As filed with the Securities and Exchange Commission on June 6, 1997
1940 Act Registration No. 811-8243
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X]
Pre-Effective Amendment No.
Post-Effective Amendment No.
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [X]
Amendment No.
POTOMAC FUNDS
(Exact name of registrant as specified in charter)
550 Mamaroneck Avenue
Harrison, New York 10528
(Address of principal executive offices)
Registrant's telephone number, including area code: (914) 381-2080
Thomas A. Mulrooney
550 Mamaroneck Avenue
Harrison, New York 10528
(Name and address of agent for service)
Copies to:
Robert J. Zutz, Esq.
Kirkpatrick & Lockhart LLP
1800 Massachusetts Avenue, N.W., 2nd Floor
Washington, D.C. 20036-1800
Telephone: (202) 778-9000
Approximate Date of Proposed Public Offering: As soon as practicable after the
effective date of this Registration Statement.
Pursuant to Rule 24f-2 under the Investment Company Act of 1940, as amended, an
indefinite number of shares of beneficial interest, no par value, is being
registered by this Registration Statement under the Securities Act of 1933, as
amended.
Registrant hereby amends this Registration Statement on such date or dates as
may be necessary to delay its effective date until the Registrant shall file a
further amendment which specifically states that this Registration Statement
shall thereafter become effective in accordance with Section 8(a) of the
Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to Section 8(a), may
determine.
Page 1 of _____ Pages
Exhibit Index Appears on Page____
<PAGE>
POTOMAC FUNDS
CONTENTS OF REGISTRATION STATEMENT
This registration document is comprised of the following:
Cover Sheet
Contents of Registration Statement
Cross Reference Sheet
Prospectus
Statement of Additional Information
Part C of Form N-1A
Signature Page
Exhibits
<PAGE>
POTOMAC FUNDS
FORM N-1A CROSS-REFERENCE SHEET
PART A ITEM NO. AND CAPTION PROSPECTUS CAPTION
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1. Cover Page Cover Page
2. Synopsis Prospectus Summary; Fees and
Expenses of the Funds
3. Condensed Financial Information Not Applicable
4. General Description of Registrant Cover Page; Prospectus Summary;
Investment Objectives and Policies;
Special Risk Considerations;
Investment Techniques and Other
Investment Policies; General
Information About the Trust
5. Management of the Fund Management and Administration of
the Trust
5A. Management's Discussion of Fund Not Applicable
Performance
6. Capital Stock and other Securities Determination of Net Asset Value;
Dividends and Distributions; Taxes
7. Purchase of Securities Being How to Invest in the Funds; Tax-
Offered Sheltered Retirement Plans;
Portfolio Transactions and
Brokerage
8. Redemption or Repurchase Redeeming Shares (Withdrawals);
Exchanges; Procedures for
Redemptions and Exchanges
9. Pending Legal Proceedings Not Applicable
STATEMENT OF ADDITIONAL
PART B ITEM NO. AND CAPTION INFORMATION CAPTION
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10. Cover Page Cover Page
11. Table of Contents Table of Contents
12. General Information and History The Potomac Funds
13. Investment Objectives and Investment Policies and Techniques;
Policies Investment Restrictions
14. Management of the Registrant Management of the Trust
15. Control Persons and Principal Principal Holders of Securities
Holders of Securities
<PAGE>
16. Investment Advisory and Other Management of the Trust -
Services Investment Adviser; Fund
Administrator, Shareholder
Servicing Agent and Transfer Agent;
Auditors and Custodian
17. Brokerage Allocation and Other Portfolio Transactions and
Provisions Brokerage
18. Capital Stock and Other The Potomac Funds; Principal
Securities Holders of Securities
19. Purchase, Redemption and Determination of Net Asset Value;
Pricing of of Securities Being Dividends and Other Distributions
Offered
20. Tax Status Taxes
21. Underwriters Management of the Trust -
Distributor
22. Calculation of Performance Data Performance Information
23. Financial Statements Not Applicable
PART C. OTHER INFORMATION
-----------------
Information required to be included in Part C is set forth under the
appropriate item, so numbered, in Part C of this Registration Statement.
<PAGE>
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED __________ __, 1997
Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor may
offers to buy be accepted prior to the time the registration statement becomes
effective. This Prospectus shall not constitute an offer to sell or the
solicitation of an offer to buy nor shall there be any sale of these securities
in any State in which such offer, solicitation or sale would be unlawful prior
to registration or qualification under the securities laws of any such State.
POTOMAC FUNDS
PROSPECTUS
550 Mamaroneck Avenue
Harrison, NY 10528
(800)XXX-XXXX (914)XXX-XXXX
The Potomac Funds (the "Trust") is a no-load management investment company, or
mutual fund, which consists of seven separate investment portfolios (the
"Funds"). The Funds are principally designed for experienced investors who
intend to follow a global asset allocation strategy. An important feature of the
Trust is that it primarily consists of pairs of Funds, one of which attempts to
provide results correlating to a specific index, while the other attempts to
provide inverse performance that is similar to a short position in the specific
index. In particular, the following Funds seek investment results that
correspond over time to the following benchmarks:
<TABLE>
<CAPTION>
FUND BENCHMARK
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<S> <C>
Potomac Japan/Long Fund Nikkei 225 Stock Average
Potomac Japan/Short Fund Inverse (opposite) of the Nikkei 225 Stock Average
Potomac U.S. Plus Fund 150% of the performance of the Standard & Poor's 500 Composite Stock Price Index(TRADEMARK)
Potomac U.S./Short Fund Inverse (opposite) of the Standard & Poor's 500 Composite Stock Price Index(TRADEMARK)
Potomac OTC Plus Fund 125% of the performance Nasdaq 100 Index(TRADEMARK)
Potomac OTC/Short Fund Inverse (opposite) of the Nasdaq 100 Index(TRADEMARK)
</TABLE>
The Trust also offers the Potomac U.S. Government Money Market Fund, which seeks
security of principal, current income and liquidity by investing primarily in
money market instruments issued or guaranteed, as to principal and interest, by
the U.S. Government, its agencies or instrumentalities. THIS FUND SEEKS TO
MAINTAIN A CONSTANT $1.00 NET ASSET VALUE PER SHARE, ALTHOUGH THIS CANNOT BE
ASSURED.
The Funds (other than the Potomac U.S. Government Money Market Fund) may engage
in certain aggressive investment techniques, which include engaging in short
sales and transactions in options and futures contracts. The Potomac U.S. Plus
Fund and the Potomac OTC Plus Fund may use the speculative technique known as
leverage to increase funds available for investment. See "Other Investment
Policies." Investors in the Potomac Japan/Long Fund, Potomac U.S. Plus Fund and
Potomac OTC Plus Fund may experience substantial losses during sustained periods
of falling equity prices. Investors in the Potomac Japan/Short Fund, Potomac
U.S./Short Fund and Potomac OTC/Short Fund may experience substantial losses
during periods of sustained periods of rising equity prices. None of the Funds
alone constitutes a balanced investment plan, and investments in certain of the
Funds involve special risks not traditionally associated with investment
companies, including significant portfolio turnover. SHARES OF THE POTOMAC U.S.
GOVERNMENT MONEY MARKET FUND ARE NOT DEPOSITS OR OBLIGATIONS, OR GUARANTEED OR
ENDORSED BY, THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE
<PAGE>
BOARD OR ANY OTHER AGENCY. AN INVESTMENT IN THIS FUND IS NEITHER INSURED NOR
GUARANTEED BY THE UNITED STATES GOVERNMENT. See "Special Risk Considerations."
There can be no assurance that a Fund will achieve its investment objective.
Investors should read this Prospectus and retain it for future reference. This
Prospectus is designed to set forth concisely the information an investor should
know about the Trust before investing. A Statement of Additional Information
("SAI"), dated ______ __, 1997, containing additional information about the
Trust, has been filed with the Securities and Exchange Commission ("SEC") and is
incorporated herein by reference. A copy of the SAI is available, without
charge, upon request to the Trust at the address or telephone numbers above.
The SEC maintains a Web site (http://www.sec.gov) that contains the SAI,
material incorporated by reference and other information regarding the Funds.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
Prospectus dated ______ __, 1997
- 2 -
<PAGE>
TABLE OF CONTENTS
Page
----
PROSPECTUS SUMMARY
FEES AND EXPENSES OF THE FUNDS
INVESTMENT OBJECTIVES AND POLICIES
SPECIAL RISK CONSIDERATIONS
INVESTMENT TECHNIQUES AND OTHER
INVESTMENT POLICIES
PORTFOLIO TRANSACTIONS AND BROKERAGE
HOW TO INVEST IN THE FUNDS
TAX-SHELTERED RETIREMENT PLANS
REDEEMING SHARES (WITHDRAWALS)
EXCHANGES
PROCEDURES FOR REDEMPTIONS AND
EXCHANGES
DETERMINATION OF NET ASSET VALUE
PERFORMANCE INFORMATION
DIVIDENDS AND OTHER DISTRIBUTIONS
TAXES
MANAGEMENT AND ADMINISTRATION OF THE TRUST
GENERAL INFORMATION ABOUT THE TRUST
- 3 -
<PAGE>
PROSPECTUS SUMMARY
THE POTOMAC FUNDS
Each Fund has its own distinct investment objective. There is no guarantee that
any Fund will achieve its investment objective. The investment objectives of the
Funds are as follows.
The POTOMAC JAPAN/LONG FUND ("Japan/Long Fund") seeks to provide investment
returns that correspond to the Nikkei 225 Stock Average ("Nikkei Index"). The
Nikkei Index is a price-weighted index of the 225 largest Japanese companies
listed on the Tokyo Stock Exchange. In attempting to achieve its objective, the
Fund may invest in securities included in that index and may enter into long
positions in Nikkei Index futures contracts, options on such futures contracts
and options on securities and on the Nikkei Index traded on foreign and domestic
exchanges. In addition, the Fund will use forward contracts on Japanese Yen,
futures contracts on Japanese Yen, options on such futures contracts, and
options on Japanese Yen to attempt to eliminate the effect that fluctuations in
the U.S. Dollar/Japanese Yen exchange rate may have on the Fund's net asset
value per share. The Fund also will invest in debt securities.
The POTOMAC JAPAN/SHORT FUND ("Japan/Short Fund") seeks to provide investment
returns that inversely correlate to the performance of the Nikkei Index. If the
Fund is successful in achieving its objective, the net asset value of the Fund
will increase in direct proportion to any decrease in the level of the Nikkei
Index and, conversely, the net asset value of the Fund will decrease in direct
proportion to any increase in the Nikkei Index. In attempting to achieve its
objective, the Fund may enter into short positions in Nikkei Index futures
contracts, options on such futures contracts and options on securities and on
the Nikkei Index traded on foreign and domestic exchanges. In addition, the Fund
will use forward contracts on Japanese Yen, futures contracts on Japanese Yen,
options on such futures contracts, and options on Japanese Yen to attempt to
eliminate the effect that fluctuations in the U.S. Dollar/Japanese Yen exchange
rate may have on the Fund's net asset value per share. The Fund involves special
risks not traditionally associated with investment companies. Investors in this
Fund may experience substantial losses during sustained periods of rising
Japanese equity prices. The Fund also will invest in debt securities.
The POTOMAC U.S. PLUS FUND ("U.S. Plus Fund") seeks to provide investment
returns that correspond to 150% of the performance of the Standard & Poor's 500
Composite Stock Price Index TM (the "S&P 500 Index"). In attempting to achieve
its objective, the Fund may invest in securities included in that index and may
enter into long positions in stock index futures contracts, options on stock
index futures contracts and options on securities and on stock indices. In
contrast to the returns of a mutual fund that seeks to approximate the return of
the S&P 500 Index, the Fund may produce gains greater than that return during
periods when the prices of securities included in the S&P 500 Index are rising
and below that return during periods when such prices are declining. Investors
in the Fund may experience substantial losses during sustained periods of
falling U.S. equity prices. The Fund also will invest in debt securities.
The POTOMAC U.S./SHORT FUND ("U.S./Short Fund") seeks to provide investment
returns that inversely correlate to the performance of the S&P 500 Index. If the
Fund is successful in meeting its objective, the Fund's net asset value per
share will increase in direct proportion to any decrease in the level of the S&P
- 4 -
<PAGE>
500 Index and, conversely, the net asset value of the Fund will decrease in
direct proportion to any increase in the level of the S&P 500 Index. In seeking
to achieve its objective, the Fund may enter into positions in stock index
futures contracts, options on stock index futures contracts and options on
securities and on stock indices. The Fund involves special risks not
traditionally associated with investment companies. Investors in the Fund may
experience substantial losses during sustained periods of rising U.S. equity
prices. The Fund also will invest in debt securities.
The POTOMAC OTC PLUS FUND ("OTC Plus Fund") seeks to provide investment returns
that correspond to 125% of the performance of the Nasdaq 100 IndexTM ("Nasdaq
Index"). The Fund will invest in the securities included in that index, as well
as enter into long positions in stock index futures contracts, options on such
index futures contracts and options on securities and on stock indices. In
contrast to the returns of a mutual fund that seeks to approximate the return of
the Nasdaq Index, the Fund may produce gains greater than that return during
periods when prices of securities in the Nasdaq Index are rising and below that
return during periods when such prices are declining. Investors in the Fund may
experience substantial losses during sustained periods of falling U.S. equity
prices. The Fund also will invest in debt securities.
The POTOMAC OTC/SHORT FUND ("OTC/Short Fund") seeks to provide investment
results that will inversely correlate to the performance of Nasdaq Index. If the
Fund is successful in meeting its objective, the Fund's net asset value per
share will increase in direct proportion to any decrease in the level of the
Nasdaq Index and, conversely, the net asset value of the Fund will decrease in
direct proportion to any increase in the level of the Nasdaq Index. In seeking
to achieve its objective, the Fund may enter into short positions in stock index
futures contracts, options on stock index futures contracts, and options on
securities and on stock indices. The Fund involves risks not traditionally
associated with investment companies. Investors in the Fund may experience
substantial losses during sustained periods of rising U.S. equity prices. The
Fund also will invest in debt securities.
The POTOMAC U.S. GOVERNMENT MONEY MARKET FUND ("Money Market Fund") seeks to
provide security of principal, current income and liquidity. To achieve its
objective, the Money Market Fund invests primarily in money market instruments
that are issued or guaranteed as to principal and interest by the U.S.
Government, its agencies or instrumentalities, as well as in repurchase
agreements collateralized fully by U.S. Government securities.
Further discussion of each Fund's investment objective and policies and the
risks associated with investing in the Funds may be found under "Investment
Objectives and Policies," "Special Risk Considerations" and "Investment
Techniques and Other Investment Policies" below.
SPECIAL RISK CONSIDERATIONS
Each Fund (except the Money Market Fund) may engage in certain aggressive
investment techniques, which may include engaging in short sales and
transactions in futures contracts and options on securities, stock indices and
futures contracts. As discussed more fully under "Investment Objectives and
Policies," "Investment Techniques and Other Investment Policies" and "Special
Risk Considerations," these techniques are specialized and involve risks not
traditionally associated with investment companies.
The Trust expects that a substantial number of the Funds' investors will be
experienced and will invest in the Funds as part of an asset allocation
- 5 -
<PAGE>
investment strategy. These shareholders likely will redeem or exchange their
Fund shares frequently to take advantage of anticipated changes in market
conditions. The strategies employed by investors in the Funds may result in
considerable assets moving in and out of the Funds and, consequently, a high
portfolio turnover rate. A high portfolio turnover rate (1) generally causes the
Funds to incur higher expenses and additional costs, (2) may adversely affect
the ability of the Funds to meet their investment objectives and (3) increases
the risk that a Fund will not qualify as a regulated investment company ("RIC")
under Subchapter M of the Internal Revenue Code of 1986, as amended ("Code"). In
addition, the investment by a Fund (other than the Money Market Fund) primarily
in options and futures positions also entails some risk that a Fund might fail
to satisfy the diversification requirements applicable to RICs. Failure to
qualify as a RIC likely would subject a Fund to substantial additional Federal
income taxes. For further information concerning the portfolio turnover rate of
the Funds and the Federal income tax treatment of the Funds, see "Investment
Objectives and Policies" and "Taxes" below.
Investors in the Japan/Long Fund and the Japan/Short Fund should be able to
assume the special risks of investing in foreign securities, which include
possible adverse political and economic developments abroad, fluctuations in
foreign currency values and differing characteristics of foreign economies and
markets.
The U.S. Plus Fund and the OTC Plus Fund may borrow money from banks for
investment purposes, which is a form of leveraging. This leverage may exaggerate
the gains and losses on a Fund's investments and the changes in a Fund's net
asset value per share. Each Fund may borrow money for temporary or emergency
purposes and to meet redemption requests without immediately selling portfolio
securities.
While the Funds do not expect their returns over a twelve-month period to
deviate adversely from their respective current benchmarks by more than 10%,
certain factors may affect each Fund's ability to achieve this correlation.
Under certain circumstances, trading on an exchange may be halted or closed
early, resulting in a Fund being unable to execute buy or sell orders that day.
If that occurs and a Fund needs to execute a high volume of trades on that
trading day, a Fund may incur substantial trading losses.
PURCHASES, REDEMPTIONS, AND EXCHANGES OF TRUST SHARES
The minimum initial investment is $10,000, which can be allocated in any amounts
among the Funds. The shares of each Fund may be purchased and redeemed without
any sales or redemption charges at the net asset value of the Fund next
determined. Exchanges must be for at least the lesser or $1,000 or the entire
account balance for the Fund from which the exchange is made. Shares of any Fund
may be exchanged at any time for shares of any other Fund, on the basis of the
relative net asset values next computed, without charge. Because of the
administrative expense of handling small accounts, the Trust reserves the right
to redeem involuntarily an investor's account, including a retirement account,
that falls below the minimum investment of $10,000 in total value in the Trust
due to redemptions. The Trust reserves the right to modify its minimum
investment requirements and the corresponding amounts below which an involuntary
redemption may be effected. See "How to Invest in the Funds," "Redeeming Shares
(Withdrawals)" and "Exchanges."
- 6 -
<PAGE>
INVESTMENT ADVISER
Rafferty Asset Management LLC ("Adviser") serves as the investment adviser to
each Fund. The Adviser is a newly created investment adviser and has had no
previous experience advising investment companies. The Adviser is a subsidiary
of Cohane-Rafferty Securities, Inc., which is located in Harrison, New York.
FEES AND EXPENSES OF THE FUNDS
Shown below are all expenses expected to be incurred by each Fund during its
initial fiscal year. Because each Fund's shares were not offered for sale prior
to the date of this Prospectus, annual operating expenses are based on estimated
expenses.
Annual Fund Operating Expenses
------------------------------
Total Fund
Management Other Operating
Fees 12b-1 Fees Expenses Expenses
---- ---------- -------- --------
Japan/Long Fund 0.75% None 0.75% 1.50%
Japan/Short Fund 0.90 None 0.75 1.65
U.S. Plus Fund 0.75 None 0.75 1.50
U.S./Short Fund 0.90 None 0.75 1.65
OTC Plus Fund 0.75 None 0.75 1.50
OTC/Short Fund 0.90 None 0.75 1.65
Money Market Fund 0.50 None 0.50 1.00
___________
+ The Funds have adopted a Rule 12b-1 Distribution Plan; however, the Board
of Trustees has not authorized payment of any fees pursuant to such Plan.
See "Distribution of Fund Shares" below.
* Each retirement plan account is charged an annual $___ maintenance fee. See
"Tax-Sheltered Retirement Plans."
EXAMPLE
Assuming hypothetical investments of $1,000 in each Fund, a 5% annual return,
and redemption at the end of each time period, an investor in each Fund would
pay transaction and operating expenses at the end of each year as follows:
1 Year 3 Years
------ -------
Japan/Long Fund $15 $47
Japan/Short Fund $17 $52
U.S. Plus Fund $15 $47
U.S./Short Fund $17 $52
OTC Plus Fund $15 $47
OTC/Short Fund $17 $52
Money Market Fund $10 $32
- 7 -
<PAGE>
The preceding table of fees and expenses is provided to assist investors in
understanding the various costs and expenses that may be borne directly or
indirectly by an investor in each of the Funds. The 5% assumed annual return is
for comparison purposes only. THE FOREGOING EXAMPLES SHOULD NOT BE CONSIDERED A
REPRESENTATION OF FUTURE EXPENSES OR PERFORMANCE. ACTUAL EXPENSES MAY BE GREATER
OR LESS THAN THOSE SHOWN AND PERFORMANCE MAY BE BETTER OR WORSE THAN THE 5%
ANNUAL RETURN ASSUMED IN THE EXAMPLES. For additional information about the
Funds' fees, see "Management of the Trust" in this Prospectus and in the SAI.
INVESTMENT OBJECTIVES AND POLICIES
General
- -------
The Funds are principally designed for experienced investors who intend to
follow an asset allocation investment strategy. Except for the Money Market
Fund, each Fund is intended to provide investment exposure to a particular
segment of the domestic or international securities markets. These Funds seek
investment results that correspond over time to a specified benchmark. The Funds
may be used independently or in combination with each other as part of an
overall investment strategy. Additional funds may be offered by the Trust from
time to time.
The Adviser uses a number of investment techniques in an effort to correlate a
Fund's return with the return of its respective benchmark. The Adviser generally
does not use fundamental securities analysis to accomplish such correlation.
Rather, the Adviser primarily uses statistical and quantitative analysis to
determine the investments a Fund makes and techniques it employs. While the
Adviser attempts to minimize any "tracking error" (the statistical measure of
the difference between the investment results of a Fund and the performance of
its benchmark), certain factors (including a Fund's investment in U.S.
Government Securities) will tend to cause a Fund's investment results to vary
from a perfect correlation to its benchmark. The Funds, however, do not expect
that their total returns will vary from their respective current benchmarks by
more than 10% over a twelve-month period. See "Special Risk Considerations." It
is the Funds' policy to pursue their respective investment objectives regardless
of market conditions, to remain fully invested and not to take defensive
positions.
Each Fund's investment objective and certain investment restrictions are
fundamental policies and may not be changed without the affirmative vote of at
least the majority of the outstanding shares of that Fund, as defined in the
Investment Company Act of 1940, as amended (the "1940 Act"). All other
investment policies of the Funds not specified as fundamental may be changed by
the Board of Trustees of the Trust ("Trustees" or the "Board") without
shareholder approval. There can be no assurance that a Fund will achieve its
objective.
The Potomac Japan/Long Fund
- ---------------------------
The investment objective of the Japan/Long Fund is to provide investment returns
that correspond to the performance of the Nikkei Index. In attempting to achieve
its objective, the Fund may enter into long positions in Nikkei Index futures
contracts, options on such futures contracts and options on securities and on
the Nikkei Index traded on domestic and foreign exchanges. Under the investment
techniques that the Fund employs, the Fund generally will incur a loss if the
price of the underlying security or index decreases between the date of the
employment of the technique and the date on which it terminates the position.
- 8 -
<PAGE>
The amount of any gain or loss on these transactions may be affected by any
premium or interest income the Fund pays or receives as a result of the
transaction. The Fund may invest in the shares of individual securities that are
included in its benchmark. The Fund will use forward contracts on Japanese Yen,
futures contracts on Japanese Yen, options on such futures contracts and options
on Japanese Yen to attempt to eliminate the effect that fluctuations in the U.S.
Dollar/Japanese Yen exchange rate may have on the Fund's net asset value per
share. The Fund also may invest in U.S. Government securities in order to
deposit such securities as initial or variation margin, as "cover" for the
investment techniques it employs, as part of a cash reserve and for liquidity
purposes. See "Investment Techniques and Other Investment Policies."
The Potomac Japan/Short Fund
- ----------------------------
The Japan/Short Fund is intended to allow investors to benefit from anticipated
decreases in the Nikkei Index or to hedge an existing portfolio of Japanese
stocks. The Fund's investment objective is to provide investment results that
will inversely correlate to the performance of the Nikkei Index.
If the Fund achieves a perfect inverse correlation for any single trading day,
the Fund's net asset value per share would increase for that day in direct
proportion to any decrease in the level of the Nikkei Index and, conversely, the
Fund's net asset value per share would decrease for that day in direct
proportion to any increase in the level of the Nikkei Index. For example, if the
Nikkei Index were to decrease by 1% by the close of business on a particular
trading day, investors in the Fund should experience a gain in net asset value
of approximately 1% for that day. Conversely, if the Nikkei Index were to
increase by 1% by the close of business on a particular trading day, investors
in the Fund should experience a loss in net asset value of approximately 1% for
that day.
The Fund intends to pursue its investment objective regardless of market
conditions and does not intend to take defensive positions in anticipation of
rising Japanese equity prices. Consequently, investors in the Fund may
experience substantial losses during sustained periods of rising Japanese equity
prices.
In pursuing its investment objective, the Fund generally does not invest in
traditional equity securities, such as common stock. Rather, the Fund employs
certain investment techniques, including engaging in short sales and entering
into short positions in Nikkei Index futures contracts, options on such futures
contracts, and options on securities and on the Nikkei Index. See "Investment
Techniques and Other Investment Policies." Under these techniques, the Fund
generally will incur a loss if the price of the underlying security or index
increases between the date the Fund initially entered into the transaction and
the date on which the Fund terminates its position. The Fund generally will
realize a gain if the underlying security or index declines in price between
those dates. This result is the opposite of what one would expect from a cash
purchase of a long position in a security. In addition, the Fund will use
forward contracts on Japanese Yen, futures contracts on Japanese Yen, options on
such futures contracts and options on Japanese Yen to attempt to eliminate the
effect that fluctuations in the U.S. Dollar/Japanese Yen exchange rate may have
on the Fund's net asset value per share. The Fund also may invest in U.S.
Government securities in order to deposit such securities as initial or
variation margin, as "cover" for the investment techniques it employs, as part
of a cash reserve and for liquidity purposes. - 9 -
<PAGE>
The Potomac U.S. Plus Fund
- --------------------------
The investment objective of the U.S. Plus Fund is to provide investment returns
that correspond to 150% of the performance of the S&P 500 Index. In attempting
to achieve its objective, the Fund may enter into long positions in stock index
futures contracts, options on stock index futures contracts, and options on
securities and on stock indices. Under these techniques, the Fund generally will
incur a loss if the price of the underlying security or index decreases between
the date the Fund initially entered into the transaction and the date on which
the Fund terminates its position. The Fund also may invest in shares of
individual stocks that are included in its benchmark. The Fund also may invest
in U.S. Government securities in order to deposit such securities as initial or
variation margin, as "cover" for the investment techniques it employs, as part
of a cash reserve and for liquidity purposes. See "Investment Techniques and
Other Investment Policies."
In contrast to a mutual fund that seeks to approximate the return of the S&P 500
Index, the Fund will attempt to increase returns to investors during periods
when the prices of the securities in the S&P 500 Index are rising and decrease
returns to investors during periods when the price of securities are declining.
Investors in the Fund may experience substantial losses during sustained periods
of falling U.S. equity prices.
The Potomac U.S./Short Fund
- ---------------------------
The U.S./Short Fund is intended to allow investors to benefit from anticipated
decreases in the S&P 500 Index or hedge an existing portfolio of U.S. securities
or mutual fund shares. The Fund's investment objective is to provide investment
results that will inversely correlate to the performance of the S&P 500 Index.
If the Fund achieves a perfect inverse correlation for any single trading day,
the net asset value of the Fund would increase for that day in direct proportion
to any decrease in the level of the S&P 500 Index and, conversely, the net asset
value of the Fund would decrease for that day in direct proportion to any
increase in the level of the S&P 500 Index. For example, if the S&P 500 Index
were to decrease by 1% by the close of business on a particular trading day,
investors in the Fund should experience a gain in net asset value of
approximately 1% for that day. Conversely, if the S&P 500 Index were to increase
by 1% by the close of business on a particular trading day, investors in the
Fund should experience a loss in net asset value of approximately 1% for that
day.
The Fund intends to pursue its investment objective regardless of market
conditions and does not intend to take defensive positions in anticipation of
rising U.S. equity prices. Consequently, investors in the Fund may experience
substantial losses during sustained periods of rising U.S. equity prices.
In pursuing its investment objective, the Fund generally does not invest in
traditional equity securities, such as common stock. Rather, the Fund employs
certain investment techniques, including engaging in short sales and entering
into short positions in stock index futures contracts, options on stock index
futures contracts, and options on securities and on indices. See "Investment
Techniques and Other Investment Policies." Under these techniques, the Fund
- 10 -
<PAGE>
generally will incur a loss if the price of the underlying security or index
increases between the date the Fund initially entered into the transaction and
the date on which the Fund terminates its position. The Fund generally will
realize a gain if the underlying security or index declines in price between
those dates. This result is the opposite of what one would expect from a cash
purchase of a long position in a security. The Fund also may invest in U.S.
Government securities in order to deposit such securities as initial or
variation margin, as "cover" for the investment techniques it employs, as part
of a cash reserve and for liquidity purposes.
