STATEMENT OF ADDITIONAL INFORMATION October 31, 1999
FOR
THE THURLOW GROWTH FUND
THE THURLOW FUNDS, INC.
1256 Forest Avenue
Palo Alto, California 94301
This Statement of Additional Information is not a prospectus and should
be read in conjunction with the prospectus of The Thurlow Funds, Inc., dated
October 31, 1999 (the "Prospectus"), for The Thurlow Growth Fund. Requests for
copies of the Prospectus should be made by writing to The Thurlow Funds, Inc.,
1256 Forest Avenue, Palo Alto, California 94301, Attention: Secretary or by
calling 1-888-848-7569.
The following financial statements are incorporated by reference to the
Annual Report, dated June 30, 1999 of The Thurlow Funds, Inc. (File No.
811-08219) for The Thurlow Growth Fund as filed with the Securities and Exchange
Commission on August 30, 1999:
o Statement of Assets and Liabilities
o Statement of Operations
o Statements of Changes in Net Assets
o Financial Highlights
o Statement of Net Assets
o Notes to the Financial Statements
o Report of Independent Public Accountants
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THE THURLOW FUNDS, INC.
Table of Contents
Page No.
GENERAL INFORMATION AND HISTORY...............................................1
INVESTMENT RESTRICTIONS.......................................................1
INVESTMENT CONSIDERATIONS.....................................................3
DIRECTORS AND OFFICERS OF THE CORPORATION....................................10
PRINCIPAL SHAREHOLDERS.......................................................12
INVESTMENT ADVISER, CUSTODIAN, TRANSFER AGENT
AND ACCOUNTING SERVICES AGENT...............................................13
DETERMINATION OF NET ASSET VALUE AND PERFORMANCE.............................16
DISTRIBUTION OF SHARES.......................................................18
REDEMPTION OF SHARES.........................................................20
ALLOCATION OF PORTFOLIO BROKERAGE............................................20
TAXES........................................................................21
SHAREHOLDER MEETINGS.........................................................23
CAPITAL STRUCTURE............................................................24
DESCRIPTION OF SECURITIES RATINGS............................................24
INDEPENDENT ACCOUNTANTS......................................................28
No person has been authorized to give any information or to make any
representations other than those contained in this Statement of Additional
Information or the Prospectus and, if given or made, such information or
representations may not be relied upon as having been authorized by The Thurlow
Funds, Inc.
This Statement of Additional Information does not constitute an offer
to sell securities.
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GENERAL INFORMATION AND HISTORY
The Thurlow Funds, Inc., a Maryland corporation incorporated on April
30, 1997 (the "Corporation"), is an open-end management investment company
consisting of one diversified portfolio, The Thurlow Growth Fund (the "Fund").
The Corporation is registered under the Investment Company Act of 1940 (the
"Act").
INVESTMENT RESTRICTIONS
The Fund has adopted the following investment restrictions which are
matters of fundamental policy and cannot be changed without approval of the
holders of the lesser of: (i) 67% of the Fund's shares present or represented at
a shareholders meeting at which the holders of more than 50% of such shares are
present or represented; or (ii) more than 50% of the outstanding shares of the
Fund.
1. The Fund will not purchase securities on margin (except for such
short term credits as are necessary for the clearance of transactions);
provided, however, that the Fund may borrow money to the extent set forth in
investment restriction no. 4.
2. The Fund may sell securities short to the extent permitted by the
Act.
3. The Fund may write put and call options to the extent permitted by
the Act.
4. The Fund may borrow money or issue senior securities to the extent
permitted by the Act.
5. The Fund may pledge or hypothecate its assets to secure its
borrowings.
6. The Fund will not lend money (except by purchasing publicly
distributed debt securities, purchasing securities of a type normally acquired
by institutional investors or entering into repurchase agreements) and will not
lend its portfolio securities, unless such loans are secured continuously by
collateral at least equal to the market value of the securities loaned in the
form of cash and/or securities issued or guaranteed by the U.S. Government, its
agencies or instrumentalities, and provided that no such loan will be made if
upon making of such loan more than 30% of the value of the Fund's total assets
would be subject to such loans.
7. The Fund will not make investments for the purpose of exercising
control or management of any company.
8. The Fund will not purchase securities of any issuer (other than the
United States or an instrumentality of the United States) if, as a result of
such purchase, the Fund would hold more than 10% of any class of securities,
including voting securities, of such issuer or more than 5% of the Fund's
assets, taken at current value, would be invested in securities of such issuer,
except that up to 25% of the Fund's total assets may be invested without regard
to these limitations.
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9. The Fund will not invest 25% or more of the value of its total
assets, determined at the time an investment is made, exclusive of U.S.
government securities, in securities issued by companies primarily engaged in
the same industry. In determining industry classifications the Fund will use the
current Directory of Companies Filing Annual Reports with the Securities and
Exchange Commission except to the extent permitted by the Act.
10. The Fund will not act as an underwriter or distributor of
securities other than shares of the Fund (except to the extent that the Fund may
be deemed to be an underwriter within the meaning of the Securities Act of 1933,
as amended (the "Securities Act"), in the disposition of restricted securities).
11. The Fund will not purchase or sell real estate or real estate
mortgage loans or real estate limited partnerships.
12. The Fund will not purchase or sell commodities or commodity
contracts, including futures contracts.
The Fund has adopted certain other investment restrictions which are
not fundamental policies and which may be changed by the Corporation's Board of
Directors without stockholder approval. These additional restrictions are as
follows:
1. The Fund will not invest more than 10% of the value of its net
assets in illiquid securities.
2. The Fund will not purchase the securities of other investment
companies except: (a) as part of a plan of merger, consolidation or
reorganization approved by the shareholders of the Fund; (b) securities of
registered open-end investment companies that invest exclusively in high
quality, short-term debt securities; or (c) securities of registered closed-end
investment companies on the open market where no commission results, other than
the usual and customary broker's commission. No purchases described in (b) and
(c) will be made if as a result of such purchases (i) the Fund and its
affiliated persons would hold more than 3% of any class of securities, including
voting securities, of any registered investment company; (ii) more than 5% of
the Fund's net assets would be invested in shares of any one registered
investment company; and (iii) more than 10% of the Fund's net assets would be
invested in shares of registered investment companies.
3. The Fund will not acquire or retain any security issued by a
company, an officer or director of which is an officer or director of the Fund
or an officer, director or other affiliated person of its investment adviser,
without authorization of the Corporation's Board of Directors.
4. The Fund will not purchase any interest in any oil, gas or other
mineral leases or any interest in any oil, gas or any other mineral exploration
or development program.
The aforementioned percentage restrictions on investment or utilization
of assets refer to the percentage at the time an investment is made. If these
restrictions (other than those relating to borrowing of money or issuing senior
securities) are adhered to at the time an
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investment is made, and such percentage subsequently changes as a result of
changing market values or some similar event, no violation of the Fund's
fundamental restrictions will be deemed to have occurred. Any changes in the
Fund's investment restrictions made by the Board of Directors will be
communicated to shareholders prior to their implementation.
INVESTMENT CONSIDERATIONS
Money Market Instruments
The money market instruments in which the Fund invests include
conservative fixed-income securities, such as United States Treasury Bills,
commercial paper rated A-2 or better by Standard & Poor's Corporation or Prime-2
or better by Moody's Investors Service, Inc., commercial paper master notes,
certificates of deposit of U.S. banks having capital, surplus and undivided
profits, as of the date of its most recently published annual financial
statements, in excess of $100,000,000, money market mutual funds and repurchase
agreements. Commercial paper master notes are unsecured promissory notes issued
by corporations to finance short-term credit needs. They permit a series of
short-term borrowings under a single note. Borrowings under commercial paper
master notes are payable in whole or in part at any time upon demand, may be
prepaid in whole or in part at any time, and bear interest at rates which are
fixed to known lending rates and automatically adjusted when such known lending
rates change. There is no secondary market for commercial paper master notes.
The Fund's investment adviser (the "Adviser") will monitor the creditworthiness
of the issuer of the commercial paper master notes while any borrowings are
outstanding.
Repurchase agreements are agreements under which the seller of a
security agrees at the time of sale to repurchase the security at an agreed time
and price. The Fund will not enter into repurchase agreements with entities
other than banks or invest over 5% of its net assets in repurchase agreements
with maturities of more than seven days. If a seller of a repurchase agreement
defaults and does not repurchase the security subject to the agreement, the Fund
will look to the collateral security underlying the seller's repurchase
agreement, including the securities subject to the repurchase agreement, for
satisfaction of the seller's obligation to the Fund. In such event, the Fund
might incur disposition costs in liquidating the collateral and might suffer a
loss if the value of the collateral declines. In addition, if bankruptcy
proceedings are instituted against a seller of a repurchase agreement,
realization upon the collateral may be delayed or limited.
