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PAINEWEBBER S&P 500 INDEX FUND
1285 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019
STATEMENT OF ADDITIONAL INFORMATION
PaineWebber S&P 500 Index Fund ("Fund") is a diversified series of
PaineWebber Index Trust ("Trust"), an open-end management investment company
organized as Delaware business trust. The Fund seeks to replicate the total
return of the Standard & Poor's 500 Composite Price Index ("S&P 500 Index"),
before fees and expenses.
Mitchell Hutchins Asset Management Inc. ("Mitchell Hutchins"), a wholly
owned asset management subsidiary of PaineWebber Incorporated ("PaineWebber"),
is the investment adviser, administrator and distributor for the Fund. As
distributor, Mitchell Hutchins has appointed PaineWebber to serve as the
exclusive dealer for the sale of the Fund shares.
This Statement of Additional Information is not a prospectus and should be
read only in conjunction with the Fund's current Prospectus dated November 1,
1997, as revised January 21, 1998. A copy of the Prospectus may be obtained by
calling any PaineWebber investment executive or correspondent firm. This
Statement of Additional Information is dated November 1, 1997, as revised
January 21, 1998.
INVESTMENT POLICIES AND RESTRICTIONS
The following supplements the information contained in the Prospectus
concerning the Fund's investment policies and limitations. Except as indicated
in the Prospectus or this Statement of Additional Information, there are no
policy limitations on the Fund's ability to use the investments or techniques
discussed in these documents.
MONEY MARKET INSTRUMENTS. Money market instruments in which the Fund may
invest include: U.S. Treasury bills and other obligations issued or guaranteed
as to interest and principal by the U.S. government, its agencies and
instrumentalities; obligations of U.S. banks (including certificates of
deposit and bankers' acceptances) with total assets in excess of $1.5 billion
at the time of purchase; interest-bearing savings deposits in U.S. commercial
and savings banks with principal amounts not greater than are fully insured by
the Federal Deposit Insurance Corporation (the aggregate amount of these
deposits may not exceed 5% of the value of the Fund's assets); commercial
paper and other short-term corporate obligations; and variable and floating-
rate securities and repurchase agreements. In addition, the Fund may hold cash
and may invest in participation interests in the money market securities
mentioned above without limitation.
SPECIAL CONSIDERATIONS RELATING TO FOREIGN SECURITIES. To the extent the
Fund holds U.S. dollar-denominated securities of foreign issuers, such
securities may not be registered with the Securities and Exchange Commission
("SEC"), nor are the issuers thereof subject to its reporting requirements.
Accordingly, there may be less publicly available information concerning
foreign issuers of securities held by the Fund than is available concerning
U.S. companies. Foreign companies are not generally subject to uniform
accounting, auditing and financial reporting standards or to other regulatory
requirements comparable to those applicable to U.S. companies.
The Fund invests in securities of foreign issuers only if such securities
are traded in the U.S. securities markets directly or through American
Depository Receipts ("ADRs"). Generally, ADRs, in registered form, are
denominated in U.S. dollars and are designed for use in the U.S. securities
markets. ADRs are receipts typically issued by a U.S. bank or trust company
evidencing ownership of the underlying securities. For purposes of the
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Fund's investment policies, ADRs are deemed to have the same classification as
the underlying securities they represent. Thus, an ADR evidencing ownership of
common stock will be treated as common stock.
Investment income and realized gains on certain foreign securities in which
the Fund may invest may be subject to foreign withholding or other taxes that
could reduce the return on these securities. Tax treaties between the United
States and foreign countries, however, may reduce or eliminate the amount of
foreign taxes to which the Fund would be subject.
REPURCHASE AGREEMENTS. Repurchase agreements are transactions in which the
Fund purchases securities from banks or recognized securities dealers and
simultaneously commits to resell the securities to the bank or dealer at an
agreed-upon date or upon demand and at a price reflecting a market rate of
interest unrelated to the coupon rate or maturity of the purchased securities.
The Fund maintains custody of the securities prior to their repurchase; thus,
the obligation of the bank or dealer to pay the repurchase price on the date
agreed to is, in effect, secured by such securities. If the value of these
securities is less than the repurchase price, plus any agreed-upon additional
amount, the other party to the agreement must provide additional collateral so
that at all times the collateral is at least equal to the repurchase price,
plus any agreed-upon additional amount. The difference between the total
amount to be received upon repurchase of the securities and the price that was
paid by the Fund upon acquisition is accrued as interest and included in its
net investment income. Repurchase agreements carry certain risks not
associated with direct investments in securities, including possible declines
in the market value of the underlying securities and delays and costs to a
Fund if the other party to a repurchase agreement becomes insolvent.
The Fund intends to enter into repurchase agreements only with banks and
dealers in transactions believed by Mitchell Hutchins to present minimal
credit risks in accordance with guidelines established by the Trust's board of
trustees (sometimes referred to as the "board"). Mitchell Hutchins reviews and
monitors the creditworthiness of those institutions under the board's general
supervision.
ILLIQUID SECURITIES. The Fund may invest up to 15% of its net assets in
illiquid securities. The term "illiquid securities" for this purpose means
securities that cannot be disposed of within seven days in the ordinary course
of business at approximately the amount at which the Fund has valued the
securities and includes, among other things, purchased over-the-counter
("OTC") options, repurchase agreements maturing in more than seven days and
restricted securities other than those Mitchell Hutchins has determined are
liquid pursuant to guidelines established by the Fund's board. The assets used
as cover for OTC options written by the Fund will be considered illiquid
unless the OTC options are sold to qualified dealers who agree that the Fund
may repurchase any OTC option it writes at a maximum price to be calculated by
a formula set forth in the option agreement. The cover for an OTC option
written subject to this procedure would be considered illiquid only to the
extent that the maximum repurchase price under the formula exceeds the
intrinsic value of the option.
Illiquid restricted securities may be sold only in privately negotiated
transactions or in public offerings with respect to which a registration
statement is in effect under the Securities Act of 1933 ("1933 Act"). Where
registration is required, the Fund may be obligated to pay all or part of the
registration expenses and a considerable period may elapse between the time of
the decision to sell and the time the Fund may be permitted to sell a security
under an effective registration statement. If, during such a period, adverse
market conditions were to develop, the Fund might obtain a less favorable
price than prevailed when it decided to sell.
Not all restricted securities are illiquid. In recent years a large
institutional market has developed for certain securities that are not
registered under the 1933 Act, including private placements, repurchase
agreements, commercial paper, foreign securities and corporate bonds and
notes. These instruments are often restricted securities because the
securities are sold in transactions not requiring registration. Institutional
investors generally will not seek to sell these instruments to the general
public, but instead will often depend either on an efficient institutional
market in which such unregistered securities can be readily resold or on an
issuer's ability to honor a demand for repayment. Therefore, the fact that
there are contractual or legal restrictions on resale to the general public or
certain institutions is not dispositive of the liquidity of such investments.
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Rule 144A under the 1933 Act establishes a "safe harbor" from the
registration requirements of the 1933 Act for resales of certain securities to
qualified institutional buyers. Institutional markets for restricted
securities have developed as a result of Rule 144A, providing both readily
ascertainable values for restricted securities and the ability to liquidate an
investment to satisfy share redemption orders. Such markets include 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. An insufficient number of
qualified institutional buyers interested in purchasing Rule 144A-eligible
restricted securities held by the Fund, however, could affect adversely the
marketability of such portfolio securities and the Fund might be unable to
dispose of such securities promptly or at favorable prices.
The board has delegated the function of making day-to-day determinations of
liquidity to Mitchell Hutchins pursuant to guidelines approved by the board.
Mitchell Hutchins takes into account a number of factors in reaching liquidity
decisions, including (1) the frequency of trades for the security, (2) the
number of dealers that make quotes for the security, (3) the number of dealers
that have undertaken to make a market in the security, (4) the number of other
potential purchasers and (5) the nature of the security and how trading is
effected (e.g., the time needed to sell the security, how offers are solicited
and the mechanics of transfer). Mitchell Hutchins monitors the liquidity of
restricted securities in the Fund's portfolio and reports periodically on such
decisions to the board.
LENDING OF PORTFOLIO SECURITIES. The Fund is authorized to lend up to 33
1/3% of its total assets to broker-dealers or institutional investors that
Mitchell Hutchins deems qualified, but only when the borrower maintains
acceptable collateral with the Fund's custodian in an amount, marked to market
daily, at least equal to the market value of the securities loaned, plus
accrued interest and dividends. Acceptable collateral is limited to cash, U.S.
government securities and irrevocable letters of credit that meet certain
guidelines established by Mitchell Hutchins. In determining whether to lend
securities to a particular broker-dealer or institutional investor, Mitchell
Hutchins will consider, and during the period of the loan will monitor, all
relevant facts and circumstances, including the creditworthiness of the
borrower. The Fund will retain authority to terminate any loans at any time.
The Fund may pay reasonable fees in connection with a loan and may pay a
negotiated portion of the interest earned on the cash held as collateral to
the borrower or placing broker. The Fund will receive reasonable interest on
the loan or a flat fee from the borrower and amounts equivalent to any
dividends, interest or other distributions on the securities loaned. The Fund
will regain record ownership of loaned securities to exercise beneficial
rights, such as voting and subscription rights, when regaining such rights is
considered to be in the Fund's interest.
Pursuant to procedures adopted by the board governing the Fund's securities
lending program, the board has approved retention of PaineWebber to serve as
lending agent for the Fund. The board also has authorized the Fund to pay fees
(including fees calculated as a percentage of invested cash collateral) to
PaineWebber for these services. The board periodically reviews all portfolio
securities loan transactions for which PaineWebber has acted as lending agent.
WARRANTS. Warrants are securities permitting, but not obligating, their
holder to subscribe for other securities or commodities. Warrants do not carry
with them the right to dividends or voting rights with respect to the
securities that they entitle their holder to purchase, and they do not
represent any rights in the assets of the issuer. As a result, warrants may be
considered more speculative than certain other types of investments. In
addition, the value of a warrant does not necessarily change with the value of
the Fund securities, and a warrant ceases to have value if it is not exercised
prior to its expiration date.
SEGREGATED ACCOUNTS. When the Fund enters into certain transactions to make
future payments to third parties, it will maintain with an approved custodian
in a segregated account cash or liquid securities, marked to market daily, in
an amount at least equal to the Fund's obligation or commitment under such
transactions. As described below under "Strategies Using Derivative
Instruments," segregated accounts may also be required in connection with
certain transactions involving options and futures contracts.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. A security purchased on a when-
issued or delayed delivery basis is recorded as an asset on the commitment
date and is subject to changes in market value, generally
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based upon changes in the level of interest rates. Thus, fluctuation in the
value of the security from the time of the commitment date will affect the
Fund's net asset value. When the Fund agrees to purchase securities on a when-
issued or delayed delivery basis, its custodian segregates assets to cover the
amount of the commitment. See "Investment Policies and Restrictions--
Segregated Accounts." The Fund purchases when-issued securities only with the
intention of taking delivery, but may sell the right to acquire the security
prior to delivery if Mitchell Hutchins deems it advantageous to do so, which
may result in a gain or loss to the Fund.