The Potomac OTC Plus Fund
- -------------------------
The investment objective of the OTC Plus Fund is to provide investment results
that correspond to 125% of the performance of the Nasdaq Index. The Fund may not
necessarily hold all 100 stocks included in the Nasdaq Index. Instead, the Fund
intends to hold representative stocks included in that index or other securities
that the Adviser believes will provide returns that correspond to those of the
Nasdaq Index. The Fund may enter into long positions in stock index futures
contracts, options on stock index futures, and options on securities and on
stock indices. The Fund also may invest in U.S. Government securities in order
to deposit such securities as initial or variation margin, as "cover" for the
investment techniques it employs, as part of a cash reserve and for liquidity
purposes.
Companies whose securities are traded on the over-the-counter ("OTC") markets,
which include the Nasdaq Stock Market ("Nasdaq"), generally are newer companies
or have smaller market-capitalization than those listed on the New York Stock
Exchange ("NYSE") or the American Stock Exchange ("AMEX"). OTC companies often
have limited product lines, or relatively new products or services, and may lack
established markets, experienced management, financial resources or the ability
to raise capital. In addition, the securities of these companies may have
limited marketability and may be more volatile in price than securities of
larger capitalized and widely recognized companies. Among the reasons for the
greater price volatility of securities of certain small OTC companies are less
certain growth prospects of comparably smaller firms, the lower degree of
liquidity in the OTC markets for such securities and the greater sensitivity of
smaller capitalized companies to changing economic conditions than larger
capitalized, exchange-traded stocks. Conversely, the Adviser believes that,
because many of these OTC securities may be overlooked by investors and
undervalued in the marketplace, there is potential for significant capital
appreciation.
In contrast to the returns of a mutual fund that seeks to approximate the return
of the Nasdaq Index, the Fund may produce greater gains than that return during
periods when the prices of the securities included in the Nasdaq Index are
rising and below that return during periods when they are declining. Investors
in the Fund may experience substantial losses during sustained periods of
falling U.S. equity prices.
The Potomac OTC/Short Fund
- --------------------------
The OTC/Short Fund is intended to allow investors to benefit from anticipated
decreases in the Nasdaq Index or hedge an existing portfolio of U.S. securities
or mutual fund shares. The Fund's investment objective is to provide investment
results that will inversely correlate to the performance of the Nasdaq Index.
- 11 -
<PAGE>
If the Fund achieves a perfect inverse correlation for any single trading day,
the net asset value of the Fund would increase for that day in direct proportion
to any decrease in the level of the Nasdaq Index and, conversely, the net asset
value of the shares of the Fund would decrease for that day in direct proportion
to any increase in the level of the Nasdaq Index. For example, if the Nasdaq
Index were to decrease by 1% by the close of business on a particular trading
day, investors in the Fund should experience a gain in net asset value of
approximately 1% for that day. Conversely, if the Nasdaq Index were to increase
by 1% by the close of business on a particular trading day, investors in the
Fund should experience a loss in net asset value of approximately 1% for that
day.
The Fund intends to pursue its investment objective regardless of market
conditions and does not intend to take defensive positions in anticipation of
rising U.S. equity prices. Consequently, investors in the Fund may experience
substantial losses during sustained periods of rising equity prices.
In pursuing its investment objective, the Fund generally does not invest in
traditional equity securities, such as common stock. Rather, the Fund employs
certain investment techniques, including engaging in short sales and entering
into short positions in stock index futures contracts, options on stock index
futures contracts, and options on securities and on indices. See "Investment
Techniques and Other Investment Policies." Under these transactions, the Fund
generally will incur a loss if the price of the underlying security or index
increases between the date the Fund initially entered into the transaction and
the date on which the Fund terminates its position. The Fund generally will
realize a gain if the underlying security or index declines in price between
those dates. This result is the opposite of what one would expect from a cash
purchase of a long position in a security. The Fund also may invest in U.S.
Government securities in order to deposit such securities as initial or
variation margin, as "cover" for the investment techniques it employs, as part
of a cash reserve and for liquidity purposes.
The Potomac U.S. Government Money Market Fund
- ---------------------------------------------
The investment objectives of the Money Market Fund are to provide security of
principal, current income, and liquidity. The Fund seeks to achieve these
objectives by investing in high quality, U.S. dollar-denominated short-term
obligations that have been determined by the Adviser or the Trustees to present
minimal credit risk. The Fund will invest exclusively in (1) obligations issued
or guaranteed by the U.S. Government, its agencies or instrumentalities ("U.S.
Government Securities"), (2) certificates of deposit, time deposits, bankers'
acceptances, commercial paper, bank deposit notes and other promissory notes,
including floating or variable rate obligations issued by U.S. bank holding
companies and their bank subsidiaries, and (3) repurchase agreements that are
fully collateralized by the obligations listed above.
The Benchmarks
- --------------
THE NIKKEI 225 STOCK AVERAGE. The Nikkei Index is a price-weighted index of 225
top-rated Japanese companies listed in the First Section of the Tokyo Stock
Exchange. The Nikkei Index was first published in 1949.
- 12 -
<PAGE>
STANDARD & POOR'S 500 COMPOSITE STOCK PRICE INDEX. Standard & Poor's
Corporation, a division of The McGraw-Hill Companies, Inc. ("Standard &
Poor's"), selects the 500 stocks comprising the S&P 500 Index on the basis of
market values and industry diversification. Most of the stocks in the S&P 500
Index are issued by the 500 largest companies, in terms of the aggregate market
value of their outstanding stock, and generally are listed on the NYSE. Standard
& Poor's is not a sponsor of, or in any way affiliated with, the Funds.
NASDAQ 100 INDEX.[TRADEMARK] The Nasdaq Index is a capitalization-weighted index
composed of 100 of the largest non-financial stocks listed on the Nasdaq. The
Index was created in 1985.
SPECIAL RISK CONSIDERATIONS
Investors should consider the following special notes in determining the
appropriateness of investing in the Funds.
AGGRESSIVE INVESTMENT TECHNIQUES. Each Fund (other than the Money Market Fund)
may engage in certain aggressive investment techniques that may include engaging
in short sales and transactions in futures contracts and options on securities,
securities indices, and futures contracts. The Japan/Long Fund, the Japan/Short
Fund, the U.S. Plus Fund, the U.S./Short Fund and the OTC/Short Fund will use
these techniques primarily in seeking to achieve their investment objectives.
The OTC Plus Fund also will use these techniques in seeking to achieve its
investment objective. In doing so, a significant portion of these Funds' assets
will be held in an account consisting of cash or liquid assets as "cover" for
these investment techniques.
The use of options, futures contracts, options on futures contracts, forward
contracts, swaps, caps, floors and collars, and the investment in indexed
securities, involve special risks, including (1) imperfect or no correlation
between the price of options and futures contracts and the movements in the
price of the underlying securities, indices, or futures contracts, (2) possible
lack of a liquid secondary market for any particular instrument at a particular
time, (3) the fact that the skills needed to use these strategies are different
from those needed to select portfolio securities, (4) losses due to
unanticipated market price movements, (5) incorrect forecasts by the Adviser
concerning interest or currency exchange rates or direction of price
fluctuations of the investment involved in the transaction, which may result in
the strategy being ineffective, (6) loss of premiums paid by a Fund on options
it purchases, and (7) the possible inability of a Fund to purchase or sell a
portfolio security at a time when it would otherwise be favorable for it to do
so, or the possible need for a Fund to sell a portfolio security at a
disadvantageous time, due to the need for the Fund to maintain "cover" or to
segregate assets in connection with such transactions and the possible inability
of a Fund to close out or liquidate its position.
These instruments may increase the volatility of a Fund and may involve a small
investment of cash relative to the magnitude of the risk assumed. In addition,
these instruments could result in a loss if the counterparty to the transaction
does not perform as promised or if there is not a liquid secondary market to
close out a position that a Fund has entered into.
The ordinary spreads between prices in the cash and futures markets, due to the
differences in the natures of those markets, are subject to distortion. Due to
- 13 -
<PAGE>
the possibility of distortion, a correct forecast of general interest rate,
currency exchange rate or stock market trends by the Adviser may still not
result in a successful transaction. The Adviser may be incorrect in its
expectations as to the extent of various interest or currency exchange rate or
stock market movements or the time span within which the movements take place.
Options and futures transactions may increase portfolio turnover rates, which
results in correspondingly greater commission expenses and transaction costs and
may result in certain tax consequences.
New financial products and risk management techniques continue to be developed.
Each Fund may use these instruments and techniques to the extent consistent with
its investment objective and regulatory requirements applicable to investment
companies. For further information regarding these techniques, see "Investment
Techniques and Other Investment Policies" below.
PORTFOLIO TURNOVER. The Trust anticipates that investors in the Funds frequently
will redeem Fund shares, as well as exchange their Fund shares for shares of
another Fund. A Fund may have to dispose of certain investments in order to
maintain sufficient liquid assets to meet such redemption and exchange requests,
thereby causing a high portfolio turnover rate. Because each Fund's portfolio
turnover rate will depend largely on the purchase, redemption, and exchange
activity of its investors, it is difficult to estimate what each Fund's actual
turnover rate will be. Based on the formula prescribed by the SEC, the portfolio
turnover rate of each Fund is calculated without regard to securities, including
options and futures contracts, having a maturity of less than one year. The
Japan/Long Fund, the Japan/Short Fund, the U.S. Plus Fund, the U.S./Short Fund,
and the OTC/Short Fund typically will hold most of their investments in options
and futures contracts, which are excluded from the portfolio turnover rate
calculations. If, however, options and futures contracts were included in such
calculation, it is expected that the portfolio turnover rate of each Fund would
be approximately 500%. The OTC Plus Fund, which will invest primarily in common
stocks, is expected to have a similar rate.
Significant portfolio turnover will tend to increase the realization by a Fund
of gains or losses on securities that have been held by it for less than three
months. Any such realized gains on securities that have been held for less than
three months, and other factors related to large cash flows into and out of a
Fund, as well as the investment by a Fund, other than the Money Market Fund,
primarily in options and futures positions, will increase the risk that in any
given year the Fund may fail to qualify as a RIC. See "Taxes." If a Fund should
fail to qualify as a RIC for any taxable year, its net investment income and net
capital gains, if any, for that year would be subject to Federal income tax at
corporate rates. The imposition of such taxes would directly reduce the return
on an investment in the Fund. In addition, a higher portfolio turnover ratio
would likely involve correspondingly higher brokerage commissions and other
expenses borne by the Fund. Such higher expenses can adversely affect the
ability of a Fund to achieve its investment objective.
FOREIGN SECURITIES. Investing in foreign companies may involve risks not
typically associated with investing in U.S. companies. The value of securities
denominated in foreign currencies, and of dividends from such securities, can
change significantly when foreign currencies strengthen or weaken relative to
- 14 -
<PAGE>
the U.S. Dollar. Foreign securities markets generally have less trading volume
and less liquidity than U.S. markets, and prices in some foreign markets can be
extremely volatile. Many foreign countries lack uniform accounting and
disclosure standards comparable to those that apply to U.S. companies, and it
may be more difficult to obtain reliable information regarding a foreign
issuer's financial condition and operations. In addition, the costs of foreign
investing, including withholding taxes, brokerage commissions and custodial
fees, generally are higher than for U.S. investments.
BORROWING. The U.S. Plus Fund and the OTC Plus Fund may borrow money from banks
for investment purposes, which is a form of leveraging. This leverage may
exaggerate the gains and losses on a Fund's investments and on changes in a
Fund's net asset value. Leverage also creates interest expenses -- if those
expenses exceed the return on the transactions that the borrowings facilitate,
the Fund will be in a worse position than if it had not borrowed. The use of the
derivatives in connection with leverage may create the potential for significant
losses.
TRACKING ERROR. While the Funds do not expect that their returns over a
twelve-month period will deviate adversely from their respective benchmarks by
more than 10%, several factors may affect the Funds' ability to achieve this
correlation. Among these factors are: (1) Fund expenses, including brokerage
expenses and commissions (which may be increased by high portfolio turnover);
(2) less than all of the securities in the benchmark being held by a Fund and
securities not included in the benchmark being held by a Fund; (3) an imperfect
correlation between the performance of instruments held by a Fund, such as
futures contracts and options, and the performance of the underlying securities
in the cash market comprising an index; (4) bid-ask spreads (the effect of which
may be increased by portfolio turnover); (5) a Fund holding instruments that are
illiquid or the market for which becomes disrupted; (6) the need to conform a
Fund's portfolio holdings to comply with that Fund's investment restrictions or
policies, or regulatory or tax law requirements and (7) market movements that
run counter to a leveraged Fund's investments (which will cause divergence
between the Fund and its benchmark over time due to the mathematical effects of
leveraging).
In the case of the Funds' whose net asset values move inversely from their
benchmarks - the Japan/Short Fund, the U.S./Short Fund and the OTC/Short Fund -
the factor of compounding also may lead to tracking error. Even if there is a
perfect inverse correlation between a Fund and the return of its applicable
benchmark on a daily basis, the symmetry between the changes in the benchmark
and the changes in the Fund's net asset value can be altered significantly over
time by a compounding effect. For example, if the Japan/Short Fund achieved a
perfect inverse correlation with the Nikkei Index on every trading day over an
extended period and the level of returns of the Nikkei Index significantly
decreased during that period, a compounding effect for that period would result,
causing in an increase on the Japan/Short Fund's net asset value by a percentage
that is somewhat greater than the percentage the Nikkei Index returns decreased.
Conversely, if the Japan/Short Fund maintained a perfect inverse correlation
with the Nikkei Index over an extended period and if the level of returns of the
Nikkei Index significantly increased over that period, a compounding effect
would result, causing a decrease of the Japan/Short Fund's net asset value by a
percentage that would be somewhat less than the percentage the Nikkei Index
returns increased.
TRADING HALTS. All of the Funds, with the exception of the OTC Plus Fund and the
Money Market Fund, typically will hold most of their investments in short-term
options and futures contracts. The major exchanges on which these contracts are
- 15 -
<PAGE>
traded, such as the Chicago Mercantile Exchange ("CME"), the Chicago Board of
Options Exchange ("CBOE"), the Singapore International Monetary Exchange
("SIME") and the Osaka Securities Exchange, have established limits on how much
an option or futures contract may decline over various time periods within a
day. If an option or futures contract's price declines more than the established
limits, trading is halted on that instrument. If such trading halts are
instituted by an options or futures exchange at the close of a trading day, a
Fund will not be able to execute purchase or sales transactions in the specific
option or futures contracts affected. In such an event, a Fund also would be
unable to accurately price its outstanding contracts. A trading halt at the end
of a business day would constitute an emergency situation under SEC regulations.
A Fund affected by such an emergency would not be able to accept investors'
orders for purchases, redemptions, or exchanges received earlier during the
business day.
EARLY NASDAQ CLOSINGS. The normal close of trading of securities listed on the
Nasdaq is 4:00 p.m. While an infrequent occurrence, trading on the Nasdaq has
closed as much as 15 minutes prior to the normal close because of computer
systems failures. Early closing of the Nasdaq may result in a Fund, particularly
the OTC Plus Fund and the OTC/Short Fund, being unable to execute buy or sell
orders on the Nasdaq that day. If that occurs and a Fund needs to execute a high
volume of trades late in a trading day, a Fund may incur substantial trading
losses.
INVESTMENT TECHNIQUES AND
OTHER INVESTMENT POLICIES
Futures Contracts and Options on Futures Contracts
- --------------------------------------------------
Each Fund, other than the Money Market Fund, may purchase and sell stock index
futures contracts and options on such futures contracts. The Japan/Long Fund and
the Japan/Short Fund may also purchase and sell futures contracts on Japanese
Yen and options on such futures contracts. Each Fund, other than the Money
Market Fund, may purchase and sell futures and options thereon as a substitute
for a comparable market position in the underlying securities or currency, to
attempt to hedge or limit the exposure of its position, to create a synthetic
money market position, for certain tax-related purposes and to effect closing
transactions.
A futures contract obligates the seller to deliver (and the purchaser to take
delivery of) the specified security or currency on the expiration date of the
contract. An index futures contract obligates the seller to deliver (and the
purchaser to take) an amount of cash equal to a specific dollar amount times the
difference between the value of a specific index at the close of the last
trading day of the contract and the price at which the agreement is made. No
physical delivery of the underlying securities in the index is made.
When a Fund writes an option on a futures contract, it becomes obligated, in
return for the premium paid, to assume a position in the futures contract at a
specified exercise price at any time during the term of the option. If a Fund
writes a call, it assumes a short futures position. If it writes a put, it
assumes a long futures position. When the Fund purchases an option on a futures
contract, it acquires the right in return for the premium it pays 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).
Whether a Fund realizes a gain or loss from futures activities depends upon
movements in the underlying security, currency or index. The extent of the
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<PAGE>
Fund's loss from an unhedged short position in futures contracts or from writing
unhedged call options on futures contracts is potentially unlimited. The Funds
will only purchase and sell futures contracts and options on futures contracts
that are traded on a U.S. exchange or board of trade or, in the case of the
Japan/Long and Japan/Short Funds, also on the Osaka Securities Exchange or
SIME.
To the extent that a Fund enters into futures contracts, options on futures
contracts or options on foreign currencies traded on an exchange regulated by
the Commodity Futures Trading Commission ("CFTC"), in each case other than for
bona fide hedging purposes (as defined by the CFTC), the aggregate initial
margin and the premiums required to establish those positions (excluding the
amount by which options are "in-the-money" at the time of purchase) will not
exceed 5% of the liquidation value of the Fund's portfolio, after taking into
account unrealized profits and unrealized losses on any contracts the Fund has
entered into. (In general, a call option on a futures contract is "in-the-money"
if the value of the underlying futures contract exceeds the strike, i.e.,
exercise, price of the call. A put option on a futures contract is
"in-the-money" if the value of the underlying futures contract is exceeded by
the strike price of the put.) This policy does not limit to 5% the percentage of
a Fund's assets that are at risk in futures contracts, options on futures
contracts and currency options.
Options on Indices, Securities and Currencies
- ---------------------------------------------
Each Fund, other than the Money Market Fund, may purchase and sell put and call
options on stock indices and on individual securities. The Japan/Long Fund and
the Japan/Short Fund may also purchase and sell put and call options on Japanese
Yen. Each Fund, other than the Money Market Fund, may purchase and sell put and
call options as a substitute for a comparable market position in the underlying
securities or currency, to attempt to hedge or limit the exposure of its
position, to create a synthetic money market position, for certain tax-related
purposes and to effect closing transactions.
An index fluctuates with changes in the market values of the securities included
in the index. Options on indices give the holder the right to receive an amount
of cash upon exercise of the option. Receipt of this cash amount will depend
upon the closing level of the index upon which the option is based being greater
than (in the case of a call) or less than (in the case of put) the exercise
price of the option. The amount of cash received, if any, will be the difference
between the closing price of the index and the exercise price of the option,
multiplied by a specified dollar multiple. The writer (seller) of the option is
obligated, in return, for the premium received from the purchaser of the option,
to make delivery of this amount to the purchaser. Unlike the option on
securities discussed below, all settlements of index options transactions are in
cash.
Some stock index options are based on a broad market index such as the S&P 500
Index, the NYSE Composite Index or the AMEX Major Market Index, or on a narrower
index such the Philadelphia Stock Exchange Over-the-Counter Index. Options
currently are traded on the CBOE, the AMEX and other exchanges. Options also are
traded in the OTC markets and each Fund may buy and sell both exchange-traded
and OTC options.
Each of the exchanges has established limitations governing the maximum number
of call or put options on the same index that may be bought or written by a
single investor, whether acting alone or in concert with others (regardless of
whether such options are written on the same or different exchanges or are held
- 17 -
<PAGE>
or written on one or more accounts or through one or more brokers). Under these
limitations, option positions of all investment companies advised by the same
investment adviser are combined for purposes of these limits. Pursuant to these
limitations, an exchange may order the liquidation of positions and may impose
other sanctions or restrictions. These positions limits may restrict the number
of listed options that a Fund may buy or sell.
By buying a call option on a security or currency, a Fund has the right, in
return for the premium paid, to buy the security or currency underlying the
option at the exercise price. By writing (selling) a call option and receiving a
premium, a Fund becomes obligated during the term of the option to deliver
securities or currency underlying the option at the exercise price if the option
is exercised. By buying a put option, a Fund has the right, in return for the
premium, to sell the security or currency underlying the option at the exercise
price. By writing a put option, a Fund becomes obligated during the term of the
option to purchase the securities or currency underlying the option at the
exercise price.
Because options premiums paid or received by a Fund are small in relation to the
market value of the investments underlying the options, buying and selling put
and call options can be more speculative than investing directly in securities.
Forward Contracts and Foreign Currency
- --------------------------------------
Both the Japan/Long Fund and the Japan/Short Fund may enter into forward
currency contracts for the purchase or sale of Japanese Yen at a specified
future date to attempt to eliminate the effect that fluctuations in the U.S.
Dollar/Japanese Yen exchange rate may have on the Fund's net asset value per
share. Forward currency contracts are traded directly between currency traders
(usually large commercial banks) and their customers.
These Funds also may purchase and sell foreign currency and invest in foreign
currency deposits. Currency conversion involves dealer spreads and other costs,
although commissions usually are not charged.
Indexed Securities
- ------------------
Each Fund (other than the Money Market Fund) may purchase indexed securities,
which are securities the value of which varies positively or negatively in
relation to the value of other securities, securities indices, currencies or
other financial indicators, consistent with its investment objective. Indexed
securities typically, but not always, are debt securities or deposits whose
value at maturity or coupon rate is determined by reference to a specific
instrument or statistic. The performance of indexed securities depends to a
great extent on the performance of the security, currency or other instrument to
which they are indexed and also may be influenced by interest rate changes in
the United States and abroad. At the same time, indexed securities are subject
to the credit risks associated with the issuer of the security, and their values
may decline substantially if the issuer's creditworthiness deteriorates. Indexed
securities may be more volatile than the underlying instruments.
Swaps, Caps, Floors and Collars
- -------------------------------
A Fund (other than the Money Market Fund) may enter into equity swaps, floors
and collars. For example, the Japan/Long Fund, the U.S. Plus Fund and the OTC
Plus Fund may enter into equity swaps where the Fund receives a return based on
the increase in value of a specified index, and pays the counterparty an amount
based on a floating rate of interest, on the notional amount of the swap. The
- 18 -
<PAGE>
Japan/Short Fund, the U.S./Short Fund and the OTC/Short Fund may enter into
reverse equity swaps where the Fund receives a floating rate of interest, and
pays an amount equal to the increase in value of a specified index, on the
notional amount of the swap. The Japan/Long Fund and the Japan/Short Fund may
also use swaps, caps, floors and collars where a payment stream is payable in
Japanese Yen or is based on the U.S. Dollar/Japanese Yen exchange rate. Each
Fund (other than the Money Market Fund) may use equity swaps, caps, floors and
collars consistent with its investment objective and may also enter into
offsetting positions.
Swaps involve the exchange by a Fund with another party of their respective
commitments to pay or receive cash flows, e.g., an exchange of payments based on
the increase in value of an equity index for floating interest rate payments.
The purchase of a cap entitles the purchaser, to the extent that a specified
index exceeds a predetermined value, to receive payments on a notional principal
amount from the party selling such cap. The purchase of a floor entitles the
purchaser, to the extent that a specified index falls below a predetermined
value, to receive payments on a notional principal amount from the party selling
such floor. A collar combines elements of buying a cap and selling a floor.
A Fund usually will enter into swaps on a net basis, i.e., the two payment
streams are netted out, with the Fund receiving or paying, as the case may be,
only the net amount of the two payments. If, however, an agreement calls for
payments by a Fund, the Fund must be prepared to make such payments when due.
The creditworthiness of firms with which a Fund enters into swaps, caps, floors
or collars will be monitored by the Adviser in accordance with procedures
adopted by the Trustees. If a firm's creditworthiness declines, the value of an
agreement would be likely to decline, potentially resulting in losses. If a
default occurs by the other party to such transaction, a Fund will have
contractual remedies pursuant to the agreements related to the transaction.
The Funds understand that the position of the staff of the SEC is that assets
involved in such transactions are illiquid investments and, therefore, are
subject to the limitations on investments in illiquid investments as described
below and in the SAI.
Short Sales
- -----------
The Japan/Short Fund, the U.S./Short Fund and the OTC/Short Fund may engage in
short sales transactions under which the Fund sells a security it does not own.
To complete such a transaction, the Fund must borrow the security to make
delivery to the buyer. The Fund then is obligated to replace the security
borrowed by purchasing the security at the market price at the time of
replacement. The price at such time may be more or less than the price at which
the security was sold by the Fund. Until the security is replaced, the Fund is
required to pay to the lender amounts equal to any dividends that accrue during
the period of the loan. The proceeds of the short sale will be retained by the
broker, to the extent necessary to meet the margin requirements, until the short
position is closed out.
Until a Fund closes its short position or replaces the borrowed stock, the Fund
will: (1) maintain an account containing cash or liquid assets at such a level
that (a) the amount deposited in the account plus that amount deposited with the
broker as collateral will equal the current value of the stock sold short and
(b) the amount deposited in the account plus the amount deposited with the
broker as collateral will not be less than the market value of the stock at the
time the stock was sold short; or (2) otherwise cover the Fund's short position.
- 19 -
<PAGE>
The Japan/Long Fund, the U.S. Plus Fund and the OTC Plus Fund each may engage in
short sales if, at the time of the short sale, the Fund owns or has the right to
acquire an equal amount of the stock being sold at no additional cost ("selling
short against the box"). Each Fund may make a short sale when the Fund wants to
sell the stock the Fund owns at a current attractive price, but also wishes to
defer recognition of a gain or loss for Federal income tax purposes and for
purposes of satisfying certain tests applicable to RICs under the Code.
Foreign Securities
- ------------------
The Japan/Long Fund and the Japan/Short Fund may invest in issuers located
outside the United States. These investments may be made by purchasing American
Depository Receipts ("ADRs"), "ordinary shares" or "New York" shares in the
United States. The Japan/Short Fund may also sell these securities short.
ADRs are dollar denominated receipts representing interests in the securities of
a foreign issuer, which securities may not necessarily be denominated in the
same currency as the securities into which they may be converted. ADRs are
receipts typically issued by United States banks and trust companies that
evidence ownership of underlying securities issued by a foreign corporation.
Generally, ADRs in registered form are designed for use in domestic securities
markets and are traded on exchanges or OTC in the United States. Ordinary shares
are shares of foreign issuers that are traded abroad and on a U.S. exchange. New
York shares are shares that a foreign issuer has allocated for trading in the
United States. ADRs, ordinary shares and New York shares all may be purchased
with and sold for U.S. dollars.
Investing in companies located abroad carries political and economic risks
distinct from those associated with investing in the United States. Foreign
investments may be affected by actions of foreign governments adverse to the
interests of U.S. investors, including the possibility of expropriation or
nationalization of assets, confiscatory taxation, restrictions on U.S.
investment, or on the ability to repatriate assets or to convert currency into
U.S. dollars. There may be a greater possibility of default by foreign
governments or foreign-government sponsored enterprises. Investments in foreign
countries also involve a risk of local political, economic, or social
instability, military action or unrest, or adverse diplomatic developments.
U.S. Government Securities
- --------------------------
The Money Market Fund will invest in U.S. Government Securities in pursuit of
its investment objectives. The other Funds may invest in U.S. Government
Securities in order to deposit such securities as initial or variation margin,
as "cover" for the investment techniques they employ, as part of a cash reserve
and for liquidity purposes. U.S. Government Securities include direct
obligations of the U.S. Treasury (such as Treasury bills, Treasury notes and
Treasury bonds).
U.S. Government Securities are high-quality instruments issued or guaranteed as
to principal or interest by the U.S. Treasury or by an agency or instrumentality
of the U.S. Government. Not all U.S. Government Securities are backed by the
full faith and credit of the United States. Some are backed by the right of the
issuer to borrow from the U.S. Treasury; others are backed by discretionary
authority of the U.S. Government to purchase the agencies' obligations; while
others are supported only by the credit of the instrumentality. In the case of
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<PAGE>
securities not backed by the full faith and credit of the United States, the
investor must look principally to the agency issuing or guaranteeing the
obligation for ultimate repayment.
Yields on short-, intermediate- and long-term U.S. Government Securities are
dependent on a variety of factors, including the general conditions of the money
and bond markets, the size of a particular offering and the maturity of the
obligation. Debt securities with longer maturities tend to produce higher
capital appreciation and depreciation than obligations with shorter maturities
and lower yields. The market value of U.S. Government Securities generally
varies inversely with changes in the market interest rates. An increase in
interest rates, therefore, generally would reduce the market value of a Fund's
portfolio investments in U.S. Government Securities; while a decline in interest
rates generally would increase the market value of a Fund's portfolio
investments in these securities.