When the Fund invests in securities of money market mutual funds, in
addition to the advisory fees and other expenses the Fund bears directly in
connection with its operations, as a shareholder of another investment company,
the Fund would bear its pro rata share of the other investment company's
advisory fees and other expenses. Such fees and other expenses will be borne
indirectly by the Fund's shareholders.
U.S. Government Securities
The Fund invests only in U.S. government securities that are backed by
the full faith and credit of the U.S. Treasury. Yields on such securities are
dependent on a variety of
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factors, including the general conditions of the money and bond markets, the
size of a particular offering and the maturity of the obligation. Debt
securities with longer maturities tend to produce higher yields and are
generally subject to potentially greater capital appreciation and depreciation
than obligations with shorter maturities. The market value of U.S. government
securities generally varies inversely with changes in market interest rates. An
increase in interest rates, therefore, would generally reduce the market value
of the Fund's portfolio of investments in U.S. government securities, while a
decline in interest rates would generally increase the market value of the
Fund's portfolio of investments in these securities.
Foreign Securities
The Fund may invest in common stocks of foreign issuers which are
publicly traded on U.S. exchanges or in the U.S. over-the-counter market
directly or in the form of American Depository Receipts ("ADRs"). The Fund will
only invest in ADRs that are issuer sponsored. Sponsored ADRs typically are
issued by a U.S. bank or trust company and evidences ownership of underlying
securities issued by a foreign corporation. Such securities involve risks that
are different from those of domestic issuers. Foreign companies are not subject
to the regulatory requirements of U.S. companies and, as such, there may be less
publicly available information about such issuers than is available in the
reports and ratings published about companies in the United States.
Additionally, foreign companies are not subject to uniform accounting, auditing
and financial reporting standards. Dividends and interest on foreign securities
may be subject to foreign withholding taxes. To the extent such taxes are not
offset by credits or deductions allowed to investors under U.S. federal income
tax laws, such taxes may reduce the net return to shareholders. Although the
Fund intends to invest in securities of foreign issuers domiciled in nations
which the Adviser considers as having stable and friendly governments, there is
the possibility of expropriation, confiscation, taxation, currency blockage or
political or social instability which could affect investments of foreign
issuers domiciled in such nations.
Illiquid Securities
The Fund may invest up to 10% of its net assets in securities for which
there is no readily available market ("illiquid securities"). The 10% limitation
includes certain securities whose disposition would be subject to legal
restrictions ("restricted securities"). However certain restricted securities
that may be resold pursuant to Rule 144A under the Securities Act may be
considered liquid. Investing in Rule 144A securities could have the effect of
decreasing the liquidity of the Fund to the extent that qualified institutional
buyers become, for a time, uninterested in purchasing these securities. The
Board of Directors of the Corporation has delegated to the Adviser the
day-to-day determination of the liquidity of a security although it has retained
oversight and ultimate responsibility for such determinations. Although no
definite quality criteria are used, the Board of Directors has directed the
Adviser to consider such factors as (i) the nature of the market for a security
(including the institutional private resale markets); (ii) the terms of these
securities or other instruments allowing for the disposition to a third party or
the issuer thereof (e.g. certain repurchase obligations and demand instruments);
(iii) the availability of market quotations; and (iv) other permissible factors.
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Restricted securities may be sold in private negotiated or other exempt
transactions or in a public offering with respect to which a registration
statement is in effect under the Securities Act. When registration is required,
the Fund may be obligated to pay all or part of the registration expenses and a
considerable time may elapse between the decision to sell and the sale date. If,
during such period, adverse market conditions were to develop, the Fund might
obtain a less favorable price than the price which prevailed when it decided to
sell. Restricted securities, if considered to be illiquid, will be priced at
fair value as determined in good faith by the Board of Directors.
Warrants
The Fund also may invest up to 5% of its net assets in warrants, which
are privileges issued by corporations enabling the owners to subscribe to and
purchase a specified number of shares of the corporation at a specific price
during a specified period of time. Warrants have no dividend or voting rights.
The 5% limitation does not include warrants acquired by the Fund in units or
attached to other securities. The Fund will invest in warrants to participate in
an anticipated increase in the market value of the underlying security without
having to purchase the security to which the warrants relate. The purchase of
warrants involves the risk that the Fund could lose the purchase price of a
warrant if the right to subscribe to additional shares is not exercised prior to
the warrant's expiration. Also, the purchase of warrants involves the risk that
the effective price paid for the warrant added to the subscription price of the
related security may exceed the value of the subscribed security's market price
such as when there is no movement in the level of the underlying security.
Borrowing to Purchase Securities (Leverage)
The Fund may borrow money, including borrowing for investment purposes.
Borrowing for investment is known as leveraging. Leveraging investments, by
purchasing securities with borrowed money, is a speculative technique which
increases investment risk, but also increases investment opportunity. Since
substantially all of the Fund's assets will fluctuate in value, whereas the
interest obligations on borrowings may be fixed, the net asset value per share
of the Fund when it leverages its investments will increase more when the Fund's
portfolio assets increase in value and decrease more when the Fund's portfolio
assets decrease in value than would otherwise be the case. Interest costs on
borrowings, which may fluctuate with changing market rates of interest, may
partially offset or exceed the returns on the borrowed funds. Under adverse
conditions, the Fund might have to sell portfolio securities to meet interest or
principal payments at a time investment considerations would not favor such
sales. The Fund intends to use leverage during periods when the Adviser believes
that the Fund's investment objective would be furthered by increasing the Fund's
investments in common stocks.
As required by the Act, the Fund may borrow money only from banks and
only if, immediately after the borrowing, the Fund maintains continuous asset
coverage (total assets, including assets acquired with borrowed funds, less
liabilities exclusive of borrowings) of 300% of all amounts borrowed. If, for
any reason, (including adverse market conditions) the Fund fails to meet the
300% coverage test, the Fund will be required to reduce the amount
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of its borrowings within three business days to the extent necessary to meet
this test. This requirement may make it necessary for the Fund to sell a portion
of its portfolio securities at a time when investment considerations otherwise
indicate that it would be disadvantageous to do so.
In addition to the foregoing, the Fund is authorized to borrow money
from a bank as a temporary measure for extraordinary or emergency purposes in
amounts not in excess of 5% of the value of the Fund's total assets. This
borrowing is not subject to the foregoing 300% asset coverage requirement. The
Fund is authorized to pledge portfolio securities as the Adviser deems
appropriate in connection with any borrowings.
Short Sales
The Fund may seek to realize additional gains through short sale
transactions in securities listed on one or more national securities exchanges,
or in unlisted securities. Short selling involves the sale of borrowed
securities. At the time a short sale is effected, the Fund incurs an obligation
to replace the security borrowed at whatever its price may be at the time the
Fund purchases it for delivery to the lender. The price at such time may be more
or less than the price at which the security was sold by the Fund. Until the
security is replaced, the Fund is required to pay the lender amounts equal to
any dividend or interest which accrue during the period of the loan. To borrow
the security, the Fund also may be required to pay a premium, which would
increase the cost of the security sold. The proceeds of the short sale will be
retained by the broker, to the extent necessary to meet margin requirements,
until the short position is closed.
No short sale will be effected which will, at the time of making such
short sale transaction and giving effect thereto, cause the aggregate market
value of all securities sold short to exceed 25% of the value of the Fund's net
assets. Until the Fund closes its short position or replaces the borrowed
security, the Fund will: (a) maintain a segregated account containing cash or
liquid securities at such a level that the amount deposited in the account plus
the amount deposited with the broker as collateral will equal the current value
of the security sold short; or (b) otherwise cover the Fund's short position.
