As filed with the Securities and Exchange Commission on July 30, 1999.
1933 Act File No. 333-44423
1940 Act File No. 811-8611
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM N-lA
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X]
Pre-Effective Amendment No. [ ]
Post-Effective Amendment No. 4 [X]
and
REGISTRATION STATEMENT UNDER
THE INVESTMENT COMPANY ACT OF 1940 [X]
Amendment No. 5 [X]
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)
It is proposed that this filing will become effective:
[ ] immediately upon filing pursuant to Rule 485(b)
[X] on August 1, 1999 pursuant to Rule 485(b)
[ ] 60 days after filing pursuant to Rule 485(a)(i)
[ ] on ________ pursuant to Rule 485(a)(i)
[ ] 75 days after filing pursuant to Rule 485(a)(ii)\
[ ] on pursuant to Rule 485(a)(ii)
If appropriate, check the following box:
[ ] This post-effective amendment designates a new effective date for a
previously filed post-effective amendment.
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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:
LM Value Institutional Portfolio
LM Special Investment Institutional Portfolio
Brandywine U.S. Small Cap Portfolio
Batterymarch Emerging Markets Portfolio
Batterymarch International Equity Portfolio
LM Total Return Institutional Portfolio
Part B
Statement of Additional Information for the following Portfolios:
LM Value Institutional Portfolio
LM Special Investment Institutional Portfolio
Brandywine U.S. Small Cap Portfolio
Batterymarch Emerging Markets Portfolio
Batterymarch International Equity Portfolio
LM Total Return Institutional Portfolio
Part C - Other Information
Signature Page
Exhibit Index
Exhibits
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LM INSTITUTIONAL FUND ADVISORS II, INC.
LM Value Institutional Portfolio
LM Special Investment Institutional Portfolio
Brandywine Small Cap Portfolio
Batterymarch Emerging Markets Portfolio
Batterymarch International Equity Portfolio
LM Total Return Institutional Portfolio
Cross Reference Sheet
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Part A. Item No. Prospectus Caption
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1 Cover Page and Back Cover Page
2 Description of Each Portfolio and Its Investment
Strategy Risk Summary; Performance Data
3 Expense Information
4 Not Applicable
5 Not Applicable
6 Management of the Portfolios
7 Purchase of Shares; Redemption of Shares; Exchange
Privilege; Net Asset Value; Dividends and
Distributions to Shareholders; Tax Information
8 Distribution Plans
9 Financial Highlights
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LM INSTITUTIONAL FUND ADVISORS II, INC.
LM Value Institutional Portfolio
LM Special Investment Institutional Portfolio
Brandywine U.S. Small Cap Portfolio
Batterymarch Emerging Markets Portfolio
Batterymarch International Equity Portfolio
LM Total Return Institutional Portfolio
Cross Reference Sheet
Statement of Additional
Part B. Item No. Information Caption
10 Cover Page and Table of Contents
11 Not Applicable
12 Additional Information About
Investment Limitations and Policies
13 Management of the Portfolios
14 Principal Holders of Securities
15 Management of the Portfolios;
Other Information
16 Portfolio Transactions and
Brokerage
17 Other Information
18 Purchases and Redemptions
19 Additional Tax Information
20 Management of the Portfolios
21 Other Information
22 Financial Statements
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LM INSTITUTIONAL FUND ADVISORS II PROSPECTUS
August 1, 1999
o LM Value Institutional Portfolio
o LM Special Investment Institutional Portfolio
o Brandywine Small Cap Value Portfolio
o Batterymarch Emerging Markets Portfolio
o Batterymarch International Equity Portfolio
o LM Total Return Institutional Portfolio
These securities have not been approved or disapproved by the securities and
exchange commission nor has the securities and exchange commission passed upon
the accuracy or adequacy of this prospectus. Any representation to the contrary
is a criminal offense.
[GRAPHIC APPEARS HERE]
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<TABLE>
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TABLE OF CONTENTS
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DESCRIPTION OF EACH PORTFOLIO AND ITS INVESTMENT OBJECTIVE AND
PRINCIPAL INVESTMENT STRATEGIES...................................................4
LM Value Institutional Portfolio.........................................4
LM Special Investment Institutional Portfolio............................5
Brandywine Small Cap Value Portfolio.....................................5
Batterymarch Emerging Markets Portfolio..................................6
Batterymarch International Equity Portfolio..............................7
LM Total Return Institutional Portfolio..................................8
PRINCIPAL RISKS...................................................................8
PERFORMANCE DATA................................................................13
FEES AND EXPENSES................................................................13
LM Value Institutional Portfolio........................................14
LM Special Investment Institutional Portfolio...........................14
Brandywine Small Cap Value Portfolio....................................15
Batterymarch Emerging Markets Portfolio.................................15
Batterymarch International Equity Portfolio.............................16
LM Total Return Institutional Portfolio.................................16
MANAGEMENT OF THE PORTFOLIOS..................................................17
Board of Directors......................................................17
Manager, Advisers.......................................................17
The Distributor.........................................................20
Portfolio Transactions..................................................20
Expenses 20
PURCHASE OF SHARES.............................................................20
Initial Investment......................................................21
Additional Investments..................................................22
Other Purchase Information..............................................22
Retirement Plans........................................................23
Account Registration Changes............................................23
DISTRIBUTION PLANS ..............................................................23
REDEMPTION OF SHARES.............................................................23
Signature Guarantee.....................................................25
EXCHANGE PRIVILEGE...............................................................25
NET ASSET VALUE..................................................................26
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS......................................27
TAX INFORMATION..................................................................28
FINANCIAL HIGHLIGHTS ............................................................29
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PROSPECTUS SUMMARY
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Manager and Advisers
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LM Institutional Advisors, Inc. (the "Manager") serves as the
investment manager to each Portfolio. Legg Mason Fund Adviser, Inc. ("LMFA"),
Brandywine Asset Management, Inc. ("Brandywine") and Batterymarch Financial
Management, Inc. ("Batterymarch") serve as the investment advisers to the
various Portfolios noted below. LMFA, Brandywine and Batterymarch are referred
to as "Advisers."
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DESCRIPTION OF EACH PORTFOLIO AND ITS INVESTMENT OBJECTIVE AND PRINCIPAL
INVESTMENT STRATEGIES
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The investment objective and policies for each Portfolio are stated
below.
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LM Value Institutional Portfolio
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Adviser: LMFA
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Objective: long-term growth of capital
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The Portfolio invests primarily in equity securities (including Common and
Preferred Stocks), and securities convertible into equity securities, that, in
the Adviser's opinion, offer the potential for capital growth. The Adviser
follows a value discipline in selecting securities, and therefore seeks to
purchase securities at large discounts to the Adviser's assessment of their
intrinsic value. Intrinsic value, according to the Adviser, is the value of the
company measured, to different extents depending on the type of company, on
factors such as the value of its assets, the future value of its earnings, and
the costs to replicate the business. 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. The
Adviser takes a long-term approach to investing, generally characterized by long
holding periods and low portfolio turnover. The Portfolio generally invests in
companies with market capitalizations greater than $1 billion, but may invest
in companies of any size.
The Adviser typically sells a security when, in the Adviser's assessment, the
security no longer appears to offer a long-term above average risk-adjusted rate
of return, or when a more compelling investment opportunity is found.
The Portfolio may also invest in debt securities of companies having one or more
of the above characteristics. The Portfolio may invest up to 25% of its net
assets in long-term debt securities. Up to 10% of its total assets may be
invested in convertible and/or debt securities not rated investment grade, i.e.,
not rated at least BBB by Standard & Poor's or Baa by Moody's Investors Service,
Inc. or, if unrated by those entities, deemed by the Adviser to be of comparable
quality, and commonly referred to as junk bonds.
For temporary purposes, or when cash is temporarily available, the Portfolio may
invest without limit in investment grade, short-term debt instruments, including
government, corporate and money market securities. The Portfolio may not achieve
its investment objective when so invested.
Among the principal risks of investing in the Portfolio are Market Risk,
Interest Rate Risk, Credit Risk, Call Risk, Special Risks of High Yield
Securities, Borrowing Risk and Hedging Risk. Please see "Principal Risks" for a
discussion of these and other risks.
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LM Special Investment Institutional Portfolio
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Adviser: LMFA
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Objective: capital appreciation
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The fund invests primarily in equity securities, and securities convertible into
equity securities, of companies whose market capitalization are typically
classified as small to mid sized. It also invests in "special situations"
without regard to market capitalization. Special situations are securities
undergoing unusual or possibly one-time developments that, in the opinion of the
adviser, make them attractive for investment. Such developments may include
actual or anticipated: sale or termination of an unprofitable part of the
company's business; change in the company's management or in management's
philosophy; a basic change in the industry in which the company operates;
introduction of new products or technologies; or the prospect or effect of
acquisition or merger activities.
The Adviser follows a value discipline in selecting securities, and therefore
seeks to purchase securities at large discounts to the adviser's assessment of
their intrinsic value. Intrinsic value, according to the Adviser, is the value
of the company measured, to different extents depending on the type of company,
on factors such as the value of its assets, the future value of its earnings,
and the costs to replicate the business. 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.
The fund also invests in debt securities of companies having one or more of the
above characteristics. The fund may invest up to 35% of its net assets in debt
securities rated below investment grade, ie., rated below BBB/Baa and commonly
referred to as junk bonds. The fund may invest up to 20% of its total assets in
securities of companies involved in actual or anticipated reorganizations or
restructurings.
The Adviser typically sells a security when, in the Adviser's assessment, the
security no longer appears to offer long-term above average risk-adjusted rates
of return, or when a more compelling investment opportunity is found.
For temporary defensive purposes, or when cash is temporarily available, the
fund may invest without limit in investment grade, short-term debt instruments,
including government, corporate and money market securities. The fund may not
achieve its investment objective when so invested.
Among the principal risks of investing in the Portfolio are Market Risk,
Interest Rate Risk, Credit Risk, Call Risk, Special Risks of High Yield
Securities, Borrowing Risk and Hedging Risk. Please see "Principal Risks" for a
discussion of these and other risks.
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Brandywine Small Cap Value Portfolio
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Adviser: Brandywine
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Objective: long-term capital appreciation
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Principal Investment Strategies: Under normal market conditions, the Portfolio
will invest at least 65% of its total assets in equity securities of "small cap"
companies. "Small cap" companies are generally defined as companies at the time
of initial investment with an equity market capitalization not in excess of the
40th percentile of the capitalization of issuers traded on the New York Stock
Exchange (currently approximately $1 billion). A company that was a "small
cap" company at the time of the Portfolio's initial investment will continue to
be treated as such for
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purposes of the 65% test, even if the equity capitalization exceeds the 40th
percentile at a time subsequent to 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.
Although the Portfolio expects to remain substantially fully invested in equity
securities, the Portfolio may invest in cash and money market instruments,
including repurchase agreements. For temporary defensive purposes, the Portfolio
may also invest in investment grade debt and fixed income investments. The
Portfolio may not achieve its investment objective when so invested. The
Portfolio may also engage in reverse repurchase agreement transactions and other
borrowings, purchase restricted and illiquid securities, loan its portfolio
securities, and invest in securities of other investment companies.
Among the principal risks of investing in the Portfolio are Market Risk,
Interest Rate Risk, Credit Risk, Call Risk, Special Risks of High Yield
Securities, Borrowing Risk and Hedging Risk. Please see "Principal Risks" for a
discussion of these and other risks.
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Batterymarch Emerging Markets Portfolio
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Adviser: Batterymarch
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Objective: long-term capital appreciation
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Principal Investment Strategies: 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 and convertible securities of emerging
market issuers. Emerging market countries are those countries having less fully
developed economic and political systems and include any country: (i) having an
"emerging stock market" or considered a "frontier market" as defined by the
International Finance Corporation; (ii) with low- to middle-income economies
according to the International Bank for Reconstruction and Developement ("World
Bank"); (iii) listed in World Bank publications as developing; or (iv) included
in the Morgan Stanley Capital International (MSCI) Emerging Markets published
index. 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 denominated in any
currency if issued by companies to finance operations in an emerging market
country; (3) securities of companies that derive a substantial portion (i.e., in
excess of 50%) 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; or (5) American depositary receipts
("ADRs") (or similar instruments) with respect to the foregoing.
The Portfolio intends to invest in Asia, Latin America, the Indian Subcontinent,
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 investment in that country or region to be inadvisable.
More than 25% of the Portfolio's total assets may be invested in securities of
issuers located in a single country. Because the Portfolio may concentrate a
significant portion of its investments in a single country or currency, it will
be more susceptible to factors adversely affecting issuers within that country
or currency than would a more diversified portfolio of securities.
The Adviser focuses on higher-quality, dominant emerging markets companies which
the adviser believes to have strong growth prospects and reasonable valuations,
selected from an investable universe of approximately 1,000 stocks. The
Adviser's emerging markets investment strategy represents a distinctive
combination of quantitative methodology and traditional fundamental analysis.
Traditional "on-the-ground" fundamental research is combined by the Adviser with
tested quantitative valuation disciplines in those markets where reliable data
is available. In determining country allocation, the Adviser also merges
quantitative and fundamental approaches.
The Portfolio may invest without limit in cash and money market instruments,
including repurchase agreements, in circumstances when cash is temporarily
available, or for temporary defensive purposes when the Adviser believes such
action is warranted by abnormal market or economic situations. The Portfolio may
not achieve its investment objective when so invested. Up to 10% of the
Portfolio's total assets may be rated below investment grade or, if unrated,
determined by the Adviser to be below investment grade (i.e. rated below BBB/Baa
and commonly referred to as Junk Bonds).
Among the principal risks of investing in the Portfolio are Market Risk, Foreign
Securities Risk, Emerging Markets Risk, Currency Risk, Interest Rate Risk,
Credit Risk, Call Risk, Special Risks of High Yield Securities, Borrowing Risk
Derivatives Risk and Hedging Risk. Please see "Principal Risks" for a discussion
of those and other risks.
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Batterymarch International Equity Portfolio
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Adviser: Batterymarch
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Objective: long-term total return
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Principal Investment Strategies: 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 non-U.S. equity securities.
The primary focus of the Adviser is stock selection, with a secondary focus on
country allocation. The Adviser uses a bottom-up, quantitative stock selection
process for the developed markets portion of the Portfolio's portfolio. The
cornerstone of this process is a proprietary stock selection model that ranks
the 2,800 stocks in the Portfolio's investable universe by relative
attractiveness on a daily basis. The quantitative factors within this model are
intended to measure growth, value, fundamental expectations and technical
indicators (i.e., supply and demand).
Country allocation for the developed markets portion of the Portfolio is based
on rankings generated by the Adviser's proprietary country model. The Adviser
examines securities from over 20 international stock markets, with emphasis on
several of the largest: Japan, the United Kingdom, France, Canada and Germany.
The Portfolio may invest up to 35% of its total assets in emerging market equity
securities. The Adviser's investment strategy for the emerging markets portion
of the Portfolio represents a distinctive combination of tested quantitative
methodology and traditional fundamental analysis. The emerging markets
allocation focuses on higher-quality, dominant companies which the Adviser
believes to have strong growth prospects and reasonable valuations. Country
allocation for the emerging markets portion of the Portfolio also combines
quantitative and fundamental approaches.
The Portfolio will normally be invested across a broad range of industries and
across a number of countries, consistent with the objective of maximum total
return. However, more than 25% of the Portfolio's total assets may be invested
in securities of issuers located in a single country, which is currently
expected to be the case with respect to both Japan and the United Kingdom.
Because the Portfolio may concentrate a significant portion of its investments
in a single country or currency, it will be more susceptible to factors
adversely affecting issuers within that country or currency than would a more
diversified portfolio of securities.
The Portfolio may invest without limit in cash and money market instruments,
including repurchase agreements, in circumstances when cash is temporarily
available, or for temporary defensive purposes when the Adviser believes such
action is warranted by abnormal market or economic situations. Up to 5% of the
Portfolio's total assets may be rated below investment grade or, if unrated,
determined by the Adviser to be below investment grade. The Adviser may also
seek to enhance portfolio returns through active currency hedging strategies,
although there can be no assurances that such strategies will be pursued or,
if pursued, will be successful.
Among the principal risks of investing in the Portfolio are Market Risk, Foreign
Securities Risk, Emerging Markets Risk, Currency Risk, Interest Rate Risk,
Credit Risk, Call Risk, Special Risks of High Yield Securities, Borrowing Risk
Derivatives Risk and Hedging Risk. Please see "Principal Risks" for a discussion
of these and other risks.
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LM Total Return Institutional Portfolio
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Adviser: LMFA
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Objective: capital appreciation and current income in order to achieve
an attractive total investment return consistent with
reasonable risk
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Principal Investment Strategies: The fund invests primarily in securities that,
in the Adviser's opinion, offer the potential for long-term capital growth and
attractive current income. The Adviser follows a value discipline in selecting
securities. This means the Adviser seeks to purchase securities at large
discounts to the Adviser's assessment of their intrinsic value. For the Adviser,
assessment of intrinsic value is an ongoing, dynamic process employing both
quantitative and qualitative analysis. The Adviser typically sells a security
when, in the Adviser's assessment, the security no longer appears to offer
long-term attractive total returns at reasonable risk, or when a more compelling
investment opportunity is found. The fund invests primarily in common stocks,
debt securities, and securities convertible into common stocks, but is not
limited to these types of securities. The fund may invest in securities that do
not pay current income but do, in the Adviser's opinion, offer prospects for
capital appreciation and future income. The fund may invest in companies of any
size. The fund may invest in debt securities, including government, corporate
and money market securities for temporary defensive purposes. The fund may not
achieve its investment objective when so invested. Consistent with the
investment objective, the fund may also invest in such securities when the
adviser believes the return on certain debt securities (including debt
securities rated below investment grade and commonly referred to as "junk
bonds") may equal or exceed the return on equity securities.
