As filed with the Securities and Exchange Commission on January 16, 1998.
1933 Act File No.
1940 Act File No.
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X]
Pre-Effective Amendment No. [ ] [ ]
Post-Effective Amendment No. [ ] [ ]
and
REGISTRATION STATEMENT UNDER
THE INVESTMENT COMPANY ACT OF 1940 [X]
Amendment No. [ ] [ ]
LM INSTITUTIONAL FUND ADVISORS II, INC.
(Exact Name of Registrant as Specified in Charter)
100 Light Street
Baltimore, Maryland 21202
(Address of Principal Executive Offices)
Registrant's Telephone Number, including Area Code: (410) 539-0000
Copies to:
CHARLES A. BACIGALUPO BRYAN CHEGWIDDEN, ESQ.
100 Light Street Ropes & Gray
Baltimore, Maryland 21202 One International Place
(Name and Address of Boston, Massachusetts 02110
Agent for Service)
Approximate Date of Proposed Public Offering: As soon as practicable after the
effective date of this Registration Statement.
Registrant hereby amends the Registration Statement under the Securities Act of
1933 on such date or dates as may be necessary to delay its effective date until
Registrant shall file a further amendment that specifically states that such
Registration Statement shall become effective on such date as the Commission,
acting pursuant to Section 8(a), shall determine.
<PAGE>
LM INSTITUTIONAL FUND ADVISORS II, INC.
Contents of Registration Statement
This registration statement consists of the following papers and documents:
Cover Sheet
Table of Contents
Cross Reference Sheets
Part A
Prospectus for the following Portfolios:
Legg Mason Fund Adviser Large Cap Value Portfolio
Legg Mason Fund Adviser Mid Cap Value Portfolio
U.S. Small Cap Portfolio
Batterymarch Emerging Markets Portfolio
Batterymarch International Equity Portfolio
Legg Mason Fund Adviser/Western Asset Balanced Portfolio
Part B
Statement of Additional Information for the following Portfolios:
Legg Mason Fund Adviser Large Cap Value Portfolio
Legg Mason Fund Adviser Mid Cap Value Portfolio
U.S. Small Cap Portfolio
Batterymarch Emerging Markets Portfolio
Batterymarch International Equity Portfolio
Legg Mason Fund Adviser/Western Asset Balanced Portfolio
Part C - Other Information
Signature Page
Exhibit Index
Exhibits
<PAGE>
LM INSTITUTIONAL FUND ADVISORS II, INC.
Legg Mason Fund Adviser Large Cap Value Portfolio
Legg Mason Fund Adviser Mid Cap Value Portfolio
U.S. Small Cap Portfolio
Batterymarch Emerging Markets Portfolio
Batterymarch International Equity Portfolio
Legg Mason Fund Adviser/Western Asset Balanced Portfolio
Cross Reference Sheet
---------------------
Part A. Item No. Prospectus Caption
- ---------------- ------------------
1 Cover Page
2 Prospectus Summary; Expense Information
3 Financial Highlights; Performance Data
4 Description of Each Portfolio and Its Investment
Strategy; Common Investment Policies and Techniques;
Risk Factors
5 Management of the Portfolios; Expense Information;
Back Cover Page
6 Dividends and Distributions to Shareholders; Tax
Information
7 Purchase of Shares; Net Asset Value
8 Redemption of Shares
9 Not Applicable
<PAGE>
LM INSTITUTIONAL FUND ADVISORS II, INC.
Legg Mason Fund Adviser Large Cap Value Portfolio
Legg Mason Fund Adviser Mid Cap Value Portfolio
U.S. Small Cap Portfolio
Batterymarch Emerging Markets Portfolio
Batterymarch International Equity Portfolio
Legg Mason Fund Adviser/Western Asset Balanced Portfolio
Cross Reference Sheet
---------------------
Statement of Additional
Part B. Item No. Information Caption
- ---------------- -----------------------
10 Cover Page
11 Table of Contents
12 Not Applicable
13 Additional Information About
Investment Limitations and
Policies
14 Management of the Portfolios
15 Principal Holders of Securities
16 Management of the Portfolios;
Other Information
17 Portfolio Transactions and
Brokerage
18 Other Information
19 Purchases and Redemptions
20 Additional Tax Information
21 Management of the Portfolios
22 Other Information
23 Financial Statements
<PAGE>
LM INSTITUTIONAL FUND ADVISORS April 1, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
IMPORTANT INFORMATION! EQUITY PAGE
- ------------------------------------------------------ ------------------------------------------------------------------
<S><C>
This prospectus offers shares in the fourteen, no-load Legg Mason Fund Adviser Large Cap Value Portfolio
mutual funds comprising LM Institutional Fund Legg Mason Fund Adviser Mid Cap Value Portfolio
Advisors (each a "Portfolio"). The Portfolios, which U.S. Small Cap Portfolio
are intended to serve as investment vehicles for Batterymarch Emerging Markets Portfolio
institutional investors such as pension plans, Batterymarch International Equity Portfolio
endowments and foundations, offer two classes of Western Asset Enhanced Equity Portfolio
shares: the Institutional Class and the Financial Legg Mason Fund Adviser/Western Asset
Intermediary Class. Balanced Portfolio
This prospectus explains concisely what you should know FIXED INCOME PAGE
before investing in the Portfolios. Please read it ------------------------------------------------------------------
carefully and keep it for future reference. You can find
more detailed information in the April 1, 1998 statement Western Asset Money Market Portfolio
of additional information (the "SAI"), as amended from Western Asset Government Money Market Portfolio
time to time. For a free copy of the SAI or other Western Asset Limited Duration Portfolio
information, call Legg Mason Wood Walker, Inc. at Western Asset Intermediate Portfolio
1-800-822-5544. The SAI has been filed with the Western Asset Core Portfolio
Securities and Exchange Commission ("SEC") and is Western Asset High Yield Portfolio
incorporated into this prospectus by reference. Western Asset Non-U.S. Fixed Income Portfolio
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED THE WESTERN ASSET HIGH YIELD PORTFOLIO MAY INVEST ALL
BY THE SECURITIES AND EXCHANGE COMMISSION NOR HAS THE OF ITS ASSETS, AND EACH OF THE LEGG MASON FUND ADVISER
SECURITIES AND EXCHANGE COMMISSION PASSED UPON THE LARGE CAP VALUE PORTFOLIO AND THE LEGG MASON FUND
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY ADVISER MID CAP VALUE PORTFOLIO MAY INVEST UP TO 35%
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. OF ITS TOTAL ASSETS, IN LOWER-RATED BONDS, COMMONLY
KNOWN AS "JUNK BONDS." INVESTMENTS OF THIS TYPE ARE
PORTFOLIO SHARES ARE NOT DEPOSITS OR OBLIGATIONS OF, SUBJECT TO A GREATER RISK OF LOSS OF PRINCIPAL AND
OR GUARANTEED OR ENDORSED BY, ANY FINANCIAL INSTITUTION, NONPAYMENT OF INTEREST. INVESTORS SHOULD CAREFULLY
ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE ASSESS THE RISKS ASSOCIATED WITH AN INVESTMENT IN THESE
CORPORATION, THE FEDERAL RESERVE BOARD OR ANY OTHER PORTFOLIOS. FOR MORE INFORMATION CONCERNING THESE
AGENCY, AND INVOLVE RISK, INCLUDING THE POSSIBLE LOSS RISKS, SEE "COMMON INVESTMENT POLICIES AND
OF THE PRINCIPAL AMOUNT INVESTED. TECHNIQUES; RISK FACTORS."
AN INVESTMENT IN THE WESTERN ASSET MONEY MARKET
PORTFOLIO OR THE WESTERN ASSET GOVERNMENT MONEY
MARKET PORTFOLIO IS NEITHER INSURED NOR GUARANTEED BY
THE U.S. GOVERNMENT. THERE CAN BE NO ASSURANCE THAT
EITHER PORTFOLIO WILL BE ABLE TO MAINTAIN A STABLE NET
ASSET VALUE OF $1.00 PER SHARE.
[Legg Mason Institutional Fund Advisors Logo Appears Here]
</TABLE>
<PAGE>
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
PROSPECTUS SUMMARY 4
EXPENSE INFORMATION 7
Legg Mason Fund Adviser Large Cap Value Portfolio 7
Legg Mason Fund Adviser Mid Cap Value Portfolio 8
U.S. Small Cap Portfolio 8
Batterymarch Emerging Markets Portfolio 9
Batterymarch International Equity Portfolio 9
Western Asset Enhanced Equity Portfolio 10
Legg Mason Fund Adviser/Western Asset Balanced Portfolio 10
Western Asset Money Market Portfolio 11
Western Asset Government Money Market Portfolio 11
Western Asset Limited Duration Portfolio 12
Western Asset Intermediate Portfolio 12
Western Asset Core Portfolio 13
Western Asset High Yield Portfolio 13
Western Asset Non-U.S. Fixed Income Portfolio 14
FINANCIAL HIGHLIGHTS 16
Western Asset Limited Duration Portfolio 16
Western Asset Intermediate Portfolio 17
Western Asset Core Portfolio 18
DESCRIPTION OF EACH PORTFOLIO AND ITS
INVESTMENT STRATEGY 20
Legg Mason Fund Adviser Large Cap Value Portfolio 20
Legg Mason Fund Adviser Mid Cap Value Portfolio 21
U.S. Small Cap Portfolio 22
Batterymarch Emerging Markets Portfolio 24
Batterymarch International Equity Portfolio 25
Western Asset Enhanced Equity Portfolio 26
Legg Mason Fund Adviser/Western Asset Balanced Portfolio 28
Western Asset Money Market Portfolio 28
Western Asset Government Money Market Portfolio 29
Western Asset Limited Duration Portfolio
Western Asset Intermediate Portfolio
Western Asset Core Portfolio 31
Western Asset High Yield Portfolio 33
Western Asset Non-U.S. Fixed Income Portfolio 34
COMMON INVESTMENT POLICIES AND TECHNIQUES;
RISK FACTORS 37
Foreign Securities 37
-2-
<PAGE>
Options and Futures 40
Foreign Currency Exchange Transactions 42
Preferred Stocks and Convertible Securities 43
Debt and Fixed Income Securities 44
Commercial Paper and Other Short-term Investments 50
Duration 51
Loan Participations and Assignments 51
Indexed Securities and Structured Notes 52
Forward Commitments 53
Restricted and Illiquid Securities 54
Securities of Other Investment Companies 54
Repurchase Agreements 54
Reverse Repurchase Agreements and Other Borrowing 55
Loans of Portfolio Securities 55
Portfolio Turnover 56
Alternative Investment Strategies 56
New Investment Products 57
Investment Policies 57
PERFORMANCE DATA 57
MANAGEMENT OF THE PORTFOLIOS 58
Boards of Directors 58
Manager, Advisers 58
The Distributor 61
Portfolio Transactions 62
Administrator 62
Expenses 62
ORGANIZATION AND HISTORY 62
PURCHASE OF SHARES 63
Initial Investment 63
Additional Investments 65
Other Purchase Information 65
Retirement Plans 66
Account Registration Changes 66
DISTRIBUTION PLANS 66
REDEMPTION OF SHARES 67
Signature Guarantee 68
EXCHANGE PRIVILEGE 69
NET ASSET VALUE 69
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS 70
TAX INFORMATION 71
APPENDIX A -- SECURITIES RATINGS A-1
-3-
<PAGE>
PROSPECTUS SUMMARY
- --------------------------------------------------------------------------------
GENERAL
- --------------------------------------------------------------------------------
LM Institutional Fund Advisors (the "Portfolios") are fourteen separate
investment portfolios of two open-end management investment companies ("mutual
funds"). LM Institutional Fund Advisors I, Inc. and LM Institutional Fund
Advisors II, Inc. were organized as Maryland corporations on May 16, 1990 and
______________, 1998, respectively.
COMPARISON OF THE PORTFOLIOS
- --------------------------------------------------------------------------------
The following chart provides general information about each Portfolio.
It is qualified in its entirety by the more complete descriptions of the
Portfolios appearing in this prospectus.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
EQUITY PORTFOLIOS INVESTMENT OBJECTIVES PRIMARY INVESTMENTS
- ------------------------------------------------------------------------------------------------------------------
<S><C>
Legg Mason Fund Adviser Long-term growth of capital Large cap equity securities that are
Large Cap Value Portfolio undervalued
- ------------------------------------------------------------------------------------------------------------------
Legg Mason Fund Adviser Capital appreciation Mid cap equity securities that are
Mid Cap Value Portfolio undervalued
- ------------------------------------------------------------------------------------------------------------------
U.S. Small Cap Portfolio Long-term capital appreciation Small cap equity securities
- ------------------------------------------------------------------------------------------------------------------
Batterymarch Emerging Long-term capital appreciation Emerging market equity securities
Markets Portfolio
- ------------------------------------------------------------------------------------------------------------------
Batterymarch International Long-term total return Foreign equity securities
Equity Portfolio
- ------------------------------------------------------------------------------------------------------------------
Western Asset Enhanced Long-term total return S&P 500 derivatives and stocks, and a
Equity Portfolio broad range of fixed income securities
- ------------------------------------------------------------------------------------------------------------------
Legg Mason Fund Adviser/ Long-term capital appreciation Mix of equity and fixed income securities
Western Asset Balanced and current income in order to
Portfolio achieve an attractive total
investment return consistent with
reasonable risk
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
-4-
<PAGE>
<TABLE>
<CAPTION>
FIXED INCOME PORTFOLIOS INVESTMENT OBJECTIVES PRIMARY INVESTMENTS
- ------------------------------------------------------------------------------------------------------------------
<S><C>
Western Asset Money Market Obtain high current income Money market instruments
Portfolio consistent with liquidity and
conservation of principal
- ------------------------------------------------------------------------------------------------------------------
Western Asset Government Obtain high current income U.S. Government money market
Money Market Portfolio consistent with liquidity and instruments
conservation of principal
- ------------------------------------------------------------------------------------------------------------------
Western Asset Limited Maximize total return, consistent Short and intermediate maturity fixed
Duration Portfolio with prudent investment income securities. Overall duration 1-3
management and liquidity needs, years.
by investing to obtain the average
duration specified for the
Portfolio
- ------------------------------------------------------------------------------------------------------------------
Western Asset Intermediate Maximize total return, consistent Short and intermediate maturity fixed
Portfolio with prudent investment income securities. Overall duration 2-4
management and liquidity needs, years.
by investing to obtain the average
duration specified for the
Portfolio
- ------------------------------------------------------------------------------------------------------------------
Western Asset Core Portfolio Maximize total return, consistent Broad range of fixed income securities.
with prudent investment Overall duration currently expected to be
management and liquidity needs, 4-6 years.
by investing to obtain the average
duration specified for the
Portfolio
- ------------------------------------------------------------------------------------------------------------------
Western Asset High Yield Maximize total return, consistent Lower-rated fixed income securities
Portfolio with prudent investment
management
- ------------------------------------------------------------------------------------------------------------------
Western Asset Non-U.S. Maximize total return, consistent Foreign fixed income securities
Fixed Income Portfolio with prudent investment
management
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
-5-
<PAGE>
PURCHASE OF SHARES
- --------------------------------------------------------------------------------
The Portfolios offer two classes of shares: Institutional Class and
Financial Intermediary Class. Shares in the Financial Intermediary Class bear a
12b-1 fee. See "Distribution Plans" below for more information. The minimum
initial investment is $1 million, subject to certain exceptions. See "Purchase
of Shares."
REDEMPTIONS AND EXCHANGES
- --------------------------------------------------------------------------------
Shares of each Portfolio may be redeemed without cost at the relevant
net asset value per share next determined after receipt of the redemption
request. The redemption price may be more or less than the purchase price. See
"Redemption of Shares." Shares of any Portfolio may be exchanged on the basis
of relative net asset values for shares of the same class of any other
Portfolio. See "Exchange Privilege."
DIVIDENDS AND DISTRIBUTIONS
- --------------------------------------------------------------------------------
The Western Asset Money Market Portfolio and the Western Asset
Government Money Market Portfolio declare dividends daily (out of their net
investment income for that day) and pay dividends monthly. The Legg Mason Fund
Adviser Large Cap Value Portfolio, the Western Asset Enhanced Equity Portfolio,
the Legg Mason Fund Adviser/Western Asset Balanced Portfolio, the Western Asset
Limited Duration Portfolio, the Western Asset Intermediate Portfolio, the
Western Asset Core Portfolio, the Western Asset High Yield Portfolio and the
Western Asset Non-U.S. Fixed Income Portfolio declare and pay dividends
quarterly out of their net investment income for that quarter. All other
Portfolios declare and pay dividends annually out of their net investment income
for that year. Distributions of net realized capital gains are made annually.
All dividends and distributions will be reinvested automatically at net asset
value in additional shares of the same class of the same Portfolio, unless cash
payment is requested. See "Dividends and Distributions to Shareholders."
-6-
<PAGE>
EXPENSE INFORMATION
- --------------------------------------------------------------------------------
Expenses are one of several factors to consider when investing. The
following tables contain expense information about the Portfolios based on the
most recent fiscal year (in the case of the Western Asset Limited Duration
Portfolio, the Western Asset Intermediate Portfolio and the Western Asset Core
Portfolio) or amounts estimated to be incurred in the current fiscal year (in
the case of the other Portfolios). The examples show the cumulative expenses
attributable to a hypothetical $1,000 investment over specified periods,
assuming 5% annual return and redemption at the end of each period. The
paragraph following the tables and examples contains additional information
about the tables, the examples and the Portfolios' expenses.
LEGG MASON FUND ADVISER LARGE CAP VALUE PORTFOLIO
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Institutional Financial
Class Intermediary Class Institutional Class Example
------------- ------------------ ---------------------------
<S><C>
SHAREHOLDER 1 year $ 8
TRANSACTION EXPENSES None None 3 years $24
ANNUAL FUND
OPERATING EXPENSES Financial Intermediary
(AS A PERCENTAGE OF Class Example
AVERAGE NET ASSETS) ----------------------
Management Fees .50% .50% 1 year $10
(reflecting expense 3 years $32
limitations)
12b-1 Fees None .25%
Other Expenses .25% .25%
--- ----
Total
Operating Expenses .75% 1.00%
=== ====
(reflecting expense
limitations)
</TABLE>
-7-
<PAGE>
LEGG MASON FUND ADVISER MID CAP VALUE PORTFOLIO
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Institutional Financial
Class Intermediary Class Institutional Class Example
------------- ------------------ ---------------------------
<S><C>
SHAREHOLDER 1 year $ 8
TRANSACTION EXPENSES None None 3 years $24
ANNUAL FUND
OPERATING EXPENSES Financial Intermediary
(AS A PERCENTAGE OF Class Example
AVERAGE NET ASSETS) ----------------------
Management Fees .50% .50% 1 year $10
(reflecting expense 3 years $32
limitations)
12b-1 Fees None .25%
Other Expenses .25% .25%
--- ----
Total
Operating Expenses .75% 1.00%
=== ====
(reflecting expense
limitations)
</TABLE>
U.S. SMALL CAP PORTFOLIO
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Institutional Financial
Class Intermediary Class Institutional Class Example
------------- ------------------ ---------------------------
<S><C>
SHAREHOLDER 1 year $ 9
TRANSACTION EXPENSES None None 3 years $27
ANNUAL FUND
OPERATING EXPENSES Financial Intermediary
(AS A PERCENTAGE OF Class Example
AVERAGE NET ASSETS) ----------------------
Management Fees .60% .60% 1 year $11
(reflecting expense 3 years $35
limitations)
12b-1 Fees None .25%
Other Expenses .25% .25%
--- ----
Total
Operating Expenses .85% 1.10%
=== ====
(reflecting expense
limitations)
</TABLE>
-8-
<PAGE>
BATTERYMARCH EMERGING MARKETS PORTFOLIO
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Institutional Financial
Class Intermediary Class Institutional Class Example
------------- ------------------ ---------------------------
<S><C>
SHAREHOLDER 1 year $15
TRANSACTION EXPENSES None None 3 years $46
ANNUAL FUND
OPERATING EXPENSES Financial Intermediary
(AS A PERCENTAGE OF Class Example
AVERAGE NET ASSETS) ----------------------
Management Fees .60% .60% 1 year $17
(reflecting expense 3 years $54
limitations)
12b-1 Fees None .25%
Other Expenses .85% .85%
---- ----
Total
Operating Expenses 1.45% 1.70%
==== ====
(reflecting expense
limitations)
</TABLE>
BATTERYMARCH INTERNATIONAL EQUITY PORTFOLIO
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Institutional Financial
Class Intermediary Class Institutional Class Example
------------- ------------------ ---------------------------
<S><C>
SHAREHOLDER 1 year $10
TRANSACTION EXPENSES None None 3 years $32
ANNUAL FUND
OPERATING EXPENSES Financial Intermediary
(AS A PERCENTAGE OF Class Example
AVERAGE NET ASSETS) ----------------------
Management Fees .60% .60% 1 year $13
(reflecting expense 3 years $40
limitations)
12b-1 Fees None .25%
Other Expenses .40% .40%
---- ----
Total
Operating Expenses 1.00% 1.25%
==== ====
(reflecting expense
limitations)
</TABLE>
-9-
<PAGE>
WESTERN ASSET ENHANCED EQUITY PORTFOLIO
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Institutional Financial
Class Intermediary Class Institutional Class Example
------------- ------------------ ---------------------------
<S><C>
SHAREHOLDER 1 year $ 7
TRANSACTION EXPENSES None None 3 years $21
ANNUAL FUND
OPERATING EXPENSES Financial Intermediary
(AS A PERCENTAGE OF Class Example
AVERAGE NET ASSETS) ----------------------
Management Fees .40% .40% 1 year $ 9
(reflecting expense 3 years $29
limitations)
12b-1 Fees None .25%
Other Expenses .25% .25%
--- ---
Total
Operating Expenses .65% .90%
=== ===
(reflecting expense
limitations)
</TABLE>
LEGG MASON FUND ADVISER/WESTERN ASSET BALANCED PORTFOLIO
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Institutional Financial
Class Intermediary Class Institutional Class Example
------------- ------------------ ---------------------------
<S><C>
SHAREHOLDER 1 year $ 8
TRANSACTION EXPENSES None None 3 years $24
ANNUAL FUND
OPERATING EXPENSES Financial Intermediary
(AS A PERCENTAGE OF Class Example
AVERAGE NET ASSETS) ----------------------
Management Fees .50% .50% 1 year $10
(reflecting expense 3 years $32
limitations)
12b-1 Fees None .25%
Other Expenses .25% .25%
--- ----
Total
Operating Expenses .75% 1.00%
=== ====
(reflecting expense
limitations)
</TABLE>
-10-
<PAGE>
WESTERN ASSET MONEY MARKET PORTFOLIO
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Institutional Financial
Class Intermediary Class Institutional Class Example
------------- ------------------ ---------------------------
<S><C>
SHAREHOLDER 1 year $ 4
TRANSACTION EXPENSES None None 3 years $13
ANNUAL FUND
OPERATING EXPENSES Financial Intermediary
(AS A PERCENTAGE OF Class Example
AVERAGE NET ASSETS) ----------------------
Management Fees .10% .10% 1 year $ 5
(reflecting expense 3 years $16
limitations)
12b-1 Fees None .10%
Other Expenses .30% .30%
--- ---
Total
Operating Expenses .40% .50%
=== ===
(reflecting expense
limitations)
</TABLE>
WESTERN ASSET GOVERNMENT MONEY MARKET PORTFOLIO
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Institutional Financial
Class Intermediary Class Institutional Class Example
------------- ------------------ ---------------------------
<S><C>
SHAREHOLDER 1 year $ 4
TRANSACTION EXPENSES None None 3 years $13
ANNUAL FUND
OPERATING EXPENSES Financial Intermediary
(AS A PERCENTAGE OF Class Example
AVERAGE NET ASSETS) ----------------------
Management Fees .10% .10% 1 year $ 5
(reflecting expense 3 years $16
limitations)
12b-1 Fees None .10%
Other Expenses .30% .30%
--- ---
Total
Operating Expenses .40% .50%
=== ===
(reflecting expense
limitations)
</TABLE>
-11-
<PAGE>
WESTERN ASSET LIMITED DURATION PORTFOLIO
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Institutional Financial
Class Intermediary Class Institutional Class Example
------------- ------------------ ---------------------------
<S><C>
SHAREHOLDER 1 year $ 4
TRANSACTION EXPENSES None None 3 years $13
5 years $22
10 years $51
ANNUAL FUND
OPERATING EXPENSES Financial Intermediary
(AS A PERCENTAGE OF Class Example
AVERAGE NET ASSETS) ----------------------
Management Fees .20% .20% 1 year $ 7
(reflecting expense 3 years $21
limitations) 5 years $36
12b-1 Fees None .25% 10 years $81
Other Expenses .20% .20%
--- ---
Total
Operating Expenses .40% .65%
=== ===
(reflecting expense
limitations)
</TABLE>
WESTERN ASSET INTERMEDIATE PORTFOLIO
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Institutional Financial
Class Intermediary Class Institutional Class Example
------------- ------------------ ---------------------------
<S><C>
SHAREHOLDER 1 year $ 5
TRANSACTION EXPENSES None None 3 years $14
5 years $25
10 years $57
ANNUAL FUND
OPERATING EXPENSES Financial Intermediary
(AS A PERCENTAGE OF Class Example
AVERAGE NET ASSETS) ----------------------
Management Fees .25% .25% 1 year $ 7
(reflecting expense 3 years $22
limitations) 5 years $39
12b-1 Fees None .25% 10 years $87
Other Expenses .20% .20%
--- ---
Total
Operating Expenses .45% .70%
=== ===
(reflecting expense
limitations)
</TABLE>
-12-
<PAGE>
WESTERN ASSET CORE PORTFOLIO
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Institutional Financial
Class Intermediary Class Institutional Class Example
------------- ------------------ ---------------------------
<S><C>
SHAREHOLDER 1 year $ 5
TRANSACTION EXPENSES None None 3 years $16
5 years $28
10 years $63
ANNUAL FUND
OPERATING EXPENSES Financial Intermediary
(AS A PERCENTAGE OF Class Example
AVERAGE NET ASSETS) ----------------------
Management Fees .30% .30% 1 year $ 8
(reflecting expense 3 years $24
limitations) 5 years $42
12b-1 Fees None .25% 10 years $93
Other Expenses .20% .20%
--- ---
Total
Operating Expenses .50% .75%
=== ===
(reflecting expense
limitations)
</TABLE>
WESTERN ASSET HIGH YIELD PORTFOLIO
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Institutional Financial
Class Intermediary Class Institutional Class Example
------------- ------------------ ---------------------------
<S><C>
SHAREHOLDER 1 year $ 6
TRANSACTION EXPENSES None None 3 years $18
ANNUAL FUND
OPERATING EXPENSES Financial Intermediary
(AS A PERCENTAGE OF Class Example
AVERAGE NET ASSETS) ----------------------
Management Fees .30% .30% 1 year $ 8
(reflecting expense 3 years $26
limitations)
12b-1 Fees None .25%
Other Expenses .25% .25%
--- ---
Total
Operating Expenses .55% .80%
=== ===
(reflecting expense
limitations)
</TABLE>
-13-
<PAGE>
WESTERN ASSET NON-U.S. FIXED INCOME PORTFOLIO
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Institutional Financial
Class Intermediary Class Institutional Class Example
------------- ------------------ ---------------------------
<S><C>
SHAREHOLDER 1 year $ 6
TRANSACTION EXPENSES None None 3 years $18
ANNUAL FUND
OPERATING EXPENSES Financial Intermediary
(AS A PERCENTAGE OF Class Example
AVERAGE NET ASSETS) ----------------------
Management Fees .30% .30% 1 year $ 8
(reflecting expense 3 years $26
limitations)
12b-1 Fees None .25%
Other Expenses .25% .25%
--- ---
Total
Operating Expenses .55% .80%
=== ===
(reflecting expense
limitations)
</TABLE>
The tables are provided to help you understand the expenses of investing
in a Portfolio and your share of the Portfolio's operating expenses. The
management fees shown in the table for each Portfolio reflect voluntary expense
limitations currently in effect. In the absence of such limitations, management
fees and total operating expenses for each Portfolio would be:
-14-
<PAGE>
<TABLE>
<CAPTION>
TOTAL OPERATING
MANAGEMENT FEE EXPENSES
PORTFOLIO CLASS WITHOUT LIMITATION WITHOUT LIMITATION
--------- ----- ------------------ ------------------
<S><C>
Legg Mason Fund Adviser Large Cap Value Institutional 0.60% 0.85%
Portfolio Financial Intermediary 0.60% 1.10%
Legg Mason Fund Adviser Mid Cap Value Institutional 0.60% 0.85%
Portfolio Financial Intermediary 0.60% 1.10%
U.S. Small Cap Portfolio Institutional 0.65% 0.90%
Financial Intermediary 0.65% 1.15%
Batterymarch Emerging Markets Portfolio Institutional 0.65% 1.50%
Financial Intermediary 0.65% 1.75%
Batterymarch International Equity Portfolio Institutional 0.65% 1.05%
Financial Intermediary 0.65% 1.30%
Western Asset Enhanced Equity Portfolio Institutional 0.50% 0.75%
Financial Intermediary 0.50% 1.00%
Legg Mason Fund Adviser/Western Asset Institutional 0.60% 0.85%
Balanced Portfolio Financial Intermediary 0.60% 1.10%
Western Asset Money Market Portfolio Institutional 0.25% 0.55%
Financial Intermediary 0.25% 0.65%
Western Asset Government Money Market Institutional 0.25% 0.55%
Portfolio Financial Intermediary 0.25% 0.65%
Western Asset Limited Duration Portfolio Institutional 0.30% 0.50%
Financial Intermediary 0.30% 0.75%
Western Asset Intermediate Portfolio Institutional 0.40% 0.60%
Financial Intermediary 0.40% 0.85%
Western Asset Core Portfolio Institutional 0.45% 0.65%
Financial Intermediary 0.45% 0.90%
Western Asset High Yield Portfolio Institutional 0.45% 0.70%
Financial Intermediary 0.45% 0.95%
Western Asset Non-U.S. Fixed Income Institutional 0.40% 0.65%
Portfolio Financial Intermediary 0.40% 0.90%
</TABLE>
"Other expenses" are based on estimated amounts for the current fiscal year in
the case of each of the Portfolios other than the Western Asset Limited Duration
Portfolio, the Western Asset Intermediate Portfolio and the Western Asset Core
Portfolio. The examples do not represent past or future expense levels. Actual
expenses may be greater or less than those shown. Federal regulations require
the examples to assume a 5% annual return, but actual annual returns will vary.
-15-
<PAGE>
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
The tables on the following pages present financial highlights for the
Western Asset Limited Duration Portfolio, the Western Asset Intermediate
Portfolio and the Western Asset Core Portfolio. This information has been
obtained from audited financial statements which are included in each
Portfolio's annual report and are incorporated by reference in this prospectus
and in the SAI (available upon request). The financial statements in the annual
reports were audited by [ ], the Portfolio's independent
accountants whose unqualified report covers the most recent five year period.
Each Portfolio's Annual Report, which contains unaudited performance
information, is available without charge upon request. The following information
should be read in conjunction with the Portfolios' audited financial statements
and related notes. No information is provided with respect to the other
Portfolios because they had not commenced operations as of the date of this
Prospectus.
WESTERN ASSET LIMITED DURATION PORTFOLIO
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years Ended June 30, 1997 1996(A)
- --------------------------------------------------------------- ---- -------
<S><C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $100.76 $100.00
------- -------
Net investment income (B) 5.94 0.84
Net realized and unrealized gain (loss) on investments, options
and futures 1.34 (0.08)
------- -------
Total from investment operations 7.28 0.76
------- -------
Distributions to shareholders from:
Net investment income (5.31) --
Net realized gain on investments (0.37) --
------- -------
Total distributions (5.68) --
------- -------
Net asset value, end of period $102.36 $100.76
======= =======
Total return 7.42% 0.76%(C)
RATIOS/SUPPLEMENTAL DATA:
RATIOS TO AVERAGE NET ASSETS:
Expenses (B) .41% 0.50%(D)
Net investment income (B) 6.24% 5.58%(D)
Portfolio turnover rate 435.47% 1,042%(D)
Net assets, end of period (in thousands) $26,537 $16,110
</TABLE>
- ----------------
(A) For the period May 1, 1996 (commencement of operations) to June 30, 1996.
(B) Net of investment advisory fees waived pursuant to a voluntary expense
limitation of 0.50% until June 30, 1996 and 0.40% until October 30, 1998;
and a voluntary administrative expense waiver of 0.05%. Pursuant to this
limitation, advisory fees of $60,550 and $7,212 were waived for the year
ended June 30, 1997 and the period ended June 30, 1996, respectively. In the
absence of this limitation, the ratio of expenses to average net assets
would have been 1.20% and 0.80%, respectively.
(C) Not Annualized
(D) Annualized
-16-
<PAGE>
WESTERN ASSET INTERMEDIATE PORTFOLIO
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years Ended June 30, 1997 1996 1995
- ------------------------------------------------------- ---- ---- ----
<S><C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year $104.83 $107.36 $100.00
------- ------- -------
Net investment income (A) 5.49 5.41 3.86
Net realized and unrealized gain (loss) on investments,
options and futures 3.00 (0.06) 6.02
------- ------- -------
Total from investment operations 8.49 5.35 9.88
------- ------- -------
Distributions to shareholders from:
Net investment income (5.42) (5.35) (2.47)
Net realized gain on investments (0.71) (2.53) (0.05)
------- ------- -------
Total distributions (6.13) (7.88) (2.52)
------- ------- -------
Net asset value, end of year $107.19 $104.83 $107.36
======= ======= =======
Total return 8.32% 5.15% 10.08%
RATIOS/SUPPLEMENTAL DATA:
RATIOS TO AVERAGE NET ASSETS:
Expenses (A) .45% 0.50% 0.50%
Net investment income (A) 6.33% 6.28% 6.11%
Portfolio turnover rate 419.26% 841.89% 764.45%
Net assets, end of year (in thousands) $224,497 $66,079 $20,313
</TABLE>
- ---------------
(A) Net of investment advisory fees waived pursuant to a voluntary expense
limitation of 0.50% until June 30, 1996 and 0.45% until October 30, 1998;
and a voluntary administrative expense waiver of 0.05%. Pursuant to this
limitation, advisory fees of $158,505, $130,938 and $29,571 were waived for
the years ended June 30, 1997, 1996 and 1995, respectively. In the absence
of this limitation, the ratio of expenses to average net assets would have
been 0.55%, 1.03% and 1.60%, respectively.
