As filed with the Securities and Exchange Commission on September 3, 1999
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. 4 [ X ]
---
and/or
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [ X ]
Amendment No. 5
---
(Check appropriate box or boxes.)
POTOMAC FUNDS
(Exact name of Registrant as Specified in Charter)
1311 Mamaroneck Avenue
White Plains, New York 10605
(Address of Principal Executive Office) (Zip Code)
Registrant's Telephone Number, including Area Code: (914) 381-2080
Thomas A. Mulrooney
1311 Mamaroneck Avenue
White Plains, New York 10605
(Name and Address of Agent for Service)
Copy to:
Robert J. Zutz, Esq.
Kirkpatrick & Lockhart LLP
1800 Massachusetts Avenue, N.W.
Washington, D.C. 20036
Approximate Date of Proposed Public Offering November 17, 1999
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It is proposed that this filing will become effective (check appropriate box)
[ ] immediately upon filing pursuant to paragraph (b)
[ ] on (date) pursuant to paragraph (b)
[ ] 60 days after filing pursuant to paragraph (a)(1)
[ ] on (date) pursuant to paragraph (a)(1)
[ x ] 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.
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THE POTOMAC FUNDS
CONTENTS OF REGISTRATION STATEMENT
This registration document is comprised of the following:
Cover Sheet
Contents of Registration Statement
Prospectus for the Potomac Funds
Statement of Additional Information for the Potomac Funds
Part C of Form N-1A
Signature Page
Exhibits
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PROSPECTUS
NOVEMBER __, 1999
POTOMAC FUNDS
[LOGO]
100 South Royal Street
Alexandria, Virginia 22314
1311 Mamaroneck Avenue
White Plains, New York 10605
(800) 851-0511
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PLUS FUNDS SHORT FUNDS
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Potomac U.S. Plus Fund Potomac U.S./Short Fund
Potomac OTC Plus Fund Potomac OTC/Short Fund
Potomac Dow Plus Fund Potomac Dow/Short Fund
Potomac Small Cap Plus Fund Potomac Small Cap/Short Fund
Potomac Internet Plus Fund Potomac Internet/Short Fund
Potomac Japan Plus Fund Potomac Japan/Short Fund
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MONEY MARKET FUNDS
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Potomac U.S. Government
Money Market Fund
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LIKE SHARES OF ALL MUTUAL FUNDS, THESE SECURITIES HAVE NOT BEEN APPROVED OR
DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
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TABLE OF CONTENTS
OVERVIEW OF THE POTOMAC FUNDS................................................1
THE POTOMAC FUNDS............................................................2
Potomac U.S. Funds.........................................................2
Potomac OTC Funds..........................................................3
Potomac Dow Funds..........................................................3
Potomac Small Cap Funds....................................................4
Potomac Internet Funds.....................................................5
Potomac Japan Funds........................................................6
Investment Techniques and Policies.........................................7
Risk Factors...............................................................8
Potomac U.S. Government Money Market Fund.................................10
Performance of the Potomac Funds..........................................11
Fees and Expenses of the Potomac Funds....................................12
ABOUT YOUR INVESTMENT.......................................................18
Share Prices of the Potomac Funds.........................................18
Classes of Shares.........................................................18
Rule 12b-1 Fees...........................................................20
How to Invest in the Potomac Funds........................................20
How to Exchange Shares of the Potomac Funds...............................22
How to Sell Shares of the Potomac Funds...................................22
Account and Transaction Policies..........................................23
ADDITIONAL INFORMATION......................................................24
Management of the Funds...................................................24
Distributions and Taxes...................................................25
Year 2000.................................................................26
Master/Feeder Structure Option............................................26
Financial Highlights......................................................27
MORE INFORMATION ON THE POTOMAC FUNDS...............................Back Cover
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OVERVIEW OF THE POTOMAC FUNDS
The Potomac Funds consist primarily of pairs of funds. Each pair is designed to
provide a return that correlates to the return provided by a particular index
and consists of one "plus" fund and one "short" fund. The "plus" fund attempts
to provide investment results that correlate to its target index, while the
"short" fund attempts to provide investment results that are opposite of the
return of its target index.
Unlike traditional index funds, however, each "plus" fund (except for the
Potomac U.S. Plus Fund) seeks to provide a return that is equal to 125% of the
return of a specific stock market index. The Potomac U.S. Plus Fund seeks to
provide a return that is equal to 150% of the return of a specific stock market
index.
As an example, the Potomac Dow Plus Fund and the Potomac Dow/Short Fund each are
targeted to the Dow Jones Industrial Average. If, for a given period of time,
the Dow gains 20%, the Potomac Dow Plus Fund should gain approximately 25%
(which is equal to 125% of 20%), while the Potomac Dow/Short Fund should lose
20%. Conversely, if the Dow loses 10%, the Potomac Dow/Short Fund is designed to
gain 10%, while the Potomac Dow Plus Fund should lose 12.5%.
To achieve these results, the Potomac Funds use aggressive investment techniques
such as engaging in futures and options transactions. As a result, the Potomac
Funds are designed principally for experienced investors who intend to follow an
asset allocation strategy. The Potomac Funds are not designed for inexperienced
or less sophisticated investors.
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THE POTOMAC FUNDS
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POTOMAC U.S. FUNDS
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OBJECTIVES:
The POTOMAC 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) (S&P 500 Index). If it is successful in meeting
its objective, the net asset value of U.S. Plus Fund shares should increase
approximately one and a half as much as the S&P 500 Index when the aggregate
prices of the securities in that index rise on a given day. Conversely, the
net asset value of shares of the U.S. Plus Fund should decrease approximately
one and a half as much when the aggregate prices of the securities in the S&P
500 Index decline on that day.
The POTOMAC U.S./SHORT FUND seeks to provide investment returns that
inversely correspond (opposite) to the performance of the S&P 500 Index. If
it is successful in meeting its objective, the net asset value of U.S./Short
Fund shares should increase in direct proportion to any decrease in the level
of the S&P 500 Index. Conversely, the net asset value of shares in the
U.S./Short Fund should decrease in direct proportion to any increase in the
level of the S&P 500 Index.
CORE INVESTMENTS:
Unlike traditional index funds, the Potomac U.S. Funds do not invest directly
in the securities of the companies that comprise the S&P 500 Index to attempt
to achieve their objectives. Rather, the POTOMAC U.S. PLUS FUND significantly
invests in Standard & Poor's Depositary Receipts (SPDRs), which are
publicly-traded index securities. This allows the Fund to invest in a
portfolio of securities consisting of all of the component common stocks of
the S&P 500 Index. The Fund also enters into long positions in stock index
futures contracts, options on stock index futures contracts and options on
securities and on stock indices to produce economically leveraged investment
results. The POTOMAC U.S./SHORT FUND enters into short positions in stock
index futures contracts, options on stock index futures contracts and options
on securities and on stock indices. On a day-to-day basis, the Funds hold
U.S. Government securities to collateralize these futures and options
contracts. The Funds also enter into repurchase agreements.
TARGET INDEX:
The STANDARD & POOR'S 500 COMPOSITE STOCK PRICE INDEX((TRADEMARK)) is a
capitalization-weighted index composed of 500 common stocks. 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 New
York Stock Exchange. Standard & Poor's is not a sponsor of, or in any way
affiliated with, the Potomac Funds.
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POTOMAC OTC FUNDS
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OBJECTIVES:
The POTOMAC OTC PLUS FUND seeks to provide investment returns that correspond
to 125% of the performance of the Nasdaq 100 Index(TRADEMARK) (Nasdaq 100
Index). If it is successful in meeting its objective, the net asset value of
OTC Plus Fund shares should increase approximately one and a quarter as much
as the Nasdaq 100 Index when the aggregate prices of the securities in that
index rise on a given day. Conversely, the net asset value of shares of the
OTC Plus Fund should decrease approximately one and a quarter as much when
the aggregate prices of the securities in the Nasdaq 100 Index decline on a
given day.
The POTOMAC OTC/SHORT FUND seeks to provide investment returns that inversely
correspond (opposite) to the performance of the Nasdaq 100 Index. If it is
successful in meeting its objective, the net asset value of OTC/Short Fund
shares should increase in direct proportion to any decrease in the level of
the Nasdaq 100 Index. Conversely, the net asset value of shares in the
OTC/Short Fund should decrease in direct proportion to any increase in the
level of the Nasdaq 100 Index.
CORE INVESTMENTS:
In attempting to achieve their objectives, the Potomac OTC Funds primarily
invest directly in the securities of the companies that comprise the Nasdaq
100 Index. In addition, POTOMAC OTC PLUS FUND enters into long positions in
stock index futures contracts, options on stock index futures contracts and
options on securities and on stock indices to produce economically leveraged
investment results. The POTOMAC OTC/SHORT FUND also enters into short
positions in stock index futures contracts, options on stock index futures
contracts and options on securities and on stock indices. On a day-to-day
basis, the Funds hold U.S. Government securities to collateralize these
futures and options contracts. The Funds also enter into repurchase
agreements.
TARGET INDEX:
The NASDAQ 100 INDEX (TRADEMARK) is a capitalization-weighted index composed
of 100 of the largest non-financial domestic companies listed on the National
Market tier of The Nasdaq Stock Market. 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 100 Index was created
in 1985.
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POTOMAC DOW FUNDS
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OBJECTIVES:
The POTOMAC DOW PLUS FUND seeks daily investment results that correspond to
125% of the performance of the Dow Jones Industrial Average (Dow). If it is
successful in meeting its objective, the net asset value of Dow Plus Fund
shares should increase approximately one and a quarter as much as the Dow
when the aggregate prices of the securities that comprise the Dow rise on a
given day. Conversely, the net asset value of shares of the Dow Plus Fund
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should decrease approximately one and a quarter as much when the aggregate
prices of the securities comprising the Dow decline on that day.
The POTOMAC DOW/SHORT FUND seeks to provide investment returns that inversely
correspond (opposite) to the performance of the Dow. If it is successful in
meeting its objective, the net asset value of Dow/Short Fund shares should
increase in direct proportion to any decrease in the level of the Dow.
Conversely, the net asset value of shares in the Dow/Short Fund should
decrease in direct proportion to any increase in the level of the Dow.
The Potomac Dow Funds' investment objectives are not fundamental policies and
may be changed by the Potomac Funds' Board of Trustees without shareholder
approval.
CORE INVESTMENTS:
In attempting to achieve their objectives, the Potomac Dow Funds primarily
invest directly in the securities of the companies that comprise the Dow. In
addition, POTOMAC DOW PLUS FUND enters into long positions in stock index
futures contracts, options on stock index futures contracts and options on
securities and on stock indices to produce economically leveraged investment
results. The Fund also may invest in DIAMONDS, which are publicly-traded
index securities. This allows the Fund to invest in a portfolio of securities
consisting of all of the component common stocks of the Dow. The POTOMAC
DOW/SHORT FUND also enters into short positions in stock index futures
contracts, options on stock index futures contracts and options on securities
and on stock indices. On a day-to-day basis, the Funds hold U.S. Government
securities to collateralize these futures and options contracts. The Funds
also enter into repurchase agreements.
TARGET INDEX:
The DOW JONES INDUSTRIAL AVERAGE(TRADEMARK) consists of 30 of the most widely
held and actively traded stocks listed on the New York Stock Exchange. The
stocks in the Dow represent companies that typically are dominant firms in
their respective industries.
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POTOMAC SMALL CAP FUNDS
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OBJECTIVES:
The POTOMAC SMALL CAP PLUS FUND seeks to provide investment returns that
correspond to 125% of the performance of the Russell 2000(REGISTERED) Index
(Russell 2000 Index). If it is successful in meeting its objective, the net
asset value of Small Cap Plus Fund shares should increase approximately one
and a quarter as much as the Russell 2000 Index when the aggregate prices of
the securities in that index rise on a given day. Conversely, the net asset
value of shares of the Small Cap Plus Fund should decrease approximately one
and a quarter as much when the aggregate prices of the securities in the
Russell 200 Index decline on that day.
The POTOMAC SMALL CAP/SHORT FUND seeks to provide investment returns that
inversely correspond (opposite) to the performance of the Russell 2000 Index.
If it is successful in meeting its objective, the net asset value of Small
Cap/Short Fund shares should increase in direct proportion to any decrease in
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the level of the Russell 2000 Index. Conversely, the net asset value of
shares in the Small Cap/Short Fund should decrease in direct proportion to
any increase in the level of the Russell 2000 Index.
The Potomac Small Cap Funds' investment objectives are not fundamental
policies and may be changed by the Potomac Funds' Board of Trustees without
shareholder approval.
CORE INVESTMENTS:
In attempting to achieve their objectives, the Potomac Small Cap Funds
primarily invest directly in the securities of the companies that comprise
the Russell 2000 Index. In addition, POTOMAC SMALL CAP PLUS FUND enters into
long positions in stock index futures contracts, options on stock index
futures contracts and options on securities and on stock indices to produce
economically leveraged investment results. The POTOMAC SMALL CAP/SHORT FUND
also enters into short positions in stock index futures contracts, options on
stock index futures contracts and options on securities and on stock indices.
On a day-to-day basis, the Funds hold U.S. Government securities to
collateralize these futures and options contracts. The Funds also enter into
repurchase agreements.
TARGET INDEX:
The RUSSELL 2000(REGISTERED) INDEX is comprised of the smallest 2000
companies in the Russell 3000 Index. As of May 31, 1999, the average market
capitalization of the companies included in the Russell 2000 was
approximately $526.4 million. That compares to $4.4 billion for the Russell
3000. The smallest 2000 companies represent approximately 8% of the total
market capitalization of the Russell 3000.
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POTOMAC INTERNET FUNDS
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OBJECTIVES:
The POTOMAC INTERNET PLUS FUND seeks daily investment results that correspond
to 125% of the performance of the Inter@ctive Week Internet Index (Internet
Index). If it is successful in meeting its objective, the net asset value of
Internet Plus Fund shares should increase approximately one and a quarter as
much as the Internet Index when the aggregate prices of the securities in
that index rise on a given day. Conversely, the net asset value of shares of
the Internet Plus Fund should decrease approximately one and a quarter as
much when aggregate prices of the securities in the Internet Index decline on
that day.
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The POTOMAC INTERNET/SHORT FUND seeks to provide investment returns that
inversely correspond (opposite) to the performance of the Internet Index. If
it is successful in meeting its objective, the net asset value of
Internet/Short Fund shares should increase in direct proportion to any
decrease in the level of the Internet Index. Conversely, the net asset value
of shares in the Internet/Short Fund should decrease in direct proportion to
any increase in the level of the Internet Index.
The Potomac Internet Funds' investment objectives are not fundamental
policies and may be changed by the Potomac Funds' Board of Trustees without
shareholder approval.
CORE INVESTMENTS:
In attempting to achieve their objectives, the Potomac Internet Funds
primarily invest directly in the securities of the companies that comprise
the Internet Index. In addition, POTOMAC INTERNET PLUS FUND enters into long
positions in stock index futures contracts, options on stock index futures
contracts and options on securities and on stock indices to produce
economically leveraged investment results. The POTOMAC INTERNET/SHORT FUND
also enters into short positions in stock index futures contracts, options on
stock index futures contracts and options on securities and on stock indices.
On a day-to-day basis, the Funds hold U.S. Government securities to
collateralize these futures and options contracts. The Funds also enter into
repurchase agreements.