FUNDAMENTAL INVESTMENT LIMITATIONS. The following fundamental investment
limitations cannot be changed for the Fund without the affirmative vote of the
lesser of (a) more than 50% of the outstanding shares of the Fund or (b) 67%
or more of the Fund's shares present at a shareholders' meeting if more than
50% of the outstanding Fund shares are represented at the meeting in person or
by proxy. If a percentage restriction is adhered to at the time of an
investment or transaction, a later increase or decrease in percentage
resulting from a change in values of portfolio securities or amount of total
assets will not be considered a violation of any of the following limitations.
The Fund will not:
(1) purchase securities of any one issuer if, as a result, more than 5%
of the Fund's total assets would be invested in securities of that issuer
or the Fund would own or hold more than 10% of the outstanding voting
securities of that issuer, except that up to 25% of the Fund's total assets
may be invested without regard to this limitation, and except that this
limitation does not apply to securities issued or guaranteed by the U.S.
government, its agencies and instrumentalities or to securities issued by
other investment companies.
The following interpretation applies to, but is not a part of, this
fundamental restriction: Mortgage- and asset-backed securities will not be
considered to have been issued by the same issuer by reason of the
securities having the same sponsor, and mortgage- and asset-backed
securities issued by a finance or other special purpose subsidiary that are
not guaranteed by the parent company will be considered to be issued by a
separate issuer from the parent company.
(2) purchase any security if, as a result of that purchase, 25% or more
of the Fund's total assets would be invested in securities of issuers
having their principal business activities in the same industry, except
that this limitation does not apply to investments in securities issued or
guaranteed by the U.S. government, its agencies or instrumentalities or to
municipal securities and provided that the Fund will invest 25% or more of
its total assets in securities of issuers in the same industry if necessary
to replicate the weighting of that particular industry in the S&P 500
Index.
(3) issue senior securities or borrow money, except as permitted under
the Investment Company Act of 1940 ("1940 Act") and then not in excess of
33 1/3% of the Fund's total assets (including the amount of the senior
securities issued but reduced by any liabilities not constituting senior
securities) at the time of the issuance or borrowing, except that the Fund
may borrow up to an additional 5% of its total assets (not including the
amount borrowed) for temporary or emergency purposes.
(4) make loans, except through loans of portfolio securities or through
repurchase agreements, provided that for purposes of this restriction, the
acquisition of bonds, debentures, other debt securities or instruments, or
participations or other interests therein and investments in government
obligations, commercial paper, certificates of deposit, bankers'
acceptances or similar instruments will not be considered the making of a
loan.
(5) engage in the business of underwriting securities of other issuers,
except to the extent that the Fund might be considered an underwriter under
the federal securities laws in connection with its disposition of portfolio
securities.
(6) purchase or sell real estate, except that investments in securities
of issuers that invest in real estate and investments in mortgage-backed
securities, mortgage participations or other instruments supported by
interests in real estate are not subject to this limitation, and except
that the Fund may exercise rights under agreements relating to such
securities, including the right to enforce security interests and to hold
real estate acquired by reason of such enforcement until that real estate
can be liquidated in an orderly manner.
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(7) purchase or sell physical commodities unless acquired as a result of
owning securities or other instruments, but the Fund may purchase, sell or
enter into financial options and futures, forward and spot currency
contracts, swap transactions and other financial contracts or derivative
instruments.
NON-FUNDAMENTAL LIMITATIONS. The following investment restrictions are non-
fundamental and may be changed by the vote of the board without shareholder
approval.
The Fund will not:
(1) invest more than 15% of its net assets in illiquid securities, a term
which means securities that cannot be disposed of within seven days in the
ordinary course of business at approximately the amount at which the Fund
has valued the securities and includes, among other things, repurchase
agreements maturing in more than seven days.
(2) purchase portfolio securities while borrowings in excess of 5% of its
total assets are outstanding.
(3) purchase securities on margin, except for short-term credit necessary
for clearance of portfolio transactions and except that the Fund may make
margin deposits in connection with its use of financial options and
futures, forward and spot currency contracts, swap transactions and other
financial contracts or derivative instruments.
(4) engage in short sales of securities or maintain a short position,
except that the Fund may (a) sell short "against the box" and (b) maintain
short positions in connection with its use of financial options and
futures, forward and spot currency contracts, swap transactions and other
financial contracts or derivative instruments.
(5) purchase securities of other investment companies, except to the
extent permitted by the 1940 Act or under the terms of an exemptive order
granted by the SEC and except that this limitation does not apply to
securities received or acquired as dividends, through offers of exchange,
or as a result of reorganization, consolidation, or merger.
STRATEGIES USING DERIVATIVE INSTRUMENTS
DERIVATIVE INSTRUMENTS. Mitchell Hutchins may use a variety of derivative
instruments ("Derivative Instruments"), including certain options, futures
contracts (sometimes referred to as "futures") and options on futures
contracts, to simulate full investment by the Fund in the S&P 500 Index until
the Fund's assets reach a level that permits investment directly in the common
stocks represented in the S&P 500 Index or while retaining a cash balance for
Fund management purposes, such as to provide liquidity to meet anticipated
shareholder sales of Fund shares and for Fund operating expenses. As part of
its use of Derivative Instruments for the Fund's cash management purposes,
Mitchell Hutchins may attempt to reduce the risk of adverse price movements
("hedge") in the securities in the S&P 500 Index while investing cash received
from investor purchases of Fund shares, to facilitate trading and selling
securities to meet shareholder redemptions. Mitchell Hutchins may also use
Derivative Instruments to reduce transaction costs for the Fund. The Fund may
enter into transactions involving one or more types of Derivative Instruments
under which the full value of its portfolio is at risk. Under normal
circumstances, however, the Fund's use of these derivative contracts will
place at risk a much smaller portion of its assets. The particular Derivative
Instruments used by the Fund are described below.
OPTIONS ON SECURITIES INDEXES--A securities index assigns relative values
to the securities included in the index and fluctuates with changes in the
market values of those securities. A securities index option operates in
the same way as a more traditional securities option, except that exercise
of a securities index option is effected with cash payment and does not
involve delivery of securities. Thus, upon exercise of a securities index
option, the purchaser will realize, and the writer will pay, an amount
based on the difference between the exercise price and the closing price of
the securities index.
SECURITIES INDEX FUTURES CONTRACTS--A securities index futures contract
is a bilateral agreement pursuant to which one party agrees to accept, and
the other party agrees to make, delivery of an amount of
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cash equal to a specified dollar amount times the difference between the
securities index value at the close of trading of the contract and the
price at which the futures contract is originally struck. No physical
delivery of the securities comprising the index is made. Generally,
contracts are closed out prior to the expiration date of the contract.
OPTIONS ON FUTURES CONTRACTS--Options on futures contracts are similar to
options on securities, except that an option on a futures contract gives
the purchaser the right, in return for the premium, to assume a position in
a futures contract (a long position if the option is a call and a short
position if the option is a put), rather than to purchase or sell a
security, at a specified price at any time during the option term. Upon
exercise of the option, the delivery of the futures position to the holder
of the option will be accompanied by delivery of the accumulated balance
that represents the amount by which the market price of the futures
contract exceeds, in the case of a call, or is less than, in the case of a
put, the exercise price of the option on the future. The writer of an
option, upon exercise, will assume a short position in the case of a call
and a long position in the case of a put.
GENERAL DESCRIPTION OF STRATEGIES. Hedging strategies can be broadly
categorized as "short hedges" and "long hedges." A short hedge is a purchase
or sale of a Derivative Instrument intended partially or fully to offset
potential declines in the value of one or more investments held in the Fund's
portfolio. Thus, in a short hedge the Fund takes a position in a Derivative
Instrument whose price is expected to move in the opposite direction of the
price of the investment being hedged. For example, the Fund might purchase a
put option on a security to hedge against a potential decline in the value of
that security. If the price of the security declined below the exercise price
of the put, the Fund could exercise the put and thus limit its loss below the
exercise price to the premium paid plus transaction costs. In the alternative,
because the value of the put option can be expected to increase as the value
of the Fund security declines, the Fund might be able to close out the put
option and realize a gain to offset the decline in the value of the security.
Conversely, a long hedge is a purchase or sale of a Derivative Instrument
intended partially or fully to offset potential increases in the acquisition
cost of one or more investments that the Fund intends to acquire. Thus, in a
long hedge, the Fund takes a position in a Derivative Instrument whose price
is expected to move in the same direction as the price of the prospective
investment being hedged. For example, the Fund might purchase a call option on
a security it intends to purchase in order to hedge against an increase in the
cost of the security. If the price of the security increased above the
exercise price of the call, the Fund could exercise the call and thus limit
its acquisition cost to the exercise price plus the premium paid and
transaction costs. Alternatively, the Fund might be able to offset the price
increase by closing out an appreciated call option and realizing a gain.
Derivative Instruments on securities generally are used to hedge against
price movements in one or more particular securities positions that the Fund
owns or intends to acquire. Derivative Instruments on stock indices, in
contrast, generally are used to hedge against price movements in broad equity
market sectors.
Derivative Instruments also can be used to increase or reduce the Fund's
exposure to the stocks in the S&P 500 Index without buying or selling those
securities.
The use of Derivative Instruments is subject to applicable regulations of
the SEC, the several options and futures exchanges upon which they are traded
and the Commodity Futures Trading Commission ("CFTC"). In addition, the Fund's
ability to use Derivative Instruments will be limited by tax considerations.
See "Taxes."
In addition to the products, strategies and risks described below and in the
Prospectus, Mitchell Hutchins expects to discover additional opportunities in
connection with options, futures contracts and other derivative contracts and
hedging techniques. These new opportunities may become available as Mitchell
Hutchins develops new techniques, as regulatory authorities broaden the range
of permitted transactions and as new options, futures contracts, or other
derivative contracts and techniques are developed. Mitchell Hutchins may
utilize these opportunities for the Fund to the extent that they are
consistent with the Fund's investment objective and permitted by its
investment limitations and applicable regulatory authorities. The Fund's
Prospectus or this Statement of Additional Information will be supplemented to
the extent that new products or techniques involve materially different risks
than those described below or in its Prospectus.
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SPECIAL RISKS OF STRATEGIES USING DERIVATIVE INSTRUMENTS. The use of
Derivative Instruments involves special considerations and risks, as described
below. Risks pertaining to particular Derivative Instruments are described in
the sections that follow.
(1) There might be imperfect correlation between price movements of a
Derivative Instrument and price movements of the investments being hedged.
For example, if the value of a Derivative Instrument used in a short hedge
increased by less than the decline in value of the hedged investment, the
hedge would not be fully successful. Such a lack of correlation might occur
due to factors unrelated to the value of the investments being hedged, such
as speculative or other pressures on the markets in which Derivative
Instruments are traded.
The effectiveness of hedges using Derivative Instruments on indices will
depend on the degree of correlation between price movements in the index
and price movements in the securities being hedged.
(2) Hedging strategies, if successful, can reduce risk of loss by wholly
or partially offsetting the negative effect of unfavorable price movements
in the investments being hedged. However, hedging strategies can also
reduce opportunity for gain by offsetting the positive effect of favorable
price movements in the hedged investments. For example, if the Fund entered
into a short hedge because Mitchell Hutchins projected a decline in the
price of a security in that Fund's portfolio, and the price of that
security increased instead, the gain from that increase might be wholly or
partially offset by a decline in the price of the Derivative Instrument.
Moreover, if the price of the Derivative Instrument declined by more than
the increase in the price of the security, the Fund could suffer a loss. In
either such case, the Fund would have been in a better position had it not
hedged at all.
