"SUBJECT TO COMPLETION"
December 8, 1999
STATEMENT OF ADDITIONAL INFORMATION
__________________, 2000
NATIONWIDE MUTUAL FUNDS
Nationwide Small Cap Value Fund II
Nationwide High Yield Bond Fund
Nationwide Focus Fund
Morley Enhanced Income Fund
Nationwide Mutual Funds (the "Trust") is a registered open-end
investment company consisting of ____ series as of the date hereof. This
Statement of Additional Information relates to four series of the Trust listed
above (each, a "Fund" and collectively, the "Funds").
This Statement of Additional Information is not a prospectus but the
Statement of Additional Information is incorporated by reference into the
Prospectuses for the Funds. It contains information in addition to and more
detailed than that set forth in the Prospectuses dated _______________, 2000 and
should be read in conjunction with the Prospectuses. Terms not defined in this
Statement of Additional Information have the meanings assigned to them in the
Prospectuses. The Prospectuses may be obtained from Nationwide Advisory
Services, Inc., P.O. Box 1492, Three Nationwide Plaza, Columbus, Ohio 43215, or
by calling toll free 1-800-848-0920.
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Information contained herein is subject to
completion or amendment. A registration statement
relating to these securities has been filed with
the Securities and Exchange Commission. These
securities may not be sold nor may offers to buy
be accepted prior to the time the registration
statement becomes effective. This prospectus shall
not constitute an offer to sell or the
solicitation of an offer to buy nor shall there be
any sale of these securities in any State in which
such offer, solicitation or sale would be unlawful
prior to registration or qualification under the
securities laws of any such State.
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Table Of Contents Page
General Information and History..............................................3
Additional Information on Portfolio Instruments
and Investment Policies....................................................4
Investment Restrictions.....................................................35
Major Shareholders..........................................................40
Trustees and Officers of the Trust..........................................40
Calculating Yield and Total Return..........................................43
Investment Advisory and Other Services......................................45
Brokerage Allocations.......................................................56
Purchases, Redemptions and Pricing of Shares................................61
Additional Information......................................................62
Tax Status..................................................................63
Other Tax Consequences......................................................64
Tax Consequences to Shareholders............................................65
Financial Statements........................................................65
Appendix A - Bond Ratings...................................................66
<PAGE>
General Information And History
Nationwide Mutual Funds (the "Trust"), formerly Nationwide Investing
Foundation III ("NIF III"), is an open-end management investment company
organized under the laws of Ohio by a Declaration of Trust, dated as of October
30, 1997, as subsequently amended. The Trust currently offers shares in
____________(____) separate series, each with its own investment objective. Each
of the Funds, except the Nationwide Focus Fund, is a diversified fund as defined
in the Investment Company Act of 1940.
Additional Information on Portfolio Instruments and Investment Policies
The Funds invest in a variety of securities and employ a number of
investment techniques that involve certain risks. The Prospectuses for the Funds
highlight the principal investment strategies, investment techniques and risks.
The following table sets forth additional information concerning permissible
investments and techniques for each of the Funds. A "Y" in the table indicates
that the Fund may invest in or follow the corresponding instrument or technique.
An empty box indicates that the Fund does not intend to invest in or follow the
corresponding instrument or technique.
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Small High
Cap Yield Enhanced
Value Bond Focus Income
Type of Investment or Technique Fund Fund Fund Fund
- --------------------------------------------------------------------------------
U.S. common stocks Y Y Y
Preferred stocks Y Y Y
Small company stocks Y Y
Special situation companies Y Y Y
Illiquid securities Y Y Y Y
Restricted securities Y Y Y Y
When-issued / delayed-delivery securities Y Y Y Y
Investment companies Y Y Y Y
Real estate investment trusts (REITS) Y Y
Securities of foreign issuers Y Y Y Y
Depository receipts Y Y Y
Wrap Contracts Y
Convertible securities Y Y Y
Long-term debt Y Y
Short-term debt Y Y Y Y
Floating and variable rate securities Y Y Y Y
Zero coupon securities Y Y
Pay-in-kind bonds Y
Deferred payment securities Y
Non-investment grade debt Y
Loan participations and assignments Y
Sovereign debt (foreign) Y Y
Foreign commercial paper Y
Duration Y
U.S. Government securities Y Y Y Y
Money market instruments Y Y Y Y
Mortgage-backed securities Y Y
Stripped mortgage-backed securities Y Y
Collateralized mortgage obligations Y Y
Mortgage dollar rolls Y
Asset-backed securities Y Y
Bank obligations Y Y Y Y
Repurchase agreements Y Y Y Y
Reverse repurchase agreements Y
Warrants Y Y Y
Futures Y Y Y Y
Options Y Y Y Y
Foreign currencies Y
Forward currency contracts Y Y Y
Borrowing money Y Y Y Y
Lending of portfolio securities Y Y Y Y
Strip Bonds Y
Participation Interests Y
Swap Agreements Y
Put Bonds Y
Private Activity and Industrial Development Bonds Y
Custodial Receipts Y
Short Selling of Securities
<PAGE>
DESCRIPTION OF PORTFOLIO INSTRUMENTS AND INVESTMENT POLICIES
Information Concerning Duration
Duration is a measure of the average life of a fixed-income security
that was developed as a more precise alternative to the concepts of "term to
maturity" or "average dollar weighted maturity" as measures of "volatility" or
"risk" associated with changes in interest rates. Duration incorporates a
security's yield, coupon interest payments, final maturity and call features
into one measure.
Most debt obligations provide interest ("coupon") payments in addition
to final ("par") payment at maturity. Some obligations also have call
provisions. Depending on the relative magnitude of these payments and the nature
of the call provisions, the market values of debt obligations may respond
differently to changes in interest rates.
Traditionally, a debt security's "term-to-maturity" has been used as a
measure of the sensitivity of the security's price to changes in interest rates
(which is the "interest rate risk" or "volatility" of the security). However,
"term-to-maturity" measures only the time until a debt security provides its
final payment, taking no account of the pattern of the security's payments prior
to maturity. Average dollar weighted maturity is calculated by averaging the
terms of maturity of each debt security held with each maturity "weighted"
according to the percentage of assets that it represents. Duration is a measure
of the expected life of a debt security on a present value basis and reflects
both principal and interest payments. Duration takes the length of the time
intervals between the present time and the time that the interest and principal
payments are scheduled or, in the case of a callable security, expected to be
received, and weights them by the present values of the cash to be received at
each future point in time. For any debt security with interest payments
occurring prior to the payment of principal, duration is ordinarily less than
maturity. In general, all other factors being the same, the lower the stated or
coupon rate of interest of a debt security, the longer the duration of the
security; conversely, the higher the stated or coupon rate of interest of a debt
security, the shorter the duration of the security.
There are some situations where the standard duration calculation does
not properly reflect the interest rate exposure of a security. For example,
floating and variable rate securities often have final maturities of ten or more
years; however, their interest rate exposure corresponds the frequency of the
coupon reset. Another example where the interest rate exposure is not properly
captured by duration is the case of mortgage pass-through securities. The stated
final maturity of such securities is generally 30 years, but current prepayment
rates are more critical in determining the securities' interest rate exposure.
In these and other similar situations, a Fund's investment adviser or subadviser
will use more sophisticated analytical techniques to project the economic life
of a security and estimate its interest rate exposure. Since the computation of
duration is based on predictions of future events rather than known factors,
there can be no assurance that a Fund will at all times achieve its targeted
portfolio duration.
The change in market value of U.S. Government fixed-income securities
is largely a function of changes in the prevailing level of interest rates. When
interest rates are falling, a portfolio with a shorter duration generally will
not generate as high a level of total return as a portfolio with a longer
duration. When interest rates are stable, shorter duration portfolios generally
will not generate as high a level of total return as longer duration portfolios
(assuming that long-term interest rates are higher than short-term rates, which
is commonly the case.) When interest rates are rising, a portfolio with a
shorter duration will generally outperform longer duration portfolios. With
respect to the composition of a fixed-income portfolio, the longer the duration
of the portfolio, generally, the greater the anticipated potential for total
return, with, however, greater attendant interest rate risk and price volatility
than for a portfolio with a shorter duration.
Debt Obligations
Debt obligations are subject to the risk of an issuer's inability to
meet principal and interest payments on its obligations ("credit risk") and are
subject to price volatility due to such factors as interest rate sensitivity,
market perception of the creditworthiness of the issuer, and general market
liquidity. Lower-rated securities are more likely to react to developments
affecting these risks than are more highly rated securities, which react
primarily to movements in the general level of interest rates. Although the
fluctuation in the price of debt securities is normally less than that of common
stocks, in the past there have been extended periods of cyclical increases in
interest rates that have caused significant declines in the price of debt
securities in general and have caused the effective maturity of securities with
prepayment features to be extended, thus effectively converting short or
intermediate securities (which tend to be less volatile in price) into long term
securities (which tend to be more volatile in price).
Ratings as Investment Criteria. High-quality, medium-quality and
non-investment grade debt obligations are characterized as such based on their
ratings by nationally recognized statistical rating organizations ("NRSROs"),
such as Standard & Poor's Rating Group ("Standard & Poor's") or Moody's Investor
Services ("Moody's"). In general, the ratings of NRSROs represent the opinions
of these agencies as to the quality of securities that they rate. Such ratings,
however, are relative and subjective, and are not absolute standards of quality
and do not evaluate the market value risk of the securities. These ratings are
used by a Fund as initial criteria for the selection of portfolio securities,
but the Fund also relies upon the independent advice of a Fund's adviser or
subadviser(s) to evaluate potential investments. This is particularly important
for lower-quality securities. Among the factors that will be considered are the
long-term ability of the issuer to pay principal and interest and general
economic trends, as well as an issuer's capital structure, existing debt and
earnings history. The Appendix to this Statement of Additional Information
contains further information about the rating categories of NRSROs and their
significance.
Subsequent to its purchase by a Fund, an issue of securities may cease
to be rated or its rating may be reduced below the minimum required for purchase
by such Fund. In addition, it is possible that an NRSRO might not change its
rating of a particular issue to reflect subsequent events. None of these events
generally will require sale of such securities, but a Fund's adviser or
subadviser will consider such events in its determination of whether the Fund
should continue to hold the securities. In addition, to the extent that the
ratings change as a result of changes in such organizations or their rating
systems, or due to a corporate reorganization, the Fund will attempt to use
comparable ratings as standards for its investments in accordance with its
investment objective and policies.
Medium-Quality Securities. Certain Funds anticipate investing in
medium-quality obligations, which are obligations rated in the fourth highest
rating category by any NRSRO. Medium-quality securities, although considered
investment-grade, may have some speculative characteristics and may be subject
to greater fluctuations in value than higher-rated securities. In addition, the
issuers of medium-quality securities may be more vulnerable to adverse economic
conditions or changing circumstances than issues of higher-rated securities.
Lower Quality (High-Risk) Securities. Non-investment grade debt or
lower quality/rated securities (hereinafter referred to as "lower-quality
securities") include (i) bonds rated as low as C by Moody's, Standard & Poor's,
or Fitch/IBCA Investors Service, Inc. ("Fitch"), or CCC by D&P; (ii) commercial
paper rated as low as C by Standard & Poor's, Not Prime by Moody's or Fitch 4 by
Fitch; and (iii) unrated debt securities of comparable quality. Lower-quality
securities, while generally offering higher yields than investment grade
securities with similar maturities, involve greater risks, including the
possibility of default or bankruptcy. There is more risk associated with these
investments because of reduced creditworthiness and increased risk of default.
Under NRSRO guidelines, lower quality securities and comparable unrated
securities will likely have some quality and protective characteristics that are
outweighted by large uncertainties or major risk exposures to adverse
conditions. Lower quality securities are considered to have extremely poor
prospects of ever attaining any real investment standing, to have a current
identifiable vulnerability to default or to be in default, to be unlikely to
have the capacity to make required interest payments and repay principal when
due in the event of adverse business, financial or economic conditions, or to be
in default or not current in the payment of interest or principal. They are
regarded as predominantly speculative with respect to the issuer's capacity to
pay interest and repay principal. The special risk considerations in connection
with investments in these securities are discussed below.
Effect of Interest Rates And Economic Changes. All interest-bearing
securities typically experience appreciation when interest rates decline and
depreciation when interest rates rise. The market values of lower-quality and
comparable unrated securities tend to reflect individual corporate developments
to a greater extent than do higher rated securities, which react primarily to
fluctuations in the general level of interest rates. Lower-quality and
comparable unrated securities also tend to be more sensitive to economic
conditions than are higher-rated securities. As a result, they generally involve
more credit risks than securities in the higher-rated categories. During an
economic downturn or a sustained period of rising interest rates, highly
leveraged issuers of lower-quality and comparable unrated securities may
experience financial stress and may not have sufficient revenues to meet their
payment obligations. The issuer's ability to service its debt obligations may
also be adversely affected by specific corporate developments, the issuer's
inability to meet specific projected business forecasts or the unavailability of
additional financing. The risk of loss due to default by an issuer of these
securities is significantly greater than issuers of higher-rated securities
because such securities are generally unsecured and are often subordinated to
other creditors. Further, if the issuer of a lower-quality or comparable unrated
security defaulted, the Fund might incur additional expenses to seek recovery.
Periods of economic uncertainty and changes would also generally result in
increased volatility in the market prices of these securities and thus in the
Fund's net asset value.
As previously stated, the value of a lower-quality or comparable
unrated security will generally decrease in a rising interest rate market, and
accordingly so will a Fund's net asset value. If a Fund experiences unexpected
net redemptions in such a market, it may be forced to liquidate a portion of its
portfolio securities without regard to their investment merits. Due to the
limited liquidity of lower-quality and comparable unrated securities (discussed
below), a Fund may be forced to liquidate these securities at a substantial
discount which would result in a lower rate of return to the Fund.
Payment Expectations. Lower-quality and comparable unrated securities
typically contain redemption, call or prepayment provisions which permit the
issuer of such securities containing such provisions to, at its discretion,
redeem the securities. During periods of falling interest rates, issuers of
these securities are likely to redeem or prepay the securities and refinance
them with debt securities at a lower interest rate. To the extent an issuer is
able to refinance the securities, or otherwise redeem them, a Fund may have to
replace the securities with a lower yielding security, which would result in a
lower return for that Fund.
Liquidity And Valuation. A Fund may have difficulty disposing of
certain lower-quality and comparable unrated securities because there may be a
thin trading market for such securities. Because not all dealers maintain
markets in all lower-quality and comparable unrated securities, there may be no
established retail secondary market for many of these securities. The Funds
anticipate that such securities could be sold only to a limited number of
dealers or institutional investors. To the extent a secondary trading market
does exist, it is generally not as liquid as the secondary market for
higher-rated securities. The lack of a liquid secondary market may have an
adverse impact on the market price of the security. As a result, a Fund's asset
value and ability to dispose of particular securities, when necessary to meet
such Fund's liquidity needs or in response to a specific economic event, may be
impacted. The lack of a liquid secondary market for certain securities may also
make it more difficult for a Fund to obtain accurate market quotations for
purposes of valuing that Fund's portfolio. Market quotations are generally
available on many lower-quality and comparable unrated issues only from a
limited number of dealers and may not necessarily represent firm bids of such
dealers or prices for actual sales. During periods of thin trading, the spread
between bid and asked prices is likely to increase significantly. In addition,
adverse publicity and investor perceptions, whether or not based on fundamental
analysis, may decrease the values and liquidity of lower-quality and comparable
unrated securities, especially in a thinly traded market.
U.S. Government Securities. U.S. government securities are issued or
guaranteed by the U.S. government or its agencies or instrumentalities.
Securities issued by the U.S. government include U.S. Treasury obligations, such
as Treasury bills, notes, and bonds. Securities issued by government agencies or
instrumentalities include obligations of the following:
-- the Federal Housing Administration, Farmers Home Administration, and
-- the Government National Mortgage Association ("GNMA"), including GNMA
pass-through certificates, whose securities are supported by the full
faith and credit of the United States;
-- the Federal Home Loan Banks whose securities are supported by the right
of the agency to borrow from the U.S. Treasury;
-- the Federal National Mortgage Association, whose securities are
supported by the discretionary authority of the U.S. government to
purchase certain obligations of the agency or instrumentality; and
the Student Loan Marketing Association and the Federal Home Loan
-- Mortgage Corporation ("FHLMC"), whose securities are supported only by
the credit of such agencies.
Although the U.S. government provides financial support to such U.S.
government-sponsored agencies or instrumentalities, no assurance can be given
that it will always do so. The U.S. government and its agencies and
instrumentalities do not guarantee the market value of their securities;
consequently, the value of such securities will fluctuate.
Mortgage and Asset-Backed Securities. Mortgage-backed securities
represent direct or indirect participation in, or are secured by and payable
from, mortgage loans secured by real property, and include single- and
multi-class pass-through securities and collateralized mortgage obligations.
Such securities may be issued or guaranteed by U.S. Government agencies or
instrumentalities by private issuers, generally originators in mortgage loans,
including savings and loan associations, mortgage bankers, commercial banks,
investment bankers, and special purpose entities (collectively, "private
lenders"). The purchase of mortgage-backed securities from private lenders may
entail greater risk than mortgage-backed securities that are issued or
guaranteed by the U.S. government, its agencies or instrumentalities.
Mortgage-backed securities issued by private lenders maybe supported by pools of
mortgage loans or other mortgage-backed securities that are guaranteed, directly
or indirectly, by the U.S. Government or one of its agencies or
instrumentalities, or they may be issued without any governmental guarantee of
the underlying mortgage assets but with some form of non-governmental credit
enhancement. These credit enhancements may include letters of credit, reserve
funds, overcollateralization, or guarantees by third parties.
Since privately-issued mortgage certificates are not guaranteed by an
entity having the credit status of GNMA or FHLMC, such securities generally are
structured with one or more types of credit enhancement. Such credit enhancement
falls into two categories: (i) liquidity protection; and (ii) protection against
losses resulting from ultimate default by an obligor on the underlying assets.
Liquidity protection refers to the provisions of advances, generally by the
entity administering the pool of assets, to ensure that the pass-through of
payments due on the underlying pool occurs in a timely fashion. Protection
against losses resulting from ultimate default enhances the likelihood of
ultimate payment of the obligations on at least a portion of the assets in the
pool. Such protection may be provided through guarantees, insurance policies or
letters of credit obtained by the issuer or sponsor from third parties, through
various means of structuring the transaction or through a combination of such
approaches.
The ratings of mortgage-backed securities for which third-party credit
enhancement provides liquidity protection or protection against losses from
default are generally dependent upon the continued creditworthiness of the
provider of the credit enhancement. The ratings of such securities could be
subject to reduction in the event of deterioration in the creditworthiness of
the credit enhancement provider even in cases where the delinquency loss
experience on the underlying pool of assets is better than expected. There can
be no assurance that the private issuers or credit enhancers of mortgage-backed
securities can meet their obligations under the relevant policies or other forms
of credit enhancement.
Examples of credit support arising out of the structure of the
transaction include "senior-subordinated securities" (multiple class securities
with one or more classes subordinate to other classes as to the payment of
principal thereof and interest thereon, with the result that defaults on the
underlying assets are borne first by the holders of the subordinated class),
creation of "reserve funds" (where cash or investments sometimes funded from a
portion of the payments on the underlying assets are held in reserve against
future losses) and "over-collateralization" (where the scheduled payments on, or
the principal amount of, the underlying assets exceed those required to make
payment of the securities and pay any servicing or other fees). The degree of
credit support provided for each issue is generally based on historical
information with respect to the level of credit risk associated with the
underlying assets. Delinquency or loss in excess of that which is anticipated
could adversely affect the return on an investment in such security.
Private lenders or government-related entities may also create mortgage
loan pools offering pass-through investments where the mortgages underlying
these securities may be alternative mortgage instruments, that is, mortgage
instruments whose principal or interest payments may vary or whose terms to
maturity may be shorter than was previously customary. As new types of
mortgage-related securities are developed and offered to investors, a Fund,
consistent with its investment objective and policies, may consider making
investments in such new types of securities.
The yield characteristics of mortgage-backed securities differ from
those of traditional debt obligations. Among the principal differences are that
interest and principal payments are made more frequently on mortgage-backed
securities, usually monthly, and that principal may be prepaid at any time
because the underlying mortgage loans or other assets generally may be prepaid
at any time. As a result, if a Fund purchases these securities at a premium, a
prepayment rate that is faster than expected will reduce yield to maturity,
while a prepayment rate that is lower than expected will have the opposite
effect of increasing the yield to maturity. Conversely, if a Fund purchases
these securities at a discount, a prepayment rate that is faster than expected
will increase yield to maturity, while a prepayment rate that is slower than
expected will reduce yield to maturity. Accelerated prepayments on securities
purchased by the Fund at a premium also impose a risk of loss of principal
because the premium may not have been fully amortized at the time the principal
is prepaid in full.
Unlike fixed rate mortgage-backed securities, adjustable rate
mortgage-backed securities are collateralized by or represent interest in
mortgage loans with variable rates of interest. These variable rates of interest
reset periodically to align themselves with market rates. A Fund will not
benefit from increases in interest rates to the extent that interest rates rise
to the point where they cause the current coupon of the underlying adjustable
rate mortgages to exceed any maximum allowable annual or lifetime reset limits
(or "cap rates") for a particular mortgage. In this event, the value of the
adjustable rate mortgage-backed securities in a Fund would likely decrease.
Also, a Fund's net asset value could vary to the extent that current yields on
adjustable rate mortgage-backed securities are different than market yields
during interim periods between coupon reset dates or if the timing of changes to
the index upon which the rate for the underlying mortgage is based lags behind
changes in market rates. During periods of declining interest rates, income to a
Fund derived from adjustable rate mortgage securities which remain in a mortgage
pool will decrease in contrast to the income on fixed rate mortgage securities,
which will remain constant. Adjustable rate mortgages also have less potential
for appreciation in value as interest rates decline than do fixed rate
investments.
There are a number of important differences among the agencies and
instrumentalities of the U.S. Government that issue mortgage-backed securities
and among the securities that they issue. Mortgage-backed securities issued by
GNMA include GNMA Mortgage Pass-Through Certificates (also known as "Ginnie
Maes") which are guaranteed as to the timely payment of principal and interest
by GNMA and such guarantee is backed by the full faith and credit of the United
States. GNMA certificates also are supported by the authority of GNMA to borrow
funds from the U.S. Treasury to make payments under its guarantee.
Mortgage-backed securities issued by FNMA include FNMA Guaranteed Mortgage
Pass-Through Certificates (also known as "Fannie Maes") which are solely the
obligations of the FNMA and are not backed by or entitled to the full faith and
credit of the United States. Fannie Maes are guaranteed as to timely payment of
the principal and interest by FNMA. Mortgage-backed securities issued by the
Federal Home Loan Mortgage Corporation ("FHLMC") include FHLMC Mortgage
Participation Certificates (also known as "Freddie Macs" or "PCs"). The FHLMC is
a corporate instrumentality of the United States, created pursuant to an Act of
Congress, which is owned entirely by Federal Home Loan Banks and do not
constitute a debt or obligation of the United States or by any Federal Home Loan
Bank. Freddie Macs entitle the holder to timely payment of interest, which is
guaranteed by the FHLMC. The FHLMC guarantees either ultimate collection or
timely payment of all principal payments on the underlying mortgage loans. When
the FHLMC does not guarantee timely payment of principal, FHLMC may remit the
amount due on account of its guarantee of ultimate payment of principal at any
time after default on an underlying mortgage, but in no event later than one
year after it becomes payable.
Asset-backed securities have structural characteristics similar to
mortgage-backed securities. However, the underlying assets are not first-lien
mortgage loans or interests therein; rather they include assets such as motor
vehicle installment sales contracts, other installment loan contracts, home
equity loans, leases of various types of property and receivables from credit
card and other revolving credit arrangements. Payments or distributions of
principal and interest on asset-backed securities may be supported by
non-governmental credit enhancements similar to those utilized in connection
with mortgage-backed securities. The credit quality of most asset-backed
securities depends primarily on the credit quality of the assets underlying such
securities, how well the entity issuing the security is insulated from the
credit risk of the originator or any other affiliated entities, and the amount
and quality of any credit enhancement of the securities.
Collateralized Mortgage Obligations and Multiclass Pass-Through
Securities. CMOs are debt obligations collateralized by mortgage loans or
mortgage pass-through securities. Typically, CMOs are collateralized by GNMA,
Fannie Mae or Freddie Mae Certificates, but also may be collateralized by whole
loans or private pass-throughs (such collateral collectively hereinafter
referred to as "Mortgage Assets"). Multiclass pass-through securities are
interests in a trust composed of Mortgage Assets. Unless the context indicates
otherwise, all references herein to CMOs include multiclass pass-through
securities. Payments of principal and interest on the Mortgage Assets, and any
reinvestment income thereon, provide the funds to pay debt service on the CMOs
or make scheduled distributions on the multiclass pass-through securities. CMOs
may be issued by agencies or instrumentalities of the U.S. government, or by
private originators of, or investors in, mortgage loans, including savings and
loan associations, mortgage banks, commercial banks, investment banks and
special purpose subsidiaries of the foregoing.
In a CMO, a series of bonds or certificates is issued in multiple
classes. Each class of CMOs, often referred to as a "tranche," is issued at a
specified fixed or floating coupon rate and has a stated maturity or final
distribution date. Principal prepayments on the Mortgage Assets may cause the
CMOs to be retired substantially earlier than their stated maturities or final
distribution dates. Interest is paid or accrues on all classes of the CMOs on a
monthly, quarterly or semi-annual basis. The principal of and interest on the
Mortgage Assets may be allocated among the several classes of a series of a CMO
in innumerable ways. In one structure, payments of principal, including any
principal prepayments, on the Mortgage Assets are applied to the classes of a
CMO in the order of their respective stated maturities or final distribution
dates, so that no payment of principal will be made on any class of CMOs until
all other classes having an earlier stated maturity or final distribution date
have been paid in full. As market conditions change, and particularly during
periods of rapid or unanticipated changes in market interest rates, the
attractiveness of the CMO classes and the ability of the structure to provide
the anticipated investment characteristics may be significantly reduced. Such
changes can result in volatility in the market value, and in some instances
reduced liquidity, of the CMO class.
A Fund may also invest in, among others, parallel pay CMOs and Planned
Amortization Class CMOs ("PAC Bonds"). Parallel pay CMOs are structured to
provide payments of principal on each payment date to more than one class. These
simultaneous payments are taken into account in calculating the stated maturity
date or final distribution date of each class, which, as with other CMO
structures, must be retired by its stated maturity date or a final distribution
date but may be retired earlier. PAC Bonds are a type of CMO tranche or series
designed to provide relatively predictable payments of principal provided that,
among other things, the actual prepayment experience on the underlying mortgage
loans falls within a predefined range. If the actual prepayment experience on
the underlying mortgage loans is at a rate faster or slower than the predefined
range or if deviations from other assumptions occur, principal payments on the
PAC Bond may be earlier or later than predicted. The magnitude of the predefined
range varies from one PAC Bond to another; a narrower range increases the risk
that prepayments on the PAC Bond will be greater or smaller than predicted.
Because of these features, PAC Bonds generally are less subject to the risks of
prepayment than are other types of mortgage-backed securities.
Stripped Mortgage Securities. Stripped mortgage securities are
derivative multiclass mortgage securities. Stripped mortgage securities may be
issued by agencies or instrumentalities of the U.S. government, or by private
originators of, or investors in, mortgage loans, including savings and loan
associations, mortgage banks, commercial banks, investment banks and special
purpose subsidiaries of the foregoing. Stripped mortgage securities have greater
volatility than other types of mortgage securities. Although stripped mortgage
securities are purchased and sold by institutional investors through several
investment banking firms acting as brokers or dealers, the market for such
securities has not yet been fully developed. Accordingly, stripped mortgage
securities are generally illiquid.