TARGET INDEX:
The INTER@CTIVE WEEK INTERNET INDEX is a modified market
capitalization-weighted index designed to measure a cross section of
companies involved in providing Internet infrastructure and access,
developing and marketing Internet content and software, and conducting
business over the Internet. The Internet Index was developed by the American
Stock Exchange and Inter@ctive Week, a weekly magazine published by
Interactive Enterprises, L.L.C.
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POTOMAC JAPAN FUNDS
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OBJECTIVES:
The POTOMAC JAPAN PLUS FUND seeks to provide investment returns that
correspond to 125% of the performance of the Nikkei 225 Stock Average (Nikkei
Index). If it is successful in meeting its objective, the net asset value of
Japan Plus Fund shares should increase approximately one and a quarter as
much as the Nikkei Index when the aggregate prices of the securities in that
index rise on a given day. Conversely, the net asset value of shares of the
Japan Plus Fund should decrease approximately one and a quarter as much when
the aggregate prices of the securities in the Nikkei Index decline on that
day.
The POTOMAC JAPAN/SHORT FUND seeks to provide investment returns that
inversely correspond (opposite) to the performance of the Nikkei Index. If it
is successful in meeting its objective, the net asset value of Japan/Short
Fund shares should increase in direct proportion to any decrease in the level
of the Nikkei Index. Conversely, the net asset value of shares in the
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Japan/Short Fund should decrease in direct proportion to any increase in the
level of the Nikkei Index.
The Potomac Japan Funds' investment objectives are not fundamental policies
and may be changed by the Potomac Funds' Board of Trustees without
shareholder approval.
CORE INVESTMENTS:
In attempting to achieve their objectives, the Potomac Japan Funds will not
invest directly in the securities of the companies that comprise the Nikkei
225 Index. Rather, the Potomac Japan Funds intend to invest in American
Depositary Receipts of such companies and other securities that the
investment adviser believes would provide a return that approximates the
Nikkei Index. The Potomac Japan Funds also will enter into long and short
positions, respectively, in stock index futures contracts, options on stock
index futures contracts and options on securities and on stock indices. On a
day-to-day basis, the Funds intend to hold U.S. Government securities to
collateralize these futures and options contracts. In addition, the Funds
will enter into repurchase agreements.
TARGET INDEX:
The NIKKEI 225 INDEX is a price-weighted index of the 225 largest Japanese
companies listed on the Tokyo Stock Exchange. The Nikkei 225 Index was first
published in 1949 and is generally considered as a proxy for the Japanese
large-capitalization equity market.
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INVESTMENT TECHNIQUES AND POLICIES
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Rafferty Asset Management, LLC (Rafferty), the investment advisor to each
Potomac Fund, uses a number of investment techniques in an effort to correlate
each Potomac Fund's return with the return of its respective target index.
Rafferty generally does not use fundamental securities analysis to accomplish
such correlation. Rather, Rafferty primarily uses statistical and quantitative
analysis to determine the investments each Potomac Fund makes and techniques it
employs. As a consequence, if a Fund is performing as designed, the return of
the target index will dictate the return for the Fund.
Each Potomac Plus Fund invests significantly in futures contracts on stock
indexes, options on futures contracts and financial instruments such as options
on securities and stock indexes options. Rafferty uses these types of
investments to produce economically "leveraged" investment results. Leveraging
allows Rafferty to generate a return that is larger than what would be generated
on the invested capital without leverage, thus changing small market movements
into larger changes in the value of the investments of a Plus Fund.
While Rafferty attempts to minimize any "tracking error" (the statistical
measure of the difference between the investment results of the Fund and the
performance of its benchmark), certain factors will tend to cause a Fund's
investment results to vary from a perfect correlation to its target index.
Rafferty, however, does not expect that each Fund's total returns will vary from
its current target index by more than 10% over a twelve-month period.
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It is the policy of each Potomac Fund to pursue its investment objective
regardless of market conditions, to remain substantially fully invested and not
to take defensive positions. A Fund will not adopt defensive positions by
investing in cash or other instruments in anticipation of an adverse climate for
its target index. However, because of the difficulty in tracking a Fund's target
index with a small amount of net assets, Rafferty may invest the assets of the
Potomac Dow Funds, the Potomac Small Cap/Short Fund, the Potomac Internet Funds
and the Potomac Japan Funds in short-term U.S. Government securities until those
Funds' net assets each reach $10 million or a level at which a Fund can invest
in a portfolio designed to achieve its objective. As a result, those Funds may
not achieve their investment objectives during this period.
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RISK FACTORS
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An investment in the Funds entails risks. The Funds could lose money, or their
performance could trail that of other investment alternatives. Rafferty cannot
guarantee that any of the Funds will achieve its objective. In addition, the
Funds present some risks not traditionally associated with most mutual funds. It
is important that investors closely review and understand these risks before
making an investment in the Funds. These and other risks are described below.
RISKS OF INVESTING IN EQUITY SECURITIES AND DERIVATIVES:
The Funds may invest in publicly issued equity securities, including common
stocks, as well as instruments that attempt to track the price movement of
stock indices. Investments in common stocks and derivatives in general are
subject to market risks that may cause their prices to fluctuate over time.
Fluctuations in the value of common stocks in which the Funds invest will
cause the net asset value of the Funds to fluctuate.
RISKS OF AGGRESSIVE INVESTMENT TECHNIQUES:
The Funds use investment techniques that may be considered aggressive. Risks
associated with the use of futures contracts, and options on securities,
securities indices, and on futures contracts include potentially dramatic
price changes (losses) in the value of the instruments and imperfect
correlations between the price of the contract and the underlying security or
index. These instruments may increase the volatility of the Funds and may
involve a small investment of cash relative to the magnitude of the risk
assumed. Investors should be aware that while index futures and options
contracts closely correlate with the applicable indices over long periods,
shorter-term deviations occur. As a result, a Fund's short-term performance
will reflect such deviation from its benchmark.
LEVERAGE RISK:
Each Potomac Plus Fund employs leveraged investment techniques. Use of
leverage can magnify the effects of changes in the value of these Plus Funds
and makes them more volatile. The leveraged investment techniques that these
Funds employ should cause investors in these Funds to lose more money in
adverse environments.
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INVERSE CORRELATION RISK:
Each Potomac Short Fund is negatively correlated to its target index and
should lose money when its target index rises - a result that is the opposite
from traditional equity mutual funds.
RISK OF POOR TRACKING:
While Rafferty does not expect that the return of any of the Funds will
deviate adversely from its respective benchmarks by more than 10%, several
factors may affect a Fund's ability to achieve its target. As a consequence,
there can be no guarantee that the Funds will be able to achieve this level
of correlation. A failure to achieve a high degree of correlation may prevent
a Fund from achieving its investment goal.
RISK OF TRADING HALTS:
In certain circumstances, an exchange may halt trading in securities held by
a Fund. If such trading halts are instituted 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
may be unable to accurately price its outstanding contracts. If a Fund is
affected by such a halt, it may reject investors' orders for purchases,
redemptions, or exchanges received earlier during the business day.
RISK OF EARLY CLOSING:
The normal close of trading of securities listed on the Nasdaq and NYSE is
4:00 p.m. Eastern time. Unanticipated early closings may result in a Fund
being unable to sell or buy securities on that day. If an exchange closes
early on a day when one or more of the Funds needs to execute a high volume
of securities trades late in the trading day a Fund might incur substantial
trading losses.
HIGH PORTFOLIO TURNOVER:
Rafferty expects a significant portion of the Potomac Funds' assets to come
from professional money managers and investors who use the Funds as part of
"asset allocation" and "market timing" investment strategies. These
strategies often call for frequent trading to take advantage of anticipated
changes in market conditions. Frequent trading could increase the rate of the
Funds' portfolio turnover, forcing realization of substantial capital gains
and losses and increasing transaction expenses. In addition, while Rafferty
does not expect it, large movements of assets into and out of the Funds may
negatively impact their abilities to achieve their investment objectives or
their level of operating expenses.
RISK OF NON-DIVERSIFICATION:
The Funds (except the Money Market Fund) are non-diversified, which means
that they may invest a high percentage of its assets in a limited number of
securities. Since the Funds' are non-diversified, their net asset values and
total returns may fluctuate more or fall greater in times of weaker markets
than a diversified mutual fund.
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RISKS OF INVESTING IN INTERNET COMPANIES:
The Potomac Internet Funds concentrate their investments in the Internet
companies. In addition, the OTC Funds may invest a substantial portion of
their assets in Internet companies listed on the Nasdaq 100 Index. The market
prices of Internet-related stocks tend to exhibit a greater degree of market
risk and sharp price fluctuations than other types of investments. These
stocks may fall in- and out-of-favor with investors rapidly, which may cause
sudden selling and dramatically lower market prices. Internet stocks also may
be affected adversely by changes in technology, consumer and business
purchasing patterns, government regulation and/or obsolete products or
services. In addition, a rising interest rate environment tends to negatively
affect Internet companies. Those Internet companies having high market
valuations may appear less attractive to investors, which may cause sharp
decreases in the companies' market prices. Further, those Internet companies
seeking to finance their expansion would have increased borrowing costs,
which may negatively impact their earnings. As a result, these factors may
negatively affect the performance of the Internet Index and the Nasdaq 100
Index.
RISKS OF INVESTING IN SMALL CAPITALIZATION COMPANIES:
Investing in the securities of small capitalization companies involves
greater risks and the possibility of greater price volatility than investing
in larger capitalization and more established companies, since smaller
companies may have limited operating history, product lines, and financial
resources, and the securities of these companies may lack sufficient market
liquidity. Any of these factors may negatively impact the performance of the
Russell 2000 Index.
RISKS OF INVESTING IN JAPANESE COMPANIES:
The Potomac Japan Funds may invest without limit indirectly in Japanese
securities through ADRs. Investments in Japanese securities involve greater
risks than investing in domestic securities. As result, the Funds' returns
and net asset values may be affected to a large degree by political,
diplomatic or economic conditions and regulatory requirements in Japan.
Japanese laws and accounting, auditing, and financial reporting standards
typically are not as strict as they are in the U.S., and there may be less
public information available about foreign companies.
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POTOMAC U.S. GOVERNMENT MONEY MARKET FUND
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OBJECTIVES:
The POTOMAC U.S. GOVERNMENT MONEY MARKET FUND seeks to provide security of
principal, current income and liquidity.
CORE INVESTMENTS:
The POTOMAC U.S. GOVERNMENT MONEY MARKET 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 Rafferty, to
present minimal credit risk. The Fund invests exclusively in obligations
issued or guaranteed by the U.S. Government, its agencies or
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instrumentalities and repurchase agreements that are fully collateralized by
such obligations.
INVESTMENT TECHNIQUES AND POLICIES:
In order to maintain a stable share price, the Fund maintains an average
dollar-weighted maturity of 90 days or less. Securities purchased by the Fund
generally have remaining maturities of 397 days or less, although instruments
subject to repurchase agreements may bear longer final maturities. The
average dollar-weighted maturity of the Fund will not exceed 90 days.
RISK FACTORS:
o The yield paid by the Fund is subject to changes in interest rates. As a
result, there is risk that a decline in short-term interest rates would
lower its yield and the overall return on your investment.
o Although the Fund seeks to preserve the value of your investment at $1.00
per share, it is possible to lose money by investing in the Fund.
o Your investment in the Fund is not insured or guaranteed by the Federal
Deposit Insurance Corporation or any other government institution.
- --------------------------------------------------------------------------------
PERFORMANCE OF THE POTOMAC FUNDS
- --------------------------------------------------------------------------------
The bar charts and the tables below illustrate the annual performance for the
Investor Class shares of the U.S. Plus Fund, U.S./Short Fund, OTC Plus Fund,
OTC/Short Fund and the U.S. Government Money Market Fund for the period ended
December 31, 1998. The tables below provide some indication of the risks of an
investment in these Funds by comparing their performance with a broad measure of
market performance and by illustrating their highest and lowest quarterly
returns during the calendar year 1998. Because this information is based on past
performance, it's not a guarantee of future results.
[insert bar chart]
- -----------
* The total return from January 1, 1999 to September 30, 1999 for the U.S. Plus
Fund, the U.S./Short Fund, the OTC Plus Fund, the OTC/Short Fund and the U.S.
Government Money Market Fund was _____%, _____%, _______%, ________% and
______%, respectively.
During the calendar year 1998, the highest and lowest return of the Funds for a
quarter during the period of the bar chart was as follows:
- ------------------------------------------------------------------------------
FUND (INVESTOR CLASS) HIGHEST QUARTERLY RETURN (%) LOWEST QUARTERLY RETURN (%)
- ------------------------------------------------------------------------------
U.S. Plus Fund _______ _______
U.S./Short Fund _______ _______
11
<PAGE>
OTC Plus Fund _______ _______
OTC/Short Fund _______ _______
U.S. Government _______ _______
Money Market Fund
- ------------------------------------------------------------------------------
The table below shows what the Funds' average annual total returns would equal
if you average out actual performance over various lengths of time.
AVERAGE ANNUAL RETURNS (for the periods ended December 31, 1998):
-----------------------------------------------------------------------------
FUND (INVESTOR CLASS) ONE YEAR SINCE INCEPTION INCEPTION DATES
-----------------------------------------------------------------------------
U.S. Plus Fund ____% ____%
U.S./Short Fund ____% ____%
S&P 500 Index* ____% ____%
OTC Plus Fund ____% ____%
OTC/Short Fund ____% ____%
Nasdaq 100 Index** ____% ____%
U.S. Government ____% ____%
Money Market Fund
-----------------------------------------------------------------------------
* The S&P 500 is an unmanaged index of 500 U.S. stocks and gives a broad
look at how stock prices have performed.
** The Nasdaq 100 is an unmanaged index composed of 100 of the largest
non-financial domestic companies with a minimum market capitalization of
$500 million and an average daily trading volume of at least 100,000
shares.
- --------------------------------------------------------------------------------
FEES AND EXPENSES OF THE POTOMAC FUNDS
- --------------------------------------------------------------------------------
The tables below describe the fees and expenses that you may pay if you buy and
hold shares of the Funds.
SHAREHOLDER FEES (fees paid directly from your investment)
- --------------------------------------------------------------------------------
Investor Advisor
Class Class Broker Class
- --------------------------------------------------------------------------------
Maximum Sales Charge Imposed on
Purchases (as a % of offering price) None None None
Maximum Deferred Sales Charge (as a %
of original purchase price or sales
proceeds, whichever is less)........ None None 5.00%*
Wire Redemption Fee................. $12.00 $12.00 $12.00
- --------------------------------------------------------------------------------
* Declining over a six-year period as follows: 5% during the first year, 4%
during the second year, 3% during the third and fourth years, 2% during the
fifth year, 1% during the sixth year and 0% thereafter. Broker Class shares
will convert to Investor Class shares eight years after purchase.