(3) As described below, the Fund might be required to maintain assets as
"cover," maintain segregated accounts or make margin payments when it takes
positions in Derivative Instruments involving obligations to third parties
(i.e., Derivative Instruments other than purchased options). If the Fund
was unable to close out its positions in such Derivative Instruments, it
might be required to continue to maintain such assets or accounts or make
such payments until the positions expired or matured. These requirements
might impair the Fund's ability to sell a portfolio security or make an
investment at a time when it would otherwise be favorable to do so, or
require that the Fund sell a portfolio security at a disadvantageous time.
The Fund's ability to close out a position in a Derivative Instrument prior
to expiration or maturity depends on the existence of a liquid secondary
market or, in the absence of such a market, the ability and willingness of
a contra party to enter into a transaction closing out the position.
Therefore, there is no assurance that any position can be closed out at a
time and price that is favorable to the Fund.
COVER FOR STRATEGIES USING DERIVATIVE INSTRUMENTS. Transactions using
Derivative Instruments, other than purchased options, expose the Fund to an
obligation to another party. The Fund will not enter into any such
transactions unless it owns either (1) an offsetting ("covered") position in
securities, other options or futures contracts or (2) cash and liquid
securities, with a value sufficient at all times to cover its potential
obligations to the extent not covered as provided in (1) above. The Fund will
comply with SEC guidelines regarding cover for these transactions and will, if
the guidelines so require, set aside cash or liquid securities in a segregated
account with its custodian in the prescribed amount.
Assets used as cover or held in a segregated account cannot be sold while
the position in the corresponding Derivative Instrument is open, unless they
are replaced with similar assets. As a result, the commitment of a large
portion of the Fund's assets to cover or segregated accounts could impede
portfolio management or the Fund's ability to meet redemption requests or
other current obligations.
OPTIONS. The Fund may purchase put and call options, and write (sell)
covered put or call options on securities on which it is permitted to invest
and indices of those securities. The purchase of call options serves as a long
hedge, and the purchase of put options serves as a short hedge. Writing
covered call options serves as a limited short hedge, because declines in the
value of the hedged investment would be offset to the extent of the premium
received for writing the option. However, if the security appreciates to a
price higher than the exercise price of the call option, it can be expected
that the option will be exercised and the Fund will be obligated to sell
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the security at less than its market value. Writing covered put options serves
as a limited long hedge because increases in the value of the hedged
investment would be offset to the extent of the premium received for writing
the option. However, if the security depreciates to a price lower than the
exercise price of the put option, it can be expected that the put option will
be exercised and the Fund will be obligated to purchase the security at more
than its market value. The securities or other assets used as cover for OTC
options written by the Fund would be considered illiquid to the extent
described under "Investment Policies and Restrictions--Illiquid Securities."
The value of an option position will reflect, among other things, the
current market value of the Fund investment, the time remaining until
expiration, the relationship of the exercise price to the market price of the
Fund investment, the historical price volatility of the Fund investment and
general market conditions. Options normally have expiration dates of up to
nine months. Options that expire unexercised have no value.
The Fund may effectively terminate its right or obligation under an option
by entering into a closing transaction. For example, the Fund may terminate
its obligation under a call or put option that it had written by purchasing an
identical call or put option; this is known as a closing purchase transaction.
Conversely, the Fund may terminate a position in a put or call option it had
purchased by writing an identical put or call option; this is known as a
closing sale transaction. Closing transactions permit the Fund to realize
profits or limit losses on an option position prior to its exercise or
expiration.
The Fund may purchase and write both exchange-traded and OTC options.
Exchange-traded options in the United States are issued by a clearing
organization affiliated with the exchange on which the option is listed which,
in effect, guarantees completion of every exchange-traded option transaction.
In contrast, OTC options are contracts between the Fund and its contra party
(usually a securities dealer or a bank) with no clearing organization
guarantee. Thus, when the Fund purchases or writes an OTC option, it relies on
the contra party to make or take delivery of the Fund investment upon exercise
of the option. Failure by the contra party to do so would result in the loss
of any premium paid by the Fund as well as the loss of any expected benefit of
the transaction.
Generally, the OTC debt options used by the Fund are European-style options.
This means that the option is only exercisable immediately prior to its
expiration. This is in contrast to American-style options, which are
exercisable at any time prior to the expiration date of the option.
The Fund's ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The Fund intends to
purchase or write only those exchange-traded options for which there appears
to be a liquid secondary market. However, there can be no assurance that such
a market will exist at any particular time. Closing transactions can be made
for OTC options only by negotiating directly with the contra party, or by a
transaction in the secondary market if any such market exists. Although the
Fund will enter into OTC options only with contra parties that are expected to
be capable of entering into closing transactions with the Fund, there is no
assurance that the Fund will in fact be able to close out an OTC option
position at a favorable price prior to expiration. In the event of insolvency
of the contra party, the Fund might be unable to close out an OTC option
position at any time prior to its expiration.
If the Fund were unable to effect a closing transaction for an option it had
purchased, it would have to exercise the option to realize any profit. The
inability to enter into a closing purchase transaction for a covered put or
call option written by the Fund could cause material losses because the Fund
would be unable to sell the investment used as cover for the written option
until the option expires or is exercised.
LIMITATIONS ON THE USE OF OPTIONS. The use of options is governed by the
following guidelines, which can be changed by the board without shareholder
vote:
(1) The Fund may purchase a put or call option, including any straddle or
spread, only if the value of its premium, when aggregated with the premiums
on all other options held by the Fund, does not exceed 5% of its total
assets.
8
<PAGE>
(2) The aggregate value of securities underlying put options written by
the Fund determined as of the date the put options are written will not
exceed 50% of its net assets.
(3) The aggregate premiums paid on all options (including options on
securities, stock indices and options on futures contracts) purchased by
the Fund that are held at any time will not exceed 20% of its net assets.
FUTURES. The Fund may purchase and sell futures contracts that are related
to securities in which it is permitted to invest, such as securities index
futures contracts. The Fund may also purchase put and call options, and write
covered put and call options, on futures in which it is allowed to invest. The
purchase of futures or call options thereon can serve as a long hedge, and the
sale of futures or the purchase of put options thereon can serve as a short
hedge. Writing covered call options on futures contracts can serve as a
limited short hedge, and writing covered put options on futures contracts can
serve as a limited long hedge, using a strategy similar to that used for
writing covered options on securities or indices.
No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract the Fund is required to deposit in a
segregated account with its custodian, in the name of the futures broker
through whom the transaction was effected, "initial margin" consisting of
cash, obligations of the United States or obligations that are fully
guaranteed as to principal and interest by the United States, in an amount
generally equal to 10% or less of the contract value. Margin must also be
deposited when writing a call option on a futures contract, in accordance with
applicable exchange rules. Unlike margin in securities transactions, initial
margin on futures contracts does not represent a borrowing, but rather is in
the nature of a performance bond or good-faith deposit that is returned to the
Fund at the termination of the transaction if all contractual obligations have
been satisfied. Under certain circumstances, such as periods of high
volatility, the Fund may be required by an exchange to increase the level of
its initial margin payment, and initial margin requirements might be increased
generally in the future by regulatory action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of the Fund's obligations to or from a futures
broker. When the Fund purchases an option on a future, the premium paid plus
transaction costs is all that is at risk. In contrast, when the Fund purchases
or sells a futures contract or writes a call option thereon, it is subject to
daily variation margin calls that could be substantial in the event of adverse
price movements. If the Fund has insufficient cash to meet daily variation
margin requirements, it might need to sell securities at a time when such
sales are disadvantageous.
Holders and writers of futures positions and options on futures can enter
into offsetting closing transactions, similar to closing transactions on
options, by selling or purchasing, respectively, an instrument identical to
the instrument held or written. Positions in futures and options on futures
may be closed only on an exchange or board of trade that provides a secondary
market. The Fund intends to enter into futures transactions only on exchanges
or boards of trade where there appears to be a liquid secondary market.
However, there can be no assurance that such a market will exist for a
particular contract at a particular time.
Under certain circumstances, futures exchanges may establish daily limits on
the amount that the price of a future or related option can vary from the
previous day's settlement price; once that limit is reached, no trades may be
made that day at a price beyond the limit. Daily price limits do not limit
potential losses because prices could move to the daily limit for several
consecutive days with little or no trading, thereby preventing liquidation of
unfavorable positions.
If the Fund were unable to liquidate a futures or related options position
due to the absence of a liquid secondary market or the imposition of price
limits, it could incur substantial losses. The Fund would continue to be
subject to market risk with respect to the position. In addition, except in
the case of purchased options, the Fund would continue to be required to make
daily variation margin payments and might be required to maintain the position
being hedged by the future or option or to maintain cash or securities in a
segregated account.
9
<PAGE>
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or related options might not
correlate perfectly with movements in the prices of the investments being
hedged. For example, all participants in the futures and related options
markets are subject to daily variation margin calls and might be compelled to
liquidate futures or related options positions whose prices are moving
unfavorably to avoid being subject to further calls. These liquidations could
increase price volatility of the instruments and distort the normal price
relationship between the futures or options and the investments being hedged.
Also, because initial margin deposit requirements in the futures market are
less onerous than margin requirements in the securities markets, there might
be increased participation by speculators in the futures markets. This
participation also might cause temporary price distortions. In addition,
activities of large traders in both the futures and securities markets
involving arbitrage, "program trading" and other investment strategies might
result in temporary price distortions.
LIMITATIONS ON THE USE OF FUTURES AND RELATED OPTIONS. The use of futures
and related options is governed by the following guidelines, which can be
changed by the board without shareholder vote:
(1) To the extent the Fund enters into futures contracts and options on
futures positions that are not for bona fide hedging purposes (as defined
by the CFTC), the aggregate initial margin and premiums on those positions
(excluding the amount by which options are "in-the-money") may not exceed
5% of its net assets.
(2) The aggregate premiums paid on all options (including options on
securities, stock indices and options on futures contracts) purchased by
the Fund that are held at any time will not exceed 20% of its net assets.
(3) The aggregate margin deposits on all futures contracts and options
thereon held at any time by the Fund will not exceed 5% of its total
assets.
TRUSTEES AND OFFICERS; PRINCIPAL HOLDERS OF SECURITIES
The trustees and executive officers of the Trust, their ages, business
addresses and principal occupations during the past five years are:
<TABLE>
<CAPTION>
POSITION WITH THE BUSINESS EXPERIENCE; OTHER
NAME AND ADDRESS*; AGE TRUST DIRECTORSHIPS
---------------------- ----------------- --------------------------
<C> <C> <S>
Margo N. Alexander*; 50 Trustee and Mrs. Alexander is president,
President chief executive officer and a
director of Mitchell Hutchins
(since January 1995) and an ex-
ecutive vice president and a di-
rector of PaineWebber. Mrs. Al-
exander is president and a di-
rector or trustee of 30 invest-
ment companies for which Mitch-
ell Hutchins or PaineWebber
serves as investment adviser.
</TABLE>
10
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH THE BUSINESS EXPERIENCE; OTHER
NAME AND ADDRESS*; AGE TRUST DIRECTORSHIPS
---------------------- ----------------- --------------------------
<C> <C> <S>
Richard Q. Armstrong; 62 Trustee Mr. Armstrong is chairman and
78 West Brother Drive principal of RQA Enterprises
Greenwich, CT 06830 (management consulting firm)
(since April 1991 and principal
occupation since March 1995).
Mr. Armstrong is also a direc-
tor of Hi Lo Automotive, Inc.