Lending of Portfolio Securities
In order to generate additional income, the Fund may lend portfolio
securities constituting up to 30% of its total assets to unaffiliated
broker-dealers, banks or other recognized institutional borrowers of securities,
provided that the borrower at all times maintains cash or equivalent collateral
or provides an irrevocable letter of credit in favor of the Fund equal in value
to at least 100% of the value of the securities loaned. During the time
portfolio securities are on loan, the borrower pays the Fund an amount
equivalent to any dividends or interest paid on such securities, and the Fund
may receive an agreed-upon amount of interest income from the borrower who
delivered equivalent collateral or provided a letter of credit. Loans are
subject to termination at the option of the Fund or the borrower. The Fund may
pay reasonable administrative and custodial fees in connection with a loan of
portfolio securities and may pay a negotiated portion of the interest earned on
the cash or
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equivalent collateral to the borrower or placing broker. The Fund does not have
the right to vote securities that have been loaned, but could terminate the loan
and regain the right to vote if that were considered important with respect to
the investment.
The primary risk in securities lending is a default by the borrower
during a sharp rise in price of the borrowed security resulting in a deficiency
in the collateral posted by the borrower. The Fund will seek to minimize this
risk by requiring that the value of the securities loaned be computed each day
and additional collateral be furnished each day if required.
High Yield Convertible Securities
The Fund may invest up to 5% of its net assets in high yield, high
risk, lower-rated convertible securities, commonly known as "junk bonds." These
convertible securities may be converted either at a stated price or rate within
a specified period of time into a specified number of shares of common stock. By
investing in convertible securities, the Fund seeks the opportunity, through the
conversion feature, to participate in a portion of the capital appreciation of
the common stock into which the securities are convertible, while earning higher
current income than is available from the common stock. Investments in such
securities are subject to the risk factors outlined below.
The market for high yield convertible securities is subject to
substantial volatility. An economic downturn or increase in interest rates may
have a more significant effect on high yield convertible securities and their
markets, as well as on the ability of securities' issuers to repay principal and
interest, than on higher-rated securities and their issuers. Issuers of high
yield convertible securities may be of low creditworthiness and the high yield
convertible securities may be subordinated to the claims of senior lenders.
During periods of economic downturn or rising interest rates the issuers of high
yield convertible securities may have greater potential for insolvency and a
higher incidence of high yield bond defaults may be experienced.
The prices of high yield convertible securities have been found to be
less sensitive to interest rate changes than higher-rated investments but are
more sensitive to adverse economic changes or individual corporate developments.
During an economic downturn or substantial period of rising interest rates,
highly leveraged issuers may experience financial stress which would adversely
affect their ability to service their principal and interest payment
obligations, to meet projected business goals, and to obtain additional
financing. If the issuer of a high yield convertible security owned by the Fund
defaults, the Fund may incur additional expenses in seeking recovery. Periods of
economic uncertainty and changes can be expected to result in increased
volatility of market prices of high yield convertible securities and the Fund's
net asset value. Yields on high yield convertible securities will fluctuate over
time. Furthermore, in the case of high yield convertible securities structured
as zero coupon or pay-in-kind securities, their market prices are affected to a
greater extent by interest rate changes and thereby tend to be more volatile
than market prices of securities which pay interest periodically and in cash.
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The secondary market for high yield convertible securities may at times
become less liquid or respond to adverse publicity or investor perceptions
making it more difficult for the Fund to value accurately high yield convertible
securities or dispose of them. To the extent the Fund owns or may acquire
illiquid or restricted high yield convertible securities, these securities may
involve special registration responsibilities, liabilities and costs, and
liquidity difficulties, and judgment will play a greater role in valuation
because there is less reliable and objective data available.
Special tax considerations are associated with investing in high yield
bonds structured as zero coupon or pay-in-kind securities. The Fund will report
the interest on these securities as income even though it receives no cash
interest until the security's maturity or payment date. Further, the Fund must
distribute substantially all of its income to its shareholders to qualify for
pass-through treatment under the tax law. Accordingly, the Fund may have to
dispose of its portfolio securities under disadvantageous circumstances to
generate cash or may have to borrow to satisfy distribution requirements.
Credit ratings evaluate the safety of principal and interest payments,
not the market value risk of high yield convertible securities. Since credit
rating agencies may fail to timely change the credit ratings to reflect
subsequent events, the Adviser should monitor the issuers of high-yield
convertible securities in the portfolio to determine if the issuers will have
sufficient cash flow and profits to meet required principal and interest
payments, and to attempt to assure the securities' liquidity so the Fund can
meet redemption requests. To the extent that the Fund invests in high yield
convertible securities, the achievement of its investment objective may be more
dependent, on its own credit analysis than is the case for higher quality bonds.
The Fund may retain a portfolio security whose rating has been changed. However,
the Adviser expects to sell promptly any convertible debt security that falls
below a B rating quality.
Options on Securities and Index Option Transactions
When buying a put option on a security, the Fund has the right in
return for a premium paid during the term of the option, to sell the securities
underlying the option at the exercise price. When buying a call option on a
security, the Fund has the right, in return for a premium paid during the term
of the option, to purchase the securities underlying the option at the exercise
price. If a put or a call option which the Fund has purchased expires
unexercised, the option will become worthless on the expiration date, and the
Fund will realize a loss in the amount of the premium paid, plus commission
costs.
A stock index fluctuates with changes in the market values of the
stocks included in the index. Options on stock indexes give the holder the right
to receive an amount of cash upon the exercise of the options. Receipt of this
cash amount will depend upon the closing level of the stock index upon which the
option is based being greater than (in the case of a call) or less than (in the
case of a put) the exercise price of the option. The amount of cash received, if
any, will be the difference between the closing price of the index and the
exercise price of the option multiplied by a specified dollar multiple. All
settlements of index option transactions are in cash.
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When writing call options on securities, the Fund may cover its
position by owning the underlying security on which the option is written.
Alternatively, the Fund may cover its position by owning a call option on the
underlying security, on a share for share basis, which is deliverable under the
option contract at a price no higher than the exercise price of the call option
written by the Fund or, if higher, by owning such call option and depositing and
maintaining in a segregated account cash or liquid securities equal in value to
the difference between the two exercise prices. In addition, the Fund may cover
its position by depositing and maintaining in a segregated account cash or
liquid securities equal in value to the exercise price of the call option
written by the Fund. The Fund will not enter into an index option position that
exposes the Fund to an obligation to another party, unless the Fund either (i)
owns an offsetting position in securities or other options; and/or (ii)
maintains with the Fund's custodian bank (and marks-to-market, on a daily basis)
a segregated account consisting of cash or liquid securities that, when added to
the premiums deposited with respect to the option, are equal to the market value
of the underlying stock index not otherwise covered.
When the Fund wishes to terminate the Fund's obligation with respect to
an option it has written, the Fund may effect a "closing purchase transaction."
The Fund accomplishes this by buying an option of the same series as the option
previously written by the Fund. The effect of the purchase is that the writer's
position will be canceled. However, a writer may not effect a closing purchase
transaction after the writer has been notified of the exercise of an option.
When the Fund is the holder of an option, it may liquidate its position by
effecting a "closing sale transaction." The Fund accomplishes this by selling an
option of the same series as the option previously purchased by the Fund. There
is no guarantee that either a closing purchase or a closing sale transaction can
be effected. If any call or put option is not exercised or sold, the option will
become worthless on its expiration date.
Exchanges generally have established limitations governing the maximum
number of call or put options on the same index which may be bought or written
(sold) by a single investor, whether acting alone or in concert with others
(regardless of whether such options are written on the same or different
exchanges or are held or written on one or more accounts or through one or more
brokers). Under these limitations, options positions of certain other accounts
advised by the same investment adviser are combined for purposes of these
limits. Pursuant to these limitations, an exchange may order the liquidation of
positions and may impose other sanctions or restrictions. These position limits
may restrict the number of listed options which the Fund may buy or sell;
however, the Adviser intends to comply with all limitations.
Because option premiums paid or received by the Fund are small in
relation to the market value of the investments underlying the options, buying
and selling put and call options can be more speculative than investing directly
in common stocks. Additionally, trading in index options requires different
skills and techniques than those required for predicting changes in individual
stocks.
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Portfolio Turnover
The Fund's annual portfolio turnover rate was substantially higher
during the fiscal year ended June 30, 1999 than the fiscal period ended June 30,
1998. The higher portfolio turnover rate was largely due to the fact the Fund
took defensive positions more frequently during the fiscal year ended June 30,
1999. Whether or not the Fund takes defensive positions is largely dependent on
the Adviser's belief as to the best way to respond to perceived volatility in
the stock market.
