STATEMENT OF ADDITIONAL INFORMATION FOR June 30, 1999
JOHNSONFAMILY INTERMEDIATE FIXED INCOME FUND
JOHNSONFAMILY LARGE CAP EQUITY FUND
JOHNSONFAMILY SMALL CAP EQUITY FUND
JOHNSONFAMILY INTERNATIONAL EQUITY FUND
JOHNSONFAMILY FUNDS, INC.
4041 North Main Street
Racine, Wisconsin 53402
This Statement of Additional Information is not a prospectus and should
be read in conjunction with the Prospectus of JohnsonFamily Funds, Inc., dated
June 30, 1999. Requests for copies of the Prospectus should be made by writing
to JohnsonFamily Funds, Inc., P.O. Box 1177, Milwaukee, Wisconsin 53201-1177,
Attention: Secretary.
The following financial statements are incorporated by reference to the
Annual Report, dated October 31, 1998, of JohnsonFamily Funds, Inc. (File No.
811-8627) as filed with the Securities and Exchange Commission on December 29,
1998.
Schedule of Investments
JohnsonFamily Intermediate Fixed Income Fund
JohnsonFamily Large Cap Equity Fund
JohnsonFamily Small Cap Equity Fund
JohnsonFamily International Equity Fund
Statements of Assets and Liabilities
Statements of Operations
Statements of Changes in Net Assets
Financial Highlights
Notes to Financial Statements
Report of Independent Public Accountants
Shareholders may obtain a copy of the Annual Report, without charge, by
calling (800) 276-8272.
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JOHNSONFAMILY FUNDS, INC.
Table of Contents
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Page No.
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FUND HISTORY AND CLASSIFICATION................................................1
INVESTMENT RESTRICTIONS........................................................1
INVESTMENT CONSIDERATIONS......................................................3
DIRECTORS AND OFFICERS OF THE CORPORATION.....................................18
OWNERSHIP OF MANAGEMENT AND PRINCIPAL SHAREHOLDERS............................20
INVESTMENT ADVISER, ADMINISTRATOR, CUSTODIAN AND TRANSFER AGENT...............20
DETERMINATION OF NET ASSET VALUE..............................................23
PERFORMANCE INFORMATION.......................................................24
DISTRIBUTION OF SHARES........................................................26
ALLOCATION OF PORTFOLIO BROKERAGE.............................................28
TAXES ........................................................................29
SHAREHOLDER MEETINGS..........................................................32
CAPITAL STRUCTURE.............................................................33
DESCRIPTION OF SECURITIES RATINGS.............................................33
INDEPENDENT ACCOUNTANTS.......................................................38
No person has been authorized to give any information or to make any
representations other than those contained in this Statement of Additional
Information and the Prospectus dated June 30, 1999, and, if given or made, such
information or representations may not be relied upon as having been authorized
by JohnsonFamily Funds, Inc.
This Statement of Additional Information does not constitute an offer
to sell securities.
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FUND HISTORY AND CLASSIFICATION
JohnsonFamily Funds, Inc. (the "Corporation") is an open-end,
diversified management investment company consisting of four separate
portfolios, the JohnsonFamily Large Cap Equity Fund (the "Large Cap Equity
Fund"), JohnsonFamily Small Cap Equity Fund (the "Small Cap Equity Fund"),
JohnsonFamily International Equity Fund (the "International Equity Fund") and
JohnsonFamily Intermediate Fixed Income Fund (the "Fixed Income Fund").
JohnsonFamily Funds, Inc. is registered under the Investment Company Act of
1940. JohnsonFamily Funds, Inc. was incorporated as a Maryland corporation on
January 27, 1998.
INVESTMENT RESTRICTIONS
Each of the Fixed Income Fund, Large Cap Equity Fund, Small Cap Equity
Fund and International Equity Fund has adopted the following investment
restrictions which are matters of fundamental policy and cannot be changed
without approval of the holders of the lesser of: (i) 67% of the Fund's shares
present or represented at a stockholders meeting at which the holders of more
than 50% of such shares are present or represented; or (ii) more than 50% of the
outstanding shares of the Fund.
1. The Funds will not purchase securities on margin (except for such
short term credits as are necessary for the clearance of transactions);
provided, however, that the Funds may borrow money to the extent set forth in
investment restriction no. 4.
2. The Funds may sell securities short to the extent permitted by the
Investment Company Act of 1940 (the "Act").
3. The Funds may write put and call options to the extent permitted by
the Act.
4. None of the Funds will borrow money or issue senior securities,
except for temporary bank borrowings (not in excess of 10% of the value of a
Fund's net assets) or for emergency or extraordinary purposes.
5. Each Fund may pledge or hypothecate its assets to secure its
borrowings.
6. The Funds will not lend money (except by purchasing publicly
distributed debt securities, purchasing securities of a type normally acquired
by institutional investors or entering into repurchase agreements) and will not
lend their portfolio securities, unless such loans are secured continuously by
collateral at least equal to the market value of the securities loaned in the
form of cash and/or securities issued or guaranteed by the U.S. government, its
agencies or instrumentalities, and provided that no such loan will be made if
upon making of such loan more than 30% of the value of the Fund's total assets
would be subject to such loans.
7. The Funds will not make investments for the purpose of exercising
control or management of any company.
8. The Funds will not purchase securities of any issuer (other than the
United States or an instrumentality of the United States) if, as a result of
such purchase, a Fund would hold more than 10% of any class of securities,
including voting securities, of such issuer or more than 5%
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of a Fund's total assets, taken at current value, would be invested in
securities of such issuer, except that up to 25% of each Fund's total assets may
be invested without regard to these limitations.
9. No Fund will invest 25% or more of the value of its total assets,
determined at the time an investment is made, exclusive of U.S. government
securities, in securities issued by companies primarily engaged in the same
industry. In determining industry classifications the Funds will use the current
Directory of Companies Filing Annual Reports with the Securities and Exchange
Commission except to the extent permitted by the Act.
10. No Fund will act as an underwriter or distributor of securities
other than shares of the Fund (except to the extent that the Funds may be deemed
to be underwriters within the meaning of the Securities Act of 1933, as amended
(the "Securities Act"), in the disposition of restricted securities).
11. The Funds will not purchase or sell real estate or real estate
mortgage loans or real estate limited partnerships.
12. The Funds will not purchase or sell commodities or commodity
contracts, except that each Fund may invest in futures contracts and options on
futures contracts.
The Funds have adopted certain other investment restrictions which are
not fundamental policies and which may be changed by the Corporation's Board of
Directors without shareholder approval. These additional restrictions are as
follows:
1. No Fund will invest more than 15% of the value of its net assets in
illiquid securities.
2. The Funds will not purchase the securities of other investment
companies except: (a) as part of a plan of merger, consolidation or
reorganization approved by the stockholders of a Fund; (b) securities of
registered open-end investment companies that invest exclusively in high
quality, short-term debt securities; or (c) securities of registered closed-end
investment companies on the open market where no commission results, other than
the usual and customary broker's commission. No purchases described in (b) and
(c) will be made if as a result of such purchases (i) a Fund and its affiliated
persons would hold more than 3% of any class of securities, including voting
securities, of any registered investment company; (ii) more than 5% of a Fund's
net assets would be invested in shares of any one registered investment company;
and (iii) more than 10% of a Fund's net assets would be invested in shares of
registered investment companies.
3. The Funds will not acquire or retain any security issued by a
company, an officer or director of which is an officer or director of the Fund
or an officer, director or other affiliated person of its investment adviser,
without authorization of the Corporation's Board of Directors.
4. The Funds will not purchase any interest in any oil, gas or other
mineral leases or any interest in any oil, gas or any other mineral exploration
or development program.
The aforementioned percentage restrictions on investment or utilization
of assets refer to the percentage at the time an investment is made. If these
restrictions (other than those
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relating to borrowing of money or issuing senior securities) are adhered to at
the time an investment is made, and such percentage subsequently changes as a
result of changing market values or some similar event, no violation of a Fund's
fundamental restrictions will be deemed to have occurred. Any changes in a
Fund's investment restrictions made by the Board of Directors will be
communicated to shareholders prior to their implementation.
INVESTMENT CONSIDERATIONS
Temporary Investments
Each Fund may invest in cash and money market securities. The Funds may
do so when taking a temporary defensive position or to have assets available to
pay expenses, satisfy redemption requests or take advantage of investment
opportunities. Money market securities include money market mutual funds,
short-term investment-grade fixed-income securities, bankers' acceptances,
commercial paper, commercial paper master notes and repurchase agreements.
The Funds may invest in commercial paper or commercial paper master
notes rated, at the time of purchase, within the two highest rating categories
by a nationally recognized statistical rating organization (NRSRO).
The Funds may enter into repurchase agreements with banks that are
Federal Reserve Member banks and non-bank dealers of U.S. government securities
which, at the time of purchase, are on the Federal Reserve Bank of New York's
list of primary dealers with a capital base greater than $100 million. When
entering into repurchase agreements, a Fund will hold as collateral an amount of
cash or government securities at least equal to the market value of the
securities that are part of the repurchase agreement. A repurchase agreement
involves the risk that a seller may declare bankruptcy or default. In this
event, a Fund may experience delays, increased costs and a possible loss.
The Funds may also invest in money market mutual funds issued by other
investment companies. As a shareholder of a money market fund, a Fund would be
subject to the same risks as any other investor and will bear a proportionate
share of any fees and expenses incurred by the mutual fund in which it invests.
These will be in addition to the advisory and other fees paid by the Fund.
During adverse market conditions, up to 100% of the International
Equity Fund's total assets may be invested in U.S. securities or in securities
primarily traded in one or more foreign countries, or in debt securities.
Investment Grade Investments
The Funds may invest in investment-grade debt securities, or unrated
securities if Johnson Asset Management, Inc. (the "Adviser") believes they are
equivalent in quality. A debt or other fixed income security is considered
investment grade if it is rated BBB or better by Duff and Phelps Credit Rating
Co. ("D&P"), Standard & Poor's Ratings Group ("S&P"), Fitch IBCA ("Fitch"); or
Baa or better by Moody's Investors Services, Inc. ("Moody's") or any other
NRSRO.
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Investment-grade bonds rated BBB by D&P, S&P or Fitch, or Baa by
Moody's are considered to be of medium-grade quality. Medium-grade securities
have certain speculative characteristics. This means they are typically more
sensitive to economic changes and subject to a higher degree of risk than higher
rated securities.
Ratings are determined at the time of investment. If a security held by
a Fund loses its rating or has its rating reduced, the Fund does not have to
sell the security immediately. However, the Adviser will closely monitor the
security to determine what action, if any, the Fund should take.
Illiquid Securities
Each Fund may invest up to 15% of its net assets in securities for
which there is no readily available market ("illiquid securities"). Because an
active market may not exist for illiquid securities, the Funds may experience
delays and additional costs when trying to sell illiquid securities. The 15%
limitation includes certain securities whose disposition would be subject to
legal restrictions ("restricted securities"). However certain restricted
securities that may be resold pursuant to Rule 144A under the Securities Act may
be considered liquid. Rule 144A permits certain qualified institutional buyers
to trade in privately placed securities not registered under the Securities Act.
Institutional markets for restricted securities have developed as a result of
Rule 144A, providing both readily ascertainable market values for Rule 144A
securities and the ability to liquidate these securities to satisfy redemption
requests. However an insufficient number of qualified institutional buyers
interested in purchasing certain Rule 144A securities held by a Fund could
adversely affect their marketability, causing the Fund to sell the securities at
unfavorable prices. The Board of Directors of the Corporation has delegated to
the Adviser the day-to-day determination of the liquidity of a security although
it has retained oversight and ultimate responsibility for such determinations.
The Board of Directors has directed the Adviser to consider such factors as (i)
the nature of the market for a security, (including the institutional private
resale markets); (ii) the terms of the securities or other instruments allowing
for the disposition to a third party or the issuer thereof (e.g. certain
repurchase obligations and demand instruments); (iii) the availability of market
quotations; and (iv) other permissible factors in determining the liquidity of a
security.
Restricted securities may be sold in privately negotiated or other
exempt transactions or in a public offering with respect to which a registration
statement is in effect under the Securities Act. When registration is required,
a Fund may be obligated to pay all or part of the registration expenses and a
considerable time may elapse between the decision to sell and the sale date. If,
during such period, adverse market conditions were to develop, a Fund might
obtain a less favorable price than the price which prevailed when it decided to
sell. Restricted securities, if considered to be illiquid, will be priced at
fair value as determined in good faith by the Board of Directors.
