be no assurance of
current income because the issuers of the convertible securities may default on
their obligations. A convertible security, in addition to providing fixed
income, offers the potential for capital appreciation through the conversion
feature, which enables the holder to benefit from increases in the market price
of the underlying common stock. There can be no assurance of capital
appreciation, however, because securities prices fluctuate. Convertible
securities, however, generally offer lower interest or dividend yields than
non-convertible securities of similar quality because of the potential for
capital appreciation.
WARRANTS. (All Portfolios) A warrant is an instrument issued by a
corporation which gives the holder the right to subscribe to a specified amount
of the corporation's capital stock at a set price for a specified period of
time. A Portfolio may invest up to 5% of its total assets in warrants, except
that this limitation does not apply to warrants purchased by the Portfolio that
are sold in units with, or attached to, other securities.
PARTICIPATION INTERESTS. (All Portfolios) Each Portfolio may
purchase from financial institutions participation interests in securities in
which the Portfolio may invest. A participation interest gives the Portfolio an
undivided interest in the security in the proportion that the Portfolio's
participation interest bears to the total principal amount of the security.
4
<PAGE>
These instruments may have fixed, floating or variable rates of interest with
remaining maturities of 13 months or less. If the participation interest is
unrated, or has been given a rating below that which is permissible for purchase
by the Portfolio, the participation interest will be collateralized by U.S.
Government securities, or, in the case of unrated participation interests, the
Investment Manager must have determined that the instrument is of comparable
quality to those instruments in which the Portfolio may invest.
Each Portfolio may invest in corporate obligations denominated in
U.S. or foreign currencies that are originated, negotiated and structured by a
syndicate of lenders ("Co-Lenders") consisting of commercial banks, thrift
institutions, insurance companies, financial companies or other financial
institutions one or more of which administers the security on behalf of the
syndicate (the "Agent Bank"). Co-Lenders may sell such securities to third
parties called "Participants." Each Portfolio may invest in such securities
either by participating as a Co-Lender at origination or by acquiring an
interest in the security from a Co-Lender or a Participant (collectively,
"participation interests"). Co-Lenders and Participants interposed between the
Portfolio and the corporate borrower (the "Borrower"), together with Agent
Banks, are referred to herein as "Intermediate Participants." Each Portfolio
also may purchase a participation interest in a portion of the rights of an
Intermediate Participant, which would not establish any direct relationship
between the Fund, on behalf of the Portfolio, and the Borrower. In such cases,
the Portfolio would be required to rely on the Intermediate Participant that
sold the participation interest not only for the enforcement of the Portfolio's
rights against the Borrower, but also for the receipt and processing of payments
due to the Portfolio under the security. Because it may be necessary to assert
through an Intermediate Participant such rights as may exist against the
Borrower, if the Borrower fails to pay principal and interest when due, the
Portfolio may be subject to delays, expenses and risks that are greater than
those that would be involved if the Portfolio were to enforce its rights
directly against the Borrower. Moreover, under the terms of a participation
interest, the Portfolio may be regarded as a creditor of the Intermediate
Participant (rather than of the Borrower), so that the Portfolio also may be
subject to the risk that the Intermediate Participant may become insolvent.
Similar risks may arise with respect to the Agent Bank if, for example, assets
held by the Agent Bank for the benefit of the Portfolio were determined by the
appropriate regulatory authority or court to be subject to the claims of the
Agent Bank's creditors. In such case, the Portfolio might incur certain costs
and delays in realizing payment in connection with the participation interest or
suffer a loss of principal and/or interest. Further, in the event of the
bankruptcy or insolvency of the Borrower, the obligation of the Borrower to
repay the loan may be subject to certain defenses that can be asserted by such
Borrower as a result of improper conduct by the Agent Bank or Intermediate
Participant.
VARIABLE AND FLOATING RATE SECURITIES. (All Portfolios) Variable
and floating rate securities provide for a periodic adjustment in the interest
rate paid on the obligations. The terms of such obligations must provide that
interest rates are adjusted periodically based upon an interest rate adjustment
index as provided in the respective obligations. The adjustment intervals may be
regular, and range from daily up to annually, or may be event based, such as
based on a change in the prime rate.
5
<PAGE>
Each Portfolio may invest in floating rate debt instruments
("floaters"). The interest rate on a floater is a variable rate which is tied to
another interest rate, such as a money-market index or Treasury bill rate. The
interest rate on a floater resets periodically, typically every six months.
Because of the interest rate reset feature, floaters provide the Portfolio with
a certain degree of protection against rises in interest rates, although the
Portfolio will participate in any declines in interest rates as well.
Each Portfolio also may invest in inverse floating rate debt
instruments ("inverse floaters"). The interest rate on an inverse floater resets
in the opposite direction from the market rate of interest to which the inverse
floater is indexed. An inverse floating rate security may exhibit greater price
volatility than a fixed rate obligation of similar credit quality.
MUNICIPAL OBLIGATIONS. (Strategic Yield Portfolio) In
circumstances where the Investment Manager determines that investment in
municipal obligations would facilitate the Portfolio's ability to accomplish its
investment objective, the Portfolio may invest its assets in such obligations,
including municipal obligations issued at a discount. Dividends on shares
attributable to interest on municipal obligations held by the Portfolio will not
be exempt from federal income taxes. Municipal obligations are susceptible to
risks arising from the financial condition of the states, public bodies or
municipalities issuing the securities. To the extent that state or local
governmental entities are unable to meet their financial obligations, the income
derived by the Portfolio from municipal obligations could be impaired.
Municipal obligations are debt obligations issued by states,
territories and possessions of the United States and the District of Columbia
and their political subdivisions, agencies and instrumentalities, or multistate
agencies or authorities. Municipal obligations bear fixed, floating or variable
rates of interest. Certain municipal obligations are subject to redemption at a
date earlier than their stated maturity pursuant to call options, which may be
separated from the related municipal obligations and purchased and sold
separately. The Portfolio also may acquire call options on specific municipal
obligations. The Portfolio generally would purchase these call options to
protect the Portfolio from the issuer of the related municipal obligation
redeeming, or other holder of the call option from calling away, the municipal
obligation before maturity.
Municipal obligations generally include debt obligations issued
to obtain funds for various public purposes as well as certain industrial
development bonds issued by or on behalf of public authorities. Municipal
obligations are classified as general obligation bonds, revenue bonds and notes.
General obligation bonds are secured by the issuer's pledge of its faith, credit
and taxing power for the payment of principal and interest. Revenue bonds are
payable from the revenue derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special excise or other
specific revenue source, but not from the general taxing power. Industrial
development bonds, in most cases, are revenue bonds and generally do not carry
the pledge of the credit of the issuing municipality, but generally are
guaranteed by the corporate entity on whose behalf they are issued. Notes are
short-term instruments which are obligations of the issuing municipalities or
agencies and are sold in anticipation of a bond sale, collection of taxes or
receipt of other revenues. Municipal
6
<PAGE>
obligations include municipal lease/purchase agreements which are similar to
installment purchase contracts for property or equipment issued by
municipalities.
While, in general, municipal obligations are tax exempt
securities having relatively low yields as compared to taxable, non-municipal
obligations of similar quality, certain municipal obligations are taxable
obligations, offering yields comparable to, and in some cases greater than, the
yields available on other permissible Portfolio investments. Dividends received
by shareholders on Portfolio shares which are attributable to interest income
received by the Portfolio from municipal obligations generally will be subject
to federal income tax. The Portfolio will invest in municipal obligations, the
ratings of which correspond with the ratings of other permissible Portfolio
investments. The Portfolio currently intends to invest no more than 25% of its
assets in municipal obligations. However, this percentage may be varied from
time to time without shareholder approval.
ZERO COUPON AND STRIPPED U.S. TREASURY SECURITIES. (International
Fixed-Income Portfolio and Strategic Yield Portfolio) Each of these Portfolios
may invest in zero coupon U.S. Treasury securities, which are Treasury notes and
Bonds that have been stripped of their unmatured interest coupons, the coupons
themselves and receipts or certificates representing interests in such stripped
debt obligations and coupons. Zero coupon securities also are issued by
corporations and financial institutions which constitute a proportionate
ownership of the issuer's pool of underlying U.S. Treasury securities. A zero
coupon security pays no interest to its holder during its life and is sold at a
discount to its face value at maturity. The market prices of zero coupon
securities generally are more volatile than the market prices of securities that
pay interest periodically and are likely to respond to a greater degree to
changes in interest rates than non-zero coupon securities having similar
maturities and credit qualities.
MORTGAGE-RELATED SECURITIES. (International Fixed-Income
Portfolio and Strategic Yield Portfolio) Mortgage-related securities are
secured, directly or indirectly, by pools of mortgages, and may include complex
instruments such as collateralized mortgage obligations and stripped
mortgage-backed securities. These securities also may include mortgage
pass-through securities, interests in REMICs or other kinds of mortgage-backed
securities. The mortgage-related securities which may be purchased include those
with fixed, floating and variable interest rates, those with interest rates that
change based on multiples of changes in interest rates and those with interest
rates that change inversely to changes in interest rates.
RESIDENTIAL MORTGAGE-RELATED SECURITIES--Each of these Portfolios may invest in
mortgage-related securities representing participation interests in pools of
one- to four-family residential mortgage loans issued by governmental agencies
or instrumentalities, such as the GNMA, FNMA and FHLMC, or by private entities.
Residential mortgage-related securities issued by private entities are
structured to provide protection to the senior class investors against potential
losses on the underlying mortgage loans. This protection is generally provided
by having the holders of the subordinated class of securities ("Subordinated
Securities") take the first loss if there are defaults on the underlying
commercial mortgage loans. Other protection, which may benefit all of the
classes or particular classes, may include issuer guarantees, reserve funds,
additional Subordinated Securities, cross-collateralization and
over-collateralization.
7
<PAGE>
COMMERCIAL MORTGAGE-RELATED SECURITIES--Each of these Portfolios may invest in
commercial mortgage-related securities, which generally are multi-class debt or
pass-through certificates secured by mortgage loans on commercial properties.
Similar to residential mortgage-related securities, commercial mortgage-related
securities have been issued using a variety of structures, including multi-class
structures featuring senior and subordinated classes.
SUBORDINATED SECURITIES--Each of these Portfolios may invest in Subordinated
Securities issued or sponsored by commercial banks, savings and loan
institutions, mortgage bankers, private mortgage insurance companies and other
non-governmental issuers. Subordinated Securities have no governmental
guarantee, and are subordinated in some manner as to the payment of principal
and/or interest to the holders of more senior mortgage-related securities
arising out of the same pool of mortgages. The holders of Subordinated
Securities typically are compensated with a higher stated yield than are the
holders of more senior mortgage-related securities. On the other hand,
Subordinated Securities typically subject the holder to greater risk than senior
mortgage-related securities and tend to be rated in a lower rating category, and
frequently a substantially lower rating category, than the senior
mortgage-related securities issued in respect of the same pool of mortgage.
Subordinated Securities generally are likely to be more sensitive to changes in
prepayment and interest rates and the market for such securities may be less
liquid than is the case for traditional fixed-income securities and senior
mortgage-related securities.
COLLATERALIZED MORTGAGE OBLIGATIONS AND MULTI-CLASS PASS-THROUGH
SECURITIES--Collateralized mortgage obligations or "CMOs" are multiclass bonds
backed by pools of mortgage pass-through certificates or mortgage loans. CMOs
may be collateralized by (a) pass-through certificates issued or guaranteed by
GNMA, FNMA or FHLMC, (b) unsecuritized mortgage loans insured by the Federal
Housing Administration or guaranteed by the Department of Veterans' Affairs, (c)
unsecuritized conventional mortgages, (d) other mortgage-related securities or
(e) any combination thereof. CMOs may be issued by agencies or instrumentalities
of the U.S. Government, or by private originators of, or investors in, mortgage
loans, including depository institutions, mortgage banks, investment banks and
special purpose subsidiaries of the foregoing. The issuer of CMOs or multi-class
pass-through securities may elect to be treated as a REMIC. The International
Fixed-Income Portfolio may invest, to a limited extent, in residual interests in
REMICs. See "Taxation."
Each class of CMOs, often referred to as a "tranche," is issued
at a specific coupon rate and has a stated maturity or final distribution date;
these characteristics will vary from one tranche to another. Principal
prepayments on collateral underlying a CMO may cause it to be retired
substantially earlier than the stated maturities or final distribution dates.
The principal and interest on the underlying mortgages may be allocated among
the several classes of a series of a CMO in many ways. One or more tranches of a
CMO may have coupon rates which reset periodically at a specified increment over
an index, such as the London Interbank Offered Rate ("LIBOR") (or sometimes more
than one index). These floating rate CMOs typically are issued with lifetime
caps on the coupon rate thereon. Each of these Portfolios also may invest in
inverse floating rate CMOs. Inverse floating rate CMOs constitute a tranche of a
CMO with a coupon rate that moves in the reverse direction to an applicable
index such as the LIBOR. Accordingly, the coupon rate thereon will increase as
interest rates decrease. Inverse floating rate CMOs are typically more volatile
than fixed or floating rate tranches of CMOs.
8
<PAGE>
Many inverse floating rate CMOs have coupons that move inversely
to a multiple of the applicable indexes. The coupon varying inversely to a
multiple of an applicable index creates a leverage factor. The markets for
inverse floating rate CMOs with highly leveraged characteristics may at times be
very thin. The Portfolio's ability to dispose of its positions in such
securities will depend on the degree of liquidity in the markets for such
securities. It is impossible to predict the amount of trading interest that may
exist in such securities, and therefore the future degree of liquidity. It
should be noted that inverse floaters based on multiples of a stated index are
designed to be highly sensitive to changes in interest rates and can subject the
holders thereof to extreme reductions of yield and loss of principal.
