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Prospectus
MARCH 1, 1998
EQUITY PORTFOLIOS
Nations Value Portfolio
Nations International Growth Portfolio
Nations Disciplined Equity Portfolio
Nations Marsico Focused Equities
Portfolio
Nations Marsico Growth & Income
Portfolio
INDEX PORTFOLIOS
Nations Managed Index Portfolio
Nations Managed SmallCap Index
Portfolio
BALANCED PORTFOLIO
Nations Balanced Assets Portfolio
INVESTMENT ADVISER: NationsBanc Advisors, Inc.
INVESTMENT SUB-ADVISER: TradeStreet Investment Associates, Inc.
INVESTMENT SUB-ADVISER: Gartmore Global Partners
INVESTMENT SUB-ADVISER: Marsico Capital Management, LLC
DISTRIBUTOR: Stephens Inc.
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Prospectus
MARCH 1, 1998
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EQUITY PORTFOLIOS:
This Prospectus describes the investment portfolios Nations Value Portfolio
listed in the column to the right (each a Nations International Growth
"Portfolio") of Nations Annuity Trust (the "Trust"), Portfolio
an open-end management investment company. Nations Disciplined Equity
Portfolio
Nations Marsico Focused
The Portfolios are made available to serve as the Equities Portfolio
underlying funding vehicles for certain variable Nations Marsico Growth &
annuity and variable life insurance separate Income Portfolio
accounts issued by participating life insurance
companies, including Hartford Life Insurance Company INDEX PORTFOLIOS:
("Hartford") ("Participating Insurance Companies"), Nations Managed Index
offering variable annuity contracts and variable Portfolio
life insurance policies (hereinafter a "Contract" or Nations Managed
"Contracts"). SmallCap Index
Portfolio
BALANCED PORTFOLIO:
Nations Balanced Assets
Investors should read this Prospectus, along with Portfolio
the prospectus for a Contract accompanying this
Prospectus, before investing and retain it for
future reference. It sets forth concisely the
information which a prospective purchaser of a
Portfolio Contract should know about the Portfolios
before making such a purchase. Additional
information about the Trust is contained in a
separate Statement of Additional Information (the
"SAI"), that has been filed with the Securities and
Exchange Commission (the "SEC") and is available
upon request without charge by writing or calling
the Trust at its address or telephone number shown
below. The SAI for the Trust, dated March 1, 1998,
is incorporated by reference in its entirety into
this Prospectus. The SEC maintains a Web site
(http://www.sec.gov) that contains the SAI, material
incorporated by reference in this Prospectus and
other information regarding registrants that file
electronically with the SEC. NationsBanc Advisors,
Inc. ("NBAI") is the investment adviser to the
Portfolios. TradeStreet Investment Associates, Inc.
("TradeStreet") is investment sub-adviser to certain
of the Portfolios, Gartmore Global Partners
("Gartmore") is investment sub-adviser to Nations
International Growth Portfolio, and Marsico Capital
Management, LLC ("Marsico Capital") is investment
sub-adviser to Nations Marsico Focused Equities
Portfolio and Nations Marsico Growth & Income
Portfolio. As used herein the term "Adviser" shall
mean NBAI, TradeStreet, Gartmore and/or Marsico
Capital as the context may require.
SHARES OF THE PORTFOLIOS ARE NOT DEPOSITS OR OTHER
OBLIGATIONS OF, OR ISSUED, ENDORSED OR GUARANTEED
BY, NATIONSBANK, N.A. ("NATIONSBANK") OR ANY OF ITS
AFFILIATES. SUCH SHARES ARE NOT INSURED BY THE U.S.
GOVERNMENT, THE FEDERAL DEPOSIT INSURANCE
CORPORATION, THE FEDERAL RESERVE BOARD OR ANY OTHER
GOVERNMENT AGENCY. AN INVESTMENT IN THE PORTFOLIOS
INVOLVES CERTAIN RISKS, INCLUDING POSSIBLE LOSS OF
PRINCIPAL.
NATIONSBANK AFFILIATES PROVIDE SERVICES TO THE
PORTFOLIOS, FOR WHICH THEY ARE COMPENSATED. STEPHENS
INC., WHICH IS NOT AFFILIATED WITH NATIONSBANK, IS
THE SPONSOR AND ADMINISTRATOR AND SERVES AS THE
DISTRIBUTOR FOR THE PORTFOLIOS.
THESE SECURITIES HAVE NOT BEEN APPROVED OR
DISAPPROVED BY THE SECURITIES AND EXCHANGE
COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR
HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY
STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
For Portfolio information
call:
1-800-765-2668
Nations Annuity Trust
c/o Stephens Inc.
One NationsBank Plaza
33rd Floor
Charlotte, NC 28255
(NATIONS FUNDS logo appears here)
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Table Of Contents
Participating Insurance Companies 3
About The
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Portfolios
Objectives 3
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How Objectives Are Pursued 3
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How Performance Is Shown 11
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How The Portfolios Are Managed 12
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Organization And History 16
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How To Buy Shares 16
About Your
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Investment
How To Redeem Shares 17
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Shareholder Servicing And Distribution Plan 17
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How The Portfolios Value Their Shares 17
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How Dividends And Distributions Are Made;
Tax Information 18
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General Information 18
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Appendix A -- Portfolio Securities 19
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Appendix B -- Description Of Ratings 27
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NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT
CONTAINED IN THIS PROSPECTUS, OR IN THE PORTFOLIOS'
SAI INCORPORATED HEREIN BY REFERENCE, IN CONNECTION
WITH THE OFFERING MADE BY THIS PROSPECTUS AND, IF
GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY
THE TRUST OR ITS DISTRIBUTOR. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFERING BY THE TRUST OR BY THE
DISTRIBUTOR IN ANY JURISDICTION IN WHICH SUCH
OFFERING MAY NOT LAWFULLY BE MADE.
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About The Portfolios
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Participating Insurance Companies
The Portfolios are made available to serve as the underlying investment vehicles
for certain variable annuity and variable life insurance separate accounts
issued by Participating Insurance Companies. Each Portfolio is an open-end
management investment company, organized as a Delaware business trust. Each of
the Portfolios have different investment objectives and policies. Each Contract
is described in a separate prospectus issued by the Participating Insurance
Companies. The Trust assumes no responsibility for such prospectus. For a
discussion of the Portfolios' objectives and policies, see "Objectives" and "How
Objectives Are Pursued" below.
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Objectives
EQUITY PORTFOLIOS:
NATIONS VALUE PORTFOLIO: Nations Value Portfolio's investment objective is to
seek growth of capital by investing in companies that are believed to be
undervalued.
NATIONS INTERNATIONAL GROWTH PORTFOLIO: Nations International Growth Portfolio's
investment objective is to seek long-term capital growth by investing primarily
in equity securities of companies domiciled in countries outside the United
States and listed on major stock exchanges primarily in Europe and the Pacific
Basin.
NATIONS DISCIPLINED EQUITY PORTFOLIO: Nations Disciplined Equity Portfolio's
investment objective is to seek growth of capital by investing in companies that
are expected to produce significant increases in earnings per share.
NATIONS MARSICO FOCUSED EQUITIES PORTFOLIO: Nations Marsico Focused Equities
Portfolio's investment objective is to seek long-term growth of capital.
NATIONS MARSICO GROWTH & INCOME PORTFOLIO: Nations Marsico Growth & Income
Portfolio's investment objective is to seek long-term growth of capital with a
limited emphasis on income.
INDEX PORTFOLIOS:
NATIONS MANAGED INDEX PORTFOLIO: Nations Managed Index Portfolio's investment
objective is to seek, over the long-term, to provide a total return which (gross
of fees and expenses) exceeds the total return of the Standard & Poor's 500
Composite Stock Price Index.
NATIONS MANAGED SMALLCAP INDEX PORTFOLIO: Nations Managed SmallCap Index
Portfolio's investment objective is to seek, over the long-term, to provide a
total return which (gross of fees and expenses) exceeds the total return of the
Standard & Poor's SmallCap 600 Index.
BALANCED PORTFOLIO:
NATIONS BALANCED ASSETS PORTFOLIO: Nations Balanced Assets Portfolio's
investment objective is to seek total return by investing in equity and fixed
income securities.
Although the Adviser will seek to achieve the investment objective of each
Portfolio, there is no assurance that it will be able to do so. No single
Portfolio should be considered, by itself, to provide a complete investment
program for any investor. Investments in a Portfolio are not insured against
loss of principal.
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How Objectives Are Pursued
EQUITY PORTFOLIOS:
NATIONS VALUE PORTFOLIO: The Portfolio invests in stocks drawn from a broad
universe of companies monitored by the Adviser. The Adviser closely monitors
these companies, rating them for quality and projecting their future earnings
and dividends as well as other factors. To qualify for purchase, an issuer would
normally have a market capitalization of $500 million or more and have an
average daily trading volume of at least $3 million. These requirements are
generally considered by the Adviser to be adequate to support normal purchase
and sale activity without materially affecting prevailing market prices of the
issuer's shares. The Adviser also analyzes key financial ratios that measure the
growth, profitability, and leverage of such issuers that it believes will help
maintain a portfolio of above-average quality.
Stocks are selected from this universe based on the Adviser's judgment of their
total return potential. The
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Adviser buys stocks that it believes are undervalued relative to the overall
stock market. The principal factor considered by the Adviser in making these
determinations is the ratio of a stock's price to earnings relative to
corresponding ratios of other stocks in the same industry or economic sector.
The Adviser believes that companies with lower price/earnings ratios are more
likely to provide better opportunities for capital appreciation. This "value"
approach generally produces a dividend yield greater than the market average.
The Adviser will attempt to temper risk by broad diversification among economic
sectors and industries. Through this strategy, the Fund pursues above-average
returns while seeking to avoid above-average risks.
The Portfolio invests under normal market conditions at least 65% of its total
assets in common stocks. In addition to common stocks, the Portfolio also may
invest in preferred stocks, securities convertible into common stock and other
types of securities having common stock characteristics (such as rights and
warrants to purchase equity securities). Although the Portfolio invests
primarily in publicly-traded common stocks of companies incorporated in the
United States, the Portfolio may invest up to 20% of its assets in foreign
securities. The Portfolio also may hold up to 20% of its total assets in U.S.
Treasury bills, notes and bonds and other instruments issued directly by the
U.S. Government ("U.S. Treasury Obligations"), other obligations issued or
guaranteed as to payment of principal and interest by the U.S. Government, its
agencies and instrumentalities (together, with U.S. Treasury Obligations, "U.S.
Government Obligations"), and investment grade securities of domestic companies.
Obligations with the lowest investment grade rating (E.G. rated "BBB" by
Standard & Poor's Corporation ("S&P") or "Baa" by Moody's Investors Service,
Inc. ("Moody's")) have speculative characteristics and changes in economic
conditions or other circumstances are more likely to lead to a weakened capacity
to make principal and interest payments than is the case with higher grade debt
obligations. Subsequent to its purchase by the Portfolio, an issue of securities
may cease to be rated or its rating may be reduced below the minimum rating
required for purchase by the Portfolio. The Adviser will consider such an event
in determining whether the Portfolio should continue to hold the obligation.
Unrated obligations may be acquired by the Portfolio if they are determined by
the Adviser to be of comparable quality at the time of purchase to rated
obligations that may be acquired.
The Portfolio may invest in various money market instruments and repurchase
agreements. The Portfolio may invest without limitation in such instruments
pending investment, to meet anticipated redemption requests, or as a temporary
defensive measure if market conditions warrant.
NATIONS INTERNATIONAL GROWTH PORTFOLIO: In pursuing its investment objective,
under normal market conditions, the Portfolio will invest at least 65% of its
total assets in foreign equity securities listed on major exchanges, consisting
of common stocks, preferred stocks and convertible securities, such as warrants,
rights and convertible debt. The Portfolio may purchase the stock of small-,
mid- and large-capitalization companies.
The Portfolio may invest up to 35% of its total assets in securities of issuers
domiciled in developing countries. These countries are generally located in
Eastern Europe, the Asia-Pacific region, Latin and South America, Africa and,
subject to approval by the Board of Trustees, the former Soviet Union and the
Middle East. Debt securities, if any, purchased by the Portfolio will be rated
in the top two categories by a nationally recognized statistical rating
organization, or, if unrated, determined by the Adviser to be of comparable
quality. S&P, Moody's, Duff & Phelps Credit Rating Co. ("D&P"), Fitch Investors
Service, Inc. ("Fitch"), IBCA Limited or its affiliate IBCA Inc. (collectively
"IBCA") or Thomson BankWatch, Inc. ("BankWatch") are the six nationally
recognized statistical rating organizations ("NRSROs"). For temporary defensive
purposes, the Portfolio may invest up to 100% of its assets in debt and equity
securities of U.S. issuers. Debt securities in which the Portfolio may invest
include short-term and intermediate-term obligations of corporations, foreign
governments and international organizations (such as the International Bank for
Reconstruction and Development (the "World Bank")), including money market
instruments.
The Portfolio may invest in common stocks (including securities convertible into
common stocks) of foreign issuers and rights to purchase common stock, options
and futures contracts on securities, securities indexes and foreign currencies,
securities lending, forward foreign exchange contracts and repurchase
agreements. The Portfolio may invest in American Depository Receipts ("ADRs"),
Global Depository Receipts ("GDRs"), European Depository Receipts ("EDRs") and
American Depository Shares ("ADSs").
NATIONS DISCIPLINED EQUITY PORTFOLIO: The investment philosophy of the Portfolio
is based on the premise that companies with positive earnings trends also should
experience positive trends in their share price. Based on this philosophy, the
Portfolio invests primarily in the common stocks of companies that the Adviser
believes are likely to experience significant increases in earnings. By pursuing
this investment philosophy, the Portfolio seeks to provide investors with
long-term capital appreciation which exceeds that of the Standard & Poor's 500
Composite Stock Price Index (the "S&P 500 Index").(1)
(1) "Standard & Poor's 500" is a registered service mark of Standard & Poor's
Corporation ("S&P").
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In selecting stocks for the Portfolio, the Adviser utilizes quantitative
analysis and optimization tools. This approach seeks to identify companies with
improving profit potential through analysis of earnings forecasts issued by
investment banks, broker/dealers and other investment professionals. The Adviser
believes that companies experiencing such earnings trends have the potential to
generate significant increases in per share earnings. The Adviser also believes
that companies with increasing earnings should experience positive trends in
their stock price. The quantitative analysis also includes ranking the
attractiveness of equity securities according to a multi-factor valuation model.
Both value and growth factors are considered in the ranking process. Value
factors such as book value, earnings yield and cash flow measure a stock's
intrinsic worth versus its market price, while growth characteristics such as
price momentum, earnings growth and earnings acceleration measure a stock
relative to others in the same industry. The objective is to maintain a broadly
diversified portfolio which ranks in the top quartile on earnings momentum and
in the top third on valuation. This approach generally produces a dividend yield
less than the market average. Although this Portfolio seeks to invest in
attractively priced securities with increasing earnings, its investment
objective focuses on long-term capital appreciation; income is not an objective
of this Portfolio.
Under normal market conditions, the Portfolio invests at least 65% of its total
assets in common stocks of domestic issuers. With respect to the remainder of
the Portfolio's assets, the Portfolio may invest in a broad range of equity and
debt instruments, including preferred stocks, securities (debt and preferred
stock) convertible into common stock, warrants and rights to purchase common
stocks, options, U.S. government and corporate debt securities and various money
market instruments. The Portfolio will invest primarily in medium- and large-
sized companies (I.E. companies with market capitalizations of $500 million or
greater) that are determined to have favorable price/earnings ratios. The
Portfolio also may invest in securities issued by companies with market
capitalizations of less than $500 million. The volatility of
small-capitalization stocks is typically greater than that of larger companies.
To help reduce risk, the Portfolio will invest in the securities of companies
representing a broad range of industries and economic sectors.
The Portfolio's investments in debt securities, including convertible
securities, will be limited to securities rated investment grade (E.G.
securities rated in one of the top four investment categories by an NRSRO or, if
not rated, are of equivalent quality as determined by the Adviser). Obligations
rated in the lowest of the top four investment grade rating categories have
speculative characteristics and changes in economic conditions or other
circumstances are more likely to lead to a weakened capacity to make principal
and interest payments than is the case with higher grade debt obligations.
The Portfolio may invest up to 20% of its total assets in foreign securities.
For temporary defensive purposes if market conditions warrant, the Portfolio may
invest without limitation in preferred stocks, investment grade debt
instruments, money market instruments and repurchase agreements.
NATIONS MARSICO FOCUSED EQUITIES PORTFOLIO: Nations Marsico Focused Equities
Portfolio is a non-diversified fund that pursues its objective by normally
investing in a core position of 20-30 common stocks. Under normal circumstances,
the Portfolio invests at least 65% of its assets in large capitalization common
stocks selected for their growth potential. The Portfolio may invest to a lesser
degree in other types of securities, including preferred stock, warrants,
convertible securities and debt securities.
In building the portfolio, the Adviser seeks to identify individual companies
with earnings growth potential that may not be recognized by the market at
large. To identify such opportunities, the Adviser looks for a combination of
four characteristics:
(Bullet) Change -- The Adviser believes that extraordinary growth derives from
products, markets and technologies that are in flux.
(Bullet) Franchise -- The Adviser looks for strong brand franchises that can be
leveraged in a changing global environment.
(Bullet) Global reach -- The Adviser selects securities without geographic bias
in the belief that the global market is both a source of growth
opportunity and a hedge against fluctuations and dislocations of local
markets.
(Bullet) Themes -- The Adviser seeks companies that are moving with, not
against, the major social, economic and cultural shifts taking place
in the world.
Once an opportunity is identified, it is subjected to a disciplined analytic
process including both "top-down" and "bottom-up" elements. The "top-down" of
the process takes into consideration such macroeconomic factors as interest
rates, inflation, the regulatory environment and the global competitive
landscape, and also analyzes such factors as the most attractive global
opportunities, industry consolidation and the sustainability of economic trends.
With respect to the "bottom-up" element, the Adviser considers company
fundamentals such as commitment to research, market franchise and management's
strength and vision to determine the present and future value of the company as
an investment.
Realization of income is not a significant investment consideration. Any income
realized on the Portfolio's investments will be incidental to its objective.
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NATIONS MARSICO GROWTH & INCOME PORTFOLIO: Under normal circumstances, the
Nations Marsico Growth & Income Portfolio pursues its objective by investing up
to 75% of its assets in equity securities selected primarily for their growth
potential and at least 25% of its assets in securities that have income
potential. The Portfolio typically emphasizes the growth component. However, in
adverse market conditions, the Portfolio may reduce the growth component of its
portfolio to 25% of its assets. The Portfolio may invest in any combination of
common stock, preferred stock, warrants, convertible securities and debt
securities. However, it is expected that the Portfolio will emphasize
investments in large capitalization common stocks. The Portfolio may shift
assets between the growth and income components of its portfolio based on the
Adviser's analysis of relevant market, financial and economic conditions. If the
Adviser believes that growth securities will provide better returns than the
yields then available or expected on income-producing securities, then the
Portfolio will place a greater emphasis on the growth component. In building the
portfolio, the Adviser seeks to identify individual companies with earnings
growth potential that may not be recognized by the market at large. To identify
such opportunities, the Adviser looks for a combination of four characteristics:
(Bullet) Change -- The Adviser believes that extraordinary growth derives from
products, markets and technologies that are in flux.
(Bullet) Franchise -- The Adviser looks for strong brand franchises that can be
leveraged in a changing global environment.
(Bullet) Global reach -- The Adviser selects securities without geographic bias
in the belief that the global market is both a source of growth
opportunity and a hedge against fluctuations and dislocations of local
markets.
(Bullet) Themes -- The Adviser seeks companies that are moving with, not
against, the major social, economic and cultural shifts taking place
in the world.
Once an opportunity is identified, it is subjected to a disciplined analytic
process including both "top-down" and "bottom-up" elements. The "top-down"
element of the process takes into consideration such macroeconomic factors as
interest rates, inflation, the regulatory environment and the global competitive
landscape, and also analyzes such factors as the most attractive global
opportunities, industry consolidation and the sustainability of economic trends.
With respect to the "bottom-up" element, the Adviser considers company
fundamentals such as commitment to research, market franchise and management's
strength and vision to determine the present and future value of the company as
an investment.
Because income is a part of the investment objective of the Portfolio, the
Adviser may also consider dividend-paying characteristics in selecting equity
securities for the Portfolio. The Portfolio may also find opportunities for
capital growth from debt securities because of anticipated changes in interest
rates, credit standing, currency relationships or other factors. Investors in
the Portfolio should keep in mind that the Portfolio is not designed to produce
a consistent level of income.
ABOUT NATIONS MARSICO FOCUSED EQUITIES PORTFOLIO AND NATIONS MARSICO GROWTH &
INCOME PORTFOLIO: Nations Marsico Focused Equities Portfolio and Nations Marsico
Growth & Income Portfolio may also invest up to 25% of their assets in mortgage-
and asset-backed securities, up to 10% of their assets in zero coupon, pay-
in-kind and step coupon securities, and may invest without limit in
indexed/structured securities. The Portfolios will invest no more than 35% of
their assets in high-yield/high-risk securities. The Portfolios may also
purchase high-grade commercial paper, certificates of deposit, and repurchase
agreements. The Portfolios may also invest in short-term debt securities as a
means of receiving a return on idle cash.
When the Adviser believes that market conditions are not favorable for
profitable investing or when the Adviser is otherwise unable to locate favorable
investment opportunities, the Portfolios may hold cash or cash equivalents and
invest without limit in obligations issued or guaranteed by the U.S. Government,
its agencies or instrumentalities ("U.S. Government Obligations") and short-term
debt securities or money market instruments if the Adviser determines that a
temporary defensive position is advisable or to meet anticipated redemption
requests. In other words, the Portfolios do not always stay fully invested in
stocks and bonds. Cash or similar investments are a residual -- they represent
the assets that remain after the Adviser has committed available assets to
desirable investment opportunities. When the Portfolios' cash positions
increase, they may not participate in stock market advances or declines to the
extent that they would if they remained more fully invested in common stocks.
The Portfolios may invest up to 25% of their assets in foreign equity and debt
securities. The Portfolios may invest directly in foreign securities denominated
in a foreign currency and not publicly traded in the United States. Other ways
of investing in foreign securities include depository receipts or shares, and
passive foreign investment companies. Foreign securities are generally selected
on a company-by-company basis without regard to any defined allocation among
countries or geographic regions. However, certain factors such as expected
levels of inflation, government policies influencing business conditions, the
outlook for currency relationships, and prospects for economic growth among
countries, regions or geographic areas may warrant greater consideration
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in selecting foreign securities. The Portfolios may use options, futures,
forward currency contracts and other types of derivatives for hedging purposes
or for non-hedging purposes such as seeking to enhance return. The Portfolios
may purchase securities on a when-issued, delayed delivery or forward commitment
basis.
GENERAL: Each Equity Portfolio also may invest in certain specified derivative
securities including: exchange-traded options; over-the-counter options executed
with primary dealers, including long calls and puts and covered calls to enhance
return; and U.S. and foreign exchange-traded financial futures approved by the
Commodity Futures Trading Commission ("CFTC") and options thereon for market
exposure risk management. Each Equity Portfolio may lend its portfolio
securities to qualified institutional investors and may invest in repurchase
agreements, restricted, private placement and other illiquid securities. Each
Equity Portfolio also may invest in real estate investment trust securities. In
addition, each Equity Portfolio may invest in securities issued by other
investment companies, consistent with the Portfolio's investment objective and
policies and repurchase agreements. Nations International Growth Portfolio,
Nations Marsico Focused Equities Portfolio and Nations Marsico Growth & Income
Portfolio may invest in forward foreign exchange contracts.
For more information concerning these and other investments in which the
Portfolios may invest and their investment practices, see "Appendix A."
INDEX PORTFOLIOS:
NATIONS MANAGED INDEX PORTFOLIO: In seeking to achieve its investment objective,
the Portfolio will invest in selected equity securities that are included in the
S&P 500 Index. The S&P 500 Index is a market capitalizaton weighted index
consisting of 500 common stocks chosen for market size, liquidity and industry
group representation.
Unlike traditional index portfolios, the Portfolio has a "managed" overlay. The
Adviser believes that a managed equity index portfolio can provide investors
with positive incremental performance relative to the S&P 500 Index while
minimizing the downside risk of underperforming the S&P 500 Index over time.
The initial stock universe considered by the Adviser is the S&P 500 Index. The
Adviser ranks the attractiveness of each security according to a multi-factor
valuation model. Both value and momentum factors are considered in the ranking
process. Value factors such as book value, earnings yield and cash flow measure
a stock's intrinsic worth versus its market price, while momentum
characteristics such as price momentum, earnings growth and earnings
acceleration measure a stock relative to others in the same industry. A second
quantitative model which measures the earnings momentum of each security is
added to the screening process to serve as a validity check in the portfolio
construction process. Each stock is assigned a ranking from 1 to 10 (best to
worst). The Adviser then either underweights or eliminates the less attractive
securities and modestly emphasizes the most attractive stocks resulting in a
portfolio of 300 to 400 holdings that capture the overall investment
characteristics of the S&P 500 Index.
Under normal conditions, the Adviser will attempt to invest as much of the
Portfolio's assets as is practical and, in any event the Portfolio will invest
at least 80% of its total assets, in common stocks which are included in the S&P
500 Index. The Portfolio is expected, however, to maintain a position in
high-quality short-term debt securities and money market instruments to meet
redemption requests. If the Adviser believes that market conditions warrant a
temporary defensive posture, the Portfolio may invest without limitation in
high-quality short-term debt securities and money market instruments. These
securities and money market instruments may include domestic and foreign
commercial paper, certificates of deposit, bankers' acceptances and time
deposits, U.S. Government Obligations and repurchase agreements.
NATIONS MANAGED SMALLCAP INDEX PORTFOLIO: In seeking to achieve its investment
objective, the Portfolio will invest in selected equity securities that are
included in the Standard & Poor's SmallCap 600 Index (the "S&P 600 Index").2 The
S&P 600 Index is a market capitalization weighted index consisting of 600
domestic stocks which capture the economic and industry characteristics of small
stock performance.
Unlike traditional index funds, the Portfolio has a "managed" overlay. The
Adviser believes that a managed equity index portfolio can provide investors
with positive incremental performance relative to the S&P 600 Index while
minimizing the downside risk of underperforming the S&P 600 Index over time.
From the initial S&P 600 Index stock universe the Adviser ranks the
attractiveness of each security according to a multi-factor valuation model.
Both value and momentum factors are considered in the ranking process. Value
factors such as book value, earnings yield and cash flow measure a stock's
intrinsic worth versus its market price, while momentum characteristics such as
price momentum, earnings growth and earnings acceleration measure a stock
relative to others in the same industry. A second quantitative model which
measures the earnings momentum of each security is added to the screening
process to serve as a validity check in the portfolio construction process. Each
stock is assigned a ranking from 1 to 10 (best to worst). The Adviser then
either
(2) "Standard & Poor's SmallCap 600" is a registered service mark of S&P.
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underweights or eliminates the less attractive securities and modestly
emphasizes the most attractive stocks resulting in a portfolio of approximately
400 to 500 holdings that capture the overall investment characteristics of the
S&P 600 Index.
Under normal conditions, substantially all of the Portfolio's assets, and, in
any event at least 80% of its total assets, will be invested in common stocks
which are included in the S&P 600 Index. The Portfolio is expected, however, to
maintain a position in high-quality short-term debt securities and money market
instruments to meet redemption requests. If the Adviser believes that market
conditions warrant a temporary defensive posture, the Portfolio may invest
without limitation in high-quality short-term debt securities and money market
instruments. These securities and money market instruments may include domestic
and foreign commercial paper, certificates of deposit, bankers' acceptances and
time deposits, U.S. Government Obligations and repurchase agreements.
ABOUT THE INDEXES: The S&P 500 Index is composed of 500 common stocks, which are
chosen by S&P on a statistical basis to be included in the S&P 500 Index. The
S&P 600 Index is composed of 600 domestic stocks, which are chosen by S&P based
on, among other things, market size, liquidity and industry group
representation.
The S&P 600 Index is designed to be a benchmark of small capitalization stock
performance. Most of these stocks are listed on either the New York, American or
NASDAQ stock exchanges.
The inclusion of a stock in the S&P 500 Index or the S&P 600 Index (the
"Indexes") in no way implies that S&P believes the stock to be an attractive
investment. The Indexes are determined, composed and calculated by S&P without
regard to the Portfolios. S&P is not a sponsor of, or in any way affiliated
with, the Portfolios, and does not make any representations or warranties,
expressed or implied, on the advisability of investing in the Portfolios or as
to the ability of the Indexes to track general stock market performance. S&P
disclaims all warranties of merchantability or fitness for a particular purpose
or use with respect to the Indexes or any data included therein.
GENERAL: Each Index Portfolio also may invest in certain specified derivative
securities including: exchange-traded options; over-the-counter options executed
with primary dealers, including long calls and puts and covered calls to enhance
return; and U.S. exchange-traded financial futures approved by the CFTC and
options thereon for market exposure risk management. Each Portfolio may lend its
portfolio securities to qualified institutional investors and may invest in
repurchase agreements, restricted, private placement and other illiquid
securities. In addition, each Portfolio may invest in securities issued by other
investment companies, consistent with such Portfolio's investment objective and
policies.
In addition, when consistent with such Portfolio's respective investment
objective, each of the Portfolios will employ various techniques to manage
capital gain distributions. These techniques include utilizing a share
identification methodology whereby the Portfolio will specifically identify each
lot of shares of portfolio securities that it holds, which will allow the
Portfolio to sell first those specific shares with the highest tax basis in
order to reduce the amount of recognized capital gains as compared with a sale
of identical portfolio securities, if any, with a lower tax basis. The Portfolio
will sell first those shares with the highest tax basis only when it is in the
best interest of the Portfolio to do so, and reserves the right to sell other
shares when appropriate. In addition, the Portfolio may, at times, sell
portfolio securities in order to realize capital losses. Such capital losses
would be used to offset realized capital gains thereby reducing capital gain
distributions. Additionally, the Adviser will, consistent with the portfolio
construction process discussed above, employ a low portfolio turnover strategy
designed to defer the realization of capital gains.
Equity mutual funds, like other investors in equity securities, incur
transaction (brokerage) costs in connection with the purchase and sale of
portfolio securities. For some funds, these costs can have a material negative
impact on performance. With respect to the Index Portfolios, the Adviser will
attempt to minimize these transaction costs by utilizing program trades and
computerized exchanges called "crossing networks" which allow institutions to
execute trades at the midpoint of the bid/ask spread and at a reduced commission
rate.
For more information concerning these and other investments in which the
Portfolios may invest and their invesment practices, see "Appendix A".
BALANCED PORTFOLIO:
NATIONS BALANCED ASSETS PORTFOLIO: In pursuing the Portfolio's objective, the
Adviser will allocate the Portfolio's assets based upon its judgment of the
relative valuation and the expected returns of the three major asset classes in
which the Portfolio invests: common stocks, fixed income securities, and cash
equivalents. In assessing relative value and expected returns, the Adviser will
evaluate current economic and financial market conditions (both domestically and
internationally), current interest rate trends, earnings and dividend prospects
for common stocks, and overall financial market stability. These asset classes
are actively managed in an effort to maximize total return. In general, the
Adviser believes that common stocks offer the best opportunity for long-term
capital appreciation.
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The Portfolio invests in common and preferred stocks of U.S. corporations and of
foreign issuers, as well as securities convertible into common stocks, and other
types of securities having common stock characteristics (such as rights and
warrants to purchase equity securities) that meet the Adviser's stringent
criteria. Fundamental research and valuation analysis are emphasized in the
stock selection process. Stock holdings are typically those of seasoned,
financially strong companies with favorable industry positioning.
Under normal circumstances, at least 25% of the total value of the Portfolio's
assets will be invested in fixed income securities. The Portfolio may invest in
government, corporate and municipal debt securities, as well as mortgage-backed
and asset-backed securities. Most obligations acquired by the Portfolio will be
issued by companies or governmental entities located within the United States.
Debt obligations acquired by the Portfolio will be rated investment grade at the
time of purchase by S&P, Moody's, D&P, Fitch, IBCA or BankWatch, or, if unrated,
determined by the Adviser to be comparable in quality to instruments so rated.
Obligations with the lowest investment grade rating (E.G. rated "BBB" by S&P or
"Baa" by Moody's) have speculative characteristics and changes in economic
conditions or other circumstances are more likely to lead to a weakened capacity
to make principal and interest payments than is the case with higher grade debt
obligations. See "Appendix B" for a description of these ratings designations.
Subsequent to its purchase by the Portfolio, an issue of securities may cease to
be rated or its rating may be reduced below the minimum rating required for
purchase by the Portfolio. The Adviser will consider such an event in
determining whether the Portfolio should continue to hold the obligation.
Unrated obligations may be acquired by the Portfolio if they are determined by
the Adviser to be of comparable quality, at the time of purchase, to rated
obligations that may be acquired.
Although the Portfolio invests primarily in securities of U.S. issuers, the
Portfolio may invest up to 25% of its total assets in foreign securities.
The Portfolio also may invest in various money market instruments and repurchase
agreements. The Portfolio may invest without limitation in such instruments
pending investment, to meet anticipated redemption requests, or as a temporary
defense measure if market conditions warrant.
The Portfolio may invest in certain specified derivative securities, including:
interest rate swaps, caps and floors for hedging purposes; exchange-traded
options; over-the-counter options executed with primary dealers, including long
calls and puts and covered calls to enhance return; and CFTC-approved U.S. and
foreign exchange-traded financial futures and options thereon for market
exposure risk-management. The Portfolio may lend its portfolio securities to
qualified institutional investors and may invest in repurchase agreements,
restricted, private placement and other illiquid securities. The Portfolio may
engage in reverse repurchase agreements and dollar roll transactions.
Additionally, the Portfolio may purchase securities issued by other investment
companies, consistent with the Portfolio's investment objective and policies.
The Portfolio also may invest in instruments issued by trusts or certain
partnerships including pass-through certificates representing participations in,
or debt investments backed by, the securities and other assets owned by such
trusts and partnerships.
Certain securities that have variable or floating interest rates or demand or
put features may be deemed to have remaining maturities shorter than their
nominal maturities for purposes of determining the average weighted maturity and
duration of the Portfolio.
For more information concerning these and other investments in which the
Portfolio may invest and its investment practices, see "Appendix A."
Although changes in the value of securities subsequent to their acquisition are
reflected in the net asset value of the Portfolio's shares, such changes will
not affect the income received by the Portfolio from such securities. However,
since available yields vary over time, no specific level of income can ever be
assured. The dividends paid by the Portfolio will increase or decrease in
relation to the income received by the Portfolio from its investments, which
will in any case be reduced by the Portfolio's expenses before being distributed
to the Portfolio's shareholders.
PORTFOLIO TURNOVER: Generally, the Equity Portfolios, the Index Portfolios and
the Balanced Portfolio will purchase portfolio securities for capital
appreciation or investment income, or both, and not for short-term trading
profits. If a Portfolio's annual portfolio turnover rate exceeds 100%, it may
result in higher brokerage costs and possible tax consequences for the Portfolio
and its shareholders. While it is not possible to exactly predict annual
portfolio turnover rates, it is expected that under normal market conditions,
the annual portfolio turnover rate will not exceed the following: Nations Value
Portfolio -- 50%; Nations International Growth Portfolio -- 100%; Nations
Disciplined Equity Portfolio -- 125%; Nations Marsico Focused Equities
Portfolio -- 100%; Nations Marsico Growth & Income Portfolio -- 100%; Nations
Managed Index Portfolio -- 25%; Nations Managed SmallCap Index Portfolio -- 25%;
and Nations Balanced Assets Portfolio -- 175%.
RISK CONSIDERATIONS: Investments by a Portfolio in common stocks and other
equity securities are subject to stock market risks. The value of the stocks
that the Portfolio holds, like the broader stock market, may decline over short
or even extended periods. The U.S. stock mar-
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<PAGE>
ket tends to be cyclical, with periods when stock prices generally rise and
periods when prices generally decline. As of the date of this Prospectus, the
stock market, as measured by the S&P 500 Index and other commonly used indexes,
was trading at or close to record levels. There can be no guarantee that these
levels will continue.
Nations Marsico Focused Equities Portfolio, as a non-diversified fund, may
invest in fewer issuers than diversified funds such as Nations Marsico Growth &
Income Portfolio. Therefore, appreciation or depreciation of an investment in a
single issuer could have a greater impact on the Portfolio's net asset value.
The Portfolio reserves the right to become a diversified fund by limiting the
investments in which more than 5% of its total assets are invested.
The value of a Portfolio's investments in debt securities, including U.S.
Government Obligations, will tend to decrease when interest rates rise and
increase when interest rates fall. In general, longer-term debt instruments tend
to fluctuate in value more than shorter-term debt instruments in response to
interest rate movements. In addition, debt securities that are not backed by the
United States Government are subject to credit risk, which is the risk that the
issuer may not be able to pay principal and/or interest when due.
Certain of the Portfolios' investments constitute derivative securities, which
are securities whose value is derived, at least in part, from an underlying
index or reference rate. There are certain types of derivative securities that
can, under certain circumstances, significantly increase a purchaser's exposure
to market or other risks. The Adviser, however, only purchases derivative
securities in circumstances where it believes such purchases are consistent with
such Portfolio's investment objective and do not unduly increase the Portfolio's
exposure to market or other risks. For additional risk information regarding the
Portfolios' investments in particular instruments, see "Appendix A -- Portfolio
Securities."
Certain of the Portfolios may invest in securities of smaller and newer issuers.
Investments in such companies may present greater opportunities for capital
appreciation because of high potential earnings growth, but also present greater
risks than investments in more established companies with longer operating
histories and greater financial capacity.
SPECIAL RISK CONSIDERATIONS RELEVANT TO AN INVESTMENT IN NATIONS INTERNATIONAL
GROWTH PORTFOLIO: Investors should understand and consider carefully the special
risks involved in foreign investing.
Investors in Nations International Growth Portfolio should be aware that the
Portfolio may, from time to time, invest up to 35% of its total assets in
securities of companies located in Eastern Europe. Economic and political
reforms in this region are still in their infancy. As a result, investment in
such countries would be highly speculative and could result in losses to the
Portfolio and, thus, to its shareholders.
Moreover, investing in securities denominated in foreign currencies and
utilization of forward foreign currency exchange contracts and other currency
hedging techniques involve certain considerations comprising both opportunities
and risks not typically associated with investing in U.S. dollar-denominated
securities. Additionally, changes in the value of foreign currencies can
significantly affect the Portfolio's share price. General economic and political
factors in the various world markets also can impact the Portfolio's share
price.
The expenses to individual investors of investing directly in foreign securities
are very high relative to similar costs for investing in U.S. securities. While
the Portfolio offers a more efficient way for individual investors to
participate in foreign markets, their expenses, including custodial fees, are
also higher than the typical domestic equity mutual fund.
Risks unique to international investing include: (1) restrictions on foreign
investment and repatriation of capital; (2) fluctuations in currency exchange
rates; (3) costs of converting foreign currency into U.S. dollars and U.S.
dollars into foreign currencies; (4) greater price volatility and less
liquidity; (5) settlement practices, including delays, which may differ from
those customary in United States markets; (6) exposure to political and economic
risks, including the risk of nationalization, expropriation of assets and war;
(7) possible imposition of foreign taxes and exchange control and currency
restrictions; (8) lack of uniform accounting, auditing and financial reporting
standards; (9) less governmental supervision of securities markets, brokers and
issuers of securities; (10) less financial information available to investors;
and (11) difficulty in enforcing legal rights outside the United States. These
risks often are heightened for investments in emerging or developing countries.
See "Appendix A" for additional discussion of the risks associated with an
investment in Nations International Growth Portfolio.
SPECIAL RISK CONSIDERATIONS RELEVANT TO AN INVESTMENT IN THE INDEX PORTFOLIOS:
The techniques employed by the Adviser to seek to manage capital gain
distributions will generally only have the effect of deferring the realization
of capital gains. For example, to the extent that the capital gains recognized
on a sale of portfolio securities arise from the sale of specifically-identified
securities with a higher tax basis, subsequent sales of the same portfolio
securities will be calculated by reference to the lower tax basis securities
that remain in the portfolio. Under this scenario, an investor who purchases
shares of an Index Portfolio after the first sale could receive capital gain
distributions that are higher than the distributions that would have been
received if
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<PAGE>
this methodology had not been used. Therefore, certain investors actually could
be disadvantaged by the techniques employed by the Portfolios to seek to manage
capital gain distributions, depending on the timing of their purchase of
Portfolio shares. Even if there are no subsequent sales, upon a redemption or
exchange of Portfolio shares an investor will have to recognize gain to the
extent that the net asset value of Portfolio shares at such time exceeds such
investor's tax basis in his or her Portfolio shares.
The various techniques employed by the Portfolios to manage capital gain
distributions may result in the accumulation of substantial unrealized gains in
the Portfolios. Moreover, the realization of capital gains is not entirely
within a Portfolio's control because it is at least partly dependent on
shareholder purchase and redemption activity. Capital gain distributions may
vary considerably from year to year.