12
<PAGE>
ANNUAL OPERATING EXPENSES (expenses that are deducted from Fund assets)
INVESTOR CLASS:
- ------------------------------------------------------------------------------
Internet Japan Small Cap
U.S. Plus OTC Plus Dow Plus^ Plus^ Plus^ Plus^
- ------------------------------------------------------------------------------
Management Fees 0.75 0.75 0.75 0.75 0.75 0.75
Distribution
(12b-1) Fees[] _____ _____ [0] [0] [0] [0]
Other Expenses* _____ _____ _____ _____ _____ _____
Total Annual
Operating Expenses _____ _____ _____ _____ _____ _____
Fee Waiver and/or
Reimbursement* _____ _____ _____ _____ _____ _____
Net Expenses 1.50 1.50 1.50 1.50 1.50 1.50
===== ===== ===== ===== ===== =====
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
Internet/ Japan/ Small Money
U.S./Short OTC/Short Dow/Short^ Short^ Short^ Cap/ Market
Short^ Fund
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Management Fees 0.90 0.90 0.90 0.90 0.90 0.90 0.50
Distribution
(12b-1) Fees[] ____ ____ [0] [0] [0] [0] None
Other Expenses* ____ ____ ____ ____ ____ ____ ____
Total Annual
Operating Expenses ____ ____ ____ ____ ____ ____ ____
Fee Waiver an/or
Reimbursement* ____ ____ ____ ____ ____ ____ ____
Net Expenses 1.65 1.65 1.65 1.65 1.65 1.65 1.00
==== ==== ==== ==== ==== ==== ====
- ------------------------------------------------------------------------------------------
</TABLE>
* Rafferty Asset Management, Inc. has contractually agreed to reimburse the
Funds for Other Expenses through [August 31, 2000] to the extent that Total
Annual Fund Operating Expenses exceed 1.50% for the Plus Funds, 1.65% for the
Short Funds and 1.00% for the Money Market Fund.
^ Based on estimated expenses to be incurred in the first year of operations.
[] The Board of Trustees has authorized payment by each Fund (except the Money
Market Fund) of Rule 12b-1 fees of an amount equal to the difference between
a Fund's Total Annual Operating Expenses and the contractual limit on Total
13
<PAGE>
Annual Operating Expenses of 1.50% for the Plus Funds and 1.65% for the Short
Funds.
ADVISOR CLASS:
- ------------------------------------------------------------------------------
Internet Japan Small Cap
U.S. Plus OTC Plus Dow Plus^ Plus^ Plus^ Plus^
- ------------------------------------------------------------------------------
Management Fees 0.75 0.75 0.75 0.75 0.75 0.75
Distribution
(12b-1) Fees None None None None None None
Other Expenses* _____ _____ _____ _____ _____ _____
Total Annual
Operating Expenses _____ _____ _____ _____ _____ _____
Fee Waiver an/or
Reimbursement* _____ _____ _____ _____ _____ _____
Net Expenses 2.50 2.50 2.50 2.50 2.50 2.50
==== ==== ==== ==== ==== ====
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
Internet/ Japan/ Small Money
U.S./Short OTC/Short Dow/Short^ Short^ Short^ Cap/ Market
Short^ Fund
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Management Fees 0.90 0.90 0.90 0.90 0.90 0.90 0.50
Distribution
(12b-1) Fees None None None None None None None
Other Expenses* ____ ____ ____ ____ ____ ____ ____
Total Annual
Operating Expenses ____ ____ ____ ____ ____ ____ ____
Fee Waiver an/or
Reimbursement* ____ ____ ____ ____ ____ ____ ____
Net Expenses 2.65 2.65 2.65 2.65 2.65 2.65 2.00
==== ==== ==== ==== ==== ==== ====
- -----------------------------------------------------------------------------------------
</TABLE>
* Rafferty Asset Management, Inc. has contractually agreed to reimburse the
Funds for Other Expenses through [August 31, 2000] to the extent that Total
Annual Fund Operating Expenses exceed 2.50% for the Plus Funds, 2.65% for the
Short Funds and 2.00% for the Money Market Fund.
^ Based on estimated expenses to be incurred in the first year of operations.
14
<PAGE>
BROKER CLASS:
- ------------------------------------------------------------------------------
Internet Japan Small Cap
U.S. Plus OTC Plus Dow Plus^ Plus^ Plus^ Plus^
- ------------------------------------------------------------------------------
Management Fees 0.75 0.75 0.75 0.75 0.75 0.75
Distribution
(12b-1) Fees 1.00 1.00 1.00 1.00 1.00 1.00
Other Expenses* _____ _____ _____ _____ _____ _____
Total Annual
Operating Expenses _____ _____ _____ _____ _____ _____
Fee Waiver an/or
Reimbursement* _____ _____ _____ _____ _____ _____
Net Expenses 2.50 2.50 2.50 2.50 2.50 2.50
==== ==== ==== ==== ==== ====
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
Internet/ Japan/ Small Money
U.S./Short OTC/Short Dow/Short^ Short^ Short^ Cap/ Market
Short^ Fund
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Management Fees 0.90 0.90 0.90 0.90 0.90 0.90 0.50
Distribution
(12b-1) Fees 1.00 1.00 1.00 1.00 1.00 1.00 None
Other Expenses* ____ ____ ____ ____ ____ ____ ____
Total Annual
Operating Expenses ____ ____ ____ ____ ____ ____ ____
Fee Waiver an/or
Reimbursement* ____ ____ ____ ____ ____ ____ ____
Net Expenses 2.65 2.65 2.65 2.65 2.65 2.65 2.00
==== ==== ==== ==== ==== ==== ====
- -----------------------------------------------------------------------------------------
</TABLE>
* Rafferty Asset Management, Inc. has contractually agreed to reimburse the
Funds for Other Expenses through [August 31, 2000] to the extent that Total
Annual Fund Operating Expenses exceed 2.50% for the Plus Funds, 2.65% for the
Short Funds and 2.00% for the Money Market Fund.
^ Based on estimated expenses to be incurred in the first year of operations.
EXPENSE EXAMPLE:
The tables below are intended to help you compare the cost of investing in the
different Classes of the Funds with the cost of investing in other mutual funds.
The tables show what you would have paid if you invested $1,000 in each Class
of each Fund over the periods shown and then redeemed all your shares at the end
of those periods. It also assumes that your investment has a 5% return each year
and the Classes' operating expenses remain the same through the first year. The
expenses shown for the first year are calculated based on the Net Expenses shown
above, taking into account any fee waivers and expense reimbursements. For the
other years, the expenses are based on Total Annual Operating Expenses. Because
15
<PAGE>
the Potomac Dow Funds, Potomac Internet Funds and Potomac Japan Funds were not
operational during the prior fiscal year, expenses for 5 Years and 10 Years are
not required to be shown. Although your actual costs may be higher or lower,
based on these assumptions your costs would be:
INVESTOR CLASS:
-------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
-------------------------------------------------------------------------
U.S. Plus $150 $470 $820 $1790
U.S./Short $170 $520 $900 $1950
OTC Plus $150 $470 $820 $1790
OTC/Short $170 $520 $900 $1950
Dow Plus $150 $470 $820 $1790
Dow/Short $170 $520 $900 $1950
Internet Plus $150 $470 $820 $1790
Internet/Short $170 $520 $900 $1950
Japan Plus $150 $470 $820 $1790
Japan/Short $170 $520 $900 $1950
Small Cap Plus $150 $470 $820 $1790
Small Cap/Short $170 $520 $900 $1950
U.S. Government
Money Market $100 $320 $550 $1220
-------------------------------------------------------------------------
ADVISOR CLASS:
-------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
-------------------------------------------------------------------------
U.S. Plus $260 $___ $___ $___
U.S./Short $280 $___ $___ $___
OTC Plus $260 $___ $___ $___
OTC/Short $280 $___ $___ $___
Dow Plus $260 $___ n/a n/a
Dow/Short $280 $___ n/a n/a
Internet Plus $260 $___ n/a n/a
Internet/Short $280 $___ n/a n/a
Japan Plus $260 $___ n/a n/a
Japan/Short $280 $___ n/a n/a
Small Cap Plus $260 $___ n/a n/a
Small Cap/Short $280 $___ n/a n/a
U.S. Government
Money Market $___ $___ $___ $___
-------------------------------------------------------------------------
<TABLE>
<CAPTION>
BROKER CLASS:
------------------------------------------ ------------ ----------- ----------- -----------
1 Year 3 Years 5 Years 10 Years
------------------------------------------ ------------ ----------- ----------- -----------
<S> <C> <C> <C> <C>
U.S. Plus
Assuming redemption at end of period $___ $___ $___ $___
Assuming no redemption $___ $___ $___ $___
U.S./Short
Assuming redemption at end of period $___ $___ $___ $___
Assuming no redemption $___ $___ $___ $___
16
<PAGE>
OTC Plus
Assuming redemption at end of period $___ $___ $___ $___
Assuming no redemption $___ $___ $___ $___
OTC/Short
Assuming redemption at end of period $___ $___ $___ $___
Assuming no redemption $___ $___ $___ $___
Dow Plus
Assuming redemption at end of period $___ $___ n/a n/a
Assuming no redemption $___ $___ n/a n/a
Dow/Short
Assuming redemption at end of period $___ $___ n/a n/a
Assuming no redemption $___ $___ n/a n/a
Internet Plus
Assuming redemption at end of period $___ $___ n/a n/a
Assuming no redemption $___ $___ n/a n/a
Internet/Short
Assuming redemption at end of period $___ $___ n/a n/a
Assuming no redemption $___ $___ n/a n/a
Japan Plus
Assuming redemption at end of period $___ $___ n/a n/a
Assuming no redemption $___ $___ n/a n/a
Japan/Short
Assuming redemption at end of period $___ $___ n/a n/a
Assuming no redemption $___ $___ n/a n/a
Small Cap Plus
Assuming redemption at end of period $___ $___ n/a n/a
Assuming no redemption $___ $___ n/a n/a
Small Cap/Short
Assuming redemption at end of period $___ $___ n/a n/a
Assuming no redemption $___ $___ n/a n/a
U.S. Government Money Market
Assuming redemption at end of period $___ $___ $___ $___
Assuming no redemption $___ $___ $___ $___
- --------------------------------------------------------------------------------------------
</TABLE>
17
<PAGE>
ABOUT YOUR INVESTMENT
- --------------------------------------------------------------------------------
SHARE PRICES OF THE POTOMAC FUNDS
- --------------------------------------------------------------------------------
A Fund's share price is known as its net asset value (NAV). For all of the Funds
except the U.S. Government Money Market Fund, the share prices are calculated at
4:15 pm Eastern time each day the New York Stock Exchange (NYSE) is open for
business. The U.S. Government Money Market Fund's share price is calculated at
1:00 pm Eastern time each day the NYSE and Federal Bank of New York are open.
Share price is calculated by dividing a Fund's net assets by its shares
outstanding. The Funds use the following methods to price securities held in
their portfolios:
o equity securities, OTC securities, options and futures are valued at
their last sales price, or if not available, the average of the last
bid and ask
o options on futures are valued at their settlement price
o short-term debt securities and money market securities are valued using
the "amortized" cost method
o securities for which a price is unavailable based on the method
described above will be valued at fair value estimates by the
investment advisor or the Board of Trustees
- --------------------------------------------------------------------------------
CLASSES OF SHARES
- --------------------------------------------------------------------------------
The Potomac Funds offers three classes of shares for investors to purchase -
Investor Class, Advisor Class and Broker Class. Each class charges different
fees and expenses.
INVESTOR CLASS:
The Investor Class is best suited for those sophisticated investors who make
their own investment decisions without the advice of an investment
professional. Investor Class shares are subject to ongoing distribution and
service (Rule 12b-1) fees of up to 1.00% of their average daily net assets.
However, because Rafferty has agreed to limit each Fund's total annual
operating expenses, these fees may be significantly lower than the ongoing
Rule 12b-1 fees for the Advisor Class and Broker Class shares.
ADVISOR CLASS:
The Advisor Class is made available through your investment advisor, bank,
trust company or other authorized representative (Financial Advisor). As an
investor in the Advisor Class, you pay no sales charges. However, Advisor
Class shares have ongoing Rule 12b-1 fees of up to 1.00 of their average
daily net assets. Under an agreement with the Funds, your Financial Advisor
may receive these fees from the Funds. In exchange, your Financial Advisor
may provide a number of services, such as:
o placing your orders and issuing confirmations,
o providing investment advice, research and other advisory services,
18
<PAGE>
o handling correspondence for individual accounts,
o acting as the sole shareholder of record for individual shareholders,
o issuing shareholder statements and reports and
o executing daily investment "sweep" functions.
For more specific information on these and other services, you should speak
to your Financial Advisor. Your Financial Advisor may charge additional
account fees for services beyond those specified above.
BROKER CLASS:
The Broker Class is made available through your broker or dealer (Broker). As
an investor in the Broker Class, your investment is subject to a contingent
deferred sales charge (CDSC). This means that if you sell shares of a Fund
within 6 years of purchase, you may have to pay a sales charge of up to 5% on
the value of the shares to be sold. However, you will not be charged a CDSC
when you exchange Broker Class shares of one Potomac Fund for another. In
addition, the Broker Class shares have ongoing Rule 12b-1 fees of up to 1.00%
of their average daily net assets.
The table below lists the different CDSCs that apply if you sell Broker Class
shares within 6 years of purchase. The CDSC is calculated by multiplying your
original purchase cost or the current market value, whichever is less by one
of the percentages listed in the table. The longer you hold your shares, the
less of a CDSC you would pay. You may sell shares after 6 years with no CDSC.
[Any period that you held Broker Class shares of the Money Market Fund will
not be counted when determining CDSC.]
BROKER CLASS DEFERRED CHARGES
REDEMPTION DURING: CDSC ON SHARES BEING SOLD:
----------------- -------------------------
1st year 5%
2nd year 4%
3rd year 3%
4th year 3%
5th year 2%
6th year 1%
After 6 years None
WAIVER OF CDSC:
--------------
The CDSC for Broker Class shares currently is waived if the shares are sold:
o to make certain distributions from retirement plans,
o due to shareholder death or disability (including shareholders who own
shares in joint tenancy with a spouse) or
o to close shareholder accounts that do not comply with the low balance
account requirements.
CONVERSION OF BROKER CLASS SHARES:
---------------------------------
If you hold your Broker Class shares for 8 years, we automatically will
convert them to Investor Class shares at no cost. In addition, we will
convert any Broker Class shares purchased with reinvested dividends or
19
<PAGE>
distributions. [We do not count any period of time that you held Broker Class
shares of the Money Market Fund in the 8 year period.]
At the time of the conversion, you will receive Investor Class shares in an
amount equal to the value of your Broker Class shares. Because both classes
have different prices, you may receive more or less Investor Class shares
after the conversion. However, the dollar amount converted will not change so
that you have not lost any money due to the conversion.
- --------------------------------------------------------------------------------
RULE 12b-1 FEES
- --------------------------------------------------------------------------------
The Funds have adopted a distribution plan under Rule 12b-1 for each class of
shares. The Plans allow the Funds to pay distribution and sales fees for the
sale of the Funds' shares and for other shareholder services. Because these fees
are paid out of the Funds' assets on an on-going basis, over time these fees
will increase the cost of your investment and may cost you more than paying
other types of sales charges.
Under each Plan, the fees may amount to up to 1.00% of that class' average daily
net assets. The Potomac Funds' Board of Trustees has authorized each Fund to pay
Rule 12b-1 fees equal to 1.00% of the average daily net assets of the Advisor
Class and the Broker Class. For the Investors Class, the Board authorized each
Fund to pay Rule 12b-1 fees of an amount equal to the difference between a
Fund's Total Annual Operating Expenses and the contractual limit on Total Annual
Operating Expenses of 1.50% for the Plus Funds and 1.65% for the Short Funds.