He was chairman of the board,
chief executive officer and co-
owner of Adirondack Beverages
(producer and distributor of
soft drinks and sparkling/still
waters) (October 1993-March
1995). He was a partner of the
New England Consulting Group
(management consulting firm)
(December 1992-September 1993).
He was managing director of
LVMH U.S. Corporation (U.S.
subsidiary of the French luxury
goods conglomerate, Louis
Vuitton Moet Hennessey Corpora-
tion) (1987-1991) and chairman
of its wine and spirits subsid-
iary, Schieffelin & Somerset
Company (1987-1991). Mr. Arm-
strong is a director or trustee
of 29 investment companies for
which Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
E. Garrett Bewkes, Jr.*; Trustee and Mr. Bewkes is a director of
71 Chairman of the Paine Webber Group Inc. ("PW
Board of Trustees Group") (holding company of
PaineWebber and Mitchell
Hutchins). Prior to December
1995, he was a consultant to PW
Group. Prior to 1988, he was
chairman of the board, presi-
dent and chief executive offi-
cer of American Bakeries Compa-
ny. Mr. Bewkes is a director of
Interstate Bakeries Corporation
and NaPro BioTherapeutics, Inc.
Mr. Bewkes is a director of
trustee of 30 investment compa-
nies for which Mitchell
Hutchins or PaineWebber serves
as investment adviser.
Richard R. Burt; 50 Trustee Mr. Burt is chairman of IEP Ad-
1275 Pennsylvania visors, Inc. (international in-
Avenue, N.W. vestments and consulting firm)
Washington, D.C. 20004 (since March 1994) and a part-
ner of McKinsey & Company (man-
agement consulting firm) (since
1991). He is also a director of
American Publishing Company and
Archer-Daniels-Midland Co. (ag-
ricultural commodities). He was
the chief negotiator in the
Strategic Arms Reduction Talks
with the former Soviet Union
(1989-1991) and the U.S. Ambas-
sador to the Federal Republic
of Germany (1985-1989). Mr.
Burt is a director or trustee
of 29 investment companies for
which Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH THE BUSINESS EXPERIENCE; OTHER
NAME AND ADDRESS*; AGE TRUST DIRECTORSHIPS
---------------------- ----------------- --------------------------
<C> <C> <S>
Mary C. Farrell*; 48 Trustee Ms. Farrell is a managing di-
rector, senior investment
strategist and member of the
Investment Policy Committee of
PaineWebber. Ms. Farrell joined
PaineWebber in 1982. She is a
member of the Financial Women's
Association and Women's Eco-
nomic Roundtable, and appears
as a regular panelist on Wall
$treet Week with Louis
Rukeyser. She also serves on
the Board of Overseers of New
York University's Stern School
of Business. Ms. Farrell is a
director or trustee of 29 in-
vestment companies for which
Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
Meyer Feldberg; 55 Trustee Mr. Feldberg is Dean and Pro-
Columbia University fessor of Management of the
101 Uris Hall Graduate School of Business,
New York, New York 10027 Columbia University. Prior to
1989, he was president of the
Illinois Institute of Technolo-
gy. Dean Feldberg is also a di-
rector of K-III Communications
Corporation, Federated Depart-
ment Stores, Inc. and Revlon,
Inc. Dean Feldberg is a direc-
tor or trustee of 29 investment
companies for which Mitchell
Hutchins or PaineWebber serves
as investment adviser.
George W. Gowen; 68 Trustee Mr. Gowen is a partner in the
666 Third Avenue law firm of Dunnington,
New York, New York 10017 Bartholow & Miller. Prior to
May 1994, he was a partner in
the law firm of Fryer, Ross &
Gowen. Mr. Gowen is a director
of Columbia Real Estate Invest-
ments, Inc. Mr. Gowen is a di-
rector or trustee of 29 invest-
ment companies for which Mitch-
ell Hutchins or PaineWebber
serves as investment adviser.
</TABLE>
12
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH THE BUSINESS EXPERIENCE; OTHER
NAME AND ADDRESS*; AGE TRUST DIRECTORSHIPS
---------------------- ----------------- --------------------------
<C> <C> <S>
Frederic V. Malek; 61 Trustee Mr. Malek is chairman of Thayer
1445 Pennsylvania Capital Partners (merchant
Avenue, N.W. bank). From January 1992 to No-
Suite 350 vember 1992, he was campaign
Washington, D.C. 20004 manager of Bush-Quayle '92.
From 1990 to 1992, he was vice
chairman and, from 1989 to
1990, he was president of
Northwest Airlines Inc., NWA
Inc. (holding company of North-
west Airlines Inc.) and Wings
Holdings Inc. (holding company
of NWA Inc.). Prior to 1989, he
was employed by the Marriott
Corporation (hotels, restau-
rants, airline catering and
contract feeding), where he
most recently was an executive
vice president and president of
Marriott Hotels and Resorts.
Mr. Malek is also a director of
American Management Systems,
Inc. (management consulting and
computer-related services), Au-
tomatic Data Processing Inc.,
CB Commercial Group, Inc. (real
estate services), Choice Hotels
International (hotel and hotel
franchising), FPL Group, Inc.
(electric services), Integra,
Inc. (bio-medical), Manor Care,
Inc. (health care), National
Education Corporation and
Northwest Airlines Inc. Mr.
Malek is a director or trustee
of 29 investment companies for
which Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
Carl W. Schafer; 61 Trustee Mr. Schafer is president of the
P.O. Box 1164 Atlantic Foundation (charitable
Princeton, NJ 08542 foundation supporting mainly
oceanographic exploration and
research). He is a director of
Roadway Express, Inc. (truck-
ing), The Guardian Group of Mu-
tual Funds, Evans Systems, Inc.
(motor fuels, convenience store
and diversified company), Elec-
tronic Clearing House, Inc.
(financial transactions
processing), Wainoco Oil Corpo-
ration and Nutraceutix, Inc.
(biotechnology). Prior to Janu-
ary 1993, Mr. Schafer was
chairman of the Investment Ad-
visory Committee of the Howard
Hughes Medical Institute. Mr.
Schafer is a director or
trustee of 29 investment compa-
nies for which Mitchell
Hutchins or PaineWebber serves
as investment adviser.
T. Kirkham Barneby; 51 Vice President Mr. Barneby is a managing di-
rector and chief investment of-
ficer--quantitative investments
of Mitchell Hutchins. Prior to
September 1994, he was a senior
vice president at Vantage
Global Management. Prior to
June 1993, he was a senior vice
president at Mitchell Hutchins.
Mr. Barneby is a vice president
of six investment companies for
which Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
</TABLE>
13
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH THE BUSINESS EXPERIENCE; OTHER
NAME AND ADDRESS*; AGE TRUST DIRECTORSHIPS
---------------------- ----------------- --------------------------
<C> <C> <S>
Ann E. Moran; 40 Vice President and Ms. Moran is a vice president
Assistant Treasurer and manager of the mutual fund
finance division of Mitchell
Hutchins. Ms. Moran is a vice
president and assistant trea-
surer of 30 investment compa-
nies for which Mitchell
Hutchins or PaineWebber serves
as investment adviser.
Dianne E. O'Donnell; 45 Vice President and Ms. O'Donnell is a senior vice
Secretary president and deputy general
counsel of Mitchell Hutchins.
Ms. O'Donnell is a vice presi-
dent and secretary of 29 in-
vestment companies and vice
president and assistant secre-
tary of one investment company
for which Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
Emil Polito; 37 Vice President Mr. Polito is a senior vice
president and director of oper-
ations and control for Mitchell
Hutchins. From March 1991 to
September 1993 he was director
of the Mutual Funds Sales Sup-
port and Service Center for
Mitchell Hutchins and
PaineWebber. Mr. Polito is a
vice president of 30 investment
companies for which Mitchell
Hutchins or PaineWebber serves
as investment adviser.
Victoria E. Schonfeld; Vice President Ms. Schonfeld is a managing di-
47 rector and general counsel of
Mitchell Hutchins. Prior to May
1994, she was a partner in the
law firm of Arnold & Porter.
Ms. Schonfeld is a vice presi-
dent of 29 investment companies
and vice president and secre-
tary of one investment company
for which Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
Paul H. Schubert; 34 Vice President and Mr. Schubert is a first vice
Treasurer president and the director of
the mutual fund finance divi-
sion of Mitchell Hutchins. From
August 1992 to August 1994, he
was a vice president of Black-
Rock Financial Management L.P.
Prior to August 1992, he was an
audit manager with Ernst &
Young LLP. Mr. Schubert is a
vice president and treasurer of
30 investment companies for
which Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
Barney A. Taglialatela; Vice President and Mr. Taglialatela is a vice
36 Assistant Treasurer president and manager of the
mutual fund finance division of
Mitchell Hutchins. Prior to
February 1995, he was a manager
of the mutual fund finance di-
vision of Kidder Peabody Asset
Management Inc. Mr.
Taglialatela is a vice presi-
dent and assistant treasurer of
30 investment companies for
which Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
</TABLE>
14
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH THE BUSINESS EXPERIENCE; OTHER
NAME AND ADDRESS*; AGE TRUST DIRECTORSHIPS
---------------------- ----------------- --------------------------
<C> <C> <S>
Keith A. Weller; 36 Vice President and Mr. Weller is a first vice
Assistant Secretary president and associate general
counsel of Mitchell Hutchins.
Prior to May 1995, he was an
attorney in private practice.
Mr. Weller is a vice president
and assistant secretary of 29
investment companies for which
Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
Ian W. Williams; 40 Vice President and Mr. Williams is a vice presi-
Assistant Treasurer dent and manager of the mutual
fund finance division of Mitch-
ell Hutchins. Mr. Williams is a
vice president and assistant
treasurer of 30 investment com-
panies for which Mitchell
Hutchins or PaineWebber serves
as investment adviser.
</TABLE>
- --------
* Unless otherwise indicated, the business address of each listed person is
1285 Avenue of the Americas, New York, New York 10019. Mrs. Alexander, Mr.
Bewkes and Ms. Farrell are "interested persons" of the Trust as defined in
the 1940 Act by virtue of their positions with PW Group, PaineWebber and/or
Mitchell Hutchins.
The Trust pays trustees who are not "interested persons" of the Trust $1,000
for each series and $150 for each board meeting and each meeting of a board
committee (other than committee meetings held on the same day as a board
meeting). The Trust has only one series and thus pays each such trustee $1,000
annually, plus any additional amounts due for board or committee meetings.
Each chairman of the audit and contract review committees of individual funds
within the PaineWebber fund complex receives additional compensation
aggregating $15,000 annually. All trustees are reimbursed for any expenses
incurred in attending meetings. Trustees and officers own no outstanding
shares of the Fund. Because PaineWebber and Mitchell Hutchins perform
substantially all the services necessary for the operation of the Trust and
the Fund, the Trust requires no employees. No officer, director or employee of
Mitchell Hutchins or PaineWebber presently receives any compensation from the
Trust for acting as a trustee or officer.
The table below shows the estimated compensation to be paid to each trustee
during the current fiscal year and the compensation of those trustees from
other PaineWebber funds during the calendar year ended December 31, 1997.