INVESTMENT LIMITATIONS: Each Portfolio is subject to a number of investment
limitations. The following investment limitations are matters of fundamental
policy and may not be changed without the affirmative vote of the holders of a
majority of the Portfolio's outstanding shares. Other investment limitations
that cannot be changed without such a vote of shareholders are described in the
SAI.
Each Portfolio may not:
1. Purchase any securities which would cause 25% or more of the value of the
Portfolio's total assets at the time of such purchase to be invested in the
securities of one or more issuers conducting their principal activities in the
same industry, provided that this limitation does not apply to investments in
obligations issued or guaranteed by the U.S. Government or its agencies and
instrumentalities.
2. Make loans, except that a Portfolio may purchase and hold debt instruments
(whether such instruments are part of a public offering or privately placed),
may enter into repurchase agreements and may lend portfolio securities in
accordance with its investment policies.
3. Each Portfolio (except Nations Marsico Focused Equities Portfolio) may not
purchase securities of any one issuer (other than securities issued or
guaranteed by the U.S. Government, its agencies or instrumentalities) if,
immediately after such purchase, more than 5% of the value of such Portfolio's
total assets would be invested in the securities of such issuer, except that up
to 25% of the value of the Portfolio's total assets may be invested without
regard to these limitations and with respect to 75% of such Portfolio's assets,
such Portfolio will not hold more than 10% of the voting securities of any
issuer.
Nations Marsico Focused Equities Portfolio may not purchase securities of any
one issuer (other than securities issued or guaranteed by the U.S. Government,
its agencies or instrumentalities) if, immediately after such purchase, more
than 25% of the value of the Portfolio's total assets would be invested in the
securities of one issuer, and with respect to 50% of the Portfolio's total
assets, more than 5% of its assets would be invested in the securities of one
issuer.
Nations International Growth Portfolio may not borrow money except as a
temporary measure and then only in amounts not exceeding 5% of the value of the
Portfolio's total assets or from banks or in connection with reverse repurchase
agreements provided that immediately after such borrowing, all borrowings of the
Portfolio do not exceed one-third of the Portfolio's total assets and no
purchases of portfolio instruments will be made while the Portfolio has
borrowings outstanding in an amount exceeding 5% of its total assets.
The investment objective and policies of each Portfolio, unless otherwise
specified, are non-fundamental and may be changed without shareholder approval.
If the investment objective or policies of a Portfolio change, shareholders
should consider whether the Portfolio remains an appropriate investment in light
of their current position and needs.
- --------------------------------------------------------------------------------
How Performance Is Shown
From time to time the Portfolios may advertise total return and yield. BOTH
TOTAL RETURN AND YIELD FIGURES ARE BASED ON HISTORICAL DATA AND ARE NOT INTENDED
TO INDICATE FUTURE PERFORMANCE. The "total return" may be calculated on an
average annual total return basis or an aggregate total return basis. Average
annual total return refers to the average annual compounded rates of return over
one-, five-, and ten-year periods or the life of a Portfolio (as stated in the
Portfolio's advertisement) that would equate an initial amount invested at the
beginning of a stated period to the ending redeemable value of the investment,
assuming the reinvestment of all dividend and capital gain distributions.
Aggregate total return reflects the total percentage change in the value of the
investment over the measuring period, again assuming the reinvestment of all
dividends and capital gain distributions. Total return may also be presented for
other periods.
"Yield" is calculated by dividing the annualized net investment income per share
during a recent 30-day (or one month) period by the maximum public offering
price per share on the last day of that period.
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Total return and yield figures quoted for the Portfolios include the effect of
deducting each Portfolio's expenses, but may not include charges and expenses
attributable to any particular insurance product. Since you can only purchase
shares of the Portfolios through an insurance product, you should carefully
review the prospectus of the insurance product you have chosen for information
on relevant charges and expenses. Excluding these charges from quotations of the
Portfolio's performance has the effect of increasing the performance quoted.
Investment performance, which will vary, is based on many factors, including
market conditions, the composition of a Portfolio's securities and a Portfolio's
operating expenses as well as the charges and fees imposed by the separate
accounts. Investment performance also often reflects the risks associated with
such Portfolio's investment objective and policies. These factors should be
considered when comparing a Portfolio's investment results to those of other
mutual funds and other investment vehicles. Since yields fluctuate, yield data
cannot necessarily be used to compare an investment in a Portfolio with bank
deposits, savings accounts, and similar investment alternatives which often
provide an agreed-upon or guaranteed fixed yield for a stated period of time.
Any Portfolio advertising will be accompanied by performance information of the
related Participating Insurance Company's separate account which fund the
Contract and by an explanation that Portfolio performance information does not
reflect separate account fees and charges.
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How The Portfolios Are Managed
The business and affairs of Nations Annuity Trust are managed under the
direction of its Board of Trustees. The Trust's SAI contains the names of and
general background information concerning each Trustee of the Trust.
The Trust and the Adviser have adopted codes of ethics which contain policies on
personal securities transactions by "access persons," including portfolio
managers and investment analysts. These policies substantially comply in all
material respects with the recommendations set forth in the May 9, 1994 Report
of the Advisory Group on Personal Investing of the Investment Company Institute.
INVESTMENT ADVISER: NationsBanc Advisors, Inc. serves as investment adviser to
the Portfolios pursuant to an investment advisory agreement with the Trust
("Investment Advisory Agreement"). NBAI is a wholly owned subsidiary of
NationsBank, which in turn is a wholly owned banking subsidiary of NationsBank
Corporation, a bank holding company organized as a North Carolina corporation.
NBAI has its principal offices at One NationsBank Plaza, Charlotte, North
Carolina 28255.
TradeStreet Investment Associates, Inc., with principal offices at One
NationsBank Plaza, Charlotte, North Carolina 28255, serves as investment
sub-adviser to all of the Portfolios except for Nations International Growth
Portfolio, Nations Marsico Focused Equities Portfolio and Nations Marsico Growth
& Income Portfolio. TradeStreet is a wholly owned subsidiary of NationsBank.
TradeStreet provides investment management services to individuals, corporations
and institutions.
Gartmore Global Partners, with principal offices at One NationsBank Plaza,
Charlotte, North Carolina 28255, serves as investment sub-adviser to Nations
International Growth Portfolio pursuant to a sub-advisory agreement. Gartmore is
a joint venture structured as a general partnership between NB Partner Corp., a
wholly owned subsidiary of NationsBank, and Gartmore U.S. Limited, an indirect,
wholly owned subsidiary of Gartmore Investment Management plc ("Gartmore plc"),
a UK company which is the holding company for a leading UK-based international
fund management group of companies. National Westminster Bank plc and affiliated
entities (collectively, "NatWest") own 100% of the equity of Gartmore Investment
Management plc.
Marsico Capital Management, LLC, located at 1200 17th Street, Suite 1300,
Denver, CO 80202, serves as the investment sub-adviser to Nations Marsico
Focused Equities Portfolio and Nations Marsico Growth & Income Portfolio
pursuant to an investment sub-advisory agreement entered into with the Trust,
which provides that Marsico Capital will furnish continuous investment advisory
and management services to the Portfolios. Thomas F. Marsico is Chairman and
Chief Executive Officer of Marsico Capital and has voting control of the
company. Prior to forming Marsico Capital in September 1997, Mr. Marsico had 18
years of experience as a securities analyst/portfolio manager. NationsBank has
an option to purchase up to 50% of Marsico Capital.
Subject to the general supervision of the Trust's Board of Trustees and NBAI,
and in accordance with each Portfolio's investment policies, the Adviser
formulates guidelines and lists of approved investments for each Portfolio,
makes decisions with respect to and places orders for each Portfolio's purchases
and sales of portfolio securities and maintains records relating to such
purchases and sales. The Adviser is authorized to allocate purchase and sale
orders for portfolio securities to certain financial institutions, including, in
the case of agency transactions, financial institutions which are affiliated
with NBAI or which have sold shares in the Portfolios, if the Adviser believes
that the quality of the transaction and
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<PAGE>
the commission are comparable to what they would be with other qualified
brokerage firms. From time to time, to the extent consistent with its investment
objective, policies and restrictions, each Portfolio may invest in securities of
companies with which NationsBank has a lending relationship.
For the services provided and expenses assumed pursuant to the Investment
Advisory Agreement, NBAI is entitled to receive advisory fees, computed daily
and paid monthly, at the annual rates of: .50% of the average daily net assets
of Nations Managed Index Portfolio and Nations Managed SmallCap Index Portfolio;
.75% of the average daily net assets of each of Nations Value Portfolio, Nations
Disciplined Equity Portfolio and Nations Balanced Assets Portfolio; .90% of the
average daily net assets of Nations International Growth Portfolio; .85% of the
average daily net assets of Nations Marsico Focused Equities Portfolio and .85%
of the average daily net assets of Nations Marsico Growth & Income Portfolio.
For the services provided pursuant to a sub-advisory agreement, NBAI will pay
TradeStreet sub-advisory fees, computed daily and paid monthly, at the annual
rates of: .10% of Nations Managed Index Portfolio's and Nations Managed SmallCap
Index Portfolio's average daily net assets; and .25% of Nations Value
Portfolio's, Nations Balanced Assets Portfolio's, and Nations Disciplined Equity
Portfolio's average daily net assets.
For services provided pursuant to a sub-advisory agreement, Gartmore is entitled
to receive from NBAI sub-advisory fees, computed daily and paid monthly at the
annual rate of .70% of Nations International Growth Portfolio's average daily
net assets.
For the services provided pursuant to a sub-advisory agreement, NBAI will pay
Marsico Capital sub-advisory fees, computed daily and paid monthly, at the
annual rate of .45% of the average daily net assets of Nations Marsico Focused
Equities Portfolio and .45% of the average daily net assets of Nations Marsico
Growth & Income Portfolio.
From time to time, NBAI (and/or TradeStreet and/or Gartmore and/or Marsico
Capital) may waive or reimburse (either voluntarily or pursuant to applicable
state limitations) advisory fees or expenses payable by a Portfolio.
Greg W. Golden is a Structured Products Manager, Equity Management for
TradeStreet and is Portfolio Manager for Nations Managed Index Portfolio and
Nations Managed SmallCap Index Portfolio. He has been Portfolio Manager for
these Portfolios since their inception. Prior to assuming his position with
TradeStreet in 1996, he was Vice President and Structured Products Manager for
the Investment Management Group at NationsBank. He has worked in the investment
community since 1990. His past experience includes portfolio management,
derivatives management and quantitative analysis for the Investment Management
Group at NationsBank and Sovran Bank of Tennessee. Mr. Golden received a B.B.A.
in Finance from Belmont University. He is a Chartered Financial Analyst
candidate and a member of Chicago Quantitative Alliance, the Association for
Investment Management and Research as well as the North Carolina Society of
Financial Analysts, Inc.
Jeffrey C. Moser is a Senior Product Manager, Equity Management for TradeStreet
and Senior Portfolio Manager for Nations Disciplined Equity Portfolio. Mr. Moser
has been with TradeStreet since 1996 and Portfolio Manager for Nations
Disciplined Equity Portfolio since the inception of the Portfolio. Prior to
assuming his position with TradeStreet, he was Senior Vice President and Senior
Portfolio Manager for the Investment Management Group at NationsBank. Mr. Moser
has worked for the Investment Management Group at NationsBank since 1983 where
his responsibilities included institutional portfolio management and equity
analysis. Mr. Moser graduated Phi Beta Kappa with a B.S. in Mathematics from
Wake Forest University. He holds the Chartered Financial Analyst designation and
is a member of the Association for Investment Management and Research as well as
the North Carolina Society of Financial Analysts, Inc.
Brian O'Neill is the Principal Senior Investment Manager of the Gartmore Global
Portfolio Team and has been the Portfolio Manager of Nations International
Growth Portfolio since its inception. Mr. O'Neill joined Gartmore as a Senior
Investment Manager on the Global Portfolio Team in 1981 with responsibility for
a variety of specialized global funds, including resource funds. Mr. O'Neill
began his career with Royal Insurance in 1970 as an investment analyst
specializing in United Kingdom research. He then expanded his field of expertise
to include management of global equities, and in 1978 he moved to Antony Gibbs &
Sons where he was appointed as a fund manager, specializing in global equities.
Mr. O'Neill graduated from Glasgow University in 1969 with a MA Honours degree
in Political Economy.
Sharon M. Herrmann is a Director of Equity Management for TradeStreet and Senior
Portfolio Manager for Nations Value Portfolio. Ms. Herrmann has been the
Portfolio Manager for Nations Value Portfolio since its inception. Prior to
assuming her position with TradeStreet, she was Senior Vice President and
Portfolio Manager for the Investment Management Group at NationsBank. Ms.
Herrmann has worked for the Investment Management Group at NationsBank since
1981 where her responsibilities included fund management and institutional
portfolio management. She attended Virginia Wesleyan College. Ms. Herrmann holds
the Chartered Financial Analyst designation and is a mem-
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ber of the Association for Investment Management and Research as well as the
North Carolina Society of Financial Analysts, Inc.
Julie L. Hale is a Senior Product Manager, Equity Management for TradeStreet and
Senior Portfolio Manager for Nations Balanced Assets Portfolio. Ms. Hale has
been Portfolio Manager for the Nations Balanced Assets Portfolio since its
inception. Prior to assuming her position with TradeStreet, she was Vice
President and Senior Portfolio Manager for the Investment Management Group at
NationsBank. She has worked in the investment community since 1981. Her past
experience includes research analysis and portfolio management for Mercantile
Safe Deposit and Trust, and National City Bank. Ms. Hale received a B.S. in
Business and Finance from Mount St. Mary's College and an M.B.A. from Kent State
University. She holds the Chartered Financial Analyst designation and is a
member of the Association for Investment Management and Research as well as the
North Carolina Society of Security Analysts, Inc. She is also a member of the
National Association for Petroleum Investment Analysts and the World Affairs
Council of Washington, D.C.
Mr. Marsico manages the investment program of Nations Marsico Focused Equities
Portfolio and Nations Marsico Growth & Income Portfolio and is primarily
responsible for the day-to-day management of the Portfolios. Prior to forming
Marsico Capital, Mr. Marsico served as Portfolio Manager of the Janus Twenty
Fund from January 31, 1988 through August 11, 1997 and served in the same
capacity for the Janus Growth and Income Fund from May 31, 1991 through August
11, 1997. The average annual returns for the Janus Twenty Fund and the Janus
Growth and Income Fund ("Janus Funds") from the date on which Mr. Marsico began
serving as Portfolio Manager of each Janus Fund through August 7, 1997 (the last
date for which performance information is available) were 22.38% and 21.19%,
respectively. On August 11, 1997, the date on which Mr. Marsico ceased serving
as the Portfolio Manager to both the Janus Twenty Fund and the Janus Growth and
Income Fund, the Janus Twenty Fund had approximately $6 billion in net assets,
and the Janus Growth and Income Fund had approximately $1.7 billion in net
assets. As Executive Vice President and Portfolio Manager of the Janus Twenty
Fund and the Janus Growth and Income Fund, Mr. Marsico had full discretionary
authority over the selection of investments for those funds. Average annual
returns for the one-year, three-year and five-year periods ended August 7, 1997
and for the period during which Mr. Marsico managed those funds compared with
the performance of the S&P 500 Index were:
<TABLE>
<CAPTION>
Janus Janus
Twenty Growth and S&P 500
Fund (a) Income Fund (a) Index (b)
-------- --------------- -------------
<S> <C> <C> <C>
One Year (8/8/96- 48.21% 47.77% 46.41%
8/7/97)
Three Years (8/11/94- 32.07% 31.13% 30.63%
8/7/97)
Five Years (8/13/92- 20.02% 21.16% 20.98%
8/7/97)
During Period of 22.38% 21.19% Janus Twenty:
Management by 18.20%(c)
Mr. Marsico (through Janus Growth
8/7/97) and Income:
18.59%(d)
</TABLE>
(a) Average annual total return reflects changes in share prices and
reinvestment of dividends and distributions and is net of fund expenses.
(b) The S&P 500 Index is an unmanaged index of common stocks that is considered
to be generally representative of the United States stock market. The S&P
500 Index is adjusted to reflect reinvestment of dividends.
(c) This figure represents the average annual return of the S&P 500 Index during
the period that Mr. Marsico managed the Janus Twenty Fund through August 7,
1997.
(d) This figure represents the average annual return of the S&P 500 Index during
the period that Mr. Marsico managed the Janus Growth and Income Fund through
August 7, 1997.
The Janus Twenty Fund has substantially similar investment policies, strategies,
and objectives as those of Nations Marsico Focused Equities Portfolio, while the
investment policies, strategies, and objectives of the Janus Growth and Income
Fund are substantially similar to those of Nations Marsico Growth & Income
Portfolio. Historical performance is not indicative of future performance. For a
majority of the periods shown above, the expenses of the Janus Twenty Fund and
the Janus Growth and Income Fund were lower than the anticipated expenses of
Nations Marsico Focused Equities Portfolio and Nations Marsico Growth & Income
Portfolio, respectively. Higher expenses, of course, would have resulted in
lower performance. The Janus Twenty Fund and the Janus Growth and Income Fund
are separate funds and their historical performance is not indicative of the
potential performance of Nations Marsico Focused Equities Portfolio and Nations
Marsico Growth & Income Portfolio, respectively. The Janus Twenty Fund and the
Janus Growth and Income Fund were the only investment vehicles that Mr. Marsico
managed during the period he was employed at Janus Capital Corporation that have
substantially similar objectives, policies, and strategies as those of the
Portfolios. Share prices and investment returns will fluctuate reflecting market
conditions, as well as changes in company-specific fundamentals of portfolio
securities.
Morrison & Foerster LLP, counsel to the Trust and special counsel to NationsBank
has advised the Trust and NationsBank that NationsBank and its affiliates may
perform the services contemplated by the Investment Advisory Agreement and this
Prospectus without violation of the Glass-Steagall Act. Such counsel has pointed
14
<PAGE>
out, however, that there are no controlling judicial or administrative
interpretations or decisions and that future judicial or administrative
interpretations of, or decisions relating to, present federal or state statutes,
including the Glass-Steagall Act, and regulations relating to the permissible
activities of banks and their subsidiaries or affiliates, as well as future
changes in such federal or state statutes, regulations and judicial or
administrative decisions or interpretations, could prevent such entities from
continuing to perform, in whole or in part, such services. If any such entity
were prohibited from performing any of such services, it is expected that new
agreements would be proposed or entered into with another entity or entities
qualified to perform such services.
OTHER SERVICE PROVIDERS: Stephens Inc. ("Stephens"), with principal offices at
111 Center Street, Little Rock, Arkansas 72201, serves as the administrator of
the Trust pursuant to an Administration Agreement. Pursuant to the terms of the
Administration Agreement, Stephens provides various administrative and corporate
secretarial services to the Portfolios, including providing general oversight of
other service providers, office space, utilities and various legal and
administrative services in connection with the satisfaction of various
regulatory requirements applicable to the Portfolios.
First Data Investor Services Group, Inc. ("First Data"), a wholly owned
subsidiary of First Data Corporation, with principal offices at One Exchange
Place, Boston, Massachusetts 02109, serves as the co-administrator of the Trust
pursuant to a Co-Administration Agreement. Under the Co-Administration
Agreement, First Data provides various administrative and accounting services to
the Portfolios including performing the calculations necessary to determine net
asset value per share and dividends, preparing tax returns and financial
statements and maintaining the portfolio records and certain of the general
accounting records for the Portfolios. For the services rendered pursuant to the
Administration and Co-Administration Agreements, Stephens and First Data are
entitled to receive a combined fee at the annual rate of up to .10% of each
Portfolio's average daily net assets.
NBAI serves as sub-administrator for the Trust pursuant to a Sub-Administration
Agreement. Pursuant to the terms of the Sub-Administration Agreement, NBAI
assists Stephens in supervising, coordinating and monitoring various aspects of
the Portfolios' administrative operations. For providing such services, NBAI
shall be entitled to receive a monthly fee from Stephens based on an annual rate
of .01% of the Portfolios' average daily net assets.
Shares of the Portfolios are sold on a continuous basis by Stephens, as the
Portfolios' sponsor and distributor. Stephens is a registered broker/dealer. The
Trust has entered into distribution agreements with Stephens which provide that
Stephens has the exclusive right to distribute shares of the Portfolios.
Stephens may pay service fees or commissions to institutions which assist
customers in purchasing shares of the Portfolios.
NationsBank of Texas, N.A. ("NationsBank of Texas" and, collectively with The
Bank of New York ("BONY"), called "Custodians") serves as Custodian for the
assets of all the Portfolios, except Nations International Growth Portfolio.
NationsBank of Texas is located at 1401 Elm Street, Dallas, Texas 75202, and is
a wholly owned subsidiary of NationsBank Corporation. In return for providing
custodial services to the Portfolios, NationsBank of Texas is entitled to
receive, in addition to out-of-pocket expenses, fees at the rate of (i) $300,000
per annum, to be paid monthly in payments of $25,000 for custodian services for
up to and including 50 Funds or Portfolios in the Nations Funds Family; and (ii)
$6,000 per annum, to be paid in equal monthly payments, for custodian services
for each additional portfolio above 50 Funds or Portfolios.
BONY, Avenue des Arts, 35 1040 Brussels, Belgium, serves as Custodian for the
assets of Nations International Growth Portfolio.
BONY has entered into an agreement with each of the Portfolios and NationsBank
of Texas, N.A., whereby BONY will serve as sub-custodian ("Sub-Custodian") for
the assets of the Portfolios except Nations International Growth Portfolio for
which it serves as Custodian. BONY is located at 90 Washington Street, New York,
New York 10286. In return for providing sub-custodial services to the Portfolios
and the other Funds in the Nations Funds Family BONY receives, in addition to
out of pocket expenses, fees at the rate of (i) 3/4 of one basis point per annum
on the aggregate net assets of all Nations' Non-Money Market Funds or Portfolios
up to $10 billion; and (ii) 1/2 of one basis point on the excess, including all
Nations' Money Market Funds or Portfolios.
First Data serves as transfer agent (the "Transfer Agent") for the Portfolios.
The Transfer Agent is located at One Exchange Place, Boston, Massachusetts
02109.
Price Waterhouse LLP serves as independent accountant to the Trust. Their
address is 160 Federal Street, Boston, Massachusetts 02110.
EXPENSES: The accrued expenses of each Portfolio are deducted from the
Portfolio's total accrued income before dividends are declared. These expenses
include, but are not limited to: fees paid to the Adviser, Stephens and First
Data; taxes; interest; fees (including fees paid to trustees and officers);
federal and state securities registration and qualification fees, if any;
brokerage fees and commissions; costs of preparing and printing prospectuses for
regulatory purposes and for distribution to existing shareholders; charges of
the Custodians and
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<PAGE>
Transfer Agent; certain insurance premiums; outside auditing and legal expenses;
costs of shareholder reports and shareholder meetings; other expenses which are
not expressly assumed by the Adviser, Stephens or First Data under their
respective agreements with the Trust; and any extraordinary expenses. Any
general expenses of the Trust that are not readily identifiable as belonging to
a particular investment portfolio are allocated among all portfolios in the
proportion that the assets of a portfolio bears to the assets of the Trust or in
such other manner as the Board of Trustees deems appropriate.
- --------------------------------------------------------------------------------
Organization And History
The Portfolios are members of the Nations Funds Family, which consists of
Nations Annuity Trust, Nations Fund Trust, Nations Fund, Inc., Nations Fund
Portfolios, Inc., Nations Institutional Reserves and Nations LifeGoal Funds,
Inc. The Nations Funds Family currently has more than 62 distinct investment
portfolios and total assets in excess of $30 billion.
NATIONS ANNUITY TRUST: Nations Annuity Trust was organized as a Delaware
business trust on November 24, 1997. Nations Annuity Trust's fiscal year end is
December 31.
Each share of the Trust is without par value, represents an equal proportionate
interest in the related fund with other shares of the same class, and is
entitled to such dividends and distributions out of the income earned on the
assets belonging to such fund as are declared in the discretion of the Trust's
Board of Trustees. The Trust's Declaration of Trust authorizes the Board of
Trustees to classify or reclassify any class of shares into one or more series
of shares.
Shareholders are entitled to one vote for each full share held and a
proportionate fractional vote for each fractional share held. Shareholders of
each Portfolio of the Trust will vote in the aggregate and not by Portfolio, and
shareholders of each Portfolio will vote in the aggregate and not by class
except as otherwise expressly required by law or when the Board of Trustees
determines that the matter to be voted on affects only the interests of
shareholders of a particular Portfolio or class. See the SAI for examples of
when the Investment Company Act of 1940 (the "1940 Act") requires voting by
Portfolio.
The Trust does not presently intend to hold annual meetings except as required
by the 1940 Act. Shareholders will have the right to remove Trustees. The
Trust's By-Laws provide that special meetings of shareholders shall be called at
the written request of the shareholders entitled to vote at least 10% of the
outstanding shares of the Trust entitled to be voted at such meeting. Individual
holders of Contracts are not the "shareholders" of or "investors" in the
Portfolios. The Participating Insurance Companies and their separate accounts
are deemed the shareholders or investors. However, it is anticipated that the
Participating Insurance Companies will pass through voting rights to the holders
of Contracts. For a discussion of voting rights of holders of Contracts, please
see the accompanying prospectuses for the Participating Insurance Companies.
About Your Investment
- --------------------------------------------------------------------------------
How To Buy Shares
Portfolio shares are made available to serve as the underlying investment
vehicles for variable annuity and variable life insurance separate accounts
issued by Participating Insurance Companies. Shares of the Portfolios are sold
at net asset value without the imposition of a sales charge. The separate
accounts of the Participating Insurance Companies place orders to purchase and
redeem shares of the Portfolios based on, among other things, the amount of
premium payments to be invested and the amount of surrender and transfer
requests to be effected on that day pursuant to the contracts.
Although this Prospectus discusses the Portfolios being made available to serve
as the underlying investment vehicles for variable life insurance separate
accounts, it is not presently contemplated that the Portfolios will accept such
investments. In addition, in no instance will the Portfolios be made available
to life insurance separate accounts without the Trust having received any
necessary SEC consents or approvals. It is conceivable that in the future it may
be disadvantageous for variable annuity separate accounts and variable life
insurance separate accounts to invest in the Portfolios simultaneously. Although
the Trust and the Portfolios do not currently foresee any such disadvantages
either to variable annuity contract owners or variable life insurance policy
owners, the Trust's Board of Trustees intends to monitor events in order to
identify any material conflicts between such contract owners and policy owners
and to determine what action, if any, should be taken in response thereto. If
the Board of Trustees were to conclude that separate funds should be established
for vari-
16
<PAGE>
able life and variable annuity separate accounts, the variable life and variable
annuity contract holders would not bear any expenses attendant to the
establishment of such separate funds.
Purchases of the Portfolios may be effected on days on which the New York Stock
Exchange (the "Exchange") is open for business (a "Business Day").
The Trust and Stephens reserve the right to reject any purchase order. The
issuance of Shares is recorded on the books of the Trust, and share certificates
are not issued.
EFFECTIVE TIME OF PURCHASES: Purchase orders for Shares in the Portfolios that
are received by Stephens or by the Transfer Agent before the close of regular
trading hours on the Exchange (currently 4:00 p.m., Eastern time) on any
Business Day are priced according to the net asset value determined on that day
but are not executed until 4:00 p.m., Eastern time, on the Business Day on which
immediately available funds in payment of the purchase price are received by the
Portfolio's Custodian.
- --------------------------------------------------------------------------------
How To Redeem Shares
Redemption proceeds are normally remitted in Federal funds wired to the
redeeming Participating Insurance Company within three Business Days following
receipt of the order. It is the responsibility of Stephens to transmit orders it
receives to the Trust. No charge for wiring redemption payments is imposed by
the Trust. Redemption orders are effected at the net asset value per share next
determined after acceptance of the order by Stephens or by the Transfer Agent.
The Trust may redeem shares involuntarily or make payment for redemption in
readily marketable securities or other property under certain circumstances in
accordance with the 1940 Act.
- --------------------------------------------------------------------------------
Shareholder Servicing And Distribution Plan
The Portfolios have adopted a Shareholder Servicing and Distribution Plan (the
"Servicing and Distribution Plan") pursuant to Rule 12b-1 under the 1940 Act
under which the Portfolios may pay banks, broker/dealers, Participating
Insurance Companies or other financial institutions that have entered into a
Sales Support Agreement with the Distributor ("Selling Agents") or a Shareholder
Servicing Agreement with the Trust ("Servicing Agents") (together with Selling
Agents ("Agents")) for certain expenses that are incurred by the Agents in
connection with sales support and shareholder support services that are provided
by the Agents. Payments under the Servicing and Distribution Plan will be
calculated daily and paid monthly at a rate not exceeding 0.25% (on an
annualized basis) of the average daily net asset value of the Shares
beneficially owned through the ownership of Contracts by customers with whom the
Agents have a relationship. Under the Servicing and Distribution Plan, the
shareholder services provided by Servicing Agents may include general
shareholder liaison services, processing purchases and redemption requests;
processing dividend and distribution payments; providing sales information
periodically to customers, including information showing their Contracts'
positions in the Portfolios; providing sub-accounting; responding to inquiries
from customers; arranging for bank wires; and providing such other similar
services as may be reasonably requested. Under the Servicing and Distribution
Plan, the Trust may make payments in connection with any activity which is
primarily intended to result in the sale of the Shares, including, but not
limited to, expenses of organizing and conducting sales seminars, printing of
prospectuses and statements of additional information (and supplements thereto)
and reports for other than existing shareholders, preparation and distribution
of advertising material and sales literature, supplemental payments to the
Trust's Distributor and the cost of administering this Servicing and
Distribution Plan, as well as the shareholder servicing activities described
above.
- --------------------------------------------------------------------------------
How The Portfolios Value Their Shares
The net asset value of a share of each class is calculated by dividing the total
value of its assets, less liabilities, by the number of shares in the class
outstanding. Shares of the Portfolios are valued as of the close of regular
trading on the Exchange (currently 4:00 p.m., Eastern time) on each Business
Day.
Portfolio securities for which market quotations are readily available are
valued at market value. Short-term investments that will mature in 60 days or
less are valued at amortized cost, which approximates market value. All other
securities are valued at their fair value following procedures approved by the
Trustees.
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<PAGE>
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How Dividends And Distributions Are Made;
Tax Information
DIVIDENDS AND DISTRIBUTIONS: Dividends from net investment income are declared
and paid annually. Each Portfolio's net realized capital gains (including net
short-term capital gains) are distributed at least annually.
Shares of the Portfolios are eligible to receive dividends when declared,
provided, however, that the purchase order for such shares is received at least
one day prior to the dividend declaration and such shares continue to be
eligible for dividends through and including the day before the redemption order
is executed.
The net asset value of shares will be reduced by the amount of any dividend or
distribution. Dividends and distributions are paid in cash within five Business
Days of the end of the month or quarter to which the dividend relates. Dividends
are paid in the form of additional shares of the same Portfolio unless the
investor has elected prior to the date of distribution to receive payment in
cash.
TAX INFORMATION
Each of the Portfolios intends to qualify as a separate "regulated investment
company" under the Internal Revenue Code of 1986, as amended (the "Code"). In
general, such qualification relieves a Portfolio of liability for Federal income
tax to the extent its net investment income and capital gains are distributed
annually in accordance with the Code. Each of the Portfolios intends to annually
distribute substantially all of its net investment income and capital gains.
The Code requires investments of a "segregated asset account," such as the
separate accounts of the Participating Insurance Companies, to be "adequately
diversified," in accordance with Treasury Regulations, in order for the holders
of the variable annuity contracts or variable life insurance policies underlying
the account to receive tax-deferred treatment on such annuities or policies,
which treatment is generally given to holders of annuities or life insurance
policies. Subject to certain conditions, shares of a regulated investment
company will not be treated as a single investment for purposes of the "adequate
diversification" test. Instead, the segregated asset account will be treated as
if it is the owner of its proportionate share of each of the assets of the
regulated investment company. Each Portfolio intends to satisfy the relevant
conditions of the Code and Treasury Regulations at all times so that shares of
such Portfolio held in a separate account of a Participating Insurance Company,
and the variable annuity contracts and variable life insurance policies
underlying such account, may qualify for favorable tax treatment under the Code.
Each year, shareholders will be notified as to the amount and Federal tax status
of all dividends and capital gains paid during the prior year. Such dividends
and capital gains may be subject to state and local taxes.
Dividends declared in October, November or December of any year payable to
shareholders of record on a specified date in such months will be deemed to have
been received by shareholders and paid by a Portfolio on December 31 of such
year in the event such dividends are actually paid during January of the
following year.
The foregoing discussion is based on tax laws and regulations that were in
effect as of the date of this Prospectus and summarizes only some of the
important tax considerations generally affecting the Portfolios and their
shareholders. It is not intended as a substitute for careful tax planning.
Accordingly, potential investors should consult their tax advisors with specific
reference to their own tax situations. Further tax information is contained in
the SAI. For a discussion of Federal income taxation of separate accounts of
life insurance companies, see the prospectuses for the Participating Insurance
Companies that accompany this Prospectus.
- --------------------------------------------------------------------------------
General Information
This Prospectus and the SAI omit certain information contained in the
Registration Statement that the Portfolios have filed with the SEC and reference
is hereby made to the Registration Statement and its exhibits and amendments.
The Registration Statement and its exhibits and amendments are available for
examination at the SEC's Washington, D.C. office.
18
<PAGE>
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Appendix A -- Portfolio Securities
The following are summary descriptions of certain types of instruments in which
a Portfolio may invest. The "How Objectives Are Pursued" section of this
Prospectus identifies each Portfolio's permissible investments, and the SAI
contains more information concerning such investments.
ASSET-BACKED SECURITIES: Asset-backed securities arise through the grouping by
governmental, government-related, and private organizations of loans,
receivables, or other assets originated by various lenders. Asset-backed
securities consist of both mortgage- and non-mortgage-backed securities.
Interests in pools of these assets may differ from other forms of debt
securities, which normally provide for periodic payment of interest in fixed
amounts with principal paid at maturity or specified call dates. Conversely,
asset-backed securities provide periodic payments which may consist of both
interest and principal payments.
The life of an asset-backed security varies depending upon rate of the
prepayment of the underlying debt instruments. The rate of such prepayments will
be a function of current market interest rates and other economic and
demographic factors may be involved. For example, falling interest rates
generally result in an increase in the rate of prepayments of mortgage loans
while rising interest rates generally decrease the rate of prepayments. An
acceleration in prepayments in response to sharply falling interest rates will
shorten the security's average maturity and limit the potential appreciation in
the security's value relative to a conventional debt security. Consequently,
asset-backed securities may not be as effective in locking in high, long-term
yields. Conversely, in periods of sharply rising rates, prepayments are
generally slow, increasing the security's average life and its potential for
price depreciation.
MORTGAGE-BACKED SECURITIES: Mortgage-backed securities represent an ownership
interest in a pool of residential mortgage loans.
Mortgage pass-through securities may represent participation interests in pools
of residential mortgage loans originated by U.S. governmental or private lenders
and guaranteed, to the extent provided in such securities, by the U.S.
Government or one of its agencies, authorities or instrumentalities. Such
securities, which are ownership interests in the underlying mortgage loans,
differ from conventional debt securities, which provide for periodic payment of
interest in fixed amounts (usually semi-annually) and principal payments at
maturity or on specified call dates. Mortgage pass-through securities provide
for monthly payments that are a "pass-through" of the monthly interest and
principal payments (including any prepayments) made by the individual borrowers
on the pooled mortgage loans, net of any fees paid to the guarantor of such
securities and the servicer of the underlying mortgage loans.
The guaranteed mortgage pass-through securities in which a Portfolio may invest
may include those issued or guaranteed by the Government National Mortgage
Association ("GNMA"), the Federal National Mortgage Association ("FNMA") and the
Federal Home Loan Mortgage Corporation ("FHLMC"). Such Certificates are
mortgage-backed securities which represent a partial ownership interest in a
pool of mortgage loans issued by lenders such as mortgage bankers, commercial
banks and savings and loan associations. Such mortgage loans may have fixed or
adjustable rates of interest.
The average life of a mortgage-backed security is likely to be substantially
less than the original maturity of the mortgage pools underlying the securities.
Prepayments of principal by mortgagors and mortgage foreclosures will usually
result in the return of the greater part of principal invested far in advance of
the maturity of the mortgages in the pool.
The yield which will be earned on mortgage-backed securities may vary from their
coupon rates for the following reasons: (i) Certificates may be issued at a
premium or discount, rather than at par; (ii) Certificates may trade in the
secondary market at a premium or discount after issuance; (iii) interest is
earned and compounded monthly which has the effect of raising the effective
yield earned on the Certificates; and (iv) the actual yield of each Certificate
is affected by the prepayment of mortgages included in the mortgage pool
underlying the Certificates and the rate at which principal so prepaid is
reinvested. In addition, prepayment of mortgages included in the mortgage pool
underlying a GNMA Certificate purchased at a premium may result in a loss to a
Portfolio.
Mortgage-backed securities issued by private issuers, whether or not such
obligations are subject to guarantees by the private issuer, may entail greater
risk than obligations directly or indirectly guaranteed by the U.S. Government.
Collateralized Mortgage Obligations or "CMOs" are debt obligations
collateralized by mortgage loans or mortgage pass-through securities (collateral
collectively hereinafter referred to as "Mortgage Assets"). Multi-class pass-
through securities are interests in a trust composed of Mortgage Assets and all
references herein to CMOs will include multi-class 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 distribution on the multi-class pass-through securities.
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Moreover, principal prepayments on the Mortgage Assets may cause the CMOs to be
retired substantially earlier than their stated maturities or final distribution
dates, resulting in a loss of all or part of the premium if any has been paid.
Interest is paid or accrues on all classes of the CMOs on a monthly, quarterly
or semiannual basis.
The principal and interest payments on the Mortgage Assets may be allocated
among the various classes of CMOs in several ways. Typically, payments of
principal, including any prepayments, on the underlying mortgages are applied to
the classes in the order of their respective stated maturities or final
distribution dates, so that no payment of principal is made on CMOs of a class
until all CMOs of other classes having earlier stated maturities or final
distribution dates have been paid in full.
Stripped mortgage-backed securities ("SMBS") are derivative multi-class mortgage
securities. A Portfolio will only invest in SMBS that are obligations backed by
the full faith and credit of the U.S. Government. SMBS are usually structured
with two classes that receive different proportions of the interest and
principal distributions from a pool of Mortgage Assets. A Portfolio will only
invest in SMBS whose Mortgage Assets are U.S. Government Obligations.
A common type of SMBS will be structured so that one class receives some of the
interest and most of the principal from the Mortgage Assets, while the other
class receives most of the interest and the remainder of the principal. If the
underlying Mortgage Assets experience greater than anticipated prepayments of
principal, a Portfolio may fail to fully recoup its initial investment in these
securities. The market value of any class which consists primarily or entirely
of principal payments generally is unusually volatile in response to changes in
interest rates.
The average life of mortgage-backed securities varies with the maturities of the
underlying mortgage instruments, which have maximum maturities of 40 years. The
average life is likely to be substantially less than the original maturity of
the mortgage pools underlying the securities as the result of mortgage
prepayments, mortgage refinancings, or foreclosures. The rate of mortgage
prepayments, and hence the average life of the certificates, will be a function
of the level of interest rates, general economic conditions, the location and
age of the mortgage and other social and demographic conditions. Such
prepayments are passed through to the registered holder with the regular monthly
payments of principal and interest and have the effect of reducing future
payments. Estimated average life will be determined by the Adviser and used for
the purpose of determining the average weighted maturity and duration of the
securities. For additional information concerning mortgage-backed securities,
see the Trust's SAI.
The mortgage-backed securities in which the Portfolios invest are subject to
extension risk. This is the risk that when interest rates rise, prepayments of
the underlying obligations slow thereby lengthening duration and potentially
reducing the value of these securities. The debt securities held by the
Portfolios also may be subject to credit risk. Credit risk is the risk that the
issuers of securities in which a Portfolio invests may default in the payment of
principal and/or interest. Any such defaults or adverse changes in an issuer's
financial condition or credit rating may adversely affect the value of the
Portfolios' portfolio investments and, hence, the value of your investment in
the corresponding Portfolio.
NON-MORTGAGE ASSET-BACKED SECURITIES: Non-mortgage asset-backed securities
include interests in pools of receivables, such as motor vehicle installment
purchase obligations and credit card receivables. Such securities are generally
issued as pass-through certificates, which represent undivided fractional
ownership interests in the underlying pools of assets. Such securities also may
be debt instruments, which are also known as collateralized obligations and are
generally issued as the debt of a special purpose entity organized solely for
the purpose of owning such assets and issuing such debt. Such securities also
may include instruments issued by certain trusts, partnerships or other special
purpose issuers, including pass-through certificates representing participations
in, or debt instruments backed by, the securities and other assets owned by such
issuers.
Non-mortgage asset-backed securities are not issued or guaranteed by the U.S.
Government or its agencies or instrumentalities; however, the payment of
principal and interest on such obligations may be guaranteed up to certain
amounts and for a certain time period by a letter of credit issued by a
financial institution (such as a bank or insurance company) unaffiliated with
the issuers of such securities.