- --------------------------------------------------------------------------------
HOW TO INVEST IN THE POTOMAC FUNDS
- --------------------------------------------------------------------------------
You may invest in the Funds through traditional investment accounts, individual
retirement accounts (including Roth IRAs), self-directed retirement plans or
company sponsored retirement plans. Applications and description of any services
fees for retirement accounts are available directly from the Potomac Funds.
MINIMUM INVESTMENT:
The minimum initial and subsequent investments set forth below may be
invested in as many of the Potomac Funds as you wish. However, you must
invest at least $100 in any one of the Funds. For example, if you decide to
invest in three of the Funds, you may allocate your minimum initial
investment as $9800, $100 and $100.
- ----------------------------------------------------------------------
Minimum Initial Subsequent Investment
Investment
- ----------------------------------------------------------------------
Regular Accounts $10,000 $1,000
Retirement Accounts $______ $_____
- ----------------------------------------------------------------------
Rafferty may waive these minimum requirements at its discretion. Contact
Rafferty, your financial advisor or your broker for further information.
20
<PAGE>
PURCHASING SHARES:
BY MAIL
-------
o Complete and sign your Account Application.
o Tell us which Fund, the class of shares and the amount you wish to
invest.
o Mail your check (payable to "Potomac Funds") along with the completed
Account Application to:
<TABLE>
<CAPTION>
<S> <C>
REGULAR MAIL EXPRESS/OVERNIGHT MAIL
- ------------ ----------------------
<S> <C>
Potomac Funds Potomac Funds
c/o Firstar Mutual Fund Services, LLC c/o Firstar Mutual Fund Services, LLC
P.O. Box 1993 Mutual Fund Services - 3rd Floor
Milwaukee, Wisconsin 53201-1993 615 East Michigan Street
Milwaukee, Wisconsin 53202
</TABLE>
o Cash, credit cards, credit card checks and third-party checks will not
be accepted by the Funds.
o All purchases must be made in U.S. Dollars through a U.S. bank.
o If your check does not clear due to insufficient funds, you will be
charged a $25.00 fee.
BY BANK WIRE TRANSFER
---------------------
o Call the Potomac Funds' Transfer Agent at (800) 851-0511 to receive
your account number.
o Wire your payment 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
(Your name)
(Your account number)
(Name of Fund(s) and Class(es) to purchase)
o Your bank may charge a fee for such services.
o Once you have wired your investment, mail [or fax] your completed and
signed Account Application to the Potomac Funds.
o Wire orders will only be accepted from 9:00 A.M. TO 3:40 P.M. Eastern
Time.
o Any orders received after this time will be processed at the NAV
calculated on the next business day.
BY CONTACTING YOUR FINANCIAL ADVISOR OR BROKER
----------------------------------------------
o Contact your Financial Advisor or Broker.
21
<PAGE>
o Your Financial Advisor or Broker will help you complete the necessary
paperwork, mail your Account Application to the Potomac Funds and place
your order to purchase shares of the Funds.
- --------------------------------------------------------------------------------
HOW TO EXCHANGE SHARES OF THE POTOMAC FUNDS
- --------------------------------------------------------------------------------
You may exchange shares of your current Fund(s) for shares of the same class of
any other Potomac Fund without any charges. To make an exchange:
o Write or call the Potomac Funds' Transfer Agent, or contact your
Financial Advisor or Broker.
o Provide your name, account number, which Funds are involved, and the
number, percentage or dollar value of shares to be exchanged.
o The Funds can only honor exchanges between accounts registered in the
same name and having the same address and tax payer identification
number.
o You must exchange at least a $1,000 or, if your account value is less
than that, your entire account balance will be exchanged.
o You may exchange by telephone only if you selected that option on your
account application.
o You may place exchange orders by telephone between 9:00 A.M. AND 3:40
P.M. Eastern time.
o Telephone exchange orders will be accepted only during the periods
indicated.
- --------------------------------------------------------------------------------
HOW TO SELL SHARES OF THE POTOMAC FUNDS
- --------------------------------------------------------------------------------
You may sell all or part of your investment in the Funds at the next determined
net asset value after we receive your order.
GENERALLY:
---------
o You normally will receive proceeds from any sales of Fund shares within
seven days from the time a Fund receives your request.
o For investments that have been made by check, payment on sales requests
may be delayed until the Potomac Funds' Transfer Agent is reasonably
satisfied that the purchase payment has been collected by the Fund,
which may require up to 10 business days.
o Your proceeds will be sent to the address or wired to the bank listed
on your Account Application.
o Your request will be processed the same day if you call between 9:00 AM
AND 3:40 P.M. Eastern time (or 4:00 p.m. for the Money Market Fund).
Requests placed after the closing time will be processed at the NAV on
the next business day.
22
<PAGE>
BY TELEPHONE OR BY MAIL
-----------------------
o Call or write the Funds (see the address and telephone number above).
o You may only sell shares of the Funds by telephone if you selected that
option on your Account Application.
o Provide your name, account number, which Fund and the number,
percentage or dollar value of shares to sell.
BY WIRE TRANSFER
----------------
o Call the Potomac Funds.
o Provide your name, account number, which Fund and the number,
percentage or dollar value of shares to sell.
o You must wire transfer at least $5,000.
o You will be charged a wire transfer fee of $12.00 in addition to any
charges imposed by your bank.
o Your proceeds will be wired only to the bank listed on your Account
Application.
THROUGH YOUR FINANCIAL ADVISOR OR BROKER
----------------------------------------
o Contact your Financial Advisor or Broker.
o He or she will place your order to sell shares of the Funds.
o [Payment can be directed to your advisory or brokerage account normally
within three days after your Financial Advisor or Broker places your
order.]
- --------------------------------------------------------------------------------
ACCOUNT AND TRANSACTION POLICIES
- --------------------------------------------------------------------------------
ORDER POLICIES:
You may buy and sell shares of the Funds at their NAV computed after your
order has been received in good order. Purchase orders will be processed the
same day at that day's NAV if received by __ p.m. Eastern Time. Sell orders
will be processed the same day if received by 3:40 p.m. Eastern time (or 4:00
p.m. for the Money Market Fund). Any order received after those times will be
processed the next business day.
There are certain times when you may be unable to sell shares of the Funds or
proceeds may be delayed. This may occur during emergencies, unusual market
conditions or when the Funds cannot determine the value of its assets or sell
its holdings. The Funds reserve the right to reject any purchase order or
suspend offering of their shares.
TELEPHONE TRANSACTIONS:
For your protection, the Funds may require some form of personal
identification prior to accepting your request such as verification of your
social security number, account number or other information. We also may
record the conversation for accuracy. During times of unusually high market
activity or extreme market changes, you should be aware that it may be
difficult to place your request in a timely manner.
23
<PAGE>
SIGNATURE GUARANTEES:
In certain instances when you sell shares of the Funds, we will need your
signature guaranteed. Signatures guarantees may be available at your bank,
stockbroker or a national securities exchange. Your signature must be
guaranteed under the following circumstances:
o if your account registration or address has changed in the last 30 days
o if the proceeds of your sale are mailed to an address other than the
one listed with the Funds
o if the proceeds are payable to a third party
o if the sale is greater than $100,000
o if the wire instructions on the account are being changed
o if there are other unusual situations as determined by the Funds'
Transfer Agent
LOW BALANCE ACCOUNTS:
If your account balance falls below $10,000, then we may sell your shares of
the Funds. We will inform you in writing 30 days prior to selliing shares. If
you do not bring your account balance up to $10,000 within 30 days, we may
sell shares and send you the proceeds. We will not sell shares if your
account value falls due to market fluctuations.
MONEY MARKET FUND CHECKING POLICIES:
You may write checks against your Money Market Fund account if you request
and complete a signature card. With these checks, you may sell shares of the
Fund simply by writing a check for at least $500. You may not write a check
to close your account. If you place a stop payment order on a check, we will
charge you $25.
ADDITIONAL INFORMATION
- --------------------------------------------------------------------------------
MANAGEMENT OF THE FUNDS
- --------------------------------------------------------------------------------
INVESTMENT ADVISOR:
Rafferty Asset Management, LLC (Rafferty) provides investment services to the
Funds. RAM manages the investment of the Funds' assets consistent with their
investment objectives, policies and limitations. RAM has been managing mutual
funds since June 1997 and has ______ assets under management as of _______,
1999. RAM is located at 1311 Mamaroneck Avenue, White Plains, New York 10605.
Under an investment advisory agreement between the Potomac Funds and RAM, the
Funds pay RAM the following fees at an annualized rate based on a percentage
of the Funds' daily net assets. The fees charged and the contractual fees are
the same.
24
<PAGE>
-------------------------------------------------
Advisory Fees Charged
-------------------------------------------------
Plus Funds 0.75
Short Funds 0.90
U.S. Government
Money Market Fund 0.50
-------------------------------------------------
PORTFOLIO MANAGEMENT:
An investment committee of Rafferty and James T. Apple share the day-to-day
responsibility for managing the Potomac Funds. Mr. Apple is the Chief
Investment Officer of the Potomac Funds and _____ with Rafferty.
Previously, Mr. Apple was portfolio manager for the Rydex OTC Fund from
February 1994 to May 1997. From December 1992 to December 1993, he was
Director of Investments for The Rushmore Funds, Inc.
- --------------------------------------------------------------------------------
DISTRIBUTIONS AND TAXES
- --------------------------------------------------------------------------------
DISTRIBUTIONS:
Each Fund, except the Money Market Fund, distributes dividends from net
investment income annually. The Money Market Fund usually distributes
dividends from its net investment income monthly. Net investment income
generally consists of interest income and dividends received on investments,
less expenses.
Each Fund, except the Money Market Fund, also distributes any realized net
capital gains annually. A Fund has capital gains when it sells its portfolio
assets for a profit. The tax consequences will vary depending on how long a
Fund has held the asset. Distributions of net gains on the sale of an asset
held for one year or less are taxed as ordinary income. Sales of assets held
longer than one year (long-term capital gains) are taxed at lower capital
gains rates.
Dividends and net capital gains will be reinvested automatically at NAV
unless you request otherwise in writing. Normally, distributions are taxable
events for shareholders whether or not the distributions are received in cash
or reinvested.
TAXES:
The following table illustrates the potential tax liabilities for taxable
accounts:
- --------------------------------------------------------------------------------
Type of Transaction Tax Status*
- --------------------------------------------------------------------------------
Dividends Ordinary income rate
Short-term capital gains Ordinary income rate
Long-term capital gains Long-term capital gains rate
Sale or exchange of Fund shares owned for Long-term capital gains or losses
more than one year (capital gains rate)
Sale or exchange of Fund shares owned for Gains are taxed at the same rate as
less than one year ordinary income; losses are subject
to special rules
- --------------------------------------------------------------------------------
25
<PAGE>
* Tax consequences for tax-deferred retirement accounts or non-taxable
shareholders may be different. You should consult your tax specialist for
more information about your personal situation.
If you are a non-retirement account holder, then each year, we will send you
a Form 1099 that tells you the amount of Fund distributions you received for
the prior calendar year, the tax status of this distributions and a list of
reportable sale transactions. Normally, distributions are taxable in the year
you receive them. However, any distributions declared in the last three
months of the year generally are taxable as if received on December 31 of the
year they are declared.
If you are a non-corporate shareholder and do not provide the Funds with your
correct taxpayer identification number (normally your social security
number), the Funds are required to withhold 31% of all dividends, other
distributions and sale proceeds payable to you. If you are otherwise subject
to backup withholding, we also are required to withhold and pay to the IRS
31% of your distributions. Any tax withheld may be applied against your tax
liability when you file your tax return. You may be subject to a $50 fee for
any penalties imposed on the Funds by the IRS.
- --------------------------------------------------------------------------------
YEAR 2000
- --------------------------------------------------------------------------------
The Funds could be affected adversely if the computer systems used by Rafferty,
the Funds' other service providers, or companies in which the Funds invest do
not properly process and calculate information that relates to dates beginning
on January 1, 2000 and beyond. Rafferty has taken steps that it believes are
reasonably designed to address the potential failure of computer systems used by
it and the Funds' service providers to address the Year 2000 issue. However, due
to the Funds' reliance on various service providers to perform essential
functions, a Fund could have difficulty calculating its net asset value,
processing orders for share sales and delivering account statements and other
information to shareholders. There can be no assurance that these steps will be
sufficient to avoid and adverse impact.
- --------------------------------------------------------------------------------
MASTER/FEEDER STRUCTURE OPTION
- --------------------------------------------------------------------------------
The Funds may in the future operate under a master/feeder structure. This means
that each Fund would be a "feeder" fund that invests objectives by investing all
its investable assets in a "master" fund with the same investment objective. The
"master" fund would purchase securities for investment. It is expected that any
such investment company would be managed by Rafferty in substantially the same
manner as the Funds. If permitted by law at that time, the Board of Trustees may
approve the implementation of such a structure for the Funds without seeking
shareholder approval. However, the Trustees decision will be made only if the
investments in the master funds are in the best interests of the Funds and their
shareholders. In making that determination, the Trustees will consider, among
other things, the benefits to shareholders and/or the opportunity to reduce
costs and achieve operational efficiencies. You also will receive 30 days notice
prior to the implementation of the master/feeder structure.
26
<PAGE>
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
The financial highlights tables are intended to help you understand each Fund's
financial performance since the Funds' commenced operation. Certain information
reflects financial results for a single Fund share. The total returns in the
table represent the rate that an investor would have earned (or lost) on an
investment in the Fund (assuming reinvestment of all dividends and
distributions). Financial highlights are not available for the Potomac Small
Cap/Short Fund, the Potomac Dow Funds, the Potomac Internet Funds and the
Potomac Japan Funds because they have not commenced active operations. More
information about the Funds is found in their Annual and Semi-Annual Reports,
which you may obtain upon request.
27
<PAGE>
<TABLE>
<CAPTION>
For a fund share outstanding throughout the period
POTOMAC FUNDS U.S. PLUS FUND */ U.S./SHORT FUND 1/
PERIODS ENDED AUGUST 31
1999 1998 1999 1998
<S> <C> <C> <C> <C>
PER SHARE DATA:
NET ASSET VALUE,
BEGINNING OF PERIOD...................... $ 10.00 $ 10.00
--------- ---------
INCOME (LOSS) FROM INVESTMENT OPERATIONS:
Net investment income (loss)................ 0.36 4/ 0.23 4/
Net realized and unrealized gain (loss) on
investments................................. (0.58) (0.77)
------- --------- ------- ---------
Total from investment operations........ (0.22) (0.54)
------- --------- ------- ---------
LESS DIVIDENDS FROM NET INVESTMENT INCOME... (0.02) --
------- --------- ------- ---------
NET ASSET VALUE, END OF PERIOD.............. $ 9.76 $ 9.46
======= ========= ======= =========
TOTAL RETURN 2/ (2.23%) (5.40%)
SUPPLEMENTAL DATA AND RATIOS:
Net assets, end of period................... $ 466,997 $7,768,652
Ratio of net expenses to average net assets:
Before expense reimbursement 3/......... 2.52% 5.29%
After expense reimbursement 3/.......... 1.50% 1.57%
Ratio of net investment income (loss)
to average net assets:
Before expense reimbursement 3/......... 2.68% (0.46%)
After expense reimbursement 3/.......... 3.70% 3.26%
Portfolio turnover rate 5/.................. 0.00% 0.00%
===============================================
</TABLE>
*/ U.S. PLUS FUND COMMENCED OPERATIONS ON OCTOBER 20, 1997.