Repurchase Agreements
- ---------------------
Under a repurchase agreement, a Fund purchases a U.S. Government Security and
simultaneously agrees to sell the security back to the seller at a mutually
agreed-upon future price and date, normally one day or a few days later. The
resale price is greater than the purchase price, reflecting an agreed-upon
market interest rate during the Fund's holding period. While the maturities of
the underlying securities in repurchase agreement transactions may be more than
one year, the term of each repurchase agreement always will be less than one
year. Each Fund may enter into repurchase agreements with banks that are members
of the Federal Reserve System or securities dealers who are members of a
national securities exchange or are primary dealers in U.S. Government
Securities. The Adviser will monitor the creditworthiness of each firm that is a
party to a repurchase agreement with any Fund. In the event of default or
bankruptcy by the seller, the Fund will liquidate those securities (whose market
value, including accrued interest, must be at least 100% of the amount invested
by the Fund) held under the applicable repurchase agreement, which securities
constitute collateral for the seller's obligation to repurchase the security.
Illiquid Investments
- --------------------
Each Fund may purchase and hold illiquid investments, including securities that
are not readily marketable and securities that are not registered ("restricted
securities") under the Securities Act of 1933, as amended ("1933 Act"), but
which can be offered and sold to "qualified institutional buyers" pursuant to
Rule 144A under the 1933 Act. A Fund will not invest more than 15% (10% with
respect to the Money Market Fund) of its net assets in illiquid investments. The
term "illiquid investments" for this purpose means investments that cannot be
disposed of within seven days in the ordinary course of business at
approximately the amount at which a Fund has valued the investments. Under the
current SEC staff guidelines, illiquid investments also include purchased OTC
options, certain cover for OTC options, securities involved in swap, cap, floor
and collar transactions, repurchase agreements not terminable in seven days and
restricted securities not determined to be liquid pursuant to guidelines
established by the Trustees.
Other Investment Practices
- --------------------------
The U.S. Plus Fund and the OTC Plus Fund may borrow for investment purposes.
Each Fund may borrow money as a temporary measure for extraordinary or emergency
purposes and to meet redemption requests without immediately selling portfolio
securities. For a more detailed discussion of these practices, see the SAI.
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<PAGE>
PORTFOLIO TRANSACTIONS
AND BROKERAGE
The Adviser will place orders to execute securities transactions that are
designed to implement each Fund's investment objective and policies. In placing
such orders, the Adviser will seek the most favorable price and efficient
execution available. In order to obtain brokerage and research services,
however, a higher commission sometimes may be paid. Brokerage commissions
normally are paid on exchange-traded securities transactions and on options and
futures transactions.
When selecting a broker or dealer to execute portfolio transactions, the Adviser
considers many factors, including the rate of commission or the size of the
broker-dealer's "spread," the size and difficulty of the order, the nature of
the market for the security, operational capabilities of the broker-dealer and
the research, statistical and economic data furnished by the broker-dealer to
the Adviser. The Adviser may select one broker-dealer over another based on
whether the broker-dealer provides research services to the Adviser.
HOW TO INVEST IN THE FUNDS
The minimum initial investment is $10,000, which can be allocated in any amounts
among the Funds. The shares of each Fund are offered at the daily public
offering price, which is the net asset value per share next computed after
receipt of the investor's order. See "Determination of Net Asset Value." No
sales charges are imposed on initial or subsequent investments in a Fund. The
Trust reserves the right to reject or refuse, at the Trust's discretion, any
order for the purchase of a Fund's shares in part or whole. The minimum amount
for subsequent investments in a Fund is $_____.
Investments in the Funds may be made (1) through securities dealers who have the
responsibility to transmit orders promptly and who may charge a processing fee
or (2) directly with the Trust by mail or bank wire transfer as follows:
By Mail: Fill out an Account Application included with this Prospectus and make
out a check payable to "Potomac Funds". Your investment will be allocated among
the Funds as you specify on the Account Application. Mail the check, along with
the Account Application, to:
xxxxxxxxxxxxxxxx
xxxxxxxxxxxxxxxx
xxxxxxxxxxxxxxxx
Third party checks will not by accepted by the Funds. All purchases must be in
U.S. dollars.
By Bank Wire Transfer: Request a wire transfer to:
xxxxxxxxxxxxxxx
xxxxxxxxxxxxxxx
xxxxxxxxxxxxxxx
xxxxxxxxxxxxxxx
xxxxxxxxxxxxxxx
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<PAGE>
After instructing your bank to transfer money by wire, please call the Trust's
transfer agent and inform it as to the amount you have sent and the name of the
bank sending the wire. Your bank may charge a fee for such services. If the
purchase is canceled because your wire transfer is not received, you may be
liable for any the loss the Trust may incur.
Physical certificates representing a Fund's shares are not issued. Shares of
each Fund are recorded on a register by the Trust's transfer agent.
TAX-SHELTERED RETIREMENT PLANS
Tax-sheltered retirement plans of the following types are available to
investors:
Individual retirement accounts ("IRAs")
Self-employed individual retirement plans ("Keogh Plans") - defined
contribution plans
Code section 403(b) plans
Retirement plans are charged an annual $____ maintenance fee. Additional
information regarding these accounts may be obtained by contacting the Trust.
REDEEMING SHARES
(WITHDRAWALS)
General
- -------
You may withdraw all or any part of your investment by redeeming Fund shares at
the next determined net asset value per share after receipt of the order.
Redemptions may be made by letter or telephone to the transfer agent subject to
the procedures described below. When you redeem shares over the telephone, those
redemption proceeds will be sent only to your address of record or to a bank
account specified in your Account Application. Redemption proceeds may be sent
by wire transfers to a bank account specified in your Account Application. The
minimum amount of a wire transfer redemption is $5,000. There is no redemption
charge.
If you request payment of redemption proceeds to a third party or to a location
other than your address of record or a bank account specified in the Account
Application, your request must be in writing and your signature guaranteed. A
signature guarantee will be accepted from a commercial bank, savings
association, securities broker or dealer, or credit union. A notary public
cannot provide a signature guarantee.
Payment of redemption proceeds will be made within seven days following a Fund's
receipt of your request for redemption. For investments that have been made by
check, payment on withdrawal requests may be delayed until the Trust's transfer
agent is reasonably satisfied that the purchase payment has been collected by
the Trust (which may require up to 10 business days).
With respect to the U.S. Plus Fund, the U.S./Short Fund, the OTC Plus Fund, the
OTC/Short Fund and the Money Market Fund, the right of redemption may be
suspended or the date of payment postponed for any period during which the NYSE,
the Nasdaq, the CME, or the CBOE, or the Federal Reserve Bank of New York, as
appropriate, is closed (other than customary weekend or holiday closings) or
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<PAGE>
trading on the NYSE, the Nasdaq, the CME, or the CBOE, as appropriate, is
restricted. With respect to the Japan/Long Fund and the Japan/Short Fund, the
right of redemption may be suspended or the date of payment postponed for any
period during which the SIME or the Osaka Securities Exchange is closed (other
than customary weekend or holiday closings) or trading on that exchange is
restricted. In addition, the rights of redemption may be suspended or the date
of payment postponed for any Fund for a period during which an emergency exists
so that disposal of the Fund's investments or the determination of its net asset
value is not reasonably practicable or for a such periods as the SEC, by order,
may permit for protection of a Fund's investors.
Draft Checks
- ------------
Checkwriting privileges are available to investors in the Money Market Fund.
With a Money Market Fund checking account, shares may be redeemed simply by
writing a check for $______ or more. The redemption will be made at the net
asset value next determined after the Adviser presents the check to the Money
Market Fund. A check should not be written to close an account. There is a $25
charge for each stop payment request on Money Market Fund checks. You are
subject to the same rules and regulations that banks apply to checking accounts.
Low Balance Accounts
- --------------------
Because of the high cost of maintaining accounts with low balances, it is the
Trust's policy to redeem involuntarily Fund shares in any account, including a
retirement account, if the account balance falls below $10,000 in total value in
the Trust. This policy does not apply to accounts that fall below the minimum
balance due to market fluctuations. The Trust will provide 30 days' written
notice to all such shareholders to bring the account balance up to the minimum
investment required or the Trust may redeem shares in the account and pay the
proceeds to the shareholder. A redemption from a tax-qualified retirement plan
may have adverse tax consequences and a shareholder contemplating such a
redemption should consult his or her tax adviser.
PROCEDURES FOR REMPTIONS AND
EXCHANGES
Shares of a Fund may be exchanged, without any charge, for shares of any other
Fund on the basis of the respective net asset values of the shares involved.
Exchanges must be for at least the lesser of $1,000 or the entire account
balance for the Fund from which the exchange is made.
Written requests for redemptions and exchanges should be sent to the Trust's
transfer agent, xxxxxxx, xxxxxxx, xxxxx and should be signed by the account
owner or owners. Telephone redemption and exchange requests may be made by
calling the Trust's transfer agent at xxxxxxxx. Telephone requests may be made
between 9:00 a.m., Eastern time, and the times listed below. For exchanges, the
earlier of the times below for the Funds whose shares are being exchanged will
apply:
Japan/Long Fund xxxx p.m.
Japan/Short Fund xxxx p.m.
U.S. Plus Fund xxxx p.m.
U.S./Short Fund xxxx p.m.
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<PAGE>
OTC Plus Fund xxxx p.m.
OTC/Short Fund xxxx p.m.
Money Market Fund xxxx p.m.
TELEPHONE REDEMPTION AND EXCHANGE ORDERS WILL BE ACCEPTED ONLY DURING THE
PERIODS INDICATED ABOVE.
In requesting an exchange, shareholders should provide their account name,
account number, the number of or percentage of shares or dollar value of shares
to be exchanged, and the names of the Funds involved. Exchanges may only be made
between identically registered accounts.
When acting on instructions believed to be genuine, the Trust, Adviser, and the
Trustees, directors, officers and employees are not liable for any loss
resulting from a fraudulent telephone transaction request and the investor will
bear the risk of loss. These parties will employ reasonable procedures to
confirm that telephone instructions are genuine. To the extent that the Trust,
Adviser, and the Trustees, directors, officers and employees do not employ such
procedures, some or all of them may be liable for losses due to unauthorized or
fraudulent transactions. These parties follow specific procedures for
transactions initiated by telephone, including requiring some form of personal
identification prior to acting upon telephone instructions, providing written
confirmation after such transactions, and recording telephone instructions. You
also should be aware that telephone redemption or exchanges may be difficult to
implement in a timely manner during periods of drastic economic or markets
changes. If such conditions occur, redemption or exchange orders can be made by
mail.
DETERMINATION OF NET ASSET VALUE
The net asset value per share of the U.S. Plus Fund, the U.S./Short Fund, the
OTC Plus Fund and the OTC/Short Fund is determined as of the close of normal
trading on the NYSE (currently 4:00 p.m., Eastern time) each day the NYSE is
open for business. The net asset value per share of the Japan/Long Fund and the
Japan/Short Fund is determined as of the close of normal trading on the Osaka
Securities Exchange (currently 1:00 a.m., Eastern time) each day that exchange
is open for business. The Money Market Fund's net asset value per share is
determined as of 1:00 p.m., Eastern time, each day that both the NYSE and the
Federal Bank of New York are open for business.
A Fund's net asset value serves as the basis for the purchase and redemption
price of its shares. The net asset value per share of a Fund is calculated by
dividing the market value of the Fund's securities plus the value of its other
assets, less all liabilities, by the number of outstanding shares of the Fund.
If market quotations are not readily available, a security will be valued at
fair value by the Trustees or by the Adviser using methods established or
ratified by the Trustees.
The Money Market Fund will utilize the amortized cost method in valuing its
portfolio securities. This method involves valuing a security at its cost
adjusted by a constant amortization to maturity of any discount or premium,
regardless of the impact of fluctuating interest rates on the market value of
the instrument. The purpose of this method of calculation is to facilitate the
maintenance of a constant net asset value per share for the Money Market Fund of
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<PAGE>
$1.00. However, there is no assurance that the $1.00 net asset value per share
will be maintained. For further information on valuing the Money Market Fund's
portfolio securities, see "Determination of Net Asset Value" in the SAI.
For purposes of determining net asset value per share of a Fund, options and
futures contracts are valued at the closing prices of the exchanges on which
they trade. Options on securities and indices purchased by a Fund generally are
valued at their last bid price in the case of exchange-traded options or, in the
case of options traded in the OTC market, the average of the last bid price as
obtained from two or more dealers unless there is only one dealer, in which case
that dealer's price is used. The value of a futures contract equals the
unrealized gain or loss on the contract that is determined by marking the
contract to the current settlement price for a like contract acquired on the day
on which the futures contract is being valued. The value of options on futures
contracts is determined based upon the current settlement price for a like
option acquired on the day on which the option is being valued. A settlement
price may not be used for the foregoing purposes if the market makes a limited
move with respect to a particular commodity.
OTC securities held by a Fund shall be valued at the last sales price or, if no
sales price is reported, the mean of the last bid and asked price is used. The
portfolio securities of a Fund that are listed on national exchanges or foreign
stock exchanges are valued at the last sales price of such securities; if no
sales price is reported, the mean of the last bid and asked price is used. For
valuation purposes, all assets and liabilities initially expressed in foreign
currency values will be converted into U.S. Dollars at the mean between the bid
and offered quotations of such currencies against U.S. Dollars as last quoted by
a recognized dealer. Dividend income and other distributions are recorded on the
ex-distribution date, except for certain dividends from foreign securities that
are recorded as soon as the Trust is informed after the ex-distribution date.
Illiquid securities, securities for which reliable quotations or pricing
services are not readily available, and all other assets not valued in
accordance with the foregoing principles will be valued at their respective fair
value as determined in good faith by, or under procedures established by, the
Trustees, which procedures may include the delegation of certain
responsibilities regarding valuation to the Adviser or the officers of the
Trust. The officers of the Trust report, as necessary, to the Trustees regarding
portfolio valuation determinations. The Trustees, from time to time, will review
these methods of valuation and will recommend changes that may be necessary to
assure that the investments of the Funds are valued at fair value.
PERFORMANCE INFORMATION
Total Return
- ------------
From time to time each Fund may advertise its average annual total return and
compare its performance to that of other mutual funds with similar investment
objectives and to relevant indices. Performance information is computed
separately for those Funds in accordance with the methods discussed below.
Each Fund may include the total return of its shares in advertisements or other
written material. When a Fund advertises the total return of its shares, it will
be calculated for the one-, five-, and ten-year periods or, if such periods have
not yet elapsed, the period since the establishment of that Fund. Total return
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<PAGE>
is measured by comparing the value of an investment in a Fund at the beginning
of the relevant period to the redemption value of the investment in that Fund at
the end of the period (assuming reinvestment of any dividends or capital gains
distribution at net asset value). For more information on Fund performance, see
"Performance Information" in the SAI.
Yield
- -----
From time to time the Money Market Fund may advertise "yield" and "effective
yield." The Money Market Fund's yield figure is based on historical earnings and
is not intended to indicate future performance. The yield of the Money Market
Fund refers to the income generated by an investment in the Fund over a
seven-day period. This income is then "annualized." The effective yield is
calculated similarly but, when annualized, the income earned by an investment in
the Fund is assumed to be reinvested. The effective yield will be slightly
higher than the average yield because of the compounding effect of this assumed
reinvestment. See "Yield Computations" in the SAI.
DIVIDENDS AND OTHER DISTRIBUTIONS
Each Fund, except the Money Market Fund, intends to distribute to its
shareholders annually any net investment income, net realized long-term and
short-term capital gains, and net realized gains from foreign currency
transactions. The Money Market Fund ordinarily will declare dividends from net
investment income on a daily basis and distribute those dividends monthly. All
income dividends and distributions of net capital gains and net gains from
foreign currency transactions, if any, of each Fund will be automatically
reinvested in additional shares of the Fund at the net asset value calculated on
the ex-distribution date, unless you request otherwise in writing. Dividends and
other distributions of a Fund are taxable to its shareholders, as discussed
below under "Taxes," whether the dividends or other distributions are reinvested
in additional shares or are received in cash. You will receive a statement of
your account at least quarterly.
TAXES
Each Fund is treated as a separate corporation for Federal income tax purposes
and will seek to qualify as a RIC. Because of the investment strategies and the
expected high turnover of the investments of each Fund other than the Money
Market Fund, there can be no assurance that any such Fund will qualify as a RIC.
If a Fund so qualifies and satisfies the distribution requirement under the Code
for a taxable year, the Fund will not be subject to Federal income tax on the
part of its investment company taxable income (generally consisting of net
investment income, net short-term capital gains, and net gains from certain
foreign currency transactions) and net capital gain (the excess of net long-term
capital gain over net short-term capital loss) it distributes to its shareholder
for that year. If a Fund fails to qualify as a RIC for any taxable year, its
taxable income, including net capital gain, will be taxed at corporate income
tax rates (up to 35%) and it will not receive a deduction for distributions to
its shareholders.
To qualify as a RIC, a Fund must satisfy certain requirements, including the
requirement that it derive less than 30% of its gross income from the sale or
other disposition of any of the following that have been held for less than
three months: (1) securities, (2) options, futures, or forward contracts (other
than those on foreign currencies), or (3) foreign currencies (or options,
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<PAGE>
futures, or forward contracts thereon) that are not directly related to the
Fund's principal business of investing in securities (or options and futures
with respect thereto) ("Short-Short Limitation"). Because of the anticipated
frequency of redemptions and exchanges of Fund shares, each Fund, other than the
Money Market Fund, will have greater difficulty than most other mutual funds in
satisfying the Short-Short Limitation. The Trust expects that investors in those
Funds, as part of their asset allocation strategy, are likely to redeem or
exchange their Fund shares frequently to take advantage of anticipated changes
in market conditions. Such redemption and exchanges are likely to require a Fund
to sell securities to meet its payment obligations. The larger the volume of
such redemptions and exchanges, the more difficult it will be for a Fund to
satisfy the Short-Short Limitation. To minimize the risk of failing the
Short-Short Limitation, each such Fund intends to satisfy obligations in
connection with redemptions and exchanges first by using available cash or
borrowing facilities and then by selling securities that have been held for at
least three months or as to which there is an unrealized loss and then by
selling securities with the smallest unrealized gain. If a Fund also must sell
securities that have been held for less than three months and as to which there
is a significant unrealized gain, then, to the extent possible, the Fund will
seek to conduct those sales in a manner that will allow it to avoid
disqualification as a RIC under the Short-Short Limitation pursuant to a special
Code provision involving sales made as a result of "abnormal redemptions." Each
Fund, other than the Money Market Fund, also may seek to minimize the risk of
failing the Short-Short Limitation by engaging in other investment techniques,
including transactions in futures contracts and options on futures contracts and
indices on an unrestricted basis (subject to the Fund's investment policies and
SEC regulations). Notwithstanding these actions, there can be no assurance that
a Fund will be able to satisfy the Short-Short Limitation.
To qualify as a RIC, a Fund also must satisfy certain diversification
requirements. The investment by a Fund, other than the Money Market Fund,
primarily in options and futures positions entails some risk that such a Fund
might fail to satisfy those diversification requirements because of some
uncertainty regarding the valuation of such positions. For additional
information concerning these requirements and the Short-Short Limitation, see
"Dividends, Other Distributions and Taxes" in the SAI.
If the Trust determines that a Fund will not qualify as a RIC and that Federal
income tax likely will be payable by the Fund for its current taxable year, the
Trust will make a good-faith estimate of the Fund's anticipated tax liability,
which will be accrued as tax expenses, and will establish procedures for the
Fund to reflect that liability in its net asset value per share. Thereafter, the
Trust will determine daily whether it is appropriate to continue to accrue that
tax expense and, if so, will make a good-faith estimate of the amount thereof.
Any amount by which any such accrual is reduced, or the entire amount of the
accrual if the Trust determines that accrual is no longer appropriate, will be
reclassified as a reduction of tax expenses.
Dividends from a Fund's investment company taxable income, if any, are taxable
to its shareholders as ordinary income (at rates up to 39.6% for individuals),
regardless of whether the dividends are reinvested in Fund shares or received in
cash. Distributions of a Fund's net capital gain, if any, when designated as
such, are taxable to its shareholders as long-term capital gains (at rates of up
to 28% for individuals), regardless of how long they have held their Fund shares
and whether the distributions are reinvested in Fund shares or received in cash.
Shareholders that are not subject to tax on their income generally will not be
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<PAGE>
required to pay tax on distributions. Statements as to the Federal tax status of
each Fund's distributions will be mailed to its shareholders annually.
Shareholders should consult their tax advisers concerning the tax status of a
Fund's distributions in their own states and localities.
Shareholders are required by law to certify that their tax identification number
("TIN") is correct and that they are not subject to back-up withholding. Each
Fund is required to withhold 31% of all dividends, capital gain distributions,
and redemption proceeds payable to individuals and certain other non-corporate
shareholders who do not provide the Fund with a correct TIN. Withholding at that
rate also is required from dividends and capital gain distributions payable to
such shareholders who otherwise are subject to backup withholding.
Dividends paid by a Fund to a shareholder who, as to the United States, is a
nonresident alien individual or nonresident alien fiduciary of a trust or
estate, foreign corporation, or foreign partnership ("foreign shareholder") will
be subject to U.S. withholding tax (at a rate of 30% or, if the United States
has an income tax treaty with the foreign country where the foreign shareholder
resides, any lower treaty rate). An investor claiming to be a foreign
shareholder will be required to provide a Fund with supporting documentation in
order for the Fund to apply a reduced withholding rate or exemption from
withholding. Withholding will not apply if a dividend paid by a Fund to a
foreign shareholder is "effectively connected with the conduct of a U.S. trade
or business," in which case the reporting and withholding requirements
applicable to domestic shareholders will apply. Distributions of net capital
gain are not subject to withholding, but in the case of a foreign shareholder
who is a nonresident alien individual, those distributions ordinarily will be
subject to U.S. income tax at a rate of 30% (or lower treaty rate) if the
individual is physically present in the United States for more than 182 days
during the taxable year and the distributions are attributable to a fixed place
of business maintained by the individual in the United States.
Because the foregoing only summarizes some of the important tax considerations
affecting the Funds and their shareholders, please see the further discussion in
the SAI. Prospective investors are urged to consult their tax advisers.
MANAGEMENT OF THE TRUST
Board of Trustees
- -----------------
The business and affairs of each Fund are managed under the direction of the
Trustees. The Trustees are responsible for the general supervision of the Funds'
business affairs and for exercising all the Funds' powers except those reserved
to the shareholders. The day-to-day operations of the Funds are the
responsibility of the Trust's officers.
Investment Adviser
- ------------------
Rafferty Asset Management LLC, 550 Mamaroneck Avenue, Harrison, New York 10528,
provides investment advice to the Funds. The Adviser is a newly created
investment adviser and has had no previous experience advising investment
companies. The Adviser was organized as a New York limited liability corporation
in May 1997. The Adviser is a subsidiary of Cohane Rafferty Securities, Inc.
("Cohane"), incorporated in the State of New York in 1987. Both the Adviser's
and Cohane's offices are located at 550 Mamaroneck Avenue, Harrison, NY 10528.
Lawrence Rafferty owns a controlling interest in both the Adviser and Cohane.
The Adviser manages the investment of the assets of each Fund, in accordance
with its investment objective, policies and limitations, subject to the general
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<PAGE>
supervision and control of the Trustees and the officers of the Trust. The
Adviser bears all costs associated with providing these advisory services and
the expenses of the Trustees who are affiliated persons of the Adviser. The
Adviser, from its own resources, also may make payments to broker-dealers and
other financial institutions for their expenses in connection with the
distribution of Fund shares, and otherwise currently pays all distribution costs
for Fund shares.
Under an investment agreement between the Trust and the Adviser, dated _______,
1997, each Fund pays the Adviser a fee at an annualized rate, based on a
percentage of its daily net assets: 0.75% for the Japan/Long Fund, the U.S. Plus
Fund, and the OTC Plus Fund; 0.90% for the Japan/Short Fund, the U.S./Short
Fund, and the OTC/Short Fund; and 0.50% for the Money Market Fund.
Portfolio Management
- --------------------
Each Fund, except for the OTC Plus Fund and the OTC/Short Fund, is managed by an
investment committee, which is responsible for the investment activities of the
Funds.
James T. Apple is the portfolio manager for the OTC Plus Fund and the OTC/Short
Fund. From 1992 to December 1993, he was Director of Investments for The
Rushmore Funds, Inc. From January 1994 to May 1997, Mr. Apple was portfolio
manager for the Rydex OTC and U.S. Government Bond Funds. The Rydex OTC Fund,
which seeks to match the performance of the Nasdaq Index, has similar investment
objectives and policies as the OTC Plus Fund. The cumulative total return for
the Rydex OTC Fund from January __, 1994 through March 31, 1997 was ___%. At
March 31, 1997, that fund had $___ million in assets. As portfolio manager of
the Rydex OTC Fund, Mr. Apple had full discretionary authority over the
selection of investments for that fund. Average annual total returns for the
one-year and three-year periods ended December 31, 1996 and for the entire
period during which Mr. Apple managed that fund compared with the performance of
the Nasdaq Index were:
Rydex OTC Nasdaq
Fund Index__
---- -------
One Year ____% ____%
Three Years ____% ____%
Entire Period Mr. Apple
managed fund ____% ____%
Historical performance is not indicative of future performance. The Rydex OTC
Fund is a separate fund and its historical performance is not indicative of the
potential performance of the Funds. Share prices and investment returns will
fluctuate reflecting market conditions, as well as changes in company-specific
fundamentals of portfolio securities.
Administrator
- -------------
The Trust/Adviser has entered into an Administrative Services Agreement with
________ that obligates ______ to provide the Funds with administrative and
management services, other than investment advisory services, _____. As
compensation for these services, XXX receives a fee of ____ of the net assets of
each Fund. The fee is payable ____.
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Distributor
- -----------
______________ ("_______"), address, serves as the distributor of the Funds'
shares. The Distributor has entered into dealer agreements with participating
dealers who will distribute shares of the Funds.
Transfer Agent and Custodian
- ----------------------------
__________, (address) serves as the transfer agent and custodian of the
portfolio securities of the Trust.
Independent Auditors
- --------------------
Deloite & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540, are the
auditors of and the independent public accountants for the Trust.
GENERAL INFORMATION ABOUT THE TRUST
Organization of the Trust and Voting Rights
- -------------------------------------------
The Trust was organized as a Massachusetts business trust on June 6, 1997 and
registered with the SEC as an open-end management investment company under the
1940 Act. The Trust may issue unlimited shares of beneficial interest, no par
value, in such separate and distinct series and classes of shares as the
Trustees shall from time to time establish. The shares of beneficial interest of
the Trust presently are divided into seven separate series.
Fund shares have equal voting rights. Only shares of a particular Fund may vote
on matters affecting that Fund. All shares of the Trust vote on matters
affecting the Trust as a whole and to elect Trustees. Share voting rights are
not cumulative, and shares have no preemptive or conversion rights. Shares of
the Trust are nontransferable.
As a Massachusetts business trust, the Trust is not obligated to conduct annual
shareholder meetings. However, the Trust will hold special shareholder meetings
whenever required to do so under the Federal securities laws or the Trust's
Declaration of Trust or its By-Laws. Shareholders may remove Trustees from
office by votes cast at a special meeting of shareholders. If requested by the
shareholders of at least 10% of the outstanding shares of the Trust, the
Trustees will call a special meeting of shareholders to vote on the removal of a
Trustee and will assist in communications with other shareholders.
Fund Expenses
- -------------
Expenses of the Trust generally will be allocated equally among the shares of
each Fund. Each Fund pays all of its own expenses. These expenses include
organizational costs, expenses for legal and auditing services, financial
accounting services, preparing (including typesetting, printing and mailing)
reports, prospectuses and notices to its then-current shareholders, advisory and
management fees, fees and expenses of the custodian and transfer and dividend
disbursing agents, the distribution fee, the expense of issuing and redeeming
shares, the cost of registering shares under the Federal and state laws,
shareholder meeting and related proxy solicitation expenses, the fees and
out-of-pocket expenses of Trustees who are not affiliated with the Adviser,
insurance, brokerage costs, litigation, and other expenses properly payable by
the Funds.
- 31 -
<PAGE>
Classification of the Funds
- ---------------------------
Each Fund (other than the Money Market Fund) is a "non-diversified" series of
the Trust pursuant to the 1940 Act. A Fund is considered "non-diversified"
because a relatively high percentage of its assets may be invested the
securities of a limited number of issuers, primarily within same the industry or
economic sector. A non-diversified Fund's portfolio securities, therefore, may
be more susceptible to any single economic, political, or regulatory occurrence
than the portfolio securities of a diversified investment company.
A Fund's classification as a "non-diversified" investment company means that the
proportion of its assets that may be invested in the securities of a single
issuer is not limited by the 1940 Act. Each Fund, however, intends to qualify as
a RIC. This requires, among other things, that each Fund, at the end of each
quarter of its tax year, meet certain diversification standards.
Concentration of Investments
- ----------------------------
The OTC Plus Fund and the OTC/Short Fund generally do not intend to concentrate
more than 25% of their respective investments in a particular industry. However,
because these Funds seek investment results that correspond to 125% and the
inverse, respectively, of the performance of the Nasdaq Index, the Funds may
invest more than 25% of their assets in securities of issuers in one industry.
When a Fund concentrates its investments in an industry, financial, economic,
business and other developments affecting issuers in that industry will have a
greater effect on the Fund than if the Fund had not concentrated its assets in
that industry. Accordingly, the performance of these Funds may be subject to a
greater risk of market fluctuation than that of a fund invested in a wider
spectrum of industries.