Among the principal risks of investing in the Portfolio are Market Risk,
Interest Rate Risk, Credit Risk, Call Risk, Special Risks of High Yield
Securities, Borrowing Risk and Hedging Risk. Please see "Principal Risks" for a
discussion of these and other risks.
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PRINCIPAL RISKS
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In General -
At any time, your investment in a mutual fund may be worth more or less than the
price you originally paid for it. You may lose money by investing in any of
these funds because: (i) the value of the investments it owns changes, sometimes
rapidly and unpredictably; (ii) the mutual fund is not successful in reaching
its goal because of its strategy or because it did not implement its strategy
properly; or (iii) unforeseen occurrences in the securities markets negatively
affect the mutual fund.
The following risks apply to the Portfolios. You should read this section
carefully before you invest in order to learn more about the Portfolio in which
you will invest.
Market Risk -
The Portfolios may invest substantially all of their assets in equity
securities. Prices of equity securities generally fluctuate more than those of
other securities. A Portfolio may experience a substantial or complete loss on
an individual stock. Market risk may affect a single issuer, industry or section
of the economy or may affect the market as a whole. The International Equity
Portfolio and Emerging Markets Portfolio invest primarily in foreign equity
securities. Foreign securities have additional risks, see "Foreign Securities
Risk" below.
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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 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. The securities of "midsized"
companies share many of these same risks.
Foreign Securities Risk -
Investments in foreign securities (including those denominated in U.S. dollars)
involve certain risks not typically associated with investments in domestic
issuers. The values of foreign securities are subject to economic and political
developments in the countries and regions where the companies operate, such as
changes in economic or monetary policies, and to changes in exchange rates.
Values may also be affected by restrictions on receiving the investment proceeds
from a foreign country.
In general, less information is publicly available about foreign companies than
about U.S. companies. Foreign companies are generally not subject to the same
accounting, auditing and financial reporting standards as are U.S. companies.
Some securities issued by foreign governments or their subdivisions, agencies
and instrumentalities may not be backed by the full faith and credit of the
foreign government. Even where a security is backed by the full faith and credit
of a foreign government, it may be difficult for a Portfolio to pursue its
rights against a foreign government in that country's courts. Some foreign
governments have defaulted on principal and interest payments.
In addition, a Portfolio's investments in foreign securities may be subject to
the risk of nationalization or expropriation of assets, imposition of currency
exchange controls or restrictions on the repatriation of foreign currency,
problems or complications with The European Markets conversion to the Euro,
confiscatory taxation, political or financial instability and diplomatic
developments which could effect the value of a Portfolio's investments in
certain foreign countries. Dividends or interest on, or proceeds from the sale
of, foreign securities may be subject to foreign withholding taxes, and special
U.S. tax considerations may apply.
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Emerging Markets Risk -
The risks of foreign investment are greater for investments in emerging markets.
Among others, these types of investments can include not only equity securities,
but also "Brady Bonds", bonds issued as a result of a debt restructuring plan,
Eurobonds, domestic and international bonds issued under the laws of a
developing country, and emerging market loans. Emerging market countries
typically have economic and political systems that are less fully developed, and
can be expected to be less stable than those of more advanced countries. Low
trading volumes may result in a lack of liquidity and in price volatility.
Emerging market countries may have policies that restrict investment by
foreigners, or that prevent foreign investors from withdrawing their money at
will.
Because some of the Portfolios may invest a significant amount of their total
assets in emerging market securities, investors should be able to tolerate
sudden, sometimes substantial fluctuations in the value of their investments. An
investment in any Portfolio that invests in emerging market securities, which
includes the Emerging Markets Portfolio and the International Equity Portfolio,
should be considered speculative.
Currency Risk -
Because certain Portfolios (such as the Emerging Markets Portfolio and the
International Equity Portfolio) may invest significantly in securities
denominated in foreign currencies, their value can be affected by changes in the
rates of exchange between those currencies and the U.S. dollar. Currency
exchange rates can be volatile and affected by, among other factors, the general
economics of a country, the actions of the U.S. and foreign governments or
central banks, the imposition of currency controls, and speculation. A security
may be denominated in a currency that is different from the currency where the
issuer is domiciled.
The Portfolios from time to time hedge a portion of their currency risk, using a
variety of techniques, including currency futures, forwards, or options.
However, these instruments may not always work as intended, and in specific
cases a Portfolio may be worse off than if had not used a hedging instrument.
For most emerging market currencies, there are not suitable hedging instruments
available.
Interest rate risk -
Each Portfolio is subject to interest rate risk, which is the possibility that
the market prices of the Portfolios' investments may decline due to an increase
in market interest rates. Generally, the longer the maturity of a fixed-income
security, the greater is the effect on its value when rates increase.
Certain securities pay interest at variable or floating rates. Variable rate
securities reset at specified intervals, while floating rate securities reset
whenever there is a change in a specified index rate. In most cases, these reset
provisions reduce the effect of market interest rates on the value of the
security. However, some securities do not track the underlying index directly,
but reset based on formulas that can produce an effect similar to leveraging;
others may provide for interest payments that vary inversely with market rates.
The market prices of these securities may fluctuate significantly when interest
rates change.
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Credit risk -
Each Portfolio is also subject to credit risk, i.e., the risk that an issuer of
securities will be unable to pay principal and interest when due, or that the
value of the security will suffer because investors believe the issuer is less
able to pay. This is broadly gauged by the credit ratings of the securities in
which each Portfolio invests. However, ratings are only the opinions of the
agencies issuing them and are not absolute guarantees as to quality.
Moody's Investors Service considers debt securities rated Baa to have
speculative characteristics. Debt securities rated below Baa/BBB are deemed by
the ratings agencies to be speculative and may involve major risk of exposure to
adverse conditions. These ratings may indicate that the securities are highly
speculative and may be in default or in danger of default as to principal and
interest.
Not all government securities are backed by the full faith and credit of the
United States. Some are backed only by the credit of the issuing agency or
instrumentality. Accordingly, there is at least a chance of default on these
securities.
Call risk -
Many fixed income securities, especially those issued at high interest rates,
provide that the issuer may repay them early. Issuers often exercise this right
when interest rates are low. Accordingly, holders of callable securities may not
benefit fully from the increase in value that other fixed-income securities
experience when rates decline. Furthermore, the fund reinvests the proceeds of
the payoff at current yields, which are lower than those paid by the security
that was paid off.
Special risks of high yield securities -
Securities rated below Baa/BBB, commonly known as junk bonds or high yield
securities, have speculative characteristics. Accordingly, there is a greater
possibility that the issuers of these securities may be unable to make timely
payments of interest and principal and thus default. If this happens, or is
perceived as likely to happen, the values of those investments will usually be
more volatile. These securities may be less liquid than higher-rated securities,
which means a Portfolio may have difficulty selling them at times, and may have
to apply a greater degree of judgment in establishing a price.
Although the Advisers consider credit ratings in making investment decisions,
they perform their own investment analysis and do not rely on ratings assigned
by the rating agencies. When a Portfolio buys lower rated debt, the achievement
of its goals depends more on the Advisers' ability than would be the case if a
Portfolio were buying investment grade debt.
Year 2000 -
Like other mutual funds (and most organizations around the world), the
Portfolios could be adversely affected by computer problems related to the year
2000. These could interfere with operations of the Portfolios, their Manager,
distributor or Adviser, or could impact companies in which the Portfolios
invest.
-11-
<PAGE>
While no one knows if these problems will have any impact on the Portfolios or
on financial markets in general, the manager and its affiliates are taking steps
to protect fund investors. These include efforts to determine that the problem
will not directly affect the systems used by major service providers.
Whether these steps will be effective can only be known for certain in the year
2000.
Derivatives -
A Portfolio may engage in a variety of transactions using "derivatives," such as
futures, options, warrants and swaps. Derivatives are financial instruments
whose value depends upon, or is derived from, the value of something else, such
as one or more underlying investments, indexes or currencies. Derivatives may be
traded on organized exchanges, or in individually negotiated transactions with
other parties (these are known as "over the counter"). A Portfolio may use
derivatives both for hedging and non-hedging purposes. Although the Advisers
have the flexibility to use these strategies, they may choose not to for a
variety of reasons, even under very volatile market conditions.
Derivatives involve special risks and costs and may result in losses to a
Portfolio. The successful use of derivatives requires sophisticated management
and a Portfolio will depend on the Advisers' ability to analyze and manage
derivatives transactions. The prices of derivatives may move in unexpected ways,
especially in abnormal market conditions. Some derivatives are "leveraged" and
therefore may magnify or otherwise increase investment losses to a Portfolio. A
Portfolio's use of derivatives may also increase the amount of taxes payable by
shareholders.
Other risks arise from the potential inability to terminate or sell derivatives
positions. A liquid secondary market may not always exist for a Portfolio's
derivatives positions at any time. In fact, many over-the-counter instruments
will not be liquid. Over-the-counter instruments also involve the risk that the
other party will not meet its obligations to a Portfolio.
Hedging -
The decision as to whether and to what extent a Portfolio will engage in hedging
transactions to hedge against such risks as credit risk, currency risk and
market risk will depend on a number of factors, including prevailing market
conditions, the composition of a Portfolio's portfolio and the availability of
suitable transactions. Accordingly, there can be no assurance that a Portfolio
will engage in hedging transactions at any given time or from time to time.
-12-
<PAGE>
Other Policies -
In addition to the main investment strategies described above, a Portfolio may
also make other types of investments, and therefore may be subject to other
risks. Some of these risks are described in the Portfolios' SAI.
At times the Advisers may judge that market conditions make pursuing a
Portfolio's investment strategies inconsistent with the best interests of its
shareholders. The Advisers then may temporarily use alternative strategies that
are mainly designed to limit a Portfolio's losses. Although the Advisers have
the flexibility to use these strategies, it may choose not to for a variety of
reasons, even in very volatile market conditions. These strategies may cause a
Portfolio to miss out on investment opportunities, and may prevent a Portfolio
from achieving its goal.
In addition, an Adviser may also keep a portion of a Portfolio's assets in cash
for temporary or defensive purposes, in order to meet redemption requests, or
for investment purposes.
- --------------------------------------------------------------------------------
PERFORMANCE DATA
- --------------------------------------------------------------------------------
None of the Portfolios have a full calendar year of performance to report. Since
each Portfolio's performance can be expected to vary from year to year, however,
there are risks of investing in the Portfolios.
- --------------------------------------------------------------------------------
FEES AND EXPENSES
- --------------------------------------------------------------------------------
The following tables describe the fees and expenses that you may pay if you buy
and hold shares of a Portfolio.
The examples beside the tables are intended to help you compare the cost of
investing in a Portfolio with the cost of investing in other mutual funds. The
examples assume that you invest $10,000 in a Portfolio for the time periods
indicated and then redeem all of your shares at the end of those periods. The
examples also assume that your investment has a 5% return each year and that the
Portfolio's operating expenses remain the same. Your actual costs may be higher
or lower.
-13-
<PAGE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------
LM Value Institutional Portfolio
- --------------------------------------------------------------------------------------------------
Institutional Financial Institutional Class Example
Class Intermediary Class ---------------------------
----- ------------------
<S> <C> <C> <C> <C> <C>
Shareholder Fees
(Fees paid directly 1 year $110
from your investment) None None 3 years $343
5 years $595
10 years $1317
Annual Fund
Operating Expenses
(Expenses that are Financial Intermediary
deducted from fund assets) Class Example
-----------------------
Management Fees .60% .60% 1 year $135
Distribution
(12b-1) Fees* None .25% 3 years $421
Other Expenses .48% .48% 5 years $729
Total Annual Fund 10 years $1601
Operating Expenses 1.08% 1.33%
Expense Reimbursement (.33%) (.33%)
Net Expenses** .75% 1.00%
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
LM Special Investment Institutional Portfolio
- --------------------------------------------------------------------------------------------------------------------
Institutional Financial Institutional Class Example
Class Intermediary Class ----------------------------
----- ------------------
<S> <C> <C> <C> <C> <C>
Shareholder Fees
(Fees paid directly 1 year $87
from your investment) None None 3 years $271
Annual Fund
Operating Expenses
(Expenses that are Financial Intermediary
deducted from fund assets) Class Example
Management Fees .60% .60% 1 year $112
Distribution
(12b-1) Fees* None .25% 3 years $350
Other Expenses .25% .25%
Total Annual Fund
Operating Expenses .85% 1.10%
Expense Reimbursement (.10%) (.10%)
Net Expenses** .75% 1.00%
</TABLE>
-14-
<PAGE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------
Brandywine Small Cap Value Portfolio
- -------------------------------------------------------------------------------------------------
Institutional Financial Institutional Class Example
Class Intermediary Class ----------------------------
----- ------------------
<S> <C> <C> <C> <C> <C>
Shareholder Fees
(Fees paid directly 1 year $642
from your investment) None None 3 years $1899
5 years $3118
10 years $6014
Annual Fund
Operating Expenses
(Expenses that are Financial Intermediary
deducted from fund assets) Class Example
-----------------------
Management Fees .65% .65% 1 year $686
Distribution
(12b-1) Fees* None .25% 3 years $1964
Other Expenses 5.82% 5.82% 5 years $3218
10 years $6170
Total Annual Fund
Operating Expenses 6.47% 6.72%
Expense Reimbursement (5.62%) (5.62%)
Net Expenses** .85% 1.10%
</TABLE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------
Batterymarch Emerging Markets Portfolio
- -------------------------------------------------------------------------------------------------
Institutional Financial Institutional Class Example
Class Intermediary Class ----------------------------
----- ------------------
<S> <C> <C> <C> <C> <C>
Shareholder Fees
(Fees paid directly 1 year $153
from your investment) None None 3 years $474
Annual Fund
Operating Expenses
(Expenses that are Financial Intermediary
deducted from fund assets) Class Example
-----------------------
Management Fees .65% .65% 1 year $178
Distributions
(12b-1) Fees* None .25% 3 years $551
Other Expenses .85% .85%
Total Annual Fund
Operating Expenses 1.50% 1.75%
Expense Reimbursement (.05%) (.05%)
Net Expenses ** 1.45% 1.70%
</TABLE>
-15-
<PAGE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Batterymarch International Equity Portfolio
- --------------------------------------------------------------------------------------------------------------------
Institutional Financial Institutional Class Example
Class Intermediary Class ---------------------------
----- ------------------
<S> <C> <C> <C> <C> <C>
Shareholder Fees
(Fees paid directly 1 year $107
from your investment) None None 3 years $334
Annual Fund
Operating Expenses
(Expenses that are Financial Intermediary
deducted from fund assets) Class Example
-----------------------
Management Fees .65% .65% 1 year $132
Distribution
(12b-1) Fees* None .25% 3 years $412
Other Expenses .40% .40%
Total Annual Fund
Operating Expenses 1.05% 1.30%
Expense Reimbursement (.05%) (.05%)
Net Expenses ** 1.00% 1.25%
<CAPTION>
- -------------------------------------------------------------------------------------------------
LM Total Return Institutional Portfolio
- -------------------------------------------------------------------------------------------------
Institutional Financial Institutional Class Example
Class Intermediary Class
----- ------------------
<S> <C> <C> <C> <C> <C>
Shareholder Fees
(Fees paid directly 1 year $87
from your investment) None None 3 years $271
Annual Fund
Operating Expenses
(Expenses that are Financial Intermediary
deducted from fund assets) Class Example
-----------------------
Management Fees .60% .60% 1 year $112
Distribution
(12b-1) Fees* None .25% 3 years $350
Other Expenses .25% .25%
Total Annual Fund
Operating Expenses .85% 1.10%
Expense Reimbursement (.10%) (.10%)
Net Expenses** .75% 1.00%
</TABLE>
* The 12b-1 fees shown in the tables reflect the amount to which the
Directors have currently limited payments under the Portfolios'
Distribution Plans. Pursuant to each Portfolio's Distribution Plan, the
Directors may increase the 12b-1 fees to 0.40% of average net assets
without shareholder approval. As a result of the 12b-1 fees, long-term
shareholders of the Financial Intermediary Class may pay more than the
economic equivalent of the maximum sales charge permitted by the National
Association of Securities Dealers, Inc.
** Reflects LMIA's contractual obligation to limit Portfolio expenses through
March 31, 2000.
"Other expenses" for the Value Institutional and Small Cap Value Portfolios
are based on actual expenses for the period from each Portfolio's inception
through March 31, 1999 (the fiscal year end). "Other Expenses" for the
other Portfolios are based on estimated amounts for the current
-16-
<PAGE>
fiscal year.
- --------------------------------------------------------------------------------
MANAGEMENT OF THE PORTFOLIOS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
General
- --------------------------------------------------------------------------------
LM Institutional Fund Advisors II, Inc. ("LMIFA II") is an open-end
management investment company comprised of a variety of separate investment
portfolios. LMIFA II was organized as a Maryland corporation on January 13,
1998.