STRIPPED MORTGAGE-BACKED SECURITIES--Each of these Portfolios
also may invest in stripped mortgage-backed securities. Stripped mortgage-backed
securities are created by segregating the cash flows from underlying mortgage
loans or mortgage securities to create two or more new securities, each with a
specified percentage of the underlying security's principal or interest
payments. Mortgage securities may be partially stripped so that each investor
class received some interest and some principal. When securities are completely
stripped, however, all of the interest is distributed to holders of one type of
security, known as an interest-only security, or IO, and all of the principal is
distributed to holders of another type of security known as a principal-only
security, or PO. Strips can be created in a pass-through structure or as
tranches of a CMO. The yields to maturity on IOs and POs are very sensitive to
the rate of principal payments (including prepayments) on the related underlying
mortgage assets. If the underlying mortgage assets experience greater than
anticipated prepayments of principal, the Portfolio may not fully recoup its
initial investment in IOs. Conversely, if the underlying mortgage assets
experience less than anticipated prepayments of principal, the yield on POs
could be materially and adversely affected.
GOVERNMENT-AGENCY SECURITIES--Mortgage-related securities issued by the
Government National Mortgage Association ("GNMA") include GNMA Mortgage
Pass-Through Certificates (also known as "Ginnie Maes") which are guaranteed as
to the timely payment of principal and interest by GNMA and such guarantee is
backed by the full faith and credit of the United States. GNMA is a wholly-owned
U.S. Government corporation within the Department of Housing and Urban
Development.
GOVERNMENT-RELATED SECURITIEs--Mortgage-related securities issued by the Federal
National Mortgage Association ("FNMA") include FNMA Guaranteed Mortgage
Pass-Through Certificates (also known as "Fannie Maes") which are solely the
obligations of FNMA and are not backed by or entitled to the full faith and
credit of the United States Government. FNMA is a government-sponsored
organization owned entirely by private stockholders.
Mortgage-related securities issued by the Federal Home Loan
Mortgage Corporation ("FHLMC") include FHLMC Mortgage Participation Certificates
(also known as "Freddie Macs" or "PCs"). FHLMC is a corporate instrumentality of
the United States Government created pursuant to an Act of Congress, which is
owned entirely by Federal Home Loan Banks.
9
<PAGE>
PRIVATE ENTITY SECURITIES--These mortgage-related securities are issued by
commercial banks, savings and loan institutions, mortgage bankers, private
mortgage insurance companies and other non-governmental issuers. Timely payment
of principal and interest on mortgage-related securities backed by pools created
by non-governmental issuers often is supported partially by various forms of
insurance or guarantees, including individual loan, title, pool and hazard
insurance. The insurance and guarantees are issued by government entities,
private insurers and the mortgage poolers. There can be no assurance that the
private insurers or mortgage poolers can meet their obligations under the
policies, so that if the issuers default on their obligations the holders of the
security could sustain a loss. No insurance or guarantee covers the Portfolio or
the price of the Portfolio's shares. Mortgage-related securities issued by
non-governmental issuers generally offer a higher rate of interest than
government-agency and government-related securities because there are no direct
or indirect government guarantees of payment.
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,
mortgage banks, commercial banks, investment banks and special purpose
subsidiaries of the foregoing.
The cash flow generated by the Mortgage Assets underlying series
of CMOs is applied first to make required payments of principal of 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 dividend or
interest 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 CMOs, prevailing interest
rates, the amount of administrative expenses and the prepayment experience on
the Mortgage Assets. In particular, the yield to maturity on CMO Residuals is
extremely sensitive to prepayments on the related underlying Mortgage Assets in
the same manner as an IO class of SMBS. See "Stripped Mortgage-Backed
Securities" above. 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 the level of the index upon which
interest rate adjustments are based. As described above with respect to SMBS, in
certain circumstances, the Portfolio may fail to fully 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.
CMO Residuals may not have the liquidity of other more established securities
trading in other markets. Transactions in CMO Residuals are generally completed
only after careful review of the characteristics of the securities in question.
In addition, CMO Residuals may or, pursuant to an exemption therefrom, may not
have been registered under the Securities Act. CMO Residuals, whether or not
registered under the Securities Act, may be subject to certain restrictions of
transferability. Ownership of certain CMO Residuals imposes liability for
certain of the expenses of the related CMO issuer on the purchaser. The
Investment Manager will not purchase any CMO Residual that imposes such
liability on the Portfolio.
10
<PAGE>
OTHER MORTGAGE-RELATED SECURITIES--Other mortgage-related securities include
securities other than those described above that directly or indirectly
represent a participation in, or are secured by and payable from, mortgage loans
on real property. Other mortgage-related securities may be equity or debt
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, partnerships, trusts and special purpose entities of the foregoing.
REAL ESTATE INVESTMENT TRUSTS. (Equity Portfolio, Small Cap
Portfolio and Global Equity Portfolio) Each of these Portfolios may invest in
Real Estate Investment Trusts ("REITs"). A REIT is a corporation, or a business
trust that would otherwise be taxed as a corporation, which meets the
definitional requirements of the Internal Revenue Code of 1986, as amended (the
"Code"). The Code permits a qualifying REIT to deduct dividends paid, thereby
effectively eliminating corporate level Federal income tax and making the REIT a
pass-through vehicle for Federal income tax purposes. To meet the definitional
requirements of the Code, a REIT must, among other things, invest substantially
all of its assets in interests in real estate (including mortgages and other
REITs) or cash and government securities, derive most of its income from rents
from real property or interest on loans secured by mortgages on real property,
and distribute to shareholders annually a substantial portion of its otherwise
taxable income.
REITs are characterized as equity REITs, mortgage REITs and
hybrid REITs. Equity REITs, which may include operating or finance companies,
own real estate directly and the value of, and income earned by, the REITs
depends upon the income of the underlying properties and the rental income they
earn. Equity REITs also can realize capital gains (or losses) by selling
properties that have appreciated (or depreciated) in value. Mortgage REITs can
make construction, development or long-term mortgage loans and are sensitive to
the credit quality of the borrower. Mortgage REITs derive their income from
interest payments on such loans. Hybrid REITs combine the characteristics of
both equity and mortgage REITs, generally by holding both ownership interests
and mortgage interests in real estate. The values of securities issued by REITs
are affected by tax and regulatory requirements and by perceptions of management
skill. They also are subject to heavy cash flow dependency, defaults by
borrowers or tenants, self-liquidation and the possibility of failing to qualify
for tax-free status under the Code or to maintain exemption from the 1940 Act.
ASSET-BACKED SECURITIES. (International Fixed-Income Portfolio
and Strategic Yield Portfolio) Each of these Portfolios may invest in
asset-backed securities, including interests in pools of receivables, such as
motor vehicle installment purchase obligations, credit card receivables, home
equity loans, home improvement loans and manufactured housing loans. These
securities may be in the form of pass-through instruments or asset-backed bonds.
The securities, all of which are issued by non-governmental entities and carry
no direct or indirect government guarantee, are structurally similar to the
collateralized mortgage obligations and mortgage pass-through securities
described above. As with mortgage-backed securities, asset-backed securities are
often backed by a pool of assets representing the obligations of a number of
different parties and use similar credit enhancement techniques.
11
<PAGE>
Asset-backed securities present certain risks that are not
presented by mortgage-related securities. Primarily, these securities may
provide the Portfolio with a less effective security interest in the related
collateral than do mortgage-related securities. Therefore, there is the
possibility that recoveries on the underlying collateral may not, in some cases,
be available to support payments on these securities. Credit card receivables
are generally unsecured and the debtors are entitled to the protection of a
number of state and federal consumer credit laws, many of which give such
debtors the right to set off certain amounts owed on the credit cards, thereby
reducing the balance due. Most organizations that issue asset-backed securities
relating to motor vehicle installment purchase obligations perfect their
interests in their respective obligations only by filing a financing statement
and by having the servicer of the obligations, which is usually the originator,
take custody thereof. In such circumstances, if the servicer were to sell the
same obligations to another party, in violation of its duty not to so do, there
is a risk that such party could acquire an interest in the obligations superior
to that of the holders of the securities. Also, although most such obligations
grant a security interest in the motor vehicle being financed, in most states
the security interest in a motor vehicle must be noted on the certificate of
title to perfect such security interest against competing claims of other
parties. Due to the large number of vehicles involved, however, the certificate
of title to each vehicle financed, pursuant to the obligations underlying the
securities, usually is not amended to reflect the assignment of the seller's
security interest for the benefit of the holders of the securities. Therefore,
there is the possibility that recoveries on repossessed collateral may not, in
some cases, be available to support payments on those securities. In addition,
various state and federal laws give the motor vehicle owner the right to assert
against the holder of the owner's obligation certain defenses such owner would
have against the seller of the motor vehicle. The assertion of such defenses
could reduce payments on the related securities.
INVESTMENT COMPANIES. (All Portfolios) Each Portfolio may invest,
to the extent permitted under the 1940 Act, in securities issued by investment
companies which principally invest in securities of the type in which the
Portfolio invests. Investments in the securities of investment companies may
involve duplication of advisory fees and certain other expenses.
ILLIQUID SECURITIES. (All Portfolios) Each Portfolio may invest
up to 15% of the value of its net assets in securities as to which a liquid
trading market does not exist, provided such investments are consistent with the
Portfolio's investment objective. Such securities may include securities that
are not readily marketable, such as certain securities that are subject to legal
or contractual restrictions on resale, repurchase agreements providing for
settlement in more than seven days after notice, certain mortgage-related
securities, and certain privately negotiated, non-exchange traded options and
securities used to cover such options. As to these securities, the Portfolio is
subject to a risk that should the Portfolio desire to sell them when a ready
buyer is not available at a price the Portfolio deems representative of their
value, the value of the Portfolio's net assets could be adversely affected.
MONEY MARKET INSTRUMENTS. (All Portfolios) When the Investment
Manager determines that adverse market conditions exist, a Portfolio may adopt a
temporary defensive position and invest some or all of its assets in money
market instruments, including U.S. Government securities, repurchase agreements,
bank obligations and commercial paper. Each Portfolio also may purchase money
market instruments when it has cash reserves or in anticipation of taking a
market position.
12
<PAGE>
INVESTMENT TECHNIQUES
The following information supplements and should be read in
conjunction with the Fund's Prospectus.
BORROWING MONEY. (All Portfolios) Each Portfolio is permitted to
borrow to the extent permitted under the 1940 Act, which permits an investment
company to borrow in an amount up to 33-1/3% of the value of its total assets.
Each Portfolio currently intends to borrow money only from banks for temporary
or emergency (not leveraging) purposes in an amount up to 15% of the value of
its total assets (including the amount borrowed) valued at the lesser of cost or
market, less liabilities (including the amount borrowed) at the time the
borrowing is made. While borrowings exceed 5% of a Portfolio's total assets, the
Portfolio will not make any additional investments.
LENDING PORTFOLIO SECURITIES. (All Portfolios) Each Portfolio may
lend securities from its portfolio to brokers, dealers and other financial
institutions needing to borrow securities to complete certain transactions. The
Portfolio continues to be entitled to payments in amounts equal to the interest,
dividends or other distributions payable on the loaned securities which affords
the Portfolio an opportunity to earn interest on the amount of the loan and on
the loaned securities' collateral. Loans of portfolio securities may not exceed
33-1/3% of the value of the Portfolio's total assets, and the Portfolio will
receive collateral consisting of cash, U.S. Government securities or irrevocable
letters of credit which will be maintained at all times in an amount equal to at
least 100% of the current market value of the loaned securities. Such loans are
terminable by the Portfolio at any time upon specified notice. The Portfolio
might experience risk of loss if the institution with which it has engaged in a
portfolio loan transaction breaches its agreement with the Portfolio. In
connection with its securities lending transactions, a Portfolio may return to
the borrower or a third party which is unaffiliated with the Portfolio, and
which is acting as a "placing broker," a part of the interest earned from the
investment of collateral received for securities loaned.
DERIVATIVES. (All Portfolios) Each Portfolio may invest in, or
enter into, derivatives to the extent described in the Prospectus, for a variety
of reasons, including to hedge certain market risks, to provide a substitute for
purchasing or selling particular securities or to increase potential income
gain. Derivatives may provide a cheaper, quicker or more specifically focused
way for the Portfolio to invest than "traditional" securities would.
Derivatives can be volatile and involve various types and degrees
of risk, depending upon the characteristics of the particular derivative and the
portfolio as a whole. Derivatives permit a Portfolio to increase or decrease the
level of risk, or change the character of the risk, to which its portfolio is
exposed in much the same way as the Portfolio can increase or decrease the level
of risk, or change the character of the risk, of its portfolio by making
investments in specific securities.
Derivatives may entail investment exposures that are greater than
their cost would suggest, meaning that a small investment in derivatives could
have a large potential impact on a Portfolio's performance.
13
<PAGE>
If a Portfolio invests in derivatives at inopportune times or
judges market conditions incorrectly, such investments may lower the Portfolio's
return or result in a loss. A Portfolio also could experience losses if its
derivatives were poorly correlated with its other investments, or if the
Portfolio were unable to liquidate its position because of an illiquid secondary
market. The market for many derivatives is, or suddenly can become, illiquid.
