<PAGE> 1
As filed with the Securities and Registration No. 333-24349
Exchange Commission on November 21, 1997. 811-08163
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [ ]
Pre-Effective Amendment No. 1 [X]
Post-Effective Amendment No. [ ]
and/or
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY
ACT OF 1940 [ ]
Amendment No. 1 [X]
(Check appropriate box or boxes)
------------------------
HOTCHKIS AND WILEY VARIABLE TRUST
(Exact name of registrant as specified in charter)
800 West 6th Street, Fifth Floor
Los Angeles, California 90017
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, including Area Code (213) 362-8888
GRACIE FERMELIA
800 WEST 6TH STREET, FIFTH FLOOR
LOS ANGELES, CALIFORNIA 90017
(Name and address of Agent for Service)
Approximate date of proposed public offering: As soon as practicable
after the effective date of the registration statement.
Title of Securities Being Registered...............Shares of Beneficial Interest
Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states that this Registration
Statement shall thereafter become effective on such date as the Commission,
acting pursuant to said Section 8(a), may determine.
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HOTCHKIS AND WILEY VARIABLE TRUST
CROSS-REFERENCE SHEET
(REQUIRED BY RULE 495)
<TABLE>
<CAPTION>
N-1A
Item No. Location in the Prospectus
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<S> <C> <C>
Part A:
Item 1. Cover Page Cover Page
Item 2. Synopsis Not Applicable
Item 3. Condensed Financial Information Not Applicable
Item 4. General Description of Registrant Cover Page; General
Information; Investment Objectives and Policies; Investment Risks;
Principal Investment Restrictions
Item 5. Management of the Fund Organization and Management; General Information
Item 5A. Management's Discussion of Fund Not Applicable
Performance
Item 6. Capital Stock and Other General Information; Dividends and Tax Status; Organization and Management
Securities
Item 7. Purchase of Securities Being Purchase and Redemption of Shares
Offered
Item 8. Redemption or Repurchase Purchase and Redemption of Shares
Item 9. Pending Legal Proceedings Not Applicable
<CAPTION>
Part B: Location in the Statement of Additional Information
---------------------------------------------------
<S> <C> <C>
Item 10. Cover Page Cover Page
Item 11. Table of Contents Table of Contents
Item 12. General Information and History General Information about the Trust
Item 13. Investment Objectives and Investment Objectives and Policies
Policies
Item 14. Management of the Registrant Management
Item 15. Control Persons and Principal General Information about the Trust
Holders of Securities
Item 16. Investment Advisory and Other Management
Securities
Item 17. Brokerage Allocation and Other Management
Practices
Item 18. Capital Stock and Other General Information about the Trust
Securities
Item 19. Purchase, Redemption and Pricing Net Asset Value
of Securities Being Offered
Item 20. Tax Status Dividends and Tax Status
Item 21. Underwriters Not Applicable
Item 22. Calculation of Performance Data Performance Information
Item 23. Financial Statements Financial Statements
</TABLE>
Part C:
Information required to be included in Part C is set forth under the
appropriate item, so numbered, in Part C to this Post-Effective
Amendment to the Registration Statement.
<PAGE> 3
HOTCHKIS AND WILEY VARIABLE TRUST
EQUITY INCOME VIP PORTFOLIO
FUND PROFILE
_______ __, 199_
THIS FUND PROFILE CONTAINS KEY INFORMATION ABOUT THE FUND. IF YOU WOULD LIKE
MORE INFORMATION BEFORE YOU INVEST, PLEASE CONSULT THE FUND'S ACCOMPANYING
PROSPECTUS. FOR DETAILS ABOUT THE FUND'S HOLDINGS OR RECENT INVESTMENT
STRATEGIES, PLEASE REVIEW THE FUND'S MOST RECENT ANNUAL OR SEMIANNUAL REPORT.
THE REPORTS MAY BE OBTAINED AT NO COST BY CALLING THE FUND AT (800) 236-4479.
1. Objective
Equity Income VIP Portfolio (the "Fund") seeks to provide current income and
long-term growth of income, accompanied by growth of capital.
2. Investment Strategy
The Fund will attempt to achieve its objective by investing in domestic equity
securities (consisting of common stocks, convertible preferred stocks,
convertible debt securities or warrants). The Fund will invest at least 80% of
its total assets in income-producing equity securities issued by companies with
a record of earnings and dividends. The remainder of its portfolio may be
invested in securities of companies which pay no dividends or interest but have
potential for growth unrecognized by the market or changes in business or
management that indicate possible growth.
3. Risks
The investment practices described above involve certain risks. The Fund's total
return may increase or decrease for reasons such as a change in the market price
of portfolio securities for a short or extended period. This means an investor's
shares may be worth more or less at redemption than at the time of purchase.
Also, the Fund may invest a small portion of its assets in non-investment grade
debt securities, commonly referred to as "junk bonds". These securities involve
greater credit risk than investment grade securities.
1
<PAGE> 4
4. Appropriateness
This Fund may be suitable for insurance companies that issue variable annuity
and variable life insurance contracts ("Participating Insurance Companies"),
whose contractholders have a long-term investment and can tolerate fluctuations
in value.
5. Fees and Expenses
The Advisor is paid a fee from the Fund's assets, computed daily and payable
monthly, at an annual rate of 0.75% of the Fund's average daily net assets. The
Advisor has voluntarily agreed to pay all annual Fund expenses in excess of
1.15% of the Fund's average daily net assets.
Sales charges, mortality and expense risk fees and other charges may be assessed
by Participating Insurance Companies to investors under the variable annuity
contracts or variable life insurance policies. Investors should refer to the
prospectus of the Participating Insurance Company's separate account for
information on fees.
6. Past Performance
As a newly created mutual fund, the Fund has no past performance.
7. Investment Advisor
Hotchkis and Wiley acts as Advisor to the Fund and generally adminsters the
affairs of the Hotchkis and Wiley Variable Trust. The Advisor is a division of
The Merrill Lynch Capital Management Group of Merrill Lynch Asset Management,
L.P. Gail Bardin and Sheldon Lieberman serve as the portfolio managers. They
have responsibility for the day-to-day management of the Fund's portfolio.
8. Purchases
Investors may not purchase shares of the Fund directly, but only through
variable annuity contracts and variable life insurance policies offered through
separate accounts of Participating Insurance Companies. Investors should refer
to the prospectus of the Participating Insurance Company's separate account for
information on how to purchase a variable annuity contract or variable life
insurance policy.
9. Redemptions
Investors may not redeem shares of the Fund directly, but only through variable
annuity contracts and variable life insurance policies offered through separate
accounts of Participating Insurance Companies. Investors should refer to the
prospectus of the Participating Insurance Company's separate account for
information on how to redeem monies from the applicable contract or policy.
2
<PAGE> 5
10. Distributions
The Fund expects to pay income dividends quarterly, which will be taxed as
ordinary income. Distributions of short-term gains also will be taxable as
ordinary income. Any net capital gains distributed to shareholders are taxable
as long-term capital gains regardless of the length of time a shareholder has
owned his shares. Dividends and distributions are paid in full and fractional
shares based on the net asset value per share at the close of business on the
record date, unless the shareholder requests, in writing to the Fund, payment in
cash.
3
<PAGE> 6
HOTCHKIS AND WILEY VARIABLE TRUST
INTERNATIONAL VIP PORTFOLIO
FUND PROFILE
_________, 199_
THIS FUND PROFILE CONTAINS KEY INFORMATION ABOUT THE FUND. IF YOU WOULD LIKE
MORE INFORMATION BEFORE YOU INVEST, PLEASE CONSULT THE FUND'S ACCOMPANYING
PROSPECTUS. FOR DETAILS ABOUT THE FUND'S HOLDINGS OR RECENT INVESTMENT
STRATEGIES, PLEASE REVIEW THE FUND'S MOST RECENT ANNUAL OR SEMIANNUAL REPORT.
THE REPORTS MAY BE OBTAINED AT NO COST BY CALLING THE FUND AT (800) 236-4479.
1. Objective
International VIP Portfolio (the "Fund") seeks to provide current income and
long-term growth of income, accompanied by growth of capital.
2. Investment Strategy
The Fund will attempt to achieve its objective by investing at least 65% of its
total assets in international equity securities, including equity securities in
at least three developed non-U.S. markets. The equity securities may consist of
common stocks, convertible preferred stocks, convertible debt securities or
warrants.
Under normal market conditions, the Fund will invest at least 80% of its total
assets in income-producing equity securities issued by companies with a record
of earnings and dividends. The remainder of its portfolio may be invested in
securities of companies which pay no dividends or interest but have potential
for growth unrecognized by the market or changes in business or management that
indicate possible growth. The Fund will not invest in foreign fixed-income
securities with a maturity in excess of one year.
3. Risks
The investment practices described above involve certain risks. The Fund's total
return may increase or decrease for reasons such as a change in the market price
of portfolio securities for a short or extended period. This means an investor's
shares may be worth more or less at redemption than at the time of purchase.
More specifically, investors in the Fund are exposed to risks of investing in
foreign securities, including currency exchange rate fluctuations, political
instability and greater price volatility and less liquidity of foreign
securities markets.
1
<PAGE> 7
4. Appropriateness
This Fund may be suitable for insurance companies that issue variable annuity
and variable life insurance contracts ("Participating Insurance Companies"),
whose contractholders have a long-term investment and can tolerate fluctuations
in value.
5. Fees and Expenses
The Advisor is paid a fee from the Fund's assets, computed daily and payable
monthly, at an annual rate of 0.75% of the Fund's average daily net assets. The
Advisor has voluntarily agreed to pay all annual Fund expenses in excess of
1.35% of the Fund's average daily net assets.
Sales charges, mortality and expense risk fees and other charges may be assessed
by Participating Insurance Companies to investors under the variable annuity
contracts or variable life insurance policies. Investors should refer to the
prospectus of the Participating Insurance Company's separate account for
information on fees.
6. Past Performance
As a newly created mutual fund, the Fund has no past performance.
7. Investment Advisor
Hotchkis and Wiley acts as Advisor to the Fund and generally administers the
affairs of the Hotchkis and Wiley Variable Trust. The Advisor is a division of
The Merrill Lynch Capital Management Group of Merrill Lynch Asset Management,
L.P. Sarah Ketterer, Harry Hartford and David Chambers serve as the portfolio
managers. They have responsibility for the day-to-day management of the Fund's
portfolio.
8. Purchases
Investors may not purchase shares of the Fund directly, but only through
variable annuity contracts and variable life insurance policies offered through
separate accounts of Participating Insurance Companies. Investors should refer
to the prospectus of the Participating Insurance Company's separate account for
information on how to purchase a variable annuity contract or variable life
insurance policy.
9. Redemptions
Investors may not redeem shares of the Fund directly, but only through variable
annuity contracts and variable life insurance policies offered through separate
accounts of Participating Insurance Companies. Investors should refer to the
prospectus of the Participating Insurance Company's separate account for
information on how to redeem monies from the applicable contract or policy.
2
<PAGE> 8
10. Distributions
The Fund expects to pay income dividends semi-annually, which will be taxed as
ordinary income. Distributions of short-term capital gains also will be taxable
as ordinary income. Any net capital gains distributed to shareholders are
taxable as long-term capital gains regardless of the length of time a
shareholder has owned his shares. Dividends and distributions are paid in full
and fractional shares based on the net asset value per share at the close of
business on the record date, unless the shareholder requests, in writing to the
Fund, payment in cash.
3
<PAGE> 9
HOTCHKIS AND WILEY VARIABLE TRUST
TOTAL RETURN BOND VIP PORTFOLIO
FUND PROFILE
_________, 199_
THIS FUND PROFILE CONTAINS KEY INFORMATION ABOUT THE FUND. IF YOU WOULD LIKE
MORE INFORMATION BEFORE YOU INVEST, PLEASE CONSULT THE FUND'S ACCOMPANYING
PROSPECTUS. FOR DETAILS ABOUT THE FUND'S HOLDINGS OR RECENT INVESTMENT
STRATEGIES, PLEASE REVIEW THE FUND'S MOST RECENT ANNUAL OR SEMIANNUAL REPORT.
THE REPORTS MAY BE OBTAINED AT NO COST BY CALLING THE FUND AT (800) 236-4479.
1. Objectives
Total Return Bond VIP Portfolio (the "Fund") seeks to maximize long-term total
return.
2. Investment Strategy
The Fund will attempt to achieve its objective by investing in a diversified
portfolio of fixed-income securities of varying maturities with a portfolio
duration of two to eight years. Portfolio holdings will be concentrated in areas
of the bond market (based on quality, sector, coupon or maturity) which the
Advisor believes to be relatively undervalued. The types of securities that may
be purchased by the Fund include securities issued by domestic or foreign
entities, such as U.S. government securities, corporate debt securities,
mortgage - and other asset-backed securities. Under normal circumstances, at
least 70% of the Fund's net assets will be invested in investment grade debt
instruments.
3. Risks
The investment practices described above involve certain risks. The Fund's total
return may increase or decrease for reasons such as a change in interest rates
for a short or extended period. Bond prices typically fall as interest rates
rise. This means an investor's shares may be worth more or less at redemption
than at the time of purchase.
Investors also are exposed to credit risk, or the risk that a bond issuer will
fail to repay principal and pay interest.
The Fund may invest up to 15% of its assets in non-investment grade debt
securities, commonly referred to as "junk bonds". These securities involve
greater credit risk than investment grade securities.
1
<PAGE> 10
4. Appropriateness
This Fund may be suitable for insurance companies that issue variable annuity
and variable life insurance contracts ("Participating Insurance Companies"),
whose contractholders have a long-term investment and can tolerate fluctuations
in value.
5. Fees and Expenses
The Advisor is paid a fee from the Fund's assets, computed daily and payable
monthly, at an annual rate of 0.55% of the Fund's average daily net assets. The
Advisor has voluntarily agreed to pay all annual Fund expenses in excess of
0.65% of the Fund's average daily net assets.
Sales charges, mortality and expense risk fees and other charges may be assessed
by Participating Insurance Companies to investors under the variable annuity
contracts or variable life insurance policies. Investors should refer to the
prospectus of the Participating Insurance Company's separate account for
information on fees.
6. Past Performance
As a newly created mutual fund, the Fund has no past performance.
7. Investment Advisor
Hotchkis and Wiley acts as Advisor to the Fund and generally adminsters the
affairs of the Hotchkis and Wiley Variable Trust. The Advisor is a division of
The Merrill Lynch Capital Management Group of Merrill Lynch Asset Management,
L.P. Roger DeBard, Michael Sanchez and John Queen serve as the portfolio
managers. They have responsibility for the day-to-day management of the Fund's
portfolio.
8. Purchases
Investors may not purchase shares of the Fund directly, but only through
variable annuity contracts and variable life insurance policies offered through
separate accounts of Participating Insurance Companies. Investors should refer
to the prospectus of the Participating Insurance Company's separate account for
information on how to purchase a variable annuity contract or variable life
insurance policy.
9. Redemptions
Investors may not redeem shares of the Fund directly, but only through variable
annuity contracts and variable life insurance policies offered through separate
accounts of Participating Insurance Companies. Investors should refer to the
prospectus of the Participating Insurance Company's separate account for
information on how to redeem monies from the applicable contract or policy.
2
<PAGE> 11
10. Distributions
The Fund expects to declare income dividends daily and pay them monthly to
shareholders, which will be taxed as ordinary income. Distributions of
short-term capital gains also will be taxable as ordinary income. Any net
capital gains distributed to shareholders are taxable as long-term capital gains
regardless of the length of time a shareholder has owned his shares. Dividends
and distributions are paid in full and fractional shares based on the net asset
value per share at the close of business on the record date, unless the
shareholder requests, in writing to the Fund, payment in cash.
3
<PAGE> 12
HOTCHKIS AND WILEY VARIABLE TRUST
LOW DURATION VIP PORTFOLIO
FUND PROFILE
_________, 199_
THIS FUND PROFILE CONTAINS KEY INFORMATION ABOUT THE FUND. IF YOU WOULD LIKE
MORE INFORMATION BEFORE YOU INVEST, PLEASE CONSULT THE FUND'S ACCOMPANYING
PROSPECTUS. FOR DETAILS ABOUT THE FUND'S HOLDINGS OR RECENT INVESTMENT
STRATEGIES, PLEASE REVIEW THE FUND'S MOST RECENT ANNUAL OR SEMIANNUAL REPORT.
THE REPORTS MAY BE OBTAINED AT NO COST BY CALLING THE FUND AT (800) 236-4479.
1. Objectives
Low Duration VIP Portfolio (the "Fund") seeks to maximize total return,
consistent with preservation of capital.
2. Investment Strategy
The Fund will attempt to achieve its objective by investing in a diversified
portfolio of fixed-income securities of varying maturities with a portfolio
duration of one to three years. The types of securities that may be purchased by
the Fund include securities issued by domestic or foreign entities, such as U.S.
government securities, corporate debt securities and mortgage - and other
asset-backed securities. The Fund's net assets primarily will be investment
grade.
3. Risks
The investment practices described above involve certain risks. The Fund's total
return may increase or decrease for reasons such as a change in interest rates
for a short or extended period. Bond prices typically fall as interest rates
rise. The total rate of return of this Fund is expected to exhibit less
volatility than that of a longer duration fixed-income fund. This means an
investor's price may be worth more or less at redemption than at the time of
purchase.
Investors also are exposed to credit risk, or the risk that a bond issuer will
fail to repay principal and pay interest.
The Fund may invest a small portion of its assets in non-investment grade debt
securities, commonly referred to as "junk bonds". These securities involve
greater credit risk than investment grade securities.
1
<PAGE> 13
4. Appropriateness
This Fund may be suitable for insurance companies that issue variable annuity
and variable life insurance contracts ("Participating Insurance Companies"),
whose contractholders have a long-term investment and can tolerate fluctuations
in value.
5. Fees and Expenses
The Advisor is paid a fee from the Fund's assets, computed daily and payable
monthly, at an annual rate of 0.46% of the Fund's average daily net assets. The
Advisor has voluntarily agreed to pay all Fund expenses in excess of 0.58% of
the Fund's average daily net assets.
Sales charges, mortality and expense risk fees and other charges may be assessed
by Participating Insurance Companies to investors under the variable annuity
contracts or variable life insurance policies. Investors should refer to the
prospectus of the Participating Insurance Company's separate account for
information on fees.
6. Past Performance
As a newly created mutual fund, the Fund has no past performance.
7. Investment Adviser
Hotchkis and Wiley acts as Advisor to the Fund and generally administers the
affairs of the Hotchkis and Wiley Variable Trust. The Adviser is a division of
The Merrill Lynch Capital Management Group of Merrill Lynch Asset Management,
L.P. Roger DeBard, Michael Sanchez and John Queen serve as the portfolio
managers. They have responsibility for the day-to-day management of the Fund's
portfolio.
8. Purchases
Investors may not purchase shares of the Fund directly, but only through
variable annuity contracts and variable life insurance policies offered through
separate accounts of Participating Insurance Companies. Investors should refer
to the prospectus of the Participating Insurance Company's separate account for
information on how to purchase a variable annuity contract or variable life
insurance policy.
9. Redemptions
Investors may not redeem shares of the Fund directly, but only through variable
annuity contracts and variable life insurance policies offered through separate
accounts of Participating Insurance Companies. Investors should refer to the
prospectus of the Participating Insurance Company's separate account for
information on how to redeem monies from the applicable contract or policy.
2
<PAGE> 14
10. Distributions
The Fund expects to declare income dividends daily and pay them monthly, which
will be taxed as ordinary income. Distributions of short-term capital gains also
will be taxable as ordinary income. Any net capital gains distributed to
shareholders are taxable as long-term capital gains regardless of the length of
time a shareholder has owned his shares. Dividends and distributions are paid in
full and fractional shares based on the net asset value per share at the close
of business on the record date, unless the shareholder requests, in writing to
the Fund, payment in cash.
3
<PAGE> 15
P R O S P E C T U S
[HOTCHKIS AND WILEY VARIABLE TRUST LOGO]
HOTCHKIS AND WILEY VARIABLE TRUST (THE "TRUST") IS AN OPEN-END, MANAGEMENT
INVESTMENT COMPANY HAVING FOUR SEPARATE DIVERSIFIED PORTFOLIOS (THE "FUNDS"),
EACH OF WHICH IS A SEPARATE MUTUAL FUND. THE FUNDS ARE INVESTMENT VEHICLES FOR
VARIABLE ANNUITY CONTRACTS AND/OR VARIABLE LIFE INSURANCE CONTRACTS ISSUED BY
PARTICIPATING INSURANCE COMPANIES.
E Q U I T Y I N C O M E
V I P P O R T F O L I O
Seeks to provide current income and long-term growth of income, accompanied by
growth of capital. The Fund invests primarily in domestic equity securities.
I N T E R N A T I O N A L
V I P P O R T F O L I O
Seeks to provide current income and long-term growth of income, accompanied by
growth of capital. The Fund invests in international equity securities.
T O T A L R E T U R N B O N D
V I P P O R T F O L I O
Seeks to maximize long-term total return. The Fund invests in a diversified
portfolio of fixed-income securities of varying maturities with a portfolio
duration of two to eight years.
L O W D U R A T I O N
V I P P O R T F O L I O
Seeks to maximize total return, consistent with preservation of capital. The
Fund invests in a diversified portfolio of fixed-income securities of varying
maturities with a portfolio duration of one to three years.
- -------------------------------------------------------------------------------
This Prospectus provides you with the basic information you should know before
investing in any of the Funds. You should read it and keep it for future
reference. A Statement of Additional Information dated _____________, 1997,
containing additional information about the Trust and each Fund has been filed
with the Securities and Exchange Commission and is incorporated by reference in
its entirety into this Prospectus. You may obtain a copy of the Statement of
Additional Information without charge by calling the Trust at 800-236-4479 or
writing the Trust at 800 West Sixth Street, Fifth Floor, Los Angeles, California
90017.
SHARES OF THE FUNDS ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, ANY BANK, NOR ARE THEY FEDERALLY INSURED BY THE FEDERAL DEPOSIT
INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD OR ANY OTHER AGENCY.
INVESTMENT IN A FUND'S SHARES INVOLVES RISK, INCLUDING THE POSSIBLE LOSS OF
PRINCIPAL.
SHARES OF THE FUNDS ARE NOT OFFERED TO THE GENERAL PUBLIC BUT MAY ONLY BE
PURCHASED BY THE SEPARATE ACCOUNTS OF PARTICIPATING INSURANCE COMPANIES FOR THE
PURPOSE OF FUNDING VARIABLE ANNUITY CONTRACTS AND/OR VARIABLE LIFE INSURANCE
CONTRACTS.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY
OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
THERE CAN BE NO ASSURANCE THAT THE INVESTMENT OBJECTIVE OF ANY FUND WILL BE
ACHIEVED.
HOTCHKIS AND WILEY VARIABLE TRUST
800 West 6th Street, Fifth Floor, Los Angeles, California 90017
800-236-4479
Investment Advisor: Hotchkis and Wiley
__________, 1997
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<PAGE> 16
T A B L E O F C O N T E N T S
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INVESTMENT OBJECTIVES AND POLICIES................ 3
SECURITIES AND TECHNIQUES USED BY THE FUNDS....... 7
INVESTMENT RISKS.................................. 13
PRINCIPAL INVESTMENT RESTRICTIONS................. 15
ORGANIZATION AND MANAGEMENT....................... 15
PURCHASE AND REDEMPTION OF SHARES................. 17
DIVIDENDS AND TAX STATUS.......................... 18
NET ASSET VALUE................................... 20
PERFORMANCE INFORMATION........................... 20
GENERAL INFORMATION............................... 21
APPENDIX -- DESCRIPTION OF RATINGS................ 22
[HOTCHKIS & WILEY LOGO]
IMPORTANT TELEPHONE NUMBER
---------------------------------------------------------
Client Services and Shareholder Inquiries 800-236-4479
<PAGE> 17
INVESTMENT OBJECTIVES AND POLICIES
- --------------------------------------------------------------------------------
GENERAL
Each Fund's investment objective is a fundamental policy, which cannot be
changed without the approval of a majority of the Fund's outstanding voting
securities, as defined in the Investment Company Act of 1940, as amended (the
"1940 Act"). There can be no assurance that any objective will be met. For a
discussion of certain risks associated with investment in the Funds, including
their use of derivatives, see "Investment Risks" on page .
HOTCHKIS AND WILEY, a division of the Merrill Lynch Capital Management Group of
Merrill Lynch Asset Management L.P. (the "Advisor"), acts as investment advisor
to each Fund.
THE EQUITY INCOME VIP PORTFOLIO
The investment objective of the EQUITY INCOME VIP PORTFOLIO is to provide
current income and long-term growth of income, accompanied by growth of capital.
The EQUITY INCOME VIP PORTFOLIO will attempt to achieve its objective by
investing in equity securities. In selecting investments for the Fund, the
Advisor focuses on securities that it believes to have superior values. In
arriving at this determination, the Advisor will generally seek securities of
companies that have such characteristics as earnings yield at least 3% greater
than the yield on long-term bonds, dividend yield which exceeds the composite
yield on the securities comprising the Standard & Poor's Index of 500 Common
Stocks ("S&P 500"), and overall financial strength.
Under normal market conditions, the EQUITY INCOME VIP PORTFOLIO will invest at
least 80% of its total assets in income-producing equity securities issued by
companies with a record of earnings and dividends. The remainder of its
portfolio may be invested in securities of companies which pay no dividends or
interest but have potential for growth unrecognized by the market or changes in
business or management that indicate possible growth.
The equity securities that the Fund may purchase consist of common stocks or
securities having characteristics of common stocks, such as convertible
preferred stocks, convertible debt securities or warrants. Any such convertible
securities to be invested in by the Fund will be rated investment grade or, if
unrated, be of comparable quality in the opinion of the Advisor, provided,
however, that the Fund may invest up to 5% of its net assets in convertible
securities rated at least B by Moody's Investors Service ("Moody's") or Standard
& Poor's Ratings Group ("S&P") or, if unrated, of comparable quality in the
opinion of the Advisor. "Investment grade" means the debt securities have been
rated at least (i) Baa by Moody's or BBB by S&P, Fitch Investors Service, Inc.
("Fitch") or Duff & Phelps Credit Rating Co. ("Duff & Phelps"); (ii) A-2 by S&P,
Prime-2 by Moody's, F-2 by Fitch or D-2 by Duff & Phelps for short-term
obligations; or (iii) of comparable quality as determined by the Advisor in the
case of unrated securities. All ratings are determined at the time of
investment. See the Appendix for a description of ratings.
Securities rated Baa are considered by Moody's to have speculative
characteristics. For Baa/BBB rated securities, changes in economic conditions or
other circumstances are more likely to lead to a weakened capacity to make
principal and interest payments than is the case with higher grade securities.
Securities rated below BBB or Baa are judged to be predominantly speculative
with respect to their capacity to pay interest and repay principal in accordance
with the terms of their obligations and are commonly known as "junk bonds." See
"Investment Risks -- Risks of Investing in Fixed-Income Securities" on page .
Investors should carefully consider the relative risks associated with
investments in securities which carry lower ratings and in comparable unrated
securities.
3
<PAGE> 18
Subsequent to its purchase by the Fund, a security may be assigned a lower
rating or cease to be rated. Such an event would not require the sale of the
security, but the Advisor will consider such an event in determining whether the
Fund should continue to hold the security in its portfolio.
For liquidity purposes and pending investment of cash receipts, the Fund may
invest in short-term (i.e., maturing or due in one year or less from date of
purchase) investment grade debt securities of the U.S. Government, its agencies
and instrumentalities, bank certificates of deposit, bankers' acceptances, high
quality commercial paper, demand notes and repurchase agreements.
When adverse market or economic conditions indicate to the Advisor that a
temporary defensive strategy is appropriate, the Fund may invest all or part of
its assets in short-term investment grade debt obligations.
The EQUITY INCOME VIP PORTFOLIO can invest on a "global" basis, although it is
not required to. See "Securities and Techniques Used by the Funds -- Foreign
Securities" on page 8.
THE INTERNATIONAL VIP PORTFOLIO
The investment objective of the INTERNATIONAL VIP PORTFOLIO is to provide
current income and long-term growth of income, accompanied by growth of capital.
The Fund will attempt to achieve its objective through a policy of investing at
least 65% of its total assets in equity securities in at least three non-U.S.
markets. Ordinarily, the Fund will invest in equity securities issued by
companies located in some or all of the developed foreign equity markets. These
markets generally include 15 markets in Europe as well as Australia, New
Zealand, Japan, Hong Kong, Singapore, Malaysia, Canada and South Korea. There
are risks associated with investment in foreign securities, as described under
"Investment Risks -- Risks of Investing in Emerging Market and Other Foreign
Securities" on page 12.
In selecting investments for the Fund, the Advisor will, in general, use the
same criteria as those used in selecting investments for the EQUITY INCOME VIP
PORTFOLIO; that is, it will focus on securities that it believes have superior
values. The Advisor will generally seek equity securities of companies in each
country that have such characteristics as dividend yield greater than the local
market average; earnings yield at least three percentage points greater than the
country's 10-year government bond yield (or low price-to-earnings ratios
relative to the local market), and financial strength.
Under normal market conditions, the INTERNATIONAL VIP PORTFOLIO will invest at
least 80% of its total assets in income-producing equity securities issued by
companies with a record of earnings and dividends. The remainder of its
portfolio may be invested in securities of companies which pay no dividends or
interest, but have potential for growth unrecognized by the market or changes in
business or management that indicate possible growth. The Fund will not invest
in foreign fixed-income securities with a maturity in excess of one year.
The equity securities that the Fund may purchase consist of common stocks or
securities having characteristics of common stocks, such as convertible
preferred stocks, convertible debt securities or warrants. Any such convertible
securities will be securities of an issuer having an outstanding issue of debt
securities rated at least A by Moody's or S&P or, if unrated, be of comparable
quality in the opinion of the Advisor.