The purchase of non-mortgage asset-backed securities raises considerations
peculiar to the financing of the instruments underlying such securities. For
example, most organizations that issue asset-backed securities relating to motor
vehicle installment purchase obligations perfect their interests in their
respective obligations only by filing a financing statement and by having the
servicer of the obligations, which is usually the originator, take custody
thereof. In such circumstances, if the servicer were to sell the same
obligations to another party, in violation of its duty not to do so, there is a
risk that such party could acquire an interest in the obligations superior to
that of the holders of the asset-backed securities. Also, although most such
obligations grant a security interest in the motor vehicle being financed, in
most states the security interest in a motor vehicle must be noted on the
certificate of title to perfect such security interest against competing claims
of other parties. Due to the larger number of vehicles involved, however, the
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certificate of title to each vehicle financed, pursuant to the obligations
underlying the asset-backed securities, usually is not amended to reflect the
assignment of the seller's security interest for the benefit of the holders of
the asset-backed securities. Therefore, there is the possibility that recoveries
on repossessed collateral may not, in some cases, be available to support
payments on those securities. In addition, various state and Federal laws give
the motor vehicle owner the right to assert against the holder of the owner's
obligation certain defenses such owner would have against the seller of the
motor vehicle. The assertion of such defenses could reduce payments on the
related asset-backed securities. Insofar as credit card receivables are
concerned, credit card holders are entitled to the protection of a number of
state and Federal consumer credit laws, many of which give such holders the
right to set off certain amounts against balances owed on the credit card,
thereby reducing the amounts paid on such receivables. In addition, unlike most
other asset-backed securities, credit card receivables are unsecured obligations
of the card holder.
BANK INSTRUMENTS: Bank instruments consist mainly of certificates of deposit,
time deposits and bankers' acceptances. The Portfolios (except Nations
International Growth Portfolio) will limit their investments in bank obligations
so they do not exceed 25% of each Portfolio's total assets at the time of
purchase.
U.S. dollar denominated obligations issued by foreign branches of domestic banks
("Eurodollar" obligations) and domestic branches of foreign banks ("Yankee
dollar" obligations) and other foreign obligations involve special investment
risks, including the possibility that liquidity could be impaired because of
future political and economic developments, the obligations may be less
marketable than comparable domestic obligations of domestic issuers, a foreign
jurisdiction might impose withholding taxes on interest income payable on such
obligations, deposits may be seized or nationalized, foreign governmental
restrictions such as exchange controls may be adopted which might adversely
affect the payment of principal of and interest on such obligations, the
selection of foreign obligations may be more difficult because there may be less
publicly available information concerning foreign issuers, there may be
difficulties in enforcing a judgment against a foreign issuer or the accounting,
auditing and financial reporting standards, practices and requirements
applicable to foreign issuers may differ from those applicable to domestic
issuers. In addition, foreign banks are not subject to examination by U.S.
Government agencies or instrumentalities.
BORROWINGS: When a Portfolio borrows money, the net asset value of a share may
be subject to greater fluctuation until the borrowing is paid off. The
Portfolios may borrow money from banks for temporary purposes in amounts of up
to one-third of their respective total assets, provided that borrowings in
excess of 5% of the value of the Portfolios' respective total assets must be
repaid prior to the purchase of portfolio securities. Pursuant to line of credit
arrangements, certain of the Portfolios may borrow primarily for temporary or
emergency purposes, including the meeting of redemption requests that otherwise
might require the untimely disposition of securities.
Reverse repurchase agreements and dollar roll transactions may be considered to
be borrowings. When a Portfolio invests in a reverse repurchase agreement, it
sells a portfolio security to another party, such as a bank or broker/dealer, in
return for cash, and agrees to buy the security back at a future date and price.
Reverse repurchase agreements may be used to provide cash to satisfy unusually
heavy redemption requests without having to sell portfolio securities, or for
other temporary or emergency purposes. In addition, certain of the Portfolios
may use reverse repurchase agreements for the purpose of investing the proceeds
in tri-party repurchase agreements. Generally, the effect of such a transaction
is that a Portfolio can recover all or most of the cash invested in the
portfolio securities involved during the term of the reverse repurchase
agreement, while it will be able to keep the interest income associated with
those portfolio securities. Such transactions are only advantageous if the
interest cost to the Portfolios of the reverse repurchase transaction is less
than the cost of obtaining the cash otherwise.
At the time a Portfolio enters into a reverse repurchase agreement, it may
establish a segregated account with its custodian bank in which it will maintain
cash, U.S. Government Securities or other liquid high grade debt obligations
equal in value to its obligations in respect of reverse repurchase agreements.
Reverse repurchase agreements involve the risk that the market value of the
securities the Portfolios are obligated to repurchase under the agreement may
decline below the repurchase price. In the event the buyer of securities under a
reverse repurchase agreement files for bankruptcy or becomes insolvent, the
Portfolios' use of proceeds of the agreement may be restricted pending a
determination by the other party, or its trustee or receiver, whether to enforce
the Portfolios' obligation to repurchase the securities. In addition, there is a
risk of delay in receiving collateral or securities or in repurchasing the
securities covered by the reverse repurchase agreement or even of a loss of
rights in the collateral or securities in the event the buyer of the securities
under the reverse repurchase agreement files for bankruptcy or becomes
insolvent. A Portfolio only enters into reverse repurchase agreements (and
repurchase agreements) with counterparties that are deemed by the Adviser to be
credit worthy. Reverse repurchase agreements are speculative techniques
involving leverage, and are subject to asset coverage requirements if the
Portfolio does not establish and maintain a segregated account (as described
above). Under the requirements of the 1940
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Act, the Portfolios are required to maintain an asset coverage (including the
proceeds of the borrowings) of at least 300% of all borrowings. Depending on
market conditions, the Portfolios' asset coverage and other factors at the time
of a reverse repurchase, the Portfolios may not establish a segregated account
when the Adviser believes it is not in the best interests of the Portfolios to
do so. In this case, such reverse repurchase agreements will be considered
borrowings subject to the asset coverage described above.
Dollar roll transactions consist of the sale by a Portfolio of mortgage-backed
or other asset-backed securities, together with a commitment to purchase
similar, but not identical, securities at a future date, at the same price. In
addition, a Portfolio is paid a fee as consideration for entering into the
commitment to purchase. If the broker/dealer to whom a Portfolio sells the
security becomes insolvent, the Portfolio's right to purchase or repurchase the
security may be restricted; the value of the security may change adversely over
the term of the dollar roll; the security that the Portfolio is required to
repurchase may be worth less than the security that the Portfolio originally
held, and the return earned by the Portfolio with the proceeds of a dollar roll
may not exceed transaction costs.
COMMERCIAL INSTRUMENTS: Commercial instruments consist of short-term U.S.
dollar-denominated obligations issued by domestic corporations or foreign
corporations and domestic and foreign commercial banks.
Investments by a Portfolio in commercial paper will consist of issues rated in a
manner consistent with such Portfolio's investment policies and objective. In
addition, a Portfolio may acquire unrated commercial paper and corporate bonds
that are determined by the Adviser at the time of purchase to be of comparable
quality to rated instruments that may be acquired by a Portfolio. Commercial
instruments include variable rate master demand notes, which are unsecured
instruments that permit the indebtedness thereunder to vary and provide for
periodic adjustments in the interest rate, and variable and floating rate
instruments.
CONVERTIBLE SECURITIES, PREFERRED STOCK, AND WARRANTS: Certain of the Portfolios
may invest in debt securities convertible into or exchangeable for equity
securities, preferred stocks or warrants. Preferred stocks are securities that
represent an ownership interest in a corporation providing the owner with claims
on a company's earnings and assets before common stock owners, but after bond or
other debt security owners. Warrants are options to buy a stated number of
shares of common stock at a specified price any time during the life of the
warrants.
FIXED INCOME INVESTING: The performance of the fixed income debt component of a
Portfolio's portfolio depends primarily on interest rate changes, the average
weighted maturity of the portfolio and the quality of the securities held. The
debt component of a Portfolio's portfolio will tend to decrease in value when
interest rates rise and increase when interest rates fall. A Portfolio's share
price and yield depend, in part, on the maturity and quality of its debt
instruments.
FOREIGN CURRENCY TRANSACTIONS: Certain of the Portfolios may enter into foreign
currency exchange transactions to convert foreign currencies to and from the
U.S. dollar. A Portfolio either enters into these transactions on a spot (I.E.,
cash) basis at the spot rate prevailing in the foreign currency exchange market,
or uses forward contracts to purchase or sell foreign currencies. A forward
foreign currency exchange contract is an obligation by a Portfolio 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.
Foreign currency hedging transactions are an attempt to protect a Portfolio
against changes in foreign currency exchange rates between the trade and
settlement dates of specific securities transactions or changes in foreign
currency exchange rates that would adversely affect a portfolio position or an
anticipated portfolio position. Although these transactions tend to minimize the
risk of loss due to a decline in the value of the hedged currency, at the same
time they tend to limit any potential gain that might be realized should the
value of the hedged currency increase. Neither spot transactions nor forward
foreign currency exchange contracts eliminate fluctuations in the prices of
portfolio securities or in foreign exchange rates, or prevent loss if the prices
of these securities should decline.
A Portfolio will generally enter into forward currency exchange contracts only
under two circumstances: (i) when the Portfolio enters into a contract for the
purchase or sale of a security denominated in a foreign currency, to "lock" in
the U.S. dollar price of the security; and (ii) when the Adviser believes that
the currency of a particular foreign country may experience a substantial
movement against another currency. Under certain circumstances, the Portfolio
may commit a substantial portion of its portfolio to the execution of these
contracts. The Adviser will consider the effects such a commitment would have on
the investment program of the Portfolio and the flexibility of the Portfolio to
purchase additional securities. Although forward contracts will be used
primarily to protect the Portfolio from adverse currency movements, they also
involve the risk that anticipated currency movements will not be accurately
predicted.
FOREIGN SECURITIES: Foreign securities include debt and equity obligations
(dollar- and non-dollar-denominated) of foreign corporations and banks as well
as obligations of foreign governments and their political subdivisions (which
will be limited to direct government obligations and government-guaranteed
securities). Such investments may subject a Portfolio to special
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investment risks, including future political and economic developments, the
possible imposition of withholding taxes on income (including interest,
distributions and disposition proceeds), possible seizure or nationalization of
foreign deposits, the possible establishment of exchange controls, or the
adoption of other foreign governmental restrictions which might adversely affect
the payment of principal and interest on such obligations. In addition, foreign
issuers in general may be subject to different accounting, auditing, reporting,
and record keeping standards than those applicable to domestic companies, and
securities of foreign issuers may be less liquid and their prices more volatile
than those of comparable domestic issuers.
Investments in foreign securities may present additional risks, whether made
directly or indirectly, including the political or economic instability of the
issuer or the country of issue and the difficulty of predicting international
trade patterns. In addition, there may be less publicly available information
about a foreign company than about a U.S. company. Further, foreign securities
markets are generally not as developed or efficient as those in the U.S., and in
most foreign markets volume and liquidity are less than in the United States.
Fixed commissions on foreign securities exchanges are generally higher than the
negotiated commissions on U.S. exchanges, and there is generally less government
supervision and regulation of foreign securities exchanges, brokers, and
companies than in the United States. With respect to certain foreign countries,
there is a possibility of expropriation or confiscatory taxation, limitations on
the removal of funds or other assets, or diplomatic developments that could
affect investments within those countries. Because of these and other factors,
securities of foreign companies acquired by a Portfolio may be subject to
greater fluctuation in price than securities of domestic companies.
The Portfolios may invest indirectly in the securities of foreign issuers
through sponsored or unsponsored ADRs, ADSs, GDRs and EDRs or other securities
representing securities of companies based in countries other than the United
States. Transactions in these securities may not necessarily be settled in the
same currency as the underlying securities which they represent. Ownership of
unsponsored ADRs, ADSs, GDRs and EDRs may not entitle the Portfolios to
financial or other reports from the issuer, to which it would be entitled as the
owner of sponsored ADRs, ADSs, GDRs or EDRs. Generally, ADRs and ADSs, in
registered form, are designed for use in the U.S. securities market. GDRs are
designed for use in both the U.S. and European securities markets. EDRs, in
bearer form, are designed for use in European securities markets. ADRs, ADSs,
GDRs and EDRs also involve certain risks of other investments in foreign
securities.
FUTURES, OPTIONS AND OTHER DERIVATIVE INSTRUMENTS: Certain of the Portfolios may
attempt to reduce the overall level of investment risk of particular securities
and attempt to protect a Portfolio against adverse market movements by investing
in futures, options and other derivative instruments. These include the purchase
and writing of options on securities (including index options) and options on
foreign currencies, and investing in futures contracts for the purchase or sale
of instruments based on financial indices, including interest rate indices or
indices of U.S. or foreign government, equity or fixed income securities
("futures contracts"), options on futures contracts, forward contracts and swaps
and swap-related products such as interest rate swaps, currency swaps, caps,
collars and floors.
The use of futures, options, forward contracts and swaps exposes a Portfolio to
additional investment risks and transaction costs. If the Adviser incorrectly
analyzes market conditions or does not employ the appropriate strategy with
respect to these instruments, a Portfolio could be left in a less favorable
position. Additional risks inherent in the use of futures, options, forward
contracts and swaps include: imperfect correlation between the price of futures,
options and forward contracts and movements in the prices of the securities or
currencies being hedged; the possible absence of a liquid secondary market for
any particular instrument at any time; and the possible need to defer closing
out certain hedged positions to avoid adverse tax consequences. A Portfolio may
not purchase put and call options which are traded on a national stock exchange
in an amount exceeding 5% of its net assets. Further information on the use of
futures, options and other derivative instruments, and the associated risks, is
contained in the Trust's SAI.
GUARANTEED INVESTMENT CONTRACTS: Guaranteed investment contracts, investment
contracts or funding agreements (each referred to as a "GIC") are investment
instruments issued by highly rated insurance companies. Pursuant to such
contracts, a Portfolio may make cash contributions to a deposit fund of the
insurance company's general or separate accounts. The insurance company then
credits to a Portfolio guaranteed interest. The insurance company may assess
periodic charges against a GIC for expense and service costs allocable to it,
and the charges will be deducted from the value of the deposit fund. The
purchase price paid for a GIC generally becomes part of the general assets of
the issuer, and the contract is paid from the general assets of the issuer.
A Portfolio will only purchase GICs from issuers which, at the time of purchase,
meet quality and credit standards established by the Adviser. Generally, GICs
are not assignable or transferable without the permission of the issuing
insurance companies, and an active secondary market in GICs does not currently
exist. Also, a Portfolio may not receive the principal amount of a GIC from the
insurance company on seven days' notice or
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less, at which point the GIC may be considered to be an illiquid investment.
ILLIQUID SECURITIES: Certain securities may be sold only pursuant to certain
legal restrictions, and may be difficult to sell. The Portfolios will not hold
more than 15% of the value of their respective net assets in securities that are
illiquid or such lower percentage as may be required by the states in which the
appropriate Portfolio sells its shares. The Adviser will take reasonable steps
to bring the Portfolios into compliance with this policy if the level of
illiquid investments exceeds 15% of the Portfolios' respective net assets.
Repurchase agreements, time deposits and GICs that do not provide for payment to
a Portfolio within seven days after notice, and illiquid restricted securities
are subject to the limitation on illiquid securities.
If otherwise consistent with their investment objectives and policies, certain
Portfolios may purchase securities that are not registered under the Securities
Act of 1933, as amended (the "1933 Act") but which can be sold to "qualified
institutional buyers" in accordance with Rule 144A under the 1933 Act, or which
were issued under Section 4(2) of the 1933 Act. Any such security will not be
considered illiquid so long as it is determined by the Portfolios' Board of
Trustees or the Adviser acting under guidelines approved and monitored by the
Portfolios' Board, after considering trading activity, availability of reliable
price information and other relevant information, that an adequate trading
market exists for that security. To the extent that, for a period of time,
qualified institutional or other buyers cease purchasing such restricted
securities pursuant to Rule 144A or otherwise, the level of illiquidity of a
Portfolio holding such securities may increase during such period.
INDEXED/STRUCTURED SECURITIES: Indexed/structured
securities are typically short- to intermediate-term debt securities whose value
at maturity or interest rate is linked to currencies, interest rates, equity
securities, indices, commodity prices or other financial indicators. Such
securities may be positively or negatively indexed (i.e., their value may
increase or decrease if the reference index or instrument appreciates).
Indexed/structured securities may have return characteristics similar to direct
investments in the underlying instruments and may be more volatile than the
underlying instruments. The Portfolio bears the market risk of an investment in
the underlying instruments, as well as the credit risk of the issuer.
INTEREST RATE TRANSACTIONS: In order to attempt to protect the value of their
portfolios from interest rate fluctuations, certain of the Portfolios may enter
into various hedging transactions, such as interest rate swaps and the purchase
or sale of interest rate caps and floors. Interest rate swaps involve the
exchange by a Portfolio with another party of their respective commitments to
pay or receive interest, E.G., an exchange of floating-rate payments for
fixed-rate payments. A Portfolio will enter into a swap transaction on a net
basis, I.E. the payment obligations of the Portfolio and the counterparty will
be netted out with the Portfolio receiving or paying, as the case may be, only
the net amount of the two payment obligations. A Portfolio will segregate, on a
daily basis, cash or liquid high quality debt securities with a value at least
equal to the Portfolio's net obligations, if any, under a swap agreement.
The purchase of an interest rate cap entitles the purchaser, to the extent that
a specified index exceeds a predetermined interest rate, to receive payments of
interest on a notional principal amount from the party selling such interest
rate cap. The purchase of an interest rate floor entitles the purchaser to
receive payments of interest on a notional principal amount from the party
selling such interest rate floor. The Adviser expects to enter into these
transactions on behalf of a Portfolio primarily to preserve a return or spread
on a particular investment or portion of its portfolio or to protect against any
increase in the price of securities the Portfolio anticipated purchasing at a
later date rather than for speculative purposes. A Portfolio will not sell
interest rate caps or floors that it does not own.
LOWER-RATED DEBT SECURITIES: Certain of the Portfolios may invest in lower-rated
debt securities. Lower rated, high-yielding securities are those rated below
"Ba" by Moody's or "BB" by S&P which are commonly referred to as "junk bonds."
These bonds provide poor protection for payment of principal and interest.
Lower-quality bonds involve greater risk of default or price changes due to
changes in the issuer's creditworthiness than securities assigned a higher
quality rating. These securities are considered to have speculative
characteristics and indicate an aggressive approach to income investing. Nations
Marsico Focused Equities Portfolio and Nations Marsico Growth & Income Portfolio
will not purchase debt securities rated below "CCC-" by S&P or "Caa" by Moody's.
Subsequent to its purchase by a Portfolio, an issue of debt securities may cease
to be rated, or its ratings may be reduced below the minimum rating required for
purchase by a Portfolio. The Adviser will consider such an event in determining
whether a Portfolio should continue to hold the security. The Portfolio may also
purchase unrated bonds of foreign and domestic issuers.
The market for lower-rated securities may be thinner and less active than that
for higher quality securities, which can adversely affect the price at which
these securities can be sold. If market quotations are not available, these
lower-rated securities will be valued in accordance with procedures established
by the Portfolios' Board, including the use of outside pricing services. Adverse
publicity and changing investor perceptions may affect the ability of outside
pricing services used by
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a Portfolio to value its portfolio securities, and a Portfolio's ability to
dispose of these lower-rated bonds.
The market prices of lower-rated securities may fluctuate more than higher-rated
securities and may decline significantly in periods of general economic
difficulty which may follow periods of rising interest rates. During an economic
downturn or a prolonged period of rising interest rates, the ability of issuers
of lower quality debt to serve their payment obligations, meet projected goals,
or obtain additional financing may be impaired.
Since the risk of default is higher for lower-rated securities, the Adviser will
try to minimize the risks inherent in investing in lower-rated debt securities
by engaging in credit analysis, diversification, and attention to current
developments and trends affecting interest rates and economic conditions. The
Adviser will attempt to identify those issuers of high-yielding securities whose
financial condition is adequate to meet future obligations, have improved, or
are expected to improve in the future.
Unrated securities are not necessarily of lower quality than rated securities,
but they may not be attractive to as many buyers. Each Portfolio's policies
regarding lower-rated debt securities is not fundamental and may be changed at
any time without shareholder approval.
MONEY MARKET INSTRUMENTS: The term "money market instruments" refers to
instruments with remaining maturities of one year or less. Money market
instruments may include, among other instruments, certain U.S. Treasury
Obligations, U.S. Government Obligations, bank instruments, commercial
instruments, repurchase agreements and municipal securities. Such instruments
are described in this Appendix A.
OTHER INVESTMENT COMPANIES: Each Portfolio may invest in securities issued by
other investment companies to the extent that such investments are consistent
with the Portfolio's investment objective and policies and permissible under the
1940 Act. As a shareholder of another investment company, a Portfolio would
bear, along with other shareholders, its pro rata portion of the other
investment company's expenses, including advisory fees. These expenses would be
in addition to the advisory and other expenses that a Portfolio bears directly
in connection with its own operations. Pursuant to an exemptive order issued by
the SEC, the Nations' Non-Money Market Portfolios and Funds may purchase shares
of Nations' Money Market Portfolios and Funds.
PASSIVE FOREIGN INVESTMENT COMPANIES: Passive foreign investment companies
("PFICs") are any foreign corporations which generate certain amounts of passive
income or hold certain amounts of assets for the production of passive income.
Passive income includes dividends, interest, royalties, rents and annuities.
Income tax regulations may require the Portfolio to recognize income associated
with the PFIC prior to the actual receipt of any such income.
PAY-IN-KIND BONDS: Pay-in-kind bonds are debt securities that normally give the
issuer an option to pay cash at a coupon payment date or give the holder of the
security a similar bond with the same coupon rate and a face value equal to the
amount of the coupon payment that would have been made.
REAL ESTATE INVESTMENT TRUSTS: A real estate investment trust ("REIT") is a
managed portfolio of real estate investments which may include office buildings,
apartment complexes, hotels and shopping malls. An Equity REIT holds equity
positions in real estate, and it seeks to provide its shareholders with income
from the leasing of its properties, and with capital gains from any sales of
properties. A Mortgage REIT specializes in lending money to developers of
properties, and passes any interest income it may earn to its shareholders.
REITs may be affected by changes in the value of the underlying property owned
or financed by the REIT, while Mortgage REITs also may be affected by the
quality of credit extended. Both Equity and Mortgage REITs are dependent upon
management skill and may not be diversified. REITs also may be subject to heavy
cash flow dependency, defaults by borrowers, self-liquidation, and the
possibility of failing to qualify for tax-free pass-through of income under the
Code.
REPURCHASE AGREEMENTS: A repurchase agreement involves the purchase of a
security by a Portfolio and a simultaneous agreement (generally with a bank or
broker/dealer) to repurchase that security from the Portfolio at a specified
price and date or upon demand. This technique offers a method of earning income
on uninvested cash. A risk associated with repurchase agreements is the failure
of the seller to repurchase the securities as agreed, which may cause a
Portfolio to suffer a loss if the market value of such securities declines
before they can be liquidated on the open market. Repurchase agreements with a
duration of more than seven days are considered illiquid securities and are
subject to the limit stated above. A Portfolio may enter into joint repurchase
agreements jointly with other investment portfolios of Nations Funds.
SECURITIES LENDING: To increase return on portfolio securities, the Portfolios
may lend their portfolio securities to broker/dealers and other institutional
investors pursuant to agreements requiring that the loans be continuously
secured by collateral equal at all times in value to at least the market value
of the securities loaned. There is a risk of delay in receiving collateral or in
recovering the securities loaned or even a loss of rights in the collateral
should the borrower of the securities fail financially. However, loans are made
only to borrowers deemed by the Adviser to be credit worthy and when, in their
judgment, the income to be earned from the loan justifies the attendant risks.
The aggregate of all out-
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standing loans of a Portfolio may not exceed 33% of the value of its total
assets. Cash collateral received by a Portfolio may be invested in a Nations'
Money Market Fund or Portfolio.
SHORT-TERM TRUST OBLIGATIONS: Certain of the Portfolios may invest in short-term
obligations issued by special purpose trusts established to acquire specific
issues of government or corporate securities. Such obligations entitle the
Portfolio to a proportional fractional interest in payments received by such
trusts, either from the underlying securities owned by the trust or pursuant to
other arrangements entered into by the trusts. A trust may enter into a swap
arrangement with a highly rated investment firm, pursuant to which the trust
grants to the counterparty certain of its rights with respect to the securities
owned by the trust in exchange for the obligation of the counterparty to make
payments to the trust according to an established formula.
STEP COUPON BONDS: Step coupon bonds are debt securities that trade at a
discount from their face value and pay coupon interest. The discount from the
face value depends on the time remaining until cash payments begin, prevailing
interest rates, liquidity of the security and the perceived credit quality of
the issuer.
STOCK INDEX, INTEREST RATE AND CURRENCY FUTURES CONTRACTS: Certain of the
Portfolios may purchase and sell futures contracts and related options with
respect to non-U.S. stock indices, non-U.S. interest rates and foreign
currencies, that have been approved by the CFTC for investment by U.S.
investors, for the purpose of hedging against changes in values of a Portfolio's
securities or changes in the prevailing levels of interest rates or currency
exchange rates. The contracts entail certain risks, including but not limited to
the following: no assurance that futures contracts transactions can be offset at
favorable prices; possible reduction of a Portfolio's total return due to the
use of hedging; possible lack of liquidity due to daily limits on price
fluctuation; imperfect correlation between the contracts and the securities or
currencies being hedged; and potential losses in excess of the amount invested
in the futures contracts themselves.
Trading on foreign commodity exchanges presents additional risks. Unlike trading
on domestic commodity exchanges, trading on foreign commodity exchanges is not
regulated by the CFTC and may be subject to greater risks than trading on
domestic exchanges. For example, some foreign exchanges are principal markets
for which no common clearing facility exists and a trader may look only to the
broker for performance of the contract. In addition, unless a Portfolio hedges
against fluctuations in the exchange rate between the U.S. dollar and the
currencies in which trading is done on foreign exchanges, any profits that such
Portfolio might realize could be eliminated by adverse changes in the exchange
rate, or the Portfolio could incur losses as a result of those changes.
U.S. GOVERNMENT OBLIGATIONS: U.S. Government Obligations consist of marketable
securities and instruments issued or guaranteed by the U.S. Government or any of
its agencies, authorities or instrumentalities. Direct obligations are issued by
the U.S. Treasury and include all U.S. Treasury instruments. U.S. Treasury
Obligations differ only in their interest rates, maturities and time of
issuance. Obligations of U.S. Government agencies, authorities and
instrumentalities are issued by government-sponsored agencies and enterprises
acting under authority of Congress. Although obligations of federal agencies,
authorities and instrumentalities are not debts of the U.S. Treasury, some are
backed by the full faith and credit of the U.S. Treasury, such as direct
pass-through certificates of the Government National Mortgage Association; some
are supported by the right of the issuer to borrow from the U.S. Government,
such as obligations of Federal Home Loan Banks, and some are backed only by the
credit of the issuer itself, such as obligations of the Federal National
Mortgage Association. No assurance can be given that the U.S. Government would
provide financial support to government-sponsored instrumentalities if it is not
obligated to do so by law.
The market value of U.S. Government Obligations may fluctuate due to
fluctuations in market interest rates. As a general matter, the value of debt
instruments, including U.S. Government Obligations, declines when market
interest rates increase and rises when market interest rates decrease. Certain
types of U.S. Government Obligations are subject to fluctuations in yield or
value due to their structure or contract terms.
VARIABLE- AND FLOATING-RATE INSTRUMENTS: Certain instruments issued, guaranteed
or sponsored by the U.S. Government or its agencies, state and local government
issuers, and certain debt instruments issued by domestic and foreign banks and
corporations may carry variable or floating rates of interest. Such instruments
bear interest rates which are not fixed, but which vary with changes in
specified market rates or indices, such as a Federal Reserve composite index. A
variable-rate demand instrument is an obligation with a variable or floating
interest rate and an unconditional right of demand on the part of the holder to
receive payment of unpaid principal and accrued interest. Certain Portfolios may
invest in securities with demand features where (a) the security or its issuer
has received a short-term rating from an NRSRO; and (b) the issuer of the demand
featuer, or another institution, undertakes to notify promptly the holder of the
security in the event that the demand feature is substituted with a demand
feature provided by another issuer. (Note, however, that certain securities
first issued on or before June 3, 1996 are not subject to these rating and
notice requirements.) An instrument with a demand period exceeding seven days
may be considered illiquid if there is no secondary market for such security.
WHEN-ISSUED, DELAYED DELIVERY AND FORWARD COMMITMENT SECURITIES: The purchase of
new issues of securities on a "when-issued," "delayed delivery" or
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"forward commitment" basis occurs when the payment for and delivery of
securities takes place at a future date. Because actual payment for and delivery
of such securities generally take place 15 to 45 days after the purchase date,
purchasers of such securities bear the risk that interest rates on debt
securities at the time of delivery may be higher or lower than those contracted
for on the security purchased.
ZERO COUPON BONDS: Zero coupon bonds are debt securities that do not pay
interest at regular intervals, but are issued at a discount from face value. The
discount approximates the total amount of interest the security will accrue from
the date of issuance to maturity. The market value of these securities generally
fluctuates more in response to changes in interest rates than interest-paying
securities of comparable maturity.
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Appendix B -- Description Of Ratings
The following summarizes the highest eight ratings used by S&P for corporate and
municipal bonds. The first four ratings denote investment grade securities.
AAA -- This is the highest rating assigned by S&P to a debt obligation and
indicates an extremely strong capacity to pay interest and repay principal.
AA -- Debt rated AA is considered to have a very strong capacity to pay
interest and repay principal and differs from AAA issues only in a 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 for those in
higher-rated categories.
BB, B -- Bonds rated BB and B are regarded, on balance, as predominantly
speculative with respect to capacity to pay interest and repay principal in
accordance with the terms of the obligation. BB represents the lowest
degree of speculation and B a higher degree of speculation. While such
bonds will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
CCC, CC -- An obligation rated CCC is vulnerable to nonpayment and is
dependent upon favorable business, financial, and economic conditions for
the obligor to meet its financial commitment on the obligation. In the
event of adverse conditions, the obligor is not likely to have the capacity
to meet its financial commitments on the obligation; an obligation rated CC
is highly vulnerable to nonpayment.
To provide more detailed indications of credit quality, the AA, A, BBB and CCC
ratings may be modified by the addition of a plus or minus sign to show relative
standing within these major rating categories.
The following summarizes the highest eight ratings used by Moody's for corporate
and municipal bonds. The first four ratings denote investment grade securities.
Aaa -- Bonds that 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 edge." 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 that 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 risks appear somewhat
larger than in Aaa securities.
A -- Bonds that are rated A possess many favorable investment attributes
and are to be considered 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 sometime in the
future.
Baa -- Bonds that are rated Baa are considered 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 as well assured. Often the protection of
interest
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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, Ca -- Bonds that 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. Bonds that are rated Ca represent obligations that
are speculative in a high degree. Such issues are often in default or have
other marked shortcomings.
Moody's applies numerical modifiers (1, 2 and 3) with respect to corporate bonds
rated Aa through B. The modifier 1 indicates that the bond being rated ranks in
the higher end of its generic rating category; the modifier 2 indicates a
mid-range ranking; and the modifier 3 indicates that the bond ranks in the lower
end of its generic rating category. With regard to municipal bonds, those bonds
in the Aa, A and Baa groups which Moody's believes possess the strongest
investment attributes are designated by the symbols Aa1, A1 or Baa1,
respectively.
The following summarizes the highest four ratings used by D&P for bonds, each of
which denotes that the securities are investment grade:
AAA -- Bonds that are rated AAA are of the highest credit quality. The risk
factors are considered to be negligible, being only slightly more than for
risk-free U.S. Treasury debt.
AA -- Bonds that are rated AA are of high credit quality. Protection
factors are strong. Risk is modest, but may vary slightly from time to time
because of economic conditions.
A -- Bonds that are rated A have protection factors which are average but
adequate. However, risk factors are more variable and greater in periods of
economic stress.
BBB -- Bonds that are rated BBB have below average protection factors but
still are considered sufficient for prudent investment. Considerable
variability in risk exists during economic cycles.
To provide more detailed indications of credit quality, the AA, A and BBB
ratings may be modified by the addition of a plus or minus sign to show relative
standing within these major categories.
The following summarizes the highest four ratings used by Fitch for bonds, each
of which denotes that the securities are investment grade:
AAA -- Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest
and repay principal, which is unlikely to be affected by reasonably
foreseeable events.
AA -- Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated AAA. Because bonds
rated in the AAA and AA categories are not significantly vulnerable to
foreseeable future developments, short-term debt of these issuers is
generally rated F-1+.
A -- Bonds considered to be investment grade and of high credit quality.
The obligor's ability to pay interest and repay principal is considered to
be strong, but may be more vulnerable to adverse changes in economic
conditions and circumstances than bonds with higher ratings.
BBB -- Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on these
bonds, and therefore impair timely payment. The likelihood that the ratings
of these bonds will fall below investment grade is higher than for bonds
with higher ratings.
To provide more detailed indications of credit quality, the AA, A and BBB
ratings may be modified by the addition of a plus or minus sign to show relative
standing within these major rating categories.
The following summarizes the two highest ratings used by Moody's for short-term
municipal notes and variable rate demand obligations:
MIG-1/VMIG-1 -- Obligations bearing these designations are of the best
quality, enjoying strong protection from established cash flows, superior
liquidity support or demonstrated broad-based access to the market for
refinancing.
MIG-2/VMIG-2 -- Obligations bearing these designations are of high quality,
with ample margins of protection although not so large as in the preceding
group.
The following summarizes the two highest ratings used by S&P for short-term
municipal notes:
SP-1 -- Very strong or strong capacity to pay principal and interest. Those
issues determined to possess
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overwhelming safety characteristics are given a "plus" (+) designation.
SP-2 -- Satisfactory capacity to pay principal and interest.
The three highest rating categories of D&P for short-term debt, each of which
denotes that the securities are investment grade, are D-1, D-2 and D-3. D&P
employs three designations, D-1+, D-1 and D-1-, within the highest rating
category. D-1+ indicates highest certainty of timely payment. Short-term
liquidity, including internal operating factors and/or access to alternative
sources of funds, is judged to be "outstanding, and safety is just below
risk-free U.S. Treasury short-term obligations." D-1 indicates very high
certainty of timely payment. Liquidity factors are excellent and supported by
good fundamental protection factors. Risk factors are considered to be minor.
D-1- indicates high certainty of timely payment. Liquidity factors are strong
and supported by good fundamental protection factors. Risk factors are very
small. D-2 indicates 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. D-3 indicates satisfactory liquidity and other protection factors which
qualify the issue as investment grade. Risk factors are larger and subject to
more variation. Nevertheless, timely payment is expected.
The following summarizes the two highest rating categories used by Fitch for
short-term obligations:
F-1+ securities possess exceptionally strong credit quality. Issues
assigned this rating are regarded as having the strongest degree of
assurance for timely payment.
F-1 securities possess very strong credit quality. Issues assigned this
rating reflect an assurance of timely payment only slightly less in degree
than issues rated F-1+.
Commercial paper rated A-1 by S&P indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely strong
safety characteristics are denoted A-1+. Capacity for timely payment on
commercial paper rated A-2 is satisfactory, but the relative degree of safety is
not as high as for issues designated A-1.
The rating Prime-1 is the highest commercial paper rating assigned by Moody's.
Issuers rated Prime-1 (or related supporting institutions) are considered to
have a superior capacity for repayment of senior short-term promissory
obligations. Issuers rated Prime-2 (or related supporting institutions) are
considered to have a strong capacity for repayment of senior short-term
promissory obligations. This will normally be evidenced by many of the
characteristics of issuers rated Prime-1, 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.
For commercial paper, D&P uses the short-term debt ratings described above.
For commercial paper, Fitch uses the short-term debt ratings described above.
BankWatch ratings are based upon a qualitative and quantitative analysis of all
segments of the organization including, where applicable, holding company and
operating subsidiaries. BankWatch ratings do not constitute a recommendation to
buy or sell securities of any of these companies. Further, BankWatch does not
suggest specific investment criteria for individual clients.
BankWatch long-term ratings apply to specific issues of long-term debt and
preferred stock. The long-term ratings specifically assess the likelihood of
untimely payment of principal or interest over the term to maturity of the rated
instrument. The following are the four investment grade ratings used by
BankWatch for long-term debt:
AAA -- The highest category; indicates ability to repay principal and
interest on a timely basis is extremely high.
AA -- The second highest category; indicates a very strong ability to repay
principal and interest on a timely basis with limited incremental risk
versus issues rated in the highest category.
A -- The third highest category; indicates the ability to repay principal
and interest is strong. Issues rated "A" could be more vulnerable to
adverse developments (both internal and external) than obligations with
higher ratings.
BBB -- The lowest investment grade category; indicates an acceptable
capacity to repay principal and interest. Issues rated "BBB" are, however,
more vulnerable to adverse developments (both internal and external) than
obligations with higher ratings.
The BankWatch short-term ratings apply to commercial paper, other senior
short-term obligations and deposit obligations of the entities to which the
rating has been assigned. The BankWatch short-term ratings specifically assess
the likelihood of an untimely payment 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.
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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 more
susceptible to adverse developments (both internal and external) than
obligations with higher ratings, 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.
The following summarizes the four highest long-term ratings used by IBCA:
AAA -- Obligations for which there is the lowest expectation of investment
risk. Capacity for timely repayment of principal and interest is
substantial such that adverse changes in business, economic or financial
conditions are unlikely to increase investment risk significantly.
AA -- Obligations for which there is a very low expectation of investment
risk. Capacity for timely repayment of principal and interest is
substantial. Adverse changes in business, economic or financial conditions
may increase investment risk albeit not very significantly.
A -- Obligations for which there is a low expectation of investment risk.
Capacity for timely repayment of principal and interest is strong, although
adverse changes in business, economic or financial conditions may lead to
increased investment risk.
BBB -- Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial
conditions are more likely to lead to increased investment risk than for
obligations in other categories.
A plus or minus sign may be appended to a rating below AAA to denote relative
status within major rating categories.
The following summarizes the two highest short-term debt ratings used by IBCA:
A1+ -- Where issues possess a particularly strong credit feature.
A1 -- Obligations supported by the highest capacity for timely repayment.
NATIONS ANNUITY TRUST
Statement of Additional Information
NATIONS BALANCED ASSETS PORTFOLIO
NATIONS DISCIPLINED EQUITY PORTFOLIO
NATIONS INTERNATIONAL GROWTH PORTFOLIO
NATIONS MANAGED INDEX PORTFOLIO
NATIONS MANAGED SMALLCAP INDEX PORTFOLIO
NATIONS MARSICO FOCUSED EQUITIES PORTFOLIO
NATIONS MARSICO GROWTH & INCOME PORTFOLIO
NATIONS VALUE PORTFOLIO
March 1, 1998
This Statement of Additional Information ("SAI") provides supplementary
information pertaining to the shares representing interests in the above listed
eight investment portfolios (individually, a "Portfolio" and collectively, the
"Portfolios") of Nations Annuity Trust (the "Trust"). This SAI is not a
prospectus, and should be read only in conjunction with the current Prospectus
for the aforementioned Portfolios in which one is interested, dated March 1,
1998 ("Prospectus"). All terms used in this SAI that are defined in the
Prospectus will have the same meanings assigned in the Prospectus. Copies of the
Prospectus may be obtained by writing the Trust c/o Stephens Inc., One
NationsBank Plaza, 33rd Floor, Charlotte, North Carolina 28255, or by calling
the Trust at (800) 321-7854.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
INTRODUCTION ................................................................................ 1
PORTFOLIO TRANSACTIONS AND BROKERAGE......................................................... 1
General Brokerage Policy............................................................. 1
Section 28(e) Standards.............................................................. 4
General.............................................................................. 5
ADDITIONAL INFORMATION ON PORTFOLIO INVESTMENTS ............................................. 6
Additional Investment Limitations ................................................... 6
Asset-Backed Securities.............................................................. 7
Commercial Instruments............................................................... 9
Delayed Delivery Transactions ....................................................... 10
Dollar Roll Transactions ............................................................ 10
Equity Swap Contracts ............................................................... 10
Foreign Currency Transactions ....................................................... 11
Futures, Options and Other Derivative
Instruments ................................................................... 12
Guaranteed Investment Contracts...................................................... 18
Illiquid Securities.................................................................. 18
Interest Rate Transactions .......................................................... 19
Lower Rated Debt Securities.......................................................... 19
Options on Currencies................................................................ 20
Real Estate Investment Trusts........................................................ 20
Repurchase Agreements ............................................................... 21
Reverse Repurchase Agreements ....................................................... 21
Risk Factors Associated with Futures and Options Transactions ....................... 21
Securities Lending................................................................... 23
Short Sales.......................................................................... 24
Special Situations................................................................... 24
Stand-By Commitments ................................................................ 24
Variable- and Floating-Rate Instruments ............................................. 25
When-Issued Purchases and Forward Commitments ...................................... 25
NET ASSET VALUE.............................................................................. 26
Purchases and Redemptions............................................................ 26
Net Asset Value Determination........................................................ 26
DESCRIPTION OF SHARES........................................................................ 27
ADDITIONAL INFORMATION CONCERNING TAXES...................................................... 28
General.............................................................................. 28
Excise Tax .......................................................................... 29
Taxation of Portfolio Investments.................................................... 29
Taxation of a Separate Account of a Participating Insurance Company.................. 30
Federal Income Tax Rates............................................................. 31
Other Matters........................................................................ 31
TRUSTEES AND OFFICERS........................................................................ 31
Nations Funds Retirement Plan........................................................ 34
Nations Funds Deferred Compensation Plan ........................................... 35
Compensation Table................................................................... 35
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Shareholder and Trustee Liability ................................................... 36
INVESTMENT ADVISORY, ADMINISTRATION, CUSTODY,
TRANSFER AGENCY AND SHAREHOLDER SERVICING
AGREEMENTS .................................................................................. 37
Investment Adviser................................................................... 37
Investment Styles.................................................................... 40
Administrator and Co-Administrator................................................... 42
Custodian and Transfer Agent......................................................... 43
Shareholder Servicing and Distribution Plan.......................................... 44
Expenses............................................................................. 44
DISTRIBUTOR ................................................................................. 45
INDEPENDENT ACCOUNTANT AND REPORTS........................................................... 45
COUNSEL...................................................................................... 46
ADDITIONAL INFORMATION ON PERFORMANCE........................................................ 46
Yield Calculations................................................................... 46
Total Return Calculations............................................................ 47
MISCELLANEOUS ............................................................................... 48
SCHEDULE A - Description of Ratings........................................................... A-1
SCHEDULE B - Additional Information Concerning Options &
Futures...................................................................................... B-1
SCHEDULE C - Additional Information Concerning Mortgage-
Backed Securities............................................................................ C-1
</TABLE>
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INTRODUCTION
Nations Annuity Trust (the "Trust") is a mutual fund. The rules and
regulations of the United States Securities and Exchange Commission (the "SEC")
require all mutual funds to furnish prospective investors with certain
information concerning the activities of the mutual fund being considered for
investment. This information about the Trust is also included in the
corresponding Prospectus.