Distribution of Fund Shares
- ---------------------------
The Funds have adopted a distribution plan (the "Plan") pursuant to Rule 12b-1
under the 1940 Act. The Plan provides that each Fund will compensate the
Distributor for certain expenses incurred in the distribution of that Fund's
shares and the servicing and maintenance of existing Fund shareholder accounts.
However, the Trustees have not authorized payment of any fees pursuant to the
Plan.
Master/Feeder Option
- --------------------
The Trust may in the future seek to achieve a Fund's investment objective by
investing all net assets of that Fund ("Feeder Fund") in another investment
company ("Master Fund") having the same investment objective and substantially
the same investment policies and restrictions as those applicable to the Feeder
Fund. It is expected than any such investment company would be managed by the
Adviser in substantially the same manner as the Feeder Fund. If permitted by
applicable laws and policies then in effect, any such investment may be made in
the sole discretion of the Trustees without further approval of shareholders of
the Funds. However, the Funds' shareholders will be given 30 days' prior notice
of any such investment. Such investment would be made only if the Trustees
determine it to be in the best interests of the Funds and their shareholders. In
making that determination, the Trustees will consider, among other things, the
benefits to shareholders and/or the opportunity to reduce costs and achieve
operational efficiencies. No assurance can be given that costs will be
materially reduced if this option is implemented.
Shareholder Inquiries
- ---------------------
Shareholder inquiries can be made by telephone to the Trust at (800) ___-_____
or by mail to ____________________.
- 32 -
<PAGE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS, OR IN THE SAI INCORPORATED
HEREIN BY REFERENCE, IN CONNECTION WITH THE OFFERING MADE BY THIS PROSPECTUS
AND, IF GIVEN OR MADE, SUCH INFORMATION OR PRESENTATIONS MUST NOT BE RELIED UPON
AS HAVING BEEN AUTHORIZED BY THE TRUST. THIS PROSPECTUS DOES NOT CONSTITUTE AN
OFFERING BY THE TRUST IN ANY JURISDICTION IN WHICH SUCH AN OFFERING MAY NOT
LAWFULLY BE MADE
- 33 -
<PAGE>
SUBJECT TO COMPLETION: DATED __________ __, 1997
Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor may
offers to buy be accepted prior to the time the registration statement becomes
effective. This statement of additional information shall not constitute an
offer to sell or the solicitation of an offer to buy nor shall there be any sale
of these securities in any State in which such offer, solicitation or sale would
be unlawful prior to registration or qualification under the securities laws of
any such State.
POTOMAC FUNDS
STATEMENT OF ADDITIONAL INFORMATION
550 Mamaroneck Avenue
Harrison, NY 10528
(800)xxx-xxxx
(914)xxx-xxxx
The Potomac Funds (the "Trust") is a no-load management investment company, or
mutual fund, which consists of seven separate investment portfolios (the
"Funds"). The Funds are principally designed for experienced investors who
intend to follow a global asset allocation strategy. An important feature of the
Trust is that it primarily consists of pairs of Funds, one of which attempts to
provide results correlating to a specific index, while the other attempts to
provide inverse performance, that is, similar to a short position in the
specific index. In particular, the following Funds seek investment results that
correspond over time to the following benchmarks:
FUND BENCHMARK
- ---- ---------
Potomac Japan/Long Fund Nikkei 225 Stock Average
Potomac Japan/Short Fund Inverse (opposite) of the Nikkei 225 Stock Average
Potomac U.S. Plus Fund 150% of the performance of the Standard & Poor's
500 Composite Stock Price Index(Trademark)
Potomac U.S./Short Fund Inverse (opposite) of the Standard & Poor's 500
Composite Stock Price Index(Trademark)
Potomac OTC Plus Fund 125% of the performance of the Nasdaq 100 Stock
Index(Trademark)
Potomac OTC/Short Fund Inverse (opposite) of the Nasdaq 100 Stock
Index(Trademark)
The Trust also offers the Potomac U.S. Government Money Market Fund, which seeks
security of principal, current income and liquidity by investing primarily in
money market instruments issued or guaranteed, as to principal and interest, by
the U.S. Government, its agencies or instrumentalities. THE FUND SEEKS TO
MAINTAIN A CONSTANT $1.00 NET ASSET VALUE PER SHARE, ALTHOUGH THIS CANNOT BE
ASSURED. SHARES OF THIS FUND ARE NOT DEPOSITS OR OBLIGATIONS, OR GUARANTEED OR
ENDORSED BY, THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE
BOARD OR ANY OTHER AGENCY. AN INVESTMENT IN THIS FUND IS NEITHER INSURED NOR
GUARANTEED BY THE UNITED STATES GOVERNMENT.
This Statement of Additional Information is not a prospectus. It should be read
in conjunction with the Trust's Prospectus dated ________ __, 1997. A copy of
the Prospectus is available, without charge, upon request to the Trust at the
address or telephone numbers above.
Statement of Additional Information dated _______ __, 1997
<PAGE>
TABLE OF CONTENTS
Page
----
THE POTOMAC FUNDS
INVESTMENT POLICIES AND TECHNIQUES
INVESTMENT RESTRICTIONS
PORTFOLIO TRANSATIONS AND BROKERAGE
MANAGEMENT OF THE TRUST
PRINCIPAL HOLDERS OF SECURITIES
DETERMINATION OF NET ASSET VALUE
PERFORMANCE INFORMATION
DIVIDENDS, OTHER DISTRIBUTIONS AND TAXES
CUSTODIAN AND AUDITORS
2
<PAGE>
THE POTOMAC FUNDS
The Trust is a Massachusetts business trust organized on June 6, 1997 and is
registered with the Securities and Exchange Commission ("SEC") as an open-end
management investment company under the Investment Company Act of 1940, as
amended ("1940 Act"). The Trust currently consists of seven separate series: the
Potomac Japan/Long Fund ("Japan/Long Fund"), the Potomac Japan/Short Fund
("Japan/Short Fund"), the Potomac U.S. Plus Fund ("U.S. Plus Fund"), the Potomac
U.S./Short Fund ("U.S. Short Fund"), the Potomac OTC Plus Fund ("OTC Plus
Fund"), the Potomac OTC/Short Fund ("OTC/Short Fund") and the Potomac U.S.
Government Money Market Fund ("Money Market Fund") (collectively, the "Funds").
The Trust may offer additional series in the future.
The Funds principally are designed for experienced investors seeking a global
asset allocation vehicle. Except for the Money Market Fund, each Fund provides
investment exposure to various securities markets. Each Fund seeks investment
results that correspond over time to a specific benchmark. The Funds may be used
independently or in combination with each other as part of an overall strategy.
INVESTMENT POLICIES AND TECHNIQUES
General
- -------
The following information supplements the discussion in the Prospectus of the
investment objective, policies and limitations of each Fund. Please refer to the
sections entitled "Investment Objectives and Policies" and "Investment
Techniques and Other Investment Policies" in the Prospectus for a discussion of
the investment objectives and policies of the Funds. Rafferty Asset Management,
Inc. (the "Adviser") serves as each Fund's investment adviser. Capitalized terms
not otherwise defined herein shall have the same meaning as assigned in the
Prospectus.
The Funds may engage in the investment strategies discussed below. There is no
assurance that any of these strategies or any other strategies and methods of
investment available to a Fund will result in the achievement of the Fund's
objectives.
Options, Futures and Other Strategies
- -------------------------------------
GENERAL. As discussed in the Prospectus, each Fund (other than the Money Market
Fund) may use certain options, futures contracts (sometimes referred to as
"futures"), options on futures contracts, forward currency contracts, swaps,
caps, floors and collars (collectively "Financial Instruments") as a substitute
for a comparable market position in the underlying security or currency, to
attempt to hedge or limit the exposure of a Fund's position, to create a
synthetic money market position, for certain tax-related purposes and to effect
closing transactions. Each of the Japan/Long Fund and the Japan/Short Fund also
may purchase and sell Financial Instruments on Japanese Yen to attempt to
eliminate the effect that fluctuations in the U.S. Dollar/Japanese Yen exchange
rate may have on each Fund's net asset value per share.
The use of Financial Instruments is subject to applicable regulations of the
SEC, the several exchanges upon which they are traded and the Commodity Futures
3
<PAGE>
Trading Commission (the "CFTC"). In addition, a Fund's ability to use Financial
Instruments will be limited by tax considerations. See "Dividends, Distributions
and Taxes."
In addition to the instruments, strategies and risks described below and in the
Prospectus, the Adviser may discover additional opportunities in connection with
Financial Instruments and other similar or related techniques. These new
opportunities may become available as the Adviser develops new techniques, as
regulatory authorities broaden the range of permitted transactions and as new
Financial Instruments or other techniques are developed. The Adviser may utilize
these opportunities to the extent that they are consistent with a Fund's
investment objective and permitted by a Fund's investment limitations and
applicable regulatory authorities. The Funds' Prospectus or SAI will be
supplemented to the extent that new products or techniques involve materially
different risks than those described below or in the Prospectus.
SPECIAL RISKS. The use of Financial Instruments involves special considerations
and risks, certain of which are described below. Risks pertaining to particular
Financial Instruments are described in the sections that follow.
(1) Successful use of most Financial Instruments depends upon the Adviser's
ability to predict movements of the overall securities and currency markets,
which requires different skills than predicting changes in the prices of
individual securities. There can be no assurance that any particular strategy
will succeed.
(2) Options and futures prices can diverge from the prices of their underlying
instruments. Options and futures prices are affected by such factors as current
and anticipated short-term interest rates, changes in volatility of the
underlying instrument and the time remaining until expiration of the contract,
which may not affect security prices the same way. Imperfect correlation may
also result from differing levels of demand in the options and futures markets
and the securities markets, from structural differences in how options and
futures and securities are traded, and from imposition of daily price
fluctuation limits or trading halts.
(3) As described below, a Fund might be required to maintain assets as "cover,"
maintain segregated accounts or make margin payments when it takes positions in
Financial Instruments involving obligations to third parties (e.g., Financial
Instruments other than purchased options). If a Fund were unable to close out
its positions in such Financial Instruments, it might be required to continue to
maintain such assets or accounts or make such payments until the position
expired or matured. These requirements might impair a 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 a Fund sell a portfolio security at a
disadvantageous time. A Fund's ability to close out a position in a Financial
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 the other party to the transaction (the "counterparty") 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 a
Fund.
COVER. Transactions using Financial Instruments, other than purchased options,
expose a Fund to an obligation to another party. A Fund will not enter into any
such transactions unless it owns either (1) an offsetting ("covered") position
in securities, currencies or other options, futures contracts or forward
4
<PAGE>
currency contracts, or (2) cash and liquid assets with a value, marked-to-market
daily, sufficient to cover its potential obligations to the extent not covered
as provided in (1) above. Each Fund will comply with SEC guidelines regarding
cover for these instruments and will, if the guidelines so require, set aside
cash or liquid assets in an account with its custodian in the prescribed amount
as determined daily.
Assets used as cover or held in an account cannot be sold while the position in
the corresponding Financial Instrument is open, unless they are replaced with
other appropriate assets. As a result, the commitment of a large portion of a
Fund's assets to cover or accounts could impede portfolio management or the
Fund's ability to meet redemption requests or other current obligations.
OPTIONS. The value of an option position will reflect, among other things, the
current market value of the underlying investment, the time remaining until
expiration, the relationship of the exercise price to the market price of the
underlying investment and general market conditions. Options that expire
unexercised have no value.
A Fund may effectively terminate its right or obligation under an option by
entering into a closing transaction. For example, a 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, a 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 a Fund to realize profits or limit
losses on an option position prior to its exercise or expiration.
RISKS OF OPTIONS ON SECURITIES. Exchange-traded options in the United States are
issued by a clearing organization affiliated with the exchange on which the
option is listed that, in effect, guarantees completion of every exchange-traded
option transaction. In contrast, over-the-counter ("OTC") options are contracts
between a Fund and its counterparty (usually a securities dealer or a bank) with
no clearing organization guarantee. Thus, when a Fund purchases an OTC option,
it relies on the counterparty from whom it purchased the option to make or take
delivery of the underlying investment upon exercise of the option. Failure by
the counterparty 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.
A Fund's ability to establish and close out positions in exchange-traded options
depends on the existence of a liquid 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 counterparty, or
by a transaction in the secondary market if any such market exists. There can be
no assurance that a Fund will in fact be liable to close out an OTC option
position at a favorable price prior to expiration. In the event of insolvency of
the counterparty, a Fund might be unable to close out an OTC option position at
any time prior to its expiration.
If a 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 call option
written by a 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.
5
<PAGE>
OPTIONS ON INDICES. Puts and calls on indices are similar to puts and calls on
securities or futures contracts except that all settlements are in cash and gain
or loss depends on changes in the index in question rather than on price
movements in individual securities or futures contracts. When a Fund writes a
call on an index, it receives a premium and agrees that, prior to the expiration
date, the purchaser of the call, upon exercise of the call, will receive from
the Fund an amount of cash if the closing level of the index upon which the call
is based is greater than the exercise price of the call. The amount of cash is
equal to the difference between the closing price of the index and the exercise
price of the call times a specified multiple ("multiplier"), which determines
the total value for each point of such difference. When a Fund buys a call on an
index, it pays a premium and has the same rights as to such call as are
indicated above. When a Fund buys a put on an index, it pays a premium and has
the right, prior to the expiration date, to require the seller of the put, upon
the Fund's exercise of the put, to deliver to the Fund an amount of cash if the
closing level of the index upon which the put is based is less than the exercise
price of the put, which amount of cash is determined by the multiplier, as
described above for calls. When a Fund writes a put on an index, it receives a
premium and the purchaser of the put has the right, prior to the expiration
date, to require the Fund to deliver to it an amount of cash equal to the
difference between the closing level of the index and the exercise price times
the multiplier if the closing level is less than the exercise price.
RISKS OF OPTIONS ON INDICES. If a Fund has purchased an index option and
exercises it before the closing index value for that day is available, it runs
the risk that the level of the underlying index may subsequently change. If such
a change causes the exercised option to fall out-of-the-money, the Fund will be
required to pay the difference between the closing index value and the exercise
price of the option (times the applicable multiplier) to the assigned writer.
OTC OPTIONS. Unlike exchange-traded options, which are standardized with respect
to the underlying instrument, expiration date, contract size and strike price,
the terms OTC options (options not traded on exchanges) generally are
established through negotiation with the other party to the option contract.
While this type of arrangement allows a Fund great flexibility to tailor the
option to its needs, OTC options generally involve greater risk than
exchange-traded options, which are guaranteed by the clearing organization of
the exchanges where they are traded.
Generally, OTC foreign currency options used by the Japan/Long Fund and the
Japan/Short 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.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS. No price is paid upon
entering into a futures contract. Instead, at the inception of a futures
contract a Fund is required to deposit "initial margin" in an amount generally
equal to 10% or less of the contract value. Margin must also be deposited when
writing a call or put option on a futures contract, in accordance with
applicable exchange rules. Unlike margin in securities transactions, initial
margin 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.
6
<PAGE>
Subsequent "variation margin" payments are made to and from the futures
commission merchant 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 commission merchant. When a Fund purchases an option on a futures
contract, the premium paid plus transaction costs is all that is at risk. In
contrast, when a Fund purchases or sells a futures contract or writes a call or
put 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.
Purchasers and sellers of futures contracts and options on futures can enter
into offsetting closing transactions, similar to closing transactions in
options, by selling or purchasing, respectively, an instrument identical to the
instrument purchased or sold. Positions in futures and options on futures
contracts may be closed only on an exchange or board of trade that provides a
secondary market. However, there can be no assurance that a liquid secondary
market will exist for a particular contract at a particular time. In such event,
it may not be possible to close a futures contract or options position.
Under certain circumstances, futures exchanges may establish daily limits on the
amount that the price of a futures contract or an option on a futures contract
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 a Fund were unable to liquidate a futures contract or an option on a futures
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 cash or liquid
assets in an account.
RISKS OF FUTURES CONTRACTS AND OPTIONS THEREON. The ordinary spreads between
prices in the cash and futures markets (including the options on futures
market), due to differences in the natures of those markets, are subject to the
following factors, which may create distortions. First, all participants in the
futures market are subject to margin deposit and maintenance requirements.
Rather than meeting additional margin deposit requirements, investors may close
futures contracts through offsetting transactions, which could distort the
normal relationships between the cash and futures markets. Second, the liquidity
of the futures market depends on participants entering into offsetting
transactions rather than making or taking delivery. To the extent participants
decide to make or take delivery, liquidity in the futures market could be
reduced, thus producing distortion. Third, from the point of view of
speculators, the deposit requirements in the futures market are less onerous
than margin requirements in the securities market. Therefore, increased
participation by speculators in the futures market may cause temporary price
distortions.
FOREIGN CURRENCY STRATEGIES - SPECIAL CONSIDERATIONS. The Japan/Long Fund and
the Japan/Short Fund may use options and futures contracts on Japanese Yen, as
7
<PAGE>
described above, and forward contracts, swaps, caps, floors and collars on
Japanese Yen, as described below.
The value of Financial Instruments on foreign currencies depends on the value of
the underlying currency relative to the U.S. Dollar. Because foreign currency
transactions occurring in the interbank market might involve substantially
larger amounts than those involved in the use of such Financial Instruments, a
Fund could be disadvantaged by having to deal in the odd lot market (generally
consisting of transactions of less than $1 million) for the underlying foreign
currencies at prices that are less favorable than for round lots.
There is no systematic reporting of last sale information for foreign currencies
or any regulatory requirement that quotations available through dealers or other
market sources be firm or revised on a timely basis. Quotation information
generally is representative of very large transactions in the interbank market
and thus might not reflect odd-lot transactions where rates might be less
favorable. The interbank market in foreign currencies is a global,
round-the-clock market. To the extent the U.S. options or futures markets are
closed while the markets for the underlying currencies remain open, significant
price and rate movements might take place in the underlying markets that cannot
be reflected in the markets for the Financial Instruments until they reopen.
Settlement of transactions involving foreign currencies might be required to
take place within the country issuing the underlying currency. Thus, a Fund
might be required to accept or make delivery of the underlying foreign currency
in accordance with any U.S. or foreign regulations regarding the maintenance of
foreign banking arrangements by U.S. residents and might be required to pay any
fees, taxes and charges associated with such delivery assessed in the issuing
country.
FORWARD CURRENCY CONTRACTS. The Japan/Long Fund and the Japan/Short Fund may
enter into forward currency contracts to purchase or sell Japanese Yen for a
fixed amount of U.S. Dollars. A forward currency contract involves an obligation
to purchase or sell a specific currency at a future date, which may by any fixed
number of days (term) from the date of the forward currency contract agreed upon
by the parties, at a price set at the time of the forward currency contract.
These forward currency contracts are traded directly between currency traders
(usually large commercial banks) and their customers.
The cost to a Fund of engaging in forward currency contracts varies with factors
such as the currency involved, the length of the contract period and the market
conditions then prevailing. Because forward currency contracts are usually
entered into on a principal basis, no fees or commissions are involved. When a
Fund enters into a forward currency contract, it relies on the counterparty to
make or take delivery of the underlying currency at the maturity of the
contract. Failure by the counterparty to do so would result in the loss of any
expected benefit of the transaction.
As is the case with futures contracts, purchasers and sellers of forward
currency contracts can enter into offsetting closing transactions, similar to
closing transactions on futures contracts, by selling or purchasing,
respectively, an instrument identical to the instrument purchased or sold.
Secondary markets generally do not exist for forward currency contracts, with
the result that closing transactions generally can be made for forward currency
8
<PAGE>
contracts only by negotiating directly with the counterparty. Thus, there can be
no assurance that a Fund will in fact be able to close out a forward currency
contract at a favorable price prior to maturity. In addition, in the event of
insolvency of the counterparty, a Fund might be unable to close out a forward
currency contract at any time prior to maturity. In either event, the Fund would
continue to be subject to market risk with respect to the position, and would
continue to be required to maintain a position in securities denominated in the
foreign currency or to maintain cash or liquid assets in a segregated account.
The precise matching of forward currency contract amounts and the value of the
securities involved generally will not be possible because the value of such
securities, measured in the foreign currency, will change after the forward
currency contract has been established. Thus, a Fund might need to purchase or
sell foreign currencies in the spot (cash) market to the extent such foreign
currencies are not covered by forward currency contracts.
COMBINED POSITIONS. A Fund may purchase and write options in combination with
each other, or in combination with futures or forward currency contracts. For
example, a Fund may purchase a put option and write a call option on the same
underlying instrument, in order to construct a combined position whose risk and
return characteristics are similar to selling a futures contract. Another
possible combined position would involve writing a call option at one strike
price and buying a call option at a lower price, in order to reduce the risk of
the written call option in the event of a substantial price increase. Because
combined options positions involve multiple trades, they result in higher
transaction costs and may be more difficult to open and close out.
SWAPS, CAPS, FLOORS AND COLLARS. Swap agreements, including caps, floors and
collars, can be individually negotiated and structured. Swap agreements will
tend to shift a Fund's investment exposure from one type of investment to
another. For example, if a Fund agrees to exchange payments based on a floating
rate of interest for payments based on a specified stock index, the swap
agreement would tend to decrease the Fund's exposure to U.S. interest rates and
increase its exposure to changes in the value of the index. Caps and floors have
an effect similar to buying or writing options.
The creditworthiness of firms with which a Fund enters into swaps, caps, floors
or collars will be monitored by the Adviser in accordance with procedures
adopted by the Trust's Board of Trustees ("Trustees" or the "Board"). If a
default occurs by the other party to such transaction, a Fund will have
contractual remedies pursuant to the agreements related to the transaction.
The net amount of the excess, if any, of a Fund's obligations over its
entitlements with respect to each swap entered into on a net basis will be
accrued on a daily basis and an amount of cash or liquid assets having an
aggregate net asset value at least equal to the accrued excess will be
maintained in an account with the Fund's custodian that satisfies the
requirements of the 1940 Act. Each Fund will also establish and maintain such
account with respect to its total obligations under any swaps that are not
entered into on a net basis and with respect to any caps or floors that are
written by the Fund. The Adviser and the Funds believe that such obligations do
not constitute senior securities under the 1940 Act and, accordingly, will not
treat them as being subject to a Fund's borrowing restrictions.
U.S. Government Securities
- --------------------------
Securities issued or guaranteed by the U.S. Government or its agencies or
instrumentalities ("U.S. Government Securities") include Treasury Bills (which
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<PAGE>
mature within one year of the date they are issued), Treasury Notes (which have
maturities of one to ten years) and Treasury Bonds (which generally have
maturities of more than 10 years). All such Treasury securities are backed by
the full faith and credit of the United States.
U.S. Government agencies and instrumentalities that issue or guarantee
securities include, but are not limited to, the Federal Housing Administration,
Fannie Mae (formerly, the Federal National Mortgage Association), the Farmers
Home Administration, the Export-Import Bank of the United States, the Small
Business Administration, the Government National Mortgage Association ("Ginnie
Mae"), the General Services Administration, the Central Bank for Cooperatives,
the Federal Home Loan Banks, the Federal Home Loan Mortgage Corporation
("Freddie Mac"), the Farm Credit Banks, the Maritime Administration, the
Tennessee Valley Authority, the Resolution Funding Corporation and the Student
Loan Marketing Association.
Securities issued or guaranteed by U.S. Government agencies and
instrumentalities are not always supported by the full faith and credit of the
United States. Some, such as securities issued by the Federal Home Loan Banks,
are backed by the right of the agency or instrumentality to borrow from the
Treasury. Others, such as securities issued by Fannie Mae, are supported only by
the credit of the instrumentality and by a pool of mortgage assets. If the
securities are not backed by the full faith and credit of the United States, the
owner of the securities must look principally to the agency issuing the
obligation for repayment and may not be able to assert a claim against the
United States in the event that the agency or instrumentality does not meet its
commitment. The Money Market Fund will invest in securities of agencies and
instrumentalities only if the Adviser is satisfied that the credit risk involved
is acceptable.
Indexed Securities
- ------------------
Each Fund (other than the Money Market Fund) may purchase securities the value
of which varies in relation to the value of other securities, securities
indices, currencies or other financial indicators, consistent with its
investment objective. Indexed securities typically, but not always, are debt
securities or deposits whose value at maturity or coupon rate is determined by
reference to a specific instrument or statistic. Currency-indexed securities
typically are short-term to intermediate-term debt securities whose maturity
values or interest rates are determined by reference to the values of one more
specified foreign currencies, and may offer higher yields than U.S.
Dollar-denominated securities of equivalent issuers. Currency-indexed securities
may be positively or negatively indexed; that is, their maturity value may
increase when the value of a specified foreign currency increases, resulting in
a security that performs similarly to a foreign-denominated instrument, or their
maturity value may decline when the value of a specified foreign currency
increases, resulting in a security whose price characteristics are similar to a
put on the underlying currency.
Recent issuers of indexed securities have included banks, corporations and
certain U.S. Government agencies. Certain indexed securities that are not traded
on an established market may be deemed illiquid. See "Illiquid Investments and
Restricted Securities."
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American Depository Receipts ("ADRs")
- -------------------------------------
ADRs include ordinary shares and New York shares. ADRs may be purchased through
"sponsored" or "unsponsored" facilities. A sponsored facility is established
jointly by the issuer of the underlying security and a depository, whereas a
depository may establish an unsponsored facility without participation by the
issuer of the depository security. Holders of unsponsored depository receipts
generally bear all the costs of such facilities and the depository of an
unsponsored facility frequently is under no obligation to distribute shareholder
communications received from the issuer of the deposited security or to pass
through voting rights to the holders of such receipts of the deposited
securities. ADRs are not necessarily denominated in the same currency as the
underlying securities to which they may be connected. Generally, ADRs in
registered form are designed for use in the U.S. securities market and ADRs in
bearer form are designed for used outside the United States.
Repurchase Agreements
- ---------------------
Each Fund may enter into repurchase agreements with banks that are members of
the Federal Reserve System or securities dealers who are members of a national
securities exchange or are primary dealers in U.S. Government Securities.
Repurchase agreements generally are for a short period of time, usually less
than a week. Repurchase agreements with a maturity of more than seven days are
considered to be illiquid investments. No Fund may enter into such a repurchase
agreement if, as a result, more than 15% (10% in the case of the Money Market
Fund) of the value of its net assets would then be invested in such repurchase
agreements and other illiquid investments. See "Illiquid Investments and
Restricted Securities."
Each Fund follows certain procedures and guidelines adopted by the Trustees
designed to minimize the risks inherent in such transactions. These procedures
include effecting repurchase transactions only with large, well-capitalized and
well-established institutions whose financial condition will be monitored by the
Adviser. In addition, each Fund will always receive, as collateral, securities
whose market value, including accrued interest, at all times will be at least
equal to 100% of the dollar amount invested by the Fund in each repurchase
agreement. If the seller defaults, a Fund might incur a loss if the value of the
collateral securing the repurchase agreement declines and might incur
disposition costs in connection with liquidating the collateral. In addition, if
bankruptcy or similar proceedings are commenced with respect to the seller of
the security, realization upon the collateral by a Fund may be delayed or
limited.
Borrowing
- ---------
The U.S. Plus Fund and the OTC Plus Fund may borrow money for investment
purposes. Each Fund may borrow money as a temporary measure for extraordinary or
emergency purposes and to meet redemption requests without immediately selling
portfolio securities.
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U.S. PLUS FUND AND OTC PLUS FUND. Borrowing for investment in known as
leveraging. Leveraging investments, by purchasing securities with borrowed
money, is a speculative technique that increases investment risk while
increasing investment opportunity. Leverage may exaggerate changes in a Fund's
net asset value. Although the principal of such borrowings will be fixed, a
Fund's assets may change in value during the time the borrowing is outstanding.
Leverage also creates interest expenses for a Fund. To the extent the income
derived from securities purchased with borrowed funds exceeds the interest a
Fund will have to pay, that Fund's net income will be greater than it would be
if leverage were not used. Conversely, if the income from the assets obtained
with borrowed funds is not sufficient to cover the cost of leveraging, the net
income of a Fund will be less than it would be if leverage were not used, and
therefore the amount available for distribution to shareholders as dividends
will be reduced.
ALL FUNDS. Each Fund may borrow money to facilitate management of the Fund's
portfolio by enabling the Fund to meet redemption requests when the liquidation
of portfolio instrument would be inconvenient or disadvantageous. Such borrowing
is not for investment purposes and will be repaid by the borrowing Fund
promptly.
As required by the 1940 Act, a Fund must maintain continuous asset coverage
(total assets, including assets acquired with borrowed funds, less liabilities
exclusive of borrowings) of 300% of all amounts borrowed. If at any time the
value of the required asset coverage declines as a result of market fluctuations
or other reasons, a Fund may be required to sell some of its portfolio
investments within three days to reduce the amount of its borrowings and restore
the 300% asset coverage, even though it may be disadvantageous from an
investment standpoint to sell portfolio instruments at that time.