-17-
<PAGE>
WESTERN ASSET CORE PORTFOLIO
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years Ended June 30, 1997 1996 1995 1994 1993 1992 1991(A)
- ------------------------------------------ ---- ---- ---- ---- ---- ---- -------
<S><C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning of period $110.46 $112.17 $105.02 $116.64 $112.04 $106.28 $100.00
------- ------- ------- ------- ------- ------- -------
Net investment income(B) 7.05 6.70 6.82 5.64 6.57 6.90 6.66
Net realized and unrealized gain (loss) on
investments, options and futures 1.86 (1.36) 7.19 (6.28) 8.71 8.72 4.28
------- ------- ------- ------- ------- ------- -------
Total from investment operations 8.91 5.34 14.01 (0.64) 15.28 15.62 10.94
------- ------- ------- ------- ------- ------- -------
Distributions to shareholders from:
Net investment income (6.51) (6.61) (6.86) (6.11) (6.72) (7.11) (4.66)
Net realized gain on investments (0.07) (0.44) -- (4.87) (3.96) (2.75) --
------- ------- ------- ------- ------- ------- -------
Total distributions (6.58) (7.05) (6.86) (10.98) (10.68) (9.86) (4.66)
------- ------- ------- ------- ------- ------- -------
Net asset value, end of period $112.79 $110.46 $112.17 $105.02 $116.64 $112.04 $106.28
======= ======= ======= ======= ======= ======= =======
Total return 8.27% 4.86% 14.12% (0.89)% 14.52% 15.61% 11.01%(C)
RATIOS/SUPPLEMENTAL DATA:
RATIOS TO AVERAGE NET ASSETS:
Expenses (B) 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.65%(D)
Net investment income (B) 6.4% 6.3% 7.0% 6.0% 6.0% 6.7% 8.0%(D)
Portfolio turnover rate 384.8% 266.0% 257.90% 272.49% 313.05% 299.65% 177.25%(D)
Net assets, end of period (in thousands) $508,353 $453,699 $336,774 $205,959 $135,886 $92,892 $43,076
</TABLE>
- ------------------
(A) For the period September 4, 1990 (commencement of operations) to June 30,
1991.
(B) Net of investment advisory fees waived pursuant to a voluntary expense
limitation as follows: 0.65% through June 30, 1991; 0.50% thereafter and a
voluntary administrative expense waiver of 0.05%. Pursuant to this
limitation, advisory fees of $22,402, $111,421, $69,442, $66,823, $71,911,
and $128,262 were waived for the years ended June 30, 1997, 1996, 1995,
1994, 1993 and June 30, 1992, respectively. Additionally, advisory fees of
$54,697 remain waived from the prior period ended June 30, 1991. In the
absence of this limitation, the ratio of expenses to average net assets
would have been .50% for the year ended June 30, 1997, .53% for the years
ended June 30, 1996 and 1995, .58% for the year ended June 30, 1994, .57%
for the year ended June 30, 1993, .70% for the year ended June 30, 1992, and
.81% for the period September 4, 1990 to June 30, 1991.
(C) Not Annualized
(D) Annualized
-18-
<PAGE>
DESCRIPTION OF EACH PORTFOLIO AND ITS
INVESTMENT STRATEGY
- --------------------------------------------------------------------------------
The investment objective and policies for each Portfolio are stated
below. The Portfolios are not intended to be a complete investment program, and
there is no assurance that any Portfolio will achieve its investment objective.
Please see "Common Investment Policies and Techniques; Risk Factors" below and
the SAI for additional information concerning the Portfolios' investment
programs and the risks associated with investing in the Portfolios. Each of the
Portfolios may from time to time depart from the policies described below for
"defensive" purposes. See "Common Investment Policies and Techniques; Risk
Factors -- Alternative Investment Strategies" for more information.
- --------------------------------------------------------------------------------
LEGG MASON FUND ADVISER LARGE CAP VALUE PORTFOLIO
- --------------------------------------------------------------------------------
Adviser: Legg Mason Fund Advisers, Inc. ("LMFA")
- --------------------------------------------------------------------------------
Objective: long-term growth of capital
- --------------------------------------------------------------------------------
Under normal market conditions, the Portfolio will invest at least 65%
of its total assets in equity securities that LMFA believes are undervalued in
relation to the long-term earning power or asset value of the issuer and
therefore offer above average potential for capital appreciation. The Portfolio
will also invest at least 65% of its total assets in equity securities of
companies that, at the time of purchase, have an equity market capitalization of
more than $2.5 billion. Equity securities include common stock, preferred stock,
securities convertible into common stock, rights and warrants to acquire such
securities and substantially similar forms of equity with comparable risk
characteristics. The Portfolio may invest in securities that pay no dividends or
interest, and current dividend income is not a prerequisite in the selection of
securities.
Securities may be undervalued because of many factors, including not
being closely followed by investors, being out of favor with investors, or
because the issuer is experiencing unusual circumstances suggesting the
possibility that the market value of the securities may increase. Other factors
that may contribute to a security being undervalued include an overall market
decline, poor economic conditions, tax-loss selling and actual or anticipated
unfavorable developments affecting the issuer. LMFA believes that the securities
of sound, well-managed companies that may be undervalued for these reasons are
likely to provide a greater opportunity for long-term growth of capital than
securities with prices that appear to reflect anticipated favorable developments
and that are therefore subject to correction should any unfavorable developments
occur.
-19-
<PAGE>
Equity securities are normally the Portfolio's main investments.
However, the Portfolio may invest up to 35% of its total assets in any type of
debt or fixed income security, including securities that, at the time of
purchase, are not rated investment grade by a nationally recognized statistical
rating organization (an "NRSRO"), if LMFA believes they would help achieve the
Portfolio's investment objective. Lower-rated securities (and unrated securities
of comparable quality) are considered to be primarily speculative and may be in
default. The Portfolio may also invest up to 25% of its total assets in
securities principally traded in foreign markets, engage in foreign currency
exchange transactions and transactions in futures contracts and options, enter
into repurchase agreements, purchase shares of other investment companies,
purchase restricted and illiquid securities, loan its portfolio securities,
borrow money for temporary or emergency purposes, and purchase or sell
securities on a forward commitment basis. See "Common Investment Policies and
Techniques; Risk Factors" below for more information. The Portfolio may also
hold a portion of its assets in cash or money market instruments.
- --------------------------------------------------------------------------------
LEGG MASON FUND ADVISER MID CAP VALUE PORTFOLIO
- --------------------------------------------------------------------------------
Adviser: LMFA
- --------------------------------------------------------------------------------
Objective: capital appreciation
- --------------------------------------------------------------------------------
Under normal market conditions, the Portfolio will invest at least 65%
of its total assets in equity securities of companies that have an equity market
capitalization at the time of purchase within the range used from time to time
for inclusion in the S&P Midcap 400 Index (currently, approximately $500 million
to $5 billion). Equity securities include common stock, preferred stock,
securities convertible into common stock, rights and warrants to acquire such
securities and substantially similar forms of equity with comparable risk
characteristics. Issuers in which the Portfolio will invest will typically
exhibit one or more of the following characteristics:
1. The companies generally are not closely followed by, or are
out of favor with, investors, and appear to be undervalued in
relation to their long-term earning power or asset values.
2. The companies are experiencing unusual and possibly
non-repetitive developments which, in LMFA's opinion, may
cause the market values of the securities to increase. Such
developments may include: (a) a sale or termination of an
unprofitable part of the company's business; (b) a change in
the company's management or in management's philosophy; (c) a
basic change in the industry in which the company operates;
(d) the introduction of new products or technologies; or (e)
the prospect or effect of acquisition or merger activities.
-20-
<PAGE>
3. The companies are involved in actual or anticipated
reorganizations or restructurings under the Bankruptcy Code.
No more than 20% of the Portfolio's total assets at the time
of purchase may be invested in such securities.
Investments in securities with such characteristics may involve greater
risks of loss than investments in securities of larger, well-established
companies with a history of consistent operating patterns and greater financial
resources. In addition, the prices of securities of mid-sized companies
generally are more volatile than those of larger companies, the securities of
mid-sized companies generally are less liquid and may, at times, be more
difficult to value, and mid-sized companies generally are more likely to be
adversely affected by poor economic or market conditions. Investments in
securities of companies involved in actual or anticipated reorganizations or
restructurings involve special risks, including difficulty in obtaining
information as to the financial condition of such issuers and the fact that the
market prices of such securities are subject to sudden and erratic market
movements and above-average price volatility.
Subject to the 65% test described above, the Portfolio may also invest
in larger, more highly capitalized companies when circumstances warrant such
investments. The Portfolio may invest in securities that pay no dividends or
interest, and current dividend income is not a prerequisite in the selection of
securities.
Equity securities are normally the Portfolio's main investments.
However, the Portfolio may invest up to 35% of its total assets in any type of
debt or fixed income security, including securities that, at the time of
purchase, are not rated investment grade by an NRSRO, if LMFA believes they
would help achieve the Portfolio's investment objective. Lower-rated securities
(and unrated securities of comparable quality) are considered to be primarily
speculative and may be in default. The Portfolio may also invest up to 25% of
its total assets in securities principally traded in foreign markets, engage in
foreign currency exchange transactions and transactions in futures contracts and
options, purchase restricted and illiquid securities, enter into repurchase
agreements, purchase shares of other investment companies, loan its portfolio
securities, borrow money for temporary or emergency purposes, and purchase or
sell securities on a forward commitment basis. See "Common Investment Policies
and Techniques; Risk Factors" below for more information. The Portfolio may also
hold a portion of its assets in cash or money market instruments.
- --------------------------------------------------------------------------------
U.S. SMALL CAP PORTFOLIO
- --------------------------------------------------------------------------------
Adviser: [ ]
- --------------------------------------------------------------------------------
Objective: long-term capital appreciation
- --------------------------------------------------------------------------------
Under normal market conditions, the Portfolio will invest at least 65%
of its total assets in equity securities of "small cap" companies (generally
defined as companies with an equity market capitalization of between $50 million
and $1 billion at the time of initial investment). A company
-21-
<PAGE>
that was a "small cap" company at the time of the Portfolio's initial investment
will continue to be treated as such for purposes of the 65% test, even if its
equity capitalization exceeds $1 billion at the time of subsequent investment.
Equity securities include common stock, preferred stock, securities convertible
into common stock, rights and warrants to acquire such securities and
substantially similar forms of equity with comparable risk characteristics.
Securities of "small cap" companies entail special risks. Such
companies often have limited operating histories and may have more restricted
product lines or more limited financial resources than larger, more established
companies. For these and other reasons, they may be more severely affected by
economic downturns or other adverse developments than are larger, more
established companies. Securities of "small cap" companies may be traded
"over-the-counter" and often trade less frequently and in more limited volume,
may be subject to greater volatility and may, at times, be more difficult to
value than securities of larger, more established companies. "Small cap"
companies are often involved in actual or anticipated reorganizations or
restructurings, which involve special risks, including difficulty in obtaining
information as to the financial condition of such companies and the fact that
market prices of such companies' securities are subject to sudden and erratic
price volatility.
Although the Portfolio expects to remain substantially fully invested
in equity securities, the Portfolio may invest in debt or fixed income
securities of U.S. or foreign issuers, cash and money market instruments,
including repurchase agreements. The Portfolio's debt and fixed income
investments may include securities that, at the time of purchase, are not rated
investment grade by an NRSRO, if the Adviser believes they would help achieve
the Portfolio's investment objective. Lower-rated securities (and unrated
securities of comparable quality) are considered to be primarily speculative and
may be in default. The Portfolio may also engage in reverse repurchase agreement
transactions and other borrowings, purchase restricted and illiquid securities,
lend its portfolio securities, invest in securities of other investment
companies, engage in foreign currency exchange transactions, and engage in
futures and options transactions. For more information, see "Common Investment
Policies and Techniques; Risk Factors."
-22-
<PAGE>
- --------------------------------------------------------------------------------
BATTERYMARCH EMERGING MARKETS PORTFOLIO
- --------------------------------------------------------------------------------
Adviser: Batterymarch
- --------------------------------------------------------------------------------
Objective: long-term capital appreciation
- --------------------------------------------------------------------------------
Under normal market conditions, the Portfolio will invest substantially
all of its assets, but in any event at least 65% of its total assets, in
"emerging market" equity securities. Emerging markets include any country: (i)
having an "emerging stock market" as defined by the International Finance
Corporation; (ii) with low- to middle-income economies according to the
International Bank for Reconstruction and Development ("World Bank"); (iii)
listed in World Bank publications as developing; or (iv) determined by
Batterymarch to be an emerging market in accordance with the criteria of those
organizations. Emerging market equity securities include common stock, preferred
stock, securities convertible into common stock, rights and warrants to acquire
such securities and substantially similar forms of equity with comparable risk
characteristics that are: (1) publicly traded on emerging market stock
exchanges, or whose principal trading market is over-the-counter (i.e.,
off-exchange) in an emerging market country; (2) securities (i) denominated in
any emerging market currency or (ii) denominated in any other currency if issued
by companies to finance operations in an emerging market country; (3) securities
of companies that derive a substantial portion of their total revenues from
goods or services produced in, or sales made in, emerging market countries; (4)
securities of companies organized under the laws of an emerging market country
or region, which are publicly traded in securities markets elsewhere; and (5)
American depositary receipts ("ADRs") (or similar instruments) with respect to
the foregoing. Investing in foreign issuers, and in particular in emerging
market equity securities, involves special risks. See "Common Investment
Policies and Techniques; Risk Factors -- Foreign Securities."
The Portfolio intends to invest in Asia, Latin America, the Indian
Sub-continent, Southern and Eastern Europe, the Middle East, and Africa,
although it may not invest in all these markets at all times and may not invest
in any particular market when it deems such an investment to be inadvisable. The
Portfolio will normally diversify its investments among a number of different
countries, although more than 25% of its total assets may be invested in
securities denominated in a single currency. The concentration of the
Portfolio's assets in this manner will increase the Portfolio's exposure to
adverse developments affecting the value of that currency, subjecting the
Portfolio to greater risk. For more information concerning the risks associated
with investments denominated in foreign currencies, see "Common Investment
Policies and Techniques; Risk Factors -- Foreign Securities." An issuer of
securities purchased by the Portfolio may be domiciled in a country other than
the country in whose currency the securities are denominated.
Assets not invested in emerging market equity securities may be
invested in any combination of fixed income securities, equity securities of
issuers in developed
-23-
<PAGE>
countries, cash and money market instruments, including repurchase agreements.
The Portfolio's fixed income investments may include lower-rated securities
(i.e., securities rated below investment grade at the time of purchase or
unrated securities of comparable quality at the time of purchase). Such
securities are primarily speculative and may be in default. The Portfolio may
also invest in securities of other investment companies, purchase restricted and
illiquid securities, borrow money for temporary or emergency purposes, engage in
futures and options transactions, and engage in foreign currency exchange
transactions. For more information, see "Common Investment Policies and
Techniques; Risk Factors." Although the Portfolio has the ability to hedge its
foreign currency risk, appropriate hedging instruments are not available with
respect to most emerging market currencies, and it is therefore unlikely that
the Portfolio will be able to employ such hedging strategies to a significant
extent, if at all.
- --------------------------------------------------------------------------------
BATTERYMARCH INTERNATIONAL EQUITY PORTFOLIO
- --------------------------------------------------------------------------------
Adviser: Batterymarch
- --------------------------------------------------------------------------------
Objective: long-term total return
- --------------------------------------------------------------------------------
Under normal market conditions, the Portfolio will invest substantially
all of its assets, but in any event at least 65% of its total assets, in equity
securities of foreign issuers representing in at least three different countries
other than the United States. For these purposes, a foreign issuer is any issuer
for which a country other than the United States is the principal trading market
for its shares or who derives more than one-half of its total revenues from
business conducted outside the United States. Equity securities include common
stock, preferred stock, securities convertible into common stock, rights and
warrants to acquire such securities and substantially similar forms of equity
with comparable risk characteristics. When selecting securities for the
Portfolio, Batterymarch examines securities from over 20 international stock
markets, with emphasis on several of the largest -- Japan, the United Kingdom,
France, Canada and Germany. Securities are chosen using Batterymarch's model for
identifying securities it believes to be undervalued. The weighting of the
Portfolio's assets among individual countries will reflect an assessment of the
attractiveness of individual securities. The Portfolio also may invest up to 35%
of its total assets in emerging market equity securities (as defined above under
"Batterymarch Emerging Markets Portfolio"). Investing in foreign issuers, and in
particular in emerging market equity securities, involves special risks. See
"Common Investment Policies and Techniques; Risk Factors -- Foreign Securities."
The Portfolio's investments will normally be diversified across a broad
range of industries and across a number of countries, consistent with the
objective of long-term total return. However, the Portfolio currently expects
that it may be heavily invested in securities of Japanese issuers. As a result,
the value of its shares will be especially affected by Japanese political,
economic, market and exchange rate conditions, and may fluctuate more widely
than the value of shares of other equity funds. Since the Japanese economy is
dependent to a significant extent on foreign trade, the relationships between
Japan and its trading partners and between the yen and other currencies are
expected to have a significant impact on the Japanese economy generally and
therefore are expected to influence the Portfolio's performance. Japan has in
the past experienced difficult relations with its trading partners, particularly
the United States. It is possible that trade sanctions or other protectionist
measures could impact the Japanese economy and markets, and have an adverse
effect on the value of the Portfolio's assets, in both the short and long term.
-24-
<PAGE>
Japan has recently experienced a recession, including a decline in real estate
values, that has adversely affected the balance sheets of many financial
institutions. Certain Japanese financial institutions have experienced extreme
financial difficulties, including bankruptcy. To the extent the Japanese
currency is strong relative to those of its trading partners, industries engaged
substantially in export will be affected. Japan's economy is heavily dependent
on foreign oil. Japan is located in a seismically active area, and severe
earthquakes may damage important elements of the country's infrastructure.
Japanese economic prospects may be affected by the economic, political and
military situations of its neighbors, notably North and South Korea, Thailand,
China, and Russia.
Although the Portfolio expects to remain substantially fully invested
in equity securities, the Portfolio may invest in any type of debt or fixed
income security (including securities issued by U.S. issuers), cash and money
market instruments, including repurchase agreements. The Portfolio may invest up
to 5% of its total assets in lower-rated fixed income securities (i.e.,
securities rated below investment grade at the time of purchase or unrated
securities of comparable quality at the time of purchase). Such securities are
primarily speculative and may be in default. The Portfolio may also purchase
restricted and illiquid securities, invest in securities of other investment
companies, borrow money for temporary or emergency purposes, engage in futures
and options transactions, and engage in foreign currency exchange transactions.
For more information, see "Common Investment Policies and Techniques; Risk
Factors."
- --------------------------------------------------------------------------------
WESTERN ASSET ENHANCED EQUITY PORTFOLIO
- --------------------------------------------------------------------------------
Adviser: Western Asset Management Company ("Western Asset")
- --------------------------------------------------------------------------------
Objective: long term total return. "Total return" includes all interest,
dividends and other income, net of expenses, paid on the
Portfolio's investments, as well as all realized and unrealized
gains and losses.
- --------------------------------------------------------------------------------
The Portfolio's assets are comprised of two components: an equity
component and a fixed income component. As more fully described below, Western
Asset attempts to manage the equity component so that the Portfolio generally
maintains full exposure to the U.S. equity market as represented by the S&P 500
Index (the "Index"). Western Asset attempts to manage the Portfolio's fixed
income component in order to generate interest and gains in excess of the
Portfolio's expenses, including transaction costs related to its investments. By
investing in both components, the Portfolio expects that its performance will
approximate that of the Index, with the extent to which the Portfolio
outperforms or underperforms the Index depending largely on whether the fixed
income component has earned sufficient amounts to offset the Portfolio's
expenses.
EQUITY COMPONENT. The Portfolio's equity component invests in common
stocks that are represented in the Index ("S&P stocks"), stock index futures,
options on stock indexes, options on stock index futures and other derivative
instruments that are based on the Index ("S&P
-25-
<PAGE>
derivatives"). The Portfolio may invest in any combination of S&P stocks and S&P
derivatives. Western Asset will determine the appropriate mix of S&P stocks and
S&P derivatives for the Portfolio based on current market conditions and the
expected costs and returns of each, while seeking to control and limit overall
risk. Based on current market conditions, Western Asset currently expects that
the Portfolio's equity component will invest predominantly, and likely
exclusively, in S&P derivatives. To the extent S&P stocks are purchased by the
Portfolio, the Portfolio will not be limited to purchasing S&P stocks in the
same proportion as such stocks are weighted in the Index.
The Index is composed of 500 selected common stocks, most of which are
listed on the New York Stock Exchange ("Exchange"). S&P chooses the stocks to be
included in the Index solely on a statistical basis. The weightings of stocks in
the Index are based on each stock's relative total market value, that is, its
market price per share times the number of shares outstanding. Stocks
represented currently in the Index represent approximately two-thirds of the
total market value of all U.S. publicly traded common stocks.
Positions in S&P derivatives will be entered into only to the extent
they constitute permissible positions for the Portfolio according to applicable
rules of the Commodity Futures Trading Commission ("CFTC"). From time to time
Western Asset may be constrained in its ability to use S&P derivatives by CFTC
rules or by an unanticipated inability to close out positions when it would be
most advantageous to do so. For more information about S&P derivatives, see
"Common Investment Policies and Techniques; Risk Factors -- Options and
Futures."
The Portfolio is neither sponsored by nor affiliated with S&P. The
Portfolio will seek to remain invested in S&P stocks and S&P derivatives even
when the Index is declining.
FIXED INCOME COMPONENT. The fixed income component will invest
primarily in the following types of securities: obligations issued or guaranteed
by the U.S. Government, its agencies or instrumentalities; fixed income
securities of non-governmental domestic or foreign issuers; municipal
securities; mortgage- and other asset-backed securities; preferred stocks; and
obligations of foreign governments or their subdivisions, agencies and
instrumentalities, international agencies or supranational entities. The fixed
income component may also invest in certificates of deposit, time deposits and
bankers' acceptances issued by domestic and foreign banks and in commercial
paper and other short-term investments, and may engage in repurchase agreements,
reverse repurchase agreements and other borrowings and purchase or sell futures
contracts and options. Up to 10% of the Portfolio's net assets may be invested
in lower-rated securities (i.e., securities rated below investment grade at the
time of purchase or unrated securities of comparable quality at the time of
purchase) and up to 20% of its net assets may be invested in foreign securities.
The fixed income component may engage in foreign currency exchange transactions
in connection with its foreign investments. For more information, see "Common
Investment Policies and Techniques; Risk Factors."
-26-
<PAGE>
- --------------------------------------------------------------------------------
LEGG MASON FUND ADVISER/WESTERN ASSET BALANCED PORTFOLIO
- --------------------------------------------------------------------------------
Advisers: LMFA (equity portion) and Western Asset (fixed income portion)
- --------------------------------------------------------------------------------
Objective: long-term capital appreciation and current income in order to
achieve an attractive total investment return consistent with
reasonable risk
- --------------------------------------------------------------------------------
The Portfolio is comprised of two separate investment components: an
equity component and a fixed income component. LMFA will allocate assets between
these two components, as it deems appropriate and market opportunities arise,
subject to the limitation that, under normal market conditions, at least 25% of
the Portfolio's total assets will be allocated to the fixed income component.
"Equity" assets will be managed by LMFA in the manner described above for the
Legg Mason Fund Adviser Large Cap Value Portfolio. "Fixed income" assets will be
managed by Western Asset in the manner described below for the Western Asset
Intermediate and Core Portfolios, except that the dollar weighted average
duration of the fixed income assets of this Portfolio is expected to be between
two years and 20% greater than what Western Asset believes to be the average
duration of the bond market as a whole (currently expected to be about six
years). For more information about how assets allocated to these two components
will be invested, and the associated risks, investors should consult the
descriptions of the Legg Mason Fund Adviser Large Cap Value Portfolio and the
Western Asset Intermediate and Core Portfolios contained in this Prospectus.
- --------------------------------------------------------------------------------
WESTERN ASSET MONEY MARKET PORTFOLIO
- --------------------------------------------------------------------------------
Adviser: Western Asset
- --------------------------------------------------------------------------------
Objective: obtain high current income consistent with liquidity and
conservation of principal
- --------------------------------------------------------------------------------
The Portfolio invests in high quality money market instruments, which
include, but are not limited to, marketable obligations issued or guaranteed by
the U.S. Government, its agencies or instrumentalities; instruments of domestic
and foreign banks and savings and loan institutions (such as certificates of
deposit, demand and time deposits, savings shares and bankers' acceptances),
provided that the issuing bank or institution has total assets of over $1
billion at the time of purchase or the principal amount of the instrument is
insured by the Federal Deposit Insurance Corporation; and commercial paper and
other short-term investments. The Portfolio may also invest in repurchase
agreements involving any of the foregoing instruments. A money market instrument
is considered to be "high quality" if it has received one of the two highest
ratings by two or more NRSROs (or by one NRSRO if only one has rated the
security) or, if unrated, is determined by Western Asset, acting pursuant to
guidelines established by the Portfolio's Board of Directors, to be of
comparable quality.
Although the Portfolio attempts to maintain a stable net asset value of
$1.00 per share, the Portfolio, of course, cannot guarantee a net asset value of
$1.00 per share. In an attempt to
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maintain that net asset value per share, the Portfolio pursues several practices
intended to minimize the effect of interest rate fluctuations. The Portfolio
will not purchase instruments having a remaining term to maturity of more than
397 days, and will maintain an average maturity, computed on a dollar-weighted
basis, of 90 days or less. The Portfolio may invest in variable and floating
rate obligations that have stated maturities in excess of 397 days if such
obligations comply with conditions established by the SEC. Securities held by
the Portfolio as collateral for repurchase agreements and other collateralized
transactions may have remaining maturities in excess of 397 days. The Portfolio
may purchase or sell securities on a forward commitment basis, and will invest
only in U.S. dollar-denominated securities.
High quality money market instruments can be divided into two
categories: "first tier" securities and "second tier" securities. An instrument
rated in the highest rating category by at least two NRSROs (or one NRSRO if
only one has rated the security) or, if unrated, determined by Western Asset to
be of comparable quality, is a "first tier" security. "Second tier" securities
are all other high quality securities. The Portfolio may not invest more than
five percent of its total assets in first tier securities of any one issuer
(other than the U.S. Government, its agencies or instrumentalities), except on a
temporary basis. The Portfolio may not invest more than one percent of its total
assets, or $1 million, whichever is greater, in the second tier securities of
any one issuer, and may not invest more than five percent of its total assets in
second tier securities generally. Both the percentages and the quality standards
set forth in this paragraph are measured at the time a security is purchased.
Purchases of unrated securities and purchases of securities rated by only a
single NRSRO must be approved or ratified by the Portfolio's Board of Directors.
The Portfolio's foreign investments (all of which will be U.S.
dollar-denominated) subject the Portfolio to investment risks different from
those associated with domestic investments. For additional information
concerning these risks, see "Common Investment Policies and Techniques; Risk
Factors -- Foreign Securities" below. To the extent permitted by applicable law,
the Portfolio may also engage in reverse repurchase agreements and other
borrowings. See "Common Investment Policies and Techniques; Risk Factors" below.
- --------------------------------------------------------------------------------
WESTERN ASSET GOVERNMENT MONEY MARKET PORTFOLIO
- --------------------------------------------------------------------------------
Adviser: Western Asset
- --------------------------------------------------------------------------------
Objective: obtain high current income consistent with liquidity and
conservation of principal
- --------------------------------------------------------------------------------
The Portfolio invests only in U.S. Government obligations and
repurchase agreements with respect to such instruments. U.S. Government
obligations include: (1) U.S. Treasury obligations, which differ only in their
interest rates, maturities and times of issuance, and (2) obligations issued or
guaranteed by U.S. Government agencies and instrumentalities which are supported
by any of the following: (a) the full faith and credit of the U.S. Government
(such as certificates of the
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Governmental National Mortgage Association ("GNMA")), (b) the right of the
issuer to borrow an amount limited to a specific line of credit from the U.S.
Government (such as obligations of the Federal Home Loan Banks), (c) the
discretionary authority of the U.S. Government to purchase certain obligations
of an agency or instrumentality (such as securities issued by Fannie Mae
("FNMA"), formerly the Federal National Mortgage Association) or (d) only the
credit of the instrumentality (such as the securities issued by Freddie Mac
(formerly the Federal Home Loan Mortgage Corporation)). In the case of
obligations not backed by the full faith and credit of the U.S. Government, the
Portfolio must look to the agency or instrumentality issuing or guaranteeing the
obligation for ultimate repayment and may not be able to assert a claim against
the United States itself in the event the agency or instrumentality does not
meet its commitments. The U.S. Government does not insure or guarantee the
market value of the Portfolio's shares.
Although the Portfolio attempts to maintain a stable net asset value of
$1.00 per share, the Portfolio, of course, cannot guarantee a net asset value of
$1.00 per share. In an attempt to maintain that net asset value per share, the
Portfolio pursues several practices intended to minimize the effect of interest
rate fluctuations. The Portfolio will not purchase instruments having a
remaining term to maturity of more than 397 days, will maintain an average
maturity, computed on a dollar-weighted basis, of 90 days or less, and will buy
only high quality securities which Western Asset believes present minimal credit
risk. The Portfolio may invest in variable and floating rate obligations that
have stated maturities in excess of 397 days if such obligations comply with
conditions established by the SEC. Securities held by the Portfolio as
collateral for repurchase agreements and other collateralized transactions may
have remaining maturities in excess of 397 days.
The Portfolio may purchase or sell securities on a forward commitment
basis. To the extent permitted by applicable law, the Portfolio may also engage
in reverse repurchase agreements and other borrowings. See "Common Investment
Policies and Techniques; Risk Factors" below.
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WESTERN ASSET LIMITED DURATION PORTFOLIO
WESTERN ASSET INTERMEDIATE PORTFOLIO
WESTERN ASSET CORE PORTFOLIO
- --------------------------------------------------------------------------------
Adviser: Western Asset
- --------------------------------------------------------------------------------
Objective: maximize total return, consistent with prudent investment
management and liquidity needs, by investing to obtain the
average duration specified for that Portfolio. "Total
return" includes interest from underlying securities,
capital gains and appreciation on the securities held in the
Portfolio, and gains from the sale of futures and options.
- --------------------------------------------------------------------------------
As set forth below, the Portfolios differ from one another primarily in
the range of duration and/or in the proportion of assets invested in certain
types of securities. Duration is a measure of the expected life of a fixed
income security on a cash flow basis. Most debt obligations provide interest
payments and a final payment at maturity. Some also have call provisions that
allow the issuer to redeem the security at specified dates prior to maturity.
Duration incorporates yield, coupon interest payments, final maturity and call
features into a single measure. It is therefore considered a more accurate
measure of a security's expected life and sensitivity to interest rate changes
than is the security's term to maturity. See "Common Investment Policies and
Techniques; Risk Factors" for a further explanation of the term "duration" and
its application to various fixed income securities.
The Portfolios invest primarily in the following types of securities:
obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities; U.S. dollar-denominated fixed income securities of
non-governmental domestic or foreign issuers rated Baa or better by Moody's
Investors Services ("Moody's") or BBB or better by Standard & Poor's ("S&P"),
securities comparably rated by another NRSRO or, if unrated, determined by
Western Asset to be of comparable quality; mortgage- and other asset-backed
securities; and U.S. dollar-denominated obligations of foreign governments or
their subdivisions, agencies and instrumentalities, international agencies or
supranational entities. The Portfolios may also invest in certificates of
deposit, time deposits and bankers' acceptances issued by domestic and foreign
banks and denominated in U.S. dollars and in commercial paper and other
short-term investments, and may engage in repurchase agreements and reverse
repurchase agreements involving any of the foregoing. See "Common Investment
Policies and Techniques; Risk Factors" for more information.
Each of these Portfolios is authorized to invest up to 25% of its total
assets in the securities of foreign issuers. However, each Portfolio presently
intends to limit such investments to securities denominated in U.S. dollars. See
"Common Investment Policies and Techniques; Risk
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<PAGE>
Factors -- Foreign Securities" for more information. Each Portfolio may invest
or hold up to 5% of its net assets in debt securities that are rated below
investment grade but rated B or higher by Moody's or S&P. See the Appendix to
the Prospectus for a description of Moody's and S&P ratings applicable to fixed
income securities and "Common Investment Policies and Techniques; Risk Factors
- -- Debt and Fixed Income Securities -- Lower-Rated Securities" for more
information concerning fixed income securities of below investment grade
quality. If the rating of a security in which a Portfolio has invested falls
below the minimum rating in which the Portfolio is permitted to invest, the
Portfolio will either dispose of that security within a reasonable time or hold
the security until maturity as the Portfolio's investment adviser determines
appropriate for that Portfolio, having due regard for market conditions, tax
implications and other applicable factors.
Each Portfolio may buy or sell futures contracts on fixed income
instruments, options on such futures contracts and options on securities to
hedge against changes in the value of securities which the Portfolio owns or
anticipates purchasing due to anticipated changes in interest rates. Each
Portfolio may use options on debt securities for non-hedging purposes, in an
effort to enhance income. See "Common Investment Policies and Techniques --
Options and Futures."
The Portfolios also may purchase preferred stocks, convertible
securities and zero coupon bonds, may purchase or sell securities on a forward
commitment basis, lend its portfolio securities, and borrow money for temporary
or emergency purposes. See "Common Investment Policies and Techniques; Risk
Factors" below for more information about these practices.
In selecting securities for each Portfolio, Western Asset may utilize
economic forecasting, interest rate anticipation, credit and call risk analysis,
and other security selection techniques. The proportion of each Portfolio's
assets committed to investment in securities with particular characteristics
(such as maturity, type and coupon rate) will vary based on Western Asset's
outlook for the U.S. and foreign economies, the financial markets and other
factors.
The composition of the Portfolios is as follows:
WESTERN ASSET LIMITED DURATION PORTFOLIO . . .
- ----------------------------------------------
invests in a portfolio with a dollar-weighted average duration normally ranging
between one and three years. The total rate of return for this Portfolio is
expected to exhibit less volatility than that of the Western Asset Intermediate
Portfolio or the Western Asset Core Portfolio because its average duration will
be shorter.
WESTERN ASSET INTERMEDIATE PORTFOLIO . . .
- ------------------------------------------
invests in a portfolio with a dollar-weighted average duration normally ranging
between two and four years. The total rate of return for this Portfolio is
expected to exhibit less volatility than that of the Western Asset Core
Portfolio because its average duration will be shorter.
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<PAGE>
WESTERN ASSET CORE PORTFOLIO . . .
- ----------------------------------
invests in a portfolio with a dollar-weighted average duration that will
normally stay within (plus/minus) 20% of what Western Asset believes to be the
average duration of the domestic bond market as a whole, but may have a longer
or shorter duration during periods of unusual market conditions, as judged by
Western Asset. Western Asset bases its analysis of the average duration of the
domestic bond market on bond market indices which it believes to be
representative. Western Asset currently uses the Lehman Brothers Aggregate Bond
Index for this purpose. As the average duration of the domestic bond market is
currently about four and one-half years, the duration of this Portfolio is
currently expected to range between four and six years. Portfolio holdings will
be concentrated in areas of the bond market (based on quality, sector, coupon or
maturity) which Western Asset believes to be relatively undervalued.
The average duration of any Portfolio may be less than that specified
during periods of unusual liquidity needs or immediately following a major
contribution of cash.