DIRECTORS AND OFFICERS OF THE CORPORATION
As a Maryland corporation, the business and affairs of the Corporation
are managed by its officers under the direction of its Board of Directors. The
name, address, principal occupations during the past five years and other
information with respect to each of the directors and officers of the
Corporation are as follows:
MARTINA HEARN* Age 43
555 Bryant Street #262
Palo Alto, California 94301
(VICE PRESIDENT, SECRETARY AND A DIRECTOR OF THE CORPORATION)
Ms. Hearn is an associate of the law firm of Thurlow & Hearn, an
association of attorneys. Ms. Hearn has been practicing law since 1989. Ms.
Hearn is the wife of Thomas F. Thurlow.
NATASHA L. MCREE Age 28
3105 Grimes Ranch Road
Austin, Texas 78732
(A DIRECTOR OF THE CORPORATION)
Ms. McRee is a marketer with the firm of GSDNM Advertising and has been
employed with this firm since September 1996. From August 1995 to August 1996,
Ms. McRee was employed with Rives Carlberg Advertising as a marketing
consultant. From September 1993 to August 1995, Ms. McRee was employed in the
Marketing Department of Slick 50, a producer of automotive oils. Ms. McRee is
the wife of Robert C. McRee.
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* Mr. Thurlow, Ms. Hearn and Ms. Rosendahl are directors who are
"interested persons" of the Fund as that term is defined in the Investment
Company Act of 1940.
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ROBERT C. MCREE Age 28
3105 Grimes Ranch Road
Austin, Texas 78732
(A DIRECTOR OF THE CORPORATION)
Mr. McRee is a marketer for Cyress Technologies Corporation, Inc. and
has been employed with this firm since 1996. Prior to such time, Mr. McRee was
employed by Slick 50 and attended college. Mr. McRee is the husband of Natasha
L. McRee.
STEPHANIE E. ROSENDAHL* Age 33
4101 Coleridge Street
Houston, Texas 77005
(A DIRECTOR OF THE CORPORATION)
Ms. Rosendahl is an independent management consultant and has been
self-employed since 1993. Ms. Rosendahl is the sister of Thomas F. Thurlow.
THOMAS F. THURLOW* Age 37
1256 Forest Avenue
Palo Alto, California 94301
(PRESIDENT, TREASURER AND A DIRECTOR OF THE CORPORATION)
Mr. Thurlow is an attorney and founder and associate of the law firm
Thurlow & Hearn, an association of attorneys. Mr. Thurlow has been practicing
law since 1989. Mr. Thurlow is also the sole officer, director and shareholder
of Thurlow Capital Management, Inc., an investment advisory firm, which he
founded in 1997. Mr. Thurlow is the husband of Martina Hearn and the brother of
Stephanie Rosendahl.
The Corporation's standard method of compensating directors, commencing
in the fiscal year ending June 30, 2000, will be to pay each director who is not
an "interested person" of the Corporation a fee of $500 for each meeting of the
Board of Directors attended.
The table below sets forth the compensation paid by the Corporation to
each of the directors of the Corporation during the fiscal year ending June 30,
1999:
- -------------
* Mr. Thurlow, Ms. Hearn and Ms. Rosendahl are directors who are
"interested persons" of the Fund as that term is defined in the Investment
Company Act of 1940.
11
<PAGE>
<TABLE>
COMPENSATION TABLE
<CAPTION>
Pension or Total
Aggregate Retirement Benefits Estimated Annual Compensation
Name of Compensation Accrued as Part of Benefits Upon from Corporation
Person from Corporation Fund Expenses Retirement Paid to Directors
------ ---------------- ------------- ---------- -----------------
<S> <C> <C> <C> <C>
Martina Hearn $0 $0 $0 $0
Robert C. McRee 0 0 0 0
Natasha G. McRee 0 0 0 0
Stephanie E. Rosendahl 0 0 0 0
Thomas F. Thurlow 0 0 0 0
</TABLE>
PRINCIPAL SHAREHOLDERS
Set forth below are the names and addresses of all holders of the
Fund's shares who as of August 27, 1999 beneficially owned more than 5% of the
Fund's then outstanding shares, as well as the number of shares of the Fund
beneficially owned by all officers and directors of the Corporation as a group.
Name and Address of Beneficial Owner
Number of Shares Percent of Class
National Investors Services Corp. 31,347 21.48%
55 Water Street
New York, NY 10041*
Heida L. Thurlow 15,428 10.57%
2030 W. Sam Houston Parkway N.
Houston, TX 77043
L. Martin Field 10,923 7.49%
900 Jefferson Avenue
Newport, News, VA 23607
Officers and Directors as a Group 6,381 4.37%
(5 persons)
- -----------------------
*All of the shares owned by National Investors Services Corp. were owned of
record only.
12
<PAGE>
INVESTMENT ADVISER, CUSTODIAN,
TRANSFER AGENT AND ACCOUNTING SERVICES AGENT
The investment adviser to the Fund is Thurlow Capital Management, Inc.
(the "Adviser"). Pursuant to the investment advisory agreement entered into
between the Corporation and the Adviser with respect to the Fund (the "Advisory
Agreement"), the Adviser furnishes continuous investment advisory services to
the Fund. The Adviser is controlled by Thomas F. Thurlow, its sole officer,
director and shareholder.
The Adviser supervises and manages the investment portfolio of the Fund
and, subject to such policies as the Board of Directors of the Corporation may
determine, directs the purchase or sale of investment securities in the
day-to-day management of the Fund. Under the Advisory Agreement, the Adviser, at
its own expense and without separate reimbursement from the Fund, furnishes
office space and all necessary office facilities, equipment and executive
personnel for managing the Fund's investments, and bears all sales and
promotional expenses of the Fund, other than distribution expenses paid by the
Fund pursuant to the Service and Distribution Plan and expenses incurred in
complying with laws regulating the issue or sale of securities. For the
foregoing, the Adviser receives a monthly fee of 1/12th of 1.25% (1.25% per
annum) of the daily net assets of the Fund.
The Fund pays all of its expenses not assumed by the Adviser pursuant
to the Advisory Agreement, including, but not limited to, the professional costs
of preparing, and the cost of printing, its registration statements required
under the Securities Act of 1933 and the Act and any amendments thereto, the
expenses of registering its shares with the Securities and Exchange Commission
and in the various states, the printing and distribution cost of prospectuses
mailed to existing shareholders, director and officer liability insurance,
reports to shareholders, reports to government authorities and proxy statements,
interest charges, brokerage commissions, and expenses in connection with
portfolio transactions. The Fund also pays the fees of directors who are not
interested persons of the Adviser or officers or employees of the Fund, salaries
of administrative and clerical personnel, association membership dues, auditing
and accounting services, fees and expenses of any custodian or trustees having
custody of Fund assets, expenses of repurchasing and redeeming shares, printing
and mailing expenses, charges and expenses of dividend disbursing agents,
registrars and stock transfer agents, including the cost of keeping all
necessary shareholder records and accounts and handling any problems related
thereto.
Pursuant to the Advisory Agreement, the Adviser has undertaken to
reimburse the Fund to the extent that the aggregate annual operating expenses,
including the investment advisory fee but excluding interest, taxes, brokerage
commissions and other costs incurred in connection with the purchase or sale of
portfolio securities, and extraordinary items, exceed 3.00% of the average net
assets of the Fund for such year, as determined by valuations made as of the
close of each business day of the year. Additionally, for the fiscal period
ended June 30, 1998 and the fiscal year ended June 30, 1999, the Adviser agreed
to reimburse the Fund for annual operating expenses in excess of 1.95% of the
Fund's average net assets for each such period. The Fund monitors its expense
ratio on a monthly basis. If the accrued amount of the expenses of the Fund
exceeds the expense limitation, the Fund creates an account
13
<PAGE>
receivable from the Adviser for the amount of such excess. In such a situation
the monthly payment of the Adviser's fee will be reduced by the amount of such
excess, subject to adjustment month by month during the balance of the Fund's
fiscal year if accrued expenses thereafter fall below this limit.
For services provided by the Adviser under the Advisory Agreement for
the fiscal period ended June 30, 1998 and the fiscal year ended June 30, 1999,
the Fund paid the Adviser $3,611 and $12,186, respectively. During the fiscal
period ended June 30, 1998 and the fiscal year ended June 30, 1999, the Adviser
reimbursed the Fund $108,421 and $109,985, respectively, for excess expenses.