Changes in liquidity may result in significant, rapid and unpredictable changes
in the prices for derivatives.
Although neither the Fund nor any Portfolio will be a commodity
pool, certain derivatives subject the Portfolios to the rules of the Commodity
Futures Trading Commission which limit the extent to which a Portfolio can
invest in such derivatives. A Portfolio may invest in futures contracts and
options with respect thereto for hedging purposes without limit. However, no
Portfolio may invest in such contracts and options for other purposes if the sum
of the amount of initial margin deposits and premiums paid for unexpired options
with respect to such contracts, other than for bona fide hedging purposes,
exceeds 5% of the liquidation value of the Portfolio's assets, after taking into
account unrealized profits and unrealized losses on such contracts and options;
provided, however, that in the case of an option that is in-the-money at the
time of purchase, the in-the-money amount may be excluded in calculating the 5%
limitation.
When required by the Commission, a Portfolio will segregate
permissible liquid assets to cover its obligations relating to its transactions
in derivatives. To maintain this required cover, the Portfolio may have to sell
portfolio securities at disadvantageous prices or times since it may not be
possible to liquidate a derivative position at a reasonable price.
Derivatives may be purchased on established exchanges or through
privately negotiated transactions referred to as over-the-counter derivatives.
Exchange-traded derivatives generally are guaranteed by the clearing agency
which is the issuer or counterparty to such derivatives. This guarantee usually
is supported by a daily variation margin system operated by the clearing agency
in order to reduce overall credit risk. As a result, unless the clearing agency
defaults, there is relatively little counterparty credit risk associated with
derivatives purchased on an exchange. By contrast, no clearing agency guarantees
over-the-counter derivatives. Therefore, each party to an over-the-counter
derivative bears the risk that the counterparty will default. Accordingly, the
Investment Manager will consider the creditworthiness of counterparties to
over-the-counter derivatives in the same manner as it would review the credit
quality of a security to be purchased by the Portfolio. Over-the-counter
derivatives are less liquid than exchange-traded derivatives since the other
party to the transaction may be the only investor with sufficient understanding
of the derivative to be interested in bidding for it.
FUTURES TRANSACTIONS--In General. (All Portfolios) Each Portfolio
may enter into futures contracts in U.S. domestic markets, or on exchanges
located outside the United States. Foreign markets may offer advantages such as
trading opportunities or arbitrage possibilities not available in the United
States. Foreign markets, however, may have greater risk potential than domestic
markets. For example, some foreign exchanges are principal markets so that no
common clearing facility exists and an investor may look only to the broker for
performance of
14
<PAGE>
the contract. In addition, any profits a Portfolio might realize in trading
could be eliminated by adverse changes in the currency exchange rate, or the
Portfolio could incur losses as a result of those changes. Transactions on
foreign exchanges may include both commodities which are traded on domestic
exchanges and those which are not. Unlike trading on domestic commodity
exchanges, trading on foreign commodity exchanges is not regulated by the
Commodity Futures Trading Commission.
Engaging in these transactions involves risk of loss to the
Portfolio which could adversely affect the value of the Portfolio's net assets.
Although each of these Portfolios intends to purchase or sell futures contracts
only if there is an active market for such contracts, no assurance can be given
that a liquid market will exist for any particular contract at any particular
time. Many futures exchanges and boards of trade limit the amount of fluctuation
permitted in futures contract prices during a single trading day. Once the daily
limit has been reached in a particular contract, no trades may be made that day
at a price beyond that limit or trading may be suspended for specified periods
during the trading day. Futures contract prices could move to the limit for
several consecutive trading days with little or no trading, thereby preventing
prompt liquidation of futures positions and potentially subjecting the Portfolio
to substantial losses.
Successful use of futures by a Portfolio also is subject to the
Investment Manager's ability to predict correctly movements in the direction of
the relevant market, and, to the extent the transaction is entered into for
hedging purposes, to ascertain the appropriate correlation between the
transaction being hedged and the price movements of the futures contract. For
example, if a Portfolio uses futures to hedge against the possibility of a
decline in the market value of securities held in its portfolio and the prices
of such securities instead increase, the Portfolio will lose part or all of the
benefit of the increased value of securities which it has hedged because it will
have offsetting losses in its futures positions. Furthermore, if in such
circumstances the Portfolio has insufficient cash, it may have to sell
securities to meet daily variation margin requirements. The Portfolio may have
to sell such securities at a time when it may be disadvantageous to do so.
Pursuant to regulations and/or published positions of the
Commission, a Portfolio may be required to segregate permissible liquid assets
in connection with its commodities transactions in an amount generally equal to
the value of the underlying commodity. The segregation of such assets will have
the effect of limiting the Portfolio's ability otherwise to invest those assets.
SPECIFIC FUTURES TRANSACTIONS. Each Portfolio, except the
International Fixed-Income Portfolio, may purchase and sell stock index futures
contracts. A stock index future obligates the Portfolio to pay or receive an
amount of cash equal to a fixed dollar amount specified in the futures contract
multiplied by the difference between the settlement price of the contract on the
contract's last trading day and the value of the index based on the stock prices
of the securities that comprise it at the opening of trading in such securities
on the next business day.
The Global Equity Portfolio, International Small Cap Portfolio,
Emerging Markets Portfolio, International Fixed-Income Portfolio and Strategic
Yield Portfolio may
15
<PAGE>
purchase and sell interest rate futures contracts. An interest rate future
obligates the Portfolio to purchase or sell an amount of a specific debt
security at a future date at a specific price.
Each Portfolio, except the Equity Portfolio and Small Cap
Portfolio, may purchase and sell currency futures. A currency future obligates
the Portfolio to purchase or sell an amount of a specific currency at a future
date at a specific price.
OPTIONS--IN GENERAL. (All Portfolios) Each Portfolio may invest up to 5% of its
assets, represented by the premium paid, in the purchase of call and put
options. A Portfolio may write (i.e., sell) covered call and put option
contracts to the extent of 20% of the value of its net assets at the time such
option contracts are written. A call option gives the purchaser of the option
the right to buy, and obligates the writer to sell, the underlying security or
securities at the exercise price at any time during the option period, or at a
specific date. Conversely, a put option gives the purchaser of the option the
right to sell, and obligates the writer to buy, the underlying security or
securities at the exercise price at any time during the option period, or at a
specified date.
A covered call option written by a Portfolio is a call option
with respect to which the Portfolio owns the underlying security or otherwise
covers the transaction by segregating permissible liquid assets. A put option
written by a Portfolio is covered when, among other things, the Portfolio
segregates permissible liquid assets having a value equal to or greater than the
exercise price of the option to fulfill the obligation undertaken. The principal
reason for writing covered call and put options is to realize, through the
receipt of premiums, a greater return than would be realized on the underlying
securities alone. A Portfolio receives a premium from writing covered call or
put options which it retains whether or not the option is exercised.
There is no assurance that sufficient trading interest to create
a liquid secondary market on a securities exchange will exist for any particular
option or at any particular time, and for some options no such secondary market
may exist. A liquid secondary market in an option may cease to exist for a
variety of reasons. In the past, for example, higher than anticipated trading
activity or order flow, or other unforeseen events, at times have rendered
certain of the clearing facilities inadequate and resulted in the institution of
special procedures, such as trading rotations, restrictions on certain types of
orders or trading halts or suspensions in one or more options. There can be no
assurance that similar events, or events that may otherwise interfere with the
timely execution of customers' orders, will not recur. In such event, it might
not be possible to effect closing transactions in particular options. If, as a
covered call option writer, a Portfolio is unable to effect a closing purchase
transaction in a secondary market, it will not be able to sell the underlying
security until the option expires or it delivers the underlying security upon
exercise or it otherwise covers its position.
SPECIFIC OPTIONS TRANSACTIONS. Each Portfolio, except the International
Fixed-Income Portfolio, may purchase and sell call and put options in respect of
specific securities (or groups or "baskets" of specific securities) or indices
listed on national securities exchanges or traded in the over-the-counter
market. An option on an index is similar to an option in respect of specific
16
<PAGE>
securities, except that settlement does not occur by delivery of the securities
comprising the index. Instead, the option holder receives an amount of cash if
the closing level of the index upon which the option is based is greater than in
the case of a call, or less than in the case of a put, the exercise price of the
option. Thus, the effectiveness of purchasing or writing index options will
depend upon price movements in the level of the index rather than the price of a
particular security.
Each Portfolio, except the Equity Portfolio and Small Cap
Portfolio, may purchase and sell call and put options on foreign currency. These
options convey the right to buy or sell the underlying currency at a price which
is expected to be lower or higher than the spot price of the currency at the
time the option is exercised or expires.
Each Portfolio may purchase cash-settled options on interest rate
swaps, interest rate swaps denominated in foreign currency (except in the case
of the Equity Portfolio) and (except in the case of the International
Fixed-Income Portfolio) equity index swaps in pursuit of its investment
objective. Interest rate swaps involve the exchange by a Portfolio with another
party of their respective commitments to pay or receive interest (for example,
an exchange of floating-rate payments for fixed-rate payments) denominated in
U.S. dollars or foreign currency. Equity index swaps involve the exchange by the
Portfolio with another party of cash flows based upon the performance of an
index or a portion of an index of securities which usually includes dividends. A
cash-settled option on a swap gives the purchaser the right, but not the
obligation, in return for the premium paid, to receive an amount of cash equal
to the value of the underlying swap as of the exercise date. These options
typically are purchased in privately negotiated transactions from financial
institutions, including securities brokerage firms.
Successful use by a Portfolio of options will be subject to the
Investment Manager's ability to predict correctly movements in the prices of
individual stocks, the stock market generally, foreign currencies or interest
rates. To the extent the Investment Manager's predictions are incorrect, the
Portfolio may incur losses.
FUTURE DEVELOPMENTS. The Portfolios may take advantage of
opportunities in the area of options and futures contracts and options on
futures contracts and any other derivatives which are not presently contemplated
for use by the Portfolio or which are not currently available but which may be
developed, to the extent such opportunities are both consistent with the
Portfolio's investment objective and legally permissible for the Portfolio.
Before entering into such transactions or making any such investment, the
Portfolio will provide appropriate disclosure in the Prospectus or Statement of
Additional Information.
FORWARD COMMITMENTS. (All Portfolios) A Portfolio may purchase or
sell securities on a forward commitment, when-issued or delayed delivery basis,
which means delivery and payment take place a number of days after the date of
the commitment to purchase or sell the securities at a predetermined price
and/or yield. Typically, no interest accrues to the purchaser until the security
is delivered. When purchasing a security on a forward commitment basis, the
Portfolio assumes the rights and risks of ownership of the security, including
the risk or price and yield fluctuations, and takes such fluctuations into
account when determining its net
17
<PAGE>
asset value. Because the Portfolio is not required to pay for these securities
until the delivery date, these risks are in addition to the risks associated
with the Portfolio's other investments. If the Portfolio is fully or almost
fully invested when forward commitment purchases are outstanding, such purchases
may result in a form of leverage. The Portfolio intends to engage in forward
commitments to increase its portfolio's financial exposure to the types of
securities in which it invests. Leveraging the portfolio in this manner will
increase the Portfolio's exposure to changes in interest rates and will increase
the volatility of its returns. The Portfolio will segregate permissible liquid
assets at least equal at all times to the amount of the Portfolio's purchase
commitments. At no time will the Portfolio have more than 33-1/3% of its assets
committed to purchase securities on a forward commitment basis.
Securities purchased on a forward commitment or when-issued basis
are subject to changes in value (generally changing in the same way, i.e.,
appreciating when interest rates decline and depreciating when interest rates
rise) based upon the public's perception of the creditworthiness of the issuer
and changes, real or anticipated, in the level of interest rates. Securities
purchased on a forward commitment or when-issued basis may expose a Portfolio to
risks because they may experience such fluctuations prior to their actual
delivery. Purchasing securities on a forward commitment or when-issued basis can
involve the additional risk that the yield available in the market when the
delivery takes place actually may be higher than that obtained in the
transaction itself. Purchasing securities on a forward commitment or when-issued
basis when the Portfolio is fully or almost fully invested may result in greater
potential fluctuation in the value of the Portfolio's net assets and its net
asset value per share.
SWAP AGREEMENTS. (All Portfolios) To the extent consistent with
the Portfolio's investment objective and management policies as set forth
herein, each Portfolio may enter into equity, interest rate, index, total return
and currency rate swap agreements. These transactions are entered into in an
attempt to obtain a particular return when it is considered desirable to do so,
possibly at a lower cost to the Portfolio than if the Portfolio had invested
directly in the asset that yielded the desired return. Swap agreements are
two-party contracts entered into primarily by institutional investors for
periods ranging from a few weeks to more than a 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 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 interest rates fall below a specified level 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 a Portfolio would calculate
the obligations of the parties to the agreement on a "net basis." Consequently,
the Portfolio's current
18
<PAGE>
obligations (or rights) under a swap agreement generally will 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").
The risk of loss with respect to swaps is limited to the net amount of payments
that the Portfolio is contractually obligated to make. If the other party to a
swap defaults, the Portfolio's risk of loss consists of the net amount of
payments that the Portfolio contractually is entitled to receive.