- --------------------------------------------------------------------------------
Board of Directors
- --------------------------------------------------------------------------------
The business affairs of LMIFA II are managed under the direction of a
Board of Directors, and the Directors of LMIFA II are responsible for generally
overseeing the conduct of each Portfolio's business. Information about the
Directors and executive officers of LMIFA II may be found in the SAI.
The Board of Directors has retained the Manager and the Advisers to
manage the Portfolios' affairs, 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 the Manager. Each Portfolio pays the
Manager a monthly fee based on the average net assets of the Portfolio at the
following rates (shown prior to any waivers or reimbursements):
Annual Percentage of
Portfolio Average Net Assets
---------- ------------------
LM Value Institutional Portfolio 0.60%
LM Special Investment Institutional Portfolio 0.60%
Brandywine Small Cap Value Portfolio 0.65%
Batterymarch Emerging Markets Portfolio 0.65%
Batterymarch International Equity Portfolio 0.65%
LM Total Return Institutional Portfolio 0.60%
-17-
<PAGE>
The Manager is a Maryland corporation formed on February 20, 1998 and
is a wholly owned subsidiary of Legg Mason, Inc., a financial services holding
company.
In order to assist in carrying out its investment advisory
responsibilities, the Manager has retained the Advisers to render advisory
services to the Portfolios. The Manager pays the fees of the Advisers.
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 ADVISER ADVISER FEE
------------------------------------------------------------- -------------------------
<S> <C> <C> <C>
LM Value Institutional LMFA .55%
------------------------------------------------------------- -------------------------
LM Special Investment Institutional LMFA .55%
------------------------------------------------------------- -------------------------
Brandywine Small Cap Value Brandywine .60%
------------------------------------------------------------- -------------------------
Batterymarch Emerging Markets Batterymarch .60%
------------------------------------------------------------- -------------------------
Batterymarch International Equity Batterymarch .60%
------------------------------------------------------------- -------------------------
LM Total Return Institutional LMFA .55%
------------------------------------------------------------- -------------------------
</TABLE>
LMFA. LMFA, founded in 1982, acts as adviser or manager to eighteen
investment company portfolios which had aggregate assets under management of
approximately $13.947 billion as of March 31, 1999. LMFA's address is 100 Light
Street, Baltimore, Maryland 21202. LMFA is a subsidiary of Legg Mason, Inc.
Brandywine. Brandywine, founded in 1986 and now 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 Brandywine were
approximately $6.951 billion as of March 31, 1999. The address of Brandywine is
Three Christina Centre, Suite 1200, 201 N. Walnut Street, Wilmington, Delaware
19801.
Batterymarch. Batterymarch, founded in 1969 and now 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 $4.473 billion as of March 31, 1999. The address of
Batterymarch is 200 Clarendon Street, Boston, Massachusetts 02116.
Expense Limitations. As reflected in the tables contained in the Fees and
Expenses section, the Manager and the Advisers have until March 31, 2000
contractually agreed to waive their fees and/or reimburse each Portfolio in any
month to the extent a Portfolio's expenses (exclusive of taxes, interest,
deferred organizational expenses, 12b-1 fees, brokerage and extraordinary
expenses) for any class exceed during that month the annual rate set forth in
the applicable table.
-18-
<PAGE>
Any amounts waived or reimbursed in a particular fiscal year will be
subject to repayment by a Portfolio to the Manager and the Advisers to the
extent that from time to time during the next three fiscal years the repayment
will not cause a Portfolio's expenses to exceed the limit, if any, agreed to by
the Manager and the Advisers at that time.
Portfolio Managers. The names and business experience for the past five
years for each portfolio manager are set forth in the following chart.
<TABLE>
<CAPTION>
- ----------------------------------------------------------- -------------------------------------------------------------
Portfolio Manager and Business Experience
Portfolio (past five years)
- ----------------------------------------------------------- -------------------------------------------------------------
<S> <C> <C>
LM Value Institutional Portfolio William H. Miller, III is a portfolio manager and President
of LMFA Mr. Miller has been employed by LMFA as a portfolio
manager since 1982.
- ----------------------------------------------------------- -------------------------------------------------------------
LM Special Investment Institutional Portfolio William H. Miller, III (see above)
- ----------------------------------------------------------- -------------------------------------------------------------
Brandywine Small Cap Value Portfolio Henry F. Otto is a senior portfolio manager at Brandywine.
Mr. Otto has been employed by Brandywine as a portfolio
manager and analyst since 1987. Steven M. Tonkovich is a
portfolio manager and analyst at Brandywine. Mr. Tonkovich
has been employed by Brandywine as a portfolio manager and
analyst since 1989.
- ----------------------------------------------------------- -------------------------------------------------------------
Batterymarch Emerging Markets Portfolio Batterymarch emerging markets team
- ----------------------------------------------------------- -------------------------------------------------------------
Batterymarch International Equity Portfolio Batterymarch developed markets (EAFE) team
- ----------------------------------------------------------- -------------------------------------------------------------
LM Total Return Institutional Portfolio Nancy T. Dennin is a portfolio manager and
Senior Vice President of LMFA. Ms. Dennin has been
employed by LMFA since 1985 and has served as a portfolio
manager or co-manager for over six years.
- ----------------------------------------------------------- -------------------------------------------------------------
</TABLE>
-19-
<PAGE>
- --------------------------------------------------------------------------------
The Distributor
- --------------------------------------------------------------------------------
Legg Mason Wood Walker, Incorporated ("LMWW") is the distributor of
each Portfolio's shares. LMWW 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.
- --------------------------------------------------------------------------------
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 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 LMWW, 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.
- --------------------------------------------------------------------------------
Expenses
- --------------------------------------------------------------------------------
Each Portfolio pays its share of all expenses of LMIFA II that are not
assumed by the Manager, the 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).
- --------------------------------------------------------------------------------
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.
-20-
<PAGE>
- --------------------------------------------------------------------------------
Initial Investment
- --------------------------------------------------------------------------------
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 LM Institutional Advisers, Inc., at
the following address: P.O. Box 17635, Baltimore, Maryland 21297-1638. The
Portfolios have established minimum investment criteria that vary depending upon
which class of shares you wish to purchase. For Institutional Class shares,
investors must have at least $50 million in assets and invest in the aggregate
at least $1 million in the Portfolios and the portfolios of LM Institutional
Fund Advisors I, Inc. For Financial Intermediary Class shares, investors must
have at least $30 million in assets and invest in the aggregate at least $1
million in the Portfolios and the portfolios of LM Institutional Fund Advisors
I, Inc. The Portfolios reserve the right to revise the minimum investment
requirement and may waive it in their sole discretion.
A purchase order, together with payment in one of the forms described in
the following paragraphs, received by Boston Financial Data Services (the
"Transfer Agent" or "BFDS") 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 9:30 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. Before wiring federal funds, the investor must first
telephone the Portfolio at 1-888-425-6432 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 DOA #49046096
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.
Shares may also be purchased and paid for by the contribution of
eligible portfolio securities, subject in each case to approval by the Manager.
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
-21-
<PAGE>
wish to purchase Portfolio shares through the contribution of securities should
contact the Portfolio at 1-888-425-6432 for instructions. Investors should also
realize that at the time of contribution they may be required to 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 pursuant
to the class' distribution plan or otherwise. 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
Portfolios or to other parties in connection with the sale of shares. 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
- --------------------------------------------------------------------------------
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
- --------------------------------------------------------------------------------
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 LMWW 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 it determines that a pattern of
frequent purchases and sales made in response to short-term fluctuations in
share price appears evident.
-22-
<PAGE>
- --------------------------------------------------------------------------------
Retirement Plans
- --------------------------------------------------------------------------------
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 Portfolio. Signature guarantees may be required. See "Signature Guarantee"
below. All correspondence must include the account number and must be sent to:
LM Institutional Advisors, Inc.
P.O. Box 17635
Baltimore, Maryland 21297-1635
- --------------------------------------------------------------------------------
DISTRIBUTION PLANS
- --------------------------------------------------------------------------------
The Board of Directors 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 0.40% on an annual basis of the average daily net assets of
that class, LMWW, financial intermediaries and other parties that provide
services in connection with or are otherwise involved in the distribution of
shares or administration of plans or programs that use Portfolio shares as their
funding medium, and to reimburse certain other expenses and payments. Payments
under the Plans are currently limited to 0.25% of average daily net assets. For
more information regarding the Plans and their terms, see the SAI.
- --------------------------------------------------------------------------------
REDEMPTION OF SHARES
- --------------------------------------------------------------------------------
Portfolio shares may be redeemed through three methods: (1) by sending
a written request for redemption to LM Institutional Advisors, Inc. at P.O. Box
17635, Baltimore, Maryland 21297-1635 (2) by calling the Portfolio at
1-888-425-6432; or (3) by wire communication with the Transfer Agent. In each
case, the investor should first notify the Portfolio
-23-
<PAGE>
at 1-888-425-6432 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 for redemption as described below (a request
"in good order") 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. 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. The
Portfolios may refuse to effect redemption requests during periods permitted by
federal securities laws.
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 the Portfolio
for further details); and
4) The name, address, and account number to which the
redemption payment should be sent.
Payment of the redemption price normally will be made by wire one
business day 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 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.
-24-
<PAGE>
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 the Portfolio by
calling 1-888-425-6432.
Any Portfolio may elect to close any shareholder account when the
current value of the account is less than $1 million due to redemptions or
exchanges by the shareholder 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
- --------------------------------------------------------------------------------
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
- --------------------------------------------------------------------------------
Shareholders in any Portfolio may exchange their shares for shares of
the same class of any of the other Portfolios or of any of the portfolios
offered by LM Institutional Fund Advisors I, Inc., provided that the shares of
that class are being offered at the 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 without notice to the extent permitted by applicable
laws, 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 1-888-425-6432.
-25-
<PAGE>
- --------------------------------------------------------------------------------
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.
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 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.
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.
-26-
<PAGE>
- --------------------------------------------------------------------------------
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS
- --------------------------------------------------------------------------------
The LM Value Institutional Portfolio and the LM Total Return
Institutional Portfolio declare and pay dividends quarterly out of their net
investment income, if available, for that quarter. All other Portfolios declare
and pay dividends annually out of their net investment income, if available,
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.
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.
Reinvestment of dividends and other distributions 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 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.
-27-
<PAGE>
- --------------------------------------------------------------------------------
TAX INFORMATION
- --------------------------------------------------------------------------------
Each Portfolio intends to qualify or continue 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. Portfolio 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) will be taxable as long-term
capital gain.
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.
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 Internal Revenue Code of 1986 could subject a Portfolio to a
U.S. federal income tax or other charge on certain "excess distributions" with
respect to the investment, and on the proceeds from disposition of the
investment. A Portfolio may make an election to mark the gains (and to a limited
extent losses) in such investments "to the
-28-
<PAGE>
market" as though it had sold and repurchased its holdings in those passive
foreign investment companies on the last day of the Portfolio's taxable year.
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).
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
The financial highlights tables are intended to help you understand
each Portfolios' financial performance since the inception of the Portfolio's
operations. Certain information reflects financial results for a single fund
share. The total returns in the table represent the rate that an investor would
have earned or lost on an investment in the Portfolios, assuming reinvestment of
all dividends and distributions. This information has been audited by Ernst &
Young LLP, whose report, along with the Portfolios' financial statements, is
included in the Portfolios' annual report to shareholders, which is available
upon request.
LEGG MASON VALUE INSTITUTIONAL PORTFOLIO, INC.
FINANCIAL HIGHLIGHTS
Contained below is per share operating data for a share of common stock
outstanding, total investment return, ratios to average net assets and other
supplemental data. This information has been derived from information provided
in the financial statements.
<TABLE>
<CAPTION>
<S> <C> <C>
Institutional Class Intermediary Class
-----------------------------------------------------------
1999 * 1999 **
------------------ ---------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $10.00 $10.81
Net investment income 0.04 A 0.03 B
Net realized and unrealized gain
on investments 5.83 5.04
------------------ ---------------
Total from investment operations 5.87 5.07
------------------ ---------------
Distributions to shareholders from
net investment income (0.02) (0.02)
------------------ ---------------
Total distributions (0.02) (0.02)
------------------ ---------------
Net asset value, end of period $15.85 $15.86
================== ===============
Total return 58.81% C 46.95% C
RATIOS / SUPPLEMENTAL DATA:
Ratios to average net assets
Expenses 0.75% A, D 1.00% B,D
Net investment income 0.84% A, D 0.43% B,D
Portfolio turnover rate 28.6% D 28.6% D
Net assets, end of period
(in thousands) $115,798 $18,751
</TABLE>
- -------------------------------
* For the period September 22, 1998 (commencement of operations) to March 31,
1999.
** For the period October 22, 1998 (commencement of operations) to March 31,
1999.
A Net of fees waived and reimbursements made by the Advisor in excess of a
voluntary expense limitation of .75% until July 31, 1999. If no fees had
been waived by LMIA the annualized ratio of expenses to average daily net
assets for the period would have been 1.08%.
B Net of fees waived and reimbursements made by the Advisor in excess of a
voluntary expense limitation of 1.00% until July 31, 1999. If no fees had
been waived by LMIA the annualized ratio of expenses to average daily
net assets for the period would have been 1.33%.
C Not annualized
D Annualized
BRANDYWINE SMALL CAP VALUE PORTFOLIO
FINANCIAL HIGHLIGHTS
Contained below is per share operating data for a share of common stock
outstanding, total investment return, ratios to average net assets and other
supplemental data. This information has been derived from information provided
in the financial statements.
August 17, 1998 A
to
March 31, 1999
-------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $10.00
-------------------------
Net investment income B 0.04
Net realized and unrealized gain (loss)
on investments (1.47)
-------------------------
Total from investment operations (1.43)
-------------------------
Distributions to shareholders from
net investment income (0.02)
-------------------------
Total distributions (0.02)
-------------------------
Net asset value, end of period $8.55
=========================
Total Return -14.38% C
RATIOS / SUPPLEMENTAL DATA:
Ratios to average net assets
Expenses B 0.85% D
Net investment income B 0.71% D
Portfolio turnover rate 45.05% D
Net assets, end of period $1,945,597
- ----------------------------------------
A Commencement of operations
B Net of fees waived by LMIA pursuant to a voluntary expense limitation of
0.85% until July 31, 1999. If no fees had been waived and reimbursed by
LMIA, the annualized ratio of expenses to average daily net asset for the
period would have been 6.47%.
C Not annualized
D Annualized
-29-
<PAGE>-
- --------------------------------------------------------------------------------
APPENDIX A -- PRIOR PERFORMANCE OF ADVISERS' OTHER ACCOUNTS
- --------------------------------------------------------------------------------
The LM Value Institutional Portfolio and the Brandywine Small Cap Value
Portfolio have performance results only for the period from September 22, 1998,
and August 17, 1998, respectively, to March 31, 1999. The other four Portfolios
have not yet commenced operations and have no performance record of their own.
However, the Advisers have managed other client accounts that have investment
objectives and policies that are similar, but not necessarily identical to,
those of the Portfolios. Representative investment performance for these
accounts is stated below. The investment performance is shown on an annual total
return basis, with returns for periods of less than one year not annualized, and
on an average annual total return basis. The performance information is provided
through March 31, 1999.
The prior performance information shown is in two forms: (1) composites
of certain of the Adviser's separately managed accounts and (2) SEC-registered,
open-end investment companies. In each case, the account or accounts have
investment objectives and policies substantially similar (although not
necessarily identical) to those of the relevant Portfolio; were managed
throughout the periods shown using investment styles and strategies
substantially similar (although not necessarily identical) to those of the
relevant Portfolio; and, to the extent a composite of accounts is shown, the
composite includes all of the fully-discretionary, fee-paying accounts managed
by such Adviser during the periods shown using investment objectives, policies
and strategies substantially similar (although not necessarily identical) to
those of the relevant Portfolio.
The performance information for composites has been adjusted to give
effect to the Portfolios' estimated fees and expenses, before waivers and
reimbursements, for the Financial Intermediary Class shares as shown in the
tables beginning on page 20. The performance information for composites assumes
reinvestment of all dividends and proceeds from capital transactions and has
been prepared in accordance with the Performance Presentation Standards
established by the Association for Investment Management and Research ("AIMR
standards"), except for the deduction of estimated fees and expenses as noted
above. The performance results would be more favorable if they had been adjusted
for estimated fees and expenses of the Institutional Class shares of the
Portfolios. Accounts included in composites are generally not subject to the
diversification requirements, specific tax restrictions and investment
limitations imposed on each of the Portfolios by the 1940 Act or the Code. The
performance results for these accounts might have been adversely affected had
the accounts been subject to these requirements, restrictions and limitations.
Performance for SEC-registered, open-end investment companies is
calculated using the SEC's standardized total return formula, which is based
upon the change in value of an assumed initial investment of $1,000 from the
beginning through the end of a period and assumes reinvestment of all dividends
and other distributions. For periods of more than one year, the result is then
annualized and expressed as a percentage of the initial investment, and includes
the effect of operating expenses, including advisory fees. Information about the
investment objectives, policies, expenses and net assets of each of the
investment companies follows the performance information.
The method for calculating performance for the composites produces a
different result than if the performance were calculated using the SEC's method
for calculating the total return of an open-end investment company.