The Trust currently consists of eight different investment portfolios,
Nations Balanced Assets Portfolio, Nations Disciplined Equity Portfolio, Nations
International Growth Portfolio, Nations Managed Index Portfolio, Nations Managed
SmallCap Index Portfolio, Nations Marsico Focused Equities Portfolio, Nations
Marsico Growth & Income Portfolio and Nations Value Portfolio (each a
"Portfolio" and collectively the "Portfolios").
As of the date of this SAI, no shares of the Portfolios have been sold.
As a result, certain financial information and performance data is not available
and thus not included in this SAI.
The Prospectus relating to these Portfolios may be obtained without
charge by written request to the Trust, c/o Stephens, Inc., One NationsBank
Plaza, 33rd Floor, Charlotte, NC 28255. Participating Insurance Companies also
may call toll-free at (800) 321-7854.
NationsBanc Advisors, Inc. ("NBAI") is the investment adviser to the
Portfolios. TradeStreet Investment Associates, Inc. ("TradeStreet") is
investment sub-adviser to all of the Portfolios except Nations Marsico Focused
Equities Portfolio and Nations Marsico Growth & Income Portfolio, which are
sub-advised by Marsico Capital Management, LLC ("Marsico Capital"), and Nations
International Growth Portfolio. Gartmore Global Partners ("Gartmore") serves as
investment sub-adviser to Nations International Growth Portfolio. As used
herein, "Adviser" shall mean NBAI, TradeStreet, Gartmore, and/or Marsico Capital
as the context may require.
This SAI is intended to furnish Participating Insurance Companies with
additional information concerning the Trust and the Portfolios. Some of the
information required to be in this SAI is also included in the Portfolios'
current Prospectus, and, in order to avoid repetition, reference will be made to
sections of the Prospectus. Additionally, the Prospectus and this SAI omit
certain information contained in the registration statement filed with the SEC.
Copies of the registration statement, including items omitted from the
Prospectus and this SAI, may be obtained from the SEC by paying the charges
prescribed under its rules and regulations. No investment in the Portfolios
should be made without first reading the Prospectus.
PORTFOLIO TRANSACTIONS AND BROKERAGE
GENERAL BROKERAGE POLICY
Subject to policies established by the Board of Trustees of the Trust,
the Adviser is responsible for decisions to buy and sell securities for each
Portfolio, for the selection of broker/dealers, for the execution of each
Portfolio's securities transactions, and for the allocation of brokerage fees in
connection with such transactions. The Adviser's primary consideration in
effecting a security transaction is to obtain the best net price and the most
favorable execution of the order. While the Adviser generally seeks reasonably
competitive commission rates, a Portfolio does not necessarily pay the lowest
commission or spread available. Purchases and sales of securities on a
securities exchange are effected through brokers who charge a negotiated
commission for their services. Orders may be directed to any broker to the
extent and in the manner permitted by applicable law.
In the over-the-counter market, securities are generally traded on a
"net" basis with dealers acting as principal for their own accounts without
stated commissions, although the price of a security usually includes a profit
to the dealer. In underwritten offerings, securities are purchased at a fixed
price that includes an amount of compensation to the underwriter, generally
referred to as the underwriter's concession or discount. On occasion, certain
money market instruments may be purchased directly from an issuer, in which case
no commissions or discounts are paid.
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In placing orders for securities of a Portfolio, the Adviser is
required to give primary consideration to obtaining the most favorable price and
efficient execution. This means that the Adviser will seek to execute each
transaction at a price and commission, if any, which provide the most favorable
total cost or proceeds reasonably attainable in the circumstances. In seeking
such execution, the Adviser will use its best judgment in evaluating the terms
of a transaction, and will give consideration to various relevant factors,
including, without limitation, the size and type of the transaction, the nature
and character of the market for the security, the confidentiality, speed and
certainty of effective execution required for the transaction, the general
execution and operational capabilities of the broker-dealer, the reputation,
reliability, experience and financial condition of the firm, the value and
quality of the services rendered by the firm in this and other transactions and
the reasonableness of the spread or commission, if any.
While the Adviser generally seeks reasonably competitive spreads or
commissions, a Portfolio will not necessarily be paying the lowest spread or
commission available. Within the framework of this policy, the Adviser will
consider research and investment services provided by brokers or dealers who
effect or are parties to portfolio transactions of a Portfolio, the Adviser or
its other clients. Such research and investment services are those which
brokerage houses customarily provide to institutional investors and include
statistical and economic data and research reports on particular companies and
industries. Such services are used by the Adviser in connection with all of its
investment activities, and some of such services obtained in connection with the
execution of transactions for a Portfolio may be used in managing other
investment accounts. Conversely, brokers furnishing such services may be
selected for the execution of transactions of such other accounts, whose
aggregate assets are far larger than those of a Portfolio. Services furnished by
such brokers may be used by the Adviser in providing investment advisory and
investment management services for the Trust.
Commission rates are established pursuant to negotiations with the
broker based on the quality and quantity of execution services provided by the
broker in the light of generally prevailing rates. The allocation of orders
among brokers and the commission rates paid are reviewed periodically by the
Trustees of the Trust. On exchanges on which commissions are negotiated, the
cost of transactions may vary among different brokers. Transactions on foreign
stock exchanges involve payment of brokerage commissions which are generally
fixed. Transactions in both foreign and domestic over-the-counter markets are
generally principal transactions with dealers, and the costs of such
transactions involve dealer spreads rather than brokerage commissions. With
respect to over-the-counter transactions, the Adviser, where possible, will deal
directly with dealers who make a market in the securities involved except in
those circumstances in which better prices and execution are available
elsewhere.
In certain instances there may be securities which are suitable for
more than one Portfolio as well as for one or more of the other clients of the
Adviser. Investment decisions for each Portfolio and for the Adviser's other
clients are made with the goal of achieving their respective investment
objectives. It may happen that a particular security is bought or sold for only
one client even though it may be held by, or bought or sold for, other clients.
Likewise, a particular security may be bought for one or more clients when one
or more other clients are selling that same security. Some simultaneous
transactions are inevitable when several clients receive investment advice from
the same investment adviser, particularly when the same security is suitable for
the investment objectives of more than one client. When two or more clients are
simultaneously engaged in the purchase or sale of the same security, the
securities are allocated among clients in a manner believed to be equitable to
each. It is recognized that in some cases this system could have a detrimental
effect on the price or volume of the security in a particular transaction as far
as a Portfolio is concerned. The Trust believes that over time its ability to
participate in volume transactions will produce superior executions for the
Portfolios.
The portfolio turnover rate for each Portfolio is calculated by
dividing the lesser of purchases or sales of portfolio securities for the
reporting period by the monthly average value of the portfolio securities owned
during the reporting period. The calculation excludes all securities, including
options, whose maturities or expiration dates at the time of acquisition are one
year or less. Portfolio turnover may vary greatly from year to year as well as
within a particular year, and may be affected by cash requirements for
redemption of shares and by requirements which enable the Portfolios to receive
favorable tax treatment. Portfolio turnover will not be a limiting factor in
making portfolio decisions.
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The Portfolios may participate, if and when practicable, in bidding for
the purchase of portfolio securities directly from an issuer in order to take
advantage of the lower purchase price available to members of a bidding group. A
Portfolio will engage in this practice, however, only when the Adviser, in its
sole discretion, believes such practice to be otherwise in the Portfolio's
interests.
The Trust will not execute portfolio transactions through, purchase or
sell portfolio securities from or to the Distributor, the Adviser, the
Administrator, the Co-Administrator, or their respective affiliates acting as
principal (including repurchase and reverse repurchase agreements), except to
the extent permitted by the SEC. In addition, the Trust will not give preference
to correspondents of NationsBank N.A. ("NationsBank") or its affiliates with
respect to such transactions or securities. (However, the Adviser is authorized
to allocate purchase and sale orders for portfolio securities to certain
financial institutions, including, in the case of agency transactions, financial
institutions which are affiliated with NationsBank or its affiliates, and to
take into account the sale of Portfolio shares if the Adviser believes that the
quality of the transaction and the commission are comparable to what they would
be with other qualified brokerage firms.) In addition, a Portfolio will not
purchase securities during the existence of any underwriting or selling group
relating thereto of which the Distributor, the Adviser, Administrator, the
Co-Administrator, or any of their affiliates, is a member, except to the extent
permitted by the SEC. Under certain circumstances, the Portfolios may be at a
disadvantage because of these limitations in comparison with other investment
companies which have similar investment objectives but are not subject to such
limitations.
Under the Investment Company Act of 1940, as amended (the "1940 Act"),
persons affiliated with the Trust are prohibited from dealing with the Trust as
a principal in the purchase and sale of securities unless an exemptive order
allowing such transactions is obtained from the SEC. Each of the Portfolios may
purchase securities from underwriting syndicates of which NationsBank or any of
its affiliates is a member under certain conditions, in accordance with the
provisions of a rule adopted under the 1940 Act and any restrictions imposed by
the Board of Governors of the Federal Reserve System.
Investment decisions for each Portfolio are made independently from
those for the Trust's other investment portfolios and other investment companies
and accounts advised or managed by the Adviser. Such other investment
portfolios, investment companies and accounts may also invest in the same
securities as the Portfolios. When a purchase or sale of the same security is
made, at substantially the same time, on behalf of one or more of the Portfolios
and another investment portfolio, investment company or account, the transaction
will be averaged as to price and available investments allocated as to amount,
in a manner which the Adviser believes to be equitable to each Portfolio and
such other investment portfolio, investment company or account. In some
instances, this investment procedure may adversely affect the price paid or
received by a Portfolio or the size of the position obtained or sold by the
Portfolio. To the extent permitted by law, the Adviser may aggregate the
securities to be sold or purchased for the Portfolios with those to be sold or
purchased for other investment portfolios, investment companies or accounts in
executing transactions.
The Adviser may from time to time determine target levels of commission
business to transact with various brokers on behalf of its clients (including
the Trust) over a certain time period. The target levels will be determined
based upon the following factors, among others: (1) the execution services
provided by the broker; (2) the research services provided by the broker; and
(3) the broker's attitude toward and interest in mutual funds in general and in
the Trust and other mutual funds advised by the Adviser in particular. No
specific formula will be used in connection with any of the foregoing
considerations in determining the target levels. However, if a broker has
indicated a certain level of desired commissions in return for certain research
services provided by the broker, this factor will be taken into consideration by
the Adviser.
Subject to the overall objective of obtaining best price and execution
for a Portfolio, the Adviser may also consider sales of shares of such Portfolio
and of the other mutual funds managed or advised by the Adviser as a factor in
the selection of broker/dealers to execute portfolio transactions for the
Portfolios.
The Adviser will seek, whenever possible, to recapture for the benefit
of a Portfolio any commission, fees, brokerage or similar payments paid by such
Portfolio on portfolio transactions. Normally, the only fees which may
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be recaptured are the soliciting dealer fees on the tender of an account's
portfolio securities in a tender or exchange offer.
The Portfolios are not under any obligation to deal with any broker or
group of brokers in the execution of transactions in portfolio securities.
Brokers who provide supplemental investment research to the Adviser may receive
orders for transactions by a Portfolio. Information so received will be in
addition to and not in lieu of the services required to be performed by the
Adviser under its agreements with each Portfolio and the expenses of the Adviser
will not necessarily be reduced as a result of the receipt of such supplemental
information. Certain research services furnished by broker/dealers may be useful
to the Adviser in connection with its services to other advisory clients,
including other investment companies which it advises. Also, a Portfolio may pay
a higher price for securities or higher commissions in recognition of research
services furnished by broker/dealers.
The Adviser and its affiliates manage several other investment
accounts, some of which may have investment objectives similar to those of one
or more of the Portfolios. It is possible that, at times, identical securities
will be appropriate for investment by one or more of the Portfolios and by one
or more of such investment accounts. The position of each account, however, in
the securities of the same issuer may vary and the length of time that each
account may choose to hold its investment in the securities of the same issuer
may likewise vary. The timing and amount of purchase by each account will also
be determined by its cash position. If the purchase or sale of securities
consistent with the investment policies of a Portfolio and one or more of these
accounts is considered at or about the same time, transactions in such
securities will be allocated among the accounts in a manner deemed equitable by
the Adviser. The Adviser may combine such transactions, in accordance with
applicable laws and regulations, in order to obtain the best net price and most
favorable execution. Simultaneous transactions could, however, adversely affect
the ability of a Portfolio to obtain or dispose of the full amount of a security
which it seeks to purchase or sell.
In some cases the procedure for allocating securities transactions
among the various investment accounts advised by the Adviser and its affiliates
could have an adverse effect on the price or amount of securities available to a
Portfolio. In making such allocations, the main factors considered by the
Adviser are the respective investment objectives and policies of such advisory
clients, the relative size of holdings of the same or comparable securities, the
availability of cash for investment, the size of investment commitments
generally held and the judgments of the persons responsible for recommending the
investment.
SECTION 28(E) STANDARDS
Under Section 28(e) of the Securities Exchange Act of 1934, the Adviser
shall not be "deemed to have acted unlawfully or to have breached its fiduciary
duty" solely because under certain circumstances it has caused the account to
pay a higher commission than the lowest available. To obtain the benefit of
Section 28(e), an adviser must make a good faith determination that the
commissions paid are "reasonable in relation to the value of the brokerage and
research services provided ...viewed in terms of either that particular
transaction or its overall responsibilities with respect to the accounts as to
which it exercises investment discretion and that the services provided by a
broker provide an adviser with lawful and appropriate assistance in the
performance of its investment decision making responsibilities." Accordingly,
the price paid by a Portfolio in any transaction may be less favorable than that
available from another broker/dealer if the difference is reasonably justified
by other aspects of the portfolio execution services offered.
Broker/dealers utilized by the Adviser may furnish statistical,
research and other information or services which are deemed by the Adviser to be
beneficial to the Portfolios' investment programs. Research services received
from brokers supplement the Adviser's own research and may include the following
types of information: statistical and background information on industry groups
and individual companies; forecasts and interpretations with respect to U.S. and
foreign economies, securities, markets, specific industry groups and individual
companies; information on political developments; portfolio management
strategies; performance information on securities and information concerning
prices of securities; and information supplied by specialized services to the
Adviser and to the Trust's Trustees with respect to the performance, investment
activities, fees and expenses of other mutual funds. Such information may be
communicated electronically, orally or in written form. Research services may
also include
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providing equipment used to communicate research information, arranging meetings
with management of the Trust and providing access to consultants who supply
research information.
The outside research assistance is useful to the Adviser since the
brokers utilized by the Adviser, as a group, tend to follow a broader universe
of securities and other matters than the Adviser's staff can follow. In
addition, this research provides the Adviser with a diverse perspective on
financial markets. Research services which are provided to the Adviser by
brokers are available for the benefit of all accounts managed or advised by the
Adviser. In some cases, the research services are available only from the broker
providing such services. In other cases, the research services may be obtainable
from alternative sources in return for cash payments. The Adviser is of the
opinion that because the broker research supplements rather than replaces its
research, the receipt of such research does not tend to decrease its expenses,
but tends to improve the quality of its investment advice. However, to the
extent that the Adviser would have purchased any such research services had such
services not been provided by brokers, the expenses of such services to the
Adviser could be considered to have been reduced accordingly. Certain research
services furnished by broker/dealers may be useful to the Adviser with clients
other than the Portfolios. Similarly, any research services received by the
Adviser through the placement of portfolio transactions of other clients may be
of value to the Adviser in fulfilling its obligations to the Portfolios. The
Adviser is of the opinion that this material is beneficial in supplementing its
research and analysis; and, therefore, it may benefit the Trust by improving the
quality of the Adviser's investment advice. The advisory fees paid by the Trust
are not reduced because the Adviser receives such services.
Some broker/dealers may indicate that the provision of research
services is dependent upon the generation of certain specified levels of
commissions and underwriting concessions by the Adviser's clients, including the
Portfolios.
GENERAL
Information concerning each Portfolio's investment objective is set
forth in the Prospectus under the heading "About the Portfolios--Objectives."
There can be no assurance that the Portfolios will achieve their objectives. The
principal features of the Portfolios' investment programs and the primary risks
associated with those investment programs are discussed in the Prospectus under
the heading "About the Portfolios--How Objectives are Pursued" and "Appendix
A--Portfolio Securities." The values of the securities in which the Portfolios
invest fluctuate based upon interest rates, foreign currency rates, the
financial stability of the issuer and market factors.
The Portfolios are dollar-denominated mutual funds and therefore
consideration is given to hedging part or all of the Portfolios back to U.S.
dollars from international currencies. All decisions to hedge are based upon an
analysis of the relative value of the U.S. dollar on an international purchasing
power parity basis (purchasing power parity is a method for determining the
relative purchasing power of different currencies by comparing the amount of
each currency required to purchase a typical bundle of goods and services to
domestic markets) and an estimation of short-term interest rate differentials
(which affect both the direction of currency movements and also the cost of
hedging).
Pursuant to one of the Trust's fundamental investment restrictions (see
"How Objectives Are Pursued--Investment Limitations" in the Portfolios'
Prospectus), the Trust does not have authority to purchase any securities which
would cause more than 25% of the value of any Portfolio's total assets, at the
time of such purchase, to be invested in the securities of one or more issuers
conducting their principal business activities in the same industry, provided
that, there is no limitation with respect to investments in obligations issued
or guaranteed by the U.S. Government, its agencies or instrumentalities. The
position of the staff of the SEC is that the exclusion with respect to banks may
only be applied to domestic banks. For this purpose, the staff also takes the
position that United States branches of foreign banks and foreign branches of
domestic banks may, if certain conditions are met, be treated as "domestic
banks." The Trust currently intends to consider only obligations of "domestic
banks" to be within the exclusion with respect to banks. For this purpose,
"domestic banks" will be construed by the Trust to include: (a) United States
branches of foreign banks, to the extent they are subject to the same regulation
as United States banks; and (b) foreign branches of domestic banks with respect
to which the domestic bank would be unconditionally liable in the event that the
foreign branch failed to pay on its instruments for any reason.
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ADDITIONAL INFORMATION ON PORTFOLIO INVESTMENTS
ADDITIONAL INVESTMENT LIMITATIONS
The most significant investment restrictions applicable to the
Portfolios' investment programs are set forth in the Prospectus under the
heading "How Objectives Are Pursued--Investment Limitations." Additionally, as a
matter of fundamental policy which may not be changed without a majority vote of
a Portfolio's shareholders (as that term is defined under the heading
"Investment Advisory, Administration, Custody, Transfer Agency and Shareholder
Servicing Agreements" in this SAI) each Portfolio will not:
1. Borrow money or issue senior securities, as defined in the 1940 Act,
except that (a) a Portfolio may borrow money from banks for temporary
purposes in amounts up to one-third of the value of such Portfolio's
total assets at the time of borrowing, provided that borrowings in
excess of 5% of the value of such Portfolio's total assets will be
repaid prior to the purchase of additional portfolio securities by such
Portfolio, (b) a Portfolio may enter into commitments to purchase
securities in accordance with the Portfolio's investment program,
including delayed delivery and when-issued securities, which
commitments may be considered the issuance of senior securities, and
(c) a Portfolio may issue multiple classes of shares in accordance with
SEC regulations or exemptions under the 1940 Act. The purchase or sale
of futures contracts and related options shall not be considered to
involve the borrowing of money or issuance of senior securities.
2. Purchase any securities on margin (except for such short-term credits
as are necessary for the clearance of purchases and sales of portfolio
securities) or sell any securities short (except short sales against
the box.) For purposes of this restriction, the deposit or payment by
the Portfolio of initial or maintenance margin in connection with
futures contracts and related options and options on securities is not
considered to be the purchase of a security on margin.
3. Underwrite securities issued by any other person, except to the extent
that the purchase of securities and the later disposition of such
securities in accordance with the Portfolio's investment program may be
deemed an underwriting. This restriction shall not limit a Portfolio's
ability to invest in securities issued by other registered investment
companies.
4. Invest in real estate or real estate limited partnership interests. (A
Portfolio may, however, purchase and sell securities secured by real
estate, or interests therein, or issued by issuers which invest in real
estate or interests therein.) This restriction does not apply to real
estate limited partnerships listed on a national stock exchange (e.g.,
the New York Stock Exchange).
5. Purchase or sell commodity contracts except that each Portfolio may, to
the extent appropriate under its investment policies, purchase publicly
traded securities of a company engaging in whole or in part in such
activities, enter into futures contracts and related options, engage in
transactions on a when-issued or forward commitment basis, and enter
into forward currency contracts in accordance with its investment
policies.
In addition, certain non-fundamental investment restrictions which may
be changed by a majority vote of the Board of Trustees at any time and without
approval of the shareholders, are also applicable to the Portfolios, including
the following:
1. No Portfolio will purchase securities of a company for the purpose of
exercising control.
2. No Portfolio will invest more than 15% of the value of its net assets
in illiquid securities, including repurchase agreements, time deposits
and Guaranteed Investment Contracts ("GICs") with maturities in excess
of seven days, illiquid restricted securities, and other securities
which are not readily marketable. For purposes of this restriction,
illiquid securities shall not include securities which may be resold
under Rule 144A and Section 4(2) of the Securities Act of 1933 that the
Board of Trustees, or its delegate, determines to be liquid, based upon
the trading markets for the specific security.
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3. No Portfolio will mortgage, pledge or hypothecate any assets except to
secure permitted borrowings and then only in an amount up to one-third
of the value of a Portfolio's total assets at the time of borrowing.
For purposes of this limitation, collateral arrangements with respect
to the writing of options, futures contracts, options on futures
contracts, and collateral arrangements with respect to initial and
variation margin are not considered to be a mortgage, pledge or
hypothecation of assets.
4. No Portfolio will invest in securities of other investment companies,
except as they may be acquired as part of a merger, consolidation or
acquisition of assets and except to the extent otherwise permitted by
the 1940 Act.
For purposes of the foregoing limitations, any limitation that involves
a maximum percentage shall not be considered violated unless an excess over the
percentage occurs immediately after, and is caused by, an acquisition or
encumbrance of securities, or assets of, or borrowings on behalf of, a
Portfolio.
ASSET-BACKED SECURITIES
IN GENERAL. Asset-backed securities arise through the grouping by
governmental, government-related, and private organizations of loans,
receivables or other assets originated by various lenders. Asset-backed
securities consist of both mortgage- and non-mortgage-backed securities.
Interests in pools of these assets may differ from other forms of debt
securities, which normally provide for periodic payment of interest in fixed
amounts with principal paid at maturity or specified call dates. Conversely,
asset-backed securities provide periodic payments which may consist of both
interest and principal payments.
The life of an asset-backed security varies depending upon the rate of
prepayment of the underlying debt instruments. The rate of such prepayments will
be a function of current market interest rates, and other economic and
demographic factors. For example, falling interest rates generally result in an
increase in the rate of prepayments of mortgage loans while rising interest
rates generally decrease the rate of prepayments. An acceleration in prepayments
in response to sharply falling interest rates will shorten the security's
average maturity and limit the potential appreciation in the security's value
relative to a conventional debt security. Consequently, asset-backed securities
may not be as effective in locking in high, long-term yields. Conversely, in
periods of sharply rising rates, prepayments are generally slow, increasing the
security's average life and its potential for price depreciation.
MORTGAGE-BACKED SECURITIES. Mortgage-backed securities represent an
ownership interest in a pool of mortgage loans.
Mortgage pass-through securities may represent participation interests
in pools of residential mortgage loans originated by U.S. governmental or
private lenders and guaranteed, to the extent provided in such securities, by
the U.S. Government or one of its agencies, authorities or instrumentalities.
Such securities, which are ownership interests in the underlying mortgage loans,
differ from conventional debt securities, which provide for periodic payment of
interest in fixed amounts (usually semi-annually) and principal payments at
maturity or on specified call dates. Mortgage pass-through securities provide
for monthly payments that are a "pass-through" of the monthly interest and
principal payments (including any prepayments) made by the individual borrowers
on the pooled mortgage loans, net of any fees paid to the guarantor of such
securities and the servicer of the underlying mortgage loans.
The guaranteed mortgage pass-through securities in which a Portfolio
may invest, may include those issued or guaranteed by Government National
Mortgage Association ("GNMA"), Federal National Mortgage Association ("FNMA")
and Federal Home Loan Mortgage Corporation ("FHLMC"). Such certificates are
mortgage-backed securities which represent a partial ownership interest in a
pool of mortgage loans issued by lenders such as mortgage bankers, commercial
banks and savings and loan associations. Such mortgage loans may have fixed or
adjustable rates of interest.
The average life of a mortgage-backed security is likely to be
substantially less than the original maturity of the mortgage pools underlying
the securities. Prepayments of principal by mortgagors and mortgage foreclosures
will
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usually result in the return of the greater part of principal invested far in
advance of the maturity of the mortgages in the pool.
The yield which will be earned on mortgage-backed securities may vary
from their coupon rates for the following reasons: (i) certificates may be
issued at a premium or discount, rather than at par; (ii) certificates may trade
in the secondary market at a premium or discount after issuance; (iii) interest
is earned and compounded monthly, which has the effect of raising the effective
yield earned on the certificates; and (iv) the actual yield of each certificate
is affected by the prepayment of mortgages included in the mortgage pool
underlying the certificates and the rate at which principal so prepaid is
reinvested. In addition, prepayment of mortgages included in the mortgage pool
underlying a GNMA certificate purchased at a premium may result in a loss to the
Portfolio.
Mortgage-backed securities issued by private issuers, whether or not
such obligations are subject to guarantees by the private issuer, may entail
greater risk than obligations directly or indirectly guaranteed by the U.S.
Government.
Collateralized mortgage obligations or "CMOs" are debt obligations
collateralized by mortgage loans or mortgage pass-through securities (such
collateral, collectively hereinafter referred to as "Mortgage Assets").
Multi-class pass-through securities are interests in a trust composed of
Mortgage Assets and all references herein to CMOs will include multi-class
pass-through securities. Payments of principal of, and interest on, the Mortgage
Assets, and any reinvestment income thereon, provide for the Portfolios to pay
debt service on the CMOs or make scheduled distribution on the multi-class
pass-through securities.
Moreover, principal prepayments on the Mortgage Assets may cause the
CMOs to be retired substantially earlier than their stated maturities or final
distribution dates, resulting in a loss of all or part of the premium if any has
been paid. Interest is paid or accrues on all classes of the CMOs on a monthly,
quarterly or semiannual basis.
The principal and interest payments on the Mortgage Assets may be
allocated among the various classes of CMOs in several ways. Typically, payments
of principal, including any prepayments, on the underlying mortgages are applied
to the classes in the order of their respective stated maturities or final
distribution dates, so that no payment of principal is made on CMOs of a class
until all CMOs of other classes having earlier stated maturities or final
distribution dates have been paid in full.
Stripped mortgage-backed securities ("SMBS") are derivative multi-class
mortgage securities. A Portfolio will only invest in SMBS that are
obligations-backed by the full faith and credit of the U.S. Government. SMBS are
usually structured with two classes that receive different proportions of the
interest and principal distributions from a pool of mortgage assets.
A common type of SMBS will be structured so that one class receives
some of the interest and most of the principal from the mortgage assets, while
the other class receives most of the interest and the remainder of the
principal. If the underlying mortgage assets experience greater than anticipated
prepayments of principal, a Portfolio may fail to fully recoup its initial
investment in these securities. The market value of any class which consists
primarily or entirely of principal payments generally is unusually volatile in
response to changes in interest rates.
The average life of mortgage-backed securities varies with the
maturities of the underlying mortgage instruments. The average life is likely to
be substantially less than the original maturity of the mortgage pools
underlying the securities as the result of mortgage prepayments, mortgage
refinancings or foreclosures. The rate of mortgage prepayments, and hence the
average life of the certificates, will be a function of the level of interest
rates, general economic conditions, the location and age of the mortgage and
other social and demographic conditions. Such prepayments are passed through to
the registered holder with the regular monthly payments of principal and
interest and have the effect of reducing future payments. Estimated average life
will be determined by the Adviser and used for the purpose of determining the
average weighted maturity and duration of the securities.
NON-MORTGAGE ASSET-BACKED SECURITIES. Non-mortgage asset-backed
securities include interests in pools of receivables, such as motor vehicle
installment purchase obligations and credit card receivables. Such securities
are
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generally issued as pass-through certificates, which represent undivided
fractional ownership interests in the underlying pools of assets. Such
securities also may be debt instruments, which are also known as collateralized
obligations and are generally issued as the debt of a special purpose entity
organized solely for the purpose of owning such assets and issuing such debt.
Such securities also may include instruments issued by certain trusts,
partnerships or other special purpose issuers, including pass-through
certificates representing participations in, or debt instruments backed by, the
securities and other assets owned by such issuers.
Non-mortgage-backed securities are not issued or guaranteed by the U.S.
Government, its agencies or instrumentalities; however, the payment of principal
and interest on such obligations may be guaranteed up to certain amounts and for
a certain time period by a letter of credit issued by a financial institution
(such as a bank or insurance company) unaffiliated with the issuers of such
securities.
The purchase of non-mortgage-backed securities raises considerations
peculiar to the financing of the instruments underlying such securities. For
example, most organizations that issue asset-backed securities relating to motor
vehicle installment purchase obligations perfect their interests in their
respective obligations only by filing a financing statement and by having the
servicer of the obligations, which is usually the originator, take custody
thereof. In such circumstances, if the servicer were to sell the same
obligations to another party, in violation of its duty not to do so, there is a
risk that such party could acquire an interest in the obligations superior to
that of the holders of the asset-backed securities. Also, although most such
obligations grant a security interest in the motor vehicle being financed, in
most states the security interest in a motor vehicle must be noted on the
certificate of title to perfect such security interest against competing claims
of other parties. Due to the larger number of vehicles involved, however, the
certificate of title to each vehicle financed, pursuant to the obligations
underlying the asset-backed securities, usually is not amended to reflect the
assignment of the seller's security interest for the benefit of the holders of
the asset-backed securities. Therefore, there is the possibility that recoveries
on repossessed collateral may not, in some cases, be available to support
payments on those securities. In addition, various state and Federal laws give
the motor vehicle owner the right to assert against the holder of the owner's
obligation certain defenses such owner would have against the seller of the
motor vehicle. The assertion of such defenses could reduce payments on the
related asset-backed securities. Insofar as credit card receivables are
concerned, credit card holders are entitled to the protection of a number of
state and Federal consumer credit laws, many of which give such holders the
right to set off certain amounts against balances owed on the credit card,
thereby reducing the amounts paid on such receivables. In addition, unlike most
other asset-backed securities, credit card receivables are unsecured obligations
of the card holder.
The development of non-mortgage-backed securities is at an early stage
compared to mortgage-backed securities. While the market for asset-backed
securities is becoming increasingly liquid, the market for mortgage-backed
securities issued by certain private organizations and non-mortgage-backed
securities is not as well developed as the market for U.S. Government issued
mortgaged-backed securities. As stated above, the Adviser, as adviser to each
Portfolio, intends to limit its purchases of mortgage-backed securities issued
by certain private organizations and non-mortgage-backed securities to
securities that are readily marketable at the time of purchase.
COMMERCIAL INSTRUMENTS
Commercial instruments consist of short-term U.S. dollar-denominated
obligations issued by domestic corporations or issued in the U.S. by foreign
corporations and foreign commercial banks. Investments by a Portfolio in
commercial paper will consist of issues rated in a manner consistent with such
Portfolio's investment policies and objectives. In addition, the Portfolios may
acquire unrated commercial paper and corporate bonds that are determined by the
Adviser at the time of purchase to be of comparable quality to rated instruments
that may be acquired by such Portfolios.
Variable-rate master demand notes are unsecured instruments that permit
the indebtedness thereunder to vary and provide for periodic adjustments in the
interest rate. Variable-rate instruments acquired by a Portfolio will be rated
at a level consistent with such Portfolio's investment objective and policies of
high quality as determined by a major rating agency or, if not rated, will be of
comparable quality as determined by the Adviser.
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Variable- and floating-rate instruments are unsecured instruments that
permit the indebtedness thereunder to vary. While there may be no active
secondary market with respect to a particular variable- or floating-rate
instrument purchased by a Portfolio, such Portfolio may, from time to time as
specified in the instrument, demand payment of the principal or may resell the
instrument to a third party. The absence of an active secondary market, however,
could make it difficult for a Portfolio to dispose of an instrument if the
issuer defaulted on its payment obligation or during periods when a Portfolio is
not entitled to exercise its demand rights, and a Portfolio could, for these or
other reasons, suffer a loss. A Portfolio may invest in variable- and
floating-rate instruments only when the Adviser deems the investment to involve
minimal credit risk. If such instruments are not rated, the Adviser will
consider the earning power, cash flows, and other liquidity ratios of the
issuers of such instruments and will continuously monitor their financial status
to meet payment on demand. In determining average weighted portfolio maturity,
an instrument will be deemed to have a maturity equal to the longer of, the
period remaining to the next interest rate adjustment or, the demand notice
period specified in the instrument.
DELAYED DELIVERY TRANSACTIONS
In a delayed delivery transaction, the Portfolio relies on the other
party to complete the transaction. If the transaction is not completed, the
Portfolio may miss a price or yield considered to be advantageous.
DOLLAR ROLL TRANSACTIONS
Certain Portfolios may enter into "dollar roll" transactions, which
consist of the sale, by a Portfolio, to a bank or broker/dealer (the
"counterparty") of GNMA certificates or other mortgage-backed securities
together with a commitment to purchase from the counterparty similar, but not
identical, securities at a future date, at the same price. The counterparty
receives all principal and interest payments, including prepayments, made on the
security while it is the holder. A Portfolio receives a fee from the
counterparty as consideration for entering into the commitment to purchase.
Dollar rolls may be renewed over a period of several months with a different
repurchase price and a cash settlement made at each renewal without physical
delivery of securities. Moreover, the transaction may be preceded by a firm
commitment agreement pursuant to which the Portfolio agrees to buy a security on
a future date.
The entry into dollar rolls involves potential risks of loss that are
different from those related to the securities underlying the transactions. For
example, if the counterparty becomes insolvent, the Portfolio's right to
purchase from the counterparty might be restricted. Additionally, the value of
such securities may change adversely before the Portfolio is able to purchase
them. Similarly, the Portfolio may be required to purchase securities in
connection with a dollar roll at a higher price than may otherwise be available
on the open market. Since, as noted above, the counterparty is required to
deliver a similar, but not identical security to the Portfolio, the security
that the Portfolio is required to buy under the dollar roll may be worth less
than an identical security. Finally, there can be no assurance that the
Portfolio's use of the cash that it receives from a dollar roll will provide a
return that exceeds borrowing costs.
EQUITY SWAP CONTRACTS
The counterparty to an Equity Swap Contract will typically be a bank,
investment banking firm or broker/dealer. For example, the counterparty will
generally agree to pay a Portfolio the amount, if any, by which the notional
amount of the Equity Swap Contract would have increased in value had it been
invested in the stocks comprising the S&P 500 Index in proportion to the
composition of the Index, plus the dividends that would have been received on
those stocks. A Portfolio will agree to pay to the counterparty a floating rate
of interest (typically the London InterBank Offered Rate) on the notional amount
of the Equity Swap Contract plus the amount, if any, by which that notional
amount would have decreased in value had it been invested in such stocks.
Therefore, the return to a Portfolio on any Equity Swap Contract should be the
gain or loss on the notional amount plus dividends on the stocks comprising the
S&P 500 Index, less the interest paid by the Portfolio on the notional amount. A
Portfolio will only enter into Equity Swap Contracts on a net basis, (i.e., the
two parties' obligations are netted out, with the Portfolio paying or receiving,
as the case may be, only the net amount of any payments). Payments under the
Equity Swap Contracts may be made at the conclusion of the contract or
periodically during its term.
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If there is a default by the counterparty to an Equity Swap Contract, a
Portfolio will be limited to contractual remedies pursuant to the agreements
related to the transaction. There is no assurance that Equity Swap Contract
counterparties will be able to meet their obligations pursuant to Equity Swap
Contracts or that, in the event of default, a Portfolio will succeed in pursuing
contractual remedies. A Portfolio thus assumes the risk that it may be delayed
in, or prevented from, obtaining payments owed to it pursuant to Equity Swap
Contracts. The Adviser will closely monitor the credit of Equity Swap Contract
counterparties in order to minimize this risk.
Certain Portfolios may from time to time enter into the opposite side
of Equity Swap Contracts (i.e., where a Portfolio is obligated to pay the
increase (net of interest) or receive the decrease (plus interest) on the
contract) to reduce the amount of the Portfolio's equity market exposure
consistent with the Portfolio's objectives. These positions are sometimes
referred to as Reverse Equity Swap Contracts.
Equity Swap Contracts will not be used to leverage a Portfolio. A
Portfolio will not enter into any Equity Swap Contract or Reverse Equity Swap
Contract unless, at the time of entering into such transaction, the unsecured
senior debt of the counterparty is rated at least "A" by Moody's Investor
Services, Inc. ("Moody's") or Standard & Poor's Corporation ("S&P"). Since the
SEC considers Equity Swap Contracts and Reverse Equity Swap Contracts to be
illiquid securities, a Portfolio will not invest in Equity Swap Contracts or
Reverse Equity Swap Contracts if the total value of such investments together
with that of all other illiquid securities which a Portfolio owns would exceed
15% of the Portfolio's total assets.
The Adviser does not believe that a Portfolio's obligations under
Equity Swap Contracts or Reverse Equity Swap Contracts are senior securities
and, accordingly, the Portfolio will not treat them as being subject to its
borrowing restrictions. However, the net amount of the excess, if any, of a
Portfolio's obligations over its respective entitlements with respect to each
Equity Swap Contract and each Reverse Equity Swap Contract will be accrued on a
daily basis and an amount of cash, U.S. Government securities or other liquid
high quality debt securities, having an aggregate market value at least equal to
the accrued excess, will be maintained in a segregated account by the
Portfolio's Custodian.
FOREIGN CURRENCY TRANSACTIONS
As described in the Prospectus, certain Portfolios may invest in
foreign currency transactions. Foreign securities involve currency risks. The
U.S. dollar value of a foreign security tends to decrease when the value of the
U.S. dollar rises against the foreign currency in which the security is
denominated, and tends to increase when the value of the U.S. dollar falls
against such currency. A Portfolio may purchase or sell forward foreign currency
exchange contracts ("forward contracts") to attempt to minimize the risk to the
Portfolio from adverse changes in the relationship between the U.S. dollar and
foreign currencies. A Portfolio may also purchase and sell foreign currency
futures contracts and related options (see "Purchase and Sale of Currency
Futures Contracts and Related Options" in this SAI). A forward contract is an
obligation to purchase or sell a specific currency for an agreed price at a
future date that is individually negotiated and privately traded by currency
traders and their customers.
Forward foreign currency exchange contracts establish an exchange rate
at a future date. These contracts are transferable in the interbank market
traded directly between currency traders (usually large commercial banks) and
their customers. A forward foreign currency exchange contract generally has no
deposit requirement, and is traded at a net price without commission. A
Portfolio will direct the Custodian to segregate high grade liquid assets in an
amount at least equal to its obligations under each forward foreign currency
exchange contract. Neither spot transactions nor forward foreign currency
exchange contracts eliminate fluctuations in the prices of a Portfolio's
portfolio securities or in foreign exchange rates, or prevent loss if the prices
of these securities should decline.