Short Sales
The Funds may seek to realize additional gains through short sale
transactions in securities listed on one or more national securities exchanges,
or in unlisted securities. Short selling involves the sale of borrowed
securities. At the time a short sale is effected, a Fund incurs
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an obligation to replace the security borrowed at whatever its price may be at
the time the Fund purchases it for delivery to the lender. The price at such
time may be more or less than the price at which the security was sold by the
Fund. Until the security is replaced, the Fund is required to pay the lender
amounts equal to any dividend or interest which accrue during the period of the
loan. To borrow the security, the Fund also may be required to pay a premium,
which would increase the cost of the security sold. The proceeds of the short
sale will be retained by the broker, to the extent necessary to meet margin
requirements, until the short position is closed.
No short sale will be effected which will, at the time of making such
short sale transaction and giving effect thereto, cause the aggregate market
value of all securities sold short to exceed 5% of the value of a Fund's net
assets. Until a Fund closes its short position or replaces the borrowed
security, the Fund will: (a) maintain a segregated account containing cash or
liquid securities at such a level that the amount deposited in the account plus
the amount deposited with the broker as collateral will equal the current value
of the security sold short; or (b) otherwise cover the Fund's short position.
Lending of Portfolio Securities
In order to generate additional income, each Fund may lend portfolio
securities constituting up to 30% of its total assets to unaffiliated
broker-dealers, banks or other recognized institutional borrowers of securities,
provided that the borrower at all times maintains cash, U.S. government
securities or equivalent collateral or provides an irrevocable letter of credit
in favor of the Fund equal in value to at least 100% of the value of the
securities loaned. During the time portfolio securities are on loan, the
borrower pays the Fund an amount equivalent to any dividends or interest paid on
such securities, and the Fund may receive an agreed-upon amount of interest
income from the borrower who delivered equivalent collateral or provided a
letter of credit. Loans are subject to termination at the option of the Fund or
the borrower. The Funds may pay reasonable administrative and custodial fees in
connection with a loan of portfolio securities and may pay a negotiated portion
of the interest earned on the cash or equivalent collateral to the borrower or
placing broker. The Funds do not have the right to vote securities on loan, but
could terminate the loan and regain the right to vote if that were considered
important with respect to the investment.
The primary risk in securities lending is a default by the borrower
during a sharp rise in price of the borrowed security resulting in a deficiency
in the collateral posted by the borrower. The Funds will seek to minimize this
risk by requiring that the value of the securities loaned be computed each day
and additional collateral be furnished each day if required.
High Yield Convertible Securities
Each equity Fund may invest in convertible debt securities when the
Adviser believes the underlying common stock is a suitable investment for the
Fund and when the convertible security offers greater potential for total return
because of its higher yield. Convertible securities are bonds or preferred
stocks that may be converted (exchanged) into common stock of the issuing
company within a certain period of time, for a specified number of shares.
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Each equity Fund may invest up to 5% of its net assets in high yield,
high risk, lower-rated convertible securities, commonly known as "junk bonds."
Investments in such securities are subject to greater credit risks than higher
rated securities. Debt securities rated below investment grade have greater
risks of default than investment grade debt securities, including medium grade
debt securities, and may in fact, be in default. Issuers of "junk bonds" must
offer higher yields to compensate for the greater risk of default on the payment
of principal and interest.
The market for high yield convertible securities is subject to
substantial volatility. An economic downturn or increase in interest rates may
have a more significant effect on high yield convertible securities and their
markets, as well as on the ability of securities' issuers to repay principal and
interest, than on higher-rated securities and their issuers. Issuers of high
yield convertible securities may be of low creditworthiness and the high yield
convertible securities may be subordinated to the claims of senior lenders.
During periods of economic downturn or rising interest rates the issuers of high
yield convertible securities may have greater potential for insolvency and a
higher incidence of high yield bond defaults may be experienced. From 1989 to
1991, the percentage of high yield securities that defaulted rose significantly
above prior default levels. The default rate has decreased subsequently.
The prices of high yield convertible securities have been found to be
less sensitive to interest rate changes than higher-rated investments but are
more sensitive to adverse economic changes or individual corporate developments
because of their lower credit quality. During an economic downturn or
substantial period of rising interest rates, highly leveraged issuers may
experience financial stress which would adversely affect their ability to
service their principal and interest payment obligations, to meet projected
business goals, and to obtain additional financing. If the issuer of a high
yield convertible security owned by a Fund defaults, the Fund may incur
additional expenses in seeking recovery. Periods of economic uncertainty and
changes can be expected to result in increased volatility of market prices of
high yield convertible securities and a Fund's net asset value. Yields on high
yield convertible securities will fluctuate over time. Furthermore, in the case
of high yield convertible securities structured as zero coupon or pay-in-kind
securities, their market prices are affected to a greater extent by interest
rate changes and thereby tend to be more volatile than market prices of
securities which pay interest periodically and in cash.
The secondary market for high yield convertible securities may at times
become less liquid or respond to adverse publicity or investor perceptions
making it more difficult for a Fund to value accurately high yield convertible
securities or dispose of them. To the extent the Fund owns or may acquire
illiquid or restricted high yield convertible securities, these securities may
involve special registration responsibilities, liabilities and costs, and
liquidity difficulties, and judgment will play a greater role in valuation
because there is less reliable and objective data available.
Special tax considerations are associated with investing in high yield
bonds structured as zero coupon or pay-in-kind securities. A Fund will report
the interest on these securities as income even though it receives no cash
interest until the security's maturity or payment date. Further, the Fund must
distribute substantially all of its income to its shareholders to qualify for
pass-through treatment under the tax law. Accordingly, a Fund may have to
dispose of its portfolio securities under disadvantageous circumstances to
generate cash or may have to borrow to satisfy distribution requirements.
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Credit ratings evaluate the safety of principal and interest payments,
not the market value risk of high yield convertible securities. Since credit
rating agencies may fail to timely change the credit ratings to reflect
subsequent events, the Adviser monitors the issuers of high-yield convertible
securities in the portfolio to determine if the issuers will have sufficient
cash flow and profits to meet required principal and interest payments, and to
attempt to assure the securities' liquidity so the Funds can meet redemption
requests. To the extent that a Fund invests in high yield convertible
securities, the achievement of its investment objective may be more dependent,
on the Adviser's own credit analysis than is the case for higher quality bonds.
A Fund may retain a portfolio security whose rating has been changed.
Mortgage-Backed and Asset-Backed Securities
Each of the Funds may purchase residential and commercial
mortgage-backed as well as other asset-backed securities (collectively called
"asset-backed securities") that are secured or backed by automobile loans,
installment sale contracts, credit card receivables, mortgages or other assets
and are issued by entities such as Government National Mortgage Association
("GNMA"), Federal National Mortgage Association ("FNMA"), Federal Home Loan
Mortgage Corporation ("FHLMC"), commercial banks, trusts, financial companies,
finance subsidiaries of industrial companies, savings and loan associations,
mortgage banks and investment banks. These securities represent interests in
pools of assets in which periodic payments of interest and/or principal on the
securities are made, thus, in effect passing through periodic payments made by
the individual borrowers on the assets that underlie the securities, net of any
fees paid to the issuer or guarantor of the securities. The average life of
these securities varies with the maturities and the prepayment experience of the
underlying instruments.
There are a number of important differences among the agencies and
instrumentalities of the U.S. government that issue mortgage-backed securities
and among the securities that they issue. Mortgage-backed securities guaranteed
by GNMA include GNMA Mortgage Pass-Through Certificates (also known as "Ginnie
Maes") which are guaranteed as to the timely payment of principal and interest
by GNMA and such guarantee is backed by the full faith and credit of the United
States. GNMA is a wholly-owned U.S. Government corporation within the Department
of Housing and Urban Development. GNMA certificates also are supported by the
authority of GNMA to borrow funds from the U.S. Treasury to make payments under
its guarantee. Mortgage-backed securities issued by FNMA include FNMA Guaranteed
Mortgage Pass-Through Certificates (also known as "Fannie Maes") which are
solely the obligations of FNMA and are not backed by or entitled to the full
faith and credit of the United States, but are supported by the right of the
issuer to borrow from the Treasury. FNMA is a government-sponsored organization
owned entirely by private stockholders. Fannie Maes are guaranteed as to timely
payment of the principal and interest by FNMA. Mortgage-backed securities issued
by the FHLMC include FHLMC Mortgage Participation Certificates (also known as
"Freddie Macs" or "PCs"). FHLMC is a corporate instrumentality of the United
States, created pursuant to an Act of Congress. Freddie Macs are not guaranteed
by the United States or by any Federal Home Loan Bank and do not constitute a
debt or obligation of the United States or of any Federal Home Loan Bank.
Freddie Macs entitle the holder to timely payment of interest, which is
guaranteed by the FHLMC. FHLMC guarantees either ultimate collection or timely
payment of all principal payments on the underlying mortgage loans. When FHLMC
does not guarantee timely payment of principal, FHLMC may remit the amount due
on account of its guarantee of ultimate payment of
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principal at any time after default on an underlying mortgage, but in no event
later than one year after it becomes payable.
Each of the Funds may also purchase mortgage-backed securities
structured as CMOs. CMOs are issued in multiple classes and their relative
payment rights may be structured in many ways. In many cases, however, payments
of principal are applied to the CMO classes in order of their respective
maturities, so that no principal payments will be made on a CMO class until all
other classes having an earlier maturity date are paid in full. The classes may
include accrual certificates (also known as "Z-Bonds"), which do not accrue
interest at a specified rate until other specified classes have been retired and
are converted thereafter to interest-paying securities. They may also include
planned amortization classes ("PACs") which generally require, within certain
limits, that specified amounts of principal be applied to each payment date, and
generally exhibit less yield and market volatility than other classes. The
classes may include "IOs", which pay distributions consisting solely or
primarily of all or a portion of the interest in an underlying pool of mortgages
or mortgage-backed securities, "POs", which pay distributions consisting solely
or primarily of all or a portion of principal payments made from the underlying
pool of mortgages or mortgage-backed securities, and "inverse floaters", which
have a coupon rate that moves in the reverse direction to an applicable index.
Investments in CMO certificates can expose the Funds to greater
volatility and interest rate risk than other types of mortgage-backed
obligations. Among tranches of CMOs, inverse floaters are typically more
volatile than fixed or adjustable rate tranches of CMOs. Investments in inverse
floaters could protect a Fund against a reduction in income due to a decline in
interest rates. A Fund would be adversely affected by the purchase of an inverse
floater in the event of an increase in interest rates because the coupon rate
thereon will decrease as interest rates increase, and like other mortgage-backed
securities, the value of an inverse floater will decrease as interest rates
increase. The cash flows and yields on IO and PO classes are extremely sensitive
to the rate of principal payments (including prepayments) on the related
underlying pool of mortgage loans or mortgage-backed securities. For example, a
rapid or slow rate of principal payments may have a material adverse effect on
the yield to maturity of IOs or POs, respectively. If the underlying assets
experience greater than anticipated prepayments of principal, the holder of an
IO may incur substantial losses irrespective of its rating. Conversely, if the
underlying assets experience slower than anticipated prepayments of principal,
the yield and market value for the holders of a PO will be affected more
severely than would be the case with a traditional mortgage-backed security.
Prepayments on mortgage-backed securities generally increase with falling
interest rates and decrease with rising interest rates. Prepayments are also
influenced by a variety of other economic and social factors.
The yield characteristics of asset-backed securities differ from
traditional debt securities. A major difference is that the principal amount of
the obligations may be prepaid at any time because the underlying assets (i.e.,
loans) generally may be prepaid at any time. As a result, if an asset-backed
security is purchased at a premium, a prepayment rate that is faster than
expected may reduce yield to maturity, while a prepayment rate that is slower
than expected may have the opposite effect of increasing yield to maturity.
Conversely, if an asset-backed security is purchased at a discount, faster than
expected prepayments may increase, while slower than expected prepayments may
decrease, yield to maturity.
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In general, the collateral supporting non-mortgage asset-backed
securities is of shorter maturity than mortgage loans. Like other fixed income
securities, when interest rates rise the value for an asset-backed security
generally will decline; however, when interest rates decline, the value of an
asset-backed security with prepayment features may not increase as much as that
of other fixed income securities.
