As filed with the Securities and Exchange Commission on November 30, 1998
1933 Act File No. 333-28697
1940 Act File 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. 2 [ X ]
---
and/or
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [ X ]
Amendment No. 3
----
(Check appropriate box or boxes.)
POTOMAC FUNDS
(Exact name of Registrant as Specified in Charter)
550 Mamaroneck Avenue
Harrison, New York 10528
(Address of Principal Executive Office) (Zip Code)
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)
Copy to:
Robert J. Zutz, Esq.
Kirkpatrick & Lockhart LLP
1800 Massachusetts Avenue, NW
Washington, D.C. 20036
Approximate Date of Proposed Public Offering DECEMBER 30, 1998
-----------------
It is proposed that this filing will become effective (check appropriate box)
[ ] immediately upon filing pursuant to paragraph (b)
[ x ] on December 30, 1998 pursuant to paragraph (b)
[ ] 60 days after filing pursuant to paragraph (a)(1)
[ ] on (date) pursuant to paragraph (a)(1)
[ ] 75 days after filing pursuant to paragraph (a)(2)
[ ] on (date) pursuant to paragraph (a)(2) of Rule 485.
If appropriate, check the following box:
[ ] This post-effective amendment designates a new effective date
for a previously filed post- effective amendment.
<PAGE>
THE POTOMAC FUNDS
CONTENTS OF REGISTRATION STATEMENT
This registration document is comprised of the following:
Cover Sheet
Contents of Registration Statement
Prospectus
Statement of Additional Information
Part C of Form N-1A
Signature Page
Exhibits
<PAGE>
POTOMAC FUNDS
(LOGO)
PROSPECTUS
100 South Royal Street
Alexandria, Virginia 22314
550 Mamaroneck Avenue
Harrison, New York 10528
(800) 851-0511
The Potomac Funds (the "Trust") is a no-load management investment company, or
mutual fund, that currently offers five separate investment portfolios (each a
"Fund" and collectively the "Funds"). The Funds are designed principally for
experienced investors who intend to follow an asset allocation strategy. The
Funds are not designed for inexperienced or less sophisticated investors. 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
<S> <C>
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 Index(TRADEMARK)
Potomac OTC/Short Fund Inverse (opposite) of the Nasdaq 100 Index(TRADEMARK)
</TABLE>
January 1, 1999
<PAGE>
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. 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 BOARD OR ANY OTHER AGENCY. AN
INVESTMENT IN THIS FUND IS NEITHER INSURED NOR GUARANTEED BY THE UNITED STATES
GOVERNMENT.
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 "Special Risk
Considerations." Investors in the 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 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. 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 January 1, 1999, 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.
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<PAGE>
TABLE OF CONTENTS
PAGE
PROSPECTUS SUMMARY...........................................................4
FEES AND EXPENSES OF THE FUNDS...............................................6
INVESTMENT OBJECTIVES AND POLICIES...........................................9
SPECIAL RISK CONSIDERATIONS.................................................12
INVESTMENT TECHNIQUES AND OTHER INVESTMENT POLICIES.........................14
PORTFOLIO TRANSACTIONS AND BROKERAGE........................................18
HOW TO INVEST IN THE FUNDS..................................................19
TAX-SHELTERED RETIREMENT PLANS..............................................20
REDEEMING SHARES (WITHDRAWALS)..............................................20
EXCHANGES...................................................................21
PROCEDURES FOR REDEMPTIONS AND EXCHANGES....................................21
DETERMINATION OF NET ASSET VALUE............................................22
PERFORMANCE INFORMATION.....................................................23
DIVIDENDS AND OTHER DISTRIBUTIONS...........................................24
TAXES.......................................................................24
MANAGEMENT AND ADMINISTRATION OF THE TRUST..................................25
GENERAL INFORMATION ABOUT THE TRUST.........................................26
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 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(TRADEMARK) (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 invests in short-term 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
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 invests in short-term 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 Index(TRADEMARK)
("Nasdaq Index"). The Fund invests in the securities included in that index, as
well as enters 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 invests in short-term debt securities.
The POTOMAC OTC/SHORT FUND ("OTC/Short Fund") seeks to provide investment
results that inversely correlate to the performance of the 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 invests in the securities included in that
index, as well as 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 invests in
short-term debt securities.
4
<PAGE>
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," "Special Risk Considerations" and "Investment Techniques and Other
Investment Policies," these techniques are specialized and involve risks not
traditionally associated with investment companies.
The Trust expects that a substantial number of the Funds' investors are
experienced and invest in the Funds as part of an asset allocation investment
strategy. These shareholders likely 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 generally causes a Fund to incur higher
expenses and additional costs and may adversely affect the ability of a Fund to
meet its investment objective.
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 will magnify
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 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. 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. 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. 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
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<PAGE>
redemption may be effected. SEE "How to Invest in the Funds," "Redeeming Shares
(Withdrawals)" and "Procedures for Redemptions and Exchanges."
INVESTMENT ADVISER
Rafferty Asset Management, LLC ("Adviser") serves as the investment adviser to
each Fund. The Adviser has been registered as an investment adviser since June
1997. Lawrence C.
Rafferty controls the Adviser.
FEES AND EXPENSES OF THE FUNDS
The following table illustrates the various expenses and fees that a shareholder
of each Fund may incur either directly or indirectly.
<TABLE>
<CAPTION>
ANNUAL FUND OPERATING EXPENSES
Total Fund
Management Other Operating
Fees* 12b-1 Fees+ Expenses* Expenses*#
----- ----------- --------- ----------
<S> <C> <C> <C> <C>
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
</TABLE>
- -----------
+ 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
"General Information about the Trust - DISTRIBUTION of Fund Shares" below.
# You will be charged $12.00 per wire redemption to cover transaction costs.
* After fee waiver amd/or expense reimbursement. Absent such fee waivers and/or
reimbursements each Fund's Other Expenses and Total Operating Expenses for the
fiscal year ended August 31, 1998 would have been as follows:
Other Expenses Total Operating Expenses
-------------- ------------------------
U.S. Plus Fund 1.77% 2.52%
U.S./Short Fund 4.39% 5.29%
OTC Plus Fund 2.46% 3.21%
OTC/Short Fund 2.80% 3.70%
Money Market Fund 3.20% 3.70%
EXAMPLE
-------
Assuming a hypothetical investment 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 period as follows:
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<PAGE>
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
U.S. Plus Fund $15 $47 $82 $179
U.S./Short Fund $17 $52 $90 $195
OTC Plus Fund $15 $47 $82 $179
OTC/Short Fund $17 $52 $90 $195
Money Market Fund $10 $32 $55 $122
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 assets of the U.S./Short
Fund and the OTC/Short Fund may decline in a rising stock market as a result of
possible net redemptions. During such periods, it is possible that the expense
ratio of those funds may increase. 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 and Administration of the Trust" in this Prospectus
and in the SAI.
FINANCIAL HIGHLIGHTS
The following table shows important financial information audited by
PricewaterhouseCoopers LLP for each fund share outstanding for the period ended
August 31, 1998, including net investment income, net realized and unrealized
gain on investments, and certain other information. The information included
below has been derived from the financial records of the Funds. Copies of the
funds' Annual Report to Shareholders may be obtained without charge, upon
request.
7
<PAGE>
<TABLE>
<CAPTION>
POTOMAC FUNDS
For a fund share outstanding throughout the period
POTOMAC FUNDS U.S. PLUS FUND U.S./SHORT FUND OTC PLUS FUND OTC/SHORT FUND U.S. GOVERNMENT
MONEY MARKET FUND
October 20, November 7, October 20, October 16, October 20,
1997(1) to 1997(1) to 1997(1) to 1997(1) to 1997(1) to
August 31, August 31, August 31, August 31, August 31,
1998 1998 1998 1998 1998
------------ ------------ ---------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
PER SHARE DATA:
NET ASSET VALUE,
BEGINNING OF PERIOD ........................ $ 10.00 $ 10.00 $ 10.00 $ 10.00 $ 1.00
-------------------------------------------- -------- ------- --------- -------- ---------
INCOME (LOSS) FROM INVESTMENT OPERATIONS:
Net investment income (loss) .................. 0.36(4) 0.23(4) (0.11)(4) 0.09(4)(8) 0.04(4)
Net realized and unrealized gain (loss) on .... (0.58) (0.77) 0.52 (1.71) --
--------- -------- --------- --------- ---------
investments
Total from investment operations .......... (0.22) (0.54) 0.41 (1.62) 0.04
--------- -------- --------- --------- ---------
LESS DIVIDENDS FROM NET INVESTMENT INCOME ..... (0.02) -- -- -- (0.04)
--------- -------- --------- --------- ---------
NET ASSET VALUE, END OF PERIOD ................ $ 9.76 $ 9.46 $ 10.41 $ 8.38 $ 1.00
======== ======== ========= ========= =========
TOTAL RETURN(2) ............................... (2.23%) (5.40%) 4.10% (16.20%) 3.89%
SUPPLEMENTAL DATA AND RATIOS:
Net assets, end of period ..................... $ 466,997 $7,768,652 $ 7,680,546 $19,168,538 $ 9,370,384
Ratio of net expenses to average net assets:
Before expense reimbursement(3) ........... 2.52% 5.29% 3.21% 3.70% 3.70%
After expense reimbursement(3) ............ 1.50% 1.57% 1.50% 1.64%(6) 1.00%
Ratio of net investment income (loss) to average
net assets:
Before expense reimbursement(3) ........... 2.68% (0.46%) (2.84%) (0.74%) 1.66%
After expense reimbursement(3) ............ 3.70% 3.26% (1.13%) 1.32%(7) 4.36%
Portfolio turnover rate(5) .................... 0.00% 0.00% 2,324.63% 3,346.25% N/A
</TABLE>
===============================================
(1) COMMENCEMENT OF OPERATIONS.