- --------------------------------------------------------------------------------
WESTERN ASSET HIGH YIELD PORTFOLIO
- --------------------------------------------------------------------------------
Adviser: Western Asset
- --------------------------------------------------------------------------------
Objective: maximize total return, consistent with prudent investment
management. "Total return" includes interest from underlying
securities, capital gains and appreciation on the securities
held in the Portfolio, and gains from the sale of futures and
options.
- --------------------------------------------------------------------------------
Under normal market conditions, the Portfolio will invest at least 75%
of its total assets in U.S. dollar-denominated debt or fixed income securities
of non-governmental domestic issuers that are rated below investment grade by
one or more NRSROs or are of a comparable quality as determined by Western
Asset. These securities are commonly known as "junk bonds" or "high yield
bonds." Western Asset expects that, under normal market conditions, all or
substantially all of the Portfolio's assets will be invested in such securities.
Non-investment grade securities and certain investment grade securities have
speculative characteristics and are therefore more volatile. A rating in the
lowest category indicates that the security is highly speculative and may be in
default or in danger of default as to principal and interest. Lower-rated fixed
income securities generally provide greater income than higher-rated securities,
but are subject to greater market fluctuations and risks of loss of income and
principal than higher-rated securities. See "Common Investment Policies and
Techniques; Risk Factors -- Debt and Fixed Income Securities -- Lower-Rated
Securities" for more information concerning fixed income securities of below
investment grade quality.
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<PAGE>
In selecting securities for the Portfolio, Western Asset may utilize
economic forecasting, interest rate anticipation, credit and call risk analysis,
and other security selection techniques. The proportion of assets committed to
investment in securities with particular characteristics (such as maturity, type
and coupon rate) will vary based on Western Asset's outlook for the U.S. and
foreign economies, the financial markets and other factors.
The Portfolio may also invest in the following U.S. dollar-denominated
securities: mortgage- and other asset-backed securities; variable and floating
rate debt securities; commercial paper and other short-term investments; various
corporate obligations (including preferred stock, convertible securities, zero
coupon securities and pay-in-kind securities); common stocks and certificates of
deposit, fixed time deposits and bankers' acceptances issued by domestic banks.
The Portfolio may also engage in repurchase agreements, reverse repurchase
agreements and dollar roll transactions involving any of the foregoing. For more
information, see "Common Investment Policies and Techniques; Risk Factors"
below.
The Portfolio also may buy or sell interest rate futures contracts and
options on fixed income instruments and bond indices and options on interest
rate futures contracts to hedge against changes in the value of securities it
owns or anticipates purchasing or for non-hedging purposes, in an effort to
enhance income. The Portfolio also may purchase or sell securities on a forward
commitment basis, engage in foreign currency exchange transactions, engage in
short sales, lend its securities, and borrow money for temporary or emergency
purposes. See "Common Investment Policies and Techniques; Risk Factors" below
for more information about these practices.
- --------------------------------------------------------------------------------
WESTERN ASSET NON-U.S. FIXED INCOME PORTFOLIO
- --------------------------------------------------------------------------------
Adviser: Western Asset Global Management Limited ("WAGM")
- --------------------------------------------------------------------------------
Objective: maximize total return, consistent with prudent investment
management. "Total return" includes interest from underlying
securities, capital gains and appreciation on the securities
held in the Portfolio, and gains from the use of futures and
options and from favorable changes in foreign currency
exchange rates.
- --------------------------------------------------------------------------------
Under normal market conditions, the Portfolio invests at least 75% of
its total assets in fixed income securities denominated in major foreign
currencies and in baskets of currencies (which may include U.S. and foreign
currencies), such as the European Currency Unit, or "ECU," or as other baskets
of currencies may further develop. WAGM anticipates that, under normal market
conditions, all or substantially all of the Portfolio's assets will be invested
in securities of foreign issuers. WAGM will manage the investments of the
Portfolio across different international bond markets so that, under normal
market conditions, the Portfolio's assets will be invested in securities of
foreign issuers representing at least three foreign countries. WAGM will select
the Portfolio's foreign country and currency composition based on its evaluation
of relative interest
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<PAGE>
rates, inflation rates, exchange rates, monetary and fiscal policies, trade and
current account balances, and any other specific factors WAGM believes relevant.
In selecting securities for the Portfolio, WAGM may utilize economic
forecasting, interest rate anticipation, credit and call risk analysis, and
other security selection techniques. The proportion of assets committed to
investment in securities with particular characteristics (such as maturity, type
and coupon rate) will vary based on WAGM's outlook for the U.S. and foreign
economies, the financial markets and other factors.
The Portfolio's foreign investments subject the Portfolio to greater
risks than those associated with domestic investments. See "Common Investment
Policies and Techniques; Risk Factors -- Foreign Securities" for more
information concerning these risks.
Within the limits described above, the Portfolio may invest in a
variety of debt and other fixed income securities, including: U.S.
dollar-denominated or foreign currency-denominated obligations of foreign
governments or their subdivisions, agencies and instrumentalities, international
agencies (such as the World Bank) or supranational entities; foreign currency
exchange-related securities, including foreign currency warrants; obligations
issued or guaranteed by the U.S. Government, its agencies or instrumentalities;
mortgage- and other asset-backed securities; variable and floating rate debt
securities; commercial paper and other short-term investments; corporate
obligations (including preferred stock, convertible securities, zero coupon
securities and pay-in-kind securities); certificates of deposit, fixed time
deposits and bankers' acceptances; loan participations and assignments; indexed
securities and structured notes; and repurchase agreements collateralized by any
security in which it may invest. The Portfolio may also engage in reverse
repurchase agreements and dollar roll transactions and may borrow money for
temporary or emergency purposes. See "Common Investment Policies and Techniques;
Risk Factors" for more information.
The Portfolio may invest up to 25% of its net assets in debt or other
fixed income securities that are rated at the time of purchase below investment
grade or are of comparable quality at the time of purchase as determined by
WAGM. These securities are commonly known as "junk bonds" or "high yield bonds."
It is likely that a substantial portion of these securities will be issued by
issuers located in emerging market countries. As a result, these securities are
subject to special risks. See "Common Investment Policies and Techniques; Risk
Factors" below for more information concerning lower-rated securities and
securities issued by issuers located in emerging market countries. In evaluating
the credit risk of a foreign debt security, the Portfolio may use ratings
assigned by rating agencies recognized in the primary market for those
securities. In the event that the rating of any security held by the Portfolio
falls below its rating at the time of purchase, the Portfolio will not be
obligated to dispose of such security and may continue to hold the security if,
in the opinion of WAGM, such investment is considered appropriate in the
circumstances.
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<PAGE>
The Portfolio also may buy or sell interest rate futures contracts and
options on fixed income instruments and bond indices and options on interest
rate futures contracts to hedge against changes in the value of securities it
owns or anticipates purchasing or for non-hedging purposes, in an effort to
enhance income. Investments in futures contracts and options on fixed income
instruments and bond indices are considered, for purposes of determining the
percentage of the Portfolio's net assets invested in "fixed income securities,"
to be fixed income securities. The Portfolio may buy or sell foreign currencies,
foreign currency options, or foreign currency futures contracts and related
options, and may enter into foreign currency forward contracts and other foreign
currency exchange transactions for the purpose of hedging against foreign
exchange risk arising from the Portfolio's investment or anticipated investment
in securities denominated in foreign currencies. The Portfolio also may engage
in such transactions for purposes of increasing exposure to a particular foreign
currency or to shift exposure to foreign currency fluctuations from one country
to another. See "Common Investment Policies and Techniques; Risk Factors" for
more information about these practices.
The Portfolio is "non-diversified" within the meaning of the Investment
Company Act. Accordingly, the Portfolio may invest a greater percentage of its
total assets in securities of any one issuer, or may invest in a smaller number
of different issuers, than it would if it were a "diversified" company under the
Investment Company Act. The Portfolio is therefore more susceptible to risks
associated with particular issuers and with the economic, political or
regulatory issues in a particular country or group of countries than would a
diversified portfolio.
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<PAGE>
COMMON INVESTMENT POLICIES AND TECHNIQUES;
RISK FACTORS
- --------------------------------------------------------------------------------
Some or all of the Portfolios may engage in the following investment
practices and techniques to the extent described in this Prospectus. See the SAI
for a further description of the uses, risks and costs of engaging in these
practices.
FOREIGN SECURITIES
- --------------------------------------------------------------------------------
Investing in the securities of issuers in any foreign country, or in
securities denominated in a foreign currency, involves special risks and
considerations not typically associated with investing in U.S. issuers or U.S.
dollar-denominated securities. These include risks resulting from differences in
accounting, auditing and financial reporting standards; lower liquidity than
U.S. securities; the possibility of nationalization, expropriation or
confiscatory taxation; adverse changes in investment or exchange control
regulations (which may include suspension of the ability to transfer currency
out of a country); and political instability. In many cases, there is less
publicly available information concerning foreign issuers than is available
concerning U.S. issuers. Additionally, purchases and sales of foreign securities
and dividends and interest payable on those securities may be subject to foreign
taxes and tax withholding. Foreign securities generally exhibit greater price
volatility and a greater risk of illiquidity.
To the extent a Portfolio purchases securities denominated in a foreign
currency, a change in the value of any such currency against the U.S. dollar
will result in a change in the U.S. dollar value of the Portfolio's assets and
the Portfolio's income available for distribution. In addition, a Portfolio is
required to compute and distribute its income in U.S. dollars. Therefore, if the
exchange rate for a foreign currency declines after a Portfolio's income has
been earned and translated into U.S. dollars (but before payment), the Portfolio
could be required to liquidate portfolio securities to make such distributions.
Similarly, if an exchange rate declines between the time a Portfolio incurs
expenses in U.S. dollars and the time such expenses are paid, the amount of such
currency required to be converted into U.S. dollars in order to pay such
expenses in U.S. dollars will be greater than the equivalent amount in any such
currency of such expenses at the time they were incurred.
The relative performance of various countries' fixed income and equity
markets historically has reflected wide variations relating to the unique
characteristics of each country's economy. Individual foreign economies may
differ favorably or unfavorably from the U.S. economy in such respects as growth
of gross domestic product, rate of inflation, capital reinvestment, resource
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<PAGE>
self-sufficiency and balance of payments position. Bank deposit insurance, if
any, may be subject to widely varying regulations and limits in foreign
countries.
Foreign securities purchased by a Portfolio may be listed on foreign
exchanges, traded over-the-counter or purchased in private transactions.
Transactions on foreign exchanges are usually subject to mark-ups or commissions
higher than negotiated commissions on U.S. transactions. There is less
government supervision and regulation of exchanges and brokers in many foreign
countries than in the United States. Additional costs associated with an
investment in foreign securities may include higher custodial fees than apply to
domestic custodial arrangements and transaction costs of foreign currency
conversions.
Certain of the foregoing risks may also apply to some extent to
securities of U.S. issuers that are denominated in foreign currencies or that
are traded in foreign markets, or to securities of U.S. issuers having
significant foreign operations.
EMERGING MARKET ISSUERS. The risks of foreign investment, described
above, are greater for investments in emerging market issuers, and such
investments should therefore be considered speculative. Debt securities of
governmental and other issuers in emerging market countries will typically be
rated below investment grade or be of comparable quality. For more information
about lower-rated securities, see "Debt and Fixed Income Securities --
Lower-Rated Securities" below.
Investors are strongly advised to consider carefully the special risks
involved in emerging markets, which are in addition to the usual risks of
investing in developed markets around the world. Emerging market countries may
experience substantial rates of inflation or deflation. Inflation, deflation and
rapid fluctuations in such rates have had, and may continue to have, very
negative effects on the economies and securities markets of certain emerging
market countries. While some emerging market countries have sought to develop a
number of corrective mechanisms to reduce inflation or deflation or mitigate
their effects, inflation and deflation may continue to have significant effects
both on emerging market countries and their securities markets. In addition,
many of the currencies of emerging market countries have experienced steady
devaluations relative to the U.S. dollar, and major devaluations have occurred
in certain countries.
Economies in emerging market countries generally are dependent heavily
upon international trade and, accordingly, have been and may continue to be
affected adversely by economic conditions, trade barriers, exchange controls,
managed adjustments in relative currency values and other protectionist measures
imposed or negotiated by the countries with which they trade.
Because of the high levels of foreign-denominated debt owed by many
emerging market countries, fluctuating exchange rates can significantly affect
the debt service obligations of those countries. This could, in turn, affect
local interest rates, profit margins and exports which are a major source of
foreign exchange earnings. Hedging instruments are not typically available with
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respect to investments in emerging market countries and, to the extent they are
available, the ongoing and indeterminate nature of the foregoing risks (and the
costs associated with hedging transactions) would make it virtually impossible
to hedge effectively against such risks.
To the extent an emerging market country faces a liquidity crisis with
respect to its foreign exchange reserves, it may increase restrictions on the
outflow of any foreign exchange. Repatriation is ultimately dependent on the
ability of a Portfolio to liquidate its investments and convert the local
currency proceeds obtained from such liquidation into U.S. dollars. Where this
conversion must be done through official channels (usually the central bank or
certain authorized commercial banks), the ability to obtain U.S. dollars is
dependent on the supply of such U.S. dollars through those channels and, if
available, upon the willingness of those channels to allocate those U.S. dollars
to the Portfolio. In such a case, a Portfolio's ability to obtain U.S. dollars
may be adversely affected by any increased restrictions imposed on the outflow
of foreign exchange. If the Portfolio is unable to repatriate any amounts due to
exchange controls, it may be required to accept an obligation payable at some
future date by the central bank or other governmental entity of the jurisdiction
involved. If such conversion can legally be done outside official channels,
either directly or indirectly, a Portfolio's ability to obtain U.S. dollars may
not be affected as much by any increased restrictions except to the extent of
the price which may be required to be paid for the U.S. dollars.
Many emerging market countries have little experience with the
corporate form of business organization, and may not have well developed
corporation and business laws or concepts of fiduciary duty in the business
context. The securities markets of emerging market countries are substantially
smaller, less developed, less liquid and more volatile than the securities
markets of the U.S. and other more developed countries. Disclosure and
regulatory standards in many respects are less stringent than in the U.S. and
other major markets. There also may be a lower level of monitoring and
regulation of an emerging market country's securities market and the activities
of investors in such markets; enforcement of existing regulations has been
extremely limited.
Some emerging markets have different settlement and clearance
procedures, which, for example, may not call for delivery of a security to a
Portfolio until well after the Portfolio has paid for such security. In certain
markets there have been times when settlements have been unable to keep pace
with the volume of securities transactions, making it difficult to conduct such
transactions. The inability of a Portfolio to make intended securities purchases
due to settlement problems could cause that Portfolio to miss attractive
investment opportunities. Inability to dispose of a portfolio security caused by
settlement problems could result either in losses to the Portfolio due to
subsequent declines in value of the portfolio security or, if the Portfolio has
entered into a contract to sell the security, in possible liability to the
purchaser.
The risk also exists that an emergency situation may arise in one or
more emerging market countries as a result of which trading of securities may
cease or may be substantially curtailed and prices for a Portfolio's portfolio
securities in such markets may not be readily available.
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SOVEREIGN DEBT SECURITIES. Sovereign debt is subject to risks in
addition to those relating to foreign investments generally. As a sovereign
entity, the issuing government may be immune from lawsuits in the event of its
failure or refusal to pay the obligations when due. The debtor's willingness or
ability to repay in a timely manner may be affected by, among other factors, its
cash flow situation, the extent of its foreign reserves, the availability of
sufficient foreign exchange on the date a payment is due, the relative size of
the debt service burden to the economy as a whole, the sovereign debtor's policy
toward principal international lenders and the political constraints to which
the sovereign debtor may be subject. Sovereign debtors also may be dependent on
expected disbursements from foreign governments or multinational agencies, the
country's access to trade and other international credits, and the country's
balance of trade. Some emerging market sovereign debtors have in the past
rescheduled their debt payments or declared moratoria on payments, and similar
occurrences may happen in the future.
DEPOSITARY RECEIPTS. American Depositary Receipts, or "ADRs," are
securities issued by a U.S. depositary (usually a bank) and represent a
specified quantity of underlying non-U.S. securities on deposit with a custodian
bank as collateral. A foreign issuer of the security underlying an ADR is
generally not subject to the same reporting requirements in the United States as
a domestic issuer. Accordingly, the information available to a U.S. investor
will be limited to the information the foreign issuer is required to disclose in
its own country and the market value of an ADR may not reflect undisclosed
material information concerning the issuer or the underlying security. ADRs may
also be subject to exchange rate risks if the underlying securities are
denominated in foreign currency. The Portfolios may also invest in similar
non-U.S. instruments issued by foreign banks or trust companies such as "GDRs"
and "EDRs." For purposes of its investment policies, each Portfolio will treat
ADRs and similar instruments as equivalent to investment in the underlying
securities.
OPTIONS AND FUTURES
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A futures contract is an agreement between the parties to buy or sell a
specified amount of one or more securities, units of an index or currencies at a
specified price and date; futures contracts are generally closed out by the
parties in advance of that date for a cash settlement. Under an option contract,
one party generally has the right to require the other to buy or sell a
specified amount of securities, units of an index, currencies or futures
contracts, and may exercise that right if the market price of the underlying
instrument moves in a direction advantageous to the holder of the option.
Options with respect to securities indices typically call for cash settlement
instead of delivery of the securities that comprise the index. Options and
futures are generally considered to be "derivatives."
The Portfolios may buy, sell and write options and futures for hedging
purposes and, to the extent permitted by applicable law, for non-hedging
purposes, such as to earn additional income. Futures contracts and options may
also be used for other non-hedging purposes, such as to simulate full investment
in underlying securities while retaining a cash balance for Portfolio
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management purposes, as a substitute for direct investment in a security, to
facilitate trading, to reduce transaction costs, or to seek higher investment
returns when a futures contract or option is priced more attractively than the
underlying security or index.
The use of options and futures involves certain investment risks and
transaction costs. These risks include (1) difficulty in predicting movements in
the prices of individual securities or an index, fluctuations in the general
securities markets or in market sectors and movements in interest rates and
currency markets; (2) imperfect correlation, or no correlation at all, between
movements in the price of options and futures contracts, movements in the price
of the underlying instruments, index or currencies and movements in the
securities or currencies that are the subject of a hedge; (3) the fact that
skills needed to use these instruments are different from those needed to select
a Portfolio's other investments; (4) the possible lack of a liquid secondary
market for any particular instrument at any particular time; (5) the possibility
that the use of cover or segregation involving a large percentage of a
Portfolio's assets could impede portfolio management or the Portfolio's ability
to meet redemption requests or other short-term obligations; and (6) the fact
that, although use of these instruments for hedging purposes can reduce the risk
of loss, they can also reduce the opportunity for gain, or even result in
losses, by offsetting favorable price movements in hedged investments. There can
be no assurance that a Portfolio's use of futures contracts or options will be
successful. Moreover, in the event that an anticipated change in the price of
the instruments, index or currencies that are the subject of the strategy does
not occur, the Portfolio might have been in a better position had it not used
that strategy at all. Options and futures traded on U.S. or other exchanges may
be subject to position and daily fluctuation limits, which may limit the ability
of a Portfolio to reduce risk using such options and futures and may limit their
liquidity.
The use of options and futures contracts for speculative purposes,
e.g., to enhance income or to increase a Portfolio's exposure to a particular
security or type of security or a particular foreign currency, subjects the
Portfolio to additional risk. The use of options and futures to hedge an
anticipated purchase also subjects a Portfolio to additional risk until the
purchase is completed or the position is closed out.
Many options on securities are traded primarily on the over-the-counter
("OTC") market. OTC options are two-party contracts with price and other terms
negotiated between buyer and seller and generally do not have as much liquidity
as exchange-traded options. Thus, when a Portfolio purchases an OTC option, it
relies on the dealer from which it has purchased the option to make or take
delivery of the instruments underlying the option or otherwise fulfill its
obligations under the contract. Failure by the dealer to do so would result in
the loss of the premium paid by that Portfolio as well as the loss of the
expected benefit of the transaction. OTC options may be considered "illiquid
securities" for purposes of each Portfolio's investment limitations.
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FOREIGN CURRENCY EXCHANGE TRANSACTIONS
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Each Portfolio that may invest in securities that are denominated in
foreign currencies may engage in a variety of foreign currency exchange
transactions to protect against uncertainty in the level of future exchange
rates. These transactions may be engaged in connection with the purchase and
sale of portfolio securities ("transaction hedging") and to protect the value of
specific portfolio positions ("position hedging").
A Portfolio may engage in transaction hedging to protect against a
change in the foreign currency exchange rates between the date on which the
Portfolio contracts to purchase or sell the security and the settlement date, or
to "lock in" the U.S. dollar equivalent of a dividend or interest payment in a
foreign currency. A Portfolio may purchase or sell a foreign currency on a spot
(or cash) basis at the prevailing spot rate. If conditions warrant, for
transaction hedging purposes, a Portfolio may also enter into contracts to
purchase or sell foreign currencies at a future date ("forward contracts") and
may purchase and sell foreign currency futures contracts. A foreign currency
forward contract is a negotiated agreement to exchange currency at a future time
at a rate or rates that may be higher or lower than the spot rate. Foreign
currency futures contracts are standardized exchange-traded contracts and have
margin requirements. Each Portfolio may also purchase, sell and write
exchange-listed and over-the-counter call and put options on foreign currency
futures contracts and on foreign currencies.
A Portfolio may engage in "position hedging" to protect against a
decline in the value relative to the U.S. dollar of the currencies in which its
portfolio securities are denominated or quoted (or an increase in the value of
the currency in which securities the Portfolio intends to buy are denominated,
when the Portfolio holds cash reserves or short-term investments). For position
hedging purposes, each Portfolio may purchase, sell or write foreign currency
futures contracts, foreign currency forward contracts, and options on exchanges
or over-the-counter markets. In connection with position hedging, a Portfolio
may also purchase or sell foreign currency on a spot basis.
A Portfolio's currency hedging transactions may call for the delivery
of one foreign currency in exchange for another foreign currency and may at
times involve currencies other than those in which its portfolio securities are
then denominated. "Cross hedging" activities will be used when a Portfolio's
investment adviser believes that such transactions provide significant hedging
opportunities for the Portfolio. Cross hedging transactions by a Portfolio
involve the further risk of imperfect correlation between changes in the values
of the currencies to which such transactions relate and changes in the values of
such currencies and of the currency or other asset or liability which is the
subject of the hedge.
The decision as to whether and to what extent a Portfolio will engage
in foreign currency exchange transactions will depend on a number of factors,
including prevailing market conditions, the composition of a Portfolio's
investments and the availability of suitable transactions.
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Accordingly, there can be no assurance that a Portfolio will engage in foreign
currency exchange transactions at any given time or from time to time.
For a further discussion of the risks associated with purchasing and
selling futures contracts and options, see "Options and Futures" above. A
Portfolio may also use other hedging instruments and techniques when available
and deemed appropriate by its adviser.
PREFERRED STOCKS AND CONVERTIBLE SECURITIES
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A preferred stock pays dividends at a specified rate and has preference
over common stock in the payment of dividends and the liquidation of an issuer's
assets but is junior to the debt securities of the issuer in those same
respects. The market prices of preferred stocks are subject to changes in
interest rates and are more sensitive to changes in an issuer's creditworthiness
than are the prices of debt securities. Shareholders of preferred stock may
suffer a loss of value if dividends are not paid. Under ordinary circumstances,
preferred stock does not carry voting rights.
A convertible security is a bond, debenture, note, preferred stock or
other security that may be converted into or exchanged for a prescribed amount
of common stock of the same or a different issuer within a particular period of
time at a specified price or formula. A convertible security entitles the holder
to receive interest paid or accrued on debt or the dividend paid on preferred
stock until the convertible security matures or is redeemed, converted or
exchanged. Before conversion, convertible securities have characteristics
similar to nonconvertible debt securities in that they ordinarily provide a
stream of income with generally higher yields than those of common stocks of the
same or similar issuers. Convertible securities are usually subordinated to
comparable-tier nonconvertible securities but rank senior to common stock in a
corporation's capital structure.
The value of a convertible security is a function of (1) its yield in
comparison with the yields of other securities of comparable maturity and
quality that do not have a conversion privilege and (2) its worth, at market
value, if converted into the underlying common stock. A convertible security may
be subject to redemption at the option of the issuer at a price established in
the convertible security's governing instrument. If a convertible security held
by a Portfolio is called for redemption, the Portfolio will be required to (1)
permit the issuer to redeem the security, (2) convert it into the underlying
common stock or (3) sell it to a third party. Any of these actions could have an
adverse effect on a Portfolio's ability to achieve its investment objective.
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DEBT AND FIXED INCOME SECURITIES
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The Portfolios may invest in a variety of debt and fixed income
securities. These securities share one principal risk: their values fluctuate
with changes in interest rates. Thus, a decrease in interest rates will
generally result in an increase in the value of a Portfolio's fixed income
investments. Conversely, during periods of rising interest rates, the value of a
Portfolio's fixed income investments will generally decline. The magnitude of
these fluctuations will generally be greater when a Portfolio's duration or
average maturity is longer. Changes in the value of portfolio securities will
not affect interest income from those securities, but will be reflected in a
Portfolio's net asset value. The most common types of these instruments, and the
associated risks, are described below.
U.S. GOVERNMENT OBLIGATIONS. U.S. Government securities include (1)
U.S. Treasury bills (maturity of one year or less), U.S. Treasury notes
(maturity of one to ten years) and U.S. Treasury bonds (maturities generally
greater than ten years) and (2) obligations issued or guaranteed by U.S.
Government agencies or instrumentalities which are supported by any of the
following: (a) the full faith and credit of the U.S. Government (such as GNMA
certificates); (b) the right of the issuer to borrow an amount limited to a
specific line of credit from the U.S. Government (such as obligations of the
Federal Home Loan Banks); (c) the discretionary authority of the U.S. Government
to purchase certain obligations of agencies or instrumentalities (such as FNMA);
or (d) only the credit of the instrumentality (such as Freddie Mac). In the case
of obligations not backed by the full faith and credit of the United States, a
Portfolio must look principally to the agency or instrumentality issuing or
guaranteeing the obligation for ultimate repayment and may not be able to assert
a claim against the United States itself in the event the agency or
instrumentality does not meet its commitments. Neither the U.S. Government nor
any of its agencies or instrumentalities guarantees the market value of the
securities they issue. Therefore, the market value of such securities will
fluctuate in response to changes in interest rates.
INFLATION-INDEXED SECURITIES. The Portfolios may also invest in
inflation-indexed U.S. Treasury securities (also known as "Treasury
Inflation-Protection Securities"). The principal value of Treasury
Inflation-Protection Securities is adjusted daily in accordance with changes in
the Consumer Price Index, while interest is calculated on the basis of the
adjusted principal value on the payment date. The principal value of these
securities declines in periods of deflation, but holders at maturity receive no
less than par. If inflation is lower than expected during the period a Portfolio
holds the security, the Portfolio may earn less on the security than on a
conventional bond. Any increase in principal value is taxable in the year the
increase occurs, even though holders do not receive cash representing the
increase at that time. Changes in market interest rates from causes other than
inflation will likely affect the price of these securities in the same manner as
more traditional obligations.
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MORTGAGE-RELATED SECURITIES. Mortgage-related securities represent an
interest in a pool of mortgages made by lenders such as commercial banks,
savings and loan institutions, mortgage bankers and others. Mortgage-related
securities may be issued by governmental, government-related or non-governmental
entities, and provide regular payments which consist of interest and, in most
cases, principal. In contrast, other forms of debt securities normally provide
for periodic payment of interest in fixed amounts with principal payments at
maturity or specified call dates. In effect, payments on mortgage-related
securities are a "pass-through" of the payments made by the individual borrowers
on their mortgage loans, net of any fees paid to the issuer or guarantor of such
securities. Additional payments to holders of mortgage-related securities are
caused by repayments resulting from the sale of the underlying property,
refinancing or foreclosure, net of fees or costs which may be incurred.
As prepayment rates of individual pools of mortgage loans vary widely,
it is not possible to predict accurately the average life of a particular
security. Although mortgage-related securities are issued with stated maturities
of up to forty years, unscheduled or early payments of principal and interest on
the underlying mortgages may shorten considerably the securities' effective
maturities. The volume of prepayments of principal on a pool of mortgages
underlying a particular mortgage-related security will influence the yield of
that security, and the principal returned to a Portfolio may be reinvested in
instruments whose yield may be higher or lower than that which might have been
obtained had such prepayments not occurred. When interest rates are declining,
such prepayments usually increase, and reinvestments of such principal
prepayments will be at a lower rate than that on the original mortgage-related
security. An increase in mortgage prepayments could cause the Portfolio to incur
a loss on a mortgage-related security that was purchased at a premium. On the
other hand, a decrease in the rate of prepayments, resulting from an increase in
market interest rates, among other causes, may extend the effective maturities
of mortgage-related securities, increasing their sensitivity to changes in
market interest rates and potentially increasing the volatility of a Portfolio's
shares. The rate of prepayment may also be affected by general economic
conditions, the location and age of the mortgages, and other social and
demographic conditions. In determining the average maturity or duration of a
mortgage-related security, a Portfolio's investment adviser must apply certain
assumptions and projections about the maturity and prepayment of such security;
actual prepayment rates may differ. Because of prepayments, mortgage-related
securities may have less potential for capital appreciation during periods of
declining interest rates than other securities of comparable maturities,
although they may have a similar risk of decline in market value during periods
of rising interest rates.
GOVERNMENT MORTGAGE-RELATED SECURITIES. GNMA is the principal federal
government guarantor of mortgage-related securities. GNMA is a wholly owned U.S.
Government corporation within the Department of Housing and Urban Development.
GNMA pass-through securities are considered to have a relatively low risk of
default in that (1) the underlying mortgage loan portfolio is comprised entirely
of government-backed loans and (2) the timely payment of both principal and
interest on the securities is guaranteed by the full faith and credit of the
U.S. Government, regardless of whether they have been collected. GNMA
pass-through securities are, however, subject to the same market risk as
comparable debt securities. Therefore, the effective
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maturity and market value of a Portfolio's GNMA securities can be expected to
fluctuate in response to changes in interest rate levels.
Residential mortgage loans are also pooled by Freddie Mac, a corporate
instrumentality of the U.S. Government. The mortgage loans in Freddie Mac's
portfolio are not government backed; Freddie Mac, not the U.S. Government,
guarantees the timely payment of interest and ultimate collection of principal
on Freddie Mac securities. Freddie Mac also issues guaranteed mortgage
certificates, on which it guarantees semiannual interest payments and a
specified minimum annual payment of principal.
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 seller/servicers, which include savings and loan associations, savings
banks, commercial banks, credit unions and mortgage bankers. Pass-through
securities issued by FNMA are guaranteed as to timely payment of principal and
interest only by FNMA, not the U.S. Government.
PRIVATELY ISSUED MORTGAGE-RELATED SECURITIES. Mortgage-related
securities offered by private issuers include pass-through securities comprised
of pools of residential mortgage loans; mortgage-backed bonds which are
considered to be debt obligations of the institution issuing the bonds and are
collateralized by mortgage loans; and bonds and collateralized mortgage
obligations ("CMOs") which are collateralized by mortgage-related securities
issued by Freddie Mac, FNMA or GNMA or by pools of mortgages.
CMOs are typically structured with classes or series which have
different maturities and are generally retired in sequence. Each class of
obligations receives periodic interest payments according to the coupon rate on
the obligations. However, all monthly principal payments and any prepayments
from the collateral pool are generally paid first to the "Class 1" holders.
Thereafter, all payments of principal are generally allocated to the next most
senior class of obligations until that class of obligations has been fully
repaid. Although full payoff of each class of obligations is contractually
required by a certain date, any or all classes of obligations may be paid off
sooner than expected because of an increase in the payoff speed of the pool.
Other allocation methods may be used. Payment of interest or principal on some
classes or series of a CMO may be subject to contingencies or some classes or
series may bear some or all of the risk of default on the underlying mortgages.
Mortgage-related securities created by non-governmental issuers
generally offer a higher rate of interest than government and government-related
securities because there are no direct or indirect government guarantees of
payment in the former securities, resulting in higher risks. Where privately
issued securities are collateralized by securities issued by Freddie Mac, FNMA
or GNMA, the timely payment of interest and principal is supported by the
government-related securities collateralizing such obligations. The market for
conventional pools is smaller and less liquid than the market for the government
and government-related mortgage pools.
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ASSET-BACKED SECURITIES. Asset-backed securities refer to securities
that directly or indirectly represent a participation in, or are secured by and
payable from, assets such as motor vehicle installment sales, installment loan
contracts, leases of various types of real and personal property and receivables
from revolving credit (credit card) agreements. Such assets are securitized
through the use of trusts or special purpose corporations. Asset-backed
securities are backed by a pool of assets representing the obligations often of
a number of different parties. Certain of such securities may be illiquid.
The principal on asset-backed securities, like that on mortgage-backed
securities, may be prepaid at any time. As a result, if such securities are
purchased at a premium, a prepayment rate that is faster than expected will
reduce yield to maturity, while a prepayment rate that is slower than expected
will have the opposite effect. Conversely, if the securities are purchased at a
discount, prepayments faster than expected will increase yield to maturity and
prepayments slower than expected will decrease it. Accelerated prepayments also
reduce the certainty of the yield because the Portfolio must reinvest the assets
at the then-current rates. Accelerated prepayments on securities purchased at a
premium also impose a risk of loss of principal.
Each type of asset-backed security also entails unique risks depending
on the type of assets involved and the legal structure used. For example, credit
card receivables are generally unsecured obligations of the credit card holder
and the debtors are entitled to the protection of a number of state and federal
consumer credit laws, many of which give such debtors the right to set off
certain amounts owed on the credit cards, thereby reducing the balance due.
There have also been proposals to cap the interest rate that a credit card
issuer may charge. In some transactions, the value of the asset-backed security
is dependent on the performance of a third party acting as credit enhancer or
servicer. Furthermore, in some transactions (such as those involving the
securitization of vehicle loans or leases) it may be administratively burdensome
to perfect the interest in the underlying collateral, and the underlying
collateral may become damaged or stolen.
MUNICIPAL OBLIGATIONS. Municipal obligations include obligations issued
to obtain funds for various public purposes, including constructing a wide range
of public facilities, such as bridges, highways, housing, hospitals, mass
transportation, schools and streets. Other public purposes for which municipal
obligations may be issued include the refunding of outstanding obligations, the
obtaining of funds for general operating expenses and the making of loans to
other public institutions and facilities. In addition, certain types of
industrial development bonds ("IDBs") and private activity bonds ("PABs") are
issued by or on behalf of public authorities to finance various privately
operated facilities, including certain pollution control facilities, convention
or trade show facilities, and airport, mass transit, port or parking facilities.