1/ U.S./SHORT FUND COMMENCED OPERATIONS ON NOVEMBER 7, 1997.
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.
<PAGE>
<TABLE>
<CAPTION>
For a fund share outstanding throughout the period
POTOMAC FUNDS OTC PLUS FUND */ OTC/SHORT FUND 1/
PERIODS ENDED AUGUST 31
1999 1998 1999 1998
<S> <C> <C> <C> <C>
PER SHARE DATA:
NET ASSET VALUE,
BEGINNING OF PERIOD...................... $ 10.00 $ 10.00
--------- ---------
INCOME (LOSS) FROM INVESTMENT OPERATIONS:
Net investment income (loss)................ (0.11) 4/ 0.09 4/ 8/
Net realized and unrealized gain (loss) on
investments................................. 0.52 (1.71)
------- --------- ------- ---------
Total from investment operations........ 0.41 (1.62)
------- --------- ------- ---------
LESS DIVIDENDS FROM NET INVESTMENT INCOME... -- --
------- --------- ------- ---------
NET ASSET VALUE, END OF PERIOD.............. $ 10.41 $ 8.38
======= ========= ======= =========
TOTAL RETURN 2/ 4.10% (16.20%)
SUPPLEMENTAL DATA AND RATIOS:
Net assets, end of period................... $7,680,546 $19,168,538
Ratio of net expenses to average net assets:
Before expense reimbursement 3/......... 3.21% 3.70%
After expense reimbursement 3/.......... 1.50% 1.64% 6/
Ratio of net investment income (loss)
to average net assets:
Before expense reimbursement 3/......... (2.84%) (0.74%)
After expense reimbursement 3/.......... (1.13%) 1.32% 7/
Portfolio turnover rate 5/.................. 2,324.63% 3,346.25%
===============================================
</TABLE>
*/ OTC PLUS FUND COMMENCED OPERATIONS ON OCTOBER 20, 1997.
1/ OTC/SHORT FUND COMMENCED OPERATIONS ON OCTOBER 16, 1997.
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.
<PAGE>
<TABLE>
<CAPTION>
For a fund share outstanding throughout the period
POTOMAC FUNDS U.S. GOVERNMENT MONEY MARKET FUND 1/
PERIODS ENDED AUGUST 31
1999 1998
<S> <C> <C>
PER SHARE DATA:
NET ASSET VALUE,
BEGINNING OF PERIOD...................... $ 1.00
------------
INCOME (LOSS) FROM INVESTMENT OPERATIONS:
Net investment income (loss)................ 0.04 4/
Net realized and unrealized gain (loss) on
investments................................. --
---------- ------------
Total from investment operations........ 0.04
---------- ------------
LESS DIVIDENDS FROM NET INVESTMENT INCOME... (0.04)
---------- ------------
NET ASSET VALUE, END OF PERIOD.............. $ 1.00
========== ============
TOTAL RETURN2/ 3.89%
SUPPLEMENTAL DATA AND RATIOS:
Net assets, end of period................... $ 9,370,384
Ratio of net expenses to average net assets:
Before expense reimbursement3/.......... 3.70%
After expense reimbursement3/........... 1.00%
Ratio of net investment income (loss)
to average net assets:
Before expense reimbursement3/.......... 1.66%
After expense reimbursement3/........... 4.36%
Portfolio turnover rate5/................... N/A
================================================
</TABLE>
1/ COMMENCED OPERATIONS ON OCTOBER 20, 1997.
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.
<PAGE>
MORE INFORMATION ON THE POTOMAC FUNDS
STATEMENT OF ADDITIONAL INFORMATION (SAI): The Funds' SAI contains more
information on the Funds and their investment policies. The SAI is incorporated
in this Prospectus by reference (it is legally part of this Prospectus). A
current SAI is on file with the Securities and Exchange Commission (SEC).
ANNUAL AND SEMI-ANNUAL REPORTS TO SHAREHOLDERS: The Funds' reports provide
additional information on their investment holdings, performance data and a
letter discussing the market conditions and investment strategies that
significantly affected the Funds' performance during that period.
CALL OR WRITE TO OBTAIN THE SAI OR FUND REPORTS FREE OF CHARGE:
Write to: Potomac Funds Call: (800) 851-0511
P.O. Box 1993
Milwaukee, Wisconsin 53201-1993
Copies of these documents and other information about the Funds are available
from the SEC Public Reference Room in Washington, D.C. The Public Reference Room
can be reached at (800) 732-0330 or by mailing a request, including a
duplicating fee to: SEC's Public Reference Section, 450 Fifth Street NW,
Washington, D.C. 20549-6009. You also may find information on the Funds at the
SEC's Internet website at http://www.sec.gov.
Investment Advisor: Rafferty Asset Management, LLC
1311 Mamaroneck Avenue
White Plains, NY 10605
Adminstrator, Transfer Agent, Firstar Mutual Fund Services, LLC
Dividend Paying Agent, P.O. Box 1993
Shareholder Servicing Agent: Milwaukee, WI 53201-1993
Custodian: Firstar Bank Milwaukee, N.A.
614 East Michigan Street
Milwaukee, WI 53202
Counsel: Kirkpatrick & Lockhart LLP
1800 Massachusetts Avenue, N.W.
Washington, D.C. 20036-1800
Independent Auditors: PricewaterhouseCoopers LLP
100 East Wisconsin Avenue
Milwaukee, WI 53202
POTOMAC FUNDS
[LOGO]
SEC File Number: 811-8243
Rafferty Capital Markets, Inc., Distributor
1311 Mamaroneck Avenue
White Plains, New York 10605
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 representations must not be relied
upon as having been authorized by the Funds or their distributor. This
Prospectus does not constitute an offering by the Funds in any jurisdiction in
which such an offering may not lawfully be made.
<PAGE>
POTOMAC FUNDS
STATEMENT OF ADDITIONAL INFORMATION
100 South Royal Street
Alexandria, Virginia 22314
1311 Mamaroneck Avenue
White Plains, New York 10605
(800) 851-0511
The Potomac Funds (the "Trust") is a management investment company, or mutual
fund, which offers to the public thirteen 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, each of which attempts to
provide results correlating to a specific index. The "plus" fund attempts to
provide investment results that correlate to its target index, while the "short"
fund attempts to provide investment results that are opposite of the return of
its target index. In particular, the following Funds seek investment results
that correspond over time to the following target indices:
<TABLE>
<CAPTION>
<S> <C>
FUND TARGET INDEX
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)
Potomac Dow Plus Fund 125% of the performance of the Dow Jones Industrial Average
Potomac Dow/Short Fund Inverse (opposite) of the Dow Jones Industrial Average
Potomac Internet Plus Fund 125% of the performance of the Inter@ctive Week Internet Index
Potomac Internet/Short Fund Inverse (opposite) of the Inter@ctive Week Internet Index
Potomac Japan Plus Fund 125% of the performance of the Nikkei 225 Index(TRADEMARK)
Potomac Japan/Short Fund Inverse (opposite) of the Nikkei 225 Index(TRADEMARK)
Potomac Small Cap Plus Fund 125% of the performance of the Russell 2000 Index
Potomac Small Cap/Short Fund Inverse (opposite) of the Russell 2000 Index
</TABLE>
The Trust also offers the Potomac U.S. Government Money Market Fund, which seeks
security of principal, current income and liquidity by investing primarily in
money market instruments issued or guaranteed, as to principal and interest, by
the U.S. Government, its agencies or instrumentalities. 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 ___________, 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 _______________, 1999
<PAGE>
TABLE OF CONTENTS
PAGE
THE POTOMAC FUNDS............................................................3
CLASSIFICATION OF THE FUNDS..................................................3
INVESTMENT POLICIES AND TECHNIQUES...........................................4
American Depository Receipts ("ADRs").....................................4
Foreign Securities........................................................4
Illiquid Investments and Restricted Securities............................4
Indexed Securities........................................................5
Investments in Other Investment Companies.................................6
Options, Futures and Other Strategies.....................................7
Repurchase Agreements....................................................14
Short Sales..............................................................14
U.S. Government Securities...............................................15
Other Investment Risks and Practices.....................................16
Tracking Error...........................................................17
INVESTMENT RESTRICTIONS.....................................................18
PORTFOLIO TRANSACTIONS AND BROKERAGE........................................21
MANAGEMENT OF THE TRUST.....................................................22
Trustees and Officers....................................................22
Five Percent Shareholders................................................25
Investment Adviser.......................................................25
Fund Administrator, Fund Accountant, Transfer Agent and Custodian........26
Distributor..............................................................27
Distribution Plans.......................................................27
Independent Accountants..................................................28
DETERMINATION OF NET ASSET VALUE............................................28
PURCHASES AND REDEMPTIONS...................................................29
Retirement Plans.........................................................29
Redemptions by Telephone.................................................30
Redemption in Kind.......................................................30
Receiving Payment........................................................30
EXCHANGE PRIVILEGE..........................................................31
CONVERSION OF BROKER CLASS SHARES...........................................31
PERFORMANCE INFORMATION.....................................................32
Comparative Information..................................................32
Total Return Computations................................................33
Yield Computations.......................................................34
SHAREHOLDER INFORMATION.....................................................35
DIVIDENDS, OTHER DISTRIBUTIONS AND TAXES....................................35
Dividends and Other Distributions........................................35
Taxes....................................................................36
FINANCIAL STATEMENTS........................................................40
2
<PAGE>
THE POTOMAC FUNDS
The Trust is a Massachusetts business trust organized on June 6, 1997 and is
registered with the Securities and Exchange Commission ("SEC") as an open-end
management investment company under the Investment Company Act of 1940, as
amended ("1940 Act"). The Trust currently consists of thirteen 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"), the Potomac Dow Plus Fund
("Dow Plus Fund"), the Potomac Dow/Short Fund ("Dow Short Fund"), the Potomac
Internet Plus Fund ("Internet Plus Fund"), the Potomac Internet/Short Fund
("Internet Short Fund"), the Potomac Japan Plus Fund ("Japan Plus Fund"), the
Potomac Japan/Short Fund ("Japan Short Fund"), the Potomac Small Cap Plus Fund
("Small Cap Plus"), the Potomac Small Cap/Short Fund ("Small Cap Short") and the
Potomac U.S. Government Money Market Fund ("Money Market Fund") (collectively,
the "Funds"). The Trust may offer additional series in the future.
Each Fund offers three classes of shares: the Investor Class, the Advisor Class
and the Broker Class. The Investor Class shares are designed for sale directly
for investors without a sales charge. The Advisor Class shares are made
available through investment advisers, bank, trust company or other authorized
representative without a sales charge but are subject to a 1.00% distribution
and service fee. The Broker Class shares are sold through brokers and dealers
and are subject to a 5% maximum contingent deferred sales charge ("CDSC")
declining over a six-year period.
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 target index. The terms "plus"
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.
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 in the
securities of a limited number of issuers. To the extent that a Fund assumes
large positions in the securities of a small number of issuers, the fund's net
asset value may fluctuate to a greater extent than that of a diversified company
as a result of changes in the financial condition or in the market's assessment
of the issuers, and the Fund may be more susceptible to any single economic,
political or regulatory occurrence than a diversified 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 meet
certain diversification standards at the end of each quarter of its tax year.
3
<PAGE>
INVESTMENT POLICIES AND TECHNIQUES
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
objective.
AMERICAN DEPOSITORY RECEIPTS ("ADRS")
The OTC Plus Fund, OTC/Short Fund, Small Cap Plus Fund, Small Cap/Short Fund,
Internet Plus Fund, Internet/Short Fund, Japan Plus Fund and Japan/Short Fund
may invest in ADRs. The OTC/Short Fund, Small Cap/Short Fund, Internet/Short
Fund and Japan/Short Fund may sell ADRs 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.
ADRs include ordinary shares and New York shares. ADRs may be purchased through
"sponsored" or "unsponsored" facilities. A sponsored facility is established
jointly by the issuer of the underlying security and a depository, whereas a
depository may establish an unsponsored facility without participation by the
issuer of the depository security. Holders of unsponsored depository receipts
generally bear all the costs of such facilities and the depository of an
unsponsored facility frequently is under no obligation to distribute shareholder
communications received from the issuer of the deposited security or to pass
through voting rights to the holders of such receipts of the deposited
securities. ADRs are not necessarily denominated in the same currency as the
underlying securities to which they may be connected. Generally, ADRs in
registered form are designed for use in the U.S. securities market and ADRs in
bearer form are designed for used outside the United States.
FOREIGN SECURITIES
The Japan Plus Fund and the Japan/Short Fund (each, a "Japan Fund" and
collectively, the "Japan Funds") may invest in ADRs of companies that comprise
the Nikkei 225 Index. The Japan Funds also may have indirect exposure to foreign
securities through investments in stock index futures contracts, options on
stock index futures contracts and options on securities and on stock indices
Investing in foreign securities 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.
ILLIQUID INVESTMENTS AND RESTRICTED SECURITIES
Each Fund may purchase and hold illiquid investments, No Fund will 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
4
<PAGE>
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 of Trustees
("Board" or "Trustees") or Rafferty Asset Management, LLC ("Rafferty") 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) over-the-counter ("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.
A Fund may not be able to sell illiquid investments when Rafferty 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.
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 maybe
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.
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.
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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. Certain indexed securities that are
not traded on an established market may be deemed illiquid. See "Illiquid
Investments and Restricted Securities" above.
The U.S. Plus Fund may invest in Standard & Poor's Depositary Receipts
("SPDRs"). SPDRs represent ownership in the SPDR Trust, a unit investment trust
that holds a portfolio of common stocks designed to track the price performance
and dividend yield of the Standard & Poor's 500 Composite Stock Price Index
("S&P 500 Index"), and whose shares trade on the American Stock Exchange. The
value of SPDRs fluctuates in relation to changes in the value of the underlying
portfolio of common stocks. The market price of SPDRs, however, may not be
equivalent to the pro rata value of the S&P 500 Index. SPDRs are subject to the
risks of an investment in a broadly based portfolio of common stocks.
The Dow Plus Fund may invest in DIAMONDSsm. DIAMONDS represent an investment in
a unit investment trust ("DIAMONDS Trust"), which owns shares in proportion to
the weightings of the stocks comprising the Dow Jones Industrial Average
("DJIA"). The DIAMONDS Trust is structured so that its shares trade at
approximately 1/100 (one one-hundredth) of the value of the DJIA. The DIAMONDS
Trust's shares trade on the American Stock Exchange ("AMEX"). An investment in
DIAMONDS is subject to risks similar to those of other diversified stock
portfolios, including market volatility and that the general level of stock
prices may decline. Although DIAMONDS are designed to provide investment results
that generally correspond to the price and yield performance of the DJIA, the
DIAMONDS Trust may not be able to exactly replicate the performance of the DJIA
because of trust expenses and other factors
An investment in SPDRs and DIAMONDS are considered investments in other
investment companies discussed below.
The Japan Funds may invest in currency-indexed securities. These securities
typically are short-term to intermediate-term debt securities whose maturity
values or interest rates are determined by reference to the values of one more
specified foreign currencies, and may offer higher yields than U.S.
Dollar-denominated securities of equivalent issuers. Currency-indexed securities
may be positively or negatively indexed; that is, their maturity value may
increase when the value of a specified foreign currency increases, resulting in
a security that performs similarly to a foreign-denominated instrument, or their
maturity value may decline when the value of a specified foreign currency
increases, resulting in a security whose price characteristics are similar to a
put on the underlying currency.