(2) NOT ANNUALIZED.
(3) ANNUALIZED.
(4) NET INVESTMENT INCOME (LOSS) PER SHARE REPRESENTS NET INVESTMENT INCOME
(LOSS) FOR THE RESPECTIVE PERIOD DIVIDED BY THE DAILY AVERAGE SHARES OF
BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH PERIOD.
(5) PORTFOLIO TURNOVER RATIO IS CALCULATED WITHOUT REGARD TO SHORT-TERM
SECURITIES HAVING A MATURITY OF LESS THAN ONE YEAR. ALL OF THE FUNDS,
WITH THE EXCEPTION OF THE OTC PLUS FUND AND THE OTC/SHORT FUND, TYPICALLY
HOLD MOST OF THEIR INVESTMENTS IN OPTIONS, FUTURES CONTRACTS AND
REPURCHASE AGREEMENTS, WHICH ARE DEEMED SHORT-TERM SECURITIES.
(6) THE OPERATING EXPENSE RATIO EXCLUDED DIVIDENDS ON SHORT POSITIONS. THE
RATIO INCLUDING DIVIDENDS ON SHORT POSITIONS FOR THE RESPECTIVE PERIOD
ENDED WAS 1.78%.
(7) THE NET INVESTMENT INCOME RATIO INCLUDED DIVIDENDS ON SHORT POSITIONS.
THE RATIO EXCLUDING DIVIDENDS ON SHORT POSITIONS FOR THE RESPECTIVE
PERIOD ENDED WAS 1.46%.
(8) NET INVESTMENT INCOME BEFORE DIVIDENDS ON SHORT POSITIONS FOR THE
RESPECTIVE PERIOD ENDED WAS $0.10.
8
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INVESTMENT OBJECTIVES AND POLICIES
GENERAL
The Funds are designed principally for experienced investors who intend to
follow an asset allocation investment strategy. The Funds are not designed for
inexperienced or less sophisticated investors. Except for the Money Market Fund,
each Fund is intended to provide investment exposure to a particular segment of
the domestic securities markets. These Funds seek investment results that
correspond over time to a specified benchmark. The terms "long" and "short" in
the Funds' names are not intended to refer to the duration of the Funds'
investment portfolios. 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 tend to cause a Fund's investment results to
vary from a perfect correlation to its benchmark. The Funds, however, do not
expect their total returns to vary from their respective current benchmarks by
more than 10% over a twelve-month period. SEE "Special Risk Considerations -
Tracking Error." 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. For a discussion of the instruments a Fund may use, sEE "Investment
Techniques and Other Investment Policies."
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.
In contrast to a mutual fund that seeks to approximate the return of the S&P 500
Index, the Fund may produce greater returns than such a fund during periods when
the prices of the securities in the S&P 500 Index are rising and lower returns
than such a fund 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.
9
<PAGE>
THE POTOMAC U.S./SHORT FUND
The U.S./Short Fund is intended to allow investors to benefit from 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 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
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
may 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.
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 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
10
<PAGE>
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 a mutual fund that seeks to approximate the return of the Nasdaq
Index, the Fund may produce greater returns than such a fund during periods when
the prices of the securities in the Nasdaq Index are rising and lower returns
than such a fund 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 OTC/SHORT FUND
The OTC/Short Fund is intended to allow investors to benefit from 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 inversely correlate to the performance of the Nasdaq 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 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 invests in stocks included in the
Nasdaq Index, although the Fund may not necessarily hold all 100 stocks included
in the Nasdaq Index. The Fund also engages 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 Trustees or by the Adviser, subject
to supervision by the Trustees, to present minimal credit risk. The Fund invests
exclusively in obligations issued or guaranteed by the U.S. Government, its
agencies or instrumentalities ("U.S. Government Securities") and repurchase
agreements that are fully collateralized by such obligations.
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THE BENCHMARKS
STANDARD & POOR'S 500 COMPOSITE STOCK PRICE INDEX.(TRADEMARK) Standard & Poor's,
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 domestic companies listed on the
Nasdaq National Market tier of the Nasdaq. All companies listed on the index
have a minimum market capitalization of $500 million and an average daily
trading volume of at least 100,000 shares. The Nasdaq Index was created in 1985.
SPECIAL RISK CONSIDERATIONS
The following factors may be important 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 U.S. Plus Fund and the U.S./Short
Fund use these techniques primarily in seeking to achieve their investment
objectives. The OTC Plus Fund and the OTC/Short Fund also use these techniques
in seeking to achieve their investment objectives. In doing so, a significant
portion of these Funds' assets are 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, 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 the 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
the possibility of distortion, a correct forecast of stock market trends by the
Adviser may still not result in a successful transaction. The Adviser may be
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incorrect in its expectations as to the extent of 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
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 depends largely on the purchase, redemption, and exchange activity of its
investors, it is difficult to estimate each Fund's actual turnover rate. 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 U.S. Plus Fund and the
U.S./Short Fund typically 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 and the OTC/Short Fund, which invest primarily in common
stocks, are expected to have a similar rate.
A higher portfolio turnover ratio would likely involve correspondingly higher
brokerage commissions and other expenses borne by a Fund. Such higher expenses
can adversely affect the ability of a Fund to achieve its investment objective.
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 will
magnify 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 creates the potential for significant
losses.
TRACKING ERROR. While the Funds do not expect their returns over a twelve-month
period to deviate 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).
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Investors should be aware that while index futures and options contracts closely
correlate with the applicable indices over long periods, shorter-term deviation,
such as on a daily basis, does occur with these instruments. As a result, a
Fund's short-term performance will reflect such deviation from its benchmark.
In the case of the Funds' whose net asset values move inversely from their
benchmarks - 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 U.S./Short Fund achieved a perfect inverse
correlation with the S&P 500 Index on every trading day over an extended period
and the level of returns of the S&P 500 Index significantly decreased during
that period, a compounding effect for that period would result, causing an
increase on the U.S./Short Fund's net asset value by a percentage that is
somewhat greater than the percentage the S&P 500 Index returns decreased.
Conversely, if the U.S./Short Fund maintained a perfect inverse correlation with
the S&P 500 Index over an extended period and if the level of returns of the S&P
500 Index significantly increased over that period, a compounding effect would
result, causing a decrease of the U.S./Short Fund's net asset value by a
percentage that would be somewhat less than the percentage the S&P 500 Index
returns increased.
TRADING HALTS. The U.S. Plus Fund and the U.S./Short Fund typically hold most of
their investments in short-term options and futures contracts. The major
exchanges on which these contracts are traded, such as the Chicago Mercantile
Exchange ("CME"), and the Chicago Board of Options Exchange ("CBOE") 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 by the CME, CBOE, Nasdaq or NYSE 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. 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, 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.
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A futures contract obligates the seller to deliver (and the purchaser to take
delivery of) the specified security 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 or index. The extent of the 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 only
purchase and sell futures contracts and options on futures contracts that are
traded on a U.S. exchange or board of trade.
To the extent that a Fund enters into futures contracts or options on futures
contracts 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 and options on futures contracts.
OPTIONS ON INDICES AND SECURITIES
Each Fund, other than the Money Market Fund, may purchase and sell put and call
options on stock indices and on individual securities. 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, 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
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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
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, a Fund has the right, in return for the
premium paid, to buy the security 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 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 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 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.
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 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 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.
SHORT SALES
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
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(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.
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").
AMERICAN DEPOSITORY RECEIPTS ("ADRS")
The OTC Plus Fund and the OTC/Short Fund may invest in ADRs. The OTC/Short Fund
also may 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.
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 invests 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
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.
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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 monitors 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, repurchase
agreements not terminable within 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. In addition, each Fund may lend securities to broker-dealers and
financial institutions, provided that the borrower at all times maintains cash
collateral in an amount equal to at least 100% of the market value of the
securities loaned. Such loans will not be made if, as a result, the aggregate
amount of all outstanding loans by any Fund would exceed 33 1/3% (10% in the
case of the Money Market Fund) of its total assets. For a more detailed
discussion of these practices, see the SAI.