Stripped mortgage securities are structured with two or more classes of
securities that receive different proportions of the interest and principal
distributions on a pool of mortgage assets. A common type of stripped mortgage
security will have at least one class receiving only a small portion of the
interest and a larger portion of the principal from the mortgage assets, while
the other class will receive primarily interest and only a small portion of the
principal. In the most extreme case, one class will receive all of the interest
("IO" or interest-only), while the other class will receive all of the principal
("PO" or principal-only class). The yield to maturity on IOs, POs and other
mortgage-backed securities that are purchased at a substantial premium or
discount generally are extremely sensitive not only to changes in prevailing
interest rates but also to the rate of principal payments (including
prepayments) on the related underlying mortgage assets, and a rapid rate of
principal payments may have a material adverse effect on such securities' yield
to maturity. If the underlying mortgage assets experience greater than
anticipated prepayments of principal, the Fund may fail to fully recoup its
initial investment in these securities even if the securities have received the
highest rating by a nationally recognized statistical rating organization.
In addition to the stripped mortgage securities described above, the
Fund may invest in similar securities such as Super POs and Levered IOs which
are more volatile than POs, IOs and IOettes. Risks associated with instruments
such as Super POs are similar in nature to those risks related to investments in
POs. IOettes represent the right to receive interest payments on an underlying
pool of mortgages with similar risks as those associated with IOs. Unlike IOs,
the owner also has the right to receive a very small portion of the principal.
Risks connected with Levered IOs and IOettes are similar in nature to those
associated with IOs. The Fund may also invest in other similar instruments
developed in the future that are deemed consistent with its investment
objective, policies and restrictions. POs may generate taxable income from the
current accrual of original issue discount, without a corresponding distribution
of cash to the Fund. See "Tax Status" in the Prospectus and "Additional
Information Concerning Taxes" in the Statement of Additional Information.
A Fund may also purchase stripped mortgage-backed securities for
hedging purposes to protect that Fund against interest rate fluctuations. For
example, since an IO will tend to increase in value as interest rates rise, it
may be utilized to hedge against a decrease in value of other fixed-income
securities in a rising interest rate environment. With respect to IOs, if the
underlying mortgage securities experience greater than anticipated prepayments
of principal, the Fund may fail to recoup fully its initial investment in these
securities even if the securities are rated in the highest rating category by an
NRSRO. Stripped mortgage-backed securities may exhibit greater price volatility
than ordinary debt securities because of the manner in which their principal and
interest are returned to investors. The market value of the class consisting
entirely of principal payments can be extremely volatile in response to changes
in interest rates. The yields on stripped mortgage-backed securities that
receive all or most of the interest are generally higher than prevailing market
yields on other mortgage-backed obligations because their cash flow patterns are
also volatile and there is a greater risk that the initial investment will not
be fully recouped. The market for CMOs and other stripped mortgage-backed
securities may be less liquid if these securities lose their value as a result
of changes in interest rates; in that case, a Fund may have difficulty in
selling such securities.
Private Activity and Industrial Development Bonds. Private activity and
industrial development bonds are obligations issued by or on behalf of public
authorities to raise money to finance various privately owned or operated
facilities for business and manufacturing, housing, sports, and pollution
control. These bonds are also used to finance public facilities such as
airports, mass transit systems, ports, parking, and sewage and solid waste
disposal facilities, as well as certain other facilities or projects. The
payment of the principal and interest on such bonds is generally dependent
solely on the ability of the facility's user to meet its financial obligations
and the pledge, if any, of real and personal property so financed as security
for such payment.
Put Bonds. "Put" bonds are tax exempt securities (including securities
with variable interest rates) that may be sold back to the issuer of the
security at face value at the option of the holder prior to their stated
maturity. The Adviser or (a subadviser) intends to purchase only those put bonds
for which the put option is an integral part of the security as originally
issued. The option to "put" the bond back to the issuer prior to the stated
final maturity can cushion the price decline of the bond in a rising interest
rate environment. However, the premium paid, if any, for an option to put will
have the effect of reducing the yield otherwise payable on the underlying
security. For the purpose of determining the "maturity" of securities purchased
subject to an option to put, and for the purpose of determining the dollar
weighted average maturity of a Fund holding such securities, the Fund will
consider "maturity" to be the first date on which it has the right to demand
payment from the issuer.
Wrap Contracts
Why Wrap Contracts May Be Purchased. A wrap contract is a contract
between the Fund and a financial institution such as a bank, insurance company
or other financial institution (a "wrap provider"), under which the wrap
provider agrees to make payments to the Fund upon the occurrence of certain
events. By purchasing wrap contracts, the Fund expects to reduce fluctuations in
NAV per share because, under normal circumstances, the value of the Fund's wrap
contracts will vary inversely with the value of Fund assets covered by the
contracts ("covered assets"). For example, when the market value of covered
assets falls below "book value" (essentially the purchase price of covered
assets plus any accrued net income thereon), wrap contracts will be assets of
the Fund with a value equal to the difference between the book and market
values. Similarly, when the market value of covered assets is greater than their
book value, wrap contracts will become a liability of the Fund equal to the
amount by which the market value of covered assets exceeds their book value. In
this manner, under normal conditions, wrap contracts are expected to reduce the
impact of interest rate risk on covered assets and, hence, the market price
variability of the Fund.
How Wrap Contracts Work. The Fund will pay premiums to wrap providers
if and when it purchases wrap contracts, and these premiums will be an expense
of the Fund. Wrap contracts obligate wrap providers to make certain payments to
the Fund in exchange for annual premiums. Payments made by wrap providers as
provided by wrap contracts are intended to enable the Fund to make redemption
payments at the current book value of covered assets rather than at the current
market price. Wrap contract payments may be made when assets are sold to fund
redemption of shares, upon termination of wrap contracts, or both. Payments are
based on the book value of wrap contracts, and are normally equal to the sum of
(i) the accrued or amortized purchase price of covered assets, minus (ii) the
sale price of covered assets liquidated to fund share redemptions, plus (iii)
interest accrued at a crediting rate, computation of which is specified in the
wrap contracts. The crediting rate is the yield on the covered assets, adjusted
to amortize the difference between market value and book value over the duration
of the covered assets, less wrap contract premiums and Fund expenses. Wrap
contracts typically provide for periodic reset of crediting rates. Crediting
rates reflect the amortization of realized and unrealized gains and losses on
covered assets and, in consequence, may not reflect the actual returns achieved
the wrapped assets. From time to time crediting rates may be significantly
greater or less than current market interest rates, although wrap contracts
generally provide that crediting rates may not fall below zero.
The Fund will normally liquidate assets not covered by wrap contracts prior to
liquidating covered assets to meet redemption requests. If circumstances arise
that require the Fund to liquidate wrapped assets, and if the fair market value
of covered assets is less than their book value, a wrap contract will, under
normal circumstances, obligate the wrap provider to pay the Fund all or some of
the difference. However, if the market value of covered assets being liquidated
exceeds the corresponding book value, the Fund would be obligated to pay all or
some of the difference to the wrap provider. Generally, wrap contract payments
will be made within one day after the Fund requests a payment. If more than one
wrap contract applies to covered assets which have been liquidated, payment
requests will be allocated among wrap contracts as specified in each wrap
contract.
Wrap contracts may require that covered assets be limited as to duration or
maturity, consist of specified types of securities, and/or be at or above a
specified credit quality. Wrap contracts purchased by the Fund will be
consistent with the Fund's investment objectives and policies as set forth in
the Prospectus and this SAI, although in some cases wrap contracts may require
more restrictive investment objectives and policies than do the Prospectus and
SAI. Wrap contracts may also allow providers to terminate their contracts if the
Fund changes the investment objectives, policies and restrictions set forth in
the Prospectus and this SAI without having obtained the consent of the wrap
providers. In the event of termination by a wrap provider, the Fund may not be
able successfully to replace contract coverage with another provider..
Wrap contracts may mature on specified dates and may be terminable upon notice
by the Fund or in the event of a default by either the Fund or the wrap
provider. "Evergreen" wrap contracts specify no maturity date. They allow either
the Fund or a provider to terminate the wrap contract through a fixed maturity
conversion. Under a fixed maturity conversion the wrap contract will terminate
on a future date which is generally determined by adding the duration of covered
assets to a date elected by the party seeking to terminate the contract. For
example, if the date elected is January 1,2002 and the duration of covered
assets is 3 years, the wrap contract will terminate as of January 1.2005. In
addition, during the conversion period, the Fund may be required to comply with
certain restrictions on covered assets, such as limitation of their duration to
the remaining term of the conversion period.
Generally, at termination of a wrap contract, the wrap provider will be
obligated to pay the Fund any excess of book value over market value of covered
assets. However, if a wrap contract terminates because of a default by the Fund
or upon election by the Fund (other than through a fixed maturity conversion),
no such payment is made.
Risks Associated with Wrap Contracts. The Fund expects wrap contracts,
if and to the extent utilized, to reduce the per share price volatility of the
Fund. However, there are certain risks associated with the use of wrap contracts
that could impair the Fund's ability to achieve this objective.
If a wrap contract matures or terminates, the Fund may be unable to obtain a
replacement wrap contract or a wrap contract with terms substantially similar
those of the maturing or terminating agreement. If at the time the market value
of covered assets is less than their book value, the Fund may be required to
reduce its NAV accordingly. Likewise, if the market value of the covered assets
is greater than their book value, the Fund's NAV may increase. In either case,
Fund shareholders may experience unexpected fluctuations in the value of their
shares. Further, if new wrap contracts are negotiated on less favorable terms
than those of the contracts being replaced, such as higher wrap premiums, the
net returns of the Fund may be negatively affected.
The Fund's Board of Trustees shall in good faith determine the value of each of
the Fund's wrap contracts and shall establish policies and procedures governing
valuation of these instruments. Other fair and reasonable valuation
methodologies may be utilized in certain circumstances including, but not
limited to, (1) default by a wrap provider under a wrap contract or other
agreement; (2) insolvency of a wrap provider; (3) reduction of the credit rating
of a wrap provider; or (4) any other situation in which the Board of Trustees
determines that a wrap provider may no longer be able to satisfy its obligations
under a wrap contract. In any such case, the fair value of any wrap contract may
be determined to be less than the difference between book value and the market
value of covered assets. In these situations the Fund may experience greater
variability in its NAV per share.
Wrap contracts do not protect the Fund from the credit risk of covered assets.
Defaults by issuers of covered assets or downgrades in their credit rating to
below investment grade status will generally cause those assets to be removed
from coverage under wrap contracts, in which event the Fund may experience a
decrease in NAV.
Currently, there is no active trading market for wrap contracts, and none is
expected to develop. The Fund may therefore be unable to liquidate wrap
contracts within seven days at fair market value, in which case the wrap
contracts will be considered illiquid. At the time of their purchase, the fair
market value of the Fund's wrap contracts, plus the fair market value of all
other illiquid assets in the Fund, may not exceed fifteen percent (15%) of the
fair market value of the Fund's net assets. If the fair market value of illiquid
assets including wrap contracts later rises above 15% of the fair market value
of the Fund's net assets, the price volatility of the Fund's shares may increase
as the Fund acts to reduce the percentage of illiquid assets to a level that
does not exceed 15% of the Fund.
Money Market Instruments
Money market instruments may include the following types of
instruments:
-- obligations issued or guaranteed as to interest and principal by the
U.S. Government, its agencies, or instrumentalities, or any federally
chartered corporation, with remaining maturities of 397 days or less;
-- obligations of sovereign foreign governments, their agencies,
instrumentalities and political subdivisions, with remaining maturities
of 397 days or less;
-- asset-backed commercial paper whose own rating or the rating of any
guarantor is in one of the two highest categories of any NRSRO;
-- repurchase agreements;
-- certificates of deposit, time deposits and bankers' acceptances
issued by domestic banks (including their branches located outside the
United States (Eurodollars) and subsidiaries located in Canada),
domestic branches of foreign banks (Yankee dollars), savings and loan
associations and similar institutions, and such obligations issued by
foreign branches of foreign banks and financial institutions;
-- commercial paper (including asset-backed commercial paper), which
are short-term unsecured promissory notes issued by corporations in
order to finance their current operations. Generally the commercial
paper will be rated within the top two rating categories by an NRSRO,
or if not rated, is issued and guaranteed as to payment of principal
and interest by companies which at the date of investment have a high
quality outstanding debt issue;
-- bank loan participation agreements representing obligations of
corporations and banks having a high quality short-term rating, at the
date of investment, and under which the Fund will look to the
creditworthiness of the lender bank, which is obligated to make
payments of principal and interest on the loan, as well as to
creditworthiness of the borrower.
-- high quality short-term (maturity in 397 days or less) corporate
obligations, these obligations will be rated within the top two rating
categories by an NRSRO or if not rated, of comparable quality.
Custodial Receipts
Certain Funds may acquire U.S. Government securities and their unmatured
interest coupons that have been separated ("stripped") by their holder,
typically a custodian bank or investment brokerage firm. Having separated the
interest coupons from the underlying principal of the U.S. Government
securities, the holder will resell the stripped securities in custodial receipt
programs with a number of different names, including "Treasury Income Growth
Receipts" ("TIGRs") and "Certificate of Accrual on Treasury Securities"
("CATS"). The stripped coupons are sold separately from the underlying
principal, which is usually sold at a deep discount because the buyer receives
only the right to receive a future fixed payment on the security and does not
receive any rights to periodic interest (cash) payments. The underlying U.S.
Treasury bonds and notes themselves are generally held in book-entry form at a
Federal Reserve Bank. Counsel to the underwriters of these certificates or other
evidences of ownership of U.S. Treasury securities have stated that, in their
opinion, purchasers of the stripped securities most likely will be deemed the
beneficial holders of the underlying U.S. Government securities for federal tax
and securities purposes. In the case of CATS and TIGRS, the Internal Revenue
Service ("IRS") has reached this conclusion for the purpose of applying the tax
diversification requirements applicable to regulated investment companies such
as the Funds. CATS and TIGRS are not considered U.S. Government securities by
the Staff of the Commission, however. Further, the IRS conclusion is contained
only in a general counsel memorandum, which is an internal document of no
precedential value or binding effect, and a private letter ruling, which also
may not be relied upon by the Funds. The Trust is not aware of any binding
legislative, judicial or administrative authority on this issue.
Repurchase Agreements
In connection with the purchase of a repurchase agreement from member
banks of the Federal Reserve System or certain non-bank dealers by a Fund, the
Fund's custodian, or a subcustodian, will have custody of, and will hold in a
segregated account, securities acquired by the Fund under a repurchase
agreement. Repurchase agreements are contracts under which the buyer of a
security simultaneously commits to resell the security to the seller at an
agreed-upon price and date. Repurchase agreements are considered by the staff of
the Securities and Exchange Commission (the "SEC") to be loans by the Fund.
Repurchase agreements may be entered into with respect to securities of the type
in which it may invest or government securities regardless of their remaining
maturities, and will require that additional securities be deposited with it if
the value of the securities purchased should decrease below resale price.
Repurchase agreements involve certain risks in the event of default or
insolvency by the other party, including possible delays or restrictions upon a
Fund's ability to dispose of the underlying securities, the risk of a possible
decline in the value of the underlying securities during the period in which a
Fund seeks to assert its rights to them, the risk of incurring expenses
associated with asserting those rights and the risk of losing all or part of the
income from the repurchase agreement. A Fund's adviser or subadviser, acting
under the supervision of the Board of Trustees, reviews the creditworthiness of
those banks and non-bank dealers with which the Funds enter into repurchase
agreements to evaluate these risks.
When-Issued Securities and Delayed-Delivery Transactions
When securities are purchased on a "when-issued" basis or purchased for
delayed delivery, then payment and delivery occur beyond the normal settlement
date at a stated price and yield. When-issued transactions normally settle
within 45 days. The payment obligation and the interest rate that will be
received on when-issued securities are fixed at the time the buyer enters into
the commitment. Due to fluctuations in the value of securities purchased or sold
on a when-issued or delayed-delivery basis, the yields obtained on such
securities may be higher or lower than the yields available in the market on the
dates when the investments are actually delivered to the buyers. The greater a
Fund's outstanding commitments for these securities, the greater the exposure to
potential fluctuations in the net asset value of a Fund. Purchasing when-issued
or delayed-delivery securities may involve the additional risk that the yield or
market price available in the market when the delivery occurs may be higher or
the market price lower than that obtained at the time of commitment.
When a Fund agrees to purchase when-issued or delayed-delivery
securities, to the extent required by the SEC, its custodian will set aside
permissible liquid assets equal to the amount of the commitment in a segregated
account. Normally, the custodian will set aside portfolio securities to satisfy
a purchase commitment, and in such a case a Fund may be required subsequently to
place additional assets in the segregated account in order to ensure that the
value of the account remains equal to the amount of such Fund's commitment. It
may be expected that the Fund's net assets will fluctuate to a greater degree
when it sets aside portfolio securities to cover such purchase commitments than
when it sets aside cash. In addition, because the Fund will set aside cash or
liquid portfolio securities to satisfy its purchase commitments in the manner
described above, such Fund's liquidity and the ability of VMF or a subadviser to
manage it might be affected in the event its commitments to purchase
"when-issued" securities ever exceed 25% of the value of its total assets. Under
normal market conditions, however, a Fund's commitment to purchase "when-issued"
or "delayed-delivery" securities will not exceed 25% of the value of its total
assets. When the Fund engages in when-issued or delayed-delivery transactions,
it relies on the other party to consummate the trade. Failure of the seller to
do so may result in a Fund incurring a loss or missing an opportunity to obtain
a price considered to be advantageous.
Lending Portfolio Securities
A Fund may lend its portfolio securities to brokers, dealers and other
financial institutions, provided it receives cash collateral which at all times
is maintained in an amount equal to at least 100% of the current market value of
the securities loaned. By lending its portfolio securities, the Fund can
increase its income through the investment of the cash collateral. For the
purposes of this policy, the Fund considers collateral consisting of cash, U.S.
Government securities or letters of credit issued by banks whose securities meet
the standards for investment by the Fund to be the equivalent of cash. From time
to time, the Fund may return to the borrower or a third party which is
unaffiliated with it, and which is acting as a "placing broker," a part of the
interest earned from the investment of collateral received for securities
loaned.
The SEC currently requires that the following conditions must be met
whenever portfolio securities are loaned: (1) a Fund must receive at least 100%
cash collateral of the type discussed in the preceding paragraph from the
borrower; (2) the borrower must increase such collateral whenever the market
value of the securities loaned rises above the level of such collateral; (3) a
Fund must be able to terminate the loan at any time; (4) a Fund must receive
reasonable interest on the loan, as well as any dividends, interest or other
distributions payable on the loaned securities, and any increase in market
value; (5) a Fund may pay only reasonable custodian fees in connection with the
loan; and (6) while any voting rights on the loaned securities may pass to the
borrower, a Fund's board of trustees must be able to terminate the loan and
regain the right to vote the securities if a material event adversely affecting
the investment occurs. These conditions may be subject to future modification.
Loan agreements involve certain risks in the event of default or insolvency of
the other party including possible delays or restrictions upon the Fund's
ability to recover the loaned securities or dispose of the collateral for the
loan.
Small Company and Emerging Growth Stocks
Investing in securities of small-sized and emerging growth companies
may involve greater risks than investing in the stocks of larger, more
established companies since these securities may have limited marketability and
thus may be more volatile than securities of larger, more established companies
or the market averages in general. Because small-sized and emerging growth
companies normally have fewer shares outstanding than larger companies, it may
be more difficult for a Fund to buy or sell significant numbers of such shares
without an unfavorable impact on prevailing prices. Small-sized and emerging
growth companies may have limited product lines, markets or financial resources
and may lack management depth. In addition, small-sized and emerging growth
companies are typically subject to wider variations in earnings and business
prospects than are larger, more established companies. There is typically less
publicly available information concerning small-sized and emerging growth
companies than for larger, more established ones.
Special Situation Companies
"Special situation companies" include those involved in an actual or
prospective acquisition or consolidation; reorganization; recapitalization;
merger, liquidation or distribution of cash, securities or other assets; a
tender or exchange offer; a breakup or workout of a holding company; or
litigation which, if resolved favorably, would improve the value of the
company's stock. If the actual or prospective situation does not materialize as
anticipated, the market price of the securities of a "special situation company"
may decline significantly. Therefore, an investment in a Fund that invests a
significant portion of its assets in these securities may involve a greater
degree of risk than an investment in other mutual funds that seek long-term
growth of capital by investing in better-known, larger companies. The
subadvisers of such Funds believe, however, that if a subadviser analyzes
"special situation companies" carefully and invests in the securities of these
companies at the appropriate time, the Fund may achieve capital growth. There
can be no assurance however, that a special situation that exists at the time
the Fund makes its investment will be consummated under the terms and within the
time period contemplated, if it is consummated at all.
Foreign Securities
Investing in foreign securities (including through the use of
depository receipts) involves certain special considerations which are not
typically associated with investing in United States securities. Since
investments in foreign companies will frequently involve currencies of foreign
countries, and since a Fund may hold securities and funds in foreign currencies,
a Fund may be affected favorably or unfavorably by changes in currency rates and
in exchange control regulations, if any, and may incur costs in connection with
conversions between various currencies. Most foreign stock markets, while
growing in volume of trading activity, have less volume than the New York Stock
Exchange, and securities of some foreign companies are less liquid and more
volatile than securities of comparable domestic companies. Similarly, volume and
liquidity in most foreign bond markets are less than in the United States and,
at times, volatility of price can be greater than in the United States. Fixed
commissions on foreign securities exchanges are generally higher than negotiated
commissions on United States exchanges, although each Fund endeavors to achieve
the most favorable net results on its portfolio transactions. There is generally
less government supervision and regulation of securities exchanges, brokers and
listed companies in foreign countries than in the United States. In addition,
with respect to certain foreign countries, there is the possibility of exchange
control restrictions, expropriation or confiscatory taxation, and political,
economic or social instability, which could affect investments in those
countries. Foreign securities, such as those purchased by a Fund, may be subject
to foreign government taxes, higher custodian fees, higher brokerage costs and
dividend collection fees which could reduce the yield on such securities.
Foreign economies may differ favorably or unfavorably from the U.S.
economy in various respects, including growth of gross domestic product, rates
of inflation, currency depreciation, capital reinvestment, resource
self-sufficiency, and balance of payments positions. Many foreign securities are
less liquid and their prices more volatile than comparable U.S. securities. From
time to time, foreign securities may be difficult to liquidate rapidly without
adverse price effects.
Investment in Companies in Developing Countries. Investments may be
made from time to time in companies in developing countries as well as in
developed countries. Although there is no universally accepted definition, a
developing country is generally considered to be a country which is in the
initial stages of industrialization. Shareholders should be aware that investing
in the equity and fixed income markets of developing countries involves exposure
to unstable governments, economies based on only a few industries, and
securities markets which trade a small number of securities. Securities markets
of developing countries tend to be more volatile than the markets of developed
countries; however, such markets have in the past provided the opportunity for
higher rates of return to investors.
The value and liquidity of investments in developing countries may be
affected favorably or unfavorably by political, economic, fiscal, regulatory or
other developments in the particular countries or neighboring regions. The
extent of economic development, political stability and market depth of
different countries varies widely. Certain countries in the Asia region,
including Cambodia, China, Laos, Indonesia, Malaysia, the Philippines, Thailand,
and Vietnam are either comparatively underdeveloped or are in the process of
becoming developed. Such investments typically involve greater potential for
gain or loss than investments in securities of issuers in developed countries.
The securities markets in developing countries are substantially
smaller, less liquid and more volatile than the major securities markets in the
United States. A high proportion of the shares of many issuers may be held by a
limited number of persons and financial institutions, which may limit the number
of shares available for investment by a Fund. Similarly, volume and liquidity in
the bond markets in developing countries are less than in the United States and,
at times, price volatility can be greater than in the United States. A limited
number of issuers in developing countries' securities markets may represent a
disproportionately large percentage of market capitalization and trading volume.
The limited liquidity of securities markets in developing countries may also
affect the Fund's ability to acquire or dispose of securities at the price and
time it wishes to do so. Accordingly, during periods of rising securities prices
in the more illiquid securities markets, the Fund's ability to participate fully
in such price increases may be limited by its investment policy of investing not
more than 15% of its total net assets in illiquid securities. Conversely, the
Fund's inability to dispose fully and promptly of positions in declining markets
will cause the Fund's net asset value to decline as the value of the unsold
positions is marked to lower prices. In addition, securities markets in
developing countries are susceptible to being influenced by large investors
trading significant blocks of securities.
Political and economic structures in many such countries may be
undergoing significant evolution and rapid development, and such countries may
lack the social, political and economic stability characteristic of the United
States. Certain of such countries have in the past failed to recognize private
property rights and have at times nationalized or expropriated the assets of
private companies. As a result, the risks described above, including the risks
of nationalization or expropriation of assets, may be heightened. In addition,
unanticipated political or social developments may affect the value of the
Fund's investments in those countries and the availability to the Fund of
additional investments in those countries.
Economies of developing countries may differ favorably or unfavorably
from the United States' economy in such respects as rate of growth of gross
national product, rate of inflation, capital reinvestment, resource
self-sufficiency and balance of payments position. As export-driven economies,
the economies of countries in the Asia Region are affected by developments in
the economies of their principal trading partners. Hong Kong, Japan and Taiwan
have limited natural resources, resulting in dependence on foreign sources for
certain raw materials and economic vulnerability to global fluctuations of price
and supply.
Certain developing countries do not have comprehensive systems of laws,
although substantial changes have occurred in many such countries in this regard
in recent years. Laws regarding fiduciary duties of officers and directors and
the protection of shareholders may not be well developed. Even where adequate
law exists in such developing countries, it may be impossible to obtain swift
and equitable enforcement of such law, or to obtain enforcement of the judgment
by a court of another jurisdiction.
Trading in futures contracts on foreign commodity exchanges may be
subject to the same or similar risks as trading in foreign securities.
Depository Receipts. A Fund may invest in foreign securities by
purchasing depository receipts, including American Depository Receipts ("ADRs"),
European Depository Receipts ("EDRs") and Global Depository Receipts ("GDRs") or
other securities convertible into securities of issuers based in foreign
countries. These securities may not necessarily be denominated in the same
currency as the securities into which they may be converted. Generally, ADRs, in
registered form, are denominated in U.S. dollars and are designed for use in the
U.S. securities markets, GDRs, in bearer form, are issued and designed for use
outside the United States and EDRs (also referred to as Continental Depository
Receipts ("CDRs")), in bearer form, may be denominated in other currencies and
are designed for use in European securities markets. ADRs are receipts typically
issued by a U.S. Bank or trust company evidencing ownership of the underlying
securities. EDRs are European receipts evidencing a similar arrangement. GDRs
are receipts typically issued by non-United States banks and trust companies
that evidence ownership of either foreign or domestic securities. For purposes
of a Fund's investment policies, ADRs, GDRs and EDRs are deemed to have the same
classification as the underlying securities they represent. Thus, an ADR, GDR or
EDR representing ownership of common stock will be treated as common stock.
A Fund may invest in depository receipts through "sponsored" or
"unsponsored" facilities. While ADRs issued under these two types of facilities
are in some respects similar, there are distinctions between them relating to
the rights and obligations of ADR holders and the practices of market
participants.
A depository may establish an unsponsored facility without
participation by (or even necessarily the acquiescence of) the issuer of the
deposited securities, although typically the depository requests a letter of
non-objection from such issuer prior to the establishment of the facility.
Holders of unsponsored ADRs generally bear all the costs of such facilities. The
depository usually charges fees upon the deposit and withdrawal of the deposited
securities, the conversion of dividends into U.S. dollars, the disposition of
non-cash distributions, and the performance of other services. The depository of
an unsponsored facility frequently is under no obligation to pass through voting
rights to ADR holders in respect of the deposited securities. In addition, an
unsponsored facility is generally not obligated to distribute communications
received from the issuer of the deposited securities or to disclose material
information about such issuer in the U.S. and thus there may not be a
correlation between such information and the market value of the depository
receipts. Unsponsored ADRs tend to be less liquid than sponsored ADRs.
Sponsored ADR facilities are created in generally the same manner as
unsponsored facilities, except that the issuer of the deposited securities
enters into a deposit agreement with the depository. The deposit agreement sets
out the rights and responsibilities of the issuer, the depository, and the ADR
holders. With sponsored facilities, the issuer of the deposited securities
generally will bear some of the costs relating to the facility (such as dividend
payment fees of the depository), although ADR holders continue to bear certain
other costs (such as deposit and withdrawal fees). Under the terms of most
sponsored arrangements, depositories agree to distribute notices of shareholder
meetings and voting instructions, and to provide shareholder communications and
other information to the ADR holders at the request of the issuer of the
deposited securities.