The Advisory Agreement will remain in effect as long as its continuance
is specifically approved at least annually (i) by the Board of Directors of the
Corporation or by the vote of a majority (as defined in the Act) of the
outstanding shares of the Fund, and (ii) by the vote of a majority of the
directors of the Fund who are not parties to the Advisory Agreement or
interested persons of the Adviser, cast in person at a meeting called for the
purpose of voting on such approval. The Advisory Agreement provides that it may
be terminated at any time without the payment of any penalty, by the Board of
Directors of the Corporation or by vote of the majority of the Fund's
shareholders on sixty (60) days' written notice to the Adviser, and by the
Adviser on the same notice to the Corporation, and that it shall be
automatically terminated if it is assigned.
The Advisory Agreement provides that the Adviser shall not be liable to
the Corporation or its shareholders for anything other than willful misfeasance,
bad faith, gross negligence or reckless disregard of its obligations or duties.
The Advisory Agreement also provides that the Adviser and its officers,
directors and employees may engage in other businesses, devote time and
attention to any other business whether of a similar or dissimilar nature, and
render services to others.
From August 8, 1997 through March 31, 1999, the administrator to the
Corporation was Firstar Mutual Fund Services, LLC, 615 East Michigan Street,
Milwaukee, Wisconsin 53202 (the "Administrator"). Pursuant to a Fund
Administration Servicing Agreement entered into between the Corporation and the
Administrator relating to the Fund (the "Administration Agreement") the
Administrator maintained the books, accounts and other documents required by the
Act, responded to shareholder inquiries, prepared the Fund's financial
statements and tax returns, prepared certain reports and filings with the
Securities and Exchange Commission and with state Blue Sky authorities,
furnished statistical and research data, clerical, accounting and bookkeeping
services and stationery and office supplies, kept and maintained the Fund's
financial and accounting records and generally assisted in all aspects of the
Fund's operations. The Administrator, at its own expense and without
reimbursement from the Fund or the Company, furnished office space and all
necessary office facilities, equipment and executive personnel for performing
the services required to be performed by it under the Administration Agreement.
For the foregoing, the Administrator received from the Fund a fee, paid monthly,
at an annual rate of .06% of the first $200,000,000 of the Fund's average net
assets, .05% of the next $500,000,000 of the Fund's average net assets, and .03%
of the Fund's net assets in excess of $700,000,000.
14
<PAGE>
Notwithstanding the foregoing, the Administrator's minimum annual fee was
$30,000. During the fiscal period ended June 30, 1998 and the period from July
1, 1998 through March 31, 1999, the Fund incurred fees of $27,440 and $22,338,
respectively, payable to the Administrator pursuant to the Administration
Agreement. Some of the services provided by the Administrator pursuant to the
Administration Agreement are now provided by Mutual Shareholder Services, Inc.
("MSS"), 1301 East Ninth Street, Suite 1005, Cleveland, Ohio 44114, pursuant to
an Accounting Services Agreement discussed below. To the extent they are not,
they are provided by the officers of the Fund.
The Fifth Third Bank, an Ohio banking trust, 38 Fountain Square Plaza,
Cincinnati, Ohio 45263, serves as custodian of the Corporation's assets pursuant
to a Custody Agreement. Under the Custody Agreement, The Fifth Third Bank has
agreed to (i) maintain a separate account in the name of the Fund, (ii) make
receipts and disbursements of money on behalf of the Fund, (iii) collect and
receive all income and other payments and distributions on account of the Fund's
portfolio investments, (iv) respond to correspondence from shareholders,
security brokers and others relating to its duties; and (v) make periodic
reports to the Fund concerning the Fund's operations. The Fifth Third Bank does
not exercise any supervisory function over the purchase and sale of securities.
MSS serves as transfer agent and dividend disbursing agent for the Fund
under a Transfer Agent Agreement. As transfer and dividend disbursing agent, MSS
has agreed to (i) issue and redeem shares of the Fund, (ii) make dividend and
other distributions to shareholders of the Fund, (iii) respond to correspondence
by Fund shareholders and others relating to its duties, (iv) maintain
shareholder accounts, and (v) make periodic reports to the Fund.
From August 8, 1997 through March 31, 1999, pursuant to a Fund
Accounting Servicing Agreement with Firstar Mutual Fund Services, LLC, Firstar
Mutual Fund Services, LLC maintained the financial accounts and records of the
Fund and provided other accounting services to the Fund. For its accounting
services, Firstar Mutual Fund Services, LLC received fees, payable monthly,
based on the total annual rate of $22,000 for the first $40 million in average
net assets of the Fund, .01% on the next $200 million of average net assets, and
.005% on average net assets exceeding $240 million. Firstar Mutual Fund
Services, LLC was reimbursed for certain out of pocket expenses, including
pricing expenses. During the fiscal period ended June 30, 1998 and the period
from July 1, 1998 through March 31, 1999, the Fund incurred fees of $20,367 and
$17,678, respectively, payable to Firstar Mutual Fund Services, LLC pursuant to
the Fund Accounting Servicing Agreement.
Effective April 1, 1999 the Corporation entered into an Accounting
Services Agreement with MSS. Pursuant to the Accounting Services Agreement, MSS
calculates the daily net asset value of the Fund, maintains the financial
accounts and records of the Fund and provides other accounting services to the
Fund. For its accounting services, MSS receives an annual fee paid in monthly
installments determined as follows:
15
<PAGE>
Fund Net Assets Yearly Fee
--------------- ----------
Less than $25,000,000 $21,000
$25,000,000 to $50,000,000 $30,500
$50,000,000 to $75,000,000 $36,250
$75,000,000 to $100,000,000 $42,000
$100,000,000 to $125,000,000 $47,750
$125,000,000 to $150,000,000 $53,500
Greater than $150,000,000 $59,250
MSS also provides a new client discount during the first year of the Accounting
Services Agreement. During the period April 1, 1999 through June 30, 1999, the
Fund incurred fees of $2,738 payable to MSS pursuant to the Accounting Services
Agreement.
DETERMINATION OF NET ASSET VALUE AND PERFORMANCE
The net asset value of the Fund is determined as of the close of
regular trading (4:00 P.M. Eastern Time) on each day the New York Stock Exchange
is open for trading. The New York Stock Exchange is open for trading Monday
through Friday except New Year's Day, Dr. Martin Luther King, Jr. Day,
President's Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day. Additionally, if any of the aforementioned
holidays falls on a Saturday, the New York Stock Exchange will not be open for
trading on the preceding Friday and when any such holiday falls on a Sunday, the
New York Stock Exchange will not be open for trading on the succeeding Monday,
unless unusual business conditions exist, such as the ending of a monthly or the
yearly accounting period. The New York Stock Exchange also may be closed on
national days of mourning.
The Fund's net asset value per share is determined by dividing the
total value of its investments and other assets less any liabilities, by the
number of its outstanding shares. Common stocks that are listed on any national
stock exchange or quoted on the Nasdaq Stock Market are valued at the last sale
price on the date the valuation is made. Price information on listed securities
is taken from the exchange where the security is primarily traded. Common stocks
which are listed on any national stock exchange or the Nasdaq Stock Market but
which are not traded on the valuation date are valued at the current bid prices.
Unlisted equity securities for which market quotations are readily available and
options are valued at the current bid prices. Debt securities which mature in
more than 60 days are valued at the latest bid prices furnished by an
independent pricing service. Short-term instruments (those with remaining
maturities of 60 days or less) are valued at amortized cost, which approximates
market value. Other assets and securities for which there are no readily
available market quotations are valued at their fair value as determined by the
Adviser in accordance with procedures approved by the Board of Directors.
16
<PAGE>
The Fund may provide from time to time in advertisements, reports to
shareholders and other communications with shareholders its average annual total
return. An average annual total return refers to the rate of return which, if
applied to an initial investment in the Fund at the beginning of a stated period
and compounded over the period, would result in the redeemable value of the
investment in the Fund at the end of the stated period assuming reinvestment of
all dividends and distributions and reflecting the effect of all recurring fees.
The Fund may also provide "aggregate" total return information for various
periods, representing the cumulative change in value of an investment in the
Fund for a specific period (again reflecting changes in share price and assuming
reinvestment of dividends and distributions).
Any total rate of return quotation for the Fund will be for a period of
three or more months and will assume the reinvestment of all dividends and
capital gains distributions which were made by the Fund during that period. Any
period total rate of return quotation of the Fund will be calculated by dividing
the net change in value of a hypothetical shareholder account established by an
initial payment of $1,000 at the beginning of the period by 1,000. The net
change in the value of a shareholder account is determined by subtracting $1,000
from the product obtained by multiplying the net asset value per share at the
end of the period by the sum obtained by adding (A) the number of shares
purchased at the beginning of the period plus (B) the number of shares purchased
during the period with reinvested dividends and distributions. Any average
annual compounded total rate of return quotation of the Fund will be calculated
by dividing the redeemable value at the end of the period (i.e., the product
referred to in the preceding sentence) by $1,000. A root equal to the period,
measured in years, in question is then determined and 1 is subtracted from such
root to determine the average annual compounded total rate of return.