COMPENSATION TABLE(1)
<TABLE>
<CAPTION>
ESTIMATED TOTAL
AGGREGATE COMPENSATION
COMPENSATION FROM THE FUND
NAME OF PERSON, POSITION(1) FROM THE TRUST(2) COMPLEX(3)
- --------------------------- ----------------- -------------
<S> <C> <C>
Richard A. Armstrong, Trustee................... 1,750 $94,885
Richard R. Burt, Trustee........................ 1,750 87,085
Meyer Feldberg, Trustee......................... 2,550 117,853
George W. Gowen, Trustee........................ 1,750 101,567
Frederic V. Malek, Trustee...................... 1,750 95,845
Carl W. Schafer, Trustee........................ 1,750 94,885
</TABLE>
- --------
(1) Only independent members of the board are compensated by the Trust and
identified above; trustees who are "interested persons," as defined by the
1940 Act, do not receive compensation.
(2) Estimated for the initial fiscal year of the Trust.
(3) Represents total compensation paid to each trustee during the calendar
year ended December 31, 1997; no fund within the fund complex has a
pension or retirement plan.
15
<PAGE>
PRINCIPAL HOLDERS OF SECURITIES. As of November 1, 1997, Mitchell Hutchins
held all outstanding securities of the Fund and thus may be deemed a
controlling person of the Fund until additional shareholders purchase shares.
INVESTMENT ADVISORY AND DISTRIBUTION ARRANGEMENTS
INVESTMENT ADVISORY ARRANGEMENTS. Mitchell Hutchins acts as the investment
adviser and administrator to the Fund pursuant to a contract (the "Advisory
Contract") with the Trust dated October 14, 1997. Under the Advisory Contract,
the Fund pays Mitchell Hutchins a fee, computed daily and paid monthly, at the
annual rate of 0.20% of average daily net assets.
Under the terms of the Advisory Contract, the Fund bears all expenses
incurred in its operation that are not specifically assumed by Mitchell
Hutchins. Expenses borne by the Fund include the following: (1) the cost
(including brokerage commissions) of securities purchased or sold by the Fund
and any losses incurred in connection therewith; (2) fees payable to and
expenses incurred on behalf of the Fund by Mitchell Hutchins; (3)
organizational expenses; (4) filing fees and expenses relating to the
registration and qualification of the Fund's shares under federal and state
securities laws and maintenance of such registrations and qualifications; (5)
fees and salaries payable to trustees and officers who are not interested
persons (as defined in the 1940 Act) of the Trust or Mitchell Hutchins; (6)
all expenses incurred in connection with the trustees' services, including
travel expenses; (7) taxes (including any income or franchise taxes) and
governmental fees; (8) costs of any liability, uncollectible items of deposit
and other insurance or fidelity bonds; (9) any costs, expenses or losses
arising out of a liability of or claim for damages or other relief asserted
against the Trust or Fund for violation of any law; (10) legal, accounting and
auditing expenses, including legal fees of special counsel for the independent
trustees; (11) charges of custodians, transfer agents and other agents; (12)
costs of preparing share certificates; (13) expenses of setting in type and
printing prospectuses, statements of additional information and supplements
thereto, reports and proxy materials for existing shareholders, and costs of
mailing such materials to shareholders; (14) any extraordinary expenses
(including fees and disbursements of counsel) incurred by the Fund; (15) fees,
voluntary assessments and other expenses incurred in connection with
membership in investment company organizations; (16) costs of tabulating
proxies and costs of meetings of shareholders, the board and any committees
thereof; (17) the cost of investment company literature and other publications
provided to trustees and officers; (18) costs of mailing, stationery and
communications equipment; (19) expenses incident to any dividend, withdrawal
or redemption options; (20) charges and expenses of any outside pricing
service used to value portfolio securities; (21) interest on borrowings of the
Fund; and (22) fees or expenses related to license agreements with respect to
securities indices.
Under the Advisory Contract, Mitchell Hutchins will not be liable for any
error of judgment or mistake of law or for any loss suffered by the Fund in
connection with the performance of the Advisory Contract, except a loss
resulting from willful misfeasance, bad faith or gross negligence on the part
of Mitchell Hutchins in the performance of its duties or from reckless
disregard of its duties and obligations thereunder. The Advisory Contract
terminates automatically upon assignment and is terminable at any time without
penalty by the Trust's board or by vote of the holders of a majority of the
Fund's outstanding voting securities on 60 days' written notice to Mitchell
Hutchins, or by Mitchell Hutchins on 60 days' written notice to the Fund.
16
<PAGE>
NET ASSETS. The following table shows the approximate net assets as of
December 31, 1997, sorted by category of investment objective, of the
investment companies as to which Mitchell Hutchins serves as adviser or sub-
adviser. An investment company may fall into more than one of the categories
below.
<TABLE>
<CAPTION>
NET ASSETS
INVESTMENT CATEGORY $ MIL
------------------- ----------
<S> <C>
Domestic (excluding Money Market)................................. $ 6,583.7
Global............................................................ 3,335.0
Equity/Balanced................................................... 5,054.7
Fixed Income (excluding Money Market)............................. 4,864.0
Taxable Fixed Income............................................ 3,281.4
Tax-Free Fixed Income........................................... 1,582.6
Money Market Funds................................................ 25,879.6
</TABLE>
PERSONNEL TRADING POLICIES. Mitchell Hutchins personnel may invest in
securities for their own accounts pursuant to a code of ethics that describes
the fiduciary duty owed to shareholders of PaineWebber mutual funds and other
Mitchell Hutchins advisory accounts by all Mitchell Hutchins' directors,
officers and employees, establishes procedures for personal investing and
restricts certain transactions. For example, employee accounts generally must
be maintained at PaineWebber, personal trades in most securities require pre-
clearance and short-term trading and participation in initial public offerings
generally are prohibited. In addition, the code of ethics puts restrictions on
the timing of personal investing in relation to trades by PaineWebber Funds
and other Mitchell Hutchins advisory clients.
DISTRIBUTION ARRANGEMENTS. Mitchell Hutchins acts as the distributor of the
Fund's Class A and Class Y shares under a distribution contract with the Trust
("Distribution Contract") that requires Mitchell Hutchins to use its best
efforts, consistent with its other businesses, to sell shares of the Fund.
Shares of the Fund are offered continuously. Under an exclusive dealer
agreement between Mitchell Hutchins and PaineWebber relating to the Class A
and Class Y shares ("Exclusive Dealer Agreement"), PaineWebber and its
correspondent firms sell the Fund's shares.
Under a plan of distribution pertaining to the Class A shares adopted by the
Trust in the manner prescribed under Rule 12b-1 under the 1940 Act ("Class A
Plan" or "Plan"), the Fund pays Mitchell Hutchins a service fee, accrued daily
and payable monthly, at the annual rate of 0.05% of the average daily net
assets of Class A shares of the Fund. The Fund pays Mitchell Hutchins no
distribution fees with respect to its Class A shares. There is no distribution
plan with respect to Class Y shares and the Fund pays no service or
distribution fees with respect to its Class Y shares.
Among other things, the Class A Plan provides that (1) Mitchell Hutchins
will submit to the board at least quarterly, and the trustees will review,
reports regarding all amounts expended under the Plan and the purposes for
which such expenditures were made, (2) the Plan will continue in effect only
so long as it is approved at least annually, and any material amendment
thereto is approved, by the board, including those trustees who are not
"interested persons" of the Trust and who have no direct or indirect financial
interest in the operation of the Plan or any agreement related to the Plan,
acting in person at a meeting called for that purpose, (3) payments by the
Fund under the Plan shall not be materially increased without the affirmative
vote of the holders of a majority of the outstanding Class A shares of the
Fund and (4) while the Plan remains in effect, the selection and nomination of
trustees who are not "interested persons" of the Trust shall be committed to
the discretion of the trustees who are not "interested persons" of the Trust.
In reporting amounts expended under the Plan to the board, Mitchell Hutchins
allocates expenses attributable to the sale of each class of the Fund's shares
to such class based on the ratio of sales of shares of such class to the sales
of all classes of shares. The fees paid by one class of the Fund's shares will
not be used to subsidize the sale of the other class of the Fund's shares.
17
<PAGE>
In approving the Class A Plan for the Fund, the board considered all the
features of the distribution system, including (1) the advantage to investors
in having no initial sales charges deducted from the Fund purchase payments
and instead having the entire amount of their purchase payments immediately
invested in Fund shares, (2) the advantage to investors in being free from
contingent deferred sales charges upon redemption of shares, (3) Mitchell
Hutchins' belief that the ability of PaineWebber investment executives and
correspondent firms to receive continuing service fees, while their customers
invest their entire purchase payments immediately in Class A shares would
prove attractive to the investment executives and correspondent firms,
resulting in greater growth to the Fund than might otherwise be the case, (4)
the advantages to the shareholders of economies of scale resulting from growth
in the Fund's assets and potential continued growth, (5) the services provided
to the Fund and its shareholders by Mitchell Hutchins, (6) the services
provided by PaineWebber pursuant to its Exclusive Dealer Agreement with
Mitchell Hutchins and (7) Mitchell Hutchins' shareholder and service-related
expenses and costs.
With respect to the Plan, the board considered all compensation that
Mitchell Hutchins would receive under the Plan and the Distribution Contract,
including service fees. The board also considered the benefits that would
accrue to Mitchell Hutchins under the Plan in that Mitchell Hutchins would
receive service and advisory fees which are calculated based upon a percentage
of the average net assets of the Fund, which would increase if the Plan were
successful and the Fund attained and maintained significant asset levels.
PORTFOLIO TRANSACTIONS
Subject to policies established by the board, Mitchell Hutchins is
responsible for the execution of the Fund's portfolio transactions and the
allocation of brokerage transactions. In executing portfolio transactions,
Mitchell Hutchins generally seeks to obtain the best net results for the Fund,
taking into account such factors as the price (including the applicable
brokerage commission or dealer spread), size of order, difficulty of execution
and operational facilities of the firm involved. While Mitchell Hutchins
generally seeks reasonably competitive commission rates, payment of the lowest
commission is not necessarily consistent with obtaining the best net results.
Prices paid to dealers in principal transactions, through which some equity
securities and most debt securities are traded, generally include a "spread,"
which is the difference between the prices at which the dealer is willing to
purchase and sell a specific security at the time. The Fund may invest in
securities traded in the OTC market and will engage primarily in transactions
directly with the dealers who make markets in such securities, unless a better
price or execution could be obtained by using a broker.
The Fund has no obligation to deal with any broker or group of brokers in
the execution of portfolio transactions. The Fund contemplates that,
consistent with the policy of obtaining the best net results, brokerage
transactions may be conducted through PaineWebber. The board has adopted
procedures in conformity with Rule 17e-1 under the 1940 Act to ensure that all
brokerage commissions paid to PaineWebber are reasonable and fair. Specific
provisions in the Advisory Contract authorize PaineWebber to effect portfolio
transactions for the Fund on such exchange and to retain compensation in
connection with such transactions. Any such transactions will be effected and
related compensation paid only in accordance with applicable SEC regulations.
Transactions in futures contracts are executed through futures commission
merchants ("FCMs"), who receive brokerage commissions for their services. The
Fund's procedures in selecting FCMs to execute its transactions in futures
contracts, including procedures permitting the use of PaineWebber, are similar
to those in effect with respect to brokerage transactions in securities.
Consistent with the interests of the Fund and subject to the review of the
board, Mitchell Hutchins may cause the Fund to purchase and sell portfolio
securities from and to dealers or through brokers who provide that Fund with
research, analysis, advice and similar services. In return for such services,
the Fund may pay to those brokers a higher commission than may be charged by
other brokers, provided that Mitchell Hutchins determines in good faith that
such commission is reasonable in terms either of that particular transaction
or of the overall responsibility of Mitchell Hutchins to the Fund and its
other clients and that the total commissions paid by the Fund will be
reasonable in relation to the benefits to the Fund over the long term.