For liquidity purposes and pending investment of cash receipts, the Fund may
invest in short-term investment grade debt securities of the U.S. Government,
its agencies and instrumentalities, bank certificates of deposit, bankers'
acceptances, high quality commercial paper, demand notes and repurchase
agreements.
When adverse market or economic conditions indicate to the Advisor that a
temporary defensive strategy is appropriate, the Fund may invest all or part of
its assets in short-term investment grade debt obligations.
THE INTERNATIONAL VIP PORTFOLIO may purchase foreign currency options or enter
into forward foreign currency exchange contracts for the purpose of hedging
against
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the effect that currency fluctuations will have on the value of Fund assets or
liabilities. See "Securities and Techniques Used by the Funds -- Other
Derivative Instruments" on page 11.
THE FIXED-INCOME FUNDS:
THE TOTAL RETURN BOND VIP PORTFOLIO
The investment objective of the TOTAL RETURN BOND VIP PORTFOLIO is to maximize
long-term total return. The Fund invests in a diversified portfolio of fixed-
income securities of varying maturities with a portfolio duration of two to
eight years. Portfolio holdings will be concentrated in areas of the bond market
(based on quality, sector, coupon or maturity) which the Advisor believes to be
relatively undervalued. The Advisor views bonds to be any interest-bearing
security that obligates the issuer to pay the bondholder specified sums of money
on specified dates and generally requires the issuer to repay the principal
amount of the loan at maturity.
THE LOW DURATION VIP PORTFOLIO
The investment objective of the LOW DURATION VIP PORTFOLIO is to maximize total
return, consistent with preservation of capital. The Fund invests in a
diversified portfolio of fixed-income securities of varying maturities with a
portfolio duration of one to three years. The total rate of return for this Fund
is expected to exhibit less volatility than that of a longer duration
fixed-income fund such as the TOTAL RETURN BOND VIP PORTFOLIO.
INVESTMENT POLICIES OF THE FIXED-INCOME FUNDS
THE TOTAL RETURN BOND VIP PORTFOLIO and the LOW DURATION VIP PORTFOLIO (the
"FIXED-INCOME FUNDS") will attempt to achieve their objectives by investing in
the following types of securities which may be issued by domestic or foreign
entities: (i) U.S. Government securities; (ii) corporate debt securities,
including bonds, notes and debentures; (iii) corporate commercial paper; (iv)
mortgage- and other asset-backed securities, including collateralized mortgage
obligations ("CMOs") and Real Estate Mortgage Investment Conduits ("REMICs");
(v) variable and floating rate debt securities (including inverse floaters);
(vi) structured debentures, bonds and notes; (vii) bank certificates of deposit;
(viii) fixed time deposits and bankers' acceptances; (ix) repurchase agreements,
reverse repurchase agreements and dollar rolls; (x) preferred stock of issuers
whose assets consist of mortgage-backed securities of U.S. Government agencies;
(xi) debt securities that are convertible into or exchangeable for equity
securities ("convertible securities"); (xii) obligations of foreign governments
or their subdivisions, agencies and instrumentalities; and (xiii) obligations of
international agencies (such as the Agency for International Development) or
supranational entities. There is no limitation on the percentage of a Fund's
assets that may be committed to any of these types of securities, except to the
extent that a security may be deemed to be illiquid. See "Securities and
Techniques Used by the Funds" on page 7.
Under normal circumstances, the TOTAL RETURN BOND VIP PORTFOLIO will invest at
least 70% of its net assets in debt instruments rated at least investment grade.
For a description of "investment grade" see "THE EQUITY INCOME VIP PORTFOLIO."
Up to 15% of the TOTAL RETURN BOND VIP PORTFOLIO's net assets may be invested in
securities rated below investment grade but rated B or higher by one of the
nationally recognized rating agencies or, if unrated, of comparable quality in
the opinion of the Advisor.
Securities rated Baa are considered by Moody's to have speculative
characteristics. For Baa/BBB rated securities, changes in economic conditions or
other circumstances are more likely to lead to a weakened capacity to make
principal and interest payments than is the case with higher grade securities.
Securities rated below BBB or Baa are judged to be predominantly speculative
with respect to their capacity to pay interest and repay principal in accordance
with the terms of their obligations and are commonly known as "junk bonds." See
"Investment Risks -- Risks of Investing in Fixed-Income Securities" on page 13.
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Under normal circumstances, the LOW DURATION VIP PORTFOLIO will invest at least
70% of its net assets in securities rated at least: (i) A by Moody's, S&P, Fitch
or Duff & Phelps; (ii) A-2 by S&P, Prime-2 by Moody's, F-2 by Fitch or D-2 by
Duff & Phelps for short-term debt obligations; or (iii) of comparable quality as
determined by the Advisor in the case of unrated securities. Up to 10% of the
LOW DURATION VIP PORTFOLIO's net assets may be invested in securities rated
below investment grade but rated B or higher by one of the nationally recognized
rating agencies or, if unrated, of comparable quality in the opinion of the
Advisor. The remainder of the LOW DURATION VIP PORTFOLIO's investments will be
rated Baa or BBB by at least one of these rating agencies or, if unrated, of
comparable quality in the opinion of the Advisor.
After its purchase by one of the Funds, a security may be assigned a lower
rating or cease to be rated. This would not require the sale of the issue, but
the Advisor will consider such an event in determining whether the Fund should
continue to hold the security in the portfolio.
Each of the FIXED-INCOME FUNDS may invest up to 15% of its net assets in
emerging market foreign securities, which are generally considered to be of a
credit quality below investment grade.
Each of the FIXED-INCOME FUNDS may invest up to 25% of its total assets in
securities of foreign issuers that are denominated in U.S. dollars. Investment
by these Funds in securities of foreign issuers that are not denominated in U.S.
dollars will be limited to a maximum of 15% of each FIXED-INCOME FUND'S total
assets. See "Securities and Techniques Used by the Funds -- Foreign Securities"
on page .
The FIXED-INCOME FUNDS each invest in a diversified portfolio of fixed-income
securities with a different portfolio "duration." Duration is a commonly used
measure of the potential volatility of the price of a debt security, or the
aggregate market value of a portfolio of debt securities, prior to maturity.
Duration measures the magnitude of the change in price of a debt security
relative to a given change in the market interest rate. Duration incorporates a
bond's yield, coupon interest payments, final maturity, call and put features
and prepayment exposure into one measure.
For any fixed-income security with interest payments occurring prior to the
payment of principal, duration is ordinarily less than maturity. In general, all
other things being equal, the lower the stated or coupon rate of interest of a
fixed-income security, the longer the duration of the security; conversely, the
higher the stated or coupon rate of interest of a fixed-income security, the
shorter the duration of the security. A Fund's computation of duration is based
on estimated rather than known factors. Thus, there can be no assurance that a
particular portfolio duration will at all times be achieved by the Fund.
Duration is used in the management of the FIXED-INCOME FUNDS as a tool to
measure interest rate risk. For example, a Fund with a 2-year duration would be
expected to change in value 2% for every 1% move in interest rates. Assuming an
expected average duration of 2 years for the LOW DURATION VIP PORTFOLIO, a 1%
decline in interest rates would cause the Fund to gain 2% in price; likewise, a
1% rise in interest rates would produce a decline of 2% in the Fund's price.
Assuming an expected average duration of 4.5 years for the TOTAL RETURN BOND VIP
PORTFOLIO, a 1% decline in interest rates would cause the Fund to gain 4.5% in
price; likewise, a 1% rise in interest rates would produce a decline of 4.5% in
the Fund's price. Other factors such as changes in credit quality, prepayments,
the shape of the yield curve and liquidity affect the net asset value of the
Funds and may be correlated with changes in interest rates. These factors can
exacerbate swings in the Funds' share prices during periods of volatile interest
rate changes.
For a more detailed discussion of duration, see "Investment Objectives and
Policies -- Duration" in the Statement of Additional Information.
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SECURITIES AND TECHNIQUES USED BY THE FUNDS
- --------------------------------------------------------------------------------
The following provides a summary of the securities and techniques used by the
Funds. The Statement of Additional Information contains more detailed
information about these investments and the risks associated with them.
U.S. GOVERNMENT SECURITIES
Each Fund may invest in U.S. Government securities. U.S. Government securities
include direct obligations issued by the United States Treasury, such as
Treasury bills, certificates of indebtedness, notes, bonds and component parts
of notes or bonds (including the principal of such obligations or the interest
payments scheduled to be paid on such obligations). U.S. Government agencies and
instrumentalities that issue or guarantee securities include, but are not
limited to, the Federal National Mortgage Association ("FNMA"), Government
National Mortgage Association ("GNMA"), Federal Home Loan Banks, Federal
Financing Bank, and Student Loan Marketing Association.
All Treasury securities are backed by the full faith and credit of the United
States. Obligations of U.S. Government agencies and instrumentalities may or may
not be supported by the full faith and credit of the United States. Some, such
as the Federal Home Loan Banks, are backed by the right of the agency or
instrumentality to borrow from the Treasury. Others, such as securities issued
by FNMA, are supported only by the credit of the instrumentality and not by the
Treasury. If the securities are not backed by the full faith and credit of the
United States, the owner of the securities must look principally to the agency
issuing the obligation for repayment and may not be able to assert a claim
against the United States in the event that the agency or instrumentality does
not meet its commitment.
Among the U.S. Government securities that may be purchased by the FIXED-INCOME
FUNDS are certain "mortgage-backed securities" of GNMA, the Federal Home Loan
Mortgage Corporation ("FHLMC") and FNMA. See the discussion of Mortgage-Related
Securities on page .
CORPORATE AND OTHER OBLIGATIONS
Each Fund may invest in corporate debt securities, variable and floating rate
debt securities and corporate commercial paper in the rating categories
described above. Floating rate securities normally have a rate of interest which
is set as a specific percentage of a designated base rate, such as the rate on
Treasury bonds or bills or the prime rate at a major commercial bank. The
interest rate on floating rate securities changes periodically when there is a
change in the designated base rate. Variable rate securities provide for a
specified periodic adjustment in the interest rate based on prevailing market
rates.
The FIXED-INCOME FUNDS may invest in structured debentures and structured notes,
which are hybrid instruments with characteristics of both bonds and swap
agreements. Like a bond, these securities make regular coupon payments and
generally have fixed principal amounts. However, the coupon payments are
typically tied to a swap agreement which can be affected by changes in a variety
of factors such as exchange rates, the shape of the yield curve and foreign
interest rates. Because of these factors, structured debentures and structured
notes can display price behavior that is more volatile than and often not
correlated to other fixed-income securities.
The FIXED-INCOME FUNDS may also invest in inverse floaters and tiered index
bonds. An inverse floater is a type of derivative that bears a floating or
variable interest rate that moves in the opposite direction to the interest rate
on another security or index level. Changes in the interest rate of the other
security or index inversely affect the residual interest rate paid on the
inverse floater, with the result that the inverse floater's price will be
considerably more volatile than that of a fixed-rate bond. Tiered index bonds
are also a type of derivative instrument. The interest rate on a tiered index
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<PAGE> 22
bond is tied to a specified index or market rate. So long as this index or
market rate is below a predetermined "strike" rate, the interest rate on the
tiered index bond remains fixed. If, however, the specified index or market rate
rises above the "strike" rate, the interest rate on the tiered index bond will
decrease. In general, the interest rates on tiered index bonds and inverse
floaters move in the opposite direction of prevailing interest rates. The market
for inverse floaters and tiered index bonds is relatively new. These corporate
debt obligations may have characteristics similar to those of mortgage-related
securities, but corporate debt obligations, unlike mortgage-related securities,
are not subject to prepayment risk other than through contractual call
provisions which generally impose a penalty for prepayment.
ASSET-BACKED SECURITIES
The FIXED-INCOME FUNDS may invest in securities whose principal and interest
payouts are backed by, or supported by, any of various types of assets. These
assets most typically include receivables related to the purchase of
automobiles, credit card loans, and home equity loans. These securities
generally take the form of a structured type of security, including
pass-through, pay-through, and stripped interest payout structures.
FOREIGN SECURITIES
Each Fund may invest in foreign securities. Foreign economies may differ from
the U.S. economy; individual foreign companies may differ from domestic
companies in the same industry; and foreign currencies may be stronger or weaker
than the U.S. dollar. The Advisor believes that the ability to invest abroad
will enable the Funds to take advantage of these differences when they are
favorable.
Fixed-income securities that may be purchased by the INTERNATIONAL and
FIXED-INCOME FUNDS include debt obligations issued or guaranteed by foreign
governments, their subdivisions, agencies or instrumentalities, or by
supranational entities that have been constituted by the governments of several
countries to promote economic development, such as The World Bank and The Asian
Development Bank. Foreign investment in certain foreign government debt is
restricted or controlled to varying degrees.
The FIXED-INCOME FUNDS may invest in fixed-income securities of issuers located
in emerging foreign markets. Such markets generally include every country in the
world other than the U.S., Canada, Japan, Australia, Malaysia, New Zealand, Hong
Kong, Singapore, South Korea and most Western European countries. From time to
time, emerging markets have offered the opportunity for higher returns but
involve a higher level of risk. Accordingly, the Advisor believes that the
Funds' limited ability to invest in emerging markets throughout the world may
enable the Funds to obtain a wider range of attractive investment opportunities.
Emerging market securities include securities issued or guaranteed by
governments, their agencies, instrumentalities or central banks ("sovereign
debt"); securities of issuers organized and operated to restructure the
investment characteristics of sovereign debt; securities of banks and other
business entities; and securities denominated in or indexed to currencies of
emerging markets. These securities include "Brady Bonds," which afford emerging
market countries a means to restructure their outstanding commercial bank debt.
Foreign governmental issuers of debt or the governmental authorities that
control repayment of the debt may be unable or unwilling to repay principal or
pay interest when due and all or a portion of the interest payments and/or
principal repayment with respect to Brady Bonds may be uncollateralized.
Emerging market securities are generally considered to be of a credit quality
below investment grade, even though they often are not rated by any nationally
recognized rating agency. The Advisor seeks to reduce the risk associated with
emerging market securities by limiting the amount of such securities held by the
Funds, by the depth of its own credit analysis, and evaluation of political,
economic, currency and other factors that may be pertinent.
There are risks in investing in emerging market and other foreign securities.
See "Investment Risks -- Risks
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<PAGE> 23
of Investing in Emerging Market and Other Foreign Securities" on page .
REPURCHASE AGREEMENTS
Each Fund may enter into repurchase agreements involving U.S. Government
securities with commercial banks or broker-dealers, whereby the seller of a
security agrees to repurchase the security on an agreed-upon date in the future.
While each Fund intends to be fully "collateralized" as to such agreements, and
the collateral will be marked to market daily, if the person obligated to
repurchase from the Fund defaults, there may be possible delays and expenses in
liquidating the securities subject to the repurchase agreement, a decline in
their value and loss of interest.
REVERSE REPURCHASE AGREEMENTS
The FIXED-INCOME FUNDS may enter into reverse repurchase agreements, whereby a
Fund sells securities concurrently with entering into an agreement to repurchase
those securities at a later date at a fixed price. During the reverse repurchase
agreement period, the Fund continues to receive principal and interest payments
on those securities. Reverse repurchase agreements are speculative techniques
involving leverage and are considered borrowings by the Funds for purposes of
the percentage limitations applicable to borrowings.
DOLLAR ROLLS
The FIXED-INCOME FUNDS may use dollar rolls as part of their investment
strategy. In a dollar roll, a Fund sells securities for delivery in the current
month and simultaneously contracts to repurchase substantially similar
securities (same type and coupon) on a specified future date from the same
party. During the roll period, the Fund forgoes principal and interest paid on
the securities. The Fund is compensated by the difference between the current
sales price and the forward price for the future purchase (often referred to as
the "drop") as well as by the interest earned on the cash proceeds of the
initial sale. A "covered roll" is a specific type of dollar roll for which there
is an offsetting cash position or cash equivalent security position that matures
on or before the forward settlement date of the dollar roll transaction.
The FIXED-INCOME FUNDS will establish a segregated account with the custodian in
which they will maintain cash, U.S. Government securities, equity securities or
other liquid, unencumbered assets, marked-to-market daily, equal in value to
their obligations in respect of dollar rolls. Dollar rolls involve the risk that
the market value of the securities retained by the Fund may decline below the
price of the securities the Fund has sold but is obligated to repurchase under
the agreement. If the buyer of the securities under a dollar roll files for
bankruptcy or becomes insolvent, the Fund's use of the proceeds of the agreement
may be restricted pending a determination by the other party, or its trustee or
receiver, whether to enforce the Fund's obligation to repurchase the securities.
Dollar rolls are speculative techniques involving leverage and are considered
borrowings by the Funds, subject to their limitations on borrowings.
BORROWING
As a fundamental policy, the EQUITY INCOME and INTERNATIONAL VIP PORTFOLIOS may
borrow money, but only from banks for temporary or emergency purposes in amounts
not exceeding 10% of each Fund's total assets. The FIXED-INCOME FUNDS may borrow
for temporary, emergency or investment purposes. This borrowing may be
unsecured. The 1940 Act requires a Fund to maintain continuous asset coverage
(that is, total assets including borrowings, less liabilities exclusive of
borrowings) of 300% of the amount borrowed. Borrowing subjects a Fund to
interest costs which may or may not be recovered by appreciation of the
securities purchased, and can exaggerate the effect on net asset value of any
increase or decrease in the market value of a Fund's portfolio. This is the
speculative factor known as leverage.
LOANS OF PORTFOLIO SECURITIES
For the purpose of achieving income, the FIXED-INCOME FUNDS may lend their
portfolio securities, provided: (i) the loan is secured continuously by
collateral consisting of short-term, high quality debt securities,
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<PAGE> 24
including U.S. Government securities, negotiable certificates of deposit,
bankers' acceptances or letters of credit, maintained on a daily
marked-to-market basis in an amount at least equal to the current market value
of the securities loaned; (ii) the Fund may at any time call the loan and obtain
the return of the securities loaned; (iii) the Fund will receive any interest or
dividends paid on the loaned securities; and (iv) the aggregate market value of
securities loaned will not at any time exceed one-third of the total assets of
the Fund.
WHEN-ISSUED SECURITIES
The INTERNATIONAL VIP PORTFOLIO and the FIXED-INCOME FUNDS may purchase
securities on a when-issued or delayed-delivery basis, generally in connection
with an underwriting or other offering. When-issued and delayed-delivery
transactions occur when securities are bought with payment for and delivery of
the securities scheduled to take place at a future time, beyond normal
settlement dates, generally from 15 to 45 days after the transaction. The price
that the Fund is obligated to pay on the settlement date may be different from
the market value on that date. While securities may be sold prior to the
settlement date, the Funds intend to purchase such securities with the purpose
of actually acquiring them, unless a sale would be desirable for investment
reasons. At the time the Fund makes a commitment to purchase a security on a
when-issued basis, it will record the transaction and reflect the value of the
security each day in determining the Fund's net asset value. The Fund will also
establish a segregated account with its custodian in which it will hold cash,
U.S. Government securities, equity securities or other liquid, unencumbered
assets, marked-to-market daily, equal in value to its obligations for
when-issued securities.
SHORT SALES AGAINST-THE-BOX
Each Fund may make short sales of securities (i.e., sales of securities the Fund
does not own) or maintain a short position only if (i) at all times when the
short position is open, the Fund owns an equal amount of such securities or
securities convertible into or exchangeable for, without payment of any further
consideration, securities of the same issue as, and equal in amount to, the
securities sold short (a short sale "against-the-box") and (ii) not more than
25% of the Fund's net assets (taken at current value) is held as collateral for
such sales at any one time.
REAL ESTATE INVESTMENT TRUSTS
Each Fund may invest in securities of real estate investment trusts or REITs.
Unlike corporations, REITs do not have to pay income taxes if they meet certain
Internal Revenue Code requirements. To qualify, a REIT must distribute at least
95% of its taxable income to its shareholders and receive at least 75% of that
income from rents, mortgages and sales of property. REITs offer investors
greater liquidity and diversification than direct ownership of a handful of
properties, as well as greater income potential than an investment in common
stocks. Like any investment in real estate, though, a REIT's performance depends
on several factors, such as its ability to find tenants for its properties, to
renew leases and to finance property purchases and renovations.
MORTGAGE-RELATED SECURITIES
The FIXED-INCOME FUNDS may invest in mortgage-related securities, including
mortgage pass-through securities and collateralized mortgage obligations.
Mortgage pass-through securities are securities representing interests in pools
of mortgages in which payments of both interest and principal on the securities
are generally made monthly, in effect "passing through" monthly payments made by
the individual borrowers on the residential mortgage loans which underlie the
securities (net of fees paid to the issuer or guarantor of the securities). For
a discussion of certain risks associated with investment in mortgage-related
securities, including their volatility, see "Investment Risks -- Risks of
Investing in Fixed-Income Securities" on page .
Payment of principal and interest on some mortgage-related securities (but not
the market value of the securities themselves) may be guaranteed by the full
faith and credit of the U.S. Government (in the case of securities guaranteed by
GNMA) or by agencies or instrumentalities of the U.S. Government (in the case of
securities guaranteed by FNMA or the FHLMC, which
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<PAGE> 25
are supported only by the discretionary authority of the U.S. Government to
purchase the agency's obligations). Mortgage pass-through securities created by
non-governmental issuers (such as commercial banks, savings and loan
institutions, private mortgage insurance companies, mortgage bankers and other
secondary market issuers) may be supported by various forms of insurance or
guarantees, including individual loan, title, pool and hazard insurance, and
letters of credit, which may be issued by governmental entities, private
insurers or the mortgage poolers.
CMOs, including CMOs that have elected to be treated as REMICs, are hybrid
instruments with characteristics of both bonds and mortgage pass-through
securities. Similar to a bond, interest and prepaid principal on a CMO are paid,
in most cases, monthly. CMOs may be collateralized by whole mortgage loans but
are more typically collateralized by portfolios of securities guaranteed by
GNMA, FHLMC or FNMA or of mortgage pass-through securities created by
non-governmental issuers. CMOs are structured into multiple classes, with each
class bearing a different stated maturity. Monthly payments of principal,
including prepayments, are first returned to investors holding the shortest
maturity class. Investors holding the longer maturity classes receive principal
only after the first class has been retired.
Other mortgage-related securities include those that directly or indirectly
represent a participation in or are secured by and payable from mortgage loans
on real property, such as CMO residuals, stripped mortgage-backed securities,
variable rate securities (including inverse floaters), or tiered index bonds and
may be structured in classes with rights to receive varying proportions of
principal and interest. Stripped mortgage-backed securities are derivative,
multi-class mortgage securities. The FIXED-INCOME FUNDS may invest in stripped
mortgage-backed securities issued by the U.S. Government, its agencies and
instrumentalities. Stripped mortgage-backed securities are usually structured
with two classes that receive different proportions of the interest and
principal distributions on a pool of mortgage assets. In certain cases, one
class will receive all of the interest (the interest-only or "IO" class), while
the other class will receive all of the principal (the principal-only or "PO"
class). The yields to maturity on IOs and POs are sensitive to the rate of
principal repayments (including prepayments) on the related underlying mortgage
assets, and principal payments may have a material effect on yield to maturity.
If the underlying mortgage assets experience greater than anticipated
prepayments of principal, a Fund may not fully recoup its initial investment in
IOs. Conversely, if the underlying mortgage assets experience less than expected
prepayments of principal, the yield on POs could be materially adversely
affected. Such securities will be considered liquid only if so determined in
accordance with guidelines established by the Trustees. The FIXED-INCOME FUNDS
also may invest in stripped mortgage-backed securities that are privately
issued. These securities will be considered illiquid for purposes of each Fund's
limit on illiquid securities.
CMOs and other mortgage-related securities that are issued or guaranteed by the
U.S. Government or by any of its agencies or instrumentalities will be
considered U.S. Government securities for purposes of applying a Fund's
diversification tests. Generally, the entity that has the ultimate
responsibility for the payment of interest and principal on a security is deemed
to be the issuer of an obligation.
OTHER DERIVATIVE INSTRUMENTS
In addition to the asset-backed securities and mortgage-related securities
(including tiered index bonds and inverse floaters) which may be purchased only
by the FIXED-INCOME FUNDS, all Funds may utilize certain other financial
instruments whose performance is derived from the performance of an underlying
asset ("derivatives"). The Funds may purchase and write call and put options on
securities, securities indexes and on foreign currencies, and enter into futures
contracts and use options on futures contracts. The Funds also may enter into
swap agreements with other institutional investors with respect to foreign
currencies, interest rates and securities indexes. The Funds may use these
techniques to hedge against changes in interest rates, foreign currency exchange
rates or securities prices or as part of
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<PAGE> 26
their overall investment strategies. Each Fund will maintain segregated accounts
consisting of cash, U.S. Government securities, equity securities or other
liquid, unencumbered assets, marked-to-market daily (or, as permitted by
applicable regulation, enter into certain offsetting positions), to cover its
obligations under options, futures contracts and swap agreements to avoid
leveraging of the Fund. See "Investment Risks -- Risks of Using Certain
Derivatives" on page .
The Funds may buy or sell interest rate futures contracts, options on interest
rate futures contracts and options on debt securities for the purpose of hedging
against changes in the value of securities which a Fund owns or anticipates
purchasing due to anticipated changes in interest rates. The Funds also may
engage in currency exchange transactions by means of buying or selling foreign
currency on a spot basis, entering into forward foreign currency exchange
contracts, and buying and selling foreign currency options, futures and options
on futures. Foreign currency exchange transactions may be entered into for the
purpose of hedging against foreign currency exchange risk arising from the
Funds' investment or anticipated investment in securities denominated in foreign
currencies. A Fund will not enter into futures contracts or options thereon for
non-hedging purposes if, immediately thereafter, the aggregate initial margin
deposits on the Fund's futures positions and premiums paid for options thereon
would exceed 5% of the liquidation value of the Fund's total assets. There is no
other percentage limitation on a Fund's use of options, futures and options
thereon, except for the limitation on foreign currency option contracts
described below.
Also, the Funds may enter into interest rate, index and currency exchange rate
swap agreements for the purpose of attempting to obtain a particular desired
return at a lower cost to a Fund than if the Fund had invested directly in an
instrument that yielded that desired return. In a standard swap agreement, two
parties agree to exchange the returns (or differentials in rates of return)
earned or realized on a particular predetermined investment or investments. Swap
agreements are subject to the Funds' overall limit that no more than 15% of net
assets may be invested in illiquid securities, and a Fund will not enter into a
swap agreement with any single party if the net amount owed or to be received
under existing contracts with that party would exceed 5% of the Fund's assets.
The Funds may purchase foreign currency options or enter into forward foreign
currency exchange contracts for the purpose of hedging against the effect that
currency fluctuations will have on the value of Fund liabilities, such as known
or expected redemptions or the payment of any declared dividends. No Fund will
enter into foreign currency option contracts if the premiums on such options
exceed 5% of the Fund's total assets. See "Investment Objectives and Policies --
Derivative Instruments" in the Statement of Additional Information.
STATE INSURANCE REGULATION
Each Fund provides an investment vehicle for variable annuity contracts and
variable life insurance policies to be offered by the separate accounts of
participating life insurance companies ("Participating Insurance Companies").
Certain states have regulations concerning concentration of investments and
purchase and sale of futures contracts, among other techniques. If these
regulations are applied to a Fund, the Fund may be limited in its ability to
engage in such techniques and to manage its investments with the flexibility
provided herein. It is each Fund's intention to operate in material compliance
with current insurance laws and regulations, as applied in each jurisdiction in
which contracts or policies of separate accounts of Participating Insurance
Companies are offered.
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INVESTMENT RISKS
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The investment practices described above involve certain risks. The net asset
value of any of the Funds may increase or decrease for many reasons. These
include changes in the market prices of portfolio securities. This means an
investor's price may be worth more or less at redemption than at the time of
purchase. The following provides a summary of the more significant risks
associated with investing in the Funds. The Statement of Additional Information
contains more detailed information about these investments and the risks that
are associated with them.
RISKS OF INVESTING IN EMERGING MARKET AND OTHER FOREIGN SECURITIES
Investments in emerging market and other foreign securities involve certain risk
considerations not typically associated with investing in securities of U.S.
issuers, including: (i) currency devaluations and other currency exchange rate
fluctuations; (ii) political uncertainty and instability; (iii) more substantial
government involvement in the economy; (iv) higher rates of inflation; (v) less
government supervision and regulation of the securities markets and participants
in those markets; (vi) controls on foreign investment and limitations on
repatriation of invested capital and on a Fund's ability to exchange local
currencies for U.S. dollars; (vii) greater price volatility; (viii)
substantially less liquidity and significantly smaller capitalization of
securities markets; (ix) absence of uniform accounting and auditing standards;
(x) generally higher commission expenses; (xi) delay in settlement of securities
transactions; and (xii) greater difficulty in enforcing shareholder rights and
remedies.
RISKS OF INVESTING IN FIXED-INCOME SECURITIES
The Funds which invest in fixed-income securities are subject primarily to
interest rate and credit risk. Interest rate risk is the potential for a decline
in bond prices due to rising interest rates. In general, bond prices vary
inversely with interest rates. The change in bond price depends on several
factors, including the bond's maturity date. In general, bonds with longer
maturities are more sensitive to changes in interest rates than bonds with
shorter maturities. Credit risk is the possibility that a bond issuer will fail
to make timely payments of interest or principal to a Fund.
The FIXED-INCOME FUNDS may invest in mortgage- and asset-backed securities. The
yield characteristics of mortgage- and asset-backed securities differ from
traditional debt securities. Among the major differences are that interest and
principal payments are made more frequently, usually monthly, and that principal
may be prepaid at any time because the underlying mortgage loans or other assets
generally may be prepaid at any time. As a result, if a Fund purchases such a
security at a premium, a prepayment rate that is faster than expected will
reduce yield to maturity, while a prepayment rate that is slower than expected
will have the opposite effect of increasing yield to maturity. Alternatively, if
the Fund purchases these securities at a discount, faster than expected
prepayments will increase yield to maturity, while slower than expected
prepayments will reduce yield to maturity. Although the extent of prepayments on
a pool of mortgage loans depends on various economic and other factors, as a
general rule, prepayments on fixed-rate mortgage loans will increase during a
period of falling interest rates and decrease during a period of rising interest
rates. Asset-backed securities, although less likely to experience the same
prepayment rates as mortgage-backed securities, may respond to certain of the
same factors influencing prepayments, while at other times different factors
will predominate. Mortgage-backed securities and asset-backed securities may
decrease in value as a result of increases in interest rates and may benefit
less than other fixed-income securities from declining interest rates because of
the risk of prepayment.