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 seeks 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
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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
GENERAL
- -------
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 $1,000.
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 either by mail or bank wire transfer to the
Trust's transfer agent, Firstar Mutual Fund Services, LLC ("Transfer Agent") as
described below.
BY MAIL
You may purchase shares of a Fund directly by completing and signing the Account
Application included with the Prospectus and making 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 completed
Account Application, to Potomac Funds, c/o Firstar Mutual Fund Services, LLC,
P.O. Box 1993, Milwaukee, Wisconsin 53201-1993.
Completed Account Applications and checks also may be sent by overnight or
express mail. To ensure proper delivery, please use the following address:
Potomac Funds, c/o Firstar Mutual Fund Services, LLC, Mutual Fund Services, 3rd
Floor, 615 East Michigan Street, Milwaukee, Wisconsin 53202.
Third party checks will not by accepted by the Funds. All purchases must be in
U.S. Dollars. A $25.00 fee will be imposed by the Transfer Agent if any check
used for investment in an account does not clear due to insufficient funds.
BY BANK WIRE TRANSFER
To establish a new account by wire transfer, please call the Transfer Agent at
(800) 851-0511 to obtain a Potomac Funds account number. You must send a
completed Account Application to the Trust at the above address immediately
following the investment. Payment for Fund shares should be wired through the
Federal Reserve System as follows:
Firstar Bank Milwaukee, N.A.
777 East Wisconsin Avenue
Milwaukee, Wisconsin 53202
ABA number 0750-00022
For credit to Firstar Mutual Fund Services, LLC
Account Number 112-952-137
For further credit to the Potomac Funds
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Shareholder name:
Shareholder account number:
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 Transfer Agent.
TAX-DEFERRED RETIREMENT PLANS
The Trust offers individual retirement accounts ("IRAs"), including Roth IRAs
that may be funded with purchases of Fund shares and may allow investors to
defer tax on their income from amounts contributed to the IRAs. A description of
applicable service fees and certain limitations on contributions and
withdrawals, as well as Application Forms, are available from the Trust upon
request.
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. The
amount received will depend on the market value of the investments in a Fund's
portfolio at the time of determination of net asset value. Shares of the Funds
may be redeemed by written request or by 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. In addition, redemption
proceeds may be sent by wire transfer to a bank account specified in your
Account Application. The minimum amount of a wire transfer redemption is $5,000.
You will be charged $12.00 for wire redemptions to cover transaction costs.
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. In
addition, if you request in writing redemption of $100,000 or more, your
signature must be 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 redemption requests may be delayed until the Transfer Agent is
reasonably satisfied that the purchase payment has been collected by the Trust
(which may require up to 10 business days). To avoid redemption delays,
purchases may be made by cashiers or certified check or by direct wire
transfers.
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 trading on the NYSE, the Nasdaq, the
CME, or the CBOE, as appropriate, 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
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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 $500 or more. The redemption will be made at the net asset
value next determined after the Transfer Agent 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.
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 may be effected by written request or by telephone to the Transfer
Agent subject to the procedures described below. 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.
PROCEDURES FOR REDEMPTIONS
AND EXCHANGES
GENERAL
- -------
In requesting a redemption or exchange, you should provide your account name,
account number, the number of or percentage of shares or the dollar value of
shares to be exchanged or redeemed, as applicable, and the names of the Funds
involved. Exchanges may only be made between identically registered accounts. In
addition, any written request must be signed by a shareholder and all co-owners
of the account with exactly the same name or names used in establishing the
account.
BY MAIL
- -------
Requests for redemptions and exchanges may be made in writing and directed to
the Potomac Funds, c/o Firstar Mutual Fund Services, LLC, P.O. Box 1993
Milwaukee, Wisconsin 53201-1993. Any such requests sent overnight or express
mail should be directed to the Potomac Funds, c/o Firstar Mutual Fund Services,
LLC, Mutual Fund Services, 3rd Floor, 615 East Michigan Street, Milwaukee,
Wisconsin 53202.
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BY TELEPHONE
You may redeem or exchange Funds shares by calling the Transfer Agent at (800)
851-0511. Shares may be redeemed by telephone only if your Account Application
reflects that option. Telephone requests may be made only between 9:00 a.m.,
Eastern time, and the times listed below. For telephone exchanges, the closing
time is the earlier closing time below of the two Funds involved in the
exchange:
U.S. Plus Fund 3:40 p.m.
U.S./Short Fund 3:40 p.m.
OTC Plus Fund 3:40 p.m.
OTC/Short Fund 3:40 p.m.
Money Market Fund 4:00 p.m.
TELEPHONE REDEMPTION AND EXCHANGE ORDERS WILL BE ACCEPTED ONLY DURING THE
PERIODS INDICATED ABOVE.
By establishing such telephone services, you authorize the Funds or their agents
to act upon verbal instructions to redeem or exchange Fund shares for any
account for which such service has been authorized. In an effort to prevent
unauthorized or fraudulent telephone transaction requests, the transfer agent
will employ reasonable procedures specified by the Funds to confirm that such
instructions are genuine. For instance, the Transfer Agent will require some
form of personal identification prior to acting upon telephone instructions,
provide written confirmation after such transactions, and record telephone
instructions. When acting on instructions believed to be genuine, the Trust,
Adviser, Transfer Agent and their 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. To the extent that the
Trust, Adviser, Transfer Agent and their 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. 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 4:15 p.m. Eastern time,
fifteen minutes after the close of normal trading on the NYSE (currently 4:00
p.m., Eastern time) each day the NYSE 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
$1.00. However, there is no assurance that the $1.00 net asset value per share
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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. 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 will 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 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. Dividend income and other
distributions are recorded on 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
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 capital gain
distributions 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 "Performance Information - Yield Computations" in the SAI.
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<PAGE>
DIVIDENDS AND OTHER DISTRIBUTIONS
Each Fund, except the Money Market Fund, intends to distribute to its
shareholders annually all of its net investment income, and net realized capital
gains. 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 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 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 regulated investment company ("RIC") under
Subchapter M of the Internal Revenue Code of 1986, as amended ("Code"). Because
of the investment strategies 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 and net short-term capital gains) and net capital gain (the excess of net
long-term capital gain over net short-term capital loss) it distributes to its
shareholders 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.
Dividends distributed by the Fund (including distributions of net short-term
capital gain), if any, are taxable income, if any, are taxable to its
shareholders as ordinary income regardless of whether the dividends are
reinvested in Fund shares or received in cash. Distributions of a Fund's net
capital gain (i.e., the excess of net long-term gain over net short-term capital
loss, if any, are taxable to its shareholders as long-term capital gains,
regardless of how long they have held their Fund shares and whether the
distributions are reinvested in Fund shares or received in cash. A shareholder's
sale (redemption) of Fund shares may result in a taxable gain, depending on
whether the redemption proceeds are more or less than the adjusted basis for the
shares. An exchange of Fund shares for shares of another portfolio of the Trust
generally will have similar consequences.
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<PAGE>
Shareholders are required by law to certify that their taxpayer 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 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.
Because the foregoing only summarizes some of the important federal income tax
considerations affecting the Funds and their shareholders, please see the
discussion in the SAI. Prospective investors are urged to consult their tax
advisers.
MANAGEMENT AND ADMINISTRATION 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
has been registered as an investment adviser since June 1997 and was organized
as a New York limited liability corporation in May 1997. Lawrence C. Rafferty
owns a controlling interest in the Adviser.
The Adviser manages the investment of the assets of each Fund, in accordance
with its investment objective, policies and limitations, subject to the general
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, each Fund pays
the Adviser a fee at an annualized rate, based on a percentage of its daily net
assets: 0.75% for the U.S. Plus Fund, and the OTC Plus Fund; 0.90% for 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 February 1994 to May 1997, Mr. Apple was portfolio
25
<PAGE>
manager for the Rydex OTC Fund, which seeks to match the performance of the
Nasdaq Index, and the U.S. Government Bond Fund.
ADMINISTRATOR
The Trust has entered into an Administrative Services Agreement with Firstar
Mutual Fund Services, LLC ("Administrator") that obligates the Administrator to
provide the Funds with administrative and management services, other than
investment advisory services. As compensation for these services, the Trust pays
the Administrator a fee of .06% of the first $200,000,000 of the Trust's average
daily net assets, .05% of the next $300,000,000 of the Trust's average net
assets, and .03% of the Trust's average net assets in excess of $500,000,000.
Notwithstanding the foregoing, the Administrator's minimum annual fee paid by
the Trust is $150,000.
DISTRIBUTOR
Rafferty Capital Markets, Inc. ('Distributor") 550 Mamaroneck Avenue, Harrison,
New York 10528, 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
Firstar Mutual Fund Services, LLC, 615 East Michigan Street, Milwaukee,
Wisconsin 53202, serves as the transfer agent of the Trust.