-1-
<PAGE>
A Portfolio's expenses, timing of purchases and sales of portfolio
securities, timing and availability of cash flows, cash positions (which are
typically greater for open-end investment companies than for separate accounts),
and brokerage commissions are some of the reasons that might cause performance
results of the Portfolio to vary from that of the accounts and/or investment
companies shown below. In particular, the large infusions of cash that are
typically associated with the commencement of operations of new mutual funds
such as the Portfolios, as well as differences in the amount of assets, which
can affect the ability and the manner in which security positions are
accumulated or liquidated, may also cause a Portfolio's performance to vary from
that of the accounts and/or investment companies shown below.
As noted above, the investment objective, policies, styles and
strategies of each Portfolio are not necessarily identical to those of the
relevant accounts and/or investment companies shown below. Again, for these and
other reasons, the performance of the Portfolios will vary from that of the
accounts and/or investment companies.
Prior Performance of Accounts Similar to the LM Value Institutional
Portfolio. The investment performance for the period from July 1, 1989 to June
30, 1999 of all accounts managed by LMFA and Legg Mason Capital Management, Inc.
("LMCM") an affiliate of LMFA that shares investment personnel with LMFA that
are substantially similar to the Portfolio is shown below. The benchmark index
to which the accounts are compared is the S&P 500 Index. The S&P 500 Index is an
unmanaged index representing the performance of 500 companies selected by S&P.
Although used as a benchmark, the Index's performance may not be comparable to
the accounts' performance because, unlike the performance of the accounts, the
Index's performance has not been adjusted for any fees or expenses.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Yearly Total Return
Year Ended June 30 Account Performance (%) S&P 500 Performance (%)
- ---------------------------------------- ------------------------------------- -------------------------------------
<S> <C> <C>
1999 42.41 22.77
- ---------------------------------------- ------------------------------------- -------------------------------------
1998 38.48 30.16
- ---------------------------------------- ------------------------------------- -------------------------------------
1997 52.16 34.71
- ---------------------------------------- ------------------------------------- -------------------------------------
1996 28.64 26.00
- ---------------------------------------- ------------------------------------- -------------------------------------
1995 27.59 26.07
- ---------------------------------------- ------------------------------------- -------------------------------------
1994 4.86 1.41
- ---------------------------------------- ------------------------------------- -------------------------------------
1993 13.95 13.63
- ---------------------------------------- ------------------------------------- -------------------------------------
1992 18.48 13.41
- ---------------------------------------- ------------------------------------- -------------------------------------
1991 -5.20 7.39
- ---------------------------------------- ------------------------------------- -------------------------------------
1990 4.80 16.49
- ---------------------------------------- ------------------------------------- -------------------------------------
</TABLE>
-2-
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------ -------------------------------------------------------------------------------
AVERAGE ANNUAL RETURNS
Period ended Account S&P 500
June 30 Performance (%) Performance (%)
- ------------------------------------ -------------------------------------------- ----------------------------------
<S> <C> <C>
1 Year 42.41 22.77
- ------------------------------------ -------------------------------------------- ----------------------------------
3 Year 44.92 29.12
- ------------------------------------ -------------------------------------------- ----------------------------------
5 Year 38.40 27.87
- ------------------------------------ -------------------------------------------- ----------------------------------
10 Year 22.26 18.78
- ------------------------------------ -------------------------------------------- ----------------------------------
</TABLE>
The number of accounts included in the composite has ranged from 1 to
12 over the relevant period and the aggregate assets of the accounts has ranged
from $637 million to $12.4 billion over the period. One of the accounts
included in the composite is the mutual fund described below. In addition, all
of the fully discretionary tax-exempt accounts of LMCM with assets greater than
$3 million are included in the composite after a period of three months and
after the account becomes fully invested. Taxable and non-fully discretionary
accounts and accounts that hold large amounts of cash are not managed by LMCM in
a manner that is substantially similar to the Portfolio. The inclusion of
taxable accounts, non-fully discretionary accounts, or accounts that hold large
amounts of cash
-3-
<PAGE>
might have adversely affected the performance of the composite. Accounts
included in the composite are generally not subject to the diversification
requirements, specific tax restrictions and investment limitations imposed on
the Portfolio by the 1940 Act or the Code. The performance results for these
accounts might have been adversely affected had the accounts been subject to
these requirements, restrictions and limitations. These potential differences do
not adversely affect the determination that the accounts included in this
composite are managed in a substantially similar manner to the Portfolio.
The investment performance for the period from July 1, 1989 to June 30, 1999 for
the Primary shares of the Legg Mason Value Trust ("Value Trust"), which has been
advised by LMFA since its inception, is shown below.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Yearly Total Return
- --------------------------------------------------------------------------------------------------------------------
Year Ended June 30 Account Performance (%) S&P 500 Performance (%)
- ---------------------------------------- ------------------------------------- -------------------------------------
<S> <C> <C>
1999 41.65 22.77
- ---------------------------------------- ------------------------------------- -------------------------------------
1998 38.48 30.16
- ---------------------------------------- ------------------------------------- -------------------------------------
1997 52.16 34.71
- ---------------------------------------- ------------------------------------- -------------------------------------
1996 28.64 26.00
- ---------------------------------------- ------------------------------------- -------------------------------------
1995 27.59 26.07
- ---------------------------------------- ------------------------------------- -------------------------------------
1994 4.86 1.41
- ---------------------------------------- ------------------------------------- -------------------------------------
1993 13.95 13.63
- ---------------------------------------- ------------------------------------- -------------------------------------
1992 18.48 13.41
- ---------------------------------------- ------------------------------------- -------------------------------------
1991 -5.20 7.39
- ---------------------------------------- ------------------------------------- -------------------------------------
1990 4.80 16.49
- ---------------------------------------- ------------------------------------- -------------------------------------
- ---------------------------------------- ---------------------------------------------------------------------------
AVERAGE ANNUAL RETURNS
- ---------------------------------------- ---------------------------------------------------------------------------
Period ended Account S&P 500
June 30 Performance (%) Performance (%)
- ---------------------------------------- ------------------------------------- -------------------------------------
<S> <C> <C>
1 Year 41.65 22.77
- ---------------------------------------- ------------------------------------- -------------------------------------
3 Year 43.98 29.12
- ---------------------------------------- ------------------------------------- -------------------------------------
5 Year 37.41 27.87
- ---------------------------------------- ------------------------------------- -------------------------------------
10 Year 21.29 18.78
- ---------------------------------------- ------------------------------------- -------------------------------------
</TABLE>
Value Trust, which commenced operations on April 16, 1982, is a
diversified open-end investment company. Value Trust's investment objective is
long-term growth of capital. Value Trust invests primarily in equity securities
that, in the adviser's opinion, offer the potential for capital growth. The
adviser follows a value discipline in selecting securities, and therefore seeks
to purchase securities at large discounts to the adviser's assessment of their
intrinsic value. Intrinsic value, according to the adviser, is the value of the
company measured, to different extents depending on the type of company, on
factors such as the value of its assets, the future value of its earnings, and
the costs to replicate the business. 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. The
adviser takes a long-term approach to investing, generally characterized by long
holding periods and low portfolio turnover. Value Trust generally invests in
companies with market capitalizations greater than $1 billion, but may invest
in companies of any size.
Value Trust may also invest in debt securities of companies having one or more
of the above characteristics. Value Trust may invest up to 25% of its net assets
in long-term debt securities. Up to 10% of its total assets may be invested in
debt securities rated below investment grade.
For temporary purposes, or when cash is temporarily available, Value Trust may
invest without limit in investment grade, short-term debt instruments, including
government, corporate and money market securities.
As of June 30, 1999, Value Trust had approximately $11.9 billion in assets. For
its fiscal year ended March 31, 1999, the Primary shares of Value Trust had a
total expense ratio of 1.69%.
The performance information does not represent the performance of the
Portfolio, which has been in operation only since September 22, 1998. The
performance information should not be considered a prediction of future
performance of the Portfolio. The Portfolio's performance may be higher or lower
than that shown.
Prior Performance of a registered investment company similar to the LM
Special Investment Institutional Portfolio. The investment performance for the
period from July 1, 1989 to June 30, 1999 for the Primary class of shares of the
Legg Mason Special Investment Trust ("Special Investment Trust") is shown below.
The benchmark index to which Special Investment Trust is compared is the S&P 500
Index. The S&P 500 Index is an unmanaged index representing 500 companies
selected by S&P. Although used as a benchmark, the Index's performance may not
be comparable to Special Investment Trust's performance since, unlike the
performance of Special Investment Trust, the Index's performance has not been
adjusted for any fees or expenses.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Yearly Total Return
- --------------------------------------------------------------------------------------------------------------------
Year Ended June 30 Account Performance (%) S&P 500 Performance (%)
- ---------------------------------------- ------------------------------------- -------------------------------------
<S> <C> <C>
1999 27.18 22.77
- ---------------------------------------- ------------------------------------- -------------------------------------
1998 38.48 30.16
- ---------------------------------------- ------------------------------------- -------------------------------------
1997 22.29 34.71
- ---------------------------------------- ------------------------------------- -------------------------------------
1996 22.52 26.00
- ---------------------------------------- ------------------------------------- -------------------------------------
1995 25.89 26.07
- ---------------------------------------- ------------------------------------- -------------------------------------
1994 8.85 1.41
- ---------------------------------------- ------------------------------------- -------------------------------------
1993 4.97 13.63
- ---------------------------------------- ------------------------------------- -------------------------------------
1992 25.72 13.41
- ---------------------------------------- ------------------------------------- -------------------------------------
1991 12.34 7.39
- ---------------------------------------- ------------------------------------- -------------------------------------
1990 14.37 16.49
- ---------------------------------------- ------------------------------------- -------------------------------------
</TABLE>
-4-
<PAGE>
<TABLE>
<CAPTION>
- ---------------------------------------- ---------------------------------------------------------------------------
AVERAGE ANNUAL RETURNS
- ---------------------------------------- ---------------------------------------------------------------------------
Period ended Account Russell 2000
June 30 Performance (%) Performance (%)
- ---------------------------------------- ------------------------------------- -------------------------------------
<S> <C> <C>
1 Year 27.18 22.77
- ---------------------------------------- ------------------------------------- -------------------------------------
3 Year 23.98 29.12
- ---------------------------------------- ------------------------------------- -------------------------------------
5 Year 21.16 27.87
- ---------------------------------------- ------------------------------------- -------------------------------------
10 Year 17.25 18.78
- ---------------------------------------- ------------------------------------- -------------------------------------
</TABLE>
Special Investment Trust, which commenced operations on December 30,
1985, is a diversified open-end investment company. Special Investment Trust's
investment objective is capital appreciation. Special Investment Trust invests
primarily in equity securities, and securities convertible into equity
securities, of companies whose market capitalization are typically classified as
small to mid sized. It also invests in "special situations" without regard to
market capitalization. Special situations are securities undergoing unusual or
possibly one-time developments that, in the opinion of the adviser, make them
attractive for investment. Such developments may include actual or anticipated:
sale or termination of an unprofitable part of the company's business; change
in the company's management or in management's philosophy; a basic change in the
industry in which the company operates; introduction of new products or
technologies; or the prospect or effect of acquisition or merger activities.
Special Investment Trust's adviser follows a value discipline in
selecting securities, and therefore seeks to purchase securities at large
discounts to the adviser's assessment of their intrinsic value. Intrinsic value,
according to the adviser, is the value of the company measured, to different
extents depending on the type of company, on factors such as the value of its
assets, the future value of its earnings, and the costs to replicate the
business. 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.
Special Investment Trust also invests in debt securities of companies
having one or more of the above characteristics. Special Investment Trust may
invest up to 35% of its net assets in debt securities rated below investment
grade. Special Investment Trust may invest up to 20% of its total assests in
securities of companies involved in actual or anticipated reorganizations or
restructurings.
For temporary defensive purposes, or when cash is temporarily
available, Special Investment Trust invest without limit in investment grade,
short-term debt instruments, including government, corporate and money market
securities. As of June 30, 1999, Special Investment Trust had approximately
$2.1 billion in assets. For its fiscal year ended March 31, 1999, the Primary
shares of Special Investment Trust had a total expense ratio of 1.84%.
The performance information does not represent the performance of the
Portfolio, which has not yet commenced operations and has no performance record
of its own. The performance of the Portfolio. The Portfolio's performance may be
higher or lower than that shown.
Prior Performance of Accounts Similar to the Brandywine Small Cap Value
Portfolio. The investment performance for the period from July 1, 1989 to June
30, 1999 of all accounts managed by Brandywine that are substantially similar to
the Portfolio is shown below. The benchmark index to which the accounts are
compared is the Russell 2000 Index. The Russell 2000 Index is an unmanaged index
representing the performance of the 2000 smallest of the 3000 largest
U.S.-domiciled corporations,
-5-
<PAGE>
ranked by market capitalization. Although used as a benchmark, the Index's
performance may not be comparable to the accounts' performance since, unlike the
performance of the accounts, the Index's performance has not been adjusted for
any fees or expenses.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
Yearly Total Return
- -----------------------------------------------------------------------------------------------------------------------
Composite
Year Ended June 30 Performance (%) Russell 2000 Performance (%)
- ------------------------------------------- -------------------------------- ------------------------------------------
<S> <C> <C>
1999 - 4.17 - 5.70
- ------------------------------------------- -------------------------------- ------------------------------------------
1998 23.28 19.90
- ------------------------------------------- -------------------------------- ------------------------------------------
1997 32.88 28.25
- ------------------------------------------- -------------------------------- ------------------------------------------
1996 19.43 21.12
- ------------------------------------------- -------------------------------- ------------------------------------------
1995 17.11 14.63
- ------------------------------------------- -------------------------------- ------------------------------------------
1994 6.48 7.60
- ------------------------------------------- -------------------------------- ------------------------------------------
1993 22.77 30.83
- ------------------------------------------- -------------------------------- ------------------------------------------
1992 18.25 20.35
- ------------------------------------------- -------------------------------- ------------------------------------------
1991 13.43 1.93
- ------------------------------------------- -------------------------------- ------------------------------------------
1990 -2.63 - 2.55
- ------------------------------------------- -------------------------------- ------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ---------------------------------------- ------------------------------------------------------------------------------
AVERAGE ANNUAL RETURNS
- ---------------------------------------- ------------------------------------------------------------------------------
Period ended Composite Russell 2000
June 30 Performance (%) Performance (%)
- ---------------------------------------- ------------------------------------- ----------------------------------------
<S> <C> <C>
1 Year - 4.17 -5.70
- ---------------------------------------- ------------------------------------- ----------------------------------------
3 Year 16.22 13.18
- ---------------------------------------- ------------------------------------- ----------------------------------------
5 Year 17.03 15.02
- ---------------------------------------- ------------------------------------- ----------------------------------------
10 Year 14.13 12.98
- ---------------------------------------- ------------------------------------- ----------------------------------------
</TABLE>
The number of accounts included in the composite has ranged from 2 to
21 over the relevant period and the aggregate assets of the accounts has ranged
from $5.6 million to $2 billion over the period. One of the accounts included in
the composite is a registered open-end investment company. Accounts included in
the composite are generally not subject to the diversification requirements,
specific tax restrictions and investment limitations imposed on the Portfolio by
the 1940 Act or the Code. The performance results for these accounts might have
been adversely affected had the accounts been subject to these requirements,
restrictions and limitations. In addition, the accounts included in the
composite have invested in so-called "micro" cap stocks to a greater extent than
the Portfolio is likely to. These
-6-
<PAGE>
potential differences do not adversely affect the determination that the
accounts included in this composite are managed in a substantially similar
manner to the Portfolio.
The performance information does not represent the performance of the
Portfolio, which has been in operation only since August 17, 1998. The
performance information should not be considered a prediction of future
performance of the Portfolio. The Portfolio's performance may be higher or lower
than that shown.