FOREIGN CURRENCY TRANSACTIONS. (All Portfolios, except the Equity
Portfolio and Small Cap Portfolio) Foreign currency transactions may be entered
into for a variety of purposes, including: to fix in U.S. dollars, between trade
and settlement date, the value of a security the Portfolio has agreed to buy or
sell; to hedge the U.S. dollar value of securities the Portfolio already owns,
particularly if it expects a decrease in the value of the currency in which the
foreign security is denominated; or to gain exposure to the foreign currency in
an attempt to realize gains.
Foreign currency transactions may involve, for example, the
Portfolio's purchase of foreign currencies for U.S. dollars or the maintenance
of short positions in foreign currencies. A short position would involve the
Portfolio agreeing to exchange an amount of a currency it did not currently own
for another currency at a future date in anticipation of a decline in the value
of the currency sold relative to the currency the Portfolio contracted to
receive. The Portfolio's success in these transactions will depend principally
on the Investment Manager's ability to predict accurately the future exchange
rates between foreign currencies and the U.S. dollar.
INVESTMENT CONSIDERATIONS AND RISKS
EQUITY SECURITIES. (All Portfolios, except the International
Fixed-Income Portfolio and Strategic Yield Portfolio) Equity securities
fluctuate in value, often based on factors unrelated to the value of the issuer
of the securities, and such fluctuations can be pronounced. Changes in the value
of a Portfolio's investments will result in changes in the value of its shares
and thus the Portfolio's total return to investors.
The securities of the smaller companies in which the Small Cap,
International Small Cap and Emerging Markets Portfolios may invest may be
subject to more abrupt or erratic market movements than larger, more established
companies, because securities of smaller companies typically are traded in lower
volume and the issuers typically are more subject to changes in earnings and
prospects. Smaller capitalization companies often have limited product lines,
markets or financial resources. They may be dependent on management for one or a
few key persons, and can be more susceptible to losses and the risk of
bankruptcy. In addition, securities of the small capitalization sector may be
thinly traded (and therefore have to be sold at a discount from current market
prices or sold in small lots over an extended period of time), may be followed
by fewer investment research analysts and may be subject to wider price swings,
and thus may create a greater chance of loss than by investing in securities of
larger capitalization companies.
19
<PAGE>
FIXED-INCOME SECURITIES. (All Portfolios) Even though
interest-bearing securities are investments which promise a stable stream of
income, the prices of such securities generally are inversely affected by
changes in interest rates and, therefore, are subject to the risk of market
price fluctuations. Certain portfolio securities, such as those with interest
rates that fluctuate directly or indirectly based on multiples of a stated
index, are designed to be highly sensitive to changes in interest rates and can
subject the holders thereof to extreme reductions of yield and possibly loss of
principal.
The values of fixed-income securities also may be affected by
changes in the credit rating or financial condition of the issuer. Certain
portfolio securities, such as those rated below investment grade by Standard &
Poor's Ratings Group ("S&P") and Moody's Investors Service, Inc. ("Moody's" and
together with S&P, the "Rating Agencies"), may be subject to such risk with
respect to the issuing entity and to greater market fluctuations than certain
lower yielding, higher rated fixed-income securities. Once the rating of a
portfolio security has been changed, the Portfolio will consider all
circumstances deemed relevant in determining whether to continue to hold the
security.
Federal income tax law requires the holder of a zero coupon
security or of certain pay-in-kind bonds to accrue income with respect to these
securities prior to the receipt of cash payments. A Portfolio investing in such
securities may be required to distribute such income accrued with respect to
these securities and may have to dispose of portfolio securities under
disadvantageous circumstances in order to generate cash to satisfy these
distribution requirements.
MORTGAGE-RELATED SECURITIES. (International Fixed-Income
Portfolio and Strategic Yield Portfolio) As with other interest-bearing
securities, the prices of certain mortgage-related securities are inversely
affected by changes in interest rates. However, although the value of a
mortgage-related security may decline when interest rates rise, the converse is
not necessarily true, since during periods of declining interest rates the
mortgages underlying the security are more likely to be prepaid. For this and
other reasons, a mortgage-related security's stated maturity may be shortened by
unscheduled prepayments on the underlying mortgages, and, therefore, it is
possible that the realized return of the security may differ materially from the
return originally expected by the Investment Manager. Moreover, with respect to
certain stripped mortgage-backed securities, if the underlying mortgage
securities experience greater than anticipated prepayments of principal, the
Portfolio may fail to fully recoup its initial investment even if the securities
are rated in the highest rating category by a nationally recognized statistical
rating organization. During periods of rapidly rising interest rates,
prepayments of mortgage-related securities may occur at slower than expected
rates. Slower prepayments effectively may lengthen a mortgage-related security's
expected maturity (but not past its stated maturity), which generally would
cause the value of such security to fluctuate more widely in response to changes
in interest rates. Were the prepayments on the Portfolio's mortgage-related
securities to decrease broadly, the Portfolio's effective duration, and thus
sensitivity to interest rate fluctuations, would increase. Commercial real
property loans, however, often contain provisions that substantially reduce the
likelihood that such securities will be prepaid. The provisions generally impose
significant prepayment penalties on loans and in some cases there may be
prohibitions on principal prepayments for several years following origination.
20
<PAGE>
Certain mortgage-related securities are subject to credit risks
associated with the performance of the underlying mortgage properties. Adverse
changes in economic conditions and circumstances are more likely to have an
adverse impact on mortgage-related securities secured by loans on commercial
properties than on those secured by loans on residential properties. In
addition, as described above, these securities are subject to prepayment risk,
although commercial mortgages typically have shorter maturities than residential
mortgages and prepayment protection features. Some mortgage-related securities
have structures that make their reactions to interest rate changes and other
factors difficult to predict, making their values highly volatile.
In certain instances, the credit risk associated with
mortgage-related securities can be reduced by third party guarantees or other
forms of credit support. Improved credit risk does not reduce prepayment risk
which is unrelated to the rating assigned to the mortgage-related security.
Prepayment risk can lead to fluctuations in value of the mortgage-related
security which may be pronounced. If a mortgage-related security is purchased at
a premium, all or part of the premium may be lost if the market value of the
security declines whether resulting from changes in interest rates or
prepayments on the underlying mortgage collateral. Certain mortgage-related
securities that may be purchased by these Portfolios, such as inverse floating
rate collateralized mortgage obligations, have coupons that move inversely to a
multiple of a specific index which may result in increased price volatility.
FOREIGN SECURITIES. (All Portfolios) Foreign securities markets
generally are not as developed or efficient as those in the United States.
Securities of some foreign issuers are less liquid and more volatile than
securities of comparable U.S. issuers. Similarly, volume and liquidity in most
foreign securities markets are less than in the United States and, at times,
volatility of price can be greater than in the United States.
Because evidences of ownership of such securities usually are
held outside the United States, the Portfolios will be subject to additional
risks which include possible adverse political and economic developments,
seizure or nationalization of foreign deposits and adoption of governmental
restrictions, which might adversely affect or restrict the payment of principal
and interest on the foreign securities to investors located outside the country
of the issuer, whether from currency blockage or otherwise.
With respect to the Emerging Markets, International Fixed-Income
and Strategic Yield Portfolios, emerging market countries have economic
structures that generally are less diverse and mature, and political systems
that are less stable, than those of developed countries. Emerging markets may be
more volatile than the markets of more mature economies; however, such markets
may provide higher rates of return to investors. Many emerging market countries
providing investment opportunities for these Portfolios have experienced
substantial, and in some periods extremely high, rates of inflation for many
years. Inflation and rapid fluctuations in inflation rates have had and may
continue to have adverse effects on the economies and securities markets of
certain of these countries.
21
<PAGE>
Since foreign securities often are purchased with and payable in
currencies of foreign countries, the value of these assets as measured in U.S.
dollars may be affected favorably or unfavorably by changes in currency rates
and exchange control regulations.
FOREIGN CURRENCY TRANSACTION. (All Portfolios, except the Equity
Portfolio and Small Cap Portfolio) Currency exchange rates may fluctuate
significantly over short periods of time. They generally are determined by the
forces of supply and demand in the foreign exchange markets and the relative
merits of investments in different countries, actual or perceived changes in
interest rates and other complex factors, as seen from an international
perspective. Currency exchange rates also can be affected unpredictably by
intervention of U.S. or foreign governments or central banks, or the failure to
intervene, or by currency controls or political developments in the United
States or abroad.
LOWER RATED SECURITIES. (International Fixed-Income Portfolio and
Strategic Yield Portfolio). Each of these Portfolios may invest in securities
rated below investment grade such as those rated Ba by Moody's or BB by S&P, and
as low as the lowest rating assigned by the Rating Agencies (commonly known as
junk bonds). They may be subject to certain risks and to greater market
fluctuations than lower yielding investment grade securities. See "Appendix" for
a general description of the Rating Agencies' ratings. Although ratings may be
useful in evaluating the safety of interest and principal payments, they do not
evaluate the market value risk of these securities. The Portfolio will rely on
the Investment Manager's judgment, analysis and experience in evaluating the
creditworthiness of an issuer.
You should be aware that the market values of many of these
securities tend to be more sensitive to economic conditions than are higher
rated securities and will fluctuate over time. These securities generally are
considered by the Rating Agencies to be, on balance, predominantly speculative
with respect to capacity to pay interest and repay principal in accordance with
the terms of the obligation and generally will involve more credit risk than
securities in the higher rating categories.
Companies that issue certain of these securities often are highly
leveraged and may not have available to them more traditional methods of
financing. Therefore, the risk associated with acquiring the securities of such
issuers generally is greater than is the case with the higher rated securities.
For example, during an economic downturn or a sustained period of rising
interest rates, highly leveraged issuers of these securities may not have
sufficient revenues to meet their interest payment obligations. The issuer's
ability to service its debt obligations also may be affected adversely by
specific corporate developments, forecasts, or the unavailability of additional
financing. The risk of loss because of default by the issuer is significantly
greater for the holders of these securities because such securities generally
are unsecured and often are subordinated to other creditors of the issuer.
Because there is no established retail secondary market for many
of these securities, the Portfolio anticipates that such securities could be
sold only to a limited number of dealers or institutional investors. To the
extent a secondary trading market for these securities
22
<PAGE>
does exist, it generally is not as liquid as the secondary market for higher
rated securities. The lack of a liquid secondary market may have an adverse
impact on market price and yield and the Portfolio's ability to dispose of
particular issues when necessary to meet the Portfolio's liquidity needs or in
response to a specific economic event such as a deterioration in the
creditworthiness of the issuer. The lack of a liquid secondary market for
certain securities also may make it more difficult for the Portfolio to obtain
accurate market quotations for purposes of valuing its portfolio and calculating
its net asset value. Adverse publicity and investor perceptions, whether or not
based on fundamental analysis, may decrease the values and liquidity of these
securities. In such cases, judgment may play a greater role in valuation because
less reliable, objective data may be available.
These securities may be particularly susceptible to economic
downturns. It is likely that an economic recession could disrupt severely the
market for such securities and may have an adverse impact on the value of such
securities. In addition, it is likely that any such economic downturn could
adversely affect the ability of the issuers of such securities to repay
principal and pay interest thereon and increase the incidence of default for
such securities.
The Portfolio may acquire these securities during an initial
offering. Such securities may involve special risks because they are new issues.
The Portfolio has no arrangement with any persons concerning the acquisition of
such securities, and the Investment Manager will review carefully the credit and
other characteristics pertinent to such new issues.
The credit risk factors pertaining to lower rated securities also
apply to lower rated zero coupon securities and pay-in-kind bonds, in which each
of these Portfolios may invest. Pay-in-kind bonds pay interest through the
issuance of additional securities. Zero coupon securities and pay-in-kind bonds
carry an additional risk in that, unlike bonds which pay interest throughout the
period to maturity, the Portfolio will realize no cash until the cash payment
date unless a portion of such securities are sold and, if the issuer defaults,
the Portfolio may obtain no return at all on its investment.
SIMULTANEOUS INVESTMENTS BY OTHER PORTFOLIOS OR FUNDS. (All
Portfolios) Investment decisions for each Portfolio are made independently from
those of the other portfolios and accounts managed by the Investment Manager.
If, however, such other portfolios or accounts desire to invest in, or dispose
of, the same securities as the Portfolio, available investments or opportunities
for sales will be allocated equitably to each. In some cases, this procedure may
adversely affect the size of the position obtained for or disposed of by a
Portfolio or the price paid or received by a Portfolio.
23
<PAGE>
INVESTMENT RESTRICTIONS
Each Portfolio's investment objective is a fundamental policy,
which cannot be changed without approval by the holders of a majority (as
defined in the 1940 Act) of the Portfolio's outstanding voting shares. In
addition, each Portfolio has adopted investment restrictions numbered 1 through
8 as fundamental policies. However, the amendment of these restrictions to add
an additional Portfolio, which amendment does not substantively affect the
restrictions with respect to an existing Portfolio, will not require approval as
described in the first sentence. Investment restrictions numbered 9 through 12
are not fundamental policies and may be changed, as to a Portfolio, by vote of a
majority of the Fund's Board members at any time. None of the Portfolios may:
1. Invest more than 25% of the value of its total assets in the
securities of issuers in any single industry, provided that there shall be no
limitation on the purchase of obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities.
2. Invest in commodities, except that a Portfolio may purchase
and sell options, forward contracts, futures contracts, including those relating
to indices, and options on futures contracts or indices.
3. Purchase, hold or deal in real estate, or oil, gas or other
mineral leases or exploration or development programs, but a Portfolio may
purchase and sell securities that are secured by real estate or issued by
companies that invest or deal in real estate or real estate investment trusts.