In addition to the foregoing, each Fund may borrow money from a bank as a
temporary measure for extraordinary or emergency purposes in amounts not in
excess of 5% of the value of its total assets. This borrowing is not subject to
the foregoing 300% asset coverage requirement. Each Fund may pledge portfolio
securities as the Adviser deems appropriate in connection with any borrowings.
Lending Portfolio Securities
- ----------------------------
Each Fund may lend portfolio securities with a value not exceeding 33 1/3% (10%
in the case of the Money Market Fund) of its total assets to brokers, dealers,
and financial institutions. Borrowers are required continuously to secure their
obligations to return securities on loan from a Fund by depositing cash
collateral with the Fund. The collateral must be equal to at least 100% of the
market value of the loaned securities, which will be marked to market daily.
While a Fund's portfolio securities are on loan, the Fund continues to receive
interest on the securities loaned and simultaneously earns either interest on
the investment of the cash collateral or fee income if the loan is otherwise
collateralized. The Fund may invest the interest received and the cash
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<PAGE>
collateral, thereby earning additional income. Loans would be subject to
termination by the lending Fund on four business days' notice or by the borrower
on one day's notice. Borrowed securities must be returned when the loan is
terminated. Any gain or loss in the market price of the borrowed securities that
occurs during the term of the loan inures to the lending Fund and that Fund's
shareholders. A lending Fund may pay reasonable finders, borrowers,
administrative and custodial fees in connection with a loan. Each Fund currently
has no intention of lending its portfolio securities.
Investments in Other Investment Companies
- -----------------------------------------
Each Fund may invest in the securities of other investment companies to the
extent that such an investment would be consistent with the requirements of the
1940 Act. Investments in the securities of other investment companies may
involve duplication of advisory fees and certain other expenses. By investing in
another investment company, a Fund becomes a shareholder of that investment
company. As a result, Fund shareholders indirectly will bear a Fund's
proportionate share of the fees and expenses paid by shareholders of the other
investment company, in addition to the fees and expenses Fund shareholders
directly bear in connection with the Fund's own operations.
Illiquid Investments and Restricted Securities
- ----------------------------------------------
Each Fund will not purchase or otherwise acquire any security if, as a result,
more than 15% (10% for the Money Market Fund) of its net assets (taken at
current value) would be invested in investments that are illiquid by virtue of
the absence of a readily available market or legal or contractual restrictions
on resale. This policy does not include restricted securities eligible for
resale pursuant to Rule 144A under the Securities Act of 1933, as amended ("1933
Act"), which the Board or the Adviser has determined under Board-approved
guidelines are liquid. None of the Funds, however, currently anticipates
investing in such restricted securities.
The term "illiquid investments" for this purpose means investments that cannot
be disposed of within seven days in the ordinary course of business at
approximately the amount at which a Fund has valued the investments. Investments
currently considered to be illiquid include: (1) repurchase agreements not
terminable within seven days, (2) securities for which market quotations are not
readily available, (3) OTC options and their underlying collateral, (4) bank
deposits, unless they are payable at principal amount plus accrued interest on
demand or within seven days after demand, (5) restricted securities not
determined to be liquid pursuant to guidelines established by the Board, and (6)
securities involved in swap, cap, floor and collar transactions. The assets used
as cover for OTC options written by a 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.
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A Fund may not be able to sell illiquid investments when the Adviser considers
it desirable to do so or may have to sell such investments at a price that is
lower than the price that could be obtained if the investments were liquid. In
addition, the sale of illiquid investments may require more time and result in
higher dealer discounts and other selling expenses than does the sale of
investments that are not illiquid. Illiquid investments also may be more
difficult to value due to the unavailability of reliable market quotations for
such investments, and investment in illiquid investments may have an adverse
impact on net asset value.
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 that have
developed as a result of Rule 144A provide both readily ascertainable values for
certain restricted securities and the ability to liquidate an investment satisfy
share redemption orders. An insufficient number of qualified institutional
buyers interested in purchasing Rule 144-eligible securities held by a Fund,
however, could affect adversely the marketability of such portfolio securities
and a Fund may be unable to dispose of such securities promptly or at reasonable
prices.
Portfolio Turnover
- ------------------
As discussed in the Prospectus, the Trust anticipates that investors in the
Funds, as part of an asset allocation investment strategy, frequently will
redeem Fund shares, as well as exchange their Fund shares for shares of other
Funds. A Fund may have to dispose of certain portfolio investments to maintain
sufficient liquid assets to meet such redemption and exchange requests, thereby
causing a high portfolio turnover.
A Fund's portfolio turnover rate is calculated by the value of the securities
purchased or securities sold, excluding all securities whose maturities at the
time of acquisition were one year or less, divided by the average monthly value
of such securities owned during the year. Based on this calculation, instruments
with remaining maturities of less than one year are excluded from the portfolio
turnover rate. Such instruments generally would include futures contracts and
options, since such contracts generally have a remaining maturity of less than
one year. In any given period, all of a Fund's investments may have a remaining
maturity of less than one year; in which case, the portfolio turnover rate for
that period would be equal to zero. However, each Fund's portfolio turnover
rate, except for the Money Market Fund, calculated with all securities whose
maturities were one year or less is anticipated to be unusually high.
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<PAGE>
INVESTMENT RESTRICTIONS
In addition to the investment policies and limitations described above and
described in the Prospectus, each Fund has adopted the following investment
limitations, which are fundamental policies and may not be changed without the
vote of a majority of the outstanding voting securities of that Fund. Under the
1940 Act, a "vote of the majority of the outstanding voting securities" of a
Fund means the affirmative vote of the lesser of: (1) more than 50% of the
outstanding shares of a Fund or (2) 67% or more of the shares of a Fund present
at a shareholders meeting if more than 50% of the outstanding shares are
represented at the meeting in person or by proxy.
For purposes of the following limitations, all percentage limitations apply
immediately after a purchase or initial investment. Except with respect to
borrowing money, if a percentage limitation is adhered to at the time of the
investment, a later increase or decrease in the percentage resulting from any
change in value or net assets will not result in a violation of such
restrictions. If at any time a Fund's borrowings exceed its limitations due to a
decline in net assets, such borrowings will be reduced promptly to the extent
necessary to comply with the limitation.
EACH FUND HAS ADOPTED THE FOLLOWING FUNDAMENTAL INVESTMENT POLICY that enables
it to invest in another investment company or series thereof that has
substantially similar investment objectives and policies:
Notwithstanding any other limitation, the Fund may invest all of its
investable assets in an open-end management investment company with
substantially the same investment objectives, policies and limitations
as the Fund. For this purpose, "all of the Fund's investable assets"
means that the only investment securities that will be held by the Fund
will be the Fund's interest in the investment company.
EACH FUND, EXCEPT THE MONEY MARKET FUND, HAS ADOPTED THE FOLLOWING INVESTMENT
LIMITATIONS:
A Fund shall not:
1. Lend any security or make any other loan if, as a result, more than 33 1/3%
of the value of the Fund's total assets would be lent to other parties,
except (1) through the purchase of a portion of an issue of debt securities
in accordance with the Fund's investment objective, policies and
limitations, or (2) by engaging in repurchase agreements with respect to
portfolio securities.
2. Underwrite securities of any other issuer.
3. Purchase, hold, or deal in real estate or oil and gas interests.
4. Issue any senior security (as such term is defined in Section 18(f) of the
1940 Act) (including the amount of senior securities issued by excluding
liabilities and indebtedness not constituting senior securities), except
(1) that the Fund may issue senior securities in connection with
transactions in options, futures, options on futures, forward contracts,
swaps, caps, floors, collars and other similar investments, (2) as
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<PAGE>
otherwise permitted herein and in Investment Limitations Nos. 5, 7, 8, and
(3) the Japan/Short Fund, the U.S./Short Fund and the OTC/Short Fund may
make short sales of securities.
5. Pledge, mortgage, or hypothecate the Fund's assets, except (1) to the
extent necessary to secure permitted borrowings, (2) in connection with the
purchase of securities on a forward-commitment or delayed-delivery basis or
the sale of securities on a delayed-delivery basis, and (3) in connection
with options, futures contracts, options on futures contracts, forward
contracts, swaps, caps, floors, collars and other financial instruments.
6. Invest in physical commodities, except that the Fund may purchase and sell
foreign currency, options, futures contracts, options on futures contracts,
forward contracts, swaps, caps, floors, collars, securities on a
forward-commitment or delayed-delivery basis, and other financial
instruments.
EACH FUND, EXCEPT THE U.S. PLUS FUND AND THE OTC PLUS FUND, HAS ADOPTED
THE FOLLOWING INVESTMENT LIMITATION:
A Fund shall not:
7. Borrow money, except (1) as a temporary measure for extraordinary or
emergency purposes and then only in amounts not to exceed 5% of the value
of the Fund's total assets, (2) in an amount up to 33 1/3% of the value of
the Fund's total assets, including the amount borrowed, in order to meet
redemption requests without immediately selling portfolio securities, (3)
to enter into reverse repurchase agreements, and (4) to lend portfolio
securities. For purposes of this investment limitation, the purchase or
sale of options, futures contracts, options on futures contracts, forward
contracts, swaps, caps, floors, collars and other financial instruments
shall not constitute borrowing.
THE JAPAN/LONG FUND, THE U.S PLUS FUND AND THE OTC PLUS FUND HAVE ADOPTED THE
FOLLOWING INVESTMENT LIMITATION:
A Fund shall not:
8. Make short sales of portfolio securities or purchase any portfolio
securities on margin but may make short sales "against the box," obtain
such short-term credits as are necessary for the clearance of transactions,
and make margin payments in connection with options, futures contracts,
options on futures contracts, forward contracts, swaps, caps, floors,
collars and other financial instruments.
THE U.S. PLUS FUND AND THE OTC PLUS FUND HAVE ADOPTED THE FOLLOWING INVESTMENT
LIMITATION:
A Fund shall not:
9. Borrow money, except (1) to the extent permitted under the 1940 Act (which
currently limits borrowing to no more than 33 1/3% of the value of the
Fund's total assets), (2) as a temporary measure and then only in amounts
not to exceed 5% of the value of the Fund's total assets, (3) to enter into
reverse repurchase agreements, and (4) to lend portfolio securities. For
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<PAGE>
purposes of this investment limitation, the purchase or sale of options,
futures contracts, options on futures contracts, forward contracts, swaps,
caps, floors, collars and other financial instruments shall not constitute
borrowing.
EACH FUND, EXCEPT THE OTC PLUS FUND AND THE OTC/SHORT FUND, HAS ADOPTED THE
FOLLOWING INVESTMENT LIMITATION:
A Fund shall not:
10. Invest more than 25% of the value of its total assets in the securities of
issuers in any single industry, provided that there shall be no limitation
on the purchase of obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities.
THE OTC PLUS FUND AND THE OTC/SHORT FUND HAVE ADOPTED THE FOLLOWING INVESTMENT
LIMITATION:
A Fund shall not:
11. Invest more than 25% of the value of its total assets in the securities of
issuers in any single industry, provided that there shall be no limitation
on the purchase of securities that are included in the Nasdaq Index and
provided further that there shall be no limitation on the purchase of
obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities.
THE MONEY MARKET FUND HAS ADOPTED THE FOLLOWING INVESTMENT LIMITATIONS:
The Money Market Fund shall not:
1. Make loans, except through the purchase of qualified debt obligations,
loans of portfolio securities and entry into repurchase agreements.
2. Lend the Fund's portfolio securities in excess of 15% of its total assets.
Any loans of the Fund's portfolio securities will be made according to
guidelines established by the Trustees, including the maintenance of cash
collateral of the borrower equal at all times to the current market value
of the securities loaned.
3. Issue senior securities, except as permitted by the Fund's investment
objective and policies.
4. Purchase or sell physical commodities; provided, however, that this
investment limitation does not prevent the Fund from purchasing and selling
options, futures contracts, options on futures contracts, forward
contracts, swaps, caps, floors, collars and other financial instruments.
5. Invest in securities of other investment companies, except to the extent
permitted under the 1940 Act.
6. Mortgage, pledge, or hypothecate the Money Market Fund's assets except to
secure permitted borrowings or in connection with options, futures
contracts, options on futures contracts, forward contracts, swaps, caps,
17
<PAGE>
floors, collars and other financial instruments. In those cases, the Money
Market Fund may mortgage, pledge, or hypothecate assets having a market
value not exceeding the lesser of the dollar amount borrowed or 15% of the
value of total assets of the Money Market Fund at the time of the
borrowing.
7. Make short sales of portfolio securities or purchase any portfolio
securities on margin, except to obtain such short-term credits as are
necessary for the clearance of purchases and sales of securities, provided,
however, that this investment limitation does not prevent the Fund from
purchasing and selling options, futures contracts, options on futures
contracts, forward contracts, swaps, caps, floors, collars and other
financial instruments.
Furthermore, each Fund has adopted the following additional investment
limitation. This limitation, together with certain limitations described in the
Prospectus, is not a fundamental investment limitation and may be changed by the
Trustees without shareholder approval.
Each Fund may not invest in real estate (including limited partnership
interests), securities secured by real estate or mortgage-related securities.
In addition, the Money Market Fund does not presently intend to purchase and
sell foreign currency, options, futures contracts, options on futures contracts,
forward contracts, swaps, caps, floors and collars.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to the general supervision by the Trustees, the Adviser is responsible
for decisions to buy and sell securities for each Fund, the selection of
brokers-dealers to effect the transactions, and the negotiation of brokerage
commissions, if any. The Adviser expects that the Funds may execute brokerage or
other agency transactions through registered broker-dealers, for a commission,
in conformity with the 1940 Act, the Securities Exchange Act of 1934, as
amended, and the rules and regulations thereunder.
In effecting portfolio transactions for the Funds, the Adviser seeks best
execution of trades either (1) at the most favorable price and efficient
execution of transactions, or (2) with respect to agency transactions, at a
higher rate of commission if reasonable in relation to brokerage and research
services provided to the Funds or the Adviser. Such services may include the
following: information as to the availability of securities for purchase or
sale; statistical or factual information or opinions pertaining to investment;
wire services; and appraisals or evaluations of portfolio securities. Each Fund
believes that the requirement always to seek the lowest possible commission cost
could impede effective portfolio management and preclude the Fund and the
Adviser from obtaining a high quality of brokerage and research services. In
seeking to determine the reasonableness of brokerage commissions paid in any
transaction, the Adviser relies upon its experience and knowledge regarding
commissions generally charged by various brokers and on its judgment in
evaluating the brokerage and research services received from the broker
effecting the transaction.
The Adviser may use research and services provided to it by brokers in servicing
all the Funds; however, not all such services may be used by the Adviser in
connection with a Fund. While the receipt of such information and services is
useful in varying degrees and generally would reduce the amount of research or
18
<PAGE>
services otherwise performed by the Adviser, this information and these services
are of indeterminable value and would not reduce the Adviser's investment
advisory fee to be paid by the Funds.
Purchases and sales of U.S. Government Securities normally are transacted
through issuers, underwriters or major dealers in U.S. Government Securities
acting as principals. Such transactions are made on a net basis and do not
involve payment of brokerage commissions. The cost of securities purchased from
an underwriter usually includes a commission paid by the issuer to the
underwriters; transactions with dealers normally reflect the spread between bid
and asked prices.
MANAGEMENT OF THE TRUST
Trustees and Officers
- ---------------------
The following table lists the Trustees and officers of the Trust, their age,
business address and principal occupation during the past five years. Unless
otherwise noted, an individual's business address is 550 Mamaroneck Avenue,
Harrison, New York 10528. Fees and expenses for non-interested Trustees will be
paid by the Trust.
LAWRENCE RAFFERTY* (xx), President and Chairman of the Board of Trustees of the
Trust. General Partner of Rafferty Asset Management, Inc., investment adviser to
the Trust; Chief Executive Officer and founder of Cohane Rafferty Securities,
Inc., 1987 to present.
JAY F. HIGGINS* (xx), Trustee.
JAMES TERRY APPLE (58), Vice President and Portfolio Manager. From January 1994
to May 1997, Portfolio Manager of Rydex OTC Fund; from 1992 to December 1993,
Director of Investments of The Rushmore Funds.
TIMOTHY P. HAGAN (55), Vice President and Treasurer. From 1993 to March 1997,
Vice President of Operations of The Rydex Series Trust; from 1981 to 1993, Vice
President of The Rushmore Funds.
PHILIP HARDING (54), Vice President and Portfolio Manager. From 1995 to 1997,
Vice President of Trading and Sales Management for Commerzbank (USA); from 1992
to 1995, Senior Vice President of Sanwa Bank (USA).
THOMAS A. MULROONEY.
- -----------------
* Messrs. Rafferty and Higgins, by virtue of their current positions with the
Adviser, are deemed to be "interested persons" of the Trust, as defined by the
1940 Act.
The Trustees will not receive compensation for their services to the Trust.
However, the Trust expects to compensate Trustees who are not "interested
persons" of the Trust as defined by the 1940 Act ("Independent Trustees") in the
future. Trustees will be reimbursed for any expenses incurred in attending Board
meetings.
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Investment Adviser
- ------------------
The Funds' investment adviser, Rafferty Asset Management LLC, was organized as a
New York limited liability corporation in 1997. The Adviser is a newly
registered investment adviser and has no prior experience advising investment
companies. The Adviser is a wholly owned subsidiary of Cohane Rafferty
Securities, Inc. ("Cohane").
Under an Investment Advisory Agreement, dated ______ __, 1997, between the
Trust, on behalf of the Funds, and the Adviser ("Advisory Agreement"), the
Adviser manages the investments of each Fund's assets in accordance with its
investment objectives, policies and limitations, and oversees the day-to-day
operations of the Funds, subject to the direction and control of the Trustees
and the officers of the Trust. The Adviser bears all costs associated with
providing these advisory services and the expenses of the Trustees who are
affiliated with or interested persons of the Adviser.
The Adviser also is obligated to furnish the Trust with office space, executive
and other personnel necessary for the operation of the Trust, and other
services. The Adviser also pays all the compensation of Trustees who are
employees of the Adviser. The Trust pays all other expenses that are not assumed
by the Adviser as described in the Prospectus. The Trust also is liable for
nonrecurring expenses as may arise, including litigation to which a Fund may be
a party. The Trust also may have an obligation to indemnify its Trustees and
officers with respect to any such litigation.
Pursuant to the Advisory Agreement, each Fund pays the Adviser the following fee
at an annual rate based on its average daily net assets:
Japan/Long Fund 0.75%
Japan/Short Fund 0.90%
U.S. Plus Fund 0.75%
U.S./Short Fund 0.90%
OTC Plus Fund 0.75%
OTC/Short Fund 0.90%
Money Market Fund 0.50%
The Advisory Agreement was approved by the Trustees (including all Independent
Trustees) and the Adviser, as sole shareholder of each Fund, in compliance with
the 1940 Act. The Advisory Agreement will continue in force for a period of two
years after the date of its approval. The Agreement is renewable thereafter from
year to year with respect to each Fund, so long as its continuance is approved
at least annually (1) by the vote, cast in person at a meeting called for that
purpose, of a majority of those Trustees who are not "interested persons" of the
Adviser or the Trust, or by (2) the majority vote of either the full Board or
the vote of a majority of the outstanding shares of a Fund. The Advisory
Agreement automatically terminates on assignment and is terminable on 60 days'
written notice either by the Trust or the Adviser.
Fund Administrator, Shareholder Servicing Agent and Transfer Agent
- ------------------------------------------------------------------
XXX, [address], provides administrative, shareholder, dividend disbursement,
transfer agent and registrar services to the Funds. Pursuant to a administrative
and service agreement between the Trust, on behalf of the Funds, and XXX dated
_____("Service Agreement"), XXX provides the Trust and each Fund with _________.
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Under the Service Agreement, the Funds pay XXX the following fees an annual rate
based on the average daily net assets of each Fund as set forth below:
Japan/Long Fund 0.__%
Japan/Short Fund 0.__%
U.S. Plus Fund 0.__%
U.S./Short Fund 0.__%
OTC Plus Fund 0.__%
OTC/Short Fund 0.__%
Money Market Fund 0.__%
Distributor
- -----------
XYZ, [address], serves as the distributor ("Distributor") in connection with the
offering of each Fund's shares on a no-load basis. The Distributor receives
$_____ from the Adviser for distributing the shares of the Funds.
Distribution Plan
- -----------------
Rule 12b-1 under the 1940 Act provides that an investment company may bear
expenses of distributing its shares only pursuant to a plan adopted in
accordance with the Rule. The Trustees have adopted such a plan (the "Plan") for
each Fund pursuant to which the Funds would compensate the Distributor for
certain expenses incurred in the distribution of that Fund's shares and the
servicing and maintenance of existing Fund shareholder accounts. Pursuant to the
Plan, a Fund may pay the Distributor a service fee of up to 0.25% and a
distribution fee of up to 0.75% of the Fund's average daily net assets. However,
the Trustees have not authorized payment of any fees pursuant to the Plan. The
Trustees will authorize such payments only when they believe that there is a
reasonable likelihood that the Plan will benefit each Fund and its shareholders.
If the Trustees do authorize payment of fees pursuant to the Plan, the Trustees
will review quarterly and annually a written report provided by the Treasurer of
the amounts expended under the Plan and the purposes for which such expenditures
were made.
The Plan will continue in effect, with respect to a Fund, from year to year as
long as its continuance is approved annually by either the Trustees or by a vote
of a majority of the outstanding voting securities of that Fund. In either case,
to continue, the Plan must be approved by the vote of a majority of Independent
Trustees. The Plan can be terminated, with respect to a Fund, at any time by a
vote of a majority of the Independent Trustees or by a vote of a majority of the
outstanding voting securities of that Fund.
DETERMINATION OF NET ASSET VALUE
As described in the Prospectus, the net asset value per share of the U.S. Plus
Fund, the U.S./Short Fund, the OTC Plus Fund and the OTC/Short Fund is
determined daily, Monday through Friday, except for New Year's Day, Presidents'
Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day,
and Christmas Day, as of the close of regular trading on the New York Stock
Exchange ("NYSE"). The net asset value per share of the Japan Plus Fund and the
Japan/Short Fund is determined each day the Osaka Securities Exchange is open
for business. Trading on the Osaka Securities Exchange may not take place on all
days on which the NYSE is open. The Osaka Securities Exchange is closed on the
following Japanese holidays: New Year's Day, New Year's Holiday, Bank Holiday,
21
<PAGE>
Coming-of-Age Day, National Foundation Day, Vernal Equinox Day, Greenery Day,
Constitution Memorial Day, Children's Day, Marine Day, Respect-for-the-Aged Day,
Autumnal Equinox Day, Health-Sports Day, Culture Day, Labor Thanksgiving Day and
the Emperor's Birthday. The net asset value per share of the Money Market Fund
is determined each day that both the NYSE and the Federal Reserve Bank of New
York are open for business.
It is the policy of the Money Market Fund to attempt to maintain a constant
price per share of $1.00. There can be no assurance that a $1.00 net asset value
per share will be maintained. The portfolio instruments held by the Money Market
Fund are valued based on the amortized cost valuation method pursuant to Rule
2a-7 under the 1940 Act. This involves valuing an instrument at its cost and
thereafter assuming a constant amortization to maturity of any discount or
premium, even though the portfolio security may increase or decrease in market
value. Such fluctuations generally are in response to changes in interest rates.
Use of the amortized cost valuation method requires the Money Market Fund to
purchase instruments having remaining maturities of 397 days or less, to
maintain a dollar-weighted average portfolio maturity of 90 days or less, and to
invest only in securities determined by the Trustees to be of high quality with
minimal credit risks. The Money Market Fund may invest in issuers or instruments
that at the time of purchase have received the highest short-term rating by any
two nationally recognized statistical rating organizations ("NRSROs").
Rule 2a-7 requires the Trustees to establish procedures reasonably deigned to
stabilize the net asset value per share as computed for purposes of distribution
and redemption. The Board's procedures include monitoring the relationship
between the amortized cost value per share and a net asset value per share based
upon available indications of market value. The Board will decide what, if any,
steps should be taken if there is a difference of more than .5% between the two
methods. The Board will take any steps they consider appropriate (such as
redemption in kind or shortening the average portfolio maturity) to minimize any
material dilution or other unfair results arising from differences between the
two methods of determining net asset value.
A security listed or traded on an exchange, domestic or foreign, is valued at
its last sales price on the principal exchange on which it is traded prior to
the time when assets are valued. If no sale is reported at that time, the most
recent bid price is used. When market quotations for options and futures
positions held by a Fund are readily available, those positions will be valued
based upon such quotations. Securities and other assets for which market
quotations are not readily available, or for which the Adviser has reason to
question the validity of quotations received, are valued at fair value as
determined in good faith by the Board. For valuation purposes, quotations of
foreign securities or other assets denominated in foreign currencies are
translated to U.S. Dollar equivalents using the net foreign exchange rate in
effect at the close of the stock exchange in the country where the security is
issued. Short-term investments having a maturity of 60 days or less are valued
at amortized cost, which approximates market value.
PERFORMANCE INFORMATION
Each Fund's performance data quoted in reports, advertising and other
promotional materials represents past performance and is not intended to
22
<PAGE>
indicate future performance. The investment return and principal value for each
Fund, except for the Money Market Fund, will fluctuate so that an investor's
shares, when redeemed, may be worth more or less than their original costs.
Comparative Information
- -----------------------
From time to time each Fund's performance may be compared with recognized stock
and other indices, such as the Standard & Poor's Composite Stock Price Index
("S&P 500 Index"), the Dow Jones Industrial Average ("DJIA"), Nasdaq 100 Stock
Index(Trademark) ("Nasdaq Index"), and the Nasdaq Composite Index(Trademark)
("Nasdaq Composite"), Nikkei 225 Stock Average ("Nikkei Index") and various
other domestic, international and global indices. The S&P 500 Index is a broad
index of common stock prices, while the DJIA represents a narrower segment of
industrial companies. Each assumes reinvestment of distributions and is
calculated without regard to tax consequences or operating expenses. The Nasdaq
Composite comparison may be provided to show how the OTC/Long and the OTC/Short
Funds' total returns compare to the record of a broad average of OTC stock
prices over the same period. The OTC/Long and the OTC/Short Funds have the
ability to invest in securities not included in the Nasdaq Index or the Nasdaq
Composite, and the OTC/Long and the OTC/Short Funds' investment portfolio may or
may not be similar in composition to the Nasdaq Index or the Nasdaq Composite.
In addition, a Fund's total return may be compared to the performance of broad
groups of comparable mutual funds with similar investment objectives, as such
performance is tracked and published by such independent organizations as Lipper
Analytical Services, Inc. ("Lipper'), and CDA Investment Technologies, Inc. When
Lipper's tracking results are used, the Fund will be compared to Lipper's
appropriate fund category, that is, by fund objective and portfolio holdings.
Accordingly, the Lipper ranking and comparison, which may be used by the Trust
in performance reports, will be drawn from the "Capital Appreciation Funds"
grouping for the U.S. Plus Fund and the U.S./Short Fund, from the "Small Company
Growth Funds" grouping for the OTC/Long and the OTC/Short Funds, and from the
"International Funds" grouping for the Japan/Long and the Japan/Short Funds.
Since the assets in all mutual funds are always changing, a Fund may be ranked
within one Lipper asset-size class at one time and in another Lipper asset-size
class at some other time. Footnotes in advertisements and other marketing
literature will include the time period and Lipper asset-size class, as
applicable, for the ranking in question. Performance figures are based on
historical results and are not intended to indicate future performance.
Total Return Computations
- -------------------------
For purposes of quoting and comparing the performance of a Fund to that of other
mutual funds and to other relevant market indices in advertisements or in
reports to shareholders, performance for the Fund may be stated in terms of
total return. Such average annual total return quotes for the Funds are
calculated according to the following formula:
n
P(1+T) =ERV
Where: P= a hypothetical initial payment of $1,000
T= average annual total return
n= number of years (either 1, 5 or 10)
ERV= ending redeemable value of a hypothetical $1,000
payment made at the beginning of the 1, 5 or 10 year
periods, as applicable, at the end of that period
23
<PAGE>
Under the foregoing formula, the time periods used in advertising will be based
on rolling calendar quarters, updated to the last day of the most recent quarter
prior to submission of the advertising for publication, and will cover 1,5 and
10 year periods or a shorter period dating from the commencement of a Fund's
operations. In calculating the ending redeemable value, all dividends and
distributions by a Fund are assumed to have been reinvested at net asset value
on the reinvestment dates during the period. Total return, or "T" in the formula
above, is computed by finding the average annual compounded rates of return over
the 1, 5 and 10 year periods (or fractional portion thereof) that would equate
the initial amount invested to the ending redeemable value.
From time to time, each Fund also may include in such advertising a total return
figure that is not calculated according to the formula set forth above in order
to compare more accurately the performance of a Fund with other measures of
investment return. For example, in comparing the total return of a Fund with
data published by Lipper or with such market indices as the performance of (1)
the S&P 500 Index or the DJIA for the U.S. Plus and the U.S./Short Funds, (2)
the Nasdaq Index for the OTC/Long and the OTC/Short Funds; and (3) the Nikkei
Index for the Japan/Long and the Japan/Short Funds, each respective Fund
calculates its aggregate total return for the specified periods of time by
assuming an investment of $10,000 in Fund shares and assuming the reinvestment
of each dividend or other distribution at net asset value on the reinvestment
date. Percentage increases are determined by subtracting the initial value of
the investment from the ending value and by dividing the remainder by the
beginning value.