Eurodollar and Yankee Obligations. Eurodollar bank obligations are
dollar-denominated certificates of deposit and time deposits issued outside the
U.S. capital markets by foreign branches of U.S. banks and by foreign banks.
Yankee bank obligations are dollar-denominated obligations issued in the U.S.
capital markets by foreign banks.
Eurodollar and Yankee bank obligations are subject to the same risks
that pertain to domestic issues, notably credit risk, market risk and liquidity
risk. Additionally, Eurodollar (and to a limited extent, Yankee) bank
obligations are subject to certain sovereign risks. One such risk is the
possibility that a sovereign country might prevent capital, in the form of
dollars, from flowing across their borders. Other risks include: adverse
political and economic developments; the extent and quality of government
regulation of financial markets and institutions; the imposition of foreign
withholding taxes, and the expropriation or nationalization of foreign issues.
However, Eurodollar and Yankee bank obligations held in a Fund will undergo the
same credit analysis as domestic issues in which the Fund invests, and will have
at least the same financial strength as the domestic issuers approved for the
Fund.
Foreign Sovereign Debt. Certain Funds may invest in sovereign debt
obligations issued by foreign governments. To the extent that a Fund invests in
obligations issued by developing or emerging markets, these investments involve
additional risks. Sovereign obligors in developing and emerging market countries
are among the world's largest debtors to commercial banks, other governments,
international financial organizations and other financial institutions. These
obligors have in the past experienced substantial difficulties in servicing
their external debt obligations, which led to defaults on certain obligations
and the restructuring of certain indebtedness. Restructuring arrangements have
included, among other things, reducing and rescheduling interest and principal
payments by negotiation new or amended credit agreements or converting
outstanding principal and unpaid interest to Brady Bonds, and obtaining new
credit for finance interest payments. Holders of certain foreign sovereign debt
securities may be requested to participate in the restructuring of such
obligations and to extend further loans to their issuers. There can be no
assurance that the foreign sovereign debt securities in which a Fund may invest
will not be subject to similar restructuring arrangements or to requests for new
credit which may adversely affect the Fund's holdings. Furthermore, certain
participants in the secondary market for such debt may be directly involved in
negotiating the terms of these arrangements and may therefore have access to
information not available to other market participants.
Brady Bonds. Brady Bonds are debt securities, generally denominated in
U.S. dollars, issued under the framework of the Brady Plan. The Brady Plan is an
initiative announced by former U.S. Treasury Secretary Nicholas F. Brady in 1989
as a mechanism for debtor nations to restructure their outstanding external
commercial bank indebtedness. In restructuring its external debt under the Brady
Plan framework, a debtor nation negotiates with its existing bank lenders as
well as multilateral institutions such as the International Bank for
Reconstruction and Development (the "World Bank") and the International Monetary
Fund (the "IMF"). The Brady Plan framework, as it has developed, contemplates
the exchange of external commercial bank debt for newly issued bonds known as
"Brady Bonds". Brady Bonds may also be issued in respect of new money being
advanced by existing lenders in connection with the debt restructuring. The
World Bank and/or the IMF support the restructuring by providing funds pursuant
to loan agreements or other arrangements which enable the debtor nation to
collateralize the new Brady Bonds or to repurchase outstanding bank debt at a
discount. Under these arrangements with the World Bank and/or the IMF, debtor
nations have been required to agree to the implementation of certain domestic
monetary and fiscal reforms. Such reforms have included the liberalization of
trade and foreign investment, the privatization of state-owned enterprises and
the setting of targets for public spending and borrowing. These policies and
programs seek to promote the debtor country's economic growth and development.
Investors should also recognize that the Brady Plan only sets forth general
guiding principles for economic reform and debt reduction, emphasizing that
solutions must be negotiated on a case-by-case basis between debtor nations and
their creditors. A Fund's adviser or subadviser may believe that economic
reforms undertaken by countries in connection with the issuance of Brady Bonds
may make the debt of countries which have issued or have announced plans to
issue Brady Bonds an attractive opportunity for investment. However, there can
be no assurance that the adviser or the subadviser's expectations with respect
to Brady Bonds will be realized.
Investors should recognize that Brady Bonds have been issued only
recently, and accordingly, do not have a long payment history. Brady Bonds which
have been issued to date are rated in the categories "BB" or "B" by Standard &
Poor's or "Ba" or "B" by Moody's or, in cases in which a rating by S&P or
Moody's has not been assigned, are generally considered by the Fund's adviser or
subadviser to be of comparable quality.
Agreements implemented under the Brady Plan to date are designed to
achieve debt and debt-service reduction through specific options negotiated by a
debtor nation with its creditors. As a result, the financial packages offered by
each country differ. The types of options have included the exchange of
outstanding commercial bank debt for bonds issued at 100% of face value of such
debt which carry a below-market stated rate of interest (generally known as par
bonds), bonds issued at a discount from the face value of such debt (generally
known as discount bonds), bonds bearing an interest rate which increases over
time and bonds issued in exchange for the advancement of new money by existing
lenders. Discount bonds issued to date under the framework of the Brady Plan
have generally borne interested computed semi-annually at a rate equal to 13/16
of 1% above the then current six month London Inter-Bank Offered Rate ("LIBOR")
rate. Regardless of the stated face amount and stated interest rate of the
various types of Brady Bonds, the applicable Funds will purchase Brady Bonds in
secondary markets, as described below, in which the price and yield to the
investor reflect market conditions at the time of purchase. Brady Bonds issued
to date have traded at a deep discount from their face value. Certain sovereign
bonds are entitled to "value recovery payments" in certain circumstances, which
in effect constitute supplemental interest payments but generally are not
collateralized. Certain Brady Bonds have been collateralized as to principal due
date at maturity (typically 30 years from the date of issuance) by U.S. Treasury
zero coupon bonds with a maturity equal to the final maturity of such Brady
Bonds. Collateral purchases are financed by the IMF, the World Bank and the
debtor nations' reserves. In addition, interest payments on certain types of
Brady Bonds may be collateralized by cash or high-grade securities in amounts
that typically represent between 12 and 18 months of interest accruals on these
instruments with the balance of the interest accruals being uncollateralized. In
the event of a default with respect to collateralized Brady Bonds as a result of
which the payment obligations of the issuer are accelerated, the U.S. Treasury
zero coupon obligations held as collateral for the payment of principal will not
be distributed to investors, nor will such obligations be sold and the proceeds
distributed. The collateral will be held by the collateral agent to the
scheduled maturity of the defaulted Brady Bonds, which will continue to be
outstanding, at which time the fact amount of the collateral will equal the
principal payments which would have then been due on the Brady Bonds in the
normal course. Based upon current market conditions, the Fund would not intend
to purchase Brady Bonds which, at the time of investment, are in default as to
payments. However, in light of the risidual risk of the Brady Bonds and, among
other factors, the history of default with respect to commercial bank loans by
public and private entities of countries issuing Brady Bonds, investments in
Brady Bonds are considered speculative. A Fund may purchase Brady Bonds with no
or limited collateralization, and will be relying for payment of interest and
(except in the case of principal collateralized Brady Bonds) principal primarily
on the willingness and ability of the foreign government to make payment in
accordance with the terms of the Brady Bonds.
Brady Bonds issued to date are purchased and sold in secondary markets
through U.S. securities dealers and other financial institutions and are
generally maintained through European transnational securities depositories. A
substantial portion of the Brady Bonds and other sovereign debt securities in
which a Fund may invest are likely to be acquired at a discount, which involves
certain considerations discussed below under "Additional Information Concerning
Taxes."
Real Estate Securities
Although no Fund will invest in real estate directly, certain Funds may
invest in securities of real estate investment trusts ("REITs") and other real
estate industry companies or companies with substantial real estate investments
and, as a result, such Fund may be subject to certain risks associated with
direct ownership of real estate and with the real estate industry in general.
These risks include, among others: possible declines in the value of real
estate; possible lack of availability of mortgage funds; extended vacancies of
properties; risks related to general and local economic conditions;
overbuilding; increases in competition, property taxes and operating expenses;
changes in zoning laws; costs resulting from the clean-up of, and liability to
third parties for damages resulting from, environmental problems; casualty or
condemnation losses; uninsured damages from floods, earthquakes or other natural
disasters; limitations on and variations in rents; and changes in interest
rates.
REITs are pooled investment vehicles which invest primarily in income
producing real estate or real estate related loans or interests. REITs are
generally classified as equity REITs, mortgage REITs or hybrid REITs. Equity
REITs invest the majority of their assets directly in real property and derive
income primarily from the collection of rents. Equity REITs can also realize
capital gains by selling properties that have appreciated in value. Mortgage
REITs invest the majority of their assets in real estate mortgages and derive
income from the collection of interest payments. Hybrid REITs combine the
investment strategies of Equity REITs and Mortgage REITs. REITs are not taxed on
income distributed to shareholders provided they comply with several
requirements of Internal Revenue Code, as amended (the "Code").
Convertible Securities
Convertible securities are bonds, debentures, notes, preferred stocks,
or other securities that may be converted into or exchanged for a specified
amount of common stock of the same or a different issuer within a particular
period of time at a specified price or formula. Convertible securities have
general characteristics similar to both debt obligations and equity securities.
The value of a convertible security is a function of its "investment value"
(determined by its yield in comparison with the yields of other securities of
comparable maturity and quality that do not have a conversion privilege) and its
"conversion value" (the security's worth, at market value, if converted into the
underlying common stock). The investment value of a convertible security is
influenced by changes in interest rates, the credit standing of the issuer and
other factors. The market value of convertible securities tends to decline as
interest rates increase and, conversely, tends to increase as interest rates
decline. The conversion value of a convertible security is determined by the
market price of the underlying common stock. The market value of convertible
securities tends to vary with fluctuations in the market value of the underlying
common stock and therefore will react to variations in the general market for
equity securities. If the conversion value is low relative to the investment
value, the price of the convertible security is governed principally by its
investment value. Generally, the conversion value decreases as the convertible
security approaches maturity. To the extent the market price of the underlying
common stock approaches or exceeds the conversion price, the price of the
convertible security will be increasingly influenced by its conversion value. A
convertible security generally will sell at a premium over its conversion value
by the extent to which investors place value on the right to acquire the
underlying common stock while holding a fixed income security. While no
securities investments are without risk, investments in convertible securities
generally entail less risk than investments in common stock of the same issuer.
A convertible security entitles the holder to receive interest normally
paid or accrued on debt or the dividend paid on preferred stock until the
convertible security matures or is redeemed, converted, or exchanged.
Convertible securities have unique investment characteristics in that they
generally (i) have higher yields than common stocks, but lower yields than
comparable non-convertible securities, (ii) are less subject to fluctuation in
value than the underlying stock since they have fixed income characteristics,
and (iii) provide the potential for capital appreciation if the market price of
the underlying common stock increases. Most convertible securities currently are
issued by U.S. companies, although a substantial Eurodollar convertible
securities market has developed, and the markets for convertible securities
denominated in local currencies are increasing.
A convertible security may be subject to redemption at the option of
the issuer at a price established in the convertible security's governing
instrument. If a convertible security held by a Fund is called for redemption, a
Fund will be required to permit the issuer to redeem the security, convert it
into the underlying common stock, or sell it to a third party.
Convertible securities generally are subordinated to other similar but
non-convertible securities of the same issuer, although convertible bonds, as
corporate debt obligations, generally enjoy seniority in right of payment to all
equity securities, and convertible preferred stock is senior to common stock of
the same issuer. Because of the subordination feature, however, convertible
securities typically are rated below investment grade or are not rated.
Certain Funds may also invest in zero coupon convertible securities.
Zero coupon convertible securities are debt securities which are issued at a
discount to their face amount and do not entitle the holder to any periodic
payments of interest prior to maturity. Rather, interest earned on zero coupon
convertible securities acretes at a stated yield until the security reaches its
face amount at maturity. Zero coupon convertible securities are convertible into
a specific number of shares of the issuer's common stock. In addition, zero
coupon convertible securities usually have put features that provide the holder
with the opportunity to sell the securities back to the issuer at a stated price
before maturity. Generally, the prices of zero coupon convertible securities may
be more sensitive to market interest rate fluctuations then conventional
convertible securities. Federal income tax law requires the holder of a zero
coupon convertible security to recognize income from the security prior to the
receipt of cash payments. To maintain its qualification as a regulated
investment company and avoid liability of federal income taxes, a Fund will be
required to distribute income accrued from zero coupon convertible securities
which it owns, and may have to sell portfolio securities (perhaps at
disadvantageous times) in order to generate cash to satisfy these distribution
requirements.
Warrants
Warrants are securities giving the holder the right, but not the
obligation, to buy the stock of an issuer at a given price (generally higher
than the value of the stock at the time of issuance), on a specified date,
during a specified period, or perpetually. Warrants may be acquired separately
or in connection with the acquisition of securities. Warrants acquired by a Fund
in units or attached to securities are not subject to these restrictions.
Warrants do not carry with them the right to dividends or voting rights with
respect to the securities that they entitle their holder to purchase, and they
do not represent any rights in the assets of the issuer. As a result, warrants
may be considered more speculative than certain other types of investments. In
addition, the value of a warrant does not necessarily change with the value of
the underlying securities, and a warrant ceases to have value if it is not
exercised prior to its expiration date.
Preferred Stock
Preferred stocks, like debt obligations, are generally fixed-income
securities. Shareholders of preferred stocks normally have the right to receive
dividends at a fixed rate when and as declared by the issuer's board of
directors, but do not participate in other amounts available for distribution by
the issuing corporation. Dividends on the preferred stock may be cumulative, and
all cumulative dividends usually must be paid prior to common shareholders
receiving any dividends. Because preferred stock dividends must be paid before
common stock dividends, preferred stocks generally entail less risk than common
stocks. Upon liquidation, preferred stocks are entitled to a specified
liquidation preference, which is generally the same as the par or stated value,
and are senior in right of payment to common stock. Preferred stocks are,
however, equity securities in the sense that they do not represent a liability
of the issuer and, therefore, do not offer as great a degree of protection of
capital or assurance of continued income as investments in corporate debt
securities. Preferred stocks are generally subordinated in right of payment to
all debt obligations and creditors of the issuer, and convertible preferred
stocks may be subordinated to other preferred stock of the same issuer.
Short Selling of Securities
In a short sale of securities, a Fund sells stock which it does not
own, making delivery with securities "borrowed" from a broker. The Fund is then
obligated to replace the security borrowed by purchasing it at the market price
at the time of replacement. This price may or may not be less than the price at
which the security was sold by the Fund. Until the security is replaced, the
Fund is required to pay the lender any dividends or interest which accrue during
the period of the loan. In order to borrow the security, the Fund may also have
to pay a fee which would increase the cost of the security sold. The proceeds of
the short sale will be retained by the broker, to the extent necessary to meet
margin requirements, until the short position is closed out.
A Fund will incur a loss as a result of the short sale if the price of
the security increases between the date of the short sale and the date on which
the Fund replaces the borrowed security. A Fund will realize a gain if the
security declines in price between those two dates. The amount of any gain will
be decreased and the amount of any loss will be increased by any interest the
Fund may be required to pay in connection with the short sale.
In a short sale, the seller does not immediately deliver the securities
sold and is said to have a short position in those securities until delivery
occurs. A Fund must deposit in a segregated account an amount of cash or liquid
assets equal to the difference between (a) the market value of securities sold
short at the time that they were sold short and (b) the value of the collateral
deposited with the broker in connection with the short sale (not including the
proceeds from the short sale). While the short position is open, the Fund must
maintain on a daily basis the segregated account at such a level that (1) the
amount deposited in it plus the amount deposited with the broker as collateral
equals the current market value of the securities sold short and (2) the amount
deposited in it plus the amount deposited with the broker as collateral is not
less than the market value of the securities at the time they were sold short.
To the extent that the Fund engages in short sales, it will provide
collateral to the broker-dealer and (excluding short sales "against the box")
will maintain additional asset coverage in the form of cash or other liquid
assets in a segregated account. The Fund does not intend to enter into short
sales (other than those "against the box") if immediately after such sale the
aggregate of the value of all collateral plus the amount in such segregated
account exceeds one-third of the value of the Fund's net assets. This percentage
may be varied by action of the [Trust's Board of Trustees/Corporation's Board of
Directors]. A short sale is "against the box" to the extent that the Fund
contemporaneously owns, or has the right to obtain at no added cost, securities
identical to those sold short.
Restricted, Non-Publicly Traded and Illiquid Securities
A Fund may not invest more than 15% (10% for the Money Market Fund) of
its net assets, in the aggregate, in illiquid securities, including repurchase
agreements which have a maturity of longer than seven days, time deposits
maturing in more than seven days and securities that are illiquid because of the
absence of a readily available market or legal or contractual restrictions on
resale. Repurchase agreements subject to demand are deemed to have a maturity
equal to the notice period.
Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act of 1933, as amended (the "Securities Act"),
securities which are otherwise not readily marketable and repurchase agreements
having a maturity of longer than seven days. Securities which have not been
registered under the Securities Act are referred to as private placements or
restricted securities and are purchased directly from the issuer or in the
secondary market. Unless subsequently registered for sale, these securities can
only be sold in privately negotiated transactions or pursuant to an exemption
from registration. Investment companies do not typically hold a significant
amount of these restricted or other illiquid securities because of the potential
for delays on resale and uncertainty in valuation. Limitations on resale may
have an adverse effect on the marketability of portfolio securities, and an
investment company might be unable to dispose of restricted or other illiquid
securities promptly or at reasonable prices and might thereby experience
difficulty satisfying redemptions within seven days. An investment company might
also have to register such restricted securities in order to dispose of them
resulting in additional expense and delay. Adverse market conditions could
impede such a public offering of securities.
In recent years, however, a large institutional market has developed
for certain securities that are not registered under the Securities Act
including repurchase agreements, commercial paper, foreign securities, municipal
securities and corporate bonds and notes. Institutional investors depend on an
efficient institutional market in which the unregistered security can be readily
resold or on an issuer's ability to honor a demand for repayment. The fact that
there are contractual or legal restrictions on resale to the general public or
to certain institutions may not be indicative of the liquidity of such
investments.
The SEC has adopted Rule 144A which allows for a broader institutional
trading market for securities otherwise subject to restriction on resale to the
general public. Rule 144A establishes a "safe harbor" from the registration
requirements of the Securities Act for resales of certain securities to
qualified institutional buyers.
Any such restricted securities will be considered to be illiquid for
purposes of a Fund's limitations on investments in illiquid securities unless,
pursuant to procedures adopted by the Board of Trustees of the Trust, VMF or the
subadviser has determined such securities to be liquid because such securities
are eligible for resale pursuant to Rule 144A and are readily saleable. To the
extent that qualified institutional buyers may become uninterested in purchasing
Rule 144A securities, the Fund's level of illiquidity may increase.
Some Funds may sell over-the-counter ("OTC") options and, in connection
therewith, segregate assets or cover its obligations with respect to OTC options
written by the Fund. 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.
The applicable subadviser or adviser will monitor the liquidity of
restricted securities in the portion of a Fund it manages. In reaching liquidity
decisions, the following factors are considered: (A) the unregistered nature of
the security; (B) the frequency of trades and quotes for the security; (C) the
number of dealers wishing to purchase or sell the security and the number of
other potential purchasers; (D) dealer undertakings to make a market in the
security and (E) the nature of the security and the nature of the marketplace
trades (e.g., the time needed to dispose of the security, the method of
soliciting offers and the mechanics of the transfer).
Private Placement Commercial Paper. Commercial paper eligible for
resale under Section 4(2) of the Securities Act is offered only to accredited
investors. Rule 506 of Regulation D in the Securities Act of 1933 lists
investment companies as an accredited investor.
Section 4(2) paper not eligible for resale under Rule 144A under the
Securities Act shall be deemed liquid if (1) the Section 4(2) paper is not
traded flat or in default as to principal and interest; (2) the Section 4(2)
paper is rated in one of the two highest rating categories by at least two
NRSROs, or if only NRSRO rates the security, it is rated in one of the two
highest categories by that NRSRO; and (3) the Adviser believes that, based on
the trading markets for such security, such security can be disposed of within
seven days in the ordinary course of business at approximately the amount at
which the Fund has valued the security.
Borrowing
A Fund may borrow money from banks, limited by each Fund's fundamental
investment restriction to 33-1/3% of its total assets (including the amount
borrowed), and may engage in mortgage dollar roll and reverse repurchase
agreements which may be considered a form of borrowing. In addition, a Fund may
borrow up to an additional 5% of its total assets from banks for temporary or
emergency purposes. A Fund will not purchase securities when bank borrowings
exceed 5% of such Fund's total assets.
Each Fund expects that its borrowings will be on a secured basis. In
such situations, either the custodian will segregate the pledged assets for the
benefit of the lender or arrangements will be made with a suitable subcustodian,
which may include the lender. The Funds have established a line-of-credit
("LOC") with their custodian by which they may borrow for temporary or emergency
purposes. The Funds intend to use the LOC to meet large or unexpected
redemptions that would otherwise force a Fund to liquidate securities under
circumstances which are unfavorable to a Fund's remaining shareholders.
Derivative Instruments
A Fund's adviser or subadviser may use a variety of derivative
instruments, including options, futures contracts (sometimes referred to as
"futures"), options on futures contracts, stock index options and forward
currency contracts to hedge a Fund's portfolio or for risk management or for any
other permissible purposes consistent with that Fund's investment objective.
Derivative instruments are securities or agreements whose value is based on the
value of some underlying asset (e.g., a security, currency or index) or the
level of a reference index.
Derivatives generally have investment characteristics that are based
upon either forward contracts (under which one party is obligated to buy and the
other party is obligated to sell an underlying asset at a specific price on a
specified date) or option contracts (under which the holder of the option has
the right but not the obligation to buy or sell an underlying asset at a
specified price on or before a specified date). Consequently, the change in
value of a forward-based derivative generally is roughly proportional to the
change in value of the underlying asset. In contrast, the buyer of an
option-based derivative generally will benefit from favorable movements in the
price of the underlying asset but is not exposed to the corresponding losses
that result from adverse movements in the value of the underlying asset. The
seller (writer) of an option-based derivative generally will receive fees or
premiums but generally is exposed to losses resulting from changes in the value
of the underlying asset. Derivative transactions may include elements of
leverage and, accordingly, the fluctuation of the value of the derivative
transaction in relation to the underlying asset may be magnified.
The use of these instruments is subject to applicable regulations of
the SEC, the several options and futures exchanges upon which they may be
traded, and the Commodity Futures Trading Commission ("CFTC"). In addition, a
Fund's ability to use these instruments will be limited by tax considerations.
Special Risks Of Derivative Instruments. The use of derivative
instruments involves special considerations and risks as described below. Risks
pertaining to particular instruments are described in the sections that follow.
(1) Successful use of most of these instruments depends upon a Fund's
adviser's or subadviser's ability to predict movements of the overall securities
and currency markets, which requires different skills than predicting changes in
the prices of individual securities. There can be no assurance that any
particular strategy adopted will succeed.
(2) There might be imperfect correlation, or even no correlation,
between price movements of an instrument and price movements of investments
being hedged. For example, if the value of an instrument used in a short hedge
(such as writing a call option, buying a put option, or selling a futures
contract) increased by less than the decline in value of the hedged investment,
the hedge would not be fully successful. Such a lack of correlation might occur
due to factors unrelated to the value of the investments being hedged, such as
speculative or other pressures on the markets in which these instruments are
traded. The effectiveness of hedges using instruments on indices will depend on
the degree of correlation between price movements in the index and price
movements in the investments being hedged, as well as, how similar the index is
to the portion of the Fund's assets being hedged in terms of securities
composition.
(3) Hedging strategies, if successful, can reduce the risk of loss by
wholly or partially offsetting the negative effect of unfavorable price
movements in the investments being hedged. However, hedging strategies can also
reduce opportunity for gain by offsetting the positive effect of favorable price
movements in the hedged investments. For example, if a Fund entered into a short
hedge because a Fund's adviser or subadviser projected a decline in the price of
a security in the Fund's portfolio, and the price of that security increased
instead, the gain from that increase might be wholly or partially offset by a
decline in the price of the instrument. Moreover, if the price of the instrument
declined by more than the increase in the price of the security, a Fund could
suffer a loss.
(4) 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 these instruments involving obligations to third parties (i.e.,
instruments other than purchased options). If the Fund were unable to close out
its positions in such instruments, it might be required to continue to maintain
such assets or accounts or make such payments until the position expired or
matured. The requirements might impair the Fund's ability to sell a portfolio
security or make an investment at a time when it would otherwise be favorable to
do so, or require that the Fund sell a portfolio security at a disadvantageous
time. The Fund's ability to close out a position in an 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 ("counter party") to enter into a transaction closing out the
position. Therefore, there is no assurance that any hedging position can be
closed out at a time and price that is favorable to the Fund.
For a discussion of the federal income tax treatment of a Fund's
derivative instruments, see "ADDITIONAL GENERAL TAX INFORMATION" below.
Options. A Fund may purchase or write put and call options on
securities and indices, and may purchase options on foreign currencies, and
enter into closing transactions with respect to such options to terminate an
existing position. The purchase of call options serves as a long hedge, and the
purchase of put options serves as a short hedge. Writing put or call options can
enable a Fund to enhance income by reason of the premiums paid by the purchaser
of such options. Writing call options serves as a limited short hedge because
declines in the value of the hedged investment would be offset to the extent of
the premium received for writing the option. However, if the security
appreciates to a price higher than the exercise price of the call option, it can
be expected that the option will be exercised, and the Fund will be obligated to
sell the security at less than its market value or will be obligated to purchase
the security at a price greater than that at which the security must be sold
under the option. All or a portion of any assets used as cover for OTC options
written by a Fund would be considered illiquid to the extent described under
"Restricted and Illiquid Securities" above. Writing put options serves as a
limited long hedge because increases in the value of the hedged investment would
be offset to the extent of the premium received for writing the option. However,
if the security depreciates to a price lower than the exercise price of the put
option, it can be expected that the put option will be exercised, and the Fund
will be obligated to purchase the security at more than its market value.
The value of an option position will reflect, among other things, the
historical price volatility of the underlying investment, the current market
value of the underlying investment, the time remaining until expiration of the
option, 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 used by a Fund may include European-style
options, which can only be exercised at expiration. This is in contrast to
American-style options which can be exercised at any time prior to the
expiration date of the option.
A Fund may effectively terminate its right or obligation under an
option by entering into a closing transaction. For example, a Fund may terminate
its obligation under a call or put option that it had written by purchasing an
identical call or put option; this is known as a closing purchase transaction.
Conversely, a Fund may terminate a position in a put or call option it had
purchased by writing an identical put or call option; this is known as a closing
sale transaction. Closing transactions permit the Fund to realize the profit or
limit the loss on an option position prior to its exercise or expiration.
A Fund may purchase or write both OTC options and options traded on
foreign and U.S. exchanges. Exchange-traded options 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. OTC
options are contracts between the Fund and the counterparty (usually a
securities dealer or a bank) with no clearing organization guarantee. Thus, when
the Fund purchases or writes an OTC option, it relies on the counter party to
make or take delivery of the underlying investment upon exercise of the option.
Failure by the counter party to do so would result in the loss of any premium
paid by the fund as well as the loss of any expected benefit of the transaction.
A Fund's ability to establish and close out positions in
exchange-listed options depends on the existence of a liquid market. A Fund
intends to purchase or write only those exchange-traded options for which there
appears to be a liquid secondary market. However, there can be no assurance that
such a market will exist at any particular time. Closing transactions can be
made for OTC options only by negotiating directly with the counterparty, or by a
transaction in the secondary market if any such market exists. Although a Fund
will enter into OTC options only with counterparties that are expected to be
capable of entering into closing transactions with a Fund, there is no assurance
that such Fund will in fact be able to close out an OTC option at a favorable
price prior to expiration. In the event of insolvency of the counter party, a
Fund might be unable to close out an OTC option position at any time prior to
its expiration.
If a Fund is 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 a cover for the written option until the option
expires or is exercised.