4. Borrow money, except to the extent permitted under the 1940
Act (which currently limits borrowing to more than 33-1/3% of the value of the
Portfolio's total assets). For purposes of this Investment Restriction, the
entry into options, forward contracts, futures contracts, including those
relating to indices, and options on futures contracts or indices shall not
constitute borrowing.
5. Make loans to others, except through the purchase of debt
obligations and the entry into repurchase agreements. However, a Portfolio may
lend its portfolio securities in an amount not to exceed 33-1/3% of the value of
its total assets. Any loans of portfolio securities will be made according to
guidelines established by the Securities and Exchange Commission and the Fund's
Board.
6. Act as an underwriter of securities of other issuers, except
to the extent a Portfolio may be deemed an underwriter under the Securities Act
of 1933, as amended, by virtue of disposing of portfolio securities.
7. Issue any senior security (as such term is defined in Section
18(f) of the 1940 Act), except to the extent the activities permitted in
Investment Restrictions Nos. 2, 4, 10 and 11 may be deemed to give rise to a
senior security.
24
<PAGE>
8. Purchase securities on margin, but a Portfolio may make
margin deposits in connection with transactions on options, forward contracts,
futures contracts, including those relating to indices, and options on futures
contracts or indices.
9. Invest in the securities of a company for the purpose of
exercising management or control, but the Portfolio will vote the securities it
owns as a shareholder in accordance with its views.
10. Pledge, mortgage or hypothecate its assets, except to the
extent necessary to secure permitted borrowings and to the extent related to the
purchase of securities on a when-issued or forward commitment basis and the
deposit of assets in escrow in connection with writing covered put and call
options and collateral and initial or variation margin arrangements with respect
to options, forward contracts, futures contracts, including those relating to
indices, and options on futures contracts or indices.
11. Purchase, sell or write puts, calls or combinations thereof,
except as described in the Prospectus and Statement of Additional Information.
12. Enter into repurchase agreements providing for settlement in
more than seven days after notice or purchase securities which are illiquid, if,
in the aggregate, more than 15% of the value of its net assets would be so
invested.
* * *
If a percentage restriction is adhered to at the time of
investment, a later change in percentage resulting from a change in values or
assets will not constitute a violation of such restriction.
In addition, each Portfolio has adopted the following policies as
non-fundamental policies. Each Portfolio intends (i) to comply with the
diversification requirements prescribed in regulations under Section 817(h) of
the Code and (ii) to comply in all material respects with insurance laws and
regulations that the Fund has been advised are applicable to investments of
separate accounts of Participating Insurance Companies. As non-fundamental
policies, these policies may be changed by vote of a majority of the Fund's
Board of Directors at any time.
25
<PAGE>
MANAGEMENT
The Fund's Board is responsible for the management and
supervision of each Portfolio. The Board approves all significant agreements
with those companies that furnish services to the Portfolios. These companies
are as follows:
Lazard Asset Management ....................Investment Manager
Lazard Freres & Co. LLC ....................Distributor
Boston Financial Data Services, Inc. .......Transfer Agent and
Dividend Disbursing
Agent
State Street Bank and Trust Company ........Custodian
The Directors and officers of the Fund and their principal
occupations during the past five years are set forth below. Unless otherwise
specified, the address of each of the following persons is 30 Rockefeller Plaza,
New York, New York 10112.
<TABLE>
<CAPTION>
NAME, ADDRESS AND AGE POSITION WITH FUND PRINCIPAL OCCUPATION DURING PAST 5 YEARS
--------------------- ------------------ ----------------------------------------
<S> <C> <C>
Norman Eig* (59) Chairman of the Board Vice Chairman and Managing Director (formerly General
Partner), Lazard.
Herbert W. Gullquist* (62) President, Director Vice Chairman and Managing Director (formerly General
Partner), Lazard; Chief Investment Officer of the
Investment Manager.
John J. Burke (71) Director Retired; Former Vice Chairman and Director, Montana
50 Burning Tree Lane Power Company.
Butte, MT 59701
Kenneth S. Davidson (55) Director President, Davidson Capital Management
Davidson Capital Management Corporation; Director, Blackthorn Fund N.V. and
Corporation Ottertail Valley Railroad.
500 Park Avenue,
Suite 510
New York, NY 10022
Carl Frischling* (63) Director Senior Partner, Kramer, Levin, Naftalis & Frankel LLP,
Kramer, Levin, Naftalis & attorneys at law.
Frankel LLP
919 Third Avenue
New York, NY 10022
Lester Z. Lieberman (69) Director Private Investor; Director of Dowel Associates;
1500 Mt. Kemble Avenue Chairman of the Board of Trustees of Newark Beth
Morristown, NJ 07960 Israel Medical Center and Irvington General Hospital;
Member of the New Jersey State Investment Council;
prior to 1994, Director of United Jersey Bank, N.A. and
Clarkson University.
Richard Reiss, Jr. (56) Director Managing Partner, Georgica Advisers LLC, an
Georgica Advisers LLC investment manager.
1114 Avenue of the Americas
New York, NY 10036
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
NAME, ADDRESS AND AGE POSITION WITH FUND PRINCIPAL OCCUPATION DURING PAST 5 YEARS
--------------------- ------------------ ----------------------------------------
<S> <C> <C>
John Rutledge (51) Director President, Rutledge & Company, an economics and
Rutledge & Company investment advisory firm; Chairman, Claremont
Greenwich Office Park Economics Institute.
51 Weaver Street
Greenwich, CT 06831
William Katz (46) Director President and Chief Operating Officer of BBDO, an
BBDO Worldwide Network advertising agency; from May 1994 to February 1996,
1285 Avenue of the Americas General Manager of BBDO; prior thereto, Executive
New York, NY 10019 Vice President and Senior Account Director of BBDO.
David M. Goldenberg (33) Vice President, Secretary Director, Legal Affairs of the Investment Manager;
from April 1998 to May 2000, Global Director of
Compliance for SSB Citi Asset Management Group;
from June 1996 to April 1998, Associate General
Counsel of Smith Barney Asset Management; prior
thereto, Branch Chief and Senior Counsel in the
Division of Investment Management at the Securities
Exchange Commission in Washington, D.C.
Gerald B. Mazzari (48) Treasurer Chief Operating Officer and Managing Director, Lazard;
from July 1995 to March 1996, Head of Non-US Equity
Operations, Merrill Lynch, Pierce, Fenner & Smith,
Inc.; prior thereto, Executive Vice President, Smith
New Court Inc.
</TABLE>
-----------
*An "interested person" of the Fund as defined in the 1940 Act.
The Fund has a standing nominating committee comprised of its
Directors who are not "interested persons" of the Fund, as defined in the 1940
Act. The function of the nominating committee is to select and nominate all
candidates who are not "interested persons" of the Fund for election to the
Fund's Board.
The Fund pays each Director who is not an employee or an
affiliated person of the Investment Manager its allocated portion of a fixed fee
of $20,000 per year, plus $1,000 per meeting attended for the Fund and the
Lazard Funds, Inc., another multi-portfolio fund advised by the Investment
Manager, and reimburses them for travel and out of pocket expenses. The
aggregate amount of compensation paid to each Director by the Fund for the year
ended December 31, 1999, was as follows:
27
<PAGE>
<TABLE>
<CAPTION>
Total Compensation from
Aggregate Compensation the Fund and
NAME OF DIRECTOR FROM THE FUND THE LAZARD FUNDS, INC.
---------------- ----------------------- ----------------------
<S> <C> <C>
John J. Burke $6,200 $24,000
Kenneth S. Davidson $6,200 $24,000
Norman Eig N/A N/A
Carl Frischling $6,200 $24,000
Herbert W. Gullquist N/A N/A
William Katz $6,200 $24,000
Lester Z. Lieberman $6,200 $24,000
Richard Reiss, Jr. $6,200 $24,000
John Rutledge $6,200 $24,000
</TABLE>
Effective January 1, 2000, each Director who is not an employee
or an affiliated person of the Investment Manager will be paid a quarterly fee
of $7,500, plus $2,500 per meeting attended for the Fund and the Lazard Funds,
Inc. and will be reimbursed for travel and other out of pocket expenses. In
addition, the Chairman of the Audit Committee for the Fund and The Lazard Funds,
Inc. also will receive an annual fee of $5,000.
The Fund does not compensate officers or Directors who are
employees or affiliated persons of the Investment Manager. As of April 3, 2000,
the Fund's officers and Directors, as a group, owned less than 1% of the shares
of each Portfolio.
INVESTMENT MANAGER AND INVESTMENT MANAGEMENT AGREEMENT
Lazard Asset Management, 30 Rockefeller Plaza, New York, New
York 10112, has entered into an investment management agreement (the "Management
Agreement") with the Fund on behalf of each Portfolio. Pursuant to the
Management Agreement, Lazard Asset Management regularly provides each Portfolio
with investment research, advice and supervision and furnishes continuously an
investment program for each Portfolio consistent with its investment objectives
and policies, including the purchase, retention and disposition of securities.
Lazard Asset Management is a division of Lazard, which is
registered as an investment adviser with the Securities & Exchange Commission
and is a member of the New York, American and Chicago Stock Exchanges. Lazard
provides its clients with a wide variety of investment banking and related
services, including investment management. It is a major underwriter of
corporate securities, conducts a broad range of trading and brokerage activities
in corporate and governmental bonds and stocks and acts as a financial adviser
to utilities. Lazard Asset Management provides investment management services to
client discretionary accounts with assets as of March 31, 2000 totaling
approximately $74 billion. Its clients are both individuals and institutions,
some of whose accounts have investment policies similar to those of several of
the Portfolios. As of April 3, 2000, Lazard Asset Management held voting and
dispositive power with respect to a sufficient number of shares of the Emerging
Markets Portfolio held by client accounts as to be considered a controlling
person of such Portfolio.
28
<PAGE>
The Fund, Lazard Asset Management and Lazard each have adopted a
Code of Ethics that permits its personnel, subject to such Code, to invest in
securities, including securities that may be purchased or held by a Portfolio.
The Lazard Asset Management Code of Ethics restricts the personal securities
transactions of its employees, and requires portfolio managers and other
investment personnel to comply with the Code's preclearance and disclosure
procedures. Its primary purpose is to ensure that personal trading by Lazard
Asset Management employees does not disadvantage any Portfolio.
Under the terms of the Management Agreement, the Investment
Manager will pay the compensation of all personnel of the Fund, except the fees
of Directors of the Fund who are not employees or affiliated persons of the
Investment Manager. The Investment Manager will make available to the Portfolios
such of the Investment Manager's members, directors, officers and employees as
are reasonably necessary for the operations of each Portfolio, or as may be duly
elected officers or directors of the Fund. Under the Management Agreement, the
Investment Manager also pays each Portfolio's office rent and provides
investment advisory research and statistical facilities and all clerical
services relating to research, statistical and investment work. The Investment
Manager, including its employees who serve the Portfolios, may render investment
advice, management and other services to others.
As compensation for its services, each of the Portfolios has
agreed to pay the Investment Manager an investment management fee, accrued daily
and payable monthly, at the annual rates set forth below as a percentage of the
average daily value of the net assets of the relevant Portfolio:
Investment Management
Name of Portfolio Fee Payable
----------------- ---------------------
Equity Portfolio .75%
Small Cap Portfolio .75%
Global Equity Portfolio .75%
International Equity Portfolio .75%
International Small Cap Portfolio .75%
Emerging Markets Portfolio 1.00%
International Fixed-Income Portfolio .75%
Strategic Yield Portfolio .75%
For the fiscal year ending December 31, 2000, the Investment
Manager has agreed to waive its management fees or otherwise bear the expenses
of the following Portfolios to the extent the aggregate expenses of the
Portfolios exceed the percentage of the value of the Portfolio's average daily
net assets set forth opposite the Portfolio's name:
29
<PAGE>
MAXIMUM TOTAL
NAME OF PORTFOLIO PORTFOLIO OPERATING EXPENSES
----------------- ----------------------------
Equity Portfolio 1.25%
Small Cap Portfolio 1.25%
International Equity Portfolio 1.25%
Emerging Markets Portfolio 1.60%
For the fiscal years ended December 31, 1997, 1998 and 1999, the
Investment Manager waived all of its management fees payable by the relevant
Portfolios.
The Management Agreement provides that each Portfolio pays all of
its expenses that are not specifically assumed by the Investment Manager.
Expenses attributable to each Portfolio will be charged against the assets of
that Portfolio. Other expenses of the Fund will be allocated among the
Portfolios in a manner which may, but need not, be proportionate in relation to
the net assets of each Portfolio. Expenses payable by each of the Portfolios
include, but are not limited to, clerical salaries, brokerage and other expenses
of executing portfolio transactions; legal, auditing or accounting expenses;
trade association dues; taxes or governmental fees; the fees and expenses of any
person providing administrative services to the Fund; the fees and expenses of
the custodian and transfer agent of the Fund; clerical expenses of issue,
redemption or repurchase of shares of the Portfolio; the expenses and fees for
registering and qualifying securities for sale; the fees of Directors of the
Fund who are not employees or affiliated persons of the Investment Manager or
its affiliates; travel expenses of all Directors, officers and employees;
insurance premiums; and the cost of preparing and distributing reports and
notices to shareholders. In addition, shares of each Portfolio are subject to an
annual distribution and servicing fee. See "Distribution and Servicing Plan."