Asset-backed securities may involve certain risks that are not
presented by mortgage-backed securities. These risks arise primarily from the
nature of the underlying assets (i.e., credit card and automobile loan
receivables as opposed to real estate mortgages). Non-mortgage asset-backed
securities do not have the benefit of the same security interest in the
collateral as mortgage-backed securities. Credit card receivables are generally
unsecured and the debtors are entitled to the protection of a number of state
and federal consumer credit laws, many of which have given debtors the right to
reduce the balance due on the credit cards. 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 the risk that the purchaser would acquire an interest superior to that
of the holders of 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 an effective security interest in all of the
obligations backing such receivables. Therefore, there is a possibility that
payments on the receivables together with recoveries on repossessed collateral
may not, in some cases, be able to support payments on these securities.
Asset-backed securities may be subject to greater risk of default
during periods of economic downturn than other instruments. Also, while the
secondary market for asset-backed securities is ordinarily quite liquid, in
times of financial stress the secondary market may not be as liquid as the
market for other types of securities, which could cause a Fund to experience
difficulty in valuing or liquidating such securities.
Hedging Instruments
Each of the Funds may engage in options, futures and options on futures
transactions that constitute bona fide hedging or other permissible risk
management transactions. The Funds may use futures transactions for several
reasons, including: (i) hedging unrealized portfolio gains; (ii) minimizing
adverse principal fluctuations in a Fund's debt and fixed-income securities; or
(iii) as a means of adjusting exposure to various markets. The Funds will deal
only in exchange-traded futures contracts and in exchange-traded or
over-the-counter securities options.
Generally, the Funds may engage in a futures contract or options
transactions if the initial margin deposits and premiums paid for unexpired
options do not exceed 5% of a Fund's total assets. In addition, each Fund will
commit no more than 5% of its net assets to futures contracts and options or
more than 5% of its net assets to cover its obligations with respect to futures
contracts and options.
Futures Contracts. When a Fund purchases a futures contract, it agrees
to purchase a specified underlying instrument at a specified future date. When a
Fund sells a futures contract, it agrees to sell the underlying instrument at a
specified future date. The price at which the purchase and sale will take place
is fixed when the Fund enters into the contract. Futures can be
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held until their delivery dates, or can be closed out before the delivery date
if a liquid secondary market is available.
The value of a futures contract tends to increase and decrease in
tandem with the value of its underlying instrument. Therefore, purchasing
futures contracts will tend to increase a Fund's exposure to positive and
negative price fluctuations in the underlying instrument, much as if the Fund
had purchased the underlying instrument directly. When a Fund sells a futures
contract, by contrast, the value of its future position will tend to move in a
direction contrary to the market. Selling futures contracts, therefore, will
tend to offset both positive and negative market price changes, much as if the
underlying instrument had been sold.
Futures Margin Payments. The purchaser or seller of a futures contract
is not required to deliver or pay for the underlying instrument unless the
contract is held until the delivery date. However, both the purchaser and seller
are required to deposit "initial margin" with a futures broker, known as a
Futures Commission Merchant ("FCM"), when the contract is entered into. Initial
margin deposits are equal to a percentage of the contract's value. If the value
of either party's position declines, that party will be required to make
additional "variation margin" payments to settle the change in value on a daily
basis. The party that has a gain may be entitled to receive all or a portion of
this amount. Initial and variation margin payments do not constitute purchasing
securities on margin for purposes of the Funds' investment limitations. In the
event of the bankruptcy of an FCM that holds margin on behalf of a Fund, the
Fund may be entitled to return of margin owed to it only in proportion to the
amount received by the FCM's other customers, potentially resulting in losses to
the Fund.
Purchasing Put and Call Options. By purchasing a put option, a Fund
obtains the right (but not the obligation) to sell the option's underlying
instrument at a fixed strike price. In return for this right, the Fund pays the
current market price for the option (known as the option premium). Each Fund may
purchase options on futures contracts as well as options on securities and stock
indices. Each of the Funds may terminate its position in a put option it has
purchased by allowing it to expire or by exercising the option. If the option is
allowed to expire, the Fund will lose the entire premium it paid. If a Fund
exercises the option, it completes the sale of the underlying instrument at the
strike price. A Fund may also terminate a put option position by closing it out
in the secondary market at its current price, if a liquid secondary market
exists. The buyer of a put option can expect to realize a gain if security
prices fall substantially. However, if the underlying instrument's price does
not fall enough to offset the cost of purchasing the option, a put buyer can
expect to suffer a loss (limited to the amount of the premium paid, plus related
transaction costs).
The features of call options are essentially the same as those of put
options, except that the purchaser of a call option obtains the right to
purchase, rather than sell, the underlying instrument at the option's strike
price. A call buyer attempts to participate in potential price increases of the
underlying instrument with risk limited to the cost of the option if security
prices fall. At the same time, the buyer can expect to suffer a loss if security
prices do not rise sufficiently to offset the cost of the option.
Stock Index Options. Stock index options are put options and call
options on various stock indexes. In most respects, they are identical to listed
options on common stocks.
10
<PAGE>
The primary difference between stock options and index options occurs when index
options are exercised. In the case of stock options the underlying security,
common stock, is delivered. However, upon the exercise of an index option,
settlement does not occur by delivery of the securities comprising the index.
The option holder who exercises the index option receives an amount of cash if
the closing level of the stock index upon which the option is based is greater
than in the case of a call, or less than, in the case of a put, the exercise
price of the option. This amount of cash is equal to the difference between the
closing price of the stock index and the exercise price of the option expressed
in dollars times a specified multiple. A stock index fluctuates with changes in
the market value of the stocks included in the index. For example, some stock
index options are based on a broad market index, such as the Standard & Poor's
500 or the Value Line Composite Index, or a narrower market index, such as the
Standard & Poor's 100. Indexes also may be based on an industry or market
segment, such the AMEX Oil and Gas Index or the Computer and Business Equipment
Index. Options on stock indexes are currently traded on the following exchanges:
the Chicago Board Options Exchange, the New York Stock Exchange, the American
Stock Exchange, the Pacific Stock Exchange, and the Philadelphia Stock Exchange.
Writing Call and Put Options. When a Fund writes a call option, it
receives a premium and agrees to sell the related investments to a purchaser of
the call during the call period (usually not more than nine months) at a fixed
exercise price (which may differ from the market price of the related
investments) regardless of market price changes during the call period. If the
call is exercised, the Fund forgoes any gain from an increase in the market
price over the exercise price. When writing an option on a futures contract, a
Fund will be required to make margin payments to an FCM as described above for
futures contracts.
To terminate its obligations on a call which it has written, a Fund may
purchase a call in a "closing purchase transaction". (As discussed above, the
Funds may also purchase calls other than as part of such closing transactions.)
A profit or loss will be realized depending on the amount of option transaction
costs and whether the premium previously received is more or less than the price
of the call purchased. A profit may also be realized if the call lapses
unexercised, because the Fund retains the premium received. Any such profits are
considered short-term gains for federal income tax purposes and, when
distributed, are taxable as ordinary income.
Generally writing calls is a profitable strategy if prices remain the
same or fall. Through receipt of the option premium, a call writer mitigates the
effects of a price decline. At the same time, because a call writer must be
prepared to deliver the underlying instrument in return for the strike price,
even if its current value is greater, a call writer gives up some ability to
participate in security price increases.
When a Fund writes a put option, it takes the opposite side of the
transaction from the option's purchaser. In return for receipt of a premium, the
Fund assumes the obligation to pay the strike price for the option's underlying
instrument if the other party to the option chooses to exercise it. The Funds
may only write covered puts. For a put to be covered, a Fund must maintain in a
segregated account cash or liquid assets equal to the option price. A profit or
loss will be realized depending on the amount of option transaction costs and
whether the premium previously received is more or less than the put purchased
in a closing purchase transaction. A profit may also be realized if the put
lapses unexercised because the Fund retains the premium
11
<PAGE>
received. Any such profits are considered short-term gains for federal income
tax purposes and, when distributed, are taxable as ordinary income.
Combined Option Positions. The Funds may purchase and write options
(subject to the limitations discussed above) in combination with each other to
adjust the risk and return characteristics of the overall position. For example,
a Fund may purchase a put option and write a call option on the same underlying
instrument, in order to construct a combined position whose risk and return
characteristics are similar to selling a futures contract. Another possible
combined position would involve writing a call option at one strike price and
buying a call option at a lower price, in order to reduce the risk of the
written call option in the event of a substantial price increase. Because
combined options involve multiple trades, they result in higher transaction
costs and may be more difficult to open and close out.
Correlation of Price Changes. Because there are a limited number of
types of exchange-traded options and futures contracts, it is likely that the
standardized contracts available will not match the applicable Fund's current or
anticipated investments. Each of the Funds may invest in options and futures
contracts based on securities which differ from the securities in which it
typically invests. This involves a risk that the options or futures position
will not track the performance of the Fund's investments.
Options and futures prices can also diverge from the prices of their
underlying instruments, even if the underlying instruments match the applicable
Fund's investments well. Options and future prices are affected by such factors
as current and anticipated short-term interest rates, changes in volatility of
the underlying instrument, and the time remaining until expiration of the
contract, which may not affect security prices the same way. Imperfect
correlation may also result from differing levels of demand in the options and
futures markets and the securities markets, from structural differences in how
options and futures and securities are traded, or from imposition of daily price
fluctuation limits or trading halts. Each of the Funds may purchase or sell
options and futures contracts with a greater or lesser value than the securities
it wishes to hedge or intends to purchase in order to attempt to compensate for
differences in historical volatility between the contract and the securities,
although this may not be successful in all cases. If price changes in the
applicable Funds' options or futures positions are poorly correlated with its
other investments, the positions may fail to produce anticipated gains or result
in losses that are not offset by gains in other investments. Successful use of
these techniques requires skills different from those needed to select portfolio
securities.
Liquidity of Options and Futures Contracts. There is no assurance a
liquid secondary market will exist for any particular options or futures
contract at any particular time. Options may have relatively low trading volume
and liquidity if their strike prices are not close to the underlying
instrument's current price. In addition, exchanges may establish daily price
fluctuation limits for options and futures contracts, and may halt trading if a
contract's price moves upward or downward more than the limit in a given day. On
volatile trading days when the price fluctuation limit is reached or a trading
halt is imposed, it may be impossible for a Fund to enter into new positions or
close out existing positions. If the secondary market for a contract is not
liquid because of price fluctuation limits or otherwise, it could prevent prompt
liquidation of unfavorable positions, and potentially could require the Fund to
continue to hold a position until
12
<PAGE>
delivery or expiration regardless of changes in its value. As a result, a Fund's
access to other assets held to cover its options or futures positions could also
be impaired.
Asset Coverage for Futures and Option Positions. Each of the Funds will
comply with guidelines established by the Securities and Exchange Commission
with respect to coverage of options and futures strategies by mutual funds, and
if the guidelines so require will set aside cash or liquid securities in a
segregated custodial account in the amount prescribed. Securities held in a
segregated account cannot be sold while the futures or option strategy is
outstanding, unless they are replaced with other suitable assets. As a result,
there is a possibility that segregation of a portion of a Fund's assets could
impede portfolio management or such Fund's ability to meet redemption requests
or other current obligations.
Special Risks of Hedging and Income Enhancement Strategies.
Participation in the options or futures markets involves investment risks and
transactions costs to which a Fund would not be subject absent the use of these
strategies. In particular, the loss from investing in futures contracts is
potentially unlimited. If the Adviser's prediction of movements in the direction
of the securities and interest rate markets are inaccurate, the adverse
consequences to the Fund may leave the Fund in a worse position than if such
strategies were not used. Risks inherent in the use of futures contracts and
options on futures contracts include: (1) dependence on the Adviser's ability to
predict correctly movements in the direction of interest rates, securities
prices and currency markets; (2) imperfect correlation between the price of
options and futures contracts and options thereon and movements in the prices of
the securities being hedged; (3) the fact that skills needed to use these
strategies are different from those needed to select portfolio securities; and
(4) the possible absence of a liquid secondary market for any particular
instrument at any time.
Depository Receipts
Each of the Funds may invest in American Depository Receipts ("ADRs").
ADR facilities may be either "sponsored" or "unsponsored". While similar,
distinctions exist relating to the rights and duties of ADR holders and market
practices. A depository may establish an unsponsored facility without the
participation by or consent of the issuer of the deposited securities, although
a letter of non-objection from the issuer is often requested. Holders of
unsponsored ADRs generally bear all the costs of such facility, which can
include deposit and withdrawal fees, currency conversion fees and other service
fees. The depository of an unsponsored facility may be under no duty to
distribute shareholder communications from the issuer or to pass through voting
rights. Issuers of unsponsored ADRs are not obligated to disclose material
information in the U.S. and, therefore, there may be not be a correlation
between such information and the market value of the ADR. Sponsored facilities
enter into an agreement with the issuer that sets out rights and duties of the
issuer, the depository and the ADR holder. This agreement also allocates fees
among the parties. Most sponsored agreements also provide that the depository
will distribute shareholder notices, voting instruments and other
communications. Each of the Funds may invest in sponsored and unsponsored ADRs.