The foregoing computation may also be expressed by the following
formula:
n
P(1 + T) = ERV
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical
$1,000 payment made at the beginning of the
stated periods at the end of the
stated periods
The Fund's average annual total returns for the one-year period ended
June 30, 1999 and for the period from the Fund's commencement of operations
(August 8, 1997) through June 30, 1999 were 126.95% and 106.30%, respectively.
Any reported performance results will be based on historical earnings
and should not be considered as representative of the performance of the Fund in
the future. An investment in the Fund will fluctuate in value and at redemption
its value may be more or less than the initial investment. The Fund may compare
its performance to other mutual funds
17
<PAGE>
with similar investment objectives and to the industry as a whole, as reported
by Morningstar, Inc., Lipper Analytical Services, Inc., Money, Forbes, Business
Week and Barron's magazines and The Wall Street Journal. (Morningstar, Inc. and
Lipper Analytical Services, Inc. are independent services that each rank over
1,000 mutual funds based upon total return performance.) The Fund may also
compare its performance to the Dow Jones Industrial Average, Nasdaq Composite
Index, Nasdaq Industrials Index, Value Line Composite Index, the Standard &
Poor's 500 Stock Index and the Consumer Price Index. Such comparisons may be
made in advertisements, shareholder reports or other communications to
shareholders.
DISTRIBUTION OF SHARES
Service and Distribution Plan
The Fund has adopted a Service and Distribution Plan (the "Plan")
pursuant to Rule 12b-1 under the Act in anticipation that the Fund will benefit
from the Plan through increased sales of shares, thereby reducing the Fund's
expense ratio and providing the Adviser with greater flexibility in management.
The Plan authorizes payments by the Fund in connection with the distribution of
their shares at an annual rate, as determined from time to time by the Board of
Directors, of up to 0.25% of the Fund's average daily net assets. Payments made
pursuant to the Plan may only be used to pay distribution expenses in the year
incurred. Amounts paid under the Plan by the Fund may be spent by the Fund on
any activities or expenses primarily intended to result in the sale of shares of
the Fund as determined by the Board of Directors, including but not limited to,
advertising, compensation for sales and sales marketing activities of financial
institutions and others, such as dealers or other distributors, shareholder
account servicing, production and dissemination of prospectuses and sales and
marketing materials, and capital or other expenses of associated equipment,
rent, salaries, bonuses, interest and other overhead. To the extent any activity
is one which the Fund may finance without a Plan, the Fund may also make
payments to finance such activity outside of the Plan and not subject to its
limitations.
The Plan may be terminated by the Fund at any time by a vote of the
directors of the Corporation who are not interested persons of the Corporation
and who have no direct or indirect financial interest in the Plan or any
agreement related thereto (the "Rule 12b-1 Directors") or by a vote of a
majority of the outstanding shares of the Fund. Ms. McRee and Mr. McRee are
currently the Rule 12b-1 Directors. Any change in the Plan that would materially
increase the distribution expenses of the Fund provided for in the Plan requires
approval of the shareholders of the Fund and the Board of Directors, including
the Rule 12b-1 Directors.
While the Plan is in effect, the selection and nomination of directors
who are not interested persons of the Corporation will be committed to the
discretion of the directors of the Corporation who are not interested persons of
the Corporation. The Board of Directors of the Corporation must review the
amount and purposes of expenditures pursuant to the Plan quarterly as reported
to it by a distributor, if any, or officers of the Corporation. The Plan will
continue in effect for as long as its continuance is specifically approved at
least annually by the Board of Directors, including the Rule 12b-1 Directors.
During the fiscal year ended
18
<PAGE>
June 30, 1999, the Fund incurred distribution fees of $2,437 pursuant to the
Plan of which all were used to pay for printing of sales literature.
Automatic Investment Plan
The Fund offers an Automatic Investment Plan whereby a shareholder may
automatically make purchases of Fund shares on a regular, convenient basis ($100
minimum per transaction). Under the Automatic Investment Plan, a shareholder's
designated bank or other financial institution debits a pre-authorized amount on
the shareholder's account on any date specified by the shareholder each month or
calendar quarter and applies the amount to the purchase of Fund shares. If such
date is a weekend or holiday, such purchase shall be made on the next business
day. The Automatic Investment Plan must be implemented with a financial
institution that is a member of the Automatic Clearing House ("ACH"). The Fund
currently does not charge a fee for participating in the Automatic Investment
Plan. the transfer agent, MSS, will impose a $20 fee if sufficient funds are not
available in the shareholder's account at the time of the automatic transaction.
An application to establish the Automatic Investment Plan is included as part of
the account application. Shareholders may change the date or amount of
investments at any time by writing to or calling MSS at 1-888-848-7569. In the
event an investor discontinues participation in the Automatic Investment Plan,
the Fund reserves the right to redeem the investor's account involuntarily, upon
60 days notice, if the account value is $500 or less.
Retirement Plans
The Fund offers the following retirement plans that may be funded with
purchases of Fund shares and may allow investors to defer some of their income
from taxes. A description of applicable service fees and certain limitations on
contributions and withdrawals, as well as applications forms, are available from
the Fund upon request. The IRA documents contain a disclosure statement that the
Internal Revenue Service requires to be furnished to individuals who are
considering adopting an IRA. Because a retirement program involves commitments
covering future years, it is important that the investment objective of the Fund
be consistent with the participant's retirement objectives. Premature
withdrawals from a retirement plan will result in adverse tax consequences. The
Fund recommends that investors consult with a competent financial and tax
adviser before investing in the Fund through the retirement plans.
Individual shareholders may establish their own tax-sheltered
Individual Retirement Accounts ("IRA"). The Fund currently offers a prototype
Traditional IRA plan, a prototype Roth IRA plan and a prototype Education IRA.
There is currently no charge for establishing an IRA account although there is
an annual maintenance fee. (See the applicable IRA Custodian Agreement and
Disclosure Statement for a discussion of the annual maintenance fee, other fees
associated with the account, eligibility requirements and related tax
consequences.)
The Fund also offers a prototype simplified employee pension ("SEP")
plan for employers, including self-employed individuals, who wish to purchase
shares of the Fund with
19
<PAGE>
tax-deductible contributions not exceeding annually for any one participant the
lesser of $30,000 or 15% of earned income. Under the SEP plan, employer
contributions are made directly to the IRA accounts of eligible participants.
REDEMPTION OF SHARES
A shareholder's right to redeem shares of the Fund will be suspended
and the right to payment postponed for more than seven days for any period
during which the New York Stock Exchange is closed because of financial
conditions or any other extraordinary reason and may be suspended for any period
during which (a) trading on the New York Stock Exchange is restricted pursuant
to rules and regulations of the Securities and Exchange commission, (b) the
Securities and Exchange Commission has by order permitted such suspension or (c)
such emergency, as defined by rules and regulations of the Securities and
Exchange Commission, exists as a result of which it is not reasonably
practicable for the Fund to dispose of its securities or fairly to determine the
value of its net assets.
ALLOCATION OF PORTFOLIO BROKERAGE
Decisions to buy and sell securities for the Fund are made by the
Adviser subject to review by the Corporation's Board of Directors. In placing
purchase and sale orders for portfolio securities for the Fund, it is the policy
of the Adviser to seek the best execution of orders at the most favorable price
in light of the overall quality of brokerage and research services provided, as
described in this and the following paragraph. In selecting brokers to effect
portfolio transactions, the determination of what is expected to result in best
execution at the most favorable price involves a number of largely judgmental
considerations. Among these are the Adviser's evaluation of the broker's
efficiency in executing and clearing transactions, block trading capability
(including the broker's willingness to position securities and the broker's
financial strength and stability). The most favorable price to the Fund means
the best net price without regard to the mix between purchase or sale price and
commission, if any. Over-the-counter securities are generally purchased and sold
directly with principal market makers who retain the difference in their cost in
the security and its selling price (i.e. "markups" when the market maker sells a
security and "markdowns" when the market maker purchases a security). In some
instances, the Adviser feels that better prices are available from non-principal
market makers who are paid commissions directly. The Fund may place portfolio
orders with broker-dealers who recommend the purchase of Fund shares to clients
if the Adviser believes the commissions and transaction quality are comparable
to that available from other brokers and may allocate portfolio brokerage on
that basis.