Yield Computations
- ------------------
The Money Market Fund's annualized current yield, as may be quoted from time to
time in advertisements and other communications to shareholders and potential
investors, is computed for a seven-day period by determining the net change,
exclusive of capital changes and including the value of additional shares
purchased with dividends and any dividends declared therefrom (which reflect
deductions of all expenses of the Fund such as advisory fees), in the value of a
hypothetical pre-existing account having a balance of one share at the beginning
of the period, subtracting a hypothetical charge reflecting deductions from
shareholder accounts, and dividing the difference by the value of the account at
the beginning of the base period to obtain the base period return, and then
multiplying the base period return by (365/7).
The Money Market Fund's annualized effective yield, as may be quoted from time
to time in advertisements and other communications to shareholders and potential
investors, is computed by determining (for the same stated seven-day period as
the current yield) the net change, exclusive of capital changes and including
the value of additional shares purchased with dividends and any dividends
declared therefrom (which reflect deductions of all expenses of the Fund such as
advisory fees), in the value of a hypothetical pre-existing account having a
balance of one share at the beginning of the period, and dividing the difference
by the value of the account at the beginning of the base period to obtain the
base period return, and then compounding the base period return by adding 1,
raising the sum to a power equal to 365 divided by 7, and subtracting 1 from the
result, according to the following formula:
Effective Yield = [(Base Period Return + 1) 365/7] - 1
24
<PAGE>
The yields quoted in any advertisement or other communication should not be
considered a representation of the yields of the Money Market Fund in the future
since the yield is not fixed. Actual yields will depend not only on the type,
quality, and maturities of the investments held by the Money Market Fund and
changes in interest rates on such investments, but also on changes in the Money
Market Fund's expenses during the period.
Yield information may be useful in reviewing the performance on the Money Market
Fund and for providing a basis for comparison with other investment
alternatives. However, unlike bank deposits or other investments, which
typically pay a fixed yield for a stated period of time, the Money Market Fund's
yield will fluctuate.
DIVIDENDS, OTHER DISTRIBUTIONS AND TAXES
Dividends and other Distributions.
- ----------------------------------
Dividends from net investment income and any distributions of realized net
capital gains and net gains from foreign currency transactions will be
distributed as described in the Prospectus under "Dividends and Distributions."
All distributions from a Fund normally will be automatically reinvested without
charge in additional shares of that Fund.
As discussed in the Prospectus, the Money Market Fund ordinarily will declare
dividends daily from net investment income and distribute such dividends
monthly. Net income, for these purposes, includes accrued interest and accretion
of original issue and market discounts, less amortization of market premium and
estimated expenses, and will be calculated immediately prior to the
determination of the Fund's net asset value per share. The Fund distributes its
net short-term capital gain, if any, annually but may make more frequent
distributions thereof if necessary to maintain its net asset value per share at
$1.00 or to avoid income or excise taxes. The Fund does not expect to realize
net long-term capital gain and thus does not anticipate payment of any
distributions of net capital gain (the excess of net long-term capital gain over
net short-term capital loss). The Trustees may revise this dividend policy, or
postpone the payment of dividends, if the Fund has or anticipates any large
unexpected expense, loss, or fluctuation in net assets that, in the Trustees'
opinion, might have a significant adverse effect on its shareholders.
Taxes
- -----
REGULATED INVESTMENT COMPANY STATUS. To qualify for treatment as a regulated
investment company ("RIC") under the Internal Revenue Code of 1986, as amended
("Code"), each Fund -- which is treated as a separate corporation for these
purposes -- must distribute to its shareholders for each taxable year at least
90% of its investment company taxable income (consisting generally of net
investment income, net short-term capital gain, and net gains from certain
foreign currency transactions) ("Distribution Requirement") and must meet
several additional requirements. For each Fund, 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 foreign
currencies, or other income (including gains from options, futures, or forward
contracts) derived with respect to its business of investing in securities or
those currencies ("Income Requirement"); (2) the Fund must derive less than 30%
of its gross income each taxable year from the sale or other disposition of
25
<PAGE>
securities, or any of the following, that were held for less than three months
- -- options or futures (other than those on foreign currencies), or foreign
currencies (or options, futures, or forward contracts thereon) that are not
directly related to the Fund's principal business of investing in securities (or
options and futures with respect to securities) ("Short-Short Limitation"); and
(3) at the close of each quarter of the Fund's taxable year, (i) 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
those 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 (ii)
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 (collectively, "Diversification Requirements"). Although the Funds
intend to satisfy all these requirements, there is no assurance that each Fund
will be able to do so.
The foregoing requirements will restrict each Fund's investments to a certain
extent. Specifically, the Short-Short Limitation will limit the extent to which
a Fund may (1) sell securities held for less than three months, (2) write
options that expire in less than three months, and (3) effect closing
transactions with respect to call or put options written or purchased within the
preceding three months. Moreover, as discussed below under "Hedging Strategies,"
the Short-Short Limitation may limit investments by a Fund in options, futures
contracts, foreign currencies and forward contracts.
As discussed in the Prospectus, each Fund other than the Money Market Fund
expects to have greater difficulty than most other mutual funds in satisfying
the Short-Short Limitation because of sales of securities and other investments
to produce proceeds necessary to satisfy payment obligations arising from
anticipated frequent redemptions and exchanges of shares by shareholders seeking
to take advantage of anticipated changes in market conditions as part of their
asset allocation strategy. However, a Fund will not be disqualified as a RIC for
failing to satisfy the Short-Short Limitation by reason of sales resulting from,
and made within five days after the day on which it experiences, "abnormal
redemptions" if (1) the sum of the percentages of abnormal redemptions during
the taxable year through that day exceeds 30% and (2) the Trust would meet the
Short-Short Limitation if all the Funds were treated as a single RIC. Abnormal
redemptions are defined as net redemptions on any day that exceed one percent of
net asset value. If abnormal redemptions require a Fund to sell securities with
a holding period of less than three months, the Fund intends to make those sale
within five days after the redemptions so as to qualify for the foregoing if it
is possible to do so.
The investment by a Fund other than the Money Market Fund primarily in options
and futures positions also entails some risk that such a Fund might fail to
satisfy the Diversification Requirements. There is some uncertainty regarding
the valuation of such positions for purposes of those requirements; accordingly,
it is possible that the method of valuation used by the Funds, pursuant to which
each of them would be treated as satisfying the Diversification Requirements,
would not be accepted in an audit by the Internal Revenue Service, which would
apply a different method resulting in disqualification of one or more of those
Funds.
GENERAL. If Fund shares 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 purchase price
back as a taxable distribution.
26
<PAGE>
Each 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.
INCOME FROM FOREIGN SECURITIES. Dividends and interest received by the
Japan/Long Fund and dividends received by the Japan/Short Fund may be subject to
income, withholding, or other taxes imposed by foreign countries and U.S.
possessions that would reduce the yield on their securities. Tax conventions
between certain countries and the United States may reduce or eliminate these
foreign taxes, however, and many foreign countries do not impose taxes on
capital gains in respect of investments by foreign investors.
The Japan/Long Fund may invest in the stock of "passive foreign investment
companies" ("PFICs"). A PFIC is a foreign corporation that, in general, meets
either of the following tests: (1) at least 75% of its gross income is passive
or (2) an average of at least 50% of its assets produce, or are held for the
production of, passive income. Under certain circumstances, the Fund will be
subject to federal income tax on a portion of any "excess distribution" received
on the stock of a PFIC or of any gain on disposition of the stock (collectively
"PFIC income"), plus interest thereon, even if the Fund distributes the PFIC
income as a taxable dividend to its shareholders. The balance of the PFIC income
will be included in the Fund's investment company taxable income and,
accordingly, will not be taxable to it to the extent that income is distributed
to its shareholders. If the Fund invests in a PFIC and elects to treat the PFIC
as a "qualified electing fund" ("QEF"), then in lieu of the foregoing tax and
interest obligation, the Fund would be required to include in income each year
its pro rata share of the QEF's annual ordinary earnings and net capital gain
(the excess of net long-term capital gain over net short-term capital loss) --
which probably would have to be distributed by the Fund to satisfy the
Distribution Requirement and avoid imposition of the Excise Tax -- even if those
earnings and gain were not received by the Fund from the QEF. In most instances
it will be very difficult, if not impossible, to make this election because of
certain requirements thereof.
Proposed regulations have been published pursuant to which open-end RICs, such
as the Funds, would be entitled to elect to "mark-to-market" their stock in
certain PFICs. "Marking-to-market," in this context, means recognizing as gain
for each taxable year the excess, as of the end of that year, of the fair market
value of such a PFIC's stock over the adjusted basis in that stock (including
mark-to-market gain for each prior year for which an election was in effect).
Gains or losses (1) from the disposition of foreign currencies, (2) from the
disposition of debt securities denominated in foreign currency that, in each
instance, are attributable to fluctuations in the value of the foreign currency
between the date of acquisition of the security and the date of disposition
thereof, and (3) that are attributable to fluctuations in exchange rates that
occur between the time a Fund accrues dividends, interest, or other receivables
or expenses or other liabilities denominated in a foreign currency and the time
the Fund actually collects the receivables or pays the liabilities, generally
will be treated as ordinary income or loss. These gains or losses, referred to
under the Code as "section 988" gains or losses, may increase or decrease the
amount of a Fund's investment company taxable income to be distributed to its
shareholders.
DERIVATIVES STRATEGIES. The use of derivatives strategies, such as writing
(selling) and purchasing options and futures contracts and entering into forward
contracts, involves complex rules that will determine for income tax purposes
the amount, character, and timing of recognition of the gains and losses a Fund
27
<PAGE>
realizes in connection therewith. Gains from the disposition of foreign
currencies (except certain gains that may be excluded by future regulations),
and gains from options, futures, and forward contracts derived by a Fund with
respect to its business of investing in securities or foreign currencies, will
qualify as permissible income under the Income Requirement. However, income from
the disposition of options and futures contracts (other than those on foreign
currencies) will be subject to the Short-Short Limitation if they are held for
less than three months. Income from the disposition of foreign currencies, and
options, futures, and forward contracts thereon, that are not directly related
to a Fund's principal business of investing in securities (or options and
futures with respect to securities) also will be subject to the Short-Short
Limitation if they are held for less than three months.
If a 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. Each
Fund will consider whether it should seek to qualify for this treatment for its
hedging transactions. To the extent a Fund does not so qualify, it may be forced
to defer the closing out of certain options, futures, forward contracts, and/or
foreign currency positions beyond the time when it otherwise would be
advantageous to do so, in order for the Fund to qualify as a RIC.
Certain options (including options on "broad-based" stock indices) and futures
in which the Funds may invest will be "section 1256 contracts." Section 1256
contracts held by a 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. Section 1256 contracts also may be marked-to-market for purposes of the
Excise Tax.
Code section 1092 (dealing with straddles) also may also affect the taxation of
options and futures contracts in which the Funds may invest. Section 1092
defines a "straddle" as offsetting positions with respect to personal property;
for these purposes, options and futures contracts are personal property. Section
1092 generally provides that any loss from the disposition of a position in a
straddle may be deducted only to the extent the loss exceeds the unrealized gain
on the offsetting position(s) of the straddle. Section 1092 also provides
certain "wash sale" rules, which apply to transactions where a position is sold
at a loss and a new offsetting position is acquired within a prescribed period,
and "short sale" rules applicable to straddles. If a Fund makes certain
elections, the amount, character ,and timing of recognition of gains and losses
from the affected straddle positions would be determined under rules that vary
according to the elections made. Because only a few of the regulations
implementing the straddle rules have been promulgated, the tax consequences to
the Funds of straddle transactions are not entirely clear.
If a call option written by a Fund lapses (i.e., terminates without being
exercised), the amount of the premium it received for the option will be
short-term capital gain. If a Fund enters into a closing purchase transaction
28
<PAGE>
with respect to a written call option, it will have a short-term capital gain or
loss based on the difference between the premium it received for the option it
wrote and the premium it pays for the option it buys. If such an option is
exercised and a Fund thus sells the securities or futures contract subject to
the option, the premium the Fund received will be added to the exercise price to
determine the gain or loss on the sale. If a call option purchased by a Fund
lapses, it will realize short-term or long-term capital loss, depending on its
holding period for the security or futures contract subject thereto. If a Fund
exercises a purchased call option, the premium it paid for the option will be
added to the basis of the subject securities or futures contract.
Prospective shareholders are urged to consult their own tax advisers regarding
the tax consequences of their investing in a Fund.
CUSTODIAN AND AUDITORS
Deloite & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540, are the
auditors of and the independent public accountants for the Trust.
PRINCIPAL HOLDERS OF SECURITIES
As of August __, 1997, Rafferty Asset Management was sole owner of record of
outstanding shares of the Funds.
29
<PAGE>
POTOMAC FUNDS
PART C. OTHER INFORMATION
-------------------------
Item 24. FINANCIAL STATEMENTS AND EXHIBITS
---------------------------------
(a) Financial Statements (to be filed)
(b) Exhibits:
(1) Declaration of Trust (filed herewith)
(2) By-Laws (filed herewith)
(3) Voting trust agreement -- None
(4) Specimen security -- None
(5)(a) Investment Advisory Agreement*
(5)(b) Administrative Services Agreement*
(6) Distribution Agreement*
(7) Bonus, profit sharing or pension plans -- None
(8) Custodian Agreement*
(9) Transfer Agency and Service Agreement*
(10) Opinion and consent of counsel*
(11) Consent of Independent Auditors*
(12) Financial statements omitted from prospectus
-- None
(13) Letter of investment intent*
(14) Prototype retirement plan*
(15) Plan pursuant to Rule 12b-1*
<PAGE>
(16) Performance Computation Schedule -- None
(17) Financial Data Schedule*
(18) Plan pursuant to Rule 18f-3 -- (not
applicable)
* To be filed by subsequent amendment.
Item 25. PERSONS CONTROLLED BY OR UNDER
COMMON CONTROL WITH REGISTRANT
------------------------------
None.
Item 26. NUMBER OF HOLDERS OF SECURITIES
-------------------------------
Number of Record Holders
Title Of Class June 5, 1997
-------------- ------------------------
Shares of beneficial interest in:
Potomac Japan/Long Fund 0
Potomac Japan/Short Fund 0
Potomac U.S. Plus Fund 0
Potomac U.S./Short Fund 0
Potomac OTC Plus Fund 0
Potomac OTC/Short Fund 0
Potomac U.S. Government Money Market Fund 0
Item 27. INDEMNIFICATION
---------------
Article XI, Section 2 of the Trust's Declaration of Trust provides that:
(a) Subject to the exceptions and limitations contained in paragraph
(b) below:
(i) every person who is, or has been, a Trustee or officer of the
Trust (hereinafter referred to as a "Covered Person") shall be indemnified by
the Trust and/or by the appropriate Series to the fullest extent permitted by
law against liability and against all expenses reasonably incurred or paid by
him or her in connection with any claim, action, suit or proceeding in which he
or she becomes involved as a party or otherwise by virtue of his or her being or
having been a Covered Person and against amounts paid or incurred by him or her
in the settlement thereof;
(ii) the words "claim," "action," "suit," or "proceeding" shall
apply to all claims, actions, suits or proceedings (civil, criminal or other,
including appeals), actual or threatened while a Covered Person is in office or
thereafter, and the words "liability" and "expenses" shall include, without
limitation, attorneys' fees, costs, judgments, amounts paid in settlement,
fines, penalties and other liabilities.
C-2
<PAGE>
(b) No indemnification shall be provided hereunder to a Covered Person:
(i) who shall have been adjudicated by a court or body before which
the proceeding was brought (A) to be liable to the Trust or its Shareholders by
reason of willful misfeasance, bad faith, gross negligence or reckless disregard
of the duties involved in the conduct of his or her office or (B) not to have
acted in good faith in the reasonable belief that his or her action was in the
best interest of the Trust; or
(ii) in the event of a settlement, unless there has been a
determination that such Covered Person did not engage in willful misfeasance,
bad faith, gross negligence or reckless disregard of the duties involved in the
conduct of his or her office, (A) by the court or other body approving the
settlement; (B) by at least a majority of those Trustees who are neither
Interested Persons of the Trust nor parties to the matter based upon a review of
readily available facts (as opposed to a full trial-type inquiry or full
investigation); or (C) by written opinion of independent legal counsel based
upon a review of readily available facts (as opposed to a full trial-type
inquiry); provided, however, that any Shareholder may, by appropriate legal
proceedings, challenge any such determination by the Trustees, or by independent
legal counsel.
(c) The rights of indemnification herein provided may be insured against
by policies maintained by the Trust, shall be severable, shall not be exclusive
of or affect any other rights to which any Covered Person may now or hereafter
be entitled, shall continue as to a person who has ceased to be such Trustee or
officer and shall inure to the benefit of the heirs, executors and
administrators of such a person. Nothing contained herein shall affect any
rights to indemnification to which Trust personnel, other than Trustees and
officers, and other persons may be entitled by contract or otherwise under law.
(d) Expenses in connection with the preparation and presentation of a
defense to any claim, action, suit or proceeding of the character described in
paragraph (a) of this Section 2 may be paid by the Trust from time to time prior
to final disposition thereof upon receipt of an undertaking by or on behalf of
such Covered Person that such amount will be paid over by him or her to the
Trust if it is ultimately determined that he or she is not entitled to
indemnification under this Section 2; provided, however, that:
(i) such Covered Person shall have provided appropriate security
for such undertaking,
(ii) the Trust is insured against losses arising out of any such
advance payments, or
(iii) either a majority of the Trustees who are neither interested
persons of the Trust nor parties to the matter, or independent legal counsel in
a written opinion, shall have determined, based upon a review of readily
available facts (as opposed to a trial-type inquiry or full investigation), that
there is reason to believe that such Covered Person will be found entitled to
indemnification under this Section 2.
According to Article XII, Section 1 of the Declaration of Trust, the Trust
is a trust and not a partnership. Trustees are not liable personally to any
person extending credit to, contracting with or having any claim against the
Trust a particular Series or the Trustees. A Trustee, however, is not protected
from liability due to willful misfeasance, bad faith, gross negligence or
reckless disregard of the duties involved in the conduct of his office.
C-3
<PAGE>
Article XII, Section 2 provides that, subject to the provisions of Section
1 of Article XII and to Article XI, the Trustees are not liable for errors of
judgment or mistakes of fact or law, or for any act or omission in accordance
with advice of counsel or other experts or for failing to follow such advice.
Item 28. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER
----------------------------------------------------
Rafferty Asset Management LLC (the "Adviser") is a New York limited liability
corporation which offers investment advisory services. The Adviser is a
subsidiary of Cohane Rafferty Securities, Inc. ("Cohane"), a New York
corporation. Both the Adviser's and Cohane's offices are located at 550
Mamaroneck Avenue, Harrison, New York 10528. Lawrence Rafferty owns a
controlling interest in both the Adviser and Cohane.
Further information to be provided by subsequent amendment.
Item 29. PRINCIPAL UNDERWRITER
---------------------
To be provided by subsequent amendment.
Item 30. LOCATION OF ACCOUNTS AND RECORDS
--------------------------------
To be provided by subsequent amendment.
Item 31. MANAGEMENT SERVICES
-------------------
Not applicable.
Item 32. UNDERTAKINGS
------------
Registrant hereby undertakes to file a Post-effective Amendment to the
Registration Statement, containing financial statements that need not be
certified, within four to six months from the effective date of this
Registration Statement or from the date of its commencement of operations.
Registrant hereby undertakes to furnish each person to whom a prospectus
is delivered with a copy of its latest annual report to Shareholders, upon
request and without charge.
C-4
<PAGE>
Registrant hereby undertakes to carry out all indemnification provisions
of its Declaration of Trust in accordance with Investment Company Act Release
No. 11330 (September 4, 1980) and successor releases. Insofar as indemnification
for liability arising under the Securities Act of 1933, as amended ("1933 Act"),
may be permitted to trustees, officers and controlling persons of the Registrant
pursuant to the provisions in under Item 27 herein, or otherwise, the Registrant
has been advised that in the opinion of the SEC such indemnification is against
public policy as expressed in the 1933 Act and is, therefore, unenforceable. In
the event that a claim for indemnification against such liabilities (other than
the payment by the Registrant of expenses incurred or paid by a trustee, officer
or controlling person of the Registrant in the successful defense of any action,
suit or proceeding) is asserted by such trustee, officer or controlling person
in connection with the securities being registered, the Registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the 1933 Act
and will be governed by the final adjudication.
C-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended,
and the Investment Company Act of 1940, as amended, the Registrant has duly
caused this Registration Statement on Form N-1A to be signed on its behalf by
the undersigned, thereunto duly authorized, in the City of Harrison and the
State of New York on June 6, 1997.
POTOMAC FUNDS
By: /s/ Lawrence Rafferty
------------------------
Lawrence Rafferty
President
Attest:
/s/ Timothy P. Hagan
- --------------------
Timothy P. Hagan
Treasurer
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed below by the following persons in
the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- --------- ----- ----
/s/ Lawrence Rafferty
- ------------------------- President and Trustee June 6, 1997
Lawrence Rafferty
/s/ Jay F. Higgins
- ------------------------- Trustee June 6, 1997
Jay F. Higgins
<PAGE>
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION PAGE
- -------- ----------- ----
1 Declaration of Trust (filed herewith)
2 By-Laws (filed herewith)
3 Voting trust agreement -- None
4 Specimen security -- None
5 (a) Investment Advisory Agreement*
(b) Administrative Services Agreement*
6 Distribution Agreement*
7 Bonus, profit sharing or pension
plans -- None
8 Custodian Agreement*
9 Transfer Agency and Service Agreement*
10 Opinion and consent of counsel*
11 Consent of Independent Auditors*
12 Financial statements omitted from
prospectus -- (not applicable)
13 Letter of investment intent*
14 Prototype retirement plan*
15 Plan pursuant to Rule 12b-1*
16 Schedule for Computation of Performance
Quotations -- None
17 Financial Data Schedule*
18 Plan Pursuant to Rule 18f-3 -- (not
applicable)
* To be filed by subsequent amendment.
POTOMAC FUNDS
A Massachusetts Business Trust
DECLARATION OF TRUST
June 3, 1997
<PAGE>
POTOMAC FUNDS
DECLARATION OF TRUST
TABLE OF CONTENTS
Page
----
ARTICLE I -NAME, PRINCIPAL PLACE OF BUSINESS AND DEFINITIONS...................1
Section 1: Name............................................................1
Section 2: Principal Place of Business.....................................1
Section 3: Resident Agent..................................................1
Section 4: Definitions......................................................2
ARTICLE II - PURPOSE OF TRUST..................................................3
ARTICLE III - BENEFICIAL INTEREST..............................................3
Section 1: Shares of Beneficial Interest...................................3
Section 2: Ownership of Shares.............................................3
Section 3: Investment in the Trust.........................................3
Section 4: Assets and Liabilities of the Trust.............................4
Section 5: No Preemptive Rights............................................4
Section 6: Limitation on Personal Liability................................4
ARTICLE IV -THE TRUSTEES.......................................................5
Section 1: Management of the Trust.........................................5
Section 2: Election of Trustees............................................5
Section 3: Term of Office of Trustees......................................5
Section 4: Resignation and Appointment of Trustees.........................5
Section 5: Temporary Absence of Trustee....................................6
Section 6: Number of Trustees..............................................6
Section 7: Effect of Death, Resignation, Etc. of a Trustee.................6
Section 8: Ownership of Trust Assets.......................................6
ARTICLE V - POWERS OF THE TRUSTEES.............................................7
Section 1: Powers..........................................................7
Section 2: Trustees and Officers as Shareholders...........................9
Section 3: Action by the Trustees..........................................9
Section 4: Chairman of the Trustees.......................................10
ARTICLE VI -- EXPENSES OF THE TRUST...........................................10
ARTICLE VII - INVESTMENT ADVISER, PRINCIPAL UNDERWRITER AND TRANSFER AGENT....11
Section 1: Investment Advisers and Subadvisers............................11
Section 2: Principal Underwriter..........................................11
Section 3: Transfer Agent.................................................11
Section 4: Parties to Contract............................................12
ARTICLE VIII - SHAREHOLDERS' VOTING POWERS AND MEETINGS.......................12
Section 1: Voting Power...................................................12
Section 2: Meetings.......................................................13
Section 3: Quorum and Required Vote.......................................13
ARTICLE IX - CUSTODIAN........................................................13
Section 1: Appointment and Duties.........................................13
Section 2: Employment of Sub-Custodians...................................14
Section 3: Central Depository System......................................14
<PAGE>
ARTICLE X - DISTRIBUTIONS AND REDEMPTIONS.....................................15
Section 1: Distributions..................................................15
Section 2: Redemptions....................................................15
Section 3: Determination of Net Asset Value and Valuation of Portfolio
Asset..........................................................16
Section 4: Suspension of the Right of Redemption..........................16
ARTICLE XI - LIMITATION OF LIABILITY AND INDEMNIFICATION......................17
Section 1: Limitation of Liability........................................17
Section 2: Indemnification................................................17
Section 3: Shareholders...................................................18
ARTICLE XII - MISCELLANEOUS...................................................19
Section 1: Trust Not A Partnership........................................19
Section 2: Trustees' Good Faith Action, Expert Advice, No Bond or Surety..19
Section 3: Establishment of Record Dates..................................19
Section 4: Termination of Trust...........................................20
Section 5: Filing of Copies, References, Headings.........................21
Section 6: Applicable Law.................................................21
Section 7: Amendments.....................................................22
Section 8: Fiscal Year....................................................22
Section 9: Notice to Other Parties........................................22
ii
<PAGE>
POTOMAC FUNDS
-------------
DECLARATION OF TRUST
--------------------
This DECLARATION OF TRUST is made on June 3, 1997, by the undersigned
Trustees and by the holders of Shares of beneficial interest to be issued
hereunder as hereinafter provided.
WITNESSETH that
WHEREAS, the Trustees have agreed to manage all property coming into their
hands as trustees of a Massachusetts voluntary association with transferable
Shares in accordance with the provisions hereinafter set forth; and
WHEREAS, the Trustees hereby desire to establish a trust fund for the
investment and reinvestment of funds contributed thereto;
NOW, THEREFORE, the Trustees hereby declare that they will hold all cash,
securities and other assets, which they may from time to time acquire in any
manner as Trustees hereunder IN TRUST to manage and dispose of the same upon the
following terms and conditions for the pro rata benefit of the holders from time
to time of Shares in this Trust as hereinafter set forth.
ARTICLE I
---------
NAME, PRINCIPAL PLACE OF BUSINESS AND DEFINITIONS
-------------------------------------------------
Name
- ----
Section 1. This Trust shall be known as the "Potomac Funds" and the
Trustees shall conduct the business of the Trust under that name or any other
name as they may from time to time determine.
Principal Place of Business
- ---------------------------
Section 2. The principal place of business of the Trust shall be 550
Mamaroneck Avenue, Harrison, New York 10528.
Resident Agent
- --------------
Section 3. The resident agent for the Trust in Massachusetts shall be CT
Corporation System, 2 Oliver Street, Boston, Massachusetts, or such other person
as the Trustees may from time to time designate.
<PAGE>
Definitions
- -----------
Section 4. Wherever used herein, unless otherwise required by the context
or specifically provided:
(a) The "1940 Act" refers to the Investment Company Act of 1940, as
amended from time to time;
(b) The terms "Affiliated Person," "Assignment," "Commission,"
"Interested Person," "Majority Shareholder Vote" (the 67% or
50% requirement of the third sentence of Section 2(a)(42) of
the 1940 Act, whichever may be applicable) and "Principal
Underwriter" shall have the meanings given them in the 1940
Act, as amended from time to time;
(c) "By-Laws" shall mean the By-Laws of the Trust, as amended from
time to time;
(d) "Class" refers to the class of Shares of a Series of the Trust
established in accordance with the provisions of Article III;
(e) "Declaration of Trust" shall mean this Declaration of Trust, as
amended or restated from time to time;
(f) "Net Asset Value" means the net asset value of each Trust
series as determined in the manner provided in Article X,
Section 3;
(g) "Series" refers to series of Shares of the Trust established in
accordance with the provisions of Article III;
(h) "Shareholder" means a record owner of Shares of the Trust;
(i) "Shares" means the equal proportionate transferable units of
interest into which the beneficial interest of each of the
Trust series or class thereof shall be divided from time to
time, and includes fractions of shares as well as whole shares
(all of the transferable units of a series or of a single class
may be referred to as "Shares" as the context may require)
consistent with the requirements of federal and/or other
securities laws;
(j) The "Trust" refers to the Potomac Funds; and
(k) The "Trustees" refers to the individual trustees in their
capacity as trustees duly elected or appointed, qualified
hereunder and serving as trustees of the Trust and their
successor or successors for the time being in office as such
trustee or trustees.