In addition to ADRs, each of the Funds may hold foreign securities in
the form of American Depository Shares ("ADSs"), Global Depository Receipts
("GDRs") and European Depository Receipts ("EDRs"), or other securities
convertible into foreign securities. These receipts may not be denominated in
the same currency as the underlying securities. Generally,
13
<PAGE>
American banks or trust companies issue ADRs and ADSs, which evidence ownership
of underlying foreign securities. GDRs represent global offerings where an
issuer issues two securities simultaneously in two markets, usually publicly in
a non-U.S. market and privately in the U.S. market. EDRs (sometimes called
Continental Depository Receipts ("CDRs")) are similar to ADRs, but usually
issued in Europe. Typically issued by foreign banks or trust companies, EDRs and
CDRs evidence ownership of foreign securities. Generally, ADRs and ADSs in
registered form trade in the U.S. securities markets, GDRs in the U.S. and
European markets, and EDRs and CDRs (in bearer form) in European markets.
Portfolio Turnover
Generally, the Funds do not purchase securities with the intent of
turning them over rapidly. However, the Adviser will continuously monitor each
Fund's investments and adjust the portfolio whenever the Adviser believes it is
in the best interest of the Fund to do so. Fund turnover may increase as a
result of large amounts of purchases and redemptions of shares of a Fund due to
economic, market or other factors that are not within the control of the Fund's
management.
Portfolio turnover measures the amount of trading that occurs in a
Fund's portfolio during the year. A 100% turnover rate, for example, means that
on average, every security in the portfolio has been replaced once during the
year. Funds with higher turnover rates often have higher transaction costs (e.g.
brokerage commissions, portfolio trading costs), which are paid by the Funds,
and may generate short-term capital gains. Distributions to shareholders of
realized gains, to the extent they consist of net short-term capital gains, will
be considered ordinary income for tax purposes. The turnover rate for the Fund
may vary from year to year. However, the Adviser expects that under normal
market conditions, the annual portfolio turnover rate for each of the Funds will
not exceed 100%.
Borrowing
The Funds may borrow money, but only from banks and only for temporary
or emergency purposes. The Funds may borrow up to 10% of their net assets.
However, they must repay any amount borrowed before buying additional
securities. If the securities held by a Fund decline in value while borrowings
are outstanding, the net asset value of the Fund's outstanding shares may also
lose value.
Reverse Repurchase Agreements
The Funds may enter into reverse repurchase agreements. In a reverse
repurchase agreement, a Fund sells securities with the understanding that it
will buy them back within a particular time at a specified price.
Reverse repurchase agreements involve certain risks, including the
chance that the market value of the securities sold may decline below the price
of the securities the Fund is obligated to repurchase. They are also subject to
the risk that the securities may not be returned to the Fund.
14
<PAGE>
To manage risk, a Fund will maintain in a segregated account with its
custodian certain cash or liquid securities. These must have a value at least
equal to the repurchase price of the securities sold, less the value of the
collateral securing the reverse repurchase agreement.
When-Issued and Delayed-Delivery Securities
To ensure the availability of suitable securities for their portfolios,
the Funds may buy when-issued or delayed-delivery securities. The Funds intend
to purchase the securities with the expectation of acquiring the underlying
securities when delivered. However, a Fund may sell when-issued securities
before the settlement date when the Adviser believes it is in the best interests
of a Fund to do so. Unless a Fund has entered into an offsetting agreement to
sell the securities, it must maintain segregated cash or liquid assets equal to
the amount of the Fund's commitment with the Fund's custodian.
When-issued and delayed-delivery securities represent securities that
have been authorized but not yet issued. The price of when-issued and
delayed-delivery securities is fixed at the time a commitment to purchase is
made, but delivery and payment take place at a later date. As a result, they are
subject to certain risks, including the chance that these securities may fall in
value by the time they are actually issued or delivered. New issues of stocks
and bonds, stocks that have split and Treasury securities are examples of
securities that are traded on a when-issued or delayed-delivery basis.
Government Obligations
Each of the Funds may invest in a variety of U.S. Treasury obligations,
including bills, notes and bonds. These obligations differ only in terms of
their interest rates, maturities and time of issuance. The Funds may also invest
in other securities issued or guaranteed by the U.S. government, its agencies
and instrumentalities.
Obligations of certain agencies and instrumentalities, such as the
Government National Mortgage Association ("GNMA"), are supported by the full
faith and credit of the U.S. Treasury. Others, such as those of the
Export-Import Bank of the United States, are supported by the right of the
issuer to borrow from the Treasury; and others, such as those of the Federal
National Mortgage Association ("FNMA"), are supported by the discretionary
authority of the U.S. government to purchase the agency's obligations; still
others, such as those of the Student Loan Marketing Association are supported
only by the credit of the agency or instrumentality that issues them. There is
no guarantee that the U.S. Government will provide financial support to its
agencies or instrumentalities, now or in the future, if it is not obligated to
do so by law.
15
<PAGE>
Warrants
Each of the equity Funds may purchase warrants and similar rights,
which are privileges issued by corporations enabling the owners to subscribe to
and purchase a specified number of shares of the corporation at a specified
price for a specified period of time. Like options, warrants involve certain
risks, including the chance that a Fund could lose the purchase value of the
warrant if the warrant is not exercised prior to its expiration. Warrants also
involve the risk that the effective price paid for the warrant added to the
subscription price of the related security may be greater than the value of the
subscribed security's market price. To manage risk, no more than 5% of each
equity Fund's net assets, valued at the time of investment, will be invested in
warrants.
Classification of Foreign Markets
Foreign markets are often classified as mature or emerging. The
countries in which the Funds may invest are classified below. The Funds also may
invest in additional countries when such investments are consistent with the
Fund's objective and policies.
Mature: Australia, Austria, Belgium, Canada, Denmark,
Finland, France, Germany, Hong Kong, Ireland,
Italy, Japan, Luxembourg, Netherlands, New
Zealand, Norway, Singapore, Spain, Sweden,
Switzerland, United Kingdom and United States.
Emerging: Argentina, Brazil, Chile, China, Czech Republic,
Ecuador, Greece, Hungary, India, Indonesia,
Jamaica, Kenya, Israel, Jordan, Malaysia, Mexico,
Morocco, Nigeria, Pakistan, People's Republic of
China, Peru, Philippines, Poland, South Africa,
South Korea, Sri Lanka, Taiwan, Thailand, Turkey,
Uruguay, Venezuela and Vietnam.
Foreign Currency Transactions
To manage the currency risk accompanying investments in foreign
securities and to facilitate the purchase and sale of foreign securities, the
Funds may engage in foreign currency transactions on a spot (cash) basis at the
spot rate prevailing in the foreign currency exchange market or through entering
into contracts to purchase or sell foreign currencies at a future date ("forward
foreign currency" contracts or "forward" contracts).
A forward foreign currency contract involves an obligation to purchase
or sell a specific currency at a future date, which may be any fixed number of
days from the date of the contract agreed upon by the parties, at a price set at
the time of the contract. These contracts are principally traded in the
inter-bank market conducted directly between currency traders (usually large
commercial banks) and their customers. A forward contract generally has no
deposit requirement and no commissions are charged at any stage for trades.
When a Fund enters into a contract for the purchase or sale of a
security denominated in a foreign currency, it may desire to "lock in" the U.S.
dollar price of the security. By entering into a forward contract for the
purchase or sale of a fixed amount of U.S. dollars equal to the amount of
foreign currency involved in the underlying security transaction, the Fund can
16
<PAGE>
protect itself against a possible loss, resulting from an adverse change in the
relationship between the U.S. dollar and the subject foreign currency during the
period between the date the security is purchased or sold and the date on which
the payment is made or received.
When the Adviser believes that a particular foreign currency may
suffer a substantial decline against the U.S. dollar, they may enter into a
forward contract to sell a fixed amount of the foreign currency approximating
the value of some or all of a Fund's portfolio securities denominated in such
foreign currency. The precise matching of the forward contract amounts and the
value of the securities involved will not generally be possible since the future
value of such securities in foreign currencies will change as a consequence of
market movements in the value of those securities between the date the forward
contract is entered into and the date it matures. The projection of short-term
currency market movement is extremely difficult and the successful execution of
a short-term hedging strategy is highly uncertain. A Fund will not enter into
such forward contracts or maintain a net exposure to such contracts where the
consummation of the contracts would obligate the Fund to deliver an amount of
foreign currency in excess of the value of the Fund's securities or other assets
denominated in that currency. Under normal circumstances, the Adviser considers
the long-term prospects for a particular currency and incorporate the prospects
into its overall long-term diversification strategies. The Adviser believes that
it is important to have the flexibility to enter into such forward contracts
when it determines that the best interests of a Fund will be served.
At the maturity of a forward contract, a Fund may either sell the
portfolio securities and make delivery of the foreign currency, or it may retain
the securities and terminate its contractual obligation to deliver the foreign
currency by purchasing an "offsetting" contract obligating it to purchase, on
the same maturity date, the same amount of foreign currency.
If a Fund retains the portfolio securities and engages in an
offsetting transaction, the Fund will incur a gain or a loss to the extent that
there has been movement in forward contract prices. If a Fund engages in an
offsetting transaction, it may subsequently enter into a forward contract to
sell the foreign currency. Should forward prices decline during the period when
the Fund entered into the forward contract for the sale of a foreign currency
and the date it entered into an offsetting contract for the purchase of the
foreign currency, the Fund will realize a gain to the extent the price of the
currency it has agreed to sell exceeds the price of the currency it has agreed
to purchase. Should forward prices increase, the Fund will suffer a loss to the
extent that the price of the currency it has agreed to purchase exceeds the
price of the currency it has agreed to sell.
Shareholders should note that: (1) foreign currency hedge transactions
do not protect against or eliminate fluctuations in the prices of particular
portfolio securities (i.e., if the price of such securities declines due to an
issuer's deteriorating credit situation); and (2) it is impossible to forecast
with precision the market value of securities at the expiration of a forward
contract. Accordingly, a Fund may have to purchase additional foreign currency
on the spot market (and bear the expense of such purchase) if the market value
of a Fund's securities is less than the amount of the foreign currency upon
expiration of the contract. Conversely, a Fund may have to sell some of its
foreign currency received upon the sale of a portfolio security if the market
value of the Fund's securities exceed the amount of foreign currency the Fund is
obligated to deliver. A Fund's dealings in forward foreign currency exchange
contracts will be limited to the transactions described above.
17
<PAGE>
Although the Funds value their assets daily in terms of U.S. dollars,
they do not intend to convert their holdings of foreign currencies into U.S.
dollars on a daily basis. A Fund will do so from time to time and investors
should be aware of the costs of currency conversion. Although foreign exchange
dealers do not charge a fee for conversion, they realize a profit based on the
difference (the "spread") between the prices at which they are buying and
selling various currencies. Thus, a dealer may offer to sell a foreign currency
to a Fund at one rate, while offering a lesser rate of exchange should the Fund
desire to resell that currency to the dealer.
Each of the Funds may purchase and sell currency futures and purchase
and write currency options to increase or decrease its exposure to different
foreign currencies. The uses and risks of currency options and futures are
similar to options and futures relating to securities or indices, as discussed
above. Currency futures contracts are similar to forward foreign currency
contracts, except that they are traded on exchanges (and have margin
requirements) and are standardized as to contract size and delivery date. Most
currency futures contracts call for payment or delivery in U.S. dollars. The
underlying instrument of a currency option may be a foreign currency, which
generally is purchased or delivered in exchange for U.S. dollars, or may be a
futures contract. The purchaser of a currency call obtains the right to purchase
the underlying currency, and the purchaser of a currency put obtains the right
to sell the underlying currency.
Currency futures and options values can be expected to correlate with
exchange rates, but may not reflect other factors that affect the value of the
respective Fund's investments. A currency hedge, for example, should protect a
Yen-dominated security from a decline in the Yen, but will not protect a
particular Fund against a price decline resulting from deterioration in the
issuer's creditworthiness. Because the value of a Fund's foreign-denominated
investments change in response to many factors other than exchange rates, it may
not be possible to match the amount of currency options and futures to the value
of the Fund's investments exactly over time.