Municipal obligations also include short-term tax anticipation notes,
bond anticipation notes, revenue anticipation notes and other forms of
short-term debt obligations. Such notes may be issued with a short-term maturity
in anticipation of the receipt of tax payments, the proceeds of bond placements
or other revenues. Municipal obligations also include municipal lease
obligations and certificates of participation. Municipal lease obligations,
which are issued by state and local
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governments to acquire land, equipment and facilities, typically are not fully
backed by the municipality's credit, and, if funds are not appropriated for the
following year's lease payments, a lease may terminate, with the possibility of
default on the lease obligation and significant loss to the Portfolio.
Certificates of participation are participations in municipal lease obligations
or installment sales contracts. Each certificate represents a proportionate
interest in or right to the payments made.
The two principal classifications of municipal obligations are "general
obligation" and "revenue" bonds. "General obligation" bonds are secured by the
issuer's pledge of its faith, credit and taxing power. "Revenue" bonds are
payable only from the revenues derived from a particular facility or class of
facilities or from the proceeds of a special excise tax or other specific
revenue source such as the corporate user of the facility being financed. IDBs
and PABs are usually revenue bonds and are not payable from the unrestricted
revenues of the issuer. The credit quality of IDBs and PABs is usually directly
related to the credit standing of the corporate user of the facilities.
The ability of state, county or local governments to meet their
obligations will depend primarily on the availability of tax and other revenues
to those governments and on their fiscal conditions generally. The amounts of
tax and other revenues available to governmental issuers may be affected from
time to time by economic, political and demographic conditions within or outside
of the particular state. In addition, constitutional or statutory restrictions
may limit a government's power to raise revenues or increase taxes. The
availability of federal, state and local aid to issuers of municipal securities
may also affect their ability to meet their obligations. Payments of principal
and interest on revenue bonds will depend on the economic condition of the
facility or specific revenue source from whose revenues the payments will be
made. The facility's economic status, in turn, could be affected by economic,
political and demographic conditions affecting the particular state.
CORPORATE DEBT SECURITIES. A Portfolio may invest in debt securities
(i.e., bonds, debentures, notes and other similar debt instruments) of domestic
or foreign non-governmental issuers which meet the minimum credit quality
criteria, if any, set forth for the Portfolio. Corporate debt securities may pay
fixed or variable rates of interest, or interest at a rate contingent upon some
other factor, such as the price of some commodity. These securities may include
warrants, may be convertible into preferred or common equity, or may be bought
as part of a unit containing common stock.
LOWER-RATED SECURITIES. Non-investment grade securities, i.e.,
securities rated below Baa by Moody's or BBB by S&P or unrated securities of
comparable quality, are described as "speculative" by Moody's and S&P and may be
subject to greater market fluctuations and greater risk of loss of income or
principal, including a greater possibility of default or bankruptcy of the
issuer of such securities, than are more highly rated debt securities. Such
securities are commonly referred to as "junk bonds." A Portfolio's investment
adviser seeks to minimize the risks of investing in all securities through
diversification, in-depth credit analysis and attention to current
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developments in interest rates and market conditions and will monitor the
ratings of securities held by the Portfolios and the creditworthiness of their
issuers. If the rating of a security in which a Portfolio has invested falls
below the minimum rating in which the Portfolio is permitted to invest, the
Portfolio will either dispose of that security within a reasonable time or hold
the security until maturity as the Portfolio's investment adviser determines
appropriate for that Portfolio, having due regard for market conditions, tax
implications and other applicable factors. See the Appendix to this Prospectus
for a description of the ratings assigned to fixed income securities by the
rating agencies.
A debt security may be callable, i.e., subject to redemption at the
option of the issuer at a price established in the security's governing
instrument. If a debt security held by a Portfolio is called for redemption, the
Portfolio will be required to permit the issuer to redeem the security or sell
it to a third party. Either of these actions could have an adverse effect on a
Portfolio's ability to achieve its investment objective because, for example,
the Portfolio may be able to reinvest the proceeds only in securities with lower
yields or may receive a price upon sale that is lower than it would have
received in the absence of the redemption.
The prices of debt securities fluctuate in response to perceptions of
the issuer's creditworthiness. Generally, lower-rated securities offer a higher
current yield than that provided by higher grade issues, but also involve higher
risks. Debt securities rated C by Moody's and S&P are bonds on which no interest
is being paid and which can be regarded as having extremely poor prospects of
ever attaining any real investment standing. Lower-rated securities are
especially affected by adverse changes in the industries in which the issuers
are engaged and by changes in the financial condition of the issuers. Highly
leveraged issuers may also experience financial stress during periods of rising
interest rates.
The market for lower-rated securities has expanded rapidly in recent
years. This growth has paralleled a long economic expansion. At certain times in
the past, the prices of many lower-rated securities declined, indicating
concerns that issuers of such securities might experience financial
difficulties. At those times, the yields on lower-rated securities rose
dramatically, reflecting the risk that holders of such securities could lose a
substantial portion of their value as a result of the issuers' financial
restructuring or default. There can be no assurance that such declines will not
recur.
The market for lower-rated securities is generally thinner and less
active than that for higher quality debt securities, which may make it difficult
for a Portfolio to value its securities or may limit a Portfolio's ability to
sell such securities at fair value. As a result, judgment plays a greater role
in pricing such securities than is the case for securities having more active
markets. Adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may also decrease the values and liquidity of lower-rated
securities, especially in a thinly traded market.
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The ratings of Moody's and S&P represent the opinions of those agencies
as to the quality of the debt securities which they rate. Such ratings are
relative and subjective, and are not absolute standards of quality. Unrated debt
securities are not necessarily of lower quality than rated securities, but they
may not be attractive to as many buyers. If securities are rated investment
grade by one rating organization and below investment grade by the other, a
Portfolio's investment adviser may rely on the rating that it believes is more
accurate.
STRIPPED SECURITIES. Stripped securities are created by separating
bonds into their principal and interest components and selling each piece
separately (commonly referred to as IOs and POs.). The yield to maturity on an
IO or PO class of stripped mortgage-backed securities is extremely sensitive not
only to changes in prevailing interest rates but also to the rate of principal
payments (including prepayments) on the underlying assets. A rapid rate of
principal prepayments may have a measurably adverse effect on a Portfolio's
yield to maturity to the extent it invests in IOs. If the assets underlying the
IOs experience greater than anticipated prepayments of principal, the fund may
fail to recoup fully its initial investment in these securities. Conversely, POs
tend to increase in value if prepayments are greater than anticipated and
decline if prepayments are slower than anticipated. The secondary market for
stripped mortgage-backed securities may be more volatile and less liquid than
that for other mortgage-backed securities, potentially limiting a Portfolio's
ability to buy or sell those securities at any particular time.
ZERO COUPON AND PAY-IN-KIND SECURITIES. A zero coupon bond is a
security that makes no fixed interest payments but instead is sold at a discount
from its face value. The bond is redeemed at its face value on the specified
maturity date. Zero coupon bonds may be issued as such, or they may be created
by a broker who strips the coupons from a bond and separately sells the rights
to receive principal and interest. The prices of zero coupon bonds tend to
fluctuate more in response to changes in market interest rates than do the
prices of interest-paying debt securities with similar maturities. A Portfolio
investing in zero coupon bonds generally accrues income on such securities prior
to the receipt of cash payments. Since each Portfolio must distribute
substantially all of its income to shareholders to qualify as a regulated
investment company under federal income tax law, a Portfolio investing in zero
coupon bonds may have to dispose of other securities to generate the cash
necessary for the distribution of income attributable to its zero coupon bonds.
Pay-in-kind securities have characteristics similar to those of zero coupon
securities, but interest on such securities may be paid in the form of
obligations of the same type rather than cash.
COMMERCIAL PAPER AND OTHER SHORT-TERM INVESTMENTS
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Commercial paper represents short-term unsecured promissory notes
issued in bearer form by banks or bank holding companies, corporations and
finance companies. The Portfolios will only purchase obligations of domestic or
foreign issuers which, at the time of investment, are (1) rated Prime-1 or
Prime-2 by Moody's, A-1 or A-2 by S&P, or F-1 or F-2 by Fitch Investors Service,
Inc., (2) issued or guaranteed as to principal and interest by issuers or
guarantors having an
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<PAGE>
existing debt security rating of A or better by Moody's or by S&P or (3) if
unrated, are determined to be of comparable quality by the Portfolio's
investment adviser. The Western Asset Money Market Portfolio and the Western
Asset Government Money Market Portfolio adhere to the quality standards
applicable to money market funds.
The Portfolios may purchase commercial paper issued pursuant to the
private placement exemption in Section 4(2) of the Securities Act of 1933.
Section 4(2) paper is restricted as to disposition under federal securities laws
in that any resale must similarly be made in an exempt transaction. The
Portfolios may or may not regard such securities as illiquid, depending on the
circumstances of each case.
Any Portfolio may also invest in obligations (including certificates of
deposit, demand and time deposits and bankers' acceptances) of U.S. banks and
savings and loan institutions if the issuer has total assets in excess of $1
billion at the time of purchase or if the principal amount of the instrument is
insured by the Federal Deposit Insurance Corporation. While domestic bank
deposits are insured by an agency of the U.S. Government, the Portfolios will
generally assume positions considerably in excess of the insurance limits.
DURATION
- --------------------------------------------------------------------------------
Duration is a measure of the expected life of a fixed income security
on a cash flow basis. Duration takes the time intervals over which the interest
and principal payments are scheduled and weights each by the present values of
the cash to be received at the corresponding future point in time. For any fixed
income security with interest payments occurring prior to the payment of
principal, duration is always less than maturity. For example, a current coupon
bond with a maturity of 3.5 years will have a duration of approximately three
years. In general, the lower the stated or coupon rate of interest of a fixed
income security, the longer its duration; conversely, the higher the stated or
coupon rate of interest of a fixed income security, the shorter its duration.
LOAN PARTICIPATIONS AND ASSIGNMENTS
- --------------------------------------------------------------------------------
The purchase of loan participations and assignments entails special
risks. A Portfolio's ability to receive payments of principal and interest and
other amounts in connection with loan participations and assignments will depend
primarily on the financial condition of the borrower. The failure by the
Portfolio to receive scheduled interest or principal payments on a loan
participation or assignment would adversely affect the income of the Portfolio
and would likely reduce the value of its assets. Because loan participations are
not generally rated by independent credit rating agencies, a decision by a
Portfolio to invest in a particular loan participation will depend almost
exclusively on its investment adviser's credit analysis of the borrower. In
addition to the other risks associated with investments in debt securities,
participations and assignments involve the additional risk that the insolvency
of any financial institution interposed between the
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<PAGE>
Portfolio and the borrower could delay or prevent the flow of payments from the
borrower on the underlying loan. A Portfolio may have limited rights to enforce
the terms of the underlying loan, and the liquidity of loan participations and
assignments may be limited.
The borrower of a loan in which a Portfolio holds a participation
interest may, either at its own election or pursuant to terms of the loan
documentation, prepay amounts of the loan from time to time. There is no
assurance that the Portfolio will be able to reinvest the proceeds of any loan
prepayment at the same interest rate or on the same terms as those of the
original loan participation.
Corporate loans in which a Portfolio may purchase a loan participation
or assignment are made generally to finance internal growth, mergers,
acquisitions, stock repurchases, leveraged buy-outs, and other corporate
activities. The highly leveraged capital structure of the borrowers in certain
of these transactions may make such loans especially vulnerable to adverse
changes in economic or market conditions.
Certain of the loan participations or assignments acquired by a
Portfolio may involve unfunded commitments of the lenders or revolving credit
facilities under which a borrower may from time to time borrow and repay amounts
up to the maximum amount of the facility. In such cases, the Portfolio would
have an obligation to advance its portion of such additional borrowings upon the
terms specified in the loan documentation.
INDEXED SECURITIES AND STRUCTURED NOTES
- --------------------------------------------------------------------------------
The values of indexed securities and structured notes are linked to
currencies, other securities, interest rates, commodities, indices or other
financial indicators ("reference instruments"). These instruments differ from
other types of debt securities in several respects. The interest rate or
principal amount payable at maturity may vary based on changes in one or more
specified reference instruments, such as a floating interest rate compared with
a fixed interest rate or the currency exchange rates between two currencies
(neither of which need be the currency in which the instrument is denominated).
An indexed security or structured note may be positively or negatively indexed;
that is, its value or interest rate may increase or decrease if the value of the
reference instrument increases. Further, the change in the principal amount
payable with respect to, or the interest rate of, an indexed security or
structured note may be a multiple of the percentage change (positive or
negative) in the value of the underlying reference instrument(s).
Investment in indexed securities and structured notes involves certain
risks, including the credit risk of the issuer and the normal risks of price
changes in response to changes in interest rates. Further, in the case of
certain indexed securities or structured notes, a decline in the reference
instrument may cause the interest rate to be reduced to zero, and any further
declines in the reference instrument may then reduce the principal amount
payable on maturity. Finally, these
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<PAGE>
securities may be less liquid than other types of securities, and may be more
volatile than their underlying reference instruments.
FORWARD COMMITMENTS
- --------------------------------------------------------------------------------
Each Portfolio may enter into commitments to purchase U.S. government
securities or other securities on a "forward commitment" basis, including
purchases on a "when-issued" basis or a "to be announced" basis. When such
transactions are negotiated, certain terms may be fixed at the time the
commitment is made, but delivery and payment for the securities takes place at a
later date. Such securities are often the most efficiently priced and have the
best liquidity in the bond market. During the period between a commitment and
settlement, no payment is made by the purchaser for the securities purchased
and, thus, no interest accrues to the purchaser from the transaction. In a "to
be announced" transaction, a Portfolio commits to purchase securities for which
all specific information is not yet known at the time of the trade, particularly
the exact face amount in forward commitment mortgage-backed securities
transactions.
A Portfolio may sell the securities subject to a forward commitment
purchase, which may result in a gain or loss. When a Portfolio purchases
securities on a forward commitment basis, it assumes the risks of ownership,
including the risk of price fluctuation, at the time of purchase, not at the
time of receipt. Purchases of forward commitment securities also involve a risk
of loss if the seller fails to deliver after the value of the securities has
risen. Depending on market conditions, a Portfolio's forward commitment
purchases could cause its net asset value to be more volatile. A Portfolio will
direct its custodian to place cash or liquid securities in a separate account
equal to the value of the commitments of the Portfolio to purchase securities on
a forward commitment basis. If the value of these assets declines, the Portfolio
will place additional liquid assets in the account on a daily basis so that the
value of the assets in the account is equal to the amount of such commitments.
Each Portfolio may also enter into a forward commitment to sell
securities it owns and will generally do so only with the intention of actually
delivering the securities. The use of forward commitments enables a Portfolio to
hedge against anticipated changes in interest rates and prices. In a forward
sale, a Portfolio does not participate in gains or losses on the security
occurring after the commitment date. Forward commitments to sell securities also
involve a risk of loss if the seller fails to take delivery after the value of
the securities has declined. A Portfolio will direct its custodian to place the
securities subject to a forward commitment in a separate account.
Forward commitment transactions involve additional risks similar to
those associated with investments in options and futures contracts. See "Options
and Futures Contracts." It is not expected that any Portfolio's purchases of
forward commitments will at any time exceed, in the aggregate, 20% of that
Portfolio's total assets.
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<PAGE>
RESTRICTED AND ILLIQUID SECURITIES
- --------------------------------------------------------------------------------
Restricted securities are securities subject to legal or contractual
restrictions on their resale, such as private placements. Such restrictions
might prevent the sale of restricted securities at a time when the sale would
otherwise be desirable. No securities for which there is not a readily available
market ("illiquid securities") will be acquired by any Portfolio if such
acquisition would cause the aggregate value of illiquid securities to exceed 15%
of the Portfolio's net assets (10% of net assets for the Western Asset Money
Market Portfolio and the Western Asset Government Money Market Portfolio).
Under SEC regulations, certain securities acquired through private
placements can be traded freely among qualified purchasers. The SEC has stated
that an investment company's board of directors, or its investment adviser
acting under authority delegated by the board, may determine that a security
eligible for trading under this rule is "liquid." The Portfolios intend to rely
on this rule, to the extent appropriate, to deem specific securities acquired
through private placement as "liquid." The Boards have delegated to a
Portfolio's investment adviser the responsibility for determining whether a
particular security eligible for trading under this rule is "liquid."
Illiquid securities may be difficult to value, and a Portfolio may have
difficulty disposing of such securities promptly. The Portfolios do not consider
foreign securities to be restricted if they can be freely sold in the principal
markets in which they are traded, even if they are not registered for sale in
the U.S.
SHORT SALES
- --------------------------------------------------------------------------------
A short sale is a transaction in which a Portfolio sells a security it
does not own in anticipation that the market price of that security will
decline. When the Portfolio makes a short sale, it must borrow the security sold
short and deliver it to the other party to the transaction. Short sales involve
certain expenses and entail risks. The Portfolio may have to pay a fee to borrow
particular securities and is often obligated to pay over any payments received
on such borrowed securities. The net proceeds of the short sale will be retained
by the broker to the extent necessary to meet margin requirements, until the
short position is closed out. If the price of the security sold short increases
between the time of the short sale and the time the Portfolio replaces the
borrowed security, the Portfolio will incur a loss; conversely, if the price
declines, the Portfolio will realize a gain. Any gain will be decreased, and any
loss increased, by the transaction costs described above. Although the
Portfolio's gain is limited to the price at which it sold the security short,
its potential loss is unlimited if the Portfolio does not own the security.
The staff of the Securities and Exchange Commission is of the opinion
that a short sale involves the creation of a senior security and is, therefore,
subject to the limitations of Section 18 of the 1940 Act. The staff has taken
the position that in order to comply with the provisions of Section 18, the
Portfolio must put in a segregated account (not with the broker) an amount of
cash or securities equal to the difference between: (a) the market value of the
securities sold short at the time they were sold short, and (b) any cash or
securities required to be deposited as collateral with the broker in connection
with the short sale (not including the proceeds from the short sale). In
addition, until the Portfolio replaces the borrowed security, it must daily
maintain the segregated account at such a level that the amount deposited in it
plus the amount deposited with the broker as collateral will equal the current
market value of the securities sold short. It is currently expected that no more
than 10% of the Portfolio's net assets will be used as collateral or deposited
in a segregated account in connection with short sales.
SECURITIES OF OTHER INVESTMENT COMPANIES
- --------------------------------------------------------------------------------
Investments in other investment companies may involve the payment of
substantial premiums above the net asset value of such issuers' portfolio
securities, and the total return on such investments will be reduced by the
operating expenses and fees of such investment companies, including advisory
fees. The Portfolios may invest in both closed-end and open-end investment
companies.
REPURCHASE AGREEMENTS
- --------------------------------------------------------------------------------
A repurchase agreement is an agreement under which securities are
acquired from a securities dealer or bank subject to resale at an agreed upon
price and date. The securities are held by a Portfolio as collateral until
retransferred and will be supplemented by additional collateral if necessary to
maintain a total market value equal to or in excess of the value of the
repurchase agreement. The Portfolio bears a risk of loss in the event that the
other party to a repurchase agreement defaults on its obligations and the
Portfolio is delayed or prevented from exercising its
-53-
<PAGE>
rights to dispose of the collateral securities. A Portfolio also bears the risk
that the proceeds from any sale of collateral will be less than the repurchase
price.
REVERSE REPURCHASE AGREEMENTS AND OTHER BORROWING
- --------------------------------------------------------------------------------
A reverse repurchase agreement is a portfolio management technique in
which a Portfolio temporarily transfers possession of a portfolio instrument to
another person, such as a financial institution or broker-dealer, in return for
cash. At the same time, the Portfolio agrees to repurchase the instrument at an
agreed upon time (normally within seven days) and price, including interest
payment. While engaging in reverse repurchase agreements, each Portfolio will
maintain cash or securities in a segregated account at its custodian bank with a
value at least equal to the Portfolio's obligation under the agreements,
adjusted daily. Reverse repurchase agreements may expose a Portfolio to greater
fluctuations in the value of its assets and renders the segregated assets
unavailable for sale or other disposition.
The Portfolios may also enter into dollar roll transactions in which a
Portfolio sells a fixed income security for delivery in the current month and
simultaneously contracts to purchase substantially similar (same type, coupon
and maturity) securities at an agreed upon future time. By engaging in the
dollar roll transaction the Portfolio foregoes principal and interest paid on
the security that is sold, but receives the difference between the current sales
price and the forward price for the future purchase. The Portfolio would also be
able to earn interest on the income that is received from the initial sale.
Each Portfolio will limit its investments in reverse repurchase
agreements and other borrowing (including dollar roll transactions) to no more
than one-third of its total assets. To avoid potential leveraging effects of
such borrowing (including reverse repurchase agreements), a Portfolio will not
make investments while its borrowing is in excess of 5% of its total assets.
LOANS OF PORTFOLIO SECURITIES
- --------------------------------------------------------------------------------
A Portfolio may lend its portfolio securities, provided that cash or
equivalent collateral, equal to at least 100% of the market value of the
securities loaned, is continuously maintained by the borrower with the
Portfolio. During the time securities are on loan, the borrower will pay the
Portfolio an amount equivalent to any dividends or interest paid on such
securities, and the Portfolio may invest the cash collateral and earn additional
income, or it may receive an agreed upon amount of interest income from the
borrower who has delivered equivalent collateral. These loans are subject to
termination at the option of the Portfolio or the borrower. A Portfolio may pay
reasonable administrative and custodial fees in connection with a loan and may
pay a negotiated portion of the interest earned on the cash or equivalent
collateral to the borrower or placing broker. No Portfolio presently expects to
have on loan at any given time securities totaling more than one-third of its
net assets. A Portfolio runs the risk that the counterparty to a
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<PAGE>
loan transaction will default on its obligation and that the value of the
collateral received may decline before the Portfolio can dispose of it.
PORTFOLIO TURNOVER
- --------------------------------------------------------------------------------
The turnover rates of the Western Asset Limited Duration Portfolio, the
Western Asset Intermediate Portfolio and the Western Asset Core Portfolio for
the fiscal year ended June 30, 1997 were 435.47%, 419.26% and 384.80%,
respectively. While it is impossible to predict portfolio turnover rates, the
Legg Mason Fund Adviser Large Cap Value Portfolio, the Legg Mason Fund Adviser
Mid Cap Value Portfolio, the U.S. Small Cap Portfolio, the Batterymarch Emerging
Markets Portfolio, the Batterymarch International Equity Portfolio, the Western
Asset Enhanced Equity Portfolio, the Western Asset High Yield Portfolio and the
Western Asset Non-U.S. Portfolio expect that their average turnover rate will
not exceed 100%, 100%, 175%, 50%, 75%, 400%, 200%, and [300%] respectively. The
Legg Mason Fund Adviser/Western Asset Balanced Portfolio expects that the
average turnover rate will not exceed 100% and 450% for the equity portion and
fixed income portion, respectively, of its portfolio.
The length of time a Portfolio has held a particular security is not
generally a consideration in investment decisions. A change in the securities
held by a Portfolio is known as "portfolio turnover." As a result of a
Portfolio's investment policies, under certain market conditions a Portfolio's
portfolio turnover rate may be higher than that of other mutual funds. Portfolio
turnover generally involves some expense to a Portfolio, including brokerage
commissions or dealer mark-ups and other transaction costs on the sale of
securities and reinvestment in other securities. These transactions may result
in realization of taxable capital gains.
ALTERNATIVE INVESTMENT STRATEGIES
- --------------------------------------------------------------------------------
At times a Portfolio's investment adviser may judge that conditions in
the securities markets make pursuing the Portfolio's typical investment strategy
inconsistent with the best interests of its shareholders. At such times, the
investment adviser may temporarily use alternative strategies, primarily
designed to reduce fluctuations in the value of the Portfolio's assets. In
implementing these defensive strategies, a Portfolio may invest without limit in
equity securities, debt securities, preferred stocks, U.S. Government and agency
obligations, cash or money market instruments, or in other securities the
investment adviser considers consistent with such defensive strategies. It is
impossible to predict when, or for how long, a Portfolio will use these
alternative strategies.
NEW INVESTMENT PRODUCTS
- --------------------------------------------------------------------------------
New types of mortgage-backed and asset-backed securities, derivative
instruments and hedging instruments are developed and marketed from time to
time. Consistent with its investment
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<PAGE>
limitations, each Portfolio expects to invest in those new types of securities
and instruments that its investment adviser believes may assist the Portfolio in
achieving its investment objective.
INVESTMENT POLICIES
- --------------------------------------------------------------------------------
Except for investment policies designated as fundamental in this
prospectus or the SAI, the investment policies described in this prospectus and
in the SAI are not fundamental policies. Changes to fundamental investment
policies require shareholder approval; the Directors may change any
non-fundamental investment policy without shareholder approval.
PERFORMANCE DATA
- --------------------------------------------------------------------------------
Advertisements and other communications to shareholders or prospective
investors may include performance information about a Portfolio. "Yield" for
each class of shares of a Portfolio (other than the Western Asset Money Market
Portfolio and the Western Asset Government Money Market Portfolio) is calculated
by dividing the annualized net investment income per share during a recent
30-day period by the maximum public offering price per share of the class on the
last day of that period. Yield for the Western Asset Money Market Portfolio and
the Western Asset Government Money Market Portfolio is derived from the income
generated by an investment in a Portfolio over a stated seven-day period. This
income is "annualized," i.e., the average daily net income generated by the
investment during that week is assumed to be generated each day over a 365-day
period, and is shown as a percentage of the investment. "Effective yield" is
calculated similarly but assumes that the income earned by an investment is
reinvested.
"Total return" is a measurement of the overall change in value,
including changes in share price and assuming reinvestment of distributions, of
an investment in a Portfolio. "Cumulative total return" shows a Portfolio's
performance over a specific period of time. "Average annual total return" for
the one-, five- and ten-year periods (or for the life of a class, if shorter)
through the most recent calendar quarter represents the average annual
compounded rate of return on an investment of $1,000 in a Portfolio invested at
the maximum public offering price.
Investment performance, which will vary, is based on many factors,
including market conditions, portfolio composition, Portfolio operating expenses
and the class of shares the investor purchases. Investment performance also
often reflects the risks associated with a Portfolio's investment objective and
policies. These factors should be considered when comparing a Portfolio's
investment results with those of other mutual funds and other investment
vehicles. Performance information is based on historical performance and should
not be viewed as representative of a Portfolio's future performance. The
investment return and principal value of an investment in a Portfolio (other
than the Western Asset Money Market Portfolio and the Western Asset Government
Money Market Portfolio, which attempt to maintain a stable net asset
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<PAGE>
value per share) will fluctuate so that an investor's shares, when redeemed, may
be worth more or less than their original cost.
Quotations of investment performance for any period when an expense
limitation was in effect will be greater than if the limitation had not been in
effect. Portfolio performance may be compared to that of various indexes. See
the SAI.
MANAGEMENT OF THE PORTFOLIOS
- --------------------------------------------------------------------------------
BOARDS OF DIRECTORS
- --------------------------------------------------------------------------------
The business affairs of each Corporation are managed under the
direction of a Board of Directors, and the Directors of the Corporations are
responsible for generally overseeing the conduct of the relevant Portfolios'
business. Information about the Directors and executive officers of each
Corporation may be found in the SAI.
Each Board of Directors has retained LM Institutional Advisors, Inc.
and the relevant advisers to furnish a continuing investment program for the
Portfolios and make investment decisions on their behalf, subject to such
policies as the Directors may determine.
MANAGER, ADVISERS, AND PORTFOLIO MANAGERS
- --------------------------------------------------------------------------------
The Portfolios are managed by LM Institutional Advisors, Inc. (the
"Manager" or "LMIA"). The Manager is a Maryland corporation formed on January
20, 1982 and is a wholly owned subsidiary of Legg Mason, Inc., a financial
services holding company. The Manager's address is 100 Light Street, Baltimore,
Maryland 21202.
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<PAGE>
In order to assist in carrying out its responsibilities, the Manager
has retained various advisers to render advisory services to the Portfolios. The
Manager pays the fees of the advisers. LMFA has been retained as the adviser for
each of the Legg Mason Fund Adviser Large Cap Value Portfolio, the Legg Mason
Fund Adviser Mid Cap Value Portfolio and the equity portion of the Legg Mason
Fund Adviser/Western Asset Balanced Portfolio. [__________] has been retained as
the adviser for the U.S. Small Cap Portfolio. Batterymarch has been retained as
the adviser for the Batterymarch International Equity Portfolio and the
Batterymarch Emerging Markets Portfolio. Western Asset has been retained as
adviser for the Western Asset Money Market Portfolio, the Western Asset
Government Money Market Portfolio, the Western Asset Limited Duration Portfolio,
the Western Asset Intermediate Portfolio, the Western Asset Core Portfolio, the
Western Asset High Yield Portfolio, and the fixed income portion of the Legg
Mason Fund Adviser/Western Asset Balanced Portfolio. WAGM has been retained as
adviser for the Western Asset Non-U.S. Portfolio. Information
about each of the advisers is set forth below.
LMFA. LMFA acts as adviser or manager to seventeen investment company
portfolios which had aggregate assets under management of approximately $___
billion as of December 31, 1997. LMFA's address is 100 Light Street, Baltimore,
Maryland 21202. LMFA is a subsidiary of Legg Mason, Inc.
WESTERN ASSET. Western Asset, a wholly owned subsidiary of Legg Mason,
Inc., acts as investment adviser to institutional accounts, such as corporate
pension plans, mutual funds and endowment funds, as well as to individual
investors. Total assets under management by Western Asset were approximately $__
billion as of December 31, 1997. The address of Western Asset is 117 East
Colorado Boulevard, Pasadena, CA 91105.
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<PAGE>
WAGM. WAGM, a wholly owned subsidiary of Legg Mason, Inc., acts as
investment adviser to institutional accounts, such as corporate pension plans,
mutual funds and endowment funds, as well as to individual investors. Total
assets under management by WAGM were approximately $__billion as of December 31,
1997. The address of WAGM is 155 Bishopsgate, London, England.
BATTERYMARCH. Batterymarch, a wholly owned subsidiary of Legg Mason,
Inc., acts as investment adviser to institutional accounts, such as corporate
pension plans, mutual funds and endowment funds, as well as to individual
investors. Total assets under management by Batterymarch were approximately $__
billion as of December 31, 1997. The address of Batterymarch is 200 Clarendon
Street, Boston, Massachusetts 02116.
Each Portfolio pays the Manager a monthly fee based on the average net
assets of the Portfolio and the Manager pays a Portfolio's Adviser a monthly fee
based on the average net assets of the Portfolio at the following rates:
<TABLE>
<CAPTION>
Portfolio Manager Manager Fee Adviser Adviser Fee
- ----------------------------------------------------------------------------------------
<S><C>
Legg Mason Fund Adviser LMIA 0.60% LMFA 0. %
Large Cap Value
- ----------------------------------------------------------------------------------------
Legg Mason Fund Adviser LMIA 0.60% LMFA 0. %
Mid Cap Value
- ----------------------------------------------------------------------------------------
U.S. Small Cap LMIA 0.65% 0. %
- ----------------------------------------------------------------------------------------
Batterymarch Emerging LMIA 0.65% Batterymarch 0. %
Markets
- ----------------------------------------------------------------------------------------
Batterymarch International LMIA 0.65% Batterymarch 0. %
Equity
- ----------------------------------------------------------------------------------------
Western Asset Enhanced LMIA 0.50% Western Asset 0. %
Equity
- ----------------------------------------------------------------------------------------
Legg Mason Fund Adviser/ LMIA 0.60% LMFA/Western 0. %
Western Asset Balanced Asset
- ----------------------------------------------------------------------------------------
Western Asset Money LMIA 0.25% Western Asset 0. %
Market
- ----------------------------------------------------------------------------------------
Western Asset LMIA 0.25% Western Asset 0. %
Government Money
Market
- ----------------------------------------------------------------------------------------
Western Asset Limited LMIA 0.30% Western Asset 0. %
Duration
- ----------------------------------------------------------------------------------------
Western Asset LMIA 0.40% Western Asset 0. %
Intermediate
- ----------------------------------------------------------------------------------------
Western Asset Core LMIA 0.45% Western Asset 0. %
- ----------------------------------------------------------------------------------------
Western Asset High Yield LMIA 0.45% Western Asset 0. %
- ----------------------------------------------------------------------------------------
Western Asset Non-U.S. Fixed Income LMIA 0.40% WAGM 0. %
- ----------------------------------------------------------------------------------------
</TABLE>
PORTFOLIO MANAGERS. The names and business experience for the past
five years for each portfolio manager is set forth in the following chart.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
Portfolio Manager and Business Experience
Portfolio (past five years)
--------- -----------------------------------------
- --------------------------------------------------------------------------------------------------------
<S><C>
Legg Mason Fund Adviser Large Cap Value William H. Miller, III is a portfolio manager
Portfolio and President of LMFA. Mr. Miller has been
employed by LMFA since 1982.
- --------------------------------------------------------------------------------------------------------
Legg Mason Fund Adviser Mid Cap Value William H. Miller, III (see above)
Portfolio
- --------------------------------------------------------------------------------------------------------
U.S. Small Cap Portfolio [To be provided.]
- --------------------------------------------------------------------------------------------------------
Batterymarch Emerging Markets Portfolio Batterymarch emerging markets team
- --------------------------------------------------------------------------------------------------------
Batterymarch International Equity Portfolio Batterymarch developed markets (EAFE) team
- --------------------------------------------------------------------------------------------------------
Western Asset Enhanced Equity Portfolio Western Asset Management Investment
Strategy Group
- --------------------------------------------------------------------------------------------------------
Legg Mason Fund Adviser/Western Asset Equity portion: William H. Miller, III (see
Balanced Portfolio above)
Fixed income portion: Western Asset
Management Investment Strategy Group
- --------------------------------------------------------------------------------------------------------
</TABLE>
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<PAGE>
<TABLE>
<S><C>
- --------------------------------------------------------------------------------------------------------
Western Asset Money Market Portfolio Western Asset Management Investment
Strategy Group
- --------------------------------------------------------------------------------------------------------
Western Asset Government Money Market Western Asset Management Investment
Portfolio Strategy Group
- --------------------------------------------------------------------------------------------------------
Western Asset Limited Duration Portfolio Western Asset Management Investment
Strategy Group
- --------------------------------------------------------------------------------------------------------
Western Asset Intermediate Portfolio Western Asset Management Investment
Strategy Group
- --------------------------------------------------------------------------------------------------------
Western Asset Core Portfolio Western Asset Management Investment
Strategy Group
- --------------------------------------------------------------------------------------------------------
Western Asset High Yield Portfolio Western Asset Management Investment
Strategy Group
- --------------------------------------------------------------------------------------------------------
Western Asset Non-U.S. Fixed Income Portfolio Western Asset Global Management
Investment Strategy Group
- --------------------------------------------------------------------------------------------------------
</TABLE>
THE DISTRIBUTOR
- --------------------------------------------------------------------------------
Legg Mason Wood Walker, Inc. ("Legg Mason") is the distributor of each
Portfolio's shares. Legg Mason pays certain expenses in connection with the
offering of shares of each Portfolio, including any compensation to its
financial advisors, the printing and distribution of prospectuses, SAIs and
periodic reports used in connection with the offering to prospective investors,
and expenses relating to any supplementary sales literature or advertising. The
Portfolios bear the expenses of preparing, setting in type and mailing the
prospectuses, SAIs and periodic reports to existing shareholders.