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For purchases or sales with broker-dealer firms which act as principal,
Mitchell Hutchins seeks best execution. Although Mitchell Hutchins may receive
certain research or execution services in connection with these transactions,
it will not purchase securities at a higher price or sell securities at a
lower price than would otherwise be paid if no weight was attributed to the
services provided by the executing dealer. Moreover, Mitchell Hutchins will
not enter into any explicit soft dollar arrangements relating to principal
transactions and will not receive in principal transactions the types of
services which could be purchased for hard dollars. Mitchell Hutchins may
engage in agency transactions in OTC equity securities in return for research
and execution services. These transactions are entered into only in compliance
with procedures ensuring that the transaction (including commissions) is at
least as favorable as it would have been if effected directly with a market-
maker that did not provide research or execution services. These procedures
include Mitchell Hutchins receiving multiple quotes from dealers before
executing the transactions on an agency basis.
Information and research services furnished by brokers or dealers through
which or with which the Fund effects securities transactions may be used by
Mitchell Hutchins in advising other funds or accounts and, conversely,
research services furnished to Mitchell Hutchins by brokers or dealers in
connection with other funds or accounts that it advises may be used in
advising the Fund. Information and research received from brokers or dealers
will be in addition to, and not in lieu of, the services required to be
performed by Mitchell Hutchins under the Advisory Contract.
Investment decisions for the Fund and for other investment accounts managed
by Mitchell Hutchins are made independently of each other in light of
differing considerations for the various accounts. However, the same
investment decision may occasionally be made for the Fund and one or more of
such accounts. In such cases, simultaneous transactions are inevitable.
Purchases or sales are then averaged as to price and allocated between the
Fund and such other account(s) as to amount according to a formula deemed
equitable to the Fund and such account(s). While in some cases this practice
could have a detrimental effect upon the price or value of the security as far
as the Fund is concerned, or upon its ability to complete its entire order, in
other cases it is believed that coordination and the ability to participate in
volume transactions will be beneficial to the Fund.
The Fund will not purchase securities that are offered in underwritings in
which PaineWebber is a member of the underwriting or selling group, except
pursuant to procedures adopted by the board pursuant to Rule 10f-3 under the
1940 Act. Among other things, these procedures require that the spread or
commission paid in connection with such a purchase be reasonable and fair, the
purchase be at not more than the public offering price prior to the end of the
first business day after the date of the public offering and that PaineWebber
or any affiliate thereof not participate in or benefit from the sale to the
Fund.
PORTFOLIO TURNOVER. The Fund's annual portfolio turnover rates may vary
greatly from year to year, but they will not be a limiting factor when
management deems portfolio changes appropriate. The portfolio turnover rate is
calculated by dividing the lesser of the Fund's annual sales or purchases of
portfolio securities (exclusive of purchases or sales of securities whose
maturities at the time of acquisition were one year or less) by the monthly
average value of securities in the portfolio during the year. Mitchell
Hutchins estimates that the Fund's annual portfolio turnover rate will not
exceed 50% during its first fiscal year.
REDEMPTION INFORMATION AND OTHER SERVICES
REDEMPTION INFORMATION. If conditions exist that make cash payments
undesirable, the Fund reserves the right to honor any request for redemption
by making payment in whole or in part in securities chosen by the Fund and
valued in the same way as they would be valued for purposes of computing the
Fund's net asset value. If payment is made in securities, a shareholder may
incur brokerage expenses in converting these securities into cash.
The Fund may suspend redemption privileges or postpone the date of payment
during any period (1) when the New York Stock Exchange ("NYSE") is closed or
trading on the NYSE is restricted as determined by the
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<PAGE>
SEC, (2) when an emergency exists, as defined by the SEC, that makes it not
reasonably practicable for the Fund to dispose of securities owned by it or
fairly to determine the value of its assets or (3) as the SEC may otherwise
permit. The redemption price may be more or less than the shareholder's cost,
depending on the market value of the Fund's portfolio at the time.
AUTOMATIC INVESTMENT PLAN. Participation in the Automatic Investment Plan
enables an investor to use the technique of "dollar cost averaging." When an
investor invests the same dollar amount each month under the Plan, the
investor will purchase more shares when the Fund's net asset value per share
is low and fewer shares when the net asset value per share is high. Using this
technique, an investor's average purchase price per share over any given
period will be lower than if the investor purchased a fixed number of shares
on a monthly basis during the period. Of course, investing through the
automatic investment plan does not assure a profit or protect against loss in
declining markets. Additionally, because the automatic investment plan
involves continuous investing regardless of price levels, an investor should
consider his or her financial ability to continue purchases through periods of
low price levels.
SYSTEMATIC WITHDRAWAL PLAN. An investor's participation in the systematic
withdrawal plan will terminate automatically if the "Initial Account Balance"
(a term that means the value of the Fund account at the time the investor
elects to participate in the systematic withdrawal plan) less aggregate
redemptions made other than pursuant to the systematic withdrawal plan is less
than $25,000 for Class A shareholders. Purchases of additional shares of the
Fund concurrent with withdrawals are ordinarily disadvantageous to
shareholders because of tax liabilities. On or about the 20th of each month
for monthly, quarterly, semiannual or annual plans, PaineWebber will arrange
for redemption by the Fund of sufficient Fund shares to provide the withdrawal
payments specified by participants in the Fund's systematic withdrawal plan.
The payments generally are mailed approximately five Business Days (defined
under "Valuation of Shares") after the redemption date. Withdrawal payments
should not be considered dividends, but redemption proceeds, with the tax
consequences described under "Dividends & Taxes" in the Prospectus. If
periodic withdrawals continually exceed reinvested dividends and other
distributions, a shareholder's investment may be correspondingly reduced. A
shareholder may change the amount of the systematic withdrawal or terminate
participation in the systematic withdrawal plan at any time without charge or
penalty by written instructions with signatures guaranteed to PaineWebber or
PFPC Inc. ("Transfer Agent"). Instructions to participate in the plan, change
the withdrawal amount or terminate participation in the plan will not be
effective until five days after written instructions with signatures
guaranteed are received by the Transfer Agent. Shareholders may request the
forms needed to establish a systematic withdrawal plan from their PaineWebber
investment executives, correspondent firms or the Transfer Agent at 1-800-647-
1568.
PAINEWEBBER RMA RESOURCE ACCUMULATION PLANSM
PAINEWEBBER RESOURCE MANAGEMENT ACCOUNT(R) (RMA)(R)
Shares of PaineWebber mutual funds, including the Fund (each a "PW Fund"
and, collectively, the "PW Funds") are available for purchase through the RMA
Resource Accumulation Plan ("Plan") by customers of PaineWebber and its
correspondent firms who maintain Resource Management Accounts ("RMA
accountholders"). The Plan allows an RMA accountholder continually to invest
in one or more of the PW Funds at regular intervals, with payment for shares
purchased automatically deducted from the client's RMA account. The client may
elect to invest at monthly or quarterly intervals and may elect either to
invest a fixed dollar amount (minimum $100 per period) or to purchase a fixed
number of shares. A client can elect to have Plan purchases executed on the
first or fifteenth day of the month. Settlement occurs three Business Days
(defined under "Valuation of Shares") after the trade date, and the purchase
price of the shares is withdrawn from the investor's RMA account on the
settlement date from the following sources and in the following order:
uninvested cash balances, balances in RMA money market funds, or margin
borrowing power, if applicable to the account.
To participate in the Plan, an investor must be an RMA accountholder, must
have made an initial purchase of the shares of each PW Fund selected for
investment under the Plan (meeting applicable minimum investment
20
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requirements) and must complete and submit the RMA Resource Accumulation Plan
Client Agreement and Instruction Form available from PaineWebber. The investor
must have received a current prospectus for each PW Fund selected prior to
enrolling in the Plan. Information about mutual fund positions and outstanding
instructions under the Plan are noted on the RMA accountholder's account
statement. Instructions under the Plan may be changed at any time, but may
take up to two weeks to become effective.
The terms of the Plan, or an RMA accountholder's participation in the Plan,
may be modified or terminated at any time. It is anticipated that, in the
future, shares of other PW Funds and/or mutual funds other than the PW Funds
may be offered through the Plan.
PERIODIC INVESTING AND DOLLAR COST AVERAGING. Periodic investing in the PW
Funds or other mutual funds, whether through the Plan or otherwise, helps
investors establish and maintain a disciplined approach to accumulating assets
over time, deemphasizing the importance of timing the market's highs and lows.
Periodic investing also permits an investor to take advantage of "dollar cost
averaging." By investing a fixed amount in mutual fund shares at established
intervals, an investor purchases more shares when the price is lower and fewer
shares when the price is higher, thereby increasing his or her earning
potential. Of course, dollar cost averaging does not guarantee a profit or
protect against a loss in a declining market, and an investor should consider
his or her financial ability to continue investing through periods of low
share prices. However, over time, dollar cost averaging generally results in a
lower average original investment cost than if an investor invested a larger
dollar amount in a mutual fund at one time.
PAINEWEBBER'S RESOURCE MANAGEMENT ACCOUNT. In order to enroll in the Plan,
an investor must have opened an RMA account with PaineWebber or one of its
correspondent firms. The RMA account is PaineWebber's comprehensive asset
management account and offers investors a number of features, including the
following:
. monthly Premier account statements that itemize all account activity,
including investment transactions, checking activity and Gold
MasterCard(R) transactions during the period, and provide unrealized and
realized gain and loss estimates for most securities held in the account;
. comprehensive preliminary 9-month and year-end summary statements that
provide information on account activity for use in tax planning and tax
return preparation;
. automatic "sweep" of uninvested cash into the RMA accountholder's choice
of one of the six RMA money market funds--RMA Money Market Portfolio, RMA
U.S. Government Portfolio, RMA Tax-Free Fund, RMA California Municipal
Money Fund, RMA New Jersey Municipal Money Fund and RMA New York
Municipal Money Fund. Each money market fund attempts to maintain a
stable price per share of $1.00, although there can be no assurance that
it will be able to do so. Investments in the money market funds are not
insured or guaranteed by the U.S. government;
. check writing, with no per-check usage charge, no minimum amount on
checks and no maximum number of checks that can be written. RMA
accountholders can code their checks to classify expenditures. All
canceled checks are returned each month;
. Gold MasterCard, with or without a line of credit, which provides RMA
accountholders with direct access to their accounts and can be used with
automatic teller machines worldwide. Purchases on the Gold MasterCard are
debited to the RMA account once monthly, permitting accountholders to
remain invested for a longer period of time;
. 24-hour access to account information through toll-free numbers, and more
detailed personal assistance during business hours from the RMA Service
Center;
. expanded account protection to $50 million in the event of the
liquidation of PaineWebber. This protection does not apply to shares of
the RMA money market funds or the PW Funds because those shares are held
at the transfer agent and not through PaineWebber; and
. automatic direct deposit of checks into your RMA account and automatic
withdrawals from the account.
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<PAGE>
The annual account fee for an RMA account is $85, which includes the Gold
MasterCard, with an additional fee of $40 if the investor selects an optional
line of credit with the Gold MasterCard.