The FIXED-INCOME FUNDS may invest in stripped mortgage- or asset-backed
securities, which receive differing proportions of the interest and principal
payments from the underlying assets. The market value of such securities
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<PAGE> 28
generally is more sensitive to changes in prepayment and interest rates than is
the case with traditional mortgage-and asset-backed securities, and in some
cases the market value may be extremely volatile. With respect to certain
stripped securities, such as interest only ("IO") and principal only ("PO")
classes, a rate of prepayment that is faster or slower than anticipated may
result in a Fund failing to recover all or a portion of its investment, even
though the securities are rated investment grade. Certain of the stripped
mortgage- and asset-backed securities held by the Funds are considered to be
illiquid under guidelines established by the Trustees.
Reverse repurchase agreements and dollar rolls, which the FIXED-INCOME FUNDS may
enter into, involve the risk that the market value of the securities retained by
the Fund may decline below the price of the securities the Fund has sold but is
obligated to repurchase under the agreement. If the buyer of securities under a
dollar roll files for bankruptcy or becomes insolvent, the Fund's use of the
proceeds of the agreement may be restricted pending a determination by the other
party, or its trustee or receiver, whether to enforce the Fund's obligation to
repurchase the securities.
The FIXED-INCOME FUNDS and, to a limited extent, the EQUITY INCOME VIP PORTFOLIO
may invest a portion of their assets in non-investment grade debt securities,
commonly referred to as "junk bonds." Low-rated and comparable unrated
securities, while generally offering higher yields than investment grade
securities with similar maturities, involve greater risks, including the
possibility of default or bankruptcy. They are regarded as speculative with
respect to the issuer's capacity to pay interest and to repay principal. The
market values of certain of these securities tend to be more sensitive to
individual corporate development and changes in economic conditions than higher
quality bonds. In addition, low-rated and comparable unrated securities tend to
be less marketable than higher-quality debt securities because the market for
them is not as broad or active. The lack of a liquid secondary market may have
an adverse effect on market price and a Fund's ability to sell particular
securities.
RISKS OF USING CERTAIN DERIVATIVES
Participation in the options or futures markets involves investment risks and
transaction costs to which a Fund would not be subject absent the use of these
strategies. If the Advisor's predictions of movements in the direction of the
securities and interest rate markets are inaccurate, the adverse consequences to
a Fund may leave the Fund in a worse position than if such strategies were not
used. Risks inherent in the use of options, futures contracts and options on
futures contracts include: (i) dependence on the Advisor's ability to predict
correctly movements in the direction of interest rates and securities prices;
(ii) imperfect correlation between the price of options and futures contracts
and options thereon and movements in the prices of the securities being hedged;
(iii) the fact that skills needed to use these strategies are different from
those needed to select portfolio securities; (iv) the absence of a liquid
secondary market for any particular instrument at any time; (v) the possible
need to defer closing out certain hedged positions to avoid adverse tax
consequences; and (vi) the possible inability of a Fund to purchase or sell a
portfolio security at a time that otherwise would be favorable for it to do so,
or the possible need for the Fund to sell the security at a disadvantageous
time, due to the requirement that the Fund maintain "cover" or segregate
securities in connection with hedging transactions. The loss from investing in
futures transactions is potentially unlimited. There also is no assurance that a
liquid secondary market will exist for futures contracts and options thereon in
which a Fund may invest. See "Investment Objectives and Policies -- Derivative
Instruments" in the Statement of Additional Information.
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<PAGE> 29
PRINCIPAL INVESTMENT RESTRICTIONS
- --------------------------------------------------------------------------------
Each Fund is subject to certain investment restrictions which are fundamental
policies. Fundamental policies are those that cannot be changed without the
approval of a majority (as defined in the 1940 Act) of that Fund's outstanding
voting securities. Each Fund's investment objective is a fundamental policy.
Among its restrictions, a Fund may not: (i) with respect to 75% of its total
assets, invest more than 5% of its total assets (determined at the time of
investment) in securities of any one issuer (other than U.S. Government
securities); (ii) with respect to 75% of its total assets, purchase more than
10% of the outstanding voting securities of any one issuer; or (iii) invest more
than 25% of its total assets (determined at the time of investment) in one or
more issuers having their principal business activities in a single industry.
Additional information about each Fund's investment restrictions is contained in
the Statement of Additional Information. It is the position of the Securities
and Exchange Commission that open-end investment companies such as the Funds
should make certain investments if thereafter more than 15% of the value of
their net assets would be invested in these securities. As a matter of operating
policy (though not a fundamental policy), the Funds limit such investments to no
more than 15% of the value of their net assets. The investments in this 15%
limit include: (i) those which are restricted, i.e., those which cannot freely
be sold for legal or contractual reasons; (ii) fixed time deposits subject to
withdrawal penalties (other than overnight deposits); and (iii) repurchase
agreements having a maturity of more than seven days. The 15% limitation does
not include obligations which are payable at principal amount plus accrued
interest within seven days after purchase.
ORGANIZATION AND MANAGEMENT
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ORGANIZATION AND VOTING RIGHTS
Each Fund is a newly established diversified series of Hotchkis and Wiley
Variable Trust (the "Trust"), an open-end, management investment company
organized as a Massachusetts business trust on February 4, 1997. The Trust's
Board of Trustees decides on matters of general policy and reviews the
activities of the Advisor, and the Trust's officers conduct and supervise the
daily business operations of the Trust. Each Fund is a series of shares, each
having separate assets and liabilities, of the Trust. The Board of Trustees may,
at its own discretion, create additional series of shares and classes within
series.
Generally, the Funds will not hold an annual meeting of shareholders unless
required by the 1940 Act. Shareholders have one vote per share owned. Matters
submitted to shareholders must be approved by a majority of the outstanding
securities of each Fund, unless it is clear that the interests of each Fund in
the matter are identical or the matter does not affect a Fund. At the request of
the holders of at least 10% of the shares, the Trust will hold a meeting to vote
on the removal of a Trustee, which can occur by a vote of a majority of the
outstanding shares. Ten shareholders holding the lesser of $25,000 worth or one
percent of a Fund's shares may advise the Trustees in writing that they wish to
communicate with other shareholders for the purpose of requesting a meeting to
remove a Trustee. The Trustees will then, if requested by the applicants, mail
at the applicants' expense the applicants' communications to all other
shareholders.
The rights accompanying Fund shares are legally vested in the separate accounts.
However, in accordance with current law and interpretations thereof,
Participating Insurance Companies will vote shares held in the separate accounts
in a manner consistent with timely voting instructions received from the holders
of variable annuity contracts and variable life insurance policies. Each
Participating Insurance Company will vote Fund shares held in separate accounts
for which no timely
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<PAGE> 30
instructions are received from the holders of variable annuity contracts and
variable life insurance policies, as well as shares it owns, in the same
proportion as those shares for which voting instructions are received. For a
further discussion, please refer to the insurance company's separate account
prospectus.
THE INVESTMENT ADVISOR
HOTCHKIS AND WILEY, located at 800 West 6th Street, Los Angeles, California
90017, acts as investment advisor to the Funds and generally administers the
affairs of the Trust. The Advisor is a division of the Merrill Lynch Capital
Management Group of Merrill Lynch Asset Management, L.P., and a separate
business unit of Merrill Lynch & Co., Inc., a financial services holding company
incorporated in Delaware. Subject to the direction and control of the Board of
Trustees, the Advisor supervises and arranges the purchase and sale of
securities held in the portfolios of the Funds.
For the services of the Advisor to the EQUITY INCOME VIP PORTFOLIO and the
INTERNATIONAL VIP PORTFOLIO, the Trust, under separate Investment Advisory
Agreements between the Trust and the Advisor, pays the Advisor a fee, computed
daily and payable monthly, at an annual rate of 0.75% of each Fund's average
daily net assets. This fee is higher than that paid by most mutual funds, but
does not reflect the reimbursement of certain of the Funds' expenses as
described below.
Under the Investment Advisory Agreement relating to the TOTAL RETURN BOND VIP
PORTFOLIO, the Trust pays a fee, computed daily and payable monthly, at an
annual rate of 0.55% of the Fund's average daily net assets.
Under the Investment Advisory Agreement relating to the LOW DURATION VIP
PORTFOLIO, the Trust pays the Advisor a fee, computed daily and payable monthly,
at an annual rate of 0.46% of the Fund's average daily net assets.
In addition to the fee payable to the Advisor, each Fund is responsible for its
operating expenses including: (i) interest and taxes; (ii) brokerage
commissions; (iii) insurance premiums; (iv) compensation and expenses of the
Trust's Trustees other than those affiliated with the Advisor; (v) legal and
audit expenses; (vi) fees and expenses of the Fund's custodian and any
subcustodian, shareholder servicing or transfer agent and accounting services
agent; (vii) expenses incident to the issuance of its shares, including issuance
on the payment of, or reinvestment of, dividends; (viii) fees and expenses
incident to the registration under federal or state securities laws of the Trust
or its shares; (ix) expenses of preparing, printing and mailing reports and
notices and proxy material to shareholders of the Trust; (x) all other expenses
incident to holding meetings of the Trust's shareholders; (xi) dues or
assessments of or contributions to the Investment Company Institute or any
successor; and (xii) such non-recurring expenses as may arise, including
litigation affecting the Trust and the legal obligations which the Trust may
have to indemnify its officers and Trustees with respect thereto.
Although not required to do so, the Advisor has agreed to reimburse the EQUITY
INCOME VIP PORTFOLIO to the extent necessary so that its regular annual
operating expenses will not exceed 1.15% of the Fund's average daily net assets.
The Advisor has agreed to reimburse the INTERNATIONAL VIP PORTFOLIO to the
extent necessary so that its regular annual operating expenses will not exceed
1.35% of the Fund's average daily net assets. The Advisor has agreed to
reimburse the TOTAL RETURN BOND VIP PORTFOLIO to the extent necessary so that
its regular annual operating expenses will not exceed 0.65% of the Fund's
average daily net assets. The Advisor has agreed to reimburse the LOW DURATION
VIP PORTFOLIO to the extent necessary so that its regular annual operating
expenses will not exceed 0.58% of the Fund's average daily net assets. The
Advisor will give shareholders at least 30 days' notice of any decision to
change this reimbursement policy.
THE ADMINISTRATOR
Firstar Trust Company, 615 East Michigan Street, Milwaukee, Wisconsin 53202,
serves as administrator to the Trust pursuant to a Fund Administration Servicing
Agreement.
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PORTFOLIO MANAGERS
The portfolio managers have responsibility for the day-to-day management of the
Funds' portfolios.
EQUITY INCOME VIP PORTFOLIO
The current portfolio managers of the EQUITY INCOME VIP PORTFOLIO are Gail
Bardin and Sheldon Lieberman. Ms. Bardin is a managing director of the Advisor
and has served as a portfolio manager of the Advisor since 1988. Mr. Lieberman
joined the Advisor in 1994. Prior to joining the Advisor, Mr. Lieberman was the
Chief Investment Officer for the Los Angeles County Employees Retirement
Association. Ms. Bardin and Mr. Lieberman have served as portfolio managers of
the Fund since its inception.
INTERNATIONAL VIP PORTFOLIO
The current portfolio managers of the INTERNATIONAL VIP PORTFOLIO are Sarah
Ketterer, Harry Hartford and David Chambers. Ms. Ketterer is a managing director
of the Advisor. Prior to joining the Advisor, Ms. Ketterer was with Bankers
Trust Company as an Associate from 1987 to 1990 and a Financial Analyst with
Dean Witter Reynolds from 1983 to 1985. Prior to joining the Advisor, Mr.
Hartford was with the Investment Bank of Ireland as a Senior Manager,
International and Global Equities, from 1985 to 1994. Prior to joining the
Advisor, Mr. Chambers was with Baring Asset Management, Inc. as Senior Vice
President, Global Equities from 1992 to 1995 and Baring Brothers, London,
England as Assistant Director, Corporate Finance from 1990 to 1991. Ms. Ketterer
and Messrs. Hartford and Chambers have served as portfolio managers to the Fund
since its inception.
FIXED-INCOME FUNDS
The current portfolio managers of the FIXED-INCOME FUNDS are Roger DeBard,
Michael Sanchez and John Queen. Mr. DeBard is a managing director of the Advisor
and has served as a portfolio manager of the Advisor since 1985. Mr. Sanchez
joined the Advisor in August 1996 as a portfolio manager. Prior to joining the
Advisor, Mr. Sanchez was with Provident Investment Counsel as a Senior Vice
President and portfolio manager from 1991 to 1995 and with ARCO Investment
Management Company as Director of Fixed Income Investments from 1988 to 1991.
Mr. Queen joined the Advisor in 1997 as a portfolio manager. Prior to joining
the Advisor, Mr. Queen was associated with the Capital Group as a member of an
analyst team responsible for $3 billion in fixed-income assets. They have served
as portfolio managers for each FIXED-INCOME FUND since its inception.
PURCHASE AND REDEMPTION OF SHARES
- --------------------------------------------------------------------------------
Investors may not purchase or redeem shares of the Funds directly, but only
through variable annuity contracts and variable life insurance policies offered
through the separate accounts of Participating Insurance Companies. Investors
should refer to the prospectus of the Participating Insurance Company's separate
account for information on how to purchase a variable annuity contract or
variable life insurance policy, how to select specific Funds as investment
options for the applicable contract or policy and how to redeem monies from the
applicable contract or policy.
The separate accounts of the Participating Insurance Companies place orders to
purchase and redeem shares of the Funds based on, among other things, the amount
of premium payments to be invested and the amount of surrender and transfer
requests (as defined in the prospectus describing the variable annuity contracts
and variable life insurance policies issued by the Participating Insurance
Companies) to be effected on that day pursuant to variable annuity contracts and
variable life insurance policies. Orders received by the Funds are effected on
business days only. Orders for the purchase of shares of a Fund are effected at
the net asset value per share next calculated after an order is received in
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<PAGE> 32
proper form by the Fund or its designee so long as payment for the shares is
received by the end of the next business day. Redemptions are effected at the
net asset value per share next calculated after receipt in proper form of a
redemption request by a Fund or its designee. For purposes of the purchase and
redemption of shares of the Funds, the separate account of a Participating
Insurance Company shall be a designee of the Fund for receipt of requests for
purchase and redemption, and receipt by such designee shall constitute receipt
by the Fund, provided that the Fund receives notice of such requests in
accordance with applicable requirements on the next following business day.
Separate accounts must transmit purchase and redemption orders promptly. Payment
for redemptions will be made by the Funds within seven days after the request is
received. The Funds may suspend the right of redemption under certain
extraordinary circumstances in accordance with the rules of the Securities and
Exchange Commission.
The Funds do not assess any sales charges or redemption fees. Sales charges,
mortality and expense risk fees and other charges may be assessed by
Participating Insurance Companies under the variable annuity contracts or
variable life insurance policies. The Participating Insurance Companies are
required to describe these fees in the prospectuses for the contracts or
policies.
Shares of the Funds may be sold to and held by separate accounts that fund
variable annuity and variable life insurance contracts issued by Participating
Insurance Companies. The Funds currently do not foresee any disadvantages to the
holders of variable annuity contracts and variable life insurance policies of
Participating Insurance Companies arising from the fact that interests of the
holders of variable annuity contracts and variable life insurance policies may
differ due to differences of tax treatment or other considerations or due to
conflicts between the Participating Insurance Companies. Nevertheless, the
Trustees will monitor events to seek to identify any material irreconcilable
conflicts which may possibly arise and to determine what action, if any, should
be taken in response to such conflicts. Should a material irreconcilable
conflict arise between the holders of variable annuity contracts and variable
life insurance policies of Participating Insurance Companies, the Participating
Insurance Companies may be required to withdraw the assets allocable to some or
all of the separate accounts from the Funds. Any such withdrawal could disrupt
orderly portfolio management to the potential detriment of such holders. The
variable annuity contracts and variable life insurance policies are described in
the separate prospectuses issued by the Participating Insurance Companies. The
Funds assume no responsibility for such prospectuses.
DIVIDENDS AND TAX STATUS
- --------------------------------------------------------------------------------
The discussion of the federal income taxation of the Funds and their
distributions is for general information only. Purchasers of variable annuity
contracts or variable life insurance policies issued by Participating Insurance
Companies should refer to the prospectuses of those contracts or policies for
additional tax information.
The EQUITY INCOME VIP PORTFOLIO expects to pay income dividends quarterly; the
INTERNATIONAL VIP PORTFOLIO expects to pay income dividends semi-annually; and
the FIXED-INCOME FUNDS expect to declare income dividends daily and pay them
monthly to shareholders.
Distributions from net realized short-term gains, if any, and distributions from
any net capital gains (i.e., the excess of net long-term capital gains over net
short-term capital losses) realized through October 31st of each year and not
previously paid out will be paid out after that date; each Fund may also pay
supplemental distributions after the end of the Trust's fiscal year. Dividends
and distributions are paid in full and fractional shares of each Fund based on
the net asset value per share at the close of business on the record date,
unless the shareholder requests, in writing to the Trust, payment in cash. The
Trust will notify each
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<PAGE> 33
shareholder after the close of its fiscal year of both the dollar amount and the
tax status of that year's distributions.
Each Fund will be treated as a separate entity for federal tax purposes. The
Funds intend to elect to qualify and remain qualified as regulated investment
companies under Subchapter M of the Internal Revenue Code (the "Code"). If so
qualified, each Fund will not be subject to federal income taxes on its net
investment income and capital gains, if any, realized during any fiscal year
which it distributes to its shareholders provided that at least 90% of its net
investment income earned in the fiscal year is distributed.
A segregated asset account upon which a variable annuity contract or variable
life insurance policy is based must meet certain diversification tests set forth
in U.S. Treasury regulations. If, as is intended, each Fund meets these tests
and complies with certain other conditions, a segregated asset account investing
solely in shares of a Fund will also be deemed to meet these diversification
requirements. However, a failure of a Fund to qualify as a regulated investment
company or to meet such conditions and to comply with such tests could cause the
owners of variable annuity contracts and variable life insurance policies based
on such accounts to recognize ordinary income each year in the amount of any net
appreciation of such contract or policy during the year (including the annual
costs of life insurance, if any, provided under such policy).
Provided that a Fund and a segregated asset account investing in the Fund
satisfy the above requirements, any distributions from the Fund will be exempt
from current federal income taxation to the extent that such distributions
accumulate in an individual's variable annuity contract or an individual's
variable life insurance contract.
All dividends from net investment income together with distributions of
short-term capital gains (collectively, "income dividends"), will be taxable as
ordinary income to the shareholders even though paid in additional shares. Any
net capital gains ("capital gains distributions") distributed to shareholders
are taxable as long-term capital gains to the shareholders regardless of the
length of time a shareholder has owned his shares.
The Code provides for a dividends-received deduction (the "deduction") by
corporations. Special provisions are contained in the Code as to the eligibility
of dividends for the deduction. The basic test under the Code for determining
the extent to which the dividends paid by each Fund are eligible for the
deduction is the extent to which the Fund's income is derived from qualifying
dividends received from domestic corporations. See "Dividends and Tax Status" in
the Statement of Additional Information for additional information about the
deduction.
Dividends and interest received by a Fund may be subject to withholding and
other taxes imposed by foreign countries. Tax conventions between certain
countries and the U.S. may reduce or eliminate these foreign taxes, and foreign
countries generally do not impose taxes on capital gains on investments by
foreign investors. If more than 50% of the value of the INTERNATIONAL VIP
PORTFOLIO'S total assets at the close of its taxable year consists of securities
of foreign corporations, the Fund may elect to enable shareholders of the Fund
to receive the benefit of the foreign tax credit with respect to any foreign
income taxes paid by the Fund.
Any gain or loss realized upon a sale or redemption of Fund shares by a
shareholder who is not a dealer in securities will be treated as long-term
capital gain or loss if the shares have been held for more than one year, and
otherwise as short-term capital gain or loss. Any such loss, however, on shares
that are held for six months or less will be treated as long-term capital loss
to the extent of any capital gain distributions received by the shareholder.
Gain or loss on shares held by individual shareholders more than 18 months will
be considered in determining such holder's adjusted net capital gain subject to
a maximum tax rate of 20%.
The Funds may be required to impose backup withholding at a rate of 31% from
income dividends and
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<PAGE> 34
capital gains distributions and upon payment of redemption proceeds if
provisions of the law relating to the furnishing and certification of taxpayer
identification numbers and reporting of dividends are not complied with by a
shareholder.
NET ASSET VALUE
- --------------------------------------------------------------------------------
The net asset value per share of each Fund is determined on each day that the
New York Stock Exchange is open for trading, as of the close of regular trading
on the New York Stock Exchange (currently 4:00 p.m., Eastern time), except on
days on which no orders to purchase, sell or redeem shares have been received or
days on which changes in the value of a Fund's portfolio securities do not
materially affect the net asset value. The net asset value per share is the
value of a Fund's assets, less its liabilities, divided by the number of shares
of the Fund outstanding. The value of a Fund's portfolio securities is
determined on the basis of the market value of such securities or, if market
quotations are not readily available, at fair value under guidelines established
by the Trustees. Short-term investments maturing in less than 60 days are valued
at amortized cost which the Board has determined to equal fair value. See "Net
Asset Value" in the Statement of Additional Information for further information.
PERFORMANCE INFORMATION
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Each Fund's performance may be quoted in advertising, shareholder reports and
other communications in terms of yield or total rate of return. All performance
information is historical and is not intended to indicate future performance.
Yield and total rates of return fluctuate in response to market conditions and
other factors, and the value of an investor's shares when redeemed may be more
or less than their original cost.
Each Fund may provide its period and average annualized "total rates of return."
The "total rate of return" refers to the change in the value of an investment in
the Fund over a stated period and reflects any change in net asset value per
share and is compounded to include the value of any shares purchased with any
dividends or capital gains declared during such period. Period total rates of
return may be "annualized." An "annualized" total rate of return assumes that
the period total rate of return is generated over a one-year period.
Each Fund may provide annualized "yield" quotations. The "yield" of a Fund
refers to the income generated by an investment in the Fund over a 30-day or
one-month period (which period is stated in any such advertisement or
communication). This income is then annualized; that is, the amount of income
generated by the investment over that period is assumed to be generated each
month over a one-year period and is shown as a percentage of the maximum public
offering price on the last day of that period. A "yield" quotation, unlike a
total rate of return quotation, does not reflect changes in net asset value.
Yields and total returns quoted for the Funds include the effect of deducting
the Funds' expenses, but may not include charges and expenses attributable to a
particular variable annuity contract or variable life insurance policy. Since
shares of the Funds can be purchased only through a variable annuity contract or
variable life insurance policy, a prospective purchaser should carefully review
the prospectus of the variable annuity contract or variable life insurance
policy he or she has chosen for information on relevant charges and expenses.
Including these charges in the quotations of the Funds' yield and total return
would have the effect of decreasing performance. Performance information for the
Funds must always be accompanied by, and be reviewed with, performance
information for the insur-
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<PAGE> 35
ance product which invests in the Funds. See the Statement of Additional
Information for more information concerning the calculation of yield and total
rate of return quotations for the Funds.
All data included in performance advertisements will reflect past performance
and is not indicative of future results. The investment return and principal
value of an investment in a Fund will fluctuate, and an investor's proceeds upon
redeeming Fund shares may be more or less than the original cost of the shares.
GENERAL INFORMATION
- --------------------------------------------------------------------------------
The Declaration of Trust contains an express disclaimer of shareholder liability
for the Trust's acts or obligations and requires that notice of such disclaimer
be given in each agreement, obligation or instrument entered into or executed by
the Trust or its Trustees. The Declaration of Trust provides for indemnification
and reimbursement of expenses out of the Trust's property for any shareholder
held personally liable for its obligations. While Massachusetts law permits a
shareholder of a trust such as this to be held personally liable as a partner
under certain circumstances, the risk of a shareholder incurring financial loss
on account of shareholder liability is highly unlikely and is limited to the
relatively remote circumstances in which the Trust would be unable to meet its
obligations.
Common expenses incurred by the Trust are allocated among the Funds based upon
(i) relative net assets; (ii) as incurred on a specific identification basis; or
(iii) evenly among the Funds, depending on the nature of the expenditure.
Except for (i) changes which do not adversely affect the rights of Trust
shareholders; (ii) a change in the name of the Trust, or a series or class
thereof; (iii) authorization of a new series or class; (iv) changes to supply
any omission or correct any ambiguous or defective provision; or (v) changes
required by any federal or state or similar regulatory authority or required by
the Code to eliminate or reduce any federal, state or local taxes which may be
payable by a Fund or its shareholders, no amendment may be made to the
Declaration of Trust without the affirmative vote of the holders of at least 67%
of the Trust's outstanding shares at a meeting at which more than 50% of its
outstanding shares are present in person or represented by proxy. The holders of
shares have no preemptive or conversion rights. Shares when issued are fully
paid and non-assessable, except as set forth above.
The Trust's custodian is Firstar Trust Company, 615 East Michigan Street,
Milwaukee, Wisconsin 53202 and its subcustodian for foreign securities is The
Chase Manhattan Bank, N.A., Four Chase MetroTech Center, Brooklyn, New York
11245.
As of the date of this Prospectus, [ ] Life Insurance Company's
Separate Account A owned all of the outstanding shares of the Funds.
21
<PAGE> 36
APPENDIX -- DESCRIPTION OF RATINGS
- --------------------------------------------------------------------------------
MOODY'S INVESTORS SERVICE
- ----------------------------------------------------------
BOND RATINGS:
"AAA" -- Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt-edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
"AA" -- Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high-grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long term risks appear somewhat larger than in Aaa securities.
Moody's applies numerical modifiers "1", "2" and "3" in each generic rating
classification from Aa through B. The modifier "1" indicates that the obligation
ranks in the higher end of its generic rating category; the modifier "2"
indicates a mid-range ranking; and the modifier "3" indicates that the company
ranks in the lower end of that generic rating category.
"A" -- Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper-medium-grade obligations. Factors giving security
to principal and interest are considered adequate but elements may be present
which suggest a susceptibility to impairment some time in the future.
"BAA" -- Bonds which are rated Baa are considered as medium-grade obligations
(i.e., they are neither highly protected nor poorly secured). Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
"BA" -- Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate, and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
"B" -- Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
- ----------------------------------------------------------
SHORT-TERM DEBT RATINGS:
Moody's short-term debt ratings are opinions of the ability of issuers to repay
punctually senior debt obligations. These obligations have an original maturity
not exceeding one year, unless explicitly noted.
"PRIME-1" -- Issuers rated "Prime-1" (or supporting institutions) have a
superior ability for repayment of senior short-term debt obligations.
"PRIME-2" -- Issuers rated "Prime-2" (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations.
STANDARD & POOR'S
RATINGS GROUP
- ----------------------------------------------------------
BOND RATINGS:
"AAA" -- Debt rated AAA has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.
"AA" -- Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small degree.
22
<PAGE> 37
"A" -- Debt rated A has a strong capacity to pay interest and repay principal,
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher-rated categories.
"BBB" -- Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher-rated categories.
Debt rated BB and B is regarded as having predominantly speculative
characteristics with respect to capacity to pay interest and repay principal.
While such debt will likely have some quality and protective characteristics,
these are outweighed by large uncertainties or major exposures to adverse
conditions.
- ----------------------------------------------------------
COMMERCIAL PAPER RATINGS:
An S&P commercial paper rating is a current assessment of the likelihood of
timely payment of debt considered short-term in the relevant market.
"A-1" -- This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus (+) designation.
"A-2" -- Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated A-1.
FITCH INVESTORS SERVICE, INC.
- ----------------------------------------------------------
BOND RATINGS:
The following summarizes the ratings used by Fitch for corporate bonds:
"AAA" -- Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest and
repay principal, which is unlikely to be affected by reasonably foreseeable
events.
"AA" -- Bonds considered to be investment grade and of very high credit quality.
The obligor's ability to pay interest and repay principal is very strong,
although not quite as strong as bonds rated "AAA". Because bonds rated in the
"AAA" and "AA" categories are not significantly vulnerable to foreseeable future
developments, short-term debt of these issuers is generally rated "F-1+."
"A" -- Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
"BBB" -- Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is considered
to be adequate. Adverse changes in economic conditions and circumstances,
however, are more likely to have adverse impact on these bonds and, therefore,
impair timely payment. The likelihood that the ratings of these bonds will fall
below investment grade is higher than for bonds with higher ratings.
"BB" -- Bonds are considered speculative. The obligor's ability to pay interest
and repay principal may be affected over time by adverse economic changes.
However, business and financial alternatives can be identified, which could
assist the obligor in satisfying its debt service requirements.
"B" -- Bonds are considered highly speculative. While bonds in this class are
currently meeting debt service requirements, the probability of continued timely
payment of principal and interest reflects the obligor's limited margin of
safety and the need for reasonable business and economic activity throughout the
life of the issue.
PLUS (+) MINUS (-) -- Plus and minus signs are used with a rating symbol to
indicate the relative position of
23
<PAGE> 38
a credit within the rating category. Plus and minus signs, however, are not used
in the "AAA" category.
- ----------------------------------------------------------
SHORT-TERM DEBT RATINGS:
"F-1+" -- Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely payment.
"F-1" -- Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues rated
"F-1+."
"F-2" -- Good Credit Quality. Issues assigned this rating have a satisfactory
degree of assurance for timely payment, but the margin of safety is not as great
as for issues assigned "F-1+" or "F-1" ratings.
DUFF & PHELPS
CREDIT RATING CO.
- ----------------------------------------------------------
BOND RATINGS:
The following summarizes the ratings used by Duff & Phelps for long-term debt:
"AAA" -- Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S. Treasury debt.