Arroyo Seco, Inc. ("Arroyo Seco"), a wholly owned subsidiary of Western
Asset, is also authorized to offer certain of the Portfolios' shares for sale to
its customers. The Portfolios make no payments to Arroyo Seco in connection with
the offer or sale of their shares, and Arroyo Seco does not collect any
commissions or other fees from customers in connection with the offer or sale of
the Portfolios' shares.
PORTFOLIO TRANSACTIONS
- --------------------------------------------------------------------------------
Each Portfolio's adviser places all orders for the purchase and sale of
portfolio investments with brokers or dealers selected by it in its discretion.
It will seek the best price and execution of each Portfolio's orders. However,
the adviser may pay higher commission rates than the lowest available when it
believes it is reasonable to do so in light of the value of brokerage and
research
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<PAGE>
services provided by the broker effecting the transaction. The adviser may also
consider sales of shares of the Portfolio (or other Portfolios or other funds
managed by it or its affiliates, to the extent permitted by applicable law) in
selecting broker-dealers to execute Portfolio transactions. The Portfolios may
use Legg Mason, among others, as broker for agency transactions in listed and
over-the counter securities at commission rates and under circumstances
consistent with the policy of best execution.
Some securities considered by an adviser for purchase by a Portfolio
may also be appropriate for other clients served by the adviser. Transactions in
such securities will be allocated among the Portfolios and such other clients in
a manner considered fair and reasonable by the adviser.
ADMINISTRATOR
- --------------------------------------------------------------------------------
LMFA (the "Administrator") serves as the Portfolios' administrator and
manages the non-investment affairs of the Portfolios, directs matters related to
the operation of the Portfolios and provides office space and administrative
staff for the Portfolios. For its services as administrator of the Portfolios,
the Administrator receives a fee, computed daily and paid monthly from each
Portfolio at the annual rate of up to 0.05% of that Portfolio's average net
assets.
EXPENSES
- --------------------------------------------------------------------------------
Each Portfolio pays its share of all expenses of the relevant
Corporation that are not assumed by the Manager, the Administrator, the relevant
adviser or other parties, including Directors', auditing, legal, custodial,
transfer agency and distribution fees (which are in turn allocated to the
Financial Intermediary Class of shares).
ORGANIZATION AND HISTORY
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LM Institutional Fund Advisors I, Inc. ("LM Institutional I") and LM
Institutional Fund Advisors II, Inc. ("LM Institutional II") were incorporated
in Maryland on May 16, 1990 and __________, respectively. Prior to _________,
1998, LM Institutional I was known as "Western Asset Trust, Inc."
Each Portfolio is an open-end, diversified management company, except
for Western Asset Non-U.S. Fixed Income Portfolio, which is a non-diversified
company. The Directors of each Corporation may, without shareholder approval,
create, in addition to the Portfolios, other series of shares representing
separate investment portfolios. Any such series may be divided without
shareholder approval into two or more classes of shares having such terms as the
Directors may determine.
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Each Corporation has a total of five billion shares of common stock at
par value $0.001. Each share has one vote, with fractional shares voting
proportionally. Voting on matters pertinent only to a particular Portfolio, such
as the adoption of an investment advisory contract for that Portfolio, is
limited to that Portfolio's shareholders. Shares of all classes of a Portfolio
will vote together as a single class except when otherwise required by law or as
determined by the Directors. Shares are freely transferable, are entitled to
dividends as declared by the Directors, and, if a Portfolio were liquidated,
would receive the net assets of that Portfolio. Voting rights are not
cumulative, and all shares of the Portfolios are fully paid and nonassessable
and have no preemptive or conversion rights.
Although no Portfolio intends to hold annual shareholder meetings, it
will hold a special meeting of shareholders when the Investment Company Act of
1940 (the "1940 Act") requires a shareholder vote on certain matters (including
the election of Directors in certain cases or approval of an advisory contract).
A Portfolio will also call a special meeting of shareholders at the request of
25% or more of the shares entitled to vote, or at the request of 10% or more of
the shareholders for the purpose of considering the removal of one or more
Directors. Shareholders wishing to call such a meeting should submit a written
request to the Secretary of the relevant Corporation, stating the purpose of the
proposed meeting and the matters to be acted upon.
Although each Portfolio is offering only its own shares in this
Prospectus, it is possible that a Portfolio might become liable for any
misstatement in the Prospectus about another Portfolio. The Directors have
considered this factor in approving the use of a single prospectus.
PURCHASE OF SHARES
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The Portfolios offer two classes of shares: Institutional Class and
Financial Intermediary Class. Shares in the Financial Intermediary Class bear a
12b-1 fee. See "Distribution Plans" below for more information.
INITIAL INVESTMENT
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Prior to or concurrent with the initial purchase of shares in any
Portfolio, each investor must open an account for that Portfolio by completing
and signing an Application and mailing it to Boston Financial Data Services (the
"Transfer Agent" or "BFDS") at the following address: P.O. Box 953, Boston,
Massachusetts 02103. In general, an investor must make a minimum initial
investment of $1,000,000 to open an account in any Portfolio. Thereafter, there
is no minimum for subsequent investments. The Portfolios reserve the right to
change the minimum requirements at their discretion. An employee benefit or
retirement plan is not subject to the minimum investment requirement provided
the plan has more than $5,000,000 in assets.
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A purchase order, together with payment in proper form, received by the
Transfer Agent prior to the close of regular trading on the Exchange (ordinarily
4:00 p.m., Eastern time) ("close of the Exchange") will be effected at that
day's net asset value. An order received after the close of the Exchange will
generally be effected at the net asset value determined on the next business
day. However, orders received by certain retirement plans and other financial
intermediaries by the close of the Exchange and communicated to the Transfer
Agent by 9:00 a.m., Eastern time, on the following business day will be effected
at the net asset value determined on the prior business day.
Purchases of shares can be made by wiring federal funds to State Street
Bank and Trust Company. Purchases of shares of the Western Asset Money Market
Portfolio or the Western Asset Government Money Market Portfolio may ONLY by
made by federal funds wire. Before wiring federal funds, the investor must first
telephone the Portfolio at [TELEPHONE #] to receive instructions for wire
transfer. On the telephone, the following information will be required:
shareholder name; name of the person authorizing the transaction; shareholder
account number; name of the Portfolio and class of shares to be purchased;
amount being wired; and name of the wiring bank.
Funds should be wired through the Federal Reserve System to:
State Street Bank and Trust Company
ABA # 011-000-028
LM Institutional Fund Advisors [insert name of Portfolio]
[Insert your account name and number]
The wire should state that the funds are for the purchase of shares of
a specific Portfolio and include the account name and number. With respect to
Portfolios whose policy is to declare dividends daily, if a purchase order for
shares is received prior to 12:00 noon, Eastern time, and payment in federal
funds is received by the Transfer Agent by the close of the federal funds wire
on the day the purchase order is received, dividends will accrue starting that
day. If a purchase order is received after 12:00 noon, Eastern time, and payment
in federal funds is received by the Transfer Agent by the close of the federal
funds wire on the day the purchase order is received, or as otherwise agreed to
by the relevant Portfolio, the order will be effected at that day's net asset
value, but dividends will not begin to accrue until the following business day.
Shares may also be purchased and paid for by the contribution of
eligible portfolio securities, subject in each case to approval by the
Portfolio. Approval will depend on, among other things, the nature and quality
of the securities offered and the current needs of the Portfolio in question.
Securities offered in payment for shares will be valued in the same way and at
the same time the Portfolio values it portfolio securities for purposes of
determining net asset value. See "How Each Portfolio Values Its Shares," below.
Investors who wish to purchase Portfolio shares through the contribution of
securities should contact the Portfolio at [TELEPHONE #] for instructions.
Investors should also realize that at the time of contribution they may be
required to
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recognize a gain or loss for tax purposes on securities contributed. The
Portfolio has full discretion to reject any securities offered as payment for
shares. As described below, each Portfolio may offer Financial Intermediary
Class shares that are offered primarily through financial intermediaries. Each
Portfolio may pay financial intermediaries for their services out of that
class's assets. Legg Mason and its affiliates (including the Manager and the
advisers) may also from time to time, at their own expense, make payments to
financial intermediaries that sell shares of the Portfolio. If investors effect
transactions through a broker or agent, investors may be charged a fee by that
broker or agent.
Any shares purchased or received as a distribution will be credited
directly to the investor's account.
ADDITIONAL INVESTMENTS
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Additional investments may be made at any time at the relevant net
asset value for that class by following the procedures outlined above. Investors
should always furnish a shareholder account number when making additional
purchases.
OTHER PURCHASE INFORMATION
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Purchases will be made in full and fractional shares. In the interest
of economy and convenience, certificates for shares will not be issued.
Each Portfolio and Distributor reserves the right, in its sole
discretion, to suspend the offering of shares or to reject any purchase order,
in whole or in part, when, in the judgment of management, such suspension or
rejection is in the best interests of the Portfolio; to waive the minimum
initial investment for certain investors; and to redeem shares if information
provided in the Application should prove to be incorrect in any manner judged by
a Portfolio to be material (e.g., in a manner such as to render the shareholder
ineligible to purchase shares of a Portfolio). A Portfolio may suspend the
offering of shares at any time and resume it at any time thereafter.
Shares of the Portfolios may not be qualified or registered for sale in
all States. Prospective investors should inquire as to whether shares of a
particular Portfolio are available for offer and sale in their State of
residence. Shares of the Portfolio may not be offered or sold in any State
unless registered or qualified in that jurisdiction or unless an exemption from
registration or qualification is available.
Purchases and sales of Portfolio shares should be made for long-term
investment purposes only. Each Portfolio reserves the right to restrict
purchases of shares (including exchanges) when a pattern of frequent purchases
and sales made in response to short-term fluctuations in share price appears
evident.
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RETIREMENT PLANS
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Shares of the Portfolios are available for purchase by retirement
plans, including 401(k) plans, 403(b) plans and Individual Retirement Accounts
("IRAs"). The administrator of a plan or employee benefits office can provide
participants or employees with detailed information on how to participate in the
plan and how to elect a Portfolio as an investment option. Participants in a
retirement or savings plan may be permitted to elect different investment
options, alter the amounts contributed to the plan, or change how contributions
are allocated among investment options in accordance with the plan's specific
provisions. The plan administrator or employee benefits office should be
consulted for details. For questions about participant accounts, participants
should contact their employee benefits office, the plan administrator, or the
organization that provides recordkeeping services for the plan. Investors who
purchase shares through retirement plans should be aware that the plan
administrator may aggregate purchase and redemption orders of participants in
the plan. Therefore, there may be a delay between the time the investor places
an order with the plan administrator and the time the order is forwarded to the
Transfer Agent for execution.
ACCOUNT REGISTRATION CHANGES
- --------------------------------------------------------------------------------
Changes in registration or account privileges may be made in writing to
the Transfer Agent. Signature guarantees may be required. See "Signature
Guarantee" below. All correspondence must include the account number and must
be sent to:
Boston Financial Data Services
P.O. Box 953
Boston, Massachusetts, 02103
DISTRIBUTION PLANS
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The Board of Directors of each Corporation has adopted Distribution
Plans pursuant to Rule 12b-1 under the 1940 Act with respect to shares of the
Financial Intermediary Class of each Portfolio. Under the terms of each Plan, a
Portfolio is permitted to pay, out of the assets of the Financial Intermediary
Class of the Portfolio, in an amount up to 0.25% on an annual basis of the
average daily net assets of that class, financial intermediaries that provide
services in connection with the distribution of shares or administration of
plans or programs that use Portfolio shares as their funding medium, and to
reimburse certain other distribution-related expenses. Payments under the Plans
for the Western Asset Money Market Portfolio and the Western Asset Government
Money Market Portfolio are currently limited to an annual rate of .10% of
average daily net assets. For more information regarding the Plans and their
terms, see the SAI.
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REDEMPTION OF SHARES
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Portfolio shares may be redeemed through three methods: (1) by sending
a written request for redemption to the Transfer Agent at P.O. Box 953, Boston,
Massachusetts, 02103; (2) by calling the Portfolio at [telephone]; or (3) by
wire communication with the Transfer Agent. In each case, the investor should
first notify [Name] at [telephone] of the intention to redeem. No charge is made
for redemptions. Shareholders who wish to be able to redeem by telephone or wire
communication must complete an authorization form in advance. Redemptions over
[$10,000,000] may be initiated by telephone, but must be confirmed in writing
prior to processing. With respect to telephone redemptions or transfers, the
Transfer Agent will process orders based on instructions from a shareholder, or
any person claiming to act as his or her representative, who can provide it with
his or her account registration and address as it appears on its records. The
Transfer Agent will employ these and other reasonable procedures to confirm that
instructions communicated by telephone are genuine; if it fails to employ
reasonable procedures, the Transfer Agent may be liable for any losses due to
unauthorized or fraudulent instructions.
Upon receipt of a request in good order for redemption before the close
of the Exchange on any day when the Exchange is open, the Transfer Agent will
redeem Portfolio shares at that day's net asset value per share. Requests for
redemption received by the Transfer Agent after the close of the Exchange will
be executed at the net asset value next determined.
Requests for redemption should indicate:
1. The number of shares or dollar amount to be redeemed and the
investor's shareholder account number;
2. The investor's name and the names of any co-owner of the account,
using exactly the same name or names used in establishing the account;
3. Proof of authorization to request redemption on behalf of any
co-owner of the account (please contact [NAME] for further details); and
4. The name, address, and account number to which the redemption
payment should be sent.
The Portfolios reserve the right to modify or terminate the redemption
procedures upon notice to shareholders.
Payment of the redemption price normally will be made by wire three
business days after receipt of a redemption request in good order. However, each
Portfolio reserves the right to postpone the payment date when the Exchange is
closed, when trading is restricted, or during other periods as permitted by
federal securities laws, or to take up to seven days to make payment
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upon redemption if the Portfolio involved could be adversely affected by
immediate payment. Redemption proceeds may also be paid in kind at the
discretion of the Portfolio. Shareholders who receive a redemption in kind may
incur costs to dispose of such securities.
Shareholders of some investment companies have experienced difficulty
contacting their funds by telephone during periods of intense market activity.
Shareholders who are unable to contact a Portfolio by telephone and wish to make
a redemption should follow the instructions for redeeming by mail or by wire.
Other supporting legal documents, such as copies of the trust
instrument or power of attorney, may be required from corporations or other
organizations, fiduciaries or persons other than the shareholder of record
making the request for redemption or repurchase. If you have a question
concerning the sale or redemption of shares, please contact [NAME] or the
Transfer Agent.
Any Portfolio may elect to close any shareholder account with a current
value of less than $1 million by redeeming all of the shares in the account and
mailing the proceeds to the investor. If a Portfolio elects to redeem the shares
in an account, the shareholder will be notified that the account is below $1
million and will be allowed 30 days in which to make an additional investment in
order to avoid having the account closed. Shares will be redeemed at the net
asset value calculated on the day of redemption. Any Portfolio may change the $1
million minimum account balance from time to time without notice to
shareholders.
SIGNATURE GUARANTEE
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When a signature guarantee is called for, the shareholder should have
"Signature Guaranteed" stamped under his signature and guaranteed by any of the
following entities: U.S. banks, foreign banks having a U.S. correspondent bank,
credit unions, savings associations, U.S. registered dealers and brokers,
municipal securities dealers and brokers, government securities dealers and
brokers, national securities exchanges, registered securities associations and
clearing agencies (each an "Eligible Guarantor Institution"). Each Portfolio and
its agents reserve the right to reject any signature guarantee pursuant to
written signature guarantee standards or procedures, which may be revised in the
future to permit them to reject signature guarantees from Eligible Guarantor
Institutions that do not, based on credit guidelines, satisfy such written
standards or procedures. Any Portfolio may change the signature guarantee
requirements from time to time without prior notice to shareholders.
EXCHANGE PRIVILEGE
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Shareholders in any Portfolio may exchange their shares for shares of
the same class of any of the other Portfolios, provided that the other Portfolio
is offering its shares of that class at the
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time of the proposed exchange. Investments by exchange among any of the
Portfolios are made at the per share net asset values next determined after the
order for exchange is received in good order.
The exchange privilege is not intended as a vehicle for short-term
trading. Excessive exchange activity may interfere with portfolio management and
have an adverse effect on all shareholders. In order to limit excessive exchange
activity and in other circumstances where a Portfolio believes doing so would be
in its best interest, the Portfolio reserves the right to revise or terminate
the exchange privilege, limit the amount or number of exchanges or reject any
exchange. For further information concerning the exchange privilege, or to make
an exchange, please contact the Portfolio at [Boston Financial Data Services],
[telephone].
NET ASSET VALUE
- --------------------------------------------------------------------------------
Net asset value per share of each class of shares is determined daily
for each Portfolio as of the close of regular trading on the Exchange (normally
4:00 p.m., Eastern time), on every day that the Exchange is open, by subtracting
the Portfolio's liabilities attributable to a given class of shares from its
total assets attributable to the class and dividing the result by the number of
shares of that class outstanding. Net asset value will not be determined on days
on which the Exchange is closed.
Except for the Western Asset Money Market Portfolio and the Western
Asset Government Money Market Portfolio, portfolio securities and other assets
for which market quotations are readily available are valued at current market
value. Current market value means the last sale price of the day for a
comparable position, or, in the absence of any such sales, the mean between
representative bid and asked prices obtained from a quotation reporting system.
Securities with remaining maturities of 60 days or less are generally valued at
amortized cost. Fixed income securities, including those to be purchased under
firm commitment agreements, are normally valued on the basis of quotations
obtained from brokers and dealers or pricing services which take into account
appropriate factors such as institutional-size trading in similar groups of
securities, yield, quality, coupon rate, maturity, type of issue, trading
characteristics and other market data. Certain fixed income securities for which
daily market quotations are not readily available may be valued, pursuant to
guidelines established by the Directors, with reference to fixed income
securities whose prices are more readily available and whose durations are
comparable to those of the securities being valued.
Other assets and securities for which no quotations are readily
available are valued at fair value as determined in good faith by the Directors
or persons acting at their direction. The values of foreign securities quoted in
foreign currencies are translated into U.S. dollars at current exchange rates or
at such other rates as the Directors or persons acting at their direction may
determine in computing net asset value.
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Because of time zone differences, foreign exchanges and securities
markets will usually be closed prior to the time of the closing of the Exchange
and values of foreign investments will be determined as of the earlier closing
of such exchanges and securities markets. However, events affecting the values
of such foreign securities may occasionally occur between the earlier closings
of such exchanges and securities markets and the closing of the Exchange which
will not be reflected in the computation of the net asset value. If an event
materially affecting the value of such foreign securities occurs during such
period, then such securities will be valued at fair value as determined in good
faith by the Directors or persons acting at their direction.
The Western Asset Money Market Portfolio and the Western Asset
Government Money Market Portfolio each attempts to maintain a per share net
asset value of $1.00 by using the amortized cost method of valuation as
permitted by SEC Rule 2a-7. Neither Portfolio can guarantee that the net asset
value will always remain at $1.00 per share.
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS
- --------------------------------------------------------------------------------
The Western Asset Money Market Portfolio and the Western Asset
Government Money Market Portfolio declare as a dividend at the close of the
Exchange each business day, to shareholders of record as of 12:00 noon that day,
substantially all of their net investment income since the prior business day's
dividend. The Western Asset Money Market Portfolio and the Western Asset
Government Money Market Portfolio pay dividends monthly.
The Legg Mason Fund Adviser Large Cap Value Portfolio, the Western
Asset Enhanced Equity Portfolio, the Legg Mason Fund Adviser/Western Asset
Balanced Portfolio, the Western Asset Limited Duration Portfolio, the Western
Asset Intermediate Portfolio, the Western Asset Core Portfolio, the Western
Asset High Yield Portfolio and the Western Asset Non-U.S. Fixed Income Portfolio
declare and pay dividends quarterly out of their net investment income for that
quarter. All other Portfolios declare and pay dividends annually out of their
net investment income for that year. Distributions of net realized capital gains
are made annually.
Shareholders may elect to receive dividends and distributions in one of
four ways:
1) Receive both dividends and other distributions in shares
of the same class of the distributing Portfolio;
2) Receive dividends in cash and other distributions in
shares of the same class of the distributing Portfolio;
3) Receive dividends in shares of the same class of the
distributing Portfolio and other distributions in cash; or
4) Receive both dividends and other distributions in cash.
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If no election is made, both dividends and other distributions are
credited to a shareholder's Portfolio account in shares (of the same class as
the shares already held) at the net asset value of the shares determined as of
the close of the Exchange on the reinvestment date.
For the Western Money Market Portfolio and the Western Asset Government
Money Market Portfolio, reinvestment of dividends and other distributions occurs
on the payment date. A shareholder who redeems all shares in the Western Asset
Money Market Portfolio or the Western Asset Government Money Market Portfolio
will receive all dividends and other distributions declared for that month cycle
prior to the redemption date (i.e., all dividends and other distributions from
the first day of that monthly cycle, if invested on that first day, to the date
of the redemption). For the other Portfolios, reinvestment occurs on the
ex-dividend date. An election to receive dividends or other distributions in
cash rather than additional shares may be made by notifying the Transfer Agent
in writing. The election must be received at least ten days before the payment
date in order to be effective for distributions paid as of that date.
If a shareholder has elected to receive dividends and/or other
distributions in cash and the postal or other delivery service is unable to
deliver checks to the shareholder's address of record, such shareholder's
distribution option will automatically be converted to having all dividends and
other distributions reinvested in additional shares. No interest will accrue on
amounts represented by uncashed distribution or redemption checks.
The Directors reserve the right to revise the dividend policy or
postpone the payment of dividends if warranted in their judgment due to unusual
circumstances, such as an unexpected large expense, loss or fluctuation in net
asset value.
TAX INFORMATION
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Each Portfolio intends to qualify as a "regulated investment company"
for federal income tax purposes and to meet all other requirements necessary for
it to be relieved of federal taxes on income and gains it distributes to
shareholders. Each Portfolio will distribute substantially all its net
investment income and net realized capital gains to its shareholders on a
current basis.
Distributions from a Portfolio (whether paid in cash or reinvested in
shares of the Portfolio) will be taxable to shareholders (other than IRAs, other
qualified retirement plans and other tax-exempt investors) as ordinary income to
the extent derived from the Portfolio's investment income and net short-term
gains. Shareholders will be taxable on distributions of net capital gains (that
is, the excess of net gains from capital assets held for more than one year over
net losses from capital assets held for not more than one year) at two different
tax rates pursuant to the Taxpayer Relief Act of 1997. One rate (generally 28%)
applies to net gains on capital assets held for more than one year but not more
than 18 months ("mid-term gains") and a second, preferred rate (generally 20%)
applies to the balance of such net capital gains ("adjusted net capital gains").
Distributions of net capital gains will be treated in the hands of shareholders
as mid-term
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gains to the extent designated by a Portfolio as deriving from net gains from
assets held for more than one year but not more than 18 months, and the balance
will be treated as adjusted net capital gains. Distributions of mid-term gains
and adjusted net capital gains will be taxable to shareholders as such,
regardless of how long a shareholder has held the shares in a Portfolio.
Special tax rules apply to investments through defined contributions
plans and other tax-qualified plans. Shareholders should consult their tax
adviser to determine the suitability of shares of a Portfolio as an investment
through such plans and the precise effect of an investment on their particular
tax situation.
To the extent distributions consist of interest from securities of the
U.S. Government and certain of its agencies and instrumentalities, they may be
exempt from state and local income taxes. Interest from obligations that are
merely guaranteed by the U.S. Government or one of its agencies, such as
mortgage participation certificates guaranteed by GNMA, generally is not
entitled to this exemption. Although there is no assurance that any such state
and local exemptions will be available, shareholders will be advised of the
portion of Portfolio distributions that might qualify for such an exemption.
A Portfolio's investments in foreign securities may be subject to
withholding taxes at the source on dividend or interest payments. In that case,
a Portfolio's yield on those securities would be decreased.
If at the end of a Portfolio's fiscal year more than 50% of the value
of its total assets represents securities of foreign corporations, the Portfolio
may make an election to treat any foreign taxes paid by it as paid by its
shareholders. In this case, shareholders who are U.S. citizens, U.S.
corporations and, in some cases, U.S. residents generally will be required to
include in U.S. taxable income their pro rata share of such taxes, but may then
generally be entitled to claim a foreign tax credit or deduction (but not both)
for their share of such taxes. A shareholder's ability to claim a foreign tax
credit or deduction in respect of foreign taxes paid by a Portfolio may be
subject to certain limitations (including a holding period requirement,
applicable to both a Portfolio and its shareholders, imposed by the Taxpayer
Relief Act of 1997).
A Portfolio's transactions in foreign currencies and hedging activities
may give rise to ordinary income or loss to the extent such income or loss
results from fluctuations in value of the foreign currency concerned. In
addition, such activities will likely produce a difference between book income
and taxable income. This difference may cause a portion of a Portfolio's income
distributions to constitute a return of capital for tax purposes or require a
Portfolio to make distributions exceeding book income to qualify as a regulated
investment company for tax purposes.
Investment in an entity that qualifies as a "passive foreign investment
company" under the Code could subject a Portfolio to a U.S. federal income tax
or other charge on certain "excess
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distributions" with respect to the investment, and on the proceeds from
disposition of the investment.
Early each year each Portfolio will notify its shareholders of the
amount and tax status of distributions paid during that year.
The foregoing is a summary of certain federal income tax consequences
of investing in a Portfolio. Shareholders are urged to consult their tax
advisers with respect to the effects of this investment on their particular tax
situation (including possible liability for state and local taxes).
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APPENDIX A -- SECURITIES RATINGS
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The following rating services describe rated securities as follows:
MOODY'S INVESTORS SERVICE, INC.
BONDS
Aaa -- Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
Aa -- Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they compromise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risk appear somewhat larger than the Aaa securities.
A -- Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper-medium grade obligations. Factors giving security
to principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment sometime in the future.
Baa -- Bonds which are rated Baa are considered as medium grade obligations,
(i.e., they are neither highly protected nor poorly secured). Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba -- Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate, and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B -- Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa -- Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
A-1
<PAGE>
Ca -- Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
C -- Bonds which are rated C are the lowest rated class of bonds, and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
NOTES
MIG 1/VMIG 1 -- This designation denotes best quality. There is present strong
protection by established cash flows, superior liquidity support or demonstrated
broad-based access to the market for refinancing.
MIG 2/VMIG 2 -- This designation denotes high quality. Margins of protection are
ample although not so large as in the preceding group.
COMMERCIAL PAPER
Issuers rated Prime-1 (or supporting institutions) have a superior ability for
repayment of senior short-term debt obligations. Prime-1 repayment ability will
often be evidenced by the following characteristics:
- -- Leading market positions in well established industries.
- -- High rates of return on funds employed.
- -- Conservative capitalization structure with moderate
reliance on debt and ample asset protection.
- -- Broad margins in earnings coverage of fixed financial
charges and high internal cash generation.
- -- Well established access to a range of financial markets
and assured sources of alternate liquidity.
Issuers rated Prime-2 (or supporting institutions) have a strong ability for
repayment of senior short-term debt obligations. This will normally be evidenced
by many of the characteristics cited above to a lesser degree. Earnings trends
and coverage ratios, while sound, may be more subject to variation.
Capitalization characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
STANDARD & POOR'S
BONDS
AAA -- Debt rated "AAA" has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
A-2
<PAGE>
AA -- Debt rated "AA" has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
A -- Debt rated "A" has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB -- Debt rated "BBB" is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
BB-B-CCC-CC-C -- Debt rated "BB", "B", "CCC", "CC" and "C" is 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"
indicates the lowest degree of speculation and "C" the highest. While such debt
will likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major exposures to adverse conditions.
BB -- Debt rated "BB" has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The "BB"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BBB" rating.
B -- Debt rated "B" has a greater vulnerability to default but currently has the
capacity to meet interest payments and principal repayments. Adverse business,
financial, or economic conditions will likely impair capacity or willingness to
pay interest and repay principal. The "B" rating category is also used for debt
subordinated to senior debt that is assigned as actual or implied "BB" or "BB-"
rating.
CCC -- Debt rated "CCC" has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial, and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial, or economic conditions, it is not likely to have
the capacity to pay interest and repay principal. The "CCC" rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied "B" or "B-" rating.
CC -- The rating "CC" typically is applied to debt subordinated to senior debt
that is assigned an actual or implied "CCC" rating.
C -- The rating "C" typically is applied to debt subordinated to senior debt
which is assigned an actual or implied "CCC-" debt rating. The "C" rating may be
used to cover a situation where a bankruptcy petition has been filed, but debt
service payments are continued.
A-3
<PAGE>
D -- Bonds rated "D" are in payment default. The "D" rating category is used
when interest payments or principal payments are not made on the date due even
if the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grace period. The "D" rating also will be used
on the filing of a bankruptcy petition if debt service payments are jeopardized.
NOTES
SP-1 -- Strong capacity to pay principal and interest. Those issues determined
to possess overwhelming safety characteristics are given a plus (+) designation.
SP-2 -- Satisfactory capacity to pay principal and interest.
SP-3 -- Speculative capacity to pay principal and interest.
COMMERCIAL PAPER
A-1 -- This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus sign (+) designation.
A-2 -- Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated "A-1."
A-3 -- Issues carrying this designation have adequate capacity for timely
payment. They are, however, more vulnerable to the adverse effects of changes in
circumstances than obligations carrying the higher designations.
FITCH INVESTORS SERVICE, INC.
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.
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.
A-4
<PAGE>
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.
BB -- Bonds considered to be speculative. The obligor's ability to pay interest
and repay principal may be affected over time by adverse economic changes.
However, business and financial alternatives can be identified which could
assist the obligor in satisfying its debt service requirements.
B -- Bonds are considered highly speculative. Bonds in this class are lightly
protected as to the obligor's ability to pay interest over the life of the issue
and repay principal when due.
CCC -- Bonds have certain characteristics which, with passing of time, could
lead to the possibility of default on either principal or interest payments.
CC -- Bonds are minimally protected. Default in payment of interest and/or
principal seems probable.
C -- Bonds are in actual or imminent default in payment of interest or
principal.
DDD -- Bonds are in default and in arrears in interest and/or principal
payments. Such bonds are extremely speculative and should be valued only on the
basis of their value in liquidation or reorganization of the obligor.
SHORT TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on demand
or have original maturities of generally up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and investment
notes.
The short-term rating places greater emphasis than a long-term rating on the
existence of liquidity necessary to meet the issuer's obligations in a timely
manner.
F-1+ -- Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely payment.
F-1 -- Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues rated
"F-1+".
A-5
<PAGE>
F-2 -- Good Credit Quality. Issues assigned this rating have a satisfactory
degree of assurance for timely payment, but the margin of safety is not as great
as for issues assigned "F-1+" and "F-1" ratings.
F-3 -- Fair Credit Quality. Issues assigned this rating have characteristics
suggesting that the degree of assurance for timely payment is adequate; however,
near-term adverse changes could cause these securities to be rated below
investment grade.
F-S -- Weak Credit Quality. Issues assigned this rating have characteristics
suggesting a minimal degree of assurance for timely payment and are vulnerable
to near-term adverse changes in financial and economic conditions.
D -- Default. Issues assigned this rating are in actual or imminent payment
default.
LOC -- The symbol LOC indicates that the rating is based on a letter of credit
issued by a commercial bank.
A-6
<PAGE>
LM INSTITUTIONAL FUND ADVISORS
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CUSTODIAN: TRANSFER AND SHAREHOLDER
STATE STREET BANK SERVICING AGENT:
AND TRUST CO. BOSTON FINANCIAL DATA
P.O. Box 1713 SERVICES
Boston, Massachusetts 02105 P.O. Box 953
Boston, Massachusetts 02103
[Legg Mason Institutional Fund Advisors Logo Appears Here]
COUNSEL: INDEPENDENT ACCOUNTANT:
ROPES & GRAY
One International Place
Boston, MA 02110
(617) 951-7000
- --------------------------------------------------------------------------------
DISTRIBUTORS:
Legg Mason Wood Walker, Incorporated Arroyo Secco, Inc.
100 Light Street 117 East Colorado Boulevard
P.O. Box 1476 Pasadena, CA 91105
Baltimore, MD 21203-1476 626-844-9400
410-539-0000
800-822-5544
<PAGE>
LM INSTITUTIONAL FUND ADVISORS April 1, 1998
- --------------------------------------------------------------------------------
STATEMENT OF ADDITIONAL INFORMATION
LM Institutional Fund Advisors I, Inc. and LM Institutional Fund
Advisors II, Inc. (each a "Fund" and together the "Funds") are each a no-load,
open-end management investment company. LM Institutional Fund Advisors I, Inc.
currently consists of eight separate professionally managed investment
portfolios and LM Institutional Fund Advisors II, Inc. currently consists of six
separate professionally managed investment portfolios. All fourteen portfolios
are described in this Statement of Additional Information ("SAI"). Each of
these portfolios is referred to herein as a "Portfolio".
This SAI is not a prospectus and should be read in conjunction with the
Prospectus for the Portfolios, dated April 1, 1998, which has been filed with
the Securities and Exchange Commission ("SEC"). Copies of the Portfolios'
Prospectus are available without charge from Legg Mason Wood Walker, Inc. at
1-800-822-5544.
<PAGE>
TABLE OF CONTENTS
-----------------
<TABLE>
<S><C>
DEFINITIONS.....................................................................................................-1-
ADDITIONAL INFORMATION ABOUT
INVESTMENT LIMITATIONS AND POLICIES....................................................................-2-
ADDITIONAL INFORMATION ABOUT SECURITIES,
INVESTMENT TECHNIQUES AND RELATED RISKS................................................................-4-
Ratings of Debt Obligations............................................................................-4-
Mortgage-Related Securities............................................................................-5-
Private Mortgage-Related Securities....................................................................-6-
Asset-Backed Securities................................................................................-6-
Non-Governmental Fixed Income and Other Debt Securities................................................-7-
Restricted Securities..................................................................................-8-
Borrowings.............................................................................................-8-
Options on Securities..................................................................................-9-
Futures Contracts and Options on Futures Contracts.....................................................-9-
Risks Associated with Futures and Options.............................................................-11-
Additional Risks of Options on Securities, Futures Contracts and Options on Futures
Contracts Traded on Foreign Exchanges........................................................-14-
Cover for Hedging Strategies..........................................................................-14-
Duration .............................................................................................-15-
VALUATION OF PORTFOLIO SHARES..................................................................................-15-
Use of the Amortized Cost Method by the Money Market Portfolios.......................................-15-
Monitoring Procedures.................................................................................-16-
Investment Restrictions...............................................................................-16-
MANAGEMENT OF THE PORTFOLIOS...................................................................................-17-
Directors and Officers................................................................................-17-
Directors and Officers; LM Institutional Fund Advisors I, Inc. .......................................-17-
Directors and Officers; LM Institutional Fund Advisors II, Inc........................................-21-
Manager and Advisers..................................................................................-22-
PURCHASES AND REDEMPTIONS......................................................................................-29-
EXCHANGE PRIVILEGE.............................................................................................-29-
PORTFOLIO TRANSACTIONS AND BROKERAGE...........................................................................-30-
</TABLE>
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<TABLE>
<S><C>
ADDITIONAL TAX INFORMATION.....................................................................................-31-
OTHER INFORMATION..............................................................................................-32-
PRINCIPAL HOLDERS OF SECURITIES................................................................................-33-
PERFORMANCE INFORMATION........................................................................................-34-
</TABLE>
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<PAGE>
DEFINITIONS
"Administrator" means LMFA.