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.
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OPTIONS, FUTURES AND OTHER STRATEGIES
GENERAL. Each Fund (other than the Money Market Fund) may use certain options
(both traded on an exchange and OTC), 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, Rafferty may discover additional opportunities in connection with
Financial Instruments and other similar or related techniques. These new
opportunities may become available as Rafferty develops new techniques, as
regulatory authorities broaden the range of permitted transactions and as new
Financial Instruments or other techniques are developed. Rafferty 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 Rafferty's
ability to predict movements of the overall securities markets, which requires
different skills than predicting changes in the prices of individual securities.
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
Rafferty may still not result in a successful transaction. Rafferty may be
incorrect in its expectations as to the extent of market movements or the time
span within which the movements take place which, thus, may result in the
strategy being unsuccessful.
(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 or no
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
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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.
(4) Losses may arise due to unanticipated market price movements, lack of a
liquid secondary market for any particular instrument at a particular time or
due to losses from premiums paid by a Fund on options transactions.
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
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. Options currently are traded on the Chicago Board
Options Exchange ("CBOE"), the AMEX and other exchanges, as well as the OTC
markets.
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.
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
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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, 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. 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. 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 as the Philadelphia Stock
Exchange Over-the-Counter Index.
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 Rafferty
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.
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
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securities or futures contracts. When a Fund writes a call on an index, it
receives a premium and agrees that, prior to the expiration date, the purchaser
of the call, upon exercise of the call, will receive from the Fund an amount of
cash if the closing level of the index upon which the call is based is greater
than the exercise price of the call. The amount of cash is equal to the
difference between the closing price of the index and the exercise price of the
call times a specified multiple ("multiplier"), which determines the total value
for each point of such difference. When a Fund buys a call on an index, it pays
a premium and has the same rights 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.
OTC FOREIGN CURRENCY OPTIONS. OTC foreign currency options that may be used by
the Japan Plus Fund and the Japan Short Fund are European-style options. This
means that the option is exercisable only immediately prior to its expiration.
This is in contrast to American-style options, which are exercisable at any time
prior to the expiration date of the option.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS. 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).
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Whether a Fund realizes a gain or loss from futures activities depends upon
movements in the underlying security or index. The extent of a 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.
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
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.
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To the extent that a Fund enters into futures contracts or options on futures
contracts, in each case other than for BONA FIDE hedging purposes (as defined by
the Commodity Futures Trading Commission ("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.
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.
FOREIGN CURRENCY STRATEGIES - SPECIAL CONSIDERATIONS. Each Japan Fund may use
options and futures contracts on Japanese Yen, as described above, and forward
contracts on Japanese Yen, as described below.
The value of Financial Instruments on foreign currencies depends on the value of
the underlying currency relative to the U.S. Dollar. Because foreign currency
transactions occurring in the interbank market might involve substantially
larger amounts than those involved in the use of such Financial Instruments,
each Japan Fund could be disadvantaged by having to deal in the odd-lot market
(generally consisting of transactions of less than $1 million) for the
underlying foreign currencies at prices that are less favorable than for round
lots.
There is no systematic reporting of last sale information for foreign currencies
or any regulatory requirement that quotations available through dealers or other
market sources be firm or revised on a timely basis. Quotation information
generally is representative of very large transactions in the interbank market
and thus might not reflect odd-lot transactions where rates might be less
favorable. The interbank market in foreign currencies is a global,
round-the-clock market. To the extent the U.S. options or futures markets are
closed while the markets for the underlying currencies remain open, significant
price and rate movements might take place in the underlying markets that cannot
be reflected in the markets for the Financial Instruments until they reopen.
Settlement of transactions involving foreign currencies might be required to
take place within the country issuing the underlying currency. Thus, each Japan
Fund might be required to accept or make delivery of the underlying foreign
currency in accordance with any U.S. or foreign regulations regarding the
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maintenance of foreign banking arrangements by U.S. residents and might be
required to pay any fees, taxes and charges associated with such delivery
assessed in the issuing country.
FORWARD CURRENCY CONTRACTS. Each Japan Fund may enter into forward currency
contracts to purchase or sell Japanese Yen for a fixed amount of U.S. Dollars. A
forward currency contract involves an obligation to purchase or sell a specific
currency at a future date, which may be any fixed number of days (term) from the
date of the forward currency contract agreed upon by the parties, at a price set
at the time of the forward currency contract. These forward currency contracts
are traded directly between currency traders (usually large commercial banks)
and their customers.
The cost to each Japan Fund of engaging in forward currency contracts varies
with factors such as the currency involved, the length of the contract period
and the market conditions then prevailing. Because forward currency contracts
are usually entered into on a principal basis, no fees or commissions are
involved. When a Japan Fund enters into a forward currency contract, it relies
on the counterparty to make or take delivery of the underlying currency at the
maturity of the contract. Failure by the counterparty to do so would result in
the loss of any expected benefit of the transaction.
As is the case with futures contracts, purchasers and sellers of forward
currency contracts can enter into offsetting closing transactions, similar to
closing transactions on futures contracts, by selling or purchasing,
respectively, an instrument identical to the instrument purchased or sold.
Secondary markets generally do not exist for forward currency contracts, with
the result that closing transactions generally can be made for forward currency
contracts only by negotiating directly with the counterparty. Thus, there can be
no assurance that a Japan Fund would in fact be able to close out a forward
currency contract at a favorable price prior to maturity. In addition, in the
event of insolvency of the counterparty, a Japan Fund may be unable to close out
a forward currency contract at any time prior to maturity. In either event, a
Japan Fund would continue to be subject to market risk with respect to the
position, and would continue to be required to maintain a position in securities
denominated in the foreign currency or to maintain cash or liquid assets in a
segregated account.
The precise matching of forward currency contract amounts and the value of the
securities involved generally will not be possible because the value of such
securities, measured in the foreign currency, will change after the forward
currency contract has been established. Thus, a Japan Fund might need to
purchase or sell foreign currencies in the spot (cash) market to the extent such
foreign currencies are not covered by forward currency contracts.
COMBINED POSITIONS. A Fund may purchase and write options in combination with
each other. 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.
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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. 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. 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" above.
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. 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. 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.
SHORT SALES
The U.S./Short Fund, the OTC/Short Fund, the Dow/Short Fund, the Internet/Short
Fund, the Small Cap/Short Fund and the Japan/Short Fund may engage in short sale
transactions under which the Fund sells a security it does not own. To complete
such a transaction, the Fund must borrow the security to make delivery to the
buyer. The Fund then is obligated to replace the security borrowed by purchasing
the security at the market price at the time of replacement. The price at such
time may be more or less than the price at which the security was sold by the
Fund. Until the security is replaced, the Fund is required to pay to the lender
amounts equal to any dividends that accrue during the period of the loan. The
proceeds of the short sale will be retained by the broker, to the extent
necessary to meet the margin requirements, until the short position is closed
out.
Until a Fund closes its short position or replaces the borrowed stock, the Fund
will: (1) maintain an account containing cash or liquid assets at such a level
that (a) the amount deposited in the account plus that amount deposited with the
broker as collateral will equal the current value of the stock sold short and
(b) the amount deposited in the account plus the amount deposited with the
broker as collateral will not be less than the market value of the stock at the
time the stock was sold short; or (2) otherwise cover the Fund's short position.
The U.S. Plus Fund, the OTC Plus Fund, the Dow Plus Fund, the Internet Plus
Fund, the Small Cap Plus Fund and the Japan Plus Fund each also may engage in
short sales if, at the time of the short sale, the Fund owns or has the right to
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acquire an equal amount of the stock being sold at no additional cost ("selling
short against the box").
U.S. GOVERNMENT SECURITIES
The Money Market Fund invests in Securities issued or guaranteed by the U.S.
Government or its agencies or instrumentalities ("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 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.
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,
the Federal National Mortgage Association ("Fannie Mae"), the Farmers Home
Administration, the Export-Import Bank of the United States, the Small Business
Administration, the Government National Mortgage Association ("Ginnie Mae"), the
General Services Administration, the Central Bank for Cooperatives, the Federal
Home Loan Banks, the Federal Home Loan Mortgage Corporation ("Freddie Mac"), the
Farm Credit Banks, the Maritime Administration, the Tennessee Valley Authority,
the Resolution Funding Corporation and the Student Loan Marketing Association.
Securities issued or guaranteed by U.S. Government agencies and
instrumentalities are not always supported by the full faith and credit of the
United States. Some, such as securities issued by the Federal Home Loan Banks,
are backed by the right of the agency or instrumentality to borrow from the
Treasury. Others, such as securities issued by Fannie Mae, are supported only by
the credit of the instrumentality and by a pool of mortgage assets. If the
securities are not backed by the full faith and credit of the United States, the
owner of the securities must look principally to the agency issuing the
obligation for repayment and may not be able to assert a claim against the
United States in the event that the agency or instrumentality does not meet its
commitment. The Money Market Fund will invest in securities of agencies and
instrumentalities only if Rafferty is satisfied that the credit risk involved is
acceptable.
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
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<PAGE>
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.
OTHER INVESTMENT RISKS AND PRACTICES
BORROWING. The U.S. Plus Fund, OTC Plus Fund, the Internet Plus Fund, the Dow
Plus Fund, the Japan Plus Fund and the Small Cap Plus Fund may borrow money for
investment purposes, which is a form of 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 and on a Fund's investments.
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. The use
of derivatives in connection with leverage creates the potential for significant
loss.
The Funds 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 Rafferty deems appropriate in connection with any borrowings.
LENDING PORTFOLIO SECURITIES. Each Fund may lend portfolio securities with a
value not exceeding 33 1/3% (15% 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
16
<PAGE>
collateral, thereby earning additional income. Loans would be subject to
termination by the lending Fund on four business days' notice or by the borrower
on one day's notice. Borrowed securities must be returned when the loan is
terminated. Any gain or loss in the market price of the borrowed securities that
occurs during the term of the loan inures to the lending Fund and that Fund's
shareholders. A lending Fund may pay reasonable finders, borrowers,
administrative and custodial fees in connection with a loan. Each Fund currently
has no intention of lending its portfolio securities.
PORTFOLIO TURNOVER. 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. 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.
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. If, for
example, options and futures were included in the calculation, then each Fund's
portfolio turnover rate, except for the Money Market Fund, would be
approximately 500%.
TRACKING ERROR
While the Funds do not expect their returns over a twelve-month period to
deviate from their respective target indices 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 target index being held by a Fund and securities not included in the target
index 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 target
index over time due to the mathematical effects of leveraging).
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 target index.
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<PAGE>
In the case of the Funds whose net asset values move inversely from their target
indices (the U.S./Short Fund, OTC/Short Fund, Dow/Short Fund, Internet/Short
Fund, Japan/Short Fund, the Small Cap/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 target index 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 a Fund achieved a perfect inverse correlation with its target
index on every trading day over an extended period and the level of returns of
that index significantly decreased during that period, a compounding effect for
that period would result, causing an increase in the Fund's net asset value by a
percentage that is somewhat greater than the percentage that the index's returns
decreased. Conversely, if a Fund maintained a perfect inverse correlation with
its target index over an extended period and if the level of returns of that
index significantly increased over that period, a compounding effect would
result, causing a decrease of the Fund's net asset value by a percentage that
would be somewhat less than the percentage that the index returns increased.
INVESTMENT RESTRICTIONS
In addition to the investment policies and limitations described above and
described in the Prospectus, each Fund has adopted the following investment
limitations, which are fundamental policies and may not be changed without the
vote of a majority of the outstanding voting securities of that Fund. Under the
1940 Act, a "vote of the majority of the outstanding voting securities" of a
Fund means the affirmative vote of the lesser of: (1) more than 50% of the
outstanding shares of a Fund or (2) 67% or more of the shares of a Fund present
at a shareholders meeting if more than 50% of the outstanding shares are
represented at the meeting in person or by proxy.
For purposes of the following limitations, all percentage limitations apply
immediately after a purchase or initial investment. Except with respect to
borrowing money, if a percentage limitation is adhered to at the time of the
investment, a later increase or decrease in the percentage resulting from any
change in value or net assets will not result in a violation of such
restrictions. If at any time a Fund's borrowings exceed its limitations due to a
decline in net assets, such borrowings will be reduced promptly to the extent
necessary to comply with the limitation.
EACH FUND HAS ADOPTED THE FOLLOWING FUNDAMENTAL INVESTMENT POLICY that enables
it to invest in another investment company or series thereof that has
substantially similar investment objectives and policies:
Notwithstanding any other limitation, the Fund may invest all of its
investable assets in an open-end management investment company with
substantially the same investment objectives, policies and limitations as
the Fund. For this purpose, "all of the Fund's investable assets" means
that the only investment securities that will be held by the Fund will be
the Fund's interest in the investment company.
EACH FUND, EXCEPT THE MONEY MARKET FUND, HAS ADOPTED THE FOLLOWING INVESTMENT
LIMITATIONS:
A Fund shall not:
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<PAGE>
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 and 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, OTC/Short Fund, Dow/Short Fund,
Internet/Short Fund, Japan/Short Fund and Small Cap Plus/Short Fund may
make short sales of securities.
5. Pledge, mortgage, or hypothecate the Fund's assets, except (1) to the
extent necessary to secure permitted borrowings, (2) in connection with
the purchase of securities on a forward-commitment or delayed-delivery
basis or the sale of securities on a delayed-delivery basis, and (3) in
connection with options, futures contracts, options on futures contracts,
forward contracts, swaps, caps, floors, collars and other financial
instruments.
6. Invest in physical commodities, except that the Fund may purchase and sell
foreign currency, options, futures contracts, options on futures
contracts, forward contracts, swaps, caps, floors, collars, securities on
a forward-commitment or delayed-delivery basis, and other financial
instruments.
EACH FUND, EXCEPT THE U.S. PLUS FUND, OTC PLUS FUND, DOW PLUS FUND, JAPAN PLUS
FUND, SMALL CAP PLUS FUND AND THE INTERNET PLUS FUND, HAS ADOPTED THE FOLLOWING
INVESTMENT LIMITATION:
A Fund shall not:
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<PAGE>
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, OTC PLUS FUND, DOW PLUS FUND, INTERNET PLUS FUND, JAPAN PLUS
FUND AND SMALL CAP 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, OTC PLUS FUND, DOW PLUS FUND, JAPAN PLUS FUND, INTERNET PLUS
FUND AND SMALL CAP 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, OTC/SHORT FUND, INTERNET PLUS FUND AND
INTERNET SHORT FUND, HAS ADOPTED THE FOLLOWING INVESTMENT LIMITATION:
A Fund shall not:
10. Invest more than 25% of the value of its total assets in the securities of
issuers in any single industry, provided that there shall be no limitation
on the purchase of obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities.
THE OTC PLUS FUND AND THE OTC/SHORT FUND HAVE ADOPTED THE FOLLOWING INVESTMENT
LIMITATION:
A Fund shall not:
11. Invest more than 25% of the value of its total assets in the securities of
issuers in any single industry, 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.
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<PAGE>
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.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to the general supervision by the Trustees, Rafferty 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. Rafferty 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.
When selecting a broker or dealer to execute portfolio transactions, Rafferty
considers many factors, including the rate of commission or the size of the
broker-dealer's "spread," the size and difficulty of the order, the nature of
the market for the security, operational capabilities of the broker-dealer and
the research, statistical and economic data furnished by the broker-dealer to
Rafferty.