DIRECTORS AND OFFICERS OF THE CORPORATION
As a Maryland corporation, the business and affairs of the Corporation
are managed by its officers under the direction of its Board of Directors. The
name, address, principal occupations during the past five years and other
information with respect to each of the directors and offices of the Corporation
are as follows:
JoAnne Brandes -- Director. Ms. Brandes, 45, has been Senior Vice
President, General Counsel and Secretary of S.C. Johnson Commercial Markets,
Inc. since October 1997. Prior to that time, Ms. Brandes served in various
capacities as an officer of S.C. Johnson & Son, Inc since 1992. Both S.C.
Johnson Commercial Markets, Inc. and S.C. Johnson & Son, Inc. are controlled by
Samuel C. Johnson as is Johnson International, Inc., the corporate parent of the
Adviser. Ms. Brandes is also a director of Alternative Resources Corporation,
Lincolnshire, Illinois, a computer servicer and supplier, and Corporate Family
Solutions, Inc., Nashville, Tennessee, a child care provider. Her address is
8310 16th Street, P.O. Box 902, Sturtevant, WI 53177.
Richard Bibler -- Director. Mr. Bibler, 67, has been an owner of
Rudolph Stone Associates, a financial consulting firm since prior to 1990. His
address is Suite 104, 500 West Brown Deer Road, Milwaukee, WI 53217.
18
<PAGE>
F. Gregory Campbell -- Director. Dr. Campbell, 59, has been the
President of Carthage College since 1987. Dr. Campbell also serves as a trustee
of AAL Mutual Funds. His address is Carthage College, 2001 Alford Drive,
Kenosha, WI 53104.
Gerald Konz -- Director. Mr. Konz, 67, is an independent consultant.
Mr. Konz was Vice President and Tax Counsel and Chairman of the pension and
savings plan investment committees of S.C. Johnson & Son, Inc. from 1982 until
1997. His address is c/o S.C. Johnson & Son, Inc., 1525 Howe Street, Racine, WI
53403.
George Nelson -- Director. Mr. Nelson, 61, has been Vice President -
Administration & Finance of Evening Telegram, Inc. since 1982. His address is
7025 Raymond Road, Madison, WI 53719.
*Wendell Perkins -- Director. Mr. Perkins, 35, has been Senior Vice
President of the Adviser since 1994. In 1993 Mr. Perkins was an Assistant Vice
President of Biltmore Investors Bank, an affiliate of the Adviser. His address
is 4041 North Main Street, Racine, WI 53402.
Joan Burke -- President and Treasurer. Ms. Burke, 48, has been
President and Chief Executive Officer of the Adviser and Johnson Trust Company
since November, 1995. From December 1994 to November 1995 Ms. Burke was Vice
President of Firstar Bank of Madison and from October 1976 to October 1994 she
was Senior Vice President of Valley Trust Company. Her address is 4041 North
Main Street, Racine, WI 53402.
George Balistreri -- Vice President and Secretary. Mr. Balistreri, 55,
has been Senior Vice President of the Adviser since 1990. His address is 4041
North Main Street, Racine, WI 53402.
The Corporation's standard method of compensating directors is to pay
each director who is not an officer of the Corporation an annual fee of $5,000
and a fee of $500 for each meeting of the Board of Directors attended.
The Corporation was incorporated on January 27, 1998. The table below
sets forth the compensation paid by the Corporation to each of the directors of
the Corporation during the fiscal year ended October 31, 1998:
COMPENSATION TABLE
<TABLE>
<CAPTION>
Total
Pension or Compensation
Aggregate Retirement Benefits Estimated Annual from Corporation
Name of Compensation Accrued as Part of Benefits Upon and Fund Complex
Person from Corporation Fund Expenses Retirement Paid to Directors
------ ---------------- ------------- ----------------- -----------------
<S> <C> <C> <C> <C>
JoAnne Brandes $6500 $0 $0 $6500
Richard Bibler 6500 0 0 6500
- --------------
*Mr. Perkins is the only director who is an "interested person" of the
Corporation as that term is defined in the Investment Company Act of 1940.
19
<PAGE>
<CAPTION>
<S> <C> <C> <C> <C>
F. Gregory Campbell 6500 0 0 6500
Gerald Konz 6500 0 0 6500
George Nelson 6500 0 0 6500
Wendell Perkins 0 0 0 0
</TABLE>
OWNERSHIP OF MANAGEMENT AND PRINCIPAL SHAREHOLDERS
As of May 31, 1999, the officers and directors of the Corporation
owned less than 1% of the outstanding securities of each Fund. Set forth below
are the names and addresses of all holders of each of the Funds' shares who as
of May 31, 1999 owned of record or to the knowledge of the Funds, beneficially
owned more than 5% of a Funds' then outstanding shares.
<TABLE>
<CAPTION>
Large Cap Small Cap International
Equity Fund Equity Fund Fixed Income Fund Equity Fund
No. of Percent No. of Percent No. of Percent No. of Percent
Shares of Class Shares of Class Shares of Class Shares of Class
------ -------- ------ -------- ------ -------- ------ --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Johnson Trust Company 4,464,154 97.39% 2,457,177 99.52% 6,223,498 99.34% 2,302,536 99.86%
4041 North Main Street
Racine, WI 53402
</TABLE>
By virtue of its stock ownership, Johnson Trust Company, as a fiduciary for its
clients, is deemed to "control," as that term is defined in the Investment
Company Act of 1940, each of the Funds and the Corporation.
INVESTMENT ADVISER, ADMINISTRATOR, CUSTODIAN
AND TRANSFER AGENT
The investment adviser to the Funds is Johnson Asset Management, Inc.
(the "Adviser"). Pursuant to the investment advisory agreements entered into
between the Corporation and the Adviser with respect to each of the Funds (the
"Advisory Agreements"), the Adviser manages the investment and reinvestment of
each Fund's assets; provides the Funds with personnel, facilities and management
services; and supervises each Fund's daily business affairs. The Adviser
formulates and implements a continuous investment program for the Funds
consistent with each Fund's investment objective, policies and restrictions. The
Adviser provides office space as well as executive and other personnel to the
Funds. For its services to the Funds, the Adviser receives a monthly fee (before
fee waivers as explained below) based on the average daily net assets of each
Fund at the annual rate of 0.45% for the Fixed Income Fund, 0.75% for the Large
Cap Equity Fund, 0.75% for the Small Cap Equity Fund and 0.90% for the
International Equity Fund. The Adviser is a wholly-owned subsidiary of Johnson
International, Inc., a Wisconsin corporation. Johnson International, Inc. is a
bank holding company. Samuel C. Johnson controls the Adviser by virtue of his
status as trustee of the Johnson International, Inc. Voting Trust, which holds
55% of the outstanding shares of Johnson International, Inc. The Adviser's
executive officers include Joan A. Burke, President and Chief Executive Officer,
George A. Balistreri, Senior Vice President, Wendell Perkins, Senior Vice
President, and Frank J. Gambino, Vice President.
20
<PAGE>
Pursuant to the Advisory Agreements, the Adviser has undertaken to
reimburse each of the Funds to the extent that the aggregate annual operating
expenses, including the investment advisory fee and the administration fee but
excluding interest, taxes, brokerage commissions and other costs incurred in
connection with the purchase or sale of portfolio securities, and extraordinary
items, exceed 2.5% of the average net assets of a Fund (1.5% for the
Intermediate Fixed Income Fund) for such year, as determined by valuations made
as of the close of each business day of the year. Other expenses borne by the
Funds include: legal, auditing and accounting expenses; insurance premiums;
governmental fees; expenses of issuing and redeeming shares; organizational
expenses; expenses of registering or qualifying shares for sale; postage and
printing for reports and notices to shareholders; fees and disbursements of the
Funds' custodian and transfer agent; fees and disbursements pursuant to the
Service and Distribution Plan; and membership fees of industry associations.
Additionally, for the fiscal year ended October 31, 1998, the Adviser reimbursed
each Fund for annual operating expenses in excess of the percentage of its
average net assets for such year set forth below.
Fund Expense Limitation
---- ------------------
Intermediate Fixed Income Fund 0.85%
Large Cap Equity Fund 1.45%
Small Cap Equity Fund 1.50%
International Equity Fund 1.85%
The Funds monitor their expense ratio on a monthly basis. If the
accrued amount of the expenses of a Fund exceeds the expense limitation, the
Fund creates an account receivable from the Adviser for the amount of such
excess. In such a situation the monthly payment of the Adviser's fee will be
reduced by the amount of such excess, subject to adjustment month by month
during the balance of the Fund's fiscal year if accrued expenses thereafter fall
below this limit.
The Funds did not commence operations until March 31, 1998. For
services by the Adviser under the Advisory Agreements during the period from
March 31, 1998 through October 31, 1998, the Funds incurred advisory fees
payable to the Adviser of $174,092 for the Large Cap Equity Fund, $93,683 for
the Small Cap Equity Fund, $173,214 for the Fixed Income Fund and $105,901 for
the International Equity Fund. During the period from March 31, 1998
(commencement of operations) through October 31, 1998, the Adviser made
reimbursements for excess expenses of $393 to the Large Cap Equity Fund, $10,276
to the Small Cap Equity Fund, $100,890 to the Fixed Income Fund and $13,163 to
the International Equity Fund.
Each Advisory Agreement will remain in effect as long as its
continuance is specifically approved at least annually (i) by the Board of
Directors of the Corporation or by the vote of a majority (as defined in the
Act) of the outstanding shares of the applicable Fund, and (ii) by the vote of a
majority of the directors of the Corporation who are not parties to the Advisory
Agreement or interested persons of the Adviser, cast in person at a meeting
called for the purpose of voting on such approval. Each Advisory Agreement
provides that it may be terminated at any time without the payment of any
penalty, by the Board of Directors of the Corporation or by vote
21
<PAGE>
of the majority of the applicable Fund's stockholders on sixty (60) days'
written notice to the Adviser, and by the Adviser on the same notice to the
Corporation, and that it shall be automatically terminated if it is assigned.
Each Advisory Agreement provides that the Adviser shall not be liable
to the Corporation or its stockholders for anything other than willful
misfeasance, bad faith, gross negligence or reckless disregard of its
obligations or duties. Each Advisory Agreement also provides that the Adviser
and its officers, directors and employees may engage in other businesses, devote
time and attention to any other business whether of a similar or dissimilar
nature, and render services to others.
The administrator to the Funds is Sunstone Financial Group, Inc., 207
East Buffalo Street, Suite 400, Milwaukee, Wisconsin 53202 (the
"Administrator"). The Administrator provides various administrative services and
fund accounting services to the Funds (which includes clerical, compliance,
regulatory fund accounting and other services) pursuant to an Administration and
Fund Accounting Agreement (the "Administration Agreement") with the Corporation
on behalf of the Funds. For its administrative services, the Administrator
receives from each Fund a fee, computed daily and payable monthly, based on each
Fund's average net assets at the annual rate of 0.20%, subject to a combined
annual minimum for all four Funds of $206,000, plus out-of-pocket expenses. The
Administration Agreement will remain in effect until December 31, 2000.
Thereafter, the Administration Agreement may be terminated at any time, without
the payment of any penalty, by the Board of Directors of the Corporation upon
the giving of ninety (90) days' written notice to the Administrator, or by the
Administrator upon the giving of ninety (90) days' written notice to the
Corporation.
For the period from March 31, 1998 (commencement of operations)
through October 31, 1998, the Large Cap Equity Fund paid the Administrator
$46,424, the Small Cap Equity Fund paid the Administrator $24,982, the Fixed
Income Fund paid the Administrator $76,984 and the International Equity Fund
paid the Administrator $23,534, pursuant to the Administration Agreement.
Under the Administration Agreement, the Administrator shall not be
liable for any loss suffered by the Funds in connection with the performance of
the Administration Agreement, except a loss resulting from willful misfeasance,
bad faith or negligence on the part of the Administrator in the performance of
its duties under the Administration Agreement. The Administration Agreement also
provides that the Administrator may provide similar services to other investment
companies.
Investors Fiduciary Trust Company serves as custodian of the
Corporation's assets pursuant to a Custody Agreement. Under the Custody
Agreement, Investors Fiduciary Trust Company has agreed to (i) maintain separate
accounts in the name of the Funds, (ii) make receipts and disbursements of money
on behalf of each of the Funds, (iii) collect and receive all income and other
payments and distributions on account of each of the Fund's portfolio
investments, (iv) respond to correspondence from shareholders, security brokers
and others relating to its duties; and (v) make periodic reports to the Funds
concerning the Funds' operations. Investors Fiduciary Trust Company does not
exercise any supervisory function over the purchase and sale of securities.