"AA+," "AA," "AA-" -- High credit quality. Protection factors are strong. Risk
is modest but may vary slightly from time to time because of economic
conditions.
"A+," "A," "A-" -- Protection factors are average but adequate. However, risk
factors are more variable and greater in periods of economic stress.
"BBB+," "BBB," "BBB-" -- Below average protection factors but still considered
sufficient for prudent investment. Considerable variability in risk during
economic cycles.
"BB+," "BB," "BB-" -- Below investment grade but deemed likely to meet
obligations when due. Present or prospective financial protection factors
fluctuate according to industry conditions or company fortunes. Overall quality
may move up or down frequently within this category.
"B+," "B," "B-" -- Below investment grade and possessing risk that obligations
will not be met when due. Financial protection factors will fluctuate widely
according to economic cycles, industry conditions and/or company fortunes.
Potential exists for frequent changes in the rating within this category or into
a higher or lower rating grade.
- ----------------------------------------------------------
SHORT-TERM DEBT RATINGS:
"D-1+" -- Highest certainty of timely payment. Short-term liquidity, including
internal operating factors and/or access to alternative sources of funds, is
outstanding and safety is just below risk-free U.S. Treasury short-term
obligations.
"D-1" -- Very high certainty of timely payment. Liquidity factors are excellent
and supported by good fundamental protection factors. Risk factors are minor.
"D-1-" -- High certainty of timely payment. Liquidity factors are strong and
supported by good fundamental protection factors. Risk factors are very small.
"D-2" -- Good certainty of timely payment. Liquidity factors and company
fundamentals are sound. Although ongoing funding needs may enlarge total
financing requirements, access to capital markets is good. Risk factors are
small.
24
<PAGE> 39
- -------------------------------------------------------------------------------
PROSPECTUS
_________________, 1997
HOTCHKIS
AND
WILEY
VARIABLE TRUST
800 WEST SIXTH STREET
FIFTH FLOOR
LOS ANGELES, CALIFORNIA 90017
800-236-4479
INVESTMENT ADVISOR
Hotchkis and Wiley
800 West Sixth Street
Fifth Floor
Los Angeles, California 90017
LEGAL COUNSEL
Gardner, Carton & Douglas
321 North Clark Street
Chicago, Illinois 60610
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP
100 East Wisconsin Avenue
Milwaukee, Wisconsin 53202
ADMINISTRATOR
CUSTODIAN AND TRANSFER AGENT
Firstar Trust Company
615 East Michigan Street
Milwaukee, Wisconsin 53202
[HOTCHKIS AND WILEY VARIABLE TRUST LOGO]
HOTCHKIS
AND
WILEY
VARIABLE TRUST
Equity Income VIP Portfolio
--------------------------------
International VIP Portfolio
--------------------------------
Total Return Bond VIP Portfolio
--------------------------------
Low Duration VIP Portfolio
--------------------------------
Hotchkis and Wiley: Investment Advisor
- -------------------------------------------------------------------------------
<PAGE> 40
HOTCHKIS AND WILEY VARIABLE TRUST
STATEMENT OF ADDITIONAL INFORMATION
DATED _____________
The Hotchkis and Wiley Variable Trust (the "Trust") is an investment company
which offers shares of four investment funds -- Equity Income VIP Portfolio,
International VIP Portfolio, Total Return Bond VIP Portfolio and Low Duration
VIP Portfolio (each, a "Fund" and collectively, the "Funds"). The Total Return
Bond VIP Portfolio and the Low Duration VIP Portfolio are sometimes also
referred to as the "Fixed-Income Funds." The shares of the Funds are offered
only to separate accounts of participating life insurance companies
("Participating Insurance Companies") for the purpose of funding variable
annuity contracts and variable life insurance contracts.
This Statement of Additional Information is not a prospectus, and it should be
read in conjunction with the prospectus dated of the Funds. Copies of
the prospectus may be obtained at no charge from the Trust, 800 West 6th Street,
Los Angeles, CA 90017. Hotchkis and Wiley (the "Advisor") is the investment
advisor to the Funds.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objectives and Policies......................................................... B-2
Investment Restrictions.................................................................. B-2
Repurchase Agreements.................................................................... B-3
U.S. Government Securities............................................................... B-3
Corporate Debt Securities................................................................ B-4
Convertible Securities................................................................... B-4
Mortgage-Related Securities.............................................................. B-5
Asset-Backed Securities.................................................................. B-8
Risk Factors Relating to Investing in Mortgage-Related and Asset-Backed Securities....... B-8
Duration................................................................................. B-9
Effective Maturity....................................................................... B-10
Derivative Instruments................................................................... B-10
Foreign Securities....................................................................... B-14
Foreign Currency Options and Related Risks............................................... B-16
Forward Foreign Currency Exchange Contracts.............................................. B-17
Risk Factors Relating to Investing in High Yield Securities.............................. B-19
Illiquid Securities...................................................................... B-20
Management................................................................................. B-22
The Advisor.............................................................................. B-24
Portfolio Transactions and Brokerage..................................................... B-24
Net Asset Value............................................................................ B-25
Dividends and Tax Status................................................................... B-26
Performance Information.................................................................... B-28
General Information About the Trust........................................................ B-29
Financial Statements.......................................................................
</TABLE>
B-1
<PAGE> 41
INVESTMENT OBJECTIVES AND POLICIES
The investment objective of the Equity Income VIP Portfolio is to provide
current income and long-term growth of income, accompanied by growth of capital.
The investment objective of the International VIP Portfolio is to provide
current income and long-term growth of income, accompanied by growth of capital.
The investment objective of the Total Return Bond VIP Portfolio is to maximize
long-term total return.
The investment objective of the Low Duration VIP Portfolio is to maximize total
return, consistent with preservation of capital.
The portfolio and strategies with respect to the composition of each Fund are
described in the Funds' prospectus.
INVESTMENT RESTRICTIONS
Each Fund has adopted the following restrictions (in addition to those indicated
in the prospectus) as fundamental policies, which may not be changed without the
favorable vote of the holders of a "majority" of that Fund's outstanding voting
securities, as defined in the Investment Company Act of 1940 (the "1940 Act").
Under the 1940 Act, the vote of the holders of a "majority" of a Fund's
outstanding voting securities means the vote of the holders of the lesser of (i)
67% of the shares of the Fund represented at a meeting at which the holders of
more than 50% of its outstanding shares are represented or (ii) more than 50% of
the outstanding shares.
Except as noted, none of the Funds may:
1. Purchase any security, other than obligations of the U.S. Government, its
agencies, or instrumentalities ("U.S. Government securities"), if as a
result: (i) with respect to 75% of its total assets, more than 5% of the
Fund's total assets (determined at the time of investment) would then be
invested in securities of a single issuer; or (ii) more than 25% of the
Fund's total assets (determined at the time of investment) would be invested
in one or more issuers having their principal business activities in a
single industry.
2. Purchase securities on margin (but any Fund may obtain such short-term
credits as may be necessary for the clearance of transactions), provided
that the deposit or payment by a Fund of initial or maintenance margin in
connection with futures or options is not considered the purchase of a
security on margin.
3. Make short sales of securities or maintain a short position, unless at all
times when a short position is open it owns an equal amount of such
securities or securities convertible into or exchangeable, without payment
of any further consideration, for securities of the same issue as, and equal
in amount to, the securities sold short (short sale against-the-box), and
unless not more than 25% of the Fund's net assets (taken at current value)
is held as collateral for such sales at any one time.
4. Issue senior securities, borrow money or pledge its assets except that any
Fund may borrow from a bank for temporary or emergency purposes in amounts
not exceeding 10% (taken at the lower of cost or current value) of its total
assets (not including the amount borrowed) and pledge its assets to secure
such borrowings; none of the Funds (except the Fixed-Income Funds) will
purchase any additional portfolio securities while such borrowings are
outstanding. (The Fixed-Income Funds may borrow from banks or enter into
reverse repurchase agreements and pledge assets in connection therewith, but
only if immediately after each borrowing there is asset coverage of 300%.)
B-2
<PAGE> 42
5. Purchase any security (other than U.S. Government securities) if as a
result, with respect to 75% of the Fund's total assets, the Fund would then
hold more than 10% of the outstanding voting securities of an issuer.
6. Buy or sell commodities or commodity contracts or real estate or interests
in real estate, although it may purchase and sell securities which are
secured by real estate and securities of companies which invest or deal in
real estate. (For the purposes of this restriction, forward foreign currency
exchange contracts are not deemed to be commodities or commodity contracts.
This restriction does not apply to the Fixed-Income Funds.)
7. Act as underwriter except to the extent that, in connection with the
disposition of portfolio securities, it may be deemed to be an underwriter
under certain federal securities laws.
8. Make investments for the purpose of exercising control or management.
9. Participate on a joint or joint and several basis in any trading account in
securities.
10. Make loans, except through repurchase agreements. (This restriction does not
apply to the Fixed-Income Funds, which may lend portfolio securities having
an aggregate market value of up to one-third of the total assets of the
Fund.)
REPURCHASE AGREEMENTS
Each of the Funds may invest in repurchase agreements collaterized by U.S.
Government securities. A repurchase agreement is an agreement where the seller
agrees to repurchase a security from a Fund at a mutually agreed-upon time and
price. The period of maturity is usually quite short, possibly overnight or a
few days, although it may extend over a number of months. The resale price is
more than the purchase price, reflecting an agreed-upon rate of return effective
for the period of time a Fund's money is invested in the repurchase agreement. A
Fund's repurchase agreements will at all time be fully collateralized in an
amount at least equal to the resale price. The instruments held as collateral
are valued daily, and if the value of instruments declines, a Fund will require
additional collateral. In the event of a default, insolvency or bankruptcy by a
seller, the Fund will promptly seek to liquidate the collateral. In such
circumstances, the Fund could experience a delay or be prevented from disposing
of the collateral. To the extent that the proceeds from any sale of such
collateral upon a default in the obligation to repurchase are less than the
repurchase price, the Fund will suffer a loss.
U.S. GOVERNMENT SECURITIES
U.S. Government agencies or instrumentalities which issue or guarantee
securities include, but are not limited to, the Federal National Mortgage
Association, Government National Mortgage Association, Federal Home Loan Banks,
Federal Home Loan Mortgage Corporation, Federal Intermediate Credit Banks,
Federal Land Banks, Tennessee Valley Authority, Inter-American Development Bank,
Asian Development Bank, Student Loan Marketing Association and the International
Bank for Reconstruction and Development.
Except for U.S. Treasury securities, obligations of U.S. Government agencies and
instrumentalities may or may not be supported by the full faith and credit of
the United States. Some are backed by the right of the issuer to borrow from the
Treasury; others by discretionary authority of the U.S. Government to purchase
the agencies' obligations; while still others, such as the Student Loan
Marketing Association, are supported only by the credit of the instrumentality.
In the case of securities not backed by the full faith and credit of the United
States, the investor must look principally to the agency or instrumentality
issuing or guaranteeing the obligation for ultimate repayment, and may not be
able to assert a claim against the United States itself in the event the agency
or instrumentality does
B-3
<PAGE> 43
not meet its commitment. Each Fund will invest in securities of such
instrumentality only when the Advisor is satisfied that the credit risk with
respect to any instrumentality is acceptable.
The Funds may invest in component parts of U.S. Treasury notes or bonds, namely,
either the corpus (principal) of such Treasury obligations or one of the
interest payments scheduled to be paid on such obligations. These obligations
may take the form of: (i) Treasury obligations from which the interest coupons
have been stripped; (ii) the interest coupons that are stripped; (iii)
book-entries at a Federal Reserve member bank representing ownership of Treasury
obligation components; or (iv) receipts evidencing the component parts (corpus
or coupons) of Treasury obligations that have not actually been stripped. Such
receipts evidence ownership of component parts of Treasury obligations (corpus
or coupons) purchased by a third party (typically an investment banking firm)
and held on behalf of the third party in physical or book-entry form by a major
commercial bank or trust company pursuant to a custody agreement with the third
party. These custodial receipts are known by various names, including "Treasury
Receipts," "Treasury Investment Growth Receipts" ("TIGRs") and "Certificates of
Accrual on Treasury Securities" ("CATS"), and are not issued by the U.S.
Treasury; therefore they are not U.S. Government securities, although the
underlying bonds represented by these receipts are debt obligations of the U.S.
Treasury.
CORPORATE DEBT SECURITIES
A Fund's investments in U.S. dollar or foreign currency-denominated corporate
debt securities of domestic or foreign issuers are limited to corporate debt
securities (corporate bonds, debentures, notes and other similar corporate debt
instruments) which meet the minimum ratings criteria set forth for the Fund, or,
if unrated, are in the Advisor's opinion comparable in quality to corporate debt
securities in which the Fund may invest. The rate of return or return of
principal on some debt obligations may be linked or indexed to the level of
exchange rates between the U.S. dollar and a foreign currency or currencies.
CONVERTIBLE SECURITIES
The Funds may invest in convertible securities of domestic or foreign issuers,
which meet the ratings criteria set forth in the Prospectus. A convertible
security is a fixed-income security (a bond or preferred stock) which may be
converted at a stated price within a specified period of time into a certain
quantity of common stock or other equity securities of the same or a different
issuer. Convertible securities rank senior to common stock in a corporation's
capital structure but are usually subordinated to similar non-convertible
securities. While providing a fixed-income stream (generally higher in yield
than the income derivable from common stock but lower than that afforded by a
similar non-convertible security), a convertible security also affords an
investor the opportunity, through its conversion feature, to participate in the
capital appreciation attendant upon a market price advance in the convertible
security's underlying common stock.
In general, the market value of a convertible security is at least the higher of
its "investment value" (i.e., its value as a fixed-income security) or its
"conversion value" (i.e., its value upon conversion into its underlying stock).
As a fixed-income security, a convertible security tends to increase in market
value when interest rates decline and tends to decrease in value when interest
rates rise. However, the price of a convertible security is also influenced by
the market value of the security's underlying common stock. The price of a
convertible security tends to increase as the market value of the underlying
stock rises, whereas it tends to decrease as the market value of the underlying
stock declines. While no securities investment is without some risk, investments
in convertible securities generally entail less risk than investments in the
common stock of the same issuer.
B-4
<PAGE> 44
MORTGAGE-RELATED SECURITIES
The Fixed-Income Funds may invest in residential or commercial mortgage-related
securities, including mortgage pass-through securities, collateralized mortgage
obligations ("CMOs"), adjustable rate mortgage securities, CMO residuals,
stripped mortgage-related securities, floating and inverse floating rate
securities and tiered index bonds.
Mortgage Pass-Through Securities. Mortgage pass-through securities represent
interests in pools of mortgages in which payments of both principal and interest
on the securities are generally made monthly, in effect "passing through"
monthly payments made by borrowers on the residential or commercial mortgage
loans which underlie the securities (net of any fees paid to the issuer or
guarantor of the securities). Mortgage pass-through securities differ from other
forms of debt securities, which normally provide for periodic payment of
interest in fixed amounts with principal payments at maturity or specified call
dates. Early repayment of principal on mortgage pass-through securities (arising
from prepayments of principal due to the sale of underlying property,
refinancing, or foreclosure, net of fees and costs which may be incurred) may
expose a Fund to a lower rate of return upon reinvestment of principal. Also, if
a security subject to repayment has been purchased at a premium, in the event of
prepayment, the value of the premium would be lost.
There are currently three types of mortgage pass-through securities: (i) those
issued by the U.S. Government or one of its agencies or instrumentalities, such
as the Government National Mortgage Association ("GNMA"), the Federal National
Mortgage Association ("FNMA") and the Federal Home Loan Mortgage Corporation
("FHLMC"); (ii) those issued by private issuers that represent an interest in or
are collateralized by pass-through securities issued or guaranteed by the U.S.
Government or one of its agencies or instrumentalities; and (iii) those issued
by private issuers that represent an interest in or are collateralized by whole
mortgage loans or pass-through securities without a government guarantee but
usually having some form of private credit enhancement.
GNMA is a wholly-owned United States Government corporation within the
Department of Housing and Urban Development. GNMA is authorized to guarantee,
with the full faith and credit of the United States Government, the timely
payment of principal and interest on securities issued by the institutions
approved by GNMA (such as savings and loan institutions, commercial banks and
mortgage banks), and backed by pools of FHA-insured or VA-guaranteed mortgages.
Obligations of FNMA and FHLMC are not backed by the full faith and credit of the
United States Government. In the case of obligations not backed by the full
faith and credit of the United States Government, the Fund must look principally
to the agency issuing or guaranteeing the obligation for ultimate repayment.
FNMA and FHLMC may borrow from the U.S. Treasury to meet its obligations, but
the U.S. Treasury is under no obligation to lend to FNMA or FHLMC.
Private mortgage pass-through securities are structured similarly to GNMA, FNMA,
and FHLMC mortgage pass-through securities and are issued by originators of and
investors in mortgage loans, including depository institutions, mortgage banks,
investment banks and special purpose subsidiaries of the foregoing.
Pools created by private mortgage pass-through issuers generally offer a higher
rate of interest than government and government-related pools because there are
no direct or indirect government or agency guarantees of payments in the private
pools. However, timely payment of interest and principal of these pools may be
supported by various forms of insurance or guarantees, including individual
loan, title, pool and hazard insurance and letters of credit. The insurance and
guarantees are issued by governmental entities, private insurers and the
mortgage poolers. The insurance and guarantees and the credit worthiness of the
issuers thereof will be considered in determining whether a mortgage-related
security meets the Funds' investment quality standards. There can be no
assurance that the private insurers or guarantors can meet their obligations
under the insurance policies or guarantee arrangements. Private
B-5
<PAGE> 45
mortgage pass-through securities may be bought without insurance or guarantees
if, through an examination of the loan experience and practices of the
originator/servicers and poolers, the Advisor determines that the securities
meet the Fund's quality standards.
Collateralized Mortgage Obligations. CMOs are debt obligations collateralized by
residential or commercial mortgage loans or residential or commercial mortgage
pass-through securities. Interest and prepaid principal are generally paid
monthly. CMOs may be collateralized by whole mortgage loans or private mortgage
pass-through securities but are more typically collateralized by portfolios of
mortgage pass-through securities guaranteed by GNMA, FHLMC, or FNMA. The issuer
of a series of CMOs may elect to be treated as a Real Estate Mortgage Investment
Conduit ("REMIC"). All future references to CMOs also include REMICs.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral which is ordinarily unrelated to the stated
maturity date. CMOs often provide for a modified form of call protection through
a de facto breakdown of the underlying pool of mortgages according to how
quickly the loans are repaid. Monthly payment of principal received from the
pool of underlying mortgages, including prepayments, is first returned to
investors holding the shortest maturity class. Investors holding the longer
maturity classes usually receive principal only after the first class has been
retired. An investor may be partially protected against a sooner than desired
return of principal because of the sequential payments.
Certain issuers of CMOs are not considered investment companies pursuant to a
rule adopted by the Securities and Exchange Commission ("SEC"), and the Funds
may invest in the securities of such issuers without the limitations imposed by
the 1940 Act on investments by the Fund in other investment companies. In
addition, in reliance on an earlier SEC interpretation, the Fund's investments
in certain other qualifying CMOs, which cannot or do not rely on the rule, are
also not subject to the limitation of the 1940 Act on acquiring interests in
other investment companies. In order to be able to rely on the SEC's
interpretation, these CMOs must be unmanaged, fixed asset issuers, that: (i)
invest primarily in mortgage-backed securities; (ii) do not issue redeemable
securities; (iii) operate under general exemptive orders exempting them from all
provisions of the 1940 Act; and (iv) are not registered or regulated under the
1940 Act as investment companies. To the extent that the Funds select CMOs that
cannot rely on the rule or do not meet the above requirements, the Funds may not
invest more than 10% of their assets in all such entities and may not acquire
more than 3% of the voting securities of any single such entity.
The Fixed-Income Funds may also invest in, among other things, parallel pay
CMOs, Planned Amortization Class CMOs ("PAC bonds"), sequential pay CMOs, and
floating rate CMOs. Parallel pay CMOs are structured to provide payments of
principal on each payment date to more than one class. PAC bonds generally
require payments of a specified amount of principal on each payment date.
Sequential pay CMOs generally pay principal to only one class while paying
interest to several classes. Floating rate CMOs are securities whose coupon rate
fluctuates according to some formula related to an existing market index or
rate. Typical indices would include the eleventh district cost-of-funds index
("COFI"), the London Interbank Offered Rate ("LIBOR"), one-year Treasury yields,
and ten-year Treasury yields.
Adjustable Rate Mortgage Securities. Adjustable rate mortgage securities
("ARMs") are pass-through securities collateralized by mortgages with adjustable
rather than fixed rates. ARMs eligible for inclusion in a mortgage pool
generally provide for a fixed initial mortgage interest rate for either the
first three, six, twelve, thirteen, thirty-six, or sixty scheduled monthly
payments. Thereafter, the interest rates are subject to periodic adjustment
based on changes to a designated benchmark index.
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The ARMs contain maximum and minimum rates beyond which the mortgage interest
rate may not vary over the lifetime of the security. In addition, certain ARMs
provide for additional limitations on the maximum amount by which the mortgage
interest rate may adjust for any single adjustment period. In the event that
market rates of interest rise more rapidly to levels above that of the ARM's
maximum rate, the ARM's coupon may represent a below market rate of interest. In
these circumstances, the market value of the ARM security will likely have
fallen.
Certain ARMs contain limitations on changes in the required monthly payment. In
the event that a monthly payment is not sufficient to pay the interest accruing
on an ARM, any such excess interest is added to the principal balance of the
mortgage loan, which is repaid through future monthly payments. If the monthly
payment for such an instrument exceeds the sum of the interest accrued at the
applicable mortgage interest rate and the principal payment required at such
point to amortize the outstanding principal balance over the remaining term of
the loan, the excess is then utilized to reduce the outstanding principal
balance of the ARM.
CMO Residuals. CMO residuals are derivative mortgage securities issued by
agencies or instrumentalities of the U.S. Government or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
homebuilders, mortgage banks, commercial banks, investment banks, and special
purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs is
applied first to make required payments of principal and interest on the CMOs
and second to pay the related administrative expenses of the issuer. The
residual in a CMO structure generally represents the interest in any excess cash
flow remaining after making the foregoing payments. Each payment of such excess
cash flow to a holder of the related CMO residual represents income and/or a
return of capital. The amount of residual cash flow resulting from a CMO will
depend on, among other things, the characteristics of the mortgage assets, the
coupon rate of each class of CMO, prevailing interest rates, the amount of
administrative expenses and the prepayment experience on the mortgage assets. In
part, the yield to maturity on the CMO residuals is extremely sensitive to
prepayments on the related underlying mortgage assets, in the same manner as an
interest-only ("IO") class of stripped mortgage-related securities. See
"Stripped Mortgage-Related Securities" below. In addition, if a series of a CMO
includes a class that bears interest at an adjustable rate, the yield to
maturity on the related CMO residual will also be extremely sensitive to changes
in the level of the index upon which interest rate adjustments are based. As
described below with respect to stripped mortgage-related securities, in certain
circumstances the Fund may fail to recoup fully its initial investment in a CMO
residual.
CMO residuals are generally purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers. The CMO
residual market has recently developed and CMO residuals currently may not have
the liquidity of other more established securities trading in other markets.
Transactions in CMO residuals are generally completed only after careful review
of the characteristics of the securities in question. In addition, CMO residuals
may or, pursuant to an exemption therefrom, may not have been registered under
the Securities Act. CMO residuals, whether or not registered under such Act, may
be subject to certain restrictions on transferability, and may be deemed
"illiquid" and subject to a Fund's limitations on investment in illiquid
securities.
Stripped Mortgage-Related Securities. Stripped mortgage-related securities
("SMBS") are derivative multi-class mortgage securities. SMBS may be issued by
agencies or instrumentalities of the U.S. Government, or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
mortgage banks, commercial banks, investment banks, and special purpose entities
of the foregoing.
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SMBS are usually structured with two classes that receive different proportions
of the interest and principal distributions on a pool of mortgage assets. A
common type of SMBS will have one class receiving some of the interest and most
of the principal from the mortgage assets, while the other class will receive
most of the interest and the remainder of the principal. In the most extreme
case, one class will receive all of the interest (the "IO" class), while the
other class will receive all of the principal (the PO class). The yield to
maturity on an IO class is extremely sensitive to the rate of principal payments
(including prepayments) on the related underlying mortgage assets, and a rapid
rate of principal payments may have a material adverse effect on a Fund's yield
to maturity from these securities. If the underlying mortgage assets experience
greater than anticipated prepayments of principal, a Fund may fail to fully
recoup its initial investment in these securities even if the security is in one
of the highest rating categories.
Although SMBSs are purchased and sold by institutional investors through several
investment banking firms acting as brokers or dealers, these securities were
only recently introduced. As a result, established trading markets have not yet
been fully developed and accordingly, these securities may be deemed "illiquid"
and subject to a Fund's limitations on investment in illiquid securities. See
"Securities and Techniques Used by the Funds -- Mortgage-Related Securities" in
the Prospectus.
Inverse Floaters. An inverse floater is a debt instrument with a floating or
variable interest rate that moves in the opposite direction to the interest rate
on another security or index level. Changes in the interest rate on the other
security or index inversely affect the residual interest rate paid on the
inverse floater, with the result that the inverse floater's price will be
considerably more volatile than that of a fixed rate bond. Inverse floaters may
experience gains when interest rates fall and may suffer losses in periods of
rising interest rates. The market for inverse floaters is relatively new.
Tiered Index Bonds. Tiered index bonds are relatively new forms of
mortgage-related securities. The interest rate on a tiered index bond is tied to
a specified index or market rate. So long as this index or market rate is below
a predetermined "strike" rate, the interest rate on the tiered index bond
remains fixed. If, however, the specified index or market rate rises above the
"strike" rate, the interest rate of the tiered index bond will decrease. Thus,
under these circumstances, the interest rate on a tiered index bond, like an
inverse floater, will move in the opposite direction of prevailing interest
rates, with the result that the price of the tiered index bond may be
considerably more volatile than that of a fixed rate bond.
ASSET-BACKED SECURITIES
The Fixed-Income Funds may invest in various types of asset-backed securities.
Through the use of trusts and special purpose corporations, various types of
assets, primarily automobile and credit card receivables and home equity loans,
are being securitized in pass-through structures similar to the mortgage
pass-through or in a pay-through structure similar to the CMO structure.
Investments in these and other types of asset-backed securities must be
consistent with the investment objectives and policies of the Funds.
RISK FACTORS RELATING TO INVESTING IN MORTGAGE-RELATED AND ASSET-BACKED
SECURITIES
The yield characteristics of mortgage-related and asset-backed securities differ
from traditional debt securities. Among the major differences are that interest
and principal payments are made more frequently, usually monthly, and that
principal may be prepaid at any time because the underlying mortgage loans or
other assets generally may be prepaid at any time. As a result, if the Funds
purchase such a security at a premium, a prepayment rate that is faster than
expected will reduce yield to maturity, while a prepayment rate that is slower
than expected will have the
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opposite effect of increasing yield to maturity. Alternatively, if the Funds
purchase these securities at a discount, faster than expected prepayments will
increase, while slower than expected prepayments will reduce, yield to maturity.
The Funds may invest a portion of their assets in derivative mortgage-related
securities which are highly sensitive to changes in prepayment and interest
rates. The Advisor will seek to manage these risks (and potential benefits) by
diversifying its investments in such securities and through hedging techniques.
During periods of declining interest rates, prepayment of mortgages underlying
mortgage-related securities can be expected to accelerate. Accordingly, a Fund's
ability to maintain positions in high-yielding mortgage-related securities will
be affected by reductions in the principal amount of such securities resulting
from such prepayments, and its ability to reinvest the returns of principal at
comparable yields is subject to generally prevailing interest rates at that
time. Conversely, slower than expected prepayments may effectively change a
security that was considered short or intermediate-term at the time of purchase
into a long-term security. Long-term securities tend to fluctuate more in
response to interest rate changes, leading to increased net asset value
volatility. Prepayments may also result in the realization of capital losses
with respect to higher yielding securities that had been bought at a premium or
the loss of opportunity to realize capital gains in the future from possible
future appreciation.
Asset-backed securities involve certain risks that are not posed by
mortgage-related securities, resulting mainly from the fact that asset-backed
securities do not usually contain the complete benefit of a security interest in
the related collateral. For example, credit card receivables generally are
unsecured and the debtors are entitled to the protection of a number of state
and federal consumer credit laws, some of which may reduce the ability to obtain
full payment. In the case of automobile receivables, due to various legal and
economic factors, proceeds from repossessed collateral may not always be
sufficient to support payments on these securities.
DURATION
In selecting securities for the Fixed-Income Funds, the Advisor makes use of the
concept of duration for fixed-income securities. Duration is a measure of the
expected life of a fixed-income security. Duration incorporates a bond's yield,
coupon interest payments, final maturity and call features into one measure.
Most debt obligations provide interest ("coupon") payments in addition to a
final ("par") payment at maturity. Some obligations also have call provisions.
Depending on the relative magnitude of these payments, the market values of debt
obligations may respond differently to changes in the level and structure of
interest rates.
Duration is a measure of the expected life of a fixed-income security on a
present value basis. Duration takes the length of the time intervals between the
present time and the time that the interest and principal payments are scheduled
or, in the case of a callable bond, expected to be received, and weights them by
the present values of the cash to be received at each future point in time. For
any fixed-income security with interest payments occurring prior to the payment
of principal, duration is always less than maturity. In general, all other
things being the same, the lower the stated or coupon rate of interest of a
fixed-income security, the longer the duration of the security; conversely, the
higher the stated or coupon rate of interest of a fixed-income security, the
shorter the duration of the security.
Futures, options and options on futures have durations which, in general, are
closely related to the duration of the securities which underlie them. Holding
long futures or call option positions (backed by a segregated account of cash
and cash equivalents) will lengthen a Fund's duration by approximately the same
amount that holding an equivalent amount of the underlying securities would.