In effecting portfolio transactions for the Funds, Rafferty 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 Rafferty. Such services may include the following: information
21
<PAGE>
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 Rafferty from obtaining
a high quality of brokerage and research services. In seeking to determine the
reasonableness of brokerage commissions paid in any transaction, Rafferty 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.
Rafferty may use research and services provided to it by brokers in servicing
all the Funds; however, not all such services may be used by Rafferty 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 Rafferty, this information and these services
are of indeterminable value and would not reduce Rafferty'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 and the fiscal year ended August 31, 1999 were
$8,938 and $_______, respectively. Those commissions were paid on brokerage
transactions worth $174,191,426 and $_________, respectively.
Aggregate brokerage commissions paid by U.S./Short Fund for the period November
7, 1997 to August 31, 1998 and the fiscal year ended August 31, 1999 were $3,618
and $_______, respectively. Those commissions were paid on brokerage
transactions worth $78,849,094 and $__________, respectively.
Aggregate brokerage commissions paid by OTC Plus Fund for the period October 20,
1997 to August 31, 1998 and the fiscal year ended August 31, 1999 were $7,628
and $_________, respectively. Those commissions were paid on brokerage
transactions worth $9,942,393 and $_________, respectively.
Aggregate brokerage commissions paid by OTC/Short Fund for the period October
16,1997 to August 31, 1998 and for the fiscal year ended August 31, 1999 were
$858 and $_______, respectively. Those commissions were paid on brokerage
transactions worth $698,439 and $_______, respectively.
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
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<PAGE>
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 1311 Mamaroneck Avenue,
White Plains, New York 10605.
Position With Principal Occupation
NAME THE TRUST DURING PAST FIVE YEARS
Lawrence C. Rafferty* Chief Executive Chairman and Chief Executive
(__) Officer, Chairman Officer of Rafferty,
of the Board of 1997-present; Chief Executive
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* (__) Trustee Managing Partner of CloverLeaf
411 West Putnam Street Partners, Inc., 1992-1997
Greenwich, CT 06830 (investment banking).
Daniel J. Byrne (__) 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.
Gerald E. Shanley III Trustee Business Consultant,
(__) 12 First Street 1985-present; Trustee of Estate
Pelham, NY 10803 of Charles S. Payson,
1987-present.
James Terry Apple (__) Chief Investment Vice President of the Rafferty,
100 S. Royal Street Officer 1997-present; Portfolio Manager
Alexandria, VA 22314 of PADCO Advisors, 1994-1997;
Portfolio Manager of Money
Management Associates, 1992-1993.
Timothy P. Hagan (__) Chief Financial Vice President of Rafferty,
100 S. Royal Street Officer 1997-present; Vice President of
Alexandria, VA 22314 PADCO Advisors, 1993-1997, Vice
President of Money Management
Associates, 1981-1993.
Philip A. Harding (__) Co-President Vice President of the Rafferty,
1997-present; Vice President of
Commerzbank (USA), 1995-1997;
Senior Vice President of Sanwa
Bank (USA), 1992-1995.
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<PAGE>
Daniel D. O'Neill (__) Co-President ______________ of the Adviser,
1999-present.
Thomas A. Mulrooney (__) Chief Operating Chief Operating Officer of
Officer Rafferty, 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 (__) Vice President Vice President of Rafferty, 1997
100 S. Royal Street to present; President &
Alexandria, VA 22314 Co-Founder of Systems Management
Group, 1990-1997.
Stephen P. Sprague (__) Treasurer, Vice President and Chief
Controller and Financial Officer of Rafferty,
Assistant Secretary 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 & Lockhart
1800 Massachusetts Ave. LLP (law firm).
Washington, DC 20036
Eric W. Falkeis (__) Assistant Secretary Compliance Officer, Firstar
615 East Michigan Street Mutual Fund Services LLC,
Milwaukee, WI 53202 1997-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.
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 currently pay the Trustees, except Mr. Rafferty, $1000 per meeting of
the Board. Trustees also are reimbursed for any expenses incurred in attending
Board meetings. Prior to August 1999, the Trust paid the Trustees who are not
"interested persons" of the Trust as defined by the 1940 Act ("Independent
Trustees") $500 per meeting. No officer, director or employee of Rafferty
receives any compensation from the Fund for acting as a director or officer. The
24
<PAGE>
following table shows the compensation earned by each Trustee for the Trust's
prior fiscal year ended August 31, 1999.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
Pension or Retirement Aggregate
Aggregate Benefits Accrued As Part Estimated Annual Compensation From
Name of Person, Compensation of the Trust's Benefits Upon the Trust Paid to the
POSITION FROM THE TRUST EXPENSES RETIREMENT TRUSTEES
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Lawrence C. Rafferty, Trustee $0 $0 $0 $0
Jay F. Higgins, Trustee $______ $0 $0 $_______
Daniel J. Byrne, Trustee $______ $0 $0 $_______
Gerald E. Shanley III, Trustee $______ $0 $0 $______
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
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 Funds as
of ________, 1999.
INVESTMENT ADVISOR
Rafferty Asset Management, LLC, 1311 Mamaroneck Avenue, White Plains, New York
10605, provides investment advice to the Funds. Rafferty 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 Rafferty ("Advisory Agreement"), Rafferty 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. Rafferty bears all costs
associated with providing these advisory services and the expenses of the
Trustees who are affiliated with or interested persons of Rafferty. The Trust
bears all other expenses that are not assumed by Rafferty as described in the
Prospectus. The Trust also is liable for nonrecurring expenses as may arise,
including litigation to which a Fund may be a party. The Trust also may have an
obligation to indemnify its Trustees and officers with respect to any such
litigation.
Pursuant to the Advisory Agreement, each Fund pays Rafferty the following fee at
an annual rate based on its average daily net assets of:
Plus Funds 0.75%
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Short Funds 0.90%
Money Market Fund 0.50%
For U.S. Plus Fund, Rafferty 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 and fiscal year ended August 31, 1999, the advisory
fees amounted to $71,062 and $_______, respectively. For the same periods,
Rafferty waived its fees in the amounts of $96,923 and $__________,
respectively.
For U.S./Short Fund, Rafferty 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 and the fiscal year ended August 31, 1999, the
advisory fees amounted to $14,663 to $__________, respectively. For the same
periods, Rafferty waived its fees in the amounts of $60,726 and $____________,
respectively.
For OTC Plus Fund, Rafferty 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 and the fiscal year ended August 31, 1999, the advisory
fees amounted to $67,763 and $___________, respectively. For the same periods,
Rafferty waived its fees in the amounts of $154,869 and $____________,
respectively.
For OTC/Short Fund, Rafferty 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 and the fiscal year ended August 31, 1999, the
advisory fees amounted to $53,805 and $________, respectively. For the same
periods, Rafferty waived its fee in the amounts of $123,475 and $_________,
respectively.
For Money Market Fund, Rafferty 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 and the fiscal year ended August 31, 1999, the
advisory fees amounted to $17,168 and $_______, respectively. For the same
period, Rafferty waived its fees in the amounts of $92,798 and $__________,
respectively.
The Advisory Agreement was approved by the Trustees (including all Independent
Trustees) and Rafferty, 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
Rafferty 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 Rafferty.
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.
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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
(other than investment advisory services). As compensation for these services,
the Trust pays the Administrator a fee of __________.
For the period ended August 31, 1999, U.S. Plus Fund, U.S./Short Fund, OTC Plus
Fund OTC/Short Fund and Money Market Fund paid the Administrator $______,
$______, $_______, $_______ and $________, 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., 1311 Mamaroneck Avenue, White Plains, New York
10605, 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, 1999, the Distributor
received $_______ as compensation from Rafferty for distribution services.
DISTRIBUTION PLANS
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 separate plans for the
Investor Class ("Investor Class Plan"), the Advisor Class ("Advisor Class Plan")
and the Broker Class ("Broker Class Plan") of each Fund pursuant to which each
Fund may pay certain expenses incurred in the distribution of that Class' shares
and the servicing and maintenance of existing Class shareholder accounts.
Pursuant to each Plan, a Fund may pay 1.00% of its average daily net assets.
However, for the Investor Class Plan, the Board has authorized each Fund to pay
distribution and services fees only in an amount equal to the difference between
a Fund's total annual operating expenses and the contractual limit on total
annual operating expenses of 1.50% for the Plus Funds and 1.65% for the Short
Funds.
Each Plan was approved by the Trustees and the Independent Trustees of the
Funds. In approving each Plan, the Trustees determined that there is a
reasonable likelihood that the Plan will benefit each Fund and its shareholders.
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.
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The Small Cap Plus Fund paid $________ in Investor Class 12b-1 fees for the
fiscal year ending August 31, 1999. All of these fees were paid to Advisor.
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
The net asset value per share of each class of the Funds (except the Money
Market Fund) is determined separately daily, Monday through Friday, as of the
close of regular trading on the New York Stock Exchange ("NYSE"), each day the
NYSE is open for business. The NYSE is not open on 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, domestic or foreign, or the Nasdaq
Stock Market, is valued at its last sales price on the principal exchange on
which it is traded prior to the time when assets are valued. If no sale is
reported at that time, the most recent bid price is used. When market quotations
for options and futures positions held by a Fund are readily available, those
positions will be valued based upon such quotations. Securities and other assets
for which market quotations are not readily available, or for which the Adviser
has reason to question the validity of quotations received, are valued at fair
value as determined in good faith by the Board. For valuation purposes,
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quotations of foreign securities or other assets denominated in foreign
currencies are translated to U.S. Dollar equivalents using the net foreign
exchange rate in effect at the close of the stock exchange in the country where
the security is issued. Short-term investments having a maturity of 60 days or
less are valued at amortized cost, which approximates market value.
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.
PURCHASES AND REDEMPTIONS
RETIREMENT PLANS
Individuals who earn compensation and who have not reached age 70 1/2 before the
close of the year generally may establish an Individual Retirement Account
("IRA"). An individual may make limited contributions to a IRA through the
purchase of shares of the Funds. The Internal Revenue Code of 1986, as amended
(the "Code"), limits the deductibility of IRA contributions to taxpayers who are
not active participants (and, under certain circumstances, whose spouses are not
active participants, unless their combined adjusted gross income does not exceed
$150,000) in employer-provided retirement plans or who have adjusted gross
income below certain levels. Nevertheless, the Code permits other individuals to
make nondeductible IRA contributions up to $2,000 per year (or $4,000, if such
contributions also are made for a nonworking spouse and a joint return is
filed). In addition, individuals whose earnings (together with their spouse's
earnings) do not exceed a certain level may establish an "education IRA" and/or
a "Roth IRA"; although contributions to these new types of IRAs (established by
the Taxpayer Relief Act of 1997) ("Tax Act") are nondeductible, withdrawals from
them will not be taxable under certain circumstances. A Heritage IRA also may be
used for certain "rollovers" from qualified benefit plans and from Section
403(b) annuity plans.
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Fund shares also may be used as the investment medium for qualified plans
(defined benefit or defined contribution plans established by corporations,
partnerships or sole proprietorships). Contributions to qualified plans may be
made (within certain limits) on behalf of the employees, including
owner-employees, of the sponsoring entity.
REDEMPTIONS BY TELEPHONE
Shareholders may redeem shares of the Funds by telephone. When acting on verbal
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. In acting upon telephone instructions, these parties use
procedures that are reasonably designed to ensure that such instructions are
genuine, such as (1) obtaining some or all of the following information: account
number, name(s) and social security number(s) registered to the account, and
personal identification; (2) recording all telephone transactions; and (3)
sending written confirmation of each transaction to the registered owner. 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.
REDEMPTION IN KIND
A Fund is obligated to redeem shares for any shareholder for cash during any
90-day period up to $250,000 or 1% of that Fund's net asset value, whichever is
less. Any redemption beyond this amount also will be in cash unless the Trustees
determine that further cash payments will have a material adverse effect on
remaining shareholders. In such a case, a Fund will pay all or a portion of the
remainder of the redemption in portfolio instruments, valued in the same way as
each fund determines net asset value. The portfolio instruments will be selected
in a manner that the Trustees deem fair and equitable. A redemption in kind is
not as liquid as a cash redemption. If a redemption is made in kind, a
shareholder receiving portfolio instruments could receive less than the
redemption value thereof and could incur certain transaction costs.
RECEIVING PAYMENT
Payment of redemption proceeds will be made within seven days following a Fund's
receipt of your request (if received in good order as described below) 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.
A redemption request will be considered to be received in "good order" if:
o the number or amount of shares and the class of shares to be redeemed and
shareholder account number have been indicated;
o any written request is signed by a shareholder and by all co-owners of the
account with exactly the same name or names used in establishing the account;
o any written request is accompanied by certificates representing the shares
that have been issued, if any, and the certificates have been endorsed for
transfer exactly as the name or names appear on the certificates or an
accompanying stock power has been attached; and
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o the signatures on any written redemption request of $100,000 or more and on
any certificates for shares (or an accompanying stock power) have been
guaranteed by a national bank, a state bank that is insured by the Federal
Deposit Insurance Corporation, a trust company or by any member firm of the
New York, American, Boston, Chicago, Pacific or Philadelphia Stock Exchanges.
Signature guarantees also will be accepted from savings banks and certain
other financial institutions that are deemed acceptable by Firstar Mutual
Funds Services, LLC, as transfer agent, under its current signature guarantee
program.
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, 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
investments or the determination of its net asset value is not reasonably
practicable or for such periods as the SEC, by order, may permit for protection
of a Fund's investors.
EXCHANGE PRIVILEGE
An exchange is effected through the redemption of the shares tendered for
exchange and the purchase of shares being acquired at their respective net asset
values as next determined following receipt by the Fund whose shares are being
exchanged of (1) proper instructions and all necessary supporting documents or
(2) a telephone request for such exchange in accordance with the procedures set
forth in the Prospectus and below. Telephone requests for an exchange received
by a Fund before the close of regular trading on the Exchange will be effected
at the close of regular trading on that day. Requests for an exchange received
after the close of regular trading will be effected on the Exchange's next
trading day. Due to the volume of calls or other unusual circumstances,
telephone exchanges may be difficult to implement during certain time periods.
The Trust reserves the right to reject any order to acquire its shares through
exchange or otherwise to restrict or terminate the exchange privilege at any
time. In addition, the Trust may terminate this exchange privilege upon 60 days'
notice.
CONVERSION OF BROKER CLASS SHARES
Broker Class shares of the Funds automatically will convert to Investor Class
shares, based on the relative net asset values per share of the two classes,
eight years after the end of the calendar month in which the shareholder's order
to purchase was accepted. For the purpose of calculating the holding period
required for conversion of Broker Class shares, the date of initial issuance
shall mean (i) the date on which the Broker Class shares were issued or (ii) for
Broker Class shares obtained through an exchange, or a series of exchanges, the
date on which the original Broker Class shares were issued. For purposes of
conversion to Investor Class shares, Broker Class shares purchased through the
reinvestment of dividends and other distributions paid in respect of Broker
Class shares will be held in a separate sub-account. Each time any Broker Class
shares in the shareholder's regular account (other than those in the
sub-account) convert to Investor Class shares, a pro rata portion of the Broker
Class shares in the sub-account will also convert to Investor Class shares. The
portion will be determined by the ratio that the shareholder's Broker Class
shares converting to Investor Class shares bears to the shareholder's total
Broker Class shares not acquired through dividends and other distributions.