"Adviser" means the investment advisory firm that manages a Portfolio's assets.
LMFA, Western Asset, Batterymarch and WAGM are each Advisers.
"Batterymarch" means Batterymarch Financial Management, Inc., 200 Clarendon
Street, Boston, Massachusetts 02116. Batterymarch is the Adviser to the
Batterymarch Emerging Markets Portfolio and the Batterymarch International
Equity Portfolio.
"Code" means the Internal Revenue Code of 1986, as amended.
"Distributor" means the broker-dealer that is responsible for the distribution
or sale of each Fund's shares. Legg Mason is each Fund's Distributor. Arroyo
Secco, Inc. also serves as the Distributor of the Western Asset Money Market
Portfolio, the Western Asset Government Money Market Portfolio, the Western
Asset Core Portfolio, the Western Asset Intermediate Portfolio, the Western
Asset Limited Duration Portfolio, the Western Asset Enhanced Equity Portfolio,
the Western Asset High Yield Portfolio and the Western Asset Non-U.S. Portfolio.
"Exchange" means the New York Stock Exchange.
"Fundamental Investment Limitation" means an investment limitation of a
Portfolio that may be changed only with the affirmative vote of the lesser of
(a) more than 50% of the outstanding shares of the relevant Portfolio or (b) 67%
or more of the shares of the relevant Portfolio present at a shareholders'
meeting if more than 50% of the outstanding shares of that Portfolio are
represented at the meeting in person or by proxy. Only those policies or
limitations expressly designated as such are fundamental investment limitations.
All other policies and restrictions may be changed without shareholder approval.
"Independent Director" means a Director of a Fund who is not an "interested
person" (as defined in the 1940 Act) of that Fund.
"Legg Mason" means Legg Mason Wood Walker, Inc.
"LMFA" means Legg Mason Fund Advisers, Inc., 100 Light Street, Baltimore, MD
21202. LMFA is the Adviser to the Legg Mason Fund Adviser Large Cap Value
Portfolio, the Legg Mason Fund Adviser Mid Cap Value Portfolio and the equity
portion of the Legg Mason Fund Adviser/Western Asset Balanced Portfolio and is
the Funds' Administrator.
"Manager" means LM Institutional Fund Advisors, Inc., 100 Light Street,
Baltimore, MD 21202.
"1940 Act" means the Investment Company Act of 1940, as amended.
-1-
<PAGE>
"NRSROs" means nationally recognized (or foreign) statistical rating
organizations, including Moody's Investors Service, Inc. ("Moody's") and
Standard & Poor's Ratings Group ("S&P").
"Plan" means each Fund's Distribution and Shareholder Services Plan.
"SEC" means the Securities and Exchange Commission.
"12b-1 Director" means a Director of a Fund who is an Independent Director and
who has no direct or indirect financial interest in the operation of the Fund's
Plan or the Fund's Underwriting Agreement.
"WAGM" means Western Asset Global Management Limited, 155 Bishopsgate, London,
England. WAGM is the Adviser to the Western Asset International Securities
Portfolio.
"Western Asset" means Western Asset Management Company, 117 East Colorado
Boulevard, Pasadena, CA 91105. Western Asset is the Adviser to each Portfolio of
LM Institutional Fund Advisors I, Inc. other than the Western Asset Non-U.S.
Portfolio and is the Adviser to the fixed income portion of the Legg Mason Fund
Adviser/Western Asset Balanced Portfolio.
ADDITIONAL INFORMATION ABOUT
INVESTMENT LIMITATIONS AND POLICIES
Each Portfolio has adopted certain fundamental investment limitations
that are set forth below.
Each Portfolio may:
(1) lend or borrow money or other property to the fullest extent
permitted by the 1940 Act, the rules or regulations thereunder or applicable
orders of the SEC, as such statute, rules, regulations or orders may be amended
from time to time.
(2) issue senior securities to the fullest extent permitted by the 1940
Act, the rules or regulations thereunder or applicable orders of the SEC, as
such statute, rules, regulations or orders may be amended from time to time.
(3) not concentrate investments in a particular industry or group of
industries as concentration is defined under the 1940 Act, the rules or
regulations thereunder or applicable orders of the SEC, as such statute, rules,
regulations or orders may be amended from time to time. Securities issued or
guaranteed by the U.S. Government, or its agencies or instrumentalities will not
be considered to represent an industry.
-2-
<PAGE>
(4) underwrite securities to the fullest extent permitted by the 1940
Act, the rules or regulations thereunder or applicable orders of the SEC, as
such statute, rules, regulations or orders may be amended from time to time.
(5) purchase or sell commodities, commodities contracts, futures
contracts, options, forward contracts or real estate to the fullest extent
permitted by the 1940 Act, the rules or regulations thereunder or applicable
orders of the SEC, as such statute, rules, regulations or orders may be amended
from time to time.
Additional Information
- ----------------------
The fundamental investment limitations set forth above limit a
Portfolio's ability to engage in certain investment practices and purchase
securities to the extent permitted by, or consistent with, the 1940 Act.
Relevant limitations of the 1940 Act are described below, which are based either
on the 1940 Act itself, the rules or regulations thereunder, or interpretations
promulgated by the SEC. As such, these limitations of the 1940 Act are not
"fundamental," that is, the limitations will change as the statute, rules,
regulations or interpretations change, and no shareholder vote will be required
or sought.
Fundamental investment restriction (1). The 1940 Act presently limits a
Portfolio's ability to borrow up to one-third of the value of its total assets.
Borrowing by a Portfolio allows it to leverage its portfolio, which exposes it
to certain risks. Leveraging increases the effect of any increase or decrease in
the value of portfolio securities on a Portfolio's net asset value, and money
borrowed will be subject to interest costs (which may include commitment fees
and/or the cost of maintaining minimum average balances) which may or may not
exceed the return from the securities purchased with borrowed funds.
The 1940 Act also restricts the ability of any mutual fund to lend.
Under the 1940 Act, a Portfolio may only make loans if expressly permitted to do
so by the Portfolio's investment policies, and a Portfolio may not make loans to
persons who control or are under common control with the Portfolio. Thus, the
1940 Act effectively prohibits a Portfolio from making loans to certain persons
when conflicts of interest or undue influence are most likely present. The
Portfolios may, however, make other loans which if made would expose
shareholders to additional risks, such as the failure of the other party to
repay the loan.
Fundamental investment restriction (2). The ability of a mutual fund to
issue senior securities is severely circumscribed by complex regulatory
constraints under the 1940 Act that restrict, for instance, the amount, timing,
and form of senior securities that may be issued. Certain portfolio management
techniques such as the purchase of securities on margin, short sales, or the
writing of puts on portfolio securities, may be considered senior securities
unless appropriate steps are taken to segregate a Portfolio's assets or
otherwise cover its obligations.
-3-
<PAGE>
Fundamental investment restriction (3). "Concentration" is interpreted
under the 1940 Act to mean investment of 25% or more of a Portfolio's total
assets in a single industry. If a Portfolio were to "concentrate" its
investments in a particular industry, investors would be exposed to greater
risks because the Portfolio's performance would be largely dependent on that
industry's performance. None of the Portfolios has reserved the right to
concentrate in any industry. For purposes of this limitation, the Portfolios do
not consider certificates of deposit or banker's acceptances issued by domestic
branches of U.S. or foreign banks to be in a single industry. If, in the future,
these instruments are considered to be in the same industry, the Portfolios
reserve the freedom of action to concentrate in such an industry.
Fundamental investment restriction (4). The 1940 Act prohibits a
diversified mutual fund from underwriting securities in excess of 25% of its
total assets.
Fundamental investment restriction (5). This restriction would permit
investment in commodities, commodities contracts (e.g., futures contracts or
options), forward contracts or real estate to the extent permitted under the
1940 Act. However, it is unlikely that the Portfolios would make such
investments, other than the use of futures contracts, options, forward contracts
and certain real estate-related securities as explained in the Prospectus and
this Statement of Additional Information. Each Portfolio, however, would like
the ability to consider using these investment techniques in the future.
Commodities, as opposed to commodity futures, represent the actual underlying
bulk goods, such as grains, metals and food stuffs. Real estate-related
instruments include real estate investment trusts, commercial and residential
mortgage-backed securities, and real estate financings, and such instruments are
generally sensitive to factors such as changes in real estate values and
property taxes, interest rates, cash flow of underlying real estate assets,
overbuilding, and the management skill and creditworthiness of the issuer.
ADDITIONAL INFORMATION ABOUT SECURITIES,
INVESTMENT TECHNIQUES AND RELATED RISKS
RATINGS OF DEBT OBLIGATIONS
Moody's, S&P and NRSROs are private organizations that provide ratings
of the credit quality of debt obligations. A description of the ratings assigned
to corporate debt obligations by Moody's and S&P is included as Appendix A to
the Prospectus. A Portfolio may consider these ratings in determining whether to
purchase, sell or hold a security. Ratings are not absolute assurances of
quality. Consequently, securities with the same maturity, interest rate and
rating may have different market prices. Credit rating agencies attempt to
evaluate the safety of principal and interest payments and do not evaluate the
risks of fluctuations in market value. Also, rating agencies may fail to make
timely changes in credit ratings in response to subsequent events, so that an
issuer's current financial condition may be better or worse than the rating
indicates.
-4-
<PAGE>
MORTGAGE-RELATED SECURITIES
Mortgage-related securities represent an ownership interest in a pool
of residential mortgage loans. These securities are designed to provide monthly
payments of interest and, in most instances, principal to the investor. The
mortgagor's monthly payments to his/her lending institution are "passed through"
to investors such as the Portfolios. Most issuers or poolers provide guarantees
of payments, regardless of whether the mortgagor actually makes the payment. The
guarantees made by issuers or poolers are often backed by various forms of
credit, insurance and collateral, although these may be in amounts less than the
full obligation of the pool to its shareholders.
Pools often consist of whole mortgage loans or participations in loans.
The majority of these loans are made to purchasers of one- to four-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, the Portfolios may purchase pools of variable-rate
mortgages, growing-equity mortgages, graduated-payment mortgages and other
types.
All poolers apply standards for qualification to 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, many mortgages included in pools are insured through private mortgage
insurance companies.
The average life of mortgage-related securities varies with the
maturities and the nature of the underlying mortgage instruments. For example,
securities issued by the Government National Mortgage Association ("GNMA") tend
to have a longer average life than participation certificates ("PCs") issued by
the Federal Home Loan Mortgage Corporation ("FHLMC") because there is a tendency
for the conventional and privately-insured mortgages underlying FHLMC PCs to
repay at faster rates than the Federal Housing Administration and Veterans
Administration loans underlying GNMAs. In addition, the term of a security 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.
In determining the dollar-weighted average maturity of a Portfolio, the
Portfolio's Adviser will follow industry practice in assigning an average life
to the mortgage-related securities held by each Portfolio unless the interest
rate on the mortgages underlying the securities is such that a different
prepayment rate is likely. For example, if a GNMA has a high interest rate
relative to the market, that GNMA is likely to have a shorter overall maturity
than a GNMA with a market rate coupon. Moreover, LMFA or Western Asset may deem
it appropriate to change the projected average life for a Portfolio's
mortgage-related securities as a result of fluctuations in market interest rates
and other factors.
-5-
<PAGE>
Yields on mortgage-related 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
yield expected on the basis of average life. Reinvestment of the prepayments may
occur at higher or lower interest rates than the original investment, thus
affecting the yield of the Portfolio. The compounding effect from reinvestments
of monthly payments received by each Portfolio will increase the yield to
shareholders compared to bonds that pay interest semi-annually.
PRIVATE MORTGAGE-RELATED SECURITIES
Certain private mortgage pools are organized in such a way that the SEC
staff considers them to be closed-end investment companies. Each Portfolio's
investment in such pools is constrained by federal statute, which restricts
investments in the shares of other investment companies.
The private mortgage-related securities in which the Portfolios may
invest include foreign mortgage pass-through securities ("Foreign
Pass-Throughs"), which are structurally similar to the pass-through instruments
described above. Such securities are issued by originators of and investors in
mortgage loans, including savings and loan associations, mortgage bankers,
commercial banks, investment bankers, specialized financial institutions and
special purpose subsidiaries of the foregoing. Foreign Pass-Throughs usually are
backed by a pool of fixed rate or adjustable-rate mortgage loans. Certain
Foreign Pass-Throughs in which the Portfolios invest typically are not
guaranteed by an entity having the credit status of GNMA, but generally utilize
various types of credit enhancement.
ASSET-BACKED SECURITIES
Asset-backed securities are structurally similar to mortgage-backed
securities, but are secured by interests in a different type of receivable.
Asset-backed securities therefore present certain risks that are not presented
by mortgage-related debt securities or other securities in which the Portfolios
may invest. Primarily, these securities do not have the benefit of the same
security interest in the related collateral. Credit card receivables are
generally unsecured and the debtors are entitled to the protection of a number
of state and federal consumer credit laws, many of which give such debtors the
right to set off certain amounts owed on the credit cards, thereby reducing the
balance due. Most issuers of automobile receivables permit the servicers to
retain possession of the underlying obligations. If the servicer were to sell
these obligations to another party, there is a risk that the purchaser would
acquire an interest superior to that of the holders of the related automobile
receivables. In addition, because of the large number of vehicles involved in a
typical issuance and technical requirements under state laws, the trustee for
the holders of the automobile receivables may not have a proper security
interest in all of the obligations backing such receivables. Therefore, there is
the possibility that recoveries on repossessed collateral may not, in some
cases, be available to support payments on these securities. Because
asset-backed
-6-
<PAGE>
securities are relatively new, the market experience in these securities is
limited and the market's ability to sustain liquidity through all phases of the
market cycle is not certain.
NON-GOVERNMENTAL FIXED INCOME AND OTHER DEBT SECURITIES
A Portfolio's investments in fixed income and other debt securities of
non-governmental domestic or foreign issuers are limited to fixed income or
other debt obligations (bonds, debentures, notes and other similar instruments)
which meet the minimum ratings criteria set forth for the Portfolio or, if
unrated, are determined by the Portfolio's Adviser to be of comparable quality
to fixed income or other debt obligations in which the Portfolio may invest.
Where one of the NRSROs has assigned an investment grade rating to an
instrument and others have given it a lower rating, the Portfolios may consider
the instrument to be investment grade. The market for lower-rated securities may
be thinner and less active than that for higher-rated securities, which can
adversely affect the prices at which these securities can be sold, and may make
it difficult for a Portfolio to obtain market quotations daily. If market
quotations are not available, these securities will be valued by a method that
the Portfolios' Boards of Directors believe accurately reflects fair market
value. Judgment may play a greater role in valuing lower-rated debt securities
than is the case with respect to securities for which a broader range of dealer
quotations and last-sale information is available.
Although the prices of lower-rated bonds are generally less sensitive
to interest rate changes than are higher-rated bonds, the prices of lower-rated
bonds may be more sensitive to adverse economic changes and developments
regarding the individual issuer. Although the market for lower-rated debt
securities is not new, and the market has previously weathered economic
downturns, there has been in recent years a substantial increase in the use of
such securities to fund corporate acquisitions and restructurings. Accordingly,
the past performance of the market for such securities may not be an accurate
indication of its performance during future economic downturns or periods of
rising interest rates. When economic conditions appear to be deteriorating,
medium- to lower-rated securities may decline in value due to heightened concern
over credit quality, regardless of the prevailing interest rates. Investors
should carefully consider the relative risks of investing in high yield
securities and understand that such securities are not generally meant for
short-term investing.
Adverse economic developments can disrupt the market for lower-rated
securities, and severely affect the ability of issuers, especially highly
leveraged issuers, to service their debt obligations or to repay their
obligations upon maturity which may lead to a higher incidence of default on
such securities. In addition, the secondary market for lower-rated securities,
which is concentrated in relatively few market makers, may not be as liquid as
the secondary market for more highly rated securities. As a result, a Portfolio
could find it more difficult to sell these securities or may be able to sell the
securities only at prices lower than if such securities were widely traded.
Therefore, prices realized upon the sale of such lower rated or unrated
securities,
-7-
<PAGE>
under these circumstances, may be less than the prices used in calculating a
Portfolio's net asset value.
Lower-rated or unrated debt obligations also present risks based on
payment expectations. If an issuer calls an obligation for redemption, the
Portfolio may have to replace the security with a lower yielding security,
resulting in a decreased return for investors. If a Portfolio experiences
unexpected net redemptions, it may be forced to sell its higher-rated
securities, resulting in a decline in the overall credit quality of the
Portfolio's investment portfolio and increasing the exposure of the Portfolio to
the risks of lower-rated securities.
RESTRICTED SECURITIES
Restricted securities may be sold only (1) pursuant to SEC Rule 144A or
other exemption, (2) in privately negotiated transactions or (3) in public
offerings with respect to which a registration statement is in effect under the
Securities Act of 1933, as amended. Rule 144A securities, although not
registered in the U.S., may be sold to qualified institutional buyers in
accordance with Rule 144A under the Securities Act of 1933, as amended. Each
Portfolio's Adviser, acting pursuant to guidelines established by its Board of
Directors, may determine that some Rule 144A securities are liquid for purposes
of limitations on the amount of illiquid investments a Portfolio may own. Where
registration is required, a Portfolio may be obligated to pay all or part of the
registration expenses and a considerable period may elapse between the time of
the decision to sell and the time the Portfolio may be permitted to sell a
security under an effective registration statement. If, during such a period,
adverse market conditions were to develop, the Portfolio might obtain a less
favorable price than prevailed when it decided to sell.
BORROWINGS
The 1940 Act requires a Portfolio to maintain continuous asset coverage
(that is, total assets including borrowings, less liabilities exclusive of
borrowings) of at least 300% of the amount borrowed. If the asset coverage
should decline below 300% as a result of market fluctuations or for other
reasons, a Portfolio may be required to sell some of its holdings within three
days to reduce the debt and restore the 300% asset coverage, even though it may
be disadvantageous from an investment standpoint to sell securities at that
time. Borrowing may increase the effect on net asset value of any increase or
decrease in the market value of the Portfolio.
Money borrowed will be subject to interest costs which may or may not
be recovered by appreciation of the securities purchased. A Portfolio also may
be required to maintain minimum average balances in connection with such
borrowing or to pay a commitment or other fee to maintain a line of credit;
either of these requirements would increase the cost of borrowing over the
stated interest rate. The Portfolios may enter into reverse repurchase
agreements and dollar roll transactions as a method of borrowing.
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<PAGE>
OPTIONS ON SECURITIES
A Portfolio may purchase call options on securities for any purpose.
For example, a call option may be purchased by a Portfolio on a security that
its Adviser intends to include in the Portfolio's investment portfolio in order
to fix the cost of a future purchase. Call options also may be used as a means
of participating in an anticipated price increase of a security on a more
limited risk basis than would be possible if the security itself were purchased.
In the event of a decline in the price of the underlying security, use of this
strategy would serve to limit the Portfolio's potential loss to the option
premium paid; conversely, if the market price of the underlying security
increases above the exercise price and the Portfolio either sells or exercises
the option, any profit realized would be reduced by the premium.
A Portfolio may purchase put options on securities for any purpose. For
example, a put option may be purchased by a Portfolio in order to hedge against
a decline in the market value of securities held in its portfolio. The put
option enables a Portfolio to sell the underlying security at the predetermined
exercise price; thus the potential for loss to the Portfolio below the exercise
price is limited to the option premium paid. If the market price of the
underlying security is higher than the exercise price of the put option, any
profit the Portfolio realizes on the sale of the security would be reduced by
the premium paid for the put option less any amount for which the put option may
be sold.
A Portfolio may also write call and put options.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
Each Portfolio will limit its use of futures contracts and futures
options to hedging transactions or other circumstances permitted to registered
investment companies by regulatory authorities. For example, a Portfolio might
use futures contracts to attempt to hedge against anticipated changes in
interest rates that might adversely affect either the value of the Portfolio's
securities or the price of the securities which the Portfolio intends to
purchase. A Portfolio's hedging may include sales of futures contracts as an
offset against the effect of expected increases in interest rates, and purchases
of futures contracts as an offset against the effect of expected declines in
interest rates. Although other techniques could be used to reduce exposure to
interest rate fluctuations, a Portfolio may be able to hedge its exposure more
effectively and perhaps at a lower cost by using futures contracts and options
on futures contracts.
A futures contract on a security or foreign currency is a bilateral
agreement pursuant to which one party agrees to make, and the other party agrees
to accept, delivery of the specified type of security or foreign currency called
for in the contract at a specified future time and at a specified price. A
Portfolio may, for example, purchase a futures contract on a security or foreign
currency when it intends to purchase securities or foreign currency but has not
yet done so. This strategy may minimize the effect of all or part of an increase
in the market price of the security or the relative value of the foreign
currency that a Portfolio intends to purchase in the future. A rise
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<PAGE>
in the price of the security or foreign currency prior to its purchase may
either be offset by an increase in the value of the futures contract purchased
by a Portfolio or avoided by taking delivery of the security or foreign currency
under the futures contract. Conversely, a fall in the market price of the
underlying security or foreign currency may result in a corresponding decrease
in the value of the futures position. A Portfolio may sell a futures contract on
a security or foreign currency, for example, in order to continue to receive the
income from a security or foreign currency, while endeavoring to avoid part or
all of the decline in the market value of that security that would accompany an
increase in interest rates.
A Portfolio may also purchase a call option on a futures contract to
hedge against a market advance in securities or foreign currency which the
Portfolio plans to acquire at a future date. The purchase of a call option on a
futures contract is analogous to the purchase of a call option on an individual
security or foreign currency which can be used as a temporary substitute for a
position in the security itself. A Portfolio also may write covered call options
on futures contracts as a partial hedge against a decline in the price of
securities or foreign currency held in the Portfolio's investment portfolio, or
purchase put options on futures contracts in order to hedge against a decline in
the value of securities or foreign currency held in the Portfolio's investment
portfolio. A Portfolio may write a covered put option as a partial anticipatory
hedge.
When a purchase or sale of a futures contract is made by a Portfolio,
the Portfolio is required to deposit with its custodian (or a broker, if legally
permitted) a specified amount of cash or U.S. Government securities ("initial
margin"). The margin required for a futures contract is set by the exchange on
which the contract is traded and may be modified during the term of the
contract. The initial margin is in the nature of a performance bond or good
faith deposit on the futures contract which is returned to the Portfolio upon
termination of the contract, assuming all contractual obligations have been
satisfied. Under certain circumstances, such as during periods of high
volatility, a Portfolio may be required by an exchange to increase the level of
its initial margin payment. Additionally, initial margin requirements may be
increased generally in the future by regulatory action. Each Portfolio expects
to earn interest income on its initial margin deposits. A futures contract held
by a Portfolio is valued daily at the official settlement price of the exchange
on which it is traded. Each day the Portfolio pays or receives cash, called
"variation margin," equal to the daily change in value of the futures contract.
This process is known as "marking to market." Variation margin does not
represent a borrowing or loan by a Portfolio but is instead settlement between
the Portfolio and the broker of the amount one would owe the other if the
futures contract expired. In computing daily net asset value, each Portfolio
will mark to market its open futures positions.
A Portfolio is also required to deposit and maintain margin with
respect to put and call options on futures contracts written by it. Such margin
deposits will vary depending on the nature of the underlying futures contract
(and the related initial margin requirements) and the current market value of
the option and other futures positions held by the Portfolio.
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<PAGE>
Although some futures contracts call for making or taking delivery of
the underlying securities or currencies, generally those contracts are closed
out prior to delivery by offsetting purchases or sales of matching futures
contracts (involving the same currency or underlying security and delivery
month). If an offsetting purchase price is less than the original sale price,
the Portfolio realizes a gain, or if it is more, the Portfolio realizes a loss.
If an offsetting sale price is more than the original purchase price, the
Portfolio realizes a gain, or if it is less, the Portfolio realizes a loss. The
Portfolio will also bear transaction costs for each contract which will be
included in these calculations.
A Portfolio will not enter into futures contracts or option positions
if, immediately thereafter, the initial margin deposits plus premiums paid by
it, less the amount by which any such options positions are "in-the-money" at
the time of purchase, would exceed 5% of the fair market value of the
Portfolio's total assets. A call option is "in-the-money" if the value of the
futures contract that is the subject of the option exceeds the exercise price. A
put option is "in-the-money" if the exercise price exceeds the value of the
futures contract that is the subject of the option.
The requirements for qualification as a regulated investment company
also may limit the extent to which a Portfolio may enter into futures or options
on futures. See "Additional Tax Information."
RISKS ASSOCIATED WITH FUTURES AND OPTIONS
In considering the Portfolios' use of futures contracts and options,
particular note should be taken of the following:
(1) Positions in futures contracts and options may be closed out only
on an exchange or board of trade which provides a secondary market for such
futures contracts or options. Futures exchanges may limit the amount of
fluctuation permitted in certain futures contract and option prices during a
single trading day. The daily limit establishes the maximum amount that the
price of a futures contract or option may vary either up or down from the
previous day's settlement price at the end of the current trading session. Once
the daily limit has been reached in a futures contract or option subject to the
limit, no more trades may be made on that day at a price beyond that limit. The
daily limit governs only price movements during a particular trading day and
therefore does not limit potential losses because the limit may work to prevent
the liquidation of unfavorable positions. For example, futures prices have
occasionally moved to the daily limit for several consecutive trading days with
little or no trading, thereby preventing prompt liquidation of positions and
subjecting some holders of futures contracts to substantial losses.
(2) The ability to establish and close out positions in either futures
contracts or exchange-listed options is also subject to the maintenance of a
liquid secondary market. Consequently, it may not be possible for a Portfolio to
close a position and, in the event of adverse price movements, the Portfolio
would have to make daily cash payments of variation
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<PAGE>
margin (except in the case of purchased options). However, in the event futures
contracts or options have been used to hedge portfolio securities, such
securities generally will not be sold until the contracts 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, there is
no guarantee that the price of the securities will, in fact, correlate with the
price movements in the contracts and thus provide an offset to losses on the
contracts. The inability to close out a futures or option position may also
restrict the Portfolio's ability to sell the underlying security or currency at
a time when the Adviser might otherwise do so.
(3) Successful use by a Portfolio of futures contracts and options will
depend upon its Adviser's ability to predict market movements, which may require
different skills and techniques than predicting changes in the prices of
individual securities. Moreover, futures contracts relate not to the current
level of the underlying instrument but to anticipated levels at some point in
the future. There is, in addition, the risk that movements in the price of the
futures contract or option will not correlate with movements in the prices of
the securities or currencies being hedged. If the price of the securities or
currencies being hedged has moved in a favorable direction, this advantage may
be partially offset by losses in the futures or option position. In addition, if
the Portfolio has insufficient cash, it may have to sell assets from its
investment portfolio to meet daily variation margin requirements. Any such sale
of assets may or may not be made at prices that reflect the rising market;
consequently, a Portfolio may need to sell assets at a time when such sales are
disadvantageous to the Portfolio. If the price of the futures or option contract
moves more than the price of the underlying securities or currencies, the
Portfolio will experience either a loss or a gain on the futures contract or
option that may or may not be completely offset by movements in the price of the
securities or currencies that are the subject of the hedge.
(4) The value of an option position will reflect, among other things,
the current market price of the underlying security, currency or futures
contract, the time remaining until expiration, the relationship of the exercise
price to the market price, the historical price volatility of the underlying
security, currency or futures contract and general market conditions. For this
reason, the successful use of options as a hedging strategy depends upon the
Adviser's ability to forecast the direction of price fluctuations in the
underlying market.
(5) In addition to the possibility that there may be an imperfect
correlation, or no correlation at all, between price movements in the futures
and options position and the securities or currencies being hedged, movements in
the prices of futures and options contracts may not correlate perfectly with
movements in the prices of the hedged securities or currencies due to price
distortions in the futures and options markets. There may be several reasons
unrelated to the value of the underlying securities or currencies which cause
this situation to occur. First, as noted above, all participants in the futures
market are subject to initial and variation margin requirements. If, to avoid
meeting additional margin deposit requirements or for other reasons, investors
choose to close a significant number of futures contracts through offsetting
transactions, distortions in the normal price relationship between the
securities or currencies and the futures markets may occur. Second, because the
margin deposit requirements in the futures market are
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<PAGE>
less onerous than margin requirements in the securities market, there may be
increased participation by speculators in the futures market; such speculative
activity in the futures market also may cause temporary price distortions.
Third, participants could make or take delivery of the underlying securities or
currencies instead of closing out their contracts. As a result, a correct
forecast of general market trends may not result in successful hedging through
the use of futures or options contracts over the short term. In addition,
activities of large traders involving arbitrage and other investment strategies
may result in temporary price distortions.
(6) Options normally have expiration dates of up to nine months. The
exercise price of the options may be below, equal to or above the current market
value of the underlying security, currency or futures contract. Options that
expire unexercised have no value, and the Portfolio will realize a loss in the
amount paid and any transaction costs.
(7) Like options on securities, options on futures contracts have a
limited life. The ability to establish and close out options on futures will be
subject to the development and maintenance of liquid secondary markets on the
relevant exchanges or boards of trade. There can be no certainty that liquid
secondary markets for all options on futures contracts will develop.
(8) Purchasers of options on futures contracts pay a premium in cash at
the time of purchase. This amount and the transaction costs are all that is at
risk. Sellers of options on futures contracts, however, must post an initial
margin and are subject to additional margin calls which could be substantial in
the event of adverse price movements. In addition, although the maximum amount
at risk when the Portfolio purchases an option is the premium paid for the
option and the transaction costs, there may be circumstances when the purchase
of an option on a futures contract would result in a loss to the Portfolio when
the use of a futures contract would not, such as when there is no movement in
the value of the securities or currencies being hedged.
(9) A Portfolio's activities in the futures and options markets may
result in a higher portfolio turnover rate and additional transaction costs in
the form of added brokerage commissions; however, a Portfolio also may save on
commissions by using such contracts as a hedge rather than buying or selling
individual securities in anticipation or as a result of market movements.
(10) A Portfolio may purchase and write both exchange-traded options
and options traded on the OTC market. Exchange markets for options on debt
securities exist but are relatively new, and the ability to establish and close
out positions on the exchanges is subject to the maintenance of a liquid
secondary market. Although the Portfolios intend to purchase or write only those
exchange-traded options for which there appears to be an active secondary
market, there is no assurance that a liquid secondary market will exist for any
particular option at any specific time. Closing transactions may be effected
with respect to options traded in the OTC markets only by negotiating directly
with the other party to the option contract, or in a secondary market for the
option if such market exists. Although the Portfolios will enter into OTC
options only with dealers which agree to enter into, and which are expected to
be capable of entering into,
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<PAGE>
closing transactions with the Portfolios, there can be no assurance that a
Portfolio will be able to liquidate an OTC option at a favorable price at any
time prior to expiration. In the event of insolvency of the contra-party, a
Portfolio may be unable to liquidate an OTC option. Accordingly, it may not be
possible to effect closing transactions with respect to certain options, with
the result that the Portfolio would have to exercise those options which it has
purchased in order to realize any profit. With respect to options written by a
Portfolio, the inability to enter into a closing transaction may result in
material losses to the Portfolio. For example, because a Portfolio must maintain
a covered position with respect to any call option it writes on a security or
futures contract the Portfolio may not sell the underlying security or futures
contract or invest any cash, U.S. Government securities or short-term debt
securities used as cover during the period it is obligated under such option.
This requirement may impair a Portfolio's ability to sell a portfolio security
or make an investment at a time when such a sale or investment might be
advantageous.
ADDITIONAL RISKS OF OPTIONS ON SECURITIES, FUTURES CONTRACTS AND OPTIONS ON
FUTURES CONTRACTS TRADED ON FOREIGN EXCHANGES
Options on securities, options on currencies, futures contracts and
options on futures contracts may be traded on foreign exchanges. Such
transactions may not be regulated as effectively as similar transactions in the
United States, may not involve a clearing mechanism and related guarantees and
are subject to the risk of governmental actions affecting trading in, or the
price of, foreign securities. The value of such positions also could be
adversely affected by (1) other complex foreign political, legal and economic
factors, (2) lesser availability than in the United States of data on which to
make trading decisions, (3) delays in the Portfolios' ability to act upon
economic events occurring in foreign markets during non-business hours in the
United States, (4) the imposition of different exercise and settlement terms and
procedures and margin requirements than in the United States and (5) lesser
trading volume.
COVER FOR HEDGING STRATEGIES
Each Portfolio will comply with guidelines established by the SEC with
respect to coverage of hedging strategies by mutual funds, and, if the
guidelines so require, will set aside cash or liquid securities in a segregated
account with its custodian in the amount prescribed, as marked to market daily.
Securities, options or futures positions used for cover and securities held in a
segregated account cannot be sold or closed out while the hedging strategy is
outstanding, unless they are replaced with similar assets. As a result, there is
a possibility that the use of cover or segregation involving a large percentage
of a Portfolio's assets could impede portfolio management or a Portfolio's
ability to meet redemption requests or other current obligations.
DURATION
Traditionally, a fixed income security's term to maturity was used to
evaluate the sensitivity of the security's price to changes in interest rates.
Duration is a measure of the
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expected life of a fixed income security on a cash flow basis, that was
developed as a more precise method of evaluating such sensitivity. A security's
term to maturity measures only the time until final payment of the security, and
does not take into account the pattern of payments made prior to maturity.
Duration takes time intervals over which the interest and principal payments are
scheduled and weights each by the present values of the cash to be received at
the corresponding future point in time.
There may be circumstances under which even duration calculations do
not properly reflect the interest rate exposure of a security. For example,
floating variable rate securities may have final maturities of ten or more
years; however, their interest exposure corresponds to the frequency of the
coupon reset. Similarly, many mortgage pass-through securities may have stated
final maturities of 30 years, but current prepayment rates are more critical in
determining the security's interest rate exposure. In these situations, the
Adviser may consider other analytical techniques that incorporate the economic
life of a security into its determination of interest rate exposure.
VALUATION OF PORTFOLIO SHARES
As described in the Prospectus, securities owned by any of the
Portfolios (other than the Money Market Portfolios) for which market quotations
are readily available are valued at current market value. Securities are valued
at the last sale price for a comparable position on the day the securities are
being valued or, lacking any sales on such day, at the last available bid price.
In cases where securities are traded on more than one market, the securities are
generally valued on the market considered by the Adviser as the primary market.