22
<PAGE>
Sunstone Financial Group, Inc. serves as transfer agent and dividend
paying agent for the Funds under a Transfer Agency Agreement between it and the
Corporation. As transfer and dividend paying agent, Sunstone Financial Group,
Inc. has agreed to (i) issue and redeem shares of the Funds, (ii) make dividend
and other distributions to shareholders of the Funds, (iii) respond to
correspondence by Fund shareholders and others relating to its duties, (iv)
maintain shareholder accounts, and (v) make periodic reports to the Funds.
DETERMINATION OF NET ASSET VALUE
Pricing Considerations
The net asset value of each of the Funds will be determined as of the
close of regular trading (3:00 P.M. Central Time) on each day the New York Stock
Exchange is open for trading. The New York Stock Exchange is open for trading
Monday through Friday except New Year's Day, Dr. Martin Luther King, Jr. Day,
President's Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day. Additionally, if any of the aforementioned
holidays falls on a Saturday, the New York Stock Exchange will not be open for
trading on the preceding Friday and when any such holiday falls on a Sunday, the
New York Stock Exchange will not be open for trading on the succeeding Monday,
unless unusual business conditions exist, such as the ending of a monthly or the
yearly accounting period.
Each Fund's net asset value is equal to the quotient obtained by
dividing the value of its net assets (its assets less its liabilities) by the
number of shares outstanding.
Common stocks and securities sold short that are listed on any
national stock exchange or quoted on the Nasdaq Stock Market will be valued at
the last sale price on the date the valuation is made. Price information on
listed securities is taken from the exchange where the security is primarily
traded. Common stocks which are listed on any national stock exchange or the
Nasdaq Stock Market but which are not traded on the valuation date are valued at
the most recent bid price. Securities sold short which are listed on any
national stock exchange or the Nasdaq Stock Market but which are not traded on
the valuation date are valued at the most recent asked price. Unlisted equity
securities for which market quotations are readily available will be valued at
the most recent bid price. Options purchased or written by the Funds are valued
at the average of the current bid and asked prices. The value of a futures
contract equals the unrealized gain or loss on the contract that is determined
by marking the contract to the current settlement price for a like contract
acquired on the day on which the futures contract is being valued. A settlement
price may not be changed if the market makes a limit move in which event the
futures contract will be valued at its fair market value as determined by the
Adviser in accordance with procedures approved by the Board of Directors. Debt
securities are valued at the latest bid prices furnished by independent pricing
services. Pricing services may determine valuations based upon normal,
institutional-size trading units of such securities using market transactions
for comparable securities and various relationships between securities generally
recognized by institutional traders. Any securities for which there are no
readily available market quotations and other assets will be valued at their
fair value as determined in good faith by the Board of Directors. Short-term
debt instruments (those with remaining maturities of 60 days or less) are valued
at amortized cost, which approximates market.
23
<PAGE>
The Funds price foreign securities in terms of U.S. dollars at the
official exchange rate. Alternatively, they may price these securities at the
average of the current bid and asked price of such currencies against the dollar
last quoted by a major bank that is a regular participant in the foreign
exchange market, or on the basis of a pricing service that takes into account
the quotes provided by a number of such major banks. If the Funds do not have
either of these alternatives available to them or the alternatives do not
provide a suitable method for converting a foreign currency into U.S. dollars,
the Board of Directors in good faith will establish a conversion rate for such
currency.
Generally, U.S. government securities and other fixed income
securities complete trading at various times prior to the close of the New York
Stock Exchange. For purposes of computing net asset value, the Funds use the
market value of such securities as of the time their trading day ends.
Occasionally, events affecting the value of such securities may occur between
such times and the close of the New York Stock Exchange, which events will not
be reflected in the computation of a Fund's net asset value. It is currently the
policy of the Funds that events affecting the valuation of Fund securities
between such times and the close of the New York Stock Exchange, even if
material, will not be reflected in such net asset value.
Foreign securities trading may not take place on all days when the New
York Stock Exchange is open, or may take place on Saturdays and other days when
New York Stock Exchange is not open and a Fund's net asset value is not
calculated. When determining net asset value, the Funds value foreign securities
primarily listed and/or traded in foreign markets at their market value as of
the close of the last primary market where the securities traded. Securities
trading in European countries and Pacific Rim countries is normally completed
well before 3:00 P.M. Central Time. It is currently the policy of the Funds that
events affecting the valuation of Fund securities occurring between the time its
net asset value is determined and the close of the New York Stock Exchange, even
if material, will not be reflected in such net asset value.
Each Fund reserves the right to suspend or postpone redemptions during
any period when: (a) trading on the New York Stock Exchange is restricted, as
determined by the Securities and Exchange Commission, or that the Exchange is
closed for other than customary weekend and holiday closings; (b) the Securities
and Exchange Commission has by order permitted such suspension; or (c) an
emergency, as determined by the Securities and Exchange Commission, exists,
making disposal of portfolio securities or valuation of net assets of the Fund
not reasonably practicable.
PERFORMANCE INFORMATION
Any total rate of return quotation for a Fund will be for a period of
three or more months and will assume the reinvestment of all dividends and
capital gains distributions which were made by the Fund during that period. Any
period total rate of return quotation of a Fund will be calculated by dividing
the net change in value of a hypothetical shareholder account established by an
initial payment of $1,000 at the beginning of the period by 1,000. The net
change in the value of a shareholder account is determined by subtracting $1,000
from the product obtained by multiplying the net asset value per share at the
end of the period by the sum obtained by adding (A) the number of shares
purchased at the beginning of the period plus (B) the number of shares purchased
during the period with reinvested dividends and distributions. Any average
annual
24
<PAGE>
compounded total rate of return quotation of a Fund will be calculated by
dividing the redeemable value at the end of the period (i.e., the product
referred to in the preceding sentence) by $1,000. A root equal to the period,
measured in years, in question is then determined and 1 is subtracted from such
root to determine the average annual compounded total rate of return.
The foregoing computation may also be expressed by the following
formula:
P(1 + T)n = ERV
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical
$1,000 payment made at the beginning of the
stated periods at the end of the stated periods
The calculations of average annual total return and total return
assume the reinvestment of all dividends and capital gain distributions on the
reinvestment dates during the period. The ending redeemable value (variable
"ERV") is determined by assuming complete redemption of the hypothetical
investment and the deduction of all nonrecurring charges at the end of the
period covered by the computations.
The total rate of return for the period from March 31, 1998
(commencement of operations) through October 31, 1998, was -3.87% for the Large
Cap Equity Fund, -17.80% for the Small Cap Equity Fund, 5.89% for the Fixed
Income Fund and -10.30% for the International Equity Fund.
The current yield for the Fixed Income Fund is based on a 30-day (or
one-month) period and is computed by dividing the net investment income per
share earned during the period by the net asset value per share on the last day
of the period, according to the following formula:
a-b
YIELD = S[(---- + 1)6 -1]
cd
Where: a = interest earned during the period.
b = expenses accrued for the period (net of
reimbursements).
c = the average daily number of shares
outstanding during the period that were
entitled to receive dividends.
d = the net asset value per share on the last
day of the period.
25
<PAGE>
The Fixed Income Fund's SEC 30-day yield for the period from October
1, 1998 through October 31, 1998 was 4.49%. Absent fee waivers, the yield would
have been 4.48%.
Each of the Funds may compare its performance to other mutual funds
with similar investment objectives and to the industry as a whole, as reported
by Morningstar, Inc. and Lipper Analytical Services, Inc.; Money, Forbes,
Business Week and Barron's magazines; and The Wall Street Journal. (Morningstar,
Inc. and Lipper Analytical Services, Inc. are independent ranking services that
each rank over 1,000 mutual funds based upon total return performance.) Each of
the Funds may also compare its performance to the Dow Jones Industrials Average,
Nasdaq Composite Index, Nasdaq Industrials Index, Value Line Composite Index,
the S&P 500r, S&P 400 Mid-Cap Growth Index, S&P Small Cap 600 Index, S&P BARRA
Value Index, Lehman Brothers Intermediate Government/Corporate Bond Index,
Russell 1000 Growth Index, Russell 2000 Index, Morgan Stanley Capital
International World (ex. U.S.) Index and the Consumer Price Index. Such
comparisons may be made in advertisements, shareholder reports or other
communications to shareholders.
DISTRIBUTION OF SHARES
Service and Distribution Plan
In addition to the sales charge deducted at the time of purchase, the
Corporation has adopted a Service and Distribution Plan pursuant to Rule 12b-1
under the Act (the "Plan") to use a portion of the Funds' assets to cover the
costs of certain activities relating to the distribution of its shares to
investors. The Corporation adopted the Plan in anticipation that the Funds will
benefit from the Plan through increased sales of shares, thereby reducing the
expense ratio of each of the Funds and providing the Adviser with greater
flexibility in management. The Plan may be terminated with respect to any Fund
at any time by a vote of the directors of the Corporation who are not interested
persons of the Corporation and who have no direct or indirect financial interest
in the Plan or any agreement related thereto (the "Rule 12b-1 Directors") or by
a vote of a majority of the outstanding shares of the Fund. JoAnne Brandes,
Richard Bibler, F. Gregory Campbell, Gerald Konz and George Nelson are currently
the Rule 12b-1 Directors. Any change in the Plan that would materially increase
the distribution expenses of a Fund provided for in the Plan requires approval
of the stockholders of that Fund and the Board of Directors, including the Rule
12b-1 Directors.
While the Plan is in effect, the selection and nomination of directors
who are not interested persons of the Corporation will be committed to the
discretion of the directors of the Corporation who are not interested persons of
the Corporation. The Board of Directors of the Corporation must review the
amount and purposes of expenditures pursuant to the Plan quarterly as reported
to it by a Distributor, if any, or officers of the Corporation. The Plan will
continue in effect for as long as its continuance is specifically approved at
least annually by the Board of Directors, including the Rule 12b-1 Directors.
Sunstone Distribution Services, LLC (the "Distributor"), an affiliate
of Sunstone Financial Group, Inc., acts as the principal underwriter of shares
of the Funds. The Distributor distributes shares of the Funds on a continuous
"best efforts" basis. The Plan permits the Funds to reimburse the Distributor
for expenses incurred in distributing the Funds' shares to investors,
26
<PAGE>
which include expenses relating to: sales representative compensation;
advertising preparation and distribution of sales literature and prospectuses to
prospective investors; implementing and operating the Plan; and performing other
promotional or administrative activities on behalf of the Funds. Pursuant to the
Plan, the Funds may reimburse the Distributor for overhead expenses incurred in
distributing the Funds' shares. The Funds may not reimburse the Distributor for
expenses of past fiscal years or in contemplation of expenses for future fiscal
years. The Funds may not use distribution fees paid by one Fund to finance the
distribution of shares for another Fund. The Distributor has entered into a
Distribution Agreement with the Corporation pursuant to which the Funds pay to
the Distributor a fee at the annual rate of 0.05% of each Fund's average daily
net assets.
The Distributor may enter into agreements from time to time with
broker-dealers ("Selected Dealers") providing for certain support and/or
distribution services to their customers who are the beneficial owners of shares
of the Funds. Under these agreements, shareowner support services may include
assisting investors in processing purchase, exchange and redemption requests;
processing dividend and distribution payments from the Funds; providing
information periodically to customers showing their positions in shares of the
Funds; and providing sub-accounting with respect to shares beneficially owned by
customers or the information necessary for sub-accounting. Such entities may
also provide assistance, such as the forwarding of sales literature and
advertising to their customers, in connection with the distribution of shares.
Under these agreements, the Distributor may pay fees at annual rates of up to
0.25% of the average daily net asset value of the shares covered by the
agreement.
During the period from March 31, 1998 (commencement of operations)
through October 31, 1998, the Funds incurred distribution fees under the Plan of
$58,031 for the Large Cap Equity Fund, $31,228 for the Small Cap Equity Fund,
$96,230 for the Fixed Income Fund and $29,417 for the International Equity Fund.