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Short futures or put options positions have durations roughly equal to the
negative duration of the securities that underlie those positions, and have the
effect of reducing portfolio duration by approximately the same amount that
selling an equivalent amount of the underlying securities would.
There are some situations where even the standard duration calculation does not
properly reflect the interest rate exposure of a security. For example, floating
and variable rate securities often have final maturities of ten or more years;
however, their interest rate exposure corresponds to the frequency of the coupon
reset. Another example where the interest rate exposure is not properly captured
by duration is the case of mortgage pass-through securities. The stated final
maturity of such securities is generally 30 years, but current prepayment rates
are more critical in determining the securities' interest rate exposure. In
these and other similar situations, the Advisor will use more sophisticated
analytical techniques that incorporate the economic life of a security into the
determination of its interest rate exposure.
EFFECTIVE MATURITY
The Fixed-Income Funds each invest in a diversified portfolio of fixed-income
securities of varying maturities. The effective maturity is the weighted average
period over which a security's principal is expected to be paid. Stated maturity
is the date when the issuer is scheduled to make the final payment of principal.
Effective maturity differs from stated maturity in that it estimates the
anticipated effect of expected principal prepayments and call provisions.
The effective maturity of a debt security will be the stated maturity, except:
(1) in the case of a security with a call provision, the maturity date will be
considered the call date if there is a high probability, in the opinion of the
Advisor, that the security will be called; (2) in the case of securities with
unconditional put provisions entitling the security holder to receive the
security's approximate amortized cost, the maturity will be considered to be the
next put date; (3) in the case of mortgage-backed or other amortizing
securities, the maturity will be considered to be the average life remaining
(the length of time it is expected to take to retire half of the remaining
principal through amortizing payments) based on prepayment assumptions that the
Advisor believes appropriate; and (4) in the case of a variable or floating rate
investment grade security which, in the Advisor's opinion, will have a market
value approximating amortized cost on the next interest rate reset date, the
maturity will be considered to be the next reset date. However, no Fixed-Income
Fund will invest more than 5% of its net assets at the time of purchase in
floating or variable rate instruments of any one issuer, nor invest more than
20% of its net assets at the time of purchase in floating or variable rate
instruments of issuers within the same industry.
DERIVATIVE INSTRUMENTS
As indicated in the Prospectus, to the extent consistent with their investment
objectives and policies, the Funds may purchase and write call and put options
on securities, securities indexes and on foreign currencies and enter into
futures contracts and use options on futures contracts. The Funds also may enter
into swap agreements with respect to foreign currencies, interest rates and
securities indexes. The Funds may use these techniques to hedge against changes
in interest rates, foreign currency exchange rates, or securities prices or as
part of their overall investment strategies. The International VIP Portfolio and
the Fixed-Income Funds may also purchase and sell options relating to foreign
currencies for the purpose of increasing exposure to a foreign currency or to
shift exposure to foreign currency fluctuations from one country to another.
Each Fund will maintain segregated accounts consisting of cash, U.S. Government
securities, equity securities or other liquid, unencumbered assets,
marked-to-market daily (or, as permitted by applicable regulation, enter into
certain offsetting positions), to cover its obligations under options and
futures contracts to avoid leveraging of the Fund.
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Options on Securities and on Securities Indexes. A Fund may purchase put options
on securities to protect holdings in an underlying or related security against a
substantial decline in market value. A Fund may purchase call options on
securities to protect against substantial increases in prices of securities the
Fund intends to purchase pending its ability to invest in such securities in an
orderly manner. A Fund may sell put or call options it has previously purchased,
which could result in a net gain or loss depending on whether the amount
realized on the sale is more or less than the premium and other transaction
costs paid on the put or call option which is sold. A Fund may write a call or
put option only if the option is "covered" by the Fund holding a position in the
underlying securities or by other means which would permit immediate
satisfaction of the Fund's obligation as writer of the option. Prior to exercise
or expiration, an option may be closed out by an offsetting purchase or sale of
an option of the same series.
The purchase and writing of options involves certain risks. During the option
period, the covered call writer has, in return for the premium on the option,
given up the opportunity to profit from a price increase in the underlying
securities above the exercise price, but, as long as its obligation as a writer
continues, has retained the risk of loss should the price of the underlying
securities decline. The writer of an option has no control over the time when it
may be required to fulfill its obligation as a writer of the option. Once an
option writer has received an exercise notice, it cannot effect a closing
purchase transaction in order to terminate its obligation under the option and
must deliver the underlying securities at the exercise price. If a put or call
option purchased by the Fund is not sold when it has remaining value, and if the
market price of the underlying security, in the case of a put, remains equal to
or greater than the exercise price or, in the case of a call, remains less than
or equal to the exercise price, the Fund will lose its entire investment in the
option. Also, where a put or call option on a particular security is purchased
to hedge against price movements in a related security, the price of the put or
call option may move more or less than the price of the related security. There
can be no assurance that a liquid market will exist when a Fund seeks to close
out an option position. Furthermore, if trading restrictions or suspensions are
imposed on the options markets, a Fund may be unable to close out a position.
There are several risks associated with transactions in options on securities
and on indexes. For example, there are significant differences between the
securities and options markets that could result in an imperfect correlation
between these markets, causing a given transaction not to achieve its
objectives. A decision as to whether when and how to use options involves the
exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
There can be no assurance that a liquid market will exist when a Fund seeks to
close out an option position. If a Fund were unable to close out an option that
it had purchased on a security, it would have to exercise the option in order to
realize any profit or the option may expire worthless. If a Fund were unable to
close out a covered call option that it had written on a security, it would not
be able to sell the underlying security unless the option expired without
exercise. As the writer of a covered call option, a Fund forgoes, during the
option's life, the opportunity to profit from increases in the market value of
the security covering the call option above the sum of the premium and the
exercise price of the call.
If trading were suspended in an option purchased by a Fund, the Fund would not
be able to close out the option. If restrictions on exercise were imposed, the
Fund might be unable to exercise an option it had purchased. Except to the
extent that a call option on an index written by the Fund is covered by an
option on the same index purchased by the Fund, movements in the index may
result in a loss to the Fund; however, such losses may be mitigated by changes
in the value of the Fund's securities during the period the option was
outstanding.
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Futures Contracts and Options on Futures Contracts. A Fund may use interest
rate, foreign currency or index futures contracts, as specified for that Fund in
the Prospectus. An interest rate, foreign currency or index futures contract
provides for the future sale by one party and purchase by another party of a
specified quantity of a financial instrument, foreign currency or the cash value
of an index at a specified price and time. A futures contract on an index is an
agreement pursuant to which two parties agree to take or make delivery of an
amount of cash equal to the difference between the value of the index at the
close of the last trading day of the contract and the price at which the index
contract was originally written. Although the value of an index might be a
function of the value of certain specified securities, no physical delivery of
these securities is made. A public market exists in futures contracts covering
several indexes as well as a number of financial instruments and foreign
currencies, including: the S&P 500; the S&P 100; the NYSE composite; U.S.
Treasury bonds; U.S. Treasury notes; GNMA Certificates; three-month U.S.
Treasury bills; 90-day commercial paper; bank certificates of deposit; the
Australian dollar; the Canadian dollar; the British pound; the German mark; the
Japanese yen; the French franc; the Swiss franc; the Mexican peso; and certain
multinational currencies, such as the European Currency Unit ("ECU"). It is
expected that other futures contracts will be developed and traded in the
future.
A Fund may purchase and write call and put options on futures. Options on
futures possess many of the same characteristics as options on securities and
indexes (discussed above). An option on a futures contract gives the holder the
right, in return for the premium paid, to assume a long position (call) or short
position (put) in a futures contract at a specified exercise price at any time
during the period of the option. Upon exercise of a call option, the holder
acquires a long position in the futures contract and the writer is assigned the
opposite short position. In the case of a put option, the opposite is true.
Each Fund will use futures contracts and options on futures contracts in
accordance with the rules of the Commodity Futures Trading Commission ("CFTC").
For example, a Fund might use futures contracts to hedge against anticipated
changes in interest rates that might adversely affect either the value of the
Fund's securities or the price of the securities which the Fund intends to
purchase. A Fund's hedging activities may include sales of futures contracts as
an offset against the effect of expected increases in interest rates, and
purchases of futures contracts as an offset against the effect of expected
declines in interest rates. Although other techniques could be used to reduce
that Fund's exposure to interest rate fluctuations, the Fund may be able to
hedge its exposure more effectively and perhaps at a lower cost by using futures
contracts and options on futures contracts.
A Fund will only enter into futures contracts and options on futures contracts
which are standardized and traded on a U.S. or foreign exchange, board of trade,
or similar entity, or quoted on an automated quotation system.
When a purchase or sale of a futures contract is made by a Fund, the Fund is
required to deposit with its custodian (or broker, if legally permitted) a
specified amount of cash or U.S. Government securities ("initial margin"). The
margin required for a futures contract is set by the exchange on which the
contract is traded and may be modified during the term of the contract. The
initial margin is in the nature of a performance bond or good faith deposit on
the futures contract which is returned to the Fund upon termination of the
contract, assuming all contractual obligations have been satisfied. Each Fund
expects to earn interest income on its initial margin deposits. A futures
contract held by a Fund is valued daily at the official settlement price of the
exchange on which it is traded. Each day the Fund pays or receives cash, called
"variation margin," equal to the daily change in value of the futures contract.
This process is known as "marking to market." Variation margin does not
represent a borrowing or loan by a Fund but is instead a settlement between the
Fund and the broker of the amount one would owe the other if the futures
contract expired. In computing daily net asset value, each Fund will mark to
market its open futures positions.
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A Fund is also required to deposit and maintain margin with respect to put and
call options on futures contracts written by it. Such margin deposits will vary
depending on the nature of the underlying futures contract (and the related
initial margin requirements), the current market value of the option, and other
futures positions held by the Fund.
Although some futures contracts call for making or taking delivery of the
underlying securities, generally these obligations are closed out prior to
delivery by offsetting purchases or sales of matching futures contracts (same
exchange, underlying security or index and delivery month). If an offsetting
purchase price is less than the original sale price, the Fund realizes a capital
gain, or if it is more, the Fund realizes a capital loss. Conversely, if an
offsetting sale price is more than the original purchase price, the Fund
realizes a capital gain, or if it is less, the Fund realizes a capital loss. The
transaction costs must also be included in these calculations.
Limitations on Use of Futures and Options Thereon. When purchasing a futures
contract, a Fund will maintain with its custodian (and mark-to-market on a daily
basis) cash, U.S. Government securities, equity securities or other liquid,
unencumbered assets that, when added to the amounts deposited with a futures
commission merchant as margin, are equal to the market value of the futures
contract. Alternatively, the Fund may "cover" its position by purchasing a put
option on the same futures contract with a strike price as high or higher than
the price of the contract held by the Fund.
When selling a futures contract, a Fund will maintain with its custodian (and
mark-to-market on a daily basis) liquid assets that, when added to the amount
deposited with a futures commission merchant as margin, are equal to the market
value of the instruments underlying the contract. Alternatively, the Fund may
"cover" its position by owning the instruments underlying the contract (or, in
the case of an index futures contract, a portfolio with a volatility
substantially similar to that of the index on which the futures contract is
based), or by holding a call option permitting the Fund to purchase the same
futures contract at a price no higher than the price of the contract written by
the Fund (or at a higher price if the difference is maintained in liquid assets
with the Trust's custodian).
When selling a call option on a futures contract, a Fund will maintain with its
custodian (and mark-to-market on a daily basis) cash, U.S. Government
securities, equity securities or other liquid, unencumbered assets that, when
added to the amounts deposited with a futures commission merchant as margin,
equal the total market value of the futures contract underlying the call option.
Alternatively, the Fund may cover its position by entering into a long position
in the same futures contract at a price no higher than the strike price of the
call option, by owning the instruments underlying the futures contract, or by
holding a separate call option permitting the Fund to purchase the same futures
contract at a price not higher than the strike price of the call option sold by
the Fund.
When selling a put option on a futures contract, a Fund will maintain with its
custodian (and mark-to-market on a daily basis) cash, U.S. Government
securities, equity securities or other liquid, unencumbered assets that equal
the purchase price of the futures contract, less any margin on deposit.
Alternatively, the Fund may cover the position either by entering into a short
position in the same futures contract, or by owning a separate put option
permitting it to sell the same futures contract so long as the strike price of
the purchased put option is the same or higher than the strike price of the put
option sold by the Fund.
In order to comply with current applicable regulations of the CFTC pursuant to
which the Trust avoids being deemed a "commodity pool operator," the Funds are
limited in their futures trading activities to positions which constitute "bona
fide hedging" positions within the meaning and intent of applicable CFTC rules,
or to non-hedging positions for which the aggregate initial margin and premiums
will not exceed 5% of the liquidation value of the Fund's assets.
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The requirements for qualification as a regulated investment company also may
limit the extent to which a Fund may enter into futures contracts, options
thereon or forward contracts. See "Dividends and Tax Status."
Risks Associated with Futures and Options on Futures Contracts. There are
several risks associated with the use of futures contracts and options on
futures contracts as hedging techniques. A purchase or sale of a futures
contract may result in losses in excess of the amount invested in the futures
contract. There can be no guarantee that there will be a correlation between
price movements in the hedging vehicle and in the Fund securities being hedged.
In addition, there are significant differences between the securities and
futures markets that could result in an imperfect correlation between the
markets, causing a given hedge not to achieve its objectives. The degree of
imperfection of correlation depends on circumstances such as variation in
speculative market demand for futures and options on futures, including
technical influences in futures trading and options on futures, and differences
between the financial instruments being hedged and the instruments underlying
the standard contracts available for trading in such respects as interest rate
levels, maturities, and creditworthiness of issuers. A decision as to whether,
when and how to hedge involves the exercise of skill and judgment, and even a
well-conceived hedge may be unsuccessful to some degree because of market
behavior or unexpected interest rate trends.
Futures exchanges may limit the amount of fluctuation permitted in certain
futures contract prices during a single trading day. The daily limit establishes
the maximum amount that the price of a futures contract may vary either up or
down from the previous day's settlement price at the end of the current trading
session. Once the daily limit has been reached in a futures contract subject to
the limit, no more trades may be made on that day at a price beyond that limit.
The daily limit governs only price movements during a particular trading day and
therefore does not limit potential losses because the limit may work to prevent
the liquidation of unfavorable positions. For example, futures prices have
occasionally moved to the daily limit for several consecutive trading days with
little or no trading, thereby preventing prompt liquidation of positions and
subjecting some holders of futures contracts to substantial losses.
There can be no assurance that a liquid market will exist at a time when a Fund
seeks to close out a futures contract or an option on futures position, and that
Fund would remain obligated to meet margin requirements until the position is
closed. In addition, many of the contracts discussed above are relatively new
instruments without a significant trading history. As a result, there can be no
assurance that an active secondary market will develop or continue to exist.
Additional Risks of Options on Securities, Futures Contracts, Options on Futures
Contracts, and Forward Currency Exchange Contracts and Options Thereon. Options
on securities, futures contracts, options on futures contracts, currencies and
options on currencies may be traded on foreign exchanges. Such transactions may
not be regulated as effectively as similar transactions in the United States;
may not involve a clearing mechanism and related guarantees; and are subject to
the risk of governmental actions affecting trading in, or the prices of, foreign
securities. The value of such positions also could be adversely affected by: (1)
other complex foreign political, legal and economic factors; (2) lesser
availability than in the United States of data on which to make trading
decisions; (3) delays in the Funds' ability to act upon economic events
occurring in foreign markets during non-business hours in the United States; and
(4) lesser trading volume.
FOREIGN SECURITIES
The Funds may invest in American Depositary Receipts ("ADRs"), European
Depositary Receipts ("EDRs") or other securities convertible into securities of
issuers based in foreign countries. These securities may not necessarily be
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denominated in the same currency as the securities into which they may be
converted. ADRs are receipts, usually issued by a U.S. bank or trust company,
evidencing ownership of the underlying securities; EDRs are European receipts
evidencing a similar arrangement. Generally, ADRs are issued in registered form,
denominated in U.S. dollars, and are designed for use in the U.S. securities
markets; EDRs are issued in bearer form, denominated in other currencies, and
are designed for use in European securities markets.
The Fixed-Income Funds may also invest in fixed-income securities of issuers
located in emerging foreign markets. Emerging markets generally include every
country in the world other than the United States, Canada, Japan, Australia,
Malaysia, New Zealand, Hong Kong, South Korea, Singapore and most Western
European countries. In determining what countries constitute emerging markets,
the Advisor will consider, among other things, data, analysis and classification
of countries published or disseminated by the International Bank for
Reconstruction and Development (commonly known as the World Bank) and the
International Finance Corporation. Currently, investing in many emerging markets
may not be desirable or feasible, because of the lack of adequate custody
arrangements for a Fund's assets, overly burdensome repatriation and similar
restrictions, the lack of organized and liquid securities markets, unacceptable
political risks or other reasons. As opportunities to invest in securities in
emerging markets develop, the Fund expects to expand and further broaden the
group of emerging markets in which it invests.
From time to time, emerging markets have offered the opportunity for higher
returns in exchange for a higher level of risk. Accordingly, the Advisor
believes that a Fixed-Income Fund's ability to invest in emerging markets
throughout the world may enable the achievement of results superior to those
produced by funds, with similar objectives to those of these Funds, that invest
solely in securities in developed markets. There is no assurance that any
Fixed-Income Fund will achieve these results.
The Fixed-Income Funds may invest in the following types of emerging market
fixed-income securities: (1) fixed-income securities issued or guaranteed by
governments, their agencies, instrumentalities or political subdivisions, or by
government owned, controlled or sponsored entities, including central banks
(collectively, "Sovereign Debt"), including Brady Bonds (described below); (2)
interests in issuers organized and operated for the purpose of restructuring the
investment characteristics of Sovereign Debt; (3) fixed-income securities issued
by banks and other business entities; and (4) fixed-income securities
denominated in or indexed to the currencies of emerging markets. Fixed-income
securities held by a Fund may take the form of bonds, notes, bills, debentures,
bank debt obligations, short-term paper, loan participations, assignments and
interests issued by entities organized and operated for the purpose of
restructuring the investment characteristics of any of the foregoing. There is
no requirement with respect to the maturity of fixed-income securities in which
the Fund may invest.
The Fixed-Income Funds may invest in Brady Bonds and other Sovereign Debt of
countries that have restructured or are in the process of restructuring
Sovereign Debt pursuant to the Brady Plan. "Brady Bonds" are debt securities
issued under the framework of the Brady Plan, an initiative announced by former
U.S. Treasury Secretary Nicholas F. Brady in 1989 as a mechanism for debtor
nations to restructure their outstanding external commercial bank indebtedness.
In restructuring its external debt under the Brady Plan framework, a debtor
nation negotiates with its existing bank lenders as well as multilateral
institutions such as the International Bank for Reconstruction and Development
(the "World Bank") and the International Monetary Fund ("IMF"). The Brady Plan
framework, as it has developed, contemplates the exchange of commercial bank
debt for newly issued Brady Bonds. Brady Bonds may also be issued in respect of
new money being advanced by existing lenders in connection with the debt
restructuring. The World Bank and/or the IMF support the restructuring by
providing funds pursuant to loan agreements or other arrangements which enable
the debtor nation to collateralize the new Brady Bonds or to repurchase
outstanding bank debt at a discount.
B-15
<PAGE> 55
Emerging market fixed-income securities generally are considered to be of a
credit quality below investment grade, even though they often are not rated by
any nationally recognized statistical rating organizations. Investment in
emerging market fixed-income securities will be allocated among various
countries based upon the Advisor's analysis of credit risk and its consideration
of a number of factors, including: prospects for relative economic growth among
the different countries in which the Fixed-Income Funds may invest; expected
levels of inflation; government policies influencing business conditions; the
outlook for currency relationships; and the range of the individual investment
opportunities available to international investors. The Advisor's emerging
market sovereign credit analysis includes an evaluation of the issuing country's
total debt levels, currency reserve levels, net exports/imports, overall
economic growth, level of inflation, currency fluctuation, political and social
climate and payment history. Particular fixed-income securities will be selected
based upon credit risk analysis of potential issuers, the characteristics of the
security and interest rate sensitivity of the various debt issues available with
respect to a particular issuer, analysis of the anticipated volatility and
liquidity of the particular debt instruments, and the tax implications to the
Fund. The emerging market fixed-income securities in which the Fixed-Income
Funds may invest are not subject to any minimum credit quality standards.
FOREIGN CURRENCY OPTIONS AND RELATED RISKS
The Funds may take positions in options on foreign currencies to hedge against
the risk of foreign exchange rate fluctuations on foreign securities the Funds
hold in their portfolios or intend to purchase. For example, if a Fund were to
enter into a contract to purchase securities denominated in a foreign currency,
it could effectively fix the maximum U.S. dollar cost of the securities by
purchasing call options on that foreign currency. Similarly, if a Fund held
securities denominated in a foreign currency and anticipated a decline in the
value of that currency against the U.S. dollar, it could hedge against such a
decline by purchasing a put option on the currency involved. The markets in
foreign currency options are relatively new, and a Fund's ability to establish
and close out positions in such options is subject to the maintenance of a
liquid secondary market. There can be no assurance that a liquid secondary
market will exist for a particular option at any specific time. In addition,
options on foreign currencies are affected by all of those factors that
influence foreign exchange rates and investments generally.
The quantities of currencies underlying option contracts represent odd lots in a
market dominated by transactions between banks, and as a result extra
transaction costs may be incurred upon exercise of an option.
There is no systematic reporting of last sale information for foreign currencies
or any regulatory requirement that quotations be firm or revised on a timely
basis. Quotation information is generally representative of very large
transactions in the interbank market and may not reflect smaller transactions
where rates may be less favorable. Option markets may be closed while
round-the-clock interbank currency markets are open, and this can create price
and rate discrepancies.
Risks of Options Trading. The Funds may effectively terminate their rights or
obligations under options by entering into closing transactions. Closing
transactions permit a Fund to realize profits or limit losses on its options
positions prior to the exercise or expiration of the option. The value of a
foreign currency option depends on the value of the underlying currency relative
to the U.S. dollar. Other factors affecting the value of an option are the time
remaining until expiration, the relationship of the exercise price to market
price, the historical price volatility of the underlying currency and general
market conditions. As a result, changes in the value of an option position may
have no relationship to the investment merit of a foreign security. Whether a
profit or loss is realized on a closing transaction depends on the price
movement of the underlying currency and the market value of the option.
B-16
<PAGE> 56
Options normally have expiration dates of up to nine months. The exercise price
may be below, equal to or above the current market value of the underlying
currency. Options that expire unexercised have no value, and a Fund will realize
a loss of any premium paid and any transaction costs. Closing transactions may
be effected only by negotiating directly with the other party to the option
contract, unless a secondary market for the options develops. Although the Funds
intend to enter into foreign currency options only with dealers which agree to
enter into, and which are expected to be capable of entering into, closing
transactions with the Funds, there can be no assurance that a Fund will be able
to liquidate an option at a favorable price at any time prior to expiration. In
the event of insolvency of the counter-party, a Fund may be unable to liquidate
a foreign currency option. Accordingly, it may not be possible to effect closing
transactions with respect to certain options, with the result that a Fund would
have to exercise those options that it had purchased in order to realize any
profit.
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
The Funds may use forward contracts to protect against uncertainty in the level
of future exchange rates. The Funds will not speculate with forward contracts or
foreign currency exchange rates.
A Fund may enter into forward contracts with respect to specific transactions.
For example, when a Fund enters into a contract for the purchase or sale of a
security denominated in a foreign currency, or when a Fund anticipates the
receipt in a foreign currency of dividend or interest payments on a security
that it holds, the Fund may desire to "lock in" the U.S. dollar price of the
security or the U.S. dollar equivalent of the payment, by entering into a
forward contract for the purchase or sale, for a fixed amount of U.S. dollars or
foreign currency, of the amount of foreign currency involved in the underlying
transaction. A Fund will thereby be able to protect itself against a possible
loss resulting from an adverse change in the relationship between the currency
exchange rates during the period between the date on which the security is
purchased or sold, or on which the payment is declared, and the date on which
such payments are made or received.
A Fund also may use forward contracts in connection with portfolio positions to
lock in the U.S. dollar value of those positions, to increase the Fund's
exposure to foreign currencies that the Advisor believes may rise in value
relative to the U.S. dollar or to shift the Fund's exposure to foreign currency
fluctuations from one country to another. For example, when the Advisor believes
that the currency of a particular foreign country may suffer a substantial
decline relative to the U.S. dollar or another currency, it may enter into a
forward contract to sell the amount of the former foreign currency approximating
the value of some or all of the Fund's portfolio securities denominated in such
foreign currency. This investment practice generally is referred to as
"cross-hedging" when another foreign currency is used.
The precise matching of the forward contract amounts and the value of the
securities involved will not generally be possible because the future value of
such securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date the forward contract
is entered into and the date it matures. Accordingly, it may be necessary for a
Fund to purchase additional foreign currency on the spot (i.e., cash) market
(and bear the expense of such purchase) if the market value of the security is
less than the amount of foreign currency the Fund is obligated to deliver and if
a decision is made to sell the security and make delivery of the foreign
currency. Conversely, it may be necessary to sell on the spot market some of the
foreign currency received upon the sale of the portfolio security if its market
value exceeds the amount of foreign currency the Fund is obligated to deliver.
The projection of short-term currency market movements is extremely difficult,
and the successful execution of a short-term hedging strategy is highly
uncertain. Forward contracts involve the risk that anticipated currency
movements will not be accurately predicted, causing the Fund to sustain losses
on these
B-17
<PAGE> 57
contracts and transaction costs. A Fund may enter into forward contracts or
maintain a net exposure to such contracts only if (1) the consummation of the
contracts would not obligate the Fund to deliver an amount of foreign currency
in excess of the value of the Fund's portfolio securities or other assets
denominated in that currency or (2) the Fund maintains in a segregated account
cash, U.S. Government securities, equity securities or other liquid,
unencumbered assets, marked-to-market daily, in an amount not less than the
value of the Fund's total assets committed to the consummation of the contracts.
Under normal circumstances, consideration of the prospect for currency parities
will be incorporated into the longer term investment decisions made with regard
to overall diversification strategies. However, the Advisor believes it is
important to have the flexibility to enter into such forward contracts when it
determines that the best interests of the Fund will be served.
At or before the maturity date of a forward contract that requires a Fund to
sell a currency, the Fund may either sell a portfolio security and use the sale
proceeds to make delivery of the currency or retain the security and offset its
contractual obligation to deliver the currency by purchasing a second contract
pursuant to which the Fund will obtain, on the same maturity date, the same
amount of the currency that it is obligated to deliver. Similarly, a Fund may
close out a forward contract requiring it to purchase a specified currency by
entering into a second contract entitling it to sell the same amount of the same
currency on the maturity date of the first contract. The Fund would realize a
gain or loss as a result of entering into such an offsetting forward contract
under either circumstance to the extent the exchange rate between the currencies
involved moved between the execution dates of the first and second contracts.
The cost to the Fund of engaging in forward contracts varies with factors such
as the currencies involved, the length of the contract period and the market
conditions then prevailing. Because forward contracts are usually entered into
on a principal basis, no fees or commissions are involved. The use of forward
contracts does not eliminate fluctuations in the prices of the underlying
securities the Fund owns or intends to acquire, but it does fix a rate of
exchange in advance. In addition, although forward contracts limit the risk of
loss due to a decline in the value of the hedged currencies, at the same time
they limit any potential gain that might result should the value of the
currencies increase.
Although the Funds value their assets daily in terms of U.S. dollars, they do
not intend to convert holdings of foreign currencies into U.S. dollars on a
daily basis. The Funds may convert foreign currency from time to time, and
investors should be aware of the costs of currency conversion. Although foreign
exchange dealers do not charge a fee for conversion, they do realize a profit
based on the difference between the prices at which they are buying and selling
various currencies. Thus, a dealer may offer to sell a foreign currency to a
Fund at one rate, while offering a lesser rate of exchange should the Fund
desire to resell that currency to the dealer.
Swap Agreements. The Funds may enter into interest rate, index and currency
exchange rate swap agreements for purposes of attempting to obtain a particular
desired return at a lower cost to the Fund than if the Fund had invested
directly in an instrument that yielded the desired return. Swap agreements are
two party contracts entered into primarily by institutional investors for
periods ranging from a few weeks to more than one year. In a standard "swap"
transaction, two parties agree to exchange the returns (or differentials in
rates of return) earned or realized on particular predetermined investments or
instruments. The gross returns to be exchanged or "swapped" between the parties
are calculated with respect to a "notional amount," i.e., the return on or
increase in value of a particular dollar amount invested at a particular
interest rate, in a particular foreign currency, or in a "basket" of securities
representing a particular index. The "notional amount" of the swap agreement is
only a fictive basis on which to calculate the obligations which the parties to
a swap agreement have agreed to exchange. A Fund's obligations (or rights) under
a swap agreement will generally be equal only to the net amount to be paid or
received under the
B-18
<PAGE> 58
agreement based on the relative values of the positions held by each party to
the agreement (the "net amount"). A Fund's obligations under a swap agreement
will be accrued daily (offset against any amounts owing to the Fund) and any
accrued but unpaid net amounts owed to a swap counter-party will be covered by
the maintenance of a segregated account consisting of cash, U.S. Government
securities, equity securities or other liquid, unencumbered assets
marked-to-market daily, to avoid any potential leveraging of the Fund's
portfolio. A Fund will not enter into a swap agreement with any single party if
the net amount owed or to be received under existing contracts with that party
would exceed 5% of the Fund's assets.
Whether a Fund's use of swap agreements will be successful in furthering its
investment objective of total return will depend on the Advisor's ability
correctly to predict whether certain types of investments are likely to produce
greater returns than other investments. Because they are two party contracts and
because they may have terms of greater than seven days, swap agreements may be
considered to be illiquid. Moreover, a Fund bears the risk of loss of the amount
expected to be received under a swap agreement in the event of the default or
bankruptcy of a swap agreement counter-party. The Advisor will cause a Fund to
enter into swap agreements only with counter-parties that would be eligible for
consideration as repurchase agreement counter-parties. Restrictions imposed by
the Internal Revenue Code may limit the Funds' ability to use swap agreements.