Prior Performance of Accounts Similar to the Batterymarch Emerging
Markets Portfolio. The investment performance for the period from January 1,
1994 to June 30, 1999 of all accounts managed by Batterymarch that are
substantially similar to the Portfolio is shown below. The benchmark index to
which the accounts are compared is the MSCI Emerging Markets Free Index with
Gross Dividends ("MSCI EMF"). The MSCI EMF is an unmanaged index representing
the performance of a market weighted aggregate of 26 individual emerging country
indices and takes into account local and market restrictions on share ownership
by foreigners. Although used as a benchmark, the Index's performance may not be
comparable to the accounts' performance since, unlike the performance of the
accounts, the Index's performance has not been adjusted for any fees or
expenses.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Yearly Total Return
- --------------------------------------------------------------------------------------------------------------------
Year Ended June 30 Composite Performance (%) MSCI EMF Performance (%)
- ---------------------------------------- ------------------------------------- -------------------------------------
<S> <C> <C>
1999 25.56 28.71
- ---------------------------------------- ------------------------------------- -------------------------------------
1998 -34.01 -39.08
- ---------------------------------------- ------------------------------------- -------------------------------------
1997 19.99 12.82
- ---------------------------------------- ------------------------------------- -------------------------------------
1996 10.61 8.47
- ---------------------------------------- ------------------------------------- -------------------------------------
1995 -7.51 0.01
- ---------------------------------------- ------------------------------------- -------------------------------------
1994 (beginning January 1, 1994) -10.82 -9.04
- ---------------------------------------- ------------------------------------- -------------------------------------
</TABLE>
-7-
<PAGE>
<TABLE>
<CAPTION>
- ---------------------------------------- ------------------------------------------------------------------------------
AVERAGE ANNUAL RETURNS
- ---------------------------------------- ------------------------------------- ----------------------------------------
Period ended Composite MSCI EMF
June 30 Performance (%) Performance (%)
- ---------------------------------------- ------------------------------------- ----------------------------------------
<S> <C> <C>
1 Year 25.56 28.71
- ---------------------------------------- ------------------------------------- ----------------------------------------
3 Year -0.19 -4.00
- ---------------------------------------- ------------------------------------- ----------------------------------------
5 Year 0.42 -0.83
- ---------------------------------------- ------------------------------------- ----------------------------------------
Since Inception
(January 1, 1994) -2.41 -2.70
- ---------------------------------------- ------------------------------------- ----------------------------------------
</TABLE>
The number of accounts included in the composite has ranged from 1 to
4 over the relevant period and the aggregate assets of the accounts has ranged
from $43 million to $1 billion over the period. One of the accounts included in
the composite is the mutual fund described below. Accounts included in the
composite are generally not subject to the diversification requirements,
specific tax restrictions and investment limitations imposed on the Portfolio by
the 1940 Act or the Code. The performance results for these accounts might have
been adversely affected had the accounts been subject to these requirements,
restrictions and limitations. These potential differences do not adversely
affect the determination that the accounts included in this composite are
managed in a substantially similar manner to the Portfolio. The performance of
the composite is calculated based on AIMR standards, including the performance
of the "mutual fund account" included in the composite, while the separate
performance of the mutual fund shown below is calculated according to the SEC's
method for calculating performance.
The investment performance for the period from May 28, 1996 to June 30,
1999 for the Primary shares of the Legg Mason Emerging Markets Trust ("Emerging
Markets Trust"), which has been advised by Batterymarch since its inception, is
shown below.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
Yearly Total Return
- -----------------------------------------------------------------------------------------------------------------------
MSCI EMF
Year Ended June 30 Account Performance (%) Performance (%)
- ------------------------------------------------- --------------------------------------- -----------------------------
<S> <C> <C>
1999 24.82 28.71
- ------------------------------------------------- --------------------------------------- -----------------------------
1998 -34.42 -39.08
- ------------------------------------------------- --------------------------------------- -----------------------------
1997 27.41 12.82
- ------------------------------------------------- --------------------------------------- -----------------------------
1996 (Inception of May 28, 1996) 0.20 -0.45
- ------------------------------------------------- --------------------------------------- -----------------------------
</TABLE>
-8-
<PAGE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
AVERAGE ANNUAL RETURNS
- ------------------------------------------------- --------------------------------------- -----------------------------
Period ended MSCI EMF
June 30 Account Performance (%) Performance (%)
- ------------------------------------------------- --------------------------------------- -----------------------------
<S> <C> <C>
1 Year 24.82 28.71
- ------------------------------------------------- --------------------------------------- -----------------------------
Since Inception
(May 28, 1996) 1.41 -3.71
- ------------------------------------------------- --------------------------------------- -----------------------------
</TABLE>
Emerging Markets Trust, which commenced operations on May 28, 1996, is
a diversified open-end investment company. Emerging Markets Trust's investment
objective is long-term capital appreciation. Emerging Markets Trust's adviser
intends to invest substantially all of the fund's assets in equity securities
and convertible securities of emerging market issuers.
Emerging Markets Trust intends to invest in Asia, Latin America, the
Indian Subcontinent, 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 investment in that country or region to
be inadvisable.
More than 25% of Emerging Market's Trust's total assets may be
denominated in a single currency or invested in securities of issuers located in
a single country.
The adviser focuses on higher-quality, dominant emerging markets
companies which the adviser believes to have strong growth prospects and
reasonable valuations, selected from a principal investable universe of
approximately 1,000 stocks. The adviser's emerging markets investment strategy
represents a distinctive combination of quantitative methodology and traditional
fundamental analysis. Traditional "on-the-ground" fundamental research is
combined by the adivser with tested quantitative valuation disciplines in those
markets where reliable data is available. In determining country allocation, the
adviser also merges quantitative and fundamental approaches. In markets with
reliable historical data, buy and sell decisions are driven by a combination of
quantitative valuations and the adviser's fundamental opinions. Stocks are sold
when the original reason for purchase no longer pertains, the fundamentals have
deteriorated or portfolio re-balancing warrants.
When cash is temporarily available, or for temporary defensive
purposes, when the adviser believes such action is warranted by abnormal market
or economic situations, the fund may invest without limit in cash and U.S.
dollar-denominated money market instruments, including repurchase agreements of
domestic issuers. Such securities will be rated investment grade or, if unrated,
will be determined by the adviser to be investment grade. As of June 30, 1999,
Emerging Markets Trust had approximately $74 million in assets. For its fiscal
year ended December 31, 1998, the Primary shares of Emerging Markets Trust had a
total expense ratio of 2.50% (after fee waivers; 2.78% in the absence of such
waivers).
THE PERFORMANCE INFORMATION DOES NOT REPRESENT THE PERFORMANCE OF THE
PORTFOLIO, WHICH HAS NOT YET COMMENCED OPERATIONS AND HAS NO PERFORMANCE RECORD
OF ITS OWN. THE PERFORMANCE INFORMATION SHOULD NOT BE CONSIDERED A PREDICTION OF
FUTURE PERFORMANCE OF THE PORTFOLIO. THE PORTFOLIO'S PERFORMANCE MAY BE HIGHER
OR LOWER THAN THAT SHOWN.
Prior Performance of Accounts Similar to the Batterymarch International
Equity Portfolio. The investment performance for the period from July 1, 1989 to
June 30, 1999 of all accounts managed by Batterymarch that are substantially
similar to the Portfolio is shown below. The benchmark index to which the
accounts are compared is the MSCI Europe Australia & Far East Index ("MSCI
EAFE"). The MSCI EAFE is an unmanaged index representing the performance of
share prices of approximately 1100 companies listed on stock exchanges around
the world. Twenty countries are included in the Index. Although used as a
benchmark, the Index's performance may not be comparable to the accounts'
performance since, unlike the performance of the accounts, the Index's
performance has not been adjusted for any fees or expenses.
-9-
<PAGE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Yearly Total Return
- ---------------------------------------- ------------------------------------- -------------------------------------
Year Ended June 30 Composite Performance (%) MSCI EAFE Performance (%)
- ---------------------------------------- ------------------------------------- -------------------------------------
<S> <C> <C>
1999 -5.93 7.92
- ---------------------------------------- ------------------------------------- -------------------------------------
1998 11.72 6.38
- ---------------------------------------- ------------------------------------- -------------------------------------
1997 18.51 13.16
- ---------------------------------------- ------------------------------------- -------------------------------------
1996 14.24 13.62
- ---------------------------------------- ------------------------------------- -------------------------------------
1995 1.20 1.95
- ---------------------------------------- ------------------------------------- -------------------------------------
1994 17.32 17.30
- ---------------------------------------- ------------------------------------- -------------------------------------
1993 6.60 20.70
- ---------------------------------------- ------------------------------------- -------------------------------------
1992 8.26 -0.31
- ---------------------------------------- ------------------------------------- -------------------------------------
1991 -15.96 -11.23
- ---------------------------------------- ------------------------------------- -------------------------------------
1990 25.04 3.53
- ---------------------------------------- ------------------------------------- -------------------------------------
<CAPTION>
- ---------------------------------------- ---------------------------------------------------------------------------
AVERAGE ANNUAL RETURNS
- ---------------------------------------- ------------------------------------- -------------------------------------
Period ended Composite MSCI EAFE
June 30 Performance (%) Performance (%)
- ---------------------------------------- ------------------------------------- -------------------------------------
<C> <C> <C>
1 Year -5.93 7.92
- ---------------------------------------- ------------------------------------- -------------------------------------
3 Year 7.59 9.12
- ---------------------------------------- ------------------------------------- -------------------------------------
5 Year 7.57 8.52
- ---------------------------------------- ------------------------------------- -------------------------------------
10 Year 7.44 6.92
- ---------------------------------------- ------------------------------------- -------------------------------------
</TABLE>
The number of accounts included in the composite has ranged from 4 to
11 over the relevant period and the aggregate assets of the accounts has ranged
from $705 million to $1.4 billion over the period. One of the accounts included
in the composite is the mutual fund described below. Accounts included in the
composite are generally not subject to the diversification requirements,
specific tax restrictions and investment limitations imposed on the Portfolio by
the 1940 Act or the Code. The performance results for these accounts might have
been adversely affected had the accounts been subject to these requirements,
restrictions and limitations. These potential differences do not adversely
affect the determination that the accounts included in this composite are
managed in a substantially similar manner to the Portfolio. The performance of
the composite is calculated based on AIMR standards, including the performance
of the "mutual fund account" included in the composite, while the separate
performance of the mutual fund shown below is calculated according to the SEC's
method for calculating performance.
-10-
<PAGE>
The investment performance for the period from February 17, 1995 to
March 31, 1999 for the Primary shares of the Legg Mason International Equity
Trust ("International Equity Trust"), which has been advised by Batterymarch
since its inception, is shown below.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
Yearly Total Return
- -----------------------------------------------------------------------------------------------------------------------
MSCI EAFE
Year Ended June 30 Account Performance (%) Performance (%)
- ------------------------------------------------- --------------------------------------- -----------------------------
<S> <C> <C>
1999 -7.03 7.92
- ------------------------------------------------- --------------------------------------- -----------------------------
1998 5.73 6.38
- ------------------------------------------------- --------------------------------------- -----------------------------
1997 18.74 13.16
- ------------------------------------------------- --------------------------------------- -----------------------------
1996 15.90 13.62
- ------------------------------------------------- --------------------------------------- -----------------------------
1995 (Inception February 17, 1995) 4.00 6.08
- ------------------------------------------------- --------------------------------------- -----------------------------
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
AVERAGE ANNUAL RETURNS
- -----------------------------------------------------------------------------------------------------------------------
Period ended
June 30 Account Performance (%) MSCI EAFE Performance (%)
- ------------------------------------------------- --------------------------------------- -----------------------------
<C> <C> <C>
1 Year -7.03 7.92
- ------------------------------------------------- --------------------------------------- -----------------------------
3 Years 5.29 9.12
- ------------------------------------------------- --------------------------------------- -----------------------------
Since Inception
(February 17, 1995) 8.13 11.16
- ------------------------------------------------- --------------------------------------- -----------------------------
</TABLE>
International Equity Trust, which commenced operations on February 17,
1995, is a diversified open-end investment company. International Equity Trust's
investment objective is maximum long-term total return. International Equity
Trust's adviser currently intends to invest substantially all of the fund's
assets in non-U.S. equity securities. The primary focus of the adviser is stock
selection, with a secondary focus on country allocation. The adviser uses a
bottom-up, quantitative stock selection process for the developed markets
portion of the fund's portfolio. The cornerstone of this process is a
proprietary stock selection model that ranks the 2,800 stocks in the fund's
principal investable universe by relative attractiveness on a daily basis. The
quantitative factors within this model are intended to measure growth, value,
fundamental expectations and technical indicators (i.e., supply and demand).
Because the same quantitative factors are not effective across all markets due
to individual market characteristics, the adviser adjusts the stock selection
model to include factors that its research indicates are effective, eliminating
factors that are not valid in a particular market. The adviser runs the stock
selection model and re-balances the portfolio daily, purchasing all stocks
ranked "buys" by the model and selling all stocks ranked "sells." Stocks are
sold when the original reason for purchase no longer pertains, the fundamentals
have deteriorated or portfolio re-balancing warrants.
Country allocations for the developed markets portion of the fund is
based on rankings generated by the adviser's proprietary country model. The
adviser examines securities from over 20 international stock markets, with
emphasis on several of the largest: Japan, the United Kingdom, France, Canada
and Germany. International Equity Trust may invest up to 35% of its total assets
in emerging market securities. The adviser's investment strategy for the
emerging markets portion of the fund represents a distinctive combination of
tested quantitative methodology and traditional fundamental analysis. The
emerging markets allocation focuses on higher-quality, dominant companies which
the adviser believes to have strong growth prospects and reasonable valuations.
Country allocation for the emerging markets portion of the portfolio also
combines quantitative and fundamental approaches.
International Equity Trust's investment portfolio will normally be
diversified across a broad range of industries and across a number of countries,
consistent with the objective of maximum total return. The adviser may also seek
to enhance portfolio returns through active currency hedging strategies. More
than 25% of International Equity Trust's total assets may be denominated in a
single currency or invested in securities of issuers located in a single
country.
When cash is temporarily available, or for temporary defensive
purposes, when the adviser believes such action is warranted by abnormal market
or economic situations, International Equity trust may invest without limit in
cash and U.S. dollar-denominated money market instruments, including repurchase
agreements of domestic issuers. Such securities will be rated investment grade
or, if unrated, will be determined by the fund's adviser to be investment grade.
-11-
<PAGE>
As of June 30, 1999, International Equity Trust had approximately $253 million
in assets. For its fiscal year ended December 31, 1998, the Primary shares of
International Equity Trust had a total expense ratio of 2.14%.
THE PERFORMANCE INFORMATION DOES NOT REPRESENT THE PERFORMANCE OF THE
PORTFOLIO, WHICH HAS NOT YET COMMENCED OPERATIONS AND HAS NO PERFORMANCE RECORD
OF ITS OWN. THE PERFORMANCE INFORMATION SHOULD NOT BE CONSIDERED A PREDICTION OF
FUTURE PERFORMANCE OF THE PORTFOLIO. THE PORTFOLIO'S PERFORMANCE MAY BE HIGHER
OR LOWER THAN THAT SHOWN.
Prior Performance of a Registered Investment Company Similar to the LM
Total Return Institutional Portfolio. The investment performance for the period
from July 1, 1989 to June 30, 1999 for the Primary class of shares of the Legg
Mason Total Return Trust, Inc. ("Total Return Trust") is shown below. The
benchmark index to which Total Return Trust is compared is the S&P 500 Index.
The S&P 500 Index is an unmanaged index representing the performance of 500
companies selected by S&P. Although used as a benchmark, the Index's performance
may not be comparable to Total Return Trust's performance since, unlike the
performance of Total Return Trust, the Index's performance has not been adjusted
for any fees or expenses.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Yearly Total Return
- --------------------------------------------------------------------------------------------------------------------
Year Ended June 30 Account Performance (%) S&P 500 Index Performance (%)
- ------------------------------------- ------------------------------------- ----------------------------------------
<S> <C> <C>
1999 3.45 22.77
- ------------------------------------- ------------------------------------- ----------------------------------------
1998 23.31 30.16
- ------------------------------------- ------------------------------------- ----------------------------------------
1997 38.14 34.71
- ------------------------------------- ------------------------------------- ----------------------------------------
1996 23.28 26.00
- ------------------------------------- ------------------------------------- ----------------------------------------
1995 11.83 26.07
- ------------------------------------- ------------------------------------- ----------------------------------------
1994 4.69 1.41
- ------------------------------------- ------------------------------------- ----------------------------------------
1993 14.66 13.63
- ------------------------------------- ------------------------------------- ----------------------------------------
1992 25.09 13.41
- ------------------------------------- ------------------------------------- ----------------------------------------
1991 2.45 7.39
- ------------------------------------- ------------------------------------- ----------------------------------------
1990 -0.84 16.49
- ------------------------------------- ------------------------------------- ----------------------------------------
</TABLE>
-12-
<PAGE>
<TABLE>
<CAPTION>
- ---------------------------------------- ---------------------------------------------------------------------------
AVERAGE ANNUAL RETURNS
- ---------------------------------------- ------------------------------------- -------------------------------------
Period ended Account S&P 500 Index
June 30 Performance (%) Performance (%)
- ---------------------------------------- ------------------------------------- -------------------------------------
<S> <C> <C>
1 Year 3.45 22.77
- ---------------------------------------- ------------------------------------- -------------------------------------
3 Year 20.78 29.12
- ---------------------------------------- ------------------------------------- -------------------------------------
5 Year 19.43 27.87
- ---------------------------------------- ------------------------------------- -------------------------------------
10 Year 14.00 18.78
- ---------------------------------------- ------------------------------------- -------------------------------------
</TABLE>
Total Return Trust, which commenced operations on November 21, 1985, is
a diversified open-end investment company. Total Return Trust's investment
objective is to obtain capital appreciation and current income in order to
achieve an attractive total investment return consistent with reasonable risk.
Total Return Trust invests primarily in securities that, in the adviser's
opinion, offer the potential for long-term capital growth and attractive current
income. Total Return Trust invests primarily in common stocks, debt securities,
and securities convertible into common stocks, but is not limited to these types
of securities. Total Return Trust may invest in securities that do not pay
current income but do, in the adviser's opinion, offer prospects for capital
appreciation and/or future income. The adviser follows a value discipline in
selecting securities. This means the adviser seeks to purchase securities at
large discounts to the adviser's assessment of their intrinsic value. For the
adviser, assessment of intrinsic value is an ongoing, dynamic process employing
both quantitative and qualitative analysis. The adviser typically sells a
security when, in the adviser's assessment, the security no longer appears to
offer long-term attractive total returns at reasonable risk, or when a more
compelling investment opportunity is found. The fund may invest in companies of
any size.