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The availability of the conversion feature is subject to the continuing
availability of an opinion of counsel to the effect that the dividends and other
distributions paid on Investor Class shares and Broker Class shares will not
result in "preferential dividends" under the Code and the conversion of shares
does not constitute a taxable event. If the conversion feature ceased to be
available, the Broker Class shares would not be converted and would continue to
be subject to the higher ongoing expenses of the Broker Class shares beyond
eight years from the date of purchase. The Adviser has no reason to believe that
this condition for the availability of the conversion feature will not be met.
PERFORMANCE INFORMATION
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 classes 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. 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 Index(TRADEMARK) ("Nasdaq Index"), the Nasdaq Composite IndexTM ("Nasdaq
Composite"), the Nikkei 225 Stock Average ("Nikkei Index"), the Russell 2000
Index ("Russell 2000"), Inter@ctive Week Internet Index ("Internet Index") and
various other domestic, international or global indices. The S&P 500 Index is a
broad index of common stock prices, while the DJIA represents a narrower segment
of industrial companies. Each assumes reinvestment of distributions and is
calculated without regard to tax consequences or operating expenses. The Nasdaq
Composite comparison may be provided to show how the OTC/Plus 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/Plus 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/Plus 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.
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
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applicable, for the ranking in question. Performance figures are based on
historical results and are not intended to indicate future performance.
TOTAL RETURN COMPUTATIONS
For purposes of quoting and comparing the performance of a Fund to that of other
mutual funds and to other relevant market indices in advertisements or in
reports to shareholders, performance for the Fund may be stated in terms of
total return. Such average annual total return quotes for the Funds are
calculated according to the following formula:
P(1+T)n=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. Additionally, in calculating the
ending redeemable value for the Broker Class shares, the applicable CDSC will be
deducted. 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 market indices, each 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 performance provided represents historical performance for the Funds listed
in the table below. The remaining Funds did not commence operations on before
the date of this SAI.
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FUND (INVESTOR CLASS) PERIOD TOTAL
RETURN
U.S. Plus Fund o October 20, 1997 (commencement
of operations) to August 31,
1999 _____%
o One Year ended August 31, 1999 _____%
U.S./Short Fund o November 7, 1997 (commencement
of operations) to August 31,
1999 _____%
o One Year ended August 31, 1999 _____%
OTC Plus Fund o October 20, 1997 (commencement
of operations) to August 31,
1999 _____%
o One Year ended August 31, 1999 _____%
OTC/Short Fund o October 16, 1997 (commencement
of operations) to August 31,
1999 _____%
o One Year ended August 31, 1999 _____%
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
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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 represents past
performance and 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.
The 7-day current yield for the Money Market Fund's Investor Class as of August
31, 1999 is ____%.
SHAREHOLDER INFORMATION
Each share of a Fund gives the shareholder one vote in matters submitted to
shareholders for a vote. Each class of each Fund have equal voting rights,
except that, in matters affecting only a particular class or series, only shares
of that class or series are entitled to vote. Share voting rights are not
cumulative, and shares have no preemptive or conversion rights. Share are not
transferable. As a Massachusetts business trust, the Trust is not required to
hold annual shareholder meetings. Shareholder approval will be sought only for
certain changes in a Trust's or a Fund's operation and for the election of
Trustees under certain circumstances. Trustees may be removed by the Trustees or
by shareholders at a special meeting. A special meeting of shareholders shall be
called by the Trustees upon the written request of shareholders owning at least
10% of a Trust's outstanding shares.
DIVIDENDS, OTHER DISTRIBUTIONS AND TAXES
DIVIDENDS AND OTHER DISTRIBUTIONS
Dividends from net investment income and any distributions of realized net
capital gains are as described in the Prospectus under "Distributions and
Taxes." All distributions from a Fund normally are automatically reinvested
without charge in additional shares of that Fund.
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
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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. Each Fund is treated as a separate
corporation for Federal income tax purposes and will seek to or continue 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.
To qualify for treatment as a RIC under the 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 satisfy or 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.
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
36
<PAGE>
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.
Dividends distributed by the Fund (including distributions of net short-term
capital gain), if any, are taxable to its shareholders as ordinary income (at
rates up to 39.6% for individuals), regardless of whether the dividends are
reinvested in Fund shares or received in cash. Distributions of a Fund's net
capital gain (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.
INCOME FROM FOREIGN SECURITIES. Dividends and interest received by a Fund and
gains realized by such Fund, may be subject to income, withholding, or other
taxes imposed by foreign countries and U.S. possessions that would reduce the
yield and/or total return on their securities. Tax conventions between certain
countries and the United States may reduce or eliminate these foreign taxes,
however, and many foreign countries do not impose taxes on capital gains in
respect of investments by foreign investors.
A Fund may invest in the stock of "passive foreign investment companies"
("PFICs"). A PFIC is any foreign corporation (with certain exceptions) that, in
general, meets either of the following tests: (1) at least 75% of its gross
income is passive or (2) an average of at least 50% of its assets produce, or
are held for the production of, passive income. Under certain circumstances, a
Fund will be subject to Federal income tax on a portion of any "excess
distribution" received on the stock of a PFIC or of any gain on disposition of
the stock (collectively, "PFIC income"), plus interest thereon, even if the Fund
distributes the PFIC income as a taxable dividend to its shareholders. The
balance of the PFIC income will be included in the Fund's investment company
taxable income and, accordingly, will not be taxable to it to the extent that
income is distributed to its shareholders. If the Fund invests in a PFIC and
elects to treat the PFIC as a "qualified electing fund" ("QEF"), then, in lieu
of the foregoing tax and interest obligation, the Fund would be required to
include in income each year its PRO RATA share of the QEF's annual ordinary
earnings and net capital gain -- which probably would have to be distributed by
the Fund to satisfy the Distribution Requirement and avoid imposition of the
Excise Tax -- even if those earnings and gain were not received by the Fund from
37
<PAGE>
the QEF. In most instances it will be very difficult, if not impossible, to make
this election because of certain requirements thereof.
A may elect to "mark to market" its stock in any PFIC. "Marking-to-market," in
this context, means including in ordinary income each taxable year the excess,
if any, of the fair market value of the PFIC's stock over the Fund's adjusted
basis therein as of the end of that year. Pursuant to the election, the Fund
also would be allowed to deduct (as an ordinary, not capital, loss) the excess,
if any, of its adjusted basis in PFIC stock over the fair market value thereof
as of the taxable year-end, but only to the extent of any net mark-to-market
gains with respect to that stock included by the Fund for prior taxable years
under the election (and under regulations proposed in 1992 that provided a
similar election with respect to the stock of certain PFICs). The Fund's
adjusted basis in each PFIC's stock with respect to which it makes this election
would be adjusted to reflect the amounts of income included and deductions taken
under the election.
Gains or losses (1) from the disposition of foreign currencies, (2) from the
disposition of debt securities denominated in foreign currency that, in each
instance, are attributable to fluctuations in the value of the foreign currency
between the date of acquisition of the security and the date of disposition
thereof, and (3) that are attributable to fluctuations in exchange rates that
occur between the time a Fund accrues dividends, interest, or other receivables
or expenses or other liabilities denominated in a foreign currency and the time
the Fund actually collects the receivables or pays the liabilities, generally
will be treated as ordinary income or loss. These gains or losses, referred to
under the Code as "section 988" gains or losses, may increase or decrease the
amount of a Fund's investment company taxable income to be distributed to its
shareholders.
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
38
<PAGE>
from any actual sales of section 1256 contracts, will be treated as long-term
capital gain or loss, and the balance will be treated as short-term capital gain
or loss. Section 1256 contracts also may be marked-to-market for purposes of the
Excise Tax.
Code section 1092 (dealing with straddles) 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.
If a Fund has an "appreciated financial position" -- generally, an interest
(including an interest through an option, futures contract, or short sale) with
respect to any stock, debt instrument (other than "straight debt"), or
partnership interest the fair market value of which exceeds its adjusted basis
- -- and enters into a "constructive sale" of the position, the Fund will be
treated as having made an actual sale thereof, with the result that it will
recognize gain at that time. A constructive sale generally consists of a short
sale, an offsetting notional principal contract, or a futures contract entered
into by a Fund or a related person with respect to the same or substantially
identical property. In addition, if the appreciated financial position is itself
a short sale or such a contract, acquisition of the underlying property or
substantially identical property will be deemed a constructive sale. The
foregoing will not apply, however, to any transaction during any taxable year
that otherwise would be treated as a constructive sale if the transaction is
closed within 30 days after the end of that year and the Fund holds the
appreciated financial position unhedged for 60 days after that closing (I.E., at
no time during that 60-day period is the Fund's risk of loss regarding that
position reduced by reason of certain specified transactions with respect to
substantially identical or related property, such as having an option to sell,
being contractually obligated to sell, making a short sale, or granting an
option to buy substantially identical stock or securities).
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.
39
<PAGE>
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 ____________, which have
been derived from the Funds' financial records, are incorporated by reference
herein this Statement of Additional Information. The financial statements and
financial highlights of the Funds that are supplied with this SAI have been
audited by PricewaterhouseCoopers LLP and are included herein in reliance upon
their authority as experts in accounting and auditing.
40
<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)(A) Form of Investment Advisory Agreement**
(i)(B) Amendment to Schedule A to Investment Advisory
Agreement+
(ii)(A) Form of Fund Administration Servicing Agreement**
(ii)(B) Form of Addendum to Fund Administration Servicing
Agreement++
(e)(i) Form of Distribution Agreement between the Potomac Funds
and Rafferty Capital Markets, Inc.***
(ii) Form of Dealer Agreement+
(f) Bonus, profit sharing contracts - None
(g)(i) Form of Custodian Agreement**
(ii) Form of Addendum to Custodian Agreement++
(h)(i)(A) Form of Transfer Agent Agreement**
(i)(B) Form of Addendum to Transfer Agent Agreement++
(ii)(A) Form of Fund Accounting Servicing Agreement**
(ii)(B) Form of Addendum to Fund Accounting Servicing
Agreement++
(iii) Form of Fulfillment Servicing Agreement**
(i) Opinion and consent of counsel+
(j) Consent of Independent Auditors+
(k) Financial statements omitted from prospectus - None
<PAGE>
(l) Letter of investment intent**
(m)(i) Investor Class Plan pursuant to Rule 12b-1+
(ii) Advisor Class Plan pursuant to Rule 12b-1+
(ii) Broker Class Plan pursuant to Rule 12b-1+
(n) Plan pursuant to Rule 18f-3+
- -------
* 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.
+ To be filed by subsequent amendment.
++ Incorporated herein by reference from the Post-effective Amendment No. 2 to
the Trust's Registration Statement on Form N-1A, filed with the Securities and
Exchange Commission on November 30, 1998 via EDGAR, Accession No.
0000898432-98-000804.
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
C-2
<PAGE>
having been a Covered Person and against amounts paid or incurred by him or her
in the settlement thereof;
(ii) the words "claim," "action," "suit," or "proceeding" shall
apply to all claims, actions, suits or proceedings (civil, criminal or other,
including appeals), actual or threatened while a Covered Person is in office or
thereafter, and the words "liability" and "expenses" shall include, without
limitation, attorneys' fees, costs, judgments, amounts paid in settlement,
fines, penalties and other liabilities.
(b) No indemnification shall be provided hereunder to a Covered Person:
(i) who shall have been adjudicated by a court or body before which
the proceeding was brought (A) to be liable to the Trust or its Shareholders by
reason of willful misfeasance, bad faith, gross negligence or reckless disregard
of the duties involved in the conduct of his or her office or (B) not to have
acted in good faith in the reasonable belief that his or her action was in the
best interest of the Trust; or
(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
C-3
<PAGE>
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.
Item 26. Business and Other Connections of Investment Adviser
----------------------------------------------------
Rafferty Asset Management, LLC (the "Adviser"), 1311 Mamaroneck Avenue,
White Plains, New York 10605, 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., 1311 Mamaroneck Avenue, White Plains,
New York 10605, 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:
Positions and Offices with Position and Offices
Name Underwriter With Registrant
---- ----------- ---------------
Thomas A. Mulrooney President Chief Operating Officer
Derek B. Park Senior Vice President, None
Equity
Lawrence C. Rafferty Director Chief Executive Officer,
Chairman of the Board
of Trustees
Stephen P. Sprague CFO/FINOP Treasurer, Controller,
and Assistant Secretary
The principal business address of each of the persons listed above is 1311
Mamaroneck Avenue, White Plains, New York 10605.
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
-------------------
C-4
<PAGE>
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-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended,
and the Investment Company Act of 1940, as amended, the Registrant has duly
caused this Post-Effective Amendment No. 4 to its Registration Statement on Form
N-1A to be signed on its behalf by the undersigned, thereunto duly authorized,
in the City of White Plains and the State of New York on September 3, 1999.
POTOMAC FUNDS
By: Lawrence C. Rafferty*
------------------------
Lawrence C. Rafferty
Chief Executive Officer
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. 4 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 September 3, 1999
- ------------------------ of Trustees and Chief
Lawrence C. Rafferty Executive Officer
Jay F. Higgins* Trustee September 3, 1999
- ------------------
Jay F. Higgins
Daniel J. Byrne* Trustee September 3, 1999
- -------------------
Daniel J. Byrne
Gerald E. Shanley III* Trustee September 3, 1999
- -------------------------
Gerald E. Shanley III
Robert J. Zutz
- ---------------------------------
*Robert J. Zutz, Attorney-in-Fact
<PAGE>
INDEX TO EXHIBITS
Exhibit
Number Description Page
- ------- ----------- ----
(a) Declaration of Trust*
(b) By-Laws*
(c) Voting trust agreement - None
(d)(i)(A) Form of Investment Advisory Agreement**
(i)(B) Amendment to Schedule A to Investment Advisory Agreement+
(ii)(A) Form of Fund Administration Servicing Agreement**
(ii)(B) Form of Addendum to Fund Administration Servicing Agreement++
(e)(i) Form of Distribution Agreement between the Potomac Funds and
Rafferty Capital Markets, Inc.***
(ii) Form of Dealer Agreement+
(f) Bonus, profit sharing contracts - None
(g)(i) Form of Custodian Agreement**
(ii) Form of Addendum to Custodian Agreement++
(h)(i)(A) Form of Transfer Agent Agreement**
(i)(B) Form of Addendum to Transfer Agent Agreement++
(ii)(A) Form of Fund Accounting Servicing Agreement**
(ii)(B) Form of Addendum to Fund Accounting Servicing Agreement++
(iii) Form of Fulfillment Servicing Agreement**
(i) Opinion and consent of counsel+
(j) Consent of Independent Auditors+
(k) Financial statements omitted from prospectus - None
(l) Letter of investment intent**
<PAGE>
(m)(i) Investor Class Plan pursuant to Rule 12b-1+
(ii) Advisor Class Plan pursuant to Rule 12b-1+
(ii) Broker Class Plan pursuant to Rule 12b-1+
(n) Financial Data Schedules (not applicable)
(o) Plan pursuant to Rule 18f-3+
- -------
* 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.
+ To be filed by subsequent amendment.
++ Incorporated herein by reference from the Post-effective Amendment No. 2 to
the Trust's Registration Statement on Form N-1A, filed with the Securities and
Exchange Commission on November 30, 1998 via EDGAR, Accession No.
0000898432-98-000804.