The swaps market is a relatively new market and is largely unregulated. It is
possible that developments in the swaps market, including potential government
regulation, could adversely affect a Fund's ability to terminate existing swap
agreements or to realize amounts to be received under such agreements.
RISK FACTORS RELATING TO INVESTING IN HIGH YIELD SECURITIES
Lower-rated or unrated (i.e., high yield) securities are more likely to react to
developments affecting market risk (such as interest rate sensitivity, market
perception of creditworthiness of the issuer and general market liquidity) and
credit risk (such as the issuer's inability to meet its obligations) than are
more highly rated securities, which react primarily to movements in the general
level of interest rates. The Advisor considers both credit risk and market risk
in making investment decisions for the Funds. Investors should carefully
consider the relative risk of investing in high yield securities and understand
that such securities are not generally meant for short-term trading.
The amount of high yield securities outstanding proliferated in the 1980's in
conjunction with the increase in merger and acquisition and leveraged buyout
activity. Under adverse economic conditions, there is a risk that highly
leveraged issuers may be unable to service their debt obligations upon maturity.
In addition, the secondary market for high yield securities, which is
concentrated in relatively few market makers, may not be as liquid as the
secondary market for more highly rated securities. Under adverse market or
economic conditions, the secondary market for high yield securities could
contract further, independent of any specific adverse changes in the condition
of a particular issuer. As a result, the Advisor could find it more difficult to
sell these securities or may be able to sell the securities only at prices lower
than if such securities were widely traded. Prices realized upon the sale of
such lower-rated or unrated securities, under these circumstances, may be less
than the prices used in calculating the Funds' net asset value.
Lower-rated or unrated debt obligations also present risks based on payment
expectations. If an issuer calls the obligation for redemption, the Fund may
have to replace the security with a lower yielding security, resulting in a
decreased return for investors. If a Fund experiences unexpected net
redemptions, it may be forced to sell its higher-rated securities, resulting in
a decline in the overall credit quality of the Fund's portfolio and increasing
the exposure of the Fund to the risks of high yield securities.
B-19
<PAGE> 59
ILLIQUID SECURITIES
A Fund may not hold more than 15% of its net assets in illiquid securities.
Illiquid securities include repurchase agreements which have a maturity of
longer than seven days, and securities that are illiquid by virtue of the
absence of a readily available market (either within or outside of the Unites
States) or legal or contractual restrictions of resale. Historically, illiquid
securities have included securities subject to contractual or legal restrictions
on resale because they have not been registered under the Securities Act,
securities which are otherwise not readily marketable and repurchase agreements
have a maturity of longer than seven days. Securities which have not been
registered under the Securities Act are referred to as private placements or
restricted securities and are purchased directly from the issuer or in the
secondary market. Mutual funds do not typically hold a significant amount of
these restricted or other illiquid securities because of the potential for
delays on resale and uncertainly in valuation. Limitations on resale may have an
adverse effect on the marketability of portfolio securities and a mutual fund
might be unable to dispose of restricted or other illiquid securities promptly
or at reasonable prices and might thereby experience difficulty satisfying
redemption within seven days. The absence of a trading market can make it
difficult to ascertain a market value for illiquid investments. Also market
quotations are less readily available. The judgment of the Advisor may at times
play a greater role in valuing these securities than in the case of unrestricted
securities. A mutual fund might also have to register such restricted securities
in order to dispose of them resulting in additional expense and delay. Adverse
market conditions could impede such a public offering of securities.
In recent years, however, a large institutional market has developed for certain
securities that are not registered under the Securities Act including repurchase
agreements, commercial paper, foreign securities, municipal securities,
convertible securities and corporate bonds and notes. Institutional investors
depend on an efficient institutional market in which the unregistered security
can be readily resold or on an issuer's ability to honor a demand for repayment.
The fact that there are contractual or legal restrictions on resale to the
general public or to certain institutions may not be indicative of the liquidity
of such investments.
Rule 144A under the Securities Act allows for a broader institutional trading
market for securities otherwise subject to restriction on resale to the general
public. Rule 144A established a "safe harbor" from the registration requirements
of the Securities Act for resales of certain securities to qualified
institutional buyers. The investment adviser anticipates that the market for
certain restricted securities such as institutional commercial paper and foreign
securities will expand further as a result of this regulation and the
development of automated systems for the trading, clearance and settlement of
unregistered securities of domestic and foreign issuers, such as the PORTAL
System sponsored by the National Association of Securities Dealers, Inc.
Restricted securities eligible for resale pursuant to Rule 144A under the
Securities Act and commercial paper for which there is a readily available
market will not be deemed to be illiquid. The Advisor will monitor the liquidity
of such restricted securities subject to the supervision of the Trustees. In
reaching liquidity decisions, the Advisor will consider, inter alia, the
following factors: (1) the frequency of trades and quotes for the security; (2)
the number of dealers wishing to purchase or sell the security and the number of
other potential purchasers; (3) dealer undertakings to make a market in the
security; and (4) the nature of the security and the nature of the marketplace
trades (e.g., the time needed to dispose of the security, the method of
soliciting offers and the mechanics of the transfer). In addition, in order for
commercial paper that is issued in reliance on Section 4(2) of the Securities
Act to be considered liquid, (1) it much be rated in one of the two highest
rating categories by at least two nationally recognized statistical rating
organizations ("NRSRO"), or if only one NRSRO rates the securities, by that
NRSRO, or, if unrated, be of comparable quality in the view of the Advisor, and
(2) it must not be "traded flat" (i.e., without accrued interest) or in default
as to principal or interest. Investing in Rule 144A securities could have the
effect of
B-20
<PAGE> 60
increasing the level of Fund illiquidity to the extent that qualified
institutional buyers become, for a time, uninterested in purchasing these
securities. Repurchase agreements subject to demand are deemed to have a
maturity equal to the notice period.
B-21
<PAGE> 61
MANAGEMENT
The Trustees and officers of the Trust are:
<TABLE>
<CAPTION>
NAME, ADDRESS AND AGE POSITION WITH TRUST PRINCIPAL OCCUPATIONS DURING PAST FIVE YEARS
- ------------------------- ------------------- ------------------------------------------------------
<S> <C> <C>
Robert L. Burch III (63) Trustee Managing Partner, A.W. Jones Co. (investments);
885 Third Avenue Chairman, Jonathan Mfg. Corp. (slide manufacturing).
New York, NY 10022
John A. G. Gavin (66) Trustee Chairman, Gamma Services Corp. (venture capital)
2100 Century Park West (since 1968); Principal, Gavin, Dailey & Partners
Los Angeles, CA 90067 (consulting) (since 1993); U.S. Ambassador to Mexico
(1981 - 1986); Director, Atlantic Richfield Co.,
Dresser Industries, Inc., Pinkertons, International
Wire Corp. and Kap Resources.
Joe Grills (62) Trustee Member of the Committee of Investment of Employee
11478 Twin Mountains Road Benefit Assets of the Financial Executives Institute
Rapidan, VA 22733 ("CIEBA") (since 1986); member of CIEBA's Executive
Committee since 1988 and its Chairman (1991 - 1992);
Assistant Treasurer of International Business Machines
Incorporated ("IBM") and Chief Investment Officer of
the IBM Retirement Funds (1986 - 1993); Member of the
Investment Advisory Committee of the State of New York
Common Retirement Fund; Director, Duke Management
Company, KIMCO Realty Corp. and LaSalle Street Fund;
Investment Advisory Committee, Howard Hughes Medical
Institute; Trustee or Director of a number of
investment companies for which Merrill Lynch Asset
Management is the advisor.
John F. Hotchkis* (66) Trustee Chairman and Portfolio Manager of the Advisor.
800 West 6th Street
Los Angeles, CA 90017
Robert B. Hutchinson (77) Trustee Former Chairman (1987 - 88) and Director (1976 - 88),
c/o Simpson Investment Prudential Bank (savings bank); Director and former
Co. Senior Vice President, Finance and Secretary, Simpson
1201 3rd Avenue Investment Co. (holding company for a wood products
Seattle, WA 98101 company, pulp and paper company and a PVC products
company); Director, Enterprises International, Inc.
(industrial strapping material manufacturer).
Michael L. Quinn* (51) Trustee Chief Executive Officer of the Advisor (since November
Merrill Lynch Capital 1996); Head of Merrill Lynch Capital Management Group
Management Group (since 1995); co-head of the Equity Division of
800 Scudders Mill Road Merrill Lynch, Pierce, Fenner & Smith Inc.
Plainsboro, NJ 08536 (1991 - 1995); Trustee, Valley Hospital and the
University of Denver.
Merle T. Welshans (79) Trustee Adjunct Professor of Finance, Washington University;
14360 Ladue Road Chairperson of the Investment Committee of the
Chesterfield, MO 63017 Missouri United Methodist Foundation; Trustee,
Deaconess Hospital Foundation.
Richard R. West (59) Trustee Dean Emeritus of New York University's Leonard N.
Box 604 Stern School of Business (since 1993); formerly Dean
Genoa, NV 89411 (1984 - 1993) and Professor of Finance (1984 - 1995),
New York University's Leonard N. Stern School of
Business; Director, Bornado, Inc., Alexander's Inc.,
Bowne & Co., Inc. and Smith Corona Corp.; Trustee or
Director of a number of investment companies for which
Merrill Lynch Asset Management is the advisor.
Nancy D. Celick (46) President and Chief Financial Officer and Director of the Advisor;
800 West 6th Street Principal Executive Chief Financial Officer Kennedy-Wilson, Inc. (auction
Los Angeles, CA 90017 Officer marketing services) (1992 - 1993); Chief Financial
Officer of First National Corporation (bank holding
company) (1984 - 1992).
</TABLE>
B-22
<PAGE> 62
<TABLE>
<CAPTION>
NAME, ADDRESS AND AGE POSITION WITH TRUST PRINCIPAL OCCUPATIONS DURING PAST FIVE YEARS
- ------------------------- ------------------- ------------------------------------------------------
<S> <C> <C>
Gail Bardin (51) Executive Vice Managing Director of the Advisor since 1995; Partner
800 West 6th Street President of the Advisor (1994 - 1995); Principal of the Advisor
Los Angeles, CA 90017 (1992 - 1994); Portfolio Manager of the Advisor
(1988 - 1992).
Mark D. Cone (29) Vice President Vice President of the Advisor; Retail Account Manager,
800 West 6th Street Neuberger & Berman (1991 - 1994).
Los Angeles, CA 90017
Gracie Fermelia (35) Secretary, Vice President of the Advisor; Senior Manager, Price
800 West 6th Street Treasurer, and Waterhouse (1985 - 1994).
Los Angeles, CA 90017 Principal Financial
and Accounting
Officer
</TABLE>
- ---------------
* "Interested" Trustee, as defined in the 1940 Act, due to the relationship
indicated with the Advisor.
The Trust does not pay salaries to any of its officers or fees to any of its
Trustees affiliated with the Advisor. The following table sets forth the
estimated aggregate compensation to be paid to the Trustees during the Trust's
fiscal year ending December 31, 1998 and the aggregate compensation paid to the
Trustees for service on the Trust's Board and that of any other fund for which
the Advisor serves as investment adviser or has an investment adviser that is an
affiliated person of the Advisor ("Fund Complex") for the calendar year ended
December 31, 1996.
<TABLE>
<CAPTION>
TOTAL 1996
COMPENSATION
PENSION OR FROM TRUST
RETIREMENT ESTIMATED ANNUAL AND FUND
AGGREGATE BENEFITS ACCRUED BENEFITS COMPLEX PAID
COMPENSATION AS PART OF FUND UPON TO TRUSTEES
NAME AND POSITION FROM TRUST EXPENSES RETIREMENT *
- -------------------------------------- ------------ ---------------- ---------------- ------------
<S> <C> <C> <C> <C>
Robert L. Burch III, $ none n/a $
Trustee
John A. G. Gavin, $ none n/a $
Trustee
Joe Grills, $ none n/a $
Trustee
John F. Hotchkis, $-0- none n/a $-0-
Trustee
Robert B. Hutchinson, $ none n/a $
Trustee
Michael L. Quinn, $-0- none n/a $-0-
Trustee
Merle T. Welshans, $ none n/a $
Trustee
Richard R. West, $ none n/a $
Trustee
</TABLE>
- ---------------
* Each Trustee also serves as a Trustee of the Hotchkis and Wiley Funds. Messrs.
Grills and West also serve on the boards of other investment companies advised
by Merrill Lynch Asset Management, LP and its advisory affiliates (Mr. Grills
serves 18 registered investment companies representing 38 portfolios and Mr.
West serves 41 registered investment companies representing 54 portfolios).
B-23
<PAGE> 63
THE ADVISOR
The Advisor provides the Funds with management and investment advisory services.
Hotchkis and Wiley is a division of The Merrill Lynch Capital Management Group
of Merrill Lynch Asset Management, L.P., located at 800 West 6th Street, Los
Angeles, California 90017 and a separate business unit of Merrill Lynch & Co.,
Inc., a financial services holding company incorporated in Delaware.
The Equity Income and International VIP Portfolios pay the Advisor for the
services performed a fee at the annual rate of 0.75% of each Fund's average net
assets. The Total Return Bond VIP Portfolio pays the Advisor a fee at the annual
rate of 0.55% of its average daily net assets. The Low Duration VIP Portfolio
pays the Advisor a fee at the annual rate of 0.46% of its average daily net
assets.
In addition, the Advisor has voluntarily agreed to limit the annual operating
expenses of the Equity Income VIP Portfolio to 1.15% of the Fund's average net
assets. The Advisor has agreed to limit the annual operating expenses of the
International VIP Portfolio to 1.35% of the Fund's average net assets. The
Advisor has agreed to limit the annual operating expenses of the Total Return
Bond VIP Portfolio to 0.65% of the Fund's average net assets. Additionally, the
Advisor has agreed to limit the annual operating expenses of the Low Duration
VIP Portfolio to 0.58% of the Fund's average net assets.
Each of the four Investment Advisory Agreements provides that the Advisor shall
not be liable to the Trust for any error of judgment by the Advisor or for any
loss sustained by any of the Funds except in the case of a breach of fiduciary
duty with respect to the receipt of compensation for services (in which case any
award of damages will be limited as provided in the 1940 Act) or of willful
misfeasance, bad faith, gross negligence or reckless disregard of duty.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Investment Advisory Agreements state that in connection with its duties to
arrange for the purchase and the sale of securities held in the portfolio of
each Fund by placing purchase and sale orders for that Fund, the Advisor shall
select such broker-dealers ("brokers") as shall, in the Advisor's judgment,
implement the policy of the Trust to achieve "best execution", i.e., prompt and
efficient execution at the most favorable securities price. In making such
selection, the Advisor is authorized in the Agreements to consider the
reliability, integrity and financial condition of the broker. The Advisor is
also authorized by the Agreements to consider whether the broker provides
brokerage and/or research services to the Fund and/or other accounts of the
Advisor. The Agreements state that the commissions paid to brokers may be higher
than another broker would have charged if a good faith determination is made by
the Advisor that the commission is reasonable in relation to the services
provided, viewed in terms of either that particular transaction or the Advisor's
overall responsibilities as to the accounts as to which it exercises investment
discretion and that the Advisor shall use its judgment in determining that the
amount of commissions paid are reasonable in relation to the value of brokerage
and research services provided and need not place or attempt to place a specific
dollar value on such services or on the portion of commission rates reflecting
such services. The Agreements provide that to demonstrate that such
determinations were in good faith, and to show the overall reasonableness of
commissions paid, the Advisor shall be prepared to show that commissions paid
(1) were for purposes contemplated by the Agreements; (2) were for products or
services which provide lawful and appropriate assistance to the Advisor's
decision-making process; and (3) were within a reasonable range as compared to
the rates charged by brokers to other institutional investors as such rates may
become known from available information. The Advisor is also authorized to
consider sales of shares of each Fund and/or of any other investment
B-24
<PAGE> 64
companies for which the Advisor acts as Advisor as a factor in the selection of
brokers to execute brokerage and principal transactions, subject to the
requirements of "best execution", as defined above, although the Advisor is not
currently doing so.
The research services discussed above may be in written form or through direct
contact with individuals and may include information as to particular companies
and securities as well as market, economic or institutional areas and
information assisting the Trust in the valuation of the Funds' investments. The
research which the Advisor receives for the Funds' brokerage commissions,
whether or not useful to a Fund, may be useful to the Advisor in managing the
accounts of the Advisor's other advisory clients. Similarly, the research
received for the commissions of such accounts may be useful to any Fund.
In the over-the-counter market, securities are generally traded on a "net" basis
with dealers acting as principal for their own accounts without a stated
commission although the price of the security usually includes a profit to the
dealer. Money market instruments usually trade on a "net" basis as well. On
occasion, certain money market instruments may be purchased by the Funds
directly from an issuer in which case no commissions or discounts are paid. In
underwritten offerings, securities are purchased at a fixed price which includes
an amount of compensation to the underwriter, generally referred to as the
underwriter's concession or discount.
The International VIP Portfolio anticipates that its brokerage transactions
involving securities of companies headquartered in countries other than the U.S.
will be conducted primarily on the principal exchanges of such countries.
Transactions on foreign exchanges are usually subject to fixed commissions which
are generally higher than negotiated commissions on U.S. transactions, although
the Trust will endeavor to achieve the best net results in effecting its
portfolio transactions. There is generally less government supervision and
regulation of exchanges and brokers in foreign countries than in the U.S.
NET ASSET VALUE
As indicated in the Funds' Prospectus, the net asset value per share of each
Fund's shares will be determined on each day that the New York Stock Exchange is
open for trading. That Exchange annually announces the days on which it will not
be open for trading; the most recent announcement indicates that it will not be
open on the following days: New Year's Day, Martin Luther King, Jr. Holiday,
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day. However, that Exchange may close on days not
included in that announcement. Also, no Fund is required to compute its net
asset value on any day on which no order to purchase or redeem its shares is
received.
Securities are valued by an independent pricing agent to the extent possible. In
determining the net asset value of each Fund's shares, equity securities that
are listed on a securities exchange (whether domestic or foreign) or quoted by
the NASDAQ National Market System are valued at the last sale price on that day
as of the close of regular trading on the New York Stock Exchange (which is
currently 4:00 p.m., New York time), or, in the absence of recorded sales, at
the average of readily available closing bid and asked prices on such exchange
or on such System. Unlisted equity securities that are not included in such
National Market System are valued at the average of the quoted bid and asked
prices in the over-the-counter market.
Fixed-income securities which are traded on a national securities exchange will
be valued at the last sale price or, if there was no sale on such day, at the
average of readily available closing bid and asked prices on such exchange.
However, securities with a demand feature exercisable within one to seven days
are valued at par. Prices for fixed-income securities may be based on quotations
received from one or more market-makers in the securities, or on
B-25
<PAGE> 65
evaluations from pricing services. Fixed-income securities for which quotations
or prices are not readily available are valued at their fair value as determined
by the Advisor under guidelines established by the Board of Trustees, with
reference to fixed-income securities whose prices are more readily obtainable or
to an appropriate matrix utilizing similar factors. As a broader market does not
exist, the proceeds received upon the disposal of such securities may differ
from their recorded value. Debt securities which mature in less than 60 days are
valued at amortized cost (unless the Board of Trustees determines that this
method does not represent fair value), if their original maturity was 60 days or
less or by amortizing the value as of the 61st day prior to maturity, if their
original term to maturity exceeded 60 days.
Options, futures contracts and options thereon which are traded on exchanges are
valued at their last sale or settlement price as of the close of the exchanges
or, if no sales are reported, at the average of the quoted bid and asked prices
as of the close of the exchange.
Trading in securities listed on foreign securities exchanges or over-the-counter
markets is normally completed before the close of regular trading on the New
York Stock Exchange. In addition, foreign securities trading may not take place
on all business days in New York and may occur on days on which the New York
Stock Exchange is not open. In addition, foreign currency exchange rates are
generally determined prior to the close of trading on the New York Stock
Exchange. Events affecting the values of foreign securities and currencies will
not be reflected in the determination of net asset value unless the Board of
Trustees determines that the particular event would materially affect net asset
value, in which case an adjustment will be made. Investments quoted in foreign
currency are valued daily in U.S. dollars on the basis of the foreign currency
exchange rate prevailing at the time of valuation. Foreign currency exchange
transactions conducted on a spot basis are valued at the spot rate prevailing in
the foreign exchange market.
Securities and other assets for which market quotations are not readily
available are valued at their fair value as determined by the Advisor under
guidelines established by and under the general supervision and responsibility
of the Board of Trustees.
DIVIDENDS AND TAX STATUS
Each Fund intends to qualify and remain qualified as a regulated investment
company under Subchapter M of the Internal Revenue Code. Qualification as a
regulated investment company requires, among other things, that (1) at least 90%
of each Fund's annual gross income, without offset for losses from the sale or
other disposition of securities, be derived from payments with respect to
securities loans, interest, dividends and gains from the sale or other
disposition of securities, foreign currencies or options (including forward
contracts) thereon; and (2) each Fund diversify its holdings so that, at the end
of each quarter of the taxable year, (i) at least 50% of the value of the Fund's
assets is represented by cash, U.S. Government securities and other securities
limited in respect of any one issuer to an amount not greater than 5% of the
Fund's assets and 10% of the outstanding voting securities of such issuer, and
(ii) not more than 25% of the value of its assets is invested in the securities
of any one issuer (other than U.S. Government securities). In addition, in order
not to be subject to federal taxation, each Fund must distribute to its
shareholders at least 90% of its net investment income, other than net capital
gains, earned in each year.
A separate account upon which a variable annuity contract or variable life
insurance contract is based must meet certain diversification requirements set
forth in U.S. Treasury regulations. Such regulations generally require, among
other things, that a regulated investment company underlying such contracts may
invest no more than (1) 55% of the value of its assets in one investment, (2)
70% of the value of its assets in two investments, (3) 80% of the value
B-26
<PAGE> 66
of its assets in three investments, and (4) 90% of the value of its assets in
four investments. If, as is intended, each Fund meets these requirements and
complies with certain other conditions, a separate account investing solely in
shares of a Fund will also be deemed to meet these diversification requirements.
However, a failure of a Fund to qualify as a regulated investment company or to
meet such conditions and to comply with such requirements could cause the owners
of variable annuity contracts and variable life insurance contracts based on
such accounts to recognize ordinary income each year in the amount of any net
appreciation of such contract during the year (including the annual costs of
life insurance, if any, provided under such contract).
Provided that each Fund and a separate account investing in such Fund satisfy
the above requirements, any distributions from a Fund will be exempt from
current federal income taxation to the extent that such distributions accumulate
in a variable annuity contract or variable life insurance contract owned by an
individual.
A Fund is required to pay an excise tax to the extent it does not distribute to
its shareholders during such calendar year at least 98% of its ordinary income
for that calendar year, 98% of its capital gains over capital losses for the
one-year period ending October 31 in such calendar year, and all undistributed
ordinary income and capital gains for the preceding respective one-year period.
The Funds intend to meet these distribution requirements to avoid excise tax
liability. The Funds also intend to continue distributing to shareholders all of
the excess of net long-term capital gain over net short-term capital loss on
sales of securities. If the net asset value of shares of a Fund should, by
reason of a distribution of realized capital gains, be reduced below a
shareholder's cost, such distribution would to that extent be a return of
capital to that shareholder even though taxable to the shareholder, and a sale
of shares by a shareholder at net asset value at that time would establish a
capital loss for federal tax purposes.
In determining the extent to which a Fund's dividends may be eligible for the
70% dividends received deduction by corporate shareholders, interest income,
capital gain net income, gain or loss from Section 1256 contracts, dividend
income from foreign corporations and income from other sources will not
constitute qualified dividends. Corporate shareholders should consult their tax
advisors regarding other requirements applicable to the dividends received
deduction.
Special rules apply to the treatment of certain forward foreign currency
exchange contracts (Section 1256 contracts). At the end of each year, such
investments held by a Fund must be "marked to market" for federal income tax
purposes; that is, treated as having been sold at market value. Except to the
extent that such gains or losses are treated as "Section 988" gains or losses,
as described below, sixty percent of any gain or loss recognized on these
"deemed sales" and on actual dispositions may be treated as long-term capital
gain or loss, and the remainder will be treated as short-term capital gain or
loss.
Under the Internal Revenue Code, gains or losses attributable to fluctuations in
exchange rates which occur between the time the Fund accrues interest or other
receivables or accrues expenses or other liabilities denominated in a foreign
currency and the time the Fund actually collects such receivables or pays such
liabilities are treated as ordinary income or loss. Similarly, gains or losses
on forward foreign currency exchange contracts or dispositions of debt
securities denominated in a foreign currency attributable to fluctuations in the
value of the foreign currency between the date of acquisition of the security
and the date of disposition are also treated as ordinary gain or loss. These
gains, referred to as "Section 988" gains or losses, increase or decrease the
amount of a Fund's investment company taxable income available to be distributed
to its shareholders as ordinary income, rather than increasing or decreasing the
Fund's net capital gain. If Section 988 losses exceed other investment company
taxable income during a taxable year, the Fund would not be able to make any
ordinary dividend distributions, or distributions made
B-27
<PAGE> 67
before the losses were realized would be recharacterized as a return of capital
to shareholders, rather than as an ordinary dividend, reducing the basis of each
shareholder's shares.
Any loss realized on a sale, redemption or exchange of shares of a Fund by a
shareholder will be disallowed to the extent the shares are replaced within a
61-day period (beginning 30 days before the disposition of shares). Shares
received in connection with the payment of a dividend by a Fund constitute a
replacement of shares.
PERFORMANCE INFORMATION
Total Return. Average annual total return quotations used in the Funds'
advertising and promotional materials are calculated according to the following
formula:
P(1+T)(n) = ERV
where P equals a hypothetical initial payment of $1000; T equals average annual
total return; n equals the number of years; and ERV equals the ending redeemable
value at the end of the period of a hypothetical $1000 payment made at the
beginning of the period.
Under the foregoing formula, the time periods used in advertising will be based
on rolling calendar quarters, updated to the last day of the most recent quarter
prior to submission of the advertising for publication. Average annual total
return, or "T" in the above formula, is computed by finding the average annual
compounded rates of return over the period that would equate the initial amount
invested to the ending redeemable value. Average annual total return assumes the
reinvestment of all dividends and distributions.
Yield. Annualized yield quotations used in a Fund's advertising and promotional
materials are calculated by dividing the Fund's interest income for a specified
thirty-day period, net of expenses, by the average number of shares outstanding
during the period, and expressing the result as an annualized percentage
(assuming semi-annual compounding) of the net asset value per share at the end
of the period. Yield quotations are calculated according to the following
formula:
<TABLE>
<S> <C>
YIELD = 2 [ ( a-b + 1)(6) - 1 ]
---
cd
</TABLE>
where a equals dividends and interest earned during the period; b equals
expenses accrued for the period, net of reimbursements; c equals the average
daily number of shares outstanding during the period that are entitled to
receive dividends; and d equals the maximum offering price per share on the last
day of the period.
Except as noted below, in determining net investment income earned during the
period ("a" in the above formula), a Fund calculates interest earned on each
debt obligation held by it during the period by: (1) computing the obligation's
yield to maturity, based on the market value of the obligation (including actual
accrued interest) on the last business day of the period or, if the obligation
was purchased during the period, the purchase price plus accrued interest; (2)
dividing the yield to maturity by 360 and multiplying the resulting quotient by
the market value of the obligation (including actual accrued interest). Once
interest earned is calculated in this fashion for each debt obligation held by
the Fund, net investment income is then determined by totaling all such interest
earned.
For purposes of these calculations, the maturity of an obligation with one or
more call provisions is assumed to be the next date on which the obligation
reasonably can be expected to be called or, if none, the maturity date.
B-28
<PAGE> 68
Other information. Each Fund's performance data quoted in advertising and other
promotional materials represents past performance and is not intended to predict
or indicate future results. The return and principal value of an investment in a
Fund will fluctuate, and an investor's redemption proceeds may be more or less
than the original investment amount. Yields and total returns quoted for a Fund
include the effect of deducting the Fund's expenses, but may not include charges
and expenses attributable to a particular variable annuity contract or variable
life insurance policy. Including these charges in the quotations of a Fund's
yield and total return would have the effect of decreasing performance. Since
shares of the Funds can be purchased only through a variable annuity contract or
variable life insurance policy, a purchaser of such contract or policy should
carefully review the prospectus for the applicable variable annuity contract or
variable life insurance policy for information on relevant charges and expenses.
Performance information for the Funds must always be accompanied by, and be
reviewed with, performance information for the insurance product which invests
in the Funds.
In advertising and promotional materials, a Fund may compare its performance
with data published by Lipper Analytical Services, Inc. ("Lipper") or CDA
Investment Technologies, Inc. ("CDA"). The Fund also may refer in such materials
to mutual fund performance rankings and other data, such as comparative asset,
expense and fee levels, published by Lipper or CDA. Advertising and promotional
materials also may refer to discussions of the Fund and comparative mutual fund
data and ratings reported in independent periodicals including, but not limited
to, The Wall Street Journal, Money Magazine, Forbes, Business Week, Financial
World and Barron's.
GENERAL INFORMATION ABOUT THE TRUST
The Declaration of Trust permits the Trustees to issue an unlimited number of
full and fractional shares of beneficial interest and to divide or combine the
shares into a greater or lesser number of shares without thereby changing the
proportionate beneficial interest in each Fund. Each share represents an
interest in a Fund proportionately equal to the interest of each other share.
Upon the Trust's liquidation, all shareholders would share pro rata in the net
assets of the Fund in question available for distribution to shareholders. If
they deem it advisable and in the best interest of shareholders, the Board of
Trustees may create classes of shares. The Board of Trustees has created three
series of shares, and may create additional series in the future, which have
separate assets and liabilities; each of such series has or will have a
designation including the word "Series." Income and operating expenses not
specifically attributable to a particular Fund are allocated fairly among the
Funds by the Trustees, generally on the basis of the relative net assets of each
Fund.