Occasionally, events affecting the value of foreign investments occur
between the time at which they are determined and the close of trading on the
Exchange, which events will not be reflected in a computation of a Portfolio's
net asset value on that day. If events materially affecting the value of such
investments occur during such time period, the investments will be valued at
their fair value as determined in good faith by, or under the direction of, the
Board of Directors.
USE OF THE AMORTIZED COST METHOD BY THE MONEY MARKET PORTFOLIOS
The Board of Directors of the Money Market Portfolios has decided that
the best method for determining the value of securities held by the Money Market
Portfolios is amortized cost. Under this method, portfolio instruments are
valued at acquisition cost as adjusted for amortization of premium or accrual of
discount rather than at current market value. The Board of Directors continually
assesses this method of valuation and recommends changes where necessary to
assure that the Money Market Portfolios' investments are valued at their fair
value as determined in good faith by, or under the direction of, the Directors.
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<PAGE>
The Money Market Portfolios' use of the amortized cost method of
valuing portfolio instruments held by it depends on its compliance with Rule
2a-7 under the 1940 Act. Under that Rule, the Board of Directors must establish
procedures reasonably designed to stabilize the net asset value per share at
$1.00 per share, taking into account current market conditions and the
Portfolio's investment objective.
MONITORING PROCEDURES
The Board of Directors' procedures include monitoring the relationship
between the amortized cost value per share and a net asset value per share based
upon available indications of market value. The Board will take any steps it
considers appropriate if there is a difference of more than 0.5% between the two
(such as redeeming in kind or shortening the average portfolio maturity) to
minimize any material dilution or other unfair results arising from differences
between the two methods of determining net asset value.
INVESTMENT RESTRICTIONS
Rule 2a-7 requires each Money Market Portfolio to limit its investments
to instruments that present minimal credit risk, in the opinion of the Board,
and are of high quality. The Rule also requires each Money Market Portfolio to
maintain a dollar-weighted average portfolio maturity of not more than 90 days
that is appropriate to the objective of maintaining a stable net asset value of
$1.00 per share. In addition, no instrument considered under SEC rules to have a
remaining maturity of more than 397 days can be purchased by the Money Market
Portfolios. The Money Market Portfolios may hold securities with maturities
greater than 397 days as collateral for repurchase agreements and other
collateralized transactions of short duration. Should the disposition of a
portfolio security result in a dollar-weighted average portfolio maturity of
more than 90 days, the relevant Money Market Portfolio will invest its available
cash to reduce the average maturity to 90 days or less as soon as possible.
In periods of declining interest rates, the indicated daily yield on
shares of each Money Market Portfolio computed by dividing the annualized daily
income on the portfolio by the net asset value computed as above may tend to be
higher than a similar computation made by using a method of valuation based upon
market prices and estimates. In periods of rising interest rates, the indicated
daily yield on shares of each Money Market Portfolio computed the same way may
tend to be lower than a similar computation made by using a method of
calculation based upon market prices and estimates.
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<PAGE>
MANAGEMENT OF THE PORTFOLIOS
DIRECTORS AND OFFICERS
Each Fund's officers are responsible for the operation of each Fund
under the direction of its Board of Directors. The officers and Directors of
each Fund and their principal occupations during the past five years are set
forth below. An asterisk (*) indicates Interested Directors.
DIRECTORS AND OFFICERS; LM INSTITUTIONAL FUND ADVISORS I, INC.
The address of each officer and Director of LM Institutional Fund
Advisors I, Inc. is 117 East Colorado Blvd., Pasadena, CA 91105, unless
otherwise stated.
William G. McGagh, 67(1,2,3), Chairman of the Board and Director;
Consultant, McGagh Associates (corporate financial consulting), January
1989-present; Director of Pacific American Income Shares, Inc.; formerly: Senior
Vice-President, Chief Financial Officer and Director of Northrop Corporation
(military aircraft).
Dr. Richard C. Gilman, 73(1,2,3), Director; President Emeritus of
Occidental College, 1988-present; Director of Pacific American Income Shares,
Inc.; formerly: President and Chief Executive Officer of Occidental College.
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(1) Member of the Executive Committee of the Board. When the full Board
is not in session, the Executive Committee may exercise all the powers held by
the Board in the management of the business and affairs of the Fund that may be
lawfully exercised by the full Board, except the power to declare a dividend, to
authorize the issuance of stock, to recommend to stockholders any matter
requiring stockholders' approval, to amend the By-Laws, or to approve any merger
or share exchange which does not require shareholder approval.
(2) Member of the Audit Committee of the Board. The Audit Committee
meets with the Fund's independent accountants to review the financial statements
of the Fund, the arrangements for special and annual audits, the adequacy of
internal controls, the Fund's periodic reporting process, material contracts
entered into by the Fund, the services provided by the accountants, any proposed
changes in accounting practices or principles, the independence of the
accountants; and to report on such matters to the Board.
The Fund has no compensation committee.
(3) Member of the Nominating Committee of the Board. The Nominating
Committee is responsible for the selection and nomination of Disinterested
Directors.
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<PAGE>
*W. Curtis Livingston, III, 53(1), President and Director; President,
Director and Chief Executive Officer of Western Asset (investment management
firm), December 1980-present; President, Pacific American Income Shares, Inc.
*Ronald L. Olson, 55(2,4), Director; Senior Partner, Munger, Tolles &
Olson (a law partnership); Director of Pacific American Income Shares, Inc.
*Louis A. Simpson, 59(5), Director; President and CEO Capital
Operations of Government Employees Insurance Company (GEICO Corporation) since
May 1993; Vice Chairman of GEICO (1985-1993); Senior Vice President and Chief
Investment Officer of GEICO (1979-1985). Director of Pacific American Income
Shares, Inc., Potomac Electric Power Company, Potomac Capital Investment
Corporation, and Salomon Inc. Formerly: President and CEO of Western Asset.
Ronald J. Arnault; 54, Director; President of RJA Consultants (energy
industry financial consulting); member, Board of Governors of The Music Center
of Los Angeles and the Center Theatre Group. Formerly: Executive Vice President,
Chief Financial Officer and Director of ARCO; Director of Pacific American
Income Shares, Inc.
William E. B. Siart, 50, Director; Director of Pacific American Income
Shares, Inc. Formerly: Chairman (1995-1996), Chief Executive Officer
(1995-1996), President (1990-1996) of First Interstate Bancorp. Member of the
Board of Trustees of the University of Southern California.
Donna E. Barnes, 36, Secretary; Secretary, Pacific American Income
Shares, Inc., since April 1996; Compliance Officer of Western Asset, 1991 -
present. Formerly: Assistant Secretary of the Fund and Pacific American Income
Shares, Inc., 1993-1996.
Carl L. Eichstaedt, 36, Vice-President; Portfolio Manager of Western
Asset since 1994; formerly: Senior Partner, Portfolio Manager of Harris
Investment Management, 1993-1994; Portfolio Manager of Pacific Investment
Management Company, 1992-1993; Director Fixed Income of Security Pacific
Investment Managers, 1990-1992; and Vice President of Chemical Securities, Inc.,
1986-1990.
Kent S. Engel, 49, Vice-President; Director and Chief Investment
Officer of Western Asset, 1969-present; Vice-President and Portfolio Manager of
Pacific American Income Shares, Inc.
Keith J. Gardner, 39, Vice-President; Portfolio Manager of Western
Asset since 1994; formerly: Senior Portfolio Manager of Legg Mason, Inc.,
1992-1994; Portfolio Manager of T. Rowe Price Associates, Inc., 1985-1992.
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(4) Mr. Olson may be deemed an interested person because the law firm
in which he is a partner has provided certain services to the Fund and Western
Asset.
(5) Because Mr. Simpson is a Director of Salomon Inc., the parent
company of a registered broker-dealer, Mr. Simpson may be an interested person.
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<PAGE>
Scott F. Grannis, 47, Vice-President; Director and Economist, Western
Asset, 1989-present; Director, Supershares Services Corp. (investment company
services); formerly: Vice-President, Leland O'Brien Rubinstein (investment
advisory firm), 1986-89.
Ilene S. Harker, 41, Vice-President; Director of Administration and
Controls, Western Asset, 1978-present; Vice President, Pacific American Income
Shares, Inc., since April 1996; Formerly: Assistant Secretary of the Fund and
Secretary of Pacific American Income Shares, Inc., 1993-1996.
James W. Hirschmann, III, 36, Vice-President; Director of Marketing,
Western Asset, April 1989-present; formerly: Vice-President and Director of
Marketing, Financial Trust Corporation (bank holding company), January 1988 -
April 1989; Vice-President of Marketing, Atalanta/Sosnoff Capital (investment
management company), January 1986-January 1988.
Marie K. Karpinski, 47, Vice-President and Treasurer; Vice-President
and Treasurer of fifteen Legg Mason funds (open-end investment companies);
Assistant Treasurer of Pacific American Income Shares, Inc. (closed-end
investment company); Treasurer of LMFA, March 1986-present; Vice-President of
Legg Mason, February 1992-present; Assistant Vice-President of Legg Mason, March
1989- February 1992.
Randolph L. Kohn, 49, Vice-President; Director of Client Services,
Western Asset, 1984-present.
S. Kenneth Leech, 42, Vice-President; Director of Portfolio Management,
Western Asset, May 1990-present; formerly: Senior Trader of Greenwich Capital,
1988-1990; Fixed Income Manager of The First Boston Corporation (holding
company; stock and bond dealers), 1985-1987.
Edward A. Moody, 46, Vice-President; Director and Portfolio Manager,
Western Asset.
Joseph L. Orlando, 36, Vice-President; Marketing Executive of Western
Asset; formerly: Regional Manager of T. Rowe Price Associates (investment
management firm), January 1988-July 1992.
Steven T. Saruwatari, 31, Assistant Treasurer; Senior Financial
Officer, Western Asset; formerly: Controller-Finance for LaSalle Paper
Company/Spicers Paper, Inc. (distributor of fine printing papers), June
1991-November 1994; and Senior Auditor for Coopers and Lybrand (international
public accounting firm), September 1988-May 1991.
Stephen A. Walsh, 37, Vice-President; Director and Portfolio Manager,
Western Asset; formerly: Portfolio Manager and Trader of Security Pacific
Investment Managers, Inc. (investment management company), 1989-1991.
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<PAGE>
Officers and Directors of the Fund who are affiliated persons of the
Manager, Western Asset, LMFA or Legg Mason receive no salary or fees from the
Fund. Each Independent Director of the Fund receives a fee of $2,000 annually
for serving as a Director, and a fee of $500 and related expenses per Portfolio
for each meeting of the Board of Directors attended by them. The Chairman of the
Board receives an additional $1,000 per year for serving in that capacity.
The following table provides certain information relating to the
compensation of the Fund's Directors and senior executive officers for the
fiscal year ended June 30, 1997.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
Aggregate Compensation
Total Compensation From the Fund and Complex
Name of Person and Position From the Fund* Paid to Directors**
- --------------------------------------------------------------------------------------------------------
<S><C>
William G. McGagh - $12,000 $20,400
Chairman of the Board and Director
- --------------------------------------------------------------------------------------------------------
Dr. Richard C. Gilman - Director $10,500 $18,500
- --------------------------------------------------------------------------------------------------------
Ronald L. Olson - Director $10,500 $18,600
- --------------------------------------------------------------------------------------------------------
W. Curtis Livingston, III - President none none
and Director
- --------------------------------------------------------------------------------------------------------
Norman Barker, Jr. - Director $10,000 $20,400
- --------------------------------------------------------------------------------------------------------
Louis A. Simpson - Director $10,500 $18,600
- --------------------------------------------------------------------------------------------------------
William E. B. Siart - Director*** $500 $500
- --------------------------------------------------------------------------------------------------------
Ronald J. Arnault - Director*** $0 $0
- --------------------------------------------------------------------------------------------------------
Ilene S. Harker - Vice President none none
- --------------------------------------------------------------------------------------------------------
Marie K. Karpinski - Vice President none none
and Treasurer
- --------------------------------------------------------------------------------------------------------
*Represents fees paid to each person during the fiscal year ended June 30, 1997.
**Represents aggregate compensation paid to each person during the calendar year
ended December 31, 1996. The complex consists of the Fund and Pacific American
Income Shares, Inc.
- --------------------------------------------------------------------------------------------------------
</TABLE>
DIRECTORS AND OFFICERS; LM INSTITUTIONAL FUND ADVISORS II, INC.
The business address of each officer and Director is 100 Light Street,
Baltimore, Maryland 21202, unless otherwise indicated.
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<PAGE>
[NAME, [AGE] POSITION; PRINCIPAL OCCUPATION; PARTICIPATION ON COMMITTEES]
Officers and Directors of the Fund who are affiliated persons of the
Manager, the Advisers, LMFA or Legg Mason, receive no salary or fees from the
Fund. Each Independent Director receives an annual retainer and a per meeting
fee [describe compensation]:
The following table provides certain information relating to the
compensation of the Fund's Directors and senior executive officers.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
Name of Person and Position Total Compensation From Aggregate Compensation
the Fund* From the Fund and Complex
Paid to Directors**
- --------------------------------------------------------------------------------------------------------
<S><C>
- --------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
*Represents fees expected to be paid to each person during the fiscal year ended
March 31, 1998.
**Represents aggregate compensation paid to each person during the calendar year
ended December 31, 1997. There are ten open-end investment companies in the Legg
Mason Complex (with a total of __________ funds).
- --------------------------------------------------------------------------------------------------------
</TABLE>
MANAGER AND ADVISERS
THE MANAGER. The Manager serves as investment manager to the Funds
under separate Investment Management Agreements dated _________, 1998 between
the Manager and each Fund (collectively, the "Management Agreement"). The
Management Agreement was most recently approved by each Board of Directors,
including a majority of Independent Directors, on _________, 1998.
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<PAGE>
Under the Management Agreement, the Manager is responsible, subject to
the general supervision of the Fund's Board of Directors, for the actual
management of the Fund's assets, including the responsibility for making
decisions and placing orders to buy, sell or hold a particular security,
consistent with the investment objectives and policies described in the
Prospectus and this Statement of Additional Information. The Manager also is
responsible for the compensation of Directors and officers of the Fund who are
employees of the Manager or its affiliates. The Manager receives for its
services a fee as described in the Prospectus. As noted below, the Manager has
delegated responsibility for the selection of the Funds' investments to the
Advisers.
Each Portfolio pays all of its other expenses which are not assumed by
the Manager or the Administrator. These expenses include, among others, expenses
of preparing and printing prospectuses, statements of additional information,
proxy statements and reports and of distributing them to existing shareholders,
custodian charges, transfer agency fees, organizational expenses, compensation
of the Directors who are not "interested persons" of the Manager, or its
affiliates, as that term is defined in the 1940 Act, legal and audit expenses,
insurance expenses, expenses of registering and qualifying shares of the
Portfolios for sale under federal and state law, Rule 12b-1 fees, governmental
fees, expenses incurred in connection with membership in investment company
organizations, interest expense, taxes and brokerage fees and commissions. The
Portfolios also are liable for such nonrecurring expenses as may arise,
including litigation to which a Portfolio or the Fund may be a party. The Fund
may also have an obligation to indemnify its Directors and officers with respect
to litigation.
Under the Management Agreement, the Manager will not be liable for any
error of judgment or mistake of law or for any loss suffered by the Portfolios
in connection with the performance of the Management Agreement, except a loss
resulting from a breach of fiduciary duty with respect to the receipt of
compensation for services or a loss resulting from willful misfeasance, bad
faith or gross negligence on its part in the performance of its duties or from
reckless disregard by it of its obligations or duties thereunder.
The Management Agreement terminates automatically upon assignment and
is terminable with respect to any Portfolio at any time without penalty by vote
of the Fund's Board of Directors, by vote of a majority of that Portfolio's
outstanding voting securities, or by the Manager, on not less than 60 days'
notice to the relevant Fund, and may be terminated immediately upon the mutual
written consent of the Manager and the relevant Fund.
-22-
<PAGE>
ADVISERS
WESTERN ASSET. Western Asset serves as Adviser to the Western Asset
Enhanced Equity Portfolio, the Western Asset Money Market Portfolio, the Western
Asset Government Money Market Portfolio, the Western Asset Limited Duration
Portfolio, the Western Asset Intermediate Portfolio, the Western Asset Core
Portfolio, the Western Asset High Yield Portfolio, and the fixed income portion
of the Legg Mason Fund Adviser/Western Asset Balanced Portfolio under an
Investment Advisory Agreement dated _________, 1998 between Western Asset and
the Manager (the "Western Asset Advisory Agreement"). The Western Asset Advisory
Agreement was most recently approved by each Board of Directors, including a
majority of the Independent Directors, on _______, 1998.
Under the Western Asset Advisory Agreement, Western Asset is
responsible, subject to the general supervision of each Fund's Board of
Directors and the Manager, for the actual management of the Portfolios' assets,
including the responsibility for making decisions and placing orders to buy,
sell or hold a particular security, consistent with the investment objectives
and policies described in the Prospectus and this Statement of Additional
Information. Western Asset receives from the Manager for its services an
advisory fee as described in the Prospectus.
Under the Western Asset Advisory Agreement, Western will not be liable
for any error of judgment or mistake of law or for any loss suffered by the
Portfolios in connection with the performance of the Western Asset Advisory
Agreement, except a loss resulting from a breach of fiduciary duty with respect
to the receipt of compensation for services or a loss resulting from willful
misfeasance, bad faith or gross negligence on its part in the performance of its
duties or from reckless disregard by it of its obligations or duties thereunder.
The Western Asset Advisory Agreement terminates automatically upon
assignment and is terminable with respect to any Portfolio at any time without
penalty by vote of the relevant Fund's Board of Directors, by vote of a majority
of that Portfolio's outstanding voting securities, or by Western Asset, on not
less than 60 days' notice, and may be terminated immediately upon the mutual
written consent of the parties.
Western Asset served as investment adviser to LM Institutional Fund
Advisors I, Inc. under an Investment Advisory Agreement dated August 24, 1990,
and as amended on February 8, 1996, between Western Asset and the Fund covering
the Western Asset Limited Duration Portfolio and Western Asset Core Portfolio
("Advisory Agreement I"), an Investment Advisory Agreement dated February 10,
1994, and as amended on February 8, 1996, between Western Asset and the LM
Institutional Fund Advisors I, Inc. covering the Western Asset Intermediate
Portfolio ("Advisory Agreement II"), and an Investment Advisory Agreement dated
June 30, 1992, between Western Asset and the LM Institutional Fund Advisors I,
Inc. covering the Western Asset International Securities Portfolio. The rate of
compensation payable to Western Asset under Advisory Agreement I and Advisory
Agreement II was the same as that payable to the Manager with respect to the
relevant Portfolios.
-23-
<PAGE>
For the Western Asset Core Portfolio, Western Asset received $2,006,880
(prior to fees waived of $22,402), $1,548,346 (prior to fees waived of $111,421)
and $963,008 (prior to fees waived of $69,442) for the years ended June 30,
1997, 1996 and 1995, respectively. For the Western Asset Intermediate Portfolio,
Western Asset received $568,685 (prior to fees waived of $158,505), $130,938
(prior to fees waived of $130,938) and $29,571 (prior to fees waived of $29,571)
for the years ended June 30, 1997, 1996 and 1995, respectively. For the Western
Asset Limited Duration Portfolio, Western Asset waived all advisory fees for the
year ended June 30, 1997 and for the period May 1, 1996 (commencement of
operations) to June 30, 1996.
LMFA. LMFA serves as Adviser to the Legg Mason Fund Adviser Large Cap
Value Portfolio, the Legg Mason Fund Adviser Mid Cap Value Portfolio and the
equity portion of the Legg Mason Fund Adviser/Western Asset Balanced Portfolio
under an Investment Advisory Agreement dated _________, 1998 between LMFA and
the Manager (the "LMFA Advisory Agreement"). The LMFA Advisory Agreement was
most recently approved by the Board of Directors, including a majority of the
Independent Directors, on _______, 1998.
Under the LMFA Advisory Agreement, LMFA is responsible, subject to the
general supervision of the Fund's Board of Directors and the Manager, for the
actual management of the Portfolios' assets, including the responsibility for
making decisions and placing orders to buy, sell or hold a particular security,
consistent with the investment objectives and policies described in the
Prospectus and this Statement of Additional Information. LMFA receives from the
Manager for its services an advisory fee as described in the Prospectus.
Under the LMFA Advisory Agreement, LMFA will not be liable for any
error of judgment or mistake of law or for any loss suffered by the Portfolios
in connection with the performance of the LMFA Advisory Agreement, except a loss
resulting from a breach of fiduciary duty with respect to the receipt of
compensation for services or a loss resulting from willful misfeasance, bad
faith or gross negligence on its part in the performance of its duties or from
reckless disregard by it of its obligations or duties thereunder.
The LMFA Advisory Agreement terminates automatically upon assignment
and is terminable with respect to any Portfolio at any time without penalty by
vote of the Fund's Board of Directors, by vote of a majority of that Portfolio's
outstanding voting securities, or by LMFA, on not less than 60 days' notice, and
may be terminated immediately upon the mutual written consent of the parties.
BATTERYMARCH. Batterymarch serves as the Adviser to the Batterymarch
Emerging Markets Portfolio and the Batterymarch International Equity Portfolio
under an Investment Advisory Agreement dated _________, 1998 between
Batterymarch and the Manager (the "Batterymarch Advisory Agreement"). The
Batterymarch Advisory Agreement was most recently approved by the Board of
Directors, including a majority of the Independent Directors, on __________,
1998.
Under the Batterymarch Advisory Agreement, Batterymarch is responsible,
subject to the general supervision of the Fund's Board of Directors and the
Manager, for the actual management of the Portfolios' assets, including the
responsibility for making decisions and placing orders to buy, sell or hold a
particular security, consistent with the investment objectives and policies
described in the Prospectus and this Statement of Additional Information.
Batterymarch also is responsible for the compensation of Directors and officers
of the Fund who are employees of Batterymarch or its affiliates. Batterymarch
receives from the Manager for its services to the Portfolios' an advisory fee as
described in the Prospectus.
Under the Batterymarch Advisory Agreement, Batterymarch will not be
liable for any error of judgment or mistake of law or for any loss suffered by
the Portfolios in connection with the performance of the Batterymarch Advisory
Agreement, except a loss resulting from a breach of fiduciary duty with respect
to the receipt of compensation for services or a loss resulting from
-24-
<PAGE>
willful misfeasance, bad faith or gross negligence on its part in the
performance of its duties or from reckless disregard by it of its obligations or
duties thereunder.
The Batterymarch Advisory Agreement terminates automatically upon
assignment and is terminable with respect to any Portfolio at any time without
penalty by vote of the Fund's Board of Directors, by vote of a majority of that
Portfolio's outstanding voting securities, or by Batterymarch, on not less than
60 days' notice, and may be terminated immediately upon the mutual written
consent of the parties.
WAGM. WAGM serves as Adviser to the Western Asset Non-U.S. Fixed Income
Portfolio, under an Investment Advisory Agreement dated ___________, 1998,
between the Manager and WAGM (the "WAGM Advisory Agreement"). The WAGM Advisory
Agreement was most recently approved by the Board of Directors, including a
majority of the Independent Directors, on __________, 1998.
Under the WAGM Advisory Agreement, WAGM is responsible, subject to the
general supervision of the Fund's Board of Directors and the Manager, for the
actual management of the Portfolio's assets, including the responsibility for
making decisions and placing orders to buy, sell or hold a particular security,
consistent with the investment objective and policies described in the
Prospectus and this Statement of Additional Information. WAGM also is
responsible for the compensation of Directors and officers of the Fund who are
employees of WAGM or its affiliates. WAGM receives from the Manager for its
services to the Portfolio an advisory fee as described in the Prospectus.
Under the WAGM Advisory Agreement, WAGM will not be liable for any
error of judgment or mistake of law or for any loss suffered by the Portfolio in
connection with the performance of the WAGM Advisory Agreement, except a loss
resulting from a breach of fiduciary duty with respect to the receipt of
compensation for services or a loss resulting from willful misfeasance, bad
faith or gross negligence on its part in the performance of its duties or from
reckless disregard by it of its obligations or duties thereunder.
The WAGM Advisory Agreement terminates automatically upon assignment
and is terminable at any time without penalty by vote of the Fund's Board of
Directors, by vote of a majority of the Portfolio's outstanding voting
securities, or by WAGM, on not less than 60 days' notice, and may be terminated
immediately upon the mutual written consent of the parties.
ADMINISTRATOR
LMFA serves as the administrator for the Funds under an Administration
Agreement with LM Institutional Fund Adviser Portfolios I, Inc. dated August 24,
1990 covering the Western Asset Core Portfolio and the Western Asset Limited
Duration Portfolio, an Administration Agreement with LM Institutional Fund
Adviser Portfolios I, Inc. dated February 10, 1994 covering the Western Asset
Intermediate Portfolio, an Administration Agreement with LM
-25-
<PAGE>
Institutional Fund Adviser Portfolios I, Inc. dated June 30, 1992 covering the
Western Asset International Securities Portfolio, and an Administration
Agreement with each Fund dated ___________, 1998 covering the other Portfolios
(together, the "Administration Agreement").
Under the Administration Agreement, the Administrator is obligated to
provide each Fund with office space and certain officers, to oversee accounting
and recordkeeping services provided by a Fund's custodian and transfer and
dividend-disbursing agent, and to provide certain shareholder services not
provided by a Fund's transfer and dividend-disbursing agent.
For the Western Asset Core Portfolio and Western Asset Limited Duration
Portfolio, the Administrator receives for its services to the Fund an
administrative fee, calculated daily and payable monthly, at an annual rate
equal to 0.10% of each Portfolio's average daily net assets. Effective July 1,
1991, the Administrator voluntarily agreed to limit its annual fee to 0.05% of
each Portfolio's average daily net assets. This agreement is voluntary and may
be terminated at any time. For services to the Portfolios, the Administrator
receives a fee, calculated daily and payable monthly, at an annual rate equal to
0.05% of the Portfolio's average daily net assets.
For the Western Asset Core Portfolio, the Administrator received fees
of $250,860, $193,547 and $120,376 for the years ended June 30, 1997, 1996 and
1995, respectively. For the Western Asset Intermediate Portfolio, the
Administrator received fees of $81,241 for the year ended June 30, 1997 and
waived all administrative fees for the years ended June 30, 1996 and 1995. For
the Western Asset Limited Duration Portfolio, the Administrator received fees of
$10,092 and $1,202 (prior to fees waived of $69) for the year ended June 30,
1997 and the period May 1, 1996 (commencement of operations) to June 30, 1996.
DISTRIBUTORS
Legg Mason acts as a distributor of the shares of LM Institutional Fund
Advisors I, Inc. pursuant to an Underwriting Agreement with that Fund dated
August 24, 1990 and amended ___________________. Legg Mason also acts as
distributor of the shares of LM Institutional Fund Advisors II, Inc. pursuant to
an Underwriting Agreement with that Fund dated __________, 1998 (together, the
"Underwriting Agreement").
Legg Mason is not obligated to sell any specific amount of Fund shares
and receives no compensation pursuant to the Underwriting Agreement. The
Underwriting Agreement is terminable with respect to any Portfolio without
penalty, at any time, by vote of a majority of the
-26-
<PAGE>
Fund's Independent Directors, or by vote of the holders of a majority of the
shares of that Portfolio, or by Legg Mason upon 60 days' notice to the Fund.
Each Fund has adopted a Plan which, among other things, permits the
Fund to pay Legg Mason fees for its services related to sales and distribution
of Financial Intermediary Class shares and the provision of ongoing services to
Financial Intermediary Class shareholders. Payments are made only from assets
attributable to Financial Intermediary Class shares. Under the Plans, the
aggregate fees may not exceed an annual rate of 0.25% of each Portfolio's
average daily net assets attributable to Financial Intermediary Class shares.
Fees for the Western Asset Money Market Portfolio and the Western Asset
Government Money Market Portfolio are currently limited to the annual rate of
0.10% of average daily net assets attributable to Financial Intermediary Class
shares. Distribution activities for which such payments may be made include, but
are not limited to, compensation to persons who engage in or support
distribution and redemption of Shares, printing of prospectuses and reports for
persons other than existing shareholders, advertising, preparation and
distribution of sales literature, overhead, travel and telephone expenses, all
with respect to Financial Intermediary Class shares only.
The Plan was approved by Legg Mason Fund Adviser, Inc., as sole
shareholder of the Financial Intermediary Class of each Portfolio on _________,
1998. Legg Mason may pay all or a portion of the fee to its investment
executives.
Each Plan will continue in effect only so long as it is approved at
least annually by the vote of a majority of the Board of Directors, including a
majority of the 12b-1 Directors, cast in person at a meeting called for the
purpose of voting on the Plan. Each Plan may be terminated by a vote of a
majority of the 12b-1 Directors or by a vote of a majority of the outstanding
voting securities of the Financial Intermediary Class shares. Any change in a
Plan that would materially increase the distribution cost to a Portfolio
requires shareholder approval; otherwise the Plan may be amended by the
Directors, including a majority of the 12b-1 Directors, as previously described.
In accordance with Rule 12b-1, each Plan provides that Legg Mason will
submit to the Fund's Board of Directors, and the Directors will review, at least
quarterly, a written report of any amounts expended pursuant to the Plan and the
purposes for which expenditures were made. In addition, as long as the Plan is
in effect, the selection and nomination of the Independent Directors will be
committed to the discretion of such Independent Directors.
Arroyo Seco, Inc. ("Arroyo Seco"), 117 East Colorado Boulevard,
Pasadena, CA 91105, a wholly owned subsidiary of Western Asset, is also
authorized to offer the shares of LM Institutional fund Advisors I, Inc. for
sale to its customers pursuant to an Agreement dated November 9, 1995. This
Agreement was most recently approved by the Board of Directors of LM
Institutional Fund Advisors I, Inc., including a majority of the Independent
Directors, on _________, 1998.
-27-
<PAGE>
LM Institutional Fund Advisors I, Inc. makes no payments to Arroyo Seco
in connection with the offer or sale of the Fund's shares, and Arroyo Seco does
not collect any commissions or other fees from customers in connection with the
offer or sale of the Fund's shares. Arroyo Seco is not obligated to sell any
specific amount of Fund shares. The Agreement is terminable without penalty, at
any time, by vote of a majority of the Fund's Directors, a majority of the
Fund's Independent Directors, or a majority of the Fund's outstanding shares, or
by Arroyo Seco upon 60 days' notice to the Fund.
PURCHASES AND REDEMPTIONS
The Funds reserve the right to modify or terminate the mail, telephone
or wire redemption services described in the Prospectus at any time. The Funds
also reserve the right to suspend or postpone redemptions (1) for any period
during which the Exchange is closed (other than for customary weekend and
holiday closings), (2) when trading in markets the Funds normally utilize is
restricted or an emergency, as defined by rules and regulations of the SEC,
exists, making disposal of the Funds' investments or determination of their net
asset value not reasonably practicable, or (3) for such other periods as the SEC
by regulation or order may permit for the protection of the Funds' shareholders.
In the case of any such suspension, an investor may either withdraw the request
for redemption or receive payment based upon the net asset value next determined
after the suspension is lifted.
The Funds agree to redeem shares of each Portfolio solely in cash up to
the lesser of $250,000 or 1% of the relevant Portfolio's net assets during any
90-day period for any one shareholder. In consideration of the best interests of
the remaining shareholders, the Fund reserves the right to pay any redemption
price exceeding this amount in whole or in part by a distribution in kind of
readily marketable securities held by a Portfolio in lieu of cash. It is highly
unlikely that shares would ever be redeemed in kind. If shares are redeemed in
kind, however, the redeeming shareholder should expect to incur transaction
costs upon the disposition of the securities received in the distribution.
EXCHANGE PRIVILEGE
Shareholders in any of the Portfolios are entitled to exchange their
shares for shares of the other Portfolios, provided that the shares of those
Portfolios are eligible for sale in the shareholder's state of residence, and
are being offered at the time.
When a shareholder decides to exchange shares of a Portfolio, the
relevant Fund's transfer agent will redeem shares of the Portfolio and invest
the proceeds in shares of the Portfolio selected. Redemptions of shares of the
Portfolio will be made at their net asset value determined on the same day that
the request is received in proper order, if received before the close of
business of the Exchange. If the request is received by the transfer agent after
the close of business on the Exchange, shares will be redeemed at their net
asset value determined as of the close of the Exchange on the next day the
Exchange is open.
-28-
<PAGE>
There is no charge for the exchange privilege and no sales charge
imposed on an exchange, but the Portfolios reserve the right to modify or
terminate the exchange privilege at any time. For more information concerning
the exchange privilege, or to make an exchange, please contact the Portfolios.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Under the various Advisory Agreements and Sub-Advisory Agreements, the
Advisers are responsible for the execution of the Portfolios' transactions. In
selecting brokers or dealers, the Advisers must seek the most favorable price
(including the applicable dealer spread) and execution for such transactions,
subject to the possible payment as described below of higher brokerage
commissions or spreads to brokers or dealers who provide research and analysis.
The Portfolios may not always pay the lowest commission or spread available.
Rather, in placing orders on behalf of the Portfolios, the Advisers will also
take into account such factors as size of the order, difficulty of execution,
efficiency of the executing broker's or dealer's facilities (including the
services described below) and any risk assumed by the executing broker or
dealer.
Consistent with the policy of obtaining most favorable price and
execution, an Adviser may give consideration to research, statistical and other
services furnished by brokers or dealers to the Adviser for its use, may place
orders with brokers or dealers who provide supplemental investment and market
research and securities and economic analysis, and may pay to those brokers or
dealers a higher brokerage commission or spread than may be charged by other
brokers or dealers. Such research, analysis and other services may be useful to
an Adviser in connection with services to clients other than the Portfolios. An
Adviser's fee is not reduced by reason of its receiving such brokerage and
research services.
The Portfolios may not buy securities from, or sell securities to, an
Adviser or its affiliated persons as principal, except as permitted by the rules
and regulations of the SEC. Subject to certain conditions, the Portfolios may
purchase securities that are offered in underwritings in which an affiliate of
an Adviser is a participant, although the Portfolios may not make such purchases
directly from such affiliate.
The Advisers will select brokers to execute portfolio transactions. In
the over-the-counter market, the Portfolios generally will deal with responsible
primary market-makers unless a more favorable execution can otherwise be
obtained.
Investment decisions for the Portfolios are made independently from
those of other funds and accounts advised by the Advisers. However, the same
security may be held in the portfolios of more than one fund or account. When
two or more accounts simultaneously engage in the purchase or sale of the same
security, the prices and amounts will be equitably allocated to each account. In
some cases, this procedure may adversely affect the price or quantity of the
security available to a particular account. In other cases, however, an
account's ability to participate in larger volume transactions may produce
better executions and prices. Brokerage commissions
-29-
<PAGE>
paid on transactions were as follows: for the years ended June 30, 1997, 1996
and 1995, the Western Asset Core Portfolio paid $150,548, $97,148 and $59,330,
respectively; the Western Asset Intermediate Portfolio paid $50,835, $11,655 and
$5,970, respectively; the Western Asset Limited Duration Portfolio paid $7,170
and $0 for the years ended June 30, 1997 and the period ended June 30, 1996,
respectively; and the Western Asset International Securities Portfolio paid
$15,440, $9,685, and $0, respectively. No brokerage commissions were paid by any
Portfolio to affiliated persons.