A Fund may engage in options transactions on indices in much the same
manner as the options on securities discussed above, except that index options
may serve as a hedge against overall fluctuations in the securities markets in
general.
The writing and purchasing of options is a highly specialized activity
that involves investment techniques and risks different from those associated
with ordinary portfolio securities transactions. Imperfect correlation between
the options and securities markets may detract from the effectiveness of
attempted hedging.
Transactions using OTC options (other than purchased options) expose a
Fund to counter party risk. To the extent required by SEC guidelines, a Fund
will not enter into any such transactions unless it owns either (1) an
offsetting ("covered") position in securities, other options, or futures or (2)
cash and liquid obligations with a value sufficient at all times to cover its
potential obligations to the extent not covered as provided in (1) above. A Fund
will also set aside cash and/or appropriate liquid assets in a segregated
custodial account if required to do so by the SEC and CFTC regulations. Assets
used as cover or held in a segregated account cannot be sold while the position
in the corresponding option or futures contract is open, unless they are
replaced with similar assets. As a result, the commitment of a large portion of
the Fund's assets to segregated accounts as a cover could impede portfolio
management or the Fund's ability to meet redemption requests or other current
obligations.
[Spread Transactions. A Fund may purchase covered spread options from
securities dealers. Such covered spread options are not presently
exchange-listed or exchange-traded. The purchase of a spread option gives a Fund
the right to put, or sell, a security that it owns at a fixed dollar spread or
fixed yield spread in relationship to another security that the Fund does not
own, but which is used as a benchmark. The risk to a Fund in purchasing covered
spread options is the cost of the premium paid for the spread option and any
transaction costs. In addition, there is no assurance that closing transactions
will be available. The purchase of spread options will be used to protect a Fund
against adverse changes in prevailing credit quality spreads, i.e., the yield
spread between high quality and lower quality securities. Such protection is
only provided during the life of the spread option.]
Futures Contracts. Certain Funds may enter into futures contracts,
including interest rate, index, and currency futures and purchase and write
(sell) related options. The purchase of futures or call options thereon can
serve as a long hedge, and the sale of futures or the purchase of put options
thereon can serve as a short hedge. Writing covered call options on futures
contracts can serve as a limited short hedge, and writing covered put options on
futures contracts can serve as a limited long hedge, using a strategy similar to
that used for writing covered options in securities. A Fund's hedging may
include purchases of futures as an offset against the effect of expected
increases in securities prices or currency exchange rates and sales of futures
as an offset against the effect of expected declines in securities prices or
currency exchange rates. A Fund may write put options on futures contracts while
at the same time purchasing call options on the same futures contracts in order
to create synthetically a long futures contract position. Such options would
have the same strike prices and expiration dates. A Fund will engage in this
strategy only when a Fund's adviser or a subadviser believes it is more
advantageous to a Fund than is purchasing the futures contract.
To the extent required by regulatory authorities, a Fund will only
enter into futures contracts that are traded on U.S. or foreign exchanges or
boards of trade approved by the CFTC and are standardized as to maturity date
and underlying financial instrument. These transactions may be entered into for
"bona fide hedging" purposes as defined in CFTC regulations and other
permissible purposes including increasing return and hedging against changes in
the value of portfolio securities due to anticipated changes in interest rates,
currency values and/or market conditions. The ability of a Fund to trade in
futures contracts may be limited by the requirements of the Code applicable to a
regulated investment company.
A Fund will not enter into futures contracts and related options for
other than "bona fide hedging" purposes for which the aggregate initial margin
and premiums required to establish positions exceed 5% of the Fund's net asset
value after taking into account unrealized profits and unrealized losses on any
such contracts it has entered into. There is no overall limit on the percentage
of a Fund's assets that may be at risk with respect to futures activities.
Although techniques other than sales and purchases of futures contracts could be
used to reduce a Fund's exposure to market, currency, or interest rate
fluctuations, such Fund may be able to hedge its exposure more effectively and
perhaps at a lower cost through using futures contracts.
A futures contract provides for the future sale by one party and
purchase by another party of a specified amount of a specific financial
instrument (e.g., debt security) or currency for a specified price at a
designated date, time, and place. An index futures contract is an agreement
pursuant to which the parties agree to take or make delivery of an amount of
cash equal to a specified multiplier times the difference between the value of
the index at the close of the last trading day of the contract and the price at
which the index futures contract was originally written. Transactions costs are
incurred when a futures contract is bought or sold and margin deposits must be
maintained. A futures contract may be satisfied by delivery or purchase, as the
case may be, of the instrument, the currency, or by payment of the change in the
cash value of the index. More commonly, futures contracts are closed out prior
to delivery by entering into an offsetting transaction in a matching futures
contract. Although the value of an index might be a function of the value of
certain specified securities, no physical delivery of those securities is made.
If the offsetting purchase price is less than the original sale price, a Fund
realizes a gain; if it is more, a Fund realizes a loss. Conversely, if the
offsetting sale price is more than the original purchase price, a Fund realizes
a gain; if it is less, a Fund realizes a loss. The transaction costs must also
be included in these calculations. There can be no assurance, however, that a
Fund will be able to enter into an offsetting transaction with respect to a
particular futures contract at a particular time. If a Fund is not able to enter
into an offsetting transaction, that Fund will continue to be required to
maintain the margin deposits on the futures contract.
No price is paid by a Fund upon entering into a futures contract.
Instead, at the inception of a futures contract, the Fund is required to deposit
in a segregated account with its custodian, in the name of the futures broker
through whom the transaction was effected, "initial margin" consisting of cash,
U.S. Government securities or other liquid obligations, in an amount generally
equal to 10% or less of the contract value. Margin must also be deposited when
writing a call or put option on a futures contract, in accordance with
applicable exchange rules. Unlike margin in securities transactions, initial
margin on futures contracts does not represent a borrowing, but rather is in the
nature of a performance bond or good-faith deposit that is returned to a Fund at
the termination of the transaction if all contractual obligations have been
satisfied. Under certain circumstances, such as periods of high volatility, a
Fund may be required by an exchange to increase the level of its initial margin
payment, and initial margin requirements might be increased generally in the
future by regulatory action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of a Fund's obligations to or from a futures
broker. When a Fund purchases an option on a future, 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 a 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 positions and options on
futures can enter into offsetting closing transactions by selling or purchasing,
respectively, an instrument identical to the instrument held or written.
Positions in futures and options on futures may be closed only on an exchange or
board of trade on which they were entered into (or through a linked exchange).
Although the Funds intend to enter into futures transactions only on exchanges
or boards of trade where there appears to be an active market, there can be no
assurance that such a market will exist for a particular contract at a
particular time.
Under certain circumstances, futures exchanges may establish daily
limits on the amount that the price of a future or 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 or option on a futures
contract position due to the absence of a liquid secondary market or the
imposition of price limits, it could incur substantial losses, because it would
continue to be subject to market risk with respect to the position. In addition,
except in the case of purchased options, the Fund would continue to be required
to make daily variation margin payments and might be required to maintain the
position being hedged by the future or option or to maintain cash or securities
in a segregated account.
Certain characteristics of the futures market might increase the risk
that movements in the prices of futures contracts or options on futures
contracts might not correlate perfectly with movements in the prices of the
investments being hedged. For example, all participants in the futures and
options on futures contracts markets are subject to daily variation margin calls
and might be compelled to liquidate futures or options on futures contracts
positions whose prices are moving unfavorably to avoid being subject to further
calls. These liquidations could increase price volatility of the instruments and
distort the normal price relationship between the futures or options and the
investments being hedged. Also, because initial margin deposit requirements in
the futures markets are less onerous than margin requirements in the securities
markets, there might be increased participation by speculators in the future
markets. This participation also might cause temporary price distortions. In
addition, activities of large traders in both the futures and securities markets
involving arbitrage, "program trading" and other investment strategies might
result in temporary price distortions.
Swap Agreements. A Fund may enter into interest rate, securities index,
commodity, or security and currency exchange rate swap agreements for any lawful
purpose consistent with such Fund's investment objective, such as for the
purpose of attempting to obtain or preserve a particular desired return or
spread at a lower cost to the Fund than if the Fund had invested directly in an
instrument that yielded that desired return or spread. A Fund also may enter
into swaps in order to protect against an increase in the price of, or the
currency exchange rate applicable to, securities that the Fund anticipates
purchasing at a later date. Swap agreements are two-party contracts entered into
primarily by institutional investors for periods ranging from a few weeks to
several years. In a standard "swap" transaction, two parties agree to exchange
the returns (or differentials in rates of return) earned or realized on
particular predetermined investments or instruments. The gross returns to be
exchanged or "swapped" between the parties are calculated with respect to a
"notional amount," i.e., the return on or increase in value of a particular
dollar amount invested at a particular interest rate, in a particular foreign
currency, or in a "basket" of securities representing a particular index. Swap
agreements may include interest rate caps, under which, in return for a premium,
one party agrees to make payments to the other to the extent that interest rates
exceed a specified rate, or "cap"; interest rate floors under which, in return
for a premium, one party agrees to make payments to the other to the extent that
interest rates fall below a specified level, or "floor"; and interest rate
collars, under which a party sells a cap and purchases a floor, or vice versa,
in an attempt to protect itself against interest rate movements exceeding given
minimum or maximum levels.
The "notional amount" of the swap agreement is the agreed upon basis
for calculating the obligations that the parties to a swap agreement have agreed
to exchange. Under most swap agreements entered into by a Fund, the obligations
of the parties would be exchanged on a "net basis." Consequently, a Fund's
obligation (or rights) under a swap agreement will generally be equal only to
the net amount to be paid or received under the agreement based on the relative
values of the positions held by each party to the agreement (the "net amount").
A Fund's obligation under a swap agreement will be accrued daily (offset against
amounts owed to the Fund) and any accrued but unpaid net amounts owed to a swap
counterparty will be covered by the maintenance of a segregated account
consisting of cash or liquid assets.
Whether a Fund's use of swap agreements will be successful in
furthering its investment objective will depend, in part, on a Fund's adviser's
or subadviser's ability to predict correctly whether certain types of
investments are likely to produce greater returns than other investments. Swap
agreements may be considered to be illiquid. Moreover, a Fund bears the risk of
loss of the amount expected to be received under a swap agreement in the event
of the default or bankruptcy of a swap agreement counterparty. Certain
restrictions imposed on a Fund by the Internal Revenue Code may limit a Fund's
ability to use swap agreements. The swaps market is largely unregulated.
A Fund will enter swap agreements only with counterparties that a
Fund's adviser or subadviser reasonably believes are capable of performing under
the swap agreements. If there is a default by the other party to such a
transaction, a Fund will have to rely on its contractual remedies (which may be
limited by bankruptcy, insolvency or similar laws) pursuant to the agreements
related to the transaction.
Foreign Currency-Related Derivative Strategies - Special
Considerations. A Fund may use options and futures and options on futures on
foreign currencies and forward currency contracts to hedge against movements in
the values of the foreign currencies in which a Fund's securities are
denominated. A Fund may engage in currency exchange transactions to protect
against uncertainty in the level of future exchange rates and may also engage in
currency transactions to increase income and total return. Such currency hedges
can protect against price movements in a security the Fund owns or intends to
acquire that are attributable to changes in the value of the currency in which
it is denominated. Such hedges do not, however, protect against price movements
in the securities that are attributable to other causes.
A Fund might seek to hedge against changes in the value of a particular
currency when no hedging instruments on that currency are available or such
hedging instruments are more expensive than certain other hedging instruments.
In such cases, a Fund may hedge against price movements in that currency by
entering into transactions using hedging instruments on another foreign currency
or a basket of currencies, the values of which a subadviser believes will have a
high degree of positive correlation to the value of the currency being hedged.
The risk that movements in the price of the hedging instrument will not
correlate perfectly with movements in the price of the currency being hedged is
magnified when this strategy is used.
The value of derivative 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 hedging
instruments, a Fund could be disadvantaged by having to deal in the odd lot
market (generally consisting of transactions of less than $1 million) for the
underlying foreign currencies at prices that are less favorable than for round
lots.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations available through
dealers or other market sources be firm or revised on a timely basis. Quotation
information generally is representative of very large transactions in the
interbank market and thus might not reflect odd-lot transactions where rates
might be less favorable. The interbank market in foreign currencies is a global,
round-the-clock market. To the extent the U.S. options or futures markets are
closed while the markets for the underlying currencies remain open, significant
price and rate movements might take place in the underlying markets that cannot
be reflected in the markets for the derivative instruments until they reopen.
Settlement of derivative transactions involving foreign currencies
might be required to take place within the country issuing the underlying
currency. Thus, a Fund might be required to accept or make delivery of the
underlying foreign currency in accordance with any U.S. or foreign regulations
regarding the maintenance of foreign banking arrangements by U.S. residents and
might be required to pay any fees, taxes and charges associated with such
delivery assessed in the issuing country.
Permissible foreign currency options will include options traded
primarily in the OTC market. Although options on foreign currencies are traded
primarily in the OTC market, a Fund will normally purchase OTC options on
foreign currency only when a Fund's adviser or subadviser believes a liquid
secondary market will exist for a particular option at any specific time.
Forward Currency Contracts
A Fund may enter into forward currency contracts. 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 from the date of the contract
agreed upon by the parties, at a price set at the time of the contract. These
contracts are entered into in the interbank market conducted directly between
currency traders (usually large commercial banks) and their customers.
At or before the maturity of a forward contract, a Fund may either sell
a portfolio security and make delivery of the currency, or retain the security
and fully or partially offset its contractual obligation to deliver the currency
by purchasing a second contract. If a Fund retains the portfolio security and
engages in an offsetting transaction, the Fund, at the time of execution of the
offsetting transaction, will incur a gain or a loss to the extent that movement
has occurred in forward contract prices.
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 foreign
currency contract has been established. Thus, the 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 contracts. The projection of short-term
currency market movements is extremely difficult, and the successful execution
of a short-term hedging strategy is highly uncertain.
Currency Hedging. While the values of forward currency contracts,
currency options, currency futures and options on futures may be expected to
correlate with exchange rates, they will not reflect other factors that may
affect the value of a Fund's investments. A currency hedge, for example, should
protect a Yen-denominated bond against a decline in the Yen, but will not
protect a Fund against price decline if the issuer's creditworthiness
deteriorates. Because the value of a Fund's investments denominated in foreign
currency will change in response to many factors other than exchange rates, a
currency hedge may not be entirely successful in mitigating changes in the value
of a Fund's investments denominated in that currency over time.
A decline in the dollar value of a foreign currency in which a Fund's
securities are denominated will reduce the dollar value of the securities, even
if their value in the foreign currency remains constant. The use of currency
hedges does not eliminate fluctuations in the underlying prices of the
securities, but it does establish a rate of exchange that can be achieved in the
future. In order to protect against such diminutions in the value of securities
it holds, a Fund may purchase put options on the foreign currency. If the value
of the currency does decline, the Fund will have the right to sell the currency
for a fixed amount in dollars and will thereby offset, in whole or in part, the
adverse effect on its securities that otherwise would have resulted. Conversely,
if a rise in the dollar value of a currency in which securities to be acquired
are denominated is projected, thereby potentially increasing the cost of the
securities, a Fund may purchase call options on the particular currency. The
purchase of these options could offset, at least partially, the effects of the
adverse movements in exchange rates. Although currency hedges limit the risk of
loss due to a decline in the value of a hedged currency, at the same time, they
also limit any potential gain that might result should the value of the currency
increase.
A Fund may enter into foreign currency exchange transactions to hedge
its currency exposure in specific transactions or portfolio positions.
Transaction hedging is the purchase or sale of forward currency with respect to
specific receivables or payables of a Fund generally accruing in connection with
the purchase or sale of its portfolio securities. Position hedging is the sale
of forward currency with respect to portfolio security positions. A Fund may not
position hedge to an extent greater than the aggregate market value (at the time
of making such sale) of the hedged securities.
Cross Hedging. At the discretion of the Adviser, each of the Funds may
employ the currency hedging strategy known as "cross-hedging" by using forward
currency contracts, currency options or a combination of both. When engaging in
cross-hedging, a Fund seeks to protect against a decline in the value of a
foreign currency in which certain of its portfolio securities are denominated by
selling that currency forward into a different foreign currency for the purpose
of diversifying the Fund's total currency exposure or gaining exposure to a
foreign currency that is expected to appreciate.
Foreign Commercial Paper
A Fund may invest in commercial paper which is indexed to certain
specific foreign currency exchange rates. The terms of such commercial paper
provide that its principal amount is adjusted upwards or downwards (but not
below zero) at maturity to reflect changes in the exchange rate between two
currencies while the obligation is outstanding. A Fund will purchase such
commercial paper with the currency in which it is denominated and, at maturity,
will receive interest and principal payments thereon in that currency, but the
amount or principal payable by the issuer at maturity will change in proportion
to the change (if any) in the exchange rate between two specified currencies
between the date the instrument is issued and the date the instrument matures.
While such commercial paper entails the risk of loss of principal, the potential
for realizing gains as a result of changes in foreign currency exchange rate
enables a Fund to hedge or cross-hedge against a decline in the U.S. dollar
value of investments denominated in foreign currencies while providing an
attractive money market rate of return. A Fund will purchase such commercial
paper for hedging purposes only, not for speculation. The staff of the SEC is
currently considering whether the purchase of this type of commercial paper
would result in the issuance of a "senior security" within the meaning of the
Investment Company Act of 1940. The Funds believe that such investments do not
involve the creation of such a senior security, but nevertheless will establish
a segregated account with respect to its investments in this type of commercial
paper and to maintain in such account cash not available for investment or other
liquid assets having a value equal to the aggregate principal amount of
outstanding commercial paper of this type.
Securities Of Investment Companies
As permitted by the Investment Company Act of 1940, a Fund may invest
up to 10% of its total assets, calculated at the time of investment, in the
securities of other open-end or closed-end investment companies. No more than 5%
of a Fund's total assets may be invested in the securities of any one investment
company nor may it acquire more than 3% of the voting securities of any other
investment company. A Fund will indirectly bear its proportionate share of any
management fees paid by an investment company in which it invests in addition to
the advisory fee paid by the Fund. Some of the countries in which a Fund may
invest may not permit direct investment by outside investors. Investments in
such countries may only be permitted through foreign government-approved or
government-authorized investment vehicles, which may include other investment
companies.
Bank Obligations
Bank obligations that may be purchased by a Fund include certificates
of deposit, banker's acceptances and fixed time deposits. A certificate of
deposit is a short-term negotiable certificate issued by a commercial bank
against funds deposited in the bank and is either interest-bearing or purchased
on a discount basis. A bankers' acceptance is a short-term draft drawn on a
commercial bank by a borrower, usually in connection with an international
commercial transaction. The borrower is liable for payment as is the bank, which
unconditionally guarantees to pay the draft at its face amount on the maturity
date. Fixed time deposits are obligations of branches of U.S. banks or foreign
banks which are payable at a stated maturity date and bear a fixed rate of
interest. Although fixed time deposits do not have a market, there are no
contractual restrictions on the right to transfer a beneficial interest in the
deposit to a third party.
Bank obligations may be general obligations of the parent bank or may
be limited to the issuing branch by the terms of the specific obligations or by
government regulation.
Floating and Variable Rate Instruments
Floating or variable rate obligations bear interest at rates that are
not fixed, but vary with changes in specified market rates or indices, such as
the prime rate, or at specified intervals. Certain of the floating or variable
rate obligations that may be purchased by the Funds may carry a demand feature
that would permit the holder to tender them back to the issuer of the instrument
or to a third party at par value prior to maturity.
Some of the demand instruments purchased by a Fund may not be traded in
a secondary market and derive their liquidity solely from the ability of the
holder to demand repayment from the issuer or third party providing credit
support. If a demand instrument is not traded in a secondary market, the Fund
will nonetheless treat the instrument as "readily marketable" for the purposes
of its investment restriction limiting investments in illiquid securities unless
the demand feature has a notice period of more than seven days in which case the
instrument will be characterized as "not readily marketable" and therefore
illiquid.
Such obligations include variable rate master demand notes, which are
unsecured instruments issued pursuant to an agreement between the issuer and the
holder that permit the indebtedness thereunder to vary and to provide for
periodic adjustments in the interest rate. A Fund will limit its purchases of
floating and variable rate obligations to those of the same quality as it is
otherwise allowed to purchase. A Fund's adviser or subadviser will monitor on an
ongoing basis the ability of an issuer of a demand instrument to pay principal
and interest on demand.
A Fund's right to obtain payment at par on a demand instrument could be
affected by events occurring between the date the Fund elects to demand payment
and the date payment is due that may affect the ability of the issuer of the
instrument or third party providing credit support to make payment when due,
except when such demand instruments permit same day settlement. To facilitate
settlement, these same day demand instruments may be held in book entry form at
a bank other than a Fund's custodian subject to a subcustodian agreement
approved by the Fund between that bank and the Fund's custodian.
Inverse Floating Instruments. Certain Funds may invest up to 5% of
their net assets in inverse floating rate securities. The interest rate on an
inverse floater resets in the opposite direction from the market rate of
interest to which the inverse floater is indexed. An inverse floater may be
considered to be leveraged to the extent that its interest rate varies by a
magnitude that exceeds the magnitude of the change in the index rate of
interest. The higher degree of leverage inherent in inverse floaters is
associated with greater volatility in their market values.
Zero Coupon Securities, Pay-in-Kind Bonds ("PIK Bonds") and Deferred
Payment Securities
Zero coupon securities are debt securities that pay no cash income but
are sold at substantial discounts from their value at maturity. When a zero
coupon security is held to maturity, its entire return, which consists of the
amortization of discount, comes from the difference between its purchase price
and its maturity value. This difference is known at the time of purchase, so
that investors holding zero coupon securities until maturity know at the time of
their investment what the expected return on their investment will be. Zero
coupon securities may have conversion features. PIK bonds pay all or a portion
of their interest in the form of debt or equity securities. Deferred payment
securities are securities that remain zero coupon securities until a
predetermined date, at which time the stated coupon rate becomes effective and
interest becomes payable at regular intervals. Deferred payment securities are
often sold at substantial discounts from their maturity value.
Zero coupon securities, PIK bonds and deferred payment securities tend
to be subject to greater price fluctuations in response to changes in interest
rates than are ordinary interest-paying debt securities with similar maturities.
The value of zero coupon securities appreciates more during periods of declining
interest rates and depreciates more during periods of rising interest rates than
ordinary interest-paying debt securities with similar maturities. Zero coupon
securities, PIK bonds and deferred payment securities may be issued by a wide
variety of corporate and governmental issuers. Although these instruments are
generally not traded on a national securities exchange, they are widely traded
by brokers and dealers and, to such extent, will not be considered illiquid for
the purposes of a Fund's limitation on investments in illiquid securities.
Current federal income tax law requires the holder of a zero coupon
security, certain PIK bonds, deferred payment securities and certain other
securities acquired at a discount to accrue income with respect to these
securities prior to the receipt of cash payments. Accordingly, to avoid
liability for federal income and excise taxes, a Fund may be required to
distribute income accrued with respect to these securities and may have to
dispose of portfolio securities under disadvantageous circumstances in order to
generate cash to satisfy these distribution requirements.
Loan Participations and Assignments
Loan Participations typically will result in a Fund having a
contractual relationship only with the lender, not with the borrower. A Fund
will have the right to receive payments of principal, interest and any fees to
which it is entitled only from the lender selling the Participation and only
upon receipt by the lender of the payments from the borrower. In connection with
purchasing Loan Participations, a Fund generally will have no right to enforce
compliance by the borrower with the terms of the loan agreement relating to the
loan, nor any rights of set-off against the borrower, and a Fund may not benefit
directly from any collateral supporting the loan in which it has purchased the
Participation. As a result, a Fund will assume the credit risk of both the
borrower and the lender that is selling the Participation. In the event of the
insolvency of the lender selling a Participation, a Fund may be treated as a
general creditor of the lender and may not benefit from any set-off between the
lender and the borrower. A Fund will acquire Loan Participations only if the
lender interpositioned between the Fund and the borrower is determined by the
applicable subadviser to be creditworthy. When a Fund purchases Assignments from
lenders, the Fund will acquire direct rights against the borrower on the loan,
except that under certain circumstances such rights may be more limited than
those held by the assigning lender.
A Fund may have difficulty disposing of Assignments and Loan
Participations. Because the market for such instruments is not highly liquid,
the Fund anticipates that such instruments could be sold only to a limited
number of institutional investors. The lack of a highly liquid secondary market
may have an adverse impact on the value of such instruments and will have an
adverse impact on the Fund's ability to dispose of particular Assignments or
Loan Participations in response to a specific economic event, such as
deterioration in the creditworthiness of the borrower.
In valuing a Loan Participation or Assignment held by a Fund for which
a secondary trading market exists, the Fund will rely upon prices or quotations
provided by banks, dealers or pricing services. To the extent a secondary
trading market does not exist, the Fund's Loan Participations and Assignments
will be valued in accordance with procedures adopted by the Board of Trustees,
taking into consideration, among other factors: (i) the creditworthiness of the
borrower under the loan and the lender; (ii) the current interest rate; period
until next rate reset and maturity of the loan; (iii) recent prices in the
market for similar loans; and (iv) recent prices in the market for instruments
of similar quality, rate, period until next interest rate reset and maturity.
Mortgage Dollar Rolls and Reverse Repurchase Agreements
A Fund may engage in reverse repurchase agreements to facilitate
portfolio liquidity, a practice common in the mutual fund industry, or for
arbitrage transactions discussed below. In a reverse repurchase agreement, a
Fund would sell a security and enter into an agreement to repurchase the
security at a specified future date and price. A Fund generally retains the
right to interest and principal payments on the security. Since a Fund receives
cash upon entering into a reverse repurchase agreement, it may be considered a
borrowing (see "Borrowing"). When required by guidelines of the SEC, a Fund will
set aside permissible liquid assets in a segregated account to secure its
obligations to repurchase the security. At the time a Fund enters into a reverse
repurchase agreement, it will establish and maintain a segregated account with
an approved custodian containing liquid securities having a value not less than
the repurchase price (including accrued interest). The assets contained in the
segregated account will be marked-to-market daily and additional assets will be
placed in such account on any day in which the assets fall below the repurchase
price (plus accrued interest). A Fund's liquidity and ability to manage its
assets might be affected when it sets aside cash or portfolio securities to
cover such commitments. Reverse repurchase agreements involve the risk that the
market value of the securities retained in lieu of sale may decline below the
price of the securities the Fund has sold but is obligated to repurchase. In the
event the buyer of securities under a reverse repurchase agreement files for
bankruptcy or becomes insolvent, such buyer or its trustee or receiver may
receive an extension of time to determine whether to enforce the Fund's
obligation to repurchase the securities, and the Fund's use of the proceeds of
the reverse repurchase agreement may effectively be restricted pending such
determination. Reverse repurchase agreements are considered to be borrowings
under the Investment Company Act of 1940.
Mortgage dollar rolls are arrangements in which a Fund would sell
mortgage-backed securities for delivery in the current month and simultaneously
contract to purchase substantially similar securities on a specified future
date. While a Fund would forego principal and interest paid on the
mortgage-backed securities during the roll period, the Fund would be compensated
by the difference between the current sales price and the lower price for the
future purchase as well as by any interest earned on the proceeds of the initial
sale. A Fund also could be compensated through the receipt of fee income
equivalent to a lower forward price. At the time the Fund would enter into a
mortgage dollar roll, it would set aside permissible liquid assets in a
segregated account to secure its obligation for the forward commitment to buy
mortgage-backed securities. Mortgage dollar roll transactions may be considered
a borrowing by the Funds. (See "Borrowing")
Mortgage dollar rolls and reverse repurchase agreements may be used as
arbitrage transactions in which a Fund will maintain an offsetting position in
investment grade debt obligations or repurchase agreements that mature on or
before the settlement date on the related mortgage dollar roll or reverse
repurchase agreements. Since a Fund will receive interest on the securities or
repurchase agreements in which it invests the transaction proceeds, such
transactions may involve leverage. However, since such securities or repurchase
agreements will be high quality and will mature on or before the settlement date
of the mortgage dollar roll or reverse repurchase agreement, the Fund's adviser
or subadviser believes that such arbitrage transactions do not present the risks
to the Funds that are associated with other types of leverage.