Firstar Bank Milwaukee, N.A., 614 East Michigan Street, Milwaukee, Wisconsin
53202, serves as the custodian of the portfolio securities of the Trust.
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP, 100 East Wisconsin Avenue, Suite 1500, Milwaukee,
Wisconsin 53202, are the auditors of and the independent 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.
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.
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FUND EXPENSES
Expenses of the Trust that are not directly attributable to a Fund are typically
allocated among the Funds in proportion to their respective net assets, number
of shareholder accounts, or net sales, where applicable. Each Fund pays all of
its own expenses. These expenses include organizational costs, expenses for
legal accounting and auditing services, preparing (including typesetting and
printing) reports, prospectuses, supplements thereto and notices to its existing
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.
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
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<PAGE>
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) 851-0511.
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.
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POTOMAC FUNDS
STATEMENT OF ADDITIONAL INFORMATION
100 South Royal Street
Alexandria, Virginia 22314
550 Mamaroneck Avenue
Harrison, New York 10528
(800) 851-0511
The Potomac Funds (the "Trust") is a no-load management investment company, or
mutual fund, which offers to the public five separate investment portfolios (the
"Funds"). The Funds are designed principally for experienced investors who
intend to follow an asset allocation strategy. The Funds are not designed for
inexperienced or less sophisticated investors. 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 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 January 1, 1999. A copy of the
Prospectus is available, without charge, upon request to the Trust at the
address or telephone number above.
STATEMENT OF ADDITIONAL INFORMATION DATED JANUARY 1, 1999
<PAGE>
TABLE OF CONTENTS
Page
----
THE POTOMAC FUNDS..............................................................3
INVESTMENT POLICIES AND TECHNIQUES.............................................3
General.....................................................................3
Options, Futures and Other Strategies.......................................3
U.S. Government Securities..................................................8
Indexed Securities..........................................................8
American Depository Receipts ("ADRs").......................................8
Repurchase Agreements.......................................................9
Borrowing...................................................................9
Lending Portfolio Securities...............................................10
Investments in Other Investment Companies..................................10
Illiquid Investments and Restricted Securities.............................10
Portfolio Turnover.........................................................11
INVESTMENT RESTRICTIONS.......................................................12
PORTFOLIO TRANSACTIONS AND BROKERAGE..........................................15
MANAGEMENT OF THE TRUST.......................................................16
Trustees and Officers......................................................16
Investment Adviser.........................................................19
Fund Administrator, Fund Accountant, Transfer Agent and Custodian..........20
Distributor................................................................21
Distribution Plan..........................................................21
Independent Accountants....................................................21
DETERMINATION OF NET ASSET VALUE..............................................22
PERFORMANCE INFORMATION.......................................................22
Comparative Information....................................................23
Total Return Computations..................................................23
Yield Computations.........................................................25
DIVIDENDS, OTHER DISTRIBUTIONS AND TAXES......................................25
FINANCIAL STATEMENTS..........................................................27
2
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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 offers five separate series to the
public: 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 are designed principally for experienced investors seeking an asset
allocation vehicle. Except for the Money Market Fund, the Funds provide
investment exposure to various securities markets. Each Fund seeks investment
results that correspond over time to a specific benchmark. The terms "long" and
"short" in the Funds' names are not intended to refer to the duration of the
Funds' investment portfolios. 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,
LLC (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") and options on futures contracts (collectively, "Financial
Instruments") as a substitute for a comparable market position in the underlying
security, 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.
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
Trading Commission (the "CFTC"). In addition, a Fund's ability to use Financial
Instruments will be limited by tax considerations. See "Dividends, Other
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
3
<PAGE>
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 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 also
may 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 or other options or futures 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, Firstar Bank Milwaukee, N.A. ("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
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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 able 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.
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
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index, it pays a premium and has the same rights 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 of 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.
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 also must 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.
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
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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
markets), 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.
COMBINED POSITIONS. A Fund may purchase and write options in combination with
each other. 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.
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
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 (the Federal National Mortgage Association), the Farmers Home
Administration, the Export-Import Bank of the United States, the Small Business
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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
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. 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" below.
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 use 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" below.
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Each Fund follows certain procedures and guidelines adopted by the Trust's Board
of Trustees ("Trustees" or the "Board") 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.
U.S. PLUS FUND AND OTC PLUS FUND. Borrowing for investment is known as
leveraging. Leveraging investments, by purchasing securities with borrowed
money, is a speculative technique that increases investment risk while
increasing investment opportunity. Leverage will magnify 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 instruments 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.
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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 any
combination of short-term government securities and cash as 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 collateral or fee income if the loan is otherwise collateralized. The Fund
may invest the interest received and the 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. The Money Market Fund will invest only in those investment companies
that invest in the same quality of investments as the Money Market Fund.
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 and (5) restricted securities not
determined to be liquid pursuant to guidelines established by the Board. 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 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 to satisfy share
redemption orders. An insufficient number of qualified institutional buyers
interested in purchasing Rule 144A-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.
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
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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 otherwise permitted herein and
in Investment Limitations Nos. 5, 7, and 8, and (3) 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.
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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 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 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:
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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, except for the software and hardware
industries when the percentage of the securities of either industry
constitutes more than 25% of the Nasdaq Index. 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. Underwrite securities of any other issuer.
4. Purchase, hold, or deal in real estate or oil and gas interests.
5. Issue senior securities, except as permitted by the Fund's investment
objective and policies.
6. 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.
7. Invest in securities of other investment companies, except to the extent
permitted under the 1940 Act.
8. 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, 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.
9. 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.
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.
14
<PAGE>
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
broker-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
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.
Aggregate brokerage commissions paid by U.S. Plus Fund for the period October
20, 1997 to August 31, 1998 was $8,938. Those commissions were paid on brokerage
transactions worth $174,191,426.
Aggregate brokerage commissions paid by U.S./Short Fund for the period November
7, 1997 to August 31, 1998 was $3,618. Those commissions were paid on brokerage
transactions worth $78,849,094.
Aggregate brokerage commissions paid by OTC Plus Fund for the period October 20,
1997 to August 31, 1998 was $7,628. Those commissions were paid on brokerage
transactions worth $9,942,393.
15
<PAGE>
Aggregate brokerage commissions paid by OTC/Short Fund for the period October
16,1997 to August 31, 1998 was $858. Those commissions were paid on brokerage
transactions worth $698,439.
MANAGEMENT OF THE TRUST
TRUSTEES AND OFFICERS
The business affairs of each Fund are managed by or under the direction of the
Board of Trustees. The Trustees are responsible for managing the Funds' business
affairs and for exercising all the Funds' powers except those reserved to the
shareholders. A Trustee may be removed by the other Trustees or by a two-thirds
vote of the outstanding Trust shares.
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.
Position With Principal Occupation
Name the Trust During Past Five Years
---- --------- ----------------------
Lawrence C. Rafferty* Chief Executive Chairman and Chief Executive
(56) Officer, President, Officer of the Adviser,
Chairman of the 1997-present; Chief Executive
Board of Trustees Officer of Rafferty Companies,
LLC, 1996-present; Chief
Executive Officer of Cohane
Rafferty Securities, Inc.,
1987-present (investment
banking); Chief Executive
Officer of Rafferty Capital
Markets, Inc., 1995-present;
Trustee of Fairfield
University.
Jay F. Higgins* (53) Trustee Managing Partner of CloverLeaf
411 West Putnam Street Partners, Inc., 1992-1997
Greenwich, CT 06830 (investment banking).
Daniel J. Byrne (54) Trustee President and Chief Executive
1325 Franklin Avenue Officer of Byrne Securities
Suite 285 Inc., 1992-present; Partner of
Garden City, NY 11530 Byrne Capital Management LLP,
1996-present.
George T. Glisker (51) Trustee President of GTG Securities
1010 Franklin Avenue Corp., April 1997-present
Garden City, NY 11530 (hedge fund); President of
New York Capital Mkts. Inc.
Gerald E. Shanley III Trustee Business Consultant, 1985-
(54) present; Trustee of Estate
12 First Street of Charles S. Payson,
Pelham, NY 10803 1987-present.
James Terry Apple (59) Chief Investment Vice President of the Adviser,
100 S. Royal Street Officer 1997-present; Portfolio
Alexandria, VA 22314 Manager of PADCO Advisors,
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<PAGE>
Position With Principal Occupation
Name the Trust During Past Five Years
---- --------- ----------------------
1994-1997; Portfolio Manager
of Money Management
Associates, 1992-1993.
Timothy P. Hagan (56) Chief Financial Vice President of the Adviser,
Officer 1997-present; Vice President
of PADCO Advisers, 1993-1997,
Vice President of Money
Management Associates,
1981-1993.
Philip A. Harding (55) Senior Vice President Vice President of the Adviser,
1997-present; Vice President
of Commerzbank (USA), 1995-
1997; Senior Vice President of
Sanwa Bank (USA), 1992-1995.