VALUATION OF SHARES
The Fund determines its net asset value per share separately for each class
of shares as of the close of regular trading (currently 4:00 p.m., Eastern
time) on the NYSE on each Business Day, which is defined as each Monday
through Friday when the NYSE is open. Currently the NYSE is closed on the
observance of the following holidays: New Year's Day, Martin Luther King, Jr.
Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day.
Securities that are listed on stock exchanges are valued at the last sale
price on the day the securities are valued or, lacking any sales on such day,
at the last available bid price. In cases where securities are traded on more
than one exchange, the securities are generally valued on the exchange
considered by Mitchell Hutchins as the primary market. Securities traded in
the OTC market and listed on the Nasdaq Stock Market ("Nasdaq") are valued at
the last trade price on Nasdaq at 4:00 p.m., Eastern time; other OTC
securities are valued at the last bid price available prior to valuation
(other than short-term investments that mature in 60 days or less which are
valued at amortized cost, unless the board determines that this does not
represent fair value). Securities and assets for which market quotations are
not readily available are valued at fair value as determined in good faith by
or under the direction of the board.
PERFORMANCE INFORMATION
The Fund's performance data quoted in advertising and other promotional
materials ("Performance Advertisements") represents past performance and is
not intended to indicate future performance. The investment return and
principal value of an investment will fluctuate so that an investor's shares,
when redeemed, may be worth more or less than their original cost.
TOTAL RETURN CALCULATIONS. Average annual total return quotes ("Standardized
Return") used in the Fund's Performance Advertisements are calculated
according to the following formula:
P(1 + T)/n/ = ERV
where: P = a hypothetical initial payment of $1,000 to purchase shares
of a specified class
T = average annual total return of shares of that class
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment at
the beginning of that period.
Under the foregoing formula, the time periods used in Performance
Advertisements will be based on rolling calendar quarters, updated to the last
day of the most recent quarter prior to submission of the advertisement for
publication. Total return, or "T" in the formula above, is computed by finding
the average annual change in the value of an initial $1,000 investment over
the period. All dividends and other distributions are assumed to have been
reinvested at net asset value.
OTHER INFORMATION. In Performance Advertisements, the Fund may compare its
Standardized Return with data published by Lipper Analytical Services, Inc.
("Lipper"), CDA Investment Technologies, Inc. ("CDA"), Wiesenberger Investment
Companies Service ("Wiesenberger"), Investment Company Data, Inc. ("ICD") or
Morningstar Mutual Funds ("Morningstar"), with the performance of recognized
stock and other indices, including (but not limited to) the S&P 500 Index, the
Dow Jones Industrial Average, the International Finance Corporation Global
Total Return Index, the Nasdaq Composite Index, the Russell 2000 Index, the
Wilshire 5000 Index, the Lehman Bond Index, the Lehman Brothers 20+ Year
Treasury Bond Index, the Lehman Brothers
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<PAGE>
Government/Corporate Bond Index, other similar Lehman Brothers indices or
components thereof, 30-year and 10-year U.S. Treasury bonds, the Morgan
Stanley Capital International Perspective Indices, the Morgan Stanley Capital
International Energy Sources Index, the Standard & Poor's Oil Composite Index,
the Morgan Stanley Capital International World Index, the Salomon Brothers
Non-U.S. Dollar Index, the Salomon Brothers Non-U.S. World Government Bond
Index, the Salomon Brothers World Government Index, other similar Salomon
Brothers indices or components thereof and changes in the Consumer Price Index
as published by the U.S. Department of Commerce. 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, CDA,
Wiesenberger, ICD or Morningstar. Performance Advertisements 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, BARRON'S,
FORTUNE, THE NEW YORK TIMES, THE CHICAGO TRIBUNE, THE WASHINGTON POST AND THE
KIPLINGER LETTERS. Comparisons in Performance Advertisements may be in graphic
form.
The Fund may include discussions or illustrations of the effects of
compounding in Performance Advertisements. "Compounding" refers to the fact
that, if dividends or other distributions on the Fund investment are
reinvested in additional Fund shares, any future income or capital
appreciation of the Fund would increase the value, not only of the original
Fund investment, but also of the additional Fund shares received through
reinvestment. As a result, the value of the Fund investment would increase
more quickly than if dividends or other distributions had been paid in cash.
The Fund may also compare its performance with the performance of bank
certificates of deposit (CDs) as measured by the CDA Certificate of Deposit
Index, the Bank Rate Monitor National Index and the averages of yields of CDs
of major banks published by Banxquote(R) Money Markets. In comparing the
Fund's performance to CD performance, investors should keep in mind that bank
CDs are insured in whole or in part by an agency of the U.S. government and
offer fixed principal and fixed or variable rates of interest, and that bank
CD yields may vary depending on the financial institution offering the CD and
prevailing interest rates. Shares of the Fund are not insured or guaranteed by
the U.S. government and returns and net asset values will fluctuate. The debt
securities held by the Fund may have longer maturities than most CDs and may
reflect interest rate fluctuations for longer term debt securities. An
investment in the Fund involves greater risks than an investment in either a
money market fund or a CD.
The Fund may also compare its performance to general trends in the stock and
bond markets, as illustrated by the following graph prepared by Ibbotson
Associates, Chicago.*
Common Stocks U.S. LT U.S. 30 Day Inflation
Gvt TR TBill TR
- -------------------------------------------------------------------------
1925 10000 10000 10000 10000
11162 10777 10327 9851
15347 11739 10649 9646
22040 11751 11028 9553
20185 12153 11552 8572
1930 15159 12719 11830 8994
8590 12044 11957 8138
7886 14073 12072 7300
12144 14062 12108 7337
1934 11968 15472 12128 7466
17674 16243 12148 7710
23669 17464 12170 7803
15379 17504 12207 8045
1938 20165 18473 12205 7821
20082 19570 12208 7784
18117 20761 12208 7859
16017 20955 12216 8622
1942 19275 21829 12248 9423
24267 22080 12291 9721
29060 22702 12332 9926
39649 25139 12372 10149
1946 36449 25113 12418 11993
38529 24454 12478 13073
40649 25285 12580 13426
48287 26916 12718 13184
1950 63601 26932 12870 13948
78875 25873 13063 14767
93363 26173 13279 14898
92439 27125 13521 14991
1954 141084 29075 13638 14916
185614 28699 13852 14972
197783 27096 14193 15400
176457 29117 14639 15866
1958 252975 27342 14864 16145
283219 26725 15303 16387
284549 30407 15711 16629
361060 30703 16045 16741
1962 329545 32818 16483 16946
404685 33216 16997 17225
471388 34381 17598 17430
530081 34625 18289 17765
1966 476737 35889 19159 18361
591038 32594 19966 18920
658415 32509 21005 19814
600590 30860 22388 21024
1970 624653 34596 23849 22179
714058 39173 24895 22924
849559 41400 25851 23706
725003 40942 27643 25792
1974 533110 42725 29855 28939
731443 46853 31588 30969
905842 54470 33193 32458
840766 54095 34893 34656
1978 895922 53458 37398 37784
1061126 52799 41279 42812
1405137 50715 45917 48120
1336161 51657 52671 52421
1982 1622226 72507 68224 54451
1987451 72979 63347 56518
2111991 84274 69588 58753
2791166 110371 74960 60968
1986 3306709 137446 79580 61657
3479675 133716 83929 64376
4064583 146650 89257 67221
5344555 173215 96728 70345
1990 5174990 183924 104286 74640
6755922 219420 110121 76927
7274115 237092 113982 79159
8000785 280339 117284 81334
1994 8105379 258556 121882 83510
11139184 340436 128681 85630
13709459 337265 135381 88475
1997 18272762 390736 142496 90092
- --------
* Source: Ibbotson Assoc., Chi., (annual updates work by Roger G. Ibbotson &
Rex A. Sinquefield).
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The chart is shown for illustrative purposes only and does not represent the
Fund's performance. These returns consist of income and capital appreciation
(or depreciation) and should not be considered an indication or guarantee of
future investment results. Year-to-year fluctuations in certain markets have
been significant, and negative returns have been experienced in certain
markets from time to time. Stocks are measured by the S&P 500 Index, an
unmanaged weighted index comprising 500 widely held common stocks and varying
in composition. Unlike investors in bonds and U.S. Treasury bills, common
stock investors do not receive fixed income payments and are not entitled to
repayment of principal. These differences contribute to investment risk.
Returns shown for long-term government bonds are based on U.S. Treasury bonds
with 20-year maturities. Inflation is measured by the Consumer Price Index.
The indexes are unmanaged and are not available for investment.
Over time, stocks have outperformed all other investments by a wide margin,
offering a solid hedge against inflation. From 1925 to 1997, stocks beat all
other traditional asset classes. A $10,000 investment in the S&P 500 grew to
$18,272,762, significantly more than any other investment.
TAXES
To qualify for treatment as a regulated investment company ("RIC") under the
Internal Revenue Code, the Fund must distribute to its shareholders for each
taxable year at least 90% of its investment company taxable income (consisting
generally of net investment income and net short-term capital gain)
("Distribution Requirement") and must meet several additional requirements.
These requirements include the following: (1) the Fund must derive at least
90% of its gross income each taxable year from dividends, interest, payments
with respect to securities loans and gains from the sale or other disposition
of securities, or other income (including gains from options and futures)
derived with respect to its business of investing in securities ("Income
Requirement"); (2) through the end of its current taxable year the Fund must
derive less than 30% of its gross income from the sale or other disposition of
securities, options or futures that were held for less than three months
("Short-Short Limitation"); (3) at the close of each quarter of the Fund's
taxable year, at least 50% of the value of its total assets must be
represented by cash and cash items, U.S. government securities, securities of
other RICs and other securities, with these other securities limited, in
respect of any one issuer, to an amount that does not exceed 5% of the value
of the Fund's total assets and that does not represent more than 10% of the
issuer's outstanding voting securities; and (4) at the close of each quarter
of the Fund's taxable year, not more than 25% of the value of its total assets
may be invested in securities (other than U.S. government securities or the
securities of other RICs) of any one issuer.
Dividends and other distributions declared by the Fund and payable to
shareholders of record on a date in December of any year will be deemed to
have been paid by the Fund and received by the shareholders on the last day of
that month if the distributions are paid by the Fund during the following
January. Accordingly, those distributions will be taxed to shareholders for
the year in which that December 31 falls.
A portion of the dividends from the Fund's investment company taxable income
(whether paid in cash or additional shares) may be eligible for the dividends-
received deduction allowed to corporations. The eligible portion may not
exceed the aggregate dividends received by the Fund from U.S. corporations.
However, dividends received by a corporate shareholder and deducted by it
pursuant to the dividends-received deduction are subject indirectly to the
alternative minimum tax.
If shares of the Fund are sold at a loss after being held for six months or
less, the loss will be treated as long-term, instead of short-term, capital
loss to the extent of any capital gain distributions received on those shares.
Investors also should be aware that if shares are purchased shortly before the
record date for any dividend or capital gain distribution, the shareholder
will pay full price for the shares and receive some portion of the price back
as a taxable distribution.
The Fund will be subject to a nondeductible 4% excise tax ("Excise Tax") to
the extent it fails to distribute by the end of any calendar year
substantially all of its ordinary income for that year and capital gain net
income for the one-year period ending on October 31 of that year, plus certain
other amounts.
The use of hedging strategies using Derivative Instruments, such as writing
(selling) and purchasing options and futures contracts, involves complex rules
that will determine for income tax purposes the amount, character
24
<PAGE>
and timing of recognition of the gains and losses the Fund realizes in
connection therewith. Gains from options and futures contracts derived by the
Fund with respect to its business of investing in securities will qualify as
permissible income under the Income Requirement. However, income from the
disposition of options and futures will be subject to the Short-Short
Limitation if they are held for less than three months.
If the Fund satisfies certain requirements, any increase in value of a
position that is part of a "designated hedge" will be offset by any decrease
in value (whether realized or not) of the offsetting hedging position during
the period of the hedge for purposes of determining whether the Fund satisfies
the Short-Short Limitation. Thus, only the net gain (if any) from the
designated hedge will be included in gross income for purposes of that
limitation. The Fund will consider whether it should seek to qualify for this
treatment for its hedging transactions. To the extent the Fund does not
qualify for this treatment, it may be forced to defer the closing out of
certain options and futures beyond the time when it otherwise would be
advantageous to do so, in order for the Fund to qualify as a RIC.
Certain options and futures in which the Fund may invest will be "section
1256 contracts." Section 1256 contracts held by the Fund at the end of each
taxable year, other than section 1256 contracts that are part of a "mixed
straddle" with respect to which the Fund has made an election not to have the
following rules apply, must be "marked-to-market" (that is, treated as sold
for their fair market value) for federal income tax purposes, with the result
that unrealized gains or losses will be treated as though they were realized.
Sixty percent of any net gain or loss recognized on these deemed sales, and
60% of any net realized gain or loss from any actual sales of section 1256
contracts, will be treated as long-term capital gain or loss, and the balance
will be treated as short-term capital gain or loss. It is not entirely clear,
as of the date of this Statement of Additional Information, whether that 60%
portion will qualify for the reduced maximum tax rates on non-corporate
taxpayers' net capital gain (the excess of net long-term capital gain over net
short-term capital loss) enacted by the Taxpayer Relief Act of 1997--20% (10%
for taxpayers in the 15% marginal tax bracket) for gain recognized on capital
assets held for more than 18 months--instead of the 28% rate in effect before
that legislation, which now applies to gain recognized on capital assets held
for more than one year but not more than 18 months. However, technical
corrections legislation passed by the House of Representatives late in 1997
would clarify that the lower rates apply. Section 1256 contracts also may be
marked-to-market for purposes of the Excise Tax.
If the Fund has an "appreciated financial position"--generally, an interest
(including an interest through an option or futures contract or short sale)
with respect to any stock, debt instrument (other than "straight debt") or
partnership interest the fair market value of which exceeds its adjusted
basis--and enters into a "constructive sale" of the same or substantially
similar property, the Fund will be treated as having made an actual sale
thereof, with the result that gain will be recognized at that time. A
constructive sale generally consists of a short sale, an offsetting notional
principal contract or futures contract entered into by the Fund or a related
person with respect to the same or substantially similar property. In
addition, if the appreciated financial position is itself a short sale of such
a contract, acquisition of the underlying property or substantially similar
property will be deemed a constructive sale.
OTHER INFORMATION
The Trust is a Delaware business trust. The Trust has authority to issue an
unlimited number of shares of beneficial interest. The board may, without
shareholder approval, divide the authorized shares into an unlimited number of
separate series and may divide the shares of any series into classes, and the
costs of doing so will be borne by the Trust. The Trust currently consist of
one series with two classes of shares.
Although Delaware law statutorily limits the potential liabilities of a
Delaware business trust's shareholders to the same extent as it limits the
potential liabilities of a Delaware corporation, shareholders of the Fund
could, under certain conflicts of laws jurisprudence in various states, be
held personally liable for the obligations of the Trust or the Fund. However,
the Trust's trust instrument disclaims shareholder liability for acts or
obligations of the Trust or its series (the Fund) and requires that notice of
such disclaimer be given in each written obligation
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made or issued by the trustees or by any officers or officer by or on behalf
of the Trust, a series, the trustees or any of them in connection with the
Trust. The trust instrument provides for indemnification from the Fund's
property for all losses and expenses of any series shareholder held personally
liable for the obligations of the Fund. Thus, the risk of a shareholder's
incurring financial loss on account of shareholder liability is limited to
circumstances in which the Fund itself would be unable to meet its
obligations, a possibility which Mitchell Hutchins believes is remote and not
material. Upon payment of any liability incurred by a shareholder solely by
reason of being or having been a shareholder of the Fund, the shareholder
paying such liability will be entitled to reimbursement from the general
assets of the Fund. The trustees intend to conduct the operations of the Fund
in such a way as to avoid, as far as possible, ultimate liability of the
shareholders for liabilities of the Fund.
Shareholders of the Fund are entitled to participate equally in the
dividends and other distributions from, and the proceeds of any liquidation
of, the Fund, except that, due to the differing expenses borne by the classes,
dividends and liquidation proceeds for each class will likely differ. Shares
are fully paid and non-assessable and have no preemptive or other right to
subscribe to any additional shares or other securities issued by the Trust.
Shareholders have non-cumulative voting rights. A shareholder is entitled to
one vote for each full share held and a proportionate fractional vote for each
fractional share held.
CLASS-SPECIFIC EXPENSES. The Fund may determine to allocate certain of its
expenses to the specific classes of the Fund's shares to which those expenses
are attributable.
COUNSEL. The law firm of Kirkpatrick & Lockhart LLP, 1800 Massachusetts
Avenue, N.W., Washington, D.C. 20036-1800, serves as counsel to the Fund.
Kirkpatrick & Lockhart LLP also acts as counsel to PaineWebber and Mitchell
Hutchins in connection with other matters.
AUDITORS. Ernst & Young LLP, 787 Seventh Avenue, New York, New York 10019,
serves as independent auditors for the Fund.
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FINANCIAL STATEMENTS
PAINEWEBBER INDEX TRUST
PAINEWEBBER S&P 500 INDEX FUND
STATEMENT OF ASSETS AND LIABILITIES
OCTOBER 9, 1997
<TABLE>
<S> <C>
ASSETS:
Cash............................................................ $100,000
Deferred organizational expenses................................ 145,000
Prepaid expenses................................................ 90,150
--------
Total assets.................................................. 335,150
--------
LIABILITIES:
Organizational expenses payable................................. 145,000
Payable to adviser.............................................. 90,150
--------
Total liabilities............................................. 235,150
--------
Net Assets (beneficial interest, $0.001 par value, issued and
outstanding)..................................................... $100,000
========
CLASS A:
Net Assets........................................................ $ 50,000
--------
Shares outstanding................................................ 4,000
--------
Net asset value, offering price and redemption value per share.... $ 12.50
========
CLASS Y:
Net Assets........................................................ $ 50,000
--------
Shares outstanding................................................ 4,000
--------
Net asset value, offering price and redemption value per share.... $ 12.50
========
</TABLE>
ORGANIZATION
PaineWebber S&P 500 Index Fund ("Fund") is a diversified series of
PaineWebber Index Trust ("Trust"), an open-end management investment company
organized as a Delaware business trust on May 27, 1997. The Fund has had no
operations other than the sale to Mitchell Hutchins Asset Management
("Mitchell Hutchins"), the investment adviser, a wholly owned subsidiary of
PaineWebber Incorporated ("PaineWebber"), of 4,000 shares of beneficial
interest of Class A for the amount of $50,000, and 4,000 shares of beneficial
interest of Class Y for the amount of $50,000, on October 6, 1997. The Fund
currently offers two classes of shares. Each class is sold without any initial
sales charges, and without any contingent deferred sales charge. Each class
represents assets of the Fund, and the classes are identical except for
differences in ongoing service fees and certain transfer agency expenses. The
trustees of the Trust have authority to issue an unlimited number of shares of
beneficial interest, par value $0.001 per share.
Costs incurred and to be incurred in connection with the organization and
initial registration of the Trust will be paid initially by Mitchell Hutchins;
however, the Trust will reimburse Mitchell Hutchins for such costs. Such
organizational costs, estimated at $145,000, will be deferred and amortized by
the Fund on the straight line method over a period not to exceed 60 months
from the date the Fund commences investment operations.
MANAGEMENT AGREEMENT
Mitchell Hutchins acts as the investment adviser and administrator to the
Fund pursuant to a contract (the "Advisory Contract") with the Trust dated
October 14, 1997. Under the Advisory Contract, the Fund pays Mitchell Hutchins
a fee, computed daily and paid monthly, at an annual rate of 0.20% of average
daily net assets.
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<PAGE>
Through the Fund's first fiscal year ending May 31, 1998, Mitchell Hutchins
has agreed voluntarily to waive its fee and reimburse Fund expenses, if
necessary, so that the total annual operating expenses do not exceed 0.40% of
average annual net assets for Class A shares and 0.35% of average annual net
assets for Class Y shares. Class Y shares are currently offered for sale only
to limited groups of investors.
DISTRIBUTION ARRANGEMENTS
Mitchell Hutchins is the distributor of the Fund's shares and has appointed
PaineWebber as the exclusive dealer for the sale of those shares. There is no
distribution plan with respect to the Fund's Class Y shares. Under the
distribution plan for Class A shares, the Fund pays Mitchell Hutchins monthly
service fees at the annual rate of 0.05% of the average daily net assets of
Class A shares.
28
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Shareholder and Board of Trustees
PaineWebber S&P 500 Index Fund
We have audited the accompany statement of assets and liabilities of the
PaineWebber S&P 500 Index Fund as of October 9, 1997. This statement of assets
and liabilities is the responsibility of the Fund's management. Our
responsibility is to express an opinion on this statement of assets and
liabilities based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether this statement of assets and
liabilities is free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the statement
of assets and liabilities. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall statement of assets and liabilities presentation. We
believe that our audit provides a reasonable basis for our opinion.
In our opinion the statement of assets and liabilities referred to above
presents fairly, in all material respects, the financial position of
PaineWebber S&P 500 Index Fund at October 9, 1997, in conformity with
generally accepted accounting principles.
Ernst & Young LLP
New York, New York
October 9, 1997
29
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NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THE PROSPECTUS OR IN THIS STATEMENT OF
ADDITIONAL INFORMATION IN CONNECTION WITH THE OFFERING MADE BY THE PROSPECTUS
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY THE FUND OR ITS DISTRIBUTOR. THE PROSPECTUS
AND THIS STATEMENT OF ADDITIONAL INFORMATION DO NOT CONSTITUTE AN OFFERING BY
THE FUND OR BY THE DISTRIBUTOR IN ANY JURISDICTION IN WHICH SUCH OFFERING MAY
NOT LAWFULLY BE MADE.
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TABLE OF CONTENTS
<TABLE>
<S> <C>
Investment Policies And Restrictions........................................ 1
Strategies Using Derivative Instruments..................................... 5
Trustees And Officers; Principal Holders Of Securities...................... 10
Investment Advisory And Distribution Arrangements........................... 16
Portfolio Transactions...................................................... 18
Redemption Information And Other Services................................... 19
Valuation Of Shares......................................................... 22
Performance Information..................................................... 22
Taxes....................................................................... 24
Other Information........................................................... 25
Financial Statements........................................................ 27
</TABLE>
(C)1998 PaineWebber Incorporated
PAINEWEBBER
S&P 500 INDEX FUND
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STATEMENT OF ADDITIONAL INFORMATION
NOVEMBER 1, 1997, AS
REVISED JANUARY 21, 1998
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[LOGO OF PAINEWEBBER APPEARS HERE]