Total Return Trust may invest in money market securities for temporary
defensive purposes or when cash is temporarily available. Consistent with the
investment objective, Total Return Trust may also invest in debt securities when
the adviser believes the return on certain debt securities may equal or exceed
the return on equity securities. Total Return Trust may invest in debt
securities of any maturity of both foreign and domestic issuers without regard
to rating, and may invest its assets in such securities without regard to a
percentage limit. The adviser currently anticipates that under normal market
conditions, the fund will invest no more than 50% of its total assets in
intermediate-term and long-term debt securities and no more than 5% of its
total assets in debt securities not rated investment grade. As of June 30, 1999,
Total Return Trust had approximately $631 million in assets. For its fiscal year
ended March 31, 1999, the Primary shares of Total Return Trust had a total
expense ratio of 1.87%.
THE PERFORMANCE INFORMATION DOES NOT REPRESENT THE PERFORMANCE OF THE
PORTFOLIO, WHICH HAS NOT YET COMMENCED OPERATIONS AND HAS NO PERFORMANCE RECORD
OF ITS OWN. THE PERFORMANCE INFORMATION SHOULD NOT BE CONSIDERED A PREDICTION OF
FUTURE PERFORMANCE OF THE PORTFOLIO. THE PORTFOLIO'S PERFORMANCE MAY BE HIGHER
OR LOWER THAN THAT SHOWN.
-13-
<PAGE>
LM INSTITUTIONAL FUND ADVISORS II, INC.
- --------------------------------------------------------------------------------
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
- --------------------------------------------------------------------------------
(LOGO)
COUNSEL: INDEPENDENT AUDITORS:
ROPES & GRAY ERNST & YOUNG LLP
One International Place 2001 Market Street
Boston, MA 02110 Philadelphia, PA 19103
(617) 951-7000
- --------------------------------------------------------------------------------
DISTRIBUTOR:
Legg Mason Wood Walker, Incorporated
100 Light Street
P.O. Box 1476
Baltimore, MD 21203-1476
410-539-0000
800-822-5544
For investors who want more information about LMIFA II, the following documents
are available upon request.
Annual Reports
The annual and semi-annual reports of LMIFA II provides additional information
about their investments. In the annual report, you will also find a discussion
of the market conditions and investment strategies that significantly affected
the performance of LMIFA II during the last fiscal year.
STATEMENT OF ADDITIONAL INFORMATION
The SAI contains additional detailed information about LMIFA II and is
incorporated by reference into (legally part of) this prospectus.
Investors can receive free copies of these materials, request other information
about the Funds and make shareholder inquiries by calling Legg Mason Wood
Walker, Incorporated ("LMWW") at 1-800-822-5544.
Information about the Portfolios, including the SAI, can be reviewed and copied
at the SEC's public reference room in Washington, DC (phone 1-800-SEC-0330).
Reports and other information about the funds are available on the SEC's
Internet site at http://www.sec.gov. Investors may also write to: SEC, Public
Reference Section, Washington, DC 20549-6009. A fee will be charged for making
copies.
LMIFA II's Investment Company Act of 1940 file number is 811-8611.
-14-
<PAGE>
- --------------------------------------------------------------------------------
LM INSTITUTIONAL FUND ADVISORS II, INC. August 1, 1999
- --------------------------------------------------------------------------------
STATEMENT OF ADDITIONAL INFORMATION
LM Institutional Fund Advisors II, Inc. (the "Fund") is a no-load,
open-end diversified management investment company. LM Institutional Fund
Advisors II, Inc. currently consists of six separate professionally managed
investment portfolios which 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 August 1, 1999, 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,
Incorporated at 1-888-42-LMIFA.
<PAGE>
TABLE OF CONTENTS
------------------
<TABLE>
<CAPTION>
<S> <C> <C>
DEFINITIONS.......................................................................................................1
ADDITIONAL INFORMATION ABOUT INVESTMENT LIMITATIONS AND POLICIES..................................................2
ADDITIONAL INFORMATION ABOUT SECURITIES, INVESTMENT TECHNIQUES AND RELATED RISKS..................................4
FOREIGN SECURITIES.......................................................................................4
OPTIONS ON SECURITIES....................................................................................7
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS................................................................8
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
FOREIGN CURRENCY EXCHANGE TRANSACTIONS..................................................................15
PREFERRED STOCKS AND CONVERTIBLE SECURITIES.............................................................16
DEBT AND FIXED INCOME SECURITIES........................................................................16
COMMERCIAL PAPER AND OTHER SHORT-TERM INVESTMENTS.......................................................26
LOAN PARTICIPATIONS AND ASSIGNMENTS.....................................................................26
INDEXED SECURITIES AND STRUCTURED NOTES.................................................................27
FORWARD COMMITMENTS.....................................................................................28
RESTRICTED AND ILLIQUID SECURITIES......................................................................28
SECURITIES OF OTHER INVESTMENT COMPANIES................................................................29
REPURCHASE AGREEMENTS...................................................................................29
REVERSE REPURCHASE AGREEMENTS AND OTHER BORROWING.......................................................30
LOANS OF PORTFOLIO SECURITIES...........................................................................31
DURATION................................................................................................31
PORTFOLIO TURNOVER......................................................................................32
ALTERNATIVE INVESTMENT STRATEGIES.......................................................................32
NEW INVESTMENT PRODUCTS.................................................................................33
INVESTMENT POLICIES.....................................................................................33
RATINGS OF DEBT OBLIGATIONS.............................................................................33
REITs...................................................................................................33
VALUATION OF PORTFOLIO SHARES....................................................................................34
MANAGEMENT OF THE PORTFOLIOS.....................................................................................35
</TABLE>
-i-
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
Directors and Officers..................................................................................35
Manager and Advisers....................................................................................37
PURCHASES AND REDEMPTIONS........................................................................................42
EXCHANGE PRIVILEGE...............................................................................................42
PORTFOLIO TRANSACTIONS AND BROKERAGE.............................................................................43
ADDITIONAL TAX INFORMATION.......................................................................................44
OTHER INFORMATION................................................................................................45
PERFORMANCE INFORMATION..........................................................................................48
</TABLE>
-ii-
<PAGE>
DEFINITIONS
"Adviser" means the investment advisory firm that manages a Portfolio's
assets. LMFA, Brandywine and Batterymarch 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.
"Brandywine" means Brandywine Asset Management, Inc., Three Christina
Centre, Suite 1200, 201 N. Walnut Street, Wilmington, Delaware 19801. Brandywine
is the Adviser to the Brandywine Small Cap Value Portfolio.
"Code" means the Internal Revenue Code of 1986, as amended.
"Distributor" means the party that is responsible for the distribution
or sale of the Fund's shares. Legg Mason is the Fund's Distributor.
"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 the Fund who is not an
"interested person" (as defined in the 1940 Act) of the Fund.
"Legg Mason" means Legg Mason Wood Walker, Incorporated.
"LMFA" means Legg Mason Fund Adviser, Inc., 100 Light Street,
Baltimore, MD 21202. LMFA is the Adviser to the LM Value Institutional
Portfolio, the LM Special Investment Institutional Portfolio and the LM Total
Return Institutional Portfolio.
"Manager" means LM Institutional Advisors, Inc., 100 Light Street,
Baltimore, MD 21202.
"1940 Act" means the Investment Company Act of 1940, as amended.
<PAGE>
"NRSROs" means nationally recognized (or foreign) statistical rating
organizations, including Moody's Investors Service, Inc. ("Moody's") and
Standard & Poor's ("S&P").
"Plan" means the Fund's Distribution and Shareholder Services Plans.
"SEC" means the Securities and Exchange Commission.
"12b-1 Director" means a Director of the Fund who is an Independent
Director and who has no direct or indirect financial interest in the operation
of the Fund's Plans or the Fund's Underwriting Agreement.
ADDITIONAL INFORMATION ABOUT
INVESTMENT LIMITATIONS AND POLICIES
Each Portfolio has adopted certain fundamental investment limitations
that are set forth below.
Each Portfolio may:
(1) make loans, borrow money or 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.
(2) 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, its agencies or instrumentalities and repurchase agreements
thereon will not be considered to represent an industry.
(3) 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.
(4) 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
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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
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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.
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.
Fundamental investment restriction (2). "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.
Fundamental investment restriction (3). The 1940 Act prohibits a
diversified mutual fund from underwriting securities in excess of 25% of its
total assets.
Fundamental investment restriction (4). 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
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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 securities 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
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' securities 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
self-sufficiency and balance of payments position. Bank deposit insurance, if
any, may be subject to widely varying regulations and limits in foreign
countries.
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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
respect to investments in emerging market countries and, to the extent they are
available, the
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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 markets 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 ON SECURITIES
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.
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
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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
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 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.
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.
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Futures contracts may also be used for non-hedging purposes, such as to
simulate full investment in underlying securities while retaining a cash balance
for Portfolio 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.
A financial futures contract sale creates an obligation by the seller
to deliver the type of financial instrument called for in the contract in a
specified delivery month for a stated price. A financial futures contract
purchase creates an obligation by the purchaser to take delivery of the type of
financial instrument called for in the contract in a specified delivery month at
a stated price. The specific instruments delivered or taken, respectively, at
settlement date are not determined until on or near that date. The determination
is made in accordance with the rules of the exchange on which the futures
contract sale or purchase was made. Futures contracts are traded in the United
States only on commodity exchanges or boards of trade -- known as "contract
markets" -- approved for such trading by the Commodity Futures Trading
Commission (the "CFTC"), and must be executed through a futures commission
merchant or brokerage firm which is a member of the relevant contract market.
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.
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
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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. If the Portfolio is unable to enter into a closing
transaction, the amount of the Portfolio's potential loss is unlimited. In
general, 40% of the gain or loss arising from the closing out of a futures
contract traded on an exchange approved by the CFTC is treated as short-term
gain or loss, and 60% is treated as long-term gain or 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.
A Portfolio may purchase and write call and put options on futures
contracts it may buy or sell and enter into closing transactions with respect to
such options to terminate existing positions. In return for the premium paid,
options on futures contracts give the purchaser the right to assume a position
in a futures contract at the specified option exercise price at any time during
the period of the option. The Portfolio may use options on futures contracts in
lieu of writing or buying options directly on the underlying securities or
purchasing and selling the underlying futures contracts. For example, to hedge
against a possible decrease in the value of its portfolio securities, a
Portfolio may purchase put options or write call options on futures contracts
rather than selling futures contracts. Similarly, a Portfolio may purchase call
options or write put options on futures contracts as a substitute for the
purchase of futures contracts to hedge against a possible increase in the price
of securities which the Portfolio expects to purchase. Such options generally
operate in the same manner as options purchased or written directly on the
underlying investments.
As with options on securities, the holder or writer of an option may
terminate his position by selling or purchasing an offsetting option. There is
no guarantee that such closing transactions can be effected.
An index futures contract is a contract to buy or sell units of an
index at a specified future date at a price agreed upon when the contract is
made. Entering into a contract to buy units of an index is commonly referred to
as buying or purchasing a contract or holding a long position in the index.
Entering into a contract to sell units of an index is commonly referred to as
selling a contract or holding a short position. A unit is the current value of
the index. A Portfolio may enter into stock index futures contracts, debt index
futures
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contracts, or other index futures contracts appropriate to its objective. A
Portfolio may also purchase and sell options on index futures contracts.
For example, the Standard & Poor's 500 Composite Stock Price Index
("S&P 500") is composed of 500 selected common stocks, most of which are listed
on the New York Stock Exchange. The S&P 500 assigns relative weightings to the
common stocks included in the Index, and the value fluctuates with changes in
the market values of those common stocks. In the case of the S&P 500, contracts
are to buy or sell 500 units. Thus, if the value of the S&P 500 were $150, one
contract would be worth $75,000 (500 units x $150). The stock index futures
contract specifies that no delivery of the actual stocks making up the index
will take place. Instead, settlement in cash must occur upon the termination of
the contract, with the settlement being the difference between the contract
price and the actual level of the stock index at the expiration of the contract.
For example, if a Portfolio enters into a futures contract to buy 500 units of
the S&P 500 at a specified future date at a contract price of $150 and the S&P
500 is at $154 on that future date, the Portfolio will gain $2,000 (500 units x
gain of $4). If the Portfolio enters into a futures contract to sell 500 units
of the stock index at a specified future date at a contract price of $150 and
the S&P 500 is at $152 on that future date, the Portfolio will lose $1,000 (500
units x loss of $2).
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.
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(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 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
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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 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.
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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,
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.
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FOREIGN CURRENCY EXCHANGE TRANSACTIONS
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).
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
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
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transactions. 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 "Risks Associated with Futures and
Options" above. A Portfolio may also use other foreign currency exchange
instruments and techniques when available and deemed appropriate by its Adviser.
PREFERRED STOCKS AND CONVERTIBLE SECURITIES
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 (or another equity security) 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.
DEBT AND FIXED INCOME SECURITIES
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
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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. Subject to its
investment policies and applicable law, each of the Portfolios may invest in
these and other instruments.
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
securities issued by Fannie Mae); or (d) only the credit of the instrumentality
(such as securities issued by 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.
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
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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 or 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 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.
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.
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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, 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.
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.
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.
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Therefore, the effective 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.
Fannie Mae is a government-sponsored corporation owned entirely by
private stockholders. It is subject to general regulation by the Secretary of
Housing and Urban Development. Fannie Mae 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 Fannie Mae are guaranteed as to timely payment
of principal and interest only by Fannie Mae, 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, Fannie Mae 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, Fannie
Mae or GNMA, the timely payment of interest and principal is supported by the
government-
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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.
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 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. On the other hand, a decrease
in the rate of prepayments may extend the effective maturities of the
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 and other social
and demographic conditions.
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
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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. 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 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.
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 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
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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 comparable ratings of
other NRSROs 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 Adviser seeks to minimize the risks
of investing in all securities through diversification, in-depth credit analysis
and attention to current 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 for so long as the Portfolio's Adviser
determines appropriate for that Portfolio, having due regard for market
conditions, tax implications and other applicable factors. See the Appendix to
the Prospectus for a description of the ratings assigned to fixed income
securities by the rating agencies.
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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 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 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. Each Portfolio's Adviser will consider a security's quality and credit
rating when determining whether such security is an appropriate investment.
Subject to its investment objective, policies and applicable law, a Portfolio
may purchase a security with the lowest rating.
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. 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.
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
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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. 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. 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, 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.
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 Portfolio
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.
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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
Each of the Portfolios may invest or hold cash or other short-term
investments, including commercial paper. Commercial paper represents short-term
unsecured promissory notes issued in bearer form by banks or bank holding
companies, corporations and finance companies. 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. 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.
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 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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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,
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these 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 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.
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.
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.
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
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acquisition would cause the aggregate value of illiquid securities to exceed 15%
of the Portfolio's net assets.
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 Adviser the responsibility for determining whether a particular
security eligible for trading under this rule is "liquid." Investing in these
restricted securities could have the effect of increasing a Portfolio's
illiquidity if qualified purchasers become, for a time, uninterested in buying
these 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.
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.
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
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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 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. Repurchase Agreements may be viewed as a loan by a
Portfolio.
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. Reverse repurchase agreements may be
viewed as a borrowing by a Portfolio.
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.
The obligation to purchase securities on a specified future date
involves the risk that the market value of the securities that a Portfolio is
obligated to purchase may decline below the purchase price. In addition, in the
event the other party to the transaction files for bankruptcy, becomes insolvent
or defaults on its obligation, a Portfolio may be adversely affected.
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, a Portfolio will not make investments while its borrowing
(including reverse repurchase agreements but excluding dollar rolls) is in
excess of 5% of its total assets. To avoid potential leveraging effects of
dollar rolls, each Portfolio will segregate assets as required by the Investment
Company Act of 1940.
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
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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.
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
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 loan transaction
will default on its obligation and that the value of the collateral received may
decline before the Portfolio can dispose of it.
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.
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
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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.
PORTFOLIO TURNOVER
While it is impossible to predict portfolio turnover rates, the
turnover rates of the LM Value Institutional Portfolio and the Brandywine Small
Cap Value Portfolio, for the period ended March 31, 1999 on an annualized basis
were 28.6% and 45.1% respectively. The LM Special Investment Institutional
Portfolio, the Batterymarch Emerging Markets Portfolio, the Batterymarch
International Equity Portfolio and the LM Total Return Institutional Portfolio
currently expect that their average turnover rate will not exceed 100%, 50%, 75%
and 100% respectively.
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. Higher portfolio turnover rates, such
as those above 100%, are likely to result in higher brokerage commissions or
other transactions costs and could give rise to a greater amount of taxable
capital gains.
ALTERNATIVE INVESTMENT STRATEGIES
At times a Portfolio's 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
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 securities that
the Adviser believes present less risk to a Portfolio, including equity
securities, debt and fixed income securities, preferred stocks, U.S. Government
and agency obligations, cash or money market instruments, or in other securities
the Adviser considers consistent with such defensive strategies. As a result of
these strategies, the Batterymarch Emerging Markets Portfolio and the
Batterymarch International Equity Portfolio may invest up to 100% of their
assets in securities of U.S. issuers. It is impossible to predict when, or for
how long, a Portfolio will use these alternative strategies.