Thomas A. Mulrooney (51) Chief Operating Chief Operating Officer of the
Officer Adviser, 1997-present;
President of Rafferty Capital
Markets, 1995-1997; Managing
Partner of Cantor Fitzgerald,
Inc., 1993-1995; Executive
Vice President and Director of
Trading for J.J. Kenny Drake,
Inc., 1985-1993.
Mark D. Edwards (40) Vice President [BIOGRAPHICAL INFORMATION
100 S. Royal Street TO BE PROVIDED]
Alexandria, VA 22314
Stephen P. Sprague (49) Treasurer, Vice President and Chief
Controller and Financial Officer of the
Assistant Secretary Adviser, 1997-present; Chief
Financial Officer of Rafferty
Companies, LLC, 1994-present;
Chief Accountant--
International Sub., Goldman
Sachs & Co., 1983-1993.
Robert J. Zutz (46) Secretary Partner, Kirkpatrick &
1800 Massachusetts Ave. Lockhart LLP (law firm).
Washington, DC 20036
Eric W. Falkeis (25) Assistant Secretary Compliance Officer, Firstar
615 East Michigan Street Mutual Fund Services LLC, 1997
Milwaukee, WI 53202 -present; Audit Senior with
PricewaterhouseCoopers LLP,
1995-1997
___________________
* Messrs. Rafferty and Higgins are deemed to be "interested persons" of the
Trust, as defined by the 1940 Act.
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<PAGE>
The Trustees and officers of the Trust, as a group, own less than 1% of each
Fund's shares outstanding. The Trust's Declaration of Trust provides that the
Trustees will not be liable for errors of judgment or mistakes of fact or law.
However, they are not protected against any liability to which they would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of their
office.
The Trust will pay the Trustees who are not "interested persons" of the Trust as
defined by the 1940 Act ("Independent Trustees") $500 per meeting of the Board.
The Adviser will pay Mr. Higgins similar compensation per meeting of the Board.
Trustees also are reimbursed for any expenses incurred in attending Board
meetings. No officer, director or employee of the Adviser receives any
compensation from the Funds for acting as a director or officer. The following
table shows the compensation earned by each Trustee for the Trust's prior fiscal
year end, August 31, 1998.
- -----------------------------------------------------------------------
Name of Person, Position Aggregate Compensation From Potomac Funds
- -----------------------------------------------------------------------
Lawrence C. Rafferty, $0
Trustee
Jay F. Higgins, Trustee $0
Daniel J. Byrne, Trustee $2,000
George T. Glisker, Trustee $2,000
Gerald E. Shanley III $2,000
- -----------------------------------------------------------------------
No Trustee will receive any benefits upon retirement. Thus, no pension or
retirement benefits have accrued as part of any Trust's expenses.
FIVE PERCENT SHAREHOLDERS
Listed below are shareholders who owned of record or were known by the Funds to
own beneficially five percent or more of the outstanding shares of the
__________ as of ________, 1998.
INVESTMENT ADVISER
Rafferty Asset Management, LLC, 550 Mamaroneck Avenue, Harrison, New York,
provides investment advice to the Funds. The Adviser was organized as a New York
limited liability corporation in June 1997.
Under an Investment Advisory Agreement between the Trust, on behalf of the
Funds, and the Adviser ("Advisory Agreement"), the Adviser provides a continuous
investment program for 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 supervision of the Trustees. 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 Trust
bears 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.
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<PAGE>
Pursuant to the Advisory Agreement, each Fund pays the Adviser the following fee
at an annual rate based on its average daily net assets of: 0.75% of the U.S.
Plus Fund and OTC Plus Fund; 0.90% of the U.S./Short Fund and OTC/Short Fund;
and 0.50% of the Money Market Fund.
For U.S. Plus Fund, the Adviser voluntarily has agreed to waive its fees to the
extent that Fund expenses exceed 1.50% of average daily net assets. For the
period October 20, 1997 to August 31, 1998, the management fee amounted to
$71,062. For the same period, the Adviser waived its fee in the amount of
$_______.
For U.S./Short Fund, the Adviser voluntarily has agreed to waive its fees to the
extent that Fund expenses exceed 1.65% of average daily net assets. For the
period November 7, 1997 to August 31, 1998, the management fee amounted to
$14,663. For the same period, the Adviser waived its fee in the amount of
$________.
For OTC Plus Fund, the Adviser voluntarily has agreed to waive its fees to the
extent that Fund expenses exceed 1.50% of average daily net assets. For the
period October 20, 1997 to August 31, 1998, the management fee amounted to
$67,763. For the same period, the Adviser waived its fee in the amount of
$________.
For OTC/Short Fund, the Adviser voluntarily has agreed to waive its fees to the
extent that Fund expenses exceed 1.65% of average daily net assets. For the
period October 16, 1997 to August 31, 1998, the management fee amounted to
$53,805. For the same period, the Adviser waived its fee in the amount of
$_________.
For Money Market Fund, the Adviser voluntarily has agreed to waive its fees to
the extent that Fund expenses exceed 1.00% of average daily net assets. For the
period October 20, 1997 to August 31, 1998, the management fee amounted to
$17,168. For the same period, the Adviser waived its fee in the amount of
$_________.
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, and (2) by 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, FUND ACCOUNTANT, TRANSFER AGENT AND CUSTODIAN
Firstar Mutual Fund Services, LLC, 615 East Michigan Street, Milwaukee,
Wisconsin 53202, provides administrative, fund accounting and transfer agent
services to the Funds. Firstar Bank Milwaukee, N.A. 615 East Michigan Street,
Milwaukee, Wisconsin 53202, provides custodian services to the Funds.
Pursuant to an Administration Servicing Agreement ("Service Agreement") between
the Trust and Firstar Mutual Fund Services, LLC ("Administrator"), the
Administrator provides the Trust with administrative and management services
19
<PAGE>
(other than investment advisory services). As compensation for these services,
the Trust pays the Administrator a fee of .06% of the first $200,000,000 of the
Trust's average daily net assets, .05% of the next $300,000,000 of the Trust's
average daily net assets, and .03% of the Trust's average daily net assets in
excess of $150,000. Notwithstanding the foregoing, the Administrator's minimum
annual fee is $150,000.
For the period ended August 31, 1998, U.S. Plus Fund, U.S./Short Fund, OTC Plus
Fund OTC/Short Fund and Money Market Fund paid the Administrator $42,305,
$6,535, $35,193, $32,578 and $13,611, respectively.
Pursuant to a Fund Accounting Servicing Agreement between the Trust and Firstar
Mutual Fund Services, LLC ("Fund Accountant"), the Fund Accountant provides the
Trust with accounting services, including portfolio accounting services, tax
accounting services and furnishing financial reports. For these services, the
Trust pays the Fund Accountant a flat annual fee of $25,000 for the first $40
million of average daily net assets for each the OTC/Short and Money Market
Funds; and $22,000 for the first $40 million of average daily net assets for
each the U.S. Plus, U.S./Short and OTC Plus Funds. The Fund Accountant also is
entitled to certain out-of-pocket expenses, including pricing expenses.
Pursuant to a Custodian Agreement, Firstar Bank Milwaukee, N.A. also serves as
the Custodian of the Funds' assets. Under the terms of the Custodian Agreement,
the Custodian holds and administers the assets in the Funds' portfolios.
DISTRIBUTOR
Rafferty Capital Markets, Inc., 550 Mamaroneck Avenue, Harrison, New York 10528,
serves as the distributor ("Distributor") in connection with the offering of
each Fund's shares on a no-load basis. The Distributor and participating dealers
with whom it has entered into dealer agreements offer shares of the Funds as
agents on a best efforts basis and are not obligated to sell any specific amount
of shares.
For the period ended August 31, 1998, the Distributor received as compensation
from the Adviser for the sale of U.S. Plus Fund, U.S./Short Fund, OTC Plus Fund,
OTC/Short Fund and Money Market Fund $_______, $_______, $_______, $_______ and
$________, respectively, of which it retained $_______, $_______, $________,
$_______ and $_________, respectively.
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 each Fund 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.
20
<PAGE>
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.
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP, 100 East Wisconsin Avenue, Suite 1500, Milwaukee,
Wisconsin 53202, are the auditors and the independent accountants for the Trust.
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, each day the New York Stock Exchange
("NYSE") is open for business, which excludes New Year's Day, Presidents' Day,
Martin Luther King's Birthday, Good Friday, Memorial Day, Independence Day,
Labor Day, Thanksgiving Day, and Christmas Day. 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 designed 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 or the Nasdaq Stock Market is valued
at its last sales price on the principal exchange or market on which it is
traded prior to the time when assets are valued. If no sale is reported at that
time, the mean of the last bid and ask price is used. When market quotations for
21
<PAGE>
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 in accordance with procedures established by
the Board. 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
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"), the Nasdaq 100
Stock IndexTM ("Nasdaq Index"), and the Nasdaq Composite IndexTM ("Nasdaq
Composite") and various other domestic 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, and from the "Small
Company Growth Funds" grouping for the OTC/Long and the OTC/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
22
<PAGE>
total return. Such average annual total return quotes for the Funds are
calculated according to the following formula:
P(1+T)n(SUPERSCRIPT)=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
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; and
(2) the Nasdaq Index for the OTC/Long and the OTC/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.