2
<PAGE>
ARTICLE II
----------
PURPOSE OF TRUST
----------------
The purpose of the Trust is to provide investors, through one or more
Series or Classes thereof as designated by the Trustees, with a continuous
source of managed investments in securities.
ARTICLE III
-----------
BENEFICIAL INTEREST
-------------------
Shares of Beneficial Interest
- -----------------------------
Section 1. The Shares of the Trust shall be issued in one or more Series
and/or Classes as the Trustees may, without Shareholder approval, authorize.
Each Series shall be preferred over all other Series in respect of the assets
allocated to that Series. The beneficial interest in each Series shall at all
times be divided into Shares, with or without par value as the Trustees may
specify, each of which shall represent an equal proportionate interest in the
Series with each other Share of the same Series, none having priority or
preference over another. Each Series shall be represented by one or more Classes
of Shares, with each Class possessing such rights (including, notwithstanding
any contrary provision herein, voting rights) as the Trustees may, without
Shareholder approval, authorize. Shares of each Series, when issued, shall be
fully paid and non-assessable. The number of Shares authorized shall be
unlimited, and the Shares so authorized may be represented in part by fractional
Shares. The Trustees may from time to time and without Shareholder approval
divide or combine the Shares of any Series or Class into a greater or lesser
number without thereby changing the proportionate beneficial interests in the
Series or Class.
Ownership of Shares
- -------------------
Section 2. The ownership of Shares shall be recorded in the books of the
Trust. The Trustees may make such rules as they consider appropriate for the
transfer of Shares and similar matters. The record books of the Trust shall be
conclusive as to who are the holders of Shares and as to the number of Shares
held from time to time by each Shareholder.
Investment in the Trust
- -----------------------
Section 3. The Trustees shall accept investments in the Trust from such
persons and on such terms as they may from time to time authorize. As determined
by guidelines established by the Trustees, such investments may be in the form
of cash or securities in which the Trust (or each designated Series) is
authorized to invest, valued as provided in Article X, Section 3. Investments in
the Trust shall be credited to each Shareholder's account in the form of full or
fractional Shares at the Net Asset Value per Share next determined after the
investment is received; provided, however, that the Trustees may, in their sole
discretion: (a) impose a sales charge upon investments in the Trust or Series or
any Classes thereof and (b) issue fractional Shares. The Trustees shall have, in
their sole discretion, the right to refuse to accept investments in the Trust at
any time.
3
<PAGE>
Assets and Liabilities of the Trust
- -----------------------------------
Section 4. All consideration received by the Trust for the issue or sale of
Shares of a particular Series, together with all assets in which such
consideration is invested or reinvested, all income, earnings, profits, and
proceeds thereof, including any proceeds derived from the sale, exchange or
liquidation of such assets, and any funds or payments derived from any
reinvestment of such proceeds in whatever form the same may be, shall be
referred to as "assets belonging to" that Series and shall be held by the
Trustees in Trust for the benefit of the Shareholders of that Series. The assets
belonging to each particular Series shall be charged with the liabilities of
that Series and all expenses, costs, charges and reserves attributable to that
Series, except that liabilities and expenses allocated solely to a particular
Class shall be borne by that Class. In addition, any assets, income, earnings,
profits, and proceeds thereof, funds, or payments or any general liabilities,
expenses, costs, charges or reserves of the Trust that are not readily
identifiable as belonging to or chargeable to any particular Series or Class
shall be allocated by the Trustees between and among one or more of the Series
or Classes in such manner as they, in their sole discretion, deem fair and
equitable. Each such allocation shall be conclusive and binding upon the
Shareholders of all Series or Classes for all purposes, and shall be referred to
as assets belonging to that Series or Class. Any creditor of any Series may look
only to the assets of that Series to satisfy such creditor's debt.
No Preemptive Rights
- --------------------
Section 5. Shareholders shall have no preemptive or other right to
subscribe to any additional Shares or other securities issued by the Trust.
Limitation on Personal Liability
- --------------------------------
Section 6. The Trustees shall have no power to bind any Shareholder
personally or to call upon any Shareholder for the payment of any sum of money
or assessment whatsoever other than such as the Shareholder may at any time
personally agree to pay by way of subscription for any Shares or otherwise.
Every note, bond, contract or other undertaking issued by or on behalf of the
Trust or the Trustees relating to the Trust shall include a recitation limiting
the obligation represented thereby to the Trust and its assets (but the omission
of such a recitation shall not operate to bind any Shareholder).
4
<PAGE>
ARTICLE IV
----------
THE TRUSTEES
------------
Management of the Trust
- -----------------------
Section 1. The business and affairs of the Trust shall be managed by the
Trustees, and they shall have all powers necessary and desirable to carry out
that responsibility.
Election of Trustees
- --------------------
Section 2. On a date fixed by the Trustees, the Shareholders shall elect
not less than three (3) Trustees. A Trustee shall not be required to be a
Shareholder of the Trust. Until such election, the Trustees shall be Lawrence
Rafferty and Jay F. Higgins and such other individuals as the Board of Trustees
shall appoint pursuant to Section 4 of Article IV.
Term of Office of Trustees
- --------------------------
Section 3. The Trustees shall hold office during the lifetime of the Trust,
and until its termination as hereinafter provided, except that: (a) any Trustee
may resign his or her trust by written instrument signed by him or her and
delivered to the Trust's President or the other Trustees, which resignation
shall take effect upon such delivery or upon such later date as is specified
therein; (b) any Trustee may be removed at any time by written instrument,
signed by at least two-thirds of the number of Trustees prior to such removal,
specifying the date when such removal shall become effective; and (c) a Trustee
may be removed at any special meeting of Shareholders of the Trust by a vote of
two-thirds of the outstanding Shares. Upon the resignation or removal of a
Trustee, or his or her otherwise ceasing to be a Trustee, he or she shall
execute and deliver such documents as the remaining Trustees shall require for
the purpose of conveying to the Trust or the remaining Trustees any Trust
property held in the name of the resigning or removed Trustee. Upon the
incapacity or death of any Trustee, his legal representative shall execute and
deliver on his or her behalf such documents as the remaining Trustees shall
require as provided in the preceding sentence.
Resignation and Appointment of Trustees
- ---------------------------------------
Section 4. Any vacancy on the Board of Trustees that results from an
increase in the number of Trustees may be filled by a majority of the entire
Board of Trustees, provided that a quorum is present, and any other vacancy that
shall exist for any reason, including, but not limited to, declination to assume
office, death, resignation, or removal, the remaining Trustees shall fill such
vacancy by appointing such other person as they in their discretion shall see
fit, consistent with the limitations under the 1940 Act. Such appointment shall
be evidenced by a written instrument signed by a majority of the Trustees then
in office or by recording in the records of the Trust, whereupon the appointment
shall take effect. An appointment of a Trustee may be made by the Trustees then
in office in anticipation of a vacancy to occur by reason of retirement,
resignation or increase in number of Trustees effective at a later date,
provided that said appointment shall become effective only at or after the
effective date of said retirement, resignation or increase in number of
Trustees. As soon as any Trustee so appointed shall have accepted this trust,
5
<PAGE>
the trust estate shall vest in the new Trustee or Trustees, together with the
continuing Trustees, without any further act or conveyance, and he or she shall
be deemed a Trustee hereunder. The power of appointment of Trustees is subject
to the provisions of Section 16(a) of the 1940 Act.
Temporary Absence of Trustee
- ----------------------------
Section 5. Any Trustee may, by power of attorney, delegate his or her power
for a period not exceeding six months at any one time to any other Trustee or
Trustees, provided that in no case shall less than two Trustees personally
exercise the other powers hereunder, except as herein otherwise expressly
provided.
Number of Trustees
- ------------------
Section 6. The number of Trustees serving hereunder at any time shall be
determined by the Trustees themselves and shall not be less than three (3) nor
more than twelve (12). Whenever a vacancy in the Board of Trustees shall occur,
until such vacancy is filled, or while any Trustee is physically or mentally
incapacitated by reason of disease or otherwise, the other Trustees shall have
all the powers hereunder and the certificate of the other Trustees of such
vacancy, absence or incapacity, shall be conclusive.
Effect of Death, Resignation, Etc. of a Trustee
- -----------------------------------------------
Section 7. The death, declination, resignation to assume office,
retirement, removal, incapacity or inability of the Trustees, or any one of
them, shall not operate to annul the Trust or to revoke any existing agency
created pursuant to the terms of this Declaration of Trust.
Ownership of Trust Assets
- -------------------------
Section 8. The assets of the Trust shall be held separate and apart from
any assets now or hereafter held in any capacity other than as Trustee hereunder
by the Trustees or any successor Trustees. All of the assets of the Trust shall
at all times be considered as vested in the Trustees. No Shareholder shall be
deemed to have a severable ownership in any individual asset of the Trust or any
right of partition or possession thereof, but each Shareholder shall have a
proportionate undivided beneficial interest in the Trust.
6
<PAGE>
ARTICLE V
---------
POWERS OF THE TRUSTEES
----------------------
Powers
- ------
Section 1. The Trustees in all instances shall act as principals, and are
and shall be free from the control of the Shareholders. The Trustees shall have
full power and authority to do any and all acts and to make and execute any and
all contracts and instruments that they may consider necessary or appropriate in
connection with the management of the Trust. The Trustees shall not in any way
be bound or limited by present or future laws or customs in regard to trust
investments, but shall have full authority and power to make any and all
investments which they, in their sole discretion, shall deem proper to
accomplish the purpose of this Trust. Without limiting the foregoing, but
subject to any applicable limitation in this Declaration of Trust or the By-Laws
of the Trust, the Trustees shall have power and authority:
(a) To invest and reinvest cash and other property, and to hold cash or
other property uninvested, without in any event being bound or limited by
any present or future law or custom in regard to investments by Trustees,
and to sell, exchange, lend, pledge, mortgage, hypothecate, write options
on and lease any or all of the assets of the Trust; to purchase and sell
options on securities, currencies, indices, futures contracts and other
financial instruments and enter into closing transactions in connection
therewith; to enter into all types of commodities contracts, including
without limitation the purchase and sale of futures contracts and forward
contracts on securities, indices, currencies, and other financial
instruments; to engage in forward commitment, "when issued" and delayed
delivery transactions; to enter into repurchase agreements and reverse
repurchase agreements; and to employ all types of hedging techniques and
investment management strategies.
(b) To adopt By-Laws not inconsistent with this Declaration of Trust
providing for the conduct of the business of the Trust and to amend and
repeal them to the extent that the rights of amendment and repeal are not
reserved to Shareholders.
(c) To elect and remove such officers and appoint and terminate such
agents as they consider appropriate.
(d) To employ a bank, trust company or other entity permitted by the
Commission to serve as custodian ("Custodian") of any assets of the Trust
subject to any conditions set forth in this Declaration of Trust or in the
By-Laws, if any.
(e) To retain a transfer agent and shareholder servicing agent, or
both.
(f) To provide for the distribution of Shares either through a
principal underwriter in the manner hereinafter provided for or by the
Trust itself, or both.
7
<PAGE>
(g) To set record dates in the manner hereinafter provided.
(h) To delegate such authority as they consider desirable to any
officers of the Trust and to any agent, independent contractor, Custodian
or underwriter.
(i) To sell or exchange any or all of the assets of the Trust, subject
to the provisions of Article XII, Section 4(b) hereof.
(j) To vote or give assent, or exercise any rights of ownership with
respect to stock or other securities or property; and to execute and
deliver powers of attorney to such person or persons as the Trustees shall
deem proper, granting to such person or persons such power and discretion
with relation to securities or property as the Trustees shall deem proper.
(k) To exercise powers and rights of subscription or otherwise which in
any manner arise out of ownership of securities.
(l) To hold any security or property in a form not indicating any
trust, whether in bearer, unregistered or other negotiable form; or in its
own name or in the name of a Custodian or a nominee or nominees, subject in
whichever case to proper safeguards according to the usual practice of
Massachusetts trust companies or investment companies.
(m) To consent to or participate in any plan for the reorganization,
consolidation or merger of any corporation or concern, any security of
which is held in the Trust; to consent to any contract, lease, mortgage,
purchase, or sale of property by such corporation or concern; and to pay
calls or subscriptions with respect to any security held in the Trust.
(n) To compromise, arbitrate, or otherwise adjust claims in favor of or
against the Trust or any matter in controversy including, but not limited
to, claims for taxes.
(o) To make distributions of income and of capital gains to
Shareholders in the manner hereinafter provided.
(p) To borrow money.
(q) To establish, from time to time, a minimum total investment for
Shareholders, and to require redemption of the Shares of any Shareholders
whose investment is less than such minimum upon giving notice to such
Shareholder. No one dealing with the Trustees shall be under any obligation
to make any inquiry concerning the authority of the Trustees, or to see to
the application of any payments made or property transferred to the
Trustees or upon their order.
8
<PAGE>
(r) To retain an administrator, manager, investment advisers and/or
investment subadvisers.
(s) To establish separate and distinct Series with separately defined
investment objectives, policies and purposes, and to allocate assets,
liabilities and expenses of the Trust to a particular series of Shares or
to apportion the same among two or more Series, provided that any liability
or expense incurred by a particular Series of Shares shall be payable
solely out of the assets of that Series.
(t) To establish separate and distinct Classes for one or more Series,
with each Class having such rights and differences as determined by the
Trustees and to allocate assets, liabilities and expenses of a particular
Class or to apportion the same among or between two or more Classes,
provided that any liabilities or expenses incurred by a particular Class
shall be payable solely out of the assets belonging to that Class.
(u) To purchase and pay for entirely out of Trust property such
insurance as they may deem necessary or appropriate for the conduct of the
business, including, without limitation, insurance policies insuring the
assets of the Trust and payment of distributions and principal on its
portfolio investments, and insurance policies insuring the Shareholders,
Trustees, officers, employees, agents, investment advisers or managers,
principal underwriters, or independent contractors of the Trust
individually against all claims and liabilities of every nature arising by
reason of holding, being or having held any such office or position, or by
reason of any action alleged to have been taken or omitted by any such
person as Shareholder, Trustee, officer, employee, agent, investment
adviser or manager, principal underwriter, or independent contractor,
including any action taken or omitted that may be determined to constitute
negligence, whether or not the Trust would have the power to indemnify such
person against such liability.
Trustees and Officers as Shareholders
- -------------------------------------
Section 2. Subject only to the general limitations herein contained as to
the sale and purchase of Trust Shares and any restrictions that may be contained
in the By-Laws:
(a) Any Trustee, officer or other agent of the Trust may acquire, own
and dispose of Shares to the same extent as if he or she were not a
Trustee, officer or agent;
(b) The Trustees may issue and sell or cause to be issued and sold
Shares to (and buy such Shares from) any Interested Person.
Action by the Trustees
- ----------------------
Section 3. The Trustees shall act by majority vote at a meeting duly called
or by unanimous written consent without a meeting or by telephone consent
provided a quorum of Trustees participate in any such telephonic meeting, unless
9
<PAGE>
the 1940 Act requires that a particular action be taken only at an in-person
meeting of the Trustees. At any meeting of the Trustees, a majority of the
Trustees shall constitute a quorum. Meetings of the Trustees may be called
orally or in writing by the Chairman of the Trustees or by any two other
Trustees. Notice of the time, date and place of all meetings of the Trustees
shall be given to each Trustee as provided in the By-Laws.
Notice need not be given to any Trustee who attends the meeting without
objecting to the lack of notice or who executes a written waiver of notice with
respect to the meeting. Subject to the requirements of the 1940 Act, the
Trustees by majority vote may delegate to any one of their number the authority
to approve particular matters or take particular actions on behalf of the Trust.
Chairman of the Trustees
- ------------------------
Section 4. The Trustees may appoint one of their number to be Chairman of
the Board of Trustees and to perform such duties as the Trustees may designate.
ARTICLE VI
----------
EXPENSES OF THE TRUST
---------------------
Subject to the provisions of Article III, Section 4, the Trustees are
authorized to have paid from the Trust property or the assets belonging to the
Trust, as they deem fair and appropriate, expenses and disbursements of the
Trust, including, without limitation, fees and expenses of Trustees who are not
Interested Persons of the Trust, interest expenses, taxes, fees and commissions
of every kind, expenses of pricing Trust portfolio securities, expenses of
issue, repurchase and redemption of Shares including expenses attributable to a
program of periodic repurchases or redemptions, expenses of registering and
qualifying the Trust and its Shares under federal and state laws and
regulations, charges of investment advisers, managers, administrators,
Custodians, transfer agents, and registrars, expenses of preparing and
typesetting Prospectuses and Statements of Additional Information, expenses of
printing and distributing such documents sent to existing Shareholders, auditing
and legal expenses, reports to Shareholders, expenses of meetings of
Shareholders and proxy solicitations therefor, insurance expenses, association
membership dues and for such non-recurring items as may arise, including
litigation to which the Trust is a party, and for all losses and liabilities by
them incurred in administering the Trust, and for the payment of such expenses,
disbursements, losses and liabilities the Trustees shall have a lien on the
assets belonging to the Trust prior to any rights or interests of the
Shareholders thereto. This section shall not preclude the Trust from directly
paying any of the aforementioned fees and expenses.
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ARTICLE VII
-----------
INVESTMENT ADVISER, PRINCIPAL UNDERWRITER AND TRANSFER AGENT
------------------------------------------------------------
Investment Advisers and Subadvisers
- -----------------------------------
Section 1. Subject to a Majority Shareholder Vote when required by the 1940
Act, the Trustees in their discretion from time to time may enter into one or
more investment advisory or similar agreements on behalf of the Trust or any
Series thereof whereby the other parties to such agreements shall undertake to
furnish the Trust and any Series thereof such investment advisory, statistical
and research facilities and services and such other facilities and services, if
any, and all upon such terms and conditions as the Trustees may in their
discretion determine. Notwithstanding any provisions of this Declaration of
Trust, the Trustees may authorize the investment advisers (subject to such
general or specific instructions as the Trustees may from time to time adopt) to
effect purchases, sales or exchanges of portfolio securities and other
investment instruments of the Trust on behalf of the Trustees or may authorize
any officer, agent, or Trustee to effect such purchases, sales or exchanges
pursuant to recommendations of the investment advisers (and all without further
action by the Trustees). Any such purchases, sales and exchanges shall be deemed
to have been authorized by all of the Trustees. Subject to a Majority Vote when
required by the 1940 Act, the Trustees in their discretion from time to time may
authorize the investment advisers to employ one or more subadvisers to perform
such of the acts and services of the investment adviser, and upon such terms and
conditions, as may be agreed upon between the investment adviser and subadviser.
Principal Underwriter
- ---------------------
Section 2. The Trustees in their discretion from time to time may enter
into an agreement(s) on behalf of the Trust or any Series or Class thereof
providing for the sale of the Shares, whereby the Trust may either agree to sell
the Shares to the other party to the agreement or appoint such other party its
sales agent for such Shares. In either case, the agreement shall be on such
terms and conditions as may be prescribed in the By-Laws, if any, and such
further terms and conditions as the Trustees may in their discretion determine
to be not inconsistent with the provisions of this Article VII, or of the
By-Laws, if any; and such agreement may also provide for the repurchase or sale
of Shares by such other party as principal or as agent of the Trust.
Alternatively, or in addition thereto, the Trust can directly distribute its
Shares and, if necessary in connection with such distribution, register as a
broker-dealer in appropriate jurisdictions. The Trustees may in their discretion
adopt a plan or plans of distribution and enter into any related agreements
whereby the Trust finances directly or indirectly any activity that is primarily
intended to result in sales of Shares.
Transfer Agent
- --------------
Section 3. The Trustees in their discretion from time to time may enter
into a transfer agency and shareholder service agreement whereby the other party
shall undertake to furnish the Trust or any Series or Class with transfer agency
and shareholder services. The agreement shall be on such terms and conditions as
11
<PAGE>
the Trustees may in their discretion determine are not inconsistent with the
provisions of this Declaration of Trust or of the By-Laws, if any. Such services
may be provided by one or more entities including one or more agents of such
parties.
Parties to Contract
- -------------------
Section 4. Any agreement of the character described in Sections 1, 2 and 3
of this Article VII or in Article IX hereof may be entered into with any
corporation, firm, partnership, trust or association, although one or more of
the Trustees or officers of the Trust may be an officer, director, trustee,
shareholder or member of such other party to the agreement, and no such
agreement shall be invalidated or rendered voidable by reason of the existence
of any relationship, nor shall any person holding such relationship be liable
merely by reason of such relationship for any loss or expense to the Trust under
or by reason of said agreement or accountable for any profit realized directly
or indirectly therefrom, provided that the agreement when entered into was
reasonable and fair and not inconsistent with the provisions of this Article VII
or the By-Laws, if any. The same person (including a firm, corporation,
partnership, trust, or association) may be the other party to agreements entered
into pursuant to Sections 1, 2 and 3 above or Article IX, and any individual may
be financially interested or otherwise affiliated with persons who are parties
to any or all of the agreements mentioned in this Section 4.
ARTICLE VIII
------------
SHAREHOLDERS' VOTING POWERS AND MEETINGS
----------------------------------------
Voting Powers
- -------------
Section 1. The Shareholders shall have power to vote: (i) for the election
of Trustees as provided in Article IV, Section 2, (ii) for the removal of
Trustees as provided in Article IV, Section 3(c), (iii) with respect to any
investment advisory agreement as provided in Article VII, Section 1, (iv) with
respect to the amendment of this Declaration of Trust as provided in Article
XII, Section 7, (v) to the same extent as the shareholders of a Massachusetts
business corporation, as to whether or not a court action, proceeding or claim
should be brought or maintained derivatively or as a class action on behalf of
the Trust or the Shareholders, provided, however, that a Shareholder of a
particular Series or Class shall not be entitled to bring any derivative or
class action on behalf of any other Series or Class of the Trust, and (vi) with
respect to such additional matters relating to the Trust as may be required or
authorized by law, by this Declaration of Trust, or the By-Laws of the Trust, if
any, or any registration statement of the Trust with the Commission or any
State, as the Trustees may consider desirable. On any matter submitted to a vote
of Shareholders, all Shares shall be voted in the aggregate and not by
individual Series or Class; except (i) when required by the 1940 Act or (ii)
when the Trustees have determined that the matter affects only the interests of
one or more Series or Classes, then only the Shareholders of such Series or
Classes shall be entitled to vote thereon. Each whole Share shall be entitled to
one vote as to any matter on which it is entitled to vote, and each fractional
Share shall be entitled to a proportionate fractional vote. There shall be no
cumulative voting in the election of Trustees. Shares may be voted in person or
by proxy. Until Shares are issued, the Trustees may exercise all rights of
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Shareholders and may take any action required or permitted by law, this
Declaration of Trust or any By-Laws of the Trust to be taken by Shareholders.
Meetings
- --------
Section 2. Special meetings of the Shareholders may be called by the
Trustees and may be held at the principal office of the Trust or such other
place as the Trustees may designate. Special meetings also shall be called by
the Trustees for the purpose of removing one or more Trustees upon the written
request for such a meeting by Shareholders owning at least 10% of the
outstanding Shares entitled to vote. Whenever ten or more Shareholders meeting
the qualifications set forth in Section 16(c) of the 1940 Act, as the same may
be amended from time to time, seek the opportunity of furnishing materials to
the other Shareholders with a view to obtaining signatures on such a request for
a meeting, the Trustees shall comply with the provisions of said Section 16(c)
with respect to providing such Shareholders access to the list of the
Shareholders of record of the Trust or the mailing of such materials to such
Shareholders of record. Shareholders shall be entitled to at least 15 days'
notice of any meeting.
Quorum and Required Vote
- ------------------------
Section 3. A majority of Shares entitled to vote in person or by proxy
shall be a quorum for the transaction of business at a Shareholders' meeting,
except that where any provision of law or of this Declaration of Trust permits
or requires that holders of any Series or Class shall vote as a Series or Class,
then a majority of the aggregate number of Shares of that Series or Class
entitled to vote shall be necessary to constitute a quorum for the transaction
of business by that Series or Class. Any lesser number shall be sufficient for
adjournments. Any adjourned session or sessions may be held, within a reasonable
time after the date set for the original meeting, without the necessity of
further notice. Except when a larger vote is required by any provision of this
Declaration of Trust, the By-Laws or applicable law, a majority of the Shares
voted in person or by proxy shall decide any questions and a plurality shall
elect a Trustee, provided that where any provision of law or of this Declaration
of Trust permits or requires that the holders of any Series or Class shall vote
as a Series or Class, then a majority of the Shares of that Series or Class
voted on the matter shall decide that matter insofar as that Series or Class is
concerned.
ARTICLE IX
----------
CUSTODIAN
---------
Appointment and Duties
- ----------------------
Section 1. The Trustees shall at all times employ a bank or trust company
having capital, surplus and undivided profits of at least two million dollars
($2,000,000) as Custodian on such basis of compensation as may be agreed upon
between the Trustees and the Custodian. The Custodian shall have authority as
agent for the Trust, but subject to such restrictions, limitations and other
requirements, if any, as may be contained in the By-Laws of the Trust:
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(a) to hold the securities owned by the Trust and any Series or
Class thereof and deliver the same upon written order;
(b) to receive and take receipt for any moneys due to the Trust and
deposit the same in its own banking department or elsewhere as the
Trustees may direct;
(c) to disburse such funds upon orders or vouchers;
(d) to keep the books and accounts of the Trust and furnish
clerical and accounting services; and
(e) to compute, if authorized to do so by the Trustees, the Trust's
Net Asset Value in accordance with the provisions hereof.
If so directed by a Majority Shareholder Vote, the Custodian shall deliver
and pay over all property of the Trust held by it as specified in such vote.
Employment of Sub-Custodians
- ----------------------------
Section 2. The Trustees also may authorize the Custodian to employ one or
more sub-Custodians from time to time to perform such of the acts and services
of the Custodian, and upon such terms and conditions, as may be agreed upon
between the Custodian and such sub-Custodian and approved by the Trustees,
provided that in every case such sub-Custodian shall be (a) a bank or trust
company organized under the laws of the United States or one of the states
thereof and having capital, surplus and undivided profits of at least two
million dollars ($2,000,000) or such other person as may be permitted by the
Commission, or otherwise in accordance with the 1940 Act as from time to time
amended, or (b) an eligible foreign custodian in accordance with Rule 17f-5
under the 1940 Act or any such applicable successor regulation.
Central Depository System
- -------------------------
Section 3. Subject to such rules, regulations and orders as the Commission
may adopt, the Trustees may direct the Custodian to deposit all or any part of
the securities owned by the Trust in a system for the central handling of
securities established by a national securities exchange or a national
securities association registered with the Commission under the Securities
Exchange Act of 1934, as amended, or such other person as may be permitted by
the Commission, or otherwise in accordance with the 1940 Act as from time to
time amended, pursuant to which system all securities of any particular class of
any issuer deposited within the system are treated as fungible and may be
transferred or pledged by bookkeeping entry without physical delivery of such
securities, provided that all such deposits shall be subject to withdrawal only
upon the order of the Trust.
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ARTICLE X
---------
DISTRIBUTIONS AND REDEMPTIONS
-----------------------------
Distributions
- -------------
Section 1.
(a) The Trustees may from time to time declare and pay
dividends and other distributions. The amount of such dividends and the
payment of them shall be wholly in the discretion of the Trustees.
(b) The Trustees shall have power, to the fullest extent
permitted by the laws of Massachusetts, at any time to declare and
cause to be paid dividends on Shares from assets of a particular
Series, which dividends and other distributions, at the election of the
Trustees, may be paid daily or otherwise pursuant to a standing
resolution or resolutions adopted only once or with such frequency as
the Trustees may determine, and may be payable in Shares, in cash or
otherwise, at the election of each Shareholder. All dividends and other
distributions on Shares of a particular Series shall be distributed pro
rata to the holders of that Series in proportion to the number of
Shares of that Series held by such holders at the date and time of
record established for the payment of such dividends or distributions,
except that such dividends and other distributions shall appropriately
reflect expenses allocated to a particular Class of such Series.
(c) Anything in this Declaration of Trust to the contrary
notwithstanding, the Trustees may at any time declare and distribute
pro rata among the Shareholders of a particular Series of a Class
thereof a "stock dividend."
Redemptions
- -----------
Section 2. In case any Shareholder of record desires to dispose of his
or her Shares, the Shareholder may deposit at the office of the transfer agent
or other authorized agent of the Trust a written request or such other form of
request as the Trustees may from time to time authorize, requesting that the
Trust purchase the Shares in accordance with this Section 2; and the Shareholder
so requesting shall be entitled to require the Trust to purchase, and the Trust
or the Principal Underwriter of the Trust shall purchase, said Shares, but only
at the Net Asset Value thereof (as described in Section 3 hereof) less such
charges as are determined by the Trustees and described in the Trust's
Registration Statement under the Securities Act of 1933, as amended, or any
Prospectus or Statement of Additional Information contained therein, as
supplemented. The Trust shall make payment for any such Shares to be redeemed,
as aforesaid, in cash to the extent required by federal law, and securities from
Trust assets, and payment for such Shares shall be made by the Trust or the
Principal Underwriter to the Shareholder of record within seven (7) days after
the date upon which the request is effective. Provided, however, that if Shares
being redeemed have been purchased by check, the Series may postpone payment
until the Trust has assurance that good payment has been collected for the
purchase of the Shares. The Trust may require Shareholders to pay a sales charge
to the Trust, the Principal Underwriter or any other person designated by the
Trustees upon redemption or repurchase of Shares of any Series or Class in such
15
<PAGE>
amount as shall be determined from time to time by the Trustees. The amount of
such sales charge may, but need not, vary depending on numerous factors,
including without limitation the holding period of the redeemed or repurchased
Shares. The Trustees also may charge a redemption or repurchase fee in such
amount as may be determined from time to time by the Trustees.