A Portfolio may enter into a forward contract, for example, when it
enters into a contract for the purchase or sale of a security denominated in a
foreign currency in order to "lock in" the U.S. dollar price of the security (a
"transaction hedge"). In addition, when the Adviser believes that a foreign
currency may suffer a substantial decline against the U.S. dollar, it may enter
into a forward sale contract to sell an amount of that foreign currency
approximating the value of some or all of the Portfolio's securities denominated
in such foreign currency, or when
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the Adviser believes that the U.S. dollar may suffer a substantial decline
against the foreign currency, it may enter into a forward purchase contract to
buy that foreign currency for a fixed dollar amount (a "position hedge").
A Portfolio may enter into a forward contract to sell a different
foreign currency for a fixed U.S. dollar amount where the Adviser believes that
the U.S. dollar value of the currency to be sold pursuant to the forward
contract will fall whenever there is a decline in the U.S. dollar value of the
currency in which the Portfolio securities are denominated (a "cross-hedge").
Foreign currency hedging transactions are an attempt to protect a
Portfolio against changes in foreign currency exchange rates between the trade
and settlement dates of specific securities transactions or changes in foreign
currency exchange rates that would adversely affect a portfolio position or an
anticipated portfolio position. Although these transactions tend to minimize the
risk of loss due to a decline in the value of the hedged currency, at the same
time they tend to limit any potential gain that might be realized should the
value of the hedged currency increase. The precise matching of the forward
contract amount and the value of the securities involved will not generally be
possible because the future value of these securities in foreign currencies will
change as a consequence of market movements in the value of those securities
between the date the forward contract is entered into and date it matures.
The Portfolio's Custodian will segregate cash, U.S. Government
securities or other high-quality debt securities having a value equal to the
aggregate amount of the Portfolio's commitments under forward contracts entered
into with respect to position hedges and cross-hedges. If the value of the
segregated securities declines, additional cash or securities will be segregated
on a daily basis so that the value of the segregated securities will equal the
amount of the Portfolio's commitments with respect to such contracts. As an
alternative to segregating all or part of such securities, the Portfolio may
purchase a call option permitting the Portfolio to purchase the amount of
foreign currency being hedged by a forward sale contract, at a price no higher
than the forward contract price, or the Portfolio may purchase a put option
permitting the Portfolio to sell the amount of foreign currency subject to a
forward purchase contract at a price as high or higher than the forward contract
price.
FUTURES, OPTIONS AND OTHER DERIVATIVE INSTRUMENTS
FUTURES CONTRACTS IN GENERAL. A futures contract is an agreement
between two parties for the future delivery of fixed income securities or equity
securities, for the payment or acceptance of a cash settlement in the case of
futures contracts on an index of fixed income or equity securities. A "sale" of
a futures contract means the contractual obligation to deliver the securities at
a specified price on a specified date, or to make the cash settlement called for
by the contract. Futures contracts have been designed by exchanges which have
been designated "contract markets" by the Commodity Futures Trading Commission
("CFTC") and must be executed through a brokerage firm, known as a futures
commission merchant, which is a member of the relevant contract market. Futures
contracts trade on these markets, and the exchanges, through their clearing
organizations, guarantee that the contracts will be performed as between the
clearing members of the exchange. Presently, futures contracts are based on such
debt securities as long-term U.S. Treasury Bonds, Treasury Notes, GNMA modified
pass-through mortgage-backed securities, three-month U.S. Treasury Bills, bank
certificates of deposit, and on indices of municipal, corporate and government
bonds.
While futures contracts based on securities do provide for the delivery
and acceptance of securities, such deliveries and acceptances are seldom made.
Generally, a futures contract is terminated by entering into an offsetting
transaction. A Portfolio will incur brokerage fees when it purchases and sells
futures contracts. At the time such a purchase or sale is made, a Portfolio must
provide cash or money market securities as a deposit known as "margin." The
initial deposit required will vary, but may be as low as 2%, or less, of a
contract's face value. Daily thereafter, the futures contract is valued through
a process known as "marking to market," and a Portfolio that engages in futures
transactions may receive or be required to pay "variation margin" as the futures
contract becomes more or less valuable. At the time of delivery of securities
pursuant to a futures contract based on securities, adjustments are made to
recognize differences in value arising from the delivery of securities with a
different interest rate than the specific security that provides the standard
for the contract. In some (but not many) cases, securities called for by a
futures contract may not have been issued when the contract was written.
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Futures contracts on indices of securities are settled through the
making and acceptance of cash settlements based on changes in value of the
underlying rate or index between the time the contract is entered into and the
time it is liquidated.
FUTURES CONTRACTS ON FIXED INCOME SECURITIES AND RELATED INDICES. As
noted in the Prospectus, certain Portfolios may enter into transactions in
futures contracts for the purpose of hedging a relevant portion of their
portfolios. A Portfolio may enter into transactions in futures contracts that
are based on U.S. Government obligations, including any index of government
obligations that may be available for trading. Such transactions will be entered
into where movements in the value of the securities or index underlying a
futures contract can be expected to correlate closely with movements in the
value of securities held in a Portfolio. For example, a Portfolio may sell
futures contracts in anticipation of a general rise in the level of interest
rates, which would result in a decline in the value of its fixed income
securities. If the expected rise in interest rates occurs, the Portfolio may
realize gains on its futures position, which should offset all or part of the
decline in value of fixed income securities. A Portfolio could protect against
such decline by selling fixed income securities, but such a strategy would
involve higher transaction costs than the sale of futures contracts and, if
interest rates again declined, the Portfolio would be unable to take advantage
of the resulting market advance without purchases of additional securities.
The purpose of the purchase or sale of a futures contract on government
securities and indices of government securities, in the case of the respective
Portfolios, which hold or intend to acquire long-term debt securities, is to
protect a Portfolio from fluctuations in interest rates without actually buying
or selling long-term debt securities. For example, if long-term bonds are held
by a Portfolio, and interest rates were expected to increase, the Portfolio
might enter into futures contracts for the sale of debt securities. Such a sale
would have much the same effect as selling an equivalent value of the long-term
bonds held by the Portfolio. If interest rates did increase, the value of the
debt securities in the Portfolio would decline, but the value of the futures
contracts to the Portfolio would increase at approximately the same rate thereby
keeping the net asset value of the Portfolio from declining as much as it
otherwise would have. When a Portfolio is not fully invested and a decline in
interest rates is anticipated, which would increase the cost of fixed income
securities that the Portfolio intends to acquire, it may purchase futures
contracts. In the event that the projected decline in interest rates occurs, the
increased cost of the securities acquired by the Portfolio should be offset, in
whole or part, by gains on the futures contracts by entering into offsetting
transactions on the contract market on which the initial purchase was effected.
In a substantial majority of transactions involving futures contracts on fixed
income securities, a Portfolio will purchase the securities upon termination of
the long futures positions, but under unusual market conditions, a long futures
position may be terminated without a corresponding purchase of securities.
Similarly, when it is expected that interest rates may decline, futures
contracts on fixed income securities and indices of government securities may be
purchased for the purpose of hedging against anticipated purchases of long-term
bonds at higher prices. Since the fluctuations in the value of such futures
contracts should be similar to that of long-term bonds, a Portfolio could take
advantage of the anticipated rise in the value of long-term bonds without
actually buying them until the market had stabilized. At that time, the futures
contracts could be liquidated and the Portfolio's cash reserves could then be
used to buy long-term bonds in the cash market. Similar results could be
accomplished by selling bonds with long maturities and investing in bonds with
short maturities when interest rates are expected to increase. However, since
the futures market is more liquid than the cash market, the use of these futures
contracts as an investment technique allows a Portfolio to act in anticipation
of such an interest rate decline without having to sell its portfolio
securities. To the extent a Portfolio enters into futures contracts for this
purpose, the segregated assets maintained by a Portfolio will consist of cash,
cash equivalents or high quality debt securities of the Portfolio in an amount
equal to the difference between the fluctuating market value of such futures
contract and the aggregate value of the initial deposit and variation margin
payments made by the Portfolio with respect to such futures contracts.
STOCK INDEX FUTURES CONTRACTS. As described in the Prospectus, certain
Portfolios may sell stock index futures contracts in order to offset a decrease
in market value of its securities, that might otherwise result from a market
decline. A Portfolio may do so either to hedge the value of its portfolio as a
whole, or to protect against declines, occurring prior to sales of securities,
in the value of securities to be sold. Conversely, a Portfolio may purchase
stock index futures contracts in order to protect against anticipated increases
in the cost of securities to be acquired.
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In addition, a Portfolio may utilize stock index futures contracts in
anticipation of changes in the composition of its portfolio. For example, in the
event that a Portfolio expects to narrow the range of industry groups
represented in its portfolio, it may, prior to making purchases of the actual
securities, establish a long futures position based on a more restricted index,
such as an index comprised of securities of a particular industry group. As such
securities are acquired, the Portfolio's futures positions would be closed out.
A Portfolio may also sell futures contracts in connection with this strategy, in
order to protect against the possibility that the value of the securities to be
sold as part of the restructuring of its portfolio will decline prior to the
time of sale.
OPTIONS ON FUTURES CONTRACTS. An option on a futures contract gives the
purchaser (the "holder") the right, but not the obligation, to purchase a
position in the underlying futures contract (i.e., a purchase of such futures
contract) in the case of an option to purchase (a "call" option), or a "short"
position in the underlying futures contract (i.e., a sale of such futures
contract) in the case of an option to sell (a "put" option), at a fixed price
(the "strike price"), up to a stated expiration date. The holder pays a
non-refundable purchase price for the option, known as the "premium." The
maximum amount of risk the purchaser of the option assumes is equal to the
premium plus related transaction costs, although this entire amount may be lost.
Upon exercise of the option by the holder, the exchange clearing corporation
establishes a corresponding long position in the case of a put option. In the
event that an option is exercised, the parties will be subject to all the risks
associated with the trading of futures contracts, such as payment of variation
margin deposits. In addition, the writer of an option on a futures contract,
unlike the holder, is subject to initial and variation margin requirements on
the option position.
OPTIONS ON FUTURES CONTRACTS ON FIXED INCOME SECURITIES AND RELATED
INDICES. As described in the Prospectus, certain Portfolios may purchase put
options on futures contracts, in which such Portfolios are permitted to invest,
for the purpose of hedging a relevant portion of their portfolios against an
anticipated decline in the values of portfolio securities resulting from
increases in interest rates, and may purchase call options on such futures
contracts as a hedge against an interest rate decline when they are not fully
invested. A Portfolio would write options on these futures contracts primarily
for the purpose of terminating existing positions.
OPTIONS ON STOCK INDEX FUTURES CONTRACTS, OPTIONS ON STOCK INDICES AND
OPTIONS ON EQUITY SECURITIES. As described in the Prospectus, certain Portfolios
may purchase put options on stock index futures contracts, stock indices or
equity securities for the purpose of hedging the relevant portion of their
portfolio securities against an anticipated market-wide decline or against
declines in the values of individual portfolio securities, and they may purchase
call options on such futures contracts as a hedge against a market advance when
they are not fully invested. A Portfolio would write options on such futures
contracts primarily for the purpose of terminating existing positions. In
general, options on stock indices will be employed in lieu of options on stock
index futures contracts only where they present an opportunity to hedge at lower
cost. With respect to options on equity securities, a Portfolio may, under
certain circumstances, purchase a combination of call options on such securities
and U.S. Treasury Bills. The Adviser believes that such a combination may more
closely parallel movements in the value of the security underlying the call
option than would the option itself.
Further, while a Portfolio generally would not write options on
individual portfolio securities, it may do so under limited circumstances known
as "targeted sales" and "targeted buys," which involve the writing of call or
put options in an attempt to purchase or sell portfolio securities at specific
desired prices. A Portfolio would receive a fee, or a "premium," for the writing
of the option. For example, where the Portfolio seeks to sell portfolio
securities at a "targeted" price, it may write a call option at that price. In
the event that the market rises above the exercise price, it would receive its
"targeted" price, upon the exercise of the option, as well as the premium
income. Also, where it seeks to buy portfolio securities at a "targeted" price,
it may write a put option at that price for which it will receive the premium
income. In the event that the market declines below the exercise price, a
Portfolio would pay its "targeted" price upon the exercise of the option. In the
event that the market does not move in the direction or to the extent
anticipated, however, the targeted sale or buy might not be successful and a
Portfolio could sustain a loss on the transaction that may not be offset by the
premium received. In addition, a Portfolio may be required to forego the benefit
of an intervening increase or decline in value of the underlying security.
OPTIONS AND FUTURES STRATEGIES. The Adviser may seek to increase the
current return of a Portfolio by writing covered call or put options. In
addition, through the writing and purchase of options and the purchase and sale
of U.S. and certain foreign stock index futures contracts, interest rate futures
contracts, foreign currency futures
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contracts and related options on such futures contracts, the Adviser may at
times seek to hedge against a decline in the value of securities included in a
Portfolio or an increase in the price of securities that it plans to purchase
for a Portfolio. Expenses and losses incurred as a result of such hedging
strategies will reduce a Portfolio's current return. A Portfolio's investment in
foreign stock index futures contracts and foreign interest rate futures
contracts, and related options on such futures contracts, are limited to only
those contracts and related options that have been approved by the CFTC for
investment by U.S. investors. Additionally, with respect to a Portfolio's
investment in foreign options, unless such options are specifically authorized
for investment by order of the CFTC, or meet the definition of trade options as
set forth in CFTC rule 32.4, a Portfolio will not make these investments.
The ability of a Portfolio to engage in the options and futures
strategies described herein will depend on the availability of liquid markets in
such instruments. Markets in options and futures with respect to stock indices,
foreign government securities and foreign currencies are relatively new and
still developing. It is impossible to predict the amount of trading interest
that may exist in various types of options or futures. Therefore, no assurance
can be given that a Portfolio will be able to utilize these instruments
effectively for the purposes stated below. Furthermore, a Portfolio's ability to
engage in options and futures transactions may be limited by tax considerations.
Although a Portfolio will only engage in options and futures transactions for
limited purposes, these activities will involve certain risks which are
described below under "Risk Factors Associated with Futures and Options
Transactions." A Portfolio will not engage in options and futures transactions
for leveraging purposes.
WRITING COVERED OPTIONS ON SECURITIES. A Portfolio may write covered
call options and covered put options on securities in which it is permitted to
invest from time to time as the Adviser determines is appropriate in seeking to
attain its objectives. Call options written by a Portfolio give the holder the
right to buy the underlying securities from the Portfolio at a stated exercise
price; put options give the holder the right to sell the underlying security to
the Portfolio at a stated price.
A Portfolio may write only covered options, which means that, so long
as the Portfolio is obligated as the writer of a call option, it will own the
underlying securities subject to the option (or comparable securities satisfying
the cover requirements of securities exchanges). In the case of put options, a
Portfolio will maintain in a separate account cash or short-term U.S. Government
securities with a value equal to or greater than the exercise price of the
underlying securities. A Portfolio may also write combinations of covered puts
and calls on the same underlying security.
A Portfolio will receive a premium from writing a put or call option,
which increases the Portfolio's return in the event the option expires
unexercised or is closed out at a profit. The amount of the premium will
reflect, among other things, the relationship of the market price of the
underlying security to the exercise price of the option, the term of the option
and the volatility of the market price of the underlying security. By writing a
call option, a Portfolio limits its opportunity to profit from any increase in
the market value of the underlying security above the exercise price of the
option. By writing a put option, a Portfolio assumes the risk that it may be
required to purchase the underlying security for an exercise price higher than
its then current market value, resulting in a potential capital loss if the
purchase price exceeds the market value plus the amount of the premium received,
unless the security subsequently appreciates in value.
A Portfolio may terminate an option that it has written prior to its
expiration by entering into a closing purchase transaction in which it purchases
an option having the same terms as the option written. A Portfolio will realize
a profit or loss from such transaction if the cost of such transaction is less
or more than the premium received from the writing of the option. In the case of
a put option, any loss so incurred may be partially or entirely offset by the
premium received from a simultaneous or subsequent sale of a different put
option. Because increases in the market price of a call option will generally
reflect increases in the market price of the underlying security, any loss
resulting from the repurchase of a call option is likely to be offset in whole
or in part by unrealized appreciation of the underlying security owned by a
Portfolio.
PURCHASING PUT AND CALL OPTIONS ON SECURITIES. A Portfolio may purchase
put options to protect its portfolio holdings in an underlying security against
a decline in market value. Such hedge protection is provided during the life of
the put option since a Portfolio, as holder of the put option, is able to sell
the underlying security at the put exercise
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price regardless of any decline in the underlying security's market price. In
order for a put option to be profitable, the market price of the underlying
security must decline sufficiently below the exercise price to cover the premium
and transaction costs. By using put options in this manner, a Portfolio will
reduce any profit it might otherwise have realized in its underlying security by
the premium paid for the put option and by transaction costs.
A Portfolio may also purchase call options to hedge against an increase
in prices of securities that it ultimately wants to buy. Such hedge protection
is provided during the life of the call option since the Portfolio, as holder of
the call option, is able to buy the underlying security at the exercise price
regardless of any increase in the underlying security's market price. In order
for a call option to be profitable, the market price of the underlying security
must rise sufficiently above the exercise price to cover the premium and
transaction costs. By using call options in this manner, a Portfolio will reduce
any profit it might have realized had it bought the underlying security at the
time it purchased the call option by the premium paid for the call option and by
transaction costs.
PURCHASE AND SALE OF OPTIONS AND FUTURES ON STOCK INDICES. A Portfolio
may purchase and sell options on non-U.S. stock indices and stock index futures
as a hedge against movements in the equity markets.
Options on stock indices are similar to options on specific securities
except that, rather than the right to take or make delivery of the specific
security at a specific price, an option on a stock index gives the holder the
right to receive, upon exercise of the option, an amount of cash if the closing
level of that stock index is greater than, in the case of a call, or less than,
in the case of a put, the exercise price of the option. This amount of cash is
equal to such difference between the closing price of the index and the exercise
price of the option, expressed in dollars multiplied by a specified multiple.
The writer of the option is obligated, in return for the premium received, to
make delivery of this amount. Unlike options on specific securities, all
settlements of options on stock indices are in cash and gain or loss depends on
general movements in the stocks included in the index rather than price
movements in particular stocks. A stock index futures contract is an agreement
in which one party agrees to deliver to the other an amount of cash equal to a
specific amount multiplied by the difference between the value of a specific
stock index at the close of the last trading day of the contract and the price
at which the agreement is made. No physical delivery of securities is made.
If the Adviser expects general stock market prices to rise, a Portfolio
might purchase a call option on a stock index or a futures contract on that
index as a hedge against an increase in prices of particular equity securities
it ultimately wants to buy. If in fact the stock index does rise, the price of
the particular equity securities intended to be purchased may also increase, but
that increase would be offset in part by the increase in the value of the
Portfolio's index option or futures contract resulting from the increase in the
index. If, on the other hand, the Adviser expects general stock market prices to
decline, a Portfolio might purchase a put option or sell a futures contract on
the index. If that index does in fact decline, the value of some or all of the
equity securities held by the Portfolio may also be expected to decline, but
that decrease would be offset in part by the increase in the value of the
Portfolio's position in such put option or futures contract.
PURCHASE AND SALE OF INTEREST RATE FUTURES. A Portfolio may purchase
and sell interest rate futures contracts on foreign government securities
including, but not limited to, debt securities of the governments and central
banks of France, Germany, Denmark and Japan for the purpose of hedging fixed
income and interest sensitive securities against the adverse effects of
anticipated movements in interest rates.
A Portfolio may sell interest rate futures contracts in anticipation of
an increase in the general level of interest rates. Generally, as interest rates
rise, the market value of the fixed income securities held by a Portfolio will
fall, thus reducing the net asset value of the Portfolio. This interest rate
risk can be reduced, without employing futures as a hedge, by selling long-term
fixed income securities and either reinvesting the proceeds in securities with
shorter maturities or by holding assets in cash. This strategy, however, entails
increased transaction costs to a Portfolio in the form of dealer spreads and
brokerage commissions.
The sale of interest rate futures contracts provides an alternative
means of hedging against rising interest rates. As rates increase, the value of
a Portfolio's short position in the futures contracts will also tend to
increase, thus offsetting all or a portion of the depreciation in the market
value of the Portfolio's investments that are being hedged.
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While a Portfolio will incur commission expenses in selling and closing out
futures positions (which is done by taking an opposite position which operates
to terminate the position in the futures contract), commissions on futures
transactions are lower than transaction costs incurred in the purchase and sale
of portfolio securities.
OPTIONS ON STOCK INDEX FUTURES CONTRACTS AND INTEREST RATE FUTURES
CONTRACTS. A Portfolio may purchase and write call and put options on non-U.S.
stock index and interest rate futures contracts. A Portfolio may use such
options on futures contracts in connection with its hedging strategies in lieu
of purchasing and writing options directly on the underlying securities or stock
indices or purchasing and selling the underlying futures. For example, a
Portfolio may purchase put options or write call options on stock index futures,
or interest rate futures, rather than selling futures contracts, in anticipation
of a decline in general stock market prices or rise in interest rates,
respectively, or purchase call options or write put options on stock index or
interest rate futures, rather than purchasing such futures, to hedge against
possible increases in the price of equity securities or debt securities,
respectively, which the Portfolio intends to purchase.
PURCHASE AND SALE OF CURRENCY FUTURES CONTRACTS AND RELATED OPTIONS. In
order to hedge its portfolio and to protect against possible variations in
foreign exchange rates pending the settlement of securities transactions, a
Portfolio may buy or sell currency futures contracts and related options. If a
fall in exchange rates for a particular currency is anticipated, a Portfolio may
sell a currency futures contract or a call option thereon, or purchase a put
option on such futures contract as a hedge. If it is anticipated that exchange
rates will rise, a Portfolio may purchase a currency futures contract or a call
option thereon or sell (write) a put option to protect against an increase in
the price of securities denominated in a particular currency a Portfolio intends
to purchase. These futures contracts and related options thereon will be used
only as a hedge against anticipated currency rate changes, and all options on
currency futures written by a Portfolio will be covered.
A currency futures contract sale creates an obligation by a Portfolio,
as seller, to deliver the amount of currency called for in the contract at a
specified future time for a specific price. A currency futures contract purchase
creates an obligation by a Portfolio, as purchaser, to take delivery of an
amount of currency at a specified future time, at a specified price. Although
the terms of currency futures contracts specify actual delivery or receipt, in
most instances the contracts are closed out before the settlement date without
the making or taking of delivery of the currency. Closing out of a currency
futures contract is effected by entering into an offsetting purchase or sale
transaction. Unlike a currency futures contract, which requires the parties to
buy and sell currency on a set date, an option on a currency futures contract
entitles its holder to decide on or before a future date whether to enter into
such a contract. If the holder decides not to enter into the contract, the
premium paid for the option is fixed at the point of sale.
The Portfolio will write only covered put and call options on currency
futures. This means that a Portfolio will provide for its obligations upon
exercise of the option by segregating sufficient cash or short-term obligations
or by holding an offsetting position in the option or underlying currency
future, or a combination of the foregoing. A Portfolio will, so long as it is
obligated as the writer of a call option on currency futures, own on a
contract-for-contract basis an equal long position in currency futures with the
same delivery date or a call option on stock index futures with the difference,
if any, between the market value of the call written and the market value of the
call or long currency futures purchased, maintained by the Portfolio in cash,
U.S. Treasury Bills, or other high grade short-term obligations in a segregated
account with its Custodian. If at the close of business on any day the market
value of the call purchased by a Portfolio falls below 100% of the market value
of the call written by the Portfolio, the Portfolio will so segregate an amount
of cash, U.S. Treasury Bills or other high grade short-term obligations equal in
value to the difference. Alternatively, a Portfolio may cover the call option
through segregating with the Custodian an amount of the particular foreign
currency equal to the amount of foreign currency per futures contract option
times the number of options written by the Portfolio. In the case of put options
on currency futures written by a Portfolio, the Portfolio will hold the
aggregate exercise price in cash, U.S. Treasury Bills, or other high grade
short-term obligations in a segregated account with its Custodian, or own put
options on currency futures or short currency futures, with the difference, if
any, between the market value of the put written and the market value of the
puts purchased or the currency futures sold, maintained by the Portfolio in
cash, U.S. Treasury Bills or other high grade short-term obligations in a
segregated account with its Custodian. If at the close of business on any day
the market value of the put options purchased or the currency futures by a
Portfolio falls below 100% of the market value of the put options
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written by the Portfolio, the Portfolio will so segregate an amount of cash,
U.S. Treasury Bills or other high grade short-term obligations equal in value to
the difference.
If other methods of providing appropriate cover are developed, a
Portfolio reserves the right to employ them to the extent consistent with
applicable regulatory and exchange requirements. In connection with transactions
in stock index options, stock index futures, interest rate futures, foreign
currency futures and related options on such futures, a Portfolio will be
required to deposit as "initial margin" an amount of cash or short-term
government securities equal to from 5% to 8% of the contract amount. Thereafter,
subsequent payments (referred to as "variation margin") are made to and from the
broker to reflect changes in the value of the futures contract.
LIMITATIONS ON PURCHASE OF OPTIONS. The staff of the SEC has taken the
position that purchased over-the-counter options and assets used to cover
written over-the-counter options are illiquid and, therefore, together with
other illiquid securities, cannot exceed 15% of a Portfolio's assets. The
Adviser intends to limit a Portfolio's writing of over-the-counter options in
accordance with the following procedure. Each Portfolio intends to write
over-the-counter options only with primary U.S. Government securities dealers
recognized by the Federal Reserve Bank of New York. Also, the contracts which a
Portfolio has in place with such primary dealers will provide that the Portfolio
has the absolute right to repurchase an option it writes at any time, at a price
which represents the fair market value, as determined in good faith through
negotiation between the parties, but which in no event will exceed a price
determined pursuant to a formula in the contract. Although the specific formula
may vary between contracts with different primary dealers, the formula will
generally be based on a multiple of the premium received by a Portfolio for
writing the option, plus the amount, if any, of the option's intrinsic value
(i.e., the amount that the option is in-the-money). The formula also may include
a factor to account for the difference between the price of the security and the
strike price of the option if the option is written out-of-the-money. A
Portfolio will treat all or a part of the formula price as illiquid for purposes
of the 15% test imposed by the SEC staff.
GUARANTEED INVESTMENT CONTRACTS
Guaranteed Investment Contracts, investment contracts or funding
agreements (each referred to as a "GIC") are investment instruments issued by a
highly rated insurance company. Pursuant to such contracts, a Portfolio may make
cash contributions to a deposit portfolio of the insurance company's general or
separate accounts. The insurance company then credits to such Portfolio
guaranteed interest. The insurance company may assess periodic charges against a
GIC for expense and service costs allocable to it, and the charges will be
deducted from the value of the deposit portfolio. The purchase price paid for a
GIC generally becomes part of the general assets of the issuer, and the contract
is paid from the general assets of the issuer.
A Portfolio will only purchase GICs from issuers which, at the time of
purchase, meet quality and credit standards established by the Adviser.
Generally, GICs are not assignable, or transferable, without the permission of
the issuing insurance company, and an active secondary market in GICs does not
currently exist. Also, a Portfolio may not receive the principal amount of a GIC
from the insurance company on seven days' notice or less, at which point the GIC
may be considered to be an illiquid investment.
ILLIQUID SECURITIES
The Portfolios may invest up to 15% of their net assets in securities
that are considered illiquid because of the absence of a readily available
market or due to legal or contractual restrictions. Certain restricted
securities that are not registered for sale to the general public but that can
be resold to institutional investors may not be considered illiquid, provided
that a dealer or institutional trading market exists.
INTEREST RATE TRANSACTIONS
Among the strategic transactions into which a Portfolio may enter are
interest rate swaps and the purchase or sale of related caps and floors. The
Portfolios expect to enter into these transactions primarily to preserve a
return or spread on a particular investment or portion of its portfolio, to
protect against currency fluctuations, as a duration management technique or to
protect against any increase in the price of securities a Portfolio anticipates
purchasing at
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a later date. The Portfolios intend to use these transactions as hedges and not
as speculative investments and will not sell interest rate caps or floors where
it does not own securities or other instruments providing the income stream a
Portfolio may be obligated to pay. Interest rate swaps involve the exchange by a
Portfolio with another party of their respective commitments to pay or receive
interest (e.g. an exchange of floating rate payments for fixed rate payments
with respect to a notional amount of principal). A currency swap is an agreement
to exchange cash flows on a notional amount of two or more currencies based on
the relative value differential among them and an index swap is an agreement to
swap cash flows on a notional amount based on changes in the values of the
reference indices. The purchase of a cap entitles the purchaser to receive
payments on a notional principal amount from the party selling such floor to the
extent that a specified index falls below a predetermined interest rate or
amount.
A Portfolio will usually enter into swaps on a net basis (i.e., the two
payment streams are netted out in a cash settlement on the payment date or dates
specified in the instrument), with the Portfolio receiving or paying, as the
case may be, only the net amount of the two payments. In as much as these swaps,
caps and floors are entered into for good faith hedging purposes, the Adviser
and the Portfolios believe such obligations do not constitute senior securities
under the 1940 Act and, accordingly, will not treat them as being subject to the
borrowing restrictions. A Portfolio will not enter into any swap, cap and floor
transaction unless, at the time of entering into such transaction, the unsecured
long-term debt of the counterparty, combined with any credit enhancements, is
rated at least "A" by S&P or Moody's, has an equivalent rating from a Nationally
Recognized Statistical Rating Organization ("NRSRO") or is determined to be of
equivalent credit quality by the Adviser. If there is a default by the
counterparty, the Portfolio may have contractual remedies pursuant to the
agreements related to the transaction. The swap market has grown substantially
in recent years with a large number of banks and investment banking firms acting
both as principals and as agents utilizing standardized swap documentation. As a
result, the swap market has become relatively liquid. Caps and floors are more
recent innovations for which standardized documentation has not yet been fully
developed and, accordingly, they are less liquid than swaps.
With respect to swaps, a Portfolio will accrue the net amount of the
excess, if any, of its obligations over its entitlements with respect to each
swap on a daily basis and will segregate an amount of cash or liquid high grade
securities having a value equal to the accrued excess. Caps and floors require
segregation of assets with a value equal to the Portfolio's net obligation, if
any.
LOWER RATED DEBT SECURITIES
The yields on lower rated debt and comparable unrated fixed-income
securities generally are higher than the yields available on higher rated
securities. However, investments in lower rated debt and comparable unrated
securities generally involve greater volatility of price and risk of loss of
income and principal, including the probability of default by or bankruptcy of
the issuers of such securities. Lower rated debt and comparable unrated
securities (a) will likely have some quality and protective characteristics
that, in the judgment of the rating organization, are outweighed by large
uncertainties or major risk exposures to adverse conditions and, (b) are
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligation. Accordingly,
it is possible that these types of factors could, in certain instances, reduce
the value of securities held by a Portfolio with a commensurate effect on the
value of the Portfolio's shares.
The market prices of lower rated securities may fluctuate more than
higher rated securities and may decline significantly in periods of general
economic difficulty which may follow periods of rising interest rates. During an
economic downturn or a prolonged period of rising interest rates, the ability of
issuers of lower quality debt to service their payment obligations, meet
projected goals, or obtain additional financing may be impaired.
Since the risk of default is higher for lower rated securities, the
Adviser will try to minimize the risks inherent in investing in lower rated debt
securities by engaging in credit analysis, diversification, and attention to
current developments and trends affecting interest rates and economic
conditions. The Adviser will attempt to identify those issuers of high-yielding
securities whose financial condition is adequate to meet future obligations,
have improved, or are expected to improve in the future.
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Unrated securities are not necessarily of lower quality than rated
securities, but they may not be attractive to as many buyers. Each Portfolio's
policies regarding lower rated debt securities is not fundamental and may be
changed at any time without shareholder approval.
While the market values of lower rated debt and comparable unrated
securities tend to react less to fluctuations in interest rate levels than the
market values of higher rated securities, the market values of certain lower
rated debt and comparable unrated securities also tend to be more sensitive to
individual corporate developments and changes in economic conditions than
higher-rated securities. In addition, lower rated debt securities and comparable
unrated securities generally present a higher degree of credit risk. Issuers of
lower rated debt and comparable unrated securities often are highly leveraged
and may not have more traditional methods of financing available to them so that
their ability to service their debt obligations during an economic downturn or
during sustained periods of rising interest rates may be impaired. The risk of
loss due to default by such issuers is significantly greater because lower rated
debt and comparable unrated securities generally are unsecured and frequently
are subordinated to the prior payment of senior indebtedness. A Portfolio may
incur additional expenses to the extent that it is required to seek recovery
upon a default in the payment of principal or interest on its portfolio
holdings. The existence of limited markets for lower rated debt and comparable
unrated securities may diminish a Portfolio's ability to (a) obtain accurate
market quotations for purposes of valuing such securities and calculating its
net asset value and, (b) sell the securities at fair value either to meet
redemption requests or, to respond to changes in the economy or in financial
markets.
Fixed income securities, including lower rated debt securities and
comparable unrated securities, frequently have call or buy-back features that
permit their issuers to call or repurchase the securities from their holders,
such as a Portfolio. If an issuer exercises these rights during periods of
declining interest rates, a Portfolio may have to replace the security with a
lower yielding security, thus resulting in a decreased return to the Portfolio.
The market for certain lower rated debt and comparable unrated
securities is relatively new and has not weathered a major economic recession.
The effect that such a recession might have on such securities is not known. Any
such recession, however, could disrupt severely the market for such securities
and adversely affect the value of such securities. Any such economic downturn
also could adversely affect the ability of the issuers of such securities to
repay principal and pay interest thereon.
OPTIONS ON CURRENCIES
The International Growth Portfolio may purchase and sell options on
currencies to hedge the value of securities the Portfolio holds or intends to
buy. Options on foreign currencies may be traded on U.S. and foreign exchanges
or over-the-counter.
REAL ESTATE INVESTMENT TRUSTS
A real estate investment trust ("REIT") is a managed portfolio of real
estate investments which may include office buildings, apartment complexes,
hotels and shopping malls. An Equity REIT holds equity positions in real estate,
and it seeks to provide its shareholders with income from the leasing of its
properties, and with capital gains from any sales of properties. A Mortgage REIT
specializes in lending money to developers of properties, and passes any
interest income it may earn to its shareholders.
REITs may be affected by changes in the value of the underlying
property owned or financed by the REIT, while Mortgage REITs also may be
affected by the quality of credit extended. Both Equity and Mortgage REITs are
dependent upon management skill and may not be diversified. REITs also may be
subject to heavy cash flow dependency, defaults by borrowers, self-liquidation,
and the possibility of failing to qualify for tax-free pass-through of income
under the Internal Revenue Code of 1986, as amended.
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REPURCHASE AGREEMENTS
The repurchase price under the repurchase agreements described in the
Prospectus generally equals the price paid by a Portfolio plus interest
negotiated on the basis of current short-term rates (which may be more or less
than the rate on the securities underlying the repurchase agreement). Securities
subject to repurchase agreements will be held by the Trust's Custodian, or a
Sub-Custodian, in a segregated account or in the Federal Reserve/Treasury
book-entry system. Repurchase agreements are considered to be loans by the Trust
under the 1940 Act.
REVERSE REPURCHASE AGREEMENTS
At the time a Portfolio enters into a reverse repurchase agreement, it
may establish a segregated account with its custodian bank in which it will
maintain cash, U.S. Government securities or other liquid high grade debt
obligations equal in value to its obligations in respect of reverse repurchase
agreements. Reverse repurchase agreements involve the risk that the market value
of the securities the Portfolios are obligated to repurchase under the agreement
may decline below the repurchase price. In the event the buyer of securities
under a reverse repurchase agreement files for bankruptcy or becomes insolvent,
a Portfolio's use of proceeds of the agreement may be restricted pending a
determination by the other party, or its trustee or receiver, whether to enforce
the Portfolio's obligation to repurchase the securities. Reverse repurchase
agreements are speculative techniques involving leverage, and are subject to
asset coverage requirements if the Portfolios do not establish and maintain a
segregated account (as described above). In addition, some or all of the
proceeds received by a Portfolio from the sale of a portfolio instrument may be
applied to the purchase of a repurchase agreement. To the extent the proceeds
are used in this fashion and a common broker/dealer is the counterparty on both
the reverse repurchase agreement and the repurchase agreement, the arrangement
might be recharacterized as a swap transaction. Under the requirements of the
1940 Act, the Portfolios are required to maintain an asset coverage (including
the proceeds of the borrowings) of at least 300% of all borrowings. Depending on
market conditions, a Portfolio's asset coverage and other factors at the time of
a reverse repurchase, the Portfolio may not establish a segregated account when
the Adviser believes it is not in the best interests of the Portfolio to do so.
In this case, such reverse repurchase agreements will be considered borrowings
subject to the asset coverage described above.
RISK FACTORS ASSOCIATED WITH FUTURES AND OPTIONS TRANSACTIONS
The effective use of options and futures strategies depends on, among
other things, a Portfolio's ability to terminate options and futures positions
at times when the Adviser deems it desirable to do so. Although a Portfolio will
not enter into an option or futures position unless the Adviser believes that a
liquid secondary market exists for such option or future, there is no assurance
that a Portfolio will be able to effect closing transactions at any particular
time or at an acceptable price. A Portfolio generally expects that its options
and futures transactions will be conducted on recognized U.S. and foreign
securities and commodity exchanges. In certain instances, however, a Portfolio
may purchase and sell options in the over-the-counter market. A Portfolio's
ability to terminate option positions established in the over-the-counter market
may be more limited than in the case of exchange-traded options and may also
involve the risk that securities dealers participating in such transactions
would fail to meet their obligations to the Portfolio.
Options and futures markets can be highly volatile and transactions of
this type carry a high risk of loss. Moreover, a relatively small adverse market
movement with respect to these types of transactions may result not only in loss
of the original investment but also in unquantifiable further loss exceeding any
margin deposited.
The use of options and futures involves the risk of imperfect
correlation between movements in options and futures prices and movements in the
price of securities which are the subject of the hedge. Such correlation,
particularly with respect to options on stock indices and stock index futures,
is imperfect, and such risk increases as the composition of a Portfolio diverges
from the composition of the relevant index. The successful use of these
strategies also depends on the ability of the Adviser to correctly forecast
interest rate movements, currency rate movements and general stock market price
movements.
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In addition to certain risk factors described above, the following sets
forth certain information regarding the potential risks associated with the
Portfolios' futures and options transactions.
RISK OF IMPERFECT CORRELATION. A Portfolio's ability to effectively
hedge all or a portion of its portfolio through transactions in futures, options
on futures or options on stock indices depends on the degree to which movements
in the value of the securities or index underlying such hedging instrument
correlate with movements in the value of the relevant portion of the Portfolio's
securities. If the values of the securities being hedged do not move in the same
amount or direction as the underlying security or index, the hedging strategy
for a Portfolio might not be successful and the Portfolio could sustain losses
on its hedging transactions which would not be offset by gains on its portfolio.
It is also possible that there may be a negative correlation between the
security or index underlying a futures or option contract and the portfolio
securities being hedged, which could result in losses both on the hedging
transaction and the Portfolio securities. In such instances, a Portfolio's
overall return could be less than if the hedging transactions had not been
undertaken. Stock index futures or options based on a narrower index of
securities may present greater risk than options or futures based on a broad
market index, as a narrower index is more susceptible to rapid and extreme
fluctuations resulting from changes in the value of a small number of
securities. A Portfolio would, however, effect transactions in such futures or
options only for hedging purposes.
The trading of futures and options on indices involves the additional
risk of imperfect correlation between movements in the futures or option price
and the value of the underlying index. The anticipated spread between the prices
may be distorted due to differences in the nature of the markets, such as
differences in margin requirements, the liquidity of such markets and the
participation of speculators in the futures and options market. The purchase of
an option on a futures contract also involves the risk that changes in the value
of underlying futures contract will not be fully reflected in the value of the
option purchased. The risk of imperfect correlation, however, generally tends to
diminish as the maturity date of the futures contract or termination date of the
option approaches. The risk incurred in purchasing an option on a futures
contract is limited to the amount of the premium plus related transaction costs,
although it may be necessary under certain circumstances to exercise the option
and enter into the underlying futures contract in order to realize a profit.
Under certain extreme market conditions, it is possible that a Portfolio will
not be able to establish hedging positions, or that any hedging strategy adopted
will be insufficient to completely protect the Portfolio.
A Portfolio will purchase or sell futures contracts or options only if,
in the Adviser's judgment, there is expected to be a sufficient degree of
correlation between movements in the value of such instruments and changes in
the value of the relevant portion of the Portfolio's portfolio for the hedge to
be effective. There can be no assurance that the Adviser's judgment will be
accurate.