The total return is as follows for each period of each Fund below.
FUND PERIOD TOTAL
---- ------ RETURN
------
U.S. Plus Fund . October 20, 1997
(commencement of operations) (2.23%)
to August 31, 1998
U.S./Short Fund . November 7, 1997
(commencement of (5.40%)
operations) to August 31,
1998
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<PAGE>
FUND PERIOD TOTAL
---- ------ RETURN
------
OTC Plus Fund . October 20, 1997
(commencement of operations) 4.10%
to August 31, 1998
OTC/Short Fund . October 16, 1997
(commencement of operations) (16.20%)
to August 31, 1998
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 preexisting 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 preexisting 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
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 of 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.
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<PAGE>
The 7-day current yield for the Money Market Fund as of August 31, 1998 is
4.17%.
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 are distributed as described in the Prospectus under "Dividends and
Other Distributions." All distributions from a Fund normally are automatically
reinvested without charge in additional shares of that Fund.
As discussed in the Prospectus, the Money Market Fund ordinarily declares
dividends daily from net investment income and distributes 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 is 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 and net short-term capital gain) ("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 other
income (including gains from options or futures, derived with respect to its
business of investing in securities ("Income Requirement"); and (2) 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 each Fund intends to continue to satisfy all the foregoing
requirements, there is no assurance that each Fund will be able to do so. 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 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 those 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 might
apply a different method resulting in disqualification of one or more of those
Funds.
25
<PAGE>
By qualifying for treatment as a RIC, a Fund (but not its shareholders) will be
relieved of Federal income tax on the part of its investment company taxable
income and net capital gain that it distributes to its shareholders. If a Fund
failed to qualify as a RIC for any taxable year, it would be taxed on the full
amount of its taxable income for that year without being able to deduct the
distributions it makes to its shareholders and the shareholders would treat all
those distributions, including distributions of net capital gain, as dividends
(that is, ordinary income) to the extent of the Fund's earnings and profits.
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.
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.
DISTRIBUTIONS TO FOREIGN SHAREHOLDERS. 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") generally 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.
DERIVATIVES STRATEGIES. The use of derivatives strategies, such as writing
(selling) and purchasing options and futures 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 realizes in connection therewith.
Gains from options, and futures, derived by a Fund with respect to its business
of investing in securities will qualify as permissible income under the Income
Requirement.
Certain options (including options on "broad-based" stock indices) and futures
in which the Funds may invest may 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
26
<PAGE>
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) 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
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.
The foregoing is only a general summary of some of the important Federal income
tax considerations generally affecting the Funds. No attempt is made to present
a complete explanation of the Federal tax treatment of their activities, and
this discussion is not intended as a substitute for careful tax planning.
Accordingly, potential investors are urged to consult their own tax advisers for
more detailed information and for information regarding any state, local or
foreign taxes applicable to the Funds and to dividends and other distributions
therefrom.
FINANCIAL STATEMENTS
The Trust's financial statements for the period ended August 31, 1998,
which have been derived from the Funds' financial records, are included herein
this Statement of Additional Information. The financial statements and financial
highlights of the Funds that appear in this SAI have been audited by
PricewaterhouseCoopers LLP, and are included herein in reliance upon their
authority as experts in accounting and auditing.
The Report of the Independent Accounts and Financial Statements are
incorporated by reference from the Trust's Annual Report to Shareholders for the
fiscal year ended August 31, 1998, filed with the Securities and Exchange
Commission on November 6, 1998, Accession No. 0000891804-98-002297.
<PAGE>
THE POTOMAC FUNDS
PART C OTHER INFORMATION
------------------------
Item 23. Exhibits
--------
(a) Declaration of Trust*
(b) By-Laws*
(c) Voting trust agreement - None
(d)(i) Form of Investment Advisory Agreement**
(ii)(A) Form of Fund Administration Servicing Agreement**
(ii)(B) Form of Addendum to Fund Administration Servicing
Agreement (filed herewith)
(e)(i) Form of Distribution Agreement between the Potomac
Funds and Rafferty Capital Markets, Inc.***
(ii) Form of Dealer Agreement (CARET)
(f) Bonus, profit sharing contracts - None
(g)(i) Form of Custodian Agreement**
(ii) Form of Addendum to Custodian Agreement (filed
herewith)
(h)(i)(A) Form of Transfer Agent Agreement**
(i)(B) Form of Addendum to Transfer Agent Agreement (filed
herewith)
(ii)(A) Form of Fund Accounting Servicing Agreement**
(ii)(B) Form of Addendum to Fund Accounting Servicing
Agreement (filed herewith)
(iii) Form of Fulfillment Servicing Agreement**
(i) Opinion and consent of counsel (filed herewith)
(j) Consent of Independent Auditors (filed herewith)
(k) Financial statements omitted from prospectus - None
<PAGE>
(l) Letter of investment intent**
(m) Plan pursuant to Rule 12b-1**
(n) Financial Data Schedules (filed herewith)
(o) Plan pursuant to Rule 18f-3 (not applicable)
- -------
* Incorporated herein by reference from the Trust's Initial Registration
Statement on Form N-1A filed with the Securities and Exchange Commission on June
6, 1997 via EDGAR, Accession No. 0000898432-97-000314.
** Incorporated herein by reference from the Pre-effective Amendment No. 1 to
the Trust's Registration Statement on Form N-1A, filed with the Securities and
Exchange Commission on September 17, 1997 via EDGAR, Accession No.
0000898432-97-000410.
*** Incorporated herein by reference from the Post-effective Amendment No.1 to
the Trust's Registration Statement on Form N-1A, filed with the Securities and
Exchange Commission on June 15, 1998 via EDGAR, Accession No.
0000898432-98-000498.
(CARET) To be filed by subsequent amendment.
Item 24 Persons Controlled by or under
Common Control With Registrant
------------------------------
None.
Item 25. 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.
(b) No indemnification shall be provided hereunder to a Covered Person:
C-2
<PAGE>
(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.
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.
C-3
<PAGE>
Item 26. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER
Rafferty Asset Management, LLC (the "Adviser"), 550 Mamaroneck Avenue,
Harrison, New York 10528, offers investment advisory services. Information as to
the officers and directors of the Adviser is included in its current Form ADV
filed with the Securities and Exchange Commission (Registration Number
801-54679) and is incorporated herein by reference.
Item 27. PRINCIPAL UNDERWRITER
---------------------
(a) Rafferty Capital Markets, Inc., 550 Mamaroneck Avenue, Harrison, New
York 10528, serves as principal underwriter for the Potomac Funds, Badgley
Funds, Homestate Group and Texas Capital Value Funds.
(b) The director and officers of Rafferty Capital Markets, Inc. are:
<TABLE>
<CAPTION>
Positions and Offices with Position and Offices
Name Underwriter With Registrant
- --------------------- -------------------------- --------------------
<S> <C> <C>
Thomas A. Mulrooney President Chief Operating Officer
Derek B. Park Senior Vice President, None
Equity
Lawrence C. Rafferty Director Chief Executive Officer,
President, Chairman of
the Board of Trustees
Stephen P. Sprague CFO/FINOP Treasurer, Controller,
and Assistant Secretary
</TABLE>
The principal business address of each of the persons listed above is 550
Mamaroneck Avenue, Harrison, New York 10528.
Item 28. Location of Accounts and Records
--------------------------------
The books and records required to be maintained by Section 31(a) of the
Investment Company Act of 1940 are maintained in the physical possession of the
Potomac Funds' investment adviser, administrator, custodian, subcustodian, or
transfer agent.
Item 29. Management Services
-------------------
Not applicable.
Item 30. Undertakings
------------
Registrant hereby undertakes to furnish each person to whom a prospectus
is delivered a copy of its latest annual report to Shareholders, upon request
and without charge.
C-4
<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 certifies
that it meets all of the requirements for effectiveness of this Registration
Statement under Rule 485(b) under the Securities Act and has duly caused this
Post-Effective Amendment No. 2 to its 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 November 30, 1998.
POTOMAC FUNDS
By: Lawrence C. Rafferty*
---------------------
Lawrence C. Rafferty
President
Attest:
Timothy P. Hagan*
- -----------------
Timothy P. Hagan
Chief Financial Officer
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Post-Effective Amendment No. 2 to its Registration Statement has been
signed below by the following persons in the capacities and on the dates
indicated.