In allocating brokerage business for the Fund, the Adviser also takes
into consideration the research, analytical, statistical and other information
and services provided by the broker, such as general economic reports and
information, reports or analyses of particular companies or industry groups,
market timing and technical information, and the availability of the brokerage
firm's analysts for consultation. While the Adviser believes these services have
substantial value, they are considered supplemental to the Adviser's own efforts
in the performance of its duties under the Advisory Agreement. Other clients of
the Adviser may indirectly benefit from the availability of these services to
the Adviser, and the Fund may
20
<PAGE>
indirectly benefit from services available to the Adviser as a result of
transactions for other clients. The Advisory Agreement provides that the Adviser
may cause the Fund to pay a broker which provides brokerage and research
services to the Adviser a commission for effecting a securities transaction in
excess of the amount another broker would have charged for effecting the
transaction, if the Adviser determines in good faith that such amount of
commission is reasonable in relation to the value of brokerage and research
services provided by the executing broker viewed in terms of either the
particular transaction or the Adviser's overall responsibilities with respect to
the Fund and the other accounts as to which it exercises investment discretion.
During the fiscal year ended June 30, 1999, the Fund paid brokerage
commissions of $56,194 on transactions having a total market value of
$13,647,430. During such year the Fund paid commissions of $14,758 on
transactions having a total market value of $4,591,918 to brokers who provided
research services to the Adviser. During the fiscal period ended June 30, 1998,
the Fund paid brokerage commissions of $9,978 on transactions having a total
market value of $2,515,844. Brokerage commissions were higher during the fiscal
year ended June 30, 1999 because of the Fund's increased portfolio turnover rate
and the increase in the Fund's average net assets.
TAXES
The Fund intends to qualify annually for and elect tax treatment
applicable to a regulated investment company under Subchapter M of the Internal
Revenue Code of 1986, as amended (the "Code"). The Fund has so qualified in each
of its fiscal years. If the Fund fails to qualify as a regulated investment
company under Subchapter M in any fiscal year, it will be treated as a
corporation for federal income tax purposes. As such, the Fund would be required
to pay income taxes on its net investment income and net realized capital gains,
if any, at the rates generally applicable to corporations. Shareholders of the
Fund would not be liable for income tax on the Fund's net investment income or
net realized capital gains in their individual capacities. Distributions to
shareholders, whether from the Fund's net investment income or net realized
capital gains, would be treated as taxable dividends to the extent of
accumulated earnings and profits of the Fund.
If a call option written by the Fund expires, the amount of the premium
received by the Fund for the option will be short-term capital gain. If the Fund
enters into a closing transaction with respect to the option, any gain or loss
realized by the Fund as a result of the transaction will be short-term capital
gain or loss. If the holder of a call option exercises the holder's right under
the option, any gain or loss realized by the Fund upon the sale of the
underlying security pursuant to such exercise will be short-term or long-term
capital gain or loss to the Fund depending on the Fund's holding period for the
underlying security.
With respect to call options purchased by the Fund, the Fund will
realize short-term or long-term capital gain or loss if such option is sold and
will realize short-term or long-term capital loss if the option is allowed to
expire depending on the Fund's holding period for the call option. If such a
call option is exercised, the amount paid by the Fund for the option will be
added to the basis of the stock so acquired.
21
<PAGE>
The Fund may purchase or write options on stock indexes. Options on
"broadbased" stock indexes are generally classified as "nonequity options" under
the Code. Gains and losses resulting from the expiration, exercise or closing of
such nonequity options will be treated as long-term capital gain or loss to the
extent of 60% thereof and short-term capital gain or loss to the extent of 40%
thereof (hereinafter "blended gain or loss") for determining the character of
distributions. In addition, nonequity options held by the Fund on the last day
of a fiscal year will be treated as sold for market value ("marked to market")
on that date, and gain or loss recognized as a result of such deemed sale will
be blended gain or loss. The realized gain or loss on the ultimate disposition
of the option will be increased or decreased to take into consideration the
prior marked to market gains and losses.
The Fund may acquire put options. Under the Code, put options on stocks
are taxed similar to short sales. If the Fund owns the underlying stock or
acquires the underlying stock before closing the option position, the option
positions may be subject to certain modified short sale rules. If the Fund
exercises or fails to exercise a put option the Fund will be considered to have
closed a short sale. The Fund will generally have a short-term gain or loss on
the closing of an option position. The determination of the length of the
holding period is dependent on the holding period of the stock used to exercise
that put option. If the Fund sells the put option without exercising it, the
holding period will be determined by looking at the holding period of the
option.
Dividends from the Fund's net investment income (including any excess
of net short-term capital gain over net long-term capital loss) are taxable to
shareholders as ordinary income, while distributions of net capital gain (the
excess of net long-term capital gain over net short-term capital loss) are
taxable as long-term capital gain regardless of the shareholder's holding period
for the shares. Such dividends and distributions are taxable to shareholders
whether received in cash or in additional shares. The 70% dividends-received
deduction for corporations will apply to dividends from the Fund's net
investment income, subject to proportionate reductions if the aggregate
dividends received by the Fund from domestic corporations in any year are less
than 100% of the net investment company income taxable distributions made by the
Fund.
Any dividend or capital gain distribution paid shortly after a purchase
of shares of the Fund, will have the effect of reducing the per share net asset
value of such shares by the amount of the dividend or distribution. Furthermore,
if the net asset value of the shares of the Fund immediately after a dividend or
distribution is less than the cost of such shares to the shareholder, the
dividend or distribution will be taxable to the shareholder even though it
results in a return of capital to the shareholder.
Redemption of shares will generally result in a capital gain or loss
for income tax purposes. Such capital gain or loss will be long term or short
term, depending upon the holding period. However, if a loss is realized on
shares held for six months or less, and the investor received a capital gain
distribution during that period, then such loss is treated as a long-term
capital loss to the extent of the capital gain distribution received.
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This section is not intended to be a complete discussion of present or
proposed federal income tax laws and the effect of such laws on an investor.
Investors are urged to consult with their respective tax advisers for a complete
review of the tax ramifications of an investment in the Fund.
SHAREHOLDER MEETINGS
The Maryland Business Corporation Law permits registered investment
companies, such as the Fund, to operate without an annual meeting of
shareholders under specified circumstances if an annual meeting is not required
by the Act. The Corporation has adopted the appropriate provisions in its bylaws
and may, at its discretion, not hold an annual meeting in any year in which the
election of directors is not required to be acted upon by the shareholders under
the Act.
The Corporation's bylaws also contain procedures for the removal of
directors by its shareholders. At any meeting of shareholders, duly called and
at which a quorum is present, the shareholders may, by the affirmative vote of
the holders of a majority of the votes entitled to be cast thereon, remove any
director or directors from office and may elect a successor or successors to
fill any resulting vacancies for the unexpired terms of removed directors.
Upon the written request of the holders of shares entitled to not less
than ten percent (10%) of all the votes entitled to be cast at such meeting, the
Secretary of the Corporation shall promptly call a special meeting of
shareholders for the purpose of voting upon the question of removal of any
director. Whenever ten or more shareholders of record who have been such for at
least six months preceding the date of application, and who hold in the
aggregate either shares having a net asset value of at least $25,000 or at least
one percent (1%) of the total outstanding shares, whichever is less, shall apply
to the Corporation's Secretary in writing, stating that they wish to communicate
with other shareholders with a view to obtaining signatures to a request for a
meeting as described above and accompanied by a form of communication and
request which they wish to transmit, the Secretary shall within five business
days after such application either: (1) afford to such applicants access to a
list of the names and addresses of all shareholders as recorded on the books of
the Corporation; or (2) inform such applicants as to the approximate number of
shareholders of record and the approximate cost of mailing to them the proposed
communication and form of request.
If the Secretary elects to follow the course specified in clause (2) of
the last sentence of the preceding paragraph, the Secretary, upon the written
request of such applicants, accompanied by a tender of the material to be mailed
and of the reasonable expenses of mailing, shall, with reasonable promptness,
mail such material to all shareholders of record at their addresses as recorded
on the books unless within five business days after such tender the Secretary
shall mail to such applicants and file with the Securities and Exchange
Commission, together with a copy of the material to be mailed, a written
statement signed by at least a majority of the Board of Directors to the effect
that in their opinion either such material contains untrue statements of fact or
omits to state facts necessary to make the
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statements contained therein not misleading, or would be in violation of
applicable law, and specifying the basis of such opinion.