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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 limitations, each Portfolio expects to
invest in those new types of securities and instruments that its Adviser
believes may assist the Portfolio in achieving its investment objective.
INVESTMENT POLICIES
The investment objective of each of the Western Asset Core, the Western
Asset Limited Duration, the Western Asset Intermediate and the Western Asset
Money Market Portfolio are "fundamental." 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.
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.
REITs
REITs pool investors' funds for investment primarily in income
producing real estate or real estate related loans or interests. Under the
Internal Revenue Code of 1986 (the "Code"), a REIT is not taxed on income it
distributes to its shareholders if it complies with several requirements
relating to its organization, ownership, assets, and income and a requirement
that it generally distribute to its shareholders at least 95% of its taxable
income (other than net capital gains) for each taxable year. REITs can generally
be classified as Equity REITs, Mortgage REITs, and Hybrid REITs. Equity REITs,
which invest the majority of their assets directly in
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real property, derive their income primarily from rents. Equity REITs can also
realize capital gains by selling properties that have appreciated in value.
Mortgage REITs, which invest the majority of their assets in real estate
mortgages, derive their income primarily from interest payments. Hybrid REITS
combine the characteristics of both Equity REITs and Mortgage REITs.
While a Portfolio will not generally invest in real estate directly, it
may be subject to risks similar to those associated with the direct ownership of
real estate. These risks include declines in the value of real estate, risks
related to general and local economic conditions, dependency on management
skill, heavy cash flow dependency, possible lack of availability of mortgage
funds, overbuilding, extended vacancies of properties, increased competition,
increases in property taxes and operating expenses, changes in zoning laws,
losses due to costs resulting from the clean-up of environmental problems,
liability to third parties for damages resulting from environmental problems,
casualty or condemnation losses, limitations on rents, changes in neighborhood
values and in the appeal of properties to tenants and changes in interest rates.
In addition to these risks, REITs may be affected by changes in the
value of the underlying property owned by the trusts, or by the quality of any
credit they extend. Further, REITs are dependent upon management skills and
generally may not be diversified. REITs are also subject to heavy cash flow
dependency, defaults by borrowers and self-liquidation. In addition, REITs could
possibly fail to qualify for tax-free pass-through of income under the Code or
to maintain their exemptions from registration under the 1940 Act. The above
factors may also adversely affect a borrower's or a lessee's ability to meet its
obligations to the REIT. In the event of a default by a borrower or lessee, the
REIT may experience delays in enforcing its rights as a mortgagee or lessor and
may incur substantial costs associated with protecting its investments. In
addition to the foregoing risks, certain "special purpose" REITs in which a
Portfolio invests may invest their assets in specific real estate sectors, such
as hotel REITs, nursing home REITs or warehouse REITs, and are therefore subject
to the risks associated with adverse developments in any such sectors.
VALUATION OF PORTFOLIO SHARES
As described in the Prospectus, securities owned by any of the
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.
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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.
MANAGEMENT OF THE PORTFOLIOS
Directors and Officers
The Fund's officers are responsible for the operation of the Fund under
the direction of its Board of Directors. The officers and Directors of the Fund
and their principal occupations during the past five years are set forth below.
An asterisk (*) indicates Interested Directors.
The business address of Mr. Livingston is 117 Colorado Boulevard,
Pasadena, California 91105. The business address of each officer and Director is
100 Light Street, Baltimore, Maryland 21202, unless otherwise indicated.
Catherine H. Bray, 41, Director; Portfolio Manager, T. Rowe Price, June
1989-May 1996.
*Edmund J. Cashman, 61, Director; Senior Executive Vice President and
Director of Legg Mason, Inc.; Officer and/or Director of various other
affiliates of Legg Mason, Inc.; President or Vice Chairman of the Board and
Director/Trustee of four Legg Mason funds.
*W. Curtis Livingston, III, 53, Director and Vice Chairman; Director of
Western Asset Management Company (investment management firm) ("Western Asset"),
March 1999-present; President, Director and Chief Executive Officer of Western
Asset, December 1980-March 1999; President, Pacific American Income Shares,
Inc.; Director, Legg Mason, Inc.; Director and President, LM Institutional Fund
Advisors I, Inc.; Director and Vice Chairman of LM Institutional Advisors, Inc.
Emmett J. Rice, 78, Director; Governor, Federal Reserve Central Bank,
June 1979-February 1987; Director, Jardine-Fleming China Region Fund, July
1992-present; Director, Albermarle Corporation and Tredegar Industries, Inc.
*Edward A. Taber, 54, Chairman, Director and President; Senior
Executive Vice President of Legg Mason, Inc.; Director of the Legg Mason Value
Trust, Inc., the Legg Mason Total Return Trust, Inc. and the Legg Mason Special
Investment Trust, Inc.; Trustee of the Legg Mason Tax-Free Income Fund and the
Legg Mason Cash Reserve Trust; President of the Legg Mason Income Trust, Inc.,
the Legg Mason Global Trust, Inc., LM Institutional Fund Advisors II, Inc. and
the Legg Mason Investors Trust, Inc.; Director of Western Asset, Western Asset
Global Management, Limited, Bartlett & Co., Batterymarch Financial Management,
Inc., Gray,
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Seifert & Co., Inc. (investment adviser), GSH & Co. Inc. (investment adviser
holding company), Fairfield Group, Inc. (investment adviser), LM Institutional
Advisors, Inc., and Legg Mason Fund Adviser, Inc.; formerly director of Taxable
Fixed Income Division of T. Rowe Price Associates, Inc.
Robert M. Tarola, 48, Director; Senior Vice President and Chief
Financial Officer, Helix Health, Inc., July 1996-present; Partner, Price
Waterhouse LLP, May 1974-June 1996.
Linda R. Taylor, 52, Director.
Marie K. Karpinski, 49, Vice President and Treasurer; Vice President
and Treasurer of twenty-one Legg Mason/Bartlett funds (open-end investment
companies), 1986-present; Vice President and Treasurer of LM Institutional Fund
Advisors I, Inc.; Assistant Treasurer of Pacific American Income Shares, Inc.
(closed-end investment company), 1988-present; Treasurer of Legg Mason Fund
Adviser, Inc., March 1986-present; Vice-President of Legg Mason Wood Walker,
Incorporated., 1992-present; Assistant Vice-President of Legg Mason Wood Walker,
Incorporated, 1989-1992.
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 of $500 per
Portfolio and a per meeting fee of $500 per Portfolio.
The following table provides certain information relating to the
compensation of the Fund's Directors and senior executive officers.
<TABLE>
<CAPTION>
- ------------------------------------------ ---------------------------------- --------------------------------------
Aggregate Compensation From the Fund
Name of Person and Position Total Compensation From the Fund* and Complex Paid to Directors**
- ------------------------------------------ ---------------------------------- --------------------------------------
<S> <C> <C>
Catherine H. Bray
Director $13,125 $13,125
- ------------------------------------------ ---------------------------------- --------------------------------------
Edmund J. Cashman
Director 0 0
- ------------------------------------------ ---------------------------------- --------------------------------------
W. Curtis Livingston, III Director 0 0
- ------------------------------------------ ---------------------------------- --------------------------------------
Emmett J. Rice
Director $13,125 $13,125
- ------------------------------------------ ---------------------------------- --------------------------------------
Edward A. Taber III
Director and President 0 0
- ------------------------------------------ ---------------------------------- --------------------------------------
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------ ---------------------------------- --------------------------------------
<S> <C> <C>
Robert M. Tarola
Director $ 6,125 $ 6,125
- ------------------------------------------ ---------------------------------- --------------------------------------
Linda R. Taylor
Director $13,125 $13,125
- ------------------------------------------ ---------------------------------- --------------------------------------
</TABLE>
*Represents fees paid to each person during the fiscal period ended March 31,
1999.
**Represents aggregate compensation paid to each person during the fiscal period
ended March 31, 1999. LM Institutional Fund Advisors I, Inc., an open-end
investment company which offers eleven separate portfolios, is also part of the
fund complex.
- --------------------------------------------------------------------------------
Manager and Advisers
The Manager. The Manager, a wholly owned subsidiary of Legg Mason,
Inc., a financial services holding company, serves as investment manager to the
Portfolios of the Fund under separate Investment Management Agreements dated
June 3, 1998 between the Manager and the Fund (the "Management Agreements"). The
Management Agreements were most recently approved by the Board of Directors,
including a majority of Independent Directors, on March 27, 1998, other than the
LM Total Return Institutional Portfolio, which was most recently approved by the
Board of Directors, including a majority of Independent Directors, on May 29,
1998.
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 Fund's investments to the
Advisers.
Each Portfolio pays all of its other expenses which are not assumed by
the Manager. 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.
-37-
<PAGE>
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 Fund, and may be terminated immediately upon the mutual written
consent of the Manager and the Fund.
For the period ended March 31, 1999, the Manager has received $62,027
(net of fees waived $78,044) and $0 (net of fees waived $7,607 and additional
reimbursements) for the LM Value Institutional Portfolio and the Brandywine
Small Cap Value Portfolio, respectively. In addition, the Manager reimbursed an
additional $58,187 to the Brandywine Small Cap Value Portfolio.
Advisers
LMFA. LMFA, a wholly owned subsidiary of Legg Mason, Inc., serves as
Adviser to the LM Value Institutional Portfolio, the LM Special Investment
Institutional Portfolio and the LM Total Return Institutional Portfolio under
separate Investment Advisory Agreements dated June 3, 1998 between LMFA and the
Manager (the "LMFA Advisory Agreements"). The LMFA Advisory Agreements were most
recently approved by the Board of Directors, including a majority of the
Independent Directors, on March 27, 1998, other than for the LM Total Return
Institutional Portfolio, which was most recently approved by the Board of
Directors, including a majority of Independent Directors, on May 29, 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.
-38-
<PAGE>
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.
Brandywine. Brandywine, a wholly owned subsidiary of Legg Mason, Inc.,
serves as the Adviser to the Brandywine Small Cap Value Portfolio under an
Investment Advisory Agreement dated June 3, 1998 between Brandywine and the
Manager (the "Brandywine Advisory Agreement"). The Brandywine Advisory Agreement
was most recently approved by the Board of Directors, including a majority of
the Independent Directors, on March 27, 1998.
Under the Brandywine Advisory Agreement, Brandywine 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.
Brandywine also is responsible for the compensation of Directors and officers of
the Fund who are employees of Brandywine or its affiliates. Brandywine receives
from the Manager for its services to the Portfolios' an advisory fee as
described in the Prospectus.
Under the Brandywine Advisory Agreement, Brandywine 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 Brandywine 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 Brandywine Advisory Agreement terminates automatically upon
assignment and is terminable with respect to the Portfolio 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 Brandywine, on not less than 60
days' notice, and may be terminated immediately upon the mutual written consent
of the parties.
Batterymarch. Batterymarch, a wholly owned subsidiary of Legg Mason,
Inc., serves as the Adviser to the Batterymarch Emerging Markets Portfolio and
the Batterymarch International Equity Portfolio under separate Investment
Advisory Agreements dated June 3, 1998 between Batterymarch and the Manager (the
"Batterymarch Advisory Agreements"). The Batterymarch Advisory Agreements were
most recently approved by the Board of Directors, including a majority of the
Independent Directors, on March 27, 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
-39-
<PAGE>
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 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.
Distributor
Legg Mason, 100 Light Street, P.O. Box 1476, Baltimore, MD 21203-1476,
acts as distributor of the Fund's shares pursuant to an Underwriting Agreement
with the Fund dated June 3, 1998 (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 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.
The Fund has adopted a Plan for each Portfolio 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 Plan, the aggregate fees may not exceed an annual rate of 0.40% of each
Portfolio's average daily net assets attributable to Financial Intermediary
Class shares. Payments under the Plan are currently limited to 0.25% of average
daily net assets. The Board of Directors may increase the limit up to 0.40% of
average daily net assets as provided by the Plan without obtaining shareholder
approval. 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
-40-
<PAGE>
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 the sole shareholder of the Financial
Intermediary Class of each Portfolio on June 3, 1998. Legg Mason may pay all or
a portion of the fee to its investment executives.
The 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. The 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 the
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.
The Plan was most recently approved on June 3, 1998.
In accordance with Rule 12b-1, the 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.
For the fiscal period ended March 31, 1999, the LM Value Institutional
Portfolio and the Brandywine Small Cap Value Portfolio paid Legg Mason $15,579
and $0, respectively in distribution and service fees under the Plan from assets
attributable to Financial Intermediate Class shares. During the period ended
March 31, 1999 Legg Mason incurred the following expenses with respect to
Financial Intermediate Class shares:
<TABLE>
<CAPTION>
- ------------------------------------ --------------------------------------- ---------------------------------------
LM Value Institutional Brandywine Small Cap Value
- ------------------------------------ --------------------------------------- ---------------------------------------
<S> <C> <C> <C>
Advertising, printing and mailing
prospectuses to prospective
shareholders $0 $0
- ------------------------------------ --------------------------------------- ---------------------------------------
Compensation to underwriters $0 $0
- ------------------------------------ --------------------------------------- ---------------------------------------
Compensation to broker-dealers $15,679 $0
- ------------------------------------ --------------------------------------- ---------------------------------------
Compensation to sales personnel $0 $0
- ------------------------------------ --------------------------------------- ---------------------------------------
</TABLE>
-41-
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
- ------------------------------------------ ---------------------------------- --------------------------------------
Interest, carrying or other
financial charges $0 $0
- ------------------------------------ --------------------------------------- ---------------------------------------
Other $0 $0
- ------------------------------------ --------------------------------------- ---------------------------------------
Total Expenses $15,679 $0
- ------------------------------------ --------------------------------------- ---------------------------------------
</TABLE>
PURCHASES AND REDEMPTIONS
The Fund reserves the right to modify the mail, telephone or wire
redemption services or to terminate the telephone or wire redemption services
described in the Prospectus at any time without prior notice to shareholders.
The Fund also reserves 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 Fund normally utilizes is
restricted or an emergency, as defined by rules and regulations of the SEC,
exists, making disposal of the Fund's investments or determination of its 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 Fund's shareholders.
The Fund agrees 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 or of the portfolios of LM
Institutional Fund Advisors I, Inc., provided that such shares 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
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 regular
trading on the Exchange. If the request is received by the transfer agent after
such close of regular trading, 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.
-42-
<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 Management Agreements and Advisory Agreements, the
Manager and 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
-43-
<PAGE>
larger volume transactions may produce better executions and prices. During the
fiscal period ended March 31, 1999 the LM Value Institutional Portfolio and the
Brandywine Small Cap Value Portfolio paid $122,652 and $9,266, respectively, in
brokerage commissions on transactions. No brokerage commissions were paid by any
Portfolio to affiliated persons.
ADDITIONAL TAX INFORMATION
General Requirements for "Pass-Through" Treatment
In order to qualify or 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) 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 but not limited to
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,
securities of other regulated investment companies 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 not 10% of
the outstanding voting securities of such issuer; 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 and
securities of other regulated investment companies) of any one issuer and two or
more issuers which the Portfolio controls and which are engaged in the same,
similar, or related trades or businesses.
If a Portfolio fails to distribute in a calendar year substantially all
of its ordinary income for such year and substantially all of its capital gain
net income for the one-year period ending October 31 (or later if the Portfolio
is permitted and so elects), plus any retained amount from the prior year, the
Portfolio will be subject to a 4% excise tax on the undistributed amounts. A
distribution declared by a Portfolio in October, November or December of any
year and payable to shareholders of record on a date in such months 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. Each Portfolio intends generally to make
distributions sufficient to avoid imposition of the 4% excise tax.
Original Issue Discount
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<PAGE>
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 dispositions, which would increase or
decrease the Portfolio's investment company taxable income and/or net capital
gain.
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 that meet certain
holding period requirements. 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.
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
LMIFA II was incorporated in Maryland on January 13, 1998. Each
Portfolio is an open-end, diversified management company. The Directors of LMIFA
II 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. Establishment and
offering of additional portfolios or classes of shares of a portfolio will not
alter the rights of the Fund's shareholders.
LMIFA II has a total of 7 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
-45-
<PAGE>
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).
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 Portfolio, each shareholder is entitled to receive
his or her pro rata share of the net assets of that 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 any class of
Portfolio as of July 28, 1999:
% of Ownership
Name and Address July 28, 1999
- ---------------- -------------
LM Value Institutional Portfolio
Financial Intermediary Class
Bank One 21.93%
LSU Foundation
451 Florida Street
Baton Rouge, LA 70801-1775
National Automatic Sprinkler 10.72%
Metal Trades Pension Fund
8000 Corporate Drive
Landover, MD 20785-2239
IBEW Local 728 Pension Fund 6.48%
c/o Administrative Services Inc.
7990 SW 117th Avenue
Miami, FL 33183-3845
Trans National Group Services L 5.54%
2 Charlesgate West
Boston, MA 02113-3340
James W. Moore Trust 5.44%
1617 Hendry Street, Suite 306
Fort Myers, FL 33901-2970
Penn Prime Trust 6.25%
530 Walnut Street, PA 4944
Philadelphia, PA 19106-3620
West Palm Beach Electrical Workers 11.37%
c/o Administrative Services Inc.