Signature Title Date
- --------- ----- ----
Lawrence C. Rafferty* Chairman of the Board November 30, 1998
- -----------------------------
Lawrence C. Rafferty of Trustees and President
Jay F. Higgins* Trustee November 30, 1998
- -----------------------------
Jay F. Higgins
Daniel J. Byrne* Trustee November 30, 1998
- -----------------------------
Daniel J. Byrne
George T. Glisker* Trustee November 30, 1998
- -----------------------------
George T. Glisker
Gerald E. Shanley Iii* Trustee November 30, 1998
- ------------------------------
Gerald E. Shanley III
/s/ Robert J. Zutz
- ---------------------------------------
*Robert J. Zutz, Attorney-in-Fact
<PAGE>
<TABLE>
<CAPTION>
INDEX TO EXHIBITS
Exhibit
Number Description Page
- ------ ----------- ----
<S> <C> <C>
(a) Declaration of Trust*
(b) By-Laws*
(c) Voting trust agreement - None
(d) (i) Form of Investment Advisory Agreement**
(ii)(A) Form of Fund Administration Servicing Agreement**
(ii)(B) Form of Addendum to Fund Administration Servicing
Agreement (filed herewith)
(e) (i) Form of Distribution Agreement between the Potomac Funds and Rafferty
Capital Markets, Inc.***
(ii) Form of Dealer Agreement (CARET)
(f) Bonus, profit sharing contracts - None
(g) (i) Form of Custodian Agreement**
(ii) Form of Addendum to Custodian Agreement (filed herewith)
(h) (i)(A) Form of Transfer Agent Agreement**
(i)(B) Form of Addendum to Transfer Agent Agreement (filed herewith)
(ii)(A) Form of Fund Accounting Servicing Agreement**
(ii)(B) Form of Addendum to Fund Accounting Servicing Agreement (filed herewith)
(iii) Form of Fulfillment Servicing Agreement**
(i) Opinion and consent of counsel (filed herewith)
(j) Consent of Independent Auditors (filed herewith)
(k) Financial statements omitted from prospectus - None
(l) Letter of investment intent**
(m) Plan pursuant to Rule 12b-1**
(n) Financial Data Schedules (filed herewith)
<PAGE>
(o) Plan pursuant to Rule 18f-3 (not applicable)
</TABLE>
- -------
* Incorporated herein by reference from the Trust's Initial Registration
Statement on Form N-1A filed with the Securities and Exchange Commission on June
6, 1997 via EDGAR, Accession No. 0000898432-97-000314.
** Incorporated herein by reference from the Pre-effective Amendment No. 1 to
the Trust's Registration Statement on Form N-1A, filed with the Securities and
Exchange Commission on September 17, 1997 via EDGAR, Accession No.
0000898432-97-000410.
*** Incorporated herein by reference from the Post-effective Amendment No. 1 to
the Trust's Registration Statement on Form N-1A, filed with the Securities and
Exchange Commission on June 15, 1998 via EDGAR, Accession No.
0000898432-98-000498.
(CARET) To be filed by subsequent amendment.
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0001040587
<NAME> POTOMAC FUNDS
<SERIES>
<NUMBER> 3
<NAME> POTOMAC U.S. PLUS FUND
<S> <C>
<PERIOD-TYPE> 11-MOS
<FISCAL-YEAR-END> AUG-31-1998
<PERIOD-START> OCT-20-1997
<PERIOD-END> AUG-31-1998
<INVESTMENTS-AT-COST> 606584
<INVESTMENTS-AT-VALUE> 600484
<RECEIVABLES> 10479
<ASSETS-OTHER> 128882
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 739845
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 272848
<TOTAL-LIABILITIES> 272848
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 387731
<SHARES-COMMON-STOCK> 47853
<SHARES-COMMON-PRIOR> 0
<ACCUMULATED-NII-CURRENT> 15745
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 166385
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> (102864)
<NET-ASSETS> 466997
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 493377
<OTHER-INCOME> 0
<EXPENSES-NET> 142125
<NET-INVESTMENT-INCOME> 351252
<REALIZED-GAINS-CURRENT> 1449351
<APPREC-INCREASE-CURRENT> (102864)
<NET-CHANGE-FROM-OPS> 1697739
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 35123
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 12380102
<NUMBER-OF-SHARES-REDEEMED> 12335720
<SHARES-REINVESTED> 3471
<NET-CHANGE-IN-ASSETS> 466997
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 71062
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 239048
<AVERAGE-NET-ASSETS> 10978928
<PER-SHARE-NAV-BEGIN> 10.00
<PER-SHARE-NII> 0.36
<PER-SHARE-GAIN-APPREC> (0.58)
<PER-SHARE-DIVIDEND> (0.02)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 9.76
<EXPENSE-RATIO> 1.50
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0001040587
<NAME> POTOMAC FUNDS
<SERIES>
<NUMBER> 4
<NAME> POTOMAC U.S./SHORT FUND
<S> <C>
<PERIOD-TYPE> 10-MOS
<FISCAL-YEAR-END> AUG-31-1998
<PERIOD-START> NOV-7-1997
<PERIOD-END> AUG-31-1998
<INVESTMENTS-AT-COST> 6526954
<INVESTMENTS-AT-VALUE> 6866942
<RECEIVABLES> 365965
<ASSETS-OTHER> 666588
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 7899495
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 130843
<TOTAL-LIABILITIES> 130843
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 7726289
<SHARES-COMMON-STOCK> 821052
<SHARES-COMMON-PRIOR> 0
<ACCUMULATED-NII-CURRENT> 4928
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (899449)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 936884
<NET-ASSETS> 7768652
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 78637
<OTHER-INCOME> 0
<EXPENSES-NET> 25526
<NET-INVESTMENT-INCOME> 53111
<REALIZED-GAINS-CURRENT> (403411)
<APPREC-INCREASE-CURRENT> 936884
<NET-CHANGE-FROM-OPS> 586584
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 0
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 10631219
<NUMBER-OF-SHARES-REDEEMED> 9810167
<SHARES-REINVESTED> 0
<NET-CHANGE-IN-ASSETS> 7768652
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 14663
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 86252
<AVERAGE-NET-ASSETS> 2015844
<PER-SHARE-NAV-BEGIN> 10.00
<PER-SHARE-NII> 0.23
<PER-SHARE-GAIN-APPREC> (0.77)
<PER-SHARE-DIVIDEND> 0
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 9.46
<EXPENSE-RATIO> 1.57
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0001040587
<NAME> POTOMAC FUNDS
<SERIES>
<NUMBER> 5
<NAME> POTOMAC OTC PLUS FUND
<S> <C>
<PERIOD-TYPE> 11-MOS
<FISCAL-YEAR-END> AUG-31-1998
<PERIOD-START> OCT-20-1997
<PERIOD-END> AUG-31-1998
<INVESTMENTS-AT-COST> 6966078
<INVESTMENTS-AT-VALUE> 7388587
<RECEIVABLES> 1177226
<ASSETS-OTHER> 611264
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 9177077
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 1496531
<TOTAL-LIABILITIES> 1496531
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 8745588
<SHARES-COMMON-STOCK> 737536
<SHARES-COMMON-PRIOR> 0
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (1237113)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 172071
<NET-ASSETS> 7680546
<DIVIDEND-INCOME> 15169
<INTEREST-INCOME> 18543
<OTHER-INCOME> 0
<EXPENSES-NET> 135527
<NET-INVESTMENT-INCOME> (101815)
<REALIZED-GAINS-CURRENT> 2282566
<APPREC-INCREASE-CURRENT> 172071
<NET-CHANGE-FROM-OPS> 2352822
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 0
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 28545895
<NUMBER-OF-SHARES-REDEEMED> 27808359
<SHARES-REINVESTED> 0
<NET-CHANGE-IN-ASSETS> 7680546
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 67763
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 290396
<AVERAGE-NET-ASSETS> 10469271
<PER-SHARE-NAV-BEGIN> 10.00
<PER-SHARE-NII> (0.11)
<PER-SHARE-GAIN-APPREC> 0.52
<PER-SHARE-DIVIDEND> 0
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 10.41
<EXPENSE-RATIO> 1.50
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0001040587
<NAME> POTOMAC FUNDS
<SERIES>
<NUMBER> 6
<NAME> POTOMAC OTC/SHORT FUND
<S> <C>
<PERIOD-TYPE> 11-MOS
<FISCAL-YEAR-END> AUG-31-1998
<PERIOD-START> OCT-16-1997
<PERIOD-END> AUG-31-1998
<INVESTMENTS-AT-COST> 11412524
<INVESTMENTS-AT-VALUE> 11413080
<RECEIVABLES> 5279033
<ASSETS-OTHER> 25670221
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 42362334
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 23193796
<TOTAL-LIABILITIES> 23193796
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 21075426
<SHARES-COMMON-STOCK> 2286861
<SHARES-COMMON-PRIOR> 0
<ACCUMULATED-NII-CURRENT> 11388
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (5468664)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 3550388
<NET-ASSETS> 19168538
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 184794
<OTHER-INCOME> 0
<EXPENSES-NET> 106147
<NET-INVESTMENT-INCOME> 78647
<REALIZED-GAINS-CURRENT> (5381857)
<APPREC-INCREASE-CURRENT> 3550388
<NET-CHANGE-FROM-OPS> (1752822)
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 0
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 35233130
<NUMBER-OF-SHARES-REDEEMED> 32946269
<SHARES-REINVESTED> 0
<NET-CHANGE-IN-ASSETS> 19168538
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 53805
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 221282
<AVERAGE-NET-ASSETS> 6840391
<PER-SHARE-NAV-BEGIN> 10.00
<PER-SHARE-NII> 0.09
<PER-SHARE-GAIN-APPREC> (1.71)
<PER-SHARE-DIVIDEND> 0
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 8.38
<EXPENSE-RATIO> 1.64
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0001040587
<NAME> POTOMAC FUNDS
<SERIES>
<NUMBER> 7
<NAME> POTOMAC U.S. GOVERNMENT MONEY MARKET FUND
<S> <C>
<PERIOD-TYPE> 11-MOS
<FISCAL-YEAR-END> AUG-31-1998
<PERIOD-START> OCT-20-1997
<PERIOD-END> AUG-31-1998
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<INVESTMENTS-AT-VALUE> 12380653
<RECEIVABLES> 3132889
<ASSETS-OTHER> 30431
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<TOTAL-ASSETS> 15543973
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<OTHER-ITEMS-LIABILITIES> 6173589
<TOTAL-LIABILITIES> 6173589
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<PAID-IN-CAPITAL-COMMON> 9352613
<SHARES-COMMON-STOCK> 9370384
<SHARES-COMMON-PRIOR> 0
<ACCUMULATED-NII-CURRENT> 17771
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 0
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 0
<NET-ASSETS> 9370384
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 184081
<OTHER-INCOME> 0
<EXPENSES-NET> 34335
<NET-INVESTMENT-INCOME> 149746
<REALIZED-GAINS-CURRENT> 0
<APPREC-INCREASE-CURRENT> 0
<NET-CHANGE-FROM-OPS> 149746
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<NUMBER-OF-SHARES-REDEEMED> 189292611
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<GROSS-EXPENSE> 127133
<AVERAGE-NET-ASSETS> 3977292
<PER-SHARE-NAV-BEGIN> 1.00
<PER-SHARE-NII> 0.04
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</TABLE>
Addendum to Firstar Servicing Agreements
This Addendum to the Fund Administration Servicing Agreement dated August 31,
1997, and the Fund Accounting and Transfer Agent Servicing Agreements dated
August 29, 1997, is entered into by and between Firstar Mutual Fund Services,
LLC and the Potomac Funds on this __________ day of November, 1998.