As to each Portfolio, the Management Agreement is subject to
annual approval by (i) the Fund's Board or (ii) vote of a majority (as defined
in the 1940 Act) of the outstanding voting securities of such Portfolio,
provided that in either event the continuance also is approved by a majority of
the Directors who are not "interested persons" (as defined in the 1940 Act) of
the Fund or the Investment Manager, by vote cast in person at a meeting called
for the purpose of voting on such approval. As to each Portfolio, the Management
Agreement is terminable without penalty, on 60 days' notice, by the Fund's Board
or by vote of the holders of a majority of the shares of such Portfolio, or,
upon not less than 90 days' notice, by the Investment Manager. The Management
Agreement will terminate automatically, as to the relevant Portfolio, in the
event of its assignment (as defined in the 1940 Act). The Management Agreement
provides that in the absence of willful misfeasance, bad faith or gross
negligence on the part of the Investment Manager, or of reckless disregard of
its obligations thereunder, the Investment Manager shall not be liable for any
action or failure to act in accordance with its duties thereunder.
ADMINISTRATOR AND CUSTODIAN
The Fund has engaged State Street Bank and Trust Company ("State
Street"), 225 Franklin Street, Boston, Massachusetts 02110, to provide certain
administrative services to the Portfolios. Each Portfolio will bear the cost of
such expenses at the annual rate of $37,500
30
<PAGE>
plus 0.02% of average assets up to $1 billion and 0.01% of average assets over
$1 billion. State Street agreed to waive the $37,500 fee for the Equity
Portfolio, Small Cap Portfolio, International Equity Portfolio and Emerging
Markets Portolio until February 29, 2000. From March 1, 2000, State Street
agreed to waive $18,750 of the fee for the Equity Portfolio, Small Cap
Portfolio, International Equity Portfolio and Emerging Markets Portfolio until
December 31, 2000.
State Street also acts as the Fund's custodian. As the Fund's
custodian, State Street, among other things, maintains a custody account or
accounts in the name of each Portfolio; receives and delivers all assets for
each Portfolio upon purchase and upon sale or maturity; collects and receives
all income and other payments and distributions on account of the assets of each
Portfolio and disburses the Portfolio's assets in payment of its expenses. The
custodian does not determine the investment policies of any Portfolio or decide
which securities any Portfolio will buy or sell.
DISTRIBUTOR
Lazard serves as the distributor of each Portfolio's shares and
conducts a continuous offering pursuant to a "best efforts" arrangement. As the
distributor, it accepts purchase and redemption orders for Portfolio shares. In
addition, the distribution agreement obligates Lazard to pay certain expenses in
connection with the offering of Portfolio shares. After the prospectus and
periodic reports have been prepared, set in type and mailed to shareholders,
Lazard also will pay for the printing and distribution of copies thereof used in
connection with the offering to prospective investors.
DETERMINATION OF NET ASSET VALUE
Net asset value per share of each Portfolio is determined by
State Street for the Fund on each day the New York Stock Exchange is open for
trading. The New York Stock Exchange is ordinarily closed on the following
national holidays: New Year's Day, Martin Luther King Jr. Day, Presidents' Day,
Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day. Net asset value per share is determined by dividing the value of
the total assets of the Portfolio represented, less all liabilities, by the
total number of Portfolio shares outstanding.
The value of securities, other than options listed on national
securities exchanges and debt securities maturing in 60 days or less, is
determined as of the close of regular trading on the New York Stock Exchange.
Options on stock and stock indices traded on national securities exchanges are
valued as of the close of options trading on such exchanges (which is currently
4:10 p.m., New York time). Debt securities maturing in 60 days or less are
valued at amortized cost, except where to do so would not reflect accurately
their fair value, in which case such securities would be valued at their fair
value as determined under the supervision of the Board of Directors. Each
security for which the primary market is on a national securities
31
<PAGE>
exchange is valued at the last sale price on the principal exchange on which it
is traded, or, if no sales are reported on such exchange on that day, at the
closing bid price.
Any security held by a Portfolio for which the primary market is
the Nasdaq National Market System is valued at the last sale price as quoted by
such system or, in the absence of any sale on the valuation date, at the closing
bid price. Any other unlisted security for which current over-the-counter market
quotations or bids are readily available is valued at its last quoted bid price
or, if available, the mean of two such prices.
All other securities and other assets for which current market
quotations are not readily available are valued at fair value as determined in
good faith by the Fund's Board of Directors and in accordance with procedures
adopted by the Board of Directors. The portfolio securities of any of the
Portfolios also may be valued on the basis of prices provided by a pricing
service when such prices are believed by the Investment Manager to reflect the
fair market value of such securities.
The Small Cap Portfolio and International Small Cap Portfolio
invest primarily in equity securities of companies with relatively small market
capitalizations. Because of the difference between the bid and asked prices of
over-the-counter securities, there may be an immediate reduction in the net
asset value of the shares of the Small Cap Portfolio or International Small Cap
Portfolio after such Portfolio has completed a purchase of securities that will
be valued by the relevant Portfolio at their bid price, since those securities
usually will have been purchased at or near the asked price.
Trading in securities on European and Far Eastern securities
exchanges and over-the-counter markets ordinarily is completed well before the
close of business on each business day in New York (i.e., a day on which the New
York Stock Exchange is open). In addition, European or Far Eastern securities
trading generally or in a particular country or countries may not take place on
all business days in New York. Furthermore, trading takes place in Japanese
markets on certain Saturdays and in various foreign markets on days which are
not business days in New York and on which the net asset value of a Portfolio is
not calculated. Each Portfolio calculates net asset value per share, and
therefore effects sales, redemptions and repurchases of its shares, as of the
close of regular trading on the New York Stock Exchange once on each day on
which the New York Stock Exchange is open. Such calculation may not take place
contemporaneously with the determination of the prices of the majority of the
portfolio securities used in such calculation. If events materially affecting
the value of such securities occur between the time when their price is
determined and the time when the Portfolio's net asset value is calculated, such
securities will be valued at fair value as determined in good faith by the Board
of Directors.
PORTFOLIO TRANSACTIONS
GENERAL
Subject to the supervision of the Board of Directors, the
Investment Manager is primarily responsible for the investment decisions and the
placing of portfolio transactions for
32
<PAGE>
each Portfolio. In selecting brokers or dealers to execute portfolio
transactions on behalf of a Portfolio, the Investment Manager seeks the best
overall terms available, taking into account such factors as price, size of
order, difficulty of execution and skill required of the executing broker. While
the Investment Manager will generally seek reasonably competitive spreads or
commissions, the Portfolios will not necessarily be paying the lowest spread or
commission available.
Purchases and sales of portfolio securities on a securities
exchange are effected by the Investment Manager through brokers who charge a
negotiated commission for their services based on the quality and quantity of
execution services provided by the broker in the light of generally prevailing
rates. Orders may be directed to any broker including, to the extent and in the
manner permitted by applicable law, Lazard. 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. In underwritten
offerings, securities are purchased at a fixed price that includes an amount of
compensation to the underwriter, generally referred to as the underwriter's
concession or discount.
To the extent consistent with applicable provisions of the 1940
Act and the rules adopted by the Commission thereunder, the Fund's Board has
determined that securities transactions for a Portfolio may be executed through
Lazard if, in the judgment of the Investment Manager, the use of Lazard is
likely to result in price and execution at least as favorable as those of other
qualified brokers or dealers, and if, in the transaction, Lazard charges the
Portfolio a rate consistent with that charged to comparable unaffiliated
customers in similar transactions.
Purchase and sale orders for securities held by a Portfolio may
be combined with those for other Portfolios in the interest of the most
favorable net results for all. When the Investment Manager determines that a
particular security should be bought for or sold by more than one Portfolio, the
Investment Manager undertakes to allocate those transactions between the
participants equitably.
RESEARCH AND STATISTICAL INFORMATION
When it can be done consistently with the policy of obtaining the
best overall terms available, the Investment Manager may select brokers or
dealers who supply market quotations to the Fund's custodian for valuation
purposes, or who supply research, market and statistical information to the
Investment Manager. Although such research, market and statistical information
may be useful to the Investment Manager, it is only supplementary to the
Investment Manager's own research efforts, since the information must still be
analyzed, weighed and reviewed by the Investment Manager's staff. Information so
received will be in addition to, and not in lieu of, the services required to be
performed by the Investment Manager under the Management Agreement with the Fund
on behalf of the Portfolios. Such information may be useful to the Investment
Manager in providing services to both the Portfolios and clients other than the
Portfolios, and, conversely, supplemental information obtained by the placement
of business of other clients may be useful to the Investment Manager in carrying
out its obligations to the Portfolios. The total
33
<PAGE>
dollar amount of transactions pursuant to which brokerage was directed in
consideration of research services provided during the year ended December 31,
1999, was $862,282,895, and the related commissions were $1,754,309. In
addition, when it can be done consistently with the above stated policy, the
Investment Manager may place orders with brokers and dealers (i) who refer
persons to the Investment Manager for the purpose of purchasing shares of the
Portfolios or (ii) who provide services to the Fund at no fee or for a reduced
fee.
BROKERAGE COMMISSIONS
In connection with its portfolio securities transactions for the
fiscal periods ended December 31, 1997, 1998 and 1999, each Portfolio indicated
below paid brokerage commissions as follows:
PERIOD ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
Percentage of
Amount of Percentage of Total Brokerage
Brokerage Total Brokerage Transactions
Total Brokerage Commissions Paid Commissions Paid Effected Through
Name of Portfolio Commissions Paid to Lazard to Lazard Lazard
---------------------- --------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Small Cap Portfolio $ 716 -0- 0.00% 0.00%
Emerging Markets Portfolio $4,048 -0- 0.00% 0.00%
</TABLE>
PERIOD ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
Percentage of
Amount of Percentage of Total Brokerage
Brokerage Total Brokerage Transactions
Total Brokerage Commissions Paid Commissions Paid Effected Through
Name of Portfolio Commissions Paid to Lazard to Lazard Lazard
---------------------- --------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Equity Portfolio $2,498 $2,054 88.71% 80.55%
Small Cap Portfolio $2,875 $ 70 2.43% 2.73%
International Equity Portfolio $ 566 $ 2 0.37% 1.20%
Emerging Markets Portfolio $3,422 $ 125 3.80% 1.40%
</TABLE>
34
<PAGE>
PERIOD ENDED DECEMBER 31, 1999
<TABLE>
<CAPTION>
Percentage of
Amount of Percentage of Total Brokerage
Brokerage Total Brokerage Transactions
Total Brokerage Commissions Paid Commissions Paid Effected Through
Name of Portfolio Commissions Paid to Lazard to Lazard Lazard
---------------------- --------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Equity Portfolio $2,267 $1,822 99.67% 99.89%
Small Cap Portfolio $5,348 $ 213 6.43% 6.25%
International Equity Portfolio $5,182 $ 40 2.87% 4.40%
Emerging Markets Portfolio $7,488 $ 2 0.80% 0.93%
</TABLE>
The Global Equity, International Small Cap, International
Fixed-Income and Strategic Yield Portfolios had not commenced operations.
BUYING AND SELLING SHARES
GENERAL. INDIVIDUALS MAY NOT PLACE PURCHASE ORDERS DIRECTLY WITH
THE FUND. INDIVIDUALS SHOULD CONSULT A PARTICIPATING INSURANCE COMPANY, THE
ADMINISTRATOR OF AN ELIGIBLE PLAN OR A FINANCIAL INTERMEDIARY FOR INFORMATION ON
THE PURCHASE OF PORTFOLIO SHARES. THE FUND DOES NOT ISSUE SHARE CERTIFICATES.
Fund shares are sold on a continuous basis. Net asset value
ordinarily is determined as of 4:00 p.m. (Eastern Time) on each day during which
the New York Stock Exchange is open for trading. Net asset value per share is
computed by dividing the value of the net assets of each Portfolio (i.e., the
value of its assets less liabilities) by the total number of shares outstanding.
For purposes of determining net asset value, options and futures contracts will
be valued 15 minutes after the close of trading on the floor of the New York
Stock Exchange. Equity securities typically are valued based on market value, or
where market quotations are not readily available, based on fair value as
determined in good faith by the Board. Debt securities having remaining
maturities of 60 days or less are valued on an amortized cost basis unless the
Board determines that such method does not represent fair value. Other debt
securities are valued using available market quotations or at fair value which
may be determined by one or more pricing services.
Portfolio shares may be redeemed at any time by the separate
accounts of the Participating Insurance Companies or by Eligible Plans.
INDIVIDUALS MAY NOT PLACE REDEMPTION ORDERS DIRECTLY WITH THE FUND. The value of
the shares redeemed may be more or less than their original cost, depending on
the Portfolio's then-current net asset value.
The Fund ordinarily will make payment for all shares redeemed
within seven days after receipt by the Transfer Agent of a redemption request in
proper form, except as provided by the rules of the Commission.
35
<PAGE>
REDEMPTION COMMITMENT. The Fund has committed to pay in cash all
redemption requests by any shareholder of record, limited in amount during any
90-day period to the lesser of $250,000 or 1% of the value of a Portfolio's net
assets at the beginning of such period. Such commitment is irrevocable without
the prior approval of the Commission. In the case of requests for redemption in
excess of such amount, the Fund's Board reserves the right to make payments, in
whole or in part, in portfolio securities (which may include non-marketable
securities) or other assets of the Portfolio in cases of emergency, or at any
time that the Investment Manager believes a cash distribution would impair the
liquidity of the Portfolio to the detriment of the existing shareholders. In
such event, the securities used to meet the redemption request would be valued
in the same manner as the Portfolio's investments are valued. If the recipient
sold such securities, brokerage charges might be incurred.