After opportunity for hearing upon the objections specified in the
written statement so filed, the Securities and Exchange Commission may, and if
demanded by the Board of Directors or by such applicants shall, enter an order
either sustaining one or more of such objections or refusing to sustain any of
them. If the Securities and Exchange Commission shall enter an order refusing to
sustain any of such objections, or if, after the entry of an order sustaining
one or more of such objections, the Securities and Exchange Commission shall
find, after notice and opportunity for hearing, that all objections so sustained
have been met, and shall enter an order so declaring, the Secretary shall mail
copies of such material to all shareholders with reasonable promptness after the
entry of such order and the renewal of such tender.
CAPITAL STRUCTURE
The Corporation's Articles of Incorporation permit the Board of
Directors to issue 500,000,000 shares of common stock. The Board of Directors
has the power to designate one or more classes ("series") of shares of common
stock and to designate or redesignate any unissued shares with respect to such
series. Currently the shares of the Fund are the only series of shares being
offered by the Corporation. Shareholders are entitled: (i) to one vote per full
share; (ii) to such distributions as may be declared by the Corporation's Board
of Directors out of funds legally available; and (iii) upon liquidation, to
participate ratably in the assets available for distribution. There are no
conversion or sinking fund provisions applicable to the shares, and the holders
have no preemptive rights and may not cumulate their votes in the election of
directors. Consequently the holders of more than 50% of the shares of the Fund
voting for the election of directors can elect the entire Board of Directors and
in such event the holders of the remaining shares voting for the election of
directors will not be able to elect any person or persons to the Board of
Directors. The shares are redeemable and are transferable. All shares issued and
sold by the Fund will be fully paid and nonassessable. Fractional shares entitle
the holder to the same rights as whole shares.
DESCRIPTION OF SECURITIES RATINGS
The Fund may invest in commercial paper master notes assigned one of
the two highest ratings of either Standard & Poor's Corporation ("Standard &
Poor's") or Moody's Investors Services, Inc. ("Moody's"). The Fund also may
invest in convertible securities assigned at least an investment grade by
Standard & Poor's or Moody's (or unrated but deemed by the Adviser to be of
comparable quality), and up to 5% of the Fund's assets may be invested in
convertible securities rated below investment grade but rated at least B by
Standard & Poor's or Moody's.
Commercial Paper Ratings
A Standard and Poor's commercial paper rating is a current assessment
of the likelihood of timely payment of debt having an original maturity of no
more than 365 days.
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The following summarizes the rating categories used by Standard & Poor's for
commercial paper in which the Funds may invest:
"A-1" - Issue's degree of safety regarding timely payment is strong.
Those issues determined to possess extremely strong safety characteristics are
denoted "A-1+."
"A-2" - Issue's capacity for timely payment is satisfactory. However,
the relative degree of safety is not as high as for issues designated "A-1."
Moody's commercial paper ratings are opinions of the ability of issuers
to repay punctually promissory obligations not having an original maturity in
excess of nine months. The following summarizes the rating categories used by
Moody's for commercial paper in which the Funds may invest:
"Prime-1" - Issuer or related supporting institutions are considered to
have a superior capacity for repayment of short-term promissory obligations.
Prime-1 repayment capacity will normally be evidenced by the following
capacities: leading market positions in well-established industries; high rates
of return on funds employed; conservative capitalization structures with
moderate reliance on debt and ample asset protection; broad margins in earning
coverage of fixed financial charges and high internal cash generation; and
well-established access to a range of financial markets and assured sources of
alternate liquidity.
"Prime-2" - Issuer or related supporting institutions are considered to
have a strong capacity for repayment of short-term promissory obligations. This
will normally be evidenced by many of the characteristics cited above but to a
lesser degree. Earnings trends and coverage ratios, while sound, will be more
subject to variation. Capitalization characteristics, while still appropriate,
may be more affected by external conditions. Ample alternative liquidity is
maintained.
Standard & Poor's Debt Ratings
A Standard & Poor's corporate or municipal debt rating is a current
assessment of the creditworthiness of an obligor with respect to a specific
obligation. This assessment may take into consideration obligors such as
guarantors, insurers, or lessees. The debt rating is not a recommendation to
purchase, sell, or hold a security, inasmuch as it does not comment as to market
price or suitability for a particular investor.
The ratings are based on current information furnished by the issuer or
obtained by Standard & Poor's from other sources it considers reliable. Standard
& Poor's does not perform an audit in connection with any rating and may, on
occasion, rely on unaudited financial information. The ratings may be changed,
suspended, or withdrawn as a result of changes in, or unavailability of, such
information, or for other circumstances.
The ratings are based, in varying degrees, on the following
considerations:
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1. Likelihood of default - capacity and willingness of the
obligor as to the timely payment of interest and repayment of
principal in accordance with the terms of the obligation.
2. Nature of and provisions of the obligation.
3. Protection afforded by, and relative position of, the
obligation in the event of bankruptcy, reorganization, or
other arrangement under the laws of bankruptcy and other laws
affecting creditors' rights.
Investment Grade
AAA - Debt rated "AAA" has the highest rating assigned by Standard &
Poor's. Capacity to pay interest an repay principal is extremely strong.
AA - Debt rated "AA" has a very strong capacity to pay interest and
repay principal and differs from the highest rated issues only in small degree.
A - Debt rated "A" has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories.
BBB - Debt rated "BBB" is regard 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.
Speculative Grade
Debt rated "BB," "B," "CCC," "CC" and "C" is regarded as having
predominantly speculative characteristics with respect to capacity to pay
interest and repay principal. "BB" indicates the least degree of speculation and
"C" the highest. While such debt will likely have some quality and protective
characteristic, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
"BB" - Debt rated "BB" has less near-term vulnerability to default than
other speculative issues. However, it faces major ongoing uncertainties or
exposure to adverse business, financial, or economic conditions which could lead
to inadequate capacity to meet timely interest and principal payments. The "BB"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BBB-"rating.
"B" - Debt rated "B" has a greater vulnerability to default but
currently has the capacity to meet interest payments and principal repayments.
Adverse business, financial, or economic conditions will likely impair capacity
or willingness to pay interest and repay principal. The "B" rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied "BB" or "BB-"rating.
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"CCC" - Debt rated "CCC" has a current identifiable vulnerability to
default, and is dependent upon favorable business, financial, and economic
conditions to meet timely payment of interest and repayment of principal. In the
event of adverse business, financial, or economic conditions, it is not likely
to have the capacity to pay interest an repay principal. The "CCC" rating
category is also used for debt subordinated to senior debt that is assigned an
actual or implied "B" or "B-" rating.
"CC" - Debt rated "CC" typically is applied to debt subordinated to
senior debt that is assigned an actual or implied "CCC" rating.
"C" - Debt rated "C" typically is applied to debt subordinated to
senior debt which is assigned an actual or implied "CCC-" debt rating. The "C"
rating may be used to cover a situation where a bankruptcy petition has been
filed, but debt service payments are continued.
"CI" - The rating "CI" is reserved for income bonds on which no
interest is being paid.
"D" - Debt rated "D" is in payment default. The "D" rating category is
used when interest payments or principal payments are not made on the date due
even if the applicable grace period has not expired, unless Standard & Poor's
believes that such payments will be made during such period. The "D" rating also
will be used upon the filing of a bankruptcy petition if debt service payments
are jeopardized.
Moody's Long-Term Debt 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
or protective elements may be of greater amplitude or there may be other
elements present which make the long-term risk appear somewhat larger than in
"Aaa" securities.
"A" - Bonds which are rated "A" possess many favorable investment
attributes and are to be considered as upper-medium grade obligations. Factors
giving security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment 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
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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.
"Caa" - Bonds which are rated "Caa" are of poor standing. Such issues
may be in default or there may be present elements of danger with respect to
principal or interest.
"Ca" - Bonds which are rated "Ca" represent obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings.
"C" - Bonds which are rated "C" are the lowest rated class of bonds,
and issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
INDEPENDENT ACCOUNTANTS
Baird, Kurtz & Dobson, 1100 Main Street, Kansas City, Missouri
64105-2112 has been selected as the independent accountants for the Fund. As
such Baird, Kurtz & Dobson performs an audit of the Fund's financial statement
and considers the Fund's internal control structure.
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