Temporary Defensive Positions
In response to economic, political or unusual market conditions, each
Fund, except the Tax-Free Income Fund, may invest up to 100% of its assets in
cash or money market obligations. The Tax-Free Income Fund may as a temporary
defensive position invest up to 20% of its assets in cash and taxable money
market instruments. In addition, a Fund may have, from time to time, significant
cash positions until suitable investment opportunities are available.
INVESTMENT RESTRICTIONS
The following are fundamental investment restrictions of each Fund
which cannot be changed without the authorization of the majority of the
outstanding shares of the Fund for which a change is proposed. The vote of the
majority of the outstanding securities means the vote of (A) 67% or more of the
voting securities present at such meeting, if the holders of more than 50% of
the outstanding voting securities are present or represented by proxy or (B) a
majority of the outstanding securities, whichever is less. None of the following
restrictions will prevent a Fund from investing all of its assets in shares of
one or more other registered investment companies.
Each of the Funds:
May not borrow money or issue senior securities, except that each Fund
may enter into reverse repurchase agreements and may otherwise borrow
money and issue senior securities as and to the extent permitted by the
1940 Act or any rule, order or interpretation thereunder.
May not purchase or sell real estate, except that each Fund may acquire
real estate through ownership of securities or instruments and may
purchase or sell securities issued by entities or investment vehicles
that own or deal in real estate (including interests therein) or
instruments secured by real estate (including interests therein).
May not lend any security or make any other loan, except that each Fund
may purchase or hold debt securities and lend portfolio securities in
accordance with its investment objective and policies, make time
deposits with financial institutions and enter into repurchase
agreements.
May not act as an underwriter of another issuer's securities, except to
the extent that the Fund may be deemed an underwriter within the
meaning of the Securities Act in connection with the purchase and sale
of portfolio securities.
May not purchase or sell commodities or commodities contracts, except
to the extent disclosed in the current Prospectus and Statement of
Additional Information of such Fund.
May not purchase the securities of any issuer if, as a result, 25% or
more than (taken at current value) of the Fund's total assets would be
invested in the securities of issuers, the principal activities of
which are in the same industry; provided, that in replicating the
weightings of a particular industry in its target index, a Series or
Fund may invest more than 25% of its total assets in securities of
issuers in that industry.
The following are the non-fundamental operating policies of the Funds
which may be changed by the Board of Trustees of the Trust without shareholder
approval:
Each Fund may not:
Sell securities short, unless the Fund owns or has the right to obtain
securities equivalent in kind and amount to the securities sold short
or unless it covers such short sales as required by the current rules
and positions of the SEC or its staff, and provided that short
positions in forward currency contracts, options, futures contracts,
options on futures contracts, or other derivative instruments are not
deemed to constitute selling securities short.
Purchase securities on margin, except that the Fund may obtain such
short-term credits as are necessary for the clearance of transactions;
and provided that margin deposits in connection with options, futures
contracts, options on futures contracts, transactions in currencies or
other derivative instruments shall not constitute purchasing securities
on margin.
Purchase or otherwise acquire any security if, as a result, more than
15% of its net assets would be invested in securities that are
illiquid.
Pledge, mortgage or hypothecate any assets owned by the Fund in excess
of 33 1/3% of the Fund's total assets at the time of such pledging,
mortgaging or hypothecating.
TRUSTEES AND OFFICERS OF THE TRUST
The business and affairs of the Trust are managed under the direction
of its Board of Trustees. The Board of Trustees sets and reviews policies
regarding the operation of the Trust, and directs the officers to perform the
daily functions of the Trust.
The principal occupation of the Trustees and Officers during the last
five years, their ages, their addresses and their affiliations are:
JOHN C. BRYANT, Trustee*, Age 63
411 Oak St., Suite 306, Cincinnati, Ohio 45219 Dr. Bryant is Executive Director,
Cincinnati Youth Collaborative, a partnership of business, government, schools
and social service agencies to address the educational needs of students. He was
formerly Professor of Education, Wilmington College.
C. BRENT DEVORE, Trustee, Age 58
North Walnut and West College Avenue, Westerville, Ohio
Dr. DeVore is President of Otterbein College.
SUE A. DOODY, Trustee, Age 64
169 East Beck Street, Columbus, Ohio
Ms. Doody is President of Lindey's Restaurant, Columbus, Ohio. She is an active
member of the Greater Columbus Area Chamber of Commerce Board of Trustees.
ROBERT M. DUNCAN, Trustee*, Age 71
1397 Haddon Road, Columbus, Ohio
Mr. Duncan is a member of the Ohio Elections Commission. He was formerly
Secretary to the Board of Trustees of The Ohio State University. Prior to that,
he was Vice President and General Counsel of The Ohio State University.
THOMAS J. KERR, IV, Trustee*, Age 65
4890 Smoketalk Lane, Westerville, Ohio
Dr. Kerr is President Emeritus of Kendall College. He was formerly President of
Grant Hospital Development Foundation.
DOUGLAS F. KRIDLER, Trustee, Age 43
55 E. State Street, Columbus, Ohio
Mr. Kridler is President of the Columbus Association of Performing Arts.
DIMON R. MCFERSON, Trustee*+, Age 61
One Nationwide Plaza, Columbus, Ohio
Mr. McFerson is President and Chief Executive Officer of the Nationwide
Insurance Enterprise and is Chairman and Chief Executive Officer of Nationwide
Advisory Services, Inc.
NANCY C. THOMAS, Trustee+, Age 64
10835 Georgetown Road, NE, Louisville, Ohio
Ms. Thomas is a farm owner and operator. She is also a Director of the
Nationwide Insurance Companies and associated companies.
DAVID C. WETMORE, Trustee, Age 50
11495 Sunset Hills Rd - Suite #210, Reston, Virginia
Mr. Wetmore is the Managing Director of The Updata Capital, a venture capital
firm.
JAMES F. LAIRD, JR., Treasurer, Age 42
Three Nationwide Plaza, Columbus, Ohio
Mr. Laird is Vice President and General Manager of Nationwide Advisory Services,
Inc., the Distributor.
CHRISTOPHER A. CRAY, Assistant Treasurer, age 40
Three Nationwide Plaza, Columbus, Ohio
Mr. Cray is Treasurer of Villanova Mutual Fund Capital Trust, the adviser and
Nationwide Advisory Services, Inc., the Distributor. Prior to that he was
Director - Corporate Accounting of Nationwide Insurance Enterprise.
ELIZABETH A. DAVIN, Secretary, age 35
Three Nationwide Plaza, Columbus, Ohio Ms. Davin is a member of Dietrich,
Reynolds & Koogler, the Trust's legal counsel.
+ A Trustee who is an "interested person" of the Trust as defined in the
Investment Company Act.
*Members of the Executive Committee. Mr. McFerson is Chairman. The Executive
Committee has the authority to act for the Board of Trustees except as provided
by law and except as specified in the Trust's Bylaws.
Bryant, Doody, DeVore, Duncan, Kerr, Kridler and Wetmore are also Trustees, and
Laird, Cray and Davin are also Officers of Nationwide Separate Account Trust and
Nationwide Asset Allocation Trust, registered investment companies in the
Nationwide Fund Complex.
All Trustees and Officers of the Trust own less than 1% of its
outstanding shares.
The Trustees receive fees and reimbursement for expenses of attending
board meetings from the Trust. VMF reimburses the Trust for fees and expenses
paid to Trustees who are interested persons of the Trust. The Compensation Table
below sets forth the total compensation to be paid to the Trustees of the Trust,
before reimbursement, for the fiscal period ended October 31, 1998. In addition,
the table sets forth the total compensation to be paid to the Trustees from all
funds in the Nationwide Fund Complex, including the predecessor investment
companies to the Trust, for the fiscal year ended October 31, 1998. Trust
officers receive no compensation from the Trust in their capacity as officers.
COMPENSATION TABLE
<TABLE>
<CAPTION>
Pension
Retirement
Aggregate Benefits Annual Total
Compensation Accured As Benefits Compensation
Name of Person, From Part of Trust Upon From the Fund
Position The Trust Expenses Retirement Complex**
<S> <C> <C> <C> <C>
John C. Bryant, Trustee $ 10,000 --0-- --0-- $21,000
C. Brent DeVore, Trustee 10,000 --0-- --0-- 12,250
Sue A. Doody, Trustee 10,000 --0-- --0-- 21,000
Robert M Duncan, Trustee 10,000 --0-- --0-- 21,000
Thomas J. Kerr, IV, Trustee 10,000 --0-- --0-- 21,000
Douglas F. Kridler, Trustee 10,000 --0-- --0-- 21,000
Dimon R. McFerson, Trustee --0-- --0-- --0-- --0--
Nancy C. Thomas, Trustee 10,000 --0-- --0-- 10,000
David C. Wetmore, Trustee 10,000 --0-- --0-- 12,250
</TABLE>
**The Fund Complex includes three trusts comprised of ______ investment company
funds or series.
Each of the Trustees and officers and their families are eligible to
purchase Class D shares of the Funds which offer such Class and generally charge
a front-end sales charge, at net asset value without a sales charge. This is
permitted because there are few marketing expenses associated with these sales.
INVESTMENT ADVISORY AND OTHER SERVICES
Investment Adviser
Under the terms of the Investment Advisory Agreement dated May 9, 1998
as amended as of December __, 1999, Villanova Mutual Fund Capital Trust ("VMF")
manages the investment of the assets of the Funds in accordance with the
policies and procedures established by the Trustees. With respect to the Mid Cap
Growth Fund, Growth Fund, Nationwide Fund, Bond Fund, Tax-Free Income Fund,
Long-Term U.S. Government Bond Fund, Intermediate U.S. Government Bond Fund, and
Money Market Fund, the Nationwide Focus Fund, Nationwide High Yield Bond Fund,
the Aggressive Fund, the Moderately Aggressive Fund, the Moderate Fund, the
Moderately Conservative Fund and the Conservative Fund, VMF manages the
day-to-day investments of the assets of such Funds. With respect to each of the
other Funds (except the Nationwide Index Funds), VMF provides investment
management evaluation services in initially selecting and monitoring on an
ongoing basis the performance of the Subadvisers, who each manage the investment
portfolio of a particular Fund. VMF is also authorized to select and place
portfolio investments on behalf of the Funds which engage Subadvisers; however
VMF does not intend to do so at this time.
VMF pays the compensation of the Trustees and officers affiliated with
VMF. VMF also furnishes, at its own expense, all necessary administrative
services, office space, equipment, and clerical personnel for servicing the
investments of the Trust and maintaining its investment advisory facilities, and
executive and supervisory personnel for managing the investments and effecting
the portfolio transactions of the Trust.
The Investment Advisory Agreement also specifically provides that VMF,
including its directors, officers, and employees, shall not be liable for any
error of judgment, or mistake of law, or for any loss arising out of any
investment, or for any act or omission in the execution and management of the
Trust, except for willful misfeasance, bad faith, or gross negligence in the
performance of its duties, or by reason of reckless disregard of its obligations
and duties under the Agreement. The Agreement will continue in effect for an
initial period of two years and thereafter shall continue automatically for
successive annual periods provided such continuance is specifically approved at
least annually by the Trustees, or by vote of a majority of the outstanding
voting securities of the Trust, and, in either case, by a majority of the
Trustees who are not parties to the Agreement or interested persons of any such
party. The Agreement terminates automatically in the event of its "assignment",
as defined under the 1940 Act. It may be terminated as to a Fund without penalty
by vote of a majority of the outstanding voting securities of that Fund, or by
either party, on not less than 60 days written notice. The Agreement further
provides that VMF may render similar services to others.
The Trust pays the compensation of the Trustees who are not interested
[affiliated][check agreement] persons of VMF and all expenses (other than those
assumed by VMF), including governmental fees, interest charges, taxes,
membership dues in the Investment Company Institute allocable to the Trust; fees
under the Trust's Fund Administration Agreement; fees and expenses of
independent certified public accountants, legal counsel, and any transfer agent,
registrar, and dividend disbursing agent of the Trust; expenses of preparing,
printing, and mailing shareholders' reports, notices, proxy statements, and
reports to governmental offices and commissions; expenses connected with the
execution, recording, and settlement of portfolio security transactions;
insurance premiums; fees and expenses of the custodian for all services to the
Trust; expenses of calculating the net asset value of shares of the Trust;
expenses of shareholders' meetings; and expenses relating to the issuance,
registration, and qualification of shares of the Trust. VMF reimburses the Trust
for fees and expenses paid to Trustees who are interested [affiliated] persons
of the Trust.
VMF, a Delaware business trust, is a wholly owned subsidiary of
Villonova Capital, Inc., 97% of the common stock of which is held by Nationwide
Financial Services, Inc. (NFS). NFS, a holding company, has two classes of
common stock outstanding with different voting rights enabling Nationwide
Corporation (the holder of all of the outstanding Class B common stock) to
control NFS. Nationwide Corporation is also a holding company in the Nationwide
Insurance Enterprise. All of the Common Stock of Nationwide Corporation is held
by Nationwide Mutual Insurance Company (95.3%) and Nationwide Mutual Fire
Insurance Company (4.7%), each of which is a mutual company owned by its
policyholders.
For services provided under the Investment Advisory Agreement, VMF
receives an annual fee paid monthly based on average daily net assets of each
Fund according to the following schedule:
<TABLE>
<CAPTION>
Fund Assets Fee
- ---- ------ ---
<S> <C> <C>
Nationwide Mid Cap Growth Fund, $0 up to $250 million 0.60%
Nationwide Growth Fund, Nationwide $250 million up to $1 billion 0.575%
Fund and Nationwide Focus Fund $1 billion up to $2 billion 0.55%
$2 billion up to $5 billion 0.525%
$5 Billion and more 0.50%
Nationwide Bond Fund, $0 up to $250 million 0.50%
Nationwide Tax-Free Income Fund, $250 million up to $1 billion 0.475%
Nationwide Long-Term U.S. Government $1 billion up to $2 billion 0.45%
Bond Fund, and Nationwide $2 billion up to $5 billion 0.425%
Intermediate U.S. Government Bond Fund $5 Billion and more 0.40%
Nationwide Money Market Fund $0 up to $1 billion 0.40%
$1 billion up to $2 billion 0.38%
$2 billion up to $5 billion 0.36%
$5 billion and more 0.34%
Nationwide S&P 500 Index Fund all assets 0.13%
Prestige Large Cap Value Fund up to $100 million 0.75%
$100 million or more 0.70%
Prestige Large Cap Growth Fund up to $150 million 0.80%
$150 million or more 0.70%
Prestige Balanced Fund up to $100 million 0.75%
$100 million or more 0.70%
Prestige Small Cap Fund up to $100 million 0.95%
$100 million or more 0.80%
Prestige International Fund up to $200 million 0.85%
$200 million or more 0.80%
The Aggressive Fund all assets 0.13%
The Moderately Aggressive Fund all assets 0.13%
The Moderate Fund all assets 0.13%
The Moderately Conservative Fund all assets 0.13%
The Conservative Fund all assets 0.13%
Nationwide Small Cap Value Fund II $0 up to $250 million 0.270%
$250 million up to $1 billion 0.675%
$1 billion up to $2 billion 0.65%
$2 billion up to $5 billion 0.625%
$5 billion and more 0.60%
Nationwide High Yield Bond Fund $0 up to $250 million 0.55%
$250 million up to $1 billion 0.525%
$1 billion up to $2 billion 0.50%
$2 billion up to $5 billion 0.475%
$5 billion and more 0.45%
</TABLE>
VMF has also agreed to waive advisory fees, and if necessary, reimburse
expenses in order to limit annual Fund operating expenses for certain of the
Funds as follows:
-- Nationwide Mid Cap Growth Fund to 1.25% for Class A shares, 2.00% for
Class B shares and 1.00% for Class D shares
-- Nationwide Long-Term U.S. Government Bond Fund and Nationwide
Intermediate U.S. Government Bond Fund to 1.04% for Class A shares,
1.64% for Class B shares and 0.79% for Class D shares
-- Prestige Large Cap Value Fund to 1.15% for Class A shares, 1.90% for
Class B shares and 1.00% for Class Y shares
-- Prestige Large Cap Growth Fund to 1.20% for Class A shares, 1.95% for
Class B shares and 1.05% for Class Y shares
-- Prestige Balanced Fund to 1.10% for Class A shares, 1.85% for Class B
shares and 0.95% for Class Y shares
-- Prestige Small Cap Fund to 1.35% for Class A shares, 2.10% for Class B
shares and 1.20% for Class Y shares
-- Prestige Large Cap Value Fund to 1.30% for Class A shares, 2.05% for
Class B shares and 1.25% for Class Y shares
-- Nationwide S&P 500 Index Fund to 0.48% for Class Y shares, 0.63% for
Class R shares and 0.35% for Local Fund shares
-- each of the Life Strategy Series to 0.56% for Class A shares, 1.31% for
Class B shares and 0.36% for Service Class shares
-- Nationwide Focus Fund to 1.20% for Class A shares, 1.70% for Class B
shares and 0.75% for Institutional Class shares Nationwide Small Cap
Value Fund II to 1.35% for Class A shares, 1.85% for Class B shares and
1.00% for Institutional Class shares
-- Nationwide High Yield Bond Fund to 1.20% for Class A shares, 1.80% for
Class B shares and 0.85% for Institutional Class shares
In the interest of limiting the expenses of each of the Funds listed
above (except the Nationwide MidCap Growth Fund, the Nationwide Long-Term U.S.
Government Bond Fund, the Nationwide Intermediate U.S. Government Bond Fund and
the Nationwide S&P 500 Index Fund, VMF has entered into an expense limitation
agreement with the Fund ("Expense Limitation Agreement"). Pursuant to the
Expense Limitation Agreement, UBT has agreed to waive or limit its fees and to
assume other expenses (except for Rule 12b-1 Fees and Administrative Service
Fees) to the extent necessary to limit the total annual operating expenses of
each Class of the Fund to the limits described above. Reimbursement by the Fund
of the advisory fees waived or limited and other expenses reimbursed by VMF
pursuant to the Expense Limitation Agreement may be made at a later date when
the Fund has reached a sufficient asset size to permit reimbursement to be made
without causing the total annual operating expense ratio of the Fund to exceed
the limits set forth above. No reimbursement will be made unless: (i) the Fund's
assets exceed $100 million; (ii) the total annual expense ratio of the Class
making such reimbursement is less than the limit set forth above; and (iii) the
payment of such reimbursement is approved by the Board of Trustees on a
quarterly basis. Except as provided for in the Expense Limitation Agreement,
reimbursement of amounts previously waived or assumed by VMF is not permitted.
VMF may from time to time waive some or all of its investment advisory
fee or other fees for any of the fund of the Trust. The waiver of such fees will
cause the total return and yield of a fund to be higher than they would
otherwise be in the absence of such a waiver.
During the fiscal years ended October 31, 1998, 1997 and 1996, NAS
received the following fees for investment advisory services*:
<TABLE>
<CAPTION>
Acquired Years Ended October 31,
Fund Fund* 1998 1997 1996
- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C>
Mid Cap Growth Growth of FHIT $ 61,706 $ 63,883 $ 54,053
Growth Growth of NIF 4,894,110 3,750,599 3,212,196
Nationwide Fund Nationwide Fund of NIF 9,977,231 5,938,011 4,425,921
Bond Bond of NIF 647,809 629,068 663,545
Tax-Free Income Tax-Free Income of NIF II and
Municipal Bond of FHIT 1,505,626 1,810,070 1,855,962
LT U.S. Govt. Government of FHIT 254,928 343,259 414,415
Intermediate U.S. Govt. U.S. Govt. of NIF II 266,473 256,016 255,149
Money Market** Money Market of NIF and 3,857,898 3,519,727 2,969,392
Cash Reserve of FHIT
</TABLE>
* As of May 9, 1998, the Funds acquired all of the assets of one or more series
of Nationwide Investing Foundation ("NIF"), Nationwide Investing Foundation II
("NIF II") and Financial Horizons Investment Trust ("FHIT") (collectively, the
"Acquired Funds"), as described above, in exchange for the assumption of the
stated liabilities of the Acquired Funds and a number of full and fractional
Class D shares of the applicable Fund (the Money Market Fund issued shares
without class designation) having an aggregate net asset value equal to the net
assets of the Acquired Funds as applicable (the "Reorganization").
** Net of waivers prior to the Reorganization of $221,174, $389,150 and $328,076
for the fiscal year ended October 31, 1998, 1997, and 1996, respectively.
During the period from July 24, 1998 (date of commencement of
operations) through October 31, 1998, NAS waived advisory fees for the S&P 500
Index Fund in the amount of $7,315. The Large Cap Value, Large Cap Growth,
Balanced, Small Cap and International Funds did not begin operations until
November 2, 1998.
The Subadvisers for the Funds are as follows:
Fund Subadviser
- ---- ----------
Large Cap Value Brinson Partners, Inc. ("Brinson Partners")
Large Cap Growth Goldman Sachs Asset Management ("GSAM")
Balanced J.P. Morgan Investment Management, Inc. ("J.P. Morgan")
Small Cap INVESCO Management & Research, Inc. ("IMR")
International Lazard Asset Management ("Lazard")
S&P 500 Index The Dreyfus Corporation
Small Cap Value II Villanova Value Investors, Inc. ("VVI")
Brinson Partners, a Delaware corporation and an investment management
firm, is an indirect wholly-owned subsidiary of UBS AG, an internationally
diversified organization headquartered in Zurich, Switzerland, with operations
in many aspects of the financial services industry. GSAM is a separate operating
division of Goldman Sachs & Co., an investment banking firm whose headquarters
are in New York, New York. J.P. Morgan is a directly wholly owned subsidiary of
J.P. Morgan & Co. Incorporated, a bank holding company organized under the laws
of Delaware. J.P. Morgan offers a wide range investment management services and
acts as investment adviser to corporate and institutional clients. IMR is part
of a global investment organization, AMVESCAP plc. AMVESCAP plc is a
publicly-traded holding company that, through its subsidiaries, engages in the
business of investment management on an international basis. Lazard is a New
York-based division of Lazard Freres & Co. LLC, a limited liability company
registered as an investment adviser and providing investment management services
to client discretionary accounts. The Dreyfus Corporation ("Dreyfus"), 200 Park
Avenue, New York, N.Y. 10166, which was formed in 1947 and is registered under
the Investment Advisers Act of 1940, serves as subadviser to the Fund pursuant
to a Subadvisory Agreement dated July 23, 1998. Dreyfus is a wholly-owned
subsidiary of Mellon Bank, N.A., which is a wholly-owned subsidiary of Mellon
Bank Corporation.
Villanova Value Investors, Inc. is a subsidiary of Villanova Capital,
Inc. which is also the parent of VMF. VVI is located at 56767 Mt. Vernon, Shelby
Township, Michigan 48316 and was formed in 1999.
Subject to the supervision of the VMF and the Trustees, each of the
Subadvisers manages the assets of the Fund listed above in accordance with the
Fund's investment objectives and policies. Each Subadviser makes investment
decisions for the Fund and in connection with such investment decisions places
purchase and sell orders for securities. For the investment management services
they provide to the Funds, the Subadvisers receive annual fees from VMF,
calculated at an annual rate based on the average daily net assets of the Funds,
in the following amounts:
Fund Assets Fee
- ---- ------ ---
Large Cap Value Fund up to $100 million 0.35%
$100 million or more 0.30%
Large Cap Growth Fund up to $150 million 0.40%
$150 million or more 0.30%
Balanced Fund up to $100 million 0.35%
$100 million or more 0.30%
Small Cap Fund up to $100 million 0.55%
$100 million or more 0.40%
International Fund up to $200 million 0.45%
$200 million or more 0.40%
S&P 500 Index Fund up to $250 million 0.07%
next $250 million 0.06%
next $500 million 0.05%
$1 billion or more 0.04%
Nationwide Small Cap Value $0 up to $250 million 0.70%
Fund II $250 million up to $1 billion 0.675%
$1 billion up to $2 billion 0.65%
$2 billion up to $5 billion 0.625%
$5 billion and more 0.60%
During the period from July 24, 1998 (date of commencement of
operations) through October 31, 1998, NAS paid $3,939 in subadvisory fees to
Dreyfus with respect to the S & P 500 Index Fund.
VMF and the Trust have received from the Securities and Exchange
Commission an exemptive order for the multi-manager structure which allows VMF
to hire, replace or terminate subadvisers without the approval of shareholders;
the order also allows VMF to revise a subadvisory agreement without shareholder
approval. If a new subadviser is hired, the change will be communicated to
shareholders within 90 days of such changes, and all changes will be approved by
the Trust's Board of Trustees, including a majority of the Trustees who are not
interested persons of the Trust or VMF. The order is intended to facilitate the
efficient operation of the Funds and afford the Trust increased management
flexibility.
VMF provides to the Funds investment management evaluation services
principally by performing initial due diligence on prospective Subadvisers for
the Fund and thereafter monitoring the performance of the Subadviser through
quantitative and qualitative analysis as well as periodic in-person, telephonic
and written consultations with the Subadviser. VMF has responsibility for
communicating performance expectations and evaluations to the Subadviser and
ultimately recommending to the Trust's Board of Trustees whether the
Subadviser's contract should be renewed, modified or terminated; however, VMF
does not expect to recommend frequent changes of subadvisers. VMF will regularly
provide written reports to the Trust's Board of Trustees regarding the results
of its evaluation and monitoring functions. Although VMF will monitor the
performance of the Subadvisers, there is no certainty that the Subadviser or the
Fund will obtain favorable results at any given time.
Morley Capital Accumulation Fund and Morley Enhanced Income Fund
Under the terms of the Trust's investment advisory agreement with UBT
(the "UBT Advisory Agreement"), UBT manages the Morley Capital Accumulation Fund
and Morley Enhanced Income Fund, subject to the supervision and direction of the
Board of Trustees. UBT will: (i) act in strict conformity with the Declaration
of Trust and the 1940 Act, as the same may from time to time be amended; (ii)
manage the Fund in accordance with the Fund's investment objectives,
restrictions and policies; (iii) make investment decisions for the Fund; and
(iv) place purchase and sale orders for securities and other financial
instruments on behalf of the Fund.
UBT has informed the Fund that, in making its investment decisions, it
does not obtain or use material inside information in its possession or in the
possession of any of its affiliates. In making investment recommendations for
the Fund, UBT will not inquire or take into consideration whether an issuer of
securities proposed for purchase or sale by the Fund is a customer of UBT, its
parent or its affiliates and, in dealing with its customers, UBT, its parent and
affiliates will not inquire or take into consideration whether securities of
such customers are held by any fund managed by UBT or any such affiliate.
Morley Financial Services, Inc. ("MFS") owns 100% of the issued and
outstanding voting securities of UBT. MFS, an Oregon corporation, is a wholly
owned subsidiary of Villanova Capital, Inc..
UBT is a state bank and trust company chartered in 1913 and reorganized
under the laws of the state of Oregon in 1992. UBT provides a range of
investment and fiduciary services to institutional clients. UBT maintains and
manages common and pooled trust funds invested primarily in fixed income assets
whose principal value is relatively stable. UBT currently has approximately $1.0
billion under management. UBT also acts as custodian with respect to similar
fixed income assets.
Under the terms of the Investment Advisory Agreement dated February 1,
1999, as amended, UBT manages the investment of the assets of the Morley Capital
Accumulation Fund and Morley Enhanced Income Fund in accordance with the
policies and procedures established by the Trustees. UBT pays the Fund's pro
rata share of the compensation of the Trustees who are interested persons of the
Trust and officers and employees of UBT. UBT also furnishes, at its own expense,
all necessary administrative services, office space, equipment, and clerical
personnel for servicing the investments of the Fund and maintaining its
investment advisory facilities, and executive and supervisory personnel for
managing the investments and effecting the portfolio transactions of the Fund.