SUSPENSION OF REDEMPTIONS. The right of redemption may be
suspended, or the date of payment postponed; (a) during any period when the New
York Stock Exchange is closed (other than customary weekend and holiday
closings); (b) when trading in the markets that the Portfolio ordinarily
utilizes is restricted, or when an emergency exists as determined by the
Commission so that disposal of the Portfolio's investments or determination of
its net asset value is not reasonably practicable; or (c) for such other periods
as the Commission, by order, may permit to protect the Portfolio's shareholders.
DISTRIBUTION AND SERVICING PLAN
Portfolio Shares are subject to a Distribution and Servicing Plan
adopted pursuant to Rule 12b-1 under the 1940 Act. Under the Distribution and
Servicing Plan, the Fund pays Lazard for advertising, marketing and distributing
each Portfolio's shares and for the provision of certain services to the holders
of shares, a fee at the annual rate of .25% of the Portfolio's average daily net
assets. Lazard may make payments to Participating Insurance Companies for
providing these services to Policy owners, or to certain financial institutions,
securities dealers and other industry professionals (collectively, "Service
Agents") for providing these services to Eligible Plan participants. The
services provided may include personal services relating to shareholder
accounts, such as answering shareholder inquiries regarding the Fund and
providing reports and other information, and services related to the maintenance
of shareholder accounts. The fee payable for such services is intended to be a
"service fee" as defined in Conduct Rules of the NASD. Depending on a
Participating Insurance Company's corporate structure and applicable state law,
Lazard may make payments to the Participating Insurance Company's affiliated
broker-dealer or other affiliated company rather than the Participating
Insurance Company itself. From time to time, Lazard may defer or waive receipt
of fees under the Distribution and Servicing Plan while retaining the ability to
be paid by the Fund under the Distribution and Servicing Plan thereafter. The
fees payable to Lazard under the Distribution and Servicing Plan for
advertising, marketing and distributing shares, and for payments to
Participating Insurance Companies and Service Agents, are payable without regard
to actual expenses incurred.
36
<PAGE>
Rule 12b-1 (the "Rule") adopted by the Commission under the 1940
Act provides, among other things, that an investment company may bear expenses
of distributing its shares only pursuant to a plan adopted in accordance with
the Rule. The Fund's Board has adopted such a plan (the "Distribution and
Servicing Plan"), pursuant to which the Fund pays Lazard for advertising,
marketing and distributing shares of the Portfolios and for the provision of
certain services to the holders of shares of the Portfolios. Lazard may make
payments to Participating Insurance Companies and Service Agents for providing
these services to Policy owners and Eligible Plan participants. The Fund's Board
determined, in the exercise of its business judgment, that the Fund's
Distribution and Servicing Plan is reasonably likely to benefit the Fund, Policy
owners and Eligible Plan participants.
A quarterly report of the amounts expended under the Distribution
Servicing Plan, and the purposes for which such expenditures were incurred, must
be made to the Board for its review. In addition, the Distribution and Servicing
Plan provides that it may not be amended to increase materially the costs which
holders of shares of a Portfolio may bear for distribution pursuant to the
Distribution and Servicing Plan without such shareholders' approval. It further
provides that other material amendments of the Distribution and Servicing Plan
must be approved by the Board and by the Board members who are not "interested
persons" (as defined in the 1940 Act) of the Fund and have no direct or indirect
financial interest in the operation of the Distribution and Servicing Plan or in
any agreements entered into in connection with the Distribution and Servicing
Plan, by vote cast in person at a meeting called for the purpose of considering
such amendments. The Distribution and Servicing Plan is subject to annual
approval by such vote cast in person at a meeting called for the purpose of
voting on the Distribution and Servicing Plan. As to each Portfolio, the
Distribution and Servicing Plan may be terminated at any time by vote of a
majority of the Board members who are not "interested persons" and have no
direct or indirect financial interest in the operation of the Distribution and
Servicing Plan or in any agreements entered into in connection with the
Distribution and Servicing Plan, or by vote of the holders of a majority of such
Portfolio's shares.
For the fiscal period ended December 31, 1999, the Portfolio's
paid the Distributor the amounts set forth below under the Distribution and
Servicing Plan:
Amount Paid to Distributor
Under Distribution and Servicing
Plan For Fiscal Period
Name of Portfolio Ended December 31, 1999
----------------- --------------------------
Equity Portfolio $6,993
Small Cap Portfolio $5,304
International Equity Portfolio $3,302
Emerging Markets Portfolio $4,701
37
<PAGE>
DIVIDENDS AND DISTRIBUTIONS
The Fund intends to declare as a dividend on the outstanding
shares of each of the International Fixed-Income Portfolio and Strategic Yield
Portfolio, substantially all of the Portfolio's net investment income at the
close of each business day to shareholders of record at 4:00 p.m. (New York
time). Net investment income for a Saturday, Sunday or holiday will be included
in the dividend declared on the previous business day. Dividends declared on the
shares of the International Fixed-Income Portfolio and Strategic Yield Portfolio
ordinarily will be paid on the last business day of each month. Shareholders who
redeem all their shares of either of these Portfolios prior to a dividend
payment date will receive, in addition to the redemption proceeds, any dividends
that are declared but unpaid through the date of their redemption. Shareholders
of either of these Portfolios who redeem only a portion of their shares will
receive all declared but unpaid dividends on those shares on the next dividend
payment date.
Dividends from net investment income on the Equity Portfolio,
Small Cap Portfolio, Global Equity Portfolio, International Equity Portfolio,
International Small Cap Portfolio and Emerging Markets Portfolio generally will
be declared and paid at least annually and may be declared and paid twice
annually.
Investment income for a Portfolio includes, among other
things, interest income, accretion of market and original issue discount and
amortization of premium and, in the case of the Equity Portfolio, Small Cap
Portfolio, Global Equity Portfolio, International Equity Portfolio,
International Small Cap Portfolio and Emerging Markets Portfolio, also would
include dividends.
With respect to all of the Portfolios, net realized capital
gains, if any, will be distributed at least annually and may be declared and
paid twice annually. If a dividend check mailed to a shareholder who elected to
receive dividends and/or capital gain distributions in cash is returned as
undeliverable by the postal or other delivery service, such shareholder's
distribution option automatically will be converted to all dividends and other
distributions reinvested in additional shares. NO INTEREST WILL ACCRUE ON
AMOUNTS REPRESENTED BY UNCASHED DISTRIBUTION OR REDEMPTION CHECKS. On dividend
payable date, each Portfolio forwards to the Fund's custodian the required
amount of cash to pay all shareholders who elected to receive dividends in cash.
TAXATION
Management believes that each of the Equity Portfolio, Small Cap
Portfolio, International Equity Portfolio and Emerging Markets Portfolio has
qualified for the fiscal year ended December 31, 1999 as a "regulated investment
company" under Subchapter M of the Code. It is intended that each such Portfolio
will continue to so qualify as a regulated investment company, if such
qualification is in the best interests of its shareholders. Each Portfolio will
be treated as a separate entity for tax purposes and thus the provisions of the
Code applicable to regulated investment companies generally will be applied to
each Portfolio separately, rather than to the Fund as a whole. As a regulated
investment company, a Portfolio
38
<PAGE>
will pay no Federal income tax on net investment income and net realized
securities gains to the extent that such income and gains are distributed to
shareholders in accordance with applicable provisions of the Code. To qualify as
a regulated investment company, the Portfolio must distribute at least 90% of
its net income (consisting of net investment income and net short-term capital
gain) to its shareholders and meet certain asset diversification and other
requirements. If the Portfolio did not qualify as a regulated investment
company, it would be treated for tax purposes, as an ordinary corporation
subject to Federal income tax. The term "regulated investment company" does not
imply the supervision of management of investment practices or policies by any
government agency.
Any dividend or distribution paid shortly after an investor's
purchase may have the effect of reducing the net asset value of the shares below
the investor's cost of those shares. Such a dividend or distribution would be a
return of investment in an economic sense, although taxable as stated in the
Prospectus. In addition, the Code provides that if a shareholder holds shares of
a Portfolio for six months or less and has received a capital gain distribution
with respect to such shares, any loss incurred on the sale of such shares will
be treated as long-term capital loss to the extent of the capital gain
distribution received.
Ordinarily, gains and losses realized from portfolio transactions
will be treated as capital gains and losses. However, all or a portion of the
gain or loss realized from the disposition of foreign currency, non-U.S. dollar
denominated debt instruments, and certain financial futures and options, may be
treated as ordinary income or loss under Section 988 of the Code. In addition,
all or a portion of the gain realized from the disposition of certain market
discount bonds will be treated as ordinary income under Section 1276 of the
Code. Finally, all or a portion of the gain realized from engaging in
"conversion transactions" may be treated as ordinary income under Section 1258
of the Code. "Conversion transactions" are defined to include certain forward,
futures, option and straddle transactions, transactions marketed or sold to
produce capital gains, or transactions described in Treasury regulations to be
issued in the future.
Under Section 1256 of the Code, gain or loss realized by a
Portfolio from certain financial futures and options transactions (other than
those taxed under Section 988 of the Code) will be treated as 60% long-term
capital gain or loss and 40% short-term capital gain or loss. Gain or loss will
arise upon the exercise or lapse of such futures and options, as well as from
closing transactions. In addition, any such futures or options remaining
unexercised at the end of the Portfolio's taxable year will be treated as sold
for their then fair market value, resulting in additional gain or loss to the
Portfolio characterized in the manner described above.
Offsetting positions held by a Portfolio involving financial
futures and options may constitute "straddles." Straddles are defined to include
"offsetting positions" in actively traded personal property. The tax treatment
of straddles is governed by Sections 1092 and 1258 of the Code, which, in
certain circumstances, overrides or modifies the provisions of Sections 988 and
1256 of the Code. As such, all or a portion of any short- or long-term capital
gain from certain "straddle" transactions may be recharacterized as ordinary
income.
39
<PAGE>
If a Portfolio were treated as entering into straddles by reason
of its futures or options transactions, such straddles could be characterized as
"mixed straddles" if the futures or options transactions comprising such
straddles were governed by Section 1256 of the Code. The Portfolio may make one
or more elections with respect to "mixed straddles." Depending upon which
election is made, if any, the results to the Portfolio may differ. If no
election is made, to the extent the straddle rules apply to positions
established by the Portfolio, losses realized by the Portfolio will be deferred
to the extent of unrealized gain in any offsetting positions. Moreover, as a
result of the straddle and conversion transaction rules, short-term capital loss
on straddle positions may be recharacterized as long-term capital loss, and
long-term capital gain may be recharacterized as short-term capital gain or
ordinary income.
If a Portfolio either (1) holds an appreciated financial position
with respect to stock, certain debt obligations, or partnership interests
("appreciated financial position") and then enters into a short sale, futures or
forward contract, or offsetting notional principal contract (collectively, a
"Contract") with respect to the same or substantially identical property or (2)
holds an appreciated financial position that is a Contract and then acquires
property that is the same as, or substantially identical to, the underlying
property, the Portfolio generally will be taxed as if the appreciated financial
position were sold at its fair market value on the date the Portfolio enters
into the financial position or acquires the property, respectively.
Income received by a Portfolio from sources within foreign
countries may be subject to withholding and other taxes imposed by such
countries. Tax conventions between certain countries and the United States may
reduce or eliminate such taxes. It is impossible to determine the effective rate
of foreign tax in advance, since the amount of each Portfolio's assets to be
invested in various countries is not known.
If a Portfolio invests in an entity that is classified as a
"passive foreign investment company" ("PFIC") for Federal income tax purposes,
the operation of certain provisions of the Code applying to PFICs could result
in the imposition of certain Federal income taxes on the Portfolio. In addition,
gain realized from the sale, other disposition or marking-to-market of PFIC
securities may be treated as ordinary income under Section 1291 or Section 1296
of the Code.
Investment by a Portfolio in securities issued at a discount or
providing for deferred interest or for payment of interest in the form of
additional obligations could, under special tax rules, affect the amount, timing
and character of distributions to shareholders by causing a Portfolio to
recognize income prior to the receipt of cash payments. For example, the
Portfolio could be required to recognize annually a portion of the discount (or
deemed discount) at which such securities were issued and to distribute an
amount equal to such income in order to maintain its qualification as a
regulated investment company. In such case, the Portfolio may have to dispose of
securities which it might otherwise have continued to hold in order to generate
cash to satisfy these distribution requirements.
Shareholders of the Fund will be variable annuity and variable
life insurance separate accounts established by insurance companies to fund
Policies. The Secretary of the Treasury may in the future issue additional
regulations or revenue rulings that will prescribe the
40
<PAGE>
circumstances in which a Policy owner's control of the investments of a separate
account may cause the Policy owner, rather than the insurance company, to be
treated as the owner of assets of the separate account. Failure to comply with
Section 817(h) of the Code or any regulation thereunder, or with any regulations
or revenue rulings on Policy owner control, if promulgated, would cause earnings
regarding a Policy owner's interest in the separate account to be includable in
the Policy owner's gross income in the year earned.