WHEREAS, the mutual funds servicing division of Firstar Trust Company became a
limited liability company and separate subsidiary of Firstar Bank Milwaukee,
N.A. on September 30, 1998; and
WHEREAS, the entity known as Firstar Trust Company ceased operations on
September 30, 1998; NOW,
THEREFORE, Firstar Mutual Fund Services, LLC will be the successor responsible
party to each of the Agreements referenced above and will assume all
responsibility for any acts or omissions during the time Firstar Trust Company
was the named service provider under these same Agreements.
Firstar Mutual Fund Services, LLC Potomac Funds
BY:______________________________ BY:________________________
ATTEST:__________________________ ATTEST:____________________
Addendum to Firstar Servicing Agreements
This Addendum to the Fund Administration Servicing Agreement dated August 31,
1997, and the Fund Accounting and Transfer Agent Servicing Agreements dated
August 29, 1997, is entered into by and between Firstar Mutual Fund Services,
LLC and the Potomac Funds on this __________ day of November, 1998.
WHEREAS, the mutual funds servicing division of Firstar Trust Company became a
limited liability company and separate subsidiary of Firstar Bank Milwaukee,
N.A. on September 30, 1998; and
WHEREAS, the entity known as Firstar Trust Company ceased operations on
September 30, 1998; NOW,
THEREFORE, Firstar Mutual Fund Services, LLC will be the successor responsible
party to each of the Agreements referenced above and will assume all
responsibility for any acts or omissions during the time Firstar Trust Company
was the named service provider under these same Agreements.
Firstar Mutual Fund Services, LLC Potomac Funds
BY:______________________________ BY:________________________
ATTEST:__________________________ ATTEST:____________________
Addendum to Firstar Servicing Agreements
This Addendum to the Fund Administration Servicing Agreement dated August 31,
1997, and the Fund Accounting and Transfer Agent Servicing Agreements dated
August 29, 1997, is entered into by and between Firstar Mutual Fund Services,
LLC and the Potomac Funds on this __________ day of November, 1998.
WHEREAS, the mutual funds servicing division of Firstar Trust Company became a
limited liability company and separate subsidiary of Firstar Bank Milwaukee,
N.A. on September 30, 1998; and
WHEREAS, the entity known as Firstar Trust Company ceased operations on
September 30, 1998; NOW,
THEREFORE, Firstar Mutual Fund Services, LLC will be the successor responsible
party to each of the Agreements referenced above and will assume all
responsibility for any acts or omissions during the time Firstar Trust Company
was the named service provider under these same Agreements.
Firstar Mutual Fund Services, LLC Potomac Funds
BY:______________________________ BY:________________________
ATTEST:__________________________ ATTEST:____________________
KIRKPATRICK LOCKHART LLP
1800 MASSACHUSETTS AVENUE, N.W.
2ND FLOOR
WASHINGTON, D.C. 20036-1800
TELEPHONE (202) 778-9000
FACSIMILE (202) 778-9100
November 30, 1998
Potomac Funds
550 Mamaroneck Avenue
Harrison, New York 10528
Ladies and Gentlemen:
You have requested our opinion, as counsel to Potomac Funds (the
"Trust"), as to certain matters regarding the issuance of Shares of the Trust.
As used in this letter, the term "Shares" means the shares of beneficial
interest of each of the following series of the Trust: Potomac U.S. Plus Fund,
Potomac U.S./Short Fund, Potomac OTC Plus Fund, Potomac OTC/Short Fund and
Potomac U.S. Government Money Market Fund.
As such counsel, we have examined certified or other copies, believed by
us to be genuine, of the Trust's Declaration of Trust and by-laws and such
resolutions and minutes of meetings of the Trust's Board of Trustees as we have
deemed relevant to our opinion, as set forth herein. Our opinion is limited to
the laws and facts in existence on the date hereof, and it is further limited to
the laws (other than the conflict of law rules) in the Commonwealth of
Massachusetts that in our experience are normally applicable to the issuance of
shares by unincorporated voluntary associations and to the Securities Act of
1933 ("1933 Act"), the Investment Company Act of 1940 ("1940 Act") and the
regulations of the Securities and Exchange Commission ("SEC") thereunder.
Based on present laws and facts, we are of the opinion that the issuance
of the Shares has been duly authorized by the Trust and that, when sold in
accordance with the terms contemplated by the Post-Effective Amendment No. 2 to
the Trust's Registration Statement on Form N-1A ("PEA"), including receipt by
the Trust of full payment for the Shares and compliance with the 1933 Act and
the 1940 Act, the Shares will have been validly issued, fully paid and
non-assessable.
We note, however, that the Trust is an entity of the type commonly known
as a "Massachusetts business trust." Under Massachusetts law, shareholders
could, under certain circumstances, be held personally liable for the
obligations of the Trust. The Declaration of Trust states that all persons
extending credit to, contracting with or having any claim against the Trust or
the Trustees shall look only to the assets of the Trust 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. It also requires that 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. The Declaration of Trust further provides: (1) for
indemnification from the assets of the Trust for all loss and expense of any
shareholder held personally liable for the obligations of the Trust by virtue of
ownership of shares of the Trust; and (2) for the Trust to assume the defense of
<PAGE>
Potomac Funds
November 30, 1998
Page 2
any claim against the shareholder for any act or obligation of the Trust. Thus,
the risk of a shareholder incurring financial loss on account of shareholder
liability is limited to circumstances in which the Trust or series would be
unable to meet its obligations.
We hereby consent to this opinion accompanying the PEA when it is filed
with the SEC and to the reference to our firm in the PEA.
Very truly yours,
KIRKPATRICK & LOCKHART LLP
By /s/ Robert J. Zutz
------------------
Robert J. Zutz
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in the Statement of Additional Information
constituting part of this Post-Effective Amendment No. 2 to the registration
statement on Form N-1A (the "Registration Statement") of our report dated
October 28, 1998, relating to the financial statements and financial highlights
of Potomac Funds, which appears in such Statement of Additional Information, and
to the incorporation by reference of our report into the Prospectus which
constitutes part of this Registration Statement. We also consent to the
references to us under the heading "Independent Accountants" in such Statement
of Additional Information and to the reference to us under the heading
"Independent Accountants" in such Prospectus.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Milwaukee, Wisconsin
November 30, 1998