POTENTIAL LACK OF A LIQUID SECONDARY MARKET. The ordinary spreads
between prices in the cash and futures markets, due to differences in the
natures of those markets, are subject to distortions. First, all participants in
the futures market are subject to initial deposit and variation margin
requirements. This could require a Portfolio to post additional cash or cash
equivalents as the value of the position fluctuates. Further, rather than
meeting additional variation margin requirements, investors may close futures
contracts through offsetting transactions which could distort the normal
relationship between the cash and futures markets. Second, the liquidity of the
futures or options market may be lacking. Prior to exercise or expiration, a
futures or option position may be terminated only by entering into a closing
purchase or sale transaction, which requires a secondary market on the exchange
on which the position was originally established. While a Portfolio will
establish a futures or option position only if there appears to be a liquid
secondary market therefor, there can be no assurance that such a market will
exist for any particular futures or option contract at any specific time. In
such event, it may not be possible to close out a position held by the
Portfolio, which could require the Portfolio to purchase or sell the instrument
underlying the position, make or receive a cash settlement, or meet ongoing
variation margin requirements. The inability to close out futures or option
positions also could have an adverse impact on a Portfolio's ability effectively
to hedge its securities, or the relevant portion thereof.
The liquidity of a secondary market in a futures contract or an option
on a futures contract may be adversely affected by "daily price fluctuation
limits" established by the exchanges, which limit the amount of fluctuation in
the price of a contract during a single trading day and prohibit trading beyond
such limits once they have been reached. The trading of futures and options
contracts also is subject to the risk of trading halts, suspensions, exchange or
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clearing house equipment failures, government intervention, insolvency of the
brokerage firm or clearing house or other disruptions of normal trading
activity, which could at times make it difficult or impossible to liquidate
existing positions or to recover excess variation margin payments.
RISK OF PREDICTING INTEREST RATE MOVEMENTS. Investments in futures
contracts on fixed income securities and related indices involve the risk that
if the Adviser's investment judgment concerning the general direction of
interest rates is incorrect, a Portfolio's overall performance may be poorer
than if it had not entered into any such contract. For example, if a Portfolio
has been hedged against the possibility of an increase in interest rates which
would adversely affect the price of bonds held in its portfolio and interest
rates decrease instead, the Portfolio will lose part or all of the benefit of
the increased value of its bonds which have been hedged, because it will have
offsetting losses in its futures positions. In addition, in such situations, if
a Portfolio has insufficient cash, it may have to sell bonds from its portfolio
to meet daily variation margin requirements, possibly at a time when it may be
disadvantageous to do so. Such sale of bonds may be, but will not necessarily
be, at increased prices which reflect the rising market.
TRADING AND POSITION LIMITS. Each contract market on which futures and
option contracts are traded has established a number of limitations governing
the maximum number of positions which may be held by a trader, whether acting
alone or in concert with others. The Adviser does not believe that these trading
and position limits will have an adverse impact on the hedging strategies
regarding the Portfolios' investments.
REGULATIONS ON THE USE OF FUTURES AND OPTIONS CONTRACTS. Regulations of
the CFTC require that the Portfolios enter into transactions in futures
contracts and options thereon for hedging purposes only, in order to assure that
they are not deemed to be a "commodity pool" under such regulations. In
particular, CFTC regulations require that all short futures positions be entered
into for the purpose of hedging the value of investment securities held by a
Portfolio, and that all long futures positions either constitute bona fide
hedging transactions, as defined in such regulations, or have a total value not
in excess of an amount determined by reference to certain cash and securities
positions maintained for a Portfolio, and accrued profits on such positions. In
addition, a Portfolio may not purchase or sell such instruments if, immediately
thereafter, the sum of the amount of initial margin deposits on its existing
futures positions and premiums paid for options on futures contracts would
exceed 5% of the market value of the Portfolio's total assets.
When a Portfolio purchases a futures contract, an amount of cash, cash
equivalents or high quality debt securities will be segregated with the
Portfolio's Custodian so that the amount so segregated, plus the initial deposit
and variation margin held in the account of its broker, will at all times equal
the value of the futures contract, thereby insuring that the use of such futures
is unleveraged.
The Portfolios may be limited by the current Federal income tax
requirement that a Portfolio derive less than 30% of its gross income from the
sale or other disposition of stock or securities held for less than three
months. The Portfolios' ability to engage in the hedging transactions described
herein may limit their ability to engage in such transactions in response to the
policies and concerns of various Federal and state regulatory agencies. Such
policies may be changed by vote of the Board of Trustees.
SECURITIES LENDING
To increase return on portfolio securities, certain of the Portfolios
may lend their portfolio securities to broker/dealers and other institutional
investors pursuant to agreements requiring that the loans be continuously
secured by collateral equal at all times in value to at least the market value
of the securities loaned. Collateral for such loans may include cash, securities
of the U.S. Government, its agencies or instrumentalities, an irrevocable letter
of credit issued by (i) a U.S. bank that has total assets exceeding $1 billion
and that is a member of the Federal Deposit Insurance Corporation, or (ii) a
foreign bank that is one of the 75 largest foreign commercial banks in terms of
total assets, or any combination thereof. Such loans will not be made if, as a
result, the aggregate of all outstanding loans of the Portfolio involved exceeds
33% of the value of its total assets. There may be risks of delay in receiving
additional collateral or in recovering the securities loaned or even a loss of
rights in the collateral should the borrower of the securities fail financially.
However, loans are made only to borrowers deemed by the Adviser to be of good
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standing and when, in its judgment, the income to be earned from the loan
justifies the attendant risks. Pursuant to the securities loan agreement a
Portfolio is able to terminate the securities loan upon notice of not more than
five business days and thereby secure the return to the Portfolio of securities
identical to the transferred securities upon termination of the loan.
SHORT SALES
As described in the Prospectus, certain Portfolios may from time to
time enter into short sales transactions. A Portfolio will not make short sales
of securities nor maintain a short position unless at all times when a short
position is open, such Portfolio owns an equal amount of such securities or
securities convertible into or exchangeable, without payment of any further
consideration, for securities of the same issue as, and equal in amount to, the
securities sold short. This is a technique known as selling short "against the
box." Such short sales will be used by a Portfolio for the purpose of deferring
recognition of gain or loss for Federal income tax purposes.
SPECIAL SITUATIONS
As described in the Prospectus, certain Portfolios may invest in
"special situations." A special situation arises when, in the opinion of the
Adviser, the securities of a particular company will, within a reasonably
estimable period of time, be accorded market recognition at an appreciated value
solely by reason of a development applicable to that company, and regardless of
general business conditions or movements of the market as a whole. Developments
creating special situations might include, among others: liquidations,
reorganizations, recapitalizations, mergers, material litigation, technical
breakthroughs and new management or management policies. Although a large and
well known company may be involved, special situations more often involve a
comparatively small or unseasoned company. Investments in unseasoned company and
special situations often involve much greater risk than is inherent in ordinary
investment securities.
STAND-BY COMMITMENTS
The Portfolios may acquire "stand-by commitments" with respect to
municipal securities held in their portfolios. Under a "stand-by commitment," a
dealer agrees to purchase from a Portfolio, at a Portfolio's option, specified
municipal securities at a specified price. Stand-by commitments are exercisable
by a Portfolio at any time before the maturity of the underlying municipal
securities, and may be sold, transferred, or assigned by a Portfolio only with
the underlying instruments.
A Portfolio's right to exercise stand-by commitments will be
unconditional and unqualified. A stand-by commitment will not be transferable by
a Portfolio, although the Portfolio could sell the underlying municipal
securities to a third party at any time. Until a Portfolio exercises its
stand-by commitment, it owns the securities in its portfolio which are subject
to the stand-by commitment.
The Portfolios expect that stand-by commitments will generally be
available without the payment of any direct or indirect consideration. However,
if necessary or advisable, a Portfolio may pay for a stand-by commitment either
separately in cash, or by paying a higher price for the security being acquired
which will be subject to the commitment (thus reducing the yield to maturity
otherwise available for the same security). When a Portfolio pays any
consideration directly or indirectly for a stand-by commitment, its cost will be
reflected as unrealized depreciation for the period during which the commitment
is held by that Portfolio.
Each Portfolio intends to enter into stand-by commitments only with
banks and broker/dealers which, in the Adviser's opinion, present minimal credit
risks. In evaluating the credit worthiness of the issuer of a stand-by
commitment, the Adviser will review periodically the issuer's assets,
liabilities, contingent claims and other relevant financial information.
The Portfolios would acquire stand-by commitments solely to facilitate
portfolio liquidity and do not intend to exercise their rights thereunder for
trading purposes. Stand-by commitments acquired by a Portfolio will be valued at
zero in determining net asset value. A Portfolio's reliance upon the credit of
these dealers, banks, and
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broker/dealers will be secured by the value of the underlying municipal
securities that are subject to the commitment. Thus, the risk of loss to a
Portfolio in connection with a "stand-by commitment" will not be qualitatively
different from the risk of loss faced by a person that is holding securities
pending settlement after having agreed to sell the securities in the ordinary
course of business.
VARIABLE- AND FLOATING-RATE INSTRUMENTS
The Portfolios may purchase variable-rate and floating-rate obligations
as described in the Prospectus. If such instrument is not rated, the Adviser
will consider the earning power, cash flows and other liquidity ratios of the
issuers and guarantors of such obligations and, if the obligation is subject to
a demand feature, will monitor their financial status to meet payment on demand.
In determining average weighted portfolio maturity, a variable-rate demand
instrument issued or guaranteed by the U.S. Government, or an agency or
instrumentality thereof, will be deemed to have a maturity equal to the period
remaining until the obligations next interest rate adjustment. Other
variable-rate obligations will be deemed to have a maturity equal to the longer
of, the period remaining to the next interest rate adjustment, or the time a
Portfolio can recover payment of principal as specified in the instrument.
The variable- and floating-rate demand instruments that the Portfolios
may purchase include participations in municipal securities purchased from and
owned by financial institutions, primarily banks. Participation interests
provide a Portfolio with a specified undivided interest (up to 100%) in the
underlying obligation and the right to demand payment of the unpaid principal
balance plus accrued interest on the participation interest from the institution
upon a specified number of days' notice, not to exceed 30 days. Each
participation interest is backed by an irrevocable letter of credit or guarantee
of a bank that the Adviser has determined meets the prescribed quality standards
for the Portfolios. The bank typically retains fees out of the interest paid on
the obligation for servicing the obligation, providing the letter of credit and
issuing the repurchase commitment.
WHEN-ISSUED PURCHASES AND FORWARD COMMITMENTS
A Portfolio may agree to purchase securities on a when-issued basis or
enter into a forward commitment to purchase securities. When a Portfolio engages
in these transactions, its Custodian will segregate cash, U.S. Government
securities or other high quality debt obligations equal to the amount of the
commitment. Normally, the Custodian will segregate portfolio securities to
satisfy a purchase commitment, and in such a case a Portfolio may be required
subsequently to segregate additional assets in order to ensure that the value of
the segregated assets remains equal to the amount of the Portfolio's commitment.
Because a Portfolio will segregate cash or liquid assets to satisfy its purchase
commitments in the manner described, the Portfolio's liquidity and ability to
manage its portfolio might be adversely affected in the event its commitments to
purchase when-issued securities ever exceeded 25% of the value of its assets. In
the case of a forward commitment to sell portfolio securities, the Portfolio's
Custodian will hold the portfolio securities themselves in a segregated account
while the commitment is outstanding.
A Portfolio will make commitments to purchase securities on a
when-issued basis or to purchase or sell securities on a forward commitment
basis only with the intention of completing the transaction and actually
purchasing or selling the securities. If deemed advisable as a matter of
investment strategy, however, a Portfolio may dispose of or renegotiate a
commitment after it is entered into, and may sell securities it has committed to
purchase before those securities are delivered to the Portfolio on the
settlement date. In these cases the Portfolio may realize a capital gain or
loss.
When a Portfolio engages in when-issued and forward commitment
transactions, it relies on the other party to consummate the trade. Failure of
such party to do so may result in the Portfolio's incurring a loss or missing an
opportunity to obtain a price considered to be advantageous.
The value of the securities underlying a when-issued purchase or a
forward commitment to purchase securities, and any subsequent fluctuations in
their value, is taken into account when determining the net asset value of a
Portfolio starting on the date the Portfolio agrees to purchase the securities.
The Portfolio does not earn dividends on the securities it has committed to
purchase until they are paid for and delivered on the settlement date. When the
Portfolio makes a forward commitment to sell securities it owns, the proceeds to
be received upon
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settlement are included in the Portfolio's assets. Fluctuations in the value of
the underlying securities are not reflected in the Portfolio's net asset value
as long as the commitment remains in effect.
NET ASSET VALUE
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PURCHASES AND REDEMPTIONS
See "About Your Investment--How To Buy Shares" and "About Your
Investment--How To Redeem Shares" in the Prospectus for a complete description
of the manner in which shares may be purchased and redeemed.
NET ASSET VALUE DETERMINATION
Shares of each Portfolio are sold at their respective net asset value
next determined after the receipt of the purchase order, Participating Insurance
Companies may at any time redeem all or a portion of their shares at the next
determined net asset value following receipt of a redemption order.
The net asset value per share of each of the Portfolios is determined
at the times and in the manner described in the Prospectus.
A security listed or traded on an exchange is valued at its last sales
price on the exchange where the security is principally traded or, lacking any
sales on a particular day, the security is valued at the mean between the
closing bid and asked prices on that day. Each security traded in the
over-the-counter market (but not including securities reported on the Nasdaq
National Market System) is valued at the mean between the last bid and asked
prices based upon quotes furnished by market makers for such securities. Each
security reported on the Nasdaq National Market System is valued at the last
sales price on the valuation date.
Securities for which market quotations are not readily available are
valued at fair value as determined in good faith by or under the supervision of
the Trust's Officers in a manner specifically authorized by the Board of
Trustees of the Trust. Short-term obligations having 60 days or less to maturity
are valued at amortized cost, which approximates market value.
Generally, trading in foreign securities, as well as U.S. Government
securities, money market instruments and repurchase agreements, is substantially
completed each day at various times prior to the close of the New York Stock
Exchange. The values of such securities used in computing the net asset value of
the shares of a Portfolio are determined as of such times. Foreign currency
exchange rates are also generally determined prior to the close of the New York
Stock Exchange. Occasionally, events affecting the value of such securities and
such exchange rates may occur between the times at which they are determined and
the close of the New York Stock Exchange, which will not be reflected in the
computation of net asset value. If during such periods, events occur which
materially affect the value of such securities, the securities will be valued at
their fair market value as determined in good faith by the Trustees.
For purposes of determining the net asset value per share of the
International Growth Portfolio, all assets and liabilities of the International
Growth Portfolio initially expressed in foreign currencies will be converted
into U.S. dollars at the mean between the bid and ask prices of such currencies
against U.S. dollars quoted by a major bank that is a regular participant in the
foreign exchange market, or on the basis of a pricing service that takes into
account the quotes provided by a number of such major banks.
The Trust may redeem shares involuntarily to reimburse the Portfolios
for any loss sustained by reason of the failure of a shareholder to make full
payment for shares purchased by the shareholder, or to collect any charge
relating to a transaction effected for the benefit of a shareholder which is
applicable to shares as provided in the Prospectus from time to time. The Trust
also may make payment for redemptions in readily marketable securities or other
property if it is appropriate to do so in light of the Trust's responsibilities
under the 1940 Act.
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<PAGE>
The right of redemption may be suspended, or the date of payment
postponed, when (a) trading on the New York Stock Exchange is restricted, as
determined by applicable rules and regulations of the SEC, (b) the New York
Stock Exchange is closed for other than customary weekend and holiday closings,
(c) the SEC has by order permitted such suspension, or (d) an emergency as
determined by the SEC exists making disposal of portfolio securities or the
valuation of the net assets of a Portfolio of the Trust not reasonably
practicable. The Exchange is closed for business on New Years Day, Martin Luther
King, Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence Day,
Labor Day, Veterans Day, Thanksgiving Day and Christmas Day. The Federal Reserve
Bank observes the following holidays: New Years Day, Martin Luther King, Jr.
Day, Presidents' Day, Memorial Day, Independence Day, Labor Day, Columbus Day,
Thanksgiving Day and Christmas Day.
DESCRIPTION OF SHARES
---------------------
DESCRIPTION OF SHARES OF THE TRUST
Nations Annuity Trust, an open-end, management investment company, was
organized as a Delaware business trust on November 24, 1997. As of the date of
this SAI, the Trust's Board of Trustees has authorized the issuance of eight
Portfolios, each representing an unlimited number of beneficial interests --
Nations Balanced Assets Portfolio, Nations Disciplined Equity Portfolio, Nations
International Growth Portfolio, Nations Managed Index Portfolio, Nations Managed
SmallCap Index Portfolio, Nations Marsico Focused Equities Portfolio, Nations
Marsico Growth & Income Portfolio and Nations Value Portfolio -- and the Board
of Trustees may, in the future, authorize the creation of additional investment
portfolios or classes of shares.
The Board of Trustees may classify or reclassify any unissued shares of
a Trust into shares of any class, classes or Portfolio in addition to those
already authorized by setting or changing in any one or more respects, from time
to time, prior to the issuance of such shares, the preferences, conversion or
other rights, voting powers, restrictions, limitations as to dividends,
qualifications, or terms or conditions of redemption, of such shares and,
pursuant to such classification or reclassification to increase or decrease the
number of authorized shares of any Portfolio or class. Any such classification
or reclassification will comply with the provisions of the 1940 Act. Fractional
shares shall have the same rights as full shares to the extent of their
proportionate interest.
All shares of a Portfolio have equal voting rights and will be voted in
the aggregate, and not by series, except where voting by a series is required by
law or where the matter involved only affects one series. For example, a change
in a Portfolio's fundamental investment policy would be voted upon only by
shareholders of the Portfolio involved. Additionally, approval of an advisory
contract is a matter to be determined separately by Portfolio. Approval by the
shareholders of one Portfolio is effective as to that Portfolio whether or not
sufficient votes are received from the shareholders of the other Portfolios to
approve the proposal as to those Portfolios. As used in the Prospectus and in
this SAI, the term "majority," when referring to approvals to be obtained from
shareholders of the Portfolio, means the vote of the lesser of (i) 67% of the
shares of the Portfolio represented at a meeting if the shareholders of more
than 50% of the outstanding interests of the Portfolio are present in person or
by proxy, or (ii) more than 50% of the outstanding shares of the Portfolio. The
term "majority," when referring to the approvals to be obtained from
shareholders of Nations Annuity Trust as a whole, means the vote of the lesser
of (i) 67% of the Trust's shares represented at a meeting if the shareholders of
more than 50% of the Trust's outstanding shares are present in person or by
proxy, or (ii) more than 50% of the Trust's outstanding shares. Shareholders are
entitled to one votE for each full share held and fractional votes for
fractional shares held.
The Trust may dispense with an annual meeting of shareholders in any
year in which it is not required to elect Trustees under the 1940 Act. However,
the Trust has undertaken to hold a special meeting of its shareholders for the
purpose of voting on the question of removal of a Trustee, or Trustees, if
requested in writing by the shareholders of at least 10% of the Trust's
outstanding voting shares, and to assist in communicating with other
shareholders as required by Section 16(c) of the 1940 Act.
27
<PAGE>
Each share of a Portfolio represents an equal proportional interest in
the Portfolio with each other share and is entitled to such dividends and
distributions out of the income earned on the assets belonging to the Portfolio,
as are declared in the discretion of the Trustees. In the event of the
liquidation or dissolution of Nations Annuity Trust, shareholders of a Portfolio
are entitled to receive the assets attributable to the Portfolio that are
available for distribution, and a distribution of any general assets not
attributable to a particular Portfolio that are available for distribution in
such manner and on such basis as the Trustees in their sole discretion may
determine.
Shareholders are not entitled to any preemptive rights. All shares,
when issued as described in the Prospectus, will be fully paid and
non-assessable by the Trust.
Net income for dividend purposes consists of (i) interest accrued and
original issue discount earned on the Portfolio's assets, (ii) plus the
amortization of market discount and minus the amortization of market premium on
such assets, (iii) less accrued expenses directly attributable to the Portfolio
and the general expenses of Nations Funds prorated to the Portfolio on the basis
of its relative net assets.
ADDITIONAL INFORMATION CONCERNING TAXES
---------------------------------------
The following information supplements and should be read in conjunction
with the Prospectus section entitled "About Your Investment--Tax Information."
The Prospectus of the Portfolios generally describes generally the tax treatment
of the Portfolios and their shareholders. This section of the SAI includes
additional information concerning Federal income taxes.
GENERAL
The Trust intends to qualify each Portfolio as a regulated investment
company under Subchapter M of the Internal Revenue Code of 1986, as amended (the
"Code") as long as such qualification is in the best interest of the Portfolio's
shareholders. Each Portfolio will be treated as a separate entity for Federal
income tax purposes and thus the provisions of the Code applicable to regulated
investment companies will generally be applied separately to each Portfolio,
rather than to the Trust as a whole. In addition, net capital gain, net
investment income, and operating expenses will be determined separately for each
Portfolio. As a regulated investment company, each Portfolio will not be subject
to Federal income tax on its net investment income and net capital gain
distributed to its shareholders.
Qualification as a regulated investment company under the Code
requires, among other things, that (a) each Portfolio derive at least 90% of its
annual gross income from dividends, interest, certain payments with respect to
securities loans, gains from the sale or other disposition of stock or
securities or foreign currencies (to the extent such currency gains are directly
related to the regulated investment company's principal business of investing in
stock or securities) and other income (including but not limited to gains from
options, futures or forward contracts) derived with respect to its business of
investing in such stock, securities or currencies; and (b) the Portfolio
diversify its holdings so that, at the end of each quarter of the taxable year,
(i) at least 50% of the market value of the Portfolio's assets is represented by
cash, government securities and other securities limited in respect of any one
issuer to an amount not greater than 5% of the Portfolio's assets and 10% of the
outstanding voting securities of such issuer, and (ii) not more than 25% of the
value of its assets is invested in the securities of any one issuer (other than
U.S. Government obligations and the securities of other regulated investment
companies) or in two or more issuers which the Portfolio controls and which are
determined to be engaged in the same or similar trades or businesses.
The Portfolios must also distribute or be deemed to distribute to their
shareholders at least 90% of their net investment income (which, for this
purpose, includes net short-term capital gains) earned in each taxable year.
Although a Portfolio must ordinarily make such distributions during the taxable
year in which it realized the net investment income, in certain circumstances,
the Portfolio may make such distributions in the following taxable year.
Furthermore, distributions declared to a shareholder of record in a day in
October, November or December of one taxable year and paid by January 31 of the
following taxable year will be treated as paid by December 31 of the first
taxable year. The Portfolios intend to pay out substantially all of their net
investment income and any net realized capital gains for each year.
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<PAGE>
EXCISE TAX
A 4% nondeductible excise tax will be imposed on each Portfolio to the
extent it does not meet certain minimum distribution requirements by the end of
each calendar year. Each Portfolio intends to actually or be deemed to
distribute substantially all of its net investment income and net capital gain
by the end of each calendar year and, thus, expects not to be subject to the
excise tax.
TAXATION OF PORTFOLIO INVESTMENTS
Except as provided herein, gains and losses on the sale of portfolio
securities by a Portfolio will generally be capital gains and losses. Such gains
and losses will ordinarily be long-term capital gains and losses if the
securities have been held by the Portfolio for more than one year at the time of
disposition of the securities.
Gains recognized on the disposition of a debt obligation (including
tax-exempt obligations purchased after April 30, 1993) purchased by a Portfolio
at a market discount (generally at a price less than its principal amount) will
be treated as ordinary income to the extent of the portion of market discount
which accrued, but was not previously recognized pursuant to an available
election, during the term the Portfolio held the debt obligation.
If an option granted by the Fund lapses or is terminated through a
closing transaction, such as a repurchase by the Fund of the option from its
holder, the Fund will realize a short-term capital gain or loss, depending on
whether the premium income is greater or less than the amount paid by the Fund
in the closing transaction. Some realized capital losses may be deferred if they
result from a position which is part of a "straddle," discussed below. If
securities are sold by the Fund pursuant to the exercise of a call option
written by it, the Fund will add the premium received to the sale price of the
securities delivered in determining the amount of gain or loss on the sale. If
securities are purchased by a Portfolio pursuant to the exercise of a put option
written by it, such Portfolio will subtract the premium received from its cost
basis in the securities purchased.
The amount of any gain or loss realized by a Portfolio on closing out a
regulated futures contract will generally result in a realized capital gain or
loss for Federal income tax purposes. Regulated futures contracts held at the
end of each fiscal year will be required to be "marked to market" for Federal
income tax purposes pursuant to Section 1256 of the Code. In this regard, they
will be deemed to have been sold at market value. Sixty percent (60%) of any net
gain or loss recognized on these deemed sales and sixty percent (60%) of any net
realized gain or loss from any actual sales, will generally be treated as
long-term capital gain or loss, and the remainder will be treated as short-term
capital gain or loss. Transactions that qualify as designated hedges are
excepted from the "mark-to-market" rule and the "60%/40%" rule.
Under Section 988 of the Code, a Portfolio will generally recognize
ordinary income or loss to the extent gain or loss realized on the disposition
of portfolio debt securities is attributable to changes in foreign currency
exchange rates. In addition, gain or loss realized on the disposition of a
foreign currency forward contract, futures contract, option or similar financial
instrument, or of foreign currency itself, will generally be treated as ordinary
income or loss. The Portfolios will attempt to monitor Section 988 transactions,
where applicable, to avoid adverse tax impact.
Offsetting positions held by a regulated investment Company involving
certain financial forward, futures or options contracts 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 Section 1092 of the Code which, in certain
circumstances, overrides or modifies the provisions of Section 1256. If a
regulated investment company were treated as entering into "straddles" by
engaging in certain financial forward, futures or option contracts, such
straddles could be characterized as "mixed straddles" if the futures, forwards,
or options comprising a part of such straddles were governed by Section 1256 of
the Code. The regulated investment company may make one or more elections with
respect to "mixed straddles." Depending upon which election is made, if any, the
results with respect to the regulated investment company may differ. Generally,
to the extent the straddle rules apply to positions established by the regulated
investment company, losses realized by the regulated investment company may be
deferred to the extent of unrealized gain in any offsetting positions. Moreover,
as a
29
<PAGE>
result of the straddle and the conversion transaction rules, short-term capital
loss on straddle positions may be recharacterized as long-term capital loss, and
long-term capital gain may be characterized as short-term capital gain or
ordinary income.
If a Portfolio enters into a "constructive sale" of any appreciated
position in stock, a partnership interest, or certain debt instruments, the
Portfolio must recognize gain (but not loss) with respect to that position. For
this purpose, a constructive sale occurs when the Portfolio enters into one of
the following transactions with respect to the same or substantially identical
property: (i) a short sale; (ii) an offsetting notional principal contract; or
(iii) a futures or forward contract.
If a Portfolio purchases shares in a "passive foreign investment
company" ("PFIC"), the Portfolio may be subject to Federal income tax and an
interest charge imposed by the IRS upon certain distributions from the PFIC or
the Portfolio's disposition of its PFIC shares. If a Portfolio invests in a
PFIC, the Portfolio intends to make an available election to mark-to-market its
interest in PFIC shares. Under the election, the Portfolio will be treated as
recognizing at the end of each taxable year the difference, if any, between the
fair market value of its interest in the PFIC shares and its basis in such
shares. In some circumstances, the recognition of loss may be suspended. The
Portfolio will adjust its basis in the PFIC shares by the amount of income (or
loss) recognized. Although such income (or loss) will be taxable to the
Portfolio as ordinary income (or loss) notwithstanding any distributions by the
PFIC, the Portfolio will not be subject to Federal income tax or the interest
charge with respect to its interest in the PFIC.
Income and dividends received by the Portfolios from sources within
foreign countries may be subject to withholding and other taxes imposed by such
countries.
TAXATION OF A SEPARATE ACCOUNT OF A PARTICIPATING INSURANCE COMPANY
Under the Code, the investments of a segregated asset account, such as
the separate accounts of the Participating Insurance Companies, must be
"adequately diversified" in order for the holders of the variable annuity
contracts or variable life insurance policies underlying the account to receive
the tax-deferred or tax-free treatment on such annuities or policies generally
afforded holders of annuities or life insurance policies.
In general, the investments of a segregated asset account are
considered "adequately diversified" only if (i) no more than 55% of the value of
the total assets of the account is represented by any one investment; (ii) no
more than 70% of the value of the total assets of the account is represented by
any two investments; (iii) no more than 80% of the value of the total assets of
the account is represented by any three investments; and (iv) no more than 90%
of the value of the total assets of the account is represented by any four
investments. In general, all securities of the same issuer are treated as a
single investment. However, Treasury Regulations provide a "look-through rule"
with respect to a segregated asset account's investments in a regulated
investment company for purposes of the applicable diversification requirements,
provided certain conditions are satisfied by the regulated investment company.
In particular, if the beneficial interests in the regulated investment company
are held by one or more segregated asset accounts of one or more insurance
companies, and if public access to such regulated investment company is
available exclusively through the purchase of a variable contract, then a
segregated asset account's beneficial interest in the regulated investment
company is not treated as a single investment. Instead, a pro rata portion of
each asset of the regulated investment company is treated as an asset of the
segregated asset account.
Each Portfolio intends to satisfy the relevant conditions at all times,
thereby enabling the investment of the corresponding separate accounts to
qualify as "adequately diversified" investments. Accordingly, each separate
account of the Participating Insurance Companies will be able to treat its
interests in a Portfolio as ownership of a pro rata portion of each asset of the
Portfolio, such that holders of the variable annuity contracts or variable life
insurance policies underlying the separate account will be subject to the
favorable Federal income tax treatment under the Code.
30
<PAGE>
For information concerning the Federal income tax consequences for the
holders of variable annuity contracts and variable rate insurance policies, such
holders should consult the prospectus used in connection with the issuance of
their particular contracts or policies and should consult their own tax
advisors.
FEDERAL INCOME TAX RATES
As of the printing of this SAI, the maximum individual tax rate
applicable to ordinary income is 39.6% (marginal tax rates may be higher for
some individuals to reduce or eliminate the benefit of exemptions and
deductions); the maximum individual marginal tax rate applicable to net capital
gain is 28%; and the maximum corporate tax rate applicable to ordinary income
and net capital gain is 35% (marginal tax rates may be higher for some
corporations to reduce or eliminate the benefit of lower marginal income tax
rates). Naturally, the amount of tax payable by an individual or corporation
will be affected by a combination of tax laws covering, for example, deductions,
credits, deferrals, exemptions, sources of income and other matters.
OTHER MATTERS
Investors should be aware that the investments to be made by the
Portfolio may involve sophisticated tax rules that may result in income or gain
recognition by the Portfolio without corresponding current cash receipts.
Although the Portfolio will seek to avoid significant noncash income, such
noncash income could be recognized by the Portfolio, in which case the Portfolio
may distribute cash derived from other sources in order to meet the minimum
distribution requirements described above.
The foregoing discussion and the discussions in the Prospectus
applicable to each shareholder address only some of the Federal tax
considerations generally affecting investments in the Portfolio. Each investor
is urged to consult his or her tax advisor regarding specific questions as to
Federal, state, local or foreign taxes.
TRUSTEES AND OFFICERS
---------------------
The Trustees and Executive Officers of the Trust and their principal
occupations during the last five years are set forth below. The address of each,
unless otherwise indicated, is 111 Center Street, Little Rock, Arkansas 72201.
Those Trustees who are "interested persons" of the Trust (as defined in the 1940
Act) are indicated by an asterisk(*).
<TABLE>
<CAPTION>
NAME ADDRESS AND AGE PRINCIPAL OCCUPATIONS
- -------------------- DURING PAST 5 YEARS
POSITION WITH AND CURRENT
THE TRUST DIRECTORSHIPS
------------- -----------------------
<S> <C> <C>
Edmund L. Benson, III, 60 Trustee Director, President and
Saunders & Benson, Inc. Treasurer, Saunders & Benson,
728 East Main Street Inc. (Insurance); Trustee,
Suite 400 Nations Institutional Reserves,
Richmond, VA 23219 Nations Fund Trust and Nations
Annuity Trust; Director, Nations
Fund, Inc., Nations LifeGoal
Funds, Inc., and Nations Fund
Portfolios, Inc.
James Ermer, 55 Trustee Senior Vice President- Finance,
13705 Hickory Nut Point CSX Corporation (transportation
Midlothian, VA 23112 and natural resources); Director,
National Mine Service; Director,
Lawyers Title Corporation; Trustee,
Nations Institutional Reserves,
Nations Fund Trust and Nations
Annuity Trust; Director, Nations
Fund, Inc., Nations LifeGoal Funds,
Inc., and Nations Fund Portfolios,
Inc.
31
<PAGE>
William H. Grigg, 65 Trustee Chairman Emeritus, Duke Power
Duke Power Co. Co., since July, 1997; April 1994
422 South Church Street to July 1997, Chairman and Chief
PB04G Executive Officer; November 1991
Charlotte, NC 28242-0001 to April 1994, Vice Chairman,
from April 1988 to November 1991,
Executive Vice President --
Customer Group, Director, Coltec
Industries, Hatteras Income Securities,
Inc., Nations Government Income Term
Trust 2003, Inc., Nations Government
Income Term Trust 2004, Inc.,
Nations Balanced Target Maturity
Fund, Inc., Nations Fund, Inc.,
Nations LifeGoal Funds, Inc. and
Nations Fund Portfolios, Inc.;
Trustee, Nations Institutional
Reserves, Nations Fund Trust and
Nations Annuity Trust.
Thomas F. Keller, 66 Trustee R.J. Reynolds Industries Professor
School of Business of Business Administration and former
P.O. Box 90120 Dean, Fuqua School of Business, Duke
Duke University University; Director, LADD Furniture,
Durham, NC 27708 Inc.; Director, Wendy's International
Inc., American Business Products,
Dimon Inc., Biogen, Inc., Hatteras
Income Securities, Inc., Nations
Government Income Term Trust 2003, Inc.,
Nations Government Income Term Trust
2004, Inc., Nations Balanced Target
Maturity Fund, Inc., Nations Fund,
Inc., Nations LifeGoal Funds, Inc.,
and Nations Fund Portfolios, Inc.;
Trustee, Nations Institutional Reserves,
Nations Fund Trust, Nations Annuity
Trust, the Mentor Funds, Mentor
Institutional Trust, Cash Resource
Trust.
Carl E. Mundy, Jr., 62 Trustee Commandant, United States Marine Corps,
9308 Ludgate Drive from July 1991 to July 1995; Commanding
Alexandria, VA 22309 General, Marine Forces Atlantic, from
June 1990 to June 1991; Director, Nations
Fund, Inc., Nations LifeGoal Funds, Inc.,
and Nations Fund Portfolios, Inc.; Trustee,
Nations Institutional Reserves, Nations
Fund Trust and Nations Annuity Trust.
James B. Sommers*, 58 Trustee President, NationsBank Trust, from January
237 Cherokee Road 1992 to September 1996; Executive Vice
Charlotte, NC 28207 President, NationsBank Corporation, from
January 1992 to May 1997; Principal,
Bainbridge & Associates; Partner, Villa
LLC; Chairman, Central Piedmont Community
College Foundation; Trustee, Central
Piedmont Community College; Board of
Commissioners, Charlotte/Mecklenberg
Hospital Authority; Director, Nations
Fund, Inc., Nations Fund Portfolios, Inc.
and Nations LifeGoal Funds, Inc.; Trustee,
Nations Institutional Reserves, Nations
Fund Trust and Nations Annuity Trust.
A. Max Walker*, 75 President, Trustee and Financial consultant; Formerly, President,
4580 Windsor Gate Court Chairman of the Board A. Max Walker, Inc.; Director and Chairman
Atlanta, GA 30342 of the Board, Hatteras Income
32
<PAGE>
Securities, Inc., Nations Government
Income Term Trust 2003, Inc., Nations
Government Income Term Trust 2004, Inc.,
Nations Balanced Target Maturity Fund, Inc.,
Nations Fund, Inc., Nations LifeGoal Funds,
Inc., and Nations Fund Portfolios, Inc.;
President and Chairman of the Board of
Trustees, Nations Institutional Reserves,
Nations Fund Trust and Nations Annuity
Trust.
Charles B. Walker, 59 Trustee Since 1989, Director, Executive Vice President,
Ethyl Corporation Chief Financial Officer and Treasurer,
330 South Fourth Street Ethyl Corporation (chemicals, plastics,
Richmond, VA 23219 and aluminum manufacturing); since 1994,
Vice Chairman, Ethyl Corporation and
Vice Chairman, Chief Financial Officer
and Treasurer, Albemarle Corporation,
Director, Nations Fund, Inc., Nations
LifeGoal Funds, Inc, and Nations Fund
Portfolios, Inc.; Trustee, Nations
Institutional Reserves, Nations Fund Trust
and Nations Annuity Trust.
Thomas S. Word, Jr.*, 59 Trustee Partner, McGuire Woods Battle &
McGuire, Woods, Battle & Boothe Boothe (law); Director, Vaughan
One James Center Bassett Furniture Trust, Director
Richmond, VA 23219 VB Williams Furniture Trust, Inc.;
Director, Nations Fund, Inc., Nations
LifeGoal Funds, Inc., and Nations Fund
Portfolios Inc.; Trustee, Nations
Institutional Reserves, Nations Fund
Trust and Nations Annuity Trust.
Richard H. Blank, Jr., 41 Secretary Since 1994, Vice President of
Stephens Inc. Mutual Fund Services, Stephens
Inc. 1990 to 1994, Manager Mutual
Portfolio Services, Stephens Inc.
1983 to 1990, Associate in
Corporate Finance Department,
Stephens Inc.; Secretary, Nations
Institutional Reserves, Nations
Fund Trust, Nations Annuity
Trust, Nations Fund, Inc.,
Nations LifeGoal Funds, Inc., and
Nations Fund Portfolios, Inc.
Michael W. Nolte, 36 Assistant Secretary Associate, Financial Services
Stephens Inc. Group of Stephens Inc.
Louise P. Newcomb, 45 Assistant Secretary Corporate Syndicate Associate,
Stephens Inc. Stephens Inc.
James E. Banks, 41 Assistant Secretary Since 1993, Attorney, Stephens
Stephens Inc. Inc.; Associate Corporate Counsel,
Federated Investors; from 1991 to
1993, Staff Attorney, Securities and
Exchange Commission from 1988 to
1991
Richard H. Rose, 42 Treasurer Since 1994, Vice President, Division
First Data Investor Services Group, Inc. Manager, First Data Investor Services
(formerly, The Shareholder Services Group, Group, Inc. since 1988, Senior Vice
Inc.) President, The Boston Company
One Exchange Place Advisors. Inc.; Treasurer, Nations
Boston, MA 02109 Institutional Reserves, Nations Fund
Trust, Nations Annuity Trust, Nations
Fund, Inc., Nations LifeGoal Funds, Inc.,
and Nations Fund Portfolios, Inc.
Steven Levy, 32 Assistant Treasurer Since 1997, Vice President of Fund
First Data Investor Services Group, Inc. Accounting, First Data Investor Services
33
<PAGE>
(formerly, The Shareholder Services Group, Group, Inc.; Prior to 1997, Investment
Inc.) Operations Manager, Franklin Templeton
One Exchange Place Group and Assistant Vice President of Fund
Boston, MA 02109 Accounting, Scudder Stevens and Clark, Inc.
</TABLE>
Mr. Rose serves as Treasurer to certain other investment companies for
which First Data Investors Services Group, Inc. (the "Co-Administrator"), or its
affiliates serve as Sponsor, Distributor, Administrator and/or Adviser.
Each Trustee of the Trust is also a Trustee of Nations Fund Trust and
Nations Institutional Reserves and a Director of Nations Fund, Inc., Nations
Fund Portfolios, Inc., and Nations LifeGoal Funds, Inc. each a registered
investment company that is part of the Nations Funds Family. Richard H. Blank,
Jr., Richard H. Rose, Steven Levy, Michael W. Nolte, Louise P. Newcomb and James
E. Banks. Jr. also are Officers of Nations Fund Trust, Nations Institutional
Reserves, Nations Fund Portfolios, Inc., Nations Fund, Inc. and Nations LifeGoal
Funds, Inc.
Each Trustee receives (i) an annual retainer of $1,000 ($3,000 for the
Chairman of the Board) plus $500 for each Portfolio of the Trust, plus (ii) a
fee of $1,000 for attendance at each "in-person" meeting of the Board of
Trustees (or committee thereof). All Trustees receive reimbursements for
expenses related to their attendance at meetings of the Board of Trustees.
Officers receive no direct remuneration in such capacity from the Trust. No
person who is an Officer, Trustee, or employee of NationsBank or its affiliates
serves as an Officer, Trustee or employee of the Trust. As of the date of this
SAI, the Trustees and Officers of the Trust as a group owned less than 1% of the
outstanding shares of each of the Portfolios.
The Trust has adopted a Code of Ethics which, among other things,
prohibits each access person of the Trust, from purchasing or selling securities
when such person knows or should have known that, at the time of the
transaction, the security (i) was being considered for purchase or sale by a
Portfolio, or (ii) was being purchased or sold by a Portfolio. For purposes of
the Code of Ethics, an access person means (i) a Trustee or Officer of the
Trust, (ii) any employee of the Trust (or any Trust in a control relationship
with the Trust) who, in the course of his/her regular duties, obtains
information about, or makes recommendations with respect to, the purchase or
sale of securities by the Trust, and (iii) any natural person in a control
relationship with the Trust who obtains information concerning recommendations
made to the Trust regarding the purchase or sale of securities. Portfolio
managers and other persons who assist in the investment process are subject to
additional restrictions, including a requirement that they disgorge to the Trust
any profits realized on short-term trading (i.e., the purchase/sale or
sale/purchase of securities within any 60-day period). The above restrictions do
not apply to purchases or sales of certain types of securities, including mutual
fund shares, money market instruments and certain U.S. Government securities. To
facilitate enforcement, the Code of Ethics generally requires that the Trust's
access persons, other than its "disinterested" Trustees, submit reports to the
Trust's designated compliance person regarding transactions involving securities
which are eligible for purchase by a Portfolio.