The Fund will not report dividends paid to Eligible Plans to the
Internal Revenue Service ("IRS"). Generally, distributions from Eligible Plans,
except those representing returns of non-deductible contributions thereto, will
be taxable as ordinary income and, if made prior to the time the participant
reaches ages 59-1/2, generally will be subject to an additional tax equal to 10%
of the taxable portion of the distribution. If the distribution from an Eligible
Plan (other than certain governmental or church plans) for any taxable year
following the year in which the participant reaches age 70-1/2 is less than the
"minimum required distribution" for that taxable year, an excise tax equal to
50% of the deficiency may be imposed by the IRS. The administrator, trustee or
custodian of such a Plan will be responsible for reporting distributions from
the Plan to the IRS. Participants in Eligible Plans will receive a disclosure
statement describing the consequences of a distribution from the Plan from the
administrator, trustee or custodian of the Plan prior to receiving distribution.
Moreover, certain contributions to an Eligible Plan in excess of the amounts
permitted by law may be subject to an excise tax. For more information
concerning the Federal income tax consequences, Policy owners should refer to
the prospectus for their contracts or policies and Eligible Plan participants
should consult the Plan's administrator or trustee.
PERFORMANCE INFORMATION
Current yield is computed pursuant to a formula which operates as
follows: The amount of the relevant Portfolio's expenses accrued for the 30-day
period (net of reimbursements) is subtracted from the amount of the dividends
and interest earned (computed in accordance with the regulatory requirements) by
such Portfolio during the period. That result is then divided by the product of:
(a) the average daily number of such Portfolio's shares outstanding during the
period that were entitled to receive dividends, and (b) the net asset value per
share on the last day of the period less any undistributed earned income per
share reasonably expected to be declared as a dividend shortly thereafter. The
quotient is then added to 1, and that sum is raised to the 6th power, after
which 1 is subtracted. The current yield is then arrived at by multiplying the
result by 2. A Portfolio's "actual distribution rate" is computed in the same
manner as yield, except that actual income dividends declared per share during
the period in question is substituted for net investment income per share.
Average annual total return is calculated by determining the
ending redeemable value of an investment purchased with a hypothetical $1,000
payment made at the beginning of the period (assuming the reinvestment of
dividends and distributions), dividing by the amount of the initial investment,
taking the "n"th root of the quotient (where "n" is the number of years in the
period) and subtracting 1 from the result.
41
<PAGE>
The average annual total return for the indicated Portfolio and
periods ended December 31, 1999 (the date listed in the footnote is the
beginning of the period for the indicated Portfolio) was as follows:
Average Annual Total Returns
For Periods Ended
December 31, 1999
-----------------
Since
Name of Portfolio 1-Year Inception
----------------- ------ ---------
Equity 8.16% 10.68%(1)
Small Cap 5.13% .13%(2)
International Equity 21.41% 26.16%(3)
Emerging Markets 52.09% 5.31%(2)
------------------
(1) Commenced operations on March 18, 1998.
(2) Commenced operations on November 4, 1997.
(3) Commenced operations on September 1, 1998.
Total return is calculated by subtracting the amount of the
relevant Portfolio's net asset value per share at the beginning of a stated
period from the net asset value per share at the end of the period (after giving
effect to the reinvestment of dividends and distributions during the period),
and dividing the result by the net asset value per share at the beginning of the
period.
The total return for the indicated Portfolio from inception
through December 31, 1999 (the date listed in the footnote is the date
operations commenced) was as follows:
Total Return Through
NAME OF PORTFOLIO DECEMBER 31, 1999
----------------- -----------------
Equity 19.94%(1)
Small Cap .28%(2)
International Equity 36.35%(3)
Emerging Markets 11.82%(2)
-------------------
(1) March 18, 1998.
(2) November 4, 1997.
(3) September 1, 1998.
A Portfolio's yield, actual distribution rate and total return
are not fixed and will fluctuate in response to prevailing market conditions or
as a function of the type and quality of the securities held by such Portfolio,
its average portfolio maturity and its expenses. Yield,
42
<PAGE>
actual distribution rate and total return information is useful in reviewing a
Portfolio's performance and such information may provide a basis for comparison
with other investments but such information may not provide a basis for
comparison with certificates of deposit, which pay a fixed rate of return, or
money market funds, which seek a stable net asset value. Investment return and
principal value of an investment in a Portfolio will fluctuate so that an
investor's shares, when redeemed, may be worth more or less than their original
cost.
No performance data is provided for the Global Equity,
International Small Cap, International Fixed-Income and Strategic Yield
Portfolios which had not commenced operations as of the date performance
information was calculated.
From time to time, the Fund may compare a Portfolio's performance
against one or more broad-based indices or data from Lipper Analytical Services,
Inc., Money Magazine, Morningstar, Inc. and other industry publications. In
addition, the Fund may compare a Portfolio's performance against inflation with
the performance of other instruments against inflation, such as short-term
Treasury Bills (which are direct obligations of the U.S. Government) and
FDIC-insured bank money market accounts.
INFORMATION ABOUT THE FUND AND PORTFOLIOS
As of April 3, 2000, the following shareholders owned
beneficially or of record 5% or more of the indicated Portfolio's outstanding
shares:
PERCENTAGE OF TOTAL
NAME AND ADDRESS SHARES OUTSTANDING
---------------- ------------------
EQUITY PORTFOLIO
Conseco Variable Insurance Co
Attn: Separate Accts Carla Higgs
11825 N. Pennsylvania Street
Carmel, IN 46032-4555 87.28%
Lazard Freres & Co. LLC
30 Rockefeller Plaza, 57th floor
New York, NY 10112-0002 12.39%
SMALL CAP PORTFOLIO
Conseco Variable Insurance Co
Attn: Separate Accts Carla Higgs
11825 N. Pennsylvania Street
Carmel, IN 46032-4555 47.05%
43
<PAGE>
PERCENTAGE OF TOTAL
NAME AND ADDRESS SHARES OUTSTANDING
---------------- ------------------
American National Insurance Co.
P.O. Box 58969
Houston, TX 77258 24.47%
The Ohio National Life Insurance Co.
Attn: Dennis Taney
Ohio National Financial Services
P.O. Box 237
Cincinnati, OH 45201-0237 18.24%
Lazard Freres & Co. LLC
30 Rockefeller Plaza, 57th floor
New York, NY 10112-0002 5.49%
INTERNATIONAL EQUITY PORTFOLIO
IDS Life Insurance Co.
1IP
IDS Tower 10 T11/340
Minneapolis, MN 55440 49.57%
IDS Life Insurance Co.
2IP
IDS Tower 10 T11/340
Minneapolis, MN 55440 36.03%
Allmerica Financial Life Insurance
and Annuity Company
440 Lincoln Street
Worcester, MA 01653-0002 5.63%
Lincoln Benefit Life
206 South 13th Street Suite 100
Lincoln, NE 68508-2040 5.24%
EMERGING MARKETS PORTFOLIO
The Ohio National Life Insurance Co.
Attn: Dennis Taney
Ohio National Financial Services
P.O. Box 237
Cincinnati, OH 45201-0237 52.85%
44
<PAGE>
PERCENTAGE OF TOTAL
NAME AND ADDRESS SHARES OUTSTANDING
---------------- ------------------
Lazard Freres & Co. LLC
30 Rockefeller Plaza, 57th floor
New York, NY 10112-0002 29.40%
American National Insurance Co.
P.O. Box 58969
Houston, TX 77258 11.92%
Lincoln Benefit Life
206 South 13th Street Suite 100
Lincoln, NE 68508-2040 5.84%
A shareholder who beneficially owns, directly or indirectly, more
than 25% of the Fund's voting securities may be deemed a "control person" (as
defined in the 1940 Act) of the Fund.
Generally, all shares have equal voting rights and will be voted
in the aggregate. As used in this Statement of Additional Information, the vote
of a majority of the outstanding voting securities means, with respect to the
Fund or a Portfolio, the vote of the lesser of (i) 67% of the shares represented
at a meeting if the holders of more than 50% of the outstanding shares of the
Fund or Portfolio, as the case may be, are present in person or by proxy, or
(ii) more than 50% of the outstanding shares of the Fund or Portfolio, as the
case may be. Shareholders are entitled to one vote for each full share held, and
fractional votes for fractional shares held.
Each share of a Portfolio is entitled to such dividends and
distributions out of the income earned on the assets belonging to that Portfolio
as are declared in the discretion of the Fund's Board of Directors. In the event
of the liquidation of a Portfolio, shares of the Portfolio are entitled to
receive the assets of that Portfolio that are available for distribution.
Shareholders are not entitled to any preemptive rights. All
shares, when issued, will be fully paid and non-assessable by the Fund.
45
<PAGE>
COUNSEL AND INDEPENDENT AUDITORS
Legal matters in connection with the issuance of the shares of
the Fund offered hereby will be passed upon by Stroock & Stroock & Lavan LLP,
180 Maiden Lane, New York, New York 10038-4982.
Anchin, Block & Anchin LLP, 1375 Broadway, New York, New York
10018, has been selected as the independent auditors for the Fund.
ADDITIONAL INFORMATION
The Fund's Registration Statement, including the Prospectus, the
Statement of Additional Information and the exhibits filed therewith, may be
examined at the office of the Commission in Washington, D.C. Statements
contained in the Prospectus or this Statement of Additional Information as to
the content 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
Registration Statement, each such statement being qualified in all respects by
such reference.
A special service is available to banks, brokers, investment
advisers, trust companies and others who have a number of accounts in the Fund.
In addition to the regular Statement of Account furnished to the registered
holder after each transaction, a monthly summary of accounts can be provided.
The monthly summary will show for each account the account number, the month-end
share balance and the dividends and distributions paid during the month. For
information on the special monthly summary of accounts, contact the Fund.
46
<PAGE>
APPENDIX
Description of certain ratings.
S&P
BOND RATINGS
AAA
Bonds rated AAA have the highest rating assigned to a debt
obligation. Capacity to pay interest and repay principal is extremely strong.
AA
Bonds rated AA have a very strong capacity to pay interest and
repay principal and differ from the highest rated issues only in small degree.
A
Bonds rated A have a strong capacity to pay interest and repay
principal although they are somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than bonds in higher rated
categories.
BBB
Bonds rated BBB are regarded as having an adequate capacity to
pay interest and repay principal. Whereas they normally exhibit 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 bonds in this category than for bonds in higher rated categories.
BB
Bonds rated BB have less near-term vulnerability to default than
other speculative grade bonds. However, they face major ongoing uncertainties or
exposure to adverse business, financial or economic conditions which could lead
to inadequate capacity to meet timely interest and principal payment.
B
Bonds rated B have a greater vulnerability to default but
presently have the capacity to meet interest payments and principal repayments.
Adverse business, financial or economic conditions would likely impair capacity
or willingness to pay interest and repay principal.
47
<PAGE>
CCC
Bonds rated CCC have a current identifiable vulnerability to
default, and are dependent upon favorable business, financial and economic
conditions to meet timely payments of interest and repayment of principal. In
the event of adverse business, financial or economic conditions, they are not
likely to have the capacity to pay interest and repay principal.
CC
The rating CC is typically applied to bonds subordinated to
senior debt which is assigned an actual or implied CCC rating.
C
The rating C is typically applied to bonds subordinated to senior
debt which is assigned an actual or implied CCC- rating.
D
Bonds rated D are in default, and payment of interest and/or
repayment of principal is in arrears.
S&P's letter ratings may be modified by the additional of a plus
or a minus sign, which is used to show relative standing within the major
ratings categories, except in the AAA (Prime Grade) category.
COMMERCIAL PAPER RATINGS
An S&P commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. Issues assigned an A rating are regarded as having the greatest
capacity for timely payment. Issues in this category are delineated with the
numbers 1, 2 and 3 to indicate the relative degree of safety.
A-1
This designation indicates the degree of safety regarding timely
payment is either overwhelming or very strong. Those issues determined to
possess overwhelming safety characteristics are denoted within a plus sign (+)
designation.
48
<PAGE>
A-2
Capacity for timely payment on issues with this designation is
strong. However, the relative degree of safety is not as high as for issues
designated A-1.
Moody's
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 edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, 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 of fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risks appear somewhat larger than in Aaa securities.
A
Bonds which are rated A possess many favorable investment
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 sometime in the
future.
Baa
Bond 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.
49
<PAGE>
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.
Caa
Bonds which are rated Caa are of poor standing. Such issues may
be in default or there may be present elements of danger with respect to
principal or interest.
Ca
Bonds which are rated Ca present obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings.
C
Bonds which are rated C are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Moody's applies the numerical modifiers 1, 2 and 3 to show
relative standing within the major rating categories, except in the Aaa category
and in the categories below B. The modifier 1 indicates a rating for the
security in the higher end of a rating category; the modifier 2 indicates a
mid-range ranking; and the modifier 3 indicates a ranking in the lower end of a
rating category.
50
<PAGE>
COMMERCIAL PAPER RATINGS
The rating Prime-1 (P-1) is the highest commercial paper rating
assigned by Moody's. Issuers of P-1 paper must have a superior capacity for
repayment of short-term promissory obligations, and ordinarily will be evidenced
by leading market positions in well established industries, high rates of return
on funds employed, conservative capitalization structures with moderate reliance
on debt and ample asset protection, broad margins in earnings coverage of fixed
financial charges and high internal cash generation, and well established access
to a range of financial markets and assured sources of alternate liquidity.
Issuers (or related supporting institutions) rated Prime-2 (P-2)
have a strong capacity for repayment of short-term promissory obligations. This
ordinarily will be evidenced by many of the characteristics cited above but to a
lesser degree. Earnings trends and coverage ratios, while sound, will be more
subject to variation. Capitalization characteristics, while still appropriate,
may be more affected by external conditions. Ample alternative liquidity is
maintained.
51