The Investment Advisory Agreement also specifically provides that UBT,
including its directors, officers, and employees, shall not be liable for any
error of judgment, or mistake of law, or for any loss arising out of any
investment, or for any act or omission in the execution and management of the
Fund, except for willful misfeasance, bad faith, or gross negligence in the
performance of its duties, or by reason of reckless disregard of its obligations
and duties under the Agreement. The Agreement will continue in effect for an
initial period of two years and thereafter shall continue automatically for
successive annual periods provided such continuance is specifically approved at
least annually by the Trustees, or by vote of a majority of the outstanding
voting securities of the Fund, and, in either case, by a majority of the
Trustees who are not parties to the Agreement or interested persons of any such
party. The Agreement terminates automatically in the event of its "assignment",
as defined under the 1940 Act. It may be terminated as to the Fund without
penalty by vote of a majority of the outstanding voting securities of the Fund,
or by either party, on not less than 60 days written notice. The Agreement
further provides that UBT may render similar services to others.
Subject to the Fund's Expense Limitation Agreement the Trust pays the
compensation of the Trustees who are not interested persons of the Trust and all
expenses (other than those assumed by UBT), including governmental fees,
interest charges, taxes, membership dues in the Investment Company Institute
allocable to the Trust; fees under the Trust's Fund Administration Agreement;
fees and expenses of independent certified public accountants, legal counsel,
and any transfer agent, registrar, and dividend disbursing agent of the Trust;
expenses of preparing, printing, and mailing shareholders' reports, notices,
proxy statements, and reports to governmental offices and commissions; expenses
connected with the execution, recording, and settlement of portfolio security
transactions, insurance premiums, fees and expenses of the custodian for all
services to the Trust; and expenses of calculating the net asset value of shares
of the Trust, expenses of shareholders' meetings, and expenses relating to the
issuance, registration, and qualification of shares of the Trust.
As compensation for UBT's services to the Morley Capital Accumulation
Fund, the Fund is obligated to pay UBT a fee computed and accrued daily and paid
monthly at an annual rate of 0.35% of the average daily net assets of the Fund.
As of October 31, 1999, the Fund had incurred investment advisory fees in the
amount of $___________. In the interest of limiting the expenses of the Fund,
UBT has entered into an expense limitation agreement with the Fund ("Expense
Limitation Agreement"). Pursuant to the Expense Limitation Agreement, UBT has
agreed to waive or limit its fees and to assume other expenses (except for Rule
12b-1 Fees) to the extent necessary to limit the total annual operating expenses
of each Class of the Fund (expressed as a percentage of average daily net assets
and excluding Rule 12b-1 Fees) to no more than 0.70% for ISC Shares 0.55% for IC
Shares and 0.70% for IRA Shares. Reimbursement by the Fund of the advisory fees
waived or limited and other expenses reimbursed by UBT pursuant to the Expense
Limitation Agreement may be made at a later date when the Fund has reached a
sufficient asset size to permit reimbursement to be made without causing the
total annual operating expense ratio of the Fund to exceed the limits set forth
above. No reimbursement will be made unless: (i) the Fund's assets exceed $50
million; (ii) the total annual expense ratio of the Class making such
reimbursement is less than the limit set forth above; and (iii) the payment of
such reimbursement is approved by the Board of Trustees on a quarterly basis.
Except as provided for in the Expense Limitation Agreement, reimbursement of
amounts previously waived or assumed by UBT is not permitted.
As compensation for UBT's services to the Morley Enhanced Income Fund,
the Fund is obligated to pay UBT a fee computed and accrued daily and paid
monthly at an annual rate of 0.35% of the average daily net assets of the Fund.
In the interest of limiting the expenses of the Fund, UBT has entered into an
expense limitation agreement with the Fund ("Expense Limitation Agreement").
Pursuant to the Expense Limitation Agreement, UBT has agreed to waive or limit
its fees and to assume other expenses (except for Rule 12b-1 Fees and
Administrative Service Fees) to the extent necessary to limit the total annual
operating expenses of each Class of the Fund to 0.90% for Class A, 0.70% for
Class Y and 0.45% for Institutional Class shares. Reimbursement by the Fund of
the advisory fees waived or limited and other expenses reimbursed by UBT
pursuant to the Expense Limitation Agreement may be made at a later date when
the Fund has reached a sufficient asset size to permit reimbursement to be made
without causing the total annual operating expense ratio of the Fund to exceed
the limits set forth above. No reimbursement will be made unless: (i) the Fund's
assets exceed $100 million; (ii) the total annual expense ratio of the Class
making such reimbursement is less than the limit set forth above; and (iii) the
payment of such reimbursement is approved by the Board of Trustees on a
quarterly basis. Except as provided for in the Expense Limitation Agreement,
reimbursement of amounts previously waived or assumed by UBT is not permitted.
The Index Funds
With respect to the Nationwide Small Cap Index, Nationwide
International Index Fund, Nationwide Bond Index Fund (collectively, the "Index
Funds") each Index Fund invests all of its assets in shares of the corresponding
Series of Quantitative Master Series Trust. Accordingly, the Index Funds do not
invest directly in portfolio securities and do not require investment advisory
services. All portfolio management occurs at the level of Quantitative Master
Series Trust. Quantitative Master Series Trust has entered into a management
agreement ("Management Agreement") with Fund Asset Management ("FAM").
FAM provides Quantitative Master Series Trust with investment advisory
and management services. Subject to the supervision of the Board of Trustees of
Quantitative Master Series Trust, FAM is responsible for the actual management
of each Series' portfolio and constantly reviews the Series' holdings in light
of its own research analysis and that from other relevant sources. The
responsibility for making decisions to buy, sell or hold a particular security
rests with FAM. FAM performs certain of the other administrative services and
provides all the office space, facilities, equipment and necessary personnel for
management of the Series.
Securities held by the Series of Quantitative Master Series Trust may
also be held by, or be appropriate investments for, other funds or investment
advisory clients for which FAM or its affiliates act as an adviser. Because of
different objectives or other factors, a particular security may be bought for
one or more clients when one or more clients are selling the same security. If
purchases or sales of securities by FAM for the Series or other funds for which
it acts as investment adviser or for its advisory clients arise for
consideration at or about the same time, transactions in such securities will be
made, insofar as feasible, for the respective funds and clients in a manner
deemed equitable to all. To the extent that transactions on behalf of more than
one client of FAM or its affiliates during the same period may increase the
demand for securities being purchased or the supply of securities being sold
there may be an adverse effect on price.
As discussed in the Prospectus, FAM receives for its services to the
Series monthly compensation at the annual rates of the average daily net assets
of each Series as follows:
Name of Series Management Fee
- -------------- --------------
Merrill Lynch Small Cap Index Series....................... 0.08%
Merrill Lynch Aggregate Bond Index Series.................. 0.06%
Merrill Lynch International Index Series................... 0.11%
The table below sets forth information about the total investment
advisory fees paid by the Series to FAM, and any amount voluntarily waived by
FAM.
<TABLE>
<CAPTION>
Small Cap Aggregate Bond International
Index Series Index Series Index Series
------------ ------------ ------------
December 31, 1997*
<S> <C> <C> <C>
Contractual amount.............................. $ 36,425 $ 88,609 $ 100,102
Amount waived (if applicable)................... $ 36,425 $ 37,562 $ 35,546
December 31, 1998
Contractual amount.............................. $ 61,476 $ 238,378 $ 142,489
Amount waived (if applicable)................... $ 61,476 $ 2,537 $ 87,182
</TABLE>
* Period is from commencement of operations (April 3, 1997 for the
Aggregate Bond Index Series, and April 9, 1997 for the Small Cap Index
Series and the International Index Series).
The Management Agreement obligates FAM to provide investment advisory
services and to pay all compensation of and furnish office space for officers
and employees of FAM Index Trust connected with investment and economic
research, trading and investment management of Index Master Series Trust, as
well as the fees of all Trustees who are affiliated persons of FAM or any of
their affiliates. Each Series pays all other expenses incurred in the operation
of the Series (except to the extent paid by Merrill Lynch Funds Distributor),
including, among other things, taxes, expenses for legal and auditing services,
costs of printing proxies, stock certificates, shareholder reports, copies of
the registration statements, charges of the custodian, any sub-custodian and
transfer agent, expenses of portfolio transactions, expenses of redemption of
shares, Securities and Exchange Commission fees, expenses of registering the
shares under federal, state or foreign laws, fees and out-of-pocket expenses of
unaffiliated Trustees, accounting and pricing costs (including the daily
calculation of net asset value), insurance, interest, brokerage costs,
litigation and other extraordinary or non-recurring expenses, and other expenses
properly payable by Index Master Series Trust or the Series. Merrill Lynch Funds
Distributor will pay certain of the expenses of Index Master Series Trust
incurred in connection with the offering of its shares of beneficial interest of
each of the Series.
FAM is a limited partnership, the partners of which are ML & Co. and
Princeton Services. ML & Co. and Princeton Services are "controlling persons" of
FAM as defined under the 1940 Act because of their ownership of its voting
securities or their power to exercise a controlling influence over its
management or policies.
Unless earlier terminated as described below, the Management Agreement
will remain in effect from year to year with respect to each Series if approved
annually (a) by the Board of Trustees or by a majority of the outstanding shares
of the Series and (b) by a majority of the Trustees who are not parties to such
contract or interested persons (as defined in the 1940 Act) of any such party.
Such contract is not assignable and may be terminated without penalty on 60
days' written notice at the option of either party thereto or by the vote of the
shareholders of the Series.
Distributor
NAS serves as underwriter for each of the Funds in the continuous
distribution of its shares pursuant to a Underwriting Agreement dated as of May
9, 1998, as amended as of November 2, 1998, (the "Underwriting Agreement").
Unless otherwise terminated, the Underwriting Agreement will continue in effect
until May 9, 2000, and year to year thereafter for successive annual periods,
if, as to each Fund, such continuance is approved at least annually by (i) the
Trust's Board of Trustees or by the vote of a majority of the outstanding shares
of that Fund, and (ii) the vote of a majority of the Trustees of the Trust who
are not parties to the Underwriting Agreement or interested persons (as defined
in the 1940 Act) of any party to the Underwriting Agreement, cast in person at a
meeting called for the purpose of voting on such approval. The Underwriting
Agreement may be terminated in the event of any assignment, as defined in the
1940 Act.
In its capacity as Distributor, NAS solicits orders for the sale of
Shares, advertises and pays the costs of advertising, office space and the
personnel involved in such activities. NAS receives no compensation under the
Underwriting Agreement with the Trust, but may retain all or a portion of the
sales charge imposed upon sales of Shares of each of the Funds.
Distribution Plan
The Funds have adopted a Distribution Plan (the "Plan") under Rule
12b-1 of the 1940 Act. The Plan permits the Funds to compensate NAS, as the
Funds' Distributor, for expenses associated with the distribution of shares of
the Funds. Although actual distribution expenses may be more or less, under the
Plan the Funds pay NAS an annual fee in an amount that will not exceed the
following amounts:
0.25% of the average daily net assets of Class A shares; and
1.00% of the average daily net assets of Class B shares for each of
the Funds
Distribution expenses paid by NAS may include the costs of marketing,
printing and mailing prospectuses and sales literature to prospective investors,
advertising, and compensation to sales personnel and broker-dealers as well as
payments to broker-dealers for shareholder services.
As required by Rule 12b-1, the Plan was approved by the Board of
Trustees, including a majority of the Trustees who are not interested persons of
the Funds and who have no direct or indirect financial interest in the operation
of the Plan (the "Independent Trustees"). The Plan was initially approved by the
Board of Trustees on March 5, 1998, and is amended from time to time upon
approval by the Board of Trustees. The Plan may be terminated as to a Class of a
Fund by vote of a majority of the Independent Trustees, or by vote of majority
of the outstanding shares of that Class. Any change in the Plan that would
materially increase the distribution cost to a Class requires shareholder
approval. The Trustees review quarterly a written report of such costs and the
purposes for which such costs have been incurred. The Plan may be amended by
vote of the Trustees including a majority of the Independent Trustees, cast in
person at a meeting called for that purpose. For so long as the Plan is in
effect, selection and nomination of those Trustees who are not interested
persons of the Trust shall be committed to the discretion of such disinterested
persons. All agreements with any person relating to the implementation of the
Plan may be terminated at any time on 60 days' written notice without payment of
any penalty, by vote of a majority of the Independent Trustees or by a vote of
the majority of the outstanding Shares of the applicable Class. The Plan will
continue in effect for successive one-year periods, provided that each such
continuance is specifically approved (i) by the vote of a majority of the
Independent Trustees, and (ii) by a vote of a majority of the entire Board of
Trustees cast in person at a meeting called for that purpose. The Board of
Trustees has a duty to request and evaluate such information as may be
reasonably necessary for them to make an informed determination of whether the
Plan should be implemented or continued. In addition the Trustees in approving
the Plan as to a Fund must determine that there is a reasonable likelihood that
the Plan will benefit such Fund and its Shareholders.
The Board of Trustees of the Trust believes that the Plan is in the
best interests of the Funds since it encourages Fund growth and maintenance of
Fund assets. As the Funds grow in size, certain expenses, and therefore total
expenses per Share, may be reduced and overall performance per Share may be
improved.
NAS may enter into, from time to time, Rule 12b-1 Agreements with
selected dealers pursuant to which such dealers will provide certain services in
connection with the distribution of a Fund's Shares including, but not limited
to, those discussed above.
Administrative Services Plan
Under the terms of an Administrative Services Plan, a Fund is permitted
to enter into Servicing Agreements with servicing organizations, such as NAS,
who agree to provide certain administrative support services in connection with
the Class A, Class D and Class Y shares of the Funds and the Prime shares and
Class R shares of the Money Market Fund and the S&P 500 Index Fund. Such
administrative support services include but are not limited to the following:
establishing and maintaining shareholder accounts, processing purchase and
redemption transactions, arranging for bank wires, performing shareholder
sub-accounting, answering inquiries regarding the Funds, providing periodic
statements showing the account balance for beneficial owners or for plan
participants or contract holders of insurance company separate accounts,
transmitting proxy statements, periodic reports, updated prospectuses and other
communications to shareholders and, with respect to meetings of shareholders,
collecting, tabulating and forwarding to the Trust executed proxies and
obtaining such other information and performing such other services as may
reasonably be required.
As authorized by the Administrative Services Plan, the Trust has
entered into a Servicing Agreement pursuant to which Nationwide Financial
Services, Inc. has agreed to provide certain administrative support services in
connection with Class A of each Fund held beneficially by its customers. In
consideration for providing administrative support services, NFS and other
entities with which the Trust may enter into Servicing Agreements (which may
include NAS) will receive a fee, computed at the annual rate of up to 0.25% of
the average daily net assets of the Class A shares of each Fund held by
customers of NFS or such other entity.
Fund Administration
Under the terms of a Fund Administration Agreement, Villanova SA
Capital Trust ("VSA"), a wholly owned subsidiary of Villanova Capital, Inc.,
provides for various administrative and accounting services, including daily
valuation of the Funds' shares, preparation of financial statements, tax
returns, and regulatory reports, and presentation of quarterly reports to the
Board of Trustees. For these services, each Fund pays VSA an annual fee based on
each Fund's average daily net assets according to the following schedule:
Fund Assets Fee
- ---- ------ ---
Nationwide Small Cap Value Fund II, $0 up to $250 million 0.07%
Nationwide High Yield Bond Fund, $250 million up to $1 billion 0.05%
Nationwide Focus Fund, Morley $1 billion and more 0.04%
Enhanced Income Fund
Sub-Administrators
VSA has entered into a Sub-Administration Agreement with BISYS Fund
Services Ohio, Inc. ("BISYS") to provide certain fund administration services
for each of the Funds. For these services, VSA pays BISYS a fee equal to the
greater of $50,000 of an annual fee at the following rates based on the average
daily net assets of the aggregate of all the funds [of the Trust] that BISYS is
providing such services for:
Assets Fee
------ ---
$0 up to $13 million 0.045%
$13 million up to $25 million 0.02%
$25 million up to $50 million 0.015%
$50 million and more 0.01%
Transfer Agent
Nationwide Investors Services, Inc. ("NISI"), a wholly owned subsidiary
of VSA, Three Nationwide Plaza, Columbus, Ohio 43215, serves as transfer agent
and dividend disbursing agent for each of the Funds. For these services, NISI
receives an annual fee from each of the Funds according to the following
schedule:
Custodian
The Fifth Third Bank ("Fifth Third"), 38 Fountain Square Plaza,
Cincinnati, OH 45263, is the custodian for the Funds and makes all receipts and
disbursements under a Custody Agreement. Fifth Third performs no managerial or
policy-making functions for the Funds.
Legal Counsel
Dietrich, Reynolds & Koogler, One Nationwide Plaza, Columbus, OH 43215,
serves as the Trust's legal counsel.
Auditors
KPMG LLP, Two Nationwide Plaza, Columbus, OH 43215, serves as the
independent auditors for the Trust.
BROKERAGE ALLOCATION
VMF (or a Subadviser) is responsible for decisions to buy and sell
securities and other investments for the Funds, the selection of brokers and
dealers to effect the transactions and the negotiation of brokerage commissions,
if any. In transactions on stock and commodity exchanges in the United States,
these commissions are negotiated, whereas on foreign stock and commodity
exchanges these commissions are generally fixed and are generally higher than
brokerage commissions in the United States. In the case of securities traded on
the over-the-counter markets or for securities traded on a principal basis,
there is generally no commission, but the price includes a spread between the
dealer's purchase and sale price. This spread is the dealer's profit. In
underwritten offerings, the price includes a disclosed, fixed commission or
discount. Most short term obligations are normally traded on a "principal"
rather than agency basis. This may be done through a dealer (e.g., a securities
firm or bank) who buys or sells for its own account rather than as an agent for
another client, or directly with the issuer.
The primary consideration in portfolio security transactions is "best
price - best execution," i.e., execution at the most favorable prices and in the
most effective manner possible. Except as described below, VMF or a Subadviser
always attempts to achieve best price - best execution, and both VMF and the
Subadvisers have complete freedom as to the markets in and the broker-dealers
through which they seek this result. In selecting broker-dealers, VMF and each
Subadviser will consider various relevant factors, including but not limited to
the size and type of the transaction, the nature and character of the markets
for the security or asset to be purchased or sold, the execution efficiency,
settlement capability, and financial condition of the broker-dealer's firm, the
broker-dealer's execution services (rendered on a continuing basis), and the
reasonableness of any commissions. In allocating orders among brokers for
execution on an [agency][agency only?] basis, in addition to price and execution
considerations, the usefuless of the brokers' overall services is also
considered. Services provided by brokerage firms include efficient handling of
orders, useful analyses of corporations, industries and the economy, statistical
reports and other related services for which no charge is made by the broker
above the negotiated brokerage commissions.
Subject to the requirement of seeking best execution, securities may be
bought from or sold to broker-dealers who have furnished statistical, research,
and other information or services to VMF or a Subadviser. In placing orders with
such broker-dealers, VMF or a Subadviser will, where possible, take into account
the comparative usefulness of such information. Such information is useful to
VMF or a Subadviser even though its dollar value may be indeterminable, and its
receipt or availability generally does not reduce VMF's or a Subadviser's normal
research activities or expenses.
Fund portfolio transactions may be effected with broker-dealers who
have assisted investors in the purchase of variable annuity contracts or
variable insurance policies issued by Nationwide Life Insurance Company or
Nationwide Life & Annuity Insurance Company. However, neither such assistance
nor sale of other investment company shares is a qualifying or disqualifying
factor in a broker-dealer's selection, nor is the selection of any broker-dealer
based on the volume of shares sold.
There may be occasions when portfolio transactions for a Fund are
executed as part of concurrent authorizations to purchase or sell the same
security for trusts or other accounts (including other mutual funds) served by
VMF or a Subadviser or by an affiliated company thereof. Although such
concurrent authorizations potentially could be either advantageous or
disadvantageous to a Fund, they are effected only when VMF or a Subadviser
believes that to do so is in the interest of the Fund. When such concurrent
authorizations occur, the executions will be allocated in an equitable manner.
The Trustees periodically review VMF's and each Subadviser's
performance of their responsibilities in connection with the placement of
portfolio transactions on behalf of the Funds and review the commissions paid by
the Funds over representative periods of time to determine if they are
reasonable in relation to the benefits to the Funds.
Each Subadviser may cause a Fund to pay a broker-dealer who furnishes
brokerage and/or research services a commission that is in excess of the
commission another broker-dealer would have received for executing the
transaction if it is determined, pursuant to the requirements of Section 28(e)
of the Securities Exchange Act of 1934, that such commission is reasonable in
relation to the value of the brokerage and/or research services provided. Such
research services may include, among other things, analyses and reports
concerning issuers, industries, securities, economic factors and trends, and
portfolio strategy. Any such research and other information provided by brokers
to a Subadviser is considered to be in addition to and not in lieu of services
required to be performed by the Subadviser under its subadvisory agreement with
VMF. The fees paid to each of the Subadvisers pursuant to its subadvisory
agreement with VMF are not reduced by reason of its receiving any brokerage and
research services. The research services provided by broker-dealers can be
useful to a Subadviser in serving its other clients or clients of the
Subadviser's affiliates. Subject to the policy of the Subadvisers to obtain best
execution at the most favorable prices through responsible broker-dealers, a
Subadviser also may consider the broker-dealer's sale of shares of any fund for
which the Subadviser serves as investment adviser, subadviser or administrator.
Under the 1940 Act, "affiliated persons" of a Fund are prohibited from
dealing with it as a principal in the purchase and sale of securities unless an
exemptive order allowing such transactions is obtained from the SEC. However,
each Fund may purchase securities from underwriting syndicates of which a
Subadviser or any of its affiliates, as defined in the 1940 Act, is a member
under certain conditions, in accordance with Rule 10f-3 under the 1940 Act.
Each of the Funds contemplate that, consistent with the policy of
obtaining best results, brokerage transactions may be conducted through
"affiliated brokers or dealers," as defined in the 1940 Act. Under the 1940 Act,
commissions paid by a Fund to an "affiliated broker or dealer" in connection
with a purchase or sale of securities offered on a securities exchange may not
exceed the usual and customary broker's commission. Accordingly, it is the
Funds' policy that the commissions to be paid to an affiliated broker-dealer
must, in the judgment of VMF or the appropriate Subadviser, be (1) at least as
favorable as those that would be charged by other brokers having comparable
execution capability and (2) at least as favorable as commissions
contemporaneously charged by such broker or dealer on comparable transactions
for the broker's or dealer's most favored unaffiliated customers, except for
accounts for which the affiliated broker or dealer acts as a clearing broker for
another brokerage firm and customers of an affiliated broker or dealer that, in
the opinion of a majority of the independent trustees, are not comparable to the
Fund. The Funds do not deem it practicable or in their best interests to solicit
competitive bids for commissions on each transaction. However, consideration
regularly is given to information concerning the prevailing level of commissions
charged on comparable transactions by other brokers during comparable periods of
time.
ADDITIONAL INFORMATION ON PURCHASES AND SALES
Class A Sales Charges
The charts below show the Class A sales charges, which decrease as the
amount of your investment increases.
Class A Shares of the Focus Fund and Small Cap Value Fund II
Sales charge as % Sales charge as %
Amount of purchase of offering price of amount invested
- ------------------ ----------------- ------------------
less than $50,000 5.75% 6.10%
$50,000 to $99,999 4.50 4.71
$100,000 to $249,999 3.50 3.63
$250,000 to $499,999 2.50 2.56
$500,000 to $999,999 2.00 2.04
$1 million to $24,999,999 0.50 0.50
$25 million or more 0.25 0.25
Class A Shares of the High Yield Bond and Enhance Income Funds
Sales charge as % Sales charge as %
Amount of purchase of offering price of amount invested
- ------------------ ----------------- ------------------
less than $50,000 4.50% 4.71%
$50,000 to $99,999 4.00 4.17
$100,000 to $249,999 3.00 3.09
$250,000 to $499,999 2.50 2.56
$500,000 to $999,999 2.00 2.04
$1 million to $24,999,999 0.50 0.50
$25 million or more 0.25 0.25
<PAGE>
Net Asset Value Purchase Privilege (Class A Shares Only).--The Sales Charge
Applicable To Class A Shares May Be Waived for the Following Purchases Due to
the Reduced Marketing Effort Required By NAS:
(1) shares sold to other registered investment companies affiliated with
VMF,
(2) shares sold:
(a) to any pension, profit sharing, or other employee benefit plan
for the employees of VMF, any of its affiliated companies, or
investment advisory clients and their affiliates;
(b) to any endowment or non-profit organization;
(c) to any pension, profit sharing, or deferred compensation plan
which is qualified under Sections 401(a), 403(b) or 457 of the
Internal Revenue Code of 1986 as amended, dealing directly
with NAS with no sales representative involved upon written
assurance of the purchaser that the shares are acquired for
investment purposes and will not be resold except to the
Trust;
(d) to any life insurance company separate account registered as a
unit investment trust;
(e) to any person purchasing through an account with an
unaffiliated brokerage firm having an agreement with NAS to
waive sales charges for those persons;
(f) to any directors, officers, full-time employees, sales
representatives and their employees or any investment advisory
clients of a broker-dealer having a dealer/selling agreement
with NAS;
(g) to any person who pays for such shares with the proceeds of
mutual fund shares redeemed from an NAS brokerage account; to
qualify, the person must have paid an initial sales charge or
CDSC on the redeemed shares and the purchase of Class A shares
must be made within 60 days of the redemption. This waiver
must be requested when the purchase order is placed, and NAS
may require evidence of qualification for this waiver;
(h) to any Class Member of Snyder vs. Nationwide Mutual Insurance
Company and Nationwide Life Insurance Company on the initial
purchase of shares for an amount no less than $5,000 and no
more than $100,000. To be eligible for this waiver, the
purchase of Class A shares must come from a source other than
the surrender of, withdrawal from, or loan against any
existing policy, mutual fund or annuity issued by Nationwide
Mutual Insurance Company or its affiliates;
(i) to any person who pays for such shares with the proceeds of
mutual funds shares redeemed from an account in the NEA
Valuebuilder Mutual Fund Program. This waiver is only
available for the initial purchase if shares were made with
such proceeds. NAS may require evidence of qualification for
such waiver; and
(j) to certain employer-sponsored retirement plan including
pension, profit sharing or deferred compensation plans which
are qualified under Sections 401(a), 403(b) or 457 of the
Internal Revenue Code.
(j) Trustees and retired Trustees of Nationwide Mutual Funds
(including its predecessor Trusts);
(k) Directors, officers, full-time employees, sales
representatives and their employees, and retired directors,
officers, employees, and sales representatives, their spouses,
children or immediate relatives (including mother, father,
brothers, sisters, grandparents and grandchildren) and
immediate relatives of deceased employees of any member of
Nationwide Insurance and Nationwide Financial companies, or
any investment advisory clients of VMF, VSA, NAS and their
affiliates; and
(l) Directors, officers, full-time employees, their spouses,
children or immediate relatives and immediate relatives of
deceased employees of any sponsor group which may be
affiliated with the Nationwide Insurance and Nationwide
Financial companies from time to time, (including but not
limited to, Farmland Insurance Industries, Inc., Maryland Farm
Bureau, Inc., Ohio Farm Bureau Federation, Inc., Pennsylvania
Farmers' Association, Ruralite Services, Inc., and Southern
States Cooperative).
Class B Shares of the Funds and CDSC
A CDSC, payable to NAS, will be imposed on any redemption of Class B
shares which causes the current value of your account to fall below the total
amount of all purchases made during the preceding six years. The CDSC is never
imposed on dividends, whether paid in cash or reinvested, or on appreciation
over the initial purchase price. The CDSC applies only to the lesser of the
original investment or current market value.
Where the CDSC is imposed, the amount of the CDSC will depend on the
number of years since you made the purchase payment from which an amount is
being redeemed, according to the following table:
Year of Redemption Contingent Deferred
After Purchase Sales Charge
- -------------- ------------
First 5.00%
Second 4.00%
Third 3.00%
Fourth 3.00%
Fifth 2.00%
Sixth 1.00%
Seventh and following 0.00%
For purposes of calculating the CDSC, it is assumed that the oldest
Class B shares remaining in your account will be sold first. All payments during
a month will be aggregated and deemed to have been made on the last day of the
preceding month.
For the Bonds Funds your money will earn daily dividends through the
date of liquidation. If you redeem all of your shares in one of the Bond Funds,
you will receive a check representing the value of your account, less any
applicable CDSC calculated as of the date of your withdrawal, plus all daily
dividends credited to your account through the date of withdrawal.