ADDITIONAL TAX INFORMATION
GENERAL REQUIREMENTS FOR "PASS-THROUGH" TREATMENT
In order to continue to qualify for treatment as a regulated investment
company ("RIC") under the Code, each Portfolio must distribute annually to its
shareholders at least 90% of its investment company taxable income (consisting
generally of net investment income and net short-term capital gain, if any)
("Distribution Requirement") and must meet several additional requirements. With
respect to each Portfolio, these requirements include the following: (1) the
Portfolio must derive at least 90% of its gross income each taxable year from
dividends, interest, payments with respect to securities loans and gains from
the sale or other disposition of securities or other income (including gains
from options or futures ) derived with respect to its business of investing in
securities ("Income Requirement"); (2) at the close of each quarter of the
Portfolio's taxable year, at least 50% of the value of its total assets must be
represented by cash and cash items, U.S. Government securities and other
securities, with those other securities limited, in respect of any one issuer,
to an amount that does not exceed 5% of the value of the Portfolio's total
assets; and (3) at the close of each quarter of the Portfolio's taxable year,
not more than 25% of its total assets may be invested in securities (other than
U.S. Government securities) of any one issuer.
A distribution declared by a Portfolio in December of any year and
payable to shareholders of record on a date in that month will be deemed to have
been paid by the Portfolio and received by the shareholders on December 31 if
the distribution is paid by the Portfolio during the following January. Such a
distribution, therefore, will be taxable to shareholders for the year in which
that December 31 falls.
ORIGINAL ISSUE DISCOUNT
A Portfolio may purchase debt securities issued with original issue
discount. Original issue discount that accrues in a taxable year will be treated
as income earned by the Portfolio and therefore an equivalent amount must be
distributed to satisfy the distribution requirement and avoid imposition of the
4% excise tax. Because the original issue discount earned by a Portfolio in a
taxable year may not be represented by cash income, the Portfolio may have to
dispose of other securities and use the proceeds thereof to make distributions
in amounts necessary to satisfy those distribution requirements. A Portfolio may
realize capital gains or losses from such
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<PAGE>
dispositions, which would increase or decrease the Portfolio's investment
company taxable income and/or net capital gain. In addition, any such gains may
be realized on the disposition of securities held for less than three months.
Because of the Short-Short Limitation, any such gains would reduce the
Portfolio's ability to sell other securities (and options and futures), held for
less than three months that it might wish to sell in the ordinary course of its
portfolio management.
MISCELLANEOUS
If a Portfolio invests in shares of preferred stock or otherwise holds
dividend-paying securities as a result of exercising a conversion privilege, a
portion of the dividends from the Portfolio's investment company taxable income
(whether paid in cash or reinvested in additional shares) may be eligible for
the dividends-received deduction allowed to corporations. The eligible portion
may not exceed the aggregate dividends received by the Portfolio from U.S.
corporations. However, dividends received by a corporate shareholder and
deducted by it pursuant to the dividends-received deduction are subject
indirectly to the alternative minimum tax.
If shares of any Portfolio are sold at a loss after being held for six
months or less, the loss will be treated as long-term, instead of short-term,
capital loss to the extent of any capital gain distributions received on those
shares. Investors also should be aware that if shares are purchased shortly
before the record date for any distribution, the shareholder will pay full price
for the shares and receive some portion of the price back as a taxable dividend
or capital gain distribution.
Dividends and interest received by a Portfolio, and gains realized by a
Portfolio on foreign securities, may be subject to income, withholding or other
taxes imposed by foreign countries and U.S. possessions that would reduce the
yield on the Portfolio's securities. Tax conventions between certain countries
and the United States may reduce or eliminate these foreign taxes, however, and
foreign countries generally do not impose taxes on capital gains in respect of
investments by foreign investors.
OTHER INFORMATION
LM Institutional Fund Advisors I, Inc. is a Maryland corporation,
incorporated on May 16, 1990 and was known as Western Asset Trust, Inc. prior to
_________, 1998. LM Institutional Fund Advisors I, Inc.'s capitalization
consists of five billion shares of common stock with a par value of $0.001 each.
LM Institutional Fund Advisors II, Inc. is a Maryland corporation, incorporated
on_________, 1998, and its capitalization also consists of five billion shares
of common stock with a par value of $0.001 each. The Board of Directors of
either Fund may establish additional portfolios (with different investment
objectives and fundamental policies) or classes of shares within a portfolio at
any time in the future. Establishment and offering of additional portfolios or
classes of shares of a portfolio will not alter the rights of a Fund's
shareholders. When issued, shares are fully paid, non-assessable, redeemable and
freely transferable. Shares do not have preemptive rights or subscription
rights. In liquidation of a
-31-
<PAGE>
Portfolio, each shareholder is entitled to receive his or her pro rata share of
the net assets of that Portfolio.
Prior to __________, the Western Asset Core Portfolio was known as the
Core Portfolio; the Western Asset Limited Duration Portfolio was known as the
Limited Duration Portfolio; the Western Asset Intermediate Portfolio was known
as the Intermediate Portfolio; and the Western Asset Money Market Portfolio was
known as the Money Market Portfolio.
PRINCIPAL HOLDERS OF SECURITIES
Set forth below is a table which contains the name, address and
percentage of ownership of each person who is known by the Fund to own
beneficially five percent or more of the outstanding shares of the Western
Asset Core Portfolio as of December 31, 1997:
- --------------------------------------------------------------------------------
% of Ownership
As of
Name and Address December 31, 1997
- --------------------------------------------------------------------------------
Newspaper and Mail Deliverers' Publishers' Pension Fund 6.93%
41-18 27th Street
Long Island City, NY 11101-3825
- --------------------------------------------------------------------------------
Thompson Consumer Electronics, Inc. 6.80%
600 North Sherman Drive
Indianapolis, IN 46201-2598
- --------------------------------------------------------------------------------
BHP Copper-Group 6.29%
7400 N. Oracle Road
Suite 200
Tucson, AZ 85704
- --------------------------------------------------------------------------------
Houghton Mifflin Company Pension Plan 5.08%
222 Berkeley Street
Boston, MA 02116-3764
- --------------------------------------------------------------------------------
The following chart contains the name, address and percentage of
ownership of each person who is known by the Fund to own of record five percent
or more of the outstanding shares of the Western Asset Core Portfolio as of
December 31, 1997:
- --------------------------------------------------------------------------------
% of Ownership
As of
Name and Address December 31, 1997
- --------------------------------------------------------------------------------
State Street Bank & Trust Company 15.89%
Solomon Willard Bldg.
Enterprise Drive
North Quincy, MA 02171
- --------------------------------------------------------------------------------
Northern Trust Company 10.81%
50 S. LaSalle Street
Chicago, IL 60675
- --------------------------------------------------------------------------------
Bankers Trust 9.08%
648 Grassmere Park Road
2nd Floor
Nashville, TN 37211
- --------------------------------------------------------------------------------
Newspaper and Mail Deliverers' Publishers' Pension Fund 6.93%
41-18 27th Street
Long Island City, NY 11101-3825
- --------------------------------------------------------------------------------
Set forth below is a table which contains the name, address and
percentage of ownership of each person who is known by the Fund to own
beneficially five percent or more of the outstanding shares of the Western
Asset Intermediate Portfolio as of December 31, 1997:
- --------------------------------------------------------------------------------
% of Ownership
As of
Name and Address December 31, 1997
- --------------------------------------------------------------------------------
Harn Industries 14.02%
P.O. Box 554
Milwaukee, WI 53201
- --------------------------------------------------------------------------------
MA Hanna Master Trust 12.16%
200 Public Square
Cleveland, OH 44114-2301
- --------------------------------------------------------------------------------
Mac & Co. 9.72%
[address to follow]
- --------------------------------------------------------------------------------
Anne Arundel County MD Master Trust 9.68%
44 Calvert Street
Annapolis, MD 21404
- --------------------------------------------------------------------------------
Allergan Inc. 6.79%
2625 Dupont Drive
P.O. Box 19534
Irvin, CA 92713-9354
- --------------------------------------------------------------------------------
Harvard Industries, Inc. 6.43%
2502 N. Rocky Point Drive
Tampa, FL 33607
- --------------------------------------------------------------------------------
The following chart contains the name, address and percentage of
ownership of each person who is known by the Fund to own of record five percent
or more of the outstanding shares of the Western Asset Intermediate Portfolio as
of December 31, 1997:
- --------------------------------------------------------------------------------
% of Ownership
As of
Name and Address December 31, 1997
- --------------------------------------------------------------------------------
Marshall & Ilsley Trust Co. 14.02%
1000 N. Water Street
Milwaukee, WI 53202
- --------------------------------------------------------------------------------
Northern Trust Company 12.16%
50 LaSalle Street
Chicago, IL 60675
- --------------------------------------------------------------------------------
Boatmen's Trust Company 11.32%
[address to come]
- --------------------------------------------------------------------------------
Key Trust 9.94%
P.O. Box 94870
Cleveland, OH 44101
- --------------------------------------------------------------------------------
State Street Bank & Trust 9.68%
P.O. Box 1992
Boston, MA 02105
- --------------------------------------------------------------------------------
First Union National Bank 7.07%
401 S. Tryon Street
Charlotte, NC 28202
- --------------------------------------------------------------------------------
Mac & Co. 6.79%
Mellon Bank NA
Pittsburgh, PA 16230
- --------------------------------------------------------------------------------
Set forth below is a table which contains the name, address and
percentage of ownership of each person who is known by the Fund to own
beneficially five percent or more of the outstanding shares of the Western
Asset Limited Duration Portfolio as of December 31, 1997:
- --------------------------------------------------------------------------------
% of Ownership
As of
Name and Address December 31, 1997
- --------------------------------------------------------------------------------
Western Michigan University 37.82%
Investment & Endowment Mgmt.
1083 Seibert Admin. Bldg.
Kalamazoo, MI 49008
- --------------------------------------------------------------------------------
University Athletic Assoc. 35.82%
P.O. Box 14485
Gainesville, FL 32604
- --------------------------------------------------------------------------------
Good Shephard Medical 15.09%
P.O. Box 160
Westerville, OH 43086
- --------------------------------------------------------------------------------
Northwestern Trust Co. 11.27%
600HFA Bldg.
914 S. 8th Street
Minneapolis, MN 55404
- --------------------------------------------------------------------------------
The following chart contains the name, address and percentage of
ownership of each person who is known by the Fund to own of record five percent
or more of the outstanding shares of the Western Asset Limited Duration
Portfolio as of December 31, 1997:
- --------------------------------------------------------------------------------
% of Ownership
As of
Name and Address December 31, 1997
- --------------------------------------------------------------------------------
Western Michigan University 37.82%
Investment & Endowment Mgmt.
1083 Seibert Admin. Bldg.
Kalamazoo, MI 49008
- --------------------------------------------------------------------------------
University Athletic Assoc. 35.82%
P.O. Box 14485
Gainesville, FL 32604
- --------------------------------------------------------------------------------
Strafe & Co. 15.09%
P.O. Box 160
Westerville, OH 43086
- --------------------------------------------------------------------------------
Northwestern Trust Co. 11.27%
600HFA Bldg.
914 S. 8th Street
Minneapolis, MN 55404
- --------------------------------------------------------------------------------
-32-
<PAGE>
PERFORMANCE INFORMATION
Each Portfolio may, from time to time, include its total return in
marketing materials or reports to shareholders or prospective investors.
Quotations of average annual total return for a class of shares of a Portfolio
will be expressed in terms of the average annual compounded rate of return of a
hypothetical investment in that class of shares over periods of one, five and
ten years (up to the life of the class), calculated pursuant to the following
formula: P (1 + T)(exponent n) = ERV (where P = a hypothetical initial payment
of $1,000, T = the average annual total return, n = number of years, and ERV =
the ending redeemable value of a hypothetical $1,000 payment made at the
beginning of the period). All total return figures reflect the deduction of a
proportional share of Portfolio expenses on an annual basis and assume that all
dividends and other distributions are reinvested when paid. The performance of
each class of a Portfolio will differ because each class is subject to different
expenses. The performance figures for the Portfolios shown below represent
performance of the Institutional Class shares, the only class of shares in
existence throughout the relevant periods.
The Western Asset Core Portfolio's total returns as of June 30, 1997
were as follows:
Average
Cumulative Annual
Total Return Total Return
One Year 8.27% 8.27%
Five Years 47.05% 8.02%
Life of Portfolio(A) 88.71% 9.76%
(A) Portfolio's inception - September 4, 1990.
The Western Asset Intermediate Portfolio's total returns as of June 30,
1997 were as follows:
Average
Cumulative Annual
Total Return Total Return
One Year 8.32% 8.32%
Life of Portfolio(A) 25.40% 7.83%
(A) Portfolio's inception - July 1, 1994.
The Western Asset Limited Duration Portfolio's total returns as of June
30, 1997 were as follows:
-33-
<PAGE>
Average
Cumulative Annual
Total Return Total Return
One Year 7.42% 7.42%
Life of Portfolio(A) 8.23% 7.01%
(A) Portfolio's inception - May 1, 1996.
The current annualized yield for the Money Market Portfolios is based
upon a specified seven-day period and is computed by determining the net change
in the value of a hypothetical account in the Portfolio. The net change in the
value of the account includes the value of dividends and of additional shares
purchased with dividends, but does not include realized gains and losses or
unrealized appreciation and depreciation. In addition, the Money Market
Portfolios may use a compound effective annualized yield quotation which is
calculated as prescribed by SEC regulations, by adding one to the base period
return (calculated as prescribed above), raising the sum to a power equal to 365
divided by 7, and subtracting one.
Each Portfolio's performance may fluctuate daily depending upon such
factors as the average maturity of its securities, changes in investments,
changes in interest rates and variations in operating expenses. Therefore,
current performance does not provide a basis for determining future performance.
The fact that a Portfolio's performance will fluctuate and that shareholders'
principal is not guaranteed or insured should be considered in comparing the
Portfolio's performance with the performance of fixed-income investments. In
comparing the performance of a Portfolio to other investment vehicles,
consideration should be given to the investment policies of each, including the
types of investments owned, lengths of maturities of the portfolio, the method
used to compute the performance and whether there are any special charges that
may reduce the yield.
From time to time each Portfolio may compare the performance of a Class
of Shares in advertising and sales literature to the performance of other
investment companies, groups of
-34-
<PAGE>
investment companies or various market indices. One such market index is the S&P
500, a widely recognized, unmanaged index composed of the
capitalization-weighted average of the prices of 500 of the largest publicly
traded stocks in the U.S. The S&P 500 includes reinvestment of all dividends. It
takes no account of the costs of investing or the tax consequences of
distributions. The Portfolios invest in many securities that are not included in
the S&P 500.
Each Portfolio may also cite rankings and ratings, and compare the
return of a Class of Shares with data published by Lipper Analytical Services,
Inc., CDA Investment Technologies, Inc., Wiesenberger Investment Company
Services, Value Line, Morningstar, and other services or publications that
monitor, compare and/or rank the performance of investment companies. Each
Portfolio may also refer in such materials to mutual fund performance rankings,
ratings, comparisons with funds having similar investment objectives, and other
mutual funds reported in independent periodicals, including, but not limited to,
Financial World, Money Magazine, Forbes, Business Week, Barron's, Fortune, the
Kiplinger Letters, the Wall Street Journal, and the New York Times.
Each Portfolio may compare the investment return of a Class of Shares
to the return on certificates of deposit and other forms of bank deposits, and
may quote from organizations that track the rates offered on such deposits. Bank
deposits are insured by an agency of the federal government up to specified
limits. In contrast, Portfolio shares are not insured, the value of Portfolio
shares may fluctuate, and an investor's shares, when redeemed, may be worth more
or less than the investor originally paid for them. Unlike the interest paid on
many certificates of deposit, which remains at a specified rate for a specified
period of time, the return of each Class of Shares will vary.
Portfolio advertisements may reference the history of Legg Mason and
its affiliates, the education and experience of the portfolio manager, and the
fact that the portfolio manager engages in a particular style of investing
(e.g., growth or value).
In advertising, each Portfolio may illustrate hypothetical investment
plans designed to help investors meet long-term financial goals, such as saving
for a child's college education or for retirement. Sources such as the Internal
Revenue Service, the Social Security Administration, the Consumer Price Index
and Chase Global Data and Research may supply data concerning interest rates,
college tuitions, the rate of inflation, Social Security benefits, mortality
statistics and other relevant information. Each Portfolio may use other
recognized sources as they become available.
Each Portfolio may use data prepared by Ibbotson Associates of Chicago,
Illinois ("Ibbotson") to compare the returns of various capital markets and to
show the value of a hypothetical investment in a capital market. Ibbotson relies
on different indices to calculate the performance of common stocks, corporate
and government bonds and Treasury bills.
Each Portfolio may illustrate and compare the historical volatility of
different portfolio compositions where the performance of stocks is represented
by the performance of an
-35-
<PAGE>
appropriate market index, such as the S&P 500, and the performance of bonds is
represented by a nationally recognized bond index, such as the Lehman Brothers
Long-Term Government Bond Index.
Each Portfolio may also include in advertising biographical information
on key investment and managerial personnel.
Each Portfolio may advertise examples of the potential benefits of
periodic investment plans, such as dollar cost averaging, a long-term investment
technique designed to lower average cost per share. Under such a plan, an
investor invests in a mutual fund at regular intervals a fixed dollar amount
thereby purchasing more shares when prices are low and fewer shares when prices
are high. Although such a plan does not guarantee profit or guard against loss
in declining markets, the average cost per share could be lower than if a fixed
number of shares were purchased at the same intervals. Investors should consider
their ability to purchase shares through low price levels.
Each Portfolio may discuss Legg Mason's tradition of service. Since
1899, Legg Mason and its affiliated companies have helped investors meet their
specific investment goals and have provided a full spectrum of financial
services. Legg Mason affiliates serve as investment advisers for private
accounts and mutual funds with assets of more than $[__] billion as of [December
31, 1997].
In advertising, each Portfolio may discuss the advantages of saving
through tax-deferred retirement plans or accounts, including the advantages and
disadvantages of "rolling over" a distribution from a retirement plan into an
IRA, factors to consider in determining whether you qualify for such a rollover,
and the other options available. These discussions may include graphs or other
illustrations that compare the growth of a hypothetical tax-deferred investment
to the after-tax growth of a taxable investment.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT
State Street Bank and Trust Company, P.O. Box 1790, Boston,
Massachusetts 02105, serves as custodian of the Funds' assets. Boston Financial
Data Services, Inc., P.O. Box 953, Boston, Massachusetts 02103, serves as
transfer and dividend-disbursing agent and administrator of various shareholder
services. Shareholders who request an historical transcript of their account
will be charged a fee based upon the number of years researched. The Funds
reserve the right, upon 60 days' written notice, to make other charges to
investors to cover administrative costs.
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP, 1306 Concourse Dr., Linthicum, MD 21090, have
been selected to serve as each Fund's independent accountants. The financial
statements incorporated in this Prospectus and this Statement of Additional
Information by reference to the Annual Reports to Shareholders of Western Asset
-36-
<PAGE>
Trust Intermediate Portfolio, Western Asset Trust Limited Duration Portfolio
and Western Asset Trust Core Portfolio for the year ended June 30, 1997 have
been so incorporated in reliance upon the report of Price Waterhouse LLP, given
on their authority as experts in accounting and auditing.
LEGAL COUNSEL
Ropes & Gray, Boston, MA, serves as legal counsel to each Fund.
FINANCIAL STATEMENTS
The audited financial statements of the Western Asset Limited Duration
Portfolio, the Western Asset Intermediate Portfolio and the Western Asset Core
Portfolio included in the Portfolios' Annual Reports to Shareholders for the
year ended June 30, 1997 are hereby incorporated by reference into this
Statement of Additional Information.
<PAGE>
PART C. OTHER INFORMATION
Item 24. Financial Statements and Exhibits
---------------------------------
(a) Financial Statements -- none
(b) Exhibits
(1) Articles of Incorporation -- filed herewith
(2) Bylaws -- none
(3) Voting trust agreement -- none
(4) Specimen security -- not applicable
(5) (a) Investment advisory contracts -- none
(b) Investment sub-advisory agreements -- none
(6) Underwriting Agreement -- none
(7) Bonus, profit sharing or pension plans -- none
(8) Custodian agreement -- none
(9) (a) Transfer Agent agreement -- none
(b) Administration agreements -- none
(10) Opinion of counsel -- none
(11) Other opinions, appraisals, rulings and consents
Accountants' consent -- none
(12) Financial statements omitted from Item 23 -- not
applicable
(13) Agreement for providing initial capital -- none
(14) Prototype retirement plans -- none
(15) Plan pursuant to Rule 12b-1 -- none
(16) Schedule for computation of performance quotations --
none
(17) Financial Data Schedules -- none
<PAGE>
Item 25. Persons Controlled by or under Common Control with Registrant
-------------------------------------------------------------
Registrant does not control any other person.
Item 26. Number of Holders of Securities
-------------------------------
Number of Recordholders
Title of Class (as of [ ], 1998)
- -------------- ----------------------------
Shares of Capital Stock,
$.001 par value Institutional Financial Intermediary
Class Class
---------------------------------------
Legg Mason Fund Adviser Large Cap
Value Portfolio
Legg Mason Fund Adviser Mid Cap
Value Portfolio
U.S. Small Cap Portfolio
Batterymarch Emerging Markets Portfolio
Batterymarch International Equity Portfolio
Legg Mason Fund Adviser/Western Asset Balanced Portfolio
Item 27. Indemnification
---------------
Insofar as indemnification for liabilities arising under the
Securities Act of 1933, as amended, may be provided to directors, officers and
controlling persons of the Registrant, pursuant to the foregoing provisions or
otherwise, the Registrant has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the Act and is, therefore, unenforceable. In the event that a claim
for indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in connection with the successful defense of any
action, suit or proceeding or payment pursuant to any insurance policy) is
asserted against the Registrant by such director, officer or controlling person
in connection with the securities being registered, the Registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is prohibited as against public policy as expressed
in the Act and will be governed by the final adjudication of such issue.
<PAGE>
Item 28. Business and Other Connections of Investment Adviser
----------------------------------------------------
I. Western Asset Management Company ("Western"), adviser for the
Legg Mason Fund Adviser/Western Asset Balanced Portfolio (fixed income portion
only), is a registered investment adviser incorporated on October 5, 1971.
Western is primarily engaged in the investment advisory business. Western also
renders investment advice to other open-end registered investment companies, one
closed-end registered investment company, and private accounts. Information as
to the officers and directors of Western is included in its Form ADV filed on
June 25, 1997 with the Securities and Exchange Commission (registration number
801-08162) and is incorporated herein by reference.
II. Legg Mason Fund Adviser, Inc. ("Fund Adviser"), adviser for
the Legg Mason Fund Adviser Large Cap Value Portfolio, Legg Mason Fund Adviser
Mid Cap Value Portfolio and Legg Mason Fund Adviser/Western Asset Balanced
Portfolio, is a registered investment adviser incorporated on January 20, 1982.
Fund Adviser is engaged primarily in the investment advisory business. Fund
Adviser also serves as investment adviser or manager to seventeen open-end
registered investment companies. Information as to the officers and directors of
Fund Adviser is included in its Form ADV filed August 11, 1997 with the
Securities and Exchange Commission (Registration Number 801-16958) and is
incorporated herein by reference.
III. Batterymarch Financial Management, Inc. ("Batterymarch"),
adviser to the Batterymarch Emerging Markets Portfolio and Batterymarch
International Equity Portfolio, is a registered investment adviser incorporated
on September 19, 1994. Batterymarch is engaged primarily in the investment
advisory business. Information as to the officers and directors of Batterymarch
is included in its Form ADV filed June 27, 1997 with the Securities and Exchange
Commission (registration number 801-48035) and is incorporated herein by
reference.
Item 29. Principal Underwriters
----------------------
(a) Legg Mason Cash Reserve Trust
Legg Mason Special Investment Trust, Inc.
Legg Mason Value Trust, Inc.
Legg Mason Tax-Exempt Trust, Inc.
Legg Mason Income Trust, Inc.
Legg Mason Total Return Trust, Inc.
Legg Mason Tax-Free Income Fund
Legg Mason Global Trust, Inc.
Legg Mason Investors Trust, Inc.
(b) The following table sets forth information concerning each
director and officer of the Registrant's principal
underwriter, Legg Mason Wood Walker, Incorporated ("LMWW").
Position and Positions and
Name and Principal Offices with Offices with
Business Address* Underwriter - LMWW Registrant
- ------------------ ------------------ -------------
Raymond A. Mason Chairman of the None
Board
John F. Curley, Jr. Vice Chairman None
<PAGE>
of the Board
James W. Brinkley President and None
Director
Edmund J. Cashman, Jr. Senior Executive None
Vice President and
Director
Richard J. Himelfarb Senior Executive Vice None
President and
Director
Edward A. Taber III Senior Executive Vice None
President and
Director
Robert A. Frank Executive Vice None
President and
Director
Robert G. Sabelhaus Executive Vice None
President and
Director
Charles A. Bacigalupo Senior Vice None
President,
Secretary and
Director
F. Barry Bilson Senior Vice None
President and
Director
Thomas M. Daly, Jr. Senior Vice None
President and
Director
Jerome M. Dattel Senior Vice None
President and
Director
Robert G. Donovan Senior Vice None
President and
Director
Thomas E. Hill Senior Vice None
One Mill Place President and
Easton, MD 21601 Director
Arnold S. Hoffman Senior Vice None
1735 Market Street President and
Philadelphia, PA 19103 Director
<PAGE>
Carl Hohnbaum Senior Vice None
24th Floor President and
Two Oliver Plaza Director
Pittsburgh, PA 15222
William B. Jones, Jr. Senior Vice None
1747 Pennsylvania President and
Avenue, N.W. Director
Washington, D.C. 20006
Laura L. Lange Senior Vice None
President and
Director
Marvin H. McIntyre Senior Vice None
1747 Pennsylvania President and
Avenue, N.W. Director
Washington, D.C. 20006
Mark I. Preston Senior Vice None
President and
Director
Joseph Sullivan Senior Vice None
President and
Director
M. Walter D'Alessio, Jr. Director None
1735 Market Street
Philadelphia, PA 19103
W. William Brab Senior Vice None
President
Deepak Chowdhury Senior Vice None
255 Alhambra Circle President
Coral Gables, FL 33134
Harry M. Ford, Jr. Senior Vice None
President
Dennis A. Green Senior Vice None
President
William F. Haneman, Jr. Senior Vice None
One Battery Park Plaza President
New York, New York 10005
Theodore S. Kaplan Senior Vice None
President and
General Counsel
Seth J. Lehr Senior Vice None
1735 Market St President
Philadelphia, PA 19103
Horace M. Lowman, Jr. Senior Vice None
President and
Asst. Secretary
<PAGE>
Robert L. Meltzer Senior Vice None
One Battery Park Plaza President
New York, NY 10004
Jonathan M. Pearl Senior Vice None
1777 Reisterstown Rd. President
Pikesville, MD 21208
John A. Pliakas Senior Vice None
125 High Street President
Boston, MA 02110
Gail Reichard Senior Vice None
President
Timothy C. Scheve Senior Vice None
President and
Treasurer
Elisabeth N. Spector Senior Vice None
President
Robert J. Walker, Jr. Senior Vice None
200 Gibraltar Road President
Horsham, PA 19044
William H. Bass, Jr. Vice President None
Nathan S. Betnun Vice President None
John C. Boblitz Vice President None
Andrew J. Bowden Vice President None
D. Stuart Bowers Vice President None
Edwin J. Bradley, Jr. Vice President None
Scott R. Cousino Vice President None
Joseph H. Davis, Jr. Vice President None
1735 Market Street
Philadelphia, PA 19380
Terrence R. Duvernay Vice President None
1100 Poydras St.
New Orleans, LA 70163
John R. Gilner Vice President None
Richard A. Jacobs Vice President None
C. Gregory Kallmyer Vice President None
Edward W. Lister, Jr. Vice President None
Marie K. Karpinski Vice President Vice President
and Treasurer
<PAGE>
Mark C. Micklem Vice President None
1747 Pennsylvania Ave.
Washington, DC 20006
Hance V. Myers, III Vice President None
1100 Poydras St.
New Orleans, LA 70163
Gerard F. Petrik, Jr. Vice President None
Douglas F. Pollard Vice President None
K. Mitchell Posner Vice President None
1735 Market Street
Philadelphia, PA 19103
Carl W. Riedy, Jr. Vice President None
Jeffrey M. Rogatz Vice President None
Thomas E. Robinson Vice President None
Douglas M. Schmidt Vice President None
Robert W. Schnakenberg Vice President None
1111 Bagby St.
Houston, TX 77002
Henry V. Sciortino Vice President None
1735 Market St.
Philadelphia, PA 19103
Chris Scitti Vice President None
Eugene B. Shephard Vice President None
1111 Bagby St.
Houston, TX 77002-2510
Lawrence D. Shubnell Vice President None
Alexsander M. Stewart Vice President None
One World Trade Center
New York, NY 10048
Robert S. Trio Vice President None
1747 Pennsylvania Ave.
Washington, DC 20006
William A. Verch Vice President None
Lewis T. Yeager Vice President None
Joseph F. Zunic Vice President None
- --------------
* All addresses are 100 Light Street, Baltimore, Maryland 21202, unless
otherwise indicated.
The following table sets forth information concerning each director and officer
of Arroyo Seco, Inc. ("Arroyo").
<PAGE>
Position and Positions and
Name and Principal Offices with Offices with
Business Address** Underwriter - Arroyo Registrant
- ------------------ -------------------- -------------
Ilene S. Harker Chief Executive Vice President
Officer and Director
Donna E. Barnes Corporate Secretary Secretary
James W. Hirschmann Director and Director Vice President
of Marketing
Randolph L. Kohn Director and Director of Vice President
Client Services
Steven T. Saruwatari Chief Financial Officer Vice President
W. Curtis Livingston, III Director President and Director
- ----------
** All addresses are 117 East Colorado Boulevard, Pasadena, California
91105, unless otherwise indicated.
(c) The Registrant has no principal underwriter which is not
an affiliated person of the Registrant or an affiliated
person of such an affiliated person.
Item 30. Location of Accounts and Records
--------------------------------
State Street Bank and Trust Company
P.O. Box 1713
Boston, Massachusetts 02105
Item 31. Management Services -- none
-------------------
Item 32. Undertakings
------------
(b) Registrant hereby undertakes to file a post-effective
amendment, using financial statements, which need not be
certified, for each of the Portfolios, within four to six
months from the effective date of this post-effective
amendment to Registrant's registration statement.
(c) Registrant hereby undertakes to provide each person to
whom a prospectus is delivered with a copy of its latest
annual report to shareholders upon request and without
charge.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant, LM Institutional Fund Advisors
II, Inc., has duly caused this Registration Statement to be signed on its behalf
by the undersigned, thereunto duly authorized, in the City of Baltimore and
State of Maryland, on the 16th day of January, 1998.
LM INSTITUTIONAL FUND ADVISORS II, INC.
By: /s/ Edward A. Taber, III
------------------------
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S><C>
/s/ Edward A. Taber, III President January 16, 1998
- ------------------------
Edward A. Taber
/s/ James D. Cahn Director January 16, 1998
- -----------------
James D. Cahn
/s/ Kathi D. Bair Director January 16, 1998
- ---------------------
Kathi D. Bair
</TABLE>
LM INSTITUTIONAL FUND ADVISORS II, INC.
---------------------------------------
ARTICLES OF INCORPORATION
THIS IS TO CERTIFY THAT:
FIRST: The undersigned, Tracy A. Bacigalupo, whose address is
Ballard Spahr Andrews & Ingersoll, 300 East Lombard Street, Baltimore, Maryland
21202, being at least eighteen (18) years of age, does hereby form a corporation
under the general laws of the State of Maryland.
SECOND: The name of the corporation (which is hereinafter called
the "Corporation") is:
LM Institutional Fund Advisors II, Inc.
THIRD: The Corporation is formed for the purpose of carrying on
any lawful business.
FOURTH: The address of the principal office of the Corporation
in this State is c/o Legg Mason Wood Walker, Incorporated, 100 Light Street,
Baltimore, Maryland 21202.
FIFTH: The name and address of the resident agent of the
Corporation are Charles A. Bacigalupo, c/o Legg Mason Wood Walker, Incorporated,
100 Light Street, Baltimore, Maryland 21202. The resident agent is a citizen of
and resides in the State of Maryland.
SIXTH: The total number of shares of stock which the Corporation
has authority to issue is 5,000,000,000 shares, $.001 par value per share, all
of one class. The aggregate par value of all authorized shares having a par
value is $5,000,000.
SEVENTH: The Corporation shall have a board of three (3)
directors unless the number is increased or decreased in accordance with the
Bylaws of the Corporation. However, the number of directors shall never be less
than the minimum number required by the Maryland General Corporation Law. The
initial directors are:
Edward A. Taber, III
Kathi Bair
James D. Cahn
EIGHTH: (a) The Corporation reserves the right to make any
amendment of the charter, now or hereafter authorized by law, including any
amendment which alters the contract rights, as expressly set forth in the
charter, of any shares of outstanding stock.
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(b) The Board of Directors of the Corporation may
authorize the issuance from time to time of shares of its stock of any class,
whether now or hereafter authorized, or securities convertible into shares of
its stock of any class, whether now or hereafter authorized, for such
consideration as the Board of Directors may deem advisable, subject to such
restrictions or limitations, if any, as may be set forth in the Bylaws of the
Corporation.
(c) The Board of Directors of the Corporation may, by
articles supplementary, classify or reclassify any unissued stock from time to
time by setting or changing the preferences, conversion or other rights, voting
powers, restrictions, limitations as to dividends, qualifications, or terms or
conditions of redemption of the stock.
NINTH: No holder of shares of stock of any class shall have any
preemptive right to subscribe to or purchase any additional shares of any class,
or any bonds or convertible securities of any nature; provided, however, that
the Board of Directors may, in authorizing the issuance of shares of stock of
any class, confer any preemptive right that the Board of Directors may deem
advisable in connection with such issuance.
TENTH: To the maximum extent that Maryland law in effect from
time to time permits limitation of the liability of directors and officers, but
subject to the limits on indemnification contained in Section 17(h) of the
Investment Company Act of 1940, as amended, no director or officer of the
Corporation shall be liable to the Corporation or its stockholders for money
damages. Neither the amendment nor repeal of this Article, nor the adoption or
amendment of any other provision of the charter or Bylaws inconsistent with this
Article, shall apply to or affect in any respect the applicability of the
preceding sentence with respect to any act or failure to act which occurred
prior to such amendment, repeal or adoption.
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IN WITNESS WHEREOF, I have signed these Articles of
Incorporation and acknowledge the same to be my act on this 13th day of January,
1998.
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Tracy A. Bacigalupo