NATIONS FUNDS RETIREMENT PLAN
Under the terms of the Nations Funds Retirement Plan for Eligible
Trustees (the "Retirement Plan"), each Trustee may be entitled to certain
benefits upon retirement from the Board of Trustees. Pursuant to the Retirement
Plan, the normal retirement date is the date on which the eligible Trustee has
attained age 65 and has completed at least five years of continuous service with
one or more of the open-end investment companies advised by the Adviser. If a
Trustee retires before reaching age 65, no benefits are payable. Each eligible
Trustee is entitled to receive an annual benefit from the Portfolios commencing
on the first day of the calendar quarter coincident with or next following
his/her date of retirement equal to 5% of the aggregate Trustee's fees payable
by the Portfolios during the calendar year in which the Trustee's retirement
occurs multiplied by the number of years of service (not in excess of ten years
of service), completed with respect to any of the Portfolios. Such benefit is
payable to each eligible Trustee in quarterly installments for a period of no
more than five years. If an eligible Trustee dies after attaining age 65, the
Trustee's surviving spouse (if any) will be entitled to receive 50% of the
benefits that would have been paid (or would have continued to have been paid)
to the Trustee if he or she had not died. The Retirement Plan is unfunded. The
benefits owed to each Trustee are unsecured and subject to the general creditors
of the Portfolios.
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<PAGE>
NATIONS FUNDS DEFERRED COMPENSATION PLAN
Under the terms of the Nations Funds Deferred Compensation Plan for
Eligible Trustees (the "Deferred Compensation Plan"), each Trustee may elect, on
an annual basis, to defer all or any portion of the annual board fees (including
the annual retainer and all attendance fees) payable to the Trustee for that
calendar year. An application was submitted to and approved by the SEC to permit
deferring trustees to elect to tie the rate of return on fees deferred pursuant
to the Deferred Compensation Plan to one or more of certain investment
Portfolios. Distributions from the deferring Trustees' deferral accounts will be
paid in cash, in generally equal quarterly installments over a period of five
years beginning on the date the deferring Trustee's retirement benefits commence
under the Retirement Plan. The Board of Trustees, in its sole discretion, may
accelerate or extend such payments after a Trustee's termination of service. If
a deferring Trustee dies prior to the commencement of the distribution of
amounts in his or her deferral account, the balance of the deferral account will
be distributed to his/her designated beneficiary in a lump sum as soon as
practicable after the Trustee's death. If a deferring Trustee dies after the
commencement of such distribution, but prior to the complete distribution of his
or her deferral account, the balance of the amounts credited to his or her
deferral account will be distributed to the designated beneficiary over the
remaining period during which such amounts were distributable to the Trustee.
Amounts payable under the Deferred Compensation Plan are not funded or secured
in any way and deferring Trustees have the status of unsecured creditors of the
Portfolios from which they are deferring compensation.
COMPENSATION TABLE
<TABLE>
<CAPTION>
AGGREGATE PENSION OR RETIREMENT
COMPENSATION FROM BENEFITS ACCRUED AS PART ESTIMATED ANNUAL TOTAL COMPENSATION FROM
NAME OF PERSON THE OF PORTFOLIO BENEFITS UPON REGISTRANT AND PORTFOLIO
POSITION (1) TRUST (2) EXPENSES RETIREMENT COMPLEX (3)(4)
------------ --------- -------- ---------- --------------
<S> <C> <C> <C> <C>
Edmund L. Benson, III, $4,894.39 $23,368.92 $11,535.67 $84,042.84
Trustee (50% Def'd)
James Ermer 8,085.49 23,368.92 11,535.67 46,716.94
Trustee
William H. Grigg 0.00 23,368.92 11,535.67 115,933.25
Trustee (100% Def'd)
Thomas F. Keller 178.90 23,368.92 11,535.67 124,575.75
Trustee (100% Def'd)
Carl E. Mundy, Jr. 9,679.25 23,368.92 11,535.67 52,092.00
Trustee
James Sommers 0.00 0.00 0.00 0.00
Trustee
A. Max Walker 11,486.99 23,368.99 11,535.67 75,322.94
Chairman of the Board
Charles B. Walker 9,215.83 23,368.92 11,535.67 51,238.33
Trustee
Thomas S. Word 417.01 23,368.92 11,535.67 118,926.66
Trustee (100% Def'd)
$43,957.85 $186,951.37 $92,285.34 $668,848.71
========== =========== ========== ===========
</TABLE>
(1) All Trustees receive reimbursements for expenses related to their
attendance at meetings of the Board of Trustees. Officers of the Trust receive
no direct remuneration in such capacity from the Trust.
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<PAGE>
(2) Each Trustee receives (i) an annual retainer of $1,000 ($3,000 for
the Chairman of the Board) plus $500 for each Portfolio of the Trust, plus (ii)
a fee of $1,000 for attendance at each "in-person" meeting of the Board of
Trustees (or Committee thereof) and $500 for attendance at each other meeting of
the Board of Trustees (or Committee thereof).
(3) Messrs. Grigg, Keller and A.M. Walker receive compensation from
nine investment companies, including the Trust, that are deemed to be part of
the Nations Funds "fund complex," as that term is defined under Rule 14a-101 of
the Securities Exchange Act of 1934, as amended. Messrs. Benson, Ermer, C.
Walker, Mundy and Word receive compensation from six investment companies,
including the Trust, deemed to be part of the fund complex.
(4) Total compensation amounts include deferred compensation (including
interest) payable to or accrued for the following Trustees: Edmund L. Benson,
III ($55,652.78); William H. Grigg ($102,683.25); Thomas F. Keller
($110,610.14); and Thomas S. Word ($114,008.63).
SHAREHOLDER AND TRUSTEE LIABILITY
Under Delaware law, shareholders of a business trust may, under certain
circumstances, be held personally liable as partners for the obligations of the
Trust. However, the Trust's Declaration of Trust provides that shareholders
shall not be subject to any personal liability for the acts or obligations of
the Trust, and that every note, bond, contract, order, or other undertaking made
by the Trust shall contain a provision to the effect that the shareholders are
not personally liable thereunder. The Declaration of Trust provides for
indemnification out of the Trust property of any shareholder held personally
liable solely by reason of his being or having been a shareholder and not
because of his acts or omissions or some other reason. The Declaration of Trust
also provides that the Trust shall, upon request, assume the defense of any
claim made against any shareholder for any act or obligation of the Trust and
shall satisfy any judgment thereon. Thus, the risk of a shareholder incurring
financial loss on account of shareholder liability is limited to circumstances
in which the Trust itself would be unable to meet its obligations.
The Declaration of Trust states further that no Trustee, Officer, or
Agent of the Trust shall be personally liable for, or on account of, any
contract, debt, tort, claim, damage, judgment or decree arising out of or
connected with the administration or preservation of the Trust estate or the
conduct of any business of the Trust; nor shall any Trustee be personally liable
to any person for any action or failure to act except by reason of his own bad
faith, willful misfeasance, gross negligence, or reckless disregard of his
duties as Trustee. The Declaration of Trust also provides that all persons
having any claim against the Trustees or the Trust shall look solely to the
Trust property for payment.
With the exceptions stated, the Declaration of Trust provides that a
Trustee is entitled to be indemnified against all liabilities and expenses
reasonably incurred by him or her in connection with the defense or disposition
of any proceeding in which he or she may be involved or with which he/she may be
threatened by reason of his or her being or having been a Trustee, and that the
Trustees have the power, but not the duty, to indemnify Officers and employees
of the Trust unless any such person would not be entitled to indemnification had
he or she been a Trustee.
INVESTMENT ADVISORY, ADMINISTRATION, CUSTODY,
TRANSFER AGENCY AND SHAREHOLDER SERVICING AGREEMENTS
INVESTMENT ADVISER
NBAI serves as investment adviser to the Portfolios of the Trust,
pursuant to an Investment Advisory Agreement. Pursuant to an Investment
Sub-Advisory Agreement entered into with the Trust, TradeStreet serves as
investment sub-adviser to the Portfolios of the Trust except Nations
International Growth Portfolio, Nations Marsico Focused Equities Portfolio and
Nations Marsico Growth & Income Portfolio. Marsico serves as investment
sub-adviser to Nations Marsico Focused Equities Portfolio and Nations Marsico
Growth & Income Portfolio and Gartmore serves as investment sub-adviser to
Nations International Growth Portfolio pursuant to respective
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<PAGE>
Sub-Advisory Agreements entered into with the Trust. All such agreements are
effective as of February 25, 1998 for a period of two years from such date.
For the services provided and expenses assumed pursuant to the
Investment Advisory Agreement, NBAI is entitled to receive advisory fees,
computed daily and paid monthly, at the annual rates of:
<TABLE>
<CAPTION>
Fund Percentage of Average Daily Net Assets
<S> <C>
Nations Balanced Assets Portfolio .75%
Nations Disciplined Equity Portfolio .75%
Nations International Growth Portfolio .90%
Nations Managed Index Portfolio .50%
Nations Managed SmallCap Index Portfolio .50%
Nations Marsico Focused Equities Portfolio .85%
Nations Marsico Growth & Income Portfolio .85%
Nations Value Portfolio .75%
</TABLE>
For the services provided pursuant to the Sub-Advisory Agreement,
TradeStreet is entitled to receive from NBAI sub-advisory fees, computed daily
and paid monthly, at the annual rates of:
<TABLE>
<CAPTION>
Fund Percentage of Average Daily Net Assets
<S> <C>
Nations Balanced Assets Portfolio .25%
Nations Disciplined Equity Portfolio .25%
Nations Managed Index Portfolio .10%
Nations Managed SmallCap Index Portfolio .10%
Nations Value Portfolio .25%
</TABLE>
For the services provided pursuant to the Sub-Advisory Agreement,
Gartmore is entitled to receive from NBAI sub-advisory fees, computed daily and
paid monthly at the annual rate of:
<TABLE>
<CAPTION>
Fund Percentage of Average Daily Net Assets
<S> <C>
Nations International Growth Portfolio .70%
</TABLE>
For the services provided pursuant to the Sub-Advisory Agreement,
Marsico is entitled to receive from NBAI sub-advisory fees, computed daily and
paid monthly at the annual rate of:
<TABLE>
<CAPTION>
Fund Percentage of Average Daily Net Assets
<S> <C>
Nations Marsico Focused Equities Portfolio .45%
Nations Marsico Growth & Income Portfolio .45%
</TABLE>
NBAI also serves as the investment adviser to Nations Fund, Inc.,
Nations Fund Trust, Nations Fund Portfolios, Inc., Nations Institutional
Reserves and Nations LifeGoal Funds, Inc., each a registered investment company
that is part of the Nations Funds Family. In addition, NBAI serves as the
investment advisor to Hatteras Income Securities, Inc., Nations Government
Income Term Trust 2003, Inc., Nations Government Income Term Trust 2004, Inc.
and Nations Balanced Target Maturity Fund, Inc., each a closed-end diversified
management investment company traded on the New York Stock Exchange. TradeStreet
also serves as the investment sub-adviser to Nations Fund, Inc., Nations Fund
Trust, Nations Life Goal Funds, Inc., Hatteras Income Securities, Inc., Nations
Government Income Term Trust 2003, Inc., Nations Government Income Term Trust
2004, Inc. and Nations Balanced Target Maturity Fund, Inc. Gartmore serves as
investment sub-adviser to Nations Fund Portfolios, Inc. and additionally, serves
as investment sub-adviser to Nations International Equity Fund, part of Nations
Fund, Inc.
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<PAGE>
Marsico Capital serves as investment sub-adviser to Nations Marsico Focused
Equities Fund and Nations Marsico Growth & Income Fund, part of Nations Fund
Trust.
NBAI and TradeStreet are each wholly owned subsidiaries of Nations
Bank, N.A. ("NationsBank"), which in turn is a wholly owned banking subsidiary
of NationsBank Corporation, a bank holding trust organized as a North Carolina
corporation. Gartmore is a joint venture structured as a Delaware general
partnership between NB Partner Corp., a wholly owned subsidiary of NationsBank
and Gartmore U.S. Limited, an indirect wholly owned subsidiary of Gartmore
Investment Management plc ("Gartmore plc"), a publicly listed U.K. company.
National Westminster Bank plc and affiliated parties (collectively, "NatWest)
own 100% of the equity of Gartmore plc. Gartmore is a registered investment
adviser in the United States and a member of the Investment Management
Regulatory Organization Limited, a U.K. regulatory authority. The respective
principal offices of NBAI, TradeStreet and Gartmore are located at One
NationsBank Plaza, Charlotte, N.C. 28255. Marsico Capital Management, LLC is
located at 1200 17th Street, Suite 1300, Denver, CO 80202.
Since 1874, NationsBank and its predecessors have been managing money
for foundations, universities, corporations, institutions and individuals.
Today, NationsBank affiliates collectively manage in excess of $50 billion,
including more than $27 billion in mutual fund assets. It is a company dedicated
to a goal of providing responsible investment management and superior service.
NationsBank is recognized for its sound investment approaches, which place it
among the nation's foremost financial institutions. NationsBank and its
affiliate organizations make available a wide range of financial services to
over 14 million customer households through over 2500 banking and investment
centers.
Pursuant to the terms of the Investment Advisory Agreement and
Sub-Advisory Agreements (at times, the "Advisory Agreements") with NBAI,
TradeStreet, Gartmore and Marsico Capital, respectively, subject at all times to
the control of the Trust's Board of Trustees and in conformance with the stated
policies of each of the Trust, NBAI, TradeStreet, Gartmore and Marsico Capital
each selects and manages the investments of the Portfolios. Each such advisory
entity obtains and evaluates economic, statistical and financial information to
formulate and implement investment policies for the respective Portfolios.
The Advisory Agreements each provide that in the absence of willful
misfeasance, bad faith, negligence or reckless disregard of obligations or
duties thereunder on the part of NBAI or TradeStreet, Gartmore or Marsico
Capital, respectively, or any of their respective Officers, Directors, employees
or agents, shall not be subject to liability to the Trust or to any shareholder
of the Trust for any act or omission in the course of, or connected with,
rendering services thereunder, or for any losses that may be sustained in the
purchase, holding or sale of any security.
The Investment Advisory Agreement with NBAI shall become effective with
respect to a Portfolio when approved in accordance with the 1940 Act, and if so
approved shall continue in effect for an initial term of two years, and shall
thereafter continue from year to year, provided that such continuation of the
Agreement is specifically approved at least annually by (a) (i) the Trust's
Board of Trustees, or (ii) the vote of "a majority of the outstanding voting
securities" of a Portfolio (as defined in Section 2(a)(42) of the 1940 Act), and
(b) the affirmative vote of a majority of the Trustees who are not parties to
such Agreement or "interested persons" (as defined in the 1940 Act) of a party
to such Agreement (other than as Trustees of the Trust), by votes cast in person
at a meeting specifically called for such purpose. The respective Investment
Advisory Agreement will terminate automatically in the event of its assignment,
and is terminable with respect to a Portfolio at any time without penalty by the
Trust (by vote of the Board of Trustees or by vote of a majority of the
outstanding voting securities of the Portfolio) or by NBAI on 60 days' written
notice.
The Sub-Advisory Agreement with TradeStreet shall become effective with
respect to the respective Portfolios when approved in accordance with the 1940
Act, and if so approved shall continue in effect for an initial term of two
years, and shall thereafter continue from year to year, provided that such
continuation of the Agreement is specifically approved at least annually by (a)
(i) the Trust's Board of Trustees, or (ii) the vote of "a majority of the
outstanding voting securities" of a Portfolio (as defined in Section 2(a)(42) of
the 1940 Act), and (b) the affirmative vote of a majority of the Trustees who
are not parties to such Agreement or "interested persons" (as defined in the
1940 Act) of a party to such Agreement (other than as Trustees of the Trust), by
votes cast in person at a meeting
38
<PAGE>
specifically called for such purpose. The Sub-Advisory Agreement will terminate
automatically in the event of its assignment, and is terminable with respect to
a Portfolio at any time without penalty by the Trust (by vote of the Board of
Trustees or by vote of a majority of the outstanding voting securities of the
Portfolio), or by NBAI, or by TradeStreet on 60 days' written notice.
The Sub-Advisory Agreement with Gartmore with respect to Nations
International Growth Portfolio shall become effective with respect to Nations
International Growth Portfolio when approved in accordance with the 1940 Act,
and if so approved shall continue in effect for an initial term of two years,
and shall thereafter continue from year to year, provided such continuance is
specifically approved at least annually by (a) (i) the Trust's Board of
Trustees, or (ii) the vote of "a majority of the outstanding voting securities"
of a Portfolio (as defined in Section 2(a)(42) of the 1940 Act), and (b) the
affirmative vote of a majority of the Trustees who are not parties to such
Agreement or "interested persons" (as defined in the 1940 Act) of a party to
such Agreement (other than as Trustees of the Trust), by votes cast in person at
a meeting specifically called for such purpose. The Portfolio, NBAI or Gartmore
may terminate the Sub-Advisory Agreement, on 60 days' written notice without
penalty. The Sub-Advisory Agreement terminates automatically in the event of its
"assignment," as defined in the 1940 Act.
The Sub-Advisory Agreement with Marsico Capital with respect to Nations
Marsico Focused Equities Portfolio and Nations Marsico Growth & Income Portfolio
when approved in accordance with the 1940 Act, and if so approved shall continue
in effect for an initial term of two years, and shall thereafter continue from
year to year, provided such continuance is specifically approved at least
annually by (a) (i) the Trust's Board of Trustees, or (ii) the vote of "a
majority of the outstanding voting securities" of a Portfolio (as defined in
Section 2(a)(42) of the 1940 Act), and (b) the affirmative vote of a majority of
the Trustees who are not parties to such Agreement or "interested persons" (as
defined in the 1940 Act) of a party to such Agreement (other than as Trustees of
the Trust), by votes cast in person at a meeting specifically called for such
purpose. The respective Portfolios, NBAI or Marsico Capital may terminate the
Sub-Advisory Agreement, on 60 days' written notice without penalty. The Advisory
Agreement terminates automatically in the event of its "assignment," as defined
in the 1940 Act.
NBAI, TradeStreet, Gartmore or Marsico Capital may waive a portion of
their fees; however, any such waiver may be discontinued at any time. As
discussed under the caption "Expenses," NBAI, TradeStreet, Gartmore and Marsico
Capital will be required to reduce their fees from the Portfolios, in direct
proportion to the fees payable by the Portfolios to NBAI, TradeStreet, Gartmore,
Marsico Capital and the Administrator, if the expenses of the Portfolios exceed
the applicable expense limitation of any state in which the Portfolios' shares
are registered or qualified for sale.
In addition, the Adviser may pay out of its own assets, amounts to
certain broker/dealers in connection with the provision of administrative and/or
distribution related services to shareholders.
The Advisory and Sub-Advisory Agreements were approved by the Board of
Trustees, including a majority of Trustees who are not parties to such
Agreements or "interest persons" at the December 9, 1997 Special Board Meeting.
INVESTMENT STYLES
When you invest in any Portfolio in the Nations Funds Family, you can be
assured your money is managed according to a disciplined investment style; one
that remains constant regardless of particular styles coming in and out of
favor. The Adviser believes this structured approach to managing portfolio
securities may provide you with consistent performance over time. The Adviser
uses various investment strategies during the process of constructing and
managing the Portfolios. These strategies have been categorized into investment
styles which consist of (i) the NationsBank Value Equity Style, (ii) the
NationsBank Balanced Asset Style, (iii) the NationsBank Disciplined Equity Style
and (iv) the International Growth Style. Investment styles described below
relate to Nations Value, Disciplined Equity, Balanced Assets and International
Growth Portfolios.
NATIONSBANK VALUE EQUITY STYLE. The Value Portfolio is managed by the
Adviser using the NationsBank Value Equity Style. The Value Equity Style
investment philosophy is premised on the belief that a well diversified
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<PAGE>
portfolio of undervalued companies exhibiting low price/earnings ratios will,
over time outperform the market while incurring lower-than-market risk.
This style utilizes a "bottom-up" approach to stock selection, focusing
on well proven factors of fundamental valuation. A low price/earnings ratio and
above market dividend yield are two of the biases which reduce market risk. A
catalyst for earnings improvement is also one of this Style's requirements as it
assists with the "timing" of the purchase of a particular company.
Stock selection process begins with a team of 10 in-house research
specialists aided by a computerized screening model. Starting with approximately
a 2,000 company universe, stocks must first pass a rigorous screening process
that selects only those companies that possess strong financial quality and a
market capitalization greater than $500 million. This results in a universe of
approximately 900 companies, representing all of the 54 major U.S. industries
and approximately 10 economic sectors.
A more sophisticated screening process is then applied to the 900
company universe. The companies are then ranked based on the following factor
weightings:
The top one-third, or approximately 300 companies, result in the final
universe from which the industry specialists make initial selections for the
Portfolio. To insure adherence to the discipline, price objectives (buy and sell
prices) are set for each company purchased, based on sound fundamental analysis.
A final diversified portfolio of approximately 65 issues is constructed by the
Value Equity Style Group Senior Portfolio Managers working closely with in-house
industry specialists, as well as expert Wall Street sources.
In summary, the low price/earnings ratio, value discipline seeks to
produce a well diversified portfolio of high quality companies, that over time,
should outperform the market, thereby adding value while incurring below-market
risk.
NATIONSBANK BALANCED ASSET STYLE. The Balanced Assets Portfolio is
managed by the Adviser using the NationsBank Balanced Asset Style. The
NationsBank Balanced Asset Style investment philosophy is premised on the belief
that a diversified portfolio of stocks, fixed income and money market securities
will provide total investment return through a combination of growth of capital
and current income consistent with preservation of capital.
In order to pursue this goal, the Balanced Asset Style utilizes an
asset allocation approach. Asset allocation is a process of allocating a
portfolio's market value among major asset classes (equities, fixed income and
cash equivalents). Different asset classes have unique return and risk
characteristics. The principle behind asset allocations is that a diversified
portfolio of equities, fixed income and cash equivalents with different
return/risk characteristics will reduce overall portfolio risk in both up and
down markets.
The asset allocation process begins by making projections for stock,
bond and cash returns and risk profiles. A computer data analysis identifies the
highest expected return and measures it against the minimum return requirements
for the balanced strategy. Recommendations are made to an Investment Policy
Committee who reviews and approves asset class allocations.
The stock, bond and asset allocation recommendations are then passed
onto the Balanced Asset Group Senior Portfolio Managers who make the final
investment decisions. The Portfolio Managers have the ability to change the
portfolio's holdings to take advantage of changing market conditions, while
seeking an optimal balance of income, stability and growth. Most stock
investments will be made in trust with above average earnings and dividend
prospects and overall financial market stability. All bond purchases will be
investment grade or above. Cash instruments will provide liquidity.
In summary, the Balanced Asset Style should provide total investment
return through a combination of growth of capital and current income consistent
with preservation of capital.
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<PAGE>
NATIONSBANK DISCIPLINED EQUITY STYLE. The Disciplined Equity Portfolio
is managed by the Adviser using the NationsBank Disciplined Equity Style. The
NationsBank Disciplined Equity Style investment philosophy seeks to identify
companies which offer future near-term earnings momentum.
The Adviser pursues this investment philosophy through the use of a
proprietary computerized tracking system (the "Alpha Model") which monitors the
earnings per share estimates of approximately 3,000 Wall Street analysts, and
through conventional securities analysis. In utilizing the computerized tracking
system, the Adviser identifies a company with respect to which there has been a
change in the consensus analyst estimate of earnings per share. The Adviser
believes that such a change often signifies the beginning of a trend for the
company, rather than an isolated occurrence, and that such trend ultimately will
be reflected in the share price of the company. The Adviser then buys or sells
stocks for the Portfolio based on the results of this analysis.
In selecting stocks pursuant to the NationsBank Disciplined Equity
Style, the Adviser also uses conventional securities analysis techniques.
Starting with a universe of approximately 2,000 companies with large market
capitalizations, the Adviser eliminates stocks that have relatively low trading
activity, as well as stocks of companies of poor credit quality and those which,
in the opinion of the Adviser, are overpriced. From the available pool of stocks
that meet all of the criteria, approximately 40 to 50 are selected for inclusion
in the Portfolio.
INTERNATIONAL GROWTH STYLE. The International Growth Style investment
philosophy is premised on the belief that a diversified portfolio of equity
securities of established, non-United States issuers can provide long-term
growth of capital and income.
This style focuses on the country selection process by utilizing
macroeconomic forecasts to identify areas of the world which will exhibit
relatively strong growth within the context of a modest inflation and low
interest rate environment. The political factors and market liquidity
constraints which can affect stock market valuations are also taken into
consideration by the Adviser prior to making stock selections.
The stock selection process begins with the elimination of equity
securities with a market capitalization of less than $250 million. The next step
in the process is the ranking of each country and industry sector by relative
price/earnings ratio using an historical range of not less than ten years from a
universe of approximately 1,000 stocks. In addition to the relative historical
price/earnings ratio, the portfolio managers also employ a fundamental analysis
of growth opportunities, management and future direction of these stocks.
The International Growth Portfolio is a dollar-denominated mutual fund and
therefore, consideration is given to hedging part or all of the Portfolio back
to U.S. dollars from international currencies. All decisions to hedge are based
upon an analysis of the relative value of the U.S. dollar on an international
purchasing power parity basis (purchasing power parity is a method for
determining the relative purchasing power of different currencies by comparing
the amount of each currency required to purchase a typical bundle of goods and
services to domestic markets) and an estimation of short-term interest rate
differentials (which affect both the direction of currency movements and also
the cost of hedging).
ADMINISTRATOR AND CO-ADMINISTRATOR
Stephens Inc. (the "Administrator"), 111 Center Street, Suite 300,
Little Rock, AR 72201, serves as Administrator of the Trust, and First Data
Investor Services Group, Inc. (the "Co-Administrator"), One Exchange Place,
B0S885, 8th Floor, Boston, MA 02109, serves as the Co-Administrator of the
Trust. NBAI serves as Sub-Administrator (the "Sub-Administrator") for the Trust.
The Administrator, Co-Administrator and Sub-Administrator serve under an
administration agreement ("Administration Agreement"), co-administration
agreement ("Co-Administration Agreement") and sub-administration agreement
("Sub-Administration Agreement"), respectively, each of which was approved by
the Board of Trustees on December 9, 1997 for a period of two years. The
Administrator receives, as compensation for its services rendered under the
Administration Agreement and as agent for the Co-Administrator for the services
it provides under the Co-Administration Agreement, an administrative fee,
computed daily and paid monthly, at the
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<PAGE>
annual rate of 0.10% of the average daily net assets of each Portfolio. For
providing Sub-Administration Service, NBAI is entitled to receive a monthly fee
from Stephens based on an annual rate of .01% of the Portfolios' average daily
net assets.
Pursuant to the Administration Agreement, the Administrator has agreed to,
among other things, (i) maintain office facilities for the Portfolios, (ii)
furnish statistical and research data, data processing, clerical, and internal
executive and administrative services to each Portfolio, (iii) furnish corporate
secretarial services to each Portfolio, including coordinating the preparation
and distribution of materials for Board of Trustees meetings, (iv) coordinate
the provision of legal advice to the Trust with respect to regulatory matters,
(v) coordinate the preparation of reports to each Portfolio's shareholders and
the SEC, including annual and semi-annual reports, (vi) coordinating the
provision of services to each Portfolio by the Co-Administrator, the Transfer
Agents and the Custodians, and (vii) generally assist in all aspects of each
Portfolio's operations. Additionally, the Administrator is authorized to
receive, as agent for the Co-Administrator, the fees payable to the
Co-Administrator by each Portfolio for its services rendered under the
Co-Administration Agreement. The Administrator bears all expenses incurred in
connection with the performance of its services.
Pursuant to the Co-Administration Agreement, the Co-Administrator has
agreed to, among other things, (i) provide accounting and bookkeeping services
for the Portfolios, (ii) compute each Portfolio's net asset value and net
income, (iii) accumulate information required for the Trust's reports to
shareholders and the SEC, (iv) prepare and file each Portfolio's Federal and
state tax returns, (v) perform monthly compliance testing for the Trust, and
(vi) prepare and furnish the Trust monthly broker security transaction summaries
and transaction listings and performance information. The Co-Administrator bears
all expenses incurred in connection with the performance of its services.
Pursuant to the Sub-Administration Agreement, the Sub-Administrator has
agreed to assist in supervising various aspects of the Portfolios'
administrative operations including:
(a) Coordinating the preparation and printing of
prospectuses and prospectus supplements;
(b) Coordinating the solicitation of shareholder proxies,
including the mailing of proxy materials and the hiring of proxy solicitors;
(c) Coordinating the holding of shareholder meetings;
(d) Coordinating the holding of Board of Trustees meetings;
(e) Monitoring, on a daily basis, the compliance of each
investment portfolio of the Portfolios with its investment objective, policies,
restrictions, tax matters and applicable laws and regulations;
(f) Coordinating the mailing of reports and other
correspondence to shareholders of record of the Portfolios;
(g) Maintaining a secondary facility for the retention of
records required to be kept by the Portfolios;
(h) Maintaining a compliance manual, and overseeing
compliance with, all compliance procedures adopted by the Portfolios;
(i) Coordinating the preparation and printing of reports to
shareholders of the Portfolios and the SEC, including, but not necessarily
limited to, Annual Reports and Semi-Annual Reports to Shareholders and on Form
N-SAR;
(j) Coordinating annual audits of the Portfolios; and
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(k) Reviewing and evaluating the services provided to the
Portfolios by service providers.
The Administration Agreement, Co-Administration Agreement and
Sub-Administration Agreement may be terminated by a vote of a majority of the
Board of Trustees or by the Administrator, Co-Administrator or
Sub-Administrator, respectively, on 60 days' written notice without penalty. The
Administration Agreement, Co-Administration Agreement or Sub-Administration are
not assignable without the written consent of the other party. Furthermore, the
Administration Agreement, Co-Administration Agreement and Sub-Administration
Agreement provide that the Administrator, Co-Administrator or Sub-Administrator,
respectively, shall not be liable to the Portfolios or to their shareholders
except in the case of the Administrator's, Co-Administrator's or
Sub-Administrator's, respectively, willful misfeasance, bad faith, gross
negligence or reckless disregard of duty.
CUSTODIAN AND TRANSFER AGENT
First Data, a wholly owned subsidiary of First Data Corporation, which
is located at One Exchange Place, Boston, Massachusetts 02109, acts as Transfer
Agent for the Trust's shares. Under the transfer agency agreement, the Transfer
Agent maintains the shareholder account records for the Trust, handles certain
communications between shareholders and the Trust, and distributes dividends and
distributions payable by the Trust to shareholders, and produces statements with
respect to account activity for the Trust and its shareholders, for these
services. The Transfer Agent receives a monthly fee computed on the basis of the
number of shareholder accounts that it maintains for the Trust during the month
and is reimbursed for out-of-pocket expenses.
NationsBank of Texas, N.A., 901 Main Street, Dallas, Texas 75201,
serves as Custodian for each Portfolio except the International Growth
Portfolio. As Custodian, NationsBank of Texas, N.A., maintains custody of such
Portfolios' securities, cash and other property, delivers securities against
payment upon sale and pays for securities against delivery upon purchase, makes
payments on behalf of such Portfolios for payments of dividends, distributions
and redemptions, endorses and collects on behalf of such Portfolios all checks,
and receives all dividends and other distributions made on securities owned by
such Portfolios. For such services, NationsBank of Texas, N.A., is entitled to
receive, in addition to out-of-pocket expenses, fees, payable at the rate of (i)
$300,000 per annum, to be paid monthly in payments of $25,000 for Custodian
services for up to and including 50 Funds or Portfolios in the Nations Funds
Family, and (ii) $6,000 per annum, to be paid in equal monthly payments, for
Custodian services for each additional portfolio above 50 Funds or Portfolios.
The Bank of New York ("BONY"), 90 Washington Street, New York, New York
10286, serves as Custodian for the International Growth Portfolio and serves as
Sub-Custodian for the portfolio securities and cash of all other Portfolio of
the Trust. In return for providing Sub-Custodial Services, BONY receives, in
addition to out-of-pocket expenses, fees at the rate of .75% per annum on
aggregate net assets of all Nations' non-money market funds or Portfolios up to
$10 billion, and (ii) .50% on the excess including all Nations' money market
funds or Portfolios up to $10 billion, and (iii) .50% on the excess including
all Nations money market funds.
SHAREHOLDER SERVICING AND DISTRIBUTION PLAN
The Portfolios have adopted a Shareholder Servicing and Distribution
Plan (the "Servicing and Distribution Plan") pursuant to Rule 12b-1 under the
1940 Act under which the Portfolios may pay banks, broker/dealers, Participating
Insurance Companies (as defined in the Prospectus) or other financial
institutions that have entered into a Sales Support Agreement with the
Distributor ("Selling Agents") or a Shareholder Servicing Agreement with the
Trust ("Servicing Agents") (together with Selling Agents ("Agents")) for certain
expenses that are incurred by the Agents in connection with sales support and
shareholder support services that are provided by the Agents. Payments under the
Servicing and Distribution Plan will be calculated daily and paid monthly at a
rate not exceeding 0.25% (on an annualized basis) of the average daily net asset
value of the Shares beneficially owned through the ownership of Contracts by
customers with whom the Agents have a relationship. Under the Servicing and
Distribution Plan, the shareholder services provided by Servicing Agents may
include general shareholder liaison services, processing purchases and
redemption requests; processing dividend and distribution payments; providing
sales information periodically to customers, including information showing their
Contracts' positions in the Portfolios; providing sub-accounting; responding to
inquiries from customers; arranging for bank wires; and providing such other
similar
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services as may be reasonably requested. Under the Servicing and Distribution
Plan, the Trust may make payments in connection with any activity which is
primarily intended to result in the sale of the Shares, including, but not
limited to, expenses of organizing and conducting sales seminars, printing of
prospectuses and statements of additional information (and supplements thereto)
and reports for other than existing shareholders, preparation and distribution
of advertising material and sales literature, supplemental payments to the
Trust's Distributor and the cost of administering this Servicing and
Distribution Plan, as well as the shareholder servicing activities described
above.
EXPENSES
The Administrator furnishes, without additional cost to the Trust, the
services of the Treasurer and Secretary of the Trust and such other personnel
(other than the personnel of the Adviser) as are required for the proper conduct
of the Trust's affairs. The Distributor bears the incremental expenses of
printing and distributing prospectuses used by the Distributor or furnished by
the Distributor to investors in connection with the public offering of the
Trust's shares and the costs of any other promotional or sales literature.
The Trust pays or causes to be paid all other expenses of the Trust,
including, without limitation: the fees of the Adviser, the Administrator,
Co-Administrator and Sub-Administrator; the charges and expenses of any
registrar, any Custodian or depository appointed by the Trust for the
safekeeping of its cash, portfolio securities and other property, and any
Transfer Agent, dividend or accounting agent or agents appointed by the Trust;
brokerage commissions chargeable to the Trust in connection with portfolio
securities transactions to which the Trust is a party; all taxes, including
securities issuance and transfer taxes; corporate fees payable by the Trust to
federal, state or other governmental agencies; all costs and expenses in
connection with the registration and maintenance of registration of the Trust
and its shares with the SEC and various states and other jurisdictions
(including filing fees, legal fees and disbursements of counsel); the costs and
expenses of typesetting prospectuses and statements of additional information of
the Trust (including supplements thereto) and periodic reports and of printing
and distributing such prospectuses and statements of additional information
(including supplements thereto) to the Trust's shareholders; all expenses of
shareholders' and Trustees' meetings and of preparing, printing and mailing
proxy statements and reports to shareholders; fees and travel expenses of
Trustees or Trustee members of any advisory board or committee; all expenses
incident to the payment of any dividend or distribution, whether in shares or
cash; charges and expenses of any outside service used for pricing of the
Trust's shares; fees and expenses of legal counsel and of independent auditors
in connection with any matter relating to the Trust; membership dues of industry
associations; interest payable on Trust borrowings; postage and long-distance
telephone charges; insurance premiums on property or personnel (including
officers and Trustees) of the Trust which inure to its benefit; extraordinary
expenses (including, but not limited to, legal claims and liabilities and
litigation costs and any indemnification related thereto); and all other charges
and costs of the Trust's operation unless otherwise explicitly assumed by the
Adviser, the Administrator or Co-Administrator.
Expenses of the Trust which are not directly attributable to the
operations of any Portfolio are pro-rated among all Portfolios of the Trust
based upon the relative net assets of each Portfolio.
The Advisory Agreement, the Sub-Advisory Agreements, and the
Administration Agreement require NBAI, TradeStreet, Gartmore, and the
Administrator to reduce their fees to the extent required to satisfy any expense
limitations which may be imposed by the securities laws or regulations
thereunder of any state in which a Portfolio's shares are registered or
qualified for sale, as such limitations may be raised or lowered from time to
time, and the aggregate of all such investment advisory, sub-advisory, and
administration fees shall be reduced by the amount of such excess. The amount of
any such reduction to be borne by NBAI, TradeStreet, Gartmore or the
Administrator shall be deducted from the monthly investment advisory and
administration fees otherwise payable to NBAI, TradeStreet, Gartmore, and the
Administrator during such fiscal year. If required pursuant to such state
securities regulations, NBAI, TradeStreet, Gartmore, and the Administrator will
reimburse the Trust no later than the last day of the first month of the next
succeeding fiscal year, for any such annual operating expenses (after reduction
of all investment advisory and administration fees in excess of such
limitation).
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DISTRIBUTOR
Stephens Inc. (the "Distributor") serves as the principal underwriter
and distributor of the shares of the Portfolios.
Pursuant to a distribution agreement (the "Distribution Agreement"),
the Distributor, as agent, sells shares of the Portfolios on a continuous basis
and transmits purchase and redemption orders that its receives to the Trust or
the Transfer Agent. Additionally, the Distributor has agreed to use appropriate
efforts to solicit orders for the sale of shares and to undertake such
advertising and promotion as it believes appropriate in connection with such
solicitation. Pursuant to the Distribution Agreement, the Distributor, at its
own expense, finances those activities which are primarily intended to result in
the sale of shares of the Portfolios, including, but not limited to,
advertising, compensation of underwriters, dealers and sales personnel, the
printing of prospectuses to other than existing shareholders, and the printing
and mailing of sales literature. The Distributor, however, may be reimbursed for
all or a portion of such expenses to the extent permitted by the Distribution
Agreement adopted by the Trust pursuant to Rule 12b-1 under the 1940 Act.
The Distribution Agreement will continue year to year as long as such
continuance is approved at least annually by (i) the Board of Trustees or a vote
of the majority (as defined in the 1940 Act) of the outstanding voting
securities of the Portfolio and (ii) a majority of the Trustees who are not
parties to the Distribution Agreement or "interested persons" of any such party
by a vote cast in person at a meeting called for such purpose. The Distribution
Agreement is not assignable and is terminable with respect to a Portfolio,
without penalty, on 60 days' notice by the Board of Trustees, the vote of a
majority (as defined in the 1940 Act) of the outstanding voting securities of
the Portfolio, or by the Distributor.
INDEPENDENT ACCOUNTANT AND REPORTS
At least semi-annually, the Trust will furnish shareholders of the
Portfolios with a list of the investments held in the Portfolios and financial
statements for the Portfolios. The annual financial statements will be audited
by the Trust's independent accountant. The Board of Trustees has selected Price
Waterhouse, LLP, 160 Federal Street, Boston, Massachusetts, 02110 as the Trust's
independent accountant to audit the Trust's books and review the Trust's tax
returns.
The Annual Reports, when available, will be sent free of charge with
this SAI to any shareholder who requests this SAI.
COUNSEL
Morrison & Foerster LLP serves as legal counsel to the Trust. Their
address is 2000 Pennsylvania Avenue, N.W., Washington, D.C. 20006.
ADDITIONAL INFORMATION ON PERFORMANCE
YIELD INFORMATION AND OTHER PERFORMANCE INFORMATION FOR THE TRUST'S
PORTFOLIOS MAY BE OBTAINED BY CALLING THE TRUST AT (800) 321-7854.
From time to time, the yield and total return of a Portfolio's shares
may be quoted in advertisements, shareholder reports, and other communications
to shareholders. Each Portfolio of the Trust also may quote information obtained
from the Investment Company Institute in its advertising materials and sales
literature. In addition, certain potential benefits of investing in world
securities markets may be discussed in promotional materials. Such benefits
include, but are not limited to: (a) the expanded opportunities for investment
in securities markets outside the U.S.; (b) the growth of securities markets
outside the U.S. vis-a-vis U.S. markets; (c) the relative return associated with
foreign securities markets vis-a-vis U.S. markets; and (d) a reduced risk of
portfolio volatility resulting from a diversified securities portfolio
consisting of both U.S. and foreign securities.