These fees were allocated to the following activities:
<TABLE>
<CAPTION>
Large Cap Small Cap Fixed Income International
Equity Fund Equity Fund Fund
<S> <C> <C> <C> <C>
Advertising $23,460 $12,684 $38,897 $11,894
Compensation to Distributor 20,903 11,154 34,673 10,594
Training of Sales Personnel 12,238 6,617 20,290 6,204
Printing and Mailing of Prospectuses 1,139 616 1,888 577
Compensation to Selected Dealers 291 157 482 148
</TABLE>
During the period from March 31, 1998 (commencement of operations)
through October 31, 1998 the Distributor received a sales charge or underwriting
commission on certain sales of shares of the Funds. The aggregate amount of
underwriting commissions paid to the Distributor and the amounts retained by the
Distributor (i.e. not reallowed to Selected Dealers) were:
27
<PAGE>
<TABLE>
<CAPTION>
Aggregate Amount of Underwriting Amounts Retained by the
Commissions Paid Distributor
to Distributor
<S> <C> <C>
Fixed Income Fund $ 572 $132
Large Cap Equity Fund $3,401 $663
Small Cap Equity Fund $1,808 $233
International Equity Fund $ 8 $ 1
</TABLE>
ALLOCATION OF PORTFOLIO BROKERAGE
Decisions to buy and sell securities for the Funds are made by the
Adviser subject to review by the Corporation's Board of Directors. In placing
purchase and sale orders for portfolio securities for a Fund, it is the policy
of the Adviser to seek the best execution of orders at the most favorable price
in light of the overall quality of brokerage and research services provided, as
described in this and the following paragraph. Many of these transactions
involve payment of a brokerage commission by a Fund. In some cases transactions
are with firms who act as principal for their own accounts. In selecting brokers
to effect portfolio transactions, the determination of what is expected to
result in best execution at the most favorable price involves a number of
largely judgmental considerations. Among these are the Adviser's evaluation of
the broker's efficiency in executing and clearing transactions, block trading
capability (including the broker's willingness to position securities and the
broker's financial strength and stability). The most favorable price to a Fund
means the best net price without regard to the mix between purchase or sale
price and commission, if any. Over-the-counter securities are generally
purchased and sold directly with principal market makers who retain the
difference in their cost in the security and its selling price (i.e. "markups"
when the market maker sells a security and "markdowns" when the market maker
purchases a security). In some instances, the Adviser feels that better prices
are available from non-principal market makers who are paid commissions
directly. The Adviser, in allocating orders for the purchase and sale of the
Funds' portfolio securities, is authorized to take into account the sale of Fund
shares, if the Adviser believes that the quality of the transaction and the
amount of the commission are comparable to what they would be with other
qualified firms.
In allocating brokerage business for a Fund, the Adviser also takes
into consideration the research, analytical, statistical and other information
and services provided by the broker, such as general economic reports and
information, reports or analyses of particular companies or industry groups,
market timing and technical information, and the availability of the brokerage
firm's analysts for consultation. While the Adviser believes these services have
substantial value, they are considered supplemental to the Adviser's own efforts
in the performance of its duties under the Advisory Agreements. Other clients of
the Adviser may indirectly benefit from the availability of these services to
the Adviser, and the Funds may indirectly benefit from services available to the
Adviser as a result of transactions for other clients. The Advisory Agreements
provide that the Adviser may cause a Fund to pay a broker which provides
brokerage and research services to the Adviser a commission for effecting a
securities transaction in excess of the amount another broker would have charged
for effecting the transaction, if the Adviser determines in good faith that such
amount of commission is reasonable in relation to the value of brokerage and
research services provided by the executing broker viewed in terms of either the
28
<PAGE>
particular transaction or the Adviser's overall responsibilities with respect to
the Fund and the other accounts as to which it exercises investment discretion.
Brokerage commissions paid by the Funds during the period from January
27, 1998 (commencement of operations) through October 31, 1998 totaled $57,336
on total transactions of $37,191,797 for the Large Cap Equity Fund, $60,012 on
total transaction of $24,513,204 for the Small Cap Equity Fund, and $68,366 on
total transactions of $20,742,290 for the International Equity Fund. The Fixed
Income Fund did not pay brokerage commissions during this period. Substantially
all of the commissions paid by the Funds were paid on transactions which were
directed to brokers providing research services.
The Adviser may have other clients for which it is making investment
and order placement decisions similar to the Funds. When making simultaneous
purchases or sales for the Funds and another client, if any, the Adviser's
decisions could have a detrimental effect on the price or volume of the
securities purchased or sold for the Funds. In other cases, simultaneous
purchases or sales of securities for the Funds and other clients could provide
the Funds with the ability to participate in volume transactions that may cost
less per share or unit traded than smaller transactions.
TAXES
General
The Funds intend to qualify annually for and elect tax treatment
applicable to a regulated investment company under Subchapter M of the Internal
Revenue Code of 1986, as amended (the "Code"). The discussion that follows is
not intended to be a full discussion of present or proposed federal income tax
laws and the effect of such laws on an investor. Investors are urged to consult
with their tax advisers for a complete review of the tax ramifications of an
investment in the Funds.
If a Fund fails to qualify as a regulated investment company under
Subchapter M in any fiscal year, it will be treated as a corporation for federal
income tax purposes. As such that Fund would be required to pay income taxes on
its net investment income and net realized capital gains, if any, at the rates
generally applicable to corporations. Shareholders in a Fund that did not
qualify as a regulated investment company under Subchapter M would not be liable
for income tax on that Fund's net investment income or net realized gains in
heir individual capacities. Distributions to shareholders, whether from that
Fund's net investment income or net realized capital gains, would be treated as
taxable dividends to the extent of current or accumulated earnings and profits
of that Fund.
Dividends from a Fund's net investment income, including short-term
capital gains, are taxable to shareholders as ordinary income, while
distributions of net capital gain are taxable as long-term capital gain
regardless of the shareholder's holding period for the shares. Such dividends
and distributions are taxable to shareholders whether received in cash or in
additional shares. The 70% dividends-received deduction for corporations will
apply to dividends from a Fund's net investment income, subject to proportionate
reductions if the aggregate dividends received by the
29
<PAGE>
Fund from domestic corporations in any year are less than 100% of the
distribution of net investment company income taxable made by the Fund.
Any dividend or capital gain distribution paid shortly after a
purchase of shares of a Fund, will have the effect of reducing the per share net
asset value of such shares by the amount of the dividend or distribution.
Furthermore, if the net asset value of the shares of a Fund immediately after a
dividend or distribution is less than the cost of such shares to the
shareholder, the dividend or distribution will be taxable to the shareholder
even though it results in a return of capital to him.
Redemption of shares will generally result in a capital gain or loss
for income tax purposes. Such capital gain or loss will be long term or short
term, depending upon the shareholder's holding period for the shares. However,
if a loss is realized on shares held for six months or less, and the investor
received a capital gain distribution during that period, then such loss is
treated as a long-term capital loss to the extent of the capital gain
distribution received.
Rule 17a-7 Transactions
The Funds have adopted procedures pursuant to Rule 17a-7 under the Act
pursuant to which each of the Funds may effect a purchase and sale transaction
with an affiliated person of the Funds (or an affiliated person of such an
affiliated person) in which a Fund issues its shares in exchange for securities
which are permitted investments for the Funds. For purposes of determining the
number of shares to be issued, the securities to be exchanged will be valued in
accordance with Rule 17a-7. Certain of the transactions may be tax-free with the
result that the Funds acquire unrealized appreciation. Most Rule 17a-7
transactions will not be tax-free.
Taxation of Hedging Instruments
If a call option written by a Fund expires, the amount of the premium
received by the Fund for the option will be short-term capital gain. If a Fund
enters into a closing transaction with respect to the option, any gain or loss
realized by a Fund as a result of the transaction will be short-term capital
gain or loss. If the holder of a call option exercises the holder's right under
the option, any gain or loss realized by the Fund upon the sale of the
underlying security or futures contract pursuant to such exercise will be
short-term or long-term capital gain or loss to the Fund depending on the Fund's
holding period for the underlying security or futures contract.
With respect to call options purchased by a Fund, the Fund will
realize short-term or long-term capital gain or loss if such option is sold and
will realize short-term or long-term capital loss if the option is allowed to
expire depending on the Fund's holding period for the call option. If such a
call option is exercised, the amount paid by a Fund for the option will be added
to the basis of the stock or futures contract so acquired.
A Fund may purchase or write options on stock indexes. Options on
"broadbased" stock indexes are generally classified as "nonequity options" under
the Code. Gains and losses resulting from the expiration, exercise or closing of
such nonequity options and on futures contracts will be treated as long-term
capital gain or loss to the extent of 60% thereof and short-term capital gain or
loss to the extent of 40% thereof (hereinafter "blended gain or loss") for
determining the character of distributions. In addition, nonequity options and
futures contracts held by a Fund on
30
<PAGE>
the last day of a fiscal year will be treated as sold for market value ("marked
to market") on that date, and gain or loss recognized as a result of such deemed
sale will be blended gain or loss. The realized gain or loss on the ultimate
disposition of the option will be increased or decreased to take into
consideration the prior marked to market gains and losses.
The trading strategies of a Fund involving nonequity options on stock
indexes may constitute "straddle" transactions. "Straddles" may affect the
short-term or long-term holding period of such instruments for distributions
characterization.
A Fund may acquire put options. Under the Code, put options on stocks
are taxed similar to short sales. If a Fund owns the underlying stock or
acquires the underlying stock before closing the option position, the Straddle
Rules may apply and the option positions may be subject to certain modified
short sale rules. If a Fund exercises or allows a put option to expire, the Fund
will be considered to have closed a short sale. A Fund will generally have a
short-term gain or loss on the closing of an option position. The determination
of the length of the holding period is dependent on the holding period of the
stock used to exercise that put option. If a Fund sells the put option without
exercising it, its holding period will be the holding period of the option.
Foreign Taxes
Each of the Funds may be subject to foreign withholding taxes on
income and gains derived from its investments outside the U.S. Such taxes would
reduce the return on a Fund's investments. Tax treaties between certain
countries and the U.S. may reduce or eliminate such taxes. If more than 50% of
the value of a Fund's total assets at the close of any taxable year consist of
stocks or securities of foreign corporations, the Fund may elect, for U.S.
federal income tax purposes, to treat any foreign country income or withholding
taxes paid by the Fund that can be treated as income taxes under U.S. income tax
principles, as paid by its shareholders. For any year that a Fund makes such an
election, each of its shareholders will be required to include in his income (in
addition to taxable dividends actually received) his allocable share of such
taxes paid by the Fund and will be entitled, subject to certain limitations, to
credit his portion of these foreign taxes against his U.S. federal income tax
due, if any, or to deduct it (as an itemized deduction) from his U.S. taxable
income, if any. Generally, credit for foreign taxes is subject to the limitation
that it may not exceed the shareholder's U.S. tax attributable to his foreign
source taxable income.
If the pass through election described above is made, the source of a
Fund's income flows through to its shareholders. Certain gains from the sale of
securities and currency fluctuations will not be treated as foreign source
taxable income. In addition, this foreign tax credit limitation must be applied
separately to certain categories of foreign source income, one of which is
foreign source "passive income." For this purpose, foreign "passive income"
includes dividends, interest, capital gains and certain foreign currency gains.
As a consequence, certain shareholders may not be able to claim a foreign tax
credit for the full amount of their proportionate share of the foreign tax paid
by the Fund.
The foreign tax credit can be used to offset only 90% of the
alternative minimum tax (as computed under the Code for purposes of this
limitation) imposed on corporations and individuals. If a Fund does not make the
pass through election described above, the foreign taxes it pays will reduce its
income and distributions by the Fund will be treated as U.S. source income.
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Each shareholder will be notified within 60 days after the close of
each Fund's taxable year whether, pursuant to the election described above, the
foreign taxes paid by the Fund will be treated as paid by its shareholders for
that year and, if so, such notification will designate: (i) such shareholder's
portion of the foreign taxes paid; and (ii) the portion of the Fund's dividends
and distributions that represent income derived from foreign sources.
SHAREHOLDER MEETINGS
The Maryland Business Corporation Law permits registered investment
companies, such as the Corporation, to operate without an annual meeting of
stockholders under specified circumstances if an annual meeting is not required
by the Act. The Corporation has adopted the appropriate provisions in its bylaws
and may, at its discretion, not hold an annual meeting in any year in which the
election of directors is not required to be acted upon by the shareholders under
the Act.
The Corporation's bylaws also contain procedures for the removal of
directors by its shareholders. At any meeting of shareholders, duly called and
at which a quorum is present, the shareholders may, by the affirmative vote of
the holders of a majority of the votes entitled to be cast thereon, remove any
director or directors from office and may elect a successor or successors to
fill any resulting vacancies for the unexpired terms of removed directors.