7990 SW 117th Avenue
Miami, FL 33183-3845
American Express Trust Co. 7.59%
FBO American Express Trust
Retirement Services Plan
Post Office Box 534 - N10/996
Minneapolis, MN 55440-0534
Institutional Class
Charles Schwab & Co. Inc. 44.15%
Special Custody Account
Benefit of Customers
101 Montgomery Street
San Francisco, CA 94104-4122
Firstar Trust Company Trust 6.91%
United Communications Corp. Ret.
515 East Wisconsin Avenue
Milwaukee, WI 53202-4604
Schneider National Inc. 6.62%
401 K Savings and Retirement Pla
510 Marquette, Suite 500
Minneapolis, MN 55401-1118
Donaldson Lufkin & Jenrette Securities 6.56%
Post Office Box 2052
Jersey City, NJ 07303-2052
Houston Muni Employees Pension 6.36%
1111 Bagby Street, Suite 1450
Houston, TX 77002-2546
LM Special Investment Institutional Portfolio
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<PAGE>
Institutional Class
LM Institutional Advisers, Inc. 100%
Brandywine Small Cap Value Portfolio
Institutional Class
The Hilda E. Bretzlaff Foundation 88.08%
Village Center Mall
400 North Main Street, Suite 303
Milford, MI 48381-1928
Metro Suburbia Inc. 6.26%
4 New York Plaza, 2nd Floor
New York, NY 10004-2413
Paul Scherer & Co. 5.00%
4 New York Plaza, 2nd Floor
New York, NY 10004-2413
Batterymarch Emerging Markets Portfolio
Institutional Class
LM Institutional Advisers, Inc. 100%
Batterymarch International Equity Portfolio
Institutional Class
LM Institutional Advisers, Inc. 100%
LM Total Return Portfolio
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<PAGE>
Institutional Class
LM Institutional Advisers, Inc. 100%
Because they hold more than 25% of the outstanding voting securities of
a Fund, LM Institutional Advisers, Inc. may be deemed to control the LM Special
Investment Institutional, Batterymarch Emerging Markets, Batterymarch
International Equity and LM Total Return Portfolios and LSU Foundation and the
Hilda E. Bretzloff Foundation may be deemed to control the LM Value
Institutional and Brandwine Small Cap Portfolios. The Officers and Directors of
the Funds own in the aggregate less than 1% of the outstanding shares of each
Portfolio.
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)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 LM Value Institutional Portfolio's total returns as of March 31,
1999 were as follows:
Average
Cumulative Annual
Total Return Total Return
Life of Portfolio(A) 58.81%(Institutional Class) N/A
48.32%(Financial Intermediary Class)
(A) Portfolio's inception - September 22, 1998 (Institutional Class) and October
22, 1998 (Financial Intermediary Class).
The Brandywine Small Cap Value Portfolio's total returns as of March
31, 1999 were as follows:
Average
-48-
<PAGE>
Cumulative Annual
Total Return Total Return
Life of Portfolio(A) -14.38% N/A
(A) Portfolio's inception - August 17, 1998 (Institutional Class).
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 other investments.
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 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).
-49-
<PAGE>
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 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 $88 billion as of March 31,
1999.
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
-50-
<PAGE>
State Street Bank and Trust Company, P.O. Box 1790, Boston,
Massachusetts 02105, serves as custodian of the Fund's 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 Fund
reserves the right, upon 60 days' written notice, to make other charges to
investors to cover administrative costs.
Independent Auditors
Ernst & Young, LLP 2001 Market Street, Philadelphia, Pennsylvania
19103, serve as the Fund's independent auditors. The financial statements and
financial highlights of the Portfolios appearing or incorporated by reference in
the Fund's Prospectus, this Statement of Additional Information and Registration
Statement have been audited by Ernst & Young LLP, independent auditors, to the
extent indicated in their reports thereon also appearing elsewhere herein and in
the Registration Statement or incorporated by reference. Such financial
statements have been included herein or incorporated herein by reference in
reliance upon such reports given upon the authority of such firm as experts in
accounting and auditing.
Financial Statements
The report of independent auditors, financial statements and financial
highlights for the fiscal year ended March 31, 1999 for the LM Value
Institutional and Brandywine Small Cap Value Portfolios included in the
Portfolios' Annual Report is hereby incorporated by reference into this
Statement of Additional Information.
Legal Counsel
Ropes & Gray, Boston, MA, serves as legal counsel to the Fund.
LM Institutional Fund Advisors II, Inc.
Statement of Assets and Liabilities
March 31, 1999
LM Special Batterymarch Batterymarch LM Total
Investment Emerging International Return
Institutional Markets Equity Institutional
Portfolio Portfolio Portfolio Portfolio
----------------------------------------------------
Assets:
Cash $15,000 $15,000 $15,000 $15,000
----------------------------------------------------
Net Assets $15,000 $15,000 $15,000 $15,000
====================================================
Offering and redemption
price per share; 1,500
shares Institutional
Class outstanding for
each Portfolio
(7,000,000,000 shares
authorized; $.001 par
value) $10.00 $10.00 $10.00 $10.00
====================================================
See accompanying Notes to Statement of Assets and Liabilities.
LM Institutional Fund Advisors II, Inc.
Notes to Statement of Assets and Liabilities
March 31, 1999
A. LM Insitutional Fund Advisors II, Inc. (the "Corporation"), consisting of the
LM Value Institutional Portfolio, LM Special Investment Institutional
Portfolio (formerly LMFA Mid Cap Portfolio), Brandywine Small Value Cap
Portfolio, Batterymarch Emerging Markets Portfolio, Batterymarch
International Equity Portfolio, and LM Total Return Institutional Portfolio,
is registered under the Investment Company Act of 1940, as amended, as an
open-end management investment company. These financial statements and
related notes pertain to the LM Special Investment Institutional Portfolio,
Batterymarch Emerging Markets Portfolio, Batterymarch International Equity
Portfolio, and LM Total Return Institutional Portfolio (the "Portfolios").
The Portfolios have had no operations other than those matters related to
their organization and registration. LM Institutional Advisors, Inc.
("LMIA"), a wholly owned subsidiary of Legg Mason, Inc. (a financial services
holding company), has provided the initial capital for the Portfolios by
purchasing 1,500 shares of each at $10.00 per share. Such shares were
acquired for investment and can be disposed of only by redemption. Legg Mason
Wood Walker, Incorporated ("Legg Mason"), a wholly owned subsidiary of Legg
Mason, Inc. and a member of the New York Stock Exchange, acts as the
distributor of the Portfolios' shares.
B. Costs incurred in connection with the organization of the Corporation were
borne by LMIA. Costs to be incurred by the Portfolios in connection with the
offering of their shares will be deferred and will be amortized over a one
year period beginning on the date each Portfolio commences operations.
-51-
<PAGE>
Report of Independent Auditors
To the Shareholders and Board of Directors
LM Institutional Fund Advisors II,Inc.
We have audited the accompanying statement of assets and liabilities of LM
Institutional Fund Advisors II, Inc., (the "Fund") (comprised of, respectively,
the LM Special Investment Institutional Portfolio, Batterymarch Emerging Markets
Portfolio, Batterymarch International Equity Portfolio, and LM Total Return
Institutional Portfolio (the "Portfolios")) as of March 31, 1999. This statement
of assets and liabilities is the responsibility of the Fund's management. Our
responsibility is to express an opinion on this statement of assets and
liabilities based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the statement of assets and liabilities is free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the statement of assets and
liabilities. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the statement of assets and liabilities referred to above
presents fairly, in all material respects, the financial position of each of the
respective Portfolios of LM Institutional Fund Advisors II, Inc. at March 31,
1999, in conformity with generally accepted accounting principles.
Ernst & Young LLP
Philadelphia, Pennsylvania
July 27, 1999
-52-
<PAGE>
PART C. OTHER INFORMATION
Item 23. Exhibits
(a) Articles of Amendment and Restatement -- previously filed (1)
(i) Articles Supplementary -- previously filed (1)
(b) Bylaws -- previously filed (1)
(c) Instruments Defining Rights of Security Holders -- none
(d) (1) Investment advisory agreements --
(i) LM Value Institutional -- previously filed (1)
(ii) LM Special Investment Institutional --
previously filed (1)
(iii) LM Total Return Institutional -- previously
filed (1) (iv) Brandywine Small Cap Value --
previously filed (1) (v) Batterymarch Emerging
Markets -- previously filed (1) (vi) Batterymarch
International Equity -- previously filed (1)
(2) Investment management agreements
(i) LM Value Institutional -- previously filed (1)
(ii) LM Special Investment Institutional --
previously filed (1)
(iii) LM Total Return Institutional-- previously
filed (1) (iv) Brandywine Small Cap Value --
previously filed (1) (v) Batterymarch Emerging
Markets -- previously filed (1) (vi) Batterymarch
International Equity -- previously filed (1)
(e) Underwriting Agreement -- previously filed (1)
(f) Bonus or profit sharing contracts -- none
(g) Custodian agreement -- previously filed (2)
(h) (i) Transfer Agent agreement -- previously filed (2)
(ii)Administration agreements -- none
(i) Opinion of counsel -- previously filed (1)
(j) Other opinions, appraisals, rulings and consents Auditor's
consent -- filed herewith
(k) Financial statements omitted from Item 22 -- not applicable
(l) Agreement for providing initial capital -- none
(m) Plan pursuant to Rule 12b-1
(i) LM Value Institutional -- previously filed (1) (ii) LM Mid
Cap Institutional -- previously filed (1) (iii) LM Total
Return Institutional -- previously filed (1) (iv) Brandywine
Small Cap Value -- previously filed (1) (v) Batterymarch
Emerging Markets -- previously filed (1) (vi) Batterymarch
International Equity -- previously filed (1)
(n) Financial Data Schedules -- not applicable
(o) Multiple Class (Rule 18F-3) Plan -- previously filed (1)
-5-
<PAGE>
(1) Incorporated herein by reference to corresponding Exhibit of
Pre-Effective Amendment No. 1 to the Registration Statement,
SEC File No. 333-44423, filed June 4, 1998.
(2) Incorporated herein by reference to corresponding exhibit of
Post-Effective Amendment No. 2 to the Registration Statement,
SEC File No. 333-44423, filed June 2, 1999.
Item 24. Persons Controlled by or under Common Control with Registrant
-------------------------------------------------------------
LM Institutional Advisors, Inc. may be deemed to control the
LM Special Investment Institutional Portfolio, Batterymarch
Emerging Markets Portfolio, Batterymarch International Equity
Portfolio and LM Total Return Institutional Portfolio as a
result of its ownership of 100% of the outstanding shares of
each such Fund.
Item 25. 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.
Item 26. Business and Other Connections of Investment Adviser
----------------------------------------------------
I. Legg Mason Fund Adviser, Inc. ("Fund Adviser"), adviser for the LM
Value Institutional Portfolio, LM Special Investment Institutional Portfolio,
and LM Total Return Institutional 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
with the Securities and Exchange Commission as in effect on the date hereof
(Registration Number 801-16958) and is incorporated herein by reference.
II. Batterymarch Financial Management, Inc. ("Batterymarch"), adviser
to the Batterymarch Emerging Markets Portfolio and Batterymarch International
Equity Portfolio, is
-6-
<PAGE>
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 with
the Securities and Exchange Commission as in effect on the date hereof
(registration number 801-48035) and is incorporated herein by reference.
III. Brandywine Asset Management, Inc. ("Brandywine"), adviser to the
Brandywine Small Cap Value Portfolio, is a registered investment adviser
incorporated on [ ]. Brandywine is engaged primarily in the investment advisory
business. Information as to the officers and directors of Brandywine is included
in its Form ADV filed with the Securities and Exchange Commission as in effect
on the date hereof (registration number 801- ) and is incorporated herein by
reference.
Item 27. 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.
LM Institutional Fund Advisors I, Inc.
LM Institutional Fund Advisors II, Inc.
Legg Mason Focus 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").
<TABLE>
<CAPTION>
Position and Positions and
Name and Principal Offices with Offices with
Business Address* Underwriter - LMWW Registrant
- ------------------ --------------------------- -------------------
<S> <C> <C> <C>
Raymond A. Mason Chairman of the Board None
John F. Curley, Jr. the Retired Vice Chairman of the Board None
</TABLE>
-7-
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
James W. Brinkley President and Director None
Edmund J. Cashman, Jr. Director None
Senior Executive Vice President
Richard J. Himelfarb Director None
Senior Executive Vice President
Edward A. Taber III Director None
Senior Executive Vice President
Robert A. Frank Director None
Executive Vice President
Robert G. Sabelhaus Director None
Executive Vice President
Charles A. Bacigalupo Senior Vice President, Secretary None
and Director
F. Barry Bilson Senior Vice President and Director None
Thomas M. Daly, Jr. Senior Vice President and Director None
Jerome M. Dattel Senior Vice President and Director None
Robert G. Donovan Senior Vice President and Director None
Thomas E. Hill Senior Vice President and Director None
One Mill Place
Easton, MD 21601
</TABLE>
-8-
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Arnold S. Hoffman Senior Vice President and Director None
1735 Market Street
Philadelphia, PA 19103
Carl Hohnbaum Senior Vice President and None
24th Floor Director
Two Oliver Plaza
Pittsburgh, PA 15222
William B. Jones, Jr. Senior Vice President and Director None
1747 Pennsylvania
Avenue, N.W.
Washington, D.C. 20006
Laura L. Lange Senior Vice President and Director None
Marvin H. McIntyre Senior Vice President and Director None
1747 Pennsylvania
Avenue, N.W.
Washington, D.C. 20006
Mark I. Preston Senior Vice President and Director None
Joseph Sullivan Senior Vice President and Director None
M. Walter D'Alessio, Jr. Director None
1735 Market Street
Philadelphia, PA 19103
W. William Brab Senior Vice President None
Deepak Chowdhury Senior Vice President None
255 Alhambra Circle
Coral Gables, FL 33134
Harry M. Ford, Jr. Senior Vice President None
Dennis A. Green Senior Vice President None
William F. Haneman, Jr. Senior Vice President None
One Battery Park Plaza
New York, New York 10005
Theodore S. Kaplan Senior Vice President and None
</TABLE>
-9-
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
General Counsel
Seth J. Lehr Senior Vice President None
1735 Market St
Philadelphia, PA 19103
Horace M. Lowman, Jr. Senior Vice President and None
Asst. Secretary
Robert L. Meltzer Senior Vice President None
One Battery Park Plaza
New York, NY 10004
Jonathan M. Pearl Senior Vice President None
1777 Reisterstown Rd.
Pikesville, MD 21208
John A. Pliakas Senior Vice President None
125 High Street
Boston, MA 02110
Gail Reichard Senior Vice President None
Timothy C. Scheve Senior Vice President and Treasurer None
Elisabeth N. Spector Senior Vice President None
Robert J. Walker, Jr. Senior Vice President None
200 Gibraltar Road
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
</TABLE>
-10-
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
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 and Treasurer None
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
</TABLE>
-11-
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
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
</TABLE>
- ----------
* All addresses are 100 Light Street, Baltimore, Maryland 21202, 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 28. Location of Accounts and Records
--------------------------------
State Street Bank and Trust Company
P.O. Box 1713
Boston, Massachusetts 02105
-12-
<PAGE>
Item 29. Management Services -- none
----------------------
Item 30. Undertakings -- none
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.
certifies that it meets all of the requirements for effectiveness of this
Registration Statement under rule 485(b) under the Securities Act and has duly
caused this 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 30th day of July, 1999.
LM INSTITUTIONAL FUND ADVISORS II, INC.
By: /s/ Marie K. Karpinski
-----------------------------
Marie K. Karpinski
Vice President
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.
Signature Title Date
- --------- ----- ----
/s/ W. Curtis Livingston, III Director July 30, 1999
- -----------------------------
W. Curtis Livingston, III*
/s/ Edward A. Taber, III President and Director July 30, 1999
- ------------------------
Edward A. Taber, III*
/s/ Catherine H. Bray Director July 30, 1999
- ---------------------
Catherine H. Bray*
/s/ Edmund J. Cashman, Jr. Director July 30, 1999
- --------------------------
Edmund J. Cashman, Jr.*
/s/ Emmett J. Rice Director July 30, 1999
- ------------------
Emmett J. Rice*
/s/ Robert M. Tarola Director July 30, 1999
- --------------------
Robert M. Tarola*
/s/ Linda R. Taylor Director July 30, 1999
- -------------------
Linda R. Taylor*
-13-
<PAGE>
/s/ Marie K. Karpinski Vice President July 30, 1999
- ---------------------- and Treasurer
Marie K. Karpinski
* By: /s/ Marie K. Karpinski
-------------------------
Marie K. Karpinski
Attorney-in Fact Pursuant to
Powers of Attorney Filed
previously and for Herself
14
<PAGE>
Exhibit Index
-------------
Exhibit 23(j) Consent of Independent Auditors
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the reference to our firm under the captions "Financial
Highlights" in the Prospectus and "Independent Auditors" and "Financial
Statements" in the Statement of Additional Information and to the use of our
report dated July 27, 1999, in this Post-Effective Amendment Number 4 to the
Registration Statement (Form N-1A)(No. 333-44423) of LM Institutional Fund
Advisors II, Inc.
We also consent to the incorporation by reference therein of our report dated
May 6, 1999 included in the 1999 Annual Report to shareholders of LM Value
Institutional Portfolio and Brandywine Small Cap Value Portfolio.
ERNST & YOUNG LLP
Philadelphia, Pennsylvania
July 27, 1999