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YIELD CALCULATIONS
The yield of the Portfolios is a measure of the net investment income
per share (as defined) earned over a 30-day period expressed as a percentage of
the maximum offering price of a share of such classes at the end of the period.
The Trust's yield figures are determined by dividing the net investment
income per share earned during the specified 30-day period by the maximum
offering price per share on the last day of the period, according to the
following formula:
Yield = 2[(a-b + 1)6-1]
cd
Where: a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = average daily number of shares outstanding during
the period that were entitled to receive dividends
d = maximum offering price per share on the last day of the period
For purposes of yield quotation, income is calculated in accordance
with standardized methods applicable to all stock and bond mutual funds. In
general, interest income is reduced with respect to bonds trading at a premium
over their par value by subtracting a portion of the premium from income on a
daily basis, and is increased with respect to bonds trading at a discount by
adding a portion of the discount to daily income.
Capital gains and losses are excluded from the calculation.
Income calculated for the purposes of calculating a Portfolio's yield
differs from income as determined for other accounting purposes. Because of the
different accounting methods used, and because of the compounding assumed in
yield calculations, the yield quoted for a Portfolio may differ from the rate of
distributions a Portfolio paid over the same period or the rate of income
reported in the Portfolio's financial statements.
TOTAL RETURN CALCULATIONS
Total return measures both the net investment income generated by, and
the effect of any realized or unrealized appreciation or depreciation of the
underlying investments in a Portfolio. The Portfolios' average annual and
cumulative total return figures are computed in accordance with the standardized
methods prescribed by the SEC.
Average annual total return figures are computed by determining the
average annual compounded rates of return over the periods indicated in the
advertisement, sales literature or shareholders' report that would equate the
initial amount invested to the ending redeemable value, according to the
following formula:
P(1 + T)n = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value at the end of the period of
a hypothetical $1,000 payment made at the beginning
of such period.
This calculation, (i) assumes all dividends and distributions are
reinvested at net asset value on the appropriate reinvestment dates as described
in the Prospectus, and (ii) deducts (a) the maximum sales charge from the
hypothetical initial $1,000 investment, and (b) all recurring fees, such as
advisory and administrative fees, charged as expenses to all shareholder
accounts.
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Cumulative total return is computed by finding the cumulative
compounded rate of return over the period indicated in the advertisement that
would equate the initial amount invested to the ending redeemable value,
according to the following formula:
CTR = (ERV-P) 100
P
Where: CTR = cumulative total return
ERV = ending redeemable value at the end of the period of
a hypothetical $1,000 payment made at the beginning
of such period
P = initial payment of $1,000.
This calculation, (i) assumes all dividends and distributions are
reinvested at net asset value on the appropriate reinvestment dates as described
in the Prospectus, and (ii) deducts (a) the maximum sales charge from the
hypothetical initial $1,000 investment, and (b) all recurring fees, such as
advisory and administrative fees, charged as expenses to all shareholder
accounts.
Each Portfolio may quote information obtained from the Investment
Company Institute, national financial publications, trade journals and other
industry sources in its advertising and sales literature. In addition, the
Portfolios also may compare the performance and yield of a class or series of
shares to those of other funds with similar investment objectives and to other
relevant indices or to rankings prepared by independent services or other
financial or industry publications that monitor the performance of mutual funds.
For example, the performance and yield of a class of shares in a Portfolio may
be compared to data prepared by Lipper Analytical Services, Inc. Performance and
yield data as reported in national financial publications such as MONEY
MAGAZINE, FORBES, BARRON'S, THE WALL STREET JOURNAL, and THE NEW YORK TIMES, or
in publications of a local or regional nature, also may be used in comparing the
performance of a class of shares in a Portfolio.
Any given performance comparison should not be considered
representative of a Portfolio's performance for any future period.
MISCELLANEOUS
CERTAIN RECORD HOLDERS
As of the date of this SAI, Stephens owned of record more than 25% of
the outstanding shares of the Trust acting as sponsor and may be deemed a
controlling person of the Trust under the 1940 Act.
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SCHEDULE A
DESCRIPTION OF RATINGS
The following summarizes the highest six ratings used by Standard &
Poor's Corporation ("S&P") for corporate and municipal bonds. The first four
ratings denote investment-grade securities.
AAA - This is the highest rating assigned by S&P to a debt
obligation and indicates an extremely strong capacity to pay interest
and repay principal.
AA - Debt rated AA is considered to have a very strong capacity to
pay interest and repay principal and differs from AAA issues only in a
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 for those
in higher-rated categories.
BB, B - Bonds rated BB and B are regarded, on balance as
predominantly speculative with respect to capacity to pay interest and
repay principal in accordance with the terms of the obligation. 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. 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.
To provide more detailed indications of credit quality, the AA, A and
BBB, BB and B ratings may be modified by the addition of a plus or minus sign to
show relative standing within these major rating categories.
The following summarizes the highest six ratings used by Moody's
Investors Service, Inc. ("Moody's") for corporate and municipal bonds. The first
four denote investment grade securities.
Aaa - Bonds that 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 edge." 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 that 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
risks appear somewhat larger than in Aaa securities.
A - Bonds that are rated A possess many favorable investment
attributes and are to be considered 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
sometime in the future.
Baa - Bonds that are rated Baa are considered medium grade
obligations (i.e., they are neither highly protected nor poorly secured).
Interest payments and principal security appear adequate for the present
but
A-1
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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 that are rated Ba are judged to have speculative
elements; their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and
thereby not as well safeguarded during both good times and bad times over
the future. Uncertainty of position characterizes bonds in this class.
B - Bonds that 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.
Moody's applies numerical modifiers (1, 2 and 3) with respect to
corporate bonds rated Aa through B. The modifier 1 indicates that the bond being
rated ranks in the higher end of its generic rating category; the modifier 2
indicates a mid-range ranking; and the modifier 3 indicates that the bond ranks
in the lower end of its generic rating category. With regard to municipal bonds,
those bonds in the Aa, A and Baa groups which Moody's believes possess the
strongest investment attributes are designated by the symbols Aal, A1 or Baal,
respectively.
The following summarizes the highest four ratings used by Duff & Phelps
Credit Rating Co. ("D&P") for bonds, each of which denotes that the securities
are investment grade.
AAA - Bonds that are rated AAA are of the highest credit quality.
The risk factors are considered to be negligible, being only slightly more
than for risk-free U.S. Treasury debt.
AA - Bonds that are rated AA are of high credit quality. Protection
factors are strong. Risk is modest but may vary slightly from time to time
because of economic conditions.
A - Bonds that are rated A have protection factors which are
average but adequate. However risk factors are more variable and greater
in periods of economic stress.
BBB - Bonds that are rated BBB have below average protection
factors but still are considered sufficient for prudent investment.
Considerable variability in risk exists during economic cycles.
To provide more detailed indications of credit quality, the AA, A and
BBB ratings may modified by the addition of a plus or minus sign to show
relative standing within these major categories.
The following summarizes the highest four ratings used by Fitch
Investors Service, Inc. ("Fitch") for bonds, each of which denotes that the
securities are investment grade:
AAA - Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by
reasonably foreseeable events.
AA - Bonds considered to be investment grade and of very high
credit quality. The obligor's ability to pay interest and repay principal
is very strong, although not quite as strong as bonds rated AAA. Because
bonds rated in the AAA and AA categories are not significantly vulnerable
to foreseeable future developments, short-term debt of these issuers is
generally rated F-1+.
A - Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
BBB - Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal
is considered to be adequate. Adverse changes in economic conditions and
A-2
<PAGE>
circumstances, however, are more likely to have adverse impact on these
bonds, and therefore impair timely payment. The likelihood that the
ratings of these bonds will fall below investment grade is higher than for
bonds with higher ratings.
To provide more detailed indications of credit quality, the AA, A and
BBB ratings may be modified by the addition of a plus or minus sign to show
relative standing within these major rating categories.
The following summarizes the two highest ratings used by Moody's for
short-term municipal notes and variable-rate demand obligations:
MIG-1/VMIG-1 - Obligations bearing these designations are of the best
quality, enjoying strong protection from established cash flows, superior
liquidity support or demonstrated broad-based access to the market for
refinancing.
MIG-2/VMIG-2 - Obligations bearing these designations are of high
quality, with ample margins of protection although not so large as in the
preceding group.
The following summarizes the two highest ratings used by S&P for
short-term municipal notes:
SP-1 - Indicates very strong or strong capacity to pay principal and
interest. Those issues determined to possess overwhelming safety characteristics
are given a "plus" (+) designation.
SP-2 - Indicates satisfactory capacity to pay principal and interest.
The three highest rating categories of D&P for short-term debt, each of
which denotes that the securities are investment grade, are D-1, D-2, and D-3.
D&P employs three designations, D-1+, D-1 and D-1-, within the highest rating
category. D-1+ indicates highest certainty of timely payment. Short-term
liquidity, including internal operating factors and/or access to alternative
sources of portfolios, is judged to be "outstanding, and safety is just below
risk-free U.S. Treasury short-term obligations." D-1 indicates very high
certainty of timely payment. Liquidity factors are excellent and supported by
good fundamental protection factors. Risk factors are considered to be minor.
D-1 indicates high certainty of timely payment. Liquidity factors are strong and
supported by good fundamental protection factors. Risk factors are very small.
D-2 indicates good certainty of timely payment. Liquidity factors and trust
fundamentals are sound. Although ongoing portfolioing needs may enlarge total
financing requirements, access to capital markets is good. Risk factors are
small. D-3 indicates satisfactory liquidity and other protection factors which
qualify the issue as investment grade. Risk factors are larger and subject to
more variation. Nevertheless, timely payment is expected.
The following summarizes the two highest rating categories used by
Fitch for short-term obligations each of which denotes that the securities are
investment grade:
F-1+ - Securities possess exceptionally strong credit quality. Issues
assigned this rating are regarded as having the strongest degree of assurance
for timely payment.
F-1 - Securities possess 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 - Securities possess good credit quality. Issues carrying this
rating have a satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as for issues assigned the F-1+ and F-1
ratings.
Commercial paper rated A-1 by S&P indicates that the degree of safety
regarding timely payment is strong. Those issues determined to possess extremely
strong safety characteristics are denoted A-1+. Capacity for timely payment on
commercial paper rated A-2 is satisfactory, but the relative degree of safety is
not as high as for issues designated A-1.
A-3
<PAGE>
The rating Prime-1 is the highest commercial paper rating assigned by
Moody's. Issuers rated Prime-1 (or related supporting institutions) are
considered to have a superior capacity for repayment of senior short-term
promissory obligations. Issuers rated Prime-2 (or related supporting
institutions) are considered to have a strong capacity for repayment of senior
short-term promissory obligations. This will normally be evidenced by many of
the characteristics of issuers rated Prime-1, 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.
For commercial paper, D&P uses the short-term debt ratings described
above.
For commercial paper, Fitch uses the short-term debt ratings described
above.
Thomson BankWatch, Inc. ("BankWatch") ratings are based upon a
qualitative and quantitative analysis of all segments of the organization
including, where applicable, holding trust and operating subsidiaries. BankWatch
ratings do not constitute a recommendation to buy or sell securities of any of
these trust. Further, BankWatch does not suggest specific investment criteria
for individual clients.
BankWatch long-term ratings apply to specific issues of long-term debt
and preferred stock. The long-term ratings specifically assess the likelihood of
untimely payment of principal or interest over the term to maturity of the rated
instrument. The following are the four investment grade ratings used by
BankWatch for long-term debt:
AAA - The highest category; indicates ability to repay principal
and interest on a timely basis is extremely high.
AA - The second highest category; indicates a very strong ability
to repay principal and interest on a timely basis with limited incremental
risk versus issues rated in the highest category.
A - The third highest category; indicates the ability to repay
principal and interest is strong. Issues rated "A" could be more
vulnerable to adverse developments (both internal and external) than
obligations with higher ratings.
BBB - The lowest investment grade category; indicates an acceptable
capacity to repay principal and interest. Issues rated "BBB" are, however,
more vulnerable to adverse developments (both internal and external) than
obligations with higher ratings.
Long-term debt ratings may include a plus (+) or minus (-) sign to
indicate where within a category the issue is placed.
The BankWatch short-term ratings apply to commercial paper, other
senior short-term obligations and deposit obligations of the entities to which
the rating has been assigned. The BankWatch short-term ratings specifically
assess the likelihood of an untimely payment 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
more susceptible to adverse developments (both internal and external) than
obligations with higher ratings, 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.
A-4
<PAGE>
The following summarizes the four highest long-term debt ratings used
by IBCA Limited and its affiliate, IBCA Inc. (collectively "IBCA"):
AAA - Obligations for which there is the lowest expectation of
investment risk. Capacity for timely repayment of principal and
interest is substantial such that adverse changes in business, economic
or financial conditions are unlikely to increase investment risk
significantly.
AA - Obligations for which there is a very low expectation of
investment risk. Capacity for timely repayment of principal and
interest is substantial. Adverse changes in business, economic or
financial conditions may increase investment risk albeit not very
significantly.
A - Obligations for which there is a low expectation of investment
risk. Capacity for timely repayment of principal and interest is
strong, although adverse changes in business, economic or financial
conditions may lead to increased investment risk.
BBB - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and
interest is adequate, although adverse changes in business, economic or
financial conditions are more likely to lead to increased investment
risk than for obligations in other categories.
A plus or minus sign may be appended to a rating below AAA to denote
relative status within major rating categories.
The following summarizes the two highest short-term debt ratings used by
IBCA:
A1+ - When issues possess a particularly strong credit feature, a
rating of A1+ is assigned.
A1 - Obligations supported by the highest capacity for timely
repayment.
A2 - Obligations supported by a good capacity for timely repayment.
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SCHEDULE B
ADDITIONAL INFORMATION CONCERNING
OPTIONS & FUTURES
As stated in the Prospectus, each Portfolio, may enter into futures
contracts and options for hedging purposes. Such transactions are described in
this Schedule. During the current fiscal year, each of the Portfolios intends to
limit its transactions in futures contracts and options so that not more than 5%
of the Portfolio's net assets are at risk. Furthermore, in no event would any
Portfolio purchase or sell futures contracts, or related options thereon, for
hedging purposes if, immediately thereafter, the aggregate initial margin that
is required to be posted by the Portfolio under the rules of the exchange on
which the futures contract (or futures option) is traded, plus any premiums paid
by the Portfolio on its open futures options positions, exceeds 5% of the
Portfolio's total assets, after taking into account any unrealized profits and
unrealized losses on the Portfolio's open contracts and excluding the amount
that a futures option is "in-the-money" at the time of purchase. (An option to
buy a futures contract is "in-the-money" if the value of the contract that is
subject to the option exceeds the exercise price; an option to sell a futures
contract is "in-the-money" if the exercise price exceeds the value of the
contract that is subject of the option.)
I. Interest Rate Futures Contracts.
Use of Interest Rate Futures Contracts. Bond prices are established in
both the cash market and the futures market. In the cash market, bonds are
purchased and sold with payment for the full purchase price of the bond being
made in cash, generally within five business days after the trade. In the
futures market, only a contract is made to purchase or sell a bond in the future
for a set price on a certain date. Historically, the prices for bonds
established in the futures market have tended to move generally in the aggregate
in concert with the cash market prices and have maintained fairly predictable
relationships. Accordingly, a Portfolio may use interest rate futures as a
defense, or hedge, against anticipated interest rate changes and not for
speculation. As described below, this would include the use of futures contract
sales to protect against expected increases in interest rates and futures
contract purchases to offset the impact of interest rate declines.
A Portfolio presently could accomplish a similar result to that which
it hopes to achieve through the use of futures contracts by selling bonds with
long maturities and investing in bonds with short maturities when interest rates
are expected to increase, or conversely, selling short-term bonds and investing
in long-term bonds when interest rates are expected to decline. However, because
of the liquidity that is often available in the futures market the protection is
more likely to be achieved, perhaps at a lower cost and without changing the
rate of interest being earned by the Portfolio, through using futures contracts.
Description of Interest Rates Futures Contracts. An interest rate
futures contract sale would create an obligation by a Portfolio, as seller, to
deliver the specific type of financial instrument called for in the contract at
a specific future time for a specified price. A futures contract purchase would
create an obligation by the Portfolio, as purchaser, to take delivery of the
specific type of financial instrument at a specific future time at a specific
price. The specific securities delivered or taken, respectively, at settlement
date, would not be determined until at or near that date. The determination
would be in accordance with the rules of the exchange on which the futures
contract sale or purchase was made.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of securities, in most cases the contracts are closed out
before the settlement date without the making or taking of delivery of
securities. Closing out a futures contract sale is effected by the Portfolio's
entering into a futures contract purchase for the same aggregate amount of the
specific type of financial instrument and the same delivery date. If the price
in the sale exceeds the price in the offsetting purchase, the Portfolio is paid
the difference and thus realizes a gain. If the offsetting purchase price
exceeds the sale price, the Portfolio pays the difference and realizes a loss.
Similarly, the closing out of a futures contract purchase is effected by the
Portfolio's entering into a futures contract sale. If the offsetting sale price
exceeds the purchase price, the Portfolio realizes a gain, and if the purchase
price exceeds the offsetting sale price, the Portfolio realizes a loss.
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Interest rate futures contracts are traded in an auction environment on
the floors of several exchanges - principally, the Chicago Board of Trade, the
Chicago Mercantile Exchange and the New York Futures Exchange. A Portfolio would
deal only in standardized contracts on recognized exchanges. Each exchange
guarantees performance under contract provisions through a clearing corporation,
a nonprofit organization managed by the exchange membership.
A public market now exists in futures contracts covering various
financial instruments including long-term United States Treasury Bonds and
Notes; Government National Mortgage Association ("GNMA") modified pass-through
mortgage-backed securities; three-month United States Treasury Bills; and
ninety-day commercial paper. The Portfolios may trade in any futures contract
for which there exists a public market, including, without limitation, the
foregoing instruments.
Examples of Futures Contract Sales. A Portfolio would engage in an
interest rate futures contract sale to maintain the income advantage from
continued holding of a long-term bond while endeavoring to avoid part or all of
the loss in market value that would otherwise act Trust a decline in long-term
securities prices. Assume that the market value of a certain security in a
Portfolio tends to move in concert with the futures market prices of long-term
United States Treasury Bonds ("Treasury Bonds"). The Adviser wishes to fix the
current market value of this portfolio security until some point in the future.
Assume the portfolio security has a market value of 100, and the Adviser
believes that, because of an anticipated rise in interest rates, the value will
decline to 95. The Portfolio might enter into futures contract sales of Treasury
Bonds for an equivalent of 98. If the market value of the portfolio securities
does indeed decline from 100 to 95, the equivalent futures market price for the
Treasury Bonds might also decline from 98 to 93.
In that case, the five-point loss in the market value of the portfolio
security would be offset by the five-point gain realized by closing out the
futures contract sale. Of course, the futures market price of Treasury Bonds
might well decline to more than 93 or to less than 93 because of the imperfect
correlation between cash and futures prices mentioned below.
The Adviser could be wrong in its forecast of interest rates and the
equivalent futures market price could rise above 98. In this case, the market
value of the portfolio securities, including the portfolio security being
protected, would increase. The benefit of this increase would be reduced by the
loss realized on closing out the futures contract sale.
If interest rate levels did not change, the Portfolio in the above
example might incur a loss of 2 points (which might be reduced by an offsetting
transaction prior to the settlement date). In each transaction, transaction
expenses would also be incurred.
Examples of Future Contract Purchases. A Portfolio would engage in an
interest rate futures contract purchase when it is not fully invested in
long-term bonds but wishes to defer for a time the purchase of long-term bonds
in light of the availability of advantageous interim investments, e.g.,
shorter-term securities whose yields are greater than those available on
long-term bonds. The Portfolio's basic motivation would be to maintain for a
time the income advantage from investing in the short-term securities; the
Portfolio would be endeavoring at the same time to eliminate the effect of all
or part of an expected increase in market price of the long-term bonds that the
Portfolio may purchase.
For example, assume that the market price of a long-term bond that the
Portfolio may purchase, currently yielding 10%, tends to move in concert with
futures market prices of Treasury Bonds. The Adviser wishes to fix the current
market price (and thus 10% yield) of the long-term bond until the time (four
months away in this example) when it may purchase the bond. Assume the long-term
bond has a market price of 100, and the Adviser believes that, because of an
anticipated fall in interest rates, the price will have risen to 105 (and the
yield will have dropped to about 9-1/2%) in four months. The Portfolio might
enter into futures contracts purchases of Treasury Bonds for an equivalent price
of 98. At the same time, the Portfolio would assign a pool of investments in
short-term securities that are either maturing in four months or earmarked for
sale in four months, for purchase of the long-term bond at an assumed market
price of 100. Assume these short-term securities are yielding 15%. If the market
price of the long-
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term bond does indeed rise from 100 to 105, the equivalent futures market price
for Treasury Bonds might also rise from 98 to 103. In that case, the 5-point
increase in the price that the Portfolio pays for the long-term bond would be
offset by the 5-point gain realized by closing out the futures contract
purchase.
The Adviser could be wrong in its forecast of interest rates; long-term
interest rates might rise to above 10%; and the equivalent futures market price
could fall below 98. If short-term rates at the same time fall to 10% or below,
it is possible that the Portfolio would continue with its purchase program for
long-term bonds. The market price of available long-term bonds would have
decreased. The benefit of this price decrease, and thus yield increase, will be
reduced by the loss realized on closing out the futures contract purchase.
If, however, short-term rates remained above available long-term rates,
it is possible that the Portfolio would discontinue its purchase program for
long-term bonds. The yield on short-term securities in the portfolio, including
those originally in the pool assigned to the particular long-term bond, would
remain higher than yields on long-term bonds. The benefit of this continued
incremental income will be reduced by the loss realized on closing out the
futures contract purchase.
In each transaction, expenses also would be incurred.
II. Index Futures Contracts.
A stock or bond index assigns relative values to the stocks or bonds
included in the index, and the index fluctuates with changes in the market
values of the stocks or bonds included. Some stock index futures contracts are
based on broad market indices, such as the Standard & Poor's 500 or the New York
Stock Exchange Composite Index. In contract, certain exchanges offer futures
contracts on narrower market indices, such as the Standard & Poor's 100, the
Bond Buyer Municipal Bond Index (an index composed of 40 term revenue and
general obligation bonds) or indices based on an industry or market segment,
such as oil and gas stocks. Futures contracts are traded on organized exchanges
regulated by the Commodity Futures Trading Commission. Transactions on such
exchanges are cleared through a clearing corporation, which guarantees the
performance of the parties to each contract.
A Portfolio will sell index futures contracts in order to offset a
decrease in market value of its portfolio securities that might otherwise result
from a market decline. The Portfolio may do so either to hedge the value of its
portfolio as a whole, or to protect against declines, occurring prior to sales
of securities, in the value of the securities to be sold. Conversely, a
Portfolio will purchase index futures contracts in anticipation of purchases of
securities. In a substantial majority of these transactions, the Portfolio will
purchase such securities upon termination of the long futures position, but a
long futures position may be terminated without a corresponding purchase of
securities.
In addition, a Portfolio may utilize index futures contracts in
anticipation of changes in the composition of its portfolio holdings. For
example, in the event that a Portfolio expects to narrow the range of industry
groups represented in its holdings it may, prior to making purchases of the
actual securities, establish a long futures position based on a more restricted
index, such as an index comprised of securities of a particular industry group.
A Portfolio also may sell futures contracts in connection with this strategy, in
order to protect against the possibility that the value of the securities to be
sold as part of the restructuring of the Portfolio will decline prior to the
time of sale.
The following are examples of transactions in stock index futures (net
of commissions and premiums, if any).
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ANTICIPATORY PURCHASE HEDGE: Buy the Future
Hedge Objective: Protect Against Increasing Price
<TABLE>
<CAPTION>
Portfolio Futures
<S> <C>
-Day Hedge is Placed
Anticipate Buying $62,500 Buying 1 Index Futures at 125
Equity Portfolio Value of Futures = $62,500/Contract
-Day Hedge is Lifted-
Buy Equity Portfolio with Sell 1 Index Futures at 130
Actual Cost = $65,000 Value of Futures = $65,000/Contract
Increase in Purchase Price = $2,500 Gain on Futures = $2,500
HEDGING A STOCK PORTFOLIO: Sell the Future Hedge
Objective: Protect Against Declining Value of the Portfolio
Factors
Value of Stock Portfolio = $1,000,000
Value of Futures Contract = 125 x $500 = $62,500
Portfolio Beta Relative to the Index - 1 0
Portfolio Futures
-Day Hedge is Placed
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
Equity Portfolio Value of Futures = $1,000,000
-Day Hedge is Lifted-
Equity Portfolio-Own Buy 16 Index Futures at 120
Stock with Value = $960,000 Value of Futures = $960,000
Loss in Portfolio Value = $40,000 Gain on Futures = $40,000
IF, HOWEVER, THE MARKET MOVED IN THE OPPOSITE DIRECTION, THAT IS, MARKET
VALUE DECREASED AND THE PORTFOLIO HAD ENTERED INTO AN ANTICIPATORY PURCHASE
HEDGE, OR MARKET VALUE INCREASED AND THE PORTFOLIO HAD HEDGED ITS STOCK
PORTFOLIO, THE RESULTS OF THE PORTFOLIO'S TRANSACTIONS IN STOCK INDEX FUTURES
WOULD BE AS SET FORTH BELOW.
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ANTICIPATORY PURCHASE HEDGE: Buy the Future
Hedge Objective: Protect Against Increasing Price
Portfolio Futures
-Day Hedge is Placed
Anticipate Buying $62,500 Buying 1 Index Futures at 125
Equity Portfolio Value of Futures = $62,500/Contract
-Day Hedge is Lifted-
Buy Equity Portfolio with Sell 1 Index Futures at 120
Actual Cost = $60,000 Value of Futures = $60,000/Contract
Decrease in Purchase Price = $2,500 Loss on Futures = $2,500
HEDGING A STOCK PORTFOLIO: Sell the Future
Hedge Objective: Protect Against Declining
Value of the Portfolio
Factors
Value of Stock Portfolio = $1,000,000
Value of Futures Contract = 125 x $500 = $62,500
Portfolio Beta Relative to the Index - 1 0
Portfolio Futures
-Day Hedge is Placed
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
Equity Portfolio Value of Futures = $1,000,000
-Day Hedge is Lifted-
Equity Portfolio-Own Buy 16 Index Futures at 130
Stock with Value = $1,040,000 Value of Futures = $1,040,000
Gain in Portfolio Value = $40 000 Loss on Futures = $40,000
</TABLE>
III. Margin Payments.
Unlike when a Portfolio purchases or sells a security, no price is paid
or received by the Portfolio upon the purchase or sale of a futures contract.
Initially, the Portfolio will be required to deposit with the broker or in a
segregated account with the Portfolio's Custodian an amount of cash or cash
equivalents, the value, of which may vary but is generally equal to 10% or less
of the value of the contract. This amount is known as initial margin. The nature
of initial margin in futures transactions is different from that of margin in
security transactions in that futures contract margin does not involve the
borrowing of portfolios by the customer to finance the transactions. Rather, the
initial margin is in the nature of a performance bond or good faith deposit on
the contract which is returned to the Portfolio upon termination of the futures
contract assuming all contractual obligations have been satisfied. Subsequent
payments, called variation margin, to and from the broker, will be made on a
daily basis as the price of the underlying security or index fluctuates making
the long and short positions in the futures contract more or less valuable, a
process known as marking to the market. For example, when a Portfolio has
purchased a futures contract
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and the price of the contract has risen in response to a rise in the underlying
instruments, that position will have increased in value and the Portfolio will
be entitled to receive from the broker a variation margin payment equal to that
increase in value. Conversely, where a Portfolio has purchased a futures
contract and the price of the futures contract has declined in response to a
decrease in the underlying instruments, the position would be less valuable, the
Portfolio would be required to make a variation margin payment to the broker. At
any time prior to expiration of the futures contract, the Adviser may elect to
close the position by taking an opposite position, subject to the availability
of a secondary market, which will operate to terminate the Portfolio's position
in the futures contract. A final determination of variation margin is then made,
additional cash is required to be paid by or released to the Portfolio, and the
Portfolio realizes a loss or gain.
IV. Risks of Transactions in Futures Contracts.
There are several risks in connection with the use of futures by a
Portfolio as a hedging device. One risk arises because of the imperfect
correlation between movements in the price of the future and movements in the
price of the securities which are the subject of the hedge. The price of the
future may move more than or less than the price of the securities being hedged.
If the price of the future moves less than the price of the securities which are
the subject of the hedge, the hedge will not be fully effective but, if the
price of securities being hedged has moved in an unfavorable direction, the
Portfolio would be in a better position than if it had not hedged at all. If the
price of the securities being hedged has moved in a favorable direction, this
advance will be partially offset by the loss on the future. If the price of the
future moves more than the price of the hedged securities, the Portfolio
involved will experience either a loss or gain on the future which will not be
completely offset by movements in the price of the securities which are the
subject of the hedge.
To compensate for the imperfect correlation of movements in the price
of securities being hedged and movements in the price of futures contracts, a
Portfolio may buy or sell futures contracts in a greater dollar amount than the
dollar amount of securities being hedged if the volatility over a particular
time period of the prices of such securities has been greater than the
volatility over such time period of the future, or if otherwise deemed to be
appropriate by the Adviser. Conversely, a Portfolio may buy or sell fewer
futures contracts if the volatility over a particular time period of the prices
of the securities being hedged is less than the volatility over such time period
of the futures contract being used, or if otherwise deemed to be appropriate by
the Adviser. It also is possible that, where a Portfolio has sold futures to
hedge its portfolio against a decline in the market, the market may advance, and
the value of securities held by the Portfolio may decline. If this occurred, the
Portfolio would lose money on the future and also experience a decline in value
in its portfolio securities.
Where futures are purchased to hedge against a possible increase in the
price of securities before a Portfolio is able to invest its cash (or cash
equivalents) in securities (or options) in an orderly fashion, it is possible
that the market may decline instead; if the Portfolio then concludes not to
invest in securities or options at that time because of concern as to possible
further market decline or for other reasons, the Portfolio will realize a loss
on the futures contract that is not offset by a reduction in the price of
securities purchased.
In instances involving the purchase of futures contracts by a
Portfolio, an amount of cash and cash equivalents, equal to the market value of
the futures contracts, will be deposited in a segregated account with the
Portfolio's Custodian and/or in a margin account with a broker to collateralized
the position and thereby insure that the use of such futures is unleveraged.
In addition to the possibility that there may be an imperfect
correlation, or no correlation at all, between movements in the futures and the
securities being hedged, the price of futures may not correlate perfectly with
movement in the cash market due to certain market distortions. Rather than
meeting additional margin deposit requirements, investors may close futures
contracts through off-setting transactions which could distort the normal
relationship between the cash and futures markets. Second, with respect to
financial futures contracts, the liquidity of the futures market depends on
participants entering into off-setting transactions rather than making or taking
delivery. To the extent participants decide to make or take delivery, liquidity
in the futures market could be reduced thus producing distortions. Third, from
the point of view of speculators, the deposit requirements in the futures market
are less onerous than margin requirements in the securities market. Therefore,
increased participation by
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speculators in the futures market may also cause temporary price distortions.
Due to the possibility of price distortion in the futures market, and because of
the imperfect correlation between the movements in the cash market and movements
in the price of futures, a correct forecast of general market trends or interest
rate movements by the Adviser still may not result in a successful hedging
transaction over a short time frame.
Positions in futures may be closed out only on an exchange or board of
trade which provides a secondary market for such futures. Although the
Portfolios intend to purchase or sell futures only on exchanges or boards of
trade where there appear to be active secondary markets, there is no assurance
that a liquid secondary market on any exchange or board of trade will exist for
any particular contract or at any particular time. In such event, it may not be
possible to close a futures investment position, and in the event of adverse
price movements, a Portfolio would continue to be required to make daily cash
payments of variation margin. However, in the event futures contracts have been
used to hedge portfolio securities, such securities will not be sold until the
futures contract can be terminated. In such circumstances, an increase in the
price of the securities, if any, may partially or completely offset losses on
the futures contract. However, as described above, there is no guarantee that
the price of the securities will in fact correlate with the price movements in
the futures contract and thus provide an offset on a futures contract.
Further, it should be noted that the liquidity of a secondary market in
a futures contract may be adversely affected by "daily price fluctuation limits"
established by commodity exchanges which limit the amount of fluctuation in a
futures contract price during a single trading day. Once the daily limit has
been reached in the contract, no trades may be entered into at a price beyond
the limit, thus preventing the liquidation of open futures positions.
Successful use of futures by a Portfolio also is subject to the
Adviser's ability to predict correctly movements in the direction of the market.
For example, if a Portfolio has hedged against the possibility of a decline in
the market adversely affecting securities held in its portfolio and securities
prices increase instead, the Portfolio will lose part or all of the benefit to
the increased value of its securities which it has hedged because it will have
offsetting losses in its futures positions. In addition, in such situations, if
the Portfolio has insufficient cash, it may have to sell securities to meet
daily variation margin requirements. Such sales of securities may be, but will
not necessarily be, at increased prices which reflect the rising market. A
Portfolio may have to sell securities at a time when it may be disadvantageous
to do so.
V. Options on Futures Contracts.
The Portfolios may purchase options on the futures contracts described
above. A futures option gives the holder, in return for the premium paid, the
right to buy (call) from or sell (put) to the writer of the option a futures
contract at a specified price at any time during the period of the option. Upon
exercise, the writer of the option is obligated to pay the difference between
the cash value of the futures contract and the exercise price. Like the buyer or
seller of a futures contract, the holder, or writer, of an option has the right
to terminate its position prior to the scheduled expiration of the option by
selling, or purchasing, an option of the same series, at which time the person
entering into the closing transaction will realize a gain or loss.
Investments in futures options involve some of the same considerations
that are involved in connection with investments in futures contracts (for
example, the existence of a liquid secondary market). In addition, the purchase
of an option also entails the risk that changes in the value of the underlying
futures contract will not be fully reflected in the value of the option
purchased. Depending on the pricing of the option compared to either the futures
contract upon which it is based, or upon the price of the securities being
hedged, an option may or may not be less risky than ownership of the futures
contract or such securities. In general, the market prices of options can be
expected to be more volatile than the market prices on the underlying futures
contract. Compared to the purchase or sale of futures contracts, however, the
purchase of call or put options on futures contracts may frequently involve less
potential risk to a Portfolio because the maximum amount at risk is the premium
paid for the options (plus transaction costs). Although permitted by their
fundamental investment policies, the Portfolios do not currently intend to write
future options, and will not do so in the future absent any necessary regulatory
approvals.
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VI. Accounting and Tax Treatment.
Accounting for futures contracts and options will be in accordance with
generally accepted accounting principles.
For the appropriate tax treatment of futures contracts and options, see
the SAI section entitled "Additional Information Concerning Taxes."
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SCHEDULE C
ADDITIONAL INFORMATION CONCERNING
MORTGAGE-BACKED SECURITIES
MORTGAGE-BACKED SECURITIES
Mortgage-backed securities represent an ownership interest in a pool of
residential mortgage loans. These securities are designed to provide monthly
payments of interest and principal to the investor. The mortgagor's monthly
payments to his/her lending institution are "passed-through" to an investor.
Most issuers or poolers provide guarantees of payments, regardless of whether or
not the mortgagor actually makes the payment. The guarantees made by issuers or
poolers are supported by various forms of credit collateral, guarantees or
insurance, including individual loan, title, pool and hazard insurance purchased
by the issuer. There can be no assurance that the private issuers or poolers can
meet their obligations under the policies. Mortgage-backed securities issued by
private issuers or poolers, whether or not such securities are subject to
guarantees, may entail greater risk than securities directly or indirectly
guaranteed by the U.S. Government.
Interests in pools of mortgage-backed securities differ from other
forms of debt securities, which normally provide for periodic payment of
interest in fixed amounts with principal payments at maturity or specified call
dates. Instead, these securities provide a monthly payment which consists of
both interest and principal payments. In effect, these payments are a
"pass-through" of the monthly payments made by the individual borrowers on their
residential mortgage loans, net of any fees paid. Additional payments are caused
by repayments resulting from the sale of the underlying residential property,
refinancing or foreclosure net of fees or costs which may be incurred. Some
mortgage-backed securities are described as "modified pass-through." These
securities entitle the holders to receive all interest and principal payments
owed on the mortgages in the pool, net of certain fees, regardless of whether or
not the mortgagors actually make the payments.
Residential mortgage loans are pooled by the Federal Home Loan Mortgage
Corporation ("FHLMC"). FHLMC is a corporate instrumentality of the U.S.
Government and was created by Congress in 1970 for the purpose of increasing the
availability of mortgage credit for residential housing. Its stock is owned by
the twelve Federal Home Loan Banks. FHLMC issues Participation Certificates
("PC's"), which represent interests in mortgages from FHLMC's national
portfolio. FHLMC guarantees the timely payment of interest and ultimate
collection of principal.
The Federal National Mortgage Association ("FNMA") is a Government
sponsored corporation owned entirely by private stockholders. It is subject to
general regulation by the Secretary of Housing and Urban Development. FNMA
purchases residential mortgages from a list of approved sellers/servicers which
include state and Federally-chartered savings and loan associations, mutual
savings banks, commercial banks and credit unions and mortgage bankers.
Pass-through securities issued by FNMA are guaranteed as to timely payment of
principal and interest by FNMA.
The principal Government guarantor of mortgage-backed securities is the
Government National Mortgage Association ("GNMA"). GNMA is a wholly-owned U.S.
Government corporation within the Department of Housing and Urban Development.
GNMA is authorized to guarantee, with the full faith and credit of the U.S.
Government, the timely payment of principal and interest on securities issued by
approved institutions and backed by pools of Federal Housing
Administration-insured or Veterans Administration-guaranteed mortgages.
Commercial banks, savings and loan institutions, private mortgage
insurance Trust, mortgage bankers and other secondary market issuers also create
pass-through pools of conventional residential mortgage loans. Pools created by
such non-governmental issuers generally offer a higher rate of interest than
government and government-related pools because there are no direct or indirect
government guarantees of payments in the former pools. However, timely payment
of interest and principal of these pools is supported by various forms of
insurance or guarantees, including individual loan, title, pool and hazard
insurance purchased by the issuer. The insurance and
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guarantees are issued by governmental entities, private insurers, and the
mortgage poolers. There can be no assurance that the private insurers or
mortgage poolers can meet their obligations under the policies.
The Portfolios expect that governmental or private entities may create
mortgage loan pools offering pass-through investments in addition to those
described above. The mortgages underlying these securities may be alternative
mortgage instruments, that is, mortgage instruments whose principal or interest
payment may vary or whose terms to maturity may be shorter than previously
customary. As new types of mortgage-backed securities are developed and offered
to investors, certain Portfolios will, consistent with their investment
objective and policies, consider making investments in such new types of
securities.
UNDERLYING MORTGAGES
Pools consist of whole mortgage loans or participations in loans. The
majority of these loans are made to purchasers of 1-4 family homes. The terms
and characteristics of the mortgage instruments are generally uniform within a
pool but may vary among pools. For example, in addition to fixed-rate,
fixed-term mortgages, a Portfolio may purchase pools of variable-rate mortgages
("VRM"), growing equity mortgages ("GEM"), graduated payment mortgages ("GPM")
and other types where the principal and interest payment procedures vary. VRM's
are mortgages which reset the mortgage's interest rate periodically with changes
in open market interest rates. To the extent that the Portfolio is actually
invested in VRM's, the Portfolio's interest income will vary with changes in the
applicable interest rate on pools of VRM's. GPM and GEM pools maintain constant
interest rates, with varying levels of principal repayment over the life of the
mortgage. These different interest and principal payment procedures should not
impact the Portfolio's net asset value since the prices at which these
securities are valued will reflect the payment procedures.
All poolers apply standards for qualification to local lending
institutions which originate mortgages for the pools. Poolers also establish
credit standards and underwriting criteria for individual mortgages included in
the pools. In addition, some mortgages included in pools are insured through
private mortgage insurance company.
AVERAGE LIFE
The average life of pass-through pools varies with the maturities of
the underlying mortgage instruments. In addition, a pool's term may be shortened
by unscheduled or early payments of principal and interest on the underlying
mortgages. The occurrence of mortgage prepayments is affected by factors
including the level of interest rates, general economic conditions, the location
and age of the mortgage, and other social and demographic conditions.
As prepayment rates of individual pools vary widely, it is not possible
to accurately predict the average life of a particular pool. For pools of
fixed-rated 30-year mortgages, common industry practice is to assume that
prepayments will result in a 12-year average life. Pools of mortgages with other
maturities or different characteristics will have varying assumptions for
average life.
RETURNS ON MORTGAGE-BACKED SECURITIES
Yields on mortgage-backed pass-through securities are typically quoted
based on the maturity of the underlying instruments and the associated average
life assumption. Actual prepayment experience may cause the yield to differ from
the assumed average life yield.
Reinvestment of prepayments may occur at higher or lower interest rates
than the original investment, thus affecting the yields of the Portfolio. The
compounding effect from reinvestments of monthly payments received by the
Portfolio will increase its yield to shareholders, compared to bonds that pay
interest semi-annually.
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