The CDSC will be waived in the case of a total or partial redemption
following the death or disability (within the meaning of Code Section 72(m)(7)
of the internal Revenue Code) of a shareholder (accounts owned by an individual
or an individual jointly with spouse) if redemption occurs within one year of
death or initial determination of disability.
CDSC applicable for Class A Shares
Employer sponsored retirement plans which purchase Class A shares at
net asset value (other than those investing in Funds through a variable
insurance product) are subject to a CDSC, payable to NAS, of 1.00% if a finder's
fee (as described below) was paid on the purchase of the shares and the shares
are redeemed within the first year after purchase, 0.50% if redeemed within the
second year and 0.25% if redeemed within the third year. The sales charge is
applied to the original purchase price, or the current market value of the
shares being sold, whichever is less. A CDSC will be charged on redemptions of
$1 million or more within a 12 month period.
NAS will pay a finder's fee at the plan sponsor level at the time of
purchase to the dealer of record at the time of purchase at the following rates:
1.00% for sales of the Funds of $1 million up to $3 million 0.50% for sales of
the Funds of $ 3 million up to $50 million 0.25% for sales of the Funds of $50
million or more
The finder's fee is paid on the aggregate assets of all Funds held at
the plan sponsor level.
Conversion Features for Class B Shares
Class B shares which have been outstanding for seven years will
automatically convert to Class A shares on the first business day of the next
month following the seventh anniversary of the date on which such Class B shares
were purchased. Such conversion will be on the basis of the relative net asset
values of the two classes, without the imposition of a sales charge or other
charge except that the lower 12b-1 fee applicable to Class A shares shall
thereafter be applied to such converted shares. Because the per share net asset
value of the Class A shares may be higher than that of the Class B shares at the
time of the conversion, a shareholder may receive fewer Class A shares than the
number of Class B shares converted, although the dollar value of the amount
converted will be the same. Reinvestments of dividends and distributions in
Class B shares will not be considered a new purchase for purposes of the
conversion feature and will convert to Class A shares in the same proportion as
the number of the shareholder's Class B shares converting to Class A shares
bears to the shareholder's total Class B shares not acquired through dividends
and distributions.
If you effect one or more exchanges among Class B shares of the Funds
during the seven-year period, the holding period for shares so exchanged will be
counted toward such period. If you exchange Class B shares into the Prime Shares
of the Money Market Fund for a period of time, the conversion aging period will
be stopped during the time period when shares are exchanged into the Money
Market Fund.
Factors To Consider When Choosing a Class of Shares
Before purchasing Class A shares or Class B shares of a Fund, investors
should consider whether, during the anticipated life of their investment in a
Fund, the accumulated 12b-1 fee and potential CDSC on Class B shares prior to
conversion (as described above) would be less than the initial sales charge and
accumulated 12b-1 fee on Class A shares purchased at the same time, and to what
extent such differential would be offset by the higher yield of Class A shares
as a result of the lower expenses. In this regard, to the extent that the sales
charge for the Class A shares is waived or reduced investments in Class A shares
become more desirable. NAS may refuse a purchase order for Class B shares of
over $100,000.
Although Class A shares are subject to a 12b-1 fee, they are not
subject to the higher 12b-1 fee applicable to Class B shares. For this reason,
Class A shares can be expected to pay correspondingly higher dividends per
shares. However, because initial sales charges are deducted at the time of
purchase, purchasers of Class A shares who do not qualify for waivers of or
reductions in the initial sales charge would have less of their purchase price
initially invested in the Fund than purchasers of Class B shares.
As described above, purchasers of Class B shares will have more of
their initial purchase price invested. Any positive investment return on this
additional invested amount may partially or wholly offset the expected higher
annual expenses borne by Class B shares. Because a Fund's future returns cannot
be predicted, there can be no assurance that this will be the case. Investors in
Class B shares would, however, own shares that are subject to higher annual
expenses and, for a six-year period, such shares would be subject to a CDSC
ranging from 5.00% to 1.00% upon redemption. Investors expecting to redeem
during this six-year period should compare the cost of the CDSC plus the
aggregate annual Class B shares' 12b-1 fees to the cost of the initial sales
charge and 12b-1 fee on the Class A shares. Over time the expense of the annual
12b-1 fee on the Class B shares may be equal to or exceed the initial sales
charge and annual 12b-1 fee applicable to Class A shares.
For example, if a Fund's net asset value remains constant and assuming
no waiver of any 12b-1 fees, the aggregate 12b-1 fee with respect to Class B
shares of a Fund would equal or exceed the initial sales charge and aggregate
12b-1 fee of Class A shares approximately eight years after the purchase. In
order to reduce such fees for Class B Shareholders, Class B shares will be
automatically converted to Class A shares, as described above, at the end of a
seven-year period. This example assumes that the initial purchase of Class A
shares would be subject to the maximum initial sales charge of 5.75% for the
Stock Funds and 4.50% for the Bond Funds. This example does not take into
account the time value of money which reduces the impact of the Class B shares'
12b-1 fee on the investment, the benefit of having the additional initial
purchase price invested during the period before it is effectively paid out as a
12b-1 fee, fluctuations in net asset value, any waiver of 12b-1 fees or the
effect of different performance assumptions. For investors who are eligible to
purchase Class D shares, the purchase of Class D shares will usually be
preferable to purchasing Class A or Class B shares.
Signature Guarantee
A signature guarantee is required if the redemption is over $100,000,
or if your account registration has changed within the last 30 days, or if the
redemption check is made payable to anyone other than the registered
shareholder, or if the proceeds are sent to a bank account not previously
designated, or are mailed to an address other than the address of record. NAS
reserves the right to require a signature guarantee in other circumstances,
without notice. Based on the circumstances of each transaction, NAS reserves the
right to require that your signature be guaranteed by an authorized agent of an
"eligible guarantor institution," which includes, but is not limited to, certain
banks, credit unions, savings associations, and member firms of national
securities exchanges. A signature guarantee is designed to protect the
shareholder by helping to prevent an unauthorized person from redeeming shares
and obtaining the proceeds. A notary public is not an acceptable guarantor. In
certain special cases (such as corporate or fiduciary registrations), additional
legal documents may be required to ensure proper authorizations. If NAS decides
to require signature guarantees in all circumstances, shareholders will be
notified in writing prior to implementation of the policy.
VALUATION OF SHARES
The net asset value per share for each Fund is determined as of the
close of regular trading on the New York Stock Exchange (usually 4 P.M. Eastern
Time), each day that the Exchange is open and on such other days as the Board of
Trustees determines and on days in which there is sufficient trading in
portfolio securities of a Fund to materially affect the net asset value of that
Fund (the "Valuation Time").
The Funds will not compute net asset value on customary business
holidays, including Christmas, New Year's Day, Martin Luther King, Jr. Day,
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day and
Thanksgiving.
The net asset value per share of a class is computed by adding the
value of all securities and other assets in a Fund's portfolio allocable to such
class, deducting any liabilities allocable to such class and any other
liabilities charged directly to that class and dividing by the number of shares
outstanding in such class.
In determining net asset value, portfolio securities listed on national
exchanges are valued at the last quoted sale price on the principal exchange, or
if there is no sale on that day at the quoted bid price, or if the securities
are traded in the over-the-counter market, at the last quoted sale price, or if
no sale price, at the quoted bid prices; U.S. Government securities are valued
at the quoted bid price; all prices obtained from an independent pricing
organization. Money market obligations with remaining maturities of 10 days or
less purchased by a non-money market fund are valued at amortized cost in
accordance with provisions contained in Rule 2a-7 of the 1940 Act, as described
below. Securities for which market quotations are not available, or for which an
independent pricing agent does not provide a value or provides a value that does
not represent fair value in the judgment of VMF or its designee are valued at
fair value in accordance with procedures adopted by the Board of Trustees.
The value of portfolio securities in the Money Market Fund is
determined on the basis of the amortized cost method of valuation in accordance
with Rule 2a-7 of the 1940 Act. This involves valuing a security at its cost and
thereafter assuming a constant amortization to maturity of any discount or
premium, regardless of the impact of fluctuating interest rates on the market
value of the instrument. While this method provides certainty in valuation, it
may result in periods during which value, as determined by amortized cost, is
higher or lower than the price the Fund would receive if it sold the instrument.
The Trustees have adopted procedures whereby the extent of deviation,
if any, of the current net asset value per share calculated using available
market quotations from the Money Market Fund's amortized cost price per share,
will be determined at such intervals as the Trustees deem appropriate and are
reasonable in light of current market conditions. In the event such deviation
from the Money Market Fund's amortized cost price per share exceeds 1/2 of 1
percent, the Trustees will consider appropriate action which might include
withholding dividends or a revaluation of all or an appropriate portion of the
Money Market Fund's assets based upon current market factors.
The Trustees, in supervising the Money Market Fund's operations and
delegating special responsibilities involving portfolio management to VMF, have
undertaken as a particular responsibility within their overall duty of care owed
to the Money Market Fund's shareholders to assure to the extent reasonably
practicable, taking into account current market conditions affecting the Fund's
investment objectives, that the Money Market Fund's net asset value per share
will not deviate from $1.
Pursuant to its objective of maintaining a stable net asset value per
share, the Money Market Fund will only purchase investments with a remaining
maturity of 397 days or less and will maintain a dollar weighted average
portfolio maturity of 90 days or less.
INVESTOR STRATEGIES
1 Money Market Plus Growth--This strategy provides the security of
principal that the Money Market Fund offers plus the opportunity for greater
long-term capital appreciation through reinvestment of dividends in one of the
Stock Funds.
An initial investment of $5,000 or more is made in the Prime Shares of
the Money Market Fund, and monthly dividends are then automatically invested
into one or more of the Stock Funds chosen by you at such Stock Fund's current
offering price. Money Market Plus Growth gives investors stability of principal
through the Money Market Fund's stable share price, and its portfolio of high
quality, short-term money market investments. And the Money Market Fund offers
fast liquidity through unlimited free checking ($500 minimum), telephone
redemption, or NAS NOW. NOTE: Money Market Fund dividends reinvested into one of
the Stock Funds are subject to applicable sales charges.
2 Money Market Plus Income--This strategy provides the security of
principal that the Money Market Fund offers plus the opportunity for greater
income by reinvesting dividends into one or more of the Bond Funds.
An initial investment of $5,000 or more is made in the Prime Shares of
the Money Market Fund and monthly dividends are then reinvested into one of the
Bond Funds chosen by you at such Fund's current offering price.
When short-term interest rates increase, Money Market Fund dividends
usually also rise. At the same time, share prices of the Bond Funds generally
decrease. So, with Money Market Plus Income, when you earn higher Money Market
Fund dividends, you can generally purchase more shares of one of the Bond Funds
at lower prices. Conversely, when interest rates and Money Market Fund dividends
decrease, the share prices of the Bond Funds usually increase--you will
automatically buy fewer shares of one of the Bond Funds at higher prices. The
Prime Shares of the Money Market Fund provides investors with stability of
principal, fast liquidity through unlimited free checking ($500 minimum),
telephone redemption, or NAS NOW. NOTE: Money Market Fund dividends reinvested
into one of the Bond Funds are subject to applicable sales charges.
3 Automatic Asset Accumulation--This is a systematic investment strategy
which combines automatic monthly transfers from your personal checking account
to your mutual fund account with the concept of Dollar Cost Averaging. With this
strategy, you invest a fixed amount monthly over an extended period of time,
during both market highs and lows. Dollar Cost Averaging can allow you to
achieve a favorable average share cost over time since your fixed monthly
investment buys more shares when share prices fall during low markets, and fewer
shares at higher prices during market highs. Although no formula can assure a
profit or protect against loss in a declining market, systematic investing has
proven a valuable investment strategy in the past.
You can get started with Automatic Asset Accumulation for as little as
$25 a month in a Fund. Another way to take advantage of the benefits that Dollar
Cost Averaging can offer is through the Money Market Plus Growth or Money Market
Plus Income investor strategies.
4 Automatic Asset Transfer--This systematic investment plan allows you to
transfer $25 or more to a Stock or Bond Fund from another Fund systematically,
monthly or quarterly, after Fund minimums have been met. The money is
transferred on the 25th day of the month as selected or on the preceding
business day. Dividends of any amount can be moved automatically from one Fund
to another at the time they are paid. This strategy can provide investors with
the benefits of Dollar Cost Averaging through an opportunity to achieve a
favorable average share cost over time. With this plan, your fixed monthly or
quarterly transfer from the Fund to any other Fund you select buys more shares
when share prices fall during low markets and fewer shares at higher prices
during market highs. Although no formula can assure a profit or protect against
loss in a declining market, systematic investing has proven a valuable
investment strategy in the past. For transfers from the Prime Shares of the
Money Market Fund to another Fund, sales charges may apply if not already paid.
5 Automatic Withdrawal Plan ($50 or More)--You may have checks for any
fixed amount of $50 or more automatically sent bi-monthly, monthly, quarterly,
three times/year, semi-annually or annually, to you (or anyone you designate)
from your account.
NOTE: If you are withdrawing more shares than your account receives in
dividends, you will be decreasing your total shares owned, which will reduce
your future dividend potential. In addition, an Automatic Withdrawal Plan for
Class B shares will be subject to the applicable CDSC.
INVESTOR PRIVILEGES
The Funds offer the following privileges to shareholders. Additional
information may be obtained by calling NAS toll-free at 1-800-848-0920.
1 No Sales Charge on Reinvestments--All dividends and capital gains will
be automatically reinvested free of charge in the form of additional shares
within the same Fund and class or another specifically requested Fund (but the
same class) unless you have chosen to receive them in cash on your application.
Unless requested in writing by the shareholder, the Trust will not mail checks
for dividends and capital gains of less than $5 but instead they will
automatically be reinvested in the form of additional shares, and you will
receive a confirmation.
2 Exchange Privilege--The exchange privilege is a convenient way to
exchange shares from one Fund to another Fund in order to respond to changes in
your goals or in market conditions. However, an exchange is a sale and purchase
of shares and, for Federal and state income tax purposes, may result in a
capital gain or loss. The registration of the account to which you are making an
exchange must be exactly the same as that of the Fund account from which the
exchange is made, and the amount you exchange must meet the applicable minimum
investment of the Fund being purchased.
Exchanges Among Funds
Exchanges may be made among any of the Funds within the same class or
among any class in any of the Funds and Prime Shares of the Money Market Fund.
For certain exchanges of Class A shares among the Funds, you may pay the
difference between the sales charges, if a higher sales charge is applicable.
Exchanges within Class B or Service Class shares may be made without incurring a
sales charge.
An exchange from the Prime Shares of the Money Market Fund into another
Fund will be subject to the applicable sales charge unless already paid. For an
exchange into the Prime Shares of the Money Market Fund, the CDSC aging period
for Class B shares will be stopped during the time period such Money Market Fund
shares are held. If the Money Market Fund shares are subsequently sold, a CDSC
will be charged at the level that would have been charged had the shares been
sold at the time when they were exchanged into the Money Market Fund. If the
Money Market Fund shares are exchanged back into Class B shares, the CDSC aging
period will continue from the point in time when the shares were originally
exchanged into the Money Market Fund.
There is no administrative fee or exchange fee. The Trust reserves the
right to reject any exchange request it believes will result in excessive
transaction costs, or otherwise adversely affect other shareholders. For a
description of CDSC see "Class B Shares of the Stock and Bond Funds and CDSC."
The Trust reserves the right to change the exchange privilege upon at least 60
days' written notice to shareholders.
Exchanges May Be Made Four Convenient Ways:
By Telephone
NAS Now--You can automatically process exchanges by calling
1-800-637-0012, 24 hours a day, seven days a week. However, if you
declined the option in the application, you will not have this
automatic exchange privilege. NAS NOW also gives you quick, easy access
to mutual fund information. Select from a menu of choices to conduct
transactions and hear fund price information, mailing and wiring
instructions as well as other mutual fund information. You must call
our toll-free number by the Valuation Time to receive that day's
closing share price. The Valuation Time is the close of regular trading
of the New York Stock Exchange, which is usually 4:00 p.m. Eastern
Time.
Customer Service Line--By calling 1-800-848-0920, you may exchange
shares by telephone. Requests may be made only by the account owner(s).
You must call our toll-free number by the Valuation Time to receive
that day's closing share price. The Valuation Time is the close of
regular trading of the New York Stock Exchange, which is usually 4:00
p.m. Eastern Time.
NAS may record all instructions to exchange shares. NAS reserves the
right at any time without prior notice to suspend, limit or terminate
the telephone exchange privilege or its use in any manner by any person
or class.
The Funds will employ the same procedure described under "Buying,
Selling and Exchanging Fund Shares" in the Prospectus to confirm that
the instructions are genuine.
The Funds will not be liable for any loss, injury, damage, or expense
as a result of acting upon instructions communicated by telephone
reasonably believed to be genuine, and the Funds will be held harmless
from any loss, claims or liability arising from its compliance with
such instructions. These options are subject to the terms and
conditions set forth in the Prospectus and all telephone transaction
calls may be tape recorded. The Funds reserve the right to revoke this
privilege at any time without notice to shareholders and request the
redemption in writing, signed by all shareholders.
By Mail or Fax-- Write or fax to Nationwide Advisory Services, Inc.,
Three Nationwide Plaza, P.O. Box 1492, Columbus, Ohio 43216-1492 or FAX (614)
249-8705. Please be sure that your letter or facsimile is signed exactly as your
account is registered and that your account number and the Fund from which you
wish to make the exchange are included. For example, if your account is
registered "John Doe and Mary Doe", "Joint Tenants With Right of Survivorship,'
then both John and Mary must sign the exchange request. The exchange will be
processed effective the date the signed letter or fax is received. Fax requests
received after 4 P.M. Eastern Time will be processed as of the next business
day. NAS reserves the right to require the original document if you use the fax
method.
By online access--You may use your personal computer to access on-line
trading of the Funds' shares at our website (www.nationwidefunds.com). To
establish this service you must first register through the website. We will then
send to you, by mail, an account access password that will enable you to make
transactions. When you click on one of the Fund's icons, you will be prompted to
enter your trading password so that the Fund can be sure each exchange is
secure. For your own protection, only you or your co-account holder(s) should
place orders through your Fund account. When you purchase shares you will be
asked to provide your e-mail address and affirm that you have read the
Prospectus. The Fund's Prospectus is readily available for viewing on the
website. The Funds may terminate the ability to buy Fund shares on its website
at any time, in which case you may continue to exchange shares by mail, wire or
telephone pursuant to the Prospectus.
3 No Sales Charge on a Repurchase--If you redeem all or part of your
Class A or D shares on which you paid a front-end sales charge, you have a
one-time privilege to reinvest all or part of the redemption proceeds in any
shares of the same class, without a sales charge, within 30 days after the
effective date of the redemption. If you redeem Class B shares, and then
reinvest the proceeds in Class B shares within 30 days, NAS will reinvest an
amount equal to any CDSC you paid on redemption.
If you realize a gain on your redemption, the transaction is taxable,
and reinvestment will not alter any capital gains tax payable. If you realize a
loss and you use the reinstatement privilege, some or all of the loss will not
be allowed as a tax deduction depending upon the amount reinvested.
INVESTOR SERVICES
1 NAS Now Automated Voice Response System--Our toll-free number
1-800-637-0012 will connect you 24 hours a day, seven days a week to NAS NOW.
Through a selection of menu options, you can conduct transactions, hear fund
price information, mailing and wiring instructions and other mutual fund
information.
2 Toll-Free Information and Assistance--Customer service representatives
are available to answer questions regarding the Funds and your account(s)
between the hours of 8 A.M. and 5 P.M. Eastern Time. Call toll-free:
1-800-848-0920 or contact NAS at our FAX telephone number (614) 249-8705.
3 Retirement Plans Shares of the Funds may be purchased for Self-Employed
Retirement Plans, Individual Retirement Accounts (IRAs), Roth IRAs, Educational
IRAs, Simplified Employee Pension Plans, Corporate Pension Plans, Profit Sharing
Plans and Money Purchase Plans. For a free information kit, call 1-800-848-0920.
4 Shareholder Confirmations--You will receive a confirmation statement
each time a requested transaction is processed. However, no confirmations are
mailed on certain pre-authorized, systematic transactions. Instead, these will
appear on your next consolidated statement.
5 Consolidated Statements--Shareholders of the Stock Funds receive
quarterly statements as of the end of March, June, September and December.
Shareholders of the Bond and Money Market Funds receive monthly statements.
Please review your statement carefully and notify us immediately if there is a
discrepancy or error in your account.
For shareholders with multiple accounts, your consolidated statement
will reflect all your current holdings in the Funds. Your accounts are
consolidated by social security number and zip code. Accounts in your household
under other social security numbers may be added to your statement at your
request. Depending on which Funds you own, your consolidated statement will be
sent either monthly or quarterly. Only transactions during the reporting period
will be reflected on the statements. An annual summary statement reflecting all
calendar-year transactions in all your Funds will be sent after year-end.
6 Average Cost Statement--This statement may aid you in preparing your
tax return and in reporting capital gains and losses to the IRS. If you redeemed
any shares during the calendar year, a statement reflecting your taxable gain or
loss for the calendar year (based on the average cost you paid for the redeemed
shares) will be mailed to you following each year-end. Average cost can only be
calculated on accounts opened on or after January 1, 1984. Fiduciary accounts
and accounts with shares acquired by gift, inheritance, transfer, or by any
means other than a purchase cannot be calculated.
Average cost is one of the IRS approved methods available to compute
gains or losses. You may wish to consult a tax advisor on the other methods
available. The average cost information will not be provided to the IRS. If you
have any questions, contact one of our service representatives at
1-800-848-0920.
7 Shareholder Reports--All shareholders will receive reports
semi-annually detailing the financial operations of the funds.
8 Prospectuses--Updated prospectuses will be mailed to you annually.
9 Undeliverable Mail--If mail from NAS to a shareholder is returned as
undeliverable on three or more consecutive occasions, NAS will not send any
future mail to the shareholder unless it receives notification of a correct
mailing address for the shareholder. Any dividends that would be payable by
check to such shareholders will be reinvested in the shareholder's account until
NAS receives notification of the shareholder's correct mailing address.
<PAGE>
FUND PERFORMANCE ADVERTISING
Calculating Yield and Total Return
The Funds may from time to time advertise historical performance,
subject to Rule 482 under the Securities Act. An investor should keep in mind
that any return or yield quoted represents past performance and is not a
guarantee of future results. The investment return and principal value of
investments will fluctuate so that an investor's shares, when redeemed, may be
worth more or less than their original cost.
All performance advertisements shall include average annual (compound)
total return quotations for the most recent one, five, and ten-year periods (or
life if a Fund has been in operation less than one of the prescribed periods).
Average annual (compound) total return represents redeemable value at the end of
the quoted period. It is calculated in a uniform manner by dividing the ending
redeemable value of a hypothetical initial payment of $1,000 minus the maximum
sales charge, for a specified period of time, by the amount of the initial
payment, assuming reinvestment of all dividends and distributions. In
calculating the standard total returns for Class A shares, the current maximum
applicable sales charge is deducted from the initial investment. For Class B
shares, the payment of the applicable CDSC is applied to the investment result
for the period shown. The one, five, and ten-year periods are calculated based
on periods that end on the last day of the calendar quarter preceding the date
on which an advertisement is submitted for publication.
Standardized yield and total return quotations will be compared
separately for each class of shares. Because of differences in the fees and/or
expenses borne by each class of shares of the Funds, the net yields and total
returns on each class can be expected, at any given time, to differ from class
to class for the same period.
The Nationwide High Yield Bond Fund and the Morley Enhanced Income may
also from time to time advertise a uniformly calculated yield quotation. This
yield is calculated by dividing the net investment income per share earned
during a 30-day base period by the maximum offering price per share on the last
day of the period, assuming reinvestment of all dividends and distributions.
This yield formula uses the average number of shares entitled to receive
dividends, provides for semi-annual compounding of interest, and includes a
modified market value method for determining amortization. The yield will
fluctuate, and there is no assurance that the yield quoted on any given occasion
will remain in effect for any period of time. The effect of sales charges are
not reflected in the calculation of the yields, therefore, a shareholders actual
yield may be less.
Nonstandard Returns
The Funds may also choose to show nonstandard returns including total
return, and simple average total return. Nonstandard returns may or may not
reflect reinvestment of all dividends and capital gains; in addition, sales
charge assumptions will vary. Sales charge percentages decrease as amounts
invested increase as outlined in the prospectus; therefore, returns increase as
sales charges decrease.
Total return represents the cumulative percentage change in the value
of an investment over time, calculated by subtracting the initial investment
from the redeemable value and dividing the result by the amount of the initial
investment. The simple average total return is calculated by dividing total
return by the number of years in the period, and unlike average annual
(compound) total return, does not reflect compounding.
The Balanced Fund may also from time to time advertise a uniformly
calculated yield quotation. This yield is calculated by dividing the net
investment income per share earned during a 30-day base period by the maximum
offering price per share on the last day of the period, assuming reinvestment of
all dividends and distributions. This yield formula uses the average number of
shares entitled to receive dividends, provides for semi-annual compounding of
interest, and includes a modified market value method for determining
amortization. The yield will fluctuate, and there is no assurance that the yield
quoted on any given occasion will remain in effect for any period of time.
Rankings and Ratings in Financial Publications
The Funds may report their performance relative to other mutual funds
or investments. The performance comparisons are made to: other mutual funds with
similar objectives; other mutual funds with different objectives; or, to other
sectors of the economy. Other investments which the Funds may be compared to
include, but are not limited to: precious metals; real estate; stocks and bonds;
closed-end funds; market indexes; fixed-rate, insured bank CDs, bank money
market deposit accounts and passbook savings; and the Consumer Price Index.
Normally these rankings and ratings are published by independent
tracking services and publications of general interest including, but not
limited to: Lipper Analytical Services, Inc., CDA/Wiesenberger, Morningstar,
Donoghue's, Schabaker Investment Management, Kanon Bloch Carre & Co.; magazines
such as Money, Fortune, Forbes, Kiplinger's Personal Finance Magazine, Smart
Money, Mutual Funds, Worth, Financial World, Consumer Reports, Business Week,
Time, Newsweek, U.S. News and World Report; and other publications such as the
Wall Street Journal, Barron's, Columbus Dispatch, Investor's Business Daily, and
Standard & Poor's Outlook.
The rankings may or may not include the effects of sales charges.
ADDITIONAL INFORMATION
Description of Shares
The Trust presently offers the following series of shares of beneficial
interest, without par value and with the various classes listed; four of these
series are the Funds:
Series Share Classes
- ------ -------------
Nationwide Mid Cap Growth Fund Class A, Class B, Class D
Nationwide Growth Fund Class A, Class B, Class D
Nationwide Fund Class A, Class B, Class D
Nationwide Bond Fund Class A, Class B, Class D
Nationwide Tax-Free Income Fund Class A, Class B, Class D
Nationwide Long-Term U.S. Government Bond Fund Class A, Class B, Class D
Nationwide Intermediate U.S. Government Bond Fund Class A, Class B, Class D
Nationwide Money Market Fund Class R, Prime Shares
Nationwide S&P 500 Index Fund Class R, Class Y,
Local Fund Shares
Morley Capital Accumulation Fund ISC Shares, IC Shares,
IRA Shares
Prestige Large Cap Value Fund Class A, Class B, Class Y
Prestige Large Cap Growth Fund Class A, Class B, Class Y
Prestige Small Cap Fund Class A, Class B, Class Y
Prestige Balanced Fund Class A, Class B, Class Y
Prestige International Fund Class A, Class B, Class Y
Nationwide Focus Fund Class A, Class B,
Institutional Class
Nationwide Small Cap Value Fund II Class A, Class B,
Institutional Class
Nationwide High Yield Bond Fund Class A, Class B,
Institutional Class
Morley Enhanced Income Fund Class A, Class Y,
Institutional Class
You have an interest only in the assets of the shares of the Fund which
you own. Shares of a particular class are equal in all respects to the other
shares of that class. In the event of liquidation of a Fund, shares of the same
class will share pro rata in the distribution of the net assets of such Fund
with all other shares of that class. All shares are without par value and when
issued and paid for, are fully paid and nonassessable by the Trust. Shares may
be exchanged or converted as described in this Statement of Additional
Information and in the Prospectus but will have no other preference, conversion,
exchange or preemptive rights.
Voting Rights
Shareholders of each class of shares have one vote for each share held
and a proportionate fractional vote for any fractional share held. An annual or
special meeting of shareholders to conduct necessary business is not required by
the Declaration of Trust, the 1940 Act or other authority except, under certain
circumstances, to amend the Declaration of Trust, the Investment Advisory
Agreement, fundamental investment objectives, investment policies, investment
restrictions, to elect and remove Trustees, to reorganize the Trust or any
series or class thereof and to act upon certain other business matters. In
regard to termination, sale of assets, the change of investment objectives,
policies and restrictions or the approval of an Investment Advisory Agreement,
the right to vote is limited to the holders of shares of the particular fund
affected by the proposal. In addition, holders of Class A shares, Class B shares
or Prime shares will vote as a class and not with holders of any other class
with respect to the approval of the Distribution Plan.
To the extent that such a meeting is not required, the Trust does not
intend to have an annual or special meeting of shareholders. The Trust has
represented to the Commission that the Trustees will call a special meeting of
shareholders for purposes of considering the removal of one or more Trustees
upon written request therefor from shareholders holding not less than 10% of the
outstanding votes of the Trust and the Trust will assist in communicating with
other shareholders as required by Section 16(c) of the 1940 Act. At such
meeting, a quorum of shareholders (constituting a majority of votes attributable
to all outstanding shares of the Trust), by majority vote, has the power to
remove one or more Trustees.
ADDITIONAL GENERAL TAX INFORMATION
Each of the Funds is treated as a separate entity for Federal income
tax purposes and intends to qualify as a "regulated investment company" under
the Code, for so long as such qualification is in the best interest of that
Fund's shareholders. In order to qualify as a regulated investment company, a
Fund must, among other things: diversify its investments within certain
prescribed limits; derive at least 90% of its gross income from dividends,
interest, payments with respect to securities loans, and gains from the sale or
other disposition of securities or foreign currencies, or other income derived
with respect to its business of investing in such stock, securities, or
currencies. In addition, to utilize the tax provisions specially applicable to
regulated investment companies, a Fund must distribute to its shareholders at
least 90% of its investment company taxable income for the year. In general, the
Fund's investment company taxable income will be its taxable income subject to
certain adjustments and excluding the excess of any net mid-term or net
long-term capital gain for the taxable year over the net short-term capital
loss, if any, for such year.
A non-deductible 4% excise tax is imposed on regulated investment
companies that do not distribute in each calendar year (regardless of whether
they otherwise have a non-calendar taxable year) an amount equal to 98% of their
ordinary income for the calendar year plus 98% of their capital gain net income
for the one-year period ending on October 31 of such calendar year. The balance
of such income must be distributed during the next calendar year. If
distributions during a calendar year were less than the required amount, the
Fund would be subject to a non-deductible excise tax equal to 4% of the
deficiency.
Although each Fund expects to qualify as a "regulated investment
company" and to be relieved of all or substantially all federal income taxes,
depending upon the extent of its activities in states and localities in which
its offices are maintained, in which its agents or independent contractors are
located, or in which it is otherwise deemed to be conducting business, a Fund
may be subject to the tax laws of such states or localities. In addition, if for
any taxable year a Fund does not qualify for the special tax treatment afforded
regulated investment companies, all of its taxable income will be subject to
federal tax at regular corporate rates (without any deduction for distributions
to its shareholders). In such event, dividend distributions would be taxable to
shareholders to the extent of earnings and profits, and would be eligible for
the dividends received deduction for corporations.
It is expected that each Fund will distribute annually to shareholders
all or substantially all of that Fund's net ordinary income and net realized
capital gains and that such distributed net ordinary income and distributed net
realized capital gains will be taxable income to shareholders for federal income
tax purposes, even if paid in additional shares of that Fund and not in cash.
Distribution by a Fund of the excess of net long-term capital gain over
net short-term capital loss, if any, is taxable to shareholders as long-term
capital gain, respectively, in the year in which it is received, regardless of
how long the shareholder has held the shares. Such distributions are not
eligible for the dividends-received deduction.
Federal taxable income of individuals is subject to graduated tax rates
of 15%, 28%, 31%, 36% and 39.6%. Further, the effective marginal tax rate may be
in excess of 39.6%, because adjustments reduce or eliminate the benefit of the
personal exemption and itemized deductions for individuals with gross income in
excess of certain threshold amounts.
Long-term capital gains of individuals are subject to a maximum tax
rate of 20% (10% for individuals in the 15% ordinary income tax bracket).
Capital losses may be used to offset capital gains. In addition, individuals may
deduct up to $3,000 of net capital loss each year to offset ordinary income.
Excess net capital loss may be carried forward and deducted in future years. The
holding period for long-term capital gains is more than one year.
Federal taxable income of corporations in excess of $75,000 up to $10
million is subject to a 34% tax rate; however, because the benefit of lower tax
rates on a corporation's taxable income of less than $75,000 is phased out for
corporations with income in excess of $100,000 but lower than $335,000, a
maximum marginal tax rate of 39% may result. Federal taxable income of
corporations in excess of $10 million is subject to a tax rate of 35%. Further,
a corporation's federal taxable income in excess of $15 million is subject to an
additional tax equal to 3% of taxable income over $15 million, but not more than
$100,000.
Capital gains of corporations are subject to tax at the same rates
applicable to ordinary income. Capital losses may be used only to offset capital
gains and excess net capital loss may be carried back three years and forward
five years.
Certain corporations are entitled to a 70% dividends received deduction
for distributions from certain domestic corporations. Each Fund will designate
the portion of any distributions which qualify for the 70% dividends received
deduction. The amount so designated may not exceed the amount received by that
Fund for its taxable year that qualifies for the dividends received deduction.
Because all of the Money Market Fund's and each of the Bond Fund's net
investment income is expected to be derived from earned interest and short term
capital gains, it is anticipated that no distributions from such Funds will
qualify for the 70% dividends received deduction.
Foreign taxes may be imposed on a Fund by foreign countries with
respect to its income from foreign securities. Tax conventions between certain
countries and the United States may reduce or eliminate such taxes. It is
impossible to determine the effective rate of foreign tax in advance since the
amount of each Fund's assets to be invested in various countries is not known.
If less than 50% in value of any Fund's total assets at the end of its
fiscal year are invested in stocks or securities of foreign corporations, such
Fund will not be entitled under the Code to pass through to its Shareholders
their pro rata share of the foreign taxes paid by that Fund. These taxes will be
taken as a deduction by the Fund. Under Section 1256 of the Code, gain or loss
realized by a Fund from certain financial futures and options transactions will
be treated as 60% long-term capital gain or loss and 40% short-term capital gain
or loss. Gain or loss will arise upon exercise or lapse of such futures and
options as well as from closing transactions. In addition, any such futures and
options remaining unexercised at the end of a Fund's taxable year will be
treated as sold for their then fair market value, resulting in additional gain
or loss to such Fund characterized in the manner described above.
If more than 50% of the value of a Fund's total assets at the close of
its taxable year consists of the stock or securities of foreign corporations,
the Fund may elect to "pass through" to its shareholders the amount of foreign
income taxes paid by the Fund. Pursuant to such election, shareholders would be
required (i) to include in gross income, even though not actually received,
their respective pro rata share of the foreign taxes paid by the Fund, (ii) to
treat their income from the Fund as being from foreign sources to the extent
that the Fund's income is from foreign sources, and (iii) to either deduct their
pro rata share of foreign taxes in computing their taxable income or use it as a
foreign tax credit against federal income (but not both). No deduction for
foreign taxes could be claimed by a shareholder who does not itemize deductions.
It is anticipated that the International Fund will be operated so as to
meet the requirements of the Code to "pass through" to its shareholders credits
for foreign taxes paid, although there can be no assurance that these
requirements will be met. Each shareholder will be notified within 45 days after
the close of the International Fund's taxable year whether the foreign taxes
paid by the International Fund will "pass through" for that year and, if so, the
amount of each shareholder's pro rata share of (i) the foreign taxes paid, and
(ii) the International Fund's gross income from foreign sources. Of course,
shareholders who are not liable for federal income taxes, such as retirement
plans qualified under Section 401 of the Code, will not be affected by any such
"pass through" of foreign tax credits.
If a Fund invests in an entity that is classified as a "passive foreign
investment company" ("PFIC") for federal income tax purposes, the operation of
certain provisions of the Code applying to PFICs could result in the imposition
of certain federal income taxes on the Fund. In addition, gain realized from the
sale, other disposition, or marking-to-market of PFIC securities may be treated
as ordinary income under Section 1291 or Section 1296 of the Code.
Offsetting positions held by a Fund involving certain futures contracts
or options transactions may be considered, for tax purposes, to constitute
"straddles." Straddles are defined to include "offsetting positions" in actively
traded personal property. The tax treatment of straddles is governed by Sections
1092 and 1258 of the Code, which, in certain circumstances, overrides or
modifies the provisions of Section 1256. As such, all or a portion of any short
or long-term capital gain from certain straddle and/or conversion transactions
may be recharacterized as ordinary income.
If a Fund were treated as entering into straddles by reason of its
engaging in futures or options transactions, such straddles would be
characterized as "mixed straddles" if the futures or options comprising a part
of such straddles were governed by Section 1256 of the Code. A Fund may make one
or more elections with respect to mixed straddles. If no election is made, to
the extent the straddle rules apply to positions established by a Fund, losses
realized by such Fund will be deferred to the extent of unrealized gain in any
offsetting positions. Moreover, as a result of the straddle and conversion
transaction rules, short-term capital losses on straddle positions may be
recharacterized as long-term capital losses and long-term capital gains may be
recharacterized as short-term capital gain or ordinary income.
Investment by a Fund in securities issued at a discount or providing
for deferred interest or for payment of interest in the form of additional
obligations could, under special tax rules, affect the amount, timing and
character of distributions to Shareholders. For example, a Fund could be
required to take into account annually a portion of the discount (or deemed
discount) at which such securities were issued and to distribute such portion in
order to maintain its qualification as a regulated investment company. In that
case, that Fund may have to dispose of securities which it might otherwise have
continued to hold in order to generate cash to satisfy these distribution
requirements.
Each Fund may be required by federal law to withhold and remit to the
U.S. Treasury 31% of taxable dividends, if any, and capital gain distributions
to any Shareholder, and the proceeds of redemption or the values of any
exchanges of Shares of the Fund, if such Shareholder (1) fails to furnish the
Fund with a correct taxpayer identification number, (2) under-reports dividend
or interest income, or (3) fails to certify to the Fund that he or she is not
subject to such withholding. An individual's taxpayer identification number is
his or her Social Security number.
Information set forth in the Prospectuses and this Statement of
Additional Information which relates to Federal taxation is only a summary of
some of the important Federal tax considerations generally affecting purchasers
of shares of the Funds. No attempt has been made to present a detailed
explanation of the Federal income tax treatment of the Funds or their
shareholders and this discussion is not intended as a substitute for careful tax
planning. Accordingly, potential purchasers of shares of a Fund are urged to
consult their tax advisers with specific reference to their own tax situation.
In addition, the tax discussion in the Prospectus and this Statement of
Additional Information is based on tax laws and regulations which are in effect
on the date of the prospectuses and this Statement of Additional Information;
such laws and regulations may be changed by legislative or administrative
action.
Information as to the federal income tax status of all distributions
will be mailed annually to each shareholder.
<PAGE>
MAJOR SHAREHOLDERS
As of December ____, 1999, there were no outstanding shares of the
Funds. Immediately prior to the public offering of shares of the Funds, ____
owned all of the issued and outstanding shares of each Fund. It is anticipated
that upon the public offering of shares of the Funds, NAS' holdings will be
reduced below 5% of the outstanding shares of each Fund.
FINANCIAL STATEMENTS
<PAGE>
APPENDIX A
BOND RATINGS
STANDARD & POOR'S DEBT RATINGS
A Standard & Poor's corporate or municipal debt rating is a current assessment
of the creditworthiness of an obligor with respect to a specific obligation.
This assessment may take into consideration obligors such as guarantors,
insurers, or lessees.
The debt rating is not a recommendation to purchase, sell, or hold a security,
inasmuch as it does not comment as to market price or suitability for a
particular investor. The ratings are based on current information furnished by
the issuer or obtained by Standard & Poor's from other sources it considers
reliable. Standard & Poor's does not perform an audit in connection with any
rating and may, on occasion, rely on unaudited financial information. The
ratings may be changed, suspended, or withdrawn as a result of changes in, or
unavailability of, such information, or for other circumstances.
The ratings are based, in varying degrees, on the following considerations:
1. Likelihood of default - capacity and willingness of the obligor as
to the timely payment of interest and repayment of principal in
accordance with the terms of the obligation.
2. Nature of and provisions of the obligation.
3. Protection afforded by, and relative position of, the obligation
in the event of bankruptcy, reorganization, or other arrangement
under the laws of bankruptcy and other laws affecting creditors'
rights.
INVESTMENT GRADE
AAA - Debt rated 'AAA' has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA - Debt rated 'AA' has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small degree.
A - Debt rated 'A' has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB - Debt rated 'BBB' is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
SPECULATIVE GRADE
Debt rated 'BB', 'B', 'CCC', 'CC' and 'C' is regarded as having predominantly
speculative characteristics with respect to capacity to pay interest and repay
principal. 'BB' indicates the least degree of speculation and 'C' the highest.
While such debt will likely have some quality and protective characteristics,
these are outweighed by large uncertainties or major risk exposures to adverse
conditions.
BB - Debt rated 'BB' has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The 'BB'
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied 'BBB-' rating.
B - Debt rated 'B' has a greater vulnerability to default but currently has the
capacity to meet interest payments and principal repayments. Adverse business,
financial, or economic conditions will likely impair capacity or willingness to
pay interest and repay principal. The 'B' rating category is also used for debt
subordinated to senior debt that is assigned an actual or implied 'BB' or 'BB-'
rating.
CCC - Debt rated 'CCC' has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial, and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial, or economic conditions, it is not likely to have
the capacity to pay interest and repay principal. The 'CCC' rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied 'B' or 'B-' rating.
CC - Debt rated 'CC' typically is applied to debt subordinated to senior debt
that is assigned an actual or implied 'CCC' rating.
C - Debt rated 'C' typically is applied to debt subordinated to senior debt
which is assigned an actual or implied 'CCC-' debt rating. The 'C' rating may be
used to cover a situation where a bankruptcy petition has been filed, but debt
service payments are continued.
CI - The rating 'CI' is reserved for income bonds on which no interest is being
paid.
D - Debt rated 'D' is in payment default. The 'D' rating category is used when
interest payments or principal payments are not made on the date due even if the
applicable grace period has not expired, unless Standard & Poor's believes that
such payments will be made during such grade period. The 'D' rating also will be
used upon the filing of a bankruptcy petition if debt service payments are
jeopardized.
<PAGE>
MOODY'S LONG-TERM DEBT RATINGS
Aaa - Bonds which are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa - Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long-term risk appear somewhat larger than in Aaa securities.
A - Bonds which are rated A possess many favorable investment attributes and are
to be considered as upper-medium grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment some time in the future.
Baa - Bonds which are rated Baa are considered as medium-grade obligations
(i.e., they are neither highly protected nor poorly secured). Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba - Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered well-assured. Often the protection of interest and
principal payments may be very moderate, and thereby not well safeguarded during
both good and bad times over the future. Uncertainty of position characterizes
bonds in this class.
B - Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa - Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca - Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
C - Bonds which are rated C are the lowest rated class of bonds, and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
STATE AND MUNICIPAL NOTES
Excerpts from Moody's Investors Service, Inc., description of state and
municipal note ratings:
MIG-1--Notes bearing this designation are of the best quality, enjoying strong
protection from established cash flows of funds for their servicing from
established and board-based access to the market for refinancing, or both.
MIG-2--Notes bearing this designation are of high quality, with margins of
protection ample although not so large as in the preceding group.
MIG-3--Notes bearing this designation are of favorable quality, with all
security elements accounted for but lacking the strength of the preceding grade.
Market access for refinancing, in particular, is likely to be less well
established.
FITCH IBCA INFORMATION SERVICES, INC. BOND RATINGS
Fitch investment grade bond ratings provide a guide to investors in determining
the credit risk associated with a particular security. The ratings represent
Fitch's assessment of the issuer's ability to meet the obligations of a specific
debt issue or class of debt in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the issuer's
future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided by
insurance policies or financial guaranties unless otherwise indicated.
Bonds that have the same rating are of similar but not necessarily identical
credit quality since the rating categories do not fully reflect small
differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other obligors,
underwriters, their experts, and other sources Fitch believes to be reliable.
Fitch does not audit or verify the truth or accuracy of such information.
Ratings may be changed, suspended, or withdrawn as a result of changes in, or
the unavailability of, information or for other reasons.
AAA Bonds considered to be investment grade and represent the
lowest expectation of credit risk. The obligor has an
exceptionally strong capacity for timely payment of financial
commitments, a capacity that is highly unlikely to be
adversely affected by foreseeable events.
AA Bonds considered to be investment grade and of very high
credit quality. This rating indicates a very strong capacity
for timely payment of financial commitments, a capacity that
is not significantly vulnerable to foreseeable events.
A Bonds considered to be investment grade and represent a low
expectation of credit risk. This rating indicates a strong
capacity for timely payment of financial commitments. This
capacity may, nevertheless, be more vulnerable to changes in
economic conditions or circumstances than long term debt with
higher ratings.
BBB Bonds considered to be in the lowest investment grade and
indicates that there is currently low expectation of credit
risk. The capacity for timely payment of financial commitments
is considered adequate, but adverse changes in economic
conditions and circumstances are more likely to impair this
capacity.
BB Bonds are considered speculative. This rating indicates that
there is a possibility of credit risk developing, particularly
as the result of adverse economic changes over time; however,
business or financial alternatives may be available to allow
financial commitments to be met. Securities rated in this
category are not investment grade.
B Bonds are considered highly speculative. This rating indicates
that significant credit risk is present, but a limited margin
of safety remains. Financial commitments are currently being
met; however, capacity for continued payment is contingent
upon a sustained, favorable business and economic environment.
CCC, CC Bonds are considered a high default risk. Default is a real
and possibility. C Capacity for meeting financial commitments is
solely reliant upon sustained, favorable business or economic
developments. A `CC' rating indicates that default of some
kind appears probable. `C' rating signal imminent default.
DDD, DD Bonds are in default. Such bonds are not meeting current
and D obligations and are extremely speculative. `DDD' designates
the highest potential for recovery of amounts outstanding on
any securities involved and 'D' represents the lowest
potential for recovery.
<PAGE>
DUFF & PHELPS, INC. LONG-TERM DEBT RATINGS
These ratings represent a summary opinion of the issuer's long-term fundamental
quality. Rating determination is based on qualitative and quantitative factors
which may vary according to the basic economic and financial characteristics of
each industry and each issuer. Important considerations are vulnerability to
economic cycles as well as risks related to such factors as competition,
government action, regulation, technological obsolescence, demand shifts, cost
structure, and management depth and expertise. The projected viability of the
obligor at the trough of the cycle is a critical determination.
Each rating also takes into account the legal form of the security, (e.g., first
mortgage bonds, subordinated debt, preferred stock, etc.). The extent of rating
dispersion among the various classes of securities is determined by several
factors including relative weightings of the different security classes in the
capital structure, the overall credit strength of the issuer, and the nature of
covenant protection. Review of indenture restrictions is important to the
analysis of a company's operating and financial constraints.
The Credit Rating Committee formally reviews all ratings once per quarter (more
frequently, if necessary). Ratings of 'BBB-' and higher fall within the
definition of investment grade securities, as defined by bank and insurance
supervisory authorities.
RATING SCALE DEFINITION
AAA Highest credit quality. The risk factors are
negligible, being only slightly more than
for risk-free U.S. Treasury debt.
AA+ High credit quality. Protection factors are
AA strong. Risk is modest, but may vary slightly
AA- from time to time because of economic conditions.
A+ Protection factors are average but adequate.
A However, risk factors are more variable and
A- greater in periods of economic stress.
BBB+ Below average protection factors but still
BBB considered ufficient for prudent investment.
BBB- Considerable ariability in risk during economic
cycles.
BB+ Below investment grade but deemed likely to meet
BB obligations when due. Present or prospective
BB- financial protection factors fluctuate according to
industry conditions or company fortunes. Overall
quality may move up or down frequently within
this category.
B+ Below investment grade and possessing risk that
B obligations will not be met when due. Financial
B- protection factors will fluctuate widely according
to economic cycles, industry conditions and/or
company fortunes. Potential exists for
frequent Changes in the rating within this
category or into a higher or lower rating
grade.
CCC Well below investment grade securities.
Considerable uncertainty exists as to timely
payment of principal, interest or preferred
dividends. Protection factors are narrow and
risk can be substantial with unfavorable
economic/industry conditions, and/or with
unfavorable company developments.
DD Defaulted debt obligations. Issuer failed to
meet scheduled principal and/or interest
payments.
DP Preferred stock with dividend arrearages.
SHORT-TERM RATINGS
STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt considered short-term in the relevant
market.
Ratings are graded into several categories, ranging from 'A-1' for the highest
quality obligations to 'D' for the lowest. These categories are as follows:
A-1 This highest category indicates that the degree of safety regarding timely
payment is strong. Those issues determined to possess extremely strong safety
characteristics are denoted with a plus sign (+) designation.
A-2 Capacity for timely payment on issues with this designation is satisfactory.
However, the relative degree of safety is not as high as for issues designated
'A-1'.
A-3 Issues carrying this designation have adequate capacity for timely payment.
They are, however, more vulnerable to the adverse effects of changes in
circumstances than obligations carrying the higher designations.
B Issues rated 'B' are regarded as having only speculative capacity for timely
payment.
C This rating is assigned to short-term debt obligations with doubtful capacity
for payment.
D Debt rated 'D' is in payment default. the 'D' rating category is used when
interest payments or principal payments are not made on the date due, even if
the applicable grace period has not expired, unless Standard & Poor's believes
that such payments will be made during such grade period.
STANDARD & POOR'S NOTE RATINGS
An S&P note rating reflects the liquidity factors and market-access risks unique
to notes. Notes maturing in three years or less will likely receive a note
rating. Notes maturing beyond three years will most likely receive a long-term
debt rating.
The following criteria will be used in making the assessment:
1. Amortization schedule - the larger the final maturity relative
to other maturities, the more likely the issue is to be treated
as a note.
2. Source of payment - the more the issue depends on the market
for its refinancing, the more likely it is to be considered a
note.
Note rating symbols and definitions are as follows:
SP-1 Strong capacity to pay principal and interest. Issues determined
to possess very strong characteristics are given a plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term of the
notes.
SP-3 Speculative capacity to pay principal and interest.
MOODY'S SHORT-TERM RATINGS
Moody's short-term debt ratings are opinions on the ability of issuers to repay
punctually senior debt obligations. These obligations have an original maturity
not exceeding one year, unless explicitly noted. Moody's employs the following
three designations, all judged to be investment grade, to indicate the relative
repayment capacity of rated issuers:
Issuers rated Prime-1 (or supporting institutions) have a superior capacity for
repayment of senior short-term debt obligations. Prime-1 repayment capacity will
normally be evidenced by the following characteristics: (I) leading market
positions in well established industries, (II) high rates of return on funds
employed, (III) conservative capitalization structures with moderate reliance on
debt and ample asset protection, (IV) broad margins in earnings coverage of
fixed financial charges and high internal cash generation, and (V) well
established access to a range of financial markets and assured sources of
alternative liquidity.
Issuers rated Prime-2 (or supporting institutions) have a strong capacity for
repayment of short-term promissory obligations. This will normally be evidenced
by many of the characteristics cited above, but to a lesser degree. Earnings
trends and coverage ratios, while sound, will be more subject to variation.
Capitalization characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or supporting institutions) have an acceptable capacity
for repayment of short-term promissory obligations. The effect of industry
characteristics and market composition may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt protection
measurements and may require relatively high financial leverage. Adequate
alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the prime rating categories.
MOODY'S NOTE RATINGS
MIG 1/VMIG 1 This designation denotes best quality. There is present strong
protection by established cash flows, superior liquidity support or demonstrated
broad based access to the market for refinancing.
MIG 2/VMIG 2 This designation denotes high quality. Margins of protection are
ample although not so large as in the preceding group.
MIG 3/VMIG 3 This designation denotes favorable quality. All security elements
are accounted for but there is lacking the undeniable strength of the preceding
grades. Liquidity and cash flow protection may be narrow and market access for
refinancing is likely to be less well established.
MIG 4/VMIG 4 This designation denotes adequate quality. Protection commonly
regarded as required of an investment security is present and although not
distinctly or predominantly speculative, there is specific risk.
SG This designation denotes speculative quality. Debt instruments in this
category lack margins of protection.
FITCH'S SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on demand
or have original maturities of up to three years, including commercial paper,
certificates of deposit, medium-term notes, and municipal and investment notes.
The short-term rating places greater emphasis than a long-term rating on the
existence of liquidity necessary to meet the issuer's obligations in a timely
manner.
F-1+ Exceptionally strong credit quality. Issues assigned this rating
are regarded as having the strongest degree of assurance for timely payment.
F-1 Very strong credit quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues
rated F-1+.
F-2 Good credit quality. Issues assigned this rating have a
satisfactory degree of assurance for timely payment but the margin of
safety is not as great as for issues assigned F-1+ and F-1 ratings.
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DUFF & PHELPS SHORT-TERM DEBT RATINGS
Duff & Phelps' short-term ratings are consistent with the rating criteria
utilized by money market participants. The ratings apply to all obligations with
maturities under one year, including commercial paper, the uninsured portion of
certificates of deposit, unsecured bank loans, master notes, bankers
acceptances, irrevocable letters of credit, and current maturities of long-term
debt. Asset-backed commercial paper is also rated according to this scale.
Emphasis is placed on liquidity which is defined as not only cash from
operations, but also access to alternative sources of funds including trade
credit, bank lines, and the capital markets. An important consideration is the
level of an obligor's reliance on short-term funds on an ongoing basis.
RATING SCALE DEFINITION
HIGH GRADE
D-1+ Highest certainty of timely payment. short-term liquidity,
including internal operating factors and/or access to
alternative sources of funds, is outstanding, and safety is
just below risk-free U.S. Treasury short-term obligations.
D-1 Very high certainty of timely payment. Liquidity factors are
excellent and supported by good fundamental protection
factors. Risk factors are minor.
D-1- High certainty of timely payment. Liquidity factors are
strong and supported by good fundamental protection factors.
Risk factors are very small.
GOOD GRADE
D-2 Good certainty of timely payment. Liquidity factors and
company fundamentals are sound. Although ongoing funding
needs may enlarge total financing requirements, access to
capital markets is good. Risk factors are small.
SATISFACTORY GRADE
D-3 Satisfactory liquidity and other protection factors qualify
issue as to investment grade. Risk factors are larger and
subject to more variation. Nevertheless, timely payment is
expected.
NON-INVESTMENT GRADE
D-4 Speculative investment characteristics. Liquidity is not
sufficient to insure against disruption in debt service.
Operating factors and market access may be subject to a high
degree of variation.
DEFAULT
D-5 Issuer failed to meet scheduled principal and/or interest
payments.
THOMSON'S SHORT-TERM RATINGS
The Thomson Short-Term Ratings apply, unless otherwise noted, to specific debt
instruments of the rated entities with a maturity of one year or less. Thomson
short-term ratings are intended to assess the likelihood of an untimely or
incomplete payments of principal or interest.
TBW-1 the highest category, indicates a very high likelihood that principal and
interest will be paid on a timely basis.
TBW-2 the second highest category, while the degree of safety regarding timely
repayment of principal and interest is strong, the relative degree of safety is
not as high as for issues rated "TBW-1".
TBW-3 the lowest investment-grade category; indicates that while the obligation
is more susceptible to adverse developments (both internal and external) than
those with higher ratings, the capacity to service principal and interest in a
timely fashion is considered adequate.
TBW-4 the lowest rating category; this rating is regarded as non-investment
grade and therefore speculative.