Upon the written request of the holders of shares entitled to not less
than ten percent (10%) of all the votes entitled to be cast at such meeting, the
Secretary of the Corporation shall promptly call a special meeting of
shareholders for the purpose of voting upon the question of removal of any
director. Whenever ten or more shareholders of record who have been such for at
least six months preceding the date of application, and who hold in the
aggregate either shares having a net asset value of at least $25,000 or at least
one percent (1%) of the total outstanding shares, whichever is less, shall apply
to the Corporation's Secretary in writing, stating that they wish to communicate
with other shareholders with a view to obtaining signatures to a request for a
meeting as described above and accompanied by a form of communication and
request which they wish to transmit, the Secretary shall within five business
days after such application either: (1) afford to such applicants access to a
list of the names and addresses of all shareholders as recorded on the books of
the Corporation; or (2) inform such applicants as to the approximate number of
shareholders of record and the approximate cost of mailing to them the proposed
communication and form of request. If the Secretary elects to follow the course
specified in clause (2) of the last sentence of the preceding paragraph, the
Secretary, upon the written request of such applicants, accompanied by a tender
of the material to be mailed and of the reasonable expenses of mailing, shall,
with reasonable promptness, mail such material to all shareholders of record at
their addresses as recorded on the books unless within five business days after
such tender the Secretary shall mail to such applicants and file with the
Securities and Exchange Commission, together with a copy of the material to be
mailed, a written statement signed by at least a majority of the Board of
Directors to the effect that in their opinion either such material contains
untrue statements of fact or omits to state facts necessary to make the
statements contained therein not misleading, or would be in violation of
applicable law, and specifying the basis of such opinion.
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After opportunity for hearing upon the objections specified in the
written statement so filed, the Securities and Exchange Commission may, and if
demanded by the Board of Directors or by such applicants shall, enter an order
either sustaining one or more of such objections or refusing to sustain any of
them. If the Securities and Exchange Commission shall enter an order refusing to
sustain any of such objections, or if, after the entry of an order sustaining
one or more of such objections, the Securities and Exchange Commission shall
find, after notice and opportunity for hearing, that all objections so sustained
have been met, and shall enter an order so declaring, the Secretary shall mail
copies of such material to all stockholders with reasonable promptness after the
entry of such order and the renewal of such tender.
CAPITAL STRUCTURE
The Company's Articles of Incorporation permit the Board of Directors
to issue 1,000,000,000 shares of common stock. The Board of Directors has the
power to designate one or more classes ("series") of shares of common stock and
to designate or redesignate any unissued shares with respect to such series.
Each series is a separate Fund. Shareholders are entitled: (1) to one vote per
full share; (2) to such distributions as may be declared by the Company's Board
of Directors out of funds legally available; and (3) upon liquidation, to
participate ratably in the assets available for distribution. There are no
conversion or sinking fund provisions applicable to the shares, and the holders
have no preemptive rights and may not cumulate their votes in the election of
directors. Consequently the holders of more than 50% of the shares of the
Company voting for the election of directors can elect the entire Board of
Directors and in such event the holders of the remaining shares voting for the
election of directors will not be able to elect any person or persons to the
Board of Directors. The shares are redeemable and are transferable. All shares
issued and sold by the Fund will be fully paid and nonassessable. Fractional
shares entitle the holder to the same rights as whole shares.
As a general matter, shares are voted in the aggregate and not by
class, except where class voting would be required by Maryland law or the Act
(e.g., a change in investment policy or approval of an investment advisory
agreement). All consideration received from the sale of shares of any Fund,
together with all income, earnings, profits and proceeds thereof, belong to that
Fund and are charged with the liabilities directly attributable to that Fund.
Expenses that are not directly attributable to a Fund are typically allocated
among the Funds in proportion to their respective net assets. The net asset
value of a share of any Fund is based on the assets belonging to that Fund less
the liabilities charged to that Fund, and dividends may be paid on shares of any
Fund only out of lawfully available assets belonging to that Fund. In the event
of liquidation or dissolution of the Funds, the holders of each Fund would be
entitled, out of the assets of the Funds available for distribution, to the
assets belonging to that Fund.
DESCRIPTION OF SECURITIES RATINGS
Set forth below is a description of ratings used by three major
nationally recognized statistical ratings organizations ("NRSROs") Standard &
Poor's Corporation ("Standard & Poor's"), Moody's Investors Service, Inc.
("Moody's") and Duff & Phelps Credit Rating Co. ("Duff & Phelps"). NRSROs base
their ratings on current information furnished by the issuer or obtained from
other sources they consider reliable. NRSROs may change, suspend or withdraw
their ratings due to changes in, unavailability of, such information or for
other reasons.
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Commercial Paper Ratings
A Standard and Poor's commercial paper rating is a current assessment
of the likelihood of timely payment of debt having an original maturity of no
more than 365 days. The following summarizes the rating categories used by
Standard & Poor's for commercial paper in which the Funds may invest:
"A-1" - Issue's degree of safety regarding timely payment is strong.
Those issues determines to possess extremely strong safety characteristics are
denoted "A-1+."
"A-2" - Issue's capacity for timely payment is satisfactory. However,
the relative degree of safety is not as high as for issues designated "A-1."
Moody's commercial paper ratings are opinions of the ability of issues
to repay punctually promissory obligations not having an original maturity in
excess of nine months. The following summarizes the rating categories used by
Moody's for commercial paper in which the Funds may invest:
"Prime-1" - Issuer or related supporting institutions are considered
to have a superior capacity for repayment of short-term promissory obligations.
Prime-1 repayment capacity will normally be evidenced by the following
capacities: leading market positions in well-established industries; high rates
of return on funds employed; conservative capitalization structures with
moderate reliance on debt and ample asset protection; broad margins in earning
coverage of fixed financial charges and high internal cash generation; and
well-established access to a range of financial markets and assured sources of
alternate liquidity.
"Prime-2" - Issuer or related supporting institutions are considered
to have a strong capacity for repayment of short-term promissory obligations.
This will normally be evidenced by many of the characteristics cited above but
to a lesser degree. Earnings trends and coverage ratios, while sound, will be
more subject to variation. Capitalization characteristics, while still
appropriate, may be more affected by external conditions. Ample alternative
liquidity is maintained.
Corporate Long-Term Debt Ratings
Standard & Poor's Debt Ratings
A Standard & Poor's corporate or municipal debt rating is a current
assessment of the creditworthiness of an obligor with respect to a specific
obligation. This assessment may take into consideration obligors such as
guarantors, insurers, or lessees. The debt rating is not a recommendation to
purchase, sell, or hold a security, inasmuch as it does not comment as to market
price or suitability for a particular investor.
The ratings are based on current information furnished by the issuer
or obtained by Standard & Poor's from other sources it considers reliable.
Standard & Poor's does not perform an audit in connection with any rating and
may, on occasion, rely on unaudited financial information. The ratings may be
changed, suspended, or withdrawn as a result of changes in, or unavailability
of, such information, or for other circumstances.
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The ratings are based, in varying degrees, on the following
considerations:
1. Likelihood of default - capacity and willingness of the
obligor as to the timely payment of interest and repayment
of principal in accordance with the terms of the obligation.
2. Nature of and provisions of the obligation.
3. Protection afforded by, and relative position of, the
obligation in the event of bankruptcy, reorganization, or
other arrangement under the laws of bankruptcy and other
laws affecting creditors' rights.
Investment Grade
AAA - Debt rated "AAA" has the highest rating assigned by Standard &
Poor's. Capacity to pay interest an repay principal is extremely strong.
AA - Debt rated "AA" has a very strong capacity to pay interest and
repay principal and differs from the highest rated issues only in small degree.
A - Debt rated "A" has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories.
BBB - Debt rated "BBB" is regarded as having an adequate capacity to
pay interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in higher rated categories.
Speculative Grade
Debt rated "BB," "B," "CCC," "CC" and "C" is regarded as having
predominantly speculative characteristics with respect to capacity to pay
interest and repay principal. "BB" indicates the least degree of speculation and
"C" the highest. While such debt will likely have some quality and protective
characteristic, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
"BB" - Debt rated "BB" has less near-term vulnerability to default
than other speculative issues. However, it faces major ongoing uncertainties or
exposure to adverse business, financial, or economic conditions which could lead
to inadequate capacity to meet timely interest and principal payments. The "BB"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BBB-"rating.
"B" - Debt rated "B" has a greater vulnerability to default but
currently has the capacity to meet interest payments and principal repayments.
Adverse business, financial, or economic conditions will likely impair capacity
or willingness to pay interest and repay principal. The "B" rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied "BB" or "BB-"rating.
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"CCC" - Debt rated "CCC" has a current identifiable vulnerability to
default, and is dependent upon favorable business, financial, and economic
conditions to meet timely payment of interest and repayment of principal. In the
event of adverse business, financial, or economic conditions, it is not likely
to have the capacity to pay interest an repay principal. The "CCC" rating
category is also used for debt subordinated to senior debt that is assigned an
actual or implied "B" or "B-" rating.
"CC" - Debt rated "CC" typically is applied to debt subordinated to
senior debt that is assigned an actual or implied "CCC" rating.
"C" - Debt rated "C" typically is applied to debt subordinated to
senior debt which is assigned an actual or implied "CCC-" debt rating. The "C"
rating may be used to cover a situation where a bankruptcy petition has been
filed, but debt service payments are continued.
"CI" - The rating "CI" is reserved for income bonds on which no
interest is being paid.
"D" - Debt rated "D" is in payment default. The "D" rating category is
used when interest payments or principal payments are not made on the date due
even if the applicable grace period has not expired, unless Standard & Poor's
believes that such payments will be made during such period. The "D" rating also
will be used upon the filing of a bankruptcy petition if debt service payments
are jeopardized.
Moody's Long-Term Debt Ratings
"Aaa" - Bonds which are rated "Aaa" are judged to be of the best
quality. They carry the smallest degree of investment risk and are generally
referred to as "gilt edged." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
"Aa" - Bonds which are rated "Aa" are judged to be of high quality by
all standards. Together with the "Aaa" group, they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds because
margins of protection may not be as large as in "Aaa" securities or fluctuation
or protective elements may be of greater amplitude or there may be other
elements present which make the long-term risk appear somewhat larger than in
"Aaa" securities.
"A" - Bonds which are rated "A" possess many favorable investment
attributes and are to be considered as upper-medium grade obligations. Factors
giving security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment some time in the
future.
"Baa" - Bonds which are rated "Baa" are considered as medium-grade
obligations (i.e., they are neither highly protected nor poorly secured).
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
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"Ba" - Bonds which are rated "Ba" are judged to have speculative
elements; their future cannot be considered as well-assured. Often the
protection of interest and principal payments may be very moderate, and thereby
not well safeguarded during both good and bad times over the future. Uncertainty
of position characterizes bonds in this class.
"B" - Bonds which are rated "B" generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
"Caa" - Bonds which are rated "Caa" are of poor standing. Such issues
may be in default or there may be present elements of danger with respect to
principal or interest.
"Ca" - Bonds which are rated "Ca" represent obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings.
"C" - Bonds which are rated "C" are the lowest rated class of bonds,
and issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Duff & Phelps Rating Scale Definitions
"AAA" - Highest credit quality. The risk factors are negligible, being
only slightly more than for risk-free U.S. Treasury debt.
"AA+", "AA", "AA-" - High credit quality. Protection factors are
strong. Risk is modest but may vary slightly from time to time because of
economic conditions.
"A+", "A", "A-" - Protection factors are average but adequate.
However, risk factors are more variable and greater in periods of economic
stress.
"BBB+", "BBB", "BBB-" - Below average protection factors but still
considered sufficient for prudent investment. Considerable variability in risk
during economic cycles.
"BB+", "BB", "BB-" - Below investment grade but deemed likely to meet
obligations when due. Present or prospective financial protection factors
fluctuate according to industry conditions or company fortunes. Overall quality
may move up or down frequently within this category.
"B+", "B", "B-" - Below investment grade and possessing risk that
obligation might not be met when due. Financial protection factors will
fluctuate widely according to economic cycles, industry conditions and/or
company fortunes. Potential exists for frequent changes in the rating within
this category or into a higher or lower rating grade.
"CCC" - Well below investment grade securities. Considerable
uncertainty exists as to timely payment of principal, interest or preferred
dividends. Protection factors are narrow and risk can be substantial with
unfavorable economic/industry conditions and/or unfavorable company
developments.
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"DD" - Defaulted debt obligations. Issuer failed to meet scheduled
principal and/or interest payments.
INDEPENDENT ACCOUNTANTS
Arthur Andersen LLP, 100 East Wisconsin Avenue, Milwaukee, Wisconsin
53201-1215 serves as the independent accountants for the Corporation. As such
Arthur Andersen LLP performs an annual audit of each Fund's financial statement
and considers each Fund's internal control structure.
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