The Declaration of Trust provides that the Trustees will not be liable for
errors of judgment or mistakes of fact or law, but nothing in the Declaration of
Trust protects a Trustee against any liability to which he or she would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his or
her office. The Declaration of Trust also provides that the Trust shall, upon
request, assume the defense of any claim made against any shareholder for any
act or obligation of the Trust and satisfy any judgment thereon.
Ten shareholders holding the lesser of $25,000 worth or one percent of a Fund's
shares may advise the Trustees in writing that they wish to communicate with
other shareholders for the purpose of requesting a meeting to remove a Trustee.
The Trustees will then, if requested by the applicants, mail at the applicants'
expense the applicants' communication to all other shareholders.
B-29
<PAGE> 69
The Trust or any Fund may be terminated if approved by the vote of a majority of
the Trustees or by the approval of the holders of a majority of the Trust's
outstanding shares, as defined in the 1940 Act. If not so terminated, the Trust
will continue indefinitely.
Rule 18f-2 under the 1940 Act provides that as to any investment company which
has two or more series outstanding and as to any matter required to be submitted
to shareholder vote, such matter is not deemed to have been effectively acted
upon unless approved by the holders of a "majority" (as defined in the Rule) of
the voting securities of each series affected by the matter. Such separate
voting requirements do not apply to the election of Trustees or the ratification
of the selection of accountants. A change in investment policy may go into
effect as to one or more series whose holders so approve the change even though
the required vote is not obtained as to the holders of other affected series.
The rights accompanying Fund shares are legally vested in the separate accounts.
However, in accordance with current law and interpretations thereof,
Participating Insurance Companies will vote shares held in the separate accounts
in a manner consistent with timely voting instructions received from the holders
of variable annuity contracts and variable life insurance policies. Each
Participating Insurance Company will vote Fund shares held in separate accounts
for which no timely instructions are received from the holders of variable
annuity contracts and variable life insurance policies, as well as shares it
owns, in the same proportion as those shares for which voting instructions are
received. For a further discussion, please refer to the insurance company's
separate account prospectus.
The Trust's custodian, Firstar Trust Company, 615 East Michigan Street,
Milwaukee, Wisconsin, is responsible for holding the Funds' assets and acts as
the Trust's accounting services agent. The Chase Manhattan Bank, N.A., through
its global custody network, provides custodial services for assets of the Trust
held outside the U.S. The Trust's independent accountants, Price Waterhouse LLP,
100 East Wisconsin Avenue, Milwaukee, Wisconsin 53202, examine the Trust's
financial statements and assist in the preparation of certain reports to the
Securities and Exchange Commission.
As of the date of this Statement of Additional Information, owns all
of the outstanding shares of the Trust.
[Statement of Assets and Liabilities to come]
B-30
<PAGE> 70
PART C
OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements:
The following audited financial statements are included in the
Statement of Additional Information constituting Part B of this Registration
Statement:**
Statement of Assets and Liabilities
Notes to Financial Statements
Report of Independent Accountants
The following financial statements are included in the Prospectuses
constituting Part A of this Registration Statement:
None.
(b) Exhibits:
(1) (a) Declaration of Trust(1)
(b) Amended Certificate of Designation*
(2) By-Laws(1)
(3) Not applicable
(4) Not applicable
(5) (a) Form of Investment Advisory Agreement
relating to the Equity Income VIP Portfolio*
(b) Form of Investment Advisory Agreement
relating to the International VIP Portfolio*
(c) Form of Investment Advisory Agreement
relating to the Low Duration VIP Portfolio*
(d) Form of Investment Advisory Agreement
relating to the Total Return Bond
VIP Portfolio*
(6) Not applicable
(7) Not applicable
(8) (a) Custodian Agreement with Firstar Trust Company**
(b) Sub-Custodian Agreement between Firstar Trust
Company and Chase Manhattan Bank, N.A. **
(9) Fund Administration Servicing Agreement**
(10) Opinion and Consent of Counsel**
(11) Consent of Independent Auditors**
(12) Not applicable
(13) Investment letter**
(14) Not applicable
(15) Not applicable
(16) Not applicable
- ----------
* Filed herewith.
** To be filed by amendment.
(1) Incorporated by reference to the Registration Statement on
Form N-1A filed on April 1, 1997 (File No. 333-24349).
ITEM 25. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT.
See "General Information About the Trust" in the Statement of
Additional Information.
ITEM 26. NUMBER OF HOLDERS OF SECURITIES.
None.
C-1
<PAGE> 71
ITEM 27. INDEMNIFICATION.
Section 12 of Article SEVENTH of Registrant's Declaration of Trust,
states as follows:
(c) As used in this paragraph the following terms shall have the
meanings set forth below:
(i) the term "indemnitee" shall mean any present or
former Trustee, officer or employer of the Trust, any present
or former Trustee or officer of another trust or corporation
whose securities are or were owned by the Trust or of which
the Trust is or was a creditor and who served or serves in
such capacity at the request of the Trust, any present or
former investment advisor, sub-advisor or principal
underwriter of the Trust and the heirs, executors,
administrators, successors and assigns of any of the
foregoing; however, whenever conduct by an indemnitee is
referred to, the conduct shall be that of the original
indemnitee rather than that of the heir, executor,
administrator, successor or assignee;
(ii) the term "covered proceeding" shall mean any
threatened, pending or completed action, suit or proceeding,
whether civil, criminal, administrative or investigative, to
which an indemnitee is or was a party or is threatened to be
made a party by reason of the fact or facts under which he or
it is an indemnitee as defined above;
(iii) the term "disabling conduct" shall mean willful
misfeasance, bad faith, gross negligence or reckless disregard
of the duties involved in the conduct of the office in
question;
(iv) the term "covered expenses" shall mean expenses
(including attorney's fees), judgments, fines and amounts paid
in settlement actually and reasonably incurred by an
indemnitee in connection with a covered proceeding; and
(v) the term "adjudication of liability" shall mean,
as to any covered proceeding and as to any indemnitee, an
adverse determination as to the indemnitee whether by judgment
order, settlement, conviction or upon a plea of nolo
contendere or its equivalent.
(d) The Trust shall not indemnify any indemnitee for any
covered expenses in any covered proceeding if there has been an
adjudication of liability against such indemnitee expressly based on a
finding of disabling conduct.
(e) Except as set forth in (d) above, the Trust shall
indemnify an indemnitee for covered expenses in any covered proceeding,
whether or not there is an adjudication of liability as to such
indemnitee, if a determination has been made that the indemnitee was
not liable by reason of disabling conduct by (i) a final decision of
the court or other body before which the covered proceeding was
brought; or (ii) in the absence of such decision, a reasonable
determination, based on a review of the facts, by either (a) the vote
of a majority of a quorum of Trustees who are neither "interested
persons," as defined in the 1940 Act, nor parties to the covered
proceeding or (b) an independent legal counsel in a written opinion;
provided that such Trustees or counsel, in reaching such determination,
may but need not presume the absence of disabling conduct on the part
of the indemnitee by reason of the manner in which the covered
proceeding was terminated.
(f) Covered expenses incurred by an indemnitee in connection
with a covered proceeding shall be advanced by the Trust to an
indemnitee prior to the final disposition of a covered proceeding upon
the request of the indemnitee for such advance and the undertaking by
or on behalf of the indemnitee to repay the advance unless it is
ultimately determined that the indemnitee is entitled to
indemnification thereunder, but only if one or more of the following is
the case: (i) the indemnitee shall provide a security for such
undertaking; (ii) the Trust shall be insured against losses arising out
of any lawful advances; or (iii) there shall have been a determination,
based on a review of the readily available facts (as, opposed to a full
trial-type inquiry) that there is a reason to believe that the
indemnitee ultimately will be found entitled to indemnification by
either independent legal counsel in a written opinion or by the vote of
a majority of a
C-2
<PAGE> 72
quorum of trustees who are neither "interested persons" as defined in
the 1940 Act nor parties to the covered proceeding.
(g) Nothing herein shall be deemed to affect the right of the
Trust and/or any indemnitee to acquire and pay for any insurance
covering any or all indemnitees to the extent permitted by the 1940 Act
or to affect any other indemnification rights to which any indemnitee
may be entitled to the extent permitted by the 1940 Act.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to trustees, officers and controlling persons of
Registrant pursuant to the foregoing provisions, or otherwise, Registrant has
been advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in that Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by Registrant of expenses incurred or
paid by a trustee, officer or controlling person of Registrant in the successful
defense of any action, suit or proceeding) is asserted by such trustee, officer
or controlling person in connection with the securities being registered,
Registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of such
issue.
ITEM 28. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER.
See "Organization and Management" in the Prospectus constituting Part A
of this Registration Statement and "Management" in the Statement of Additional
Information constituting Part B of this Registration Statement. Information as
to Hotchkis and Wiley, a division of Merrill Lynch Asset Management, L.P., is
included in its Form ADV filed with the Securities and Exchange Commission (File
No. 801-11583), as most recently amended, the text of which is incorporated
herein by reference.
ITEM 29. PRINCIPAL UNDERWRITERS.
Not applicable.
ITEM 30. LOCATION OF ACCOUNTS AND RECORDS.
The accounts, books and other documents required to be maintained by
Registrant pursuant to Section 31(a) of the Investment Company Act of 1940 and
the rules promulgated thereunder are in the possession of Registrant and
Registrant's custodian, as follows: the documents required to be maintained by
paragraphs (4), (5), (6), (7), (10) and (11) of Rule 31a-1(b) will be maintained
by the Registrant, and all other records will be maintained by the Custodian.
ITEM 31. MANAGEMENT SERVICES.
Not applicable.
ITEM 32. UNDERTAKINGS.
The Registrant hereby undertakes to file a post-effective amendment,
using financial statements which need not be certified, within four to six
months from the effective date of this Registration Statement.
The Registrant hereby undertakes to furnish to each person to whom a
Prospectus is delivered a copy of Registrant's latest annual report to
shareholders upon request and without charge.
C-3
<PAGE> 73
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this Amendment
to the Registration Statement to be signed on its behalf by the undersigned,
thereto duly authorized, in the City of Los Angeles and State of California on
the 21st day of November, 1997.
HOTCHKIS AND WILEY VARIABLE TRUST
By: /s/ Nancy D. Celick
------------------------------------
Nancy D. Celick
President
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities and on the date indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Nancy D. Celick Principal Executive Officer November 21, 1997
- ------------------------------------
Nancy D. Celick
/s/ Gracie Fermelia Principal Financial and Accounting November 21, 1997
- ------------------------------------
Gracie Fermelia Officer
/s/ Robert L. Burch III Trustee November 21, 1997
- ------------------------------------
Robert L. Burch III
/s/ John Gavin Trustee November 21, 1997
- ------------------------------------
John Gavin
/s/ Joe Grills Trustee November 21, 1997
- ------------------------------------
Joe Grills
/s/ John F. Hotchkis Trustee November 21, 1997
- ------------------------------------
John F. Hotchkis
/s/ Robert B. Hutchinson Trustee November 21, 1997
- ------------------------------------
Robert B. Hutchinson
/s/ Michael L. Quinn Trustee November 21, 1997
- ------------------------------------
Michael L. Quinn
/s/ Merle T. Welshans Trustee November 21, 1997
- ------------------------------------
Merle T. Welshans
/s/ Richard R. West Trustee November 21, 1997
- ------------------------------------
Richard R. West
</TABLE>
<PAGE> 74
EXHIBIT INDEX
Exhibit No. Exhibit Page
- ----------- ------- ----
1(a) Declaration of Trust(1)
1(b) Amended Certificate of Designation*
2 By-Laws(1)
3 Not Applicable
4 Not Applicable
5(a) Form of Investment Advisory Agreement relating to
the Equity Income VIP Portfolio*
5(b) Form of Investment Advisory Agreement relating to
the International VIP Portfolio*
5(c) Form of Investment Advisory Agreement relating to
the Low Duration VIP Portfolio*
5(d) Form of Investment Advisory Agreement relating to
the Total Return Bond VIP Portfolio*
6 Not Applicable
7 Not Applicable
8(a) Custodian Agreement with Firstar Trust Company**
8(b) Sub-Custodian Agreement between Firstar Trust
Company and Chase Manhattan Bank, N.A.**
9 Fund Administration Servicing Agreement**
10 Opinion and Consent of Counsel**
11 Consent of Independent Auditors**
12 Not Applicable
13 Investment Letter**
14 Not Applicable
15 Not Applicable
16 Not Applicable
- -----------------------
* Filed herewith.
** To be filed by amendment.
(1) Incorporated by reference to the Registration Statement on Form N-1A
filed on April 1, 1997 (File No. 333-24349).
<PAGE> 1
EXHIBIT (1)(B)
Amended
Certificate of Designation
HOTCHKIS AND WILEY VARIABLE TRUST
The undersigned, being the Secretary of Hotchkis and Wiley Variable
Trust (hereinafter referred to as the "Trust"), a trust with transferable shares
of the type commonly called a Massachusetts business trust, DOES HEREBY CERTIFY
that, pursuant to the authority conferred upon the Trustees of the Trust by
Article FOURTH, paragraph 1(a) of the Declaration of Trust dated February 4,
1997 (hereinafter referred to as the "Declaration of Trust"), and by the
affirmative vote of a majority of the Trustees at a meeting duly called and held
on October 9, 1997, the Certificate of Designation dated February 11, 1997 and
filed with the Secretary of The Commonwealth of Massachusetts on March 27, 1997
amending the Declaration of Trust is amended and restated as follows:
The shares of beneficial interest of the Trust are divided into four
separate series, each series to have the following special and relative rights:
(1) The series shall be designated as follows:
Equity Income VIP Series
International VIP Series
Low Duration VIP Series
Total Return Bond VIP Series
(2) Each series shall be authorized to invest in cash,
securities, instruments and other property as from time to time described in the
Trust's then currently effective registration statement under the Securities Act
of 1933. Each share of beneficial interest of each series ("share") shall be
redeemable, shall be entitled to one vote or fraction thereof in respect of a
fractional share on matters on which shares of that series shall be entitled to
vote and shall represent a pro rata beneficial interest in the assets allocated
to that series, and shall be entitled to receive its pro rata share of net
assets of that series upon liquidation of that series, all as provided in the
Declaration of Trust.
<PAGE> 2
(3) The shares of beneficial interest of each series of the
Trust shall consist of a single class; provided, however, that the Trustees
reserve the right to hereafter create one or more classes of shares of any
series of the Trust. An unlimited number of shares of each series may be issued.
(4) Shareholders of each series shall vote as a separate
class on any matter to the extent required by, and any matter shall be deemed to
have been effectively acted upon with respect to any series as provided in, Rule
18f-2, as from time to time in effect, under the 1940 Act, or any successor rule
and by the Declaration of Trust.
(5) The assets and liabilities of the Trust shall be
allocated among the above-referenced series as set forth in paragraph 6 of
Article FOURTH of the Declaration of Trust, except that the liabilities,
expenses, costs, charges or reserves of the Trust which are not readily
identifiable as belonging to any particular series shall be allocated among the
series (a) on the basis of their relative average daily net assets, (b) as
incurred on a specific identification basis or (c) evenly among the series,
depending on the nature of the expenditure.
(6) The Trustees (including any successor Trustees) shall
have the right at any time and from time to time to reallocate assets and
expenses or to change the designation of any series now or hereafter created, or
to otherwise change the special and relative rights of any such series provided
that such change shall not adversely affect the rights of holders of shares of a
series.
IN WITNESS WHEREOF, the undersigned has set her hand and seal this
10th day of October, 1997.
/s/ Gracie V. Fermelia
-----------------------------
Gracie V. Fermelia, Secretary
-2-
<PAGE> 3
ACKNOWLEDGMENT
STATE OF CALIFORNIA )
) SS October 10, 1997
COUNTY OF LOS ANGELES )
Then personally appeared before me the above named Gracie V.
Fermelia, Secretary, and acknowledged the foregoing instrument to be her free
act and deed.
/s/ Karen Bynum II
-----------------------
Notary Public
-3-
<PAGE> 1
Exhibit 99.B5(a)
HOTCHKIS AND WILEY VARIABLE TRUST
INVESTMENT ADVISORY AGREEMENT
AGREEMENT made this______ day of______, 1997, by and between HOTCHKIS
AND WILEY VARIABLE TRUST, a Massachusetts business trust (the "Trust"), on
behalf of the Equity Income VIP Series (the "Portfolio"), and HOTCHKIS AND
WILEY, a division of the Capital Management Group of Merrill Lynch Asset
Management, L.P. (the "Advisor").
WITNESSETH:
WHEREAS, the Trust has been organized and intends to operate as an
investment company registered under the Investment Company Act of 1940 ("1940
Act") and is currently comprised of three series, one of which is the
Portfolio; and each series will engage in the business of investing and
reinvesting its assets; and
WHEREAS, the Advisor is a registered investment advisor under the
Investment Advisors Act of 1940 and engages in the business of providing
investment advisory services; and
WHEREAS, the Trust's Board of Trustees, including a majority of the
Trustees who are not parties to this Agreement or "interested persons" (as
defined in the 1940 Act) of any such party, and the Portfolio's initial
shareholder have approved this Agreement;
NOW, THEREFORE, in consideration of the mutual promises and agreements
herein contained and other good and valuable consideration, the receipt of
which is hereby acknowledged, it is hereby agreed by and between the parties
hereto as follows:
1. IN GENERAL
The Advisor agrees, all as more fully set forth herein, to act as
managerial investment advisor to the Trust with respect to the investment of
the assets of the Portfolio and to supervise and arrange the purchase and sale
of securities held in the portfolio of the Portfolio.
2. DUTIES AND OBLIGATIONS OF THE ADVISOR WITH RESPECT TO
INVESTMENT OF ASSETS OF THE PORTFOLIO
(a) Subject to the succeeding provisions of this section
and subject to the direction and control of the Board of
Trustees of the Trust, the Advisor shall:
(i) Decide what securities or other assets shall
be purchased or sold by the Trust with respect to the Portfolio
and when; and
(ii) Arrange for the purchase and the sale of
securities or other assets held in the portfolio of the
Portfolio by placing purchase and sale orders for the Trust
with respect to the Portfolio.
<PAGE> 2
(b) Any investment purchases or sales made by the Advisor
shall at all times conform to, and be in accordance with, any
requirements imposed by: (1) the provisions of the 1940 Act
and of any rules or regulations in force thereunder; (2) any
other applicable provisions of law; (3) the provisions of the
Declaration of Trust and By-Laws of the Trust as amended from
time to time: (4) any policies and determinations of the Board
of Trustees of the Trust; and (5) the fundamental policies of
the Trust relating to the Portfolio, as reflected in the
Trust's Registration Statement under the 1940 Act, or as
amended by the shareholders of the Portfolio.
(c) The Advisor shall give the Trust the benefit of its
best judgment and effort in rendering services hereunder, but
the Advisor shall not be liable for any loss sustained by
reason of the purchase, sale or retention of any security
whether or not such purchase, sale or retention shall have
been based on its own investigation and research or upon
investigation and research made by any other individual, firm
or corporation, if such purchase, sale or retention shall have
been made and such other individual, firm or corporation shall
have been selected in good faith. Nothing herein contained
shall, however, be construed to protect the Advisor against
any liability to the Trust or its security holders by reason
of willful misfeasance, bad faith, or gross negligence in the
performance of its duties, or by reason of its reckless
disregard of obligations and duties under this Agreement.
(d) Nothing in this Agreement shall prevent the Advisor
or any affiliated person (as defined in the 1940 Act) of the
Advisor from acting as investment advisor or manager and/or
principal underwriter for any other person, firm or
corporation and shall not in any way limit or restrict the
Advisor or any such affiliated person from buying, selling or
trading any securities for its or their own accounts or the
accounts of others for whom it or they may be acting,
provided, however, that the Advisor expressly represents that
it will undertake no activities which, in its judgment, will
adversely affect the performance of its obligations to the
Trust under this Agreement.
(e) It is agreed that the Advisor shall have no
responsibility or liability for the accuracy or completeness
of the Trust's Registration Statement under the 1940 Act or
the Securities Act of 1933 except for information supplied by
the Advisor for inclusion therein. The Trust may indemnify
the Advisor to the full extent permitted by the Trust's
Declaration of Trust.
3. BROKER-DEALER RELATIONSHIPS
The Advisor is responsible for decisions to buy and sell securities
for the Portfolio, broker-dealer selection, and negotiation of brokerage
commission rates. The Advisor's primary consideration in effecting a
securities transaction will be execution at the most favorable price. In
selecting a broker-dealer to execute each particular transaction, the Advisor
will take the following into consideration: the best net price available; the
reliability, integrity and financial
2
<PAGE> 3
condition of the broker-dealer; the size of and difficulty in executing the
order; and the value of the expected contribution of the broker-dealer to the
investment performance of the Portfolio on a continuing basis. Accordingly,
the price to the Portfolio in any transaction may be less favorable than that
available from another broker-dealer if the difference is reasonably justified
by other aspects of the portfolio execution services offered. Subject to such
policies as the Board of Trustees of the Trust may determine, the Advisor shall
not be deemed to have acted unlawfully or to have breached any duty created by
this Agreement or otherwise solely by reason of its having caused the Portfolio
to pay a broker or dealer that provides brokerage or research services to the
Advisor an amount of commission for effecting a portfolio transaction in excess
of the amount of commission another broker or dealer would have charged for
effecting that transaction, if the Advisor determines in good faith that such
amount of commission was reasonable in relation to the value of the brokerage
and research services provided by such broker or dealer, viewed in terms of
either that particular transaction or the Advisor's overall responsibilities
with respect to the Trust. The Advisor is further authorized to allocate the
orders placed by it on behalf of the Portfolio to such brokers or dealers who
also provide research or statistical material, or other services, to the Trust,
the Advisor, or any affiliate of either. Such allocation shall be in such
amounts and proportions as the Advisor shall determine, and the Advisor shall
report on such allocations regularly to the Trust, indicating the
broker-dealers to whom such allocations have been made and the basis therefor.
The Advisor is also authorized to consider sales of shares as a factor in the
selection of brokers or dealers to execute portfolio transactions, subject to
the requirements of best execution, i.e., that such brokers or dealers are able
to execute the order promptly and at the best obtainable securities price.
4. ALLOCATION OF EXPENSES
The Advisor agrees that it will furnish the Trust, at the Advisor's
expense, with all office space and facilities, and equipment and clerical
personnel necessary for carrying out its duties under this Agreement. The
Advisor (or an affiliate thereof) will also pay all compensation of all
Trustees, officers and employees of the Trust who are affiliated persons of the
Advisor. All operating costs and expenses relating to the Portfolio not
expressly assumed by the Advisor under this Agreement shall be paid by the
Trust from the assets of the Portfolio, as applicable, including, but not
limited to (i) interest and taxes; (ii) brokerage commissions, (iii) insurance
premiums; (iv) compensation and expenses of the Trust's Trustees other than
those affiliated with the Advisor; (v) legal and audit expenses; (vi) fees and
expenses of the Trust's custodian, shareholder servicing or transfer agent and
accounting services agent; (vii) expenses incident to the issuance of the
Portfolio's shares, including issuance on the payment of, or reinvestment of,
dividends; (viii) fees and expenses incident to the registration under Federal
or state securities laws of the Trust or the shares of the Portfolio; (ix)
expenses of preparing, printing and mailing reports and notices and proxy
materials to shareholders of the Portfolio; (x) all other expenses incident to
holding meetings of the Portfolio's shareholders; (xi) dues or assessments of
or contributions to the Investment Company Institute or any successor; (xii)
such non-recurring expenses as may arise, including litigation affecting the
Trust and the legal obligations which the Trust may have to indemnify its
officers and Trustees with respect thereto; and (xiii) all expenses which the
Trust or the Portfolio agree to bear in any distribution agreement or in any
plan adopted by the Trust and/or the Portfolio pursuant to Rule 12b-1 under the
1940 Act.
3
<PAGE> 4
5. COMPENSATION OF THE ADVISOR
The Trust agrees to pay the Advisor and the Advisor agrees to accept
as full compensation for all services rendered by the Advisor hereunder. an
annual management fee, payable monthly and computed on the value of the average
net assets of the Portfolio as of the close of business each business day, at
the annual rate of .75%.
6. DURATION AND TERMINATION
(a) This Agreement shall go into effect on the date hereof and
shall, unless terminated as hereinafter provided, continue in
effect until _________, 1999, and thereafter from year to year,
but only so long as such continuance is specifically approved
at least annually by the Trust's Board of Trustees, including
the vote of a majority of the Trustees who are not parties to
this Agreement or "interested persons" (as defined in the 1940
Act) of any such party cast in person at a meeting called for
the purpose of voting on such approval, or by the vote of the
holders of a "majority" (as so defined) of the outstanding
voting securities of the Portfolio and by such a vote of the
Trustees.
(b) This Agreement may be terminated by the Advisor at any time
without penalty upon giving the Trust sixty (60) days' written
notice (which notice may be waived by the Trust) and may be
terminated by the Trust at any time without penalty upon giving
the Advisor sixty (60) days' written notice (which notice may
be waived by the Advisor), provided that such termination by
the Trust shall be directed or approved by the vote of a
majority of all of its Trustees in office at the time or by the
vote of the holders of a majority (as defined in the 1940 Act)
of the voting securities of the Trust at the time outstanding
and entitled to vote. This Agreement shall automatically
terminate in the event of its assignment (as so defined).
7. USE OF ADVISOR'S NAME
The Trust may use the name "Hotchkis and Wiley Variable Trust" or any
name including the words "Hotchkis and Wiley" only for so long as this
Agreement or any other advisory agreement relating to the Trust is in effect.
If the Agreement or any other advisory agreement relating to the Trust is no
longer in effect, the Trust will (to the extent that it lawfully can) cease to
use such a name or any other name indicating that it is advised by or otherwise
connected with the Advisor, or any organization that shall have succeeded to
the Advisor's business. In no event shall the Trust use the name "Hotchkis and
Wiley Variable Trust" or any name including the words "Hotchkis and Wiley" if
the Advisor's function is transferred or assigned to a company over which
Merrill Lynch & Co., Inc. does not have control.
4
<PAGE> 5
8. AGREEMENT BINDING ONLY ON TRUST PROPERTY
The Advisor understands that the obligations of this Agreement are not
binding upon any shareholder of the Trust personally, but bind only the Trust's
property; the Advisor represents that it has notice of the provisions of the
Trust's Declaration of Trust disclaiming shareholder liability for acts or
obligations of the Trust.
IN WITNESS WHEREOF, the parties hereto have caused the foregoing
instrument to be executed by duly authorized persons and their seals to be
hereunto affixed. all as of the day and year first above written.
HOTCHKIS AND WILEY VARIABLE
TRUST
By___________________________
ATTEST:
______________________________
HOTCHKIS AND WILEY, a division of the
Capital Management Group of Merrill
Lynch Asset Management, L.P.
By___________________________
ATTEST:
_______________________________
5
<PAGE> 6
EXHIBIT 99.B5(b)
HOTCHKIS AND WILEY VARIABLE TRUST
INVESTMENT ADVISORY AGREEMENT
AGREEMENT made this day of , 1997, by and between HOTCHKIS
AND WILEY VARIABLE TRUST, a Massachusetts business trust (the "Trust"), on
behalf of the International VIP Series (the "Portfolio"), and HOTCHKIS AND
WILEY, a division of the Capital Management Group of Merrill Lynch Asset
Management, L.P. (the "Advisor").
WITNESSETH:
WHEREAS, the Trust has been organized and intends to operate as an
investment company registered under the Investment Company Act of 1940 ("1940
Act") and is currently comprised of three series, one of which is the
Portfolio; and each series will engage in the business of investing and
reinvesting its assets; and
WHEREAS, the Advisor is a registered investment advisor under the
Investment Advisors Act of 1940 and engages in the business of providing
investment advisory services; and
WHEREAS, the Trust's Board of Trustees, including a majority of the
Trustees who are not parties to this Agreement or "interested persons" (as
defined in the 1940 Act) of any such party, and the Portfolio's initial
shareholder have approved this Agreement;
NOW, THEREFORE, in consideration of the mutual promises and agreements
herein contained and other good and valuable consideration, the receipt of
which is hereby acknowledged, it is hereby agreed by and between the parties
hereto as follows:
1. IN GENERAL
The Advisor agrees, all as more fully set forth herein, to act as
managerial investment advisor to the Trust with respect to the investment of
the assets of the Portfolio and to supervise and arrange the purchase and sale
of securities held in the portfolio of the Portfolio.
2. DUTIES AND OBLIGATIONS OF THE ADVISOR WITH RESPECT TO
INVESTMENT OF ASSETS OF THE PORTFOLIO
(a) Subject to the succeeding provisions of this section and
subject to the direction and control of the Board of Trustees
of the Trust, the Advisor shall:
(i) Decide what securities or other assets shall be
purchased or sold by the Trust with respect to the
Portfolio and when; and
(ii) Arrange for the purchase and the sale of
securities or other assets held in the portfolio of the
Portfolio by placing purchase and sale orders for the
Trust with respect to the Portfolio.
<PAGE> 7
(b) Any investment purchases or sales made by the Advisor
shall at all times conform to, and be in accordance with, any
requirements imposed by: (1) the provisions of the 1940 Act
and of any rules or regulations in force thereunder, (2) any
other applicable provisions of law; (3) the provisions of the
Declaration of Trust and By-Laws of the Trust as amended from
time to time: (4) any policies and determinations of the Board
of Trustees of the Trust; and (5) the fundamental policies of
the Trust relating to the Portfolio, as reflected in the
Trust's Registration Statement under the 1940 Act, or as
amended by the shareholders of the Portfolio.
(c) The Advisor shall give the Trust the benefit of its
best judgment and effort in rendering services hereunder, but
the Advisor shall not be liable for any loss sustained by
reason of the purchase, sale or retention of any security
whether or not such purchase, sale or retention shall have
been based on its own investigation and research or upon
investigation and research made by any other individual, firm
or corporation, if such purchase, sale or retention shall have
been made and such other individual, firm or corporation shall
have been selected in good faith. Nothing herein contained
shall, however, be construed to protect the Advisor against
any liability to the Trust or its security holders by reason
of willful misfeasance, bad faith, or gross negligence in the
performance of its duties, or by reason of its reckless
disregard of obligations and duties under this Agreement.
(d) Nothing in this Agreement shall prevent the Advisor
or any affiliated person (as defined in the 1940 Act) of the
Advisor from acting as investment advisor or manager and/or
principal underwriter for any other person, firm or
corporation and shall not in any way limit or restrict the
Advisor or any such affiliated person from buying, selling or
trading any securities for its or their own accounts or the
accounts of others for whom it or they may be acting,
provided, however, that the Advisor expressly represents that
it will undertake no activities which, in its judgment, will
adversely affect the performance of its obligations to the
Trust under this Agreement.
(e) It is agreed that the Advisor shall have no
responsibility or liability for the accuracy or completeness
of the Trust's Registration Statement under the 1940 Act or
the Securities Act of 1933 except for information supplied by
the Advisor for inclusion therein. The Trust may indemnify
the Advisor to the full extent permitted by the Trust's
Declaration of Trust.
3. BROKER-DEALER RELATIONSHIPS
The Advisor is responsible for decisions to buy and sell securities
for the Portfolio, broker-dealer selection, and negotiation of brokerage
commission rates. The Advisor's primary consideration in effecting a
securities transaction will be execution at the most favorable price. In
selecting a broker-dealer to execute each particular transaction, the Advisor
will take the following into consideration: the best net price available; the
reliability, integrity and financial
2
<PAGE> 8
condition of the broker-dealer; the size of and difficulty in executing the
order; and the value of the expected contribution of the broker-dealer to the
investment performance of the Portfolio on a continuing basis. Accordingly,
the price to the Portfolio in any transaction may be less favorable than that
available from another broker-dealer if the difference is reasonably justified
by other aspects of the portfolio execution services offered. Subject to such
policies as the Board of Trustees of the Trust may determine, the Advisor shall
not be deemed to have acted unlawfully or to have breached any duty created by
this Agreement or otherwise solely by reason of its having caused the Portfolio
to pay a broker or dealer that provides brokerage or research services to the
Advisor an amount of commission for effecting a portfolio transaction in excess
of the amount of commission another broker or dealer would have charged for
effecting that transaction, if the Advisor determines in good faith that such
amount of commission was reasonable in relation to the value of the brokerage
and research services provided by such broker or dealer, viewed in terms of
either that particular transaction or the Advisor's overall responsibilities
with respect to the Trust. The Advisor is further authorized to allocate the
orders placed by it on behalf of the Portfolio to such brokers or dealers who
also provide research or statistical material, or other services, to the Trust,
the Advisor, or any affiliate of either. Such allocation shall be in such
amounts and proportions as the Advisor shall determine, and the Advisor shall
report on such allocations regularly to the Trust, indicating the
broker-dealers to whom such allocations have been made and the basis therefor.
The Advisor is also authorized to consider sales of shares as a factor in the
selection of brokers or dealers to execute portfolio transactions, subject to
the requirements of best execution, i.e., that such brokers or dealers are able
to execute the order promptly and at the best obtainable securities price.
4. ALLOCATION OF EXPENSES
The Advisor agrees that it will furnish the Trust, at the Advisor's
expense, with all office space and facilities, and equipment and clerical
personnel necessary for carrying out its duties under this Agreement. The
Advisor (or an affiliate thereof) will also pay all compensation of all
Trustees, officers and employees of the Trust who are affiliated persons of the
Advisor. All operating costs and expenses relating to the Portfolio not
expressly assumed by the Advisor under this Agreement shall be paid by the
Trust from the assets of the Portfolio, as applicable, including, but not
limited to (i) interest and taxes; (ii) brokerage commissions; (iii) insurance
premiums; (iv) compensation and expenses of the Trust's Trustees other than
those affiliated with the Advisor; (v) legal and audit expenses; (vi) fees and
expenses of the Trust's custodian, shareholder servicing or transfer agent and
accounting services agent; (vii) expenses incident to the issuance of the
Portfolio's shares, including issuance on the payment of, or reinvestment of,
dividends; (viii) fees and expenses incident to the registration under Federal
or state securities laws of the Trust or the shares of the Portfolio; (ix)
expenses of preparing, printing and mailing reports and notices and proxy
materials to shareholders of the Portfolio; (x) all other expenses incident to
holding meetings of the Portfolio's shareholders; (xi) dues or assessments of
or contributions to the Investment Company Institute or any successor; (xii)
such non-recurring expenses as may arise, including litigation affecting the
Trust and the legal obligations which the Trust may have to indemnify its
officers and Trustees with respect thereto; and (xiii) all expenses which the
Trust or the Portfolio agree to bear in any distribution agreement or in any
plan adopted by the Trust and/or the Portfolio pursuant to Rule 12b-1 under
the 1940 Act.
3
<PAGE> 9
5. COMPENSATION OF THE ADVISOR
The Trust agrees to pay the Advisor and the Advisor agrees to accept
as full compensation for all services rendered by the Advisor hereunder, an
annual management fee, payable monthly and computed on the value of the average
net assets of the Portfolio as of the close of business each business day, at
the annual rate of .75%.
6. DURATION AND TERMINATION
(a) This Agreement shall go into effect on the date hereof and
shall, unless terminated as hereinafter provided, continue in
effect until , 1999, and thereafter from year to year,
but only so long as such continuance is specifically approved
at least annually by the Trust's Board of Trustees, including
the vote of a majority of the Trustees who are not parties to
this Agreement or "interested persons" (as defined in the 1940
Act) of any such party cast in person at a meeting called for
the purpose of voting on such approval, or by the vote of the
holders of a "majority" (as so defined) of the outstanding
voting securities of the Portfolio and by such a vote of the
Trustees.
(b) This Agreement may be terminated by the Advisor at any
time without penalty upon giving the Trust sixty (60) days'
notice written notice (which notice may be waived by the
Trust) and may be terminated by the Trust at any time without
penalty upon giving the Advisor sixty (60) days' written
notice (which notice may be waived by the Advisor), provided
that such termination by the Trust shall be directed or
approved by the vote of a majority of all of its Trustees in
office at the time or by the vote of the holders of a majority
(as defined in the 1940 Act) of the voting securities of the
Trust at the time outstanding and entitled to vote. This
Agreement shall automatically terminate in the event of its
assignment (as so defined).
7. USE OF ADVISOR'S NAME
The Trust may use the name "Hotchkis and Wiley Variable Trust" or any
name including the words "Hotchkis and Wiley" only for so long as this
Agreement or any other advisory agreement relating to the Trust is in effect.
If the Agreement or any other advisory agreement relating to the Trust is no
longer in effect, the Trust will (to the extent that it lawfully can) cease to
use such a name or any other name indicating that it is advised by or otherwise
connected with the Advisor, or any organization that shall have succeeded to
the Advisor's business. In no event shall the Trust use the name "Hotchkis and
Wiley Variable Trust" or any name including the words "Hotchkis and Wiley" if
the Advisor's function is transferred or assigned to a company over which
Merrill Lynch & Co., Inc. does not have control.
4
<PAGE> 10
8. AGREEMENT BINDING ONLY ON TRUST PROPERTY
The Advisor understands that the obligations of this Agreement are not
binding upon any shareholder of the Trust personally, but bind only the Trust's
property, the Advisor represents that it has notice of the provisions of the
Trust's Declaration of Trust disclaiming shareholder liability for acts or
obligations of the Trust.
IN WITNESS WHEREOF, the parties hereto have caused the foregoing
instrument to be executed by duly authorized persons and their seals to be
hereunto affixed, all as of the day and year first above written.
HOTCHKIS AND WILEY VARIABLE
TRUST
By__________________________________
ATTEST:
_______________________________
HOTCHKIS AND WILEY, a division of the
Capital Management Group of Merrill
Lynch Asset Management, L.P.
By__________________________________
ATTEST:
_______________________________
5
<PAGE> 11
EXHIBIT 99.B5(c)
HOTCHKIS AND WILEY VARIABLE TRUST
INVESTMENT ADVISORY AGREEMENT
AGREEMENT made this __ day of __________, 1997, by and between HOTCHKIS
AND WILEY VARIABLE TRUST, a Massachusetts business trust (the "Trust"), on
behalf of the Low Duration VIP Series (the "Portfolio"), and HOTCHKIS AND WILEY,
a division of the Capital Management Group of Merrill Lynch Asset Management,
L.P. (the "Advisor").
WITNESSETH:
WHEREAS, the Trust has been organized and intends to operate as an
investment company registered under the Investment Company Act of 1940 ("1940
Act") and is currently comprised of three series, one of which is the
Portfolio; and each series will engage in the business of investing and
reinvesting its assets; and
WHEREAS, the Advisor is a registered investment advisor under the
Investment Advisors Act of 1940 and engages in the business of providing
investment advisory services; and
WHEREAS, the Trust's Board of Trustees, including a majority of the
Trustees who are not parties to this Agreement or "interested persons" (as
defined in the 1940 Act) of any such party, and the Portfolio's initial
shareholder have approved this Agreement;
NOW, THEREFORE, in consideration of the mutual promises and agreements
herein contained and other good and valuable consideration, the receipt of
which is hereby acknowledged, it is hereby agreed by and between the parties
hereto as follows:
1. IN GENERAL
The Advisor agrees, all as more fully set forth herein, to act as
managerial investment advisor to the Trust with respect to the investment of
the assets of the Portfolio and to supervise and arrange the purchase and sale
of securities held in the portfolio of the Portfolio.
2. DUTIES AND OBLIGATIONS OF THE ADVISOR WITH RESPECT TO
INVESTMENT OF ASSETS OF THE PORTFOLIO
(a) Subject to the succeeding provisions of this section
and subject to the direction and control of the Board of
Trustees of the Trust, the Advisor shall:
(i) Decide what securities or other assets shall
be purchased or sold by the Trust with respect to the
Portfolio and when; and
(ii) Arrange for the purchase and the sale of
securities or other assets held in the portfolio of
the Portfolio by placing purchase and sale orders for
the Trust with respect to the Portfolio.
<PAGE> 12
(b) Any investment purchases or sales made by the Advisor
shall at all times conform to, and be in accordance with, any
requirements imposed by: (l) the provisions of the 1940 Act
and of any rules or regulations in force thereunder; (2) any
other applicable provisions of law; (3) the provisions of the
Declaration of Trust and By-Laws of the Trust as amended from
time to time; (4) any policies and determinations of the Board
of Trustees of the Trust; and (5) the fundamental policies of
the Trust relating to the Portfolio, as reflected in the
Trust's Registration Statement under the 1940 Act, or as
amended by the shareholders of the Portfolio.
(c) The Advisor shall give the Trust the benefit of its
best judgment and effort in rendering services hereunder, but
the Advisor shall not be liable for any loss sustained by
reason of the purchase, sale or retention of any security
whether or not such purchase, sale or retention shall have
been based on its own investigation and research or upon
investigation and research made by any other individual, firm
or corporation, if such purchase, sale or retention shall have
been made and such other individual, firm or corporation shall
have been selected in good faith. Nothing herein contained
shall, however, be construed to protect the Advisor against
any liability to the Trust or its security holders by reason
of willful misfeasance, bad faith, or gross negligence in the
performance of its duties, or by reason of its reckless
disregard of obligations and duties under this Agreement.
(d) Nothing in this Agreement shall prevent the Advisor
or any affiliated person (as defined in the 1940 Act) of the
Advisor from acting as investment advisor or manager and/or
principal underwriter for any other person, firm or
corporation and shall not in any way limit or restrict the
Advisor or any such affiliated person from buying, selling or
trading any securities for its or their own accounts or the
accounts of others for whom it or they may be acting,
provided, however, that the Advisor expressly represents that
it will undertake no activities which, in its judgment, will
adversely affect the performance of its obligations to the
Trust under this Agreement.
(e) It is agreed that the Advisor shall have no
responsibility or liability for the accuracy or completeness
of the Trust's Registration Statement under the 1940 Act or
the Securities Act of 1933 except for information supplied by
the Advisor for inclusion therein. The Trust may indemnify
the Advisor to the full extent permitted by the Trust's
Declaration of Trust.
3. BROKER-DEALER RELATIONSHIPS
The Advisor is responsible for decisions to buy and sell securities
for the Portfolio, broker-dealer selection, and negotiation of brokerage
commission rates. The Advisor's primary consideration in effecting a
securities transaction will be execution at the most favorable price. In
selecting a broker-dealer to execute each particular transaction, the Advisor
will take the following into consideration: the best net price available; the
reliability, integrity and financial
2
<PAGE> 13
condition of the broker-dealer; the size of and difficulty in executing the
order; and the value of the expected contribution of the broker-dealer to the
investment performance of the Portfolio on a continuing basis. Accordingly,
the price to the Portfolio in any transaction may be less favorable than that
available from another broker-dealer if the difference is reasonably justified
by other aspects of the portfolio execution services offered. Subject to such
policies as the Board of Trustees of the Trust may determine, the Advisor shall
not be deemed to have acted unlawfully or to have breached any duty created by
this Agreement or otherwise solely by reason of its having caused the Portfolio
to pay a broker or dealer that provides brokerage or research services to the
Advisor an amount of commission for effecting a portfolio transaction in excess
of the amount of commission another broker or dealer would have charged for
effecting that transaction, if the Advisor determines in good faith that such
amount of commission was reasonable in relation to the value of the brokerage
and research services provided by such broker or dealer, viewed in terms of
either that particular transaction or the Advisor's overall responsibilities
with respect to the Trust. The Advisor is further authorized to allocate the
orders placed by it on behalf of the Portfolio to such brokers or dealers who
also provide research or statistical material, or other services, to the Trust,
the Advisor, or any affiliate of either. Such allocation shall be in such
amounts and proportions as the Advisor shall determine, and the Advisor shall
report on such allocations regularly to the Trust, indicating the
broker-dealers to whom such allocations have been made and the basis therefor.
The Advisor is also authorized to consider sales of shares as a factor in the
selection of brokers or dealers to execute portfolio transactions, subject to
the requirements of best execution, i.e., that such brokers or dealers are able
to execute the order promptly and at the best obtainable securities price.
4. ALLOCATION OF EXPENSES
The Advisor agrees that it will furnish the Trust, at the Advisor's
expense, with all office space and facilities, and equipment and clerical
personnel necessary for carrying out its duties under this Agreement. The
Advisor (or an affiliate thereof) will also pay all compensation of all
Trustees, officers and employees of the Trust who are affiliated persons of the
Advisor. All operating costs and expenses relating to the Portfolio not
expressly assumed by the Advisor under this Agreement shall be paid by the
Trust from the assets of the Portfolio, as applicable, including, but not
limited to (i) interest and taxes; (ii) brokerage commissions; (iii) insurance
premiums; (iv) compensation and expenses of the Trust's Trustees other than
those affiliated with the Advisor; (v) legal and audit expenses; (vi) fees and
expenses of the Trust's custodian, shareholder servicing or transfer agent and
accounting services agent; (vii) expenses incident to the issuance of the
Portfolio's shares, including issuance on the payment of, or reinvestment of,
dividends; (viii) fees and expenses incident to the registration under Federal
or state securities laws of the Trust or the shares of the Portfolio; (ix)
expenses of preparing, printing and mailing reports and notices and proxy
materials to shareholders of the Portfolio; (x) all other expenses incident to
holding meetings of the Portfolio's shareholders; (xi) dues or assessments of
or contributions to the Investment Company Institute or any successor; (xii)
such non-recurring expenses as may arise, including litigation affecting the
Trust and the legal obligations which the Trust may have to indemnify its
officers and Trustees with respect thereto; and (xiii) all expenses which the
Trust or the Portfolio agree to bear in any distribution agreement or in any
plan adopted by the Trust and/or the Portfolio pursuant to Rule 12b-1 under
the 1940 Act.
3
<PAGE> 14
5. COMPENSATION OF THE ADVISOR
The Trust agrees to pay the Advisor and the Advisor agrees to accept
as full compensation for all services rendered by the Advisor hereunder, an
annual management fee, payable monthly and computed on the value of the average
net assets of the Portfolio as of the close of business each business day, at
the annual rate of .46%.
6. DURATION AND TERMINATION
(a) This Agreement shall go into effect on the date hereof and
shall, unless terminated as hereinafter provided, continue in
effect until ____________, 1999, and thereafter from year to
year, but only so long as such continuance is specifically
approved at least annually by the Trust's Board of Trustees,
including the vote of a majority of the Trustees who are not
parties to this Agreement or "interested persons" (as defined
in the 1940 Act) of any such party cast in person at a meeting
called for the purpose of voting on such approval, or by the
vote of the holders of a "majority" (as so defined) of the
outstanding voting securities of the Portfolio and by such a
vote of the Trustees.
(b) This Agreement may be terminated by the Advisor at any
time without penalty upon giving the Trust sixty (60) days'
notice written notice (which notice may be waived by the
Trust) and may be terminated by the Trust at any time without
penalty upon giving the Advisor sixty (60) days' written
notice (which notice may be waived by the Advisor), provided
that such termination by the Trust shall be directed or
approved by the vote of a majority of all of its Trustees in
office at the time or by the vote of the holders of a majority
(as defined in the 1940 Act) of the voting securities of the
Trust at the time outstanding and entitled to vote. This
Agreement shall automatically terminate in the event of its
assignment (as so defined).
7. USE OF ADVISOR'S NAME
The Trust may use the name "Hotchkis and Wiley Variable Trust" or any
name including the words "Hotchkis and Wiley" only for so long as this
Agreement or any other advisory agreement relating to the Trust is in effect.
If the Agreement or any other advisory agreement relating to the Trust is no
longer in effect, the Trust will (to the extent that it lawfully can) cease to
use such a name or any other name indicating that it is advised by or otherwise
connected with the Advisor, or any organization that shall have succeeded to
the Advisor's business. In no event shall the Trust use the name "Hotchkis and
Wiley Variable Trust" or any name including the words "Hotchkis and Wiley" if
the Advisor's function is transferred or assigned to a company over which
Merrill Lynch & Co., Inc. does not have control.
4
<PAGE> 15
8. AGREEMENT BINDING ONLY ON TRUST PROPERTY
The Advisor understands that the obligations of this Agreement are not
binding upon any shareholder of the Trust personally, but bind only the Trust's
property; the Advisor represents that it has notice of the provisions of the
Trust's Declaration of Trust disclaiming shareholder liability for acts or
obligations of the Trust.
IN WITNESS WHEREOF, the parties hereto have caused the foregoing
instrument to be executed by duly authorized persons and their seals to be
hereunto affixed, all as of the day and year first above written.
HOTCHKIS AND WILEY VARIABLE
TRUST
By_______________________________
ATTEST:
_____________________________
HOTCHKIS AND WILEY, a division of the
Capital Management Group of Merrill
Lynch Asset Management, L.P.
By______________________________
ATTEST:
_____________________________
5
<PAGE> 16
EXHIBIT (5)(D)
HOTCHKIS AND WILEY VARIABLE TRUST
INVESTMENT ADVISORY AGREEMENT
AGREEMENT made this ____ day of _________, 1997, by and between
HOTCHKIS AND WILEY VARIABLE TRUST, a Massachusetts business trust (the "Trust"),
on behalf of the Total Return Bond VIP Series (the "Portfolio"), and HOTCHKIS
AND WILEY, a division of the Capital Management Group of Merrill Lynch Asset
Management, L.P. (the "Advisor").
WITNESSETH:
WHEREAS, the Trust has been organized and intends to operate as an
investment company registered under the Investment Company Act of 1940 ("1940
Act") and is currently comprised of four series, one of which is the Portfolio;
and each series will engage in the business of investing and reinvesting its
assets; and
WHEREAS, the Advisor is a registered investment advisor under the
Investment Advisors Act of 1940 and engages in the business of providing
investment advisory services; and
WHEREAS, the Trust's Board of Trustees, including a majority of the
Trustees who are not parties to this Agreement or "interested persons" (as
defined in the 1940 Act) of any such party, and the Portfolio's initial
shareholder have approved this Agreement;
NOW, THEREFORE, in consideration of the mutual promises and
agreements herein contained and other good and valuable consideration, the
receipt of which is hereby acknowledged, it is hereby agreed by and between the
parties hereto as follows:
1. IN GENERAL
The Advisor agrees, all as more fully set forth herein, to act as
managerial investment advisor to the Trust with respect to the investment of the
assets of the Portfolio and to supervise and arrange the purchase and sale of
securities held in the portfolio of the Portfolio.
2. DUTIES AND OBLIGATIONS OF THE ADVISOR WITH RESPECT TO
INVESTMENT OF ASSETS OF THE PORTFOLIO
(a) Subject to the succeeding provisions of this section
and subject to the direction and control of the Board of
Trustees of the Trust, the Advisor shall:
(i) Decide what securities or other assets
shall be purchased or sold by the Trust with
respect to the Portfolio and when; and
(ii) Arrange for the purchase and the sale
of securities or other assets held in the
portfolio of the Portfolio by placing
purchase and sale orders for the Trust with
respect to the Portfolio.
<PAGE> 17
(b) Any investment purchases or sales made by the
Advisor shall at all times conform to, and be in
accordance with, any requirements imposed by: (1) the
provisions of the 1940 Act and of any rules or
regulations in force thereunder; (2) any other
applicable provisions of law; (3) the provisions of the
Declaration of Trust and By-Laws of the Trust as amended
from time to time; (4) any policies and determinations
of the Board of Trustees of the Trust; and (5) the
fundamental policies of the Trust relating to the
Portfolio, as reflected in the Trust's Registration
Statement under the 1940 Act, or as amended by the
shareholders of the Portfolio.
(c) The Advisor shall give the Trust the benefit of its
best judgment and effort in rendering services
hereunder, but the Advisor shall not be liable for any
loss sustained by reason of the purchase, sale or
retention of any security whether or not such purchase,
sale or retention shall have been based on its own
investigation and research or upon investigation and
research made by any other individual, firm or
corporation, if such purchase, sale or retention shall
have been made and such other individual, firm or
corporation shall have been selected in good faith.
Nothing herein contained shall, however, be construed to
protect the Advisor against any liability to the Trust
or its security holders by reason of willful
misfeasance, bad faith, or gross negligence in the
performance of its duties, or by reason of its reckless
disregard of obligations and duties under this
Agreement.
(d) Nothing in this Agreement shall prevent the Advisor
or any affiliated person (as defined in the 1940 Act) of
the Advisor from acting as investment advisor or manager
and/or principal underwriter for any other person, firm
or corporation and shall not in any way limit or
restrict the Advisor or any such affiliated person from
buying, selling or trading any securities for its or
their own accounts or the accounts of others for whom it
or they may be acting, provided, however, that the
Advisor expressly represents that it will undertake no
activities which, in its judgment, will adversely affect
the performance of its obligations to the Trust under
this Agreement.
(e) It is agreed that the Advisor shall have no
responsibility or liability for the accuracy or
completeness of the Trust's Registration Statement under
the 1940 Act or the Securities Act of 1933 except for
information supplied by the Advisor for inclusion
therein. The Trust may indemnify the Advisor to the full
extent permitted by the Trust's Declaration of Trust.
3. BROKER-DEALER RELATIONSHIPS
The Advisor is responsible for decisions to buy and sell securities
for the Portfolio, broker-dealer selection, and negotiation of brokerage
commission rates. The Advisor's primary consideration in effecting a securities
transaction will be execution at the most favorable price. In selecting a
broker-dealer to execute each particular transaction, the Advisor will take the
following into consideration: the best net price available; the reliability,
integrity and financial
2
<PAGE> 18
condition of the broker-dealer; the size of and difficulty in executing the
order; and the value of the expected contribution of the broker-dealer to the
investment performance of the Portfolio on a continuing basis. Accordingly, the
price to the Portfolio in any transaction may be less favorable than that
available from another broker-dealer if the difference is reasonably justified
by other aspects of the portfolio execution services offered. Subject to such
policies as the Board of Trustees of the Trust may determine, the Advisor shall
not be deemed to have acted unlawfully or to have breached any duty created by
this Agreement or otherwise solely by reason of its having caused the Portfolio
to pay a broker or dealer that provides brokerage or research services to the
Advisor an amount of commission for effecting a portfolio transaction in excess
of the amount of commission another broker or dealer would have charged for
effecting that transaction, if the Advisor determines in good faith that such
amount of commission was reasonable in relation to the value of the brokerage
and research services provided by such broker or dealer, viewed in terms of
either that particular transaction or the Advisor's overall responsibilities
with respect to the Trust. The Advisor is further authorized to allocate the
orders placed by it on behalf of the Portfolio to such brokers or dealers who
also provide research or statistical material, or other services, to the Trust,
the Advisor, or any affiliate of either. Such allocation shall be in such
amounts and proportions as the Advisor shall determine, and the Advisor shall
report on such allocations regularly to the Trust, indicating the broker-dealers
to whom such allocations have been made and the basis therefor. The Advisor is
also authorized to consider sales of shares as a factor in the selection of
brokers or dealers to execute portfolio transactions, subject to the
requirements of best execution, i.e., that such brokers or dealers are able to
execute the order promptly and at the best obtainable securities price.
4. ALLOCATION OF EXPENSES
The Advisor agrees that it will furnish the Trust, at the Advisor's
expense, with all office space and facilities, and equipment and clerical
personnel necessary for carrying out its duties under this Agreement. The
Advisor (or an affiliate thereof) will also pay all compensation of all
Trustees, officers and employees of the Trust who are affiliated persons of the
Advisor. All operating costs and expenses relating to the Portfolio not
expressly assumed by the Advisor under this Agreement shall be paid by the Trust
from the assets of the Portfolio, as applicable, including, but not limited to
(i) interest and taxes; (ii) brokerage commissions; (iii) insurance premiums;
(iv) compensation and expenses of the Trust's Trustees other than those
affiliated with the Advisor; (v) legal and audit expenses; (vi) fees and
expenses of the Trust's custodian, shareholder servicing or transfer agent and
accounting services agent; (vii) expenses incident to the issuance of the
Portfolio's shares, including issuance on the payment of, or reinvestment of,
dividends; (viii) fees and expenses incident to the registration under Federal
or state securities laws of the Trust or the shares of the Portfolio; (ix)
expenses of preparing, printing and mailing reports and notices and proxy
materials to shareholders of the Portfolio; (x) all other expenses incident to
holding meetings of the Portfolio's shareholders; (xi) dues or assessments of or
contributions to the Investment Company Institute or any successor; (xii) such
non-recurring expenses as may arise, including litigation affecting the Trust
and the legal obligations which the Trust may have to indemnify its officers and
Trustees with respect thereto; and (xiii) all expenses which the Trust or the
Portfolio agree to bear in any distribution agreement or in any plan adopted by
the Trust and/or the Portfolio pursuant to Rule 12b-1 under the 1940 Act.
3
<PAGE> 19
5. COMPENSATION OF THE ADVISOR
The Trust agrees to pay the Advisor and the Advisor agrees to accept
as full compensation for all services rendered by the Advisor hereunder, an
annual management fee, payable monthly and computed on the value of the average
net assets of the Portfolio as of the close of business each business day, at
the annual rate of .55%.
6. DURATION AND TERMINATION
(a) This Agreement shall go into effect on the date
hereof and shall, unless terminated as hereinafter
provided, continue in effect until _____________, 1999,
and thereafter from year to year, but only so long as
such continuance is specifically approved at least
annually by the Trust's Board of Trustees, including the
vote of a majority of the Trustees who are not parties
to this Agreement or "interested persons" (as defined in
the 1940 Act) of any such party cast in person at a
meeting called for the purpose of voting on such
approval, or by the vote of the holders of a "majority"
(as so defined) of the outstanding voting securities of
the Portfolio and by such a vote of the Trustees.
(b) This Agreement may be terminated by the Advisor at
any time without penalty upon giving the Trust sixty
(60) days' notice written notice (which notice may be
waived by the Trust) and may be terminated by the Trust
at any time without penalty upon giving the Advisor
sixty (60) days' written notice (which notice may be
waived by the Advisor), provided that such termination
by the Trust shall be directed or approved by the vote
of a majority of all of its Trustees in office at the
time or by the vote of the holders of a majority (as
defined in the 1940 Act) of the voting securities of the
Trust at the time outstanding and entitled to vote. This
Agreement shall automatically terminate in the event of
its assignment (as so defined).
7. USE OF ADVISOR'S NAME
The Trust may use the name "Hotchkis and Wiley Variable Trust" or
any name including the words "Hotchkis and Wiley" only for so long as this
Agreement or any other advisory agreement relating to the Trust is in effect. If
the Agreement or any other advisory agreement relating to the Trust is no longer
in effect, the Trust will (to the extent that it lawfully can) cease to use such
a name or any other name indicating that it is advised by or otherwise connected
with the Advisor, or any organization that shall have succeeded to the Advisor's
business. In no event shall the Trust use the name "Hotchkis and Wiley Variable
Trust" or any name including the words "Hotchkis and Wiley" if the Advisor's
function is transferred or assigned to a company over which Merrill Lynch & Co.,
Inc. does not have control.
4
<PAGE> 20
8. AGREEMENT BINDING ONLY ON TRUST PROPERTY
The Advisor understands that the obligations of this Agreement are
not binding upon any shareholder of the Trust personally, but bind only the
Trust's property; the Advisor represents that it has notice of the provisions of
the Trust's Declaration of Trust disclaiming shareholder liability for acts or
obligations of the Trust.
IN WITNESS WHEREOF, the parties hereto have caused the foregoing
instrument to be executed by duly authorized persons and their seals to be
hereunto affixed, all as of the day and year first above written.
HOTCHKIS AND WILEY VARIABLE
TRUST
By
-----------------------------
ATTEST:
- -----------------------------
HOTCHKIS AND WILEY, a division
of the Capital Management Group
of Merrill Lynch Asset
Management, L.P.
By
-----------------------------
ATTEST:
- -----------------------------
5