Determination of Net Asset Value and Valuation of Portfolio Assets
- ------------------------------------------------------------------
Section 3. The term "Net Asset Value" of any Series or Class shall mean
that amount by which the assets of any Series or any Class thereof exceed its
liabilities, all as determined by or under the direction of the Trustees. Such
value shall be determined separately for each Series or Class of Shares, as
applicable, and shall be determined on such days and at such times as the
Trustees may determine. The determination shall be made with respect to
securities for which market quotations are readily available, at the market
value of such securities; and with respect to other securities and assets, at
the fair value as determined in good faith by the Trustees, provided, however,
that the Trustees, without Shareholder approval, may alter the method of
appraising portfolio securities insofar as permitted under the 1940 Act and the
rules, regulations and interpretations thereof promulgated or issued by the
Commission or insofar as permitted by any order of the Commission. The Trustees
may delegate any powers and duties under this Section 3 with respect to
appraisal of assets and liabilities. At any time the Trustees may cause the net
asset value per Share last determined to be determined again in similar manner
and may fix the time when such redetermined value shall become effective.
Suspension of the Right of Redemption
- -------------------------------------
Section 4. The Trustees may declare a suspension of the right of redemption
or postpone the date of payment to the extent permitted under the 1940 Act. Such
suspension shall take effect at such time as the Trustees shall specify but not
later than the close of business on the business day next following the
declaration of suspension, and thereafter there shall be no right of redemption
or payment until the Trustees shall declare the suspension at an end. In the
case of a suspension of the right of redemption, a Shareholder may either
withdraw his or her request for redemption or receive payment based on the Net
Asset Value per Share existing after the termination of the suspension.
16
<PAGE>
ARTICLE XI
----------
LIMITATION OF LIABILITY AND INDEMNIFICATION
-------------------------------------------
Limitation of Liability
- -----------------------
Section 1. Provided they have exercised reasonable care and have acted
under the reasonable belief that their actions are in the best interest of the
Trust, the Trustees shall not be responsible for or liable in any event for
neglect or wrongdoing committed by them or any officer, agent, employee or
investment adviser of the Trust, but nothing contained herein shall protect any
Trustee against any liability to which he or she would otherwise be subject by
reason of willful misfeasance, bad faith, gross negligence or reckless disregard
of the duties involved in the conduct of his or her office.
Indemnification
- ---------------
Section 2.
(a) Subject to the exceptions and limitations contained in
paragraph (b) below:
(i) every person who is, or has been, a Trustee or officer
of the Trust (hereinafter referred to as a "Covered Person") shall
be indemnified by the Trust and/or by the appropriate Series to
the fullest extent permitted by law against liability and against
all expenses reasonably incurred or paid by him or her in
connection with any claim, action, suit or proceeding in which he
or she becomes involved as a party or otherwise by virtue of his
or her being or having been a Covered Person and against amounts
paid or incurred by him or her in the settlement thereof;
(ii) the words "claim," "action," "suit," or "proceeding"
shall apply to all claims, actions, suits or proceedings (civil,
criminal or other, including appeals), actual or threatened while
a Covered Person is in office or thereafter, and the words
"liability" and "expenses" shall include, without limitation,
attorneys' fees, costs, judgments, amounts paid in settlement,
fines, penalties and other liabilities.
(b) No indemnification shall be provided hereunder to a Covered
Person:
(i) who shall have been adjudicated by a court or body
before which the proceeding was brought (A) to be liable to the
Trust or its Shareholders by reason of willful misfeasance, bad
faith, gross negligence or reckless disregard of the duties
involved in the conduct of his or her office or (B) not to have
acted in good faith in the reasonable belief that his or her
action was in the best interest of the Trust; or
17
<PAGE>
(ii) in the event of a settlement, unless there has been a
determination that such Covered Person did not engage in willful
misfeasance, bad faith, gross negligence or reckless disregard of
the duties involved in the conduct of his or her office, (A) by
the court or other body approving the settlement; (B) by at least
a majority of those Trustees who are neither Interested Persons of
the Trust nor parties to the matter based upon a review of readily
available facts (as opposed to a full trial-type inquiry or full
investigation); or (C) by written opinion of independent legal
counsel based upon a review of readily available facts (as opposed
to a full trial-type inquiry); provided, however, that any
Shareholder may, by appropriate legal proceedings, challenge any
such determination by the Trustees, or by independent legal
counsel.
(c) The rights of indemnification herein provided may be
insured against by policies maintained by the Trust, shall be
severable, shall not be exclusive of or affect any other rights to
which any Covered Person may now or hereafter be entitled, shall
continue as to a person who has ceased to be such Trustee or officer
and shall inure to the benefit of the heirs, executors and
administrators of such a person. Nothing contained herein shall
affect any rights to indemnification to which Trust personnel, other
than Trustees and officers, and other persons may be entitled by
contract or otherwise under law.
(d) Expenses in connection with the preparation and
presentation of a defense to any claim, action, suit or proceeding of
the character described in paragraph (a) of this Section 2 may be
paid by the Trust from time to time prior to final disposition
thereof upon receipt of an undertaking by or on behalf of such
Covered Person that such amount will be paid over by him or her to
the Trust if it is ultimately determined that he or she is not
entitled to indemnification under this Section 2; provided, however,
that:
(i) such Covered Person shall have provided appropriate
security for such undertaking,
(ii) the Trust is insured against losses arising out of
any such advance payments, or
(iii) either a majority of the Trustees who are neither
interested persons of the Trust nor parties to the matter, or
independent legal counsel in a written opinion, shall have
determined, based upon a review of readily available facts (as
opposed to a trial-type inquiry or full investigation), that there
is reason to believe that such Covered Person will be found
entitled to indemnification under this Section 2.
Shareholders
- ------------
Section 3. In case any Shareholder or former Shareholder of any Series of
the Trust shall be held to be personally liable solely by reason of his or her
being or having been a Shareholder and not because of his acts or omissions or
18
<PAGE>
for some other reason, the Shareholder or former Shareholder (or his heirs,
executors, administrators or other legal representatives or, in the case of a
corporation or other entity, its corporate or other general successor) shall be
entitled out of the assets belonging to the applicable Series to be held
harmless from and indemnified against all loss and expense arising from such
liability. The Series shall, upon request by the Shareholder, assume the defense
of any claim made against the Shareholder for any act or obligation of the Trust
and satisfy any judgment thereon.
ARTICLE XII
-----------
MISCELLANEOUS
-------------
Trust Not A Partnership
- -----------------------
Section 1. It is hereby expressly declared that a trust and not a
partnership is created hereby. No Trustee hereunder shall have any power to bind
personally either the Trust's officers or any Shareholder. All persons extending
credit to, contracting with or having any claim against the Trust or a
particular Series or the Trustees shall look only to the assets of the Trust or
of such Series, as the case may be, for payment under such credit, contract or
claim; and neither the Shareholders nor the Trustees, nor any of their agents,
whether past, present or future, shall be personally liable therefor. Nothing in
this Declaration of Trust shall protect a Trustee against any liability to which
the Trustee would otherwise be subject by reason of willful misfeasance, bad
faith, gross negligence or reckless disregard of the duties involved in the
conduct of the office of Trustee hereunder.
Trustees' Good Faith Action, Expert Advice, No Bond or Surety
- -------------------------------------------------------------
Section 2. The exercise by the Trustees of their powers and discretion
hereunder in good faith and with reasonable care under the circumstances then
prevailing, shall be binding upon everyone interested. Subject to the provisions
of Section 1 of this Article XII and to Article XI, the Trustees shall not be
liable for errors of judgment or mistakes of fact or law. The Trustees may take
advice of counsel or other experts with respect to the meaning and operation of
this Declaration of Trust, and subject to the provisions of Section 1 of this
Article XII and to Article XI, shall be under no liability for any act or
omission in accordance with such advice or for failing to follow such advice.
The Trustees shall not be required to give any bond as such, nor any surety if a
bond is obtained.
Establishment of Record Dates
- -----------------------------
Section 3. The Trustees may close the stock transfer books of the Trust for
a period not exceeding 60 days preceding the date of any meeting of
Shareholders, or the date for the payment of any dividends, or the date for the
allotment of rights, or the date when any change or conversion or exchange of
Shares shall go into effect; or in lieu of closing the stock transfer books as
aforesaid, the Trustees may fix in advance a date, not exceeding 60 days
preceding the date of any meeting of Shareholders, or the date for payment of
any dividend, or the date for the allotment of rights, or the date when any
change or conversion or exchange of Shares shall go into effect, as a record
date for the determination of the Shareholders entitled to notice of, and to
vote at, any such meeting, or entitled to receive payment of any such dividend,
or to any such allotment of rights, or to exercise the rights in respect of any
such change, conversion or exchange of Shares, and in such case such
Shareholders and only such Shareholders as shall be Shareholders of record on
19
<PAGE>
the date so fixed shall be entitled to such notice of, and to vote at, such
meeting, or to receive payment of such dividend, or to receive such allotment or
rights, or to exercise such rights, as the case may be, notwithstanding any
transfer of any Shares on the books of the Trust after any such record date
fixed as aforesaid. The Trustees need not set a new record date when a
Shareholder meeting is adjourned to achieve a quorum and reconvened more than 60
days after the record date for that meeting.
Termination of Trust
- --------------------
Section 4.
---------
(a) This Trust shall continue without limitation of time but
subject to the provisions of paragraph (b) of this Section 4.
(b) Subject to a Majority Shareholder Vote of each Series
affected by the matter or, if applicable, by a Majority Shareholder
vote of the Trust, the Trustees may:
(i) sell and convey the assets of the Trust or any
affected Series to another Series or to another trust,
partnership, association or corporation organized under the
laws of any state which is an open-end management investment
company as defined in the 1940 Act, for adequate consideration
which may include the assumption of all outstanding
obligations, taxes and other liabilities; accrued or
contingent, of the Trust and which may include shares of
beneficial interest or stock of such trust, partnership,
association or corporation; or
(ii) at any time sell and convert into money all or
substantially all of the assets of the Trust or any affected
Series.
Upon making provision for the payment of all such liabilities
in either (i) or (ii) above, by such assumption or otherwise, the
Trustees shall distribute the remaining proceeds or assets (as the case
may be) ratably among the holders of the Shares of the Trust or any
affected Series then outstanding; however, the payment to any
particular Class within such Series may be reduced by any fees,
expenses or charges allocated to that Class. Nothing in this
Declaration of Trust shall preclude the Trustees from distributing such
remaining proceeds or assets so that holders of the Shares of a
particular Class of the Trust or any affected Series receive as their
ratable distribution Shares solely of an analogous class, as determined
by the Trustees, of such Series, trust, partnership, association or
corporation.
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The Trustees may take any of the actions specified in clauses (i) and
(ii) above without obtaining a Majority Shareholder Vote of any Series
or Class or of the Trust if a majority of the Trustees makes a
determination that the continuation of a Series or Class or the Trust
is not in the best interests of such Series or Class, or the Trust or
their respective Shareholders as a result of factors or events
adversely affecting the ability of such Series or Class or the Trust to
conduct its business and operations in an economically viable manner.
Such factors and events may include: the inability of a Series or
Class, or the Trust to maintain its assets at an appropriate size,
changes in laws or regulations governing the Series or Class, or the
Trust or affecting assets of the type in which such Series or Class, or
the Trust invests or economic developments or trends having a
significant adverse impact on the business or operations of such Series
or Class, or the Trust.
(c) Upon completion of the distribution of the remaining
assets as provided in paragraph (b), the Trust or any affected Series
shall terminate and the Trustees shall be discharged of any and all
further liabilities and duties hereunder and the right, title and
interest of all parties shall be canceled and discharged.
Filing of Copies, References, Headings
- --------------------------------------
Section 5. The original or a copy of this instrument and of each amendment
hereto shall be kept at the office of the Trust where it may be inspected by any
Shareholder. A copy of this instrument and of each amendment hereto shall be
filed by the Trustees with the Secretary of the Commonwealth of Massachusetts
and any other governmental office where such filing may from time to time be
required. Anyone dealing with the Trust may rely on a certificate by an officer
or Trustee of the Trust as to whether or not any such amendments to this
Declaration of Trust have been made and as to any matters in connection with the
Trust hereunder, and with the same effect as if it were the original, may rely
on a copy certified by an officer or Trustee of the Trust to be a copy of this
instrument or of any such amendments. In this instrument or in any such
amendments, references to this instrument, and the expressions "herein,"
"hereof" and "hereunder," shall be deemed to refer to this instrument as amended
from time to time. Headings are placed herein for convenience of reference only
and in case of any conflict, the text of this instrument, rather than the
headings, shall control. This instrument may be executed in any number of
counterparts each of which shall be deemed an original.
Applicable Law
- --------------
Section 6. The trust set forth in this instrument is made in the
Commonwealth of Massachusetts, and it is created under and is to be governed by
and construed and administered according to the laws of said Commonwealth. The
Trust shall be of the type commonly called a Massachusetts business trust, and
without limiting the provisions hereof, the Trust may exercise all powers which
are ordinarily exercised by such a trust.
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Amendments
- ----------
Section 7. This instrument can be amended, supplemented or restated by a
majority vote of the Trustees. Amendments, supplements or restatements having
the purpose of materially decreasing the rights of Shareholders in regard to
liability and indemnification, as set forth in Article III, Section 6 and
Article XI, Section 3, respectively, shall require a Majority Shareholder Vote.
Copies of the amended, supplemented or restated Declaration of Trust shall be
filed as specified in Section 5 of this Article XII.
Fiscal Year
- -----------
Section 8. The fiscal year of the Trust or of each Series thereof shall end
on a specified date as determined by the Trustees; provided, however, that the
Trustees may, without Shareholder approval, change the fiscal year of the Trust.
Notice to Other Parties
- -----------------------
Section 9. Every note, bond, contract, instrument, certificate or
undertaking made or issued by the Trustees or by any officer or officers shall
give notice that this Declaration of Trust is on file with the Secretary of the
Commonwealth of Massachusetts and shall recite that the same was executed or
made by or on behalf of the Trust or by them as Trustee or Trustees or as
officer or officers and not individually, and that the obligations of such
instrument are not binding upon any of them or the Shareholders individually but
are binding only upon the assets and property of the Trust, and may contain such
further recital as he and she or they may deem appropriate, but the omission
thereof shall not operate to bind any Trustee or Trustees or officer or officers
or Shareholder or Shareholders.
IN WITNESS WHEREOF, the undersigned, being the initial Trustees of the
Potomac Funds, have executed this instrument.
May 30, 1997 /s/ Lawrence Rafferty
- ------------------- ---------------------------
Date Lawrence Rafferty
Trustee
June 3, 1997 /s/ Jay F. Higgins
- ------------------- -----------------------------
Date Jay F. Higgins
Trustee
22
POTOMAC FUNDS
A Massachusetts Business Trust
BY-LAWS
June 3, 1997
<PAGE>
POTOMAC FUNDS
BY-LAWS
TABLE OF CONTENTS
Page
----
ARTICLE I - OFFICERS AND THEIR ELECTION....................................1
Section 1: Officers...........................................1
Section 2: Election of Officers...............................1
Section 3: Resignations and Removals..........................1
Section 4: Vacancies and Newly Created Offices................1
ARTICLE II - POWERS AND DUTIES OF OFFICERS AND TRUSTEES.....................1
Section 1: Management of the Trust - General..................1
Section 2: Right to Engage in Business........................2
Section 3: Executive and Other Committees.....................2
Section 4: Chairman of the Trustees...........................2
Section 5: President..........................................2
Section 6: Treasurer..........................................2
Section 7: Secretary..........................................2
Section 8: Vice President.....................................3
Section 9: Assistant Treasurer................................3
Section 10: Assistant Secretary...............................3
Section 11: Other Officers....................................3
ARTICLE III - SHAREHOLDERS' MEETINGS.........................................3
Section 1: Special Meetings...................................3
Section 2: Notice.............................................3
Section 3: Place of Meeting...................................4
Section 4: Ballots............................................4
Section 5: Proxies............................................4
Section 6: Action Without a Meeting...........................4
ARTICLE IV - TRUSTEES' MEETINGS.............................................4
Section 1: Special Meetings...................................4
Section 2: Regular Meetings...................................5
Section 3: Quorum.............................................5
Section 4: Notice.............................................5
Section 5: Special Action.....................................5
Section 6: Action By Consent..................................5
ARTICLE V - SHARES OF BENEFICIAL INTEREST..................................5
Section 1: Beneficial Interest................................5
Section 2: Transfer of Shares.................................6
Section 3: Equitable Interest Not Recognized..................6
ARTICLE VI - INSPECTION OF BOOKS............................................6
ARTICLE VII - FISCAL YEAR....................................................6
ARTICLE VIII - AMENDMENTS.....................................................6
ARTICLE IX - PRINCIPAL OFFICE OF THE TRUST..................................6
<PAGE>
BY-LAWS FO THE POTOMAC FUNDS
----------------------------
These By-Laws of the Potomac Funds (the "Trust"), a Massachusetts
business trust, are subject to the Trust's Declaration of Trust as from time to
time amended.
ARTICLE I
---------
OFFICERS AND THEIR ELECTION
---------------------------
Officers
- --------
Section 1. The officers of the Trust shall be a President, a Treasurer,
a Secretary, and such other officers as the Trustees may from time to time
elect. It shall not be necessary for any Trustee or officer to be a holder of
shares in the Trust.
Election of Officers
- --------------------
Section 2. The President, Treasurer and Secretary shall be chosen
annually by the Trustees. Two or more offices may be held by a single person
except the offices of President and Secretary. The officers shall hold office
until their successors are chosen and qualified.
Resignations and Removals
- -------------------------
Section 3. Any officer of the Trust may resign by filing a written
resignation with the President, the Trustees or the Secretary, which resignation
shall take effect on being so filed or at such time as may be therein specified.
The Trustees may at any meeting remove any officer by a majority vote of the
voting Trustees.
Vacancies and Newly Created Offices
- -----------------------------------
Section 4. If any vacancy shall occur in any office or if any new
office shall be created, such vacancies or newly created offices may be filled
by the Trustees at any regular or special meeting of the Trustees.
ARTICLE II
----------
POWERS AND DUTIES OF OFFICERS AND TRUSTEES
------------------------------------------
Management of the Trust - General
- ---------------------------------
Section 1. The business and affairs of the Trust shall be managed by
the Trustees, and they shall have all powers necessary and desirable to carry
out their responsibilities, so far as such powers are not inconsistent with the
laws of the Commonwealth of Massachusetts, the Declaration of Trust, or these
By-Laws.
<PAGE>
Right to Engage in Business
- ---------------------------
Section 2. Any officer or Trustee of the Trust, the investment adviser,
the manager, the administrator and any officers or directors of the investment
adviser, manager or administrator may have personal business interests and may
engage in personal business activities.
Executive and Other Committees
- ------------------------------
Section 3. The Trustees may elect from their own number an executive
committee which shall have the power and duty to conduct the current and
ordinary business of the Trust, including the purchase and sale of securities,
while the Trustees are not in session, and such other powers and duties as the
Trustees may from time to time delegate to such committee. The Trustees also may
elect from their own number other committees from time to time. The number
composing such committees and the powers conferred upon the same are to be
determined by vote of the Trustees.
Chairman of the Trustees
- ------------------------
Section 4. The Trustees may, but need not, appoint from among their
number a Chairman. He or she shall perform such duties as the Trustees may from
time to time designate.
President
- ---------
Section 5. The President shall be the chief executive officer of the
Trust and, subject to the supervision of the Trustees, shall have general
supervision over the business and policies of the Trust. When present, he or she
shall preside at all meetings of the Shareholders and the Trustees, and he or
she may, subject to the approval of the Trustees, appoint a Trustee to preside
at such meetings in his or her absence. The President shall perform such duties
additional to all of the foregoing as the Trustees may from time to time
designate.
Treasurer
- ---------
Section 6. The Treasurer shall be the principal financial and
accounting officer of the Trust. He or she shall deliver all funds and
securities of the Trust that may come into his or her hands to such bank or
trust company as the Trustees shall employ as Custodian. He or she shall have
the custody of the seal of the Trust. He or she shall make annual reports
regarding the business and condition of the Trust, which reports shall be
preserved in Trust records, and he or she shall furnish such other reports
regarding the business and condition of the Trust as the Trustees may from time
to time require. The Treasurer shall perform such additional duties as the
Trustees may from time to time designate.
Secretary
- ---------
Section 7. The Secretary shall record in books kept for the purpose all
votes and proceedings of the Trustees and the Shareholders at their respective
meetings. The Secretary shall perform such additional duties as the Trustees may
from time to time designate.
2
<PAGE>
Vice President
- --------------
Section 8. Any Vice President of the Trust shall perform such duties as
the Trustees may from time to time designate.
Assistant Treasurer
- -------------------
Section 9. Any Assistant Treasurer of the Trust shall perform such
duties as the Trustees may from time to time designate.
Assistant Secretary
- -------------------
Section 10. Any Assistant Secretary of the Trust shall perform such
duties as the Trustees may from time to time designate.
Other Officers
- --------------
Section 11. The Trustees from time to time may appoint such other
officers or agents as they may deem advisable, each of whom shall have such
title, hold office for such period, have such authority and perform such duties
as the Trustees may determine. The Trustees from time to time may delegate to
one or more officers or agents the power to appoint any such subordinate
officers or agents and to prescribe their respective rights, terms of office,
authorities and duties.
ARTICLE III
-----------
SHAREHOLDERS' MEETINGS
----------------------
Special Meetings
- ----------------
Section 1. A special meeting of the Shareholders shall be called by the
Secretary whenever (a) ordered by the Trustees or (b) requested, for the purpose
of removing a Trustee from office, in writing by the holder or holders of at
least 10% of the outstanding Shares entitled to vote. If the Secretary, when so
ordered or requested, refuses or neglects for more than 30 days to call such
special meeting, the Trustees or the Shareholders so requesting may, in the name
of the Secretary, call the meeting by giving notice thereof in the manner
required when notice is given by the Secretary. If the meeting is a meeting of
the Shareholders of one or more series or classes of Shares, but not a meeting
of all Shareholders of the Trust, then only the Shareholders of such one or more
series shall be entitled to notice of and to vote at such meeting.
Notice
- ------
Section 2. Except as provided above, notices of the place, date and
hour, and purpose(s) for which any special meeting of the Shareholders is called
shall be given by the Secretary by delivering or mailing, postage prepaid, to
each Shareholder entitled to vote at such meeting, a written or printed
notification of such meeting, at least 15 days before the meeting, to such
address as may be registered with the Trust by the Shareholder.
3
<PAGE>
Place of Meeting
- ----------------
Section 3. All special meetings of the Shareholders shall be held at
the principal place of business of the Trust or at such other place in the
United States as the Trustees may designate.
Ballots
- -------
Section 4. The vote upon any question shall be by ballot whenever
requested by any person entitled to vote, but, unless such a request is made,
voting may be conducted in any way approved by the meeting.
Proxies
- -------
Section 5. Shareholders entitled to vote may vote either in person or
by proxy, provided that an instrument authorizing such proxy to act is executed
by the Shareholder in writing and dated not more than eleven months before the
meeting, unless the instrument specifically provides for a longer period.
Shareholders may have their votes recorded by telephone, at which time
Shareholders may authorize proxies to vote their Shares in accordance with their
instructions. Shareholders will not execute telephone proxies in writing, but
will receive a confirmation of their instructions by mail and be provided an
opportunity to correct any incorrect instructions. Proxies shall be delivered to
the Secretary of the Trust or other person responsible for recording the
proceedings before being voted. A proxy with respect to Shares held in the name
of two or more persons shall be valid if executed by one of them unless at or
prior to exercise of such proxy the Trust receives a specific written notice to
the contrary from any one of them. Unless otherwise specifically limited by
their terms, proxies shall entitle the holder thereof to vote at any adjournment
of a meeting. A proxy purporting to be exercised by or on behalf of a
Shareholder shall be deemed valid unless challenged at or prior to its exercise
and the burden of providing invalidity shall rest on the challenger. At all
meetings of the Shareholders, unless the voting is conducted by inspectors, all
questions relating to the qualifications of voters, the validity of proxies, and
the acceptance or rejection of votes shall be decided by the chairman of the
meeting.
Action Without a Meeting
- ------------------------
Section 6. Any action to be taken by Shareholders may be taken without
a meeting if all Shareholders entitled to vote on the matter consent to the
action in writing and the writen consents are filed with the records of meetings
of Shareholders of the Trust. Such consent shall be treated for all purposes as
a vote at a meeting.
ARTICLE IV
----------
TRUSTEES' MEETINGS
------------------
Special Meetings
- ----------------
Section 1. Special meetings of the Trustees shall be called by the
Secretary at the written request of the President, the Treasurer, or any two
Trustees, and if the Secretary, when so requested, refuses or fails for more
than 24 hours to call such meeting, the President, the Treasurer, or such two
4
<PAGE>
Trustees may, in the name of the Secretary, call such meeting by giving due
notice in the manner required when notice is to be given by the Secretary. All
special meetings of the Trustees shall be held at the principal place of
business of the Trust or such other place in the United States as the person or
persons requesting such meeting to be called may designate, but any meeting may
adjourn to any other place.
Regular Meetings
- ----------------
Section 2. Regular meetings of the Trustees may be held without call or
notice at such places and at such times as the Trustees may from time to time
determine, provided that any Trustee who is absent when such determination is
made shall be given notice of the determination.
Quorum
- ------
Section 3. A majority of the Trustees shall constitute a quorum for the
transaction of business.
Notice
- ------
Section 4. Except as otherwise provided, notice of any special meeting
of the Trustees shall be given by the Secretary to each Trustee orally or by
mail, hand delivery or telegram. A notice may be mailed, postage prepaid,
addressed to him or her at his or her address as registered on the books of the
Trust or, if not so registered, at his or her last known address at least three
days before the meeting or delivered to him or her at least two days before the
meeting, provided orally by telephone at least 24 hours before the meeting or
sent to him or her at least 24 hours before the meeting by prepaid telegram
addressed to him or her at said registered address, if any, or if he has no such
registered address, at his last known address.
Special Action
- --------------
Section 5. When all the Trustees shall be present at any meeting,
however called or wherever held, or shall assent to the holding of the meeting
without notice, or after the meeting shall sign a written assent thereto on the
record of such meeting, the acts of such meeting shall be valid as if such
meeting had been regularly held.
Action By Consent
- -----------------
Section 6. Any action by the Trustees may be taken without a meeting if
a written consent thereto is signed by all the Trustees and filed with the
records of the Trustees' meeting or by telephone consent provided a quorum of
Trustees participate in any such telephone meeting. Such consent shall be
treated as a vote of the Trustees for all purposes.
ARTICLE V
---------
SHARES OF BENEFICIAL INTEREST
-----------------------------
Beneficial Interest
- -------------------
Section 1. The beneficial interest in the Trust shall at all times be
divided into an unlimited number of transferable Shares without par value, each
5
<PAGE>
of which shall represent an equal proportionate interest in the series or class
thereof with each other Share of any outstanding series or class thereof. No
Share shall have priority or preference over another Share.
Transfer of Shares
- ------------------
Section 2. The Shares of the Trust shall be transferable, so as to
affect the rights of the Trust, only by transfer recorded on the books of the
Trust, in person or by attorney.
Equitable Interest Not Recognized
- ---------------------------------
Section 3. The Trust shall be entitled to treat the holder of record of
any Share or Shares of beneficial interest as the holder in fact thereof and
shall not be bound to recognize any equitable or other claim or interest in such
Share or Shares on the part of any other person except as may be otherwise
expressly provided by law.
ARTICLE VI
----------
INSPECTION OF BOOKS
-------------------
The Trustees shall from time to time determine whether and to what
extent, and at what times and places, and under what conditions and regulations
the accounts and books of the Trust or any of them shall be open to the
inspection of the Shareholders; and no Shareholder shall have any right to
inspect any account or book or document of the Trust except as conferred by law
or otherwise by the Trustees or by resolution of the Shareholders.
ARTICLE VII
-----------
FISCAL YEAR
-----------
The fiscal year of the Trust shall end on such date as the Trustees
shall from time to time determine.
ARTICLE VIII
------------
AMENDMENTS
----------
These By-Laws may be amended at any meeting of the Trustees of the
Trust by a majority vote.
ARTICLE IX
----------
PRINCIPAL OFFICE OF THE TRUST
-----------------------------
The principal place of business of the Trust shall be located within or
without the Commonwealth of Massachusetts as the Trustees may determine or as
they may authorize.